Medicare Part D is a voluntary prescription drug benefit for Medicare beneficiaries that was established in 2003 under the Medicare Modernization Act. Prior to this law, Medicare did not offer a prescription drug benefit. In 2015, over 39 million Medicare beneficiaries were enrolled in a Part D plan.

Medicare Part D went into effect in 2006, providing prescription drugs through private stand-alone prescription drug plans (PDPs) and Medicare Advantage (MA) plans, which provide drug coverage as part of comprehensive Medicare coverage. While the Medicaid program, the U.S. Department of Veterans Affairs (VA) and the Department of Defense are able to negotiate with drug companies for lower prices, the federal government is prohibited by law from negotiating for Medicare drug prices.

Part D drug prices are determined through a negotiation between the private drug plan that administers the benefit and the drug manufacturer. The dependence on private plans to administer the program keeps the Medicare program at arm’s length from the negotiation process. The private plan structure dilutes the market power of the Medicare program, because individual plans negotiate only on behalf of their enrollees and not the entire Medicare population.

National polls show that most Americans, across party lines, support allowing the federal government to negotiate with drug companies as a way to bring down the cost of prescription drugs. Two current legislative proposals, the Medicare Prescription Drug Price Negotiation Act of 2015 (S. 31, H.R. 3061), introduced by Sen. Amy Klobuchar and Rep. Peter Welch, and the Prescription Drug Affordability Act of 2015 (S. 2023, H.R. 3513) introduced by Sen. Bernie Sanders and Rep. Elijah Cummings, lift the prohibition on Medicare negotiating drug prices. But the extent to which negotiation would be effective in lowering prices depends on how negotiation would be implemented. CBO believes that CMS needs additional tools beyond negotiation authority in order to produce savings, such as the ability to establish a government run formulary, the ability to set prices, or to take other regulatory actions in order to pressure manufacturers to provide discounts on drugs.

Some options for structuring price negotiation in ways that lower drug costs include:

Price negotiation for sole source drugs

CBO has said that price negotiation could lower the cost of drugs that lack competition. Private Part D plans currently have no leverage to negotiate for lower prices when a drug has no competitor. The high-priced therapies for hepatitis C, Sovaldi and Harvoni—drugs that were on the market without competition for a year exemplify this situation. According to a December 2015 Senate Finance Committee report on Sovaldi, Medicare spent $8.2 billion in the first 18 months the drug was on the market. Compare that to $6 billion spent outside the U.S. in the first 21 months after launch—disproportionately in Europe where government-run health programs have the ability to negotiate drug prices.

The Medicare Fair Drug Pricing Act (H.R. 4207), introduced by Rep. Jan Schakowsky would provide the Department of Health and Human Services (HHS) with tools to obtain rational prices for sole source drugs by allowing the Secretary of HHS to negotiate with manufacturers and, in the event negotiations fail, to set a price. The President’s proposed budget for Fiscal Year 2017 allows the Secretary of HHS to negotiate prices for biologics and high-cost prescription drugs for Medicare beneficiaries.

The National Committee supports these proposals because we believe that Medicare should receive the best price for prescription drugs for all beneficiaries, especially those with low incomes.

Restoring drug rebates for low-income beneficiaries

Another specific type of drug negotiation would require drug companies to restore paying a minimum rebate to the federal government for Medicare Part D drugs provided to low-income individuals.

Prior to the implementation of Part D, Medicaid paid the drug costs for individuals who were dually eligible for Medicare and Medicaid. These individuals are generally low-income, sicker and expensive to treat. Nineteen percent of Medicare enrollees are dually eligible but they account for 34 percent of the program’s expenditures. When Part D went into effect, dually eligible beneficiaries’ drug coverage switched from Medicaid to Medicare Part D and the manufacturer discounts were discontinued.

In Medicaid, the drug manufacturer provides the federal government discounts for drugs, which are shared with the states. (Medicaid is funded jointly by the federal government and the states and is operated locally by state government.) The discount is either the minimum drug amount or an amount based on the best price paid by private drug purchasers, whichever is less. Current law requires drug companies to charge Medicaid at least 23 percent less than the average price they receive for the sale of a drug to retail pharmacies. Drug companies also must provide another discount if a drug’s price rises faster than the rate of inflation.

