Co-Pay Cards and the Stalling of Drug Rebate Growth

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Richard Evans / Scott Hinds

203.901.1631 /.1632

richard@ / hinds@sector-sovereign.com

January 5, 2010

Co-Pay Cards and the Stalling of Drug Rebate Growth

  • For the first time, because of growth in both rebate percentages and brand drug prices, rebates paid for preferred formulary status now appear to roughly equal the spread in non-preferred (e.g. tier 3) and preferred (e.g. tier 2) co-pays
  • Co-pay cards, wherein manufacturers subsidize consumers’ co-pay costs, have become widespread; we find that about half of the 100 top-selling drugs offer co-pay support programs. For manufacturers, these cards are an alternative to paying rebates larger than non-preferred v. preferred co-pay spreads
  • Because higher co-pays are demonstrably linked to under-consumption of necessary medications, formulary managers cannot simply raise co-pays and co-pay spreads as a competitive response to more widespread use of co-pay cards by manufacturers
  • Rapid absolute dollar rebate growth until now has been fueled by both rising drug prices and rising rebate percentages; now that the full economic value of the non-preferred and preferred status is fully rebated, rebate growth is constrained by the (much slower) rate of growth in co-pays and co-pay spreads
  • Coming patent expiries shift brand mix further toward specialty, where formulary managers’ negotiating leverage is lower; as a general rule (with notable exceptions) formulary managers cannot exclude or substitute specialty products nearly as efficiently as traditional / non-specialty products. Thus not only are ‘maximum achievable’ rebates newly constrained by co-pay spreads, formulary managers are less able to capture the full value of co-pays spreads in a market dominated by less substitutable specialty brands
  • These findings are bearish for formulary managers generally, especially PBMs (MHS, ESRX, CVS). Brand drug manufacturers, particularly those that have been paying growing rebates on heavily substitutable US brands, benefit by being able to more fully capture real price increases as rebate growth slows, though we expect this advantage is late in coming, as the pace of US real price growth is very likely to fall as primaries heat up in advance of 2012 general elections

For all the complexities of pharmaceuticals pricing, we believe that brand-drug rebates follow simple and obvious economic rules. In particular, rebates reflect a given product’s degree of substitutability, the ability of the formulary manager to effect product substitution; and, the marginal value to the manufacturer of being either the beneficiary or victim of that product substitution.

Until recently, the manufacturer v. formulary manager game was played in such a manner that only the manufacturer faced the threat of substitution. Going forward, formulary managers too are at least partially exposed to a substitution threat – specifically in the form of co-pay cards provided to patients directly by manufacturers.

For products with moderate to high degrees of substitutability, manufacturers typically pay a basic ‘access’ rebate in order to be included on a given formulary – and co-pay cards do very little to change this. However once on the formulary, these manufacturers face another (heretofore binary) choice, namely whether to offer an additional ‘preferred’ rebate in order to assure that their brand is available to patients at a preferred (lower) co-pay (e.g. tier 2 instead of tier 3).

Co-pay cards as an alternative to large rebates

A third option is emerging, which to our minds reduces the negotiating leverage of formulary managers. Because of both rising retail drug prices and rising rebate percentages, the absolute dollar value of the marginal ‘preferred’ rebate required to move from tier 3 (i.e. non-preferred) to tier 2 (i.e. preferred) may now be as large or larger than the difference in tier 3 v. tier 2 out-of-pocket (OOP) cost to consumers. Consider for example a drug priced at $150 / Rx (ex-manufacturer), a formulary having tier 3 co-pays of $50 and tier 2 co-pays of $30, and a 15% marginal rebate required to move the drug from ‘on-formulary’ tier 3 to ‘preferred’ tier 2 status. The cost to the manufacturer of a 15% preferred rebate on the $150 ex-manufacturer price is $22.50, but the difference in tier 3 and tier 2 co-pays to the consumer is only $20. Assuming for the moment that co-pay cards can reach 100% of the plan’s beneficiaries with zero incremental transaction cost, the manufacturer would be $2.50 better off by giving consumers a $20 co-pay card (and staying on tier 3) than by agreeing to the 15% ($22.50) marginal preferred rebate which moves the drug to tier 2. Again assuming perfect information and zero friction, the consumer is indifferent between paying the tier 2 co-pay ($30), or paying the tier 3 co-pay net of the co-pay card (also $30, i.e. the $50 tier 3 co-pay – the $20 co-pay card received direct from the manufacturer). Only the formulary manager loses; its ability to extract rebates from manufacturers is impaired, making this service less valuable to the plan sponsor[1].

