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The real impact of the IRA drug price controls

Cost savings for seniors are real—but there are thousands of ways to squeeze the balloon

When the Inflation Reduction Act passed in 2022, much ink was spilled on its provisions for controlling drug prices, allowing Medicare to begin negotiating (i.e., setting) prices for on-patent, branded pharmaceuticals well before their patents have expired (with some exceptions; more on that in a moment). Well now we have the first 10 drugs subject to negotiation, which will swell to a total of 60 by 2029.

When the law was passed last year, I was skeptical about the drug price provisions. Wasn’t Big Pharma so powerful that such controls could never make it to any president’s desk? Or did the drugmakers have a different master plan, one not obvious to casual observers? After speaking to life science executives and lobbyists, I’m here to confirm that, no, the IRA drug provisions were not part of some corporate cabal’s master plan. Quite simply, the drugmakers lost that lobbying battle, an event so exceedingly rare that it was met with incredulity nearly everywhere (including from yours truly, at first). But they don’t intend to keep losing. And that’s why I find the praise and laments generated by the release of the first 10 drugs on the list so…unhelpful. In case you haven’t been following the rhetoric on the IRA’s drug price negotiation provisions, I can sum it up quickly:

The pro- and anti- arguments for the IRA's drug provisions

Boosters say the IRA is an important step toward reining in drug costs for seniors and improving Medicare’s financial outlook, with little to no harm on innovation or drug development. Detractors say “negotiated” rates are really just effective price controls that were unnecessary to help pay for seniors’ drug expenses, will have little impact on spending, and are likely to stifle investment in new medicines. As usual, there’s some truth in both of the previous statements, and a whole lot of nonsense. So let’s unpack what’s going on.

Let me upfront about one thing: I’ve been known to be a cynical guy on…just about everything. But I’m not here today to throw cold water on the IRA and say “Everyone just calm down; this is way less of a deal than you think.” I actually do think the IRA matters. But the rhetoric I’ve read in both the mainstream media and even much of the industry press has neglected how drugmakers will respond, and what will drive Medicare decisions going forward. I should also note that legal challenges to the price controls are working their way through the courts. I’m not a lawyer and have no comment on those lawsuits. But assuming the controls pass constitutional muster, here are five thoughts on the actual impacts these price caps are likely to have.

#1 When it comes to absorbing price cuts, there are thousands of ways to squeeze a balloon

I’m going to start with the price controls themselves, because they lie at the heart of the IRA’s drug provisions. (And yes, I know that the law technically allows Medicare to negotiate, not set prices, but come on. The negotiation process sets drug companies up for offers they can’t refuse in practice. And while they are free to charge private buyers different prices, Medicare is effectively controlling the prices that it will pay.) To paraphrase what a peer of mine recently said to me: “If you want to curb spending on drugs, you don’t fix prices for 60 of them, you fix them for 6,000. And if you fix prices for 6,000, you shrink the industry, which no serious person actually wants to do.” But in the meantime, reducing prices on 10 or even 60 drugs provides a strong incentive to raise them elsewhere. Because discounts are typically granted based on drug list prices, new pharmaceuticals are likely to launch with inflated list prices—both to offset losses on those drugs subject to negotiation, and to hedge against mandated rebates for 27 other drugs that kick in if prices rise higher than inflation (another, and less heralded, provision of the IRA).

And speaking of rebates, private companies that provide Medicare Part D coverage already negotiate rebates for tens of billions of dollars from pharmaceutical companies—benefiting both the private companies, Medicare, and even the manufacturer (ensuring that its drug is included in the formulary). The incentive to provide those rebates for drugs subject to negotiation now evaporates (though it’s likely that the pharmacy benefit managers are squeezed the most here).

But most important, drugmakers could do what health care providers have done for decades: shift the cost to the employer-sponsored insurance market where possible. And let’s face it, we all know that’s the most likely part of the balloon to get squeezed. If employers were nervous about price hikes related to increased costs for healthcare workers, then they should buckle up for more.

The law’s proponents say the price caps could reduce government spending on drugs by nearly $100 billion over 10 years. That logic is sensible as far as it goes—but it doesn’t take into account the likely response from the pharmaceutical industry. So don’t expect those manufactures to be making $100 billion less a decade from now. And don’t expect the government to end up saving all that much either, in the end.

#2 The price caps will definitely reduce out-of-pocket costs for seniors who rely on the selected drugs, and that fact will undoubtedly influence which drugs are selected

The drugs that were eventually selected by regulators raised some eyebrows with the life sciences experts and executives I spoke to. Some of them, such as Bristol Myers Squibb’s Eliquis, are high-priced and widely-used, and frankly were expected candidates for the list. Others, and I won’t name which ones, were a bit of a headscratcher. They serve much smaller populations, and probably won’t save Medicare all that much money. But they definitely will reduce out-of-pocket costs for specific senior populations with high levels of cost-sharing in their plans; the IRA also caps out-of-pocket drug spending for Medicare beneficiaries. And that gets at the political heart of it all. The goals of these drug price caps are almost certainly more focused on currying favor with politically powerful voting blocs than they are with reducing spending overall (see above). That’s not a criticism, by the way—that’s just politics. But keep it in mind when the next round of drugs is announced.

