Congress has passed the Inflation Reduction Act, and with it, significant changes are coming for drug pricing and payment in the United States. For the first time, the U.S. federal government will place direct price controls on many drugs covered by Medicare. The Medicare Part D benefit also will be restructured, and an annual patient out-of-pocket cap will be introduced.
The broad contours of this legislation’s impact have been discussed and debated for several months. Most prominently, the Congressional Budget Office (CBO) estimated both the revenue impact to the pharma industry and the relationship between that revenue impact and resulting decline in drug development. PhRMA, citing a brief from the University of Chicago, projected a 27-fold greater decline in drug development than CBO’s figures.
Given the preferences in the legislation for biologics over small molecule drugs, industry leaders have indicated that they intend to shift their portfolio focus accordingly. For example, in Eli Lilly’s Q2 earnings call, CEO Dave Ricks explained that the legislation indicates that small molecule treatments “really aren’t wanted and are worth a lot less. So we’ll focus our resources on other areas of innovation.”
Downstream from the big-picture impact, there are many other implications that drugmakers will need to consider across the full drug discovery, development and commercialization spectrum as they think about adapting to this emerging U.S. marketplace reality. Here, we summarize the key elements of the new policy, the most important unknowns at this stage and some areas where industry leaders will need to reassess their strategies.
There are three key drug pricing provisions: inflation rebates, Part D reform and drug price negotiations.
Inflation rebates: Manufacturers that raise prices faster than inflation will be responsible for a rebate to the Centers for Medicare and Medicaid Services (CMS) for all Medicare paid units, set to begin in October 2022 for Part D and January 2023 for Part B drugs. Inflation will be measured relative to the base period of the January 2021 Urban Consumer Price Index. Products launching after 2021 are benchmarked to the first calendar year they are marketed.
Part D reform: Medicare Part D reform represents a structural shift in Part D coverage plans, as well as in supportive administrative changes. Under the new structure, the coverage gap phase will be eliminated, and patients will have a $2,000 annual out of pocket cap (2025) with the option to smooth the payments over the course of the year. The mandated manufacturer discounts have now shifted from 70% for patients in the current coverage gap phase, to 10% for prescriptions when patients are in the new initial coverage phase and 20% for prescriptions when patients are in the new catastrophic phase (after the out-of-pocket cap is met). These mandated discounts will phase in for prescriptions for low-income subsidy patients over the course of five years from 1% in 2025 to 10% in 2029, and a full 20% for the catastrophic phase by 2031. Plan sponsors also are expected to cover 60% of the costs for patients in the catastrophic phase, reducing the liability of CMS from 80% to 20%. Additional future provisions stipulate that premiums cannot rise faster than 6% each year (2024-2029), and the low-income subsidy eligibility threshold will increase from 135% to 150% of the federal poverty line (2024).
Medicare negotiation: Under the Medicare negotiation provision, the Department of Health and Human Services (HHS) will select and negotiate a set number of high-spend, mature drugs across Part D and Part B each year. Mature drugs are defined as nine-plus years post-approval for small molecule drugs and 13-plus years post-approval for biologics. Initially, 10 Part D drugs can be negotiated in 2026. This increases to 15 Part D drugs in 2027, 15 Part D and Part B drugs in 2028 and 20 Part D and Part B drugs in 2029 and beyond.
Each year, the HHS Secretary will choose at their discretion the drugs to be negotiated from the list of top 50 eligible Part D and top 50 Part B drugs by Medicare spend. Once a product is negotiated, it remains negotiated until a generic or biosimilar enters the market. A maximum fair price (MFP) will be established based on the drug’s time on market and a corresponding percentage of the drug’s non-federal average manufacturer price, with further negotiations taking place below this upper-limit price.
Manufacturers must provide the HHS-mandated price for eligible individuals (i.e., Medicare patients) to the pharmacy, mail-order or other dispensers for dispensed Part D drugs, and to the hospital, physician or other providers for physician-administered Part B drugs.
Some exceptions would preclude a drug from being selected for negotiation, including:
- Drugs that have one orphan indication only
- A grace period from 2026-28 for small biotech drugs that account for less than 1% of Medicare spend and for 80% of the drugmaker’s revenue
- Low-spend products that contribute less than $200M in Medicare spend, as well as biologics with biosimilar entry expected within two years of the negotiated price becoming effective
There are four significant areas where the industry lacks clarity following passage of the Inflation Reduction Act. First and most immediately, the statute provides no guidance as to exactly how the price “negotiation” will work with respect to the most important part: price determination. The executive branch has been provided a maximum price that it is permitted to accept, but there is no guidance around how it might arrive at a number other than this price ceiling, beyond a description of some potential parameters to consider. The rulemaking process may bring further clarity.
Second, for drugs covered under the medical benefit, it is unclear how the price controls set by the government will affect commercial prices. The legislation, as written, seems to suggest that providers who treat Medicare beneficiaries need to have access to the negotiated price. However, the current provider purchase-based contracting model doesn’t allow for separation of purchases for Medicare patients only, therefore increasing exposure of these discounts. Similarly for Part D drugs, it is unclear how pharmacies will get access to the negotiated prices from manufacturers for Medicare patients only. Will we see a system similar to the 340B replenishment model put in place?
