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Picture of Christopher A. Hopkins, CFA

Christopher A. Hopkins, CFA

Medicare steps cautiously into negotiating drug prices

On August 16, President Biden signed a landmark bill encompassing initiatives dealing with health care, tax policy, and climate change. The legacy “Build Back Better” plan, scaled down and cleverly rebranded as the “Inflation Reduction Act of 2022”, garnered the support of the two Democratic holdouts in the Senate to secure passage under a budgetary maneuver known as reconciliation. Although its actual effect on inflation is widely expected to be nil, it creates a mechanism allowing Medicare to negotiate with pharmaceutical manufacturers over the price of a small number of the most expensive drugs.

Most other Federal health agencies like the Veterans’ Administration and the Department of Defense have haggled with drug makers over prescription prices for years. Yet fierce opposition by the pharmaceutical industry has successfully fended off efforts to allow the massive Medicare program to leverage its buying power. The modest new authority granted by the IRA should best be considered a pilot project to test the concept on a small scale.

Congress adopted the Medicare Prescription Drug Act (Medicare Part D) in 2003 as a voluntary supplement to basic Medicare. The original legislation expressly prohibited the Secretary of HHS from negotiating prices with manufacturers. Instead, it was believed that competition could be fostered by encouraging private insurance companies to offer competing Part D plans to consumers, each of which would contract drug prices separately. What ultimately ensued was a confusing thicket of diverse plans with widely varying premiums and benefits. There are currently 766 separate stand-alone Part D plans offered across the country, with 20 to 25 separate plans available in most states. Although the three largest insurance companies account for 60% of plans, this fragmentation limits the potential for price reduction without the ability to consolidate behind a single negotiator. Size matters, since the Medicare program as a whole accounts for one third of all prescription drug spending the US.

A 2019 bill to cap Medicare drug spending passed the House of Representative but proved too ambitious to clear the Senate. The current scaled down plan strikes just about the right balance and will provide an opportunity to evaluate the impact both on government outlays and on the profit margins of the pharmaceutical manufacturers.

The Secretary of HHS is directed to select a limited number of drugs for consideration subject to specific guidelines. Candidates must be costly single-manufacturer products that do not have an equivalent generic formulation or biosimilar (a generic version of biologic treatments).  In addition, the drugs in contention must have been on the market for sufficient time to allow the manufacturer a reasonable return on investment, at least 9 years for drugs and 13 years for biologics. The structure of the plan also allows drug makers to delay negotiation if there is a reasonable likelihood that a generic equivalent will emerge within two years.

The process is subject to a very gradual phase-in schedule. HHS may select 10 drugs to target for 2026, 15 for 2027 and 2028, and 20 per year for 2029 and beyond. Despite the limited scope, the Congressional Budget Office estimates that the negotiation regime will save US taxpayers $102 billion over 10 years.

Pharmaceutical industry lobbyists have been vocal in opposition and somewhat feverish in their rhetoric. A spokesperson for the Biotechnology Innovation Organization stated that the bill “could propel us light-years back into the dark ages of biomedical research”, while a group of venture capital investors sent a letter to Congress stating that the act “immediately will halt private funding of drug discovery and development.” Even for lobbyists, that takes hyperbole to a new level.

In fact, the CBO analyzed the impact of the IRA Act on anticipated research and development spending and estimated that the provisions would result in a modest reduction of just 1% or 15 new drugs out of the 1,300 products expected to come to market over the next 30 years.

Often overlooked in the ominous rhetoric are the direct and implicit subsidies received by the pharmaceutical industry. First and foremost is the contribution of taxpayer-funded basic research sponsored by the National Institutes for Health that can be monetized by for-profit manufacturers. Between 2010 and 2019, funding from the NIH to universities and public-private partnerships totaled $230 billion and produced 424 thousand research publications. In fact, NIH funding played a role in the development of every single new drug that came to market during that period. Consider how IBM benefitted from the Apollo program for an analog.

NIH funding is also used to train scientists in cutting edge methods and practices. Many of these scientists go on to work for drug companies.

Then there is the Medicare program itself. Far from self-funding, Medicare Part D premiums only cover 25% of the program cost, leaving the government to pick up the remaining 75% of the drug tab. Perhaps a better way to frame the argument is to consider the IRA as a slight reduction in taxpayer funding that at least in part supports industry profits.

Of course, the potential for lucrative rewards to shareholders is essential to fostering the massive investment required to bring life-saving medications and treatments to market. But it is also true that in the absence of competition, monopoly power inflates prices at the expense of beneficiaries and taxpayers. The IRA represents a nicely scaled opportunity to test the balance.

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