According to CBO, Medicaid rebates, if applied to Part D, would save the federal government $123 billion over 10 years. The HHS Office of the Inspector General found in a 2015 study that Medicaid unit costs were less than half of Part D unit costs for 110 brand-name drugs.

The National Committee supports the Medicare Drug Savings Act of 2015 (S. 1083, H.R. 2005) introduced by Sen. Bill Nelson and Rep. Kathy Castor and the Prescription Drug Affordability Act of 2015 introduced by Sen. Bernie Sanders and Rep. Elijah Cummings (S. 2023, H.R. 3513) because they would allow the Medicare program to collect rebates for low-income beneficiaries.

Establishing a National Formulary

Another way to implement drug price negotiation is a Medicare-run formulary. Under one approach, Medicare could create a public Part D plan to compete with private Part D plans. The Secretary would set up a formulary for the public Part D plan and negotiate prices for covered drugs on that formulary. This would allow the government to provide preferential placement for a drug on a formulary in exchange for a favorable price. If an alternative drug exists, the government could decide not to cover it (e.g., leave a drug off the formulary altogether) or put the drug in a tier that requires a higher copayment from beneficiaries. This would provide companies with an incentive to give Medicare a favorable price.

A related option is for the government to set a price it negotiates with manufacturers as the maximum payment for drugs sold by private Medicare Part D plans and allow private plans to negotiate a lower price with drug manufacturers when possible. This would create an incentive for plans to continue to bargain with drug manufacturers for even lower prices than the federally negotiated one. This approach would allow plans to enjoy a competitive advantage for obtaining even lower prices, while guaranteeing that the Medicare program pays no more than the negotiated price.

Debunking Arguments Against Price Negotiation

Research and Development. Opponents argue that if the drug industry loses profits due to Medicare drug negotiation and restoration of rebates for low-income beneficiaries, there will be less money for research and development of new drugs. One analysis estimates the profit loss would be about two to seven percent, and some contend that the drug industry can afford a reduction in profits of this magnitude. Drug companies revenues were more than $200 billion between 2005 and 2010, and they spent 19 times more on promotion and marketing of new drugs than on research. The Congressional Budget Office also suggests that the impact on the incentive to develop break through drugs by reinstating rebates for dual eligible would be relatively small.

Market Competition. Another argument is that allowing the federal government to negotiate for lower Medicare drug costs is a form of price control, which would interfere with market competition and the Part D program’s success. Specifically, opponents point to the fact that Part D program costs are less than originally estimated. The Medicare Trustees projected in 2004 that Part D would cost $131.4 billion in 2011, but the cost was $67.4 billion, 51.3 percent less than originally predicted.

However, some research disputes the idea that market competition is the cause of lower Part D prices. A 2012 Kaiser Family Foundation study found that other factors besides market competition, such as greater use of generic drugs and fewer new drugs coming to the market, were the reasons for lower than expected Part D costs.

Higher Drug Costs. A third argument is that Medicare drug negotiation and restoring drug rebates paid by pharmaceutical companies for low-income beneficiaries would negatively affect employers. Proponents of this view argue that profits lost through Medicaid rebates would have to be recouped by requiring employers to pay more for the drug coverage they provide to their employees. According to Douglass Holtz-Eakin, restoring Medicaid rebates for low-income beneficiaires could “create incentives for drug companies to offer fewer rebates to private payers, such as employers, and possibly to launch new drugs at higher prices.” For example, a RAND study from 1997 that examined the best price formula for Medicaid drug rebates found that private drug purchasers, such as employers, did see small cost increases that could affect employers. The Kaiser Family Foundation study dismissed these findings, noting that in today’s market there is greater access to and use of lower cost generic drugs, so employers would be less likely to be affected negatively by the rebate.

National Committee Position

At a time when policymakers are seeking ways to lower the federal deficit and overall health care spending, proposals that reduce Medicare prescription drug costs cannot be overlooked. Allowing the federal government to negotiate for lower Medicare drug prices and restoring discounts for low-income beneficiaries make sense because these proposals save money without shifting costs to beneficiaries and have broad public support.

Government Relations and Policy, August 2016