Prescription drug prices are one of the biggest drivers of rising health care costs. To address this issue, the Trump administration issued its Executive Order on Lowering Prices for Patients by Eliminating Kickbacks to Middlemen (the “Order”) on July 24, 2020. The Order is in fact the latest chapter in a saga over drug prices that has been going on for several years and which had culminated in February 2019 with a proposed rule by the United States Department of Health and Human Services (“HHS”) which aimed to rewrite the existing Anti-Kickback Statute (“AKS”) safe harbor for discounts (“Discount Safe Harbor”). Specifically, the rule proposes to eliminate the protection of rebates provided by pharmaceutical manufacturers to Medicare Part D prescription drug plan (“PDP”) sponsors and their pharmacy benefit managers (“PBMs”) and shift those discounts to consumers at the point of sale. The Order directs HHS to finalize the proposed rule but requires that the final rule not “increase Federal spending, Medicare beneficiary premiums, or patients’ total out-of-pocket costs.”[1] Questions remain, however, as to whether HHS has the legal authority to carry out the Order and, if it does, whether it can do so in a manner that will not increase costs. This article provides a background on the legal issues surrounding HHS’s approach to the use of rebates by pharmaceutical manufacturers, then addresses the February 2019 proposed rule in light of the Order, and concludes with a discussion of future considerations.

Pharmaceutical Manufacturer Rebates and Medicare Part D.

Currently, PDP sponsors negotiate discounts with pharmaceutical manufacturers in exchange for placement of a manufacturer’s drugs in the plan’s formulary. These negotiations are typically administered by PBMs, and these discounts often take the form of a percentage-based rebate to the PBM based on the volume of drugs used by the PDP’s beneficiaries. The percentage for the rebate is based on the wholesale or “list” price of the drug. The PDP’s payments to pharmacies dispensing the drug, and consequently the beneficiary’s cost-sharing amounts, i.e., deductible credit, co-pay and co-insurance, are also based on the list price because the rebate is not paid to the PBM until after the beneficiary receives the drug. As a result, the rebates do not reduce beneficiaries’ out-of-pocket costs at the pharmacy counter. PBMs may pass a portion of the rebate on to the PDP sponsors to reduce spending and associated premiums, but PDP sponsors have expressed concern over a lack of transparency which limits their ability to leverage the rebates to lower costs. Moreover, PBMs are often compensated based on the size of the rebate, but not necessarily on lower net drug prices (i.e., list price minus rebate). Thus, PBMs are incentivized to negotiate higher rebates and manufacturers are incentivized to raise list prices in order to maintain comparable net prices. The increase in list prices raises overall drug spending and patient cost-sharing amounts.

The AKS and Discounts: Safe Harbor and Exception.

The current AKS Discount Safe Harbor can be found at 42 C.F.R. § 1001.952(h). To understand the safe harbor, a brief overview of the AKS is necessary. The AKS makes it a criminal offense to knowingly and willfully offer, pay, solicit, or receive any remuneration, directly or indirectly, to induce or reward referrals, purchases, leases, recommendations or orders of items or services reimbursable by a Federal health care program.[2] The statute covers any arrangement where “one purpose” of the remuneration is to obtain money for the referral of services or to induce further referrals.[3] Current rebate practices described above where pharmaceutical manufacturers pay rebates to PBMs in return for placement on PDP formularies implicate the AKS.

Violation of the AKS can lead to criminal prosecution resulting in fines, prison and exclusion from Federal health programs.[4] It can also lead to administrative enforcement including penalties and potential exclusion from Federal health programs.[5] Finally, a violation of the AKS can lead to civil liability under the False Claims Act (“FCA”) for treble damages, penalties and costs.[6]

HHS’s Office of Inspector General (“OIG”) is responsible for enforcing the AKS. In this role, the OIG promulgates regulatory safe harbors that define practices that, when followed completely, protect a party from prosecution under the statute.[7] A financial arrangement does not have to satisfy a regulatory safe harbor in order to comply with the AKS, however. In fact, the OIG has found on several occasions that an arrangement which did not meet the requirements of a safe harbor should nevertheless not result in liability under the statute.[8]

