Could Arbitration Help Control Medicare Part D Costs?

Medicare Part D costs have leveled off in recent years as pharmaceutical innovation has slowed and a number of blockbuster drugs lost patent protection, but a new wave of expensive specialty drugs threatens to revitalize cost growth. To help control the high prices of unique drugs paid for by Part D, Richard Frank and Joseph Newhouse recommend an innovative approach to apply binding arbitration as a fallback to price-setting negotiations.

The authors argue that policymakers overestimated the negotiating power that prescription drug plans (PDPs) would hold in setting prices when they created Part D through the Medicare Modernization Act (MMA) of 2003. Price negotiation in Part D proves most difficult for unique drugs, or those without any direct substitute. Setting prices too low for important, clinically unique drugs could harm future research and development as pharmaceutical companies could lose vital capital to continue incentivizing such research and development.

Frank and Newhouse offer a solution that incorporates binding arbitration into price setting for unique drugs. In their proposal, binding arbitration would take effect only after the government and manufacturer cannot come to an agreement, thereby encouraging the two parties to reach a negotiated settlement.

The authors propose one of two arbitration models when a negotiation is not met. The first is a final-offer arbitration system in which both parties cases are heard and then offer their best and final prices. The arbitrator then evaluates the case and sets the drug price at one of the two final prices.

Another potential model would be tri-offer arbitration in which a third-party expert or “fact finder” offers a third price for arbitrator consideration. The tri-offer model may be desirable because neither the Center for Medicare and Medicaid Services nor drug manufacturers alone hold the final say in a drug’s price. The system encourages informed negotiations, and an arbitrator only steps in if the two parties cannot reach an agreement.

Under either system, whether final-offer or tri-offer, pharmaceutical research and development is less threatened because the government is not able to set a take-it or leave-it as they do in other parts of Medicare.

With baby boomers reaching Medicare eligibility age and drug spending projected to increase at faster rates in the coming years, Medicare drug spending demands attention, and this proposal deserves revisiting.