Forecasting Medicare: Price Controls in the Years Ahead

Medicare Part D as a windfall for pharma? Don't believe the hype. While it has generated a nominal increase in prescription volume, the great windfall that was expected for pharma may not occur. But forget for a moment about Part D as a driver of sales. Instead, companies should conceptualize the benefit as serving a much more strategic and longer-term role—to alleviate the pressure for price concessions and controls by creating market-based systems for Medicare.

The introduction of Medicare Advantage Prescription Drug plans (MA-PDs) and Prescription Drug Plans (PDPs) is a significant departure from the traditional government-defined reimbursement model for Medicare. Some point to the high enrollment, consumer satisfaction, and low premiums in 2007 as proof that this experiment is well on its way to success. But, the risk of failure for the current Medicare system remains very real. And although initial data show good uptake, the Medicare Modernization Act of 2003 (MMA) set the stage for two serious complications: rapid and easy conversion to government-controlled pricing and the adoption of government pricing by private payers.

Private Lessons for Government Pricing

The demand for price controls is cyclical. In the early 1990s, the government tried to control drug costs through rebates to state Medicaid plans. Today, members of Congress talk of other tactics to keep costs down: legalizing re-importation, creating European- and Canadian-style pricing bodies, and even the "boogie man" of price control—instituting nominal federal pricing. But so far, it's just that—talk.

So, executives may wonder, what makes today's environment particularly vulnerable to price controls? Part of the answer can be found when one examines who is footing the nation's pharmaceutical bill.

Part D creates two equally powerful groups of purchasers: the government and employers. By January 2010, the US government will pay for 37 percent of all drug expenditures under Medicare and Medicaid, and employer-provided private insurance will pay for another 39 percent, according to various sources. Cash and out-of-pocket expenses will represent the remaining 24 percent of drug purchases.

As the single-largest payer, the federal government has the size and purchasing power to demand the greatest discounts from the industry—think of the Centers for Medicare and Medicaid Services (CMS) as the Wal-Mart of healthcare. Currently, the government is prohibited from negotiating directly with pharma companies for discounts. Although there is pressure to reverse this, for now it seems the debate for CMS price negotiations will be kept at bay for the next two or three years.

However, it's important for the industry to understand that—if price controls come—it would be hard to limit their impact on government programs. Certainly, it has happened before. In the mid-1970s, in an effort to control costs, the government changed from paying hospital list prices to prices based upon Diagnosis Related Groups (DRGs). Following the success of DRGs in reducing costs, the federal government developed price lists for durable medical equipment and complex reimbursement models for physician services, long-term care facilities, and even drugs provided in the physician office that private payers have adopted as standards for their own business. Now negotiations between insurers and physicians begin at the Medicare rate rather than the physician's own price list. Indeed, it is reasonable to believe that the price controls implemented under Medicare could easily be adopted by private health insurance, and expanded to this 39 percent of the market.

Imagine the Future

Picture what Part D will look like in 2010. Costs will have risen, and Congress will be pressured to find a solution. For certain, Congress will demand that CMS provide more pricing information about the drugs covered under Medicare, and compare those prices to a variety of sources, including foreign markets and even other government programs like those offered through the Veteran's Affairs/Department of Defense (VA/DoD). Congress and policy makers will publicly debate this information to decide how to reduce pharmaceutical costs, while employers and consumers will begin asking why they are required to pay so much more than the government for the same drugs. The result will be unpredictable, and it is easy to imagine the worst possible outcome.

Rather than focusing on the worst possible outcome, it is more useful for pharma companies to develop a series of scenarios that describe how the world might look in the future, and then develop plans to compete in each environment. In this case, the potential scenarios range from the best possible outcome—MMA succeeding as planned—to draconian price controls under a single-payer model.

Scenario #1

MMA as Planned

This scenario assumes the successful implementation of Part D as outlined in the Medicare Modernization Act of 2003, and represents the best possible outcome for pharmaceutical manufacturers because price controls and spill-over from government to private payers is virtually non-existent.

This will happen only if:

• There are approximately 15 million Medicare enrollees in MA-PDs, and the remaining enrollees are in PDPs

• The cost of the program remains below $100 billion per year by 2010

• The increases in cost are no greater than three to five percent per year.

There needs to be at least 15 million people enrolled in MA-PDs to achieve the goal of establishing a private-market solution for all Medicare services. This reduces the risk that pharmacy will go the way of hospital and physician reimbursement, and promotes a focus on outcomes and total health management—MA-PDs have incentives to manage the total health of the patient while PDPs do not.

This paradigm represents an open competitive market for pharmaceutical services in which consumers have choice—though it comes with a price tag. The number of plan options and sets of rules surrounding them cause confusion among consumers and Medicare recipients, resulting in a lower level of consumer satisfaction than traditional Part A or Part B Medicare—where there is only one benefit to figure out.

To date, it seems possible to reach the enrollment goals for MA-PDs. However, it's the cost projections that will be more difficult to meet, given that drug prices have exceeded five percent for the past 10 years.

