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CMS Targets Spread Pricing with Clarification of Medical Loss Ratio Calculation

By Erica Bartlett, Product Manager, Model N Life Sciences

The passage of the Affordable Care Act (ACA) in 2010 turned the medical loss ratio (MLR) into a critical financial target and measure of the effectiveness of U.S. health plans.  Since 2010, the Centers for Medicare and Medicaid Services (CMS) has continued to clarify the details of this calculation.  On May 15, 2019, CMS addressed the issue of how prescription drug rebates are counted in MLR with updated guidance on the practice of spread pricing.  

For pharmaceutical manufacturers, the updated spread pricing guidance is the latest step toward price transparency. It’s designed to make health plans aware of the spread pricing problem and where the proceeds from the gross-to-net-bubble land, with the end goal of building awareness and increasing the financial consequences for the spread for payers.

The Spread Pricing Guidance I

The CMS spread pricing guidance comes in response to the continued focus on drug pricing transparency in the U.S. The guidance addresses concern about excessive spreads and PBMs profiting unfairly at the expense of patients. This leads to higher dr­­ug prices, since PBMs can charge health plans a significantly higher amount than what they reimbursed to the pharmacies. 

According to CMS, “the policy underpinning this guidance is that spread pricing should not be used to artificially inflate a Medicaid or CHIP managed care plan’s MLR.”

Impact on MLR Calculation

The intent of the MLR is to ensure that most of the money health plans spend goes toward paying for healthcare services for patients and quality improvement efforts. To achieve this, CMS limits expenses for administration, marketing and profits to 15% for large insurance plans.  The ACA MLR requirement applies to Medicaid managed care programs and Children’s Health Insurance Programs (CHIP) with managed care contracts.  These plan types are thought to be the areas where rebates are most common and significant.

As part of the newly-clarified MLR calculation, prescription drug rebates need to be excluded from claim costs. To remove any confusion about what’s included in “prescription drug rebates,” the new spread pricing guidance broadens the definition of rebate to include any price concession or discount, regardless of whether it goes to the health plan or PBM.  Some examples are payments from pharmacies, wholesalers, and pharmaceutical manufacturers as the drug makes its way through the supply chain to the patient. These must all be accounted for and deducted from the claim amount of the MLR, according to the updated guidance.

Why Spread Pricing Is So Important

Spread pricing happens when plans contract with pharmacy benefit managers (PBMs), and the PBMs charge the health plans more than was needed to reimburse the pharmacy. The PBM keeps this difference, which is the spread. 

The following example shows how spread pricing works, with a rebate being pocketed by the PBM:

  • A pharmacy pays a certain amount to buy a covered drug, say $5. After someone with employer-provided insurance gets a prescription, the plan or PBM reimburses the pharmacy at a certain rate, say $7. The pharmacy keeps any difference as their profit.
  • The PBM then bills the employer for the drug, often at a significantly higher cost than what they reimbursed the pharmacy, say $15. This difference, in this case $8, is the spread and is pocketed by the PBM.
  • When this is not correctly accounted for, the spread inflates the cost of the drugs and impacts Medicaid taxpayers.

Spread pricing is becoming more common and accounts for a higher percentage of drug prices, especially for generic drugs, and it impacts some states more than others. CMS Administrator Seema Verma called out Ohio and Texas in a press release as states where this is increasingly common, but they’re not alone.

The updated guidance from CMS is meant to help address rising costs by targeting this up-charging for prescription drugs. The bulletin clearly states that PBMs need to exclude the spread pricing from the cost of claims when calculating the MLR.  CMS will also begin audits to verify that the PBM costs and other expenditures are correctly reflected in the MLR calculations.

More Changes to Come

This change is the latest designed to reduce drug costs and increase transparency, but more changes are expected. CMS has already indicated that they are looking at other ways to focus on spread pricing and rebates more broadly. 

It’s important to point out that this guidance does not impede the pending safe harbor ruling for prescription drug rebates and may be additive to it.  The focus on spread pricing only applies to any additional value that needs to be excluded from the cost of claims used in the MLR calculation. It does not impact the prescription drug rebates directly, which will be addressed on their own in the Safe Harbor rule. Pharmaceutical manufacturers preparing to implement the changes to the safe harbor rule that is expected to eliminate point of sale rebates should take this interim guidance into account. For more information about the Safe Harbor Rule changes, please join our A World Without Rebates customer community by signing up here.  You can also sign up for a webinar with Model N and High Point experts on June 19, 2019, to access the live event or the replay, sign up here.

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