If you have not already read it, you can read our main summary of the Tennessee waiver approval HERE.

Now that we have had the chance to read and meditate on the historic Medicaid waiver approved on Friday January 8th, giving Tennessee permission from the Federal government to fundamentally alter Medicaid’s traditional “matching” financing structure for the 1.5 million Tennesseans who rely on the program for healthcare services, I wanted to dive into a subject near-and-dear to many of our reader’s hearts: the Medicaid pharmacy benefit. As I mentioned in our detailed summary of the Tennessee waiver approval, the Tennessee waiver includes a number of “firsts”, including the first state in the nation to receive permission from CMS to adopt a closed, commercial-like prescription drug formulary. As set forth in CMS Administrator Verma’s remarks:

Among those flexibilities, CMS has approved several new approaches to help Tennessee better serve its Medicaid population and lower prescription drug costs. With the exception of drugs for individuals eligible for Early and Periodic Screening, Diagnostic and Treatment benefits, the state will have the authority to implement a “commercial-style” closed drug formulary, while continuing to receive statutory Medicaid drug rebates for covered drugs. Specifically, the state will have authority not to cover certain medications when there is at least one drug available per therapeutic class under essential health benefit rules (with the exception of certain protected drug classes), and to exclude certain new drugs from its formulary, with an exceptions process for specialty drugs. With this approval, Tennessee will have greater ability to negotiate other supplemental rebates directly with drug manufacturers.

The significance of this approval should not be ignored, even if the chances of the Tennessee waiver remaining in place under the incoming Biden administration are, to say the least, tenuous, your editors believe it is not inconceivable that a Biden Administration could consider closed formularies in different contexts. As such, let’s dive a bit deeper into the the pharmacy benefit under the Tennessee waiver, unpack the legal authority, and do some fortune telling on the future of closed formularies in the Medicaid program.

TennCare III and Pharmacy Flexibilities

Under the approved Tennessee waiver (known as TennCare III), in exchange for accepting an aggregate financing cap on dollars committed by the Federal government through Federal Financial Participation (FFP), CMS is granting Tennessee a number of unprecedented flexibilities, not least of which is the authority to adopt a closed, commercial-like formulary for nearly its entire Medicaid population. We have talked about closed formularies on this blog before, because they are not a new idea. States, looking for new tools to control costs, have long been tempted to adopt the prescription drug management tools used by insurers and PBMs in nearly every other health insurance sector: closed formularies, utilization management (such as step therapy and prior authorization), and significant cost sharing obligations for specialty drugs. Perhaps most recently, my colleague Tom Barker discussed closed formularies in response to a request from Massachusetts to the Trump Administration seeking precisely this flexibility (albeit outside the context of a block grant). The Trump Administration subsequently rejected this request. Why are closed formularies so attractive to states? The argument goes that if a state is essentially required to cover a manufacturer’s drug, the manufacturer has little incentive to negotiate steeper discounts (in Medicaid, in the form of supplemental rebates) beyond the otherwise required mandatory rebates. Of course, today, states do use formularies and prior authorization to negotiate significant supplemental rebates from manufacturers, but still, it remains true (at least theoretically) that a state has less leverage under an open formulary system. Under a closed formulary system, Tennessee argued in its waiver request: “the federal government has deprived state Medicaid programs of basic formulary management tools commonly
used by other payers to manage prescription drug spending. Whereas commercial payers can elect whether or not to cover drugs based on considerations such as clinical efficacy and affordability, TennCare is required to cover any drug for which the manufacturer participates in the federal Medicaid drug rebate program. This coverage mandate, coupled with the volatility of prescription drug costs and
the state's lack of authority to meaningfully manage its prescription drug benefit, leads to extreme financial pressures for states.”

