Wednesday, March 20, 2019

A World Without Rebates: Predictions for How the Channel Will Evolve and Why Drug Prices Will Go Down

Two years ago on Drug Channels, I wrote about a shift from rebates to discounts as a black swan event—a massively important yet unexpected break from current practice.

Given recent developments, I believe that we are moving ever closer to a world without rebates. Yet there are many unanswered questions were such a radical shift to occur.

As I see it, a world without rebates would force manufacturers to use net price as a competitive weapon. If PBMs and payers behave logically, then drug prices would drop as manufacturers are forced to compete more aggressively for prescriptions.

These conclusions are based on the predictions about market changes that I describe below. Other key implications include:
  • Winner-take-all auctions and narrow formularies for categories with therapeutically comparable products
  • Broader formularies to encourage indication-based price competition for other therapeutic categories
  • Faster patient access to new drugs with superior efficacy for certain subgroups of patients
  • Fewer pharmacy benefit tiers and a greater ability for physicians and patients to make cost/value tradeoffs
  • The popping of the gross-to-net bubble and declines in brand-name list prices
  • Slower growth in drug prices
This is a longer-than-average post, but I still only scratch the surface in speculating how our world could change. If the black swan continues to spread its wings, I’ll expand in future posts on implications for drug makers, pharmacy benefit managers (PBMs), wholesalers, pharmacies, health plans, and patients. As always, I encourage you to leave your comments and ideas below.

SAVE THE DATE: Drug Channels Institute will hold a special live, interactive webinar titled Preparing for a World Without Rebates on April 12, 2019, at 12 PM ET. Details and registration information will be announced in the first week of April.


As we all know, the Department of Health and Human Services (HHS) has proposed a rule that would dramatically alter the rebate system in federal programs. If the rule were to be finalized, rebates on prescription drugs paid by manufacturers to PBMs, Part D plans, and Medicaid managed care organizations would no longer receive safe harbor protection under the Anti-Kickback Statute (AKS). HHS has released multiple analyses of the potential impact, which I consider briefly in an appendix at the bottom of this post.

If HHS implements its safe harbor rule, I expect spillover to the commercial market within 3 years. It could happen even sooner if Congress passes legislation to mandate a shift. My discussion below presumes that the rebates are also removed from commercial plans. Note that a bifurcated system in which rebates remain in the commercial market but are eliminated from Part D may not have the same market dynamics that I describe below.

For background on key terms and current industry dynamics, I suggest the following material from our new 2019 Economic Report on U.S. Pharmacies and Pharmacy Benefit Managers:
  • Section 5.1. Overview of Pharmacy Benefit Management
  • Chapter 9: Drug Pricing, Rebates, and Payer Costs
  • Section 12.4.1. Issues with Current Rebate System
You should also review our Drug Channels Negotiated Discount (NDM) Model. The Institute for Clinical and Economic Review (ICER) recently referred to our NDM as “the most detailed description of how a discount model could work.”


1) PBMs’ services will remain crucial to the proper functioning of the U.S. drug channel.

As long as we have third-party payment for our prescriptions, PBMs will not be removed from the drug channel.

In Section 5.1. of our 2019 pharmacy/PBM report, we describe the many services associated with the management of prescription drug benefit plans. These include: plan design and administration; formulary development and management; rebate negotiation; enrollment and member services; utilization management; claims adjudication; reporting, and more.

In a world without rebates, a plan sponsor would still hire a PBM for these administrative services associated with prescription drug benefit plans. PBMs would continue to play a role in negotiating with manufacturers, though how they operate would evolve, as I describe below.

2) Pharmacy benefits will operate more like traditional insurance. Plans and PBMs will seek drugs with the lowest net costs, regardless of list price.

