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JKHPpeat Marwick POLICY ECONOMICS GROUP ISSUES RELATED TO THE FEDERAL GOVERNMENT DRUG PAYMENT POLICIES IN THE REFORMEDHEALTH CARE ENVIRONMENT FINAL REPORT This is acompetitively awarded contract, awarded in responseto RFPNo. HCFA-94-036/PK. ISSUES RELATED TO THE FEDERAL GOVERNMENT DRUG PAYMENT POLICIES IN THE REFORMED HEALTH CARE ENVIRONMENT FINAL REPORT Principal Investigator: DAVTD J. GROSS, Ph.D. HCFA Contract Number: 500-93-0031 ContractAmount: $128,288 Project Director: KathrynLangwell Prepared for: Health Care FinancingAdministration OfficeofResearch and Demonstration Jay Bae, Ph.D. Project Officer , 6325 Security Boulevard MD Baltimore, 21207 Submitted by: KPMG Peat MarwickLLP Policy Economics Group M 2001 Street, N.W. Washington, DC 20036 September 14, 1995 EXECUTIVE SUMMARY The impact of federal prescription drug pricing policies on the pharmaceutical market is an issue that has been long debated and has gone long unresolved. The federal government has a major role in the market as the largest single payer for prescription drugs (through Medicaid) as well as a large direct purchaser of drugs (through VA and DoD programs). In addition, the federal government has over the years considered a number of policies that would expand access to prescription drugs or restrict the way that prices and reimbursements are set for both public and private sector prescription drug purchases. The debate on comprehensive health reform increased the importance of understanding the impact federal prescription drug pricing issues. Even in the absence of federally legislated health reform, it is important to realize that the federal government's drug payment policies can affect the types ofreforms that are being driven by managed care in the private sector, and can have an impact on the operation of competitive forces in the pharmaceutical sector. The evaluation of federal drug payment policies requires a recognition that the federal government has different and often conflicting concerns that influence its choices ofprescription drug payment policies. These concerns include: • containing costs ofdrug benefit programs, including Medicaid. Department of Defense programs, and veterans" drug benefits • expanding access to drug therapies by increasing levels of prescription drug coverage (which are much lower than for hospital care and physician services) and by increasing consumer affordability ofprescription drugs • promoting competitive forces in the pharmaceutical sector, and minimizing the impact of federal drug payment policies in hindering the effectiveness of private drug cost containment efforts, and • encouraging the development ofcost effective new products and promoting an atmosphere in which prescription drug manufacturers can maintain their world leadership in the pharmaceutical research and development. In issuing its request for this study, the Office of Research and Demonstrations (ORD) of the Health Care Financing Administration (HCFA) noted the absence of a conceptual framework for evaluating the impact of federal drug payment policies on the pharmaceutical market. Most of the economics and policy literature on the effects of federal drug payment policy focuses on a particular element of the prescription drug sector. Although federally-driven comprehensive health reform is no longer on the immediate policy agenda, the importance of analyzing these factors within a single framework has not diminished. Current federal prescription drug payment policies, as i well as any that might be considered in the future, will affect a market that is currently undergoing major changes. The Office of Research and Demonstrations of the Health Care Financing KPMG Administration contracted with the Policy Economics Group of Peat Marwick to: (1) conduct a comprehensive study of work pertinent to Federal Government drug payment policies; (2) develop a theoretical model of the prescription drug market, capturing the effects ofFederal Government drug payment policies on the overall market for prescription drugs; and (3) assess the appropriateness of current or alternative mechanisms for prescription drug payment, including an analysis of various economic incentives that current and proposed policies and drug benefits create for different players in the prescription drug market. Background Legislative History ofPrescription Drug Payment Policies While federal involvement in the regulation of prescription drugs dates back to the 1938 (with the passage of the Federal Food, Drug and Cosmetic Act), the federal government took no direct role in drug pricing and reimbursement until the 1960s. The first federal prescription drug benefit was implemented through the Medicaid program which, since its 1965 inception, has