Inflation Reduction Act to Have Uncertain Side Effects on Big Biopharma

Drug pricing policy changes in the United States were signed into law as part of the Inflation Reduction Act on Aug. 16, 2022. We see three key impacts to drug firm revenue from the bill: shifting Medicare Part D cost-sharing away from the government and toward payers as well as biopharma firms with more expensive drugs; penalizing biopharma firms that raise Medicare prices by more than the rate of inflation annually; and mandatory price cuts on Medicare drugs that have extended patent protection.

In our models, we’ve pushed Part D redesign effects to 2025 (from 50% probability in 2023), moved inflation caps to our base case (from our bear case), and now include Medicare negotiation for drugs which could lose years of pricing power. While these changes did not significantly affect competitive advantages and moat ratings, they resulted in an average 2% cut to our fair value estimates across large-cap biopharma firms. We estimate that 15% of global branded drug sales stem from Medicare, and biopharma firms will see varying effects depending on their reliance on Medicare sales, price increases, expensive specialty drugs, and lengthened patent protection. Overall, the policy elements net out to a moderate negative that we believe is manageable through agreements with generic firms for authorized generic launches (to avoid the negotiated drug list) and higher launch prices (to counter price increase caps and earlier declines due to negotiation).

• Firms with higher exposure to these policy changes include AstraZeneca (oncology negotiation), Bristol (expensive oncology drugs), Gilead (HIV negotiation) and Novo Nordisk (Ozempic negotiation and list price increases).
• Factors reducing exposure include low Medicare exposure (Biogen and BioMarin), global diversification (BioMarin, Pfizer, and Roche), and biologics focus (BioMarin and Roche).

At 15% of Global Branded Biopharma Sales, Medicare Is the Focus of the Inflation Reduction Act

Biopharma-related policy changes in the Inflation Reduction Act fall squarely on branded drug sales via Medicare. In a $1.4 trillion global prescription drug market, the U.S. comprises approximately 40% of overall sales, of which roughly 30% stems from Medicare, either as self-administered Part D drugs or physician-administered Part B drugs. This puts Medicare at 12% of overall global drug spending. We estimate that branded Medicare sales are roughly 15% of the global branded drug market, as the U.S. is a higher percentage of the global branded drug market than the overall drug market (generics are a higher percentage of sales in other developed and particularly developing markets).

Indirect Effects of Inflation Reduction Act Could Be Just as Meaningful

We see several indirect effects from the Inflation Reduction Act’s biopharma-related provisions, which we’ve sorted from potentially most impactful to least impactful to biopharma’s long-term growth potential.

Reduced Innovation Looms as Biggest Threat to Long-Term Industry Growth

With more penalties and rebates, the drug industry in the U.S. will be marginally less profitable, which could deter investment and therefore reduce innovation. The Congressional Budget Office has estimated that Medicare negotiation could eventually reduce the number of new drugs entering the market each year from roughly 44 to 40, amounting for four fewer drugs each year within 20 years of implementation. That said, we think there are several countermeasures that firms can use to redirect long-term development toward medicines with better prospects for stronger coverage.

Close Competitors to Negotiated Drugs Could See Steeper Discounts

Prices for drugs within a therapeutic class are often priced at parity to one another. As the oldest drug in a given class begins to face steep discounts with Medicare negotiation eligibility, it could prove more difficult for peers to maintain prices, sending a ripple effect throughout the market. This would increase the importance of being a first (or at least, early) mover in a given market, as late entrants could see earlier potential fading sales.

Private Market Price re Could Also Be Pulled Down by Medicare Inflation Caps

If biopharma firms attempt to avoid penalties in Medicare by keeping annual price increases below inflation, we expect it could be difficult for the firms to increase prices at a faster rate in private markets. However, we expect firms will continue to raise prices at mid-single-digit levels, allowing continued similar price growth in private markets, but with new inflation cap discounts to be paid to Medicare.

Reduced Development Beyond Key Initial Market

Firms may reassess launch schedules that traditionally have favored launching as rapidly as possible in niche indications, followed by later launches in indications that require larger and longer trials for approval. Eli Lilly CEO David Ricks sees oncology development as particularly affected, with development in rarer late-stage niches and in earlier-stage disease likely to be sidelined as firms focus on initial approvals in larger, established indications.