U.S. Life Sciences

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Technical Update

Certain Accounting and Financial Reporting Implications of the Health Care Reform Legislation on Life Sciences Companies

LS: 10-2

April 16, 2010

Background

On March 23, 2010, President Obama signed into law the Patient Protection and Affordable Care Act (HR 3590) (the “Act”), the Senate version of health reform legislation. Then on March 30, 2010, President Obama signed into law the Health Care and Education Affordability Reconciliation Act of 2010 (HR 4872) (the “reconciliation bill”), which amends several aspects of the Act. The Act and reconciliation bill are collectively referred to herein as the “Legislation.”

The Legislation is projected to cost $940 billion over 10 years. According to a preliminary analysis by the Congressional Budget Office, proposed sources of funding for the Legislation include an estimated $27 billion in fees on manufacturers and importers of branded pharmaceuticals (2011–2019), plus $2.8 billion per year thereafter (see Deloitte’s Technical Update LS: 10-1, Imposition of Annual Fee on Branded Pharmaceutical Manufacturers Under Health Care Reform Legislation), and a 2.3 percent excise tax starting in 2013 on medical devices. The Legislation is expected to increase the use of Medicaid because the eligibility threshold will rise to 133 percent of the federal poverty level by 2014. Seniors enrolled in Medicare Part D will start receiving discounts up to 50 percent for brand name medications.

While many of the provisions of the Legislation will phase in over time or not become effective until 2014 or later, the Legislation contains several provisions that are effective in the near term and could therefore potentially affect life sciences companies more immediately (pharmaceutical, biotech, medical device, and diagnostics), and in certain circumstances the effect could be significant. 

Life sciences companies are evaluating many aspects of the Legislation to assess, among other things:

· The preparedness of their government pricing functions.

· The potential accounting and financial reporting impact to their organizations.

· The potential impact to existing contracts, if any. 

Some of the provisions of the Legislation, including their impact on an entity’s accounting and financial reporting and related disclosures, are complex, especially as they pertain to life sciences companies. Management and its professional advisers are encouraged to work together to fully understand the Legislation’s accounting and financial reporting implications. The intent of this document is to highlight only the aspects of the Legislation that may potentially affect life sciences entities more immediately. For a broader summary of its financial reporting and disclosure implications, see Deloitte’s April 9, 2010, Heads Up, which discusses the potential impact of the Legislation on an entity's disclosures in its financial statements and Management's Discussion and Analysis in periodic reports (such as Forms 10-K and 10-Q filings) and registration statements. The Heads Up also summarizes key provisions of the Legislation that could affect entities in a range of industries in addition to those related to health care. Further, as various provisions of the Legislation are implemented, life science companies may need to evaluate the impact on other operational areas, such as systems, controls, or administrative functions.

The information below summarizes certain sections of the Legislation that (1) could potentially affect accounting and financial reporting considerations for life sciences companies and (2) address estimates associated with sales rebates and discounts that could affect quarterly and annual financial statements for 2010. These sales rebates and discounts require careful consideration because they will most likely affect an entity’s estimates of sales rebates and discounts. Further, in certain circumstances, the changes may potentially affect an entity’s overall ability to reasonably estimate Medicaid rebate accruals and could therefore affect an entity’s ability to recognize revenue until reliable estimates can be determined.  

Editor’s Note: As discussed in a Q&A in Deloitte’s FASB Accounting Codification Manual, 605-15-25 (Q&A 06), “Accounting for Rebates, Chargebacks, and Other Adjustments to the Price Charged for a Product Sale,” to recognize revenue upon shipment of a product under the guidance in ASC 605-15 (assuming all other revenue recognition criteria have been met), an entity must be able to reasonably estimate any potential future pricing adjustment. An entity must often use significant judgment to make such an estimate. If an entity determines that the price of the product is not fixed and determinable upon shipment because the entity cannot estimate rebates, discounts, or other similar adjustments to the price charged for the product, the entity would have to evaluate whether revenue should be deferred until the price can be determined. Whether a price is determinable depends on the entity’s ability to reasonably estimate future adjustments to the amount billed for the product. This ability may be affected by many of the same factors affecting returns, including but not limited to the existence of historical information and the availability of customer-specific pricing information, information related to product in the distribution channels, and customer-specific inventory levels. Although ASC 605-15 does not provide specific considerations, entities can apply the factors they used in evaluating returns to their evaluation of whether a price is fixed and determinable, to the extent that such factors are applicable. As with product returns, the nonexistence or existence of one or more such factors does not necessarily preclude an entity from estimating pricing adjustments. However, there must be sufficient evidence to support an entity’s conclusion that the impact of these factors or of similar factors does not change an entity’s determination that the price is fixed or determinable. 

