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Drug pricing is secretive. Fix that first

If the rebate system is a complex web, consumers are the ones who get caught

Abuse of the patent system by brand-name drug manufacturers is exacerbating the financial burden faced by American patients for their prescription drugs, Lane writes. (George Frey/Getty Images file photo)
Abuse of the patent system by brand-name drug manufacturers is exacerbating the financial burden faced by American patients for their prescription drugs, Lane writes. (George Frey/Getty Images file photo)

OPINION — Health care economist Uwe Reinhardt once described pricing in the health care sector as “chaos behind a veil of secrecy.” That description aptly applies to the opaque U.S. pharmaceutical market.

To make health care policy that works, we must lift the secret veil on drug pricing. The administration’s recent proposal to fundamentally change the drug rebate process is one step in that direction.

Voters in 2018 said health care was their biggest priority, and the cost of prescriptions was the top concern. Despite public perception, brand-name drugs didn’t skyrocket off the charts last year. Instead, list prices grew by less than 6 percent, marking the fourth year in a row that growth has slowed. Why the mismatch between the hard data and what voters believe? One reason could be the $166 billion “rebate” system.

Patients usually interact with two people to get their prescription drugs — their doctor and pharmacist. But the drug distribution supply chain is more complex than that.

First in the chain is the drug manufacturer, who sets a list price — the figure that’s commanded the attention of Congress. Next come the wholesalers, health insurers and pharmacy benefit managers. By the time a patient sees a final price tag, it has passed through many hands.

The rebate game

When the competing incentives of all these stakeholders in the supply chain collide, the outcome doesn’t favor the patient or the taxpayer. This is particularly true for the Part D program that provides drug coverage for more than 44 million Medicare beneficiaries at an annual cost of over $100 billion, rising at an annual rate of nearly 18 percent.

Health and Human Services Secretary Alex Azar has a plan to change that. He has outlined a proposed rule to overhaul the rebate system for Medicare Part D and Medicaid managed care organizations, with the goal of bringing transparency to the pricing system and cutting out-of-pocket costs for the patient.

When a seller issues a “rebate,” it returns part of the purchase price to the buyer. Why would drug manufacturers do that? For one thing, they want preferential placement on PBM formularies, which in turn can increase demand.

The incentive for the PBM is to get the largest discount from the list price — and to retain a portion of the rebate for its services before passing on the remainder to the health insurer.

The incentive for the health insurer is to apply all the rebates to the price of average plans, thus boosting business by trimming overall premiums.

Perversely, the drug with the highest individual rebate for the most chronic, complex disease can end up slashing premiums for the least sick patients. One result is that the average net price of a brand-name specialty drug in Part D grew at an annual rate of 22 percent from 2010 to 2015, while 25 percent of Part D spending applied to fewer than 1 percent of all beneficiaries.

Finding the cost

If the rebate system is a complex pricing web, consumers are the ones who get caught in it.

Patients usually pay a coinsurance percentage, particularly for a high-cost brand-name or specialty drug. Because the coinsurance is calculated on the prescription price before rebates, patients often pay a greater share of the true cost to the health insurer. This may help explain why voters have not seen the benefits of slowing list price growth over the last four years.

Even the administration admits that accurately quantifying the outcome of their proposed changes is almost impossible. Interactions with the current health insurance system could mean that premiums for Part D participants could increase between 8 and 19 percent. But depending on a person’s insurance plan and the drugs covered, cost-sharing expenses could offset the premium increases, such that on balance the person’s actual costs could decline from 2 to 3 percent.

While the consumer might benefit from lower copays, the federal taxpayer would not, according to the administration’s actuaries. Due to premium increases, federal expenditures might increase as much as $200 billion over the next 10 years. Private actuaries suggest the impact on the federal budget could range from a savings of $100 billion to a cost of $35 billion.

No wonder analysts have difficulty estimating the future path of health care spending. But with this proposal and others, we may slowly be casting light on the secrets of drug pricing.

G. William Hoagland is a senior vice president at the Bipartisan Policy Center and a former staff director of the Senate Budget Committee.

The Bipartisan Policy Center is a D.C.-based think tank that actively promotes bipartisanship. BPC works to address the key challenges facing the nation through policy solutions that are the product of informed deliberations by former elected and appointed officials, business and labor leaders, and academics and advocates from both ends of the political spectrum. BPC is currently focused on health, energy, national security, the economy, financial regulatory reform, housing, immigration, infrastructure, and governance. Follow BPC on Twitter or Facebook.

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