In a Move Designed to Benefit Patients, the President Signs an Executive Order to Pass Drug Manufacturer Rebates Directly to Medicare Part D Patients

Wilson Sonsini Goodrich & Rosati

Recently, the President issued an executive order (EO) for the purpose of ensuring that discounts offered on prescription drugs be passed down to patients. The subject matter of EO represents a key plank of a platform to 1) ensure that patients who need drugs can get them with little to no out-of-pocket costs; and 2) to ensure that pharmaceutical companies—drivers of innovation, creators of jobs, and a net U.S. export industry—can continue on their important mission to bring innovative new medicines to patients.

To understand the purpose and importance of the EO, it is helpful to understand certain key players in U.S. drug distribution and payment system in the U.S., and how rebates, at multiple levels, contribute to higher patient costs. The key players are outlined in the diagram below:

Diagram Overview

The diagram outlines the: key players (in black), drug distribution path (in red), a key contract (in blue), key payments (in green), and two key actions which counter each other to patient detriment (in purple). Reference to the diagram will be made, as appropriate, in the following discussion.

Problems with PBMs and Insurance Companies

Insurance companies hire pharmacy benefits managers (PBMs) to negotiate rebates, also known as discounts, from drug companies. Normally, a discount is applied at the point of sale (think of a 20 percent off coupon for a gallon of orange juice that is applied at checkout in a grocery store). Rebates in the drug industry work differently, to the benefit of PBMs and insurance companies, and to the detriment of drug companies and patients.

Drug companies are in the business of selling drugs. Drug sales are influenced to a large extent by whether an insurer will reimburse the drug prescribed to its patient beneficiaries. If insurers decide to cover a particular drug for their beneficiaries, this will likely result in a high volume of drug sales.

A. Rebates From Drug Companies Are Not Passed Along to Patients

Insurance company decisions on which drugs to reimburse are partially driven by law, and partially driven by the price the insurance company pays for each drug. This is where PBMs come in. PBMs negotiate directly with drug companies on behalf of insurance companies (see Pays PBM to Negotiate Rebates in the diagram) (see also Negotiates Rebates in the diagram) to obtain rebates from the drug companies. The rebates, which occur after purchases by patient beneficiaries, have the effect of lowering each drug's price paid by insurers.

For example, if a drug costs $1,000 for a course of therapy, and a PBM is able to negotiate a 40 percent rebate, then the actual cost of the drug is theoretically $600. This could, for example, be a good thing IF the rebates were passed along directly to patients OR if the rebates resulted in proportionately lower insurance premium prices. Unfortunately, neither of these is generally the case.

PBMs are paid at least twice for negotiating rebates (see Negotiating Rebates in the diagram) for insurance companies. PBMs first get paid by insurance companies to negotiate rebates. (see Pays PBMs to Negotiate Rebates in the diagram). PBMs also get paid by negotiating with the insurance company to retain a percentage of the rebate the drug company pays (see Drug Cos Pay Rebates to PBMs and PBM Pays Portion of Rebates to Insurance Companies in the diagram).

B. PBM Negotiations Result in Higher Drug List Prices Hurting Patients and Drug Companies

In this scheme, higher drug list prices typically result in a greater rebate dollar amount. Because PBMs are paid a percentage of the total dollar amount of any rebate, PBMs want larger total rebate dollars, so PBMs encourage drug companies to charge higher drug list prices. Remember that PBMs can steer insurance companies toward or away from reimbursing for a drug and can also determine where any drug is placed in a drug formulary.

For example, assume a drug's list price is $10,000 for a course of therapy. Assume the PBM contracts with the insurance company to keep 20 percent of any rebate amount it negotiates with a drug company, and the PBM negotiates a 40 percent rebate from the drug company. Then for a $10,000 drug list price, the drug company pays a $4,000 rebate, of which the PBM keeps $800 and pays the insurance company the remaining $3,200.

