President Trump announced last Friday that he is planning to sign four executive orders aimed at lowering pharmaceutical prices. However, we view the likelihood that any of these proposals will be implemented in the near term as low. Therefore, we do not expect them to have any effect on the earnings of, or our ratings on, the pharmaceutical companies we cover in the near to intermediate term. Given that it is a presidential election year and health care spending is one of the top issues, it is likely there will be more such pronouncements. While we do not forecast any significant impact over the near to intermediate term, these frequent headlines underscore the elevated pressure the pharmaceutical industry is facing to address high drug pricing/spending.
- No near- to intermediate-term effects. We do not expect the executive orders to have a significant impact on pharmaceutical companies' earnings (or our ratings on these companies) over the next two years until they are established as law given the difficulties involved in implementing them.
- While these proposals are not new, implementation hurdles remain. Conceptually, the proposals specified in the executive orders could have a material effect on the sales and earnings of select companies if implemented as proposed. However, the concepts are not new and significant questions about their implementation remain.
- Increasing headline risk expected. Investors should expect increased headline risk related to pharmaceutical pricing and broader health care pricing over the near term, despite the temporary diversion of the public's attention by the coronavirus pandemic, as we get closer to the U.S. election.
- Equal pressure coming from commercial payors. In addition to reimbursement risk from government payors, we see similar pressure on the commercial payor front as insurers such as CVS/Aetna and Cigna/Express Scripts leverage their increased negotiating power following their respective mergers. Moreover, the increased noise on the legislative front may embolden commercial payors to extract further cost savings.
- We see bipartisan support for a reduction in prescription drug costs. Therefore, we expect prescription drug spending to continue to be pressured, regardless of the outcome of the 2020 U.S. presidential election. At the same time, given the supportive climate for sustaining future innovation and investment in the U.S., we expect only moderate erosion in pharmaceutical companies' profitability (a few hundred basis points of their margin), which will leave the industry profitable enough to attract capital to continue funding innovation.
- We expect the intensifying political pressure to constrain price increases across the industry in 2020, as it did in 2018 and 2019, because industry players will seek to maintain good relations with lawmakers and the administration.
The four announced executive orders mandate:
- Requiring intermediaries, such as pharmacy benefit managers (PBMs), to pass along discounts from pharmaceutical companies to Medicare Part D patients;
- Medicare to receive the same drug prices as other countries for drugs in the Medicare Part B program;
- Allowing certain drugs to be imported from Canada; and
- Requiring 340B participants to pass on discounts on insulin and EpiPens to their patients.
Each of the executive orders are versions of previously introduced legislation and do not provide any more details on possible timing or implementation. We have listed the four executive orders, along with our thoughts on each, in the order of their potential impact on the pharmaceutical industry.
An International Pricing Index For Medicare Part B Drugs
Main obstacles: Likely legal challenges, questions around the effect on research and development (R&D).
Ratings impact: Limited to select companies depending on their exposure to Medicare Part B, though the concern is that the International Pricing Index (IPI) may be extended to additional areas of the industry if implemented.
The IPI calls for Medicare to receive pricing on a select number of Medicare Part B drugs (drugs administered in doctors' offices) based on an index of foreign list prices, which are much lower than U.S. list prices. This mandate, which the administration previously proposed in 2018, would materially effect pharmaceutical companies that derive a significant portion of their sales from Medicare Part B drugs. The Medicare Part B pharmaceutical market accounts for only $22 billion of the roughly $335 billion of annual U.S. pharmaceutical spending. However, the greater concern for the industry is that the government will extend the IPI to other segments of the market. The president has indicated that he will delay this executive order until Aug. 24, 2020, pending alternative proposals from the pharmaceutical industry. There will certainly be major legal challenges from the industry related to this mandate. We also believe that lingering questions about the effect of de facto price controls on R&D productivity may sap some political will for implementing this regulation.
Intermediaries Passing Along Rebates To Medicare Part D Patients
Main obstacles: Unclear whether it would actually provide savings for patients.
Ratings impact: Uncertain but widespread because it would lead to the resetting of agreements and, potentially, market shares across the pharmaceutical industry.
Originally proposed in 2018, the mandate calls for the abolishment of rebates for intermediaries, such as PBMs, involved in Medicare Part D (outpatient drugs) by removing the safe harbor protection for pharmaceutical rebates. PBMs typically negotiate drug savings for their clients (plan sponsors) in the form of rebates from pharmaceutical companies that they then share with their clients. Many PBMs say that they pass along the majority, if not all, of the rebates to their clients, especially for plan sponsors in government programs. The concern is that insurers will raise their patient premiums if they no longer receive these rebates, which is counter to the intention of the proposal and significantly lessens its likelihood of implementation. The pharmaceutical industry has indicated that they support abolishing rebates because it would increase industry transparency and reduce list prices. However, it would also lessen the PBMs' negotiating leverage with pharmaceutical companies.