Third, it’s unclear how payers will manage classes that have a mix of negotiated and non-negotiated drugs. The bill currently states that negotiated drugs need to be “covered” by the plans. But will payers prefer drugs that provide discretionary rebates? Payers will continue to try to find value elsewhere to make up for the loss in rebate revenue for negotiated products, as well as their increase in contributions for patients with catastrophic coverage.
Finally, we don’t know where federal policy will go next. Federal action on drug pricing has been politically popular because many people either struggle to afford their prescription drugs or know someone who does. It’s important to note that, as ZS research has demonstrated, the affordability problems of the overwhelming majority of healthcare consumers in the U.S. will not be addressed by this law. The creation of significant new price control authority for prescription drugs, coupled with the very limited patient affordability benefit will be a politically combustible mix.
Going deeper, the legislation’s different treatment of drugs in different types of situations will affect the entire development and commercialization cycle. Here are several areas where industry leaders will need to reassess their strategies.
Biopharma portfolio strategy and business development
The biopharma industry ecosystem will be subject to disruption from the new legislation, stemming from both the top-line impact and from multiple distortions in the law. This includes the preference for biologics and the temporary exclusion of small biotech companies (with 80% or more of their Medicare revenue coming from a single drug) from price controls, protection of single-indication orphan assets and exclusions on smaller Medicare spend assets.
Asset valuation for business development will need to be revisited. New questions will emerge, such as:
- What is the exposure to Medicare price controls?
- What pricing flexibility exists in the commercial market?
- How rapidly can an asset build market share?
- How dependent is the asset on longer-range clinical development to drive value?
- What life cycle management programs will be more likely to be value destructive?
The temporary exclusion of small biotech companies from price controls runs counter to industry trends of investors seeking to fund platforms over single assets and larger pharma companies acquiring individual drugs or smaller companies. Some novel arrangements may emerge to capitalize on a situation where an asset is more valuable in the hands of a single-product company than in the hands of a larger one. For example, might a large company spin off a successful small molecule drug in its eighth year into a single-product company to protect it from price controls? Others have noted that the biosimilar clause could create situations where drugmakers may wish to accelerate time to competitive introduction.
All of these potential impacts or distortions are likely to back up to the broader financing environment. Venture capital funds will have obvious leanings on the basis of what the market will ultimately favor (e.g., large molecules). These shifts could shift the balance of technologies, or perhaps even diseases in some cases, that are funded. This will affect public markets, including IPO windows for those assets that are more likely to face negotiation (e.g., small molecules focused on broad cardiovascular indication) versus those that are less likely to face negotiation (e.g., smaller orphan assets or diseases that skew to younger individuals).
Drug discovery and clinical development
At a high level, we anticipate both lower early-stage investment in drug discovery and development and a shift from small molecule to large molecule investments. However, that investment shift will likely vary significantly by disease area. Diseases where pharma either has more pricing flexibility at launch (for example, oncology) or where populations skew younger (for example, genetic diseases like cystic fibrosis) could be more insulated from the policy. By contrast, diseases with highly competitive pricing and significant rebates today, such as diabetes, will look much less attractive for small molecule development.
Drugmakers will need to assess their clinical development and evidence strategy. Today, it is common in oncology to seek accelerated approval in niche patient populations and grow indicated populations subsequently through post-approval clinical development. A price negotiation clock that starts ticking at approval may change this calculus. Do you seek to enter the market as rapidly as possible in the U.S., or do you wait until you have a stronger evidence package and a broader indicated population? Do you consider launching in other countries first while holding off in the U.S.?
Post-approval clinical development will be affected. With less time available to capitalize fully on new evidence or indications, the bar on any clinical investments after FDA approval will be higher. The successes of drugs such as Humira and Keytruda in building an array of indications after launching may not be replicable in the new environment, particularly for some indications with smaller populations.
For in-line and launch products, pharma will need to reassess its pricing and access strategy. Drugmakers will consider more aggressive pricing actions in categories including pharmacy benefit oncology or rare diseases, where payer control and provider reimbursement are less constraining. Changes in Part D affordability dynamics for standard eligible patients will facilitate better uptake in that segment. Drugmakers should be prepared to support that growth opportunity. In competitive Part B categories, strange dynamics will emerge when only a subset of drugs are subject to price controls, as provider economics are skewed by differences in reimbursement between those drugs and the ones that are not.
Operationalizing these changes will present new challenges for compliance and revenue leakage mitigation. With steep penalties that may amount to 10 times the mandated discount across all Medicare sales, or $1 million per day for violations to the terms of agreement, pharma will need to ensure visibility and traceability for Medicare volume to remain compliant. This traceability also will allow pharma to mitigate discount leakage outside of Medicare, improving both the bottom line and preventing further average manufacturer price and average sales price erosion. As we’ve seen with the 340B program, without this visibility, the impact on pharma’s gross-to-net can grow exponentially.
The healthcare elements of the Inflation Reduction Act will affect not only pharmaceutical industry profitability and investment, but also many of the strategic choices and operating premises that have been in place for the past decade. Biopharma companies that are able to fully assess the implications on their portfolio, clinical and commercialization strategies will have the best chance to mitigate the emerging risks.
Watch this on-demand webinar covering what pharma manufacturers need to know about the Inflation Reduction Act.