THE SHEEP IN WOLF’S CLOTHING: WHAT BIOTECH INVESTORS NEED TO KNOW ABOUT HEALTHCARE REFORM

The passage of the Inflation Reduction Act (IRA) has been hailed by many as a crackdown on Big Pharma. The focal point of the legislation has been the Federal Government’s new authorization to negotiate prices for drugs offered through Medicare. This authorization has long been feared by biotech and Big Pharma investors, the rationale being that the government will simply name whatever price it wants, robbing pharma investors of profit and stunting incentive to innovate new medicines. 

However, it turns out, fears have not matched reality. In fact, many provisions of the new law stand to benefit pharma investors in a big way. What was supposed to represent a “crackdown” on excessive pharmaceutical profits may, in fact, represent one of the largest investor bonanzas of the twenty-first century. 

By the Sick Economist 

Price negotiation with Medicare. Just this little phrase sent shivers down the spines of pharmaceutical investors for years. It was the ultimate boogeyman. For decades, Medicare had to pay the same rate as the best rate offered to commercial insurers. Even though the program represented the single largest buyer of pharmaceuticals in the world, the program was not allowed to negotiate directly on drug prices. The rationale was simple; there would be no real negotiating with the largest provider of healthcare services in the world. Coverage by Medicare is so essential for the success of a drug, access to millions of elderly patients so critical, that Medicare would unfairly dominate any negotiation. Without access to tens of millions of elderly Americans, a drug would have little chance of success. Thus, Medicare could just name its price, whether that price covered Big Pharma’s costs for research and development, or not. Negotiation with Medicare was seen as a potential catastrophe for the global pharmaceutical industry. 

But reality has not turned out that way. Some would blame the IRA’s generous provisions on an overly powerful pharmaceutical lobby in Washington, others would say that our government, in its wisdom, decided to keep the profit flowing in order to encourage the development of new treatments and cures. But whatever the cause, two things happened. 

First, the actual Medicare negotiation provision of the law is not so bad. What, when, and how Medicare can negotiate price is quite limited. 

Second, perhaps most importantly, Big Pharma got something in exchange for giving up pricing power in its Medicare business. While pharma investors will receive somewhat less profit on certain highly visible blockbuster drugs, the new law contains a gift to the pharmaceutical industry unparalleled in American history. 

Medicare Negotiation: Limits on the Price Limits

The scenario that made pharmaceutical executives wake up in a cold sweat was the idea that Medicare would be able to negotiate prices the way that any commercial insurer negotiates prices. For example, United Health offers pharmaceutical coverage for thousands of drugs. Very simply put, they are free to use every tool in their substantial arsenal to wrangle the lowest prices they can for the wide range of pharmaceutical products that United’s patients expect and demand.  

Big Pharma’s struggles with PBM’s are infamous. Suffice it to say, as America’s largest insurers have gone from big to behemoth, those negotiations have gotten tough. It’s the massive, all-encompassing nature of these insurance companies that allows them to drive hard bargains. If you miss out on a deal with United, you miss out on millions upon millions of patients. 

The “sum of all fears” was that the global pharmaceutical industry would wind up in the same position with Medicare. If United is huge, then Medicare is mind boggling. 10,000 Americans per day receive Medicare cards. 83,000,000 Americans currently depend on Medicare for their prescription medications. If a pharmaceutical company were to be excluded  by Medicare, it would be catastrophic for their business. Thus, if Medicare were allowed to negotiate dirty, like United Health, Aetna, or other private entities, it would be the stuff of nightmares for pharma executives everywhere. 

But that is not what wound up happening. As German statesman Otto Von Bismark once famously quipped, “One ought not witness the making of sausages or the making of laws.”  

The actual provisions of the new IRA are quite gentle on pharma. Law firm Holland and Knight describes the new legal provisions: 

The legislation allows the Medicare program to set the price of certain high-expenditure prescription drugs. Negotiation is limited to the single-source drugs with the highest-spend in Part B or Part D for 1) U.S. Food and Drug Administration (FDA)-approved drugs for which at least seven years have elapsed from approval and for which there is no generic on the market and 2) FDA-licensed biologics for which at least 11 years have elapsed since licensure and for which there is no biosimilar on the market. Small biotech drugs (until 2028), orphan drugs, low-spend Medicare drugs and plasma-derived products are excluded from price negotiation.

Drugs subject to the new negotiated price requirement will be initially selected in 2023, and the prices set will be applied beginning in 2026. Drugs must be selected by the Centers for Medicare & Medicaid Services (CMS) and an agreement must be reached with the manufacturer two years before the new price will apply.

Specifically, the bill directs HHS to negotiate prices for:

• 2026 (only Part D drugs eligible for negotiation): 10 drugs based on Part D spending

• 2027 (only Part D drugs eligible for negotiation): 15 drugs based on Part D spending

• 2028 (first year both Part B and D drugs are eligible for negotiation): 15 drugs based on combined Part B and Part D spending

• 2029 and beyond: 20 drugs based on combined Part B and Part D spending

On the most simple level, the IRA does not unchain the Federal Government to perform the kinds of “no holds barred” negotiations that are common in private industry. The provisions ensure that new, groundbreaking drugs will still remain highly profitable for pharma investors for between seven and eleven years. Additionally, certain kinds of highly specialized drugs will remain protected and highly profitable. Lastly, the Federal Government must choose a limited number of drugs that can be negotiated. It’s likely that Medicare will choose only the most established, high profile and expensive drugs to negotiate. That means that one of today’s pharmaceutical titans might only have to negotiate 20% or less of their portfolio with Medicare. For every other drug, it’s business as usual.  