While there may be other provisions that could affect an entity’s accounting and financial reporting under the Legislation, the following specific provisions are discussed herein:

· Prescription drug rebates (HR 3590 Sec. 2501).

· Providing adequate pharmacy reimbursement (HR 3590 Sec. 2503).

· Section 340B Program:

· Expanded participation in 340B Program (HR 3590 Sec. 7101).

· Improvements to 340B program integrity (HR 3590 Sec. 7102).

· Drugs purchased by covered entities (HR 4872 Sec. 2302).

· Medicare coverage:

· Medicare coverage gap discount program (HR 3590 Sec. 3301).

· Closing the Medicare prescription drug “donut hole” (HR 4872 Sec. 1101).

· Medical Devices:

· Imposition of annual fee on medical device manufacturers and importers (HR 3590 Sec. 9009).

· Excise tax on medical device manufacturers (HR 4872 Sec. 1405 and Sec. 4191).

· Part B special enrollment period for disabled TRICARE beneficiaries (HR 3590 Sec. 3110).

· Medicaid coverage for the lowest income populations (HR 3590 Sec. 2001).

· Income eligibility for nonelderly determined using modified adjusted gross income (HR 3590 Sec. 2002), Income Definitions (HR 4872 Sec. 1004), and Federal Funding for States (HR 4872 Sec. 1201).

Prescription Drug Rebates (HR 3590 Sec. 2501)

Effective: January 1, 2010

General Summary

The Legislation increases the Medicaid drug rebate percentage (often referred to as the “minimum basic rebate”) for single-source and innovator-multiple-source drugs to 23.1 percent (currently 15.1 percent) and sets the minimum rebate percentage to 17.1 percent for a single-source or innovator-multiple-source drug that is defined in the Act as a clotting factor for which a separate payment is made or a pediatric-only drug. For non-innovator multiple-source products (i.e., generics), the Medicaid drug rebate increases to 13 percent (currently 11 percent). The Legislation also provides for additional rebates on new formulations of existing drugs, with certain exclusions for orphan drugs.¹

Prescription drug discounts are extended to enrollees of Medicaid managed-care organizations. The extension of prescription drug discounts to these enrollees under the Legislation will require managed care organizations to report Medicaid utilization information to the states to allow them to invoice drug manufacturers and consequently collect rebates under the Medicaid drug rebate program.

This provision of the Legislation also establishes that the maximum rebate for a single-source or innovator-multiple-source drug would, for rebate periods beginning after December 31, 2009, not exceed 100 percent of the average manufacturer price.

Accounting Considerations

Entities may need to evaluate the impact of the increase in the Medicaid drug rebate percentages on expected Medicaid claim rebate payments after January 1, 2010. This would include not only the impact on Medicaid utilization starting January 1, 2010, but also on product sales that have yet to be prescribed to Medicaid-eligible individuals. Because of the time lag between when a product is sold and when a rebate or discount is submitted and processed for payment (commonly referred to as a product in the “pipeline”),² entities may need to consider the impact of the Medicaid drug rebate on their products in the pipeline. Depending on each entity’s specific facts and circumstances, such evaluation may need to take into account the impact of the higher rebate percentages on existing rebate accruals as of March 31, 2010, for product sold before and after the enactment date of the Legislation that would be subject to the increased Medicaid drug rebate percentages.   

With the extension of Medicaid drug rebates to enrollees of Medicaid managed care organizations, entities will need to consider the associated accounting and financial reporting implications. Currently, some states may outsource the administration and claim adjudication of covered outpatient drugs that are dispensed to individuals who are eligible for medical assistance and who are enrolled with a managed care organization. As a result of the Legislation, managed care organizations are now required to provide Medicaid utilization information to the states to allow them to recover Medicaid drug rebates from life sciences companies. Such entities may need to consider the following when evaluating the potential accounting and reporting effects of the Legislation:

· How many enrollees in Medicaid managed-care organizations are there in a particular state?

