The Prescription for Change: Unpacking Medicare’s New Drug Price Negotiation Rules
August marks the one-year anniversary of the enactment of the Inflation Reduction Act (IRA), which for the first time allowed the Department of Health and Human Services (HHS) to negotiate Medicare drug prices with pharmaceutical companies. Under the new guidance, there is genuine potential to curtail outlandish drug prices. However, the new guidance carries some real risk for Medicare beneficiaries.
The anatomy of the negotiations
Currently, 97 percent of new drugs are reimbursed by at least one Medicare plan within three years of the drug’s approval. This creates an unbalanced playing field, giving drug manufacturers the ability to charge high prices knowing their medications will be covered by Medicare. Under the new rules designed to combat this imbalance, the federal government will have the power to negotiate directly with pharmaceutical manufacturers to set prices for ten of the most expensive drugs in Medicare Part B and later Part D — which cover over 3,500 drugs — with more drugs entering the negotiation process over time. Specifically, drugs are eligible for negotiation if they avoid certain exclusion criteria, have no direct competitors (e.g., biosimilars or generics), and if they have been FDA-approved for at least seven years for small molecule drugs or eleven years for biologics.
During negotiations, HHS sets an upper ceiling to the price pharmaceutical companies can charge for a drug, termed the “maximum fair price” (MFP). Determining the MFP is somewhat complex, requiring the HHS secretary to consider variables like the manufacturer’s research and development costs, whether or not these costs have been recouped, the current cost of the drug, existing or pending exclusivities on the drug, revenue of the drug at its current price, and the extent to which alternative treatments are available.
Once HHS sets the MFP, all Part D plans will be required to cover that drug, and all Part B plans will start reimbursing the drug at 106 percent of the MFP. (Previously, Part B drugs were reimbursed at 106 percent of the average sales price, higher than what the MFP will be.) Although the MFP will likely decrease reimbursement to providers for certain drugs, it will guarantee savings to the government, unless pharmaceutical companies walk away from the negotiation table and the $250 billion Medicare market for pharmaceuticals.
Consequences for pharmaceutical companies
Under the new regulations, pharmaceutical companies face a choice: participate in negotiations or face a series of escalating penalties. Companies that decline to negotiate or fail to comply with the negotiation process may be subject to tax penalties of up to 95 percent on the drug’s sales. Because of this extraordinary tax, companies can rightly choose to withdraw all of their drugs from Medicare coverage and restrict sales to the private drug market.
This enforcement mechanism creates a powerful incentive for drug manufacturers to negotiate and remain in the Medicare market, with the hope that each party operates in good faith and that no one walks away from the table. Lawmakers included the penalties to encourage fair pricing discussions, thereby fostering a more sustainable and affordable drug market. But manufacturers may opt to remove negotiated drugs from the Medicare market and forfeit up to 95 percent of U.S. sales for those drugs. In practice, if pharmaceutical companies opt to withdraw these drugs from the Medicare market, they can also choose to raise prices in the private market to compensate for the lost revenue. In this sense, it is possible that savings from price negotiations could be entirely offset by price hikes elsewhere, leaving overall spending unchanged.
The financial impact: a balancing act
The primary motivation behind these regulations is to save money for taxpayers and Medicare patients without sacrificing quality of care. According to the Congressional Budget Office (CBO), successful negotiations could save nearly $100 billion to Medicare alone over ten years while only modestly reducing the number of new drugs produced. What hasn’t been measured is the potential increase in seniors’ healthcare costs if negotiations fail and life-saving drugs come off the market.
Amidst failed negotiations, many patients will be forced to change drug regimens, pay out of pocket for the same medications, or stop their medication altogether if no suitable alternative exists. These transitions have myriad negative effects, such as missed medication doses and increased need for additional interventions among these individuals, all of which can lead to more hospitalizations and lower overall quality of care for a population that already has significant healthcare needs. The total cost of these adverse effects is difficult to predict. However, they will be significant, as the cost of missed medication doses to Medicare is estimated at over $13 billion annually.
What about drug manufacturers?
Drug manufacturers unanimously stand against the regulations in the IRA, claiming it violates portions of the First, Fifth, and Eighth Amendments of the Constitution. The pharmaceutical industry argues that these negotiations will ultimately increase drug costs and decrease innovation. However, the data supporting this argument is insufficient. The CBO’s analysis and prior work published at FREOPP suggest that pharmaceutical companies are extremely inefficient at converting added revenue from price hikes into new drugs, and that reductions in drug pricing will in all likelihood have minimal impact on drug availability or innovation. The consequences pharmaceutical companies have threatened are further diminished by the negotiations between government and pharmaceutical companies that work without controversy in many other countries throughout the world.
A prescription for progress
The IRA’s new drug price negotiation rules are a monumental step towards reigning in the cost of prescription drugs. By empowering the government to engage in negotiations with pharmaceutical companies, these regulations aim to strike a balance between affordability and innovation, ultimately benefiting patients and the healthcare system at large. Despite this, HHS should consider that the negotiation process could cause pharmaceutical companies to pull their drugs from the Medicare marketplace or hike prices for non-negotiated drugs, which would harm beneficiaries for years to come.