Obviously the assumptions of perfect information and zero friction can’t hold, but because of the widespread acceptance and low marginal costs of electronic forms of payment, co-pay cards nevertheless represent a reasonably (and increasingly) efficient alternative. Thus yet another straightforward economic rule applies to drug rebates: The marginal (‘preferred’) rebate paid by a manufacturer to gain preferred status (e.g. to move from tier 3 to tier 2), cannot be significantly larger than the difference in non-preferred (e.g. tier 3) and preferred (e.g. tier 2) OOP costs to the consumer.

How rising drug prices are making co-pay cards more feasible

As drug prices rise (as a result of drug price inflation near-term, and more importantly as the result of mix shifts to specialty drugs mid- to longer-term), an ever larger proportion of ‘rebatable’ brands are becoming subject to this constraint. Average prices (ex-manufacturer) for brand drugs sold at retail hit $143.06 in 2009 (Exhibit 1); higher prices obviously increase the absolute dollar value of a given percentage rebate. And, average drug rebate percentages (averaged across all brands) have been rising as well – particularly recently – so that the average rebate paid by brands sold at retail is roughly 14.3%, or $18.39 (Exhibit 2).

It’s critical to recognize that average brand rebate figures aren’t terribly informative – relatively few brands pay any substantial rebate at all, and those brands that do pay any meaningful rebate pay the great majority of total rebates paid[2]. We know this from various combinations of Congressional Budget Office (CBO) and Federal Trade Commission (FTC) data. CBO has on several occasions published data on rebates received by Medicaid, which provide some read-thru as to the status of commercial rebates (Exhibit 3).

 

Recall that Medicaid collects either a flat rebate (which has grown from 15.1% to 23.1% with the passage of the Patient Protection and Affordable Care Act), or the deepest rebate provided to any commercial customer; whichever rebate applies is termed the ‘basic rebate’. We know the national average Medicaid basic rebates (weighted by sales to Medicaid, which roughly reflect commercial sales) for ’03, ’05, and ’07; and, for ’03 we know the percentage of drugs (again Medicaid sales weighted) that paid either the flat rebate or a higher commercial rebate. This allows us to solve for the average rebate paid by brands that offered commercial rebates larger than the Medicaid flat rebate. We know that in ’03, 36% of brand drugs paid commercial rebates above the Medicaid minimum, which allows us to calculate that the average rebate offered by a ‘heavily rebated’ brand in that year was 27.6%. Knowing how the basic rebate collected changed in ’05 and ’07, and assuming the percent of brand sales that were heavily rebated remained constant as compared to ’03, we estimate that heavily rebated brands paid average rebates of 28.7% and 37.3% in ’05 and ’07, respectively.

Extrapolating beyond the limits of the CBO observations, we estimate average commercial rebates for ‘heavily rebated’ brands of roughly 40% in ’09, or at average prices, roughly $51 per prescription (Exhibit 4). This figure is larger than average tier 3 rebates (Exhibit 5), and is certainly much larger than average tier 3 – tier 2 spreads (Exhibit 6). Bear in mind that the $51 commercial rebate has two ‘parts’: an ‘access’ rebate for formulary access, and an additional ‘preferred’ rebate for preferred formulary position. Again invoking the premise that rebates follow simple economic rules,

we would expect the size of each portion of the commercial rebate to reflect the value of what that rebate ‘buys’; i.e., the access rebate should reflect the value of formulary access, and the preferred rebate should reflect the incremental value of preferred status. A number of authors have measured share changes in competitive (and thus presumably highly rebated) retail drug categories as a function of changes in formulary status[3], and we rely on these analyses when we divide average commercial rebates roughly 55/45 into access and preferred components. Obviously the relative values of formulary access and preferred status vary according to multiple variables, including in particular whether the formulary manager can offer a credible threat of excluding the drug from a formulary altogether (e.g. a brand that is available as a generic), and whether the drug is at least reasonably substitutable with a highly similar drug (e.g. one branded statin for another), particularly if the substitution can reliably be made well after the patient has begun treatment with a different brand. So we recognize that our 55/45 estimate is subject to considerable variation, though the findings that access and preferred components of commercial rebates appear to be nearly equal in size makes intuitive sense – drugs that face a high risk of exclusion (which drives the size of the access rebate) face such risks in large part because they can be substituted with other drugs (which drives the size of the preferred rebate).

