Meet the Rebate, the New Villain of High Drug Prices

An increasingly popular culprit in the debate over high drug prices is the pharmaceutical rebate, the after-the-fact discounts that form the heart of the nation’s arcane — many would say broken — market for prescription drugs.

Now, a growing chorus wants to get rid of them, or at least change the way they are applied after drug companies have already set their prices. Rebates, critics say, have pushed up the list price of brand-name drugs, which consumers are increasingly responsible for paying. Insurers generally get to keep the rebates without passing them along to their members.

Last week, the drug industry’s largest trade group, the Pharmaceutical Research and Manufacturers of America, took aim at the rebate system, proposing a change to the way middlemen handle rebates, and how those companies are paid.

And the Trump administration has taken the first step toward eliminating a “safe-harbor” provision that allows rebates to be paid in Medicare’s Part D drug program without violating federal anti-kickback laws.

The details, though sparse, briefly caused the fall of the stocks of major pharmacy benefit managers like Express Scripts and CVS Health as investors worried that company profits would be hurt by the rebate’s demise.

Here’s a rundown on everything you need to know about rebates.

What is a rebate?

Pharmaceutical rebates are similar to the type that you get when you buy a toaster — discounts that are redeemed after the transaction has taken place.

Except with the toaster, you get to keep the money. With drug rebates, it’s the insurer or employers who usually reap the benefit.

Under the current system, drug makers set a list price for their products, then negotiate with pharmacy benefit managers like Express Scripts or CVS over how much of a discount they will provide off that list price.

The size of the rebate depends on a range of factors, including how many drugs are used by the insurers’ members, and how generously the product will be covered on a formulary, or list of covered medicines. Companies that offer bigger rebates are often rewarded with better access like smaller co-payments.

Most of the rebate — and sometimes, all of it — goes to those who are paying the bill for the drugs, mainly insurers or large employers who cover their workers’ health care. Pharmacy benefit managers usually keep a percentage of the rebate as payment.

Insurers and employers get their rebates in lump sums that they say are often used to offset general health care costs and to hold down premiums.

What’s all the fuss about?

Although rebates have been used to negotiate drug prices for years, they didn’t catch much attention until 2011, when CVS, which operates one of the country’s largest pharmacy benefit managers, announced it was excluding 34 drugs from its national formulary.

The rebate then became a potent negotiating tool, pitting drug companies against each other in an effort to secure a place on the formulary. Other benefit managers, like Express Scripts, soon followed suit.

But that has led to an escalating game, where drug companies raise their list prices to maintain their profits and to offer bigger rebates.

Some say the system has created a series of perverse incentives, where the middlemen have an interest in keeping the list price high. In addition to pharmacy benefit managers, wholesalers and pharmacies are also paid based on a percentage of the list price.

Drug makers — on the defensive after weathering attacks by President Trump, other elected officials and the public — have pointed fingers at the pharmacy benefit managers, saying they are under pressure to raise list prices to keep all of these players happy.

But pharmacy benefit managers and insurers disagree, arguing that rebates are a diversion and that their negotiating tactics have kept total drug costs in check. As proof they point to data that shows that in 2017, net spending on brand-name drugs grew only 1.9 percent, according to IQVIA, a drug research firm, while list prices grew 6.9 percent.

In a twist, the pharmaceutical companies cite the same research to show that drug prices are not as steep as they seem.

How are consumers affected?

Even as insurers’ drug spending has grown slowly, critics say the rebate game has served to inflate the list price of drugs, which consumers are increasingly responsible for paying. This is especially true for expensive specialty drugs, which treat serious conditions like cancer and multiple sclerosis — and whose prices have been skyrocketing.

As the cost of these products has gone up, insurers have raised deductibles and out-of-pocket contributions so that many of the sickest Americans must now pay thousands of dollars a year to cover their drug costs. These out-of-pocket costs are calculated using something close to the list price of a product, not the net price.

What’s being proposed?

Alex M. Azar II, the secretary of health and human services, has singled out rebates as a primary way that patients’ costs could fall.

“Right now, everybody in the system makes their money off a percentage of list prices,” Mr. Azar testified in June before a Senate committee. “We may need to move toward a system without rebates.”

Last week, the Trump administration signaled that it might try to end the “safe harbor” exemption that protects rebates from falling under anti-kickback laws. That would affect government programs like Medicare’s Part D drug plans, but it wouldn’t affect rebates in private plans — like those offered by employers. Changes to large programs like Medicare often have a rippling effect across the industry.

Pharmacy benefit managers and insurers warn that eliminating rebates could face legal hurdles, and said that the move could wind up raising consumers’ premiums because insurers and employers use their rebate payments to plug other holes.

“Plan costs in the short run would go up, that’s just the reality of the situation,” said David Dross, the national leader of the managed pharmacy practice at Mercer, which negotiates with pharmacy benefit managers on behalf of employers.

Doing away with rebates won’t fix other problems. The companies that sell the most expensive drugs — newly approved products that cost hundreds of thousands of dollars a year — don’t offer many discounts because they have little to no competition. IQVIA, the drug research firm, found that rebates amounted to about 40 percent of the list price for treatments of some diseases, like diabetes. But they reduced the list price by only 10 percent in treating other diseases, like cancer.

The Trump administration is also considering a proposal, first floated last fall, that would give a portion of rebates to Medicare beneficiaries at the pharmacy counter. The move would lower out-of-pocket costs for people with high drug bills, but could increase premiums for Medicare drug plans. Private insurers, like UnitedHealthcare, have also recently introduced plans that offer these “point-of-sale” rebates to some of their members.

How likely are rebates to disappear?

It’s unclear.

The drug industry, though it hasn’t specifically called for an end to rebates, has targeted the discounts and blamed the pharmacy benefit managers for the current situation. The industry is one of the most powerful lobbying forces in Washington, and with the support of Mr. Azar — until recently a top executive with Eli Lilly — they are not to be underestimated.

But doing away with the rebate would create disruption that may be fought by a host of players.

“Things that seem simple, like let’s cut the list price, are not actually simple,” said Mr. Fein, of the Drug Channels Institute.

Under the current rebate system, he said, “unless everybody does it at the same time, you can’t reset the system. That’s the challenge of this.”