This analysis is part of the USC-Brookings Schaeffer Initiative for Health Policy, which is a partnership between Economic Studies at Brookings and the University of Southern California Schaeffer Center for Health Policy & Economics. The Initiative aims to inform the national health care debate with rigorous, evidence-based analysis leading to practical recommendations using the collaborative strengths of USC and Brookings. The Commonwealth Fund has provided a grant to the Brookings Institution to support the work on which this post is based. This post originally appeared in Health Affairs on July 9, 2019.
Nonresident Fellow - Economic Studies, USC-Brookings Schaeffer Initiative for Health Policy
Leonard D. Schaeffer Chair in Health Policy Studies
Senior Fellow - Economic Studies
For many years, Americans have paid significantly more than the rest of the world for prescription drugs. Medicare spent an estimated $140 billion in 2017 on outpatient prescription drugs, with this large total fueled by double-digit annual spending growth since 2013. To lower the Part B portion of drug spending, the Trump Administration has proposed a demonstration project tying Medicare reimbursement for outpatient, physician-administered drugs to international prices. The proposal would not affect self-administered drugs dispensed by retail pharmacies and reimbursed by private insurance plans under Part D, which are the focus of separate reform initiatives, including significant revisions by the HHS Office of Inspector General to the “safe harbors” regulating manufacturer rebates.
Substantially lowering the prices paid when US patients receive a drug by incorporating international prices in Medicare reimbursement involves specifying policy details that could lower drug prices either only for Medicare patients or more broadly for all patients. Any implementation approach must deal with the difficulties that, when a provider purchases a drug from a wholesaler, the supply chain currently does not capture data on the insured status of patients and the acquisition price does not vary by patient.
Moreover, the Administration’s initiative relies on Medicare market power to lower prices to the level of Part B reimbursement, but some manufacturers may resist lowering prices, in part because lower Part B prices could automatically increase the statutory rebates they pay to Medicaid. Alternative policy specifications could avoid the possibility of impaired access for Medicare patients and effectively compel manufacturers to reduce prices.
Pursuing a demonstration under existing administrative authority could significantly limit reductions in drug spending compared to what could be accomplished by legislation. As an additional consideration, manufacturer efforts to counter lower US revenues by raising prices and/or restricting access outside of the US would prompt actions to limit the adverse effects by countries that have traditionally had access to drugs at lower prices.
On October 30, 2018, the Trump Administration published in the Federal Register an Advance Notice of Proposed Rulemaking (ANPRM) seeking comments on shifting to an “International Pricing Index” (IPI) model, reforming the current “average sales price” (ASP) methodology. The Advance Notice represents the first step in initiating the proposed reform, which the Administration plans to implement under existing demonstration authority. CMS expects to issue a proposed rule in 2019 and envisions starting the demonstration in the Spring 2020, after considering the comments generated by the proposed rule and issuing a final rule.
The Administration intends the IPI model to lower Medicare reimbursements by an average of 30 percent, achieved by smaller reductions for some drugs and substantially larger cuts for others, depending on the magnitude of the existing gap between the US and international price for a drug. The Administration expects manufacturers to drop drug prices in response to lower Part B reimbursement. However, if manufacturers refuse to lower the price for a drug to the IPI model reimbursement level, Medicare patients would likely face restricted access to needed treatment because prescribers cannot be expected to lose money when providing a drug.
Part B Drug Reimbursement Under Current Law
Existing Part B rules strictly limit the ability of CMS to either lower prevailing market prices or act to influence drug utilization. Medicare bases Part B reimbursement on ASPs, which reflect the average of actual (net) US prices for a drug and include all price concessions such as discounts and rebates. Updated by CMS every quarter, ASPs incorporate sales data (with a two-quarter lag) that manufacturers must report, consistent with detailed CMS instructions.
Medicare reimburses providers for the cost of acquiring a drug and pays a separate fee for administering the drug. Despite the statute setting Part B drug reimbursement at 106 percent of ASP, budget “sequestration” has reduced payment to 104.3 percent of ASP since 2013. Intended to cover any added acquisition-related expenses, the percentage add-on also has the effect of paying physicians more for prescribing drugs with higher costs than for prescribing less expensive therapeutic alternatives.
