Thursday, April 26, 2018

This blog was originally posted on Health Affairs and is reprinted with permission.

One way to boost sales of a prescription drug is to reduce what it costs the consumer at the point-of-purchase. For high-use consumers who have exceeded their deductible, this cost depends more upon the drug’s placement in their health plan’s formulary than it does upon the retail price. Often, the retail price is irrelevant to the consumer as they are charged a fixed copay amount (e.g., $10) whose size depends solely on the drug’s formulary tier. While retail prices do impact consumers under coinsurance formulary designs, tier placement remains a key determinant of consumer cost.


Pharmaceutical manufacturers are motivated to influence the tier placement of their products to increase sales. Rebates—payments from manufacturers to health plans in exchange for favorable formulary placement—are the mechanism they often use to achieve this. Rebates appear, at first, to be a triple win. The consumer benefits from lower costs, the manufacturer benefits from greater sales, and the health plan benefits from rebate revenues. Yet the rebate system has come under intense criticism.

Much of the criticism is directed at pharmacy benefit managers (PBMs), characterized as “middlemen”, who are hired by health plans to design formularies, negotiate rebates, set up pharmacy networks, and process claims. Manufacturers and health plans contend that a large share of rebates are retained by PBMs rather than being passed through to payers and policy holders as intended. It has been alleged that PBMs pressure manufacturers to raise their list prices and rebates in ways that advantage PBM profits. The system has been characterized as unfair to consumers at the point of purchase because the price they are charged does not usually reflect rebates. Finally, PBM contracts with health plans are criticized for their complexity and opaqueness, with multiple, hard to track, sources of revenue that leave health plans unclear as to how much they are paying for PBM services.


Exhibit 1: Simplified Flow Of Prescription Drugs (Rx) And Payments ($) In Prescription Drug Supply Chain

Simplified Flow Of Prescription Drugs (Rx) And Payments ($) In Prescription Drug Supply Chain

Estimates Of Rebates And Coupons In 2016

The first step in untangling the various claims and counterclaims about rebates and coupons is to estimate their amounts, a task that is easier said than done (see our data and methods appendix). We reconciled a wide variety data sources, research findings, and expert opinions, to put a dollar value on rebates and coupons in 2016. We estimate a total of $89 billion in rebates on brand name drugs were passed through to health plans and insurers, with the largest amounts collected by Medicaid ($32 billion) and Medicare Part D ($31 billion), and a smaller amount collected by private insurers ($23 billion). These figures exclude rebates that were retained by PBMs and not reported in our data sources. Manufacturers also provided about $10 billion in copay coupons.

Beneficiaries Of Rebates And Coupons

The $32 billion in rebates to Medicaid flow back to the federal and state governments who jointly finance Medicaid. The $31 billion in rebates to Medicare Part D plans are allocated, formulaically, toward reducing premiums and reducing federal subsidies. The $23 billion in rebates to private plans are not regulated and can be allocated toward increased plan profits, lower premiums, or more generous formularies. The beneficiaries of rebates include taxpayers via lower government costs, health plan enrollees via lower premiums, the health plans themselves via increased profits and more competitive premiums, and consumers at the point-of-purchase via lower copays.

While rebates benefit consumers as a whole, there are exceptions. For example, those who do not exceed their deductibles will usually experience no benefit from lower copays. Consumers would benefit even more, at the point-of-purchase, if rebates were routinely reflected in retail prices. Yet, this consumer gain would come at the expense of health plans who would likely raise premiums, experience reduced profits, or both.

We estimate that when used, coupons reduced consumer out-of-pocket costs for brand name drugs by about 70 percent at point-of-purchase for the privately insured. As noted, coupons are banned for Medicare Part D and Medicaid enrollees. It seems likely that coupons drive up health plan costs, since they eliminate some of the formulary incentives for purchasing lower cost drugs. It also seems likely that coupons reduce manufacturer rebates by reducing the impact of formulary placement. Thus, while coupons reduce consumer costs, they also likely result in some combination of higher premiums, lower health plan profits, and less generous formularies.

PBM Profits, Retained Rebates, And The Medical Loss Ratio

We estimate that total PBM profits in 2016 were about $11 billion or 4.5 percent of PBM revenues, (this excludes revenues and profits from PBM-operated mail-order and specialty pharmacies). It is difficult to judge how much of these profits might be deemed “excessive” due to the inappropriate diversion of rebate dollars to PBM bottom lines. But even if half was found to be excessive, it would amount to less than $6 billion dollars, or roughly 10 percent of total rebates to Medicare Part D and private plans (we exclude Medicaid rebates from this total because PBMs are not involved in their negotiation). Importantly, the PBM practice of retaining a share of rebates is often built into their health plan contracts and may occur largely in lieu of fees rather than flowing to the bottom line. Thus, PBMs could be retaining much more than $6 billion in rebates but with the revenues mainly covering PBM costs rather than boosting profits.

The PBM practice of retaining rebates in lieu of fees may be favored by health plans because of medical loss ratio (MLR) regulations that require administrative costs plus profits to be below a specified threshold. Fees paid to PBMs would appear as health plan administrative costs but not so for retained rebates. Using retained rebates to cover PBM costs in lieu of fees could artificially lower reported administrative costs and make it easier to meet government MLR requirements.

It has been suggested that the rebate system has led manufacturers to raise list prices above what they would be in the absence of rebates. If so, this would offset some of the gains we attribute to rebates. While not conclusive, available evidence suggests that any such offset is likely to be small.

Comparing Prices After Rebates By Payer

Rebate percentages vary considerably across Medicare, Medicaid, and private insurers. In the chart below, we converted these figures into the share of brand name retail prices paid after rebates. Private plans pay the highest share of retail at 84 cents on the dollar, followed by Medicare Part D (0.69), and Medicaid (0.39). We used published figures for seven high-selling brand name drugs to approximate what other advanced countries pay relative to US retail prices. This rough estimate (due to the small sample size) came to 0.29, which is even less than the Medicaid share.

Exhibit 2: Relative Us Price Of Branded Drugs By Payer Type After Rebates, With International Comparison

Relative Us Price Of Branded Drugs By Payer Type After Rebates, With International Comparison

Concluding Observations

As a general observation, the size of rebates increases with the level of government involvement. Rebates are smallest for private plans. Medicare Part D is next. Although it is administered through private plans, the government is involved via its ban of coupons, which raises the value of formulary placement to manufacturers, driving up rebates. Medicaid achieves the highest rebates and these are essentially dictated by the government. The high Medicaid rebates have less to do with the particular policy specifications than with the fact that the government is in a strong enough negotiating position to gain manufacturer acceptance. The low prices in other advanced countries are also indicative of high government involvement in price setting.

Editor’s Note

This blog provides a summary of a comprehensive report on prescription drug rebates that Altarum released today.

All postings to the Health Policy Forum (whether from employees or those outside the Institute) represent the views of the individual authors and/or organizations and do not necessarily represent the position, interests, strategy, or opinions of Altarum Institute. Altarum is a nonprofit, nonpartisan organization. No posting should be considered an endorsement by Altarum of individual candidates, political parties, opinions or policy positions.


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