So begins a post from Rachel Sachs, Darius Lakdawalla, and me at the Health Affairs Blog on the complicated interplay between value-based pricing and Medicaid’s best-price rule.

What is the best-price rule? Does it really impede the adoption of value-based pricing? If so, what can be done about it?

To keep federal spending in check, state Medicaid programs never pay full price for a drug. By statute, they receive rebates worth about one-quarter of a drug’s average manufacturer price. But if a manufacturer chooses to sell the drug to someone else for less than the rebated amount, Medicaid will only pay that “best price.” It’s a guarantee that Medicaid can buy the drug at the cheapest price that the manufacturer can afford to sell it.

Now consider outcome-based pricing, in which manufacturers get paid less when their drugs perform poorly. A manufacturer, for example, might agree to pay a $75 rebate on a $100 drug that fails to work for a particular patient. If it did, however, $25 would now be the drug’s “best price.” Every Medicaid program would be legally entitled to that price, decimating the manufacturer’s revenue from Medicaid.

That’s why the pharmaceutical industry complains that the best-price rule impedes outcome-based pricing. Its objection is accurate so far as it goes, but it ignores a technique that drug companies and insurers could use to contract around the best-price rule. Instead of granting a rebate if a drug fails to work for a particular patient, manufacturers can offer a rebate based on the performance of the drug across a patient population. To return to the earlier example, a drug manufacturer might sell a drug for $100 but offer a $75 rebate per patient for whom the drug doesn’t work, based on the drug’s performance across 1,000 patients. If the drug is 75 percent effective, the average price for the drugs sold to the 1,000 patients would be north of $80, high enough not to trigger the best-price rule. Indeed, the fact that drug companies have begun to enter into some of these contracts suggests that companies may already be doing some weighted average pricing.

Even so, tremendous uncertainty remains. In a rule, the Centers for Medicare and Medicaid Services (CMS) has said that best price must be determined on a “unit basis.” Depending on what CMS understands the term to mean, the unit-basis rule may thwart efforts to contract around the best-price rule. At the same time, however, CMS has the authority to change its rule. The statute itself does not contain any unit-basis requirement, meaning that it could be amended to encourage outcome-based pricing arrangements.

There’s more at the post, which builds off a paper, a draft of which is available here, that Rachel, Darius, and I will be publishing at the Journal of Health Politics, Policy and Law. Comments on the draft are welcome!

@nicholas_bagley