Drug Supply Chain Operation
As noted earlier and discussed in more detail in the next section, the IPI model could aim to lower prices only for Medicare patients or more broadly. Lowering prices for all patients would magnify the revenue losses for manufacturers, generate drug savings beyond Medicare, and be consistent with how the drug supply chain currently operates. Alternatively, two different approaches would permit lowering prices only for Medicare patients. Of the two approaches that lower Medicare costs, only one – using rebates — would be consistent with drug supply chain operations; the other approach would require significant changes to current operations.
The current drug supply chain operates by having providers purchase drugs from wholesalers after wholesalers have purchased products from manufacturers. Wholesalers charge a provider such as a pharmacy or physician practice a contract price to acquire a product; the acquisition price paid to the wholesaler for each national drug code (NDC) is unrelated to the insured status of a provider’s patient. Manufacturers of single-source brand drugs and biologics—the medicines targeted by the IPI model—do not pay rebates to providers. As currently configured, the drug supply chain neither charges a provider different prices nor includes the data needed to indicate whether patients are covered by Medicare, Medicaid, or commercial insurance.
The approach that would avoid significantly disrupting the drug supply chain would use rebates in one of two ways to target savings on Medicare patients. Achieving savings by using rebates would not reduce the high prices currently paid by providers to acquire, and by patients to receive, Part B drugs. This approach would also be inconsistent with the Administration initiative to eliminate the rebate “safe harbor”. In addition, a rebate approach could require modifying Medicare rules on coinsurance, because patient cost sharing would otherwise reflect higher “gross” prices rather than actual net prices.
First Rebate Option
Under one rebate option, providers would pay wholesalers the normal contract price currently applicable for a drug regardless of the patients receiving the medicine, but each provider would receive rebates from manufacturers for each drug dispensed to a Part B patient. The manufacturer rebate would reimburse each provider for the difference between the contract price paid to acquire drugs and the Medicare reimbursement. Providing a reliable basis for calculating rebate payments under this option might require CMS to supply manufacturers with detailed, provider-specific counts of Medicare patients receiving a drug (especially if rebates vary by dosage). Even though Medicare would share data with manufacturers for rebate purposes under this option, the data could also help target marketing to physicians.
Second Rebate Option
Another option using rebates would lower Part B costs by having manufacturers pay the difference between IPI-related and ASP-based reimbursement directly to Medicare. Medicare reimbursement to providers would continue to reflect current prices, with rebates lowering Medicare costs after the fact. This option would broadly parallel Medicaid, in which manufacturers pay rebates directly to state Medicaid agencies.
The non-rebate approach to charging a provider lower acquisition costs for drugs used by Part B patients and higher prices for other patients would require significant change in how the drug supply chain operates. The standardized, highly automated, electronic data transaction sets exchanged between manufacturers and wholesalers would have to expand markedly and include much more data. Unlike the detailed exchange of protected health information (PHI) that routinely occurs between payers and providers when processing drug claims, wholesalers and manufacturers currently exchange only aggregated data that does not identify individual patients or providers.
To limit fraud and abuse, manufacturers would need auditable, patient-level data, which would almost certainly have privacy implications. Over and above the significant costs and time required to implement new data requirements, the Health Insurance Portability and Accountability Act (HIPAA) would likely require executing “business associate agreements” between each provider and each manufacturer before exchanging PHI.
Effects Of The IPI Model On Manufacturer Revenue
Although the IPI model would unambiguously reduce manufacturer Part B revenue, its effects on Medicaid and commercial revenue are uncertain. For Medicaid sales, the effect of lower Part B prices on manufacturer revenue would depend on whether the requirement that Medicaid receive the lowest price a manufacturer offers was construed to include sales under the IPI model; unless such sales were explicitly exempted, this “best price” requirement would automatically increase statutory rebates paid to state Medicaid programs by manufacturers. Alternatively, a best price exemption would limit reductions in manufacturer revenue, focus savings on Medicare, but not lower state and federal Medicaid costs.
IPI model policies, market forces, and operational considerations would determine the effect of lower Part B prices on commercial prices. Manufacturers would try to avoid losing revenue from commercial sales, but the discussion in the previous section, along with the public visibility of dramatically lower Medicare prices, illustrates factors that could undermine the ability of manufacturers to maintain current prices. While some observers suggest that manufacturers might seek to increase their commercial prices to offset lower Medicare revenue, many economists question manufacturers’ ability to raise drug prices because firms have presumably already sought to maximize revenue in setting prices for each market segment.