Payers and their PBMs currently have incentives to select higher-priced, heavily rebated drugs instead of lower-cost alternatives. Put simply: A $100 drug with a $50 rebate is more attractive than a $50 drug without a rebate. That’s because most health plans use rebate funds to offset overall plan costs or reduce premiums, not to reduce costs for the patients whose prescriptions generated the rebates. (See my Wall Street Journal op-ed.) The incentives are especially tricky, since large health plans and the largest PBMs now operate within the same large companies.

What’s more, PBMs’ compensation is linked to the undiscounted list price, because admin fees and rebates are computed using those list prices. Products with high list prices and significant rebates generate greater dollar payments for plan sponsors and for PBMs’ services.

In a world without rebates, these incentives vanish. Neither PBMs nor plan sponsors would handle the discounts provided by a brand-name manufacturer. Plans would focus on directly managing drug spending, rather than capturing rebate dollars to offset general plan costs or reduce premiums. The drugs with the visibly lowest net cost and best therapeutic outcome would be placed on formularies.

We would also see formularies in which generic drugs play an even greater role than they do today. Some plans may market plans that have formularies with fewer brand-name drugs.

3) PBMs will force manufacturers of therapeutically comparable products to bid for coverage in formulary auctions.

PBMs encourage manufacturers of therapeutically comparable brand-name drugs to compete for placement on the plan sponsor’s formulary—or even to avoid being cut from the formulary. A PBM recommends preferred status on the formulary for those products that offer the most competitive pricing and rebates along with evidence-based efficacy and safety.

Manufacturers make pricing concessions, in the form of rebates, via negotiations between manufacturers and PBMs. The resulting discounts from list prices are hidden from patients and also from the plan sponsors that provide third-party payment for prescriptions.

I expect that in a world without rebates, PBMs would hold winner-take-all auctions. These tenders (as the auctions would likely be called) would lead to intense competition and result in very steep discounts.

PBMs would manage these auctions by pitting manufacturers against one another. Such highly-rebated categories as insulin products would have net prices comparable to—and perhaps even lower than—net prices than today’s unseen post-rebate costs. However, these low prices would not produce the distorting effects associated with humongous rebates.

Formularies for some therapeutic categories could therefore become slimmer, offering fewer choices in those categories. However, patients and prescribers may not consider these to be arbitrary exclusions based on hidden rebates or unseen fees. We may also see the emergence of net price competition by excluded brands, as I discuss below.

4) Rebate walls will crumble, leading to aggressive indication-based price competition.

Rebate walls are an aspect of today’s formularies that can limit patient choice, slow the adoption of therapeutically superior new drugs, and blunt net price competition.

Here’s a simplified example of how rebate walls work. Consider an established product with significant market share. The manufacturer of this product makes its rebates contingent on preferred or exclusive formulary position for multiple indications (therapeutic uses).

In today’s world, a new drug struggles to get formulary coverage. PBMs often block access to a newly approved product with superior efficacy in only one indication, even if the new product offers a greater per-prescription rebate. That’s because the new product has few prescriptions, so even a larger per-prescription rebate won’t overcome the sheer volume of rebate dollars at risk from the market-leading product. The market leader’s per-prescription rebate provides much more revenue than a bigger rebate per prescription from a drug with few prescriptions. Patients and physicians therefore become frustrated, especially when the patient’s out-of-pocket costs are linked to the list price.

In a world without rebates, this strategy would be much less viable.

The manufacturer of the new drug would have no reason to match the list price of the market-leading product. It would instead launch with a list price below the net price of the market leader. The manufacturer could communicate the new drug’s superior efficacy—and lower price—to patients and prescribers. A patient with a coinsurance or in the deductible phase would insist on getting access to the lower-priced, clinically-superior option. They can therefore make a direct cost/value tradeoff.

The forces of competition will constrain prices, because patients and their physicians will see the true net price of both drugs. What’s more, the market leader would be forced to cut prices to match the new product’s net price.

The market leader would likely attempt to establish a discount wall. However, this wall would be harder to maintain against a drug that attacks narrowly with superior efficacy for a single indication. PBMs and plans would not credibly be able to block the new drug when it clearly and obviously has a lower price.

