Can States Regulate Prescription Drug Costs? Questions and Answers About NASHP’s Rate-Setting Model Legislation

The National Academy for State Health Policy’s (NASHP) has crafted model legislation – called the Prescription Drug Rate-Setting Model Act – that states can use to regulate drug costs. The legislation creates a drug cost review commission that evaluates the affordability of certain drugs in the same way that states now regulate Medicaid, state employee health care costs, and public utilities to protect consumers.

These questions and answers explore issues that arise as state leaders consider rate setting as a legislative strategy to manage drug costs. More information about NASHP’s model legislation is found here. 

Question 1: Why would a state set up a drug cost review commission?
Question 2: Can a single state regulate its drug costs?
Question 3: How is rate setting different than imposing drug price controls?
Question 4: What is a reimbursement or payment rate?
Question 5: How would state reimbursement rate setting help patients?
Question 6: Would rate setting apply to all drugs?
Question 7: What happens if a manufacturer refuses to sell a particular drug in a state because of rate regulation?
Question 8: What happens to the current system, where manufacturers negotiate rebate deals that lower costs to payors?
Question 9: Does statewide, drug rate setting create a single, statewide list of drugs that all state and commercial insurers will cover (called a formulary) that leaves consumers with no choice?
Question 10: How would rate setting affect pharmacies and wholesalers?
Question 11: Why does the model bill that establishes a drug cost review commission fail to mention anything about the “value” of drugs?
Question 12: Won’t creation of a drug cost review commission result in patent law challenges?
Question 13: Won’t a drug cost review commission result in legal challenges under the US Commerce Clause?

Question 1. Why would a state set up a drug cost review commission?
The United States has the highest prescription drug prices in the world. It spent $457 billion on prescription drugs in 2015, or 16.7 percent of overall personal health care spending.[i] For employers, retail prescription drug spending represents 21 percent of benefit costs. These costs are only projected to rise — the price for branded (brand-name) drugs rose 14.8 percent in 2015.[iii]

Affordability of vital prescription drugs is a growing problem for patients, health insurers, and state and local governments. To date, the federal government has not acted to make drugs more affordable. States, however, have a policy window to step in and develop innovative approaches to manage drug costs.

Because drug costs involve many complicated issues affecting numerous stakeholders, including state and commercial insurer budgets and consumers, a drug cost review commission that has the authority to establish drug payment rates would be able to examine the affordability of certain drugs and address affordability concerns.

Rate setting for health care and other public goods has existed for many decades. State employee benefit programs and Medicaid already set rates for most covered health care services, including prescription drugs. All commercial health plans also set payment rates for health care service and products. More broadly, states also regulate important public goods and services in markets with little or no market competition, and drug manufacturers often exert monopoly power in ways that may decrease access to life-sustaining medications. A drug cost review commission would build on the various regulatory precedents for drugs that have only a few suppliers, mitigating a particular market failure in health care that seems to grow worse over time.

Question 2: Can a single state regulate its drug costs?

Yes, an individual state can regulate how much health plans and other payors will reimburse for drugs and what consumers pay. While controlling the prices manufacturers set for their drugs is more challenging and legally complicated based on existing court decisions, payment rate setting is well-established. As a result, NASHP’s prescription drug rate-setting model bill would regulate what is paid for certain drugs within a state by various payors – not what manufacturers charge for drugs. Managing health care costs through rate setting is a fundamental state function in all states. All states set how much they will reimburse for every health care service and product covered by their Medicaid programs and their state employee health insurance programs. This includes maximum allowable cost rates for generics and off-patent brand drugs and other payment limits for patent-protected brand drugs. Private insurers also set limits on what they pay for health services.

Like all other examples of health care rate setting, a commission’s drug rate setting would put some pressure on the wholesalers and distributors to negotiate better deals with manufacturers. Rate setting promotes cost-consciousness and helps lower both payor costs and consumer costs.

Question 3: How is rate setting different than imposing drug price controls?

Price controls limit what a supplier can charge for a product or service. Payment or reimbursement rates establish what the purchaser or payor will pay. A commission has authority to consider many economic factors when it determines what payors (such as state Medicaid programs, insurers, or providers who purchase drugs to administer in their practices) pay for a product. Under a drug cost review commission model, the commission would examine the cost a drug would impose on the health system and set payment rate limits that apply throughout the state health care system – from distributors to doctors, pharmacies, hospitals, insurers, and consumers.

