California prescription drug purchasing initiative raises numerous questions

On January 7, 2019, hours after taking office, California Governor Gavin Newsom signed an Executive Order creating an initiative to “create the nation’s biggest single purchaser system for drugs. ...”1 The proposal contemplates that the state would negotiate with manufacturers on behalf of its Medicaid (Medi-Cal) program, other state purchasers such as the California Public Employees’ Retirement System (CalPERS), and private purchasers electing to opt in to the purchasing program, to strengthen their bargaining power and “make prescription drugs more affordable for all.”2

Specifically, the Executive Order requires the following:

• The California Department of Health Care Services (DHCS) shall “take all necessary steps to transition all pharmacy services for Medi-Cal managed care to a fee-for-service benefit by January 2021 in order to create significant negotiating leverage on behalf of over 13 million Californians and generate substantial annual savings.” Accordingly, the Governor apparently intends to carve out the pharmacy benefit from California Medi-Cal managed care plans and have Medi-Cal provide that benefit directly.
• DHCS, in consultation with the Health and Human Services Agency and California Pharmaceutical Collaborative (CPC), “shall review all State purchasing initiatives and consider additional options to maximize the State’s bargaining power....” This review “may include recommended changes in state law or current processes for procuring and reimbursing for pharmacy services.” This review is to be completed by July 12, 2019.
• The Department of General Services (DGS), in cooperation with CPC, “shall develop a list of prescription drugs that could appropriately be prioritized for future bulk purchasing initiatives or reexamined for potential renegotiation with the manufacturer.” Prioritization must be based upon, among other things, “the price of the drug and the extent to which the drug is subject to competition, such as a sole-source drug without a generic or alternative option.” The list of prioritized drugs is to be delivered to the Governor by March 15, 2019, with a brief rationale for why any of the 25 highest-cost drugs have not been included.3
• Based on the prioritized list, DGS, in consultation with CPC, “shall develop and implement bulk purchasing arrangements for high-priority drugs.” DGS is directed to encourage local governments to participate, and provide a written status report on the effort to the Governor by April 12, 2019.
• DGS, in consultation with CPC, shall “develop a framework for enabling ... private purchasers—including small businesses, health plans, and the self-insured—to opt in to a State purchasing program.” If appropriate, DGS “should recommend legislative changes to make prescription drugs more affordable for all.” DGS must provide a written report to the Governor by May 17, 2019.

This initiative could have significant ramifications for pharmaceutical manufacturers, managed care companies, pharmacies and other industry participants, as well as for consumers of prescription drugs. It also raises numerous important legal and policy questions, including the following:

