The US Congress and Prescription Drug Pricing

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Richard Evans / Scott Hinds / Ryan Baum

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richard@ / hinds@ / baum@ssrllc.com

@SSRHealth

September 30, 2015

The US Congress and Prescription Drug Pricing

  • Average prices grow when: 1) new products bring higher prices than the old products they displace; and/or 2) existing products increase their prices over time
  • Price inflation on existing products follows either of two patterns: 2a) list price gains within a reasonable range of the (+/- 10 percent) nominal market pace; or 2b) list price gains that are dramatically beyond the market pace
  • ‘Type 1’ pricing (new product premia) for innovative products is on safe ground in the US for the foreseeable future. There is no current mechanism to deny US patients access to (or influence prices of) technical advances that improve well-being; and none is likely to soon emerge. At the very worst, the subset of innovations approved under the Orphan Drug Act (ODA) might soon face pricing limits
  • ‘Type 2a’ pricing (market-rate list-price inflation of existing products) also is relatively safe; however the issue here is not the rate of list price gains, but the fact that companies are struggling to translate these into net pricing gains, especially in categories where therapeutic alternatives are available. Federal policy is irrelevant here
  • The immediate controversy is ‘type 2b’ gains, i.e. list price inflation on existing products at rates dramatically in excess of the broader market. VRX, HZNP, and CXRX have taken these types of highly visible pricing actions on multiple products, and several others have taken ‘type 2’ actions on at least one product (most notably Questcor on Acthar Gel, now owned by MNK; and Turing Pharmaceuticals on Daraprim). Like it or not, these extreme pricing actions are likely to continue, if the companies have the nerve to face the resulting public pressure. We suspect they do
  • Congress hopes to hear testimony from VRX and Turing next week – classic use of Congressional ‘soft’ power. In the past, when traditional large cap companies dominated US pricing gains, fear of the political spotlight commonly resulted in pricing slowdowns. Soft power worked
  • Now, it’s not so clear. If the companies taking ‘type 2b’ actions are willing to face public scrutiny – and how can they not be if they took such highly visible actions in the first place – then all they should really fear is the prospect of Congress enacting pricing limits that affect them directly
  • Trouble is, Congress has few ‘hard power’ options that would impact the companies behind these ‘type 2a’ actions. Congress cannot reasonably expect to enact sweeping price reforms, particularly those that might affect pricing outside the limits of government programs. At best, Congress might alter policy in Medicare and/or Medicaid; and/or might place limits on pricing freedoms for drugs approved under the Orphan Drug Act (ODA). We see few other ‘hard power’ pricing options within Congress’ political / parliamentary reach
  • Neither of Congress’ hard policy options really matter to the companies taking the ‘type 2b’ extreme pricing actions. If Congress were to extend Medicaid rebates to low-income Medicare beneficiaries covered under Part-D, this could drive average Part D rebates from 29.5 percent to 50.5 percent, equal to a roughly 5 percent net pricing loss for the typical retail product. This would mainly impact companies with significant branded retail sales, particularly the traditional large caps – but not those behind the present controversy
  • And/or, Congress might place constraints on pricing of drugs approved under the ODA. However even though we tend to think of the drugs that have taken very large pricing actions and ‘orphan drugs’ as similar groups of products, the companies with the largest numbers of recent ODA approvals (e.g. NVS, ABBV, Roche, AMGN, CELG) aren’t the companies taking the extreme pricing actions
  • On net, the only companies likely to lose pricing freedoms if Congress reacts to recent pricing headlines are companies with significant brand sales to Medicare Part D (basically the traditional large caps), and/or companies with significant numbers of ODA approvals (see Appendix 2 for a complete list)

 

Where we’re BULLISH: Biopharma companies with undervalued pipelines (e.g. AMGN, BMY, CELG, GILD, SNY, VRTX); Biopharma companies with pending major product approvals (e.g. ABBV, ACAD, ADMA, ALIOF, AZN, BDSI, BIIB, BMY, CHMA, CLVS, CPRX, ENDP, GNMSF, ICPT, JAZZ, LLY, LPCN, MACK, MRK, NVS, PTCT, RLYP, RPRX, SHPG, SRPT, TEVA, UCBJY, ZSPH); SNY on undervalued basal insulin franchise and sales potential for Praluent (alirocumab), in addition to its undervalued pipeline; RAD as an acquisition target as WBA and CVS seek to defend against narrowing retail networks; CFN, BCR, CNMD and TFX on rising hospital patient volumes; XRAY and PDCO on rising dental patient volumes and rising average dollar values of dental products and services consumed per visit; CNC, MOH and WCG on bullish prospects for Medicaid HMOs; and, DVA and FMS for the likely gross margin effects of generic forms of Epogen

Where we’re BEARISH: PBMs facing loss of generic dispensing margin as the AWP pricing benchmark is replaced (e.g. ESRX); Drug Retail as dispensing margins are pressured by narrowing retail networks and replacement of AWP (e.g. WBA, CVS); Research Tools & Services companies as growth expectations and valuations are too high in an environment of falling biopharma R&D spend (e.g. CRL, Q, ICLR); and, suppliers of capital equipment to hospitals on the likelihood hospitals over-invested in capital equipment before the roll-out of the Affordable Care Act (e.g. ISRG, EKTAY, HAE)