· Which states have Medicaid managed-care coverage?

· Does the state outsource only a portion of its respective Medicaid-eligible individuals to managed care organizations?

· Do the managed care organizations have the appropriate level of information needed by the states to invoice the life sciences companies (e.g., do the managed care organizations have the “total number of units of each dosage form and strength and package size by National Drug Code of each covered outpatient drug dispensed”)?

While the states will now have the opportunity to begin to invoice life sciences companies for rebates on the basis of Medicaid utilization, as discussed above, managed care organizations may also continue to include Medicaid-related claim utilization in their submissions to life sciences companies to recover rebates under their commercial rebate contracts for the same Medicaid utilization. Note that because the Legislation did not state an effective date for this provision, some may conclude that this provision becomes effective upon enactment of the Legislation.

The Legislation further creates additional Medicaid rebates on new formulations, such as extended release formulations, of a single-source or innovator-multiple-source drug. This provision applies to drugs paid for by a state after December 31, 2009, and creates an additional rebate equal to the greater of: 

(I)    the average manufacturer price for each dosage form and strength of the new formulation of the single source drug or innovator multiple source drug;

(II)   the highest additional rebate (calculated as a percentage of average manufacturer price) under this section for any strength of the original single source drug or innovator multiple source drug; and

(III)  the total number of units of each dosage form and strength of the new formulation paid for under the State plan in the rebate period (as reported by the State).^[3]

These changes will most likely affect an entity’s estimates of the associated rebate accruals for periods ending after the enactment of the Legislation. 

Providing Adequate Pharmacy Reimbursement (HR 3590 Sec. 2503)

Effective: First day of the first calendar-year quarter that begins at least 180 days after the date of enactment of the Patient Protection and Affordable Care Act⁴ (effective starting October 1, 2010)

General Summary

The Legislation provides that the Department of Health and Human Services (HHS) shall calculate the federal upper reimbursement limit as “no less than 175 percent of the weighted average (determined on the basis of utilization) of the most recently reported monthly average manufacturer prices for pharmaceutically and therapeutically equivalent multiple source drug products that are available for purchase by retail community pharmacies on a nationwide basis.” 

This provision also includes revisions to the definition of average manufacturer price (AMP) that describe certain inclusions and exclusions that entities need to consider in their AMP calculations. In general, AMP is used in the determination of rebates under various drug rebate programs, such as the Medicaid Drug Rebate Program, and is the average unit price paid to the manufacturer for the drug in the United States by wholesalers for drugs distributed to the retail pharmacy class of trade. The Legislation states in general that the average manufacturer price for a covered outpatient drug excludes the following:

(I)    customary prompt pay discounts extended to wholesalers;

(II)   bona fide service fees paid by manufacturers to wholesalers or retail community pharmacies, including (but not limited to) distribution service fees, inventory management fees, product stocking allowances, and fees associated with administrative services agreements and patient care programs (such as medication compliance programs and patient education programs);

(III)  reimbursement by manufacturers for recalled, damaged, expired, or otherwise unsalable returned goods including (but not limited to) reimbursement for the cost of the goods and any reimbursement of costs associated with return goods handling and processing, reverse logistics, and drug destruction; and;

(IV)  payments received from, and rebates or discounts provided to, pharmacy benefit managers, managed care organizations, health maintenance organizations, insurers, hospitals, clinics, mail order pharmacies, long term care providers, manufacturers, or any other entity that does not conduct business as a wholesaler or a retail community pharmacy.^[5]

The Legislation also describes the inclusion of other discounts and payments as “any other discounts, rebates, payments or other financial transactions that are received by, paid by, or passed through to, retail community pharmacies shall be included in the average manufacturer price for a covered outpatient drug.”⁶  Manufacturers are also required to report to the Centers for Medicare & Medicaid Services “not later than 30 days after the last day of each month of a rebate period . . . the manufacturer’s total number of units that are used to calculate the monthly average manufacturer’s price for each covered outpatient drug.”

This provision also revises the definitions of multiple sourced drugs, retail community pharmacies, and wholesalers.

