Drug Pricing Reforms and Value-Based Pricing: Future and Current Implications for Drug Companies

Originally published on August 3, 2020 in Health Law360

Tom Bulleit is a partner and Elana Bengualid is an associate in the Health Care practice at Ropes & Gray, LLP. Along with partner Deborah Gardner and counsel Peter Holman, Tom and Scott serve on the steering committee of the firm’s Drug Pricing working group.

This article is the first in a series to examine how the current wave of drug pricing reforms may affect drug companies’ business operations and, in particular, their compliance with existing federal price reporting and pricing requirements. It will examine the current bevy of federal administrative and legislative proposals in the context of existing federal law governing drug prices, with the aim of identifying the future and current effects that such proposals may hold for the drug industry. The second article will address the implications of state drug pricing initiatives, and the third article will explore enforcement of federal pricing requirements.

On July 24, President Trump announced a series of executive orders on prescription drug prices, making no current changes in law, but ordering rulemaking on what with one minor exception are longstanding administration proposals that have languished for months.¹ The orders most notably direct the administration to revive the rulemaking process for proposals to tie what Medicare pays for certain drugs to international prices and to eliminate rebates in Medicare and Medicaid. Even if adopted as final rules, these proposals would face serious legal challenges, casting doubt on whether they ever could take effect.² Nevertheless, the widely-publicized ceremony, coming only 100 days before the presidential election, is the latest evidence of the political potency of prescription drug prices.

Members of both parties in Congress also have sought to capitalize on voters’ concerns about drug prices. The politically divided Congress, however, has little to show for itself in terms of enacted legislation. In 2019, the Democratic House passed a sweeping bill that would bring dramatic changes to the U.S. drug market, most notably through required government price negotiations, but has little support among Republicans.³ In the Senate, Republican Finance Committee Chairman Chuck Grassley crafted an initially bipartisan drug pricing package (the “Prescription Drug Pricing Reduction Act” or “PDPRA”)⁴ that despite a White House endorsement, now seems doomed because it has lost the support of key Democrats.⁵

While the COVID-19 pandemic and election-year politics may have temporarily halted momentum for these and other such efforts,⁶ drug prices clearly will remain a focal point of the 2020 election campaign, and many of the proposals discussed below will remain on the table whatever the election’s outcome.

I. The Current Drug Pricing Regulatory Landscape

MDRP. In 1990, Congress created the Medicaid Drug Rebate Program (“MDRP”). In exchange for guaranteeing their drugs are covered by Medicaid, manufacturers must pay rebates through the MDRP that ensure state Medicaid programs receive the “best price” for drugs. Under the MDRP, a manufacturer must track and report various pricing information that is used to calculate its rebate obligations.⁷

MDRP Calculations. A drug’s Average Manufacturer Price (“AMP”)⁸ and Best Price (“BP”)⁹ determine the rebate amount. In short, a drug’s AMP is the average price paid to the manufacturer by wholesalers and retail community pharmacies. BP is the lowest price offered by the manufacturer for that drug to most purchasers, subject to certain exclusions.¹⁰

Each drug’s rebate per unit consists of a basic rebate plus, if applicable, an additional rebate. In general, the basic rebate for a brand-name drug equals the greater of the drug’s AMP minus its BP, or 23.1% of its AMP.¹¹ Brand-name manufacturers seek to avoid sales that might result in a new, lower BP that would increase the drug’s rebate. Rebates for generic drugs do not depend on BP and simply equal 13.0% of the product’s AMP.¹² When a drug’s AMP increases faster than the rate of inflation, the manufacturer must pay an additional rebate for the amount by which the drug’s AMP exceeds the inflation-adjusted base AMP.¹³ A drug’s unit rebate amount (the basic rebate plus the additional rebate), however, cannot exceed 100% of AMP.¹⁴ Finally, the manufacturer’s total rebate obligations will equal the unit rebate amount multiplied by the number of units paid for by the Medicaid program during the reporting period.¹⁵

340B. Under the MDRP, manufacturers also must participate in the 340B Program, under which manufacturers can charge “covered entities”—certain federal grantees and hospitals that serve low-income patients—only up to a “ceiling price.”¹⁶ Each drug’s ceiling price derives from values calculated under the MDRP: the ceiling price equals the drug’s AMP minus its unit rebate amount.¹⁷

ASP. MDRP-participating manufacturers also must report each drug’s Average Sales Price (“ASP”), which the Centers for Medicare & Medicaid Services (“CMS”) use to calculate Medicare Part B reimbursement rates.¹⁸ ASP refers to a manufacturer’s quarterly sales of a drug to all U.S. purchasers, divided by the total units sold, subject to certain exclusions.¹⁹

Each of these federal pricing and price reporting programs pose significant compliance risks for drug makers. Failing to report, reporting false pricing information, and miscalculating and underpaying rebates all can result in civil monetary penalties and False Claims Act (“FCA”) lawsuits.²⁰ The third article in this series will examine more closely the ways in which pricing reforms may affect the FCA risks associated with government price reporting laws.