Congress’[1] pending subpoena of VRX to a hearing next week – alongside Turing Pharmaceuticals – has, along with Secretary Clinton’s release of a drug pricing plan, triggered a rerating of biopharma shares

Setting aside the fact that investors may have been looking for excuses to sell in light of relatively high valuations, our aim in this brief is to consider whether Congressional action is likely, and what forms it might take

It’s that time again …

Simply by shifting attention to the issue, Congress’ (and various administrations, and presidential candidates) have caused US drug pricing slowdowns in the past. In fact since the election of Bill Clinton in 1992, in part on a health reform agenda, with the exception of the 2008 real drug pricing gains have been relatively weak in the general election run-ups (Exhibit 1)

Despite drug pricing’s ability to capture voters’ attention, all modern legislation restricting drug pricing freedoms and/or imposing mandatory rebates has been a quid pro quo – pricing concessions being made in exchange for policies that gave industry offsetting benefits[2]. With the potential exception of price limits for Epogen in end stage renal disease, Congress has never enacted zero-sum restrictions on drug pricing

So at the very minimum, as we head into a general election cycle with accelerating list[3] pricing gains and headline grabbing examples of extreme pricing gains, it’s a safe bet the industry’s pricing practices will once again be in the political spotlight. The questions are: 1) whether simply being in the spotlight (soft power) causes companies who’ve taken large pricing gains to decelerate the gains; and/or 2) whether Congress enacts any de facto restrictions on drug pricing (hard power)

Soft power – will a public shaming really matter this time?

I held US drug pricing responsibilities for a large cap company at various points from 1991 to 1998, and operated according to three simple rules: 1) I wanted my sales-weighted pricing gains to be better than the peer average; 2) I didn’t want my sales weighted pricing gains to be among the 3 largest gains in the peer group; and 3) I didn’t want my boss subpoenaed by Congress

During that period, for a (very) traditionally minded large cap company, being subpoenaed by Congress was something to be avoided at (almost) any cost. The times have changed, and the players have changed even more

Questcor inflated Acthar Gel from $50 to $28,000 a vial in 2012, and just last week Turing inflated Daraprim from $13.50 to $750 per pill. These are very extreme pricing actions that are well in excess of other very large gains; however because the products and companies are relatively small these most extreme pricing actions have very little impact on overall sales-weighted gains for the industry

Looking more broadly, a quick partial review of very large (>50 percent year-on-year) list pricing increases over the past 5 years shows that at least 20 manufacturers have taken big pricing actions on at least one product – with VRX, HZNP, and CXRX being by far the most aggressive (Exhibit 2). And, we can identify at least 12 specialty pharmaceutical companies whose aggregate real list pricing gains over the past 3 years have exceeded 10 percent (Exhibit 3, red columns). In most cases these list pricing gains are as large as or larger than these same companies’ total US organic net sales gains (Exhibit 3, blue columns)

In somewhat rough terms, this gives us a working list of specialty pharmaceutical companies that almost certainly need to keep prices moving rapidly in order to keep revenues growing at trailing rates. In all honesty it’s anyone’s guess whether the companies will slow their rates of US price growth. It’s very clear that these companies are far less concerned about being forced into public spotlight – or compelled to testify before Congress – than the companies (traditional large caps) that dominated the price trend going into every other general election. Our guess is that the pricing gains will continue

Hard power – what’s the worst that could happen?

Other than the change in the nature of companies driving pricing gains, the main reason we expect pricing actions to continue is the reality that Congress has few hard options for restricting US drug prices in a manner that would directly target the main offenders

Ignoring policies intended to deal with economy-wide hyperinflation in the 70’s and 80’s, sustained, systematic, generalized restriction of pricing freedoms is unprecedented. All of which means Congress almost certainly cannot (yet) develop a consensus behind market-wide restrictions on drug pricing

If we narrow the focus a notch to government programs, specifically Medicare and Medicaid, then we believe there is at least some risk Congress would use public dissatisfaction over drug pricing to push through relatively well-developed, ‘off-the-shelf’ policy options, but we doubt Congress would have the bandwidth to develop new policy options from scratch. We believe that within Medicare and Medicaid, the most fully-formed policy option is the extension of Medicaid rebates to low-income Medicare Part D beneficiaries. This would have the effect of increasing the average effective rebate on Part D brand sales from 29.5 percent to about 50.5 percent (See Appendix 1). Part D covers around ¼ of US retail prescriptions, so we estimate the weighted effect of this policy on US retail sales would be substantial: a net price reduction of roughly 5 percent (0.25 * (50.5 percent – 29.5 percent))

