Investing in the prospect of drug pricing reforms

Restrictions on the pricing of drugs delivered in doctors’ offices and hospitals could have significant investment implications.

The Trump Administration is considering reforms in the payment for prescription drugs covered under Medicare Part B. The changes include ones that could be accomplished without the need to pass legislation through Congress. The reforms could have significant implications for the companies that manufacture the drugs covered under Part B.

Medicare Part B covers drugs that are administered in a doctor’s office or a hospital outpatient setting. There about 600 such drugs and they range from flu shots to infusion and oncology drugs. They are distinct from the drugs patients can get from their local pharmacy and give to themselves. The latter group of drugs is covered by Medicare Part D.

Part D was established in 2006 to help seniors meet the cost of prescription drugs. When it was put in place, there were also controls on the rates at which Medicare would reimburse for covered drugs. Part B, which has existed since Medicare was introduced in 1965, has not yet been subject to any significant drug pricing reforms.

The lack of reform in Part B pricing may explain why Medicare’s payments, per beneficiary, for these drugs has risen by 11.1% since 2006 – almost triple the rate of growth in expenditures for Medicare Part D drugs. Figure 1

Figure 1: Medicare Part B and D per-beneficiary expenditure growth rates (2006-2016)

Source: Medicare Trustees Report from 2016 (for 2006) and 2018 (for 2011 and 2016); Part B annual National Summary Files; OPPS Final Rules from 2008, 2013, and 2018. Percent changes reported are annually over the five-year periods shown. Net payments exclude beneficiary cost-sharing.

Potential reforms looming on several paths

Currently, there are separate House and Senate bills to reform Part B drug pricing, but the bills are distinctly different, and the two legislative chambers have not yet shown much inclination to reconcile their differences. If drug pricing legislation passes this year, it will likely be part of a spending bill that will have to be voted on by both houses of Congress by late May. That creates a small window of opportunity in the coming months for some drug pricing reforms to be made by Congress.

Even if Congress doesn’t act, the Trump Administration has signaled it may take regulatory steps to reform Part B pricing. Currently, three measures are under consideration.

  • Currently, doctors and hospitals are paid 106% for the price of Part B drugs. The first administration proposal would eliminate the 6% mark-up. Instead, there would be a flat fee paid for a particular category of drug. That would eliminate the incentive doctors have to use a brand-name drug and could allow for wider use of generics and biosimilar drugs. This change could bring significant cost savings for Medicare.
  • The second initiative would be to drive doctors and hospitals out of the business of buying and storing large quantities of drugs, which they can then get at significant discounts off the cost of the drug while they’re still getting reimbursed from Medicare for 106% of the cost.
  • The third measure would be to still pay the 106% reimbursement, but not at the U.S. price. Instead, the payment would be based on the average of prices for each drug in various developed markets outside of the United States.

While the third proposal would likely be opposed by Republican legislators, who generally prefer more market-based solutions to problems, it is in line with President Trump’s oft-stated goal to introduce more fairness across international markets. Currently, US drug prices average about 150% of the cost of drugs in international markets. That means the United States is currently funding pharmaceutical companies’ research and development. Bringing U.S. prices in line with the rest of the world might ultimately force international markets to share more of that cost.

Time will tell how much political appetite there is to get reforms for Part B drug pricing reforms passed through Congress during an election year. But an interesting change in recent years has been that pharmaceutical companies are not just targeting Republicans with lobbying and campaign financing support. They are focused on Democrats as well.

Interest in drug pricing reform does seem to be widespread, perhaps because it impacts such an important constituency. The average American is taking four prescription drugs. The heaviest users of prescription are people in older age brackets – a segment of the population with a large percentage that gets out and votes.

Recognizing the investment implications

With our portfolio, the Invesco Oppenheimer Fundamental Alternatives Fund, we look to provide financial advisors and investors with an option to diversify and counter the risks of the equity markets. We aim to participate in up markets but also mitigate risk in down markets. We have the potential to do that because we can go long or short on equities, credit or broad economies.

