Roundtable: Deficit Reduction Act

November 1, 2006
Pharmaceutical Executive

Volume 0, Issue 0

The Deficit Reduction Act was designed to save the government money on Medicaid. But it also has the potential to change the very way pharma companies conduct business-if they can just figure it out.

Last year it was the Medicare Modernization Act. This year, a rash of state-level laws aimed at limiting pharma marketing. And next year? As things stand today, the most disruptive, confusing, and impossible-to-comply-with regulations will be the ones springing from the Deficit Reduction Act (DRA) of 2005, signed into law by President Bush this past February. Framed as a way to squeeze costs out of Medicaid, the law promises instead to bring a new level of transparency to pharma pricing by requiring monthly reports, and publication, of a newly redefined Average Manufacturers Price (AMP), which will be used by Medicaid to calculate both rebates paid by pharma companies and reimbursements paid by the government.

It's an ambitious undertaking—all the more so since the Centers for Medicare and Medicaid Services (CMS), in the 16 years since Medicaid came into existence, has been unwilling or unable to define AMP. And the new law gives reason for worry. It removes the prompt-pay discounts granted to wholesalers from the calculation of net price—though there is no word yet on just what CMS thinks is or isn't a wholesaler. It requires monthly reports to be filed within two months—though for most companies, the data for the report are not available for five or six months. It requires originator companies that have authorized generics to calculate their AMP using data from the generics partner that legally they should have no access to. And, of course, it creates a new array of legal threats for pharma companies that don't live up to the Office of the Inspector General's (OIG) expectations in complying.

The first round of DRA changes go into effect in January 2007, and a guidance from CMS is due in July. That means forward-looking companies are already analyzing their data systems and thinking about business processes for complying with DRA. To understand what they're thinking, we conducted a roundtable discussion with industry experts, consultants, and others. What follows is an edited transcript of the conversation.

THE LAY OF THE LAND

PATRICK CLINTON (EDITOR, PHARMACEUTICAL EXECUTIVE): What is the government hoping to accomplish through the Deficit Reduction Act?

MICHAEL HEPBURN (CONTROLLER, GOVERNMENT CONTRACT COMPLIANCE, ORTHO-MCNEIL JANSSEN): Deficit reduction. They're looking at healthcare costs in general and trying to find ways to reduce the budget, and trying to find where you get that money. You have manufacturers, you have the government, you have consumers themselves. And then you have the input of interest groups like manufacturers, national retailers, pharmacies. The struggle we're starting to see is around trying to craft a policy that satisfies everyone and which can actually be implemented.

Christopher Zant Accenture

CHRISTOPHER ZANT (PARTNER, ACCENTURE): I think another big piece of it is the perception of taking action. Healthcare is politically charged. It's important to the political process to take steps that appear to control cost, or change utilization of products, or manage how the industry behaves.

BILL SHRIGLEY (GOVERNMENT COMPLIANCE SPECIALIST, ENVISION): One goal is to steer us away from using Average Wholesale Price as a basis for reimbursement. There's been so much criticism and so many problems with AWP—yet it is still widely used by the state Medicaid agencies.

HEPBURN: The government is trying to use that single number for both reimbursement and rebates, when it was originally designed only as a rebate mechanism. And that's not an easy thing to do. Historically, the Medicaid rebate was based on AMP—average manufacturer's price—and best price. Reimbursement was tied to AWP. I think everybody agrees AWP was inflated. Now they're trying to find a reimbursement mechanism that more closely approximates pharmacies' costs.

Conceptually, AMP was based on the retail class of trade. The thinking was that if this number is based on retail pharmacies, then perhaps we can use it to calculate the appropriate reimbursement for what these pharmacies pay. But when you start to peel apart the layers of what goes into that number, it may not be adequate reimbursement or it may not be appropriate.

SHRIGLEY: OIG always looked at the use of multiple prices as a disconnect. In other words, you base your reimbursement on average wholesale price. But you pay the rebate based on average manufacturer price. There's really no relationship there.

Stephen Zocchi Model N

CLINTON: One of the goals of the DRA legislation is to standardize the reporting of pricing. But there's nothing in the law, or in the guidelines, that actually gives you the tools to standardize pricing, even if you wanted to.

