United States: HHS Prescription Drug Rebate Rule Has Medicaid Implications

Last Updated: February 8 2019
Article by Thomas Barker

On January 31, 2019 the HHS Office of Inspector General (OIIG) issued a proposed rule that will be published in the Federal Register on February 6.  The proposed rule has the potential to fundamentally re-structure the prescription drug marketplace in the United States by dramatically altering the economics of pharmaceutical pricing.  Although much of the attention surrounding the rule has been focused on its effect on the Medicare Part D prescription drug program, the rule clearly applies to Medicaid prescription drug spending as well.  As a result, we thought it was worth discussing here.

First, a bit of background.  The new rule involves the interpretation of a 1972 federal law called the Anti-Kickback Statute, or AKS.  In short, the AKS makes it a crime for any person to pay anything of value as a way to reward or incentivize the use of a health care service that would be reimbursed by a federal health care program like Medicare or Medicaid.  In the most blatant example of the type of conduct the law is intended to prohibit, an unscrupulous physician might give a Medicare beneficiary a $100 bill in order to undergo a medically unnecessary CT scan for which the physician might be able to bill Medicare $1,000.

But, the economics of health care are a lot more sophisticated today than they were in 1972, or in 1990 when the first President Bush signed the Medicaid prescription drug rebate program into law, or even in 2003 when the second President Bush signed the Medicare Part D benefit into law.  With all of the rhetoric around drug pricing over the past several years, it was only a matter of time before policy-makers looked deeper at the economic machinations behind prescription drug pricing.

One issue that has gotten a lot of attention lately is the practice of paying rebates:  when a pharmaceutical manufacturer pays a rebate to a health plan in exchange for providing services such a designing a formulary recommending the manufacturer's drug, or developing a pharmacy network that will dispense the manufacturer's drug.  If that manufacturer's drug is going to be dispensed to a Medicare Part D enrollee, and Medicare Part D is paying for that drug, isn't that a quintessential violation of the AKS?  Aren't the manufacturer (the entity that pays the rebate) and the health plan (the entity that receives it) both violating the law by engaging in such a practice?

While the AKS would normally consider such a practice a violation, in 1991 the OIG established by regulation what is called a "safe harbor" to the AKS that specifically protects discounts – including rebates – from scrutiny under the AKS as long as the discount arrangement meets the terms of the safe harbor.  In fact, Congress directed the OIG to issue that safe harbor.  Since 1991, that has been the state of the law and the economics of pharmaceutical pricing have evolved around that model, in both the private sector (the individual health insurance market and employer-based insurance) and in government health care programs like Medicare and Medicaid.

That all may change, however, based on a proposal released by the Trump Administration on January 31, 2019.

Background on the Proposed Rule

Under the proposed rule, if it were to be adopted in its proposed form, rebates in their current form in the Medicare Part D program and Medicaid managed care would go away, as soon as January 1, 2020.  In addition, two new safe harbors would take effect that would dramatically shake up the economics of the pharmaceutical marketplace.

Most observers expected that the new rule would only apply to Part D, so the repeated references to Medicaid in the proposed rule came as a bit of a surprise.  Under the proposed rule, the existing rebate paradigm could not be used to protect rebate payments by manufacturers to Medicaid managed care plans.

So what is in the rule?  There are really three main provisions to pay attention to:

First, the OIG announced that, as of January 1, 2020, the existing discount safe harbor will no longer protect rebate arrangements intended to incentivize formulary placement for a manufacturer's product (or any other purpose) when such rebates are made to Part D plans, Medicaid managed care plans, or pharmacy benefit managers (PBM) under contract with them.  Price reductions from manufacturers to health plans would only be protected if those reductions were mandated by federal law.  For example, mandatory Medicaid rebates that a manufacturer makes to a Medicaid MCO that are required under section 1927 and 1903(m)(2)(A)(xiii) of the Social Security Act would be permitted.

HHS solicits comments on whether the policy should apply more broadly:  for example, to a Medicaid managed care plan operated under different authorities than the basic Medicaid managed care rules.  The Department is also soliciting comments on whether the proposal could in any way hinder beneficiary access due either to cost or formulary placement.  HHS also notes that it does not anticipate that the proposal will affect supplemental rebate agreements that manufacturers have negotiated with states, but is soliciting comments on this issue.  Lastly, the Department solicits comments on whether the proposal would hinder the growth of value-based payment arrangements.  We recently wrote about a supplemental rebate approved by CMS for the state of Michigan involving value-based payment arrangements; a similar rebate arrangement has been approved in Oklahoma as well.

Second, the proposed rule creates a new safe harbor that would protect price discounts so long as the full value of the discount is passed along at the point of sale (in most cases, to the pharmacy dispensing the drug).  To be protected under the new safe harbor, these payments must:

  • Be set in advance. This means that the price reduction to the pharmacy would be fixed, and disclosed in writing to the Part D or Medicaid MCO sponsor by the time of the initial purchase.
  • Not involve a rebate. Under the proposed safe harbor, the discount in price could not be structured as a rebate unless the full value of the reduction in price was passed through to the pharmacy in its entirety, or if the rebate is required by law (e.g., the mandatory Medicaid prescription drug rebate).  The dispensing pharmacy must receive the full value of the reduction in price.
  • Fully transparent to the beneficiary. The new safe harbor would require that the reduction in price be fully reflected in the price that the pharmacy charges to the Part D enrollee or Medicaid beneficiary.

This new safe harbor would be effective 60 days after the promulgation of the final rule.  OIG intends that it apply at all phases of the Part D benefit.

Third, and finally, the proposed rule creates a second new safe harbor to protect service fees paid by manufacturers to PBMs to compensate PBMs for services they provide for the benefit of manufacturers.  These include such services as pharmacy contracting; setting reimbursement levels for network pharmacies; negotiating rebate arrangements; development and management of formularies, preferred drug lists, and prior authorization programs; performing drug utilization review; and operating disease management programs.

To be protected under this safe harbor, the payments must meet three conditions: (1) the agreement must set out all of the services that the PBM will perform; (2) it must be set in advance, reflect fair market value and not vary based on the volume or value of referrals; and (3) it must meet transparency requirements such as letting health plans with which the PBM contracts know the services that will be performed.  The Department is considering expanding these transparency requirements so that it can get access to these contract terms as well.


There is now a 60-day comment period during which interested parties can share their views on the proposed rule with HHS and the Inspector General.  Given the rule's unanticipated application to the Medicaid program, we expect that we will see comments from state Medicaid plans, Medicaid MCOs and Medicaid beneficiary groups as well as from PBMs, health plans, and pharmaceutical manufacturers.  What happens after the comment period is anyone's guess.  This represents a major change to the economics of pharmaceutical payment in the United States, and HHS wants it to go into effect quickly.  We expect HHS to review the comments quickly and publish a final rule by the Spring so Part D plans and Medicaid managed care plans have sufficient time to incorporate the changes into their bids for the CY 2020 plan year.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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