included prescription drug coverage as an optional benefit for states. In 1967, 37 states included prescription drug coverage for Medicaid beneficiaries. This number has gradually increased so that, by 1992, all state Medicaid programs had some type ofoutpatient drug benefits (Gondek, 1994). In contrast to its role in Medicaid, outpatient prescription drug coverage was not originally part ofthe Medicare program. Several efforts were made to include this benefit in the years following the introduction of Medicare. In 1968, President Johnson's Task Force on Prescription Drugs recommended the incremental adoption of a Medicare outpatient prescription drug benefit (Kudrle and Lennox, 1980). However, the Task Force's recommendations were not adopted; nor was a 1972 effort to add a similar drug benefit. During the 1970s, Congress considered several comprehensive health reform and national health insurance proposals which would have increased access to prescription drugs. Three major bills considered in the mid-1970s~the 1974 Nixon-Ford Comprehensive Health Insurance Plan (CHIP), the 1974 Comprehensive National Health Insurance (Kennedy-Mills>Act, and the 1976 Health Security (Kennedy-Corman) Act- all included prescription drug coverage. However, prescription drug coverage was far less generous in the comprehensive reform proposals that were considered in the late 1970s. The Health Care for All Americans (Kennedy-Waxman) Act of 1979 included a drug benefit only for elderly people suffering from chronic illnesses. President Carter's proposed National Health Plan included no prescription drug benefits. ii Along with efforts to expand access, the 1970s also saw the first federal efforts to restrict prescription drug costs in the Medicaid program. The Maximum Allowable Cost/Estimated Acquisition Cost (MAC/EAC), developed in 1975, set the maximum reimbursement limit for purchases under Medicaid at the estimated acquisition cost plus a dispensing fee. The program was designed to ensure reasonable pharmacist profits and encourage low cost substitution. In the 1980s, prescription drug access and availability were broadened by two major pieces of legislation, one of which was repealed before taking effect. The Orphan Drug Act of 1983 gave drug manufacturers tax credits and exclusive marketing rights as incentives for developing drugs with small patient populations that might not otherwise be profitable. The 1988 passage ofthe Medicare Catastrophic Coverage Act was the first major expansion ofhealth care benefits passed by Congress since 1965. This legislation added an outpatient prescription drug benefit to the Medicare program, with costs controlled through shared costs (a $600 deductible in 1991), reimbursement based on average wholesale price, and a computerized drug utilization review system. The prescription drug benefit was scheduled to start in 1990, but the law was repealed in 1989 before implementation. Federal prescription drug policies in the 1980s and early 1990s focused more on pharmaceutical cost containment initiatives than on expanding prescription drug benefits. In 1984, the Drug Price Competition and Patent Restoration (Waxman-Hatch) Act changed the cost containment focus from regulation to a reliance on market forces by reducing FDA requirements for generic drug approval. Under the Waxman-Hatch Act, generic drug producers no longer needed to prove safety or efficacy to obtain FDA approval, but were required only to show bioequivalence to originator drugs. The regulation also authorized patent life extensions for patented drugs of up to five years to compensate for regulatory delays, with a maximum effective patent life of 14 years. With the passage ofthe Omnibus Budget Reconciliation Act of 1990 (OBRA '90), the federal government adopted new regulatory cost containment strategies to reduce OBRA Medicaid payments to drug manufacturers. '90 mandated a manufacturer rebate agreement on all Medicaid purchases of prescription drugs. The rebate is based on the best price and the average price charged by drug manufacturers to all customers. Since OBRA '90, these rebates have cost drug companies an estimated $1.5 billion a year (Guenther, 1994). OBRA '90 also placed limits on state prescription drug payment regulations. It originally banned formularies and prior authorization for newly approved OBRA drugs. (These provisions were revoked in '93.) It also limited states' prior approval response time to 24 hours and required state Medicaid programs to conduct drug utilization review (DUR).. The Veterans' Health Care Act of 1992 had even stronger discount requirements than OBRA '90. It required that the prices for Veterans' Affairs (VA) and Department of Defense (DoD) contracts be discounted to inflation-adjusted 1990 levels. Manufacturers iii