In 2022, the Inflation Reduction Act (IRA) became law, marking the biggest health reform effort since the passage of the Affordable Care Act. The legislation made several changes to Medicare to lower prescription drug costs, including setting a yearly limit on what Medicare patients pay for drugs and putting a cap on insulin costs.

The law also allows Medicare to negotiate with pharma companies to lower drug prices and penalizes companies that increase drug prices faster than the inflation rate. In 2023, the U.S. government named the first ten drugs chosen for price negotiation.

While the Inflation Reduction Act will cut costs and improve access to prescription drugs for millions of Americans, it also creates uncertainty for drugmakers and could reshape the business of drugs in the U.S. Below, we explore the possible knock-on effects of this new law.

1. Patients will benefit from lower drug costs

Medicare enrollees will pay less for prescription drugs thanks to several IRA provisions. One caps Medicare Part D out-of-pocket spending at $2,000 a year, starting in 2025. Another, already in effect, limits insulin costs to $35 a month in Medicare Part B and Part D. The IRA also gets rid of cost sharing for certain vaccines and expands the Low-Income Subsidy program.

What's more, if drugmakers raise prices for Medicare-covered drugs faster than inflation, they'll have to pay a penalty (in the form of a rebate to Medicare). This could put the brakes on steep price hikes of existing medications.

Medicare has also taken a historic step by starting to negotiate drug prices, something it hasn't done in its 58-year history. Under the IRA, the Centers for Medicare and Medicaid Services (CMS) has the authority to negotiate prices for a select list of drugs, with the first round of negotiations set to impact prices starting in 2026. Below are the 10 drugs chosen for this initial round of Medicare price negotiations, along with their new prices.

The first ten drugs selected for the new Medicare Drug Price Negotiation Program

Drug	Drugmaker	Conditions	Number of Medicare Part D enrollees	Total Part D gross covered drug costs (in billions)	Drug list price in 2023 for 30-day supply	Negotiated price for 2026 for 30-day supply
Eliquis	Brisol Myers Squibb and Pfizer	Blood clots and stroke	3,706,000	$16.5B	$521	$231
Jardiance	Boehringer Ingelheim and Eli Lilly	Diabetes and heart failure	1,573,000	$7.1B	$573	$197
Xarelto	Johnson & Johnson	Blood clots and stroke	1,337,000	$6.0B	$517	$197
Januvia	Merck	Diabetes	869,000	$4.1B	$527	$113
Farxiga	AstraZeneca	Diabetes, heart failure, and chronic kidney disease	799,000	$3.3B	$556	$178.50
Fiasp and Novolog	Novo Nordisk	Diabetes	777,000	$2.6B	$495	$119
Entresto	Novartis	Heart failure	587,000	$2.9B	$628	$295
Enbrel	Amgen	Rheumatoid arthritis, psoriasis, and psoriatic arthritis	48,000	$2.8B	$7,106	$2,355
Stelara	Johnson & Johnson	Psoriasis, psoriatic arthritis, Crohn's disease, and ulcerative colitis	22,000	$2.6B	$13,836	$4,695
Imbruvica	AbbVie and Johnson & Johnson	Blood cancers	20,000	$2.7B	$14,934	$9,319

Fig. 1 - Data is from the Centers for Medicare and Medicaid Services. Data represents Medicare Part D enrollees who used the drug from June 2022 - May 2023 and total Part D gross covered drug costs from June 2022 - May 2023. Negotiated prices for these drugs will go into effect in 2026.

2. New drugs will launch with higher prices

Drugmakers will probably raise the launch prices of new drugs because of the law's rebate provision. The Congressional Budget Office (CBO) expects the pharma industry to set higher list prices for new drugs than they otherwise would have to try to recoup the revenue lost from slower price growth. According to the CBO, plans would still be able to negotiate rebates with drug companies and potentially refuse to cover drugs with very high launch prices. But plans would have less leverage when there are no alternatives available.

3. Demand for specialty drugs could increase

Medicare Part D's catastrophic coverage currently has no out-of-pocket limit, leading to high out-of-pocket costs for specialty drugs. For example, enrollees with cystic fibrosis spent $9,522 a year, on average, for Part D drugs. When patients have to pay high out-of-pocket costs, they're more likely to abandon their prescriptions or not follow treatment plans. In one study, 14.4% of Medicare enrollees reported cost-related drug nonadherence. The IRA's $2,000 out-of-pocket cap should increase demand for more expensive specialty drugs. If this happened, drugmakers could offset some of the revenue impacts of the law's price controls by driving greater volumes.

4. Medicare plans will ramp up utilization management

Medicare Part D plans will probably use tools like step therapy and prior authorizations more often to control drug spending. Right now, many Medicare patients have to pay coinsurance for prescription drugs. As noted above, high out-of-pocket costs discourage people from getting needed medications. If patients don't have to pay out-of-pocket, they're more likely to get their prescriptions. Part D plans will thus have to manage drug use more tightly for higher-cost enrollees whose spending exceeds $2,000 a year.

This push to control costs could also affect the broader Medicare Advantage (MA) market. Many payors are re-evaluating their positions in the face of financial pressures, with some insurers like Centene and Humana already exiting MA markets for 2025. This could lead to significant changes in the MA landscape, including further market consolidation and exits by smaller plans.

5. The small molecule pipeline could shrink

Many drug companies have warned that the IRA will disincentivize the development of small-molecule drugs. That's because the law grants small molecule drugs only nine years of pricing freedom after drug approval, compared with 13 years for biologics. Eli Lilly canned a small molecule cancer drug, blaming the IRA for making the investment unviable, and Vir Biotechnology discontinued its innate immunity small molecule pipeline. Novartis also cited the IRA when it dropped an early-stage cancer drug from its pipeline. Drug companies are unlikely to move away from small molecules entirely, but these dynamics could speed up the industry's shift towards biologics, especially for conditions that are more common in the Medicare population.

6. Market entry strategies will shift

Drug companies commonly introduce new drugs to small patient populations, like those with cancer or rare conditions, then broaden use to more populations. With nine years to maximize returns, companies may try to delay the clock by launching drugs for the largest (and most lucrative) disease areas first. This would allow companies to sell more drugs before Medicare price negotiations begin. For example, Genentech said it may delay the launch of a small-molecule drug for ovarian cancer so it could wait until the drug has been cleared for use in the much larger prostate cancer market.

Drugmakers may also have fewer incentives to pursue additional uses for orphan drugs. While the IRA exempts orphan drugs from price negotiations, it only applies to drugs with one indication. Alnylam Pharmaceuticals cited that provision's implications in sidelining plans to develop one of its rare disease drugs for an additional condition, Stargardt disease. Finding a second use for the drug would disqualify it from orphan status and could open it up to price negotiations.

Learn more

The Inflation Reduction Act is expected to make prescription drugs more affordable for millions of Americans. At the same time, it's already influencing development decisions that could disrupt the innovation pipeline. How it will impact the drug market in the long run remains to be seen. In the meantime, companies will need to plan and move forward with this new reality.

To learn more about how Definitive Healthcare helps biopharma companies drive success from drug discovery to commercialization, start a free trial today.

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