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 $52 billion in 2010. (Those subsidies include payments to stand-alone prescription drug plans and prescription drug plans associated with Medicare Advantage plans, but they exclude subsidies provided to employers for prescription drug coverage provided by their retiree health plans.) One way that those drug plans limit the cost of the Part D benefit 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 most likely to be effective for "single-source" drugs that are not available in generic form but face competition from other brand- name drugs to treat the same medical condition. The Congressional Budget Office estimates that in 2008, rebates under Part D averaged about 14 percent of gross spending on all brand-name drugs and a slightly higher percentage of spending on single-source brand-name drugs.
Prior to the establishment of Part D in 2006, Medicare beneficiaries who were also eligible for full benefits under Medicaid--known as "dual eligibles"--received drug coverage through Medicaid. Drug manufacturers are required to pay a significant rebate on their sales to Medicaid enrollees. In 2010, the minimum rebate in the Medicaid program was increased from 15.1 percent to 23.1 percent of the average manufacturer price (AMP)-- that is, the price that manufacturers receive for sales to retail pharmacies; additional rebates are required if a drug's price rises faster than general inflation. When Part D was established, dual eligibles were enrolled automatically in a low-income-subsidy (LIS) program, which typically covers the premiums and most of the cost sharing required under the basic Part D benefit. Overall, LIS beneficiaries account for about 40 percent of Part D enrollees and about 56 percent of Part D spending; most, but not all, LIS recipients are dual eligibles. Currently, the prices and rebates for drugs used by LIS enrollees are established in the same way as those for other Part D enrollees--that is, through negotiations between 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 LIS program, starting in 2013. The program would reflect the current rebate system for Medicaid: Manufacturers would be responsible for a total rebate of at least 23.1 percent of the AMP, plus an additional rebate for price increases that exceeded the rate of inflation since the drug's introduction.1 The difference between that amount and the amount of discounts and rebates that manufacturers already provide to Part D drug plans (as defined below) would be paid to the federal government. If the average Part D rebate for a given drug already exceeded the sum of 23.1 percent of the AMP plus the inflation-based rebate, however, no rebate would be paid to the federal government for that drug.
Manufacturers would be required to participate in the new Part D rebate program in order for their drugs to be covered by Parts B and D of Medicare, by Medicaid, and by the Veterans Health Administration. To reduce the amount of rebates owed to the federal government, rebates provided to Part D plans would have to apply to all drug purchases by all Part D enrollees. Therefore, if manufacturers set different rebate levels for different subgroups of beneficiaries, only the lowest rebate provided would be subtracted when determining the amount owed to the federal government on purchases by LIS beneficiaries. In particular, under this option, the 50 percent discount on brand-name drugs that manufacturers now have to provide for certain drug purchases would not reduce the rebate owed to the federal government on purchases by LIS beneficiaries because that 50 percent discount applies only to a subgroup of drug purchases (those made by beneficiaries who are not enrolled in the LIS program for drugs purchased within a specified range of spending).
Under this option, manufacturers would continue to have an incentive to provide rebates to drug plans in exchange for preferred coverage of brand-name drugs, but that incentive would be smaller than under current law because the federal rebate would make the additional sales that would result from preferred coverage less profitable. The rebates obtained by drug plans for purchases by Part D enrollees would therefore be reduced, CBO expects. Moreover, drug makers would be expected to set higher "launch" prices for new drugs to limit the impact of the new rebate, particularly for new drugs that do not have close substitutes. Higher launch prices in response to a minimum rebate requirement in Part D would have varying effects on other drug purchasers. Employment- based health insurance plans would probably negotiate for larger rebates to offset the higher launch prices, but state Medicaid programs would pay a higher price for new drugs. Even after accounting for such offsets, CBO estimates that this option will generate savings to the federal government--about $38 billion over the 2012-2016 period and about $112 billion over the 2012-2021 period.
The main advantage of this option is that Medicare would pay less for drugs used by LIS beneficiaries in Part D. Advocates of this option might argue that manufacturers previously paid a rebate to Medicaid for drugs purchased by the dual-eligible population (who constitute the majority of LIS beneficiaries) before those beneficiaries were reassigned to the Part D benefit, so there is a recent precedent for requiring such rebates for that population.
A disadvantage of the option is that the net reduction in the prices paid for drugs under Part D might reduce the amount of funds that manufacturers invest in research and development of new products. Relative to current law, the option would not significantly reduce the incentive to develop "breakthrough" drugs because those drugs could be launched at prices that were high enough to largely offset the rebate. However, the new rebate would apply to LIS beneficiaries who are not dual eligibles, so the magnitude of the total required rebates would be larger than when dual eligibles received their drug coverage from Medicaid; consequently, the adverse impact on manufacturers' incentives would probably be larger than it was prior to the creation of Part D.