The Centers for Medicare & Medicaid Services made a decision last week that could cut into the profits of Part D plans and certainly focuses more attention on how they are spending premium revenue.

Much to the dismay of large pharmacy benefit managers and some insurers who are big in this space, CMS said it will apply minimum spending rules on stand-alone Part D plans, just as the agency does for commercial and Medicare Advantage plans. As part of the Affordable Care Act, MA plans are required to spend at least 80 percent to 85 percent of their premiums on medical care (called a medical loss ratio), or rebate money back to clients when they do not meet this threshold.

There are a number of reasons why this ruling is important, but let's first start with the basic math. Although stand-alone Part D plans account for more lives than MA plans (22.6 million versus 12.9 million at last count), the stand-alone plans generate far less revenue for companies than MA plans (about $1,000 per beneficiary per year in PDP versus more than $10,000 in MA if you use publicly traded companies. SEC filings as proxies). Spending on PDPs is just a fraction of that in MA. In fact, one of the greatest successes to date from the stand-alone Part D program has been that costs have consistently come in under original projections. That's because of a handful of issues that we've seen play out in the decade since the 2003 Medicare Modernization Act that created Part D took effect.

First, Part D plans are much less generous than previously expected. The experience of Humana and Sierra Health regarding rich plans that offered branded drugs in the doughnut hole scared the market away from adverse selection. Second, PDPs have been pretty aggressive around tiering. In our Physician & Payer Forum reports, we consistently see that MCOs Part D plans are never as generous to branded therapies as commercial plans are. A branded drug that may be covered on a preferred tier on a commercial plan may be nonpreferred or even excluded from some PDPs. Third, the generic erosion of blockbusters like Lipitor further reduces the cost pressures on PDPs. And since many of the drugs with the fastest-growing sales are infused specialty drugs, there's a chance that PDPs don't have to cover them at all if they're paid for under Medicare Part B.

This narrative about lower-than-expected costs for PDPs has hidden the fact that Part D vendors may have been operating lower MLRs in their stand-alone PDP plans than in their MA plans. By and large, the major MCOs don't break out premium and benefit costs for PDP and MA separately; they try to merge them in their SEC filings and it's hard to get a real representation of their costs. However, WellCare Health Plans does break them out separately and the data show interesting findings. First, despite the fact that WellCare has four times the membership in its PDPs as in MA, MA generates twice the revenue of PDP. Importantly, though, MA has a higher MLR 84.2% in 2012 versus 78.7% for PDP, SEC filings show.

If WellCare is an example, PDPs are not reaching the 80 percent to 85 percent threshold and are therefore under-spending on drugs. The issue will become more pronounced because the effects of the patent cliff are just now taking hold. We've already seen Lipitor, Zyprexa, Plavix, Seroquel and Singulair go generic. As this happens, PDPs typically punish branded therapies with nonpreferred coverage or exclusion where they can. As a result, the under-spending by PDPs could actually increase without the MLR rule. If WellCare's MLR is standard, we could be looking at close to $300 million in under-spending nationally at the 80 percent MLR level and much more at 85 percent MLR (the 80 percent applies to individual and small-group plans, the 85 percent to large-group plans).

PDPs do not want to rebate money and the doughnut hole is already being filled, so they have few options available. They aren't going to improve the benefits of their plans because of their negative experience in the past, which doesn't help the drug industry. Instead, PDPs may consider reducing premiums over the next two years as they adapt to this new rule. As a result, a simple rule clarification could have substantial impact on the market.

Roy Moore is senior director of U.S. Physician & Payer Forum at Decision Resources.

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