The Trump administration's latest plan to lower prescription drug prices could make a big difference for patients and healthcare investors of all stripes.

Recently, the Department of Health and Human Services (HHS) proposed a rule change that the pharmaceutical industry actually appreciates. The proposed changes could crush the middlemen they blame for rapidly rising drug prices. Here's what you need to know.

Hand with a needle popping a bubble with a dollar sign inside.

Image source: Getty Images.

How to boost demand by increasing prices

Pharmacy benefits managers (PBMs) help health-plan sponsors negotiate with drug manufacturers as a larger group with more leverage than the sponsors would have on their own. In a nutshell, PBMs wrangle discounts and rebates from drugmakers in return for a preferred position on their formulary and the increased market share that comes with it.

Insurers receive a slice of these rebates, which they don't necessarily pass on to their customers. Since out-of-pocket costs for pricey drugs are often linked to their list prices, there's a warped incentive for unsavory characters to transition patients to treatments that cost a fortune when something less expensive might be adequate.

HHS didn't point any fingers, but it remarked that reimbursement for branded drugs covered under Medicare part D rose 77% from 2011 to 2015. Over the same short span, the percentage of beneficiaries responsible for out-of-pocket costs for brand-name drugs nearly doubled.

If you think restricting customer access to certain drugs if manufacturers don't offer big rebates sounds like an illegal shakedown, it's because it nearly is. PBMs operate under specific safe-harbor protections from federal anti-kickback laws aimed at organized crime and corruption.

Pair of hands passing several $100 bills to a doctor.

Image source: Getty Images.

A bad time to buy a middleman?

Over the summer, HHS unveiled a plan to end safe-harbor protections for the PBM industry but didn't provide many details. The latest iteration of the proposed rule would make rebates illegal again while protecting certain PBM service fees. To prevent PBMs from disguising payments for patient access as service fees, the proposed rule also includes new safe-harbor protections that would only allow PBMs to collect fees at flat rates unrelated to list prices.

If PBMs are limited to flat fees, Cigna (CI) could have a hard time making its Express Scripts acquisition work out for investors. The large health insurer recently paid $54 billion for the largest independent PBM around, and now it manages prescription benefits for 73 million Americans.

Cigna insists the HHS proposal isn't a problem because it already passes 95% of collected rebates to customers. Investors should know that PBMs operate on such slim margins that a slight change can be the difference between profits and losses. Cigna's 17 million health-coverage patients would still benefit from any concessions wrangled from drugmakers, but realizing a profit from this deal could be a lot harder than expected.

Doctor holding a light bulb.

Image source: Getty Images.

Thinking ahead

Rather than pay another PBM for the service, UnitedHealth Group (UNH 0.06%) has been pushing vertical integration for years. America's largest health insurer operates a PBM called Optum, and it's been the third largest behind CVS Health (CVS -0.33%) and Express Scripts for years.

CVS Health acquired a large insurance company last year, and integrating its pharmacy benefits manager will probably push up overall profits. The retailer would like to add clinics to its stores and use insights from its PBM to drive savings for patients. 

UnitedHealth Group is miles ahead of Cigna and CVS Health. It's in-house PBM began acquiring physician groups in 2008, and it's already the largest employer of physicians in the country, with around 47,000 doctors.

Last March, UnitedHealth Group began offering point-of-sale rebates to over 7 million people enrolled in its commercial group. CVS Health followed suit in December, by offering 100% of rebates to plan sponsors. 

Check out the latest UnitedHealth earnings call transcript.

Scientist looking through test tubes.

Image source: Getty Images.

Time for transparency?

Drugmakers have always set their prices as high as possible, and that will never change. In recent years, though, they've been receiving a lot more complaints than they deserve. 

In 2013, Eli Lilly (LLY 2.35%) offered an average discount of 30% across its U.S. product portfolio. In 2017, it's average discount had risen to 51% of list prices. Lilly isn't the only pharma fed up with raising list prices a lot faster than the portion they get to keep.

Despite raising list prices, net prices that Johnson & Johnson can report as revenue actually fell between 6% and 8% last year. A handful of big pharma companies have disappointed investors with a softer-than-expected outlook in 2019, driven in part by offering higher rebates.

Of course, nothing is going to change until Congress passes a law based on the HHS proposal for full rebate transparency. With backing from the pharmaceutical industry, there's a solid chance it could become law and eventually change how insurers and drugmakers do business together.