Clearing Up Confusion about the Medicaid Rebate Program: Part II

As federal efforts to address prescription drug costs intensifies, 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 I | Part III

Aggressive negotiation and closed formularies are only one factor in the VA’s success in lowering its prescription drug costs. While the Medicaid Drug Rebate Program ensures that Medicaid receives among the largest discounts of any payer, the Department of Veterans Affairs (VA) likely obtains somewhat larger rebates and lower net prices.  But VA’s effectiveness in lowering its drug costs is typically attributed to its aggressive use of a closed formulary as part of its negotiations with drug manufacturers. For example, VA’s success is often cited to support efforts to allow Medicare to negotiate directly with manufacturers in Medicare Part D.  But I would argue that this is an overly simplistic view, especially for the purposes of the debate over Medicaid.

Today, except for a very limited set of drug classes, state Medicaid programs cannot outright deny coverage of drugs produced by manufacturers participating in the rebate program.  The Trump Administration, however, has called for eliminating this protection and allowing states to impose closed formularies.   Even though the Administration claims its proposal would allow states to extract larger discounts from manufacturers, it is virtually certain that this approach would result in higher federal and state Medicaid drug costs unless states use the closed formulary to unduly restrict access to needed prescription drugs.  In addition, some states and some outside analysts have called for allowing limited use of closed formularies with the rebate program remaining in place.  That, however, still raises serious concerns about beneficiary access.  

Discussions over allowing closed formularies in Medicaid often bring up the benefit of having the power to “say no” as the VA does, implying that VA’s success is solely or largely due to its aggressive negotiation tied to closed formularies.  But the authority to impose a closed formulary is only one element — albeit a critical one — of the successful VA drug pricing system. Elevating its importance over other aspects of the VA pricing system glosses over the reality of why the VA is effective in lowering its prescription drug costs.  

While VA’s national contract prices — negotiated between the VA and drug manufacturers — receives the attention, those discounts are obtained on top of the minimum rebates required under federal law.  Under the VA pricing system, manufacturers must provide discounts equal to the higher of the following: (1) the largest “Most Favored Customer (MFC)” discount, subject to some negotiation by the VA and provided under the Federal Supply Schedule (FSS) price available to most federal agencies and (2) the Federal Ceiling Price (FCP) discount for brand-name drugs equal to 24 percent of the non-federal Average Manufacturer Price (non-FAMP) plus any additional rebates if drug prices rise faster than inflation, which is available to the “Big Four” agencies (VA, the Department of Defense, the Public Health Service and the Coast Guard).  These minimum rebate provisions were instituted after the Medicaid rebate program was enacted to ensure that the VA continued to get sizable discounts. (Manufacturers had raised prices for the VA after the rebate program was first implemented, which implies that the minimum rebate provisions are critical aspects of the VA pricing system.) The VA may then negotiate national contract prices for certain drugs which provide further discounts (that may be quite sizable) in exchange for placement on the VA’s national formulary.

The national contract prices are thus somewhat akin to the voluntary supplemental rebates that states negotiate in Medicaid on top of the federally required base rebate (which is the higher of the “best price” discount and 23.1 percent of Average Manufacturer Price) and the inflation-related rebate.  In fact, only about 4 percent of the drugs listed by the VA’s Office of Procurement, Acquisition and Logistics for 2019 are subject to national contract prices.  The remaining drugs are subject to either FSS or FCP prices including notable high-cost specialty drugs like Actimmune and Sovaldi (which are subject to Big Four FCP prices).  In other words, the VA would likely not be able to successfully obtain the same amount of overall rebates or the rebates for most drugs it now achieves, without the Medicaid-like minimum rebate structure within its pricing system.  

Moreover, it is not widely understood that Medicaid also facilitates the success of VA’s pricing system in several ways.  As a condition of the Medicaid Drug Rebate Program, manufacturers must participate in the VA’s pricing system and provide FSS and FCP discounts.  Otherwise, none of their drugs may be covered under Medicaid. Like the minimum VA rebates, this requirement was put in place after the Medicaid Drug Rebate Program was established because some manufacturers threatened to stop participating in the VA or, as noted above, reduced the rebate amounts they were previously providing.  Because Medicaid is now the largest health insurance program in the United States, Medicaid’s influence in buttressing VA’s overall pricing system and enhancing its negotiating leverage is likely far more pronounced than it was three decades ago.

In addition, some of the negotiating leverage VA now wields in its national contract pricing with manufacturers likely comes from its closed delivery system in which the VA directly operates hospitals and clinics and employs its physicians and other prescribers.  As the Congressional Budget Office notes, this helps ensure that drugs placed on the VA’s national formulary will be used throughout the VA system.  In addition, because so many physicians and other prescribers receive their professional training in the VA system, the prescribing patterns they use in the VA would likely carry over to post-training practice.  As a result, manufacturers may be more willing to negotiate larger voluntary national contract discounts with the VA than would otherwise be the case due to the specific characteristics of the VA system. Increasing use of private providers outside the VA system, however, could dilute VA’s existing leverage with manufacturers in its national contract price negotiations if that results in less consistent prescribing and less adherence to the national formulary.

As a result, the VA’s ability to aggressively negotiate rebates in exchange for national formulary placement is only one aspect of its highly successful pricing regime.  In other words, the power to say “no” is not the only reason that the VA is successful and thus the VA’s success is not necessarily an argument for allowing a closed formulary in Medicaid (whether the rebate program remains in place or not) as a way to lower costs.

Moreover, it is always important to remember that private insurers and Medicare Part D plans are largely able to impose closed formularies today yet negotiate much smaller discounts than Medicaid does.   Altarum previously estimated that relative to the full retail or “point of purchase” price for brand-name drugs, Medicaid receives rebates of about 61 percent, while Medicare Part D plans obtain rebates of about 31 percent and private insurance plans negotiate rebates of only about 16 percent, on average.  Moreover, as the Pew Charitable Trusts finds, the rebates negotiated by Part D plans within the six protected classes for which plans are required to cover most drugs appear to be similar in amounts to drugs outside the protected classes (where Part D plans can exclude drugs using more restrictive formularies).  

At the same time, there are real-life examples of what states may do without the prohibition against closed formularies.  For example, Puerto Rico is not subject to the Medicaid Drug Rebate Program until 2020 and can therefore impose a closed formulary.  It does not cover any drugs that treat Hepatitis C in its Medicaid program due to longstanding fiscal issues resulting from insufficient federal and Commonwealth funding.  The only alternative available to residents of Puerto Rico on Medicaid is a public health program that has exhausted its funding and is not accepting additional patients.  Similarly, initial state actions to impose unduly restrictive prior authorization and coverage criteria for high cost Hepatitis C drugs, in apparent violation of the requirements of the rebate program, are instructive and could be an indication of what states may do with new closed formulary authority.  

A closed formulary could therefore place low-income Medicaid beneficiaries, especially vulnerable populations such as people with disabilities and chronic conditions, at serious risk of going without needed drug treatments if the medications they need are simply dropped from Medicaid on the basis of cost.  As MACPAC has stated, policymakers must not only consider how to rein in Medicaid spending but “must also consider how such efforts would affect Medicaid beneficiaries’ access to therapies that extend lives and improve health and functional status.”

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

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