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n health care circles, 21 words have rarely caused as much speculation as “Removal of Safe Harbor Protection for Rebates to Plans or PBMs Involving Prescription Pharmaceuticals and Creation of New Safe Harbor Protection,” the title of proposed regulations currently under review at the Office of Management and Budget.

Much of the buzz about the document’s content has centered on Department of Health and Human Services Secretary Alex Azar’s oft-mentioned complaint that rebates for prescription drugs contribute to high drug prices. Health plans, and their intermediaries known as pharmaceutical benefit managers (PBMs), negotiate with drug companies for rebate payments in return for covering their drugs.

Here’s how that works: Say a drug has a list price of $1,000. A health plan will tell a manufacturer that, unless it pays a $200 rebate, the plan either won’t cover the drug or will charge patients a high copayment that will discourage its use. Heath plans say they use the rebates to reduce premiums and cost sharing by patients.

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The “safe harbor” that protects drug rebates is among many legislative and regulatory provisions that give health care buyers and sellers confidence that their business arrangements won’t be seen as “kickbacks,” which are illegal under federal law. Without the safe harbor protection, drug companies, health plans, and pharmacy benefit managers who enter into rebate deals could face civil or even criminal consequences.

In a recent interview with Reuters, Azar said that the “question of rebates may very well be fundamental to the issue of how you reverse these constant incentives to higher list prices” for medicines. He believes that, because health plans and pharmacy benefit managers profit by keeping some of the rebates, they are happy to see higher prices and higher rebates. If there were no rebates, so the thinking goes, there would be less incentive for drug makers to raise their list prices.

In testimony before Congress in June, Azar said, “We may need to move toward a system without rebates, where PBMs and drug companies just negotiate fixed-price contracts. Such a system’s incentives, detached from artificial list prices, would likely serve patients far better.” He also claimed the power to end rebates, presumably through the proposed safe harbor regulation, which came from HHS’s Office of Inspector General.

Many health plan and pharmacy benefit manager executives dispute the premise that rebates lead to higher drug prices. Even if there is a kernel of truth to the idea, it raises the question of what a world without rebates might look like. Since rebates have been the principal way that health plans have negotiated prices with drug manufacturers for more than two decades, it is difficult to imagine that world. Yet if we are going to limit or eliminate rebating, we need to use our imaginations.

What Azar appears to have in mind as an alternative to rebates is a system in which each health plan would negotiate with each drug company for an upfront discount price that would be reflected at the pharmacy at the time a beneficiary fills her or his prescription — no more rebates and no hidden incentives for a big spread between list prices and true net prices.

That sounds simple and good until you consider the possible consequences, like how a post-rebate system would maintain the confidentiality of negotiated prices. A commonly held view is that price transparency is a necessary prerequisite to healthy competition. While that’s true for prices to the ultimate consumer, it’s not so true for intermediary prices such as the ones health plans will pay for drugs.

As staff members at the Federal Trade Commission succinctly articulated in a well-titled 2015 commentary, “Price transparency or TMI?”

Transparency is not universally good. When it goes too far, it can actually harm competition and consumers. Some types of information are not particularly useful to consumers, but are of great interest to competitors. Especially worrisome are disclosures of information that allow competitors to figure out what their rivals are charging. That dampens each competitor’s incentive to offer a low price, or increases the likelihood that they might coordinate on higher prices.

The Federal Trade Commission has consistently maintained this view and the Congressional Budget Office appears to agree, saying in 2003 and in 2007 that proposals requiring disclosure of net drug prices would raise government costs because it would lead to higher prices for some purchasers.

In recent comments on the Trump administration’s drug pricing blueprint, health plans and pharmacy benefit managers opposed revealing negotiated prices. America’s Health Insurance Plans, which represents those bargaining for lower drug prices, wrote Azar that eliminating rebates would “increase transparency for up-front discounts negotiated by drug companies, likely creating an even more anticompetitive pharmaceutical pricing environment and possibly increasing drug costs at a higher rate.” Similarly, the pharmacy benefit manager trade group PCMA wrote that “restricting rebates will introduce the wrong kind of transparency into the program and thus significantly hamper negotiating leverage, leading to higher costs.”

Do we actually want to implement something that carries the risk of leading to higher drug prices?

At first glance, ending rebates might seem like a windfall for the drug industry. In the long run, though, it wouldn’t be a good bargain. Rebates for drugs have worked for decades to provide a mechanism for health plans and their clients to negotiate drug prices. Many challenge whether this mechanism is working well enough. But the pharmaceutical industry strongly opposes the alternative of government price negotiation or price setting. Ending rebates could move the industry one step closer to that place. That may be why, in its own comments on the drug pricing blueprint, the industry trade group PhRMA did not appear to embrace an end to rebates.

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The current rebate system certainly has its downsides. While the post-rebate net price is really what we should care about, the gap between list price and net price has negative consequences. Most importantly, patients are often paying their deductibles and coinsurance based on an inflated list price. And because those in the drug distributions system — wholesalers, pharmacy benefit managers, and even pharmacies — are compensated based on list price, the gap between list and net raises costs to the system. After all, why should distributors be paid a lot more to handle a $500 pill than a 10 cent one?

The answer to these problems isn’t to end rebating. Two other steps would work without risking the consequences of revealing negotiated prices.

  • First, base beneficiary cost sharing on a price that is closer to the negotiated net price than it is to the inflated list price. That can be done without revealing the actual net price.
  • Second, end the practice of compensating the drug distribution system based on list price by moving to fixed payments based on the value of the work rather than the price of the product.

When (and if) we finally see what’s contained in the administration’s drug rebate proposal, we need to evaluate whether the solution offered will make things better or lead to a worse outcome for all involved. And before kicking drug rebates to the curb, we need to make sure we have a replacement that works better.

Ian D. Spatz is an instructor at the Sol Price School of Public Policy of the University of Southern California; a senior advisor to Manatt Health, where he advises health care organizations and corporations, including pharmaceutical companies, pharmacy benefit managers, and health plans; and principal of the Rock Creek Policy Group.

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