ZANT: The existing guidances don't set steadfast guidelines for what the calculations mean. And they're not simple. At even the simplest level, you're taking sales in and out of the calculation, you're considering customers or not considering them. There are so many dynamics that haven't been well defined.

STEPHEN ZOCCHI (VICE PRESIDENT OF MARKETING, MODEL N): Coming back to the question of what [DRA] means to the manufacturers, it's not only the issue of the management of the program and aligning the rebates and the reimbursement pieces, but then what is the impact on business practices that have developed over the years?

For example, many companies have made use of authorized generics. Now, DRA has provisions that may cause companies to ask, "Well, is this the right approach for doing business going forward?" I think DRA will have a spillover effect on the commercial business of a pharmaceutical manufacturer, as well.

MASKED AND MOVING TARGET

CLINTON: What type of financial impact will DRA have on the industry?

JOEL WINTERTON (OWNER, SET ENTERPRISES): Over the next 10 years, Medicaid will spend about $3 trillion, of which about 15 percent goes for drugs. The Congressional Budget Office estimates they're going to save $12.6 billion over the next 10 years through DRA—and basically all the savings will come from the pharmaceutical side.

CLINTON: So a billion plus per year?

WINTERTON: Roughly. It's going to start slower and then ramp up.

ZANT: It's not an enormous financial impact, but it continues a trend that requires companies to change processes, systems, and the way they behave with regulators and their customers—and that means significant expenditures to stay compliant with the continuously changing legislation.

Joel Winterton SET Enterprises

HEPBURN: It's a critical step for CMS. DRA requires them to clarify the definition of AMP by July 1 of next year. That's something they haven't accomplished in the 16 years since the Medicaid legislation went into effect. We'll see how good a job they do.

WINTERTON: Not only that—it's a moving target. Whatever CMS defines in July will potentially be different in 2009. And the industry keeps changing.

HEPBURN: Another issue I see with the DRA is that a number of the provisions are effective January 1, such as the changes to the way prompt-pay discounts are treated and the provisions for authorized generics. But the broader clarification of AMP is not due until July 1. We see that as an issue: having to adjust systems to hit January, then having to adjust systems again.

SHRIGLEY: The legislation required the Inspector General to do an audit and make recommendations on what AMP should look like. I don't know if you've seen the report.

CLINTON: It was discouraging, I thought. It basically said, "OK, everyone does this a different way."

SHRIGLEY: We've been saying that since '92. You audit five manufacturers on AMP, and you're going to come back with three or four different methods for calculating it. We've told CMS over and over that you need to define AMP, you need to tell people which classes of customers are included, which aren't, and so forth. They just refused.

PROBLEMS WITH PRICE

CLINTON: What are the problems with defining classes of trade?

WINTERTON: If we look at the AMP calculation, in essence we're coming up with a numerator and a denominator. The denominator is the net units that went to retail customers. The numerator is all the net sales related to retail transactions.

Michael Hepburn Ortho-Mcneil Janssen

But in the pharmaceutical industry, the vast majority of my transactions go through a wholesaler. When I sell to a wholesaler, one of three things happens. Either the product goes to a class of trade that I consider to be retail, and I need to include it in my AMP numerator, or it goes into a class of trade that I consider to be non-retail, like a hospital or the federal government, so I don't include it in the AMP calculation.

And then there's the third category: In this category I don't know where the product went, because I don't have data that indicate where that sale to the wholesaler subsequently went.

There are other issues. Are prescription benefit managers considered to be retail? If so, we could consider rebates paid to PBMs in the AMP calculation, which would have the effect of reducing the numerator. Then there's state Medicaid. Do I categorize that as sales that went to a wholesaler that subsequently went to a non-retail class? If I take those sales out, it lowers the AMP.

Also, prompt-pay discounts provided to wholesalers used to be subtracted from the AMP numerator. Now they're going to be left in, which has the effect of raising the AMP by two percent. That's fairly clear. But although the Deficit Reduction Act specifically speaks about wholesalers, it doesn't mention what happens if I sell to a mail-order customer. Should I take those terms discounts out or should I leave them in?

