This week, President Donald Trump is expected to outline new policies to deliver on his campaign pledge to bring down drug prices. The move will likely deal another blow to the U.S. pharmaceutical and healthcare sectors at a time when both are already under duress from rising competition, intensified scrutiny on pricing practices, and litigation related to negligent marketing of opioids and drug costs.

Americans spend over $450 billion on prescription medicines a year, three-quarters of which goes towards brand name drugs. But, alternatives in the form of generic drugs, biosimilar versions of biotech drugs, and cannabis-based treatments are taking market share away. Generic drug approvals hit a record high in the U.S last year, a trend that will only accelerate with the FDA’s efforts to fast track the approval process. FDA chief Scott Gottlieb has repeatedly called for closing loopholes that can delay the entry of competing generic and biosimilar drugs.

The industry also faces competition from big tech firms trying to enter their space. For example, Verily, formerly known as Google Life Sciences, is attempting to break into a segment of health insurance called population health management; Apple is building medical-monitoring device into the Apple Watch and pushing its Healthkit as an industry-wide standard for health-data storage; Amazon, JP Morgan and Berkshire Hathaway are thinking of creating a not-for-profit system to lower health care costs for their employees.

But, the biggest threat confronting the industry comes from efforts by the administration and various states to bring down drug prices through regulation. Here are some ideas being tossed around.

Allowing Medicare to negotiate drug prices: While private insurance companies (and foreign governments) are able to negotiate the price they pay for prescription drugs, such negotiation by the U.S. government are forbidden by law. Trump believes changing this rule and allowing systems such as Medicare to negotiate drug prices for its beneficiaries would allow the government to save up to $300 billion every year.

Outlawing drug rebates: Drug rebates have become an essential, but opaque part of the pharmaceutical industry. Right now, it is common practice for pharmaceutical companies to set a high “list price” for a drug, and then lower that cost for insurance plans by offering hefty rebates in exchange for the broadest access to patients. With this system, drug manufacturers end up doling billions of dollars in rebates every year. However, Pharmacy Benefit Managers (“PBMs”), which act as financial middlemen between the drug manufacturers and insurers, keep a portion of the rebate for themselves, so most of the savings don’t trickle down to the patient.

Some officials believe the rebates actually contribute to drug price inflation because they incentivize manufacturers to set higher and higher prices. So, as prices go up, the manufacturer, the insurance company and the PBM all win at the expense of the patient. Insurers received $89 billion in rebates, reducing their spending on prescription drugs to $279 billion in 2016. The $89 billion does not include the portion of the rebate that PBMs kept, which isn’t disclosed.

In the middleman role, PBMs are able to dictate which drugs are sold and at what price to the majority of commercial health plans, self-insured employer plans, and government employee plans in the country. Earlier this year, the Council of Economic Advisers (CEA) criticized PBMs for their lack of transparency, also noting that the three PBMs that account for 85% of the U.S. market have undue power against the manufacturers, health plans and patients they are supposed to be representing.

One proposal under consideration by the Trump administration would effectively outlaw the drug rebates. Another would require insurers and PBMs to pass a greater share of the rebates to consumers and Medicare enrollees. The first option would threaten the business models of PBMs such as Express Scripts, CVS’ Caremark and UnitedHealth’s Optum. It could also erode the bargaining power of some drugmakers that offer hefty rebates. The second option would eat into the profitability of PBMs. However way you look at it, PBMs are most at risk of being disrupted by changes to the drug rebate system.

Buying drugs from Canada or anywhere else: Many drugs, even those produced in the United States, are available for much lower prices in other countries, with the result that Americans pay more for their medicines than people in those other countries. According to OECD data, the U.S. shelled out $1,162 per capita for prescription drugs in 2015. Second-place Switzerland spent $1,056, and third-place Canada came in at $807. Given this situation, several U.S. states want to be able to import (or “re-import”) cheaper medicines from Canada and other places, which would result in lower revenues for drug companies.

Only time will tell if any of these measure come to pass. In the meantime, U.S. pharmaceutical companies and health care providers will remain under pressure from the uncertainty, rising regulatory risk, competition and waves of litigation. Given these headwinds, MRP is reaffirming its bearish view on the industry. Short US Healthcare Providers has been on our list of themes since October 16, 2017. We added Short US Pharmaceuticals to that list on October 27, 2017, but suspended the theme in January on the basis that a brutal flu season and dollar weakness would lift the pharma sector’s first quarter earnings. We are now reinstating the Short Pharmaceuticals theme. We also continue to believe the PBMs are an especially vulnerable segment of the healthcare space.


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