#3 Rather than killing innovation, we could see a revolution in the ways clinical trials are conducted

The single biggest criticism leveled against Medicare’s drug price negotiations is the potential effect on innovation. It’s not an unreasonable fear, but the impact is likely to play out in some surprising ways. First, I’ll stipulate one thing: if these provisions are truly the political tip of the spear, and eventually lead to a price-setting bureaucracy for the entire pharmaceutical industry, then yes, I agree that the net impact will be a shrunken industry, with far lower incentives to fund basic science, pursue clinical trials, and release new therapies. In that case, innovation suffers. But that’s a big if. I won’t pretend to know the ways the political winds will shift, even if and when these price caps become wildly popular. But as I mentioned above, you’ll need caps on thousands of drugs, not 60, for that fear to materialize.

The more interesting impact is how the regulations create an incentive to bring more drugs to market in much faster ways. Need to make up for Medicare losses on 10 to 60 drugs, aside from raising prices elsewhere? Bring more products to market. I had hoped that the pandemic—and the innovation it unleashed on the clinical trial process (using big data to source participants, identify populations more effectively, widen the demographic pool, etc.)—would spur more such innovation to help speed the development and approval process. But that doesn’t seem to have happened to any significant extent. There are several reasons for that, regulations and liability among them, but drugmakers now have more incentive than ever to maximize the return on their patents, and that means getting as much revenue as quickly as clinically possible. The law gives a boost to anyone who can boost clinical trial efficiency without sacrificing quality.

#4 For biologics, we could see an acceleration in biosimilar development rather than a contraction

One of the more bizarre criticisms I’ve seen make the rounds is that price controls on branded drugs could discourage the development of generics or biosimilars for those drugs, simply because the price cap will have undercut the pricing advantage. Depending on the negotiated rate, that could be true for generics, which often have prices that are 80% cheaper than their branded originals. But I don’t think this is true for biosimilars, at least not all of them. (Quick refresher: generics are small-molecule drugs developed chemically that are identical in formulation to their branded counterparts. Biosimilars are versions of large-molecule biologics—drugs produced using living cells—and are therefore rarely molecularly identical).

Rather than discourage biosimilar development, the law could actually accelerate it. For one, biologics have a longer timeframe on the market before being subject to negotiation. But more important, biosimilars aren’t all that much cheaper than their branded originals. Unlike small molecule generic drugs, biosimilars are expensive to develop, manufacture, and administer, making their price cuts much smaller—often more like 30% instead of 80%. And for any given biologic, if there is a biosimilar on the market, or will be within two years, it’s excluded from negotiation. So from a drugmaker’s perspective, the presence of a biosimilar may be preferable to negotiating with Medicare. Why would the law contain such a provision? Because biologics are extremely expensive relative to small-molecule drugs. A 30% price cut for a biosimilar is typically worth more in absolute dollars than an 80% cut from other generics. Bottom line: biologics overall were relative winners here, and I don’t think the law will discourage biosimilar rollout.

#5 But we will likely see a reduced incentive to develop drugs for niche indications

This criticism is probably quite valid. A number of drugs developed in recent years—especially biologics—have been developed with so-called orphan status. These drugs typically treat niche populations or indications, often in oncology. Because their development is so expensive (think about the cost of doing clinical trials when the available population is low), their prices are quite high. But even so, to recoup costs, such drugs are often expanded to new indications (such as different cancers, for example) to widen the overall market and maximize revenue. Orphan drugs are specifically excluded from the law’s provisions, but as soon as the FDA approves them for new indications, that status disappears. The complaint is that drugmakers will have a reduced incentive to develop drugs for niche populations, and it’s hard to argue with this one. These drugs are pricey and reliant on indication expansion. If you cut the price, or the incentive to expand the numbers of indications, investment in such therapeutics could fall. This risk bears watching.

Real benefits for seniors, probably limited savings for taxpayers, and hopefully a much needed boost to innovation

All in all, the IRA drug provisions as currently constructed, are certain to save Medicare beneficiaries money on the drugs under negotiation, though they could (and probably will) lead to higher costs elsewhere. The impact on pharmaceutical innovation and development is likely to be a mixed bag. If the drug industry innovates on clinical trials—and is permitted to do so by regulators—we could be on the cusp of new era of growth in new medicines. But much will depend on how voters view the new rules, and what course the government will take next.

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