HEPBURN: Even on prompt pay, we have lots of questions. Who is classified as a wholesaler? Do we include big retail chains? In many cases we sell directly to them. What is it exactly that defines what a wholesaler is? Under DRA, prompt-pay discounts to wholesalers are not subtracted from AMP. But prompt-pay discounts to retailers are not mentioned.

Bill Shrigley Envision

This gets back to the original issue of using AMP to calculate both rebates and reimbursement. Pharmacies don't want the AMP reduced by the two percent prompt-pay discount, because that doesn't necessarily get passed along to them. And now it has an impact on the rebate, as well. Anything you do from a reimbursement side to try and make AMP match cost causes changes on the rebate side, as well.

SHRIGLEY: It can also trigger the additional Consumer Price Index penalty rebate if you don't go back and adjust the original baseline AMP.

HEPBURN: As AMP goes up, most mature products are paying a CPI inflation penalty. And that's fairly significant for large products.

ZANT: It appears to be a price increase. Manufacturers have treated it as if they've had a two-percent price increase, when really it's a change in how the calculation is being done.

SHRIGLEY: But if you were allowed to adjust baselines, would you even have the records from 1989 or '90 available?

HEPBURN: No. That's the whole issue. People don't have that information. I would argue that if CMS made wholesale changes that lowered AMP, they might want to make adjustments to the baseline AMP, from a fairness perspective.

WINTERTON: There is a precedent going back to the Omnibus Budget Reconciliation Act of '93. The original legislation had a problem with baselines. So CMS put in place two different baseline schemes, depending on the rebate period.

NEW MODELS

CLINTON: The law also addresses authorized generics, an increasingly important strategy for a lot of pharmaceutical companies and one that DRA makes treacherous.

HEPBURN: Very treacherous. Again, it's unclear from a technical implementation perspective exactly how a branded manufacturer is supposed to include pricing data on authorized generics in calculating AMP and best price. But the thinking is that it will likely lower AMP significantly, which lowers the rebate. Again, there are a lot of financial implications, depending on the pricing of the branded product and the authorized generic, and the percent of sales that they garner. That stuff now needs to be factored into authorized generic deals.

WINTERTON: The real complexity is that some of the data belongs to your authorized generics manufacturer. Are the data compatible? Can you combine them? Can you analyze them together? Is someone else going to analyze them?

HEPBURN: There are anti-trust concerns. We compete against those authorized generics in the marketplace, so we should not be privy to their pricing data. So how do we get the data? Do they just calculate the AMP on their own and send it to us? Does CMS do that?

And from the reimbursement perspective, you could end up now with a single AMP that doesn't match the price paid for either product.

WINTERTON: Then you could have pharmacy chains or pharmacies skewing purchasing patterns to maximize the value of some price that's in between the pricing they pay for different types of branded and generic products.

HEPBURN: It's interesting, because we're trying to get rid of the spread [between out-of-pocket costs and reimbursement] by eliminating the AWP. But, the way the authorized generics provision is laid out, it introduces a spread. The question also remains whether the authorized generic company has to combine the data, as well.

CLINTON: How about nominal pricing?

WINTERTON: The nominal pricing piece is fascinating, because it really does nothing to affect reimbursement or rebates. It doesn't affect AMP, because we're typically talking about customers that are excluded from the AMP anyway. And it doesn't change the best price, because now those nominal prices will be taken away. What it does do is solve a political problem where you'd have a hospital paying 10 cents and Medicaid paying 85 cents for the same product. It eliminates that.

A lot of this came out of a widely publicized lawsuit against Merck a few years ago, where they were offering teaching hospitals nominal prices as a way to get their product introduced to young doctors who would then start their own practices and use the products. That was totally within the law. The law just said nominal price is 10 percent of Average Manufacturers Price. It didn't discriminate against types of customers.

So there was concern in the government that manufacturers were using nominal pricing in a way that was inconsistent with the intent of law. So now they're going back and saying, "No, the intent of the law was to provide nominal pricing only to certain customers."

HEPBURN: That creates a compliance risk. The new members are the mental retardation institutions, state-owned nursing home facilities, and safety net providers determined by the Secretary [of Health and Human Services].

WINTERTON: Yet to be determined.

HEPBURN: There needs to be a single controlled list so manufacturers know "Can I offer this customer nine percent or 10 percent of AMP and exclude it from my best price?" And we need to ask: "Who is going to manage updates and changes to the list?"