But what if the drug company, without prompting from the PBM, originally wanted to charge a $6,000 list price for the drug? In this example, the PBM negotiated 40 percent rebate would amount to only $2,400 (instead of $4,000), of which the PBM would retain $480 (compared to $800) and pass along the remaining $1,920 to the insurance company. Summed over a high drug sales volume, the PBM in this example could lose tens of millions of dollars, and the list price of the drug would be $4,000 less for a course of therapy.

C. Ways in Which Higher Drug List Prices Hurt Patients

Why is this scheme bad for patients and drug companies? First, because the rebates are generally not passed along to the patients, resulting in higher drug and insurance prices. Second, most insurance plans require co-pays, which are typically a percentage of the drug's list price; or require the patient to pay the full list price until a certain deductible level is reached. In either case, a higher drug list price—favored by the PBM—means insured patients pay more than they should for drugs—especially in the co-pay period. Third, some patients do not have insurance. For these patients, the higher drug list price can result in significantly more out-of-pocket drug expense. Finally, the higher drug list prices make it appear that drug companies are gouging patients, when in fact PBMs and insurance companies are significant contributors to high drug list price.

D. How Insurance Companies Use Higher Drug List Prices to Enrich Themselves at Patient Expense

And insurance companies, to maximize profits, often make the situation worse. For example, what if an insured patient—because of a deductible—has to pay full price for a medication whose list price is $10,000 and does so through insurance? In many cases, that medication still counts as an insurance drug purchase. So, the drug company, seeing the purchase, will issue a rebate (e.g., $4,000) which goes directly to the PBM and the insurance company, even though the insurance company did not pay for the medication.

Also, what if the drug company instead assists the patient by providing a form of payment—perhaps in the form of a discount—so that the drug is available to the patient at reduced or no cost (see Provides Patient Assistance in the diagram) until the patient's deductible has been met? Insurance companies, looking to pay out as little as possible, have imposed co-accumulator provisions (CAPs) on patients. The CAP, in essence, makes sure that any assistance provided to the patient by the drug company does not count towards the patient's deductible or co-pay.

The EO

Earlier, the administration published a proposed rule in the Federal Register to redirect rebates away from PBMs and insurance companies to patients (see here). Post publication, the administration announced it was withdrawing the proposed rule. At the time, the Congressional Budget Office (CBO) projected that implementing the proposed rule would have "increased federal spending by about $177 billion over the 2020-2029 period."

The EO recites it is now moving forward with the proposed rule, in relevant part, and instructs that the Secretary of Health and Human Services (HHS) shall complete the rulemaking process seeking to:

a) exclude from safe harbor protections under the anti-kickback statute, section 1128B(b) of the Social Security Act, 42 U.S.C. 1320a-7b, certain retrospective reductions in price that are not applied at the point-of-sale or other remuneration that drug manufacturers provide to health plan sponsors, pharmacies, or PBMs in operating the Medicare Part D program; and

b) establish new safe harbors that would permit health plan sponsors, pharmacies, and PBMs to apply discounts at the patient's point-of-sale in order to lower the patient's out-of-pocket costs, and that would permit the use of certain bona fide PBM service fees. (Emphasis added.)

In essence, the EO orders the Secretary of HHS to a) remove safe harbor protections for portions of rebates kept by PBMs and insurance companies under Medicare Part D; and to b) establish new safe harbors to redirect those rebates to patients at the point of sale. Perhaps mindful of the earlier CBO estimate, the EO also requires the Secretary of HHS to "confirm—and make public such confirmation—that the action is not projected to increase federal spending, Medicare beneficiary premiums, or patients total out-of-pocket costs." Whether, if, and how this will be possible remains to be seen. Based on the CBO's early cost projections, this will require a creative solution from the Secretary.


The EO, if implemented, would be a game changer for at least PBMs, insurers, and patients under Medicare Part D. We expect to see legal challenges mounted to the EO, and caution that the EO may be cancelled or withdrawn in the event of a change of administration in November. If the EO is successful in its objective, we would reasonably expect to see legislation introduced which would broaden the redirection of rebates outside of Medicare Part D. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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