Prescription drug affordability is a perennial issue in the United States. Legislative solutions have been slow to materialize until the 2022 Inflation Reduction Act (IRA), which significantly changes how Medicare pays for prescription drugs. Historically, Medicare has acted as a price taker, paying for drugs at list prices, which are set by manufacturers. Two key IRA reforms will have a direct impact on list prices:
- The “inflation rebate,” which requires manufacturers to pay Medicare back for any list price increases above inflation.
- A provision empowering Medicare to bargain with manufacturers for what it pays for certain drugs.
Because drug manufacturers set list prices for the entire U.S. market, these policy changes will be felt beyond Medicare. The Congressional Budget Office (CBO) expects manufacturers