Medicare’s recent actions to promote access to lower cost drugs

Medicare prescription drug benefits are administered by private insurance companies in Medicare Part D. Part D is dominated by a handful of large health plans that offer prescription drug benefits, and also offer drug benefits and serve as Pharmacy Benefit Manufacturers (PBMs) across insurance market segments. Like much of the health care industry, Part D and the PBM market more generally is characterized by a variety of market failures and inefficiencies. In Part D in particular, plans face strong incentives to prefer drugs with high list prices that generally offer large rebates—rather than alternative drugs that achieve the same or lower net prices through lower list prices and smaller rebates. The Centers for Medicare & Medicaid Services (CMS) is pursuing reforms that attempt to regulate this behavior in the Medicare program to ensure that Medicare beneficiaries have access to lower cost drugs. The policy being pursued is consistent with the Medicare statute and offers a sensible, if limited, approach to address the issue, which the agency should finalize. 

Part D plans face incentives to prefer drugs with high list prices and large rebates

In all markets, one of PBMs’ major functions is to negotiate with drug companies to achieve lower drug prices for the patients served. The lower negotiated prices are generally achieved through rebates that drug manufacturers pay back to PBMs in exchange for placement on the PBM’s formulary. PBMs attempt to achieve the largest possible discount from the list price and deliver the lowest net price for covered prescription drugs. PBMs use the purchasing power they have to lower net prices in the form of rebates—not to discipline list prices in any way.

In fact, in many cases, PBMs prefer to achieve a given net price through high list prices and large rebates rather than a lower list price. In Medicare Part D, in particular, the preference for higher list prices and larger rebates is especially acute, where peculiarities in the design of the Medicare prescription drug benefit mean the Part D plan will bear a smaller share of total costs if a given net price is paired with a higher list price. Indeed, within Medicare, Part D plans can be financially better off when patients use a product with a high list price with a sizable rebate, even if alternative products offer a meaningfully lower net price. Medicare Part D calculates patients’ overall liability for prescription drug spending by reference to list prices, so Part D plans are able to charge greater total cost-sharing when list prices are high. This allows them to offer lower premiums and less generous overall benefit structures. Further, the pre-2025 structure of Medicare’s reinsurance payments would exacerbate this dynamic for certain high cost drugs. By capping overall patient liability and restructuring reinsurance, recent legislation has blunted this incentive, but it has not eliminated it, and plans serving Part D continue to face an incentive to prefer products with higher list prices. 

Other market actors can also reinforce this preference. Manufacturers offer rebates in exchange for favorable formulary placement for their drugs. But manufacturers facing competition from an alternative with a lower net price also turn to “rebate walls”—under which they condition the availability of their rebate on the exclusion of a lower cost product from the formulary or on the PBM delivering sufficiently high market share to the higher price product. Manufacturers with multiple products also use rebate walls to condition rebates for one product on the exclusion of a lower price product that is a competitor for an entirely different drug. This strategy is especially effective in preserving market share for a higher cost product when the lower cost alternative is relatively new: even if a large number of patients may ultimately switch to the lower cost alternative, rebate walls can make it unreasonably costly for the PBM to encourage that switching in the early years of the transition.

As a result of these factors, Medicare Part D plans have shown some preference for higher list price products. For example, the HHS Inspector General (OIG) investigated Part D plans coverage of biosimilar medications—which offer a significantly lower net price than brand name biologics, but generally without rebates and often facing off against rebate walls. The OIG found limited uptake of lower cost biosimilars, costing the Medicare program an estimated $84 million in 2019. 

The statutory framework

Despite an inefficient status quo, federal regulators have historically been skittish about attempting to reign in this behavior. Much of the reticence has derived from the perceived force of Medicare’s “non-interference clause,” which prohibits certain regulatory action related to drug prices in Medicare Part D. Specifically, the non-interference clause (SSA § 1860D-11(i)) specifies¹:

[T]he Secretary—

(1) may not interfere with the negotiations between drug manufacturers and pharmacies and PDP sponsors; and

(2) may not require a particular formulary or institute a price structure for the reimbursement of covered part D drugs.

Consistent with its name, this language clearly prohibits the federal government from promulgating regulations that would act directly upon—i.e., interfere with—the negotiations between plans and drug manufacturers. It would not be lawful for the Secretary to specify minimum rebates in particular drug classes, require uniform rebates across all Medicare plans, or otherwise attempt to directly regulate how plans negotiate with manufacturers. Medicare could not design a single required formulary, or institute other mandatory formulary or compensation arrangements. 

At the same time, the terms of these prohibitions are limited. Medicare cannot interfere in negotiations between drug manufacturers and plans—but that does not mean the program cannot impose standards that may affect those negotiations in some way. Medicare has significant power to establish standards for Part D, and the fact that those standards may have implications for how plans and manufacturers choose to contract is not a violation of non-interference. Similarly, the statute prohibits requiring a particular formulary, but that is far from a prohibition on Medicare standards that impact formulary design. Indeed, the Medicare statute includes a variety of requirements related to how formularies are established (see SSA § 1860D-4(b)-(c)), and Medicare has broad latitude to implement those standards in any way other than establishing a particular formulary.

