The Inflation Reduction Act (IRA), signed into law in August 2022, was intended in part to lower healthcare costs for families and small businesses. The IRA contains several provisions aimed at prescription drug costs which will roll out over the next few years, with the earliest taking effect this year. As of 2023, CMS will require pharmaceutical manufacturers to pay rebates to Medicare if their drugs’ prices increase at a rate which outpaces inflation.
The steady increase of drug prices has been under public scrutiny for the better part of the past decade. Last year, the Kaiser Family Foundation published “Prices Increased Faster Than Inflation for Half of all Drugs Covered by Medicare in 2020,” which found that about half of all Part D and Part B drugs covered by Medicare had price increases which outpaced inflation in 2020.
The IRA takes aim at this trend by benchmarking drug price increases to that of the Consumer Price Index for All Urban Consumers (CPI-U). The act requires pharmaceutical manufacturers with product pricing that has increased at a rate higher than the CPI-U to pay Medicare the difference for the number of units sold to Medicare at the higher price. This may seem like a straightforward response to the price increases seen in the pharmaceutical industry, but it may create more problems than it solves.
Why do pharmaceutical manufacturers increase the price of their drugs?
Pharmaceutical manufacturers are often accused of raising drug prices for the sole reason of returning greater profits to shareholders and investors. While this is likely the case some of the time, there are many other factors which can lead manufacturers to increase the cost of their products.
When determining an appropriate price point, manufacturers must take current pharmaceutical manufacturing and distribution costs into account. While the IRA allows for price increases as determined by the CPI-U, the CPI-U reflects the spending patterns of urban consumers and may not accurately reflect the spending of all consumers. It also does not reflect changes in production and distribution costs for a pharmaceutical manufacturer.
The research and development of new pharmaceuticals has always been a key driver of drug costs for pharma companies. Given the expense of research and development, manufacturing and distribution, and regulatory compliance, the cost of developing a drug can ultimately run to hundreds of millions of dollars. The price of an approved drug may increase to fund future research and recoup the costs of the company’s initial R&D investment, particularly if those costs include a failed clinical trial.
One of the greatest contributing factors driving higher price points is the rising percentage of contracts which include rebates provided to health plans and pharmacy benefit managers (PBMs). In a recent report on price increases for prescription drugs between 2016 and 2022, the office of the Assistant Secretary for Planning and Evaluation (ASPE) noted that “Rebates as a percent of total drug spending have grown in recent years from 11.7% in 2012 to a projected 32.5% in 2022.”
Manufacturers are clearly facing growing demand to provide payers and PBMs with deeper rebates to achieve or maintain patient access to their therapies. As a result, price increases may be seen as an appropriate option to offset these added costs. While price increases and greater rebates do minimize the financial impact for a health plan or PBM, patient out-of-pocket expenses are typically based on the list price of products. Since the rebated amount does not change the list price, patients often end up spending more for higher-cost products, regardless of rebates received by a health plan or PBM.
How could the IRA lead to the price of drugs increasing?
An important note worth reiterating about the IRA provision is that it does not ban price increases over the rate of inflation; it just requires the manufacturers to reimburse Medicare for the volume of units sold to Medicare at that price differential. So where does the reimbursed money go? All manufacturer reimbursements are funneled into the Medicare Trust Fund, which finances health services for beneficiaries of Medicare.
As the trust fund is financed by payroll taxes, general tax revenue, and members’ premiums, the addition of manufacturer reimbursements should theoretically reduce the cost paid by the American people. However, according to the Kaiser Family Foundation, the majority of Part D enrollees pay a coinsurance versus a flat copayment. Just as health plan/PBM drug rebates are not passed along to patients, manufacturer reimbursements will not be passed along to beneficiaries. Medicare patients will continue to incur greater out-of-pocket expense for products which take a price increase, despite the rebate Medicare receives.
While the CPI penalty for Medicare may dissuade some manufacturers from raising prices, other manufacturers may have no other option. In these cases, the CPI penalty may even exacerbate price increases. The CPI penalty for Medicare does not affect all books of business. If a manufacturer needed to reach a specific revenue target, they could choose to raise drug prices further despite the penalty, thus relying on their commercial book of business to offset the Medicare rebate while still reaching their revenue target.
Manufactures of already available drugs have little recourse to avoid the IRA provision penalizing price increases. However, the IRA may have some unintended consequences for drugs which have yet to come to market. Pharmaceutical manufacturers may opt to launch drugs at a higher price, since they realize their ability to adjust prices later will be hindered. Instead of raising prices over time, frontloading all of the cost may be seen as the safer solution.
Given the overall lack of regulation of prescription drug costs, it is understandable why the IRA focused on curbing excessive drug pricing. However, it is uncertain if this rebating approach will solve any of our existing issues. The net cost of the rebates manufacturers pay to health plans and PBMs has tripled over the last 10 years, and drug prices have climbed accordingly. With Medicare now requiring a rebate of its own, it remains to be seen whether applying a page out of this same playbook can actually reduce the list price of drugs.
Now that the precedent of Medicare rebates is here, Pandora’s box has opened, and pharmaceutical manufacturers should be on the lookout for future expansions. CMS should consider releasing updated guidance to pass some of the savings recognized in rebates along to patients, by basing their coinsurance off the rebated amount rather than the drug’s list price. Barring any such change, it is not yet clear how this IRA provision will lead to savings for patients.