Domestic Reference Pricing and Its Potential Role in Medicare Pharmaceutical Price Negotiations

To control rising prescription drug costs, the U.S. Congress is currently considering legislation to allow the Medicare program to directly negotiate pharmaceutical prices with drugmakers. A bill in the House of Representatives, H.R. 3, would rely on international benchmarks to set upper limits for prices. But according to recent media reports, the Senate is considering using domestic price benchmarks for Medicare negotiations, which could be based on prices paid by the Department of Veterans Affairs (VA) or any number of other government purchasers.

Below we delve into what’s known as domestic reference pricing, including the various pricing benchmarks that Medicare might use in negotiations with drug companies.

What is domestic reference pricing, and what role might it play in Medicare drug price negotiations?

Domestic reference pricing is an approach to informing price negotiations with drug manufacturers by calculating a benchmark price, or reference price, based on U.S. prices for a given medication. The reference price also can be based on prices for therapeutically comparable medications — those in the same pharmaceutical class or those with the same mechanism of action. As is the case with international reference pricing, the domestic reference price represents a percentage of whichever pricing benchmark is chosen (see below). If used the same way as international reference pricing in H.R. 3, this percentage establishes an upper limit, or maximum, to bound the negotiation process.

Which benchmarks could be used for domestic reference pricing?

Domestic referencing pricing could be based on one of the current statutory definitions for U.S. drug prices. In order from highest to lowest cost, these include:

• Wholesale acquisition cost (WAC): Price set by the manufacturer that’s often referred to as the list price, before any discounts or rebates. Publicly available.
• Average manufacturer price (AMP): Average price wholesalers pay for a drug distributed to retail pharmacies, either through wholesalers or through sales directly from manufacturers to pharmacies. Does not include drugs distributed through mail-order pharmacies or payer discounts or rebates. The AMP, which is not publicly available, is used to calculate Medicaid rebates — the partial cost refunds that drug manufacturers provide.
• Nonfederal average manufacturer price (non-FAMP): Average price wholesalers pay for drugs distributed to nonfederal purchasers. It reflects some discounts, but no rebates or discounts provided to payers. Not publicly available.
• Federal supply schedule (FSS): Price negotiated between manufacturers and the VA. Available to all federal direct purchasers of pharmaceuticals, among them, the Department of Defense (DoD), Public Health Service, Coast Guard, Bureau of Prisons, National Aeronautics and Space Administration, and Department of State. However, FSS prices may not be the prices that federal purchasers actually pay, since some can negotiate further manufacturer discounts, either on their own or in tandem with other federal purchasers. Publicly available.
• Federal ceiling price (FCP): Price used to determine the maximum amount charged to the “Big Four” agencies — VA, DoD, Public Health Service (including Indian Health Service), and Coast Guard. Equal to 76 percent of a drug’s previous-year non-FAMP, minus the difference between the price increases and inflation (as measured by the consumer price index for all urban consumers). The Big Four can negotiate further discounts from manufacturers to determine the final price paid. Not publicly available.

The Congressional Budget Office recently released a report comparing these pricing benchmarks to the prices of best-selling drugs in several federal health programs — Medicare Part D, Medicaid, the VA, and the DoD. Despite being the largest program, Part D — which doesn’t use a pricing benchmark — paid among the highest prices. In comparing net prices for high-priced drugs, Part D pays nearly triple the prices Medicaid pays and nearly double those paid by the DoD and VA.

How can domestic reference pricing be used by Medicare in negotiating drug prices?

The domestic reference price could be a percentage of one of the statutory pricing benchmarks listed above. In the Medicaid Drug Rebate program, a discount of 23 percent is applied to the average manufacturer price of brand-name drugs to determine the Medicaid price, then adjusted for inflation rebates. Similarly, a statutory discount of 24 percent is applied to the non-FAMP for brand-name drugs that the Big Four agencies purchase; these prices also are adjusted annually for inflation.

The domestic reference price could be an index based on a pricing benchmark of therapeutically comparable drugs. A basket of therapeutically similar drugs would be selected, and then an average of the drugs’ pricing benchmarks — weighted by sales, market share, or another measure — would form the basis for the domestic reference price. The pricing benchmark could be the initial launch prices, adjusted for inflation, or the current prices. The domestic reference price also could be adjusted upward to account for certain premiums, such as a drug that is first in class or of significant clinical value.

What are the trade-offs of domestic reference pricing?

Unlike international reference pricing, domestic reference pricing is normally based on prices originally set by manufacturers themselves. That means drugmakers would have an incentive to raise their launch prices for new drugs (although a mechanism could be designed to ensure future launch prices are reasonable).

Some policymakers are also worried that if Medicare-reimbursed drugs are pegged to price points that reflect negotiated discounts below statutory ceilings that another purchasing agency received, those discounts might be at risk — as manufacturers would also now provide discounts to the much larger Medicare market. This echoes concerns over international reference pricing, which analysts expect would lead to price increases in the countries that Medicare uses as a benchmark.

Nonetheless, depending on which benchmark is used, domestic reference pricing could bring needed transparency to prescription drug costs in Medicare. And, given the far lower prices that other government purchasers pay, it would likely provide a ceiling below current Part D prices, yielding savings to the Medicare program and its beneficiaries.