Scenario #2

FEHBP Lite

In this scenario, the federal government alters the Medicare program to more closely match the Federal Employees Health Benefit Program (FEHBP). Under FEHBP, the federal government has established a standard benefit that private insurers are required to copy and bid competitively to provide health insurance for all federal employees. The federal government chooses insurers based upon a variety of factors, including cost, network, and quality. Applied to Medicare, all beneficiaries would have the same benefit, and all or part of the risk would be borne by the private companies. For pharma, the risks would be low because hospital, physician, and pharmaceutical costs all would be managed by the same entity (the insurer), and opportunities would exist to demonstrate the value of pharmaceutical care.

This scenario is likely to occur if:

• The cost increases of Part D are high, but not astronomical (under 10 percent per year)

• There are large numbers (greater than 10 million) of enrollees in MA-PDs, so the political risks of eliminating the programs are too great

• PDPs are not viewed as significantly more cost effective.

Consumers and physicians would be reasonably supportive of this model because they would still have a level of choice. Given that there would be little variation in benefits or coverage, it would also reduce the confusion that's associated with the "MMA as Planned" scenario.

This scenario is only likely to occur if MMA is kept on track as planned, and is dependent upon the continued success of Part D. In all probability, this scenario would occur in combination with one of the following scenarios because some Medicare beneficiaries will not be willing to adopt MA-PDs.

Scenario #3

Standard Discounts

Under this scenario, the federal government requires companies that want their branded products covered under Part D to provide a specified discount—in effect, creating single-payer price controls. This model has long-term risks to pharma because the only option that would be available to CMS to address cost increases is to demand greater discounts. Moreover, it would permanently place pharmacy into a separate budget because it isolates pharmacy as a single cost category, without any linkage to hospital or physician services. Pharmacy would compete with physicians and hospitals for funding.

For this scenario to occur, the following needs to happen:

• A lift on the prohibition against direct price negotiation by CMS

• The current Part D program exceeds 10 percent of cost increases per year

• Employers begin dropping their retirees into Medicare Part D to cut costs.

To sell this benefit to Medicare enrollees, Congress could sweeten the deal by decreasing co-pays and filling the doughnut hole. It also could streamline the program by eliminating PDPs and choosing one to two administrators to manage claims and reimbursements (similar to how Part A and B are administered).

This scenario is more likely than the first two, only because it is an easy political solution to cost increases in Part D. To understand this, think about the year 2009: In this scenario, the political pressure to address the cost of Medicare and other social programs, combined with high federal deficits and dissatisfaction from consumers about the problems with the donut hole and confusing benefits, prompts Congress to act quickly. The political answer to all of these pressures is to attack private insurers and pharmaceutical companies, and propose a new benefit that is funded with deeper discounts from pharmaceutical companies.

Scenarios #4 and #5

Reference Pricing and/or Therapeutic Maximum Pricing

Because their overall threats to the pharmaceutical industry are the same, it's useful to think about Reference Pricing and Therapeutic Maximum Pricing together. Here, the primary risk to the pharmaceutical industry is that the government quickly reduces reimbursements to the generic level, and only the most cutting-edge, innovative treatments have pricing leverage.

Reference pricing, which is already used by several countries—Germany and New Zealand, for example—would operate largely like a Maximum Allowable Cost list. CMS would fix the maximum level of reimbursement for classes of drugs. Retail and mail-service pharmacies would receive only the specified per-unit reimbursement—no matter what they dispensed—and pharmacy margins would be driven by the ability to purchase drug products below the class price.

Therapeutic pricing is the equivalent of DRG reimbursement for hospitals. The goal under this model is to identify the optimal treatment regimen and price for a specific disease. For example, treatment for a "simple patient" with high cholesterol may be $1.00 per day, but more complex cases would have higher reimbursements based upon the drug and other therapies required.

These models attempt to address the issues of quality of care, value of outcomes, and variances in patient need. They are, in theory, better than straight price controls for the industry because they offer a place at the table for addressing issues of optimizing outcomes and total cost of care—price controls do not.

For these scenarios to occur, the following needs to happen:

• Cost increases for Medicare, and Part D in particular, must remain between five and eight percent per year for the next three to five years, taking some pressure off the need to act quickly

• The MA-PD model demonstrates success at measuring population-based health outcomes, but fails to attract more than 10 million lives

• Strong alliances of private and public groups must form to demonstrate how to implement and measure these designs before the cost debate begins.

The probability of these scenarios occurring is very low unless action is taken now to lay a foundation for these complex programs. The greatest barrier to these two scenarios is the complexity of developing and maintaining the evaluation and pricing mechanisms. Either of these models would require a significant amount of time to develop and test. What's more, reference-based pricing and therapeutic maximum models would be far more difficult to describe and explain to consumers than the current choice of MA-PDs and PDPs.