MISSION IMPOSSIBLE?

CLINTON: Overall, how great are the compliance challenges of DRA?

SHRIGLEY: I think it pales in comparison to the problems with regard to AWP. That's the biggest change with regard to pharmaceuticals that I've seen in 34 years in government. Best price has been the big compliance issue to date. But I think AWP is going to be bigger. I've seen a lot of big settlements on best price—$300, $400 million settlements. I don't recall one on AMP.

When I'm talking about compliance, I'm really talking about dollars. The smaller issues—the policies, the documentation, the procedural recommendations—are still compliance, but it's not that big a deal.

WINTERTON: There are two things to consider, if one wanted to take the devil's advocate position on Average Manufacturer's Price. As of July 1 2007, AMP is going to be more closely defined. So far with AMP, pharmaceutical companies have had a get-out-of-jail-free card, because CMS has provided so little guidance. You could have a lot of different AMPs out there and they could all be valid. As that narrows, there will be more boundaries in terms of what is acceptable and what's not.

The other side is this: So far, AMP has been used only for rebates. In today's dollars, that's about $10 billion a year.

The traditional ratio between rebates and reimbursements is five to one. So now the pharmaceutical industry is going into a situation where AMP is controlling not $10 billion, but $60 billion worth of Medicaid. If you did have a compliance problem with AMP going forward, it could be significant.

SHRIGLEY: You know, if we had a regulation that told the pharmaceutical manufacturers exactly how to treat PBM rebates or mail-order customers, or large retailers, they would do it. Probably 100 percent of manufacturers would do exactly what the regulation said. The problem is the gray areas.

CLINTON: I know that one big concern is the move toward filing monthly reports. What are the problems with filing at this frequency?

WINTERTON: It appears that companies are required to file both monthly and quarterly reports. The rebate remains quarterly-based and reimbursement becomes monthly-based. But unless you have some kind of smoothing process—which they haven't mentioned—you're going to have big variations in the monthly AMP, which would cause problems with reimbursement.

HEPBURN: One big problem is that we don't have the data. Even on a quarterly basis, we struggle to get proper discounted rebate data from our customers. They don't submit it.

Most large pharmaceutical companies close their books on a quarterly basis. That means we don't necessarily have all of the books closed in a way that lets us tie the payment data in our general ledger. Even from a validation perspective, how exactly would the industry conduct this process each month? We just don't have the answer.

CLINTON: How prompt are the retailers and wholesalers at getting the information back to you? How big is that class of "don't know"?

WINTERTON: There are two sides to your business, a purchase side and a non-purchase side. On the purchase side, you've pretty much got all the data in five, six, seven days, whether you sold it directly or through a wholesaler.

The problem is the non-purchase side. The non-purchase side of the business is where rebates and fees are paid. Most of the agreements are quarterly. A typical turnaround is 60 days after the quarter. And then, as a manufacturer, I've got to reconcile that, which may take another 30 days.

So if I've got a rebate that was paid on a January 5th transaction, I may not know definitively what it is until July.

CLINTON: And when do you have to file the January report?

WINTERTON: By March 2.

HEPBURN: So how do you estimate that? On a quarterly basis, we do some estimation. As it gets to monthly, it gets even more difficult.

ZOCCHI: Clearly, the resources applied to this particular problem are going to go up dramatically. When you go from quarterly to monthly reporting of AMP and best price, companies go from eight submissions to 32. Their workload increases tremendously—and we're not even talking about getting the information or selecting a way to produce that information because you'll have to make some estimates for a monthly AMP.

WINTERTON: Just to make it practical, one of my clients has a situation where it currently takes them 36 days to do their AMP calculation. The AMP calculation is due in 30 days. The way they get those extra six days is, starting the second weekend of the month, everybody comes in and works on the weekends. That's in a quarterly environment. But there is absolutely no room to maneuver when you're going from one calculation in a quarter to four—there are just not enough days.

CLINTON: What's the motivation of the wholesalers and retailers to play along and provide data more promptly?

WINTERTON: Without a fundamental redefinition of the purchase/non-purchase model, it's not a matter of cooperation—it's a matter of the business model. And the business model doesn't support the required calculations. It's a disconnect between the way the industry works and what's being required by the government.

