President’s Budget Proposal Points to More Pressure on Innovators

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Richard Evans / Scott Hinds

203.901.1631 /.1632

richard@ / hinds@sector-sovereign.com

twitter.jpg @SecSovHealth

October 6, 2011

President’s Budget Proposal Points to More Pressure on Innovators

  • The bipartisan ‘debt super-committee’ must find by November 23, and the whole Congress must pass by December 23, aggregate 2013-2021 deficit savings of $1.2T or else automatic cuts will kick-in to generate at least the savings level required by the Budget Control Act passed in August. The threat of automatic cuts (which contain political pain for both parties) makes it more likely than not that the committee will succeed to some degree, suggesting they will tend to focus on areas of easy agreement
  • In healthcare, automatic cuts to Medicare (up to $139B) would probably be in the form of across the board provider cuts. Relative to provider cuts, new rebates / discounts applied to innovators (pharma, biotech, devices) who sell to Medicare are politically ‘safe’. New rebates on drugs sold under Medicare Part D remain the biggest threats to innovators – and in fact all of healthcare – from deficit reduction efforts
  • The president’s proposed deficit reduction strategy – to the extent it guides the Democratic side of the super committee – is consistent with this view. Of his $320B in proposed savings from healthcare, 43 percent are from innovators, including $135B in new rebates on drugs sold under Part D
  • Since passage of the BCA, share prices reflect far more pressure on Facilities than any other subsector – we believe more than is warranted since any agreement reached by the super committee limits the automatic Medicare cuts. Large-Cap Pharmaceuticals and Biotech have outperformed during the same period, not reflecting the increased pressure likely to fall on innovators

The congressional ‘super committee’ created by the Budget Control Act (“BCA”) this summer and tasked with cutting the cumulative 2013-2021 deficit by $1.2T by November 23[1] met for the third time on September 22. Ahead of this meeting, President Obama released his own $3.6T Deficit Reduction plan – of which, $320B (less than 9 percent) comes from healthcare savings

Recall that if Congress fails to find and pass $1.2T in cuts by December 23, automatic spending cuts (up to $139B from Medicare, we believe in the form of across-the-board cuts in provider payment rates) would kick in to guarantee at least the required level of deficit reduction. We have argued (see: http://www.sector-sovereign.com/?p=4548 and http://www.sector-sovereign.com/?p=5199 ) that odds are better than even that the super committee produces at least some of their mandated reductions. Even partial success would likely be most negative for innovators, whereas outright failure (which we view as unlikely) would be negative for hospitals / providers

Practically, the ideological rift between the White House and congressional Republicans likely leaves the president’s aggregate proposal as written dead on arrival (Moody’s called the chances of passage “extremely low”). While we have not seen a comparable position paper from Boehner or McConnell since passage of the BCA, the rhetoric from the right describing the Obama proposal as “class warfare” certainly does not suggest that they are ready to reach across the aisle. However putting aside the package taken in aggregate, we actually believe that the bulk of proposed healthcare savings are relatively non-controversial / politically palatable (save for an expansion of the IPAB; more on that later), reflect the varying exposure of the different players (innovators, providers, beneficiaries) that we have long anticipated, and could very well serve as a blueprint for the super committee to extract savings from healthcare

The President’s Proposals

The burden of the proposed White House cost savings falls on four broad spending categories, with the first two disproportionately affected (Exhibit 1,2):

  1. Innovators: As we have argued was likely for some time, the package proposed by the president disproportionately targets Rx pharmaceuticals for the largest share of healthcare savings. Requiring pharmaceutical manufacturers to extend the same rebate for Medicare Low-Income Subsidy beneficiaries as is currently paid to Medicaid on Part D drugs, generates an estimated $135B in savings over 10 years – 42 percent of the total. Further, Obama suggests prohibiting “pay-for-delay” deals between generic and brand manufacturers
  2. Providers: Skilled nursing facilities, Long-term care hospitals, inpatient rehab facilities and home health providers bear the brunt of provider cuts ($42B) proposed. These savings are achieved through a combination of across-the-board rate cuts, compliance requirements and targeted rate cuts for underperforming facilities. An additional $19B comes from cuts to the favorable rates received by disproportionate share hospitals and teaching hospitals (through the IME add-on payments); and reductions to the number of rural facilities receiving special payments (currently one-third of all hospitals). Finally, the White House suggests that reducing Medicare’s coverage of beneficiaries’ bad debts (i.e., failure to pay deductibles, co-pays, etc.) from 70 percent to 25 percent (in line with private insurers) will save another $20B
  3. Fraud / Waste / Abuse / Loopholes: Programs that pledge to reduce Medicare and Medicaid fraud, waste and abuse – those perpetual panaceas for all spending ills – generate $6B of the projected savings. However, an additional $45B comes from closing Medicaid loopholes and cutting spending that almost exclusively goes to state funds. The proposal would limit Medicaid provider taxes (i.e., taxes imposed on providers by states, which are offset by payment increases back to the providers in the amount of the tax – but which are eligible for Federal matching dollars); creating a single match rate for all Medicaid / CHIP beneficiaries per state; and cutting the Prevention and Public Health Fund, which provides grants $3.5B (~20 percent). We’ve written about the dire circumstances across almost all state budgets and the impact of Medicaid spending in the past (see: http://www.sector-sovereign.com/?p=3564 ); the President’s plan could exacerbate those issues
  4. Beneficiaries: Medicare beneficiaries would pay an additional $24B in the form of Part B deductible increases and premium surcharges; increased home health cost sharing; and Part B and Part D premium increases for high income beneficiaries. Further, adjusting the MAGI calculation for HIE premium tax credits / cost sharing to include Social Security income (in effect, reducing exchange subsidies for low income enrollees) would yield $15B

