On Jan. 30, 2020, the Centers for Medicare & Medicaid Services (CMS) announced the new Healthy Adult Opportunity (HAO) initiative through a State Medicaid Director letter, accompanied by a press release and fact sheet. One significant result of the initiative is that it will allow states to limit drug coverage under Medicaid without reducing manufacturer rebate obligations.

The HAO initiative offers states a different Medicaid funding approach, sometimes referred to as “block grants.” A major aspect of that approach will be permitting states to create a closed formulary for certain populations not covered under the state Medicaid plan, thereby excluding drugs from Medicaid coverage. This will have potentially significant consequences for Medicaid patients and their treating providers, as states may exclude from coverage a broad universe of drugs that historically have been covered under Medicaid. Additionally, such a closed formulary will have significant implications for pharmaceutical manufacturers. Despite not receiving mandatory Medicaid coverage for all their covered outpatient drugs, CMS expects that pharmaceutical manufacturers enrolled in the Medicaid Drug Rebate Program (MDRP) will remain obligated to pay Medicaid rebates on drugs available under the limited formulary.

According to CMS, the HAO initiative offers “new opportunities” for states to alter their Medicaid program design. Under the HAO initiative, states may pursue demonstrations under Section 1115(a)(2) of the Social Security Act (the “Act”) that enable them “to provide cost‑effective coverage using flexible benefit designs under either an aggregate or per‑capita cap financing model for certain populations without being required to comply with a list of Medicaid provisions identified by CMS.”

Potential breach of a Medicaid Drug Rebate Program“grand bargain”?

The Section 1115(a)(2) demonstrations that states may submit to CMS for approval can include a “closed formulary” for populations not covered under the state Medicaid plan. State Medicaid programs may thereby offer narrow formularies, akin to those offered in commercial health insurance markets, subject to comparable limitations. According to CMS, states that implement such a closed formulary will not be subject to the general MDRP requirement to cover all covered outpatient drugs of manufacturers enrolled in the MDRP. Nevertheless, CMS asserts that manufacturers that participate in the MDRP will remain subject to their Medicaid drug rebate obligation for any covered outpatient drugs that state Medicaid programs dispense or administer to the demonstration population.

Relieving states of their MDRP coverage obligation but continuing to subject manufacturers to their MDRP rebate obligation is unprecedented and represents a departure from previous CMS guidance. In 2018, CMS denied Massachusetts’ request for a “one-sided” waiver of its MDRP coverage obligation under section 1115 of the Act. CMS explained in its denial letter that it would not grant a waiver to permit a closed formulary unless the state fully forgoes the applicability of the MDRP within the state – including its entitlement to rebates. The agency stated in that case that, if it were to grant a waiver to Massachusetts, the state could negotiate directly with manufacturers and have flexibility to establish a closed formulary, but that the state would not be entitled to MDRP rebates with respect to individuals receiving drug coverage under the demonstration. 

CMS’s asserted legal basis for a closed formulary

Under the HAO initiative, the agency justifies its closed formulary policy by reference to the same legal authority underlying the contemplated demonstrations.

Under Section 1115(a)(2) of the Act, CMS must determine that a demonstration project is “likely to assist in promoting the objectives of [the Medicaid program].” CMS explains that, in its view, the open formulary requirements under the MDRP apply only to Medicaid state plan coverage of prescription drugs. The agency asserts that, because prescription drug coverage for the demonstration population will not be provided under the state Medicaid plan, but rather under a demonstration, such open formulary requirements of Section 1927 do not apply. At the same time, the agency reasons that a manufacturer that participates in the MDRP still has a rebate obligation for any covered outpatient drugs that are dispensed or administered to the demonstration population.

CMS states that “Section 1115(a)(2) provides that expenditures made under its authority are to be ‘regarded as expenditures under the State plan,’” so “the requirement in section 1927(b) of the Act to pay rebates on drugs ‘for which payment was made under the State plan’ would apply, even though the drugs would not be covered under the state plan, and the beneficiaries would not be regarded as eligible under the state plan” (emphases in original). CMS notes that “expenditures under section 1115(a)(2) of the Act are treated as ‘expenditures under the State plan’ for other purposes as well (e.g., in calculating disproportionate state hospital (DSH) payments.” CMS also advises that states are free to negotiate supplemental rebates with manufacturers in exchange for inclusion of the manufacturers’ drugs on these state formularies, and that states wishing to continue to meet the coverage requirements under the MDRP “would be free to do so.”

CMS advises that under the HAO initiative, states can apply for demonstrations that involve populations not covered under a state Medicaid plan, with a focus on adults under age 65 who qualify for Medicaid on a basis other than disability or need for long-term care services and supports, including individuals in the Medicaid expansion population (i.e., patients who received Medicaid coverage because the state opted to expand Medicaid under the Affordable Care Act). Demonstrations under the initiative “also could be used to extend coverage to populations a state has previously covered in its state plan or under other section 1115 demonstrations, but for which the state has elected to end coverage.” Notwithstanding this language from CMS, the HAO initiative appears likely to reduce the number of Medicaid beneficiaries, as well as the scope of available drugs and other benefits.

Open questions

It remains to be seen how states will respond to the initiative and how many demonstrations, including those featuring closed formularies, will be submitted to CMS for approval. Tennessee submitted a Section 1115 waiver to CMS in November 2019 that remains pending and, if approved, would permit the state to establish a closed formulary – seemingly through a formal waiver of the applicability of Section 1927’s requirements. It also is unclear whether CMS’s purported legal basis for suggesting that MDRP rebate obligations would apply will be subject to challenge. An effort by one or more states to move forward in pursuit of a closed formulary in connection with the HAO initiative could have significant implications for manufacturers that participate in the MDRP, as well as for Medicaid beneficiaries and their treating health care providers – and, we expect, will trigger scrutiny.