President’s Budget Proposal Points to More Pressure on Innovators

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The congressional ‘super committee’ created by the Budget Control Act (“BCA”) this summer and tasked with cutting the cumulative 2013-2021 deficit by $1.2T by November 23[1] met for the third time on September 22. Ahead of that meeting, President Obama released his own $3.6T deficit reduction plan – of which, $320B (less than 9 percent) comes from healthcare savings

Recall that if Congress fails to find and pass $1.2T in cuts by December 23, automatic spending cuts (up to $139B from Medicare, we believe in the form of across-the-board cuts in provider payment rates) would kick in to guarantee at least the required level of deficit reduction. We have argued (see: and that odds are better than even that the super committee produces at least some of their mandated reductions, mitigating the impact of the automatic cuts. Even partial success by the committee would likely be negative for innovators, whereas outright failure (which we view as unlikely) would be negative for hospitals / providers

Practically, the ideological rift between the White House and congressional Republicans likely leaves the president’s proposal – in aggregate and as written — dead on arrival. While we have not seen a comparable position paper from Boehner or McConnell since passage of the BCA, the rhetoric from the right describing the Obama proposal as “class warfare” augurs stiff opposition. Despite limited prospects for the president’s proposal as a cohesive package, we actually believe that the bulk of proposed healthcare savings are relatively non-controversial / politically palatable (save for an expansion of the IPAB; more on that later), reflect the varying exposure of the different players (innovators, providers, beneficiaries) that we have long anticipated, and could very well reflect the type of healthcare changes the committee might produce

The President’s Proposals

The burden of the proposed White House cost savings falls on four broad spending categories, with the first two disproportionately affected (Exhibit 1, 2):

  1. Innovators: As we have argued was likely, the package disproportionately targets Rx pharmaceuticals for the largest share of healthcare savings. Requiring pharmaceutical manufacturers to extend the same rebate for Medicare Low-Income Subsidy beneficiaries as is currently paid to Medicaid on Part D drugs, this change generates an estimated $135B in savings over 10 years – 42 percent of the total. Further, Obama suggests prohibiting ‘pay-for-delay’ deals between generic and brand manufacturers
  2. Providers: Skilled nursing facilities, long-term care hospitals, inpatient rehab facilities and home health providers bear the brunt of provider cuts ($42B) proposed. These savings are achieved through a combination of across-the-board rate cuts, compliance requirements and targeted rate cuts for underperforming facilities. An additional $19B comes from cuts to the favorable rates received by disproportionate share hospitals and teaching hospitals (through the IME add-on payments); and reductions to the number of rural facilities receiving special payments (currently one-third of all hospitals). Finally, the White House suggests that reducing Medicare’s coverage of beneficiaries’ bad debts (i.e., failure to pay deductibles, co-pays, etc.) from 70 percent to 25 percent (in line with private insurers) will save another $20B
  3. Fraud / Waste / Abuse / Loopholes: Programs that pledge to reduce Medicare and Medicaid fraud, waste and abuse – those perpetual panaceas for all spending ills – generate $6B of the projected savings. However, an additional $45B comes from closing Medicaid loopholes and cutting spending that almost exclusively goes to state funds. The proposal would limit Medicaid provider taxes (i.e., taxes imposed on providers by states, which are offset by payment increases back to the providers in the amount of the tax – but which are eligible for   federal matching dollars); creating a single match rate for all Medicaid / CHIP beneficiaries per state; and cutting the Prevention and Public Health Fund created by the ACA by $3.5B (~20 percent). We’ve written about the dire circumstances across almost all state budgets and the impact of Medicaid spending in the past (see: ); the president’s plan could exacerbate those issues
  4. Beneficiaries: Medicare beneficiaries would pay an additional $24B in the form of Part B deductible increases and premium surcharges; increased home health cost sharing; and Part B and Part D premium increases for high income beneficiaries. Further, adjusting the MAGI calculation for HIE premium tax credits / cost sharing to include Social Security income (in effect, reducing exchange subsidies for low income enrollees) would yield $15B

