Profiting from Most-Favored Customer Procurement Rules: Evidence from Medicaid
How do most-favored customer clauses work?
Most-favored customer clauses (MFCC), or "best price" rules, are contract provisions that guarantee a buyer the lowest price offered to any other customer by the seller. MFCCs are common in government procurement. The Medicaid Drug Rebate Program uses an MFCC to ensure that Medicaid receives the biggest discount offered to any commercial payer. MFCCs can help lower government spending, but they also incentivize firms to keep prices higher in commercial markets to avoid triggering the clause.
Overview of Medicaid drug pricing rules
For each prescription given to Medicaid enrollees, the Centers for Medicare and Medicaid Services (CMS) pay drug manufacturers the Average Manufacturer Price (AMP), which is a measure of list price that does not consider rebates or discounts offered to private payers. Manufacturers then send CMS a quarterly rebate equal to the highest rebate given to any commercial payer but not lower than a minimum rebate percentage (15.1% until 2009 and 23.1% starting in 2010). As a result, the actual price paid by Medicaid for each unit is calculated as AMP times (1 - rebate).
How does the Medicaid MFCC affect firm revenue?
Drug manufacturers negotiate rebates off of list price with large payers called pharmacy benefit managers (PBMs). Even though brand drugs are patent-protected, PBMs can leverage their market power in these negotiations to extract higher discounts and keep net prices below monopoly levels.
The Medicaid MFCC makes it harder to obtain higher discounts because each marginal increase in the discount rate lowers not only the effective price of the payer who is negotiating the discount but also the Medicaid price.
Because the Medicaid MFCC only kicks in above a certain threshold, it creates a kink in the revenue function of the manufacturer. Firms can use the kink as a “commitment” to keep prices higher.
Increasing the minimum rebate threshold makes it easier for payers to extract higher discounts because it makes it harder to trigger the Medicaid MFCC.
Diff-in-diff estimates of the change in non-Medicaid discount rates for drugs with high Medicaid Market Share after the ACA rule change.
Diff-in-diff estimates of the change in non-Medicaid revenue for drugs with high Medicaid Market Share after the ACA rule change.
Evaluating the ACA reform
In 2010, the ACA raised the minimum rebate threshold from 15.1% to 23.1%.
Economic theory predicts that the reform had a bigger effect on drugs that receive a higher share of their revenue from Medicaid.
Using a difference-in-difference framework based on differential exposure to the Medicaid market, we look for changes in average discounts and total revenue in non-Medicaid segments of the market. We find that discounts for drugs with a high Medicaid Market Share (MMS) increased after the reform.
Our results imply that the ACA reform lowered prescription drug spending in the commercial market by approximately 2.5%
Using a model-driven calibration, we estimate that removing the MFCC altogether would further reduce spending by 3.5%, though it would also likely increase Medicaid spending.
Key takeaways
We provide quasi-experimental evidence of the impact of Medicaid rules on the commercial drug market
Without data on net prices and revenue it would have been impossible to uncover the effect of the Medicaid MFCC on commercial market outcomes. This is important because most research on the pharmaceutical market uses invoice prices and sales numbers.
The ACA rule change appears to have lowered drug spending for both Medicaid and commercial payers, although our analysis is limited to drugs already on the market. Drugs launching in the future have more flexibility in setting list prices and may be able to counteract the effects of the policy more effectively.