- Global Industry Analyst
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On August 16, US President Biden signed into law the Inflation Reduction Act (IRA) of 2022, a sweeping US$700 billion legislative package comprised of various health care, climate change, and taxation policy reforms. Among the new law’s most significant health care provisions are those relating to US drug pricing, which take effect beginning in 2023 and are broadly intended to deliver the benefits of 1) lowering prescription drug costs for Medicare beneficiaries; and 2) reducing health care spending by the federal government.
However, the potential impact on the biopharmaceutical industry is mixed — modest in the near term, but negative longer term. Let us take a closer look at the legislation, starting with some of the recent history behind it.
Background of US drug pricing reform
The specter of US drug pricing reform has been an overhang on the biopharmaceutical industry over the past seven years. Reining in drug costs has become a major political objective of the Democratic Party since 2015; the populist idea was also embraced by former President Trump.
Over the past seven years, there were several legislative and administrative attempts by both parties to regulate drug pricing, but nothing had succeeded until this year. Under the Biden administration, the Democrat-controlled Congress included drug pricing provisions in the 2021 “Build Back Better” (BBB) bill, aiming to pass the law via the budget reconciliation process.
Fast forward to the summer of 2022: The pace of congressional negotiations accelerated, culminating in a legislative breakthrough and August 2022 passage of the IRA, which incorporates the drug pricing provisions of the BBB.
Budgetary impact and major components of drug pricing legislation
The budgetary impact of the drug pricing legislation, according to projections by the US Congressional Budget Office, is a net reduction of the federal deficit by US$288 billion over 10 years (2022 – 2031).
The legislation includes the following components:
- Drug pricing negotiation: Reduce federal spending by US$100 billion, effective in 2026 (Figure 1)
- Inflation cap: Reduce spending by US$62 billion, increase revenue by US$38 billion, effective in 2023
- Medicare Part D redesign: Increase spending by US$25 billion, effective in 2024
- Repeal of the “rebate rule”: Reduce spending by US$122 billion, effective in 2027
- Miscellaneous: Increase spending by US$9 billion
Potential implications for the biopharma industry
It may take some time to assess the full implications of this new legislation for the biopharma industry, but the near-term impact — prior to 2026 — should be modest. Of the first three major components cited above, the industry mostly supports one (Medicare Part D redesign), seems willing to tolerate another (the inflation cap), and strongly opposes the third (drug price negotiation).
Not surprisingly, the most fiercely opposed provision is also the one with potentially the most impact on the industry: drug price negotiation, which will take effect starting in 2026 and expand in scope annually thereafter. By 2028, many of the fifty top-selling drugs under Medicare may experience price cuts ranging from 25% to 60%. (Read: This is not really price “negotiation.”) Other drugs may also be affected in the coming years if strong revenue growth puts them among the top-selling Medicare drugs.
This is a mid-to-longer-term negative for the biopharma industry. However, the multiyear impact on these companies’ earnings is difficult to calculate at this point, given uncertainties around the implementation by the HHS Secretary (who has considerable discretion), challenges to the law on constitutional grounds, and industry efforts to find loopholes in the law and to calibrate its research & development (R&D) pipeline in response to changes in financial incentives.
Final thoughts for health care investors
In addition to negatively affecting the net present value (NPV) of some very popular drugs, price negotiation will likely distort long-term incentives in pharmaceuticals R&D, favoring drugs for younger people over ones for the elderly, biologics over small molecules, and favoring orphan drugs with a single indication. It may also disincentivize biopharma companies from pursuing additional indications once a drug is already on the market, given the likelihood of price cuts.
Although smaller biotech firms with a single main drug are exempt from the price negotiation process for a few years, negotiation may still dim some firms’ attractiveness to large-cap pharma companies as potential M&A targets.
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