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Explainer

What Is an Inflationary Rebate, and How Can It Help Bring Down Drug Prices?

The idea of requiring manufacturers to pay Medicare a penalty if their list price grows faster than inflation is being discussed in both the House and Senate. Here are some key questions and answers about the mechanics of the policy.

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Arnold Ventures has encouraged lawmakers to consider requiring pharmaceutical manufacturers to pay Medicare a penalty if their list price — the price set by the manufacturer before rebates and discounts are applied — grows faster than inflation. This idea is now being discussed in both the House and the Senate, so we thought it would be helpful to answer some key questions about the mechanics of the policy.

Why penalize list price inflation when that isn’t the price paid by the Part D program?

Many Part D beneficiaries pay a share of a drug’s list price — or coinsurance — when they purchase their drugs at the pharmacy. They also pay a share of a drug’s list price during the deductible phase of the Part D benefit. 

The list price is a price that manufacturers can set at any level. It does not include the rebates and discounts that Part D plans negotiate with manufacturers. These discounts help keep health plan costs and premiums low but do not directly affect the amount many Part D beneficiaries pay for their drugs at the pharmacy counter.

Between 2006 and 2017, list prices for more than 100 chronic-use, brand-name drugs increased cumulatively by 214 percent relative to the inflation rate in the U.S. economy, which was 25.1 percent over the same period, according to a recent AARP report.

When list prices increase that quickly, so does beneficiary cost-sharing for many drugs in Part D.  This impedes access and adherence to needed medications. While this is felt the most in cases where Part D beneficiaries take high-cost specialty drugs, this also affects beneficiaries taking brand drugs that have been on the market for a very long time, like insulin, to which access is critical. According to a recent Kaiser Family Foundation report, cost-sharing for high-cost drugs can be as high as a third of a drug’s list price.

Health plans and pharmaceutical manufacturers like to blame each other for the rapid pace of list price growth. The dynamics are complicated, but it is important to note two things:

  1. Most Part D plans are making an active decision to use list price as a base for cost-sharing to shift costs to beneficiaries and keep premiums low; and
  2. Manufacturers have full control over list prices. They can choose to keep inflating those prices regardless of the affordability issues they create for many Part D beneficiaries.

We need to find a way to finance benefit design changes that lower out-of-pocket costs so taxpayers are not burdened and premiums stay affordable for all Part D beneficiaries.  A penalty paid by pharmaceutical manufacturers who excessively inflate list prices is one way to do it.

How would Medicare calculate the penalty?

Medicare would calculate the penalty for each drug covered under Medicare Part D based on the list price, which could be measured using a drug’s Wholesale Acquisition Cost (WAC).     

Other prices that do not reflect rebates and discounts negotiated between Part D plans and manufacturers could also be considered, such as (1) the Negotiated Price in Part D, which, despite its name, is not the net price of rebates negotiated by Part D plans but instead reflects the price of the drug paid at the pharmacy; or (2) the Average Manufacturer Price, which is used by Medicaid.

The policy would have to specify a “base year.” This is the year Medicare would start calculating actual price increases relative to inflation. The difference between the two prices in any given year would be the amount paid by the manufacturer to Medicare. The closer the base year to the start of policy, the less savings the policy would generate.

The following walks through why the base year is important and how it affects the size of the penalty collected by Medicare. These examples use WAC as the price benchmark and the Consumer Price Index for All Urban Consumers (CPI-U) as the inflation benchmark, but both are policy levers for Congress.

Example Parameters:

  • A drug has a $100 WAC in 2019.
  • Its WAC in 2006 was $50.
  • We assume that inflation in every year is 2 percent.
  • The two illustrative policies below are both effective in 2020. Policy #1 uses a 2019 base year, and Policy #2 uses a 2006 base year.

Policy #1: 2019 base year

2019 WAC: $100

2020 WAC if it grew by inflation over the 2019-2020 period: $102

Actual 2020 WAC: $106

2020 Rebate to Medicare ($106-$102): $4

Policy #2: 2006 base year

2006 WAC: $50

2020 WAC if it grew by inflation over the 2006-2020 period: $66

Actual 2020 WAC: $106 (same as above)

2020 Rebate to Medicare ($106-$66): $40

You can see that the base year is a key lever in generating savings to Medicare. As stated earlier, the closer the base year to start of policy, the less savings the policy would generate.

Congress can choose to take the entire amount of the calculated penalty or a portion of that amount.

What are the pricing dynamics to consider?

The inflation penalty would be paid directly to Medicare and generate a sizable savings to taxpayers and beneficiaries. However, the penalty does create a new cost for manufacturers that they would look to offset in some capacity.

Manufacturers can reduce their liability by lowering their list prices, which would be beneficial to Part D beneficiaries. However, we identified two additional manufacturer responses that are likely and would have to be addressed by Congress using other policy tools such as negotiation or reference pricing:

  • Launch prices for new drugs could increase over time. The magnitude to which this offsets savings generated from the penalty is uncertain.  A lot depends on how much spending is for new drugs over time and the extent to which people taking drugs already on the market switch to new drugs that will launch at higher prices in the future.
  • Net prices for drugs with limited competition could become less generous.  However, these drugs are less likely to have deep discounts now so it is unclear how much manufacturers can use this lever to offset their new liability.

These manufacturer responses highlight the importance of Congress addressing high drug prices comprehensively by tackling both high launch prices of new drugs coming to market and excessive list price increases for drugs already on the market.