In his first pre-inaugural press conference on January 11, President Trump stated the pharmaceutical industry has been “disastrous” and is “getting away with murder.” The remarks were very much in line with those made on the campaign trail and in the days following his election. If President Trump truly intends to control drug costs, we offer four proposals that leverage existing drug pricing systems to reduce prices for both public and private payers; in this Blog post, we will describe two of the proposals in depth.

President Trump’s rhetoric is understandable. Net spending on drugs and biologics grew 8.5 percent in 2015 alone, to $310 billion. Those increases hurt Americans’ health – in 2015, 24 percent of Americans reported that affording their prescription medicine was difficult; nearly a quarter reported that they or a family member had not filled a prescription, skipped a dose, or cut dosing in half because of the cost. However, the Trump Administration’s actual plans to control drug prices—more specifically, spending on drugs and biologics by public and private payers and prohibitive out-of-pocket costs passed on to consumers—remain unclear.

In a January 31 meeting with pharmaceutical industry executives, Trump suggested that current Food and Drug Administration (FDA) approval processes prohibit the competition necessary to control drug prices – a contested assertion, as numerous mechanisms intended to speed the development and approval of breakthrough therapies already exist. But if the aim is free-market competition, the U.S. patent system is a better target than the FDA, as it allows 20-plus years of protection from generic alternatives and monopolistic drug pricing.

President Trump also has supported empowering the Department of Health and Human Services (HHS) to negotiate drug prices for Medicare. Challenges to the noninterference clause, tacked on to the Medicare Modernization Act of 2003 that enacted the Medicare Part D prescription benefit, are not new. President Obama proposed granting the HHS Secretary the authority to negotiate Medicare prices for high-cost specialty drugs and monopoly products without direct competition. An Office of Management and Budget assessment, however, suggested that this would result in only negligible savings in the context of the negotiating power already enjoyed by private insurers.

Bold ideas to overhaul existing payer systems and rein in drug costs abound. However, the Trump Administration and Congress should first focus on strengthening and modernizing cost control regulations and statutes that already exist.

Fix The Formulas

Our first proposal is to make corrections to formulas. Manufacturers have expertly gamed the formulas used to regulate prices for Medicare, Medicaid, and other federal purchasers. These formulas were originally designed to leverage the power of private industry negotiations for government purchasers, but privately negotiated discounts are now excluded from these averages. Consider the Average Manufacturer Price (AMP), which sets prices for Medicaid and 340B programs. As amended under Section 2503 of the Affordable Care Act (ACA), the formula only considers “the average price paid to the manufacturer for the drug in the United States by (i) wholesalers for drugs distributed to retail community pharmacies; and (ii) retail community pharmacies that purchase drugs directly from the manufacturer, specifically excluding “rebates or discounts provided to pharmacy benefit managers, managed care organizations, health maintenance organizations, insurers,” and others.

Exhibit 1

The result of this is that instead of offering discounts to wholesalers and pharmacies, which would result in lower AMPs (and, by extension, lower Medicaid and 340B ceiling prices), manufacturers provide back-end rebates and incentive payments to insurers and pharmacy benefit managers, which are not reflected in government price reporting calculations.

This is how we know manufacturers are not including these discounts in government price reporting calculations: Pharmacy invoice prices are only 1 percent greater than the AMP for brand name drugs, consistent with the requirement that manufacturers only include pharmacy sales prices in the AMP calculation. Yet in 2015, “discounts, rebates, and other price concessions” on brand name drugs amounted to 27.1 percent of invoice drug costs. If these had been included in AMP, then AMP would be 27 percent lower than the pharmacy invoice price, not 1 percent lower. Shockingly, this implies that governments could be paying more for drugs than the private market – while Medicaid receives 23.1 percent off the calculated market price, overall manufacturers offer discounts of 27.1 percent.

The Medicaid rebate amount begins with the AMP, and therefore the AMP should reflect true market prices. Medicaid rebates have an additional safeguard, called “Best Price,” intended to ensure that Medicaid realizes the benefit of all commercial discounts. The Medicaid rebate can be greater than 23.1 percent of AMP if the manufacturer offers a discount to certain purchasers greater than 23.1 percent of AMP, establishing a “Best Price” that Medicaid is entitled to receive; however, the most important discounts—pharmacy benefit manager rebates—are excluded from Best Price. Best Price only considers prices, net of all discounts, to “any wholesaler, retailer, provider, health maintenance organization, nonprofit entity, or governmental entity,” explicitly excluding prices paid by most Federal agencies, manufacturer co-pay assistance programs, and prices negotiated by private Medicare Part D plans. In regulatory guidance, CMS clarifies that Best Price specifically excludes pharmacy benefit manager “rebates, discounts, or other financial transactions except their mail order pharmacy's purchases or where such rebates, discounts, or other financial transactions are designed to adjust prices at the retail or provider level.” While the pharmaceutical market has shifted from offering discounts to pharmacies to offering discounts to PBMs, Medicaid is prohibited from realizing those discounts through either a reduced AMP or through establishing a Best Price. Note 1

The duplicity doesn’t end with Medicaid and 340B. Back-end price reductions also keep pharmacy prices artificially high, increasing out-of-pocket costs to both uninsured consumers and insured consumers subject to high co-insurance rates. Discouraging back-end rebates and discounts could lead to normalized prices across the entire drug delivery system, passing discounts onto consumers rather than to pharmacy benefit managers and private insurers.

This proposal to “Fix the Formulas”—along with others, such as including all commercial discounts in Average Sales Price and non-Federal Average Manufacturer Price calculations—will help modernize how public payers finance prescription drugs and could save billions.

