Drug pricing reform continues

06/11/2018

Download

​Portfolio Manager Ethan Lovell discusses a new proposal to overhaul drug pricing in the US in Medicare Part B and what it could mean for drug manufacturers.

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.

 

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

For promotional purposes.

Anything non-factual in nature is an opinion of the author(s), and opinions are meant as an illustration of broader themes, are not an indication of trading intent, and are subject to change at any time due to changes in market or economic conditions. It is not intended to indicate or imply that any illustration/example mentioned is now or was ever held in any portfolio. No forecasts can be guaranteed and there is no guarantee that the information supplied is complete or timely, nor are there any warranties with regard to the results obtained from its us.


Important information

Please read the following important information regarding funds related to this article.

Janus Henderson Global Life Sciences Fund

Key investment risks to be considered before investing.

  • The Fund may invest in any one or a combination of the following instruments:
    • futures, options and swaps and other financial derivative instruments (“FDI”) for investment purposes, up to 10% of the net asset value ("NAV") of the Fund. Given the leverage effect of FDI, such investments may result in substantial loss (as much as 100% of the NAV of the relevant Fund);
    • debt securities rated below investment grade; and
    • mortgage and asset-backed securities and/or in index/structured securities. These financial instruments may be rated below investment grade.
  • Investing in any one of the above instruments may involve substantial credit/counterparty, market, liquidity, currency, leverage, index, interest and swap risks. If the issuers default, or such securities or their underlying assets, cannot be realised or perform badly, investors’ entire investments may be lost.
  • The Fund's investments involve developing markets. Owing to its potentially higher volatility and risk levels, as well as lower political and economic stability than developed markets, asset values could be affected in various levels.
  • The Fund’s investments may be more concentrated in terms of industry risk than others that diversify across industries and may therefore be subject to higher industry risk than funds with more diversified holdings.
  • The investment decision is yours. If you are in any doubt about the contents of this document, you should seek independent professional financial advice.
  • Investors should not only base on this document alone to make investment decisions and should read the Prospectus including the risk factors for further details.

Specific risks

Risk rating

Share

Important message