The OIG issued the Discount Safe Harbor in 1991. At that time, the OIG stated the safe harbor was “intended to encourage price competition that benefits the Medicare and Medicaid programs.”[9] The safe harbor defines the term discount as “a reduction in the amount a buyer (who buys either directly or through a wholesaler or a group purchasing organization) is charged for an item or service based on an arms-length transaction.”[10] A discount may “take the form of a specified price break, or the inclusion of an extra quantity of the item purchased ‘at no extra charge.’”[11]

In 1999, the OIG revised the Discount Safe Harbor. The final rule clarified the definition of “rebates” as discounts that are set forth in writing at the time of the purchase, but are not given to the purchaser until later.[12] In addition, the revised safe harbor requires that participants to the discount arrangement must meet certain disclosure and notification requirements which depend on the participant’s place in the arrangement (offeror, purchaser, seller) and ensure that the benefit of the discount inures to Medicare or other Federal health program.[13]

The AKS also has a statutory exception for discounts (“Discount Exception”).[14] The Discount Exception protects “a discount or other reduction in price obtained by a provider of services or other entity under a Federal health care program if the reduction in price is properly disclosed and appropriately reflected in the costs claimed or charges made by the provider or entity under a Federal health care program”.[15] The OIG takes the position that the Discount Exception only applies to arrangements that comply with the Discount Safe Harbor.[16] This view is not necessarily shared by the courts.[17] The OIG does not have the authority to take action contrary to the AKS’s statutory provisions.

Proposed Rule.

On February 6, 2019, the OIG issued proposed revisions to the Discount Safe Harbor (the “Proposed Rule”). According to the OIG, the Proposed Rule is intended “to update the discount safe harbor to address the modern prescription drug distribution model and ensure safe harbor protections extend only to arrangements that present a low risk of harm to the Federal health care programs and beneficiaries.”[18] Citing concerns that the current system of drug manufacturer rebates to PDP sponsors (directly and through PBMs) leads to higher costs for patients and Medicare, creates improper incentives for placement of drugs on PDP formularies, and diminishes competition, the OIG concluded that “the current system works to the disadvantage of beneficiaries, and the Federal health care programs.”[19]

The Proposed Rule excludes from Discount Safe Harbor protection all reductions in price and other remuneration from pharmaceutical manufacturers to PDP sponsors, Medicaid Managed Care Organizations (“Medicaid MCOs”) and PBMs unless such remuneration is required by law.[20] The Proposed Rule also includes a new safe harbor which would protect drug manufacturer rebates if the rebate is (1) set in advance; (2) paid in full to the pharmacy through one or more chargebacks;[21] and (3) completely reflected in the price the pharmacy charges to the patient at the point of sale.[22]

The OIG makes clear its position that these revisions do not mean the rebate practices at issue are protected under the current version of the Discount Safe Harbor.[23] For example, the OIG does not consider PBMs to be “buyers” under the Discount Safe Harbor, so any rebate, or portion thereof, retained by a PBM and not passed on to the PDP sponsor would not qualify for protection. The OIG also states that it does not believe such practices are protected by the statutory Discount Exception.[24]

According to the OIG, it received approximately 26,000 comments to the Proposed Rule.[25] Many, including from the American Benefits Council, cite data from the Centers for Medicare and Medicaid Services Office of the Actuary (“CMS OACT”), to note that the Proposed Rule will lead to increased Medicare Part D premiums.[26] Likewise, the Pew Charitable Trusts, also citing CMS OACT, noted in a letter to the Senate Special Committee on Aging that the Proposed Rule is likely to increase both Medicare Part D premiums and overall Medicare spending on prescription drugs.[27] Other comments, including from the Pharmaceutical Care Management Association, noted the OIG’s lack of legal authority to revise the regulatory Discount Safe Harbor in a manner that conflicts with the statutory Discount Exception.[28]

The Order.

