Takeaway: The proposed safe harbor rule is going to put more pressure on plans to manage medical cost trend and or margins in Medicare Advantage

The drug supply chain names managed to overcome the HHS Office of the Inspector General's proposed new safe harbor regulations on Friday, the impact will be significant. You don't disrupt anywhere between $30 billion and $150 billion in revenue without something happening. The biggest changes are likely to be modest increases in Medicare Advantage premiums, accompanied by reduced cost-sharing. Other impacts include a tailwinds for biosimilars and generics that have been struggled against the anti-competitive force of rebate-linked formulary placement and a corresponding headwind for manufacturers that have relied on that same device. Wholesalers and distributers are also likely to suffer.

We believe the proposed rule will be finalized as proposed. Unknowns are date of implementation, though we are biased toward a January 2020 start date, and the uptake or a rebate-less system for commercial payers.

Since the HHS Office of the Inspector General released it proposed safe harbor rule Thursday on drug rebates, we have fielded several questions about the impact on the drug supply chain. In short, you don’t mess with the $150 billion gross to net spread in the drug supply channel and it not matter.

FAQ: SAFE HARBOR PROPOSED RULE IMPACT | UNH, HUM, CVS, CI, MCK, CAH, AGN, LLY, NVS - Slide1

Below are the most commonly questions we have been asked. If you have others, let us know.

This proposal is just the opening ask, right? It will get watered down, won’t it?

Not likely.

The nature of rulemaking always dictates that the most aggressive proposal be offered first. However, most of the time rules are finalized as proposed or something very close to it. A common device for mitigating change brought by rulemaking is to delay implementation. Otherwise, to know what parts of a proposal are likely to be altered, you need only look at what alternatives the agency considered and on which it invites comment.

In this case, there are none.

In the proposed rule, the OIG requests comments on definitions, application, closing loopholes but does not suggest any of the alternatives offered in public speeches and testimony, like passing through a portion of the rebate to beneficiaries. If the administration were to move forward with another way of dealing with rebates, they are most likely going to have to withdraw this proposed rule and offer another, thus delaying the process significantly.

Finally, the proposed rule has been thoroughly vetted. The administration issued an RFI in connection with their May 2017 Blueprint and received extensive comments from across the health care industry. Secretary Azar has signaled the change for well over a year at speeches before relevant trade organizations and testimony before congressional committees.

In other words, the Trump administration has thought about rebates. A lot.

The absence of alternatives and the extensive vetting done leaves us to conclude that the OIG will move forward with a new safe harbor regime that eliminates all list price linked compensation for Medicare Part D and Medicaid MCOs pharmacy benefit managers.

Sunsetting the current safe harbor by Jan. 1, 2020, is aggressive. Will there be a delay?

Possibly but don’t count on it.

Because the OIG requested comment on the Jan. 1, 2020, implementation date, a delay is possible. There will certainly be pressure from trade organizations to do so. However, the White House would love to see reduced beneficiary cost sharing at the start of a critical election year. The political ads of new and improved access to lifesaving or life enhancing drugs will write themselves. Secretary Azar gave a preview of that political narrative in a speech at the Bipartisan Policy Center Friday that is short and well worth a read.

Another impetus for moving forward in January is the administration’s interest in making changes to Part B reimbursement. While Congress considers eliminating the 6 percent add-on payment, the administration is looking for ways to move Part B drugs into Part D. The rebate system in Part D means that prices are frequently higher in Part D than Part B.

FAQ: SAFE HARBOR PROPOSED RULE IMPACT | UNH, HUM, CVS, CI, MCK, CAH, AGN, LLY, NVS - Slide2

To address concerns about implementation, the OIG could adopt a posture of enforcement discretion for a couple of years to allow the supply chain to adjust to the new rules and contracts to be renegotiated.

This doesn’t affect [choose your PBM] because they pass all their rebate income to plan sponsors.

If we are talking about PBM’s contracts with commercial plans, the answer to yes. Medicare Advantage plans, especially those under common ownership with a PDP, are a different matter.

The Medicare Part D benefit is served by plan sponsors that combine both Part C and Part D benefits (medical care and pharmacy) and by stand-alone PDPs (pharmacy only). There are approximately 20 million people enrolled in a combined MA-PDP plan. There are another 25 million people enrolled in a stand-alone PDP plan, which they combine with traditional Medicare or traditional Medicare and other commercial insurance.

According to the HHS Office of the Actuary and CMS, manufacturer rebates in Part D totaled about $29.6 billion in 2017. In those circumstances where a MA-PDP plan uses a third party PBM, rebates would and probably are passed on to the plan sponsor. Express Scripts, for example, could act as a PBM to a regional Blue Cross MA-PDP plan and be required to pass on all rebates to the plan, thus reducing premium costs to the enrollees.