• How will the new arrangement work? While described as “bulk purchasing,” it appears that the arrangement is focused on negotiation of prices with manufacturers (rather than with pharmacies), and the Executive Order makes specific reference to DHCS’s negotiation of supplemental Medicaid rebates with manufacturers under Medi-Cal. As such, it appears most likely that the program would be implemented primarily through negotiation of rebates from pharmaceutical manufacturers.
• Would DHCS really be able to negotiate better rebates for Medi-Cal than managed care organizations? Under federal law, manufacturers already must pay “statutory” Medicaid rebates on Medicaid prescription drug utilization, whether covered under a Medicaid managed care plan or a state fee-for-service program. However, states can also attempt to negotiate “supplemental” Medicaid rebates with manufacturers, paid by manufacturers on a voluntary basis, and Medicaid managed care organizations (or their pharmacy benefit managers (PBMs)) can similarly attempt to negotiate rebates in addition to the statutory rebates. Notably, states’ principal leverage for negotiating supplemental rebates is their ability to require prior authorization before a given drug is covered by their Medicaid program; under federal law, they generally cannot exclude drugs from coverage, establish different formulary cost-sharing tiers, or use similar tools available to non-Medicaid commercial health plans. As such, it is not clear that DHCS – despite negotiating for an additional 11 million Medi-Cal covered lives – will be able to negotiate greater supplemental rebate rates than those it receives today, or than Medi-Cal managed care plans currently receive through their PBMs. Indeed, many of the most expensive drugs may already be prior authorized – a control that DHCS might be unwilling to remove in exchange for rebates.
• Is the program permissible under federal law, and if so, does it require Trump Administration approval? California is not the first state to try to use its negotiating leverage under Medicaid to negotiate rebates on non-Medicaid drug utilization. Most notably, during 2000–2003, Maine’s “Maine Rx” program for uninsured patients contained such a requirement; if manufacturers did not agree to pay rebates on Maine Rx prescription utilization, their drugs would be subject to prior authorization under the Maine Medicaid program. The Supreme Court considered this in PhRMA v. Walsh, 538 U.S. 644 (2003). While the Court did not strike down the Maine program at the stage of the litigation presented to the Court (ruling on a motion for preliminary injunction), its decision was based upon four separate opinions from six justices concurring in the judgment on varying rationales. Significantly, there was no consensus on whether permissibility was dependent upon a Medicaid-related benefit or harm, or on whether it would be determined or influenced by the view of the Secretary of Health and Human Services (HHS) upon remand. Following the Supreme Court decision, Maine decided not to implement the program, and consequently, these issues were not resolved. Similarly, the program envisioned would most likely require HHS approval of a state plan amendment and/or a Medicaid waiver; the Trump Administration may refuse or resist granting any such approval.
• Are changes in California law required? The Executive Order provides that the reports to the Governor to be completed by May 17, 2019 and July 12, 2019 should identify “recommended” changes in California law to implement the program. Given the scope of the changes contemplated (including, but not limited to, inclusion of private purchasers in the program), it is highly questionable whether the Newsom Administration can implement everything contemplated in the program without additional statutory authorization. As such, the next major development relative to the initiative may be consideration of statutory changes by the California legislature. While the legislature is controlled by Democrats, the numerous issues and details associated with the Governor’s plan make the timing, substance and outcome of any legislative changes a major question mark.
• Is the initiative permissible under the antitrust laws? Under the state action immunity doctrine, states may generally engage in conduct that would violate the antitrust laws if undertaken by private actors. However, the program could be challenged as not entitled to state action immunity in light of its express purpose that California would act as a market participant to negotiate lower drug prices for private purchasers. If no immunity applies, there is the potential for a violation of federal antitrust laws, depending upon the details of how the program is structured and operates. For example, if the program enhances the state’s purchasing power so vastly as to potentially give it monopsony power in the marketplace, it could implicate Sherman Act Section 2.
• How would “the self-insured” receive the benefit of the negotiated discounts? The Executive Order states that the program framework “should incorporate the opportunity for private purchasers—including small businesses, health plans, and the self-insured—to opt in to a State purchasing program.” If “the self-insured” is intended to refer to uninsured individuals (as opposed to self-insured health plans), how would they receive the benefit of any discounts negotiated by the state? One potential might be a new program under which California pharmacies dispensing prescriptions for cash (that is, without third-party coverage) would submit a claim to a state program for partial reimbursement to reduce the amount payable by the patient at the point of sale, funded by rebates paid under the program – similar to what Maine Rx contemplated. However, such a program would involve decisions on numerous details, such as who would be eligible to participate and how they would enroll, and whether the state would provide funding for pharmacy reimbursement amounts to be paid to pharmacies prior to the program’s receipt of rebates from manufacturers.
• Other issues. The foregoing list only scratches the surface of the myriad issues raised by Governor Newsom’s proposal. Other major questions include how state reimbursement to Medi-Cal managed care plans would change if the drug benefit is carved out and the impact on pharmacy reimbursement of moving the Medi-Cal pharmacy benefit to a fee-for-service program. Similarly, it is not clear whether or what mechanisms would exist to coordinate discounts under the new program with the many existing prescription drug discount, coverage and access programs, including manufacturers’ patient assistance programs, the federal 340B program, and existing private insurance coverage. Moreover, there may be a significant potential for the program to affect drug pricing outside of California, particularly to the extent private employers can opt into it for their employees outside of California, and/or through drugs delivered via mail order – potentially raising constitutional Commerce Clause issues. More generally, there are numerous potential grounds for legal challenges by various parties – including but not limited to those noted in this client alert – and the timing and outcome of any such litigation is highly unclear. Finally, assuming the program is implemented, it is far from clear that the contemplated savings from manufacturers will be realized, and it is entirely possible that the state’s drug costs could actually increase if the rebates negotiated by the state are less than those that Medi-Cal managed care plans would be able to obtain through their PBMs.

Consequently, Governor Newsom’s new initiative raises numerous questions. We may very well only be in the first inning, relative to knowing if, how and when the contemplated program will be implemented. Even so, the potential ramifications for industry and consumers are significant, and we expect a high degree of evaluation and engagement as the program develops.