Health care reimbursement rate setting, which regulates how much insurance payors or state programs pay or reimburse providers for health care generally, and drugs in particular, is an old, well-tested practice. Commercial and employer health plans, also routinely set health services and drug payment rates. State programs and health care payors step in to set rates when markets don’t work well. Arguably, prescription drugs are a public good and new drugs start out as monopoly markets – with just one producer. It can take a decade before a drug loses its patent protection and becomes a more affordable generic. While patented (brand-name) drugs can and do benefit society, the high costs that patent holders sometimes impose can harm patients, decrease access, and strain state and commercial insurer budgets.

Question 4: What is a reimbursement or payment rate?

Payors (including commercial health insurers, and federal and state government health programs) set payment rates for drugs, often called “upper payment limits” or “maximum allowable cost” payment limit programs. For generic drug payment formulas, the price of the drug’s brand-name and generic competitors are all factored into a formula to come up with a payment that is an average of all the prices. If the brand-name drug is prescribed and purchased by a consumer, the payor pays only the upper payment limit, which is usually less than the brand-name drug’s list price.

Medicare Part B sets the reimbursement rate for all physician-administered drug products it covers and the manufacturer list price does not matter in Medicare’s formula. The reimbursement rate for a drug is the average of all sales (discounted) prices (ASP) in the market and is unrelated to the manufacturer’s list price. By definition, the ASP is lower than the highest prices paid for the drug in the market and is certainly below the manufacturer’s list price. Yet, the ASP is the basis of the Medicare reimbursement rate to physicians for a Part B-covered drug.

Another variation on rate setting involves Medicare payment for biosimilars. Biosimilars are akin to generics but because they are biologics and are not manufactured chemicals, they cannot be identical to the original product in the same way that a generic pill is. A biologic is derived from living organisms rather than manufactured chemicals. Biosimilars are currently reimbursed at one rate by Medicare for all biosimilars that treat the same disease and are based on the same original biologic — regardless of the price of any individual biosimilar drug in the group.

Other examples of drug rate setting include insurers’ inpatient hospital reimbursement rates. These all-inclusive rates that apply to a patient’s hospital stay may or may not cover the full price of all elements of that inpatient stay – including drugs. Under Medicare, a new drug that is extraordinarily expensive may be covered outside of the all-inclusive rate, but the hospital is only reimbursed 50 percent of the drug’s cost for first three years the drug is on the market — until average costs are factored into the payment bundle.

The list price, or even any one price for a drug, is not a key factor in current drug payment rate setting. A drug cost review commission would follow the strong tradition of health care rate-setting, which has historically improved access to health care by protecting consumers against escalating costs, and working to slow down health care cost growth.

Question 5: How would state reimbursement rate setting help patients?

Patients purchasing drugs at a pharmacy point of service would pay the state commission-established rate for their drugs. Drugs would cost less for everyone, including the uninsured, the insured people during a deductible period, and for people paying coinsurance. And, when what insurers pay for drugs decline, there is less pressure on insurance premiums, which also benefits consumers.

Question 6: Would rate setting apply to all drugs?

No. Rate setting would only apply to drugs that are very costly and create affordability challenges for a state’s health care system. NASHP’s model act defines drugs that might be subject to rate setting as:

  • New brand-name drugs that cost more than $30,000 per year or per course of treatment or brands that increase in price by more than 10 percent over a 12-month period; or
  • New generic drugs that cost more than $3,000 per year or generics that have price increases exceeding 25 percent over a 12-month period.

The thresholds that trigger cost reviews can be modified to meet a state’s specific needs.

Question 7: What happens if a manufacturer refuses to sell a particular drug in a state because of rate regulation?

It is unlikely that a manufacturer would refuse to sell a drug in a state that regulates drug reimbursement rates. There is already ongoing public and private reimbursement rate regulation that impacts brand-name and generic drug products across the marketplace – directly or indirectly. The pharmaceutical industry has never refused to sell drugs in those programs. In practice, the industry does not like to exit a market because it creates ill will and lost revenue — even if the revenue is less than it would be without rate setting. In most cases, other manufacturers with therapeutically-similar drugs would quickly gain market share in their competitors’ absence. Rate setting may actually benefit manufacturers because if insurer and consumer costs decline, more patients can afford the drugs and sales will increase.

Question 8: What happens to the current system, where manufacturers negotiate rebate deals that lower costs to payors?