II. Price Reporting Challenges Posed by Value-Based Pricing

Value-based pricing presents new opportunities and challenges. For drug makers, these arrangements can help demonstrate a product’s value, overcome market access restrictions, and justify higher price points. For insurers, providers, and patients, they can mitigate risk, expand access, and reduce uncertainty about the value of new, unproven drugs.²¹ Both the Trump administration and members of Congress have touted their potential.²²

Although value-based arrangements for prescription drugs have become more common in recent years,²³ widespread adoption remains hampered not only by significant operational issues, but also by what are widely perceived to be substantial regulatory challenges associated with developing and implementing such models.²⁴ Surveys of drug companies indicate that government price reporting laws pose one of the largest obstacles.²⁵

The Increased Rebate Dilemma. One of the key issues is that if a contract ties price to outcomes, a drug that underperforms clinically can result in a much lower price. If that new price qualifies as the drug’s BP, then the manufacturer must extend the same discount to all state Medicaid programs through the MDRP. This is far from a trivial concern, since even a single 100% refund of a drug that fails to meet its guaranteed outcome for one patient could have a disastrous effect. Value-based contracts can influence a drug’s AMP and ASP, in addition to BP, all of which in turn can affect Medicaid drug rebate liabilities, 340B ceiling prices, and Medicare Part B reimbursement rates. Careful contracting is required to account for these considerations. Common workarounds include limiting potential rebates or discounts under an outcomes-based contract to no more than 23.1% of the drug’s AMP (i.e., the MDRP’s rebate floor for brand-name drugs), aggregating prices across a class of patients as a “bundled sale” (discussed below), or tying value-based prices to specific types of sales or purchasers that are excluded from price reporting calculations altogether.²⁶

The Supplemental Rebate Work-Around. An example of the latter approach is to limit any outcome-based price concessions to a Medicaid supplemental rebate agreement (“SRA”), since rebates paid under SRAs are excluded from BP, AMP, and ASP.²⁷ Under the MDRP, states may negotiate agreements directly with manufacturers to pay supplemental rebates in addition to the MDRP rebate. While manufacturers are under no obligation to enter SRAs, many do so to secure more favorable coverage terms for their drugs. As our second article on state drug pricing initiatives will explore in more detail, over the past two years, eight states have obtained CMS approval to enter SRAs that use value-based pricing.²⁸ The PDPRA also would offer some relief in the form of installment payment options.²⁹

The Recently Proposed Rule Fix. CMS recently issued a proposed rule that, if finalized, would provide manufacturers interested in value-based purchasing with additional flexibility regarding government price reporting requirements.³⁰ The rule would offer manufacturers two new options for calculating and reporting BP.

Bundled Sales. Blessing an existing industry reporting practice to remove ambiguity, the rule would modify the MDRP’s definition of “bundled sale” to clarify that manufacturers may “bundle” prices for all units of a drug sold through an outcomes-based contract so that no one sale will set the BP.³¹ This ensures that a substantial discount for one patient who had particularly poor outcomes would not require the manufacturer to offer the same discount to all state Medicaid programs.

For example, suppose a manufacturer rebates 50% of the drug’s price for each patient who does not achieve a desired treatment outcome. Without bundling, the drug’s BP becomes 50% of the “full price” if just one patient fails to have the expected results. However, a manufacturer who takes advantage of the bundling option would report the drug’s average net price across all patients and sales under the value-based contract. Bundling’s effect on BP can be substantial (e.g., if half-off rebates for 10% of patients, but full price paid for the rest, BP will be significantly higher (95% of full price)).

Multiple BPs. CMS’s other proposal would change radically how BPs are calculated. The rule would offer drug makers the option to report multiple BPs: the lowest prices available for each outcome in a value-based arrangement, as well as the traditional BP for sales outside of the value-based arrangement.³² Without having to negotiate an outcomes-based contract of its own, each state Medicaid program then would have the opportunity to “participate” in the value-based arrangement according to the terms negotiated between the manufacturer and the original payor.³³

Remaining Challenges. Although the rule should be welcome news to industry and should facilitate value-based models, it likely would create significant operational and legal challenges for which the proposed rule provides little guidance. These include:

• Reporting multiple BPs will require manufacturers to update their current data collection and information systems to capture information at the individual patient level;
• Identifying and reporting BPs at each outcome level (i.e., tracking patient outcomes and prices within each defined outcome);
• Tracking which Medicaid beneficiaries are “participating” in value-based arrangements, monitoring outcomes to determine which BP applies, and calculating varying rebate amounts;
• Resolving issues with value-based arrangements where prices depend on outcomes over time (e.g., rebates based on outcomes at multiple stages);³⁴
• Considering the impact of privacy and fraud and abuse laws on the additional data to be captured and payments for the data and attendant services (notably, the administration’s proposed rules last fall to protect value-based arrangements under the Anti-Kickback Statute would not apply to drug manufacturers).³⁵

