Medicare Part D premiums have been flat in recent years but will increase by 13 percent from 2015 to 2016. For 2016, the average monthly premium across Part D plans (PDPs) is $41.46. PDPs are also increasingly placing high-cost drugs on specialty tiers within formularies, which require patients to pay as much as 33 percent of the cost of these medications.

Given these rising costs, a growing number of policymakers believe the government, through the Secretary of Health and Human Services (HHS), should be allowed to negotiate drug prices in Medicare Part D. Eighty-three percent of the public supports allowing the government to negotiate with drug companies for a better deal on Medicare drug prices. However, federal law currently prohibits the government from negotiating with the pharmaceutical industry to lower the cost of drugs purchased under Medicare Part D. Instead, PDPs are required to negotiate directly with pharmaceutical manufacturers to obtain rebates and other discounts on drugs.

Proponents of government negotiation argue that HHS—because of its significant purchasing power—can more effectively negotiate drug prices than individual Part D plans. Opponents argue that allowing the government to negotiate prices for Part D would inhibit innovation and limit beneficiary access to medications.

In order to advance the debate on the appropriate role, if any, for HHS in Medicare Part D pricing negotiations, it is essential to understand what it means for the government to “negotiate” drug prices.

Potential Scope Of Negotiations

Before HHS could negotiate drug prices in Medicare Part D, policymakers would first need to define the scope of the government’s authority by considering these questions:

  • Which drugs would HHS have the authority to negotiate?
  • Would HHS be able to negotiate both the price of drugs and formulary design?
  • Would the negotiated terms apply to all Part D plans?

Which Drugs Would Be Negotiated?

Policymakers could choose either to specify the scope of HHS’ negotiating authority or to leave it to HHS to determine which drugs to negotiate. For example, HHS could be given the authority to select a drug to enter into the negotiation process based on its total cost to Medicare and/or based on a year-over-year price increase in excess of a predetermined threshold

Another key factor could be whether a drug has therapeutically equivalent substitutes, including generic drugs or other branded medications that produce similar patient outcomes. Some evidence suggests that PDPs effectively negotiate lower drug prices for medications that have substitutes.

It can be more difficult for PDPs to negotiate lower prices for drugs that do not have substitutes, such as those that are either first-in-class or superior to drugs in an existing class. The lack of competition for these medications presents a price-negotiating challenge for PDPs, which may face pressure from patients to cover them and are limited by regulation from excluding drugs from coverage.

What Is Being Negotiated?

Another important consideration is whether HHS would negotiate solely the price of drugs or, instead, both the drug price and formulary placement. Giving HHS broader authority over formulary design, such as the ability to give drugs preferred status on a formulary (e.g. requiring a lower patient copay), could enhance its ability to obtain discounts from manufacturers.

Would HHS Negotiate For All PDPs?

Lastly, HHS would have to decide how to implement its negotiated prices. One option would be to set the negotiated price as a ceiling for all PDPs, which would then retain the ability to negotiate even lower prices with manufacturers.

Another option would be for HHS to create a new Medicare-sponsored Part D drug plan that would compete against private PDPs, as has been previously proposed. Drug prices for private PDPs would still be determined by each PDP’s negotiations with drug manufacturers. The opportunity for cost savings would depend on the government-sponsored plan’s ability to provide coverage more efficiently than private plans and whether there would be increased competition among PDPs with the addition of a new public option.

The Negotiation Process

A mechanism would also need to be created for negotiations to take place between HHS and drug manufacturers. Congress could, in theory, grant the Centers for Medicare & Medicaid Services (CMS) the authority to set the price of drugs or require manufacturers to give PDPs a certain discount on their medications. These approaches, however, would be different from a “true” negotiation between Medicare and drug companies, in which the two parties enter into a predefined process to reach a mutually beneficial outcome. One model for such a true negotiation process was proposed by economist Richard Frank before he became the HHS Assistant Secretary for Planning and Evaluation in 2014.

Frank proposed that the government and manufacturers be given a set period to negotiate a price. If they were unable to come to an agreement, the parties would enter into binding arbitration led by an independent arbitrator who, after considering the arguments of both sides, would choose between their best-and-final offers. An alternative model is tri-offer arbitration, in which the arbitrator selects a third price named by an independent expert.

With either model, Frank argues, the arbitrator would need additional “fact-finding” support from experts, such as the Congressional Budget Office (CBO), to help arrive at a decision based on the expected break-even price, the market size of a drug’s indication, research and development costs, and the incremental benefit of the drug relative to its cost.

Additional Details Needed

Under an arbitration model, policymakers would also need to select a pricing framework to guide arbitrators in their decision-making, including how different types of evidence and other considerations ought to inform conclusions on drug price. For example, an arbitrator could take into account evidence of clinical benefit and the impact of drug pricing on future pharmaceutical innovation. How the pricing framework incorporates such criteria would inform the negotiating positions of the government and drug manufacturers

Estimated Cost Savings Of HHS Price Negotiations

In 2007, CBO estimated that there would be a “negligible effect” from allowing HHS to negotiate Part D drug prices if there were a ban on a federally required formulary. So the government’s ability to pressure drug companies to lower their prices depends on the additional authority to establish formularies or take other regulatory action. To date, there is no CBO estimate on the effect of allowing HHS to negotiate both drug prices and formulary placement

Researchers have also concluded that the federal government could save $15.2 billion to $16 billion annually if it negotiated with drug manufacturers and achieved the same prices as those paid by Medicaid or the Veterans Health Administration (programs that receive mandatory rebates on drug prices). Other researchers have suggested that Medicare would save $541 billion over 10 years if prices were negotiated down to the levels paid for prescription drugs by consumers in Denmark.

However, these analyses assume that the prices obtained from negotiations would equal those obtained in other federal or state programs or by international payers. Without additional information on the scope of HHS’ negotiating authority, including which drugs are selected for negotiations and the extent to which HHS would be able to negotiate on both price and formulary placement, it is unclear whether similar cost savings could be achieved for Medicare Part D.

Next Steps

Any proposal advocating for an HHS role in Medicare Part D price negotiations must include details on the scope of the government’s authority as well as the mechanism for negotiating drug prices. Important considerations, such as what is being negotiated (e.g., prices and/or formulary placement) and what to do if the negotiating parties are unable to come to agreement, need to be specified. A pricing framework to guide an arbitrator in determining the price of drugs is also needed to facilitate the negotiation process and capture the relevant factors that would be considered in determining the appropriate price for a drug.

Author’s Note

The Pew Charitable Trusts has taken no position regarding government negotiation of drug prices in Medicare Part D. The authors’ intent is to outline considerations for federal policymakers and regulators as they address the issue.