Wednesday, February 21, 2024

Surprise! Thanks to the IRA, Part D Plans Will Prefer High-List, High-Rebate Drugs

Like many of you, I have believed that the Inflation Reduction Act of 2022 (IRA) will encourage Medicare Part D plans to adopt low-list-price products over their high-list/high-rebate counterparts, thereby popping the gross-to-net bubble.

Actually, maybe not.

Below, I explain why the IRA will encourage Part D plans to prefer high-list, high-rebate specialty drugs, even as the government and manufacturers will prefer a low-list-price version. Just another IRA-inflicted hit for biosimilars?

The warped incentives don't stop there. Even more weirdly, both products with a negotiated maximum fair price (MFP) and low-list-price products will raise total costs for the healthcare system and increase beneficiary premiums.

Did I get this latest unintended consequence right? Or have I been spending too much time underwater in Bikini Bottom? Read on and see what you think. As always, I encourage you to share your own thoughts with the Drug Channels community on social media.

P.S. Want to learn more? Join me on April 5 for DCI's next live webinar: Drug Channel Implications of the Inflation Reduction Act. Official announcement coming soon!


Beginning in 2025, the Part D benefit structure will be dramatically altered. The figure below compares the structure of the standard Medicare prescription drug benefit for 2025 with the current 2024 structure. Note that the figures below reflect only brand-name drugs and show the beneficiary’s out-of-pocket spending.

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Under this structure, I had instinctively believed that high-list / high-rebate products will become less attractive to Part D plans.

My intuition behind this widely-held belief seems straightforward. Part D plans often require enrollees to use products with higher list prices over equivalent drugs with lower list prices. (Consider my 2020 analysis of Part D market share for products that treat hepatitis C or AAM’s data on the adoption of biosimilars for Lantus.)

This behavior has been consistent with plans’ incentives to progress Part D beneficiaries towards the catastrophic coverage phase, where the federal government provides 80% of the funding. This progression is based on gross, pre-rebate (direct and indirect remuneration; DIR) prescription prices.

Consequently, more than half of Part D spending now occurs above the catastrophic threshold, so that Part D plans have become at risk for a significantly lower share of Part D spending. DCI’s analysis of the 2023 Medicare Trustees report makes this trend clear. As you can see below, the government’s reinsurance liability has increased, from 27% of spending in 2010 to 73% in 2023.

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The IRA significantly alters these legacy incentives. The standard deductible for 2025 will be $590. Under the restructured 2025 benefit:
  • When total out-of-pocket costs are between $590 and $2,000, payment will be split between the beneficiary (25%), the plan (65%), and the manufacturer (10%).
  • Total out-of-pocket expenses are capped at $2,000. Beneficiaries can choose to spread those out-of-pocket costs over the benefit year.
  • When out-of-pocket costs exceed $2,000, payment will be split among the plan (60%), the manufacturer (20%), and the Medicare program (20%).
Consequently, it may seem logical that plans will begin to shift formularies to favor products with lower list prices over those with higher list prices. After all, the Medicare trustees project that the Medicare program’s reinsurance liability share will decline to 59% for 2024 and then drop to only 16% of spending for 2025.


However, there are two crucial reasons why this general conclusion will not necessarily be true:
  • The Medicare trustees' data above reflects the government’s funding of the Part D benefit, but do not account for manufacturers’ greater liability to reduce gross drug costs during the initial and catastrophic coverage phases under the 2025 structure.
  • The catastrophic phase contributions from the Part D plan and the government will depend on the allocation of a manufacturer’s DIR rebate. We expect that most of the rebate will be allocated to the plans' share of gross drug costs, while the balance will be allocated to the government’s share of gross drug costs. (Today, about 65% of DIR is allocated to the plans' costs, but we estimate that 85% will be allocated to plans beginning in 2025.)
Consequently, plans will prefer a high-list/high-rebate product over its low-list/low-rebate counterpart because a higher share of manufacturers' rebates will be applied to the plans' obligations.

