The recently-passed Inflation Reduction Act (IRA) gives the Secretary of Health and Human Services significant flexibility to set the prices of some drugs in Medicare. Recent data from the Congressional Budget Office can shed light on the likely upper bound of these price controls relative to current prices.

Under the IRA, high-selling drugs which have been on the market for at least nine years can be subject to rate regulation if they do not face generic or biosimilar competition. However, the Secretary is afforded significant flexibility in setting a drug’s “Maximum Fair Price.” The IRA instructs the Secretary to consider a host of factors—including drug production costs, clinical efficacy, and information about research and development—but gives very little instruction about how to translate these considerations into a price. The lack of structure makes it difficult to forecast how this will ultimately affect drug prices. 

The legislation does, however, provide an upper bound on the price of a drug subject to the Secretary’s price-setting authority. Prices must be at least 25-60 percent lower than the non-Federal Average Manufacturers Price (non-FAMP) of a drug depending on how long it has been on the market (see Table 1).

It is not immediately clear how much these discounts reduce prices in Medicare Part D. Notably, the non-FAMP is not the price paid by insurers. Instead, it is an intermediate wholesale price, not reflective of rebates paid by the manufacturer to the insurer.

CBO recently documented how the non-FAMP compares to net prices paid by insurers for high-selling drugs in Medicare Part D. The non-FAMP of a standardized prescription was $458. In Figure 1, I apply the required discounts from the IRA to determine the hypothetical maximum negotiated price under Medicare negotiation. In addition, I include the typical net price for these drugs.

In comparison to current net prices, these upper limit mandates very steep reductions for older drugs, on average, but is less binding for drugs between 9 and 11 years past approval. For the youngest group of drugs, the limit is almost equal to the current net price, on average. For the oldest drugs, the required discount is nearly 50 percent of current net prices.

The exact discounts will differ on a product-by-product basis. Moreover, the relationship between the non-FAMP and net prices may vary with the age of the drug. Nonetheless, these data give a first-order approximation for the minimum discounts required by the IRA for Part D drugs relative to current prices.

Of course, these represent the upper bound on Medicare prices for selected drugs and the Secretary has considerable leeway in whether they will reduce prices further, and by how much. As the current and future administrations outline guidance for this process, it will be interesting to see how prominent a role these legislated bounds play.

Given the loose guidance about how drug prices should be set, regulators face a significant challenge in establishing a system to evaluate drugs and the potential for litigation contesting their interpretation of the statute. All else equal, that may make it attractive to use these legislated bounds as default price reductions for many drugs (or otherwise serve as the anchor for prices).

The fact that the upper limit will mandate little-to-no price reductions for many drugs between 9 and 11 years of approval, however, may make this approach more or less attractive to an administration. If an administration’s goal was to reduce prices steeply, they may favor a process largely divorced from the legislated upper limits. An administration less inclined to reduce pharmaceutical spending may instead view this relatively favorably.

The post Estimating Maximum Prices Under Medicare Negotiation in Part D appeared first on American Enterprise Institute – AEI.