Co-Pay Cards: A Bottle for the Drug Pricing Genie

Richard

Drug manufacturers pay rebates to avoid exclusion from a formulary and/or to gain preferred formulary position. At retail, formulary position translates into co-pays; consumers pay higher ‘tier 3’ co-pays for non-preferred brands and lower ‘tier 2’ amounts for preferred brands. Co-pays commonly are fixed dollar amounts that do not vary according to drug price (a given tier’s co-pay is the same regardless of drug price), and over time these amounts have grown much more slowly than drug prices

Manufacturer-sponsored co-pay cards are a relatively new phenomenon; these subsidize consumers’ co-pay obligations, and serve as an alternative to paying additional rebates for preferred formulary status (particularly if the preferred rebate is more than the tier 3 – tier 2 spread). Last year 28% of commercial (non-Medicare / non-Medicaid) retail prescriptions were processed with a co-pay card, up from 14% in 2010; currently 69 of the top 100 US brands (by sales) offer co-pay cards

Before co-pay cards, formulary managers could not grow tier 3 co-pay amounts at (or anywhere near) the rate of drug pricing for (plan sponsors’ wholly accurate) fear that medically necessary consumption would be lost. Now that co-pay cards are commonplace, this constraint is vanishing. More to the point: because manufacturers can be relied on to use co-pay cards (or pay rebates) to limit growth in consumers’ out-of-pocket costs, we believe formulary managers are free to accelerate growth in co-pay amounts (particularly tier 3)

The optimal formulary strategy appears to be: fixed dollar tier 2 co-pays that grow slowly if at all; and percentage tier 3 co-insurance that grows at the rate of drug pricing. This accelerates growth in the tier 3-2 spread, creating the potential for larger preferred rebates (or forcing manufacturers to offer larger co-pay subsidies)

Very few claims are currently processed with percentage tier 3 co-insurance; most tier 3 co-payments remain fixed dollar amounts. If we assume the share of tier 3 commercial claims processed under a percentage co-insurance design grows to 80% over a five-year period (and that the current average tier 3 co-insurance rate of 37% holds), pricing power during this period (for brands subject to tier 3 status) is reduced by about one-third (i.e. a 10% rate of list price increase yields a 6.8% rate of net price gain after rebates). If we assume the tier 3 co-insurance rate grows to 50%, pricing power over this period for affected brands is reduced by more than two-thirds (i.e. a 10% rate of list price increase yields only a 2.9% rate of net price increase). For comparison, rebate growth in the trailing decade reduced brand list price growth by less than one-tenth (from 10% to 9.3%)

Since 1980, US real price gains explain almost half of US drugs’ total top-line growth; over the last several years US pricing is more than 100% of US drugs’ sales growth. Current valuations imply pricing power continues at or near current levels through the period covered by consensus estimates; we expect pricing power to erode

Manufacturers for whom price increases are a higher percentage of current growth, and who have higher average prices (the effect of the strategy we outline is more pronounced at higher starting prices), are most at risk; LLY, AZN, BMY are most at risk; ABT, BAY, GSK, NVS and SNY are somewhat less exposed

We recognize such a shift in formulary strategy is bullish vis a vis PBMs; however because generic dispensing spreads are more important than rebates, and likely to fall, on net our bearish PBM thesis is unchanged

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