Are Drug-Price Cut Plans a Depressant?

In July, President Joe Biden signed an executive order ostensibly to promote competition in a broad swath of sectors and industries, including Health Care and Pharmaceuticals. Last week, the US Department of Health and Human Services (HHS) released its plan to cut prescription drug prices by empowering the federal government to bargain for them in Medicare, among other measures. The concern among investors: As Medicare purchases a lot of prescription drugs for seniors, prices it negotiates could also serve as a baseline for private insurers. So how would this affect Health Care stocks’ earnings in the near and longer term? Before expecting this to create big waves, we think it is helpful to step back and consider what this executive order actually does and what the likelihood of change is.

The Biden administration’s drug-price reduction initiative mostly amounts to a series of proposals outlining legislative approaches for Congress to take, as well as a few studies for HHS to undertake. We will start with the latter, as these are actually under HHS’s direct purview. The plan would have HHS perform a series of analyses, including:

• Studying payments based on drugs’ clinical effectiveness
• Collecting data from insurers and pharmacy benefit managers about prices, rebates and out-of-pocket spending on medications to improve transparency
• Working with states to develop drug importation programs

The private sector already conducts drug effectiveness studies and pays accordingly, so we doubt this is a huge shift. Drug pricing may be opaque to consumers, but not to hospitals and insurers. Data collection could make their negotiations more transparent, but it won’t change their outcomes by itself. The third provision is most significant, as imports could theoretically hit Health Care firms’ profits. Drug importation could gain steam, but so far only a handful of states have signed on. While they notably include Florida, which recently received FDA approval, it is a slow and onerous process—and allows importation from Canada only. The meager interest and uptake thus far may be why HHS is offering to facilitate the process, but it still requires state legislatures to move it forward, which isn’t exactly a lightning-fast route.

But the part getting most attention in the press is the HHS’s policy recommendations. These include drug price negotiation in Medicare Parts B and D, limits on drug price increases and reforms to expedite generics, including shortening branded drugs’ exclusivity periods. They are only recommendations though. To enact them would take a new law, which HHS’s statement makes an effort to influence.

This isn’t the first time an administration has attempted something like this. For example, the Trump administration tried to curb Medicare drug costs by referencing them to foreign countries’ lower rates. But executive action can’t conflict with existing law. Without Congressional backing, presidents’ orders are subject to legal challenges and judicial review. In this case, it went nowhere after a federal judge blocked the Trump administration’s rule following an industry group suit.

Is Congress more amenable to a different outcome now? We have our doubts. Although the House and Senate are nominally under Democratic control, given the former’s historically slim split and the latter’s 50/50 one, driving down drug costs is easier said than done. Consider: Currently, there are measures circulating in House committees that aim to act on these recommendations. Early votes on these reveal a tough road ahead. One committee vote saw several Democratic representatives vote against allowing Medicare to negotiate drug prices. Another committee pushed it through. That doesn’t bode well for a floor vote, though. There is also another House Democrat-backed bill that waters down HHS’s pitch. Which of these advance, if either one does, remains to be seen. It isn’t clear moderate Democrats from states with substantial Health Care industry presence support President Biden’s plan. Getting near unanimity from them for passage may present a challenge.

If, if, that legislation passes, keep in mind Medicare prescription drug spending makes up only about a third of the US total.^[i] While a big chunk, it isn’t everything. Moreover, negotiations would be just that—they don’t guarantee price reductions, nor would any actual reductions promise to be widespread. Whether they can be replicated anywhere—or everywhere—depends on legislative measures.

Stocks move most on the gap between reality and expectations. Potential Medicare drug price negotiations, lower-cost drug imports, outcome-based pricing and the like are long-standing issues, which have been part of the political conversation for ages. Given the headline attention and news flow possible drug price reform receives, it isn’t sneaking up on markets. For these factors to sway stocks materially, they would have to lower profit margins or dissuade drug development enough to shrink revenue more than already expected. Given the political reality on the ground presently, that doesn’t seem likely to us.

Now, sentiment may be weighing—the S&P 500 Pharmaceuticals group is down -8.5% since August 17 versus the benchmark’s 0.9% rise.^[ii] This extends Pharma’s (and Health Care’s) cumulative underperformance since this bull market’s birth in March 2020. Worries over potential legislation like those mooted now might partly explain that. That said, COVID’s impacts on elective care and such can’t be dismissed. Nor can factors like Health Care’s relatively defensive characteristics when more growthy sectors (e.g., Tech and Consumer Discretionary) have led. Drug pricing worries may linger, but we think markets already reflect concerns. Longer term, if reality proves better than feared, they could get a bit of a boost.

So all in all, while some policy plans currently swirling may come to pass, don’t overrate them, especially from where expectations now seem to stand.