CLINTON: So what should companies do internally? What kinds of systems or procedures or personnel should they put into place to let them get at least close to complying with the regulations?

SHRIGLEY: There's never really been any enforcement with regard to the quarterly AMP. Lots of manufacturers do not report their AMPs on time. All [the government] does is call you up and say, "Where's your AMP?"

I don't understand the motivation for the monthly reporting. Why is a monthly AMP better than a quarterly AMP for reimbursement?

PAVING THE BUMPY ROAD AHEAD

CLINTON: Is the monthly report more about enabling the government to fine-tune reimbursements and rebates, or is it about increasing transparency—especially the kind that shows variability so that there's more pressure on prices?

HEPBURN: All of those things.

WINTERTON: I think it's in the best interest of all parties—the government, the pharmacy, and the pharmaceutical manufacturer—to have a stable reimbursement basis.

It's better for the pharmacy because they know what they're going to pay and what they're going to get reimbursed. It's better for Medicaid because AMP is not bouncing all over the place. And it's better for the manufacturer because customers aren't making decisions based on price fluctuations.

The AMP should be kept as stable as possible. But it's unclear that monthly reporting achieves that stability. Quarterly would be more stable and as representative. But that's not what was written in the law.

CLINTON: Here you have this new challenge facing companies, with some problems that look more or less insoluble. What are the smart folks doing to get ready?

ZANT: There are two pieces to it. Part one is for the specific obligation. It's obviously helpful to have the technology that supports you in doing your government pricing. It takes some of the burden off the human beings. It takes some of the risk of error out of the process. And it potentially enables analyzing these volumes of data more easily.

The second part, though, is just getting ready for ongoing change. If the Deficit Reducation Act isn't the last thing we see—and next year there's something else—the pharmaceutical industry still needs to have a systematic approach, a repository of data, an ability to understand what they've done in the past and make changes on some kind of a rapid basis when the legislation changes in the future.

HEPBURN: At the end of the day, you make your assumptions. Even in today's environment where there's not a lot of clarity, you just have to say, "Here are the assumptions we're going to make. Here's how we're going to do it." Be consistent. Try and match your assumptions to intent, but be consistent.

And if that involves estimation and using other sources to get data, then that's what you do. That's what we do today. We have policies today that interpret our view of what the law and CMS requires, and we document them and follow them consistently. We think that's the best you can do from a compliance perspective.

CLINTON: Is there an upside in all the additional data people have to collect?

ZANT: Certainly, as these data are automated, additional commercial analytics and contracting analytics can be performed. You can be more proactive in how you contract. You can use a bigger repository of data to analyze customer trends or product trends or discount trends.

But, you know, that's even a step beyond what we are talking about in getting these government systems in and managing the regulations within those systems, because you need to invest even further to get a comprehensive data warehouse or a comprehensive analytical tool. That can be a challenge, particularly for the smaller and mid-size pharmaceutical companies.

WINTERTON: That's a great question. If you look at the landscape of pharmaceuticals, there's really a blending of commercial and government markets. This started back in '91 when the law passed.

The more control pharmaceutical companies have over their data, the better they can understand the relationship between the commercial and government markets. And understanding the impact of commercial pricing decisions on the government market is a huge, very much untapped resource for pharmaceutical manufacturers.

That's where the industry is headed. Look at the acceleration of the regulations, the integration with Part D, and now more integration here with DRA. The sense is that we are building momentum to combine the impact of commercial and government pricing. We're not splitting it. It's becoming more integrated.

ZOCCHI: In some senses, is it an upside or is it really just a necessary aspect of doing business in this environment now? The line between your commercial and your government business is becoming very fine. Pretty soon, it may not exist.

In addition to the automation that this type of legislation is driving, there's a need to come up with architectures that combine your business in a much more holistic way, so you can start to look at implications. What about Medicare contracts? How do I treat those in this particular business? What do I do with my authorized generics?

WINTERTON: How do I go to market? How do I keep my business strategies one step ahead of regulations? I mean, that's really what we're talking about.

CLINTON: Or only one step behind?

WINTERTON: Yes, or only one step behind.