As a refresher to our newer readers, while prescription drugs are an “optional” benefit under the Medicaid program for states, all states currently offer coverage for outpatient prescription drugs. In offering prescription drug coverage under their state plan authority, states must agree (by way of section 1902(a)(54) of the Social Security Act) to certain conditions which are set forth in section 1927. Section 1927 sets forth the requirements for the Medicaid Drug Rebate Program (MDRP). Under the MDRP, once a prescription drug manufacturer has agreed to pay rebates under the law's rebate scheme to be shared between the state and Federal government, states are generally required to cover the manufacturer's drug. This is that historic, grand bargain I reference in the title (and as we will discuss in a future post, 340B was later incorporated into that grand bargain). While states can adopt utilization management techniques (such as prior authorization), and can even adopt a formulary, unlike in employer or commercial (or even Medicare) drug coverage, if a manufacturer's drug offers a “significant, clinically meaningful therapeutic advantage” compared to other drugs on the formulary, the state has no choice and must cover the drug. In this way, Medicaid formularies are “open” (meaning no drug is expressly not covered), while other health insurance programs adopt “closed” formularies. Manufacturers commit to rebates — states commit to open access. 

The Tennessee waiver approval upends this bargain, albeit with more protections for Medicaid enrollees than originally envisioned by Tennessee. In lieu of an open formulary, Tennessee will now have the following flexibilities in offering its pharmacy benefit (largely based off of the flexibilities outline in CMS’ 2020 “Health Adult Opportunity” guidance, which we discussed here and here):

• Borrows from the “Obamacare” marketplaces the Essential Health Benefit (EHB) requirements for benchmark prescription drug coverage, requiring Tennessee to adopt an already approved EHB formulary which must include the great of one drug per category/class, or the same number of drugs in each category/class as EHB-benchmark plan.
• In addition to one drug per category class, the formulary must also:
  • Offer coverage for all forms of drugs and biologicals that the FDA has approved or licensed for Medication Assisted Treatment (MAT) to treat Opioid Use Disorder;
  • Offer coverage for “substantially all” of the drugs otherwise required to be covered under the Medicare Part D protected classes policy (i.e., antidepressants, anticonvulsants, antipsychotics, immunosuppressants, antineoplastics, and antiretroviral drugs, including PreP).
• Maintain and publish in print and on a website an up-to-date list of all drugs in the formulary.
• Establish a P&T Committee (or use the state’s current DUR board) to develop and manage the formulary).
• Establish a state exceptions process for enrollees to request and gain access to clinically appropriate drugs (as defined by the state) not on the plan’s formulary.

Why does this disrupt the grand bargain, you may ask, if CMS is simply relieving Tennessee of its obligations under 1927? The answer: while Tennessee will be permitted to establish a closed formulary, it will still be entitled to retain mandatory (and supplemental) rebates paid by manufacturers under section 1927. Using some legal jujitsu (discussed below), as my colleague Haider Andazola likes to call it, CMS believes it was both able to relieve the state of its coverage obligations to manufacturers, while permitting the state to retain the financial benefit otherwise associated with a state’s participation in the MDRP.

Legal Basis for New Closed Formulary Flexibilities

In the Tennessee waiver approval, CMS borrows the legal rationale it offered up in its “Healthy Adult Opportunity” guidance, which we previously dissected here, in order to permit the state to establish a closed formulary while still collecting rebates under the MDRP. CMS relies on section 1115(a)(2) expenditure authority which provides, in part:

“In the case of any experimental, pilot, or demonstration project which, in the judgment of the Secretary, is likely to assist in promoting the objectives of title… XIX… costs of such project which would not otherwise be included as expenditures under section … 1903 … shall, to the extent and for the period prescribed by the Secretary, be regarded as expenditures under the State plan…”