Perhaps the greatest ratio of (high) deficit impact to (low) political risk is the proposal for some form of de novo rebates on Part B / D drugs. By themselves, these rebates generate more than more than 11 percent of the committee’s mandated $1.2T in cuts

We have also argued that the committee has the power to wield a scalpel in terms of provider cuts, and that this approach is preferable to the proverbial chainsaw of the automatic cuts (the effects of which would likely be far broader, and far more severe for constituents that no one is interested in alienating). The White House’s proposal is consistent with this view, singling out providers that are generally less favorably viewed than traditional hospitals or clinical physicians (i.e. SNFs, LTCHs, IRFs, home health) for the vast majority of payment rate reductions

We believe that the market continues to misprice the impact of the BCA on health subsectors – in particular, overestimating the likelihood that automatic cuts kick-in, and underestimating the probability of rebates on innovators. Since passage of the BCA, and since the president’s proposal was published, Facilities have dramatically underperformed the rest of healthcare and – in particular – Large Cap Pharma  and Biotech. Curiously, Devices – whom we have contended could face similar de novo rebate / discount risks as drug innovators but were completely spared by the White House proposal – have also underperformed drug innovators.  To the extent that these share price reactions reflect skepticism that the White House proposal in toto is a viable piece of legislation (or even guiding document) we obviously have no objection. However, the sustained underperformance of Facilities relative to drug innovators (again, since BCA passage in early August; but more to the point since the Obama proposal on September 19) suggests to us that the markets are missing an important implication of the president’s proposal. Specifically, if one accepts that the super committee is more likely to succeed in part than to fail altogether, then some package of proposals with bipartisan support must be crafted. The bulk of the healthcare savings proposed by Obama are relatively painless (versus inaction and automatic cuts) in the sense that they don’t target either party’s key interests or constituents disproportionately


…And Then There’s the IPAB

To our minds the most (only?) surprising aspect of the Obama proposal is a call to strengthen the Independent Payment Advisory Board (IPAB) – one of the most controversial pieces of the Affordable Care Act. For a detailed analysis of the IPAB, please see: The short story is that the IPAB is tasked with constraining annual per-beneficiary Medicare cost growth within a range of CPI, and later GDP growth. As written in the ACA, that later growth rate constraint is defined as trailing 5-yr GDP growth plus 1 percent. As part of his deficit reduction proposal, the president proposed ‘doubling down’ on the IPAB and setting its target growth rate at just GDP plus 0.5 percent

In the note referenced above, we showed that the IPAB as originally constructed would require Medicare cuts of $27-50B over the 2015-2019 period, which amounted to 3 to 5 percent of total spending; but more meaningfully 11 to 19 percent of what we termed ‘fair-game’ non-clinician spending[2]. Re-running the same analysis, but with the president’s proposed new (stricter) target growth rate in 2018-2019 (the target in earlier years is benchmarked to inflation; this is not addressed in the White House plan thus we assume no change)  increases the required cuts to $37-58B – somewhere on the order of 25 percent higher. This is 4 to 6 percent of total spending and 15 to 23 percent of ‘fair-game’ non-clinician spending

To be clear, we believe such an expansion of the IPAB has relatively little chance of passing. With House Republicans in the majority and united in their opposition to the Board, and even some House Democrats (at least 11) crossing the aisle to cosponsor legislation to eliminate the IPAB altogether, there is no obvious route to passage


[1] Legislation must be presented to Congress by November 23; Congress must (without modification) vote on the committee’s legislation by December 23.

[2] By statute, the IPAB may only seek cuts from certain Medicare categories. Further, even if they could cut physician reimbursement rates, Congress’ willingness to routinely increase the physician rate makes us skeptical that it would ever be politically feasible to allow doctor rates to decline meaningfully. Hence, we exclude both those costs that are (legally) not ‘fair-game’ and (practically) not ‘fair-game’ (i.e., clinicians). For readers interested in the legislative details, we again encourage you to read

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