The Inflation Reduction Act & the Economics of Drug Development


David H. Crean, Managing Partner for Cardiff Advisory, discusses the economic impact of the signing and implementation of the Inflation Reduction Act (IRA) on the biopharmaceutical industry and innovation.


America’s biopharmaceutical research companies are researching and developing new medicines to meet unmet needs and continuing research and development even after US Food and Drug Administration (FDA) approval, all with the goal of improving patients’ health, quality of life, and saving lives. The business model for biopharmaceutical research and manufacturing is unique and unlike most other industries. Drug makers invest in research and development (R&D) at high cost and with high risk and long-time horizons. Despite those hurdles, the industry has brought to market transformative treatments including immune checkpoint inhibitors for solid tumor cancers, a new curative treatment for hepatitis C, cell therapy for leukemia and lymphoma, and vaccines and treatments for COVID-19.

Since 2000, nearly 900 new medicines have been approved by the FDA, helping patients live longer, healthier lives. Importantly, the US is widely considered the most critical market for biopharmaceutical companies due in part to a range of factors, including access to capital and talent, regulatory frameworks that promote innovation, and favorable pricing conditions.

The Inflation Reduction Act of 2022 (IRA; P.L. 117-169) is a United States federal law that involves significant healthcare, tax, and energy policy reforms. The Congressional Budget Office has released an official score of the law, estimating it will reduce deficits by USD 238 billion over a decade, and more commentary is available here.

Within the healthcare and pharmaceutical industries, the IRA requires Medicare, for the first time, to negotiate drug prices with manufacturers; imposes penalties on drug price increases above inflation; limits out-of-pocket costs in Medicare Part D; and extends premium subsidies in the Affordable Care Act’s marketplaces.

But just like in drug development with many efficacious drugs, the law has many safety issues and consequences. Many thought leaders and advocacy organizations have offered their perspectives on the consequences including Vital Transformation, Biotechnology Innovation Organization (BIO), PhRMA, STAT, BioCentury, and Endpoints. The potential implications of these policies and other provisions in the IRA on drug developers and manufacturers are several-fold including:

  • Drug makers will likely face shortened revenue cycles
    • Medicare will gain power to negotiate prices of up to 60 drugs by 2029, starting with 10 in 2026
    • The law aims to curb spending on top Medicare drugs that have been approved for 9 or more years for small molecules and (13 or more years for biologics) ; the IRA centers on Congress’s decision to start Medicare negotiations for New Drug Application drugs seven (7) years after approval and at 11 years for those regulated under Biologic Licensed Applications and the prices will come into effect two (2) years later
    • The difference between the seven and 11 years before negotiation sets the case for biologics to be preferred and incentivized if manufacturers have a choice in development
  • R&D priorities will continue to accelerate towards innovation (and away from “me-too”)
    • Drug manufacturers will become increasingly less inclined to develop high-cost competitive “me-too” therapies; innovators must pursue transformative therapies rather than drugs that offer potential added benefit (e.g., a need to demonstrate meaningfully higher efficacy for coverage and/or better formulary placement. On the flip side, having several drugs in a class incentivizes competition and works to bring down prices, while that process may now be hindered if companies aren’t working on “me too” drugs.
    • Drug manufacturers that have started or plan to move away from less complex, more competitive market segments that have limited growth potential but are still impactful to patients (e.g., small molecule drugs) now have greater incentive to invest in more scientifically innovative areas. There are potential issues, however, around reduced investment in small molecules such as diseases that can only be treated by small molecules, and that pills are easier and cheaper for the health care systems to deliver to underserved populations.
  • Pharma companies may rethink how they set launch pricing and negotiate with their customers
    • Starting in 2023, the inflationary rebate arm of the IRA will require drug manufacturers to pay rebates if the price of a drug (with no generic equivalent) rises faster than inflation
    • Given more than 50 percent of all drugs covered by Medicare had price increases above the rate of inflation between 2019 and 2020, one of the possible primary outcomes of capitation will be the shrinking margin of manufacturers’ existing portfolio and contracts
    • Medicare Part D benefit redesign will eliminate 5% coinsurance for Part D catastrophic coverage (starting in 2024) and cap Medicare beneficiaries’ annual OOP at USD 2,000 (starting in 2025); these changes mean lowering beneficiary spending by reducing coverage gap and shifting costs to plans and drug manufacturers
    • It is likely that drug manufacturers could explore launching their products with higher initial prices (especially for highly differentiated assets) to offset slower growth in prices over time
    • The IRA provides an exemption from price-setting for drugs that are approved for a single orphan condition, but that exemption disappears if the drug is approved for any other indication, which may encourage manufacturers to not seek approval for additional indications.
    • Manufacturers may start to think on how to adjust how they engage in payer and provider (for Part B/physician administered products) negotiations; there may likely be less willingness to offer significant discounts in negotiations and an attempt to be made “whole” by shifting prospective costs to other “books of business” to buffer for projected revenue reduction from Medicare and Medicaid
    • There may also be fundamental considerations made at the pre-commercial stage to affect how a manufacturer wants to compete in the marketplace with launch pricing and contracting strategies tailored to commercial versus Medicare markets
  • Bioequivalent-focused generics players may see more opportunity in complex generic assets
    • To incentivize biosimilar uptake, the IRA temporarily increases Medicare Part B add-on payment for certain biosimilars from 6% to 8% of the reference product’s average sales price (ASP) through the end of 2027
    • This provision, along with cost saving at the core of the IRA’s mission, may create attractive opportunities for bioequivalent-focused Generics manufacturers to turn their focus to higher complexity generics

The new law is expected to reconfigure the commercial landscape so profoundly that a deep understanding of the law, and effective strategies for adapting to it, will become critical success factors for biopharmaceutical companies. Global biopharmaceutical companies have initially reacted to the law suggesting there will be reduce investments in small molecule drugs, bolster  investments in biologics, and cause companies to consider deferring US launches of drugs for smaller indications if there is a potential for later launches of larger indications.

From an investor standpoint, most, if not all, investment calculations are based on the concept of return on investment and net present value (NPV) of future profits, and the IRA will likely have a deep and meaningful impact on future profits. Investors must be prepared for the worst consequences — a major shift in where pharma partners and buys, with a prioritization of biologics versus small molecules and of larger indications versus precision subsets of patients — and adjust projected discounted cash flows, NPVs and company valuations to the potential new math. When evaluating a portfolio of marketed drugs and pipeline of potential products, they may reduce their projections and treat nine years for small molecules like patent expiration.


Final thoughts

With the enactment of the IRA, biopharmaceutical companies will need to rethink their portfolio management and adjust approaches to R&D, clinical, and commercial strategy in order to navigate nuanced market changes, optimize commercial success, and ensure outcome and access to therapies by patients. Every company that operates in the biopharmaceutical space needs to have an IRA strategy. It’s going to change the economics of drug development. Pharmaceutical manufacturers, developers, and investors are making capital allocation and deployment decisions, pipeline prioritization and business development decisions based on the implementation of the IRA. Given the time scale of drug development, it is not possible to wait for certainty. This is not just a big pharma issue – it affects all companies of any size.  All investment decisions will be impacted and will adjust valuation expectations of investors.  There are critical economic consequences that must be considered.

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