We predicted last year that prescription drug rebates’ days could be numbered as more healthcare stakeholders clamor for price transparency. Judging by the new rule proposed by Health and Human Services Secretary Alex Azar and Inspector General Daniel Levinson, this has now come to pass. The proposal aims to wipe out the behind-the-scenes negotiation tool—which has been linked to a growing discrepancy between a drug’s list and net prices—and instead share the savings directly with Medicare patients. 

If the rule is adopted, this latest move by the Trump Administration to lower drug prices would exclude the drug rebates that manufacturers pay to pharmacy benefit managers, Part D plans and Medicaid MCOs from safe-harbor protection under the Anti-Kickback Statute. It also aims to institute a fixed-fee arrangement in which the PBM administration fee becomes a flat fee per prescription, effectively delinking it from the list price. In place of the current system, the HHS has outlined a plan to make rebates a pass-through to consumers and provide some much-needed relief with point-of-sale discounts.

But it’s not that simple: The changes in the proposed rule won’t hand down savings to all patients, some savings will be minimal and member premiums could rise in certain cases. Patients with chronic conditions potentially could save the most on their prescriptions, but rebates often aren’t in play in those scenarios (particularly when a patient is prescribed a drug with no approved competitor), which means that nothing would change. Surprisingly, the HHS is aware of, and has acknowledged, some of the limitations on the patient front. It’s not even a sure thing for federal spending: Rebate elimination could cut federal spending by $100 billion, or it could swing the other way and increase it by $140 billion. It all depends on how healthcare stakeholders respond to the proposed changes.

“Skyrocketing drug prices” are arguably the No. 1 debate among healthcare pundits today, but the Drug Channels Institute’s Adam Fein questions whether they’re really rising. As he says, the system isn’t paying much more over time, but the patient is. The drivers behind this trend, including the PBM process and its linkage to list prices and the gross-to-net bubble, are precisely what Azar is attacking in his proposal. The pharma industry is cautiously supporting the proposed rule, but there may be unintended consequences: It’s unclear what will happen to prices even if the patient gets some out-of-pocket relief.

Price transparency by way of rebate elimination will give consumers more insight into real costs, and force pharma companies to think differently about how they market to providers, payers and patients. And a big focus will be on communicating the value of their products, justifying prices by demonstrating the products’ efficacy and outcomes.

Why All the Fuss About Rebates?

In the current pharma cost structure, manufacturers offer rebates (or negotiated discounts off the list price) to payers and pharmacy benefit managers to secure top spots on formularies. Tapping into his expertise in brand access strategy and payer organization and operations, my colleague Howard Deutsch explains it like so: “Regular price increases are a feature of the pharma industry model because the middlemen demand it. Wholesalers make money by buying up in advance of a price increase and selling at the higher price, and PBMs make money on a price increase by collecting bigger administrative fees and rebates through their price-protected contracts.”

Even before the latest from the HHS, the practice of offering rebates had been called into question. First, the Trump administration proposed a plan to eliminate a safe-harbor provision that has traditionally served as a rebate workaround, the Pharmaceutical Research and Manufacturers of America announced its support of plans that delink supply chain payments from list prices, and Pfizer chief executive Ian Read went public with his belief (contrary to Cigna’s assertion that commercial rebates aren’t going anywhere) that drug rebates are on their way out. Since that comment, a few pharma CEOs have voiced their support for phasing out the rebate system.

With this new rule, we’d see a partial elimination of rebates, where only the rebates that fall under the federal government’s jurisdiction (Medicare Part D and Medicaid) would disappear. Strictly speaking, when the Office of Inspector General created the safe harbor for rebates, it was meant to apply to government-funded patients only. Now that we’re getting closer to this reality, it renews the hope that the commercial business also will shake free of rebates—upending a long-standing model centered on private-sector negotiations.

What If We Dismantle the Whole Rebate System?

Instituting a rebate-free world in both the private and public sectors could have both short- and long-term consequences, and some could be market-altering. Here are a few potential scenarios:

• There could be good news for patients with high-deductible plans or no insurance. In the near term, we’d expect that the high-price/high-rebate model would no longer be preferred over a low-price/no-rebate model—and that could help the uninsured and those with high-deductible plans who have been exposed to full list/retail prices. Co-pays that are indexed to a percentage of the list price would also come down initially.

Broadly, pharma’s high gross-to-net prices bring costs down for non-patients, while driving higher costs for patients. When you’re in the deductible, the out-of-pocket cost is based on the list price, so you’re paying more per prescription even as the net price realized by pharma has gone down. Net prices for many drug categories have declined in recent years, meaning that either patients are paying less (as will be more often the case with point-of-sale rebates), or plan members have lower premiums.

