The Inflation Reduction Act: What Drugmakers Should Know

The Inflation Reduction Act is one of the Biden administration’s signature pieces of legislation, and its drug pricing provisions should bring major changes to America’s pharmaceutical industry. New rules will likely affect the bottom lines of drugmakers, trim margins for pharmacy benefit managers, and lower out-of-pocket costs for Medicare beneficiaries. But changing the intricacies of the Medicare prescription drug pricing system won’t come without unintended consequences.

Inflation Reduction Act (IRA) and Medicare

To understand what the implications of the IRA are for drugmakers, it’s important to first review Medicare itself.

Medicare was instituted in 1965 and offers pharmacy and medical benefits to Americans over the age of 65, as well as disabled people. The government has expanded Medicare benefits over the years. Medicare Part B, which covers physician-administered drugs, was added a year after Medicare was signed into law. Medicare Part D, which covers outpatient drugs, was enacted in 2006. Beneficiaries who want Part D coverage choose an appropriate plan from a private entity that contracts with Medicare. Pharmacy benefit managers (PBMs) tend to run such plans.

It’s important to note that Medicare is not a single payer. It operates as an administrative oversight body that contracts with private entities to manage the pharmacy and medical benefits.

Medicare does operate as a reinsurer of beneficiaries with the highest drug costs, which helps to mitigate the risk private entities take on when they participate in the Medicare program as contractors.

Furthermore, Medicare acts as an oversight body for the hundreds of payers and PBMs that contract with it. On an annual basis, Medicare examines their formularies, for example, and approves them or recommends changes. This system of oversight will remain under the IRA, but we’re seeing certain provisions instituted that will change the ways in which drugs are priced.

Drug Pricing Provisions in the Inflation Reduction Act

The drug pricing provisions in the IRA contain three main pillars.

The first is inflationary rebates. The IRA now compels drugmakers to provide a rebate to Medicare when they raise a drug’s price faster than the rate of inflation. This applies to most Part D drugs (including generics) and branded Part B drugs. The rule is similar to how Medicaid operates. The government implemented it in October 2022 for Part D. The policy went into effect for Part B drugs in January 2023.

The next pillar is Medicare drug price negotiations. The new law allows Medicare to negotiate drug prices on a limited subset of drugs. Medicare will choose 10 Part D drugs to start with by the end of 2023, begin a negotiation process for these drugs, and implement so-called fair prices in 2026. The number of drugs in the subset will increase to 15 Part D drugs in 2027, 20 Part D and Part B drugs (in total) in 2028, 20 in 2029, and so on. To be selected for negotiation, a drug must not have generic or biosimilar competition, must be 9 years post-launch if a small molecule and 13 years post-launch if a large molecule (biologic), and be in the top 50 in terms of Medicare spend in either Part D or Part B. My estimate of the so-called fair prices negotiated by Medicare and drugmakers suggests they will be around 15% to 20% lower than they would have been without the IRA. At the same time, there will be some volume offset due to lower out-of-pocket costs for drugs, perhaps as much as 5% to 10%. This does imply that overall there will be some downward pressure on revenues of drugs selected for price negotiation.

The third pillar restructures the entire Medicare Part D benefits like the first pillar (inflationary rebates), and the Part D overhaul is comprehensive. That is, unlike the second pillar, it doesn’t select a limited set of individual drugs for restructuring. All Part D drugs will undergo changes in their payment structure throughout the coverage phases of the benefit. First, the Part D restructuring establishes a $2,000 out-of-pocket spending cap on an annual basis for Medicare beneficiaries. This is a major change, which will help reduce beneficiaries’ out-of-pocket costs, especially those who are on high-cost specialty pharmaceuticals (cancer patients, for instance). The overhaul of Part D also significantly reallocates the liability for catastrophic cost management from the government to Part D plans. In the current situation, Medicare covers 80% of the cost in the catastrophic phase, while plans cover 15%. Following implementation of the Part D overhaul, the government will cover only 20%, while plans must manage 60% of costs. Furthermore, for those drugs that enter the catastrophic phase — high-cost specialty drugs — the drug industry must pay 20% of the costs. Currently, drug companies aren’t responsible for any of the cost in the catastrophic phase, though for branded products they do have to pay a 70% discount in part of the coverage gap phase.

The IRA also introduces a $35 monthly cap on out-of-pocket costs for insulin products and enacts an add-on payment (average sales price + 8% instead of average sales price + 6%) for biosimilars in the buy-and-bill space (physician-administered Part B drugs).

Evolution of the Inflation Reduction Act

Some of the provisions in the IRA appear to build on work carried out in the Trump administration, as well as recent proposals in Congress. This includes a $35 monthly cap on insulin out-of-pocket costs and also the restructuring of Medicare Part D. In addition, the Trump administration proposed a series of drug price negotiation measures — including international price referencing — that for Part B drugs would have gone much further than the IRA had they been implemented. The Trump administration executive order on Medicare price negotiations based on international price referencing was issued but not implemented. The Trump administration also proposed eliminating rebates in Medicare, forcing a 100% pass-through to Medicare beneficiaries at the point of sale (pharmacy). This proposal also failed to go through. However, the Federal Trade Commission is scrutinizing the rebate system (as well as its transparency). Moreover, Congress is looking to pass legislation that would ban certain anti-competitive practices by PBMs, including spread pricing and exclusionary contracting.

The Trump administration did eliminate PBM gag clauses that — in certain instances — prevented pharmacies from telling customers that their copay exceeded the retail price of the drug. It also changed reimbursement in the 340B program to stimulate biosimilar prescribing, creating a differential between reimbursement of originator biologics and biosimilars that favored biosimilars. The Trump administration also altered the Medicaid best-price rule to allow for multiple best prices to incentivize value-based contracting, in addition to working with state Medicaid programs to experiment with a number of value-based pricing initiatives as well as the potential for closed formularies put forward by a number of states. It appears that several of these changes to Medicaid will be upheld by the Biden administration, including multiple best prices.

Market Access Hurdles

As recently as 20 years ago, drug manufacturers didn’t have to worry too much about market access once the FDA approved their products because FDA approval virtually guaranteed access and pricing was largely set in a free market. But now firms must begin to strategize their marketing approach — including positioning their product relative to competitors in terms of pricing and reimbursement — earlier in the drug development process. Part of this is because as prices of newly launched drugs have soared in the past 20 years, payer hurdles with respect to pricing and reimbursement have become greater and harder to overcome. And this is now partly due to the IRA enhancing, if you will, the various market access hurdles.

The IRA may have some unintended consequences. For example, because pricing provisions impact only existing drugs, drugmakers will launch newly approved drugs at higher prices. Also, Part D insurance premiums will likely increase, as will premiums in the commercial sector, as payers try to manage a higher share of the costs in Medicare along with rising costs of new drugs in Medicare and commercial markets.

The IRA may lead to slightly less research and development in certain areas like specialty drugs and therefore fewer numbers of new approvals.

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About Joshua P. Cohen

Dr. Joshua P. Cohen is an independent healthcare consultant with more than 24 years of experience examining pharmaceutical and healthcare policy. Previously, he was an Associate Research Professor at Tufts University’s Center for the Study of Drug Development.

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This pharmaceutical industry article is adapted from the GLG Webcast “Inflation Reduction Act: Implications for Pharmaceutical Industry, PBMs, and Payers.” If you would like access to this event or would like to speak with pharma industry experts like Dr. Joshua P. Cohen or any of our approximately 1 million industry experts, contact us.