If we narrow the focus a bit further, we believe the next most likely arena for enactment of drug pricing limits is the Orphan Drug Act of 1983 (ODA). The Act provides companies with 7 years of exclusivity from the date approval and generous tax credits (half of development costs), and has been credited with expanding drug development for relatively rare and/or underserved conditions. Prices for orphan-designated drugs have in many cases been extremely high, which has caused consternation in Congress among both Republicans and Democrats. In the plus column, conditioning benefits of the Act on (some definition of) responsible pricing behavior is an easier political and parliamentary lift than extending Medicaid rebates to low-income Medicare Part D beneficiaries; and, such pricing restrictions would fall a bit closer to the ideological target (very large pricing gains taken on relatively obscure products) than the added Part D rebates. See Appendix 2 for a list of ODA approvals made within the last five years, by company, product, and Orphan indication. On the negative side, while ODA pricing restrictions might be closer to the ideological target than greater Part D rebates, they still wouldn’t cause much damage to the companies whose pricing actions have captured Congress’ interest. Appendix 2 shows that the list of companies benefiting from recent ODA approvals (e.g. NVS, ABBV, Roche, AMGN, CELG, etc.) is very different from the list of specialty drug companies who have taken extreme pricing actions on individual products. Also on the negative side, price-restricting the ODA would benefit a much narrower swath of voters than Part D revisions, and would have a much smaller immediate effect on market wide average pricing
Conclusions

Soft power isn’t what it used to be. Today’s drivers of large pricing gains are more likely to continue rapid pricing than the prior generation, for two reasons: 1) they’ve shown they’re willing to accept public scrutiny as a consequence of large pricing actions; and 2) Congress has few if any ‘hard’ options for price controls that would target these companies directly

That’s not to say Congress has no hard options, only that the effect of passing those options either creates a very large effect (net pricing loss of around 5 percent on average) across a very broad swath of companies (all companies with significant Part D sales – which is very nearly all companies); or, creates a much smaller effect on companies who have tenuous ideological commonalities with the offenders, but who in most cases will still not be the actual offenders themselves

Appendix 1

Current Status of, and Likely Changes to Drug Pricing under Medicare Part D

Manufacturers currently pay two forms of rebate on Part D sales. Rebates are paid to the private entities that organize and operate Part D prescription drug plans (PDP’s) on Medicare’s behalf; these rebates follow no set formula and are negotiated between the manufacturers and the PDPs, rather than being set by any agreement between the manufacturers and Medicare. Manufacturers also pay a growing ‘donut hole’ rebate designed to reduce beneficiaries’ exposure to out-of-pocket costs in the Part D coverage gap that exists between (for 2014) $2850 and $4550 levels of annual spending for a given beneficiary. Specifically, manufacturers pay an additional 50 percent rebate off of the negotiated price for drugs consumed by beneficiaries in the donut hole. About 25 percent of Part D spending falls into the donut hole (Exhibit 4), thus this provision creates an effective average additional rebate of roughly 12.5 percent. In 2010, the average negotiated rebate was approximately 17 percent (on par with the best available commercial pricing)[4]; this plus the roughly 12.5 percent additional ‘donut hole’ rebate equals an estimated average Part D rebate of 29.5 percent

There are active efforts to increase the average Part D rebate. Specifically, the proposal is that drug spending for Low-Income Subsidy (LIS) Medicare beneficiaries (once again) become subject to Medicaid drug pricing policies, which on average yield much larger rebates (56 percent) than Medicare (17 percent). We believe this ultimately will occur; budget pressures are an obvious driving force, and the politics are eased somewhat by the fact that many current Medicare LIS beneficiaries were shifted out of the more highly rebated Medicaid drug coverage when Medicare Part D was enacted in 2005 – i.e. all that’s being proposed is to put these beneficiaries back where they originally were. The potential effect is significant. About 55 percent of Part D spending is for LIS beneficiaries, thus shifting the associated pricing policies for these beneficiaries back to the Medicaid standard would be expected to reduce average (all beneficiaries) Part D pricing by roughly 21 percent (65 percent × (56 percent – 17 percent)), sharply increasing the average Part D rebate to 50.5 percent (29.5 percent current average + 21 percent effect of shifting LIS to Medicaid pricing)


©2015, SSR, LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. Through a wholly-owned subsidiary, SSR Health provides paid advisory services to Pfizer Inc (PFE) on both securities-related and non-securities-related topics.

  1. Specifically the House Committee on Oversight and Government Reform
  2. Medicaid rebates were tied to generous Medicaid drug coverage policies; Medicare Part D rebates were tied to: 1) creation of the Part-D program and 2) funding of the Affordable Care Act (ACA); ACA fees (sales related, and thus arguably price concessions in effect) were pay-fors for an expansion of coverage under the ACA
  3. Despite accelerating list pricing gains, net pricing gains have weakened. See “Why US Brand Rx Pricing Has Stalled, and Who’s At Risk”, SSR Health LLC, September 8, 2015
  4. “Costs under Medicare’s Prescription Drug Benefit and a Comparison with the Cost of Drugs under Medicaid Fee-for-Service”, Anna Cook, CBO, June 24, 2013
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