Janus Henderson: Drug pricing reform continues

In another step toward reforming drug pricing, the US Department of Health and Human Services (HHS) recently introduced a proposal to change how drug prices are set in Medicare Part B. According to the proposal, prices would be tied to a so-called International Pricing Index (IPI) based on costs in other countries such as Canada, Japan and the UK. According to an analysis by HHS, the prices of physician-administered drugs in Medicare Part B were 1.8x higher than prices in 16 other developed economies. By moving to the IPI model, HHS estimates total spending in the US for these drugs would fall by roughly 30%.

The potential impact to drug makers

At first blush, HHS's proposal may seem negative for drug makers as it would limit companies’ pricing power. However, as is often the case in healthcare reform, the details must be considered.

According to HHS and the Centers for Medicare and Medicaid Services, annual US drug spending in Medicare Part B was $28 billion in 2016, a third of the total outlay in Part D (Medicare’s standalone outpatient drug benefit). Medicare Part B primarily covers drugs administered by a doctor or affiliated health care professional. The new proposal would exclude patients in Medicare Advantage plans (who account for about a third of Part B participants). Even then, among qualifying patients, the proposal would apply to just 50% of people (a limitation needed in order to avoid Congress from weighing in) and would roll out over a five-year period, starting in 2020. In addition, HHS is in the process of soliciting comments on the proposal, which won’t be finalised until next year.

The net effect

We think the bite from the IPI model is likely to be minimal when you consider that Medicare Part B accounts for only a small percentage of the $1 trillion global pharmaceutical market. Furthermore, initial proposals tend to be more draconian than what eventually gets implemented as industry participants argue their case. For many companies, we think the IPI model would be, at its worst, a minor headwind to earnings.

What’s next?

In the near term, some stocks could be pressured, particularly those of drug manufacturers that have a large presence in Part B. However, we believe many of these firms have other long-term growth drivers in their business models. Should the IPI proposal create market volatility and weigh on valuations, these drivers could become all the more attractive.

To be clear, we think Medicare Part B is due for change. Under the current system, healthcare providers purchase medicines and are reimbursed based on an average sales price for the drug, plus an add-on of 6%. Because the add-on is a percentage, doctors have a financial incentive to prescribe higher-cost medicines. The proposed reform would remove doctors from the purchase of drugs – giving the responsibility to private vendors – and pay doctors a flat fee for handling and storing medicines.

These reforms seem like a step in the right direction for Medicare Part B. Can they be applied to larger areas of the US pharmaceutical market, such as Part D? We don’t think so. Already in Part D, plan administrators such as United Healthcare work with drug makers to establish prices in exchange for placement on a plan formulary. Introducing an IPI model, where the government establishes price, would require a legislative overhaul and could face litigation. Even though the Republicans maintained their majority position in the Senate after the midterm elections, the party will still need a broad coalition of support to effect change.

Meanwhile, the industry may act preemptively to satisfy President Trump’s dogged pursuit of lowering drug prices in the US. Already, major biopharmaceutical companies such as Amgen and Gilead have lowered the list price of brand drugs for cash-paying customers. We could see more firms follow suit – and with potentially little detriment to the bottom line. After all, the net price realised by drug makers tends to be much lower than the list price after accounting for rebates paid to companies that manage prescription benefit plans for insurers. However, these rebates do not show up at the point of sale as financial concessions for consumers to enjoy. By lowering the list price and effectively eliminating rebates, drug manufacturers could improve patient affordability and consequently drive up sales volumes. In the end, that’s better for patients and better for the drug industry.

Glossary

Medicare (part B and part D): the national health insurance programme administered in the US for people over the age of 65 and younger people with a disability status. Medicare B plan is a subsection of the Medicare programme, where costs for medically necessary and preventative services are covered. In the Medicare part D plan, the cost of prescription medication for beneficiaries is subsidised by the US Federal Government.