Clearing Up Confusion about the Medicaid Rebate Program: Part I

As federal efforts to address prescription drug costs intensify, this three-part blog series addresses misleading claims or confusion about Medicaid, its highly effective drug rebate program and overall drug pricing issues in the hopes of better informing the debate moving forward.

Part II | Part III

In response to federal Medicaid rebate increases, drug manufacturers would not be able to simply raise prices to avoid greater rebate liability and to shift costs to other payers.  In a recent paper, I outlined several federal policy options to strengthen the Medicaid Drug Rebate Program to help state Medicaid programs better address rising prescription drug costs.  This includes increasing the Medicaid rebates to deter excessive launch prices and annual price increases and eliminating the cap on total rebate amounts.

Opponents of Medicaid rebate increases, as well as critics of the Medicaid Drug Rebate Program more generally, may misleadingly argue that drug manufacturers would respond by merely raising prices for their drugs in order to offset higher Medicaid rebates and shift costs to Medicare Part D, private insurance and other payers.  For example, a conservative think tank blames recent overall drug price increases, at least in part, on the Affordable Care Act’s Medicaid rebate improvements.  As I have previously written, such a claim displays a fundamental misunderstanding of the causal relationship between drug spending and Medicaid rebates.  

Because Medicaid rebates are based on drug pricing and utilization, if drug prices and/or utilization rise overall, Medicaid rebate amounts correspondingly increase in response to offset a portion of the resulting increase in state Medicaid costs, with the ACA’s improvements helping state Medicaid programs better absorb those higher drug costs.  Furthermore, a simple examination of drug pricing trends shows no causal relationship between when the Affordable Care Act’s Medicaid rebate improvements took effect and overall drug pricing and spending trends. For example, the rebate improvements took full effect during calendar year 2010. Yet this coincided with several years of very modest prescription drug spending growth, with major contributors being the loss of patent exclusivity for major brand-name drugs, fewer innovative new brand-name products entering the market and reduced utilization in the aftermath of the recession.  The fifth year of the Affordable Care Act’s Medicaid rebate improvements — 2014 — coincided with a rapid increase in overall prescription drug spending but, as is well understood, the key factors driving this growth in overall spending were a significant increase in the number of new innovative brand-name drugs like those treating Hepatitis C drugs, fewer costly brand-name drugs going off-patent, and the rapidly rising share of drug spending attributable to specialty drugs. While prescription drug spending growth has since moderated, some of these trends have continued, particularly the growth in specialty drugs.  

Moreover, in evaluating the impact of the ACA’s Medicaid rebate provisions in 2010, the Congressional Budget Office expected little or no effect on pricing for existing drugs and only modestly higher launch prices for new breakthrough drugs.  It stated:

“Manufacturers’ ability to raise prices on drugs that are already on the market is constrained, however, by the additional rebate required for drugs whose prices grow faster than inflation.  Moreover, competition from drugs already on the market will probably limit the extent to which manufacturers charge higher prices for certain drugs, particularly those that are different formulations or strengths of products already on the market.  In addition, states’ continuing efforts to negotiate supplemental rebates in return for preferred treatment will tend to limit manufacturers’ ability to reduce such rebates.”

While CBO estimated that the average price paid by retail pharmacies for new drugs covered by Medicaid would rise by 4 percent relative to prior law, CBO noted that any price increases “would not fully offset the increase in the rebate, so that Medicaid would pay a lower price for drugs, on average.”  CBO also assumed that people in employer-sponsored insurance would not be affected because it “expected that net prices would probably not increase because those plans would be able to negotiate larger rebates that roughly offset the higher prices….”

Critics of the ACA’s Medicaid rebate improvements seem to ignore the CBO estimate from 2010 and may instead cite a far older CBO analysis and a National Bureau of Economic Research (NBER) working paper, both from 1996, as justifying their cost-shifting claims.  Both found that manufacturers raised drug prices for certain drugs in response to the Medicaid Drug Rebate Program, particularly its best price requirement.  It is important to recognize, however, that these research papers from more than two decades ago were conducted soon after the drug rebate program was first implemented and when the drug pricing landscape was far different.  

Prior to the drug rebate program, Medicaid was effectively paying full list price for drugs so manufacturers would have seen a sharp reduction in their Medicaid revenues, relative to prior law (as compared to any incremental rebate increase on top of the already large rebate amounts that manufacturers currently pay in Medicaid).  At the same time, use of pharmacy benefit managers by insurers and self-insured employers — as well as other management strategies such as formularies, preferred drug lists and tiered co-payments —was far more limited in the 1990s than today, making it far more difficult to negotiate for rebates to offset any higher drug prices manufacturers charged in response to establishment of the drug rebate program.  Private insurance plans and Medicare Part D plans would be able to resist efforts by manufacturers to raise prices substantially today by seeking additional rebates. In addition, manufacturers are now facing intense scrutiny from policymakers and the public also views curbing prescription drug costs as a top health priority. That political environment would make it exceedingly difficult for drug manufacturers to respond to Medicaid rebate increases by simply raising prices significantly in order to avoid paying greater Medicaid rebates or to shift all or most costs to other programs and payers.  As a result, the applicability of that research to today’s drug pricing debate is likely quite limited.

Edwin Park
Edwin Park is a Research Professor at the Georgetown University McCourt School of Public Policy.

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