This NASHP model drug-rate setting legislation does not limit rebates or other price concessions negotiated between payors and manufacturers. Rebates and other price concessions would certainly continue for drugs that do not come under-rate setting jurisdiction. For high-priced drugs affected by commission rate setting, the rebate mechanism could easily continue alongside commission-established rates. The real change is that more of the front-end financial transactions between wholesalers and pharmacies, pharmacies and customers, pharmacies and insurers, would be based on the rate set by the commission. This front-end effect is important to ensure that all patients and consumers benefit from the lower cost. Rebates and other back-room price deals are not visible to patients and consumers — whereas rate setting is transparent and benefits more patients and consumers directly.

Question 9: Does statewide, drug rate setting create a single, statewide list of drugs that all state and commercial insurers will cover (called a formulary) that leaves consumers with no choice?

No. State drug reimbursement rate setting would not limit or otherwise dictate what drugs are available to patients and prescribers. What drugs are covered and how they are covered would remain the decision of each health insurer and state health program – just like today. A commission would not make value and coverage decisions.

The commission would only look at drugs that create affordability challenges in the state. Then, it would consider how to address those affordability challenges so more people would have access to important medicines.

Question 10: How would rate setting affect pharmacies and wholesalers?

There should be little or no effect on standard operating procedures in the regular drug distribution system. For decades, drug manufacturers have distributed their drugs through different market channels and each drug’s price (after rebates and other discount deals) is different in different channels. One example is the mandatory federal discount 340B program, where the manufacturer sells at Medicaid-level prices direct to safety net providers who serve uninsured or low-income patients. This is an example of a market that gets a drug at a price substantially lower than the list price, and the drug goes to the exact customers who need those specific low prices. Manufacturers even provide additional discounts to some entities in the 340B program. That’s an example of a distribution channel with distinct markets and specific price concessions that exists today.

For drugs subject to state rate setting, a similar effect would occur. Pharmacies would not segregate drugs that are regulated by the commission from drugs that are not regulated by the state. There would be only one payment rate for a drug that the commission has acted on. The wholesaler would have to negotiate with the manufacturer for a price that allowed the wholesaler and others in the chain of ownership to not lose money when distributing or dispensing the drug.

Alternately, the manufacturer would approach sales that reach the state to be another 340B-type of program and manage it in a similar manner. Managing these types of sales is already built into manufacturer business models.

Question 11: Why does the model bill that establishes a drug cost review commission fail to mention anything about the “value” of drugs?

The bill requires a state’s drug cost review commission to consider costs and affordability rather than “value.” The concept of value is highly subjective. There is no national consensus about how to translate value. Instead, the model act leaves the value assessment to payors as they make their drug coverage decisions.

Question 12: Won’t creation of a drug cost review commission result in patent law challenges?

A federal appeals court has held that drug price-setting by states violates the rights of a patent holder, but a state’s drug cost review commission is not regulating price, it is regulating payment – which Medicare, Medicaid, and the private sector already do. This is familiar territory in terms of health care financing policy and law. Additionally, the bill provides confidentiality protections to all proprietary health industry information provided to the commission to ensure protection of trade secrets and patent-holder rights.

Question 13: Won’t a drug cost review commission result in legal challenges under the US Commerce Clause?

The Commerce Clause prohibits state laws and policies that place a significant burden on the interstate commerce of a company. This act would not fall under the purview of the clause.

First, it is important to note that the drug industry is wildly complicated. Operating procedures for different markets and different products even within a single company can vary widely. Currently, one drug product can have many markets, market net prices, distribution channels depending on the market, complex and multiple rebate strategies, and complex and multiple patient assistance discount programs – again, all for one drug. And that’s all by choice of the manufacturer.

Given the very complex business model that manufacturers now use by choice, experts do not expect that a traditional rate setting review process for a small number of drugs would create a significant burden rising to the level of violating the Commerce Clause.

In fact, rate setting fits right into the industry’s business model – drugs sold in a state become just another distinct market and distribution channel – much like a manufacturer’s 340B or specialty drugs. Also, each state already sets rates for drugs in its Medicaid and other programs

For more information, contact Jane Horvath, jhorvath@nashp.org

[i] ASPE “Observations on Trends in prescription Drug Spending.” March 8, 2016. Accessed online.

[ii] Cox, C. Anthony Damico, Gary Claxton, Larry Levitt. “Examining high prescription drug spending for people with employer sponsored health insurance.” Peterson-Kaiser Health System Tracker. October 27,2016. Accessed online.

[iii] Dennis, B. “Prescription Drug Prices jumped more than 10% in 2015, analysis finds.” January 11, 2016. Accessed online.