The Part D direct negotiations movement

Last Thursday, House Democratic Leader Nancy Pelosi and other senior House Democrats asked for a floor vote on direct negotiations between the US government and drug manufacturers for Medicare Part D. (Read the press release here.) The Senate rejected similar amendments to the Medicare act last November by a 51-48 vote and in March 2005 by 50-49.

The Democrats are making Part D “reform” into a major theme of the 2006 elections. Our charter at Drug Channels includes examining the effects of policy on the pharmaceutical supply chain, so I’ll defer comment on the political angles.

Nevertheless, a direct negotiations scenario is certainly possible. This shift could have dramatic consequences for manufacturers in the areas of channel strategy, pricing, and trade account management. Wholesalers, retailers, and PBMs should also be paying close attention to the strategic business implications as the “cost of the channel” becomes more prominent and visible.

A Direct Negotiations Scenario
Let me sketch a few factors (beyond political posturing) that could favor a direct negotiations scenario:

• The government will be paying almost half of the entire US prescription drug budget within a few years via Medicaid and Medicare. Yikes!
• The tab for Part D, an unfunded expenditure from general revenues and premiums, is likely to force some uncomfortable trade-offs among non-entitlement budget spending. According to the 2006 Medicare Trustees Report, Part D costs are projected to increase at an average annual rate of 11.5 percent from 2006 to 2015.
• A steady drumbeat of research studies (Example One and Example Two) purport to show how much could be saved with direct negotiations. (No hate mail, please – these are examples, not endorsements.)
• A Democratic Congress and/or President Hilary Clinton

I assume that you agree that we can assign a non-zero probability to the direct negotiations scenario.

How much should we pay for the drug channel?
Currently, pharmacy reimbursement levels for Medicare Part D are determined by the marketplace through network contracting negotiations between pharmacies and Medicare PDPs, not set by CMS.

I believe that a direct negotiations scenario will migrate CMS Part D reimbursement to an “average price plus” model. In my post from early May, I noted that government reimbursement for pharmaceuticals is moving away from “discount off list” (AWP minus). Consider:

• Medicare Part B now reimburses outpatient drugs to providers at Average Sales Price (ASP) plus 6 percent.
• Starting in January, Medicaid’s reimbursement to retail pharmacy for generic drugs will be the to-be-defined Average Manufacturer Price (AMP) plus 250 percent. (See my June 8 post for more on AMP.)

Key point here: An “average price plus” model does not claim to measure actual pharmacy or provider acquisition costs for drugs. Instead, these models use actual manufacturer transaction prices plus a drug channel cost factor. Dr. McClellan voiced his support for these models in his comments to last summer’s OIG comparison of AMP to AWP and WAC. (See pages 24 to 26 of this OIG report.)

Some uncomfortable questions
It’s beyond the scope of my blog to write about all of the strategic implications here. (Hey, that’s my real job!) But here are a few questions to ponder:

1. A “price plus” approach effectively caps the total compensation that can be earned by wholesalers, retailers, providers, or anyone else handling the product after it leaves the manufacturer’s factory. Who will win if wholesalers and retailers begin competing for the fixed (and probably lower) channel margin?
2. Prescription pharmacy is 69% of CVS’ revenue and 66% of Walgreen’s revenue, making the government responsible for at least a third of top line at the biggest chains. Will this accelerate pharmacy consolidation, reduce margins, or both?
3. The next round of fee-for-service negotiations will be coming up in the next 18 months. How much will/should a manufacturer compensate the drug channel to perform activities that become uneconomic in a “price plus’ reimbursement model?
4. How will the relative attractiveness of alternate distribution models, such as third-party logistics providers, change once drug channel margins are subject to more scrutiny?

Direct negotiation is just a scenario – for now.

P.S. A few people wrote to ask me about the meaning of disambiguation, which I used in the title of my last post. For the record, disambiguation means “clarification that follows from the removal of ambiguity.” See? This blog really does make you more perspicacious!