Accounting Considerations

To calculate their AMP, entities have used the guidance in the Deficit Reduction Act of 2005 and the July 2007 Final Rule issued by the Department of Health and Human Services;⁷ accordingly, under the Legislation entities may need to evaluate the potential impact on their AMP calculations. Revisions to such calculations could potentially increase an entity’s AMP. Furthermore, because this provision of the Legislation is generally effective starting October 1, 2010, the change in the AMP calculations could affect an entity’s estimates of the associated rebate accruals for periods ending after the enactment of the Legislation. In addition, implementing changes to regulations could take time and may require life science companies to modify their current policies, procedures, and/or information systems.

Expanded Participation in 340B Program (HR 3590 Sec. 7101), Improvements to 340B Program Integrity (HR 3590 Sec. 7102), and Drugs Purchased by Covered Entities (HR 4872 Sec. 2302)

Effective: January 1, 2010

General Summary

Section 340B of the Public Health Services Act (PHS) requires drug manufacturers to provide drugs (currently only outpatient) to certain covered entities at a reduced priced. The Legislation extends participation in the 340B program to certain children’s hospitals, cancer hospitals, critical-access and sole-community hospitals, and rural referral centers. The Legislation also expands 340B coverage to certain hospitals with inpatient service and provides for restrictions on purchases of covered outpatient drugs by hospitals through group purchasing organizations. 

In addition, the Legislation provides for the development of a system to enable HHS to verify the accuracy of ceiling prices calculated by manufacturers and charged to covered entities and for the creation of a system to monitor the reporting process for such prices. Sanctions may be imposed on manufacturers or covered entities in the event of noncompliance.

Accounting Considerations

To participate in the PHS program, an entity must register with the Office of Pharmacy Affairs (OPA).  According to the OPA’s registration requirements, as noted on the Health Resources and Services Administration’s Web site:

[The entity] must notify the OPA of its intention to participate by completing and submitting the appropriate registration form. Once the OPA receives this information, the entity will be eligible to receive pharmaceuticals at the 340B discounted price at the beginning of the next calendar quarter. The quarterly deadlines for data submission to OPA are December 1 for the quarter beginning January 1; March 1 for the quarter beginning April 1; June 1 for the quarter beginning July 1; and September 1 for the quarter beginning October 1. It is the entity's responsibility to tell its wholesaler or manufacturer that it is registered for 340B discount prices when it places an order.

The potential increase of participants in the PHS program will most likely affect an entity’s estimates of the associated rebate accruals and could affect the overall process for calculating such accruals for periods ending after the enactment of the Legislation.

Medicare Coverage Gap Discount Program (HR 3590 Sec. 3301) and Closing the Medicare Prescription Drug “Donut Hole” (HR 4872 Sec. 1101)

Effective: January 1, 2011

General Summary

Under the Legislation, brand-name drug makers will begin, in 2011, to provide a 50 percent discount to Medicare beneficiaries that reach the gap (commonly referred to in the industry as the “donut hole”) in their Medicare drug coverage. In subsequent years, the discounts are expanded, and coverage is extended to generic drugs. By 2020, the discounts would reach 75 percent.

HHS will establish a Medicare coverage-gap discount program in which the Secretary of HHS contracts with pharmaceutical manufacturers for discounts on drugs in the Medicare Part D “donut hole.” The Secretary of HHS will establish a model agreement for use under the program by no later than April 1, 2010, in consultation with manufacturers, and will allow for comment on the model agreement. Manufacturers must enter into such agreements by May 1, 2010, which will allow beneficiaries access to discounted prices for the manufacturer’s drugs between July 1, 2010, and December 31, 2011. After that, manufacturers must contract by January 30 of the preceding year for an arrangement that would be effective the following year (e.g., January 30, 2011, for calendar/plan-year 2012).

Accounting Considerations

These changes will most likely affect an entity’s estimates of the discounts associated with benefits provided to Medicare beneficiaries expected to reach the Medicare coverage gap after January 1, 2011. Since this coverage is not effective until January 1, 2011, and individual beneficiaries may reach the Medicare coverage gap at different times, entities will need to evaluate how periods ending after the enactment of the Legislation are affected by these changes.

Imposition of Annual Fee on Medical Device Manufacturers and Importers (HR 3590 Sec. 9009) and Excise Tax on Medical Device Manufacturers (HR 4872 Sec. 1405 and Sec. 4191)

Effective: January 1, 2013 

General Summary

Under the Legislation, medical device manufacturers and importers are required to pay an annual fee equal to 2.3 percent of sales of taxable medical devices (as defined in section 201(h) of the Federal Food, Drug, and Cosmetic Act intended for humans), subject to certain exclusions described in the reconciliation bill. The annual fee for taxable medical devices is applied to sales after December 31, 2012.

