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Here's Why Big Pharma Loves This Plan to Lower Drug Prices

Cory Renauer, The Motley Fool

The White House is currently mulling a proposal that could slash list prices on branded drugs. If you find that hard to believe, this next one will make your head explode: We can expect Big Pharma to put a lot of weight behind this proposal's passage.

The Health and Human Services Department (HHS) recently submitted a plan that could block the rebates that keep expanding the rift between listed drug prices the smaller sums that companies such as Merck & Co. (NYSE: MRK)Eli Lilly (NYSE: LLY), and Johnson & Johnson (NYSE: JNJ) actually collect. Regulating these rebates could be a huge win for drugmakers and consumers. Here's what you need to know.

EKG made of pills with a big heart.

Image source: Getty Images.

Worse than you probably imagined

Drugmakers make themselves awfully unpopular when they raise prices on branded drugs each year, and the industry's claim that entities between consumers and their products are at fault makes a lot more sense now than it did just a couple of years ago. 

Government-run health schemes generally negotiate prices with drugmakers as a single entity, but not in the United States. Instead, insurers hire, and acquire, pharmacy benefits managers (PBMs) to negotiate on their behalf. These PBMs wrangle discounts and rebates from the world's drugmakers in return for placing their high-priced drugs on affordable copay tiers.

In recent years, insurers have been supplementing premiums by charging copay percentages on list prices that have accelerated way past the net prices drugmakers realize. According to IQVIA, a healthcare analytics provider, the chasm between list and net prices on branded drugs rose to $153 billion in 2017.

The practice has become so bothersome to Johnson & Johnson, Merck, and Eli Lilly that all three broke protocol and shared some disturbing figures that show the practice is getting out of hand.

Company

Average Discount to List Price in 2013 Average Discount to List Price in 2017 List Price Change in 2017 Net Price Change in 2017
Merck & Co.  32% 45% 6.6% (1.9%)
Johnson & Johnson  N/A 42% 8.5% (-4.6%)
Eli Lilly 30% 51% 9.7% 6%

Data source: company presentations.

The average total discount that Merck provides has surged from an arguably generous 27% in 2010 to a whopping 45% last year. Lilly enjoyed a reprieve in 2017, but its list price raises exceeded realized net price increases by 10.2% in 2014 and 12.6% in 2016. 

Why it could happen

Nothing changes quickly in healthcare, but big pharma stock investors will be happy to know that the Trump administration can probably make this happen. Anti-kickback laws aimed at curbing corruption and organized crime are specifically relaxed when it comes to everyday drug pricing practices. Rescinding exemptions that make rebates possible won't go over well with the PBM industry, but the proposal in front of the Trump administration doesn't require any new legislation to make its way through Congress. 

Details of the HHS proposal aren't available yet, but its title, "Removal of Safe Harbor Protection for Rebates to Plans or PBMs Involving Prescription Pharmaceuticals and Creation of New Safe Harbor Protection," sounds like music to the ears of pharmaceutical companies tired of receiving negative publicity despite lowering net prices.

The pharma industry traditionally defends its right to charge any price it sees fit, so it's been shocking to see that RocheNovartisBayer, and Merck KFaA have pledged not to raise drug prices for the rest of the year following a similar agreement Pfizer made with the president earlier this month. I'm sure all these pricing pledges are just benevolent acts on behalf of corporations that realized how grateful they are at the same time, but that doesn't mean their collective action won't ease the HHS proposal's passage.

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Image source: Getty Images.

What to look for

As far as we know, the proposed rebate regulation isn't anything more than a descriptive title at the moment, and I imagine details concerning new safe-harbor regulations are still being hashed out. Following recent promises to limit price increases by the world's largest pharmaceutical companies, though, it looks as if the days of escalating rebates are coming to a close.

Tighter regulation of rebates could be a big step toward the sort of drug pricing transparency that consumers crave. America's largest insurer, UnitedHealth Group Inc., acquired its own PBM years ago, which allowed it to begin passing some rebates from drugmakers directly to its customers earlier this year.

Amazon.com has taken several steps into the healthcare arena, the most recent of which gave it licenses to distribute drugs throughout all 50 states. Nobody's quite sure how the online retail giant will shake up the way Americans shop for prescription drugs, but more pricing transparency could accelerate the process.

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Cory Renauer owns shares of Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. The Motley Fool has a disclosure policy.