An example illustrates the differing implications for manufacturers if reduced Part B prices have (i) no effect on, (ii) partially lower, or (iii) sharply lower non-Medicare revenue. A fourth scenario illustrates the revenue implications for a manufacturer of not cutting prices and exiting the Medicare market. (In 2007 and 2008, when Part B reimbursement for an inhaled drug, Xopenex®, fell sharply, the manufacturer (Sepracor) did not change its prices, thereby retaining revenue from Medicaid and commercial sales but effectively withdrawing from the Medicare market. When prices exceeded Medicare payment, suppliers stopped providing Xopenex® to Medicare beneficiaries.)
For simplicity, all four scenarios assume two hypothetical drugs, each of which currently has sales revenue of 100 and faces a 30 percent IPI-related reduction to current ASPs. Medicare constitutes 80 percent of Drug I total sales, and non-Medicare sales account for 20 percent. Conversely, for Drug II, Medicare constitutes 20 percent of total sales, with non-Medicare sales accounting for 80 percent. For both drugs, Medicaid constitutes half of the non-Medicare sales and commercial sales constitute the other half.
Exhibit 1 below displays for each drug the results from the four scenarios, along with “Baseline-Current Law” sales. Scenario 1 has the most favorable outcome for each manufacturer and the smallest aggregate savings in drug costs. It reflects lowering drug prices for Medicare patients by 30 percent but no change in non-Medicare prices, which requires a Medicaid best price exemption. Scenario 1 would generate the smallest reduction in combined Medicare and non-Medicare drug spending.
Exhibit 1: Effects on Manufacturer Revenue When IPI Lowers Medicare Payments by 30%
Source: Authors’ calculations
Scenario 2 assumes a 20 percent cut in non-Medicare revenue, which would occur if commercial prices fell by one-third of the reduction in Part B prices (i.e., 10 percent) and revenue from Medicaid sales fell by 30 percent due to the Medicaid best price fully incorporating the cut in Part B prices. (For simplicity, the examples assume that best price would increase Medicaid rebates by the amount of the IPI reduction. Actual changes in Medicaid rebates arising from the IPI model would vary based on a variety of factors, such as the reflecting the lowest price, not the average, paid by Part B providers, and the effect of the lowest IPI-related price on the current Medicaid rebate for a drug.) Scenario 2 is the second-best revenue option for the manufacturer of Drug I but only third best for Drug II.
Scenario 3 assumes the 30 percent Part B price cut also lowers revenue from commercial and Medicaid sales by 30 percent, reflecting best price requirements in Medicaid and the effects of IPI model policies, market forces, and/or operational issues on commercial prices. Scenario 3 generates the biggest savings in health care spending without adversely affecting access, represents the third-best revenue option for the manufacturer of Drug I, but produces the worst option for Drug II revenue.
Scenario 4 explores the implications of manufacturers refusing to cut Part B prices, which would be economically irrational for the manufacturer of Drug I, with total revenues falling from 100 to 20 due to eliminating Medicare sales (and patient access). In stark contrast, Scenario 4 generates the second most revenue for the manufacturer of Drug II (behind Scenario 1). Importantly, exiting the Medicare market works economically because Part B comprises only a modest share of Drug II revenue.
As the four scenarios illustrate, the approach that minimizes reduction in manufacturer revenue depends on the mix of Medicare, Medicaid, and commercial sales, the treatment of Medicaid best price requirements, and the ability to insulate commercial sales from pressures to cut prices. Scenario 1 generates the highest revenue under the IPI model for the manufacturers of both Drug I and Drug II but depends on lower Part B prices being exempt from Medicaid best price calculations and not reducing commercial prices. The extreme option (Scenario 4) of exiting the Medicare market produces the second highest revenue for Drug II but the lowest revenue for Drug I.
How Will CMS Determine IPI Prices And Administer the IPI Model?