Some would say that these provisions have been watered down, while others would say that the new law wisely preserves the strong profit motive that drives business people to take big risks in pursuit of innovative new drugs. Suffice it to say: Medicare’s new, but limited, mandate to negotiate will have far reaching effects on corporate strategy, but is very far from the calamity that Biopharma executives feared. 

Backdoor Bonus 

Perhaps the single most important provision of the law is the least understood. As of 2025, no American over the age of 65 will ever pay more than $2,000 a year for medication. Ever. 

As Anchorman’s Ron Burgundy would say, “Uhhhh, I’m kind of a big deal.” 

This change is indeed, a “big deal.”  Obviously, this sounds like a great thing for America’s seniors. Although their exposure to pharmaceutical costs is already limited on Medicare, they still often wind up facing co-pays, and “catastrophic” pharmaceutical coverage doesn’t kick in until they spend $7,000 per year on drugs. Now, that limit will effectively be just $2,000. 

Obviously, this will be a popular change amongst America’s senior citizens. But what the general public doesn’t realize, is that it will be an even more popular change amongst American’s senior pharmaceutical executives. Right now, both seniors directly on Medicare, and Seniors on Medicare Advantage programs, must deal with a system that forces them to share at least a modest amount of cost for their own pharmaceutical decisions. For many disease states, there are a variety of pharmaceutical choices, and the different copays force a senior to think like a competitive shopper. Does Grandma  really need the latest, most advanced drug for her diabetes, or would an older, generic drug work almost as well for a much lower price? Right now, both doctors and patients are incentivized to design the most affordable medication regimen that works. 

Starting in 2025, that all goes away. After Grandma pays $2,000 out of pocket in one year, she and her doctor can choose any medication for her, and the price will be the same: $0.  Why bother with an older generic, when the latest, greatest medicines will all be free?  

Untethering senior citizens from financial responsibility will enable Big Pharma to push the most expensive new drugs. As long as they are just a little bit better than older, cheaper drugs, doctors will feel free to recommend the newest, most expensive stuff to every one of those 85,000,000 Medicare Beneficiaries. If, today, your typical senior takes five medications, four being generic and one being a new, branded drug, by 2030 it’s’ very likely that the ratio will be the exact opposite. Except for the poorest seniors (who may still see $2,000 as a lot of money), Medicare beneficiaries will now have every incentive to choose the newest, most expensive medication every time. 

The result is a colossal “win/win” for elderly patients and pharma investors. The big loser will be the American taxpayer, who would probably kick the wall and scream if she really understood what was happening. How on earth does unlimited drug expenditure for seniors help to reduce inflation?  You would have to ask the people who decided to call the new law “the Inflation Reduction Act.”   I guess it sounded better than the “Big Pharma Profit Improvement Act.” 

Other Provisions 

There are other pieces of the law that are attracting a lot of media attention, but, in reality, will be of minor significance to patients or investors. 

Perhaps the part of the new law that has attracted the most media hype is a $35 out of pocket maximum for insulin. While this will help millions of Americans in the short term, this new provision will be more or less neutral in the long run for a few reasons. 

The first reason is that science has gone about as far as it’s going to go with insulin. In the last twenty years, we have seen radical improvements in the features and benefits of various kinds of insulin. Rather than insulin being something that patients must take several times a day with mercurial highs and lows, millions of patients can now take insulin once a week, or less. This is about as far as this technology is going. The $35 price cap is nice, but most of the medicines will be going generic over the next few years anyhow. 

The second, most important reason why the insulin copay cap is over hyped is: insulin as a category is rapidly losing its importance. The recent domination of the GILP-1 family of medicines means many millions fewer people will need insulin moving forward. Famous medicines such as Ozempic and Mounjaro will help millions lose enough weight that their diabetes will never progress, and they will never need insulin. However, currently, millions upon millions of pre-diabetic and early diabetic patients are not taking a GLP-1 because Big Pharma has set these prices very high. By 2025, it won’t even matter what the price is: 85,000,000 senior citizens will have unfettered access to modern, expensive diabetic and obesity medicine no matter how high the price is set.  Of course pharma executives are happy to cap the price of insulin. Medicare negotiators just won yesterday’s war. 

Lastly, the new legislation provides some modest incentives to support the adoption of “biosimilar” drugs. Biosimilar drugs are the twenty-first century equivalent of generic drugs. The only difference is that these drugs are produced by genetically modified, living bacteria, rather than churned out in a lab. This makes them more challenging to produce than traditional generic medications. The new incentives should help foster further innovation in the creation and adoption of biosimilars. However, this remains a niche category, and is unlikely to cause too many headaches for pharmaceutical investors. 

Overall, the Inflation Reduction Act should please millions of Americans. It means the Boomers will essentially enjoy any medications they want for decades to come. It means that the companies who provide these medications should find ways to reap unprecedented profits. The only loser would be the American taxpayer, or any American who worries about our national debt and our nation’s rapidly deteriorating fiscal picture.  But that is a different analysis, for a different day. 

The Inflation Reduction Act will limit medication costs for millions of American seniors while opening up the floodgates to unlimited profits for biopharma investors. That’s a deal we can live with. 

To Read More about the IRA In Detail:

https://www.hklaw.com/