Medicare’s recent steps

In a little-noticed provision in recent rulemaking, Medicare has built on this understanding of their authority to take a modest step to regulate plan behavior that unreasonably prefers high rebate drugs when lower net price products are available. Specifically, in a recent proposed rule, CMS proposed that it would review bid submissions to ensure that Part D plans “provide beneficiaries with broad access to generics, biosimilars, and other lower cost drugs.” CMS stated that it views this requirement as stemming from plans’ obligation under the statute to have a “cost-effective drug utilization management program, including incentives to reduce costs when medically appropriate” (SSA § 1860D-4(c)(1)(A)). 

CMS explained that they were not requiring any particular plan design: “This does not mean that a sponsor is required to include all generics and biosimilars associated with a brand drug or reference product on the formulary, or if they are included, that they all be placed on a more preferred formulary tier relative to the brand drug or reference product.” CMS would, however, review plans to ensure that “broad access” to lower cost products was available, by examining whether the formulary appropriately includes lower cost products, and whether tier placement and utilization management processes appropriately reflect the lower cost of the product. By making this part of CMS’s existing formulary review process, CMS would have the ability to require the plan to provide better access or deny plan submissions that did not provide adequately broad access.

There are a number of instances where this provision may be invoked. Generics and biosimilars are named in the CMS language and are a clear target. Indeed, there is a well-documented need for regulatory intervention to support access to biosimilars in Part D, where uptake has been sluggish for the variety of reasons discussed above. By requiring plans to provide “broad access” to biosimilars, CMS can counteract plans’ inefficient incentives and also make it difficult or impossible for them to agree to “rebate wall” arrangements. In addition, researchers examining Part D formularies from 2019 found that nearly three-quarters of formularies placed a generic drug on a higher tier than the brand product for at least one product, though the number of drugs involved is small. Failure to provide adequate access to low-priced generics and biosimilars in order to favor higher net cost products that generate large rebates clearly runs afoul of the statute’s requirement that Part D formularies take a “cost-effective” approach. Of course, in isolated cases where the net price for a brand drug falls below the net price for a generic or biosimilar, more favorable formulary placement for the brand will be appropriate—and is clearly permitted by the CMS language. And CMS’s formulary review process calls for “broad access,” not specific formulary tiering, and so plans retain flexibility to respond to the actual dynamics of particular drugs. 

Beyond generics and biosimilars, there are other circumstances where pricing patterns and incentives facing Part D plans are similar. Most prominently, under the Inflation Reduction Act, Medicare is for the first-time directly negotiating the price of certain high-cost products in Medicare. The Medicare negotiated price will be available to all payers with no rebate attributable to the plan (though plans may negotiate additional rebates below the negotiated price). A drug class with two clinically similar products, where only one of the products has a negotiated price, will look very similar to a biologic with a new biosimilar: one product has a fixed price and no or only a small rebate, and another product has a somewhat higher net price with a large rebate paid to the plans. (Notably, however, unlike a new biosimilar, the negotiated drug will generally already have an established and large market share.) Just as a formulary that does not provide adequate access to biosimilars under these circumstances cannot be “cost-effective,” so too can failure to provide adequate access to the lower-priced negotiated product be problematic under the statute. Of course, providing adequate access does not necessarily require better formulary placement for the negotiated product compared to its competitors, but it will generally mean that plans cannot disfavor the negotiated product compared to higher cost alternatives absent product-specific dynamics.

One can also imagine more speculative applications of the principle. For example, in the period from 2010 to 2020, list prices for insulin rose sharply, while net prices remained roughly the same: a handful of manufacturers were offering larger and larger rebates and increasing list prices accordingly, a dynamic which PBMs market-wide welcomed and, in some tellings, demanded. If, in this period, CMS had had adequate tools to enforce the concept that broad access to lower cost drugs is necessary for a Part D plan’s formulary to be cost-effective, then an insulin manufacturer that took a different pricing approach without large rebates may have had greater success in securing formulary access and pushing back against the trend. Certainly, only a limited set of drug classes are at risk of insulin-like spirals, and the policy environment has changed in important ways in recent years, but the basic market dynamics that precipitated the problem persist. As new entrants like Mark Cuban’s Cost Plus Drug Company move into manufacturing with a focus on lowering costs, we may see market participants seeking to disrupt any new list-price-rebate spirals, and a CMS standard requiring broad access to lower cost drugs can support those efforts.  

What comes next

CMS proposed their standard requiring broad access to lower cost drugs in their annual rule governing the Part D program, released in late 2024. Industry reaction was predictable. The trade association for PBMs opposed the policy, arguing that CMS reviews would be burdensome and unnecessary and that plans always prefer products with the lowest net price. Conversely, the trade associations for brand, generic, and biosimilar manufacturers all supported CMS’s efforts. Unsurprisingly, the brand manufacturers argued that a CMS review was important to protect access to drugs with negotiated prices—an issue that has been critically important to them—and underscored the importance of focusing on net prices to determine lower cost products. Generic and biosimilar manufacturers pointed to evidence that biosimilar adoption remained slow and generic adoption has shown signs of slowing, and argued that the Part D plan continued to exclude lower cost products, so CMS reviews were necessary. 

CMS will decide whether to finalize the proposal in the months ahead. It is a well-tailored and legally supportable approach—albeit a modest one—that counteracts some inefficient incentives, and the agency should finalize the policy.