Will The Script Be Flipped on Drug Pricing?

The State of New York recently audited CVS's performance on its Empire Drug Plan (over 1.1 million active and retired state and local government employees). The results showed that CVS, the plan's pharmacy benefits manager (PBM) failed to pass on over $2.2 million in drug rebate savings over four years. The failures are worth noting, but assuming typical usage patterns, it's likely that the errors represent less than 1% of the total rebate amounts. There are three lessons to be learned from the audit. First, the fact that these errors occurred shows how opaque the system is. While 1% doesn't seem huge, it is surprising given the sophistication of the systems CVS has in place. Second, is the scope of the rebates themselves. If $2.2 million is less than 1%, then there is a huge amount of money in rebates available (nationally the number approached $100 billion). The third is that rebates and how they are administered and accounted for have become a hot button issue. No one other than the PBMs and Drug Manufacturers seem to like them very much. The Trump Administration had taken steps forward to fundamentally address rebates but those steps were halted on July 11th. Let's talk about what was planned and what happened.

What was supposed to change?

The Department of Health and Human Services' (HHS) released a proposed rule (withdrawn as of July 11, 2019) that would have limited the ability of manufacturers to offer rebates on pharmaceuticals for Medicare and Medicaid plans. The change wasn't exactly a modification of current law, but instead a closing of a loophole that removed a safe harbor provision that had allowed the rebates to exist, even though similar behavior in other aspects of healthcare had been disallowed. The private commercial markets were not in play for the rule, but they often follow the lead set by Medicare and Medicaid. Industry and trade groups on both sides of the rule had argued their points and lobbied Congress and the administration. Many patient advocates saw this as a great step in reforming and lowering drug pricing. On the flip side, however, many PBMs and other industry gurus argued that overall healthcare premiums would have increased since the rebate money was used to subsidize overall costs.

It's unclear if this rule would have fundamentally changed the system or instead forced PBMs to get more creative with pricing models. One result could have been shifting of drug costs from Medicare and Medicaid to the Commercial Markets. The changed regulation could also have resulted in lost negotiating leverage for PBMs. Manufacturers could have simply eliminated rebates and not lowered prices commensurately, resulting in higher net prices. In other words, this rule could have made no changes at all, except where the costs came from.

This is largely a bipartisan issue and while many admired the administration's intent, they questioned how the specifics would have played out. The takeaway is that drug pricing and transparency have become focal issues without consensus on solutioning. As stated above, after many months of lobbying and disagreements within government, the rule was officially withdrawn on July 11, 2019. This doesn't mean that drug pricing is off the table for government intervention. In fact, the President has already discussed a potential new Executive Order that may tackle how drugs are priced and bought in the U.S. compared to other countries. In addition, the rebate issue is still very much in play so we expect new legislation or rulemaking to occur. That being said, it's an interesting exercise to consider how health plans react to these types of regulatory changes. Let's examine.

How do health plans react to regulatory changes?

As with any regulatory changes, health plans have to be nimble. It's difficult to be nimble when faced with aggressive filing deadlines (for regulated products) and when lacking information on potential changes that may impact product design and pricing. That said, it's not the industry's first rodeo when it comes to this. The ability to quickly model and remodel for pricing and design is a core competency of the best health plans. That's why scenario planning and modeling is so important when it comes to line of business profit and loss analysis and risk allocation. Regulated products have limited levers to vary price and design (deductibles, cost sharing, maximums, etc.), but there are different ways to get to the end result or "actuarial value" of a product.

The best pricing models in the world are only as good as the assumptions that feed the calculations. Insurance pricing is much more art than science and in today's world, health actuaries are the Picasso's of this micro-verse. Pricing is affected by the way a product's design affects usage patterns (encouraging and discouraging the use of some benefits) and what kind of risk profile is attracted to a product. If you're young and healthy, buy a high deductible, narrow-network product priced very low. If you're older and sicker, buy a lower deductible product with full network access. The prices differ for actuarially sound reasons. The simplified scenario modeling described here happens year round at health plans both at the company level and by line of business. A global view of available data is needed to decide where and how strategic bets are placed. From there, products can be designed and priced accordingly to meet those needs.

These same modeling and pricing concepts will need to be used to react to any potential drug rebate changes. For this particular rule, it's not as simple to say that drug costs will be lower on the back end (list price). Nothing in the rule stated that drug makers have to do that. It's not as simple to say that list prices stay the same but instead, the patient received a significant point of sale discount. The PBM is squeezed out of this scenario and would inevitably increase their own fees to make up the difference. This would have impacted the entire pricing of the supply chain immensely. This isn't a matter of cost shifting but instead scenario planning using multiple decision trees that could have many, many branches. Once all of those scenarios are sized up from a cost and pricing standpoint, you have to place a bet on what is the most likely scenario that will play out. Placing bad bets could be disastrous for the health plan. In most cases the bets are placed once or twice a year with an inability to make course corrections mid-stream.

Product and pricing data needs to be collected in advance. The data must be scrubbed and available in a format already useable for modeling. Industry regulatory changes are fast and frequent and only leave enough time to update models and assumptions. There isn't enough time to start from scratch. The drug pricing issue will not be resolved anytime soon. Regulatory changes and shifting market forces have been and will continue to be the new norm. The most successful companies will have their data and modeling needs developed as a foundation so when new issues arise, they can quickly adapt instead of scrambling to keep up.