As we put more of the healthcare onus on the patient, we also need to encourage price comparisons across therapy areas and services when possible. Up to 40% of healthcare is “shoppable,” yet very few patients are shopping, even when they’re paying for care out of pocket.

Part of the problem, according to Howard, is that many people talk about things like “costs” or “patients” as if they were monolithic, when they’re not. The diversity of therapy costs and how those costs hit patients’ wallets adds to the complexity of the drug pricing discussion.

• The rebate hangover advantage would disappear. In the current rebate model, incumbent therapies can leverage their rebate volumes to maintain a preferred access advantage over new treatments, even if those new treatments are clinically superior. By removing rebates from the negotiation table, new drugs would be on a more level playing field with incumbents, Howard says.

My colleague Bill Coyle believes that playing up the anti-competitive angle might help the government meet its price reform goals. As he explains it: “Rebates create a really high hurdle for new (maybe better?) brands to overcome. Are we keeping better options from patients because of our rebate-driven system? I suspect that we are, to some extent.”

The current “rebate wall” keeps some new drugs from competing directly with drugs that already have favorable market position, unless the manufacturers drastically reduce prices—which many aren’t willing to do. And even if they did, it likely would make little difference. If the wall comes down, manufacturers have the chance to make a case for coverage based entirely on the value-for-money their products offer, rather than living in today’s rebate-distorted environment.

• Leverage the product’s features and value, not its price. Bill’s expertise in pharma sales, marketing, and market access and pricing has led him to question what happens once we get through the resettling of prices: What mechanisms other than generics entry would cause prices to drop?
• New entrants, according to Bill, could drop their prices below the incumbents by a decent amount and either, (a) force them to match or, (b) capture some share via payers, physicians and patients who see the product’s overall value proposition as superior. “In this way, entrants can use price better than they are today because incumbents wouldn’t have installed rebate leverage to keep the new entrant out,” he says.
• According to Bill, a more dominant strategy in general might be to simply price a therapy in line with the therapy area’s benchmark. Without a lot of haggling over rebates to be done, payers likely wouldn’t favor one brand vs. another except for true clinical reasons. So, if I’m new, my product is like the others and I price like the others, it comes down to promotion and winning with doctors and patients. 
• The transition would be very interesting. Going to a common, public net price would disadvantage the big payers with deeper than average rebates, so it may happen in stages: Publish an average gross-to-net price first, and then establish a common fund to handle the zero-sum shift of rebate dollars from bigger payers to smaller payers. It might be easier to work a grandfather clause with a sunset date into current contracts, but that avenue is sure to cause some pain.
• PBMs and payers will feel the effects. This will drive the final nail into the PBM model’s coffin and reduce payer leverage. What good is being large and controlling if you can’t turn it into a competitive advantage? On top of that, a common net price is almost certainly worse for the larger payers (and for the government, which is the largest payer), so they would incur additional cost and may demand an Obamacare-style cost-shifting subsidy remedy from the government where plans that pay less now pay into a fund that makes the others whole. Expect a huge pushback from that side.
• For a PBM, no rebate revenue and no gross-linked administrative fees will mean a low attractiveness: They may turn into a pure utility. However, PBMs have signaled that they’ll survive the transition and they’re preparing for a world without rebates. One way is to apply their knowledge of, and the same approach to, infused drug contracts. How will PBMs’ price negotiation prowess be used now that the Justice Department has approved both Cigna’s acquisition of Express Scripts and CVS Health’s purchase of Aetna? Another tack for PBMs to take, according to Howard, is to become data and analytics hubs to bring value to their customers, rather than to powerful group purchasers.
• As far as the fate of PBMs is concerned, pharma should be careful what it wishes for, according to Howard. “Once you’ve killed off your non-government negotiating counterparts, what happens when folks don’t like your pricing behavior?” he says. “The PBMs can reconfigure into a utility model, but pharma can’t.” What will pharma’s strategy in this new reality be to stave off government-enforced price controls? Will the industry agree voluntarily to certain pricing practices?

While price remains a primary lever, purchase decision makers in most industries today are just as concerned with a product’s overall value. Take the food industry: Consumers now look beyond the price tag to consider the origin of their food, the quality of the ingredients, and the nutritional benefits. And their demands are being heard: Manufacturers have adjusted their promotional practices (and often the portfolios, themselves), focusing more on demonstrating the value that their products offer—value to consumers’ wallets and to their health and well-being.

Doing away with the opaque system of discounts between payers and drugmakers could be the incentive that pharma companies need to evolve their own promotional practices, moving the conversation away from price and focusing, instead, on value and outcomes.