Should Drug Investors Worry About Medicare Revenues?

(A version of this article was published by Forbes.)

The pharmaceutical sector has held up quite well in this aging bull market. Now, a new political risk is on the horizon: The Independent Payment Advisory Board (IPAB), which was instituted in the 2010 Affordable Care Act. Starting in 2015, the IPAB was empowered to cut Medicare spending if costs increased faster than a certain rate. It quickly faded into the background as the growth in Medicare spending moderated after President Obama signed the Affordable Care Act.

Those days are gone. The latest annual Medicare Trustees’ report, published on June 22, indicates Medicare spending will cross the threshold for IPAB to swing into action in 2017. The 2017 threshold is determined by a target rate of growth which is the average of the change in the Consumer Price Index (CPI) and the medical-care component of the CPI. Estimates of both actual Medicare spending per capita and the target rate are calculated as five-year averages.

Table I, extracted from a recent presentation by Medicare’s Chief Actuary, illustrates why investors are becoming concerned. Table I highlights this year’s Medicare spending per capita will increase 2.21 percent (averaged over the five years, 2014 through 2018). The target rate is 2.33 percent, higher than the estimated actual rate, so the threshold is not crossed. IPAB remains asleep.

However, in 2017, actual spending is estimated to grow at 2.82 percent while the target rate will be just 2.62 percent, causing IPAB to propose cuts to spending in 2019 comprising 0.2 percent of Medicare spending. Before 2020, IPAB may not target providers for which rates are already cut by Obamacare – primarily hospitals. Further, Congress and the Administration made a new deal for Medicare payments to doctors as recently as April 2015. Every physicians’ organization strongly endorsed this new payment model, so the government would hardly renege on it so soon.

So, investors are right to be concerned that IPAB will propose cuts to prescription spending. However, let’s put this in perspective. Net Medicare spending (less Part B and Part D premiums) will be about $708.7 billion in 2019, of which 0.2 percent is $142 million. Medicare Part D spending on prescription drugs will be about $134.3 billion in 2019. Further, Medicare Part B, which covers physicians, also pays for drugs by injection. This amounted to $18.5 billion in 2014. So, taking the big-picture view, the pharmaceutical industry will suffer little harm if the IPAB tries to cut $142 million of its Medicare revenues.

This disguises that Medicare drug spending is highly concentrated. For Medicare Part B, the top 10 drugs accounted for 38 percent of payments in 2014. For Medicare Part D, the top 10 drugs accounted for 23 percent of payments in 2011. So, depending on how the IPAB decides to cut payments for drugs, it could have a significant effect on revenues of drug-makers which produce drugs which cost Medicare a lot.

However, it is hard to predict where IPAB will cut because there is no IPAB. Nor will there be one in 2017, when it is supposed to make its recommendations on 2019 spending cuts. If it existed as it should have since 2014, the IPAB would comprise 15 members nominated by the president and confirmed by the Senate.

President Obama saw no upside in nominating candidates, which would simply re-ignite the debate over Obamacare’s death panels. If the IPAB fails to perform its duties, its powers fall to the U.S. Secretary of Health & Human Services. In a constitutionally suspect provision of the legislation, the Affordable Care Act grants Congress very little ability to debate or propose alternatives to the cuts proposed by the IPAB or the Secretary.

Pharmaceutical investors can expect the following sequence of events. By April 30, 2017, Medicare’s Chief Actuary will issue his official determination that the rate of growth of Medicare spending per capita will be higher than the target rate, and spending in 2017 must be cut. By January 25, 2018, the Secretary will propose spending cuts to Congress, which has to “fast track” its approval or propose alternative cuts in a very short time.

A proposal to cut drug spending with price controls, which would be the easiest political score, would also provoke a legal challenge. Although reimbursement for Medicare Part B drugs is subject to administrative changes, the Medicare Modernization Act of 2003 (which created Medicare Part D for prescription drugs) included a “non-interference clause” preventing the federal government from interfering in Part D drug prices.

Although President Obama and Democrats in general would love to topple the non-interference clause, they refrained from attacking it directly in the Affordable Care Act in order to prevent the research-based pharmaceutical industry from opposing Obamacare. Using the IPAB determination to attack the non-interference clause would provoke a flurry of litigation, the outcome of which I would hesitate to predict at this point.