Scenario #6

VA/DoD Model

Members of Congress and special interest groups have suggested that the VA system is the solution to maintaining cost controls because it leverages the government's size to obtain the lowest possible price. In this scenario, the government uses a competitive bidding mechanism to choose the single-lowest-cost product in a category for coverage by Medicare. Non-selected products would be available at significantly higher cost to members (50 percent of retail). This would, in essence, limit consumers and physicians to one or two therapeutic choices in most categories.

Some groups have projected that this model can save Medicare 50 to 75 percent compared with current costs.

For this scenario to occur, the following needs to happen:

• Costs of Part D exceed $100 billion per year by 2009 and inflation trends suggest that it will continue to grow by more than 10 percent per year

• The financial condition of Medicare and the general health of the US economy are so poor that there is no alternative, short of eliminating Medicare completely

• Medicare beneficiaries and physicians in private practice agree to significantly fewer treatment options in exchange for a low-cost program.

The strength of the VA/DoD scenario for the government creates the Achilles heel for the Medicare market. Under the VA/DoD Model, many classes of drugs would be limited to one or two treatment options. Physicians and patients in the VA/DoD system accept these tight restrictions largely because they have military traditions that permit highly restrictive controls. However, Medicare recipients and physicians in private practice who are accustomed to multiple options would not be satisfied. In reality, this is probably the least likely scenario to actually take place—political realities would make it very difficult to implement.

Move Beyond the Pill

The least-risky scenarios for the pharmaceutical industry are MMA as Planned and FEHBP Lite. Unfortunately, those two scenarios could not be maintained unless the industry kept cost increases below five to eight percent per pharmaceutical product.

The Reference Pricing or Therapeutic Maximum models are not the most favorable scenarios, but they do provide the opportunity to explore other options that reduce the risks of more price controls, such as the Standard Discounts and VA/DoD Model scenarios. Moreover, it is in the best interest of pharma, patients, and physicians to avoid these draconian price-control models because quality and treatment options will fall at the altar of cost. The reality is that the price-control models represent the easiest and quickest political solutions to the complex problem of providing important pharmacy services to the nation's senior population.

Here are some other ways companies can better manage the risk for price controls.

Recognize and support the importance of data integration Identify and support organizations that are developing the tools and resources that integrate data from pharmacy and medical claims records. Employers, private plans, and the federal government are all struggling to use the data they have to measure health outcomes and assess medical interventions.

CMS will soon have the largest single database of claims information. The agency will be able to use the knowledge derived from this database to determine how programs like the ones described under the Reference Pricing and Therapeutic Maximum Pricing scenarios are implemented and measured.

Provide incremental discounts to the right plans Over the next two or three years, MA-PDs and PDPs will approach the negotiating table seeking greater discounts from the pharmaceutical industry. But, in determining a health plan's value—and in turn, these discounts—pharma companies must consider factors other than a health plan's size, such as its ability to add value by integrating medical care with prescription drugs. Companies should grant the best discounts to health plans that provide these additional measures, even if they aren't the largest.

Linking discounts to outcomes or patient care and satisfaction may seem like a radical concept, but it's an important and wise strategy. If the pharmaceutical industry finds itself in 2010 with CMS demanding the best price as a starting point for more discounts under the Standard Discount scenario, companies can reframe the discussion from being about size and control to being about outcomes. This will at least broaden the discussion of best price to include other components of value—even if they do not have an immediately demonstrable return.

On the topic of investing in the right plans, companies' short-term focus must be on helping MA-PDs become the dominant players under Part D. The reason for this is that MA-PDs have a greater interest in measuring outcomes, patient satisfaction, and the appropriate use of pharmaceuticals than do PDPs, which will be increasingly focused on cost, as premiums are reduced and price becomes the competitive advantage to attract members.

In addition, with more people in MA-PDs, it is more difficult to implement the approaches described under the Standard Discount and VA/DoD Model scenarios. To implement these two scenarios, the federal government would be forced to reduce or eliminate benefits, which is not easy to do in public programs.

Move beyond the brand issues In any industry, and especially in pharma, it's difficult to integrate long-term planning and short-term sales, particularly with brand management. With limited budgets, current sales initiatives normally take priority over funding a series of pilot programs that support organizations that integrate and measure outcomes. Even more complicated is the debate over accepting a third-tier position with a plan that has not demonstrated interest in measuring outcomes or patient satisfaction, and as a result does not qualify for the best price.

These are difficult decisions that will force pharma to measure the long-term implications of its choices in an uncertain future. However, without the discipline to make these difficult decisions today, the pharmaceutical industry may be reducing its options in the future.

No one can predict the future of Medicare with certainty. But what executives can be certain of is that Medicare will change and evolve. Even if Part D meets the objectives pharmaceutical manufacturers envision, over time it will come under price and access pressure. Current pricing and contracting strategy will determine both the near-term outcome of MMA and the rules by which the industry must play in the future. As a result, there's no better time than now, at the beginning of the Part D program, to start changing those rules.

Rod Cavin is a principal and managing director of Health Strategies Group. He can be reached at rcavin@healthstrategies.com