Of the two commercial rebate ‘components’, the ‘preferred rebate’ (roughly 45% of the total rebate) concerns us most. The reason is that co-pay cards are effectively useless as substitutes for the ‘access’ rebate – if the drug isn’t covered, the manufacturer can in theory provide enough subsidy to reduce the consumer’s OOP cost for the non-covered drug to a level equal to the co-pay they face for purchasing the alternative, but this is roughly equivalent to giving the drug away for free. Not so the preferred rebate – once the access rebate has been paid, if the additional ‘preferred’ rebate is greater than the difference in the applicable co-pays (e.g. tier 3 – tier 2), then as we’ve already argued, the manufacturer has a reasonable substitute — namely providing consumers with co-pay cards in order to reduce their net OOP costs to the same level as the tier 2 co-pay.

Thus the relevant comparison is the average dollar gap between tier 3 and tier 2 co-pays, vs. 45 percent of the average rebate paid by ‘highly rebatable’ brands – specifically the former minus the latter (Exhibit 7). As drug prices and average rebate percentages have grown (Exhibits 1 & 4, again), and as the tier 3 – tier 2 co-pay gap (Exhibit 6, again) has remained comparatively stable, we’ve reached a point wherein the average ‘highly rebatable’ brand is better off giving out co-pay cards than providing the additional rebates necessary to achieve preferred formulary status. We’ll be the first to admit that there may be no such thing as an ‘average highly rebatable brand’ – it may be that only a few drugs are in this circumstance, or that many are – rather, we’re simply trying to show that as long as drug prices rise faster than co-pay spreads, formulary managers will have an increasingly difficult time coaxing preferred rebates out of manufacturers.

A quick snapshot of the co-pay card status quo

We looked at the top 109 drugs in terms of 2009 U.S. sales and found active co-pay cards / multi-use coupons for approximately half (at least 54) of them [4]. Note that we believe this is a conservative estimate of the proliferation of the cards, as the list includes (1) some off-patent brands; and (2) some aging brands that had loyalty discount programs in place, but which have expired. Specialist drugs were slightly more likely (57 percent) to have an active co-pay card program than primary care drugs (43 percent). These programs vary considerably in generosity (e.g., $10-15 / Rx for Lipitor v. $4,000 annual assistance for Rituxan), and almost all are available to any individual with private insurance and out-of-pocket prescription expenses[5]. With very few exceptions, the pharmacy can process the card at checkout (exactly like secondary insurance or a credit card) without any need for the patient to submit receipts for reimbursement or file additional paperwork.

Where things go from here – if drug prices grow faster than co-pay spreads, co-pay cards are increasingly preferred (by manufacturers) over rebates

We believe that branded drug prices will grow faster than co-pay spreads: average brand price growth will be fueled by a continued mix-shift toward higher-priced specialty products; and, co-pay spreads will (continue to be) held back by the preferences of plan sponsors.

The trend to higher branded drug average price is straightforward; specialty products are far more expensive than traditional / primary care products (Exhibit 8), and traditional / pc products are falling out of mix fairly rapidly as a result of patent losses. Thus rebate percentages almost certainly will fall. Recall our rule that brand drug ‘preferred’ rebates should not exceed the difference between preferred and non-preferred co-pays – tier 2: tier 3 spreads are a much smaller percentage of specialty prices than of traditional / non-specialty prices (Exhibit 9). Very simply, this means it would be (to our minds) unreasonable to expect formulary managers to earn traditional rebate percentages on specialty drugs; rather, the rebate percentages paid should fall so that the absolute rebate paid bears some close relation (presumably close to but not greater than) to the relevant co-pays and co-pay spreads.

Absent any other considerations, formulary managers’ competitive response to the rising use of co-pay cards would logically be to make co-pays larger, establishing a cycle in which manufacturers have to give ever larger co-pay subsidies. Critical to our arguments regarding the impact of co-pay cards is our belief that formulary managers simply cannot do this, i.e. that formulary managers’ ability to increase co-pays and co-pay spreads is far more constrained than manufacturers’ abilities to raise prices and/or distribute co-pay cards. Specifically, we believe that formulary managers are limited by the fact that increasing consumers’ out-of-pocket cost sharing – particularly on high-cost specialty drugs – demonstrably reduces medically necessary drug consumption; and, that as a result, plan sponsors will constrain growth in co-pays and co-pay spreads.

A growing body of empirical literature supports this conclusion, showing that as out-of-pocket costs per Rx rise, particularly toward triple-digits, compliance falls (Exhibit 10). Most recently, a CVS study showed a spike in prescription abandonment[6] at co-pays as low as $40 – 50. Starner et al found that patients with out-of-pocket expenses of $100 – 200 were 33 percent more likely to abandon an oral oncology prescription at the pharmacy counter than those with expenses less than $100 (and there is a 6-fold abandonment rate above $500). Gleason et al find largely similar dynamics in the TNF market, and an abandonment rate increase of nearly 5-fold for MS prescriptions with a co-pay over $200 (relative to co-pays less than $100).

The additional matter of formulary managers’ (presumably reduced) negotiating leverage over specialty products, as compared to traditional / non-specialty

Summarizing briefly: we’ve argued that because of rising drug prices and rising percentage rebates (which rise faster than co-pays and co-pay spreads), that brand drug rebates have grown to be equal or nearly equal to the applicable co-pays or co-pay spreads; and, that going forward brand drug rebates should grow much more slowly, in that they are now constrained by co-pays / co-pay spreads, which themselves grow more slowly than drug prices and drug rebate percentages have in the past. On net, this suggests at best a leveling-off in rebate growth. Up to this point we’ve made no provision for changes in formulary managers’ negotiating leverage over brands, which we believe is actually falling as a result of the mix shift from traditional / non-specialty products to specialty products. Accordingly, we frame the spread between preferred and non-preferred co-pays as the maximum available rebate, but would argue that formulary managers’ ability to win all of this ‘available rebate’ is impaired by the simple fact that specialty brands tend to be less excludable / substitutable than traditional, non-specialty brands.

In broad terms, the threat of exclusion or substitution is far more real to the Lipitor brand manager than to, for example, the Avastin brand manager. Excluding Lipitor from formulary, or putting another statin in a more preferred status than Lipitor, is plainly a credible threat. In contrast, excluding Avastin from formulary is not a credible threat. Similarly, the threat to allow or dis-allow use of Avastin in some patients but not others, or to move Avastin higher or lower in a step protocol, is at best very weakly credible as a function of Avastin’s pricing, though plainly Avastin’s formulary status can and does change as a result of the underlying clinical evidence. We recognize that there are important exceptions to the rule (e.g. growth hormones), but in general we believe that formulary access and preference in specialty care is more determined by clinical than economic considerations; and, that formulary managers have less negotiating leverage over specialty products (as compared to traditional products) as a result. It follows that as mix shifts to specialty, that formulary managers will likely capture less of the maximum available rebate.

  1. In this stylized example the plan sponsor is nearly indifferent, because the ($20) higher tier 3 co-pay almost equals the ($22.50) marginal rebate the plan sponsor would have largely retained if the manufacturer had opted to pay the higher rebate and position the drug on tier 2.
  2. In 2003, roughly 71 percent of total commercial rebates were paid by just 25 products. (FTC, August 2005)
  3. See particularly: Huskamp et al, “The Impact of a Three-Tier Formulary on Demand Response for Prescription Drugs;” Journal of Economics & Management Strategy, Volume 14, Number 3, Fall 2005, 729–753
  4. We did not count single-use coupons.
  5. Government insured patients and Massachusetts residents are not eligible. Some Roche / Genentech cards require annual household income <$100,000
  6. Abandonment occurs when a patient fails to take possession of a medication despite evidence of a written prescription generated by a prescriber. It could mean, for example, a patient who never goes to the pharmacy to pick up a called-in prescription, or a patient who walks away upon learning their out-of-pocket cost.
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