Drug Pricing Reform Shifts Course

Last week, the Trump administration abandoned plans to overhaul drug rebates in Medicare while a federal judge ruled against listing prescription drug prices in TV ads. But U.S. drug reform is far from over, with implications for investors, says Portfolio Manager Andy Acker and Health Care Research Analysts Luyi Guo and Rich Carney.

Key Takeaways

  • Last week, the Trump administration abandoned plans to reform drug rebates in Medicare and a federal judge overturned a rule that would have required pharmaceutical companies to display prescription drug prices in television ads.
  • Despite these setbacks, we believe the administration will continue to pursue drug pricing reform, a key agenda of President Trump, especially as the 2020 presidential election looms.
  • New proposals could create more uncertainty for drug prices, making it all the more important for investors to focus on health care companies delivering innovation and value, in our opinion.

The road to drug pricing reform in the U.S. continues to take some surprising turns. Last week, President Trump abandoned a plan to overhaul drug rebates in Medicare after months of pushing for it. The same week, a federal judge blocked a Health and Human Services rule that would require prescription drug prices to be displayed in television ads. Both initiatives had been part of the Trump administration’s broader blueprint to curb drug costs for consumers – an initiative that, despite recent setbacks, the administration looks set to continue, with implications for investors.

What Comes After Rebates

Not long ago, the rebate rule seemed like one of the more likely health care reforms to pass. With it, drug manufacturer rebates would be shared with Medicare beneficiaries, rather than the pharmacy benefit managers (PBMs) and insurers that normally pocket the savings. We believed this could have lowered out of pocket costs for Medicare consumers, helping improve patient access and adherence (in our view, the crux of the drug pricing debate). Pharma companies were also supportive, arguing that rebates – calculated as a percentage of a medication’s list price – actually create a perverse incentive for list price increases. Only PBMs and other members of the drug supply chain stood to lose, one reason we had been cautious on these sub-sectors.

But Trump ultimately decided to drop the proposal. That’s because if the rebates had disappeared, premiums would most likely rise for many Medicare beneficiaries, as insurers often use a portion of the rebates to defray broader Medicare costs. The total additional expense to taxpayers was another concern, estimated at $177 billion by the Congressional Budget Office, though we believe this number was likely overstated.

Still, the forecasted budgetary impact would have likely delayed the implementation of rebate reform. In addition, Trump wanted to avoid potential increases to Part D premiums, even if many individuals would have benefited from lower drug prices.

However, with the 2020 presidential election looming, the pursuit of drug pricing reform is likely to continue. One option favored by the president is the rollout of an International Pricing Index. Under this model, prices for prescription drugs in Medicare Part B (which covers outpatient medications) would be adjusted based on prices paid in other nations. Without legislation, we believe this could only be applied as a demo project to a portion of the country. Another proposal floated by the Trump administration and being considered in Congress would cap price increases at inflation for drugs in Medicare Part D (self-administered prescriptions).

Innovation, Now Even More Critical

These proposals face their own set of challenges. For one, current law does not allow the government to directly negotiate drug prices. Congressional Republicans also usually prefer to rely on market forces rather than government interference. But in general, the recent shift has removed some pressure from PBMs and insurers (as evidenced by these stocks’ recent bounce) and created what could be a modest headwind for biopharmaceuticals in the near term.

Long term, though, any restrictions on pricing could drive health care companies to become even more focused on developing advanced medicines, as these drugs will likely stand a better chance of receiving attractive reimbursement. They could also fuel more mergers and acquisitions since large pharmaceutical and biotech companies may look to diversify pipelines. Meanwhile, PBMs and insurers might still distance themselves from rebates, given months of negative attention. In short, our long-term view – to focus on companies delivering innovation and value to the health care system – could become even more paramount, as these firms look well positioned to take market share on the long and winding road to reform.

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