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Prescription Drug “Rebates” Raise Prices, Limit Drug Choice, and Make Patients Sicker

By Erik Sass


Anti-competitive practices in the prescription drug marketplace like “rebate walls” routinely cost ordinary Americans thousands of dollars every year while restricting patient access to medications. These costs and restrictions will only grow more onerous in years to come, unless the incoming Biden administration acts swiftly to take on these anti-market arrangements. The good news is there should be broad bipartisan support for this fair, commonsense approach to lowering drug prices, holding out hope for an early, easy “win” during a divided government.


The wasteful costs of prescription drug “rebate walls” were laid bare in a new study for the Pacific Research Institute by Dr. Wayne Winegarden, who analyzes rising healthcare costs to formulate market-friendly solutions. The study presents the findings in detail, with robust supporting evidence and an overview of potential policy solutions. The PRI report takes a deep dive into the structure of rebate walls and their unintended consequences on patient choice, focusing on costs to patients who get insurance through their employers, patients on Medicare, and patients who receive IV drugs in a clinical setting. The results were startling: in 2019 the total value of opaque concessions, including rebates, accounted for almost half of drug list prices, amounting to $303 billion out of total list prices of $671 billion, with much of the excess cost borne by consumers.


In the prescription drug marketplace, “rebates” refer to the practice of pharmaceutical companies offering undisclosed payments to pharmacy benefits managers (PBMs, like CVS and ExpressScripts) and health insurers who agree to add their medications to their formularies (lists of accepted drugs) and commit to buy a certain amount from the drug maker. PBMs typically pass on most of the savings from those rebates to health insurers and employers, who often use them to reduce premiums for the people covered by their health plan


While this might sound like a good way to lower costs for consumers, the “rebates” can actually be counterproductive when they give rise to “rebate walls.” Rebate walls are created when a pharmaceutical company offers rebates for an old drug with multiple indications in a bundle, covering all its potential uses. This bundling creates even more substantial savings for PBMs, insurers and employer-sponsored health plans – which are sometimes so sizeable that it makes more financial sense to stick with old drugs in their formularies rather than make newer or cheaper medicines easily available. 


Unfortunately, not all these savings reach consumers. Rebate walls allow insurers and PBMs to charge consumers high prices for prescriptions based on the drugs’ list prices, then pocket the difference when they receive rebates from the drug makers. These are often very considerable sums: by one estimate, rebates raise the cost of Humalog insulin for an average Medicare Part D patient with diabetes to $193 per prescription, compared to $64 if rebates were abolished.


These perverse disincentives to competition don’t just keep costs high: they also serve to limit patient access to newer or more effective drugs. In some cases patients can only qualify to receive an off-formulary drug after first trying an on-formulary alternative without success – a “fail first” approach presenting the clear risk of deterioration for patients with chronic conditions, making their treatment even more expensive in the long term. By tying the hands of doctors, rebate walls sacrifice patients’ long-term health for financial reasons having nothing to do with their welfare.


Benefits of Reform


Tackling rebate walls would lower drug prices in several ways. Rebate walls encourage PBMs to favor more expensive brand-name drugs, since they get to keep a large part of the higher prices paid by consumers. Lowering rebate walls will force PBMs to “comparison shop” based on prices and efficacy (as in any normal marketplace), creating competitive pressure to force actual prices down. This is especially important because rebate walls often serve to protect older, expensive drugs from potential competition from newer rivals, which may do the same job – or better – for a lower price.


Meanwhile threats to patient welfare extend beyond harm inflicted by “fail first” formularies. Numerous studies have shown that patient adherence to prescription drug regimens falls off sharply with higher costs, as reflected in an increasing proportion of medications abandoned “at the counter” when patients see their high out-of-pocket cost. A 2017 survey found that 69% of patients with commercial insurance chose not to fill a prescription when the out-of-pocket cost exceeded $250, while 52% skipped prescriptions costing from $125-$250. This deterrent effect has real negative health impacts, especially in people with chronic diseases, which in turn carry a hefty price tag for the U.S. healthcare system at large: by one calculation non-adherence by people with chronic disease costs $213 billion in excess healthcare spending, equal to about 8% of annual spending. Considering one of the most prevalent chronic diseases, OptumRx calculates that a 1 percentage point increase in diabetes patients’ drug adherence decreases overall spending by $95.14.


Hollow Arguments Against Rebate Reform


As Winegarden’s report for PRI notes, a number of attempts have already been made to roll back rebate walls, but so far without success. In July 2020 the Trump administration issued an executive order to eliminate rebates paid by drug makers to PBMs, and instead pass these savings on to consumers. And just before Thanksgiving, the administration finalized a new rule that removed the anti-kickback statute safe harbor for rebates in the Medicare Part D program.


Opponents of reform typically point to a few arguments. The most common critique is that eliminating rebate walls might actually result in higher costs for patients and Medicare, since PBMs and insurers use rebate payments to subsidize lower costs for insurance premiums. However this practice runs counter to the economic rationale of health insurance schemes in general, which exist to spread the costs of treatments across large populations, thus sparing individuals from catastrophic expenses. By concentrating the financial burden of treatment on individuals when they are sick, the rebates defeat the risk-sharing purpose of insurance, canceling out its economic benefit.


Furthermore, these arguments are based on questionable or obviously incorrect economic assumptions by the Center for Medicare and Medicaid Services, Office of the Actuary (CMS). In short, the CMS calculations rest on the assumption that market players – especially PBMs – wouldn’t use increased price transparency resulting from rebate reforms to obtain lower prices through marketplace competition in the absence of closed-door rebates. This runs counter to the PBM’s economic self-interest and sustainability as businesses, especially as they will also come under pressure to deliver lower costs from insurers also competing on price.


Finally, according to figures from the California Department of Managed Health Care, drug rebates actually represent a fairly small proportion of insurance premiums, at just 1.5% in 2018. That’s considerably smaller than actual net spending on drugs, which represents 11% of premium costs, and insurance profit margins, at 3.9% in 2018. Offsetting these small revenue decreases would require insurers to raise Medicare Part D premiums modestly, from $350 to $391 per year. Meanwhile consumers would reap a much larger savings from rebate reform: based on 2017 figures, patients with high out-of-pocket costs would see these expenditures fall by almost half, from $3,214 to $1,763.


An Opportunity for Change


At a minimum, the incoming administration should preserve the new rebate rule. But there’s a bigger opportunity here to tackle rising healthcare costs. The Biden administration and the 117th Congress should evaluate and monitor rebate walls from an antitrust perspective given the impact these practices have on innovation and free-market competition. Biden’s proposed pick to lead HHS, California’s attorney general Xavier Becerra, may signal the administration’s intent to do just that. Earlier this year Becerra sent a letter to the FTC urging it to review AbbVie’s rebate wall practices in the context of acquiring Allergan.


Both parties have a broad mandate from their voters to contain spiraling out-of-pocket expenses for healthcare consumers, particularly in the areas of prescription drugs and “surprise” medical expenses. Beyond the immediate benefits in terms of lower costs and increased patient adherence, after years of gridlock and acrimony, rebate reform is an easy way for policymakers from both sides of the aisle to deliver a “win” during divided government. Commonsense and common cause – rebate reform’s time has come.


Erik Sass, is Editor-in-Chief of The Economic Standard.