In the case where the PBM and the plan sponsor have common ownership, such as the Caremark PBM and SilverScript PDP, the rebate is retained by the parent organization, CVS. The reduced drug costs take the form of lower premiums for CVS’s 8.2 million enrollees and reduced costs for the Pharmacy Services Segment. A similar analysis will apply to Express Scripts Medco insurer which has about 3.0 million enrollees after considering CI and UNH which has about 10 million members.

In fact, in CVS’s 2Q 2018 earnings presentation a footnote offered the following definition of rebate:

Rebate calculation includes all rebates, including price protection, and administrative fees paid by manufacturers for commercial and MAPD clients. Excludes SilverScript.

(emphasis added)

So, when CVS says 95 percent of rebates are passed on the plan sponsors they have explicitly excluded rebates obtained through their stand-alone PDP plans. Since CVS has approximately 16 percent of all MA-PDP and stand-alone PDP enrollees, approximately $4 billion in manufacturer rebates were retained by CVS in 2017. Similar estimates for CI/ESRX and UNH would be $2 billion and $7 billion, respectively, and probably used to reduce premiums for enrollees.

 FAQ: SAFE HARBOR PROPOSED RULE IMPACT | UNH, HUM, CVS, CI, MCK, CAH, AGN, LLY, NVS - Slide4

In short, the amount of revenue PBMs capture in the drug supply chain, the vast majority of it is attributable to manufacturer rebates in Medicare Advantage.

FAQ: SAFE HARBOR PROPOSED RULE IMPACT | UNH, HUM, CVS, CI, MCK, CAH, AGN, LLY, NVS - Slide3

With most of the $30 billion in rebates eliminated, plan sponsors will need to raise premiums. Milliman, which performed an actuarial study for HHS, estimates the premiums will rise $1.8 billion or about $3.20 PMPM on average, but cost sharing will decline $1 billion in 2020, assuming no changes in behavior. The HHS Office of the Actuary concluded the impact would be greater. Premiums would increase $3.2 billion and cost sharing would be reduced $1.4 billion in 2020.

With the commercially insured on a low/no growth trajectory in a low unemployment environment, Medicare Advantage represents the best expansion opportunity for plans. To that point, Secretary Azar has indicated that he does not believe plan sponsors will be able to raise premiums significantly and instead will turn their attention to more aggressively managing pharmacy costs through utilization management and generic and biosimilar substitution.  

Finally, it is important to consider the change in the safe harbor regulations in the context of CMS’s proposal in December to eliminate all Pharmacy Price Concessions in 2020 or later. Pharmacy Concessions are typically clawed back after the point of sale and used by the pharmacy networks to implement their preferred networks. CVS is, of course, the top Part D preferred network. According to CMS, $4 billion was retained by Part D plan sponsors in the form of Pharmacy Price Concessions in 2017.

The headwinds created by the necessary trade-offs between increased premiums and more aggressive utilization and management and substitution means 2019 and 2020 will be difficult years for the industry as that process unfolds.

This rule does not apply to commercial plans and that is where all the rebates are, so nothing to worry about, right?

Not entirely. Both the Office of the Actuary and the Milliman reports that accompanied the proposed rule acknowledge certain spillover effects in the commercial market. Milliman cites the following reasons commercial insurers will follow Medicare’s lead:

  • Uptake by commercial plans like UNH and AET has already begun with their announcements that POS rebates will be available in 2019.
  • Managing two different reimbursement systems for plans that operate in both Medicare and commercial may prove difficult
  • Adopting Medicare Part D’s approach will allow commercial insurers to lower premiums and reduce cost sharing.

Milliman does acknowledge that PBMs and plan sponsors could value rebates more in the commercial market and work hard to defend them.

The Office of the Actuary concludes the commercially insured will see a $700 million decline in cost-sharing and premiums largely due to reduced list prices and the effects of the rule applied to all drug manufacturers who frequently negotiate across all books of business with insurers.

The quandary for commercial plans, and specifically employer-sponsored, is that they have been playing the same game as MA-PDP and PDP plans, using manufacturer rebates to keep premiums and other cost-sharing artificially low. As with MA-PDP and PDP plans, commercial insurers are sponsoring what is, in effect, “reverse insurance.” People with chronic or serious illnesses and use drugs which generate most rebates are subsidizing the premiums of everyone else.

FAQ: SAFE HARBOR PROPOSED RULE IMPACT | UNH, HUM, CVS, CI, MCK, CAH, AGN, LLY, NVS - Slide5

FAQ: SAFE HARBOR PROPOSED RULE IMPACT | UNH, HUM, CVS, CI, MCK, CAH, AGN, LLY, NVS - Slide6

A Pharmacy Benefit Management Institute survey in 2017 asked plan sponsors how they used rebates. A full 2/3 indicated that they used them to reduce the plan’s drug spend. The PBMI did not include the question in their 2018 report.