That’s why formularies for some therapeutic categories could become broader and more inclusive. PBMs will want to encourage indication-based price competition among different products.

5) Biosimilars will be adopted more quickly—and have deeper price cuts.

We expect that patient-administered, pharmacy-dispensed biosimilars will be marketed as brand alternatives rather than as interchangeable generics. Without interchangeability, payers, PBMs, and prescribers would control access and product selection. See Section 12.3. of our 2019 pharmacy/PBM report.

Consequently, rebate-based decisions can dampen price competition and slow the adoption of biosimilars. Here’s how FDA commissioner Scott Gottlieb described this dynamic for biosimilars:
“Competition is, for the most part, anemic. It’s anemic because consolidation across the supply chain has made it more attractive for manufacturers, Pharmacy Benefit Managers, Group Purchasing Organizations and distributors to split monopoly profits through lucrative volume-based rebates on reference biologics—or on bundles of biologics and other products—rather than embrace biosimilar competition and lower prices. “
This is another variation of the rebate wall, described above. The unseen net price of the brand name product could be equal to its biosimilar. But today, PBMs and plans are incentivized to use the innovator product with higher list price.

I believe that in a world without rebates, we would see open, aggressive price competition that would take biosimilar prices down much faster than our current system would.

6) Manufacturers will reduce current list prices. Drug prices will grow slowly.

Today, manufacturers are encouraged to increase list prices and rebates at the same time. This makes their products more attractive to plan sponsors and PBMs.

That’s why a drug with a $100 list price and a $50 rebate becomes a $105 drug with a $54 rebate. The manufacturer’s net price increases slightly, from $50 to $51, while the rebate grows from $50 to $54. It’s the essence of the gross-to-net bubble, which we cover in Section 9.2.2. of our new 2019 pharmacy/PBM report.

This dynamic also explains why drug list prices of therapeutically comparable products often rise in tandem, but net prices remain stable. A drug with a $100 list price and a $50 rebate is less attractive than its peer with a $105 list price and $55 rebate. The drug with the $100 list price therefore matches the list price increase and rebate of its competitor. Neither manufacturer can cut the list price of its product to the net price, because the competitor would gain an insurmountable advantage.

These incentives and rationales vanish in a world without rebates. A brand-name manufacturer would no longer need to increase the list price to maintain formulary position with PBMs or match a competitor’s rebate. Any increase in list price would be based on business conditions and would reflect (1) additional therapeutic value and/or (2) increased operating costs.

Put more simply: the gross-to-net bubble would pop.

Some analyses have expressed a simplistic view of markets that assume manufacturers would realize higher net prices. However, I expect that the competitive dynamics described above would constrain manufacturers from being able to raise prices at historic rates.


Above, I speculate about how the drug channel might evolve if rebates were removed from both commercial and Medicare Part D plans.

The HHS proposed safe harbor rule for rebates applies to Part D plans and Medicaid managed care organizations, but not to commercial plans. Nonetheless, it’s useful to compare the two primary actuarial analyses of the rule’s potential impact.

The Center for Medicare & Medicaid Services’ Office of the Actuary (OACT) put a very high price tag on this proposal, primarily because OACT focused on how manufacturers would adjust their overall pricing and rebate strategies. (Click here for the OACT report.) However, OACT chose not to model any countervailing changes in PBM or plan behavior.

By comparison, an HHS-commissioned report from Milliman modeled alternative scenarios in which stakeholders made strategic behavior changes in response to the AKS changes. Click here for the Milliman report.) These alternative scenarios included increased formulary controls by PBMs, greater price concessions from manufacturers, changes in brand-name drug list prices, and other factors. In contrast to the OACT analysis, Milliman found that program costs would decline in six of its seven alternative scenarios.

SAVE THE DATE: Drug Channels Institute will hold a special live, interactive webinar titled Preparing for a World Without Rebates on April 12, 2019, at 12 PM ET. Details and registration information will be announced in the first week of April.

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