The Order underscores these two challenges to the Proposed Rule. With respect to the Order’s requirement that any final rule not increase Medicare costs, PDP premiums, or beneficiary out-of-pocket payments, Medicare’s own estimates demonstrate that the Proposed Rule cannot meet this condition. Specifically, the elimination of discounts at the PDP level, both directly and through PBMs, is estimated to raise Medicare spending on prescription drugs and with it Medicare Part D premiums.[29]

In this regard, it is important to note that the Order reflects a shift in the Government’s perspective on discounts. Since the institution of the Discount Safe Harbor in 1991, the OIG’s position has been that discounts are favored because they lower costs to Medicare and other Federal health programs. The Order, however, states that the policy of the United States is “that discounts offered on prescription drugs should be passed on to patients.” This shift in priorities creates tension because the framework of cost-sharing for prescription drug charges under Medicare Part D means that a reduction in the patient’s out-of-pocket cost does not necessarily decrease, and may in fact increase, the PDP sponsor’s cost. Specifically, as noted above, removal of any discount at the PDP level will directly increase the amount PDP sponsors spend on prescription drugs. Furthermore, PDP advocates note that significantly reducing beneficiary cost-sharing amounts – through realization of the full discount at the point of sale – will increase utilization which in turn will increase Medicare costs and PDP premiums.[30] As a result, a final rule will likely not be able to meet the Order’s requirements unless it allows PDP sponsors to receive discounts, including rebates, from pharmaceutical manufacturers.

With respect to legal challenges, shifting the goal of the AKS to protect patient out-of-pocket spending rather than Federal health program spending undermines the Discount Exception which the OIG has no authority to change. In this regard, a final rule that completely eliminates any ability of PDP sponsors to receive discounts from pharmaceutical manufacturers risks being ignored as parties rely on the Discount Exception or overturned as overreaching the OIG’s authority.

The Discount Exception could protect the type of rebates currently provided by pharmaceutical manufacturers to PDP sponsors and PBMs. As noted above, a financial arrangement does not have to satisfy a regulatory safe harbor in order to comply with the AKS. Notably, however, neither PDPs nor PBMs existed in 1977 when the Discount Exception was written into the AKS. As a result, neither is mentioned in the text of the exception and there will likely be vigorous legal disputes over whether Congress intended to protect these arrangements. In this regard, the OIG has stated its position that the Discount Exception does not protect this practice. Disputes in this context will likely arise over whether discounts under the current rebate practice are “appropriately reflected in the costs claimed or charges made by the provider or entity under a Federal health care program.”[31] There is currently no case law interpreting the Discount Exception which provides insight on this and other questions that will come up if parties cannot rely on the Discount Safe Harbor.

For that reason, opponents of the Proposed Rule challenge the OIG’s authority to eliminate pharmaceutical manufacturer rebates from the Discount Safe Harbor. In this regard, HHS has had an uneven record in the courts with recent administrative actions. For example, the Supreme Court of the United States struck down the Center for Medicare and Medicaid Services’ (“CMS”) revisions to Medicare Part A disproportionate share reimbursements.[32] Similarly, HHS has met with resistance in Federal court over its recent final regulations implementing the anti-discrimination provisions of the Affordable Care Act (“ACA”) because they remove protections for transgender patients.[33] On the other hand, the Supreme Court recently approved the Health Resources and Services Administration’s (“HRSA”)[34] expansion of the exemption for private employers with religious or moral objections to opt out of the ACA’s birth control requirements.[35] Each of these cases was decided based on its own facts and the particular statute at issue, and so a deep understanding of the legal underpinnings for the opinions is essential to determining their impact on the Proposed Rule.

Future Considerations.

In order to meet the requirements of the Order, the OIG will likely need to revise the Proposed Rule. In this regard, the OIG may continue to target potentially abusive practices while preserving legitimate financial incentives that reduce costs for patients, PDP sponsors and the Medicare Part D program. For example, critics of the current practice of awarding percentage-based volume rebates in exchange for formulary placement complain that it reduces access to prescription drugs and corrupts the decision-making process regarding which drugs are available to PDP beneficiaries. A final rule that excludes protection for volume-based rebates while implementing safeguards for formulary integrity could achieve the AKS’s goals and satisfy the conditions of the Order. Similarly, allowing rebate arrangements that reduce PDP premiums along with patient cost-sharing, and require documentation of premium reductions, could also serve the purposes of both the AKS and the Order. Finally, the OIG may consider coordinating a revised or new safe harbor for discounts with the current proposed safe harbors for value based arrangements.[36]

Regardless of the OIG’s final action, it will likely face legal challenges. These challenges will be determined in the context of recent precedent setting the boundaries of agency rulemaking authority and will hopefully shed light on the extent of the Discount Exception. If current trends in this regard continue, the elimination of rebates in the Medicare Part D context has a long, drawn out and potentially losing battle ahead.