Enhance Existing Penalties

The second proposal is to enhance penalties for aggressive drug price increases. These penalties already exist, but they have failed to halt runaway prices. An example is the Medicaid penalty, called the “Additional Rebate” or “inflation penalty,” which assesses whether the current quarter’s AMP is greater than the drug’s initial AMP adjusted for inflation to the present. For example, a drug was approved in 2005 and had an initial AMP of $10. Adjusting that initial AMP for inflation, the current AMP should be $15. However, the manufacturer reported a current quarter AMP of $70. Based on this, the Additional Rebate would be $55, the difference between the current AMP and the inflation-adjusted initial AMP. This rebate is then added to the base rebate of 23.1 percent (~$16), for a total rebate of $71. Since the total rebate exceeds the quarterly AMP ($70), the rebate is capped at $70 – a practice that must be changed through legislation.

The cap on the total Medicaid rebate, added under Section 2501 of the ACA, encourages manufacturers to institute excessive price increases, which previously were penalized by higher Medicaid rebates. Because of the Additional Rebate, Medicaid rebates on brand name drugs are, on average, three times higher than the privately-negotiated rebates paid to Medicare Part D plans. However, Medicaid drug expenditures before rebates are just 9 percent of the market, indicating that manufacturers are willing to forgo profits on Medicaid in favor of profits from the rest of the market. Consider the 5,000 percent price increase for Daraprim (an infection treatment for certain diseases, including HIV), which established a net $0 price for Medicaid. In Congressional testimony, Turing’s Chief Commercial Officer stated that two-thirds of Daraprim sales were sold at nominal cost due to the inflation penalty. Yet, Turing is still able to profit despite this because of the revenue from the remaining one-third of sales, highlighting the perverse incentives under the current penalty.

The Medicaid inflation penalty must therefore be heightened in order for Medicaid’s 9 percent market power to shape prices in the rest of the market. This can be achieved by adding a multiplier to the Additional Rebate for large price increases and eliminating the rebate cap when the total rebate exceeds the quarterly AMP. For price increases more than 5 percent greater than the rate of inflation, we suggest the Additional Rebate be doubled; for increases more than 25 percent greater than the rate of inflation, the rebate should be tripled. Manufacturers should then be required to pay Medicaid the total rebate for the drug, even if it would result in a loss. Conforming changes should also be made to the Federal Ceiling Price inflation penalty for the “Big Four”—the Department of Veterans Affairs, the Department of Defense, Public Health Service/Indian Health Service, and the Coast Guard—which are the largest federal purchasers of pharmaceuticals.

Enhancing the existing inflation penalty leverages long-standing policy and systems infrastructure and does not require government price-setting or controls on the private market; rather, manufacturers will have to rationally price drugs in the private market to ensure full reimbursement by government payers. Moreover, by fixing the formulas and including back-end rebates and discounts in the calculation of AMP, current AMPs should drop, lessening the immediate impact of the inflation penalty while still holding future price increases closer to the rate of inflation.

Reforming the existing penalties, however, will not address new drugs that come to market with high prices. To keep launch prices in check, the Administration should cap the initial AMP of a new drug—the baseline for the inflation penalty—at a modest increase over the average inflation-adjusted initial AMPs of the top third of drugs prescribed in the same class or to treat the same condition. For example, a new drug is approved with an initial AMP of $100. There are ten other drugs in the class, and the average inflation-adjusted initial AMP of the top three drugs by prescription volume is $50. Various thresholds could establish the allowable initial AMP for the new drug: if the average age of the top third of drugs prescribed in the class is over 10 years, the allowable initial AMP could be no more than 200 percent of the average inflation-adjusted initial AMP of the class; if the average age is 5-10 years, 150 percent of the average; less than 5 years would be 125 percent of the average. This would allow reasonable comparisons of the new drug to the most frequently prescribed drugs in the class and would allow for greater initial AMPs for innovation in a drug class filled with older drugs.

Manufacturers should be able to petition the Secretary of HHS to allow for a different calculation based on the value of the drug if the drug is exceptionally novel, pursuant to regulations issued by the Secretary. Explicit definitions of, and calculations for, exceptionally novel drugs could be based on recommendations from a neutral body—such as the Institute for Clinical and Economic Review, which is currently developing a value assessment framework—to assess the impact and limitations of value-based tendering on access and public payer budgets. Manufacturers would continue to be free to price their drug as they see fit, but they will be subject to greater inflation penalties based on the modified initial AMP if prices are excessive.

Additional Proposals

The third and fourth recommendations, described more fully in the Fair Pricing Coalition’s Tackling Drug Costs – A 100-Day Roadmap, are:

Pool Purchasing Power through the establishment of a coordinated national Medicaid negotiating pool while continuing to allow states to negotiate on their own, along with expansion of existing inter- and intra-agency negotiations.

Pull Back the Curtain on the true price of drugs by modernizing price reporting formulas; requiring manufacturers to detail drug development costs, marketing costs, and executive compensation for egregious price increases; studying whether additional transparency, such as public and private payer discount and rebate amounts, will reduce costs or lead to anti-competitive price fixing; and studying the relationship between drug development costs and prices.

Together, these four proposals direct a clear path to reduce drug prices while incentivizing scientific ingenuity and discovery, simply by leveraging existing tools to modernize a broken system. The Administration and Congress must move swiftly and decisively – the health care system, taxpayers, and those who rely on life-saving prescription drugs, are in need of action.

Note 1

This paragraph was added on April 13, 2017, to provide additional clarity.