Drug Importation From Canada.
Main obstacles: Supply availability, Canadian objections, and safety concerns.
Ratings impact: Minimal to moderate depending on what drugs it affects. Industry is concerned the mandate may be expanded to cover more drugs and more countries if adopted.
The idea of allowing the importation of drugs from Canada has been around for years. Most recently, in December 2019, the Republicans announced a draft proposal to allow states, drug wholesalers, and pharmacies to import lower-cost drugs from Canada. The proposal would authorize the Secretary of Health and Human Services, Alex Azar, to determine which drugs would be allowed for importation based on whether the drug is safe and whether importation would provide significant cost savings for patients. In Canada, drug prices are typically 40%-60% below U.S. levels because the Canadian federal government sets a price ceiling on branded medications. The two main obstacles to the enactment of this mandate are the need to ensure the safety of the imported drugs and the availability of an adequate supply of drugs to import. Over the years, several states, such as Florida, Vermont, Colorado, and Oklahoma, have passed legislation that would allow the importation of medications by licensed wholesalers from licensed Canadian sources, which has alleviated some of the safety concerns. However, none of the state programs, which require federal approval, have been implemented. In addition, the Canadian pharmaceutical market is much smaller than the U.S. market and the Canadian government is unlikely to permit distributors to send material supply south if it would lead to a shortage in Canada. Limited quantities would mean that patients are unlikely to see significant savings.
Discounts Provided For Insulin And EpiPens Under 340B Programs To Be Passed On To Patients.
Main obstacles: Questionable and limited effect on savings.
Ratings impact: None as proposed.
We view the executive order requiring health care clinics and hospitals that receive discounts for insulin and EpiPens under the 340B program to pass along the discounts to patients as having the lowest impact among the four executive orders. This is due to the relatively narrow scope of the order and questions regarding its ability to reduce drug spending. The 340B program requires pharmaceutical companies participating in Medicaid to provide steep discounts (typically 20%-50%) on outpatient drugs to qualified facilities that then use the savings to help treat indigent populations. The program has been scrutinized in recent years due to concerns regarding hospital abuse of the program. The proposal, if implemented, would hurt hospitals and health centers more than it does the pharmaceutical industry and would only modestly reduce the overall cost of drugs in the U.S.
Major Doubts Around The Implementation, Timing, And Effects Of The Proposals
We remain skeptical that these proposals will be implemented, especially in the near term. All four executive orders have been proposed in previous initiatives and progress toward their implementation has been limited. Given the rising level of partisanship in the U.S. due to the approaching presidential election, we believe it is unlikely that congress will pass any significant health care legislation in 2020. Moreover, we expect lengthy court challenges related to certain mandates, such as the IPI, and believe it would take multiple years for the various agencies, such as the Department of Health and Human Services and others, to develop and implement the proposed rule changes.
However, these executive orders underscore how drug pricing and the continued growth in pharmaceutical spending remain major political issues. Despite the recent goodwill the pharmaceutical industry has been experiencing related to its ongoing COVID-19 vaccine development efforts, we believe its legislative risk remains high. The uncertain U.S. economic outlook and large stimulus-driven deficits related to the pandemic will likely further pressure legislators to take action to reduce health care spending. We believe the continued adverse political headlines for the pharmaceutical industry will lead to increased reimbursement pressure from PBMs and insurers, such as CVS Health (merged with Aetna in 2018) and Cigna Corp. (merged with leading PBM Express Scripts in 2018), which we believe are increasingly anxious to further demonstrate their ability to reduce drug spending.
- What Does Pharma’s Quest For A COVID-19 Vaccine Mean For Its Credit Quality And ESG Profile?, July 8, 2020
- Health Care Legislation Guide: With The Rebate Rule Off the Table, What Else is Lurking?, July 11, 2019
This report does not constitute a rating action.
|Primary Credit Analyst:||Arthur C Wong, Toronto (1) 416-507-2561;|
|Secondary Contacts:||David A Kaplan, CFA, New York (1) 212-438-5649;|
|Ji Liu, CFA, New York (1) 212-438-1217;|
|Tulip Lim, New York (1) 212-438-4061;|
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