The 15,000-word ANPRM extensively discusses many important design choices associated with creating the IPI model, some of which pose relatively straightforward issues while others have complex implications. In addition to potentially changing how the drug supply chain operates as discussed earlier, other examples of potential complications arising from the IPI model involve its effects on the calculation of ASPs and what countries and data to include in the international price comparisons. Among the technically straightforward policy choices, CMS plans to select an initial list of about 30 single-source drugs and biologics, which it hopes to expand after the second year. CMS would need to make many other decisions, such as:
- what parts of the country would participate in the IPI model;
- whether to permit exemptions and/or exclude rural areas, Critical Access Hospitals, durable medical equipment suppliers, ambulatory surgical centers (ASCs), and other entities supplying Part B drugs;
- what the rules would be for calculating reimbursement for new and existing drugs;
- whether to phase-in IPI reductions; and
- how to adjust drug-specific payments to achieve the overall savings target.
Complications In Setting ASPs
Because the ANPRM anticipates including IPI-related prices in ASP calculations, the lower prices associated with IPI-related sales would, with a two-quarter lag, automatically lower
the nationwide ASPs that dictate Part B reimbursement in the excluded geographic regions. ASPs would spiral down based on the continuing reduction in actual prices paid two quarters previously. If CMS specifies that lower ASPs would also reduce IPI reimbursement, the downward effects on prices would increase.
Exhibit 2 below illustrates the dynamic caused as the IPI reduces ASPs. The exhibit tracks the IPI effects on Part B prices in areas included and excluded from the demonstration, and how those effects would continue to reduce ASPs over time. The example assumes: current law ASP is 100 and IPI reimbursement is 70; sales are split evenly between IPI-Part B, non-IPI Part B, and commercial patients; commercial prices do not change; and IPI-related reimbursement is not updated by reduced prices.
Exhibit 2: ASPs Spiral Down Over Time Due To Demo And Non-Demo Part B Sales
Source: Authors’ calculations
Exempting IPI-related prices from the calculation of ASPs could help limit this complication, but CMS would have to specify the alternative basis for reporting and computing ASPs. One option might have the Medicare Actuary estimate what ASPs would have been “but for” the IPI model, but CMS would also have to specify the treatment of any “spill over” effects from the IPI demonstration on non-Medicare prices.
Countries And Prices To Be Included In The IPI Model
CMS needs to specify the countries and data included in the IPI model and how it would incorporate international prices when computing IPI-related Part B reimbursement; under normal administrative procedures, CMS would have to explain the rationale for its choices. CMS could consider whether to adjust prices (or exclude a country) on factors such as per capita income relative to the United States, whether a country uses comparative effectiveness analysis to set drug reimbursements, and whether a country’s regulations limit prices or limit access to therapies based on factors like patient age. To generate comparable data from the countries being included in the IPI model, CMS might have to specify the source of drug price data, including whether prices are transparent, net or gross, and reflect the price of products intended for sale in a given country or a composite that includes lower-priced products imported through “parallel trade.” It is also not clear that demonstration authority would empower CMS to mandate that manufacturers accurately report international net prices.
Implementing The IPI Model As A Demonstration Versus With New Legislative Authority
CMS has proposed implementing the IPI model as a demonstration operated under the authority of the Center for Medicare and Medicaid Innovation (Innovation Center). This avoids the uncertainty and delay associated with passing legislation but adds complexity, such as having to restrict policies to what can be done under administrative authority and to divide the country into participating and non-participating geographic areas. In addition to complicating ASPs, dividing the country into participating and non-participating areas would affect providers with sites in multiple states, as might occur in the Cincinnati, Kansas City, or Philadelphia metropolitan areas. As a demonstration, the IPI model could face legal challenges from manufacturers and patient groups concerned about access, as well as opposition to making the demonstration mandatory or including rural areas.
CMS demonstration authority broadly allows it to reduce reimbursement and rely on market forces, but mandating that manufacturers lower drug prices to the IPI payments—setting prices as distinct from reimbursement—would be unprecedented. CMS authority requires that a demonstration “addresses a defined population for which there are deficits in care leading to poor clinical outcomes or potentially avoidable expenditures.” Stakeholders might legally challenge the IPI demonstration by arguing that the IPI model targets beneficiaries at random rather than a “defined population”, but this seems to overread the statute’s limitation because a large population can be considered “defined”.