Using the Medicare Trustees’ data on manufacturer rebates as a proxy for all rebates and comparing to growth in premium cost for employer plans bears out the survey finding:

 FAQ: SAFE HARBOR PROPOSED RULE IMPACT | UNH, HUM, CVS, CI, MCK, CAH, AGN, LLY, NVS - Slide7

We are in the camp that commercial insurance will follow Medicare’s as quickly as contracts allow – about 24 to 36 months. While a two-tiered system seems to have worked with copay cards, using the same approach with Medicare Advantage and commercial plans is fraught with problems.

Perhaps anticipating one issue, the proposed rule contained clear warnings that it is and will continue to be violation of the safe harbor if plan sponsors negotiate large rebates in commercial plans for inducements such as favorable formulary placement in Medicare Advantage plans. When both commercial and Medicare plans used rebates, detecting that behavior is more difficult. With two sets of rules, it will be easier to enforce, thus exposing plan sponsors and their executives to criminal prosecution.

Another concern for plan sponsors will be the perpetuation of “reverse insurance.”  CMS has called attention to the inequity, raising the profile of the issue and likely to attract the attention of civil rights attorneys. The Senate, according to Sen. John Cornyn, will be holding oversight hearings on drug rebates which promises to elevate the issue even further.

Finally, labor market dynamics will certainly influence the transition away from rebates. A continued tight labor market makes employer-based sponsors hesitant to raise premiums and cost-sharing which may prolong the use of rebates.

Critical to the uptake by commercial insurers will be the Trump Administration’s continued forbearance in applying Federal kick-back statute to ACA exchange plans. Since 2013, these plans have not been considered federal programs for the purposes of the anti-kickback statute. The Trump administration has shown no signs of revisiting that interpretation but if they do, the new rebate rule would apply and accelerate uptake in the commercial market.

This rule represents a windfall for Pharma, right?

Depends.

The Office of the Actuary anticipates that about 15 percent of Part D rebates will be recaptured by drug manufacturers. That amount could be greater as manufacturers try to compensate for their increased liability in the Part D coverage gap created by the 2018 budget agreement.

Longer term, a pharmaceutical manufacturer that has struggled to obtain favorable formulary status because they could not or would not match the rebate terms of a competing drug should find the new safe harbor rules to be a tail wind, assuming clinical comparability. If a manufacturer has been using its deep pockets to buy placement on the formulary and thus improve sales, the rule change is a headwind. Secretary Azar makes this point in a speech to the Bipartisan Policy Center Friday:

We heard a story recently from a woman in Oregon, a retired nurse named Ann. She has what’s called chronic dry eye disease—a painful condition that impedes the production of tears … She’s been prescribed a drug that treats her effectively, but it costs her more than $2,000 a year out of pocket … Because Ann’s costs are so high, at times she hasn’t been able to take the full dose of her drugs, putting her not just in pain but at risk of permanent eye damage. It’s not just about the fact that Ann likely isn’t getting the full value of discounts supposedly negotiated on her behalf. One thing she’s noted is that she’s been waiting for the price of her drug to go down—it’s been on the market for 16 years now. A similar drug, also to treat chronic dry eye disease, was approved by the FDA a few years ago. But that drug has not been adopted by many drug plans, making it harder for it to drive down costs through competition. Why not? Not because the new drug wouldn’t work for many patients, but because the old drug Ann takes offers a huge kickback to drug plans to block access to the new competing product.

Azar appears to be talking about AGN’s Restasis and other Cyclosporine drugs made by Teva, Novartis, etc. Restasis is the 31st most costly Medicare drug in aggregate, according to 2016 data. Assuming Secretary Azar is describing the situation correctly, and we have every reason to believe him, the new safe harbor rule will level the field between AGN and other manufacturers like NVS and TEVA when negotiating with PDP plans for placement on the formulary. Further, the value of any rebates will be reflected in the beneficiary cost sharing.

Other manufacturers that could be similarly affected are insulin makers, LLY, Sanofi and Novo Nordisk.

Manufacturers of biosimilars, like NVS, Boehringer, MYLN, PFE which heretofore have been hesitant to dedicate the resources necessary for development and marketing, now have one less thing to worry about – poor or no formulary placement. As PBMs and their clients no longer rely on rebates as a factor, things like price and efficacy will move to the forefront

What about the wholesalers and distributers? Won’t they get hurt?

At the moment, OIG is asserting that the rule is not meant to apply to wholesalers and distributers. It would be naïve, maybe even stupid, to think there will be no impact on this part of the supply chain, which is paid a percentage of list price, when the federal government removes a significant driver of price inflation. Slowing price growth and possibly even deflation due to elimination of rebates will be magnified if PBMs respond to the safe harbor rule as expected and restructure formularies with more biosimilars and generics to compete against brands.

If you have questions we have not considered with the above, send them in!

Emily Evans
Managing Director – Health Policy



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Thomas Tobin
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Andrew Freedman, CFA
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