This week, PhRMA, the country’s leading biopharmaceutical research industry group made a bold statement about bringing down the cost of medicines. In a comment letter sent to the Department of Health and Human Services, the group outlined eight discrete areas they detail as a proposal to fundamentally change the way that patients’ access medicine.

Among these were a few specific areas that I want to focus on because I believe that, if executed as described, they would transform the drug price and experience for patients in every category.

PhRMA on rebates: Delink supply chain payment from list price, empower payers, and ensure patients benefit from rebates

Perhaps the most impactful recommendation by PhRMA is the first listed in the letter. Group President Stephen Ubl announced their position that pharmacy benefit managers (PBMs) and other middlemen in the supply chain should no longer be paid based on the list price of medicine.

The world of payment rebates is complex and opaque. In this context, rebates are payments that manufacturers make to pharmacy benefits managers to ensure that their product is on the formulary. Specific details on rebates are closely held and agreements can be different for each plan, drug, and market.

PBM rebates are made on a percent of price basis – meaning that the pharmacy benefits managers get a certain percent of the list price for each sale of a drug to a member of a plan they represent. In exchange, the biopharmaceutical company maintains access to the lives covered by the PBMs and the many insurance plans that they represent.

One of the ways that this manifests is that a PBM is incented for a higher drug price, because they maintain a percent of that sale (a 2% rebate on a sale of a $10 Rx results in a 20 cent revenue for the PBM, where a 2% rebate on the sale of a $500 Rx results in a $10 revenue).

The growth of large dollar rebates is one of the reasons that drug prices have risen so much over the past decade. Data from IQVIA and Credit Suisse reports that manufacturer’s average rebates as a percentage of gross US sales were 37% in 2015, and will climb to nearly 47% in 2019. That means that for an average $50 list price prescription fill, about $23.50 goes to the pharmacy benefits manager. In addition, the lack of transparency in the rebate system (and as a result, the lack of congressional governance of the system), has frustrated healthcare institutions of all kinds.

PhRMA’s very direct stance that payments should be decoupled from price represents an extreme departure from industry norms – and a move that could prove deflationary to drug costs.

Yet, instituting this change would require extreme coordination (perhaps an as yet unseen level of coordination) among America’s biopharmaceutical manufacturers.

Execution requires the navigation of a bit of prisoner’s dilemma – if one company refutes percentage-based rebates and the PBM takes that company off formulary in an indication with multiple available products (about 78% of drugs, per our research), their competitor stands to benefit if they maintain the status quo with the PBM.

There are also several questions that remain unanswered, especially around the PBM industry’s response to this disruption to their business model. Evolving from administrative outsourcing companies decades ago, the industry has consolidated to control formulary coverage for most private American health insurance plans. The National Community of Pharmacists Association (NCPA) concurs, arguing that pharmacy benefits managers raise series questions about prices, where three companies control approximately 80 percent of the market.

Empower Payers: Payers should have greater visibility into PBM compensation agreements

In the common scenario, insurance companies do not have visibility into PBM compensation arrangements with manufacturers, and as a result, neither organization is able to act in the best overall cost interest of the patient. The PBM may favor some therapies at a lower cost (for their benefit), but those therapies may or may not be more costly to insurers, and the system overall.

The way that insurance companies have grabbed back this lost leverage to PBM companies is by buying them or creating them internally. UnitedHealth created OtptumRx to manage its pharmacy benefits. Aetna received a PBM from the Humana acquisition. CVS purchased Aetna and will likely merge that PBM with their Caremark PBM.

A strong denouncement of the lack of visibility into these agreements by one of the signing parties (manufacturers) could spell the end of an era for PBMs. Transparency driven into any dark market creates an extreme amount of change – and opportunity for disruption. There is no doubt that PBMs have been a recent focus in the joint venture by Amazon, JPMorgan, and Berkshire Hathaway as the group looks to remove wasted middle management from the healthcare value chain.

Another notable factor in this announcement is the degree to which one industry group is supporting an industry group – in two industries historically at odds with one another. In essence, insurance and manufacturers have some of the same priorities (better patient care) and opposite financial incentives.

To see the manufacturer’s industry group supporting the empowerment of insurance demonstrates the resolve of the group to create greater healthcare efficiencies that bring down the cost for all patients.

Make sure patients benefit from rebates

Historically, rebates and other price concession have flowed directly into the P&L of the pharmacy benefits manager and stopped there. The patient has received no direct benefit (albeit an indirect benefit in the case of the funds being used by PBMs to help control for drug prices). Some argue that the rebates system is too complex, deeply rooted, and fundamental to the functioning of the healthcare system to remove it entirely. The industry can do better – and can start by instituting rebate agreements with direct patient benefit. The agreements like this have started to emerge in the last two years.

The manufacturer is one negotiating player at the table that ultimately decides the price of a product – but their resolution to ensure that the patient benefits from rebate agreements are one of the most direct affirmations of patient-centricity I have seen in the years we have been studying it.

Change regulation to better accommodate value-based contracts

Perhaps no commercial innovation has the potential of being more impactful for drug prices and individual patients than the concept of value-based care. As discussed in several of my previous blog posts, value-based care is essentially the notion that patients (and payers) should pay for medicines that work, and pay less or nothing for those that don’t.

The PhRMA companies are in a leadership position as the manufacturers of some of the most complex drugs, in some cases with few alternatives. The first commercialized value-based agreements are already starting to make major cost impact, and the PhRMA comment letter noted that 19 biopharmaceuticals have announced agreements over the last decade. We concur and expect that number to rise significantly as more companies view value-based pricing as a competitive imperative, not just a means to be patient-centric or justify the price.

The real world experience the industry has gained in value-based contracting has also demonstrated some of the major challenges that the model has to face to be successful and sustainable in the future. Among the largest of these is the intersection of value-based care and the CMS best price rule.

Value-based care prices are set according to specific clinical quality measures, or the measurement of how much better a patient gets. Because results can fluctuate, the price can fluctuate significantly as well. The idea underpinning value-based care is that something that doesn’t work shouldn’t cost full price.

At the same time, the Medicare best price rule is a national regulation that requires manufacturers to always offer a better price to patients covered under government insurance. Under this policy, a drug manufacturer must offer state Medicaid programs the best price given to any other purchaser. But how do you ensure that you are giving the government the best price when you will also offer an extreme discount to patients where the therapy doesn’t work?

Therein lies the rub – to adapt to this new commercial innovation, biopharmaceutical companies need the government to update the regulation and find a way to accommodate both price controls on the pay-per-drug model and the value-based model. The FDA recently issued two guidance documents helping to address some regulatory barriers to value-based contracts, but questions in the industry remain.

The Bottom Line

This release by PhRMA represents a bold stance and a stake in the sand describing their perspective on ways to reduce healthcare spending. To achieve their goals, the manufacturers will need to demonstrate significant levels of coordination among their industry, cooperation with other related industries, and determination to stay the course. Boldness to act is the first step toward implementing these models and improving patient care throughout the country.