By being able to go short, we can potentially benefit from sectors and securities that are facing challenges, while also taking long positions on countries, sectors and companies with promising prospects.

One of the current themes we’ve been investing in is the changing structure and potential reforms in the health care sector. That has been in response to legislative action and the increased focus on providing affordable healthcare to broader segments of the population. The impact of Part B reforms is part of our health care theme. We looked at companies that have high exposure to Part B and found a number have additional issues that could drive down their stocks’ value. Many of their profits are concentrated because they offer only a small number of high-priced drugs. Some are facing increased competition as other companies enter their market or their patents expire, and much less expensive generics and biosimilars can be prescribed.

One of these companies markets a drug to treat age-related macular degeneration and other eye disorders. This drug was the single largest Part B drug expenditure in 2017 (the most recent year for which data is available). Medicare paid 1.6 times more for the drug than its price in the basket of international countries. If the international market basket reform had been implemented, Medicare would have saved about $1.06 billion, or 48% of its expenditures on just this one drug.

Another of the largest biotech companies could also be seriously affected by Medicare Part B drug pricing reform because it has four drugs that rank in the top 20 of Medicare Part B drug expenditures. One of them can counter the impact of chemotherapy on white blood cell levels. The US price of the drug is 3.6 times more than the international average. Medicare could have saved $950 million in 2017 if it had paid the international basket price.

For two other drugs marketed by this firm, which are used to treat bone complications related to osteoporosis and breast cancer, Medicare paid 4.8 times more than the international basket price in 2017. It could have saved $850 million if the international average price had been used as the basis for reimbursements.

Change likely to be a matter of when, not if

Europe may provide a sense of what the future of the US pharmaceutical drug market could look like. Biosimilars for a major brand-name drug  that is used to treat arthritis, psoriasis and other conditions currently have a 67% share of the European market. In the US, the biosimilars have only a 11% share. If the incentives to prescribe higher-priced drugs are removed in the US market, doctors and physicians will begin prescribing the lower-priced alternatives more often.

The Trump Administration is focused on reforming drug pricing for portions of the market and there are a few avenues that it could take. Passing legislation in Congress during an election year may prove difficult. However, the scale of savings that could be realized from Part B reforms may drive the administration to act on its own. We’re looking to provide investors with the potential to benefit when it does.

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Michelle Borré is Head of the Fundamental Alternative Strategies team at Invesco. In this role, she conducts day-to-day portfolio management activities, as well as developing content addressing the use of liquid alternatives in portfolios.

Ms. Borré joined Invesco when the firm combined with OppenheimerFunds in 2019. Prior to her role as a portfolio manager at OppenheimerFunds, Ms. Borré served as a senior research analyst covering special situations for the OppenheimerFunds value investment team. Before joining OppenheimerFunds in 2003, she held various positions at J&W Seligman, including managing director and partner. Additionally, Ms. Borré was an adjunct professor of finance and economics for a decade at Columbia Business School, where she also served on the Executive Advisory Board at the Heilbrunn Center for Graham and Dodd Investing from 2004 to 2005.

Ms. Borré earned a bachelor’s degree, cum laude, from Barnard College, Columbia University, and an MBA from Columbia Business School. She is a Chartered Financial Analyst® (CFA) charterholder and member of the Beta Gamma Sigma Society.

Brian Giesen is an Intermediate Research Analyst for the Fundamental Equity Alternatives
team. His responsibilities include coverage of equity securities in the healthcare and consumer
discretionary sectors.

Mr. Giesen joined Invesco when the firm combined with OppenheimerFunds in 2019. Prior to
joining OppenheimerFunds in 2011, he was an analyst with the portfolio analytics team at
AllianceBernstein and worked at Fidelity Investments.

Mr. Giesen earned a BS degree from Boston College and an MS from Brandeis University. He is
a Chartered Financial Analyst® (CFA) charterholder.

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