The end of inflated pharma pricing?

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07/17/2019 | 04:17 pm
Last Thursday’s broad fall in US pharmaceutical stocks is less about what the Trump administration is doing as opposed to what it might do next. After years of profit driving inflated pricing, the US healthcare market's tight grip on high prices may be coming to an end.
The Trump administration last week experienced two consecutive setbacks to its healthcare reform plans. Whilst providing short term relief to insurers and drug companies, in the long run these setbacks may signal the start of substantive reforms to tackle drug pricing in the United States.

The proposals at a glance

The administration’s drug pricing efforts collapsed in the face of legal and industry challenges. On July 9, part of the president’s ‘Putting American Patients First’ blueprint aimed at lowering drug prices was blocked by a federal judge. The proposal would have required drug makers to disclose list pricing of their medicines in adverts in a bid to increase price transparency and lower prices. Drug companies expressed their criticism suggesting high prices in adverts could dissuade patients from seeking care. But a federal judge blocked this measure on the grounds that the Department of Health and Human Services has overstepped its authority in forcing such a plan onto drug makers. 

The administration faced a further setback on Thursday after its decision to scrap it second drug pricing proposal. The plan would have removed the safe harbor exemption from rebates which are currently exempted from anti-kickback statutes. Rebates are discounts provided by drug companies off the list price of their medicine. Alex Azar, Secretary of Health and Human Services, coined these discounts as a ‘shadowy system of kickbacks.’ Manufacturers pay them to insurance middlemen, which administer drug benefits for health plans known as pharmacy benefit manufacturers (PBMs). In turn, this enables manufacturers to have their medicines covered by an insurer’s health plan. PBMs argue rebates are a small element of the discounts they negotiate to lower costs for insurers. They also argue that the problem lies in too high list prices by manufacturers. Drug companies however believe that PBM’s do not pass these savings to consumers. This is supported by Senator Ron Wyden, member of the Senate finance Committee, who argues PBMs ‘have no accountability and consumers don’t see any savings.’

Insurers and Manufacturers

Healthcare insurers were trading up on the news of the second failed proposal. The removal of the safe harbor exemption would have resulted in rebates being considered as kickbacks. Therefore, forcing PBMs to forgo rebates or pass them onto consumers, notably Medicare beneficiaries. This would arguably have dampened PBMs profits. The scrapping of this plan was therefore positive for insurers, many of which own PBMs.

This was shown with Cigna, which traded up 9.24% on Thursday, whose acquisition of Express Scripts for $67 Billion provided the insurer with exposure to the PBM market. Other insurers with PBM business such as UnitedHealth, Anthem and Humana also rose on the news. This is significant as it provided short term relief for many insurers whose shares had been under pressure since the start of the year following the rebate’s proposals announcement. PBMs, who lobbied members of the Domestic Policy council to drop the measures and would have been hurt by such a plan, praised the decision on Thursday. CVS stated it was ‘pleased with the administration’s move’ and that ‘any solution should start with addressing drug prices instead.

Drug manufactures were trading down on the news. Although the plan wouldn’t have significantly changed pricing models and could have led to savings by not paying rebates, investors fear the administrations future proposals. The withdrawal of the plan is expected to put pressure on the administration to pursue more radical and substantive proposals, turning its attention more directly to the pricing practices of manufacturers. In turn, investors are worried that whatever comes next will significantly hurt the drug makers. Manufacturers felt the wake of this concern with Merck & Company trading down 4.5% and Bristol-Myers down 3%.

From $750 to $1 for the same drug

The administration has signaled that it is open to allowing Americans to import cheaper drugs from other countries such as Canada. This is significant as it may help drive competition for single-source drugs or those without generic competitors which currently hold monopolistic market power. The impact of competition is seen through drugs such as Pyrimethamine (Daraprim) who’s $750 list price per pill in America contrasts with a list price below $1 in countries with multiple Pyrimethamine manufacturers. Furthermore, importing drugs may also help reduce exclusivity periods held by branded variants due to the existence of significant barriers to entry in the US for generic competitors of branded drugs. The cumulative effect of importing drugs may in turn drive prices down by encouraging competition. However, Azar raised concerns that such proposals could be at the determent of patient health. Furthermore, this reluctance to foster a competitive climate is not limited to Republicans as shown by the FDA’s reluctance to enact similar proposals under previous Democratic administrations.

The biggest concern however is the International Pricing Index Model proposal (IPI). This plan would link the price that Medicare pays for drugs to an index of prices paid overseas, which are often multiples lower. This would cut into US drug manufacturers profits. The impact of this cumulative uncertainty was reflected in share prices across a range of drug manufacturers on Thursday, falling on average 3%.

Chart showing industry expectations before the start of 2019 on the probability of healthcare reforms before the 2020 presidential elections (Source: Jefferies)

Going forward, it is unclear whether concrete change will materialize. Trump talked regularly about drug prices during his 2016 campaign, but he has so far failed to deliver on his promises. However, drug prices directly affect consumers making it a central concern for voters who have yet to see this administration make concrete strides to lowering their health costs. This could encourage more significant reform in the mind of an administration aware of the upcoming election. Part of their reasoning for scrapping their rebates plan was a fear of initially raising drug prices during an election year.

Lowering drug prices requires policies that drive competition, reduce barriers to entry and limit anti-competitive behavior by manufacturers. Policies of such a scale are necessary but present political risks. Movements seen last week in key pharma stocks signals investors believe change is on the horizon. However, pharma lobbying groups have successfully dedicated billions over the years to stifling reform to maintain the status quo. This trend sees no sign of slowing unless this administration decides to confront the political risk of reforming healthcare. Whether this promise to reform is little more than a political ploy to play on voter’s concerns, only time will tell. Investors fear the progressive reform but this may just end up being another case of easier said than done.

Written by Benjamin.P
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