Budget Options
December 8, 2016

Mandatory Spending Health Option 11

Function 570 - Medicare

Require Manufacturers to Pay a Minimum Rebate on Drugs Covered Under Part D of Medicare for Low-Income Beneficiaries

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

Billions of Dollars 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2017-2021 2017-2026
Change in Mandatory Outlays 0 0 -7 -15 -18 -18 -19 -20 -22 -26 -40 -145

This option would take effect in January 2019.

Medicare Part D is a voluntary, federally subsidized prescription drug benefit program delivered to beneficiaries by private-sector plans. Federal subsidies for Part D drug benefits, net of the premiums paid by enrollees, totaled about $63 billion in calendar year 2013. (Federal subsidies include payments to stand-alone prescription drug plans and Medicare Advantage plans; they exclude subsidies to employers for prescription drug coverage provided outside of Part D for retirees.) Private drug plans can limit their costs for providing benefits to their Part D enrollees by negotiating to receive rebates from manufacturers of brand-name drugs in return for charging enrollees smaller copayments for those drugs. The negotiation of rebate amounts is a business strategy for a Part D plan that is most effective when a few manufacturers’ drugs are competing for market share in the treatment of a particular medical condition. The Congressional Budget Office estimates that in 2013, manufacturers’ rebates paid to Part D plans amounted to about 18 percent of gross spending on all brand-name drugs under Part D.

Before Part D took effect in 2006, dual-eligible beneficiaries—Medicare enrollees who also were eligible for full benefits under Medicaid—received drug coverage through Medicaid. Under federal law, drug manufacturers that participate in Medicaid (which is a joint federal-and-state program) must pay a portion of their revenues to the federal and state governments through rebates. In 2010, those rebates increased from 15.1 percent to 23.1 percent of the average manufacturer price (AMP) for a drug. (The AMP is the amount, on average, that manufacturers receive for sales to retail pharmacies.) If a drug’s price rises faster than overall inflation, the drug manufacturer pays a larger rebate. And those inflation-based rebates can be significant: In 2013, for example, the average statutory rebate under Medicaid, weighted by the dollar amount of drug purchases, was 63 percent of the AMP; about half of that came in the form of inflation-based rebates.

When Medicare Part D was established, dual-eligible beneficiaries were automatically enrolled in its Low-Income Subsidy (LIS) program, which typically covers premiums and most cost sharing required under the basic Part D benefit. LIS enrollees—most of whom are dual-eligible beneficiaries—accounted for about 30 percent of Part D enrollment in 2013, and their drug costs represented about 50 percent of total spending for Part D enrollees’ drugs in that year. Currently, the rebates on drug sales to LIS enrollees and on those sold to other Part D enrollees are set through negotiations between the Part D plans and the drug manufacturers.

Starting in 2019, this option would require manufacturers to pay a rebate to the federal government for brand-name drugs sold to LIS enrollees. As under Medicaid, the rebate would be at least 23.1 percent of the drug’s AMP plus an additional, inflation-based amount if warranted. In many cases, a manufacturer might already have negotiated discounts or rebates that applied to all Part D enrollees equally. In those instances, any difference between the negotiated amount and the amount of the total rebate owed by the manufacturer would be paid to the federal government. If, however, the average Part D rebate for the drug was already more than 23.1 percent of the AMP plus the inflation-based rebate, the federal government would receive no rebate. Participation in the program would be mandatory for manufacturers who wanted their drugs to be covered by Part B (Medical Insurance) and Part D of Medicare, by Medicaid, and by the Veterans Health Administration.

CBO estimates that this option would reduce federal spending by $145 billion through 2026 because, on average, the rebates negotiated for brand-name drugs are smaller than the statutory discounts obtained by Medicaid. However, drug manufacturers would be expected to set higher “launch” prices for new drugs as a way to limit the effect of the new rebate, particularly for new drugs that do not have close substitutes. Over time, that response would reduce the savings to Medicare from this option. Those higher prices also would affect other drug purchasers: Employment-based health insurance plans would probably negotiate larger rebates to offset a portion of the higher prices, but state Medicaid programs would pay more for new drugs, which in turn would increase federal spending.

In addition, this option could change manufacturers’ incentives to offer Part D plans rebates for existing drugs—but the pressures on those rebates would push in both directions, so CBO concluded that the average rebates would not change appreciably. In general, manufacturers offer rebates in exchange for preferred coverage of their drugs in order to increase sales and market share. A key provision of the option is that the amount of a rebate that a manufacturer paid to a Part D plan would count toward the total rebate that manufacturer owed the federal government. On the one hand, that provision would make it less costly for manufacturers to increase their rebates as a way to boost sales to non-LIS enrollees. On the other hand, the higher required rebate for sales of drugs to LIS enrollees would reduce the benefit to manufacturers of increasing those sales. The net effects of the reductions—in both the costs and in the benefits of offering rebates—are unclear and would vary by drug. But the overall effects on rebates for existing drugs would probably be negligible, in CBO’s estimation.

An argument in favor of this option is that the Part D benefit could provide the same amount of drugs to Medicare beneficiaries at a lower total cost, particularly for brand-name drugs with no close substitutes whose prices are less subject to market competition. An argument against the option is that the lower revenues that manufacturers receive for drugs under Part D could cause them to reduce their investments in research and development.

The development of “breakthrough” drugs would be least affected by any decline in investments, CBO expects, because purchasers of those drugs tend to be willing to pay more for them. Manufacturers initially can set a higher price for a breakthrough drug, which can offset a portion of the new rebate without substantially affecting sales. Consequently, Medicare’s savings under this option would be limited for new drugs because of their higher launch prices, and, eventually, the savings on existing brand-name drugs would dissipate as those drugs lost patent protection and were replaced by less expensive generic versions.

There is a precedent for requiring rebates: Before 2006, manufacturers were already paying rebates to Medicaid for drugs purchased by the dual-eligible population (who were then enrolled under Medicaid’s drug benefit). However, the new rules also would apply to drugs purchased by LIS enrollees who were not dual-eligible beneficiaries, and therefore (all else being equal) the total required rebate would be larger than it was when dual-eligible beneficiaries received drug coverage through Medicaid. In addition, because of the 2010 increase in the rebate required for drugs sold under coverage by Medicaid, the reduction in manufacturers’ incentives to invest in research and development would probably be greater under this option than under the earlier system.