III. Price Reporting Challenges Posed by Congressional Proposals

Although prominent members of both parties have expressed interest in drug pricing reforms, and Congress enacted two minor MDRP reforms as part of larger bills in 2019,³⁶ a comprehensive drug pricing bill has eluded Congress thus far. With initial bipartisan support, Sen. Grassley’s PDPRA was the leading proposal. In light of COVID-19, the upcoming elections, and a breakdown in cooperation between Sen. Grassley and top Democrats, the PDPRA now faces an uphill, if not impossible, battle in 2020.³⁷ Nevertheless, the bill’s range of bipartisan proposals will remain options for future congressional efforts, especially after election-year politics recede.

Reporting of Price Justifications and Increasing Scrutiny of Reporting. The PDPRA would copy states that have enacted new manufacturer reporting laws. Upon notification by the Department of Health and Human Services (“HHS”), manufacturers would have to submit justifications for qualifying list price increases and for new drugs with high initial prices, and HHS could require such justifications to contain a wide range of information.³⁸ The bill also would expand MDRP auditing and create new penalties.³⁹

Changes to Medicare Part B ASP Reporting. The PDPRA would attempt to reduce Medicare payments by:

• Extending the obligation to report ASP data for Part B drugs beyond MDRP participants to all manufacturers with products covered by Part B;⁴⁰
• Requiring manufacturers to subtract from ASP price concessions provided directly to patients through coupons for privately-insured individuals;⁴¹
• Narrowing the definition of “bona fide service fee” to expressly exclude fees based on the percentage of sales and fees that take into account the volume or value of any referrals or business between parties.⁴²

Expanded Inflationary Rebates. Finally, the PDPRA would expand manufacturer rebate obligations by (1) raising the MDRP rebate ceiling from 100% of AMP to 125% (thus increasing the potential cost of price increases that exceed the rate of inflation and trigger the MDRP’s inflationary “additional rebate”),⁴³ and (2) adding new Medicare rebates for price increases greater than the rate of inflation, initially for Part B and then for Part D.⁴⁴

IV. Pricing Challenges Posed by Less Likely Administration Proposals

As noted at the outset, two of the Trump administration’s most controversial proposals, recently revived by executive order, would eliminate rebates in Medicare Part D and Medicaid and use international prices to determine what Medicare Part B pays for drugs. Despite the orders, there are reasons to doubt either will result in final rules.

Limiting Rebates. This proposal adopts the pharmaceutical industry’s narrative, that rebate arrangements incentivize plans and pharmacy benefit managers (“PBMs”) to negotiate for, and design formularies that reward, drugs with higher rebates, rather than lower list prices, which ultimately results in greater out-of-pocket costs for patients with deductibles or coinsurance.⁴⁵ Putting aside objections that this would fundamentally change how the industry negotiates and pays for drugs, and despite some continued congressional interest,⁴⁶ since the EO reviving this rulemaking mandates no increased spending (and the administration’s own estimates show a ten-year price tag of nearly $200 billion), it is difficult to see how it could become law.⁴⁷

International Reference Pricing. The Trump administration’s 2018 advance notice of proposed rulemaking would have established a demonstration project using an international pricing index, instead of ASP, to set Medicare Part B reimbursement rates at the average price paid for certain drugs in other countries.⁴⁸ The recent order resumes the rulemaking process, but this time proposes an even harsher price reduction, replacing the index with a more aggressive most favored nation policy where Medicare would pay the lowest, rather than the average, price paid in select countries.⁴⁹ If implemented, either approach would have significant consequences for manufacturers. By creating market pressure to force manufacturers to lower prices for affected drugs, the rule could result in lower AMPs and BPs and affect manufacturers’ MDRP rebates.⁵⁰ Putting aside that the industry will mobilize all its forces to prevent the rule from being finalized (including likely pushing Congress to undo it), there are questions about whether a mandatory program affecting half the Medicare Part B population would exceed the agency’s demonstration authority.⁵¹

V. Conclusion

While COVID-19 temporarily has taken the wind out of the sails of federal drug pricing reform, drug companies must stay vigilant while preparing for the potential changes to come. For example, as industry and regulators alike embrace the shift towards value-based care, manufacturers must rethink how they negotiate contracts, track and collect data, and report prices, while staying in compliance with privacy and fraud and abuse laws. While direct price regulations, such as inflationary rebates and rebate reforms, obviously will affect pricing decisions, more modest tweaks to price reporting laws that more easily can garner bipartisan support also can have significant implications. With drug prices likely to remain on the minds of Congress and the White House—regardless of the outcome of the 2020 elections—drug companies must look ahead and plan for how the regulatory landscape might change.