Under the new Tennessee waiver, Tennessee will not provide prescription drug coverage under section 1927 (the MDRP), thereby relieving it of any obligations to maintain an open formulary. Instead, such coverage will be offered under 1115(a)(2) which permits the state to treat as expenditures eligible for Federal matching payments services not otherwise covered (in this case, prescription drug coverage not complying with the MDRP). But how can you relieve the state of complying with 1927’s formulary requirements, while still requiring manufacturers to provide rebates under section 1927? CMS argues that this is possible because, as noted above, 1115(a)(2) provides that expenditures “be regarded as expenditures under the State plan.” Thus, the manufacturer rebate obligation remains even though the drugs provided will not be covered under 1927, because the amounts Tennessee expends on drugs will be treated as if they were provided under 1927. In other words, payment for prescription drugs involves “expenditures under the State plan,” and section 1927(b)(1)(A), which outlines rebate requirements, requires that manufacturers provide rebates for drugs “for which payment was made under the State plan….”  But section 1927(d), which limits state's ability to adopt closed formularies, does not contain analogous language referring to “expenditures under the State plan.”  CMS seems to construe the explicit “expenditures” phrase in section 1927(b)(1)(A) and corresponding omission under section 1927(d) to allow states to claim rebates for prescription drugs under a section 1115(a)(2) waiver while not being limited in their formulary authority.

Interesting jujitsu, right?

I would be remiss not to mention that, although this legal justification tracks the HAO guidance, it does not track CMS’ guidance to MassHealth when it rejected the state’s request to establish a closed formulary in 2018. In its letter rejecting this proposal, CMS wrote:

With respect to Massachusetts’ formulary proposals, CMS would be willing to consider a demonstration that would give the state the ability to exclude certain Medicaid covered outpatient drugs from coverage under its Medicaid program, as requested, on the condition that the state would drop optional State plan drug coverage under section 1902(a)(54) of the Social Security Act (the Act) so that individuals currently receiving coverage under section 1902(a)(54) could receive coverage of outpatient drugs under the expenditure authority in section 1115(a)(2). This would mean that, with respect to such individuals, drug coverage would no longer be provided in accordance with the provisions outlined in Section 1927 of the Social Security Act. Under such a demonstration, with respect to individuals receiving drug coverage under section 1115(a)(2), the state would have to negotiate directly with manufacturers and forgo all manufacturer rebates available under the federal Medicaid Drug Rebate Program.

Aha! While CMS has far back as 2018 had taken the position that 1115(a)(2) was the vehicle to institute closed prescription drug formularies, it still had not connected the dots on how to let states keep rebates. So either its thinking evolved, or the Trump Administration was more inclined to stretch its legal logic when a block grant was on the line.

Next Step and Future Implications for the Medicaid Program

As discussed in our main post, the future of the TennCare waiver is far from certain given the incoming Biden Administration’s likely opposition to its structure. But the question of whether or not closed formularies have a future in the Medicaid program is far more nuanced. Separate and apart from the Tennessee waiver, we believe the Biden Administration will carefully balance and consider the negative implications of a closed formulary for beneficiaries (reduced access and negative health implications) with the possibility for cost-savings for states (particularly if tied to quality metrics, maintenance of effort requirements, or a commitment to expand coverage). We see two possible scenarios in which a closed formulary model could look “appetizing” to a Biden Administration:

1. If a state like Massachusetts approaches the Biden Administration with a request similar to the one it proposed early on in the Trump Administration, we do not believe it would be inconceivable that the request would receive due consideration given the state’s history of expanding coverage and benefits.
2. The Biden Administration will also be strongly focused on securing nationwide Medicaid expansion and closed formularies could be a carrot for some reluctant red states to expand.

Taking a longer view, over time, Medicaid has admittedly started to look more and more like commercial coverage, by and large as a result of the growth in managed care. One of the big holdouts (in addition to nominal cost-sharing), is the pharmacy benefit embedded in 1927. We already know the legal pathway to accomplish changes via an 1115 waiver, so in the long run, we do think it is more likely than not that Medicaid formularies will begin to look more like their commercial counterparts. Will manufacturers really be required to pay rebates if states opt out of the MDRP? We think that is a tough question given the Trump Administration’s legal argument has yet to be tested. But if it is – you know we will cover it here.