Another basis for challenge rests on whether CMS’s planned implementation of the IPI model could properly be characterized as a test: the large size, transformational nature, and lack of evaluative intent embodied in the agency’s proposals suggest that the IPI model would create a new payment system, not a test. Accepting that its demonstration authority gives CMS the ability to implement large scale transformations like the IPI model arguably amounts to an unconstitutional delegation of legislative authority to the executive branch.
Federal policies aimed at lowering drug costs, such as Medicaid rebates and the 340B Drug Pricing Program, rely on statutory provisions to effectively compel manufacturers to make drugs available at sharply reduced (net) prices. Without legal authority causing manufacturers to reduce prices for Medicare patients to IPI-related payments, access would turn on the market power of Medicare, along with IPI model policies and operational considerations. Because Part B prices are included in ASP calculations, and because the Innovation Center waiver authority does not appear to extend to the Medicaid best price provisions, IPI prices would increase Medicaid rebates (unless changed by legislation). To the extent that the IPI initiative raises serious concerns about access, sensitivity to senior citizens and adversely affected interests could threaten the viability of the CMS demonstration.
Legislative provisions could effectively compel manufacturers to sell drugs at prices that do not exceed Part B reimbursement. Examples of approaches that would bolster Medicare’s market power include:
- Exempting IPI-related prices from Medicaid best price and modifying Medicare rules, as previously discussed.
- Requiring a manufacturer to set its Part B drug prices at or below IPI-related payments as a condition of being permitted to sell any of its drugs to Medicare or Medicaid, adapting the approach currently used to get manufacturers to participate in the notionally voluntary Medicaid rebate program.
- Linking the duration of market exclusivity associated with patents, data, or Food and Drug Administration rules with pricing Part B drugs at or below IPI-related payments.
- Linking favorable tax treatment (for example, for research and development expenses) to pricing Part B drugs at or below IPI-related payments.
Issues For Other Countries
The IPI model intends to reduce drug prices by linking Part B payments to international prices, which could effectively constrain the ability of manufacturers to price discriminate across countries. If pushed in the direction of charging a single price for a drug in all markets, manufacturers would seek to maintain total revenue and prevent global prices from being substantially lower than US prices. Absent counter measures by manufacturers or other nations, the likely effect of the IPI model would be to lower US prices and increase prices abroad, with the expected effects increasing over time. However, to the extent that manufacturers cannot offset IPI-related reductions in revenues by increased prices and revenues from other countries, some economists believe the reduced revenues would decrease pharmaceutical company investment in research and development of new drugs, possibly slowing innovation.
In seeking to minimize reductions in US drug revenues, manufacturer strategies might include eliminating sales in smaller markets with low prices, such as Portugal and Greece, if prices in those countries were factored into IPI prices and especially if country prices were not weighted by population or units. Manufacturers might also agree to sell their products only if they obtained higher prices, or they might delay launching new drugs in countries that had historically benefitted from low prices. Alternatively, depending on the specific IPI model rules, manufacturers might reorganize into two independent companies, with one selling products only in the US and a separate company selling outside the US, so that the US company would have no international sales that would count toward setting IPI prices.
Other nations would likely use sovereign authority to limit price increases and protect their access to drugs, with the ultimate threat of disregarding intellectual property rules and allowing the production of products by competitors to the brand manufacturers (as countries like Brazil currently do). As they jockey to limit the damage, companies and countries would potentially set off an escalating round of action and reaction.
Steven Lieberman is the president of Lieberman Consulting, Inc, and routinely works with trade associations and private equity firms on general policy analysis on healthcare developments. The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. He is currently a board member for Tuple Health, a healthcare design and technology company, and Primary Care Coalition of Montgomery County, a non-profit.
In 2017, the Congressional Budget Office reported Part D benefits of $95 billion and the Centers for Medicare and Medicaid Services reported $29.5 billion in Part B drug benefits in Original Medicare. Increasing Part B fee-for-service spending to reflect the proportionate enrollment in Medicare Advantage results in an estimated Part B drug spending of $45 billion, for total Medicare outpatient drug spending of $140 billion. The compound annual growth rate for 2013—2017 in Part B was 10.1 percent and 11.3 percent in Part D.
The Initiative is a partnership between the Economic Studies program at Brookings and the USC Schaeffer Center for Health Policy & Economics, and aims to inform the national health care debate with rigorous, evidence-based analysis leading to practical recommendations using the collaborative strengths of USC and Brookings.