Yes, this may sound insane. So, here’s a simple mathematical example with some illustrative—but realistic—figures .

Consider a specialty drug product with gross annual prescription costs of $90,000. Assume the manufacturer provides a 50% rebate, so the net cost to the Part D program is $45,000. The table below computes the share of net costs by payer and coverage phase.

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  • Initial coverage phase
    • The beneficiary’s out-of-pocket obligation equals 25% of gross drug costs, but is capped at $2,000. The remaining patient liability after the deductible phase is $1,410.
    • The contributions from the plan (65%) and the manufacturer (10%) are allocated using the remaining gross drug costs, which are $5,640 (= $1,410 / 0.25).
    • Total gross drug costs in the first two phases are therefore $6,230.
  • Catastrophic coverage phase
    • The other liabilities are computed based on remaining gross drug costs of $83,770 (=$90,000 minus $6,230). The manufacturer therefore owes $16,754 (=$83,770 x 20%), the plan pays $50,262, and the government pays $16,754. 
    • Including the $45,000 rebate, the manufacturer will have paid $62,318 (69%) of the drug’s gross cost. The manufacturer’s net revenues are $27,682.
  • Net Costs
    • The net costs for the plan and the government depend on the rebate allocation. Let’s assume that the plan gets 85% of the rebate, while the government gets the remaining 15%. 
    • The plan’s liability equals $15,678 [=$53,928 minus ($45,000 x 85%)], which equates to 35% of net costs. 
    • The government’s liability equals $10,004 [=$16,754 minus ($45,000 x 15%)], which equates to 22% of net costs.
Now consider the same product with gross prescription costs of $50,000 and a $5,000 rebate. The net cost to the Part D program is still $45,000. While the first two phases are comparable, the allocation of net costs changes dramatically.

[Click to Enlarge]

  • Manufacturer costs
    • The manufacturer’s 20% liability is now computed based on remaining gross drug costs of $43,770 (=$50,000 minus $6,230). The manufacturer therefore owes $8,754 (=$43,770 x 25%) in the catastrophic phase. Including the $5,000 rebate, the manufacturer will have paid $14,318 (29%) of the drug’s gross cost. 
    • The manufacturer’s net revenues are $35,682 ($8,000 more than the high-list/high-rebate scenario).
  • Plan and government costs
    • The plan’s net costs increase to $25,678 [=$3,666 plus ($50,000-$6,230) x 60% minus ($5,000 x 85%)]. That's $10,000 more than the low-list-price version.
    • The government’s net cost has declined to $8,004 [=($50,000-$6,230) x 20% minus ($5,000 x 15%)].
Based on the figures in this example, the government’s costs will be lower with high-list-price products whenever less than 80% of the manufacturer’s rebate is allocated to the plan. 


There are two more bizarre implications of the new Part D benefit structure:
  • For a product with a maximum fair price (MFP) equal to its current net price, the manufacturer’s net revenues will rise, while plan costs will go up! That happens because negotiated products with an MFP will not have discretionary rebates, nor will manufacturers owe their 10% and 20% shares of gross costs in the initial and catastrophic coverage phases. Instead, the government will be absorbing these rebates and discounts. 
  • Premiums will be higher with low-list-price products. The base beneficiary premium in Part D is computed using a share (25.5%) of the costs incurred by the government and the plans. In the examples above, the incurred cost is $8,000 higher for the low-list/low-rebate product, implying upward pressure on premiums.
Making manufacturers pay 20% of Part D catastrophic coverage costs probably seemed like a great idea when the IRA was rushed through Congress. Alas, this new structure will create an unintended formulary tension. The government and brand-name manufacturers will do better with low-list-price products, while plans will do better with high-list-price products. 

While I have changed my views on the outlook for the gross-to-net bubble in Part D, my assessment of the IRA remains the same: Legislate in haste, repent at leisure.

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