How the price increase penalty on generic drugs will affect manufacturers

The latest pricing structure shift from Medicaid won’t be the destruction of the generic industry. But drug manufacturers will be impacted and need to take steps to comply with the proposed regulation.

Background on the Medicaid pricing program and its rebate system

The Medicaid pricing program was initiated in 1965. The initial legislation and subsequent amendments:

  • Enacted mandatory rebates to be paid to state Medicaid organizations;
  • Mandated that the best possible price be given to state Medicaid organizations;
  • Allowed states to negotiate additional rebates to be paid on drugs.

The mandatory rebate is often the choice between either a flat rebate (23% of the Average Manufacturer Price (AMP)) or the price difference between the AMP and the best price given to any other organization.

In addition to any flat rebate, drug manufacturers are required to provide an inflation-adjusted rebate to government organizations to protect government payers from dramatic price increases. This additional rebate is calculated by comparing the quarter AMP of the drug to the baseline AMP (determined by release date of the drug). If that quarterly AMP is in excess of the baseline AMP plus inflation, the manufacturer must provide a rebate in that amount.

Until recently, these rebates were not required of generic drug manufacturers.

Background on the price increase penalty

The most recently implemented update to the generic drug pricing structure comes from the Bipartisan Budget Act of 2015 (BBA).

The Bipartisan Budget Act of 2015 (BBA) Sec. 602 required generic drug manufacturers to join manufacturers of single-source or innovator drugs in paying state Medicaid rebate programs for price increases over inflation.

Until this act, rebates on generic drugs were calculated to be AMP minus 13% of AMP. After the BBA rebate calculation took effect in early 2017, these rebate calculations were adjusted to be calculated by taking the AMP and subtracting the total of 13% of AMP plus the product’s Consumer Price Index (CPI).

The new proposed legislation

The new originally had language surrounding price increase penalties. While these items were removed from the final legislation, it’s more than fair to anticipate that further measures will be enacted within the next few years.

Looking forward, bills like H.R.5150 – Protecting Medicare from Excessive Price Increases Act of 2018 have been put forth. This bill is aiming to “require drug manufacturers to pay Medicare part B rebates for certain drugs if the price increases faster than inflation”. While this iteration of the legislation does not specifically call out generic drugs, it is likely that since these additional penalties will be applied to generics on top of what the BBA has implemented.

Implications for drug manufacturers

The ramifications, both short and long term, are open to speculation, but changes are certain. There are considerations that manufactures need to bring attention to given the introduction of this legislation.

The most apparent and important change is the rebate that manufacturers are mandated to now provide to the states, based upon price increases over inflation. This will directly impact manufacturer processes (for example, requiring adjustments to current reporting processes).

Because of the Baseline AMP value requirement for the BBA regulations, two new pieces of information are required for Drug Data Reporting (DDR) to Medicaid. These new pieces are the BBA ’15 Base AMP and the BBA ’15 Base AMP Quarter. There has been some recent clarification on special cases for these new requirements, and more are sure to come out with time.

While the infrastructure for these additional price reportings may be in place, generic manufacturers will be forced to enact calculation and process changes to accommodate for these new price types. These process changes may already be in place for companies who are also involved in innovator and single-sourced drug manufacturing, but for those dedicated to making generics, the act of putting formal processes into place (and continuing to adapt them as new legislation comes out) is a potential challenge.

Operational changes are sure to follow with these pieces of legislation. Manufacturers should take into consideration the resources required to analyze the business impact, train the relevant employees, and adapt any existing systems (or update if necessary) to be in compliance with the guidelines.

Fiscal considerations

In conjunction with the above administrative impact, it’s also important to discuss and analyze the fiscal considerations. Frankly, this legislation can and will make profit margins tighter – more money is being paid out than before.

It’s true that in the last few years, generic drug prices have been increasing. In some cases, dramatically. But the money made in the pharmaceutical industry is spread out. There are many different entities involved in facilitating the creation, manufacture, distribution, and sale of products. Each and every entity along the way receives compensation for these actions, and the increase in entities in the pharmaceutical process has only meant that fewer and fewer dollars are being returned to the manufacturers themselves. These new laws may make the returns on individual drugs smaller as time goes on.

Another fiscal consideration for manufacturers is the possibility of not being able to cover manufacturing costs. In the last few years, one of the biggest concerns plaguing generic drug manufacturers is the ever-decreasing availability of key ingredients. These shortages are one of the factors driving prices upward, which were not taken into consideration when price increase penalties were implemented.