Accounting Considerations

Given the above implementation dates, medical device manufacturers are expected to begin to accrue for the annual fee on sales starting in calendar year 2013.

Part B Special Enrollment Period for Disabled TRICARE Beneficiaries (HR 3590 Sec. 3110)

Effective: For elections related to initial enrollment periods that end after the Act’s enactment date.

General Summary

The Legislation creates a special enrollment period for eligible disabled TRICARE beneficiaries who have elected not to enroll during their individual initial enrollment period. The special enrollment period is the 12-month period beginning on the day after the last day of the individual’s initial enrollment period or, if later, the 12-month period beginning with the month the individual is notified of enrollment. For individuals that enroll during this special enrollment period, coverage begins the first day of the month the individual enrolls or, at the option of the individual, on the first month after the end of the individual’s initial enrollment period.

Accounting Considerations

The potential increase in enrollment for disabled TRICARE beneficiaries could affect an entity’s estimate of the associated rebate accruals for periods ending after the enactment of the Legislation. 

Expansion of the Medicaid Program: Medicaid Coverage for the Lowest Income Populations (HR 3590 Sec. 2001), Income Eligibility for Nonelderly Determined Using Modified Adjusted Gross Income (HR 3590 Sec. 2002), Income Definitions (HR 4872 Sec. 1004), and Federal Funding for States (HR 4872 Sec. 1201)

Effective: Not before January 1, 2014

General Summary

Medicaid will expand to include at least the minimum essential benefits to any uninsured individuals who are under 65 years old, not pregnant, not entitled to other coverage, and have incomes below 133 percent of the federal poverty level (or as applicable to the family size). Exceptions may be granted in states in which enrollment is not required. States will receive 100 percent federal medical assistance for all mandatory newly eligible enrollees from 2014 through 2016; partial assistance will be available in subsequent years. Children must be covered for their parents to be covered. The Legislation requires states to use modified adjusted gross income to determine eligibility for medical assistance. Under the terms of the Legislation, a state “shall establish income eligibility thresholds for populations to be eligible for medical assistance under the State plan or a waiver of the plan” by using “modified adjusted gross income [and] household income that are not less than the effective income eligibility levels that applied under the State plan or waiver on the date of enactment of the Patient Protection and Affordable Care Act.” Further, each State shall submit to the Secretary for the Secretary’s approval the income eligibility thresholds proposed to be established by using guidelines established by the Legislation.

Accounting Considerations

Given the above implementation dates, entities may need to evaluate the potential accounting and financial reporting impact of this provision, such as the impact on its rebates, discounts, and other related accruals, for calendar year 2014 (or earlier depending on an entity’s specific facts and circumstances). 

__________________

1   A single-source drug or an innovator-multiple-source drug refers to “a brand name drug,” as defined in the July 2007 Final Rule issued by the Department of Health and Human Services, Centers for Medicare and Medicaid Services (42 CFR Part 447[CMS-2238-FC] RIN 0938- AO20),“Medicaid Program; Prescription Drugs.”

2   A time lag occurs because in the pharmaceutical industry, product is primarily sold to wholesalers that sell it to retailers, pharmacies, hospitals, or other entities before it is prescribed to a patient.

3   The additional rebate for new formulations of existing drugs is described in the Act in Section 2501, “Prescription Drug Rebates.”

4   The effective date is described in the Act in Section 2503, “Providing Adequate Pharmacy Reimbursement.”

5   The revision to the definition of Average Manufacturer Price is described in the Act in Section 2503, “Providing Adequate Pharmacy Reimbursement.”

6   The inclusion of other discounts and payments is described in the Act in Section 2503, “Providing Adequate Pharmacy Reimbursement.”

7   The Deficit Reduction Act of 2005 is a United States Act of Congress concerning the budget, that became law in 2006 and the July 2007 Final Rule issued by the Department of Health and Human Services, Centers for Medicare and Medicaid Services (42 CFR Part 447[CMS-2238-FC] RIN 0938- AO20),“Medicaid Program; Prescription Drugs”.

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