Potential Negative Impact of the Inflation Reduction Act on Pharmaceutical Drug Innovation

Over the weekend, Democrats in the US Senate achieved a legislative victory passing, 51-50, the Inflation Reduction Act. One big element of Inflation Reduction Act is the provision that gives the US Government the ability to negotiate prices with Pharmaceutical and Biotechnology companies with the intent to lower drug costs. The bill now goes to the House where it will be voted on sometime this week.

In broad strokes, the Inflation Reduction Act passed by the Senate includes the following:

• The provision gives the HHS Secretary, the ability to negotiate prices on single source drugs prescribed under Part B, C or D, from 2026 onwards
• The HHS Secretary will select 10 products in 2026, 15 each in 2027 and 2028, and 20 in 2029 for price negotiations
• Small molecule drugs will be required to negotiate prices after being on the market for 7 years, and biologics after 11 years
• It caps the price increases to increase in CPI
• The provision places administrative burden on companies whose drugs are selected, to provide the information on which the HHS will base it’s analysis 

Over the last few hours, several analysts have reported that the legislation will have a modest impact on the EPS of companies starting in 2026. Why? Because at a high level, most Pharma companies source only about 50-60% of their business in the US. And within US, most companies have about 40% of their business from Medicare. So that means, at most 15-20% of the business will be impacted by price negotiations. This will differ from company to company depending on its Medicare business, and each Pharma and Biotech will need to do its own impact assessment.

While the near term EPS impact assessment may be correct, I am more concerned that the legislation targets the wrong segment of health care expenditure to control costs. Let’s look at the Health Care expenditure from 2020. According to CMS1, the United States spent altogether $4.1 Trillion on Healthcare in 2020, of which $1,270B was spent on Hospitals (+6.3% growth), $809B on Physician and Clinical services (+5.4% growth), and $348B on prescription drugs (+ 4.3% growth)1. As you can see, by targeting prescription drugs, the legislation attacks one of the smallest categories of expenditure that is also growing the slowest. Yes, Medicare will generate some savings ($240B over 10 years, or on average $24B per year) but will it matter much? Savings of $24B in a $4.1+ Trillion dollar budget won’t move the needle at all. The real impact would have been felt if all the components of health care segments were addressed. Instead, the Act choses the smallest segment. 

On the other hand, I am much more worried about the long term impact of the legislation on drug innovation. The unfortunate fact is that the legislation attacks one of the basic tenets of drug innovation - the investors fund Pharma and Biotech industry innovation because they believe that under the current patent system, they have sufficient time to recoup the investment and generate a return on investment (ROI). By taking away the ability to price the drugs freely until patent expires, the legislation strikes at the heart of the innovation model. Once this legislation goes into effect, the investors who fund biotechnology companies will be carefully modeling the impact of price negotiations at year 8 to assess if the ROI will be sufficient or not.  

Most drugs start their development in most difficult to treat (and often rare) populations where the unmet medical need is highest but commercial opportunity is small. The real commercial potential of the drug is uncovered when, over a period of time, the manufacturer develops the drug in additional indications impacting much larger patient populations. With the proposed time of drug price negotiation (7 years for small molecules, and 11 for biologics), the time to recoup the investment will be significantly reduced and will negatively impact the willingness and ability of Pharma and Biotech companies to invest in the drugs a few years after market entry, thus depriving larger patient populations of the much needed innovation. We will need to continue to assess the impact of this legislation on innovation and develop strategies to address it.

The legislation may also negatively impact innovation in rare diseases. Recently, we have seen a significant interest in developing drugs for rare diseases and for diseases impacting smaller patient populations. These diseases may be small in population sizes, but because of their chronic nature they end up consuming significant health care resources. In most cases, due to the impact of this legislation on pricing, the NPV of the assets can be expected to go down. The companies developing drugs for rare diseases may now have a significant road block in convincing investors to fund them, and with that we will probably see a reduction in the innovation driving development of new drugs. Again, we need to continue to assess the impact of the Act on the development of drugs for rare diseases.

In addition, the Congressional Budget Office2 (CBO) is already predicting that the inflation-rebate and negotiations provisions would increase the launch prices for new drugs yet to be launched, and Wall Street Journal3 is predicting a cascading impact - steeper discounts to Medicare will result in higher drug prices in private sector, which means potentially higher health care premiums. This may ultimately end up costing the consumer more, not less.

There is one good thing in the legislation which is worth celebrating. The Act takes away the heavy burden of out-of-pocket costs of drug treatment on patients suffering from chronic diseases. At the moment, patients have to spend thousands of dollars out-of-pocket to benefit from the drugs covered by Medicare. This often results in many patients walking away from treatments simply because they cannot afford the out-of-pocket costs. And Pharma and Biotech companies cannot do much to help them for fear of violating federal kick-back statues. The new legislation caps the out-of-pocket burden to $2000, which is a welcome change from patients perspective. My hope is that this change will bring back many a patients who walked away from life saving treatments because they could not afford them in the past.

The Act will be up for a vote in the House this week so we don’t know what the final language in the bill will be. Let us keep reading and become better informed so that we can better assess its impact on our development strategies.

In summary, the prescription drug reform provision of the Inflation Reduction Act is likely to have marginal impact on EPS of pharmaceutical companies in the near term. However, over the long term, the act is likely to have a negative impact on innovation in the field of drug development, and will likely end up increasing the healthcare premiums over the long haul.

#inflationreductionact #pharmaceuticalindustry #biotechnologyindustry #ussenate #ushouse #raredisease #medicare #outofpocketcosts #drugcosts #pricenegotiation #cbo #wsj #drugdevelopment

1. https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/NHE-Fact-Sheet
2. https://www.cbo.gov/system/files/2022-08/58355-Prescription-Drug.pdf
3. https://www.wsj.com/articles/democrats-vote-to-raise-drug-prices-11659909247