Require Manufacturers to Pay a Minimum Rebate on Drugs Covered Under Part D of Medicare for Low-Income Beneficiaries

Medicare’s voluntary outpatient drug benefit, known as Part D, is delivered by private drug plans; federal subsidies for that coverage, net of the premiums that enrollees pay, totaled about $58 billion in calendar year 2012. (Those subsidies include payments to stand-alone prescription drug plans as well as to prescription drug plans associated with Medicare Advantage plans, but they exclude subsidies paid to employers for prescription drug coverage provided by their health plans for retirees.) One way that private drug plans limit the cost of providing Part D benefits is by negotiating rebates from the manufacturers of brand-name drugs in return for favorable coverage of those drugs, such as lower copayments for preferred drugs. That strategy is generally most effective for drugs that face competition from other drugs to treat the same medical condition. The Congressional Budget Office estimates that in 2011, manufacturers’ rebates amounted to about 15 percent of gross spending on all brand-name drugs in Part D.

Before the establishment of Part D in 2006, Medicare beneficiaries who were also eligible for full benefits from Medicaid—known as “dual-eligible beneficiaries”—received drug coverage through Medicaid. That program requires drug manufacturers to pay state and federal governments a significant rebate on their sales to Medicaid enrollees. The rebate amount, which is set in statute, was raised in 2010 from 15.1 percent to 23.1 percent of the price that manufacturers receive for sales to retail pharmacies (known as the average manufacturer price, or AMP). Additional rebates are required if a drug’s price rises faster than overall inflation. (Those inflation-based rebates can be significant; in 2011, for example, the average statutory rebate under Medicaid, weighted by the dollar amount of drug purchases, was 58 percent of the AMP, with about half of that amount coming from the inflation-based rebate.)

When Part D of Medicare was established, dual-eligible beneficiaries were enrolled automatically in a low-income-subsidy (LIS) program in Part D, which typically covers the premiums and most of the cost sharing required under the basic Part D benefit. LIS enrollees—most of whom are dual-eligible beneficiaries—account for about 35 percent of Part D enrollees and about 55 percent of Part D spending. Currently, the rebates for drugs used by LIS enrollees are established in the same way as those for drugs used by other Part D enrollees: through negotiations between private Part D plans and drug makers.

This option would require manufacturers of brand-name drugs to pay the federal government a rebate on drugs purchased by enrollees in the Part D LIS program, starting in 2015. As with the current rebate system for Medicaid, manufacturers would have to pay a total rebate of at least 23.1 percent of a drug’s average manufacturer price, plus an additional rebate for price increases that exceeded the rate of inflation since the drug’s introduction. If a drug manufacturer already provides discounts or rebates to Part D plans that apply equally to all Part D enrollees, any difference between those discounts or rebates and the total rebate amount that the manufacturer would owe under this option would be paid to the federal government. If, however, the average Part D rebate for a drug already exceeded 23.1 percent of the AMP plus the inflation-based rebate, no rebate would be paid to the federal government for that drug. Manufacturers would be required to participate in this rebate program in order to have their drugs covered by Parts B and D of Medicare, by Medicaid, and by the Veterans Health Administration.

The rebates in this option would change the incentive for manufacturers to offer rebates to drug plans in exchange for preferred coverage of brand-name drugs and thus could change the average amount of rebates paid to drug plans. However, the impact on those rebates would be small because those rebates would count toward the total rebate amount owed to the federal government. Drug makers would also be expected to set higher “launch” prices for new drugs to limit the impact of the new rebate, particularly for new drugs that did not have close substitutes. Those higher launch prices would have varying effects on other drug purchasers: Employment-based health insurance plans would probably negotiate for larger rebates to offset some of the increase in launch prices, but state Medicaid programs would pay a higher price for new drugs, which in turn would raise federal spending for Medicaid. Even after accounting for such offsets, CBO estimates that this option would produce substantial savings for the federal government—a total of $123 billion through 2023.

The main advantage of this option is that Medicare would pay less for drugs used by beneficiaries of the Part D LIS program. A disadvantage is that the net reduction in the prices paid for drugs under Part D might lead manufacturers to reduce the amount of funds they invest in researching and developing new products. The development of “breakthrough” drugs would be least affected, however, because those drugs could be launched at prices that would offset much of the new rebate.

Because manufacturers paid rebates to Medicaid for drugs purchased by the dual-eligible population before 2006, when those beneficiaries were still enrolled in Medicaid’s drug benefit, there is a recent precedent for requiring such rebates for that population. However, the new rebate would also apply to LIS enrollees who were not dual-eligible beneficiaries, so the total required rebate would be larger than when dual-eligible beneficiaries received their drug coverage through Medicaid (all else being equal). In addition, because the size of Medicaid’s statutory rebate was increased in 2010, the adverse impact on manufacturers’ incentives would probably be larger under this option than it was under the Medicaid rebate that applied to dual-eligible beneficiaries before the creation of Part D.