State Drug Price Cap Laws: How Do They Work?

By Rachel Sachs

Two weeks ago, I blogged here about various state bills designed to encourage transparency in the pharmaceutical industry, by requiring companies to disclose information about their research & development costs, marketing expenses, and prices charged to different purchasers. In that post, I glossed over the state initiatives to cap drug prices directly, but as these initiatives have been more recently in the news, I want to focus on them here and ask a basic question: can someone explain to me how they would work?

Let’s back up. Two states, California and Ohio, are considering ballot initiatives that propose to cap what drug manufacturers can charge to public payers in the state (such as Medicaid).  The texts of the initiatives are nearly identical, with a few state-specific differences in the enumeration of entities eligible to pay the capped price.  As clearly stated in a comprehensive POLITICO article earlier this week by Nancy Cook and Sarah Karlin-Smith, the initiatives “would require the state to pay no more for prescription drugs than the U.S. Department of Veterans Affairs — one of the few federal agencies allowed to negotiate drug prices.”

We can and should debate whether price caps like these are a good idea, as a policy matter, and the Cook & Karlin-Smith piece canvasses a number of the arguments on both sides.  But first, we should be clear that the laws we’re enacting can actually accomplish their intended purpose.  And if they can’t, we should acknowledge that publicly.  I see at least two primary obstacles to the implementation of these price cap initiatives, and since they’ve largely been absent from the public discussion, it’s useful to state them explicitly.

First, capping state prices at VA prices seems to require the state to know what the VA is paying for a drug.  The problem is that the prices paid by the VA are not public.  Nothing in either state initiative requires pharmaceutical companies to disclose these prices to the relevant state actors, and it’s not clear that the states would have the ability to access the information otherwise.  So how are the states supposed to know what the VA is paying?  To be fair, several of the separate state transparency laws would require pharmaceutical companies to disclose the prices they charge to different purchasers.  But California’s bill (which, to be clear, is distinct from the ballot initiative I’m discussing in this post) does not seem to require disclosure of VA prices in particular.  In Ohio, which has no such companion bill, the situation is even more confusing.  (As a note, I can envision a number of situations in which the state doesn’t have to know what the VA is paying, but they all require additional factors, like penalties or third-party actions, which are missing from the initiatives.)

Second, even if a state knows the VA prices, it doesn’t clearly have the legal ability to demand that it also pay those prices.  The VA has much greater ability to set a formulary than do most public payers, including state Medicaid programs. (Although here there are interesting complications as between Medicaid fee-for-service and Medicaid managed care, which is perhaps why California distinguishes the two in its initiative.)  Basically, the VA can often get up and walk away from the bargaining table if it doesn’t like what the pharmaceutical company is offering.  That leverage allows them to demand and receive lower prices than many other public payers receive.  Medicaid, by contrast, is required by law to cover nearly all FDA-approved drugs.  To be sure, competitors in a class can compete for preferred access in a state by providing greater discounts.  But there isn’t always such competition.  By law, Medicaid can’t easily walk away from the table, limiting its ability to demand VA prices.

California’s initiative does allow the state to “adopt rules and/or regulations to implement” the initiative, and to “seek any waivers of federal law, rule, and/or regulation necessary to implement” the initiative.  Ohio’s initiative has nearly identical language.  So it’s possible that the state would figure out another way to deal with the disclosure problem (such as through a transparency bill), and the state would surely ask the federal government for waivers that would provide them with greater ability to deal with the negotiating power problem.  But it’s not obvious that the federal government is empowered to grant such waivers.

So these initiatives may very well not work, although in that case it’s puzzling to me that we haven’t seen arguments to this effect by pharma companies.  (It’s possible I’m just not aware of them, as I don’t live in either state and don’t see the ads. But the ads described in POLITICO don’t clearly lay out these problems.)  As I noted before, there are real, substantive debates to be had about whether these or similar initiatives are a good idea as a policy matter.  And if we’re having those debates, even if the thing we’re fighting about wouldn’t accomplish its stated goal, in some sense that’s good.  But in another sense it’s frustrating.

Some policy energy might instead be focused on a practical way to force the initiative’s solution, legally: a reform of the Medicaid best price rule.  Medicaid is generally entitled to the “best price” available for a drug.  If a large commercial insurer can extract large rebates for enrollees in employer-sponsored plans, Medicaid generally gets those same rebates.  But there are exceptions to the best price rule – there are payers who can receive lower prices for drugs without impacting Medicaid prices.  For instance, entities participating in the 340B Plan – hospitals that serve primarily the poorest patients, Ryan White HIV/AIDS Program Grantees, Black Lung Clinics, etc. – may receive lower prices.  And prices charged to the VA are also excluded from the best price calculation.  A change in the law to include the VA in the best price calculation would seem to achieve the result sought by the proponents of the ballot initiative.  To be sure, there would be intense political opposition, and it’s not obvious how pharma companies would respond if such a change were enacted.  But it’s a practical way to achieve the same goal, and it’s interesting that it’s absent from the conversation.

Like the transparency bills, these ballot initiatives give voice to much of the anger consumers feel about drug prices, particularly in the wake of Martin Shkreli, Valeant, and other scandals.  The focus on pricing isn’t going away, as it sometimes has in the past, and I’m heartened to see the real public conversations about these issues.  But in my view we should focus on policies that will actually make change, and I’m not sure these initiatives meet that requirement.

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About rachelsachs

Rachel Sachs is an Associate Professor at the Washington University in St. Louis School of Law. Previously, she was an Academic Fellow at the Petrie-Flom Center. Rachel earned her J.D. in 2013 magna cum laude from Harvard Law School, where she was the Articles Chair of the Harvard Law Review and a student fellow with both the Petrie-Flom Center and the John M. Olin Center for Law, Economics, and Business. Rachel has also earned a Master of Public Health from the Harvard School of Public Health, during which she interned at the United States Department of Health and Human Services. Rachel's primary research interests lie at the intersection of patent law and health law, with a particular focus on problems of innovation and access and the ways in which law helps or hinders these problems.