Both for the sheer magnitude of the impact and for the political safety we believe that some form of the de novo rebates on Part B / D drugs proposed by the president are likely to pass. By themselves, they generate more than more than 11 percent of the committee’s mandated $1.2T in cuts

We have also argued that the committee has the power to wield a scalpel in terms of provider cuts – particularly compared to the chainsaw of the automatic cuts – and that this approach is preferable to the proverbial chainsaw of the automatic cuts (the effects of which would likely be far broader, and far more severe for constituents that no one is interested in alienating). The White House’s proposal is perfectly consistent with this view, singling out providers that are generally less favorably viewed than traditional hospitals or clinical physicians (i.e. SNFs, LTCHs, IRFs, home health) for the vast majority of payment rate reductions

We believe that the market continues to misprice the impact of the BCA on health subsectors – in particular, overestimating the likelihood that automatic cuts kick-in. Since the president’s proposal was published, facilities have dramatically underperformed the rest of healthcare and – in particular – pharma / biotech. Curiously, device innovators – whom we have contended could face similar de novo rebate / discount risks as drug innovators but were completely spared by the White House proposal – have also underperformed drug innovators (. To the extent that these share price reactions reflect skepticism that the White House proposal in toto is a viable piece of legislation (or even guiding document) we obviously have no objection. However, the sustained underperformance of facilities relative to drug innovators (really since BCA passage in early August; but more to the point since the Obama proposal last week) suggests to us that the markets are missing an important implication of the president’s proposal. Specifically, if one accepts that the super committee will succeed to at least some degree (we concede a big “if”, but one we believe more likely true than not), then some package of proposals with bipartisan support must be crafted. The bulk of the healthcare savings proposed by Obama are relatively painless in the sense that they don’t seem to target either party’s key interests or constituents disproportionately. Further, agreement on even a subset of the proposals could give both sides with an opportunity to demonstrate their willingness to reach across the aisle without actually compromising on a key priority

…And Then There’s the IPAB

To our minds the most (only?) surprising aspect of the Obama proposal was his desire to strengthen the Independent Payment Advisory Board (IPAB) – one of the most controversial pieces of the Affordable Care Act. For a detailed analysis of the IPAB, please see: http://www.sector-sovereign.com/?p=1406 . The short story is that the IPAB is tasked with constraining annual per-beneficiary Medicare cost growth within a range of CPI, and later GDP. As written in the ACA, that growth rate is the trailing 5-yr GDP growth plus 1 percent. As part of the his deficit reduction proposal, the president proposed ‘doubling down’ on the IPAB and setting their target growth rate at just GDP plus 0.5 percent

In the note referenced above, we showed that the IPAB as originally constructed would require Medicare cuts of $27-50B over the 2015-2019 period, which amounted to 3 to 5 percent of total spending; but more meaningfully 11 to 19 percent of what we termed “fair-game” non-clinician spending[2]. Re-running the same analysis, but with the new stricter target growth rate in 2018-2019 (the target in earlier years is benchmarked to inflation; as this is unmentioned in the White House plan we assume no change) increases the required cuts to $37-58B – somewhere on the order of 25 percent higher. This is 4 to 6 percent of total spending and 15 to 23 percent of “fair-game” non-clinician spending

To be clear, we believe such an expansion of the IPAB has very little chance of passing. With House Republicans in the majority and united in their opposition to the board, and even some House Democrats (at least 11) crossing the aisle to cosponsor legislation to eliminate the IPAB altogether, there is no clear route to passage [

  1. Legislation must be presented to Congress by November 23; Congress must (without modification) vote on the committee’s legislation by December 23.
  2. By statute, the IPAB may only seek cuts from certain Medicare categories. Further, even if they could cut physician reimbursement rates, Congress’ willingness to routinely increase the physician rate makes us skeptical that it would ever be politically feasible to allow doctor rates to decline meaningfully. Hence, we exclude both those costs that are (legally) not “fair-game” and (practically) not “fair-game” (i.e., clinicians). For interested in the legislative details, we again encourage you to read http://www.sector-sovereign.com/?p=1406

Richard Evans / Scott Hinds

203.901.1631 /.1632

richard@ / hinds@sector-sovereign.com

@SecSovHealth

 

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