Investing in the prospect of drug pricing reforms

The Trump Administration is
considering reforms in the payment for prescription drugs covered under
Medicare Part B. The changes include ones that could be accomplished without
the need to pass legislation through Congress. The reforms could have
significant implications for the companies that manufacture the drugs covered
under Part B.

Medicare Part B covers drugs
that are administered in a doctor’s office or a hospital outpatient setting. There
about 600 such drugs and they range from flu shots to infusion and oncology
drugs. They are distinct from the drugs patients can get from their local
pharmacy and give to themselves. The latter group of drugs is covered by
Medicare Part D.

Part D was established in 2006
to help seniors meet the cost of prescription drugs. When it was put in place,
there were also controls on the rates at which Medicare would reimburse for
covered drugs. Part B, which has existed since Medicare was introduced in 1965,
has not yet been subject to any significant drug pricing reforms.

The lack of reform in Part B
pricing may explain why Medicare’s payments, per beneficiary, for these drugs has
risen by 11.1% since 2006 – almost triple the rate of growth in expenditures
for Medicare Part D drugs. Figure 1

Figure 1: Medicare Part B and D per-beneficiary expenditure growth rates (2006-2016)

Source: Medicare Trustees Report from 2016 (for 2006) and 2018 (for 2011 and 2016); Part B annual National Summary Files; OPPS Final Rules from 2008, 2013, and 2018. Percent changes reported are annually over the five-year periods shown. Net payments exclude beneficiary cost-sharing.

Potential reforms looming on several paths

Currently, there are separate
House and Senate bills to reform Part B drug pricing, but the bills are
distinctly different, and the two legislative chambers have not yet shown much
inclination to reconcile their differences. If drug pricing legislation passes
this year, it will likely be part of a spending bill that will have to be voted
on by both houses of Congress by late May. That creates a small window of
opportunity in the coming months for some drug pricing reforms to be made by

Even if Congress doesn’t act,
the Trump Administration has signaled it may take regulatory steps to reform
Part B pricing. Currently, three measures are under consideration.

  • Currently, doctors and hospitals are paid 106%
    for the price of Part B drugs. The first administration proposal would
    eliminate the 6% mark-up. Instead, there would be a flat fee paid for a
    particular category of drug. That would eliminate the incentive doctors have to
    use a brand-name drug and could allow for wider use of generics and biosimilar
    drugs. This change could bring significant cost savings for Medicare.
  • The second initiative would be to drive doctors
    and hospitals out of the business of buying and storing large quantities of
    drugs, which they can then get at significant discounts off the cost of the
    drug while they’re still getting reimbursed from Medicare for 106% of the cost.
  • The third measure would be to still pay the 106%
    reimbursement, but not at the U.S. price. Instead, the payment would be based
    on the average of prices for each drug in various developed markets outside of
    the United States.

While the third proposal would
likely be opposed by Republican legislators, who generally prefer more market-based
solutions to problems, it is in line with President Trump’s oft-stated goal to
introduce more fairness across international markets. Currently, US drug prices
average about 150% of the cost of drugs in international markets. That means the
United States is currently funding pharmaceutical companies’ research and
development. Bringing U.S. prices in line with the rest of the world might
ultimately force international markets to share more of that cost.

Time will tell how much
political appetite there is to get reforms for Part B drug pricing reforms passed
through Congress during an election year. But an interesting change in recent
years has been that pharmaceutical companies are not just targeting Republicans
with lobbying and campaign financing support. They are focused on Democrats as

Interest in drug pricing
reform does seem to be widespread, perhaps because it impacts such an important
constituency. The average American is taking four prescription drugs. The
heaviest users of prescription are people in older age brackets – a segment of
the population with a large percentage that gets out and votes.

Recognizing the investment implications

With our portfolio, the
Invesco Oppenheimer Fundamental Alternatives Fund, we look to provide financial
advisors and investors with an option to diversify and counter the risks of the
equity markets. We aim to participate in up markets but also mitigate risk in
down markets. We have the potential to do that because we can go long or short
on equities, credit or broad economies.

By being able to go short, we
can potentially benefit from sectors and securities that are facing challenges,
while also taking long positions on countries, sectors and companies with
promising prospects.

One of the current themes
we’ve been investing in is the changing structure and potential reforms in the
health care sector. That has been in response to legislative action and the increased
focus on providing affordable healthcare to broader segments of the population.
The impact of Part B reforms is part of our health care theme. We looked at
companies that have high exposure to Part B and found a number have additional
issues that could drive down their stocks’ value. Many of their profits are
concentrated because they offer only a small number of high-priced drugs. Some
are facing increased competition as other companies enter their market or their
patents expire, and much less expensive generics and biosimilars can be

One of these companies markets
a drug to treat age-related macular degeneration and other eye disorders. This
drug was the single largest Part B drug expenditure in 2017 (the most recent
year for which data is available). Medicare paid 1.6 times more for the drug
than its price in the basket of international countries. If the international
market basket reform had been implemented, Medicare would have saved about
$1.06 billion, or 48% of its expenditures on just this one drug.

Another of the largest biotech
companies could also be seriously affected by Medicare Part B drug pricing
reform because it has four drugs that rank in the top 20 of Medicare Part B
drug expenditures. One of them can counter the impact of chemotherapy on white
blood cell levels. The US price of the drug is 3.6 times more than the
international average. Medicare could have saved $950 million in 2017 if it had
paid the international basket price.

For two other drugs marketed
by this firm, which are used to treat bone complications related to
osteoporosis and breast cancer, Medicare paid 4.8 times more than the
international basket price in 2017. It could have saved $850 million if the
international average price had been used as the basis for reimbursements.

Change likely to be a matter of when, not if

Europe may provide a sense of
what the future of the US pharmaceutical drug market could look like. Biosimilars
for a major brand-name drug  that is used
to treat arthritis, psoriasis and other conditions currently have a 67% share
of the European market. In the US, the biosimilars have only a 11% share. If
the incentives to prescribe higher-priced drugs are removed in the US market,
doctors and physicians will begin prescribing the lower-priced alternatives
more often.

The Trump Administration is
focused on reforming drug pricing for portions of the market and there are a
few avenues that it could take. Passing legislation in Congress during an
election year may prove difficult. However, the scale of savings that could be
realized from Part B reforms may drive the administration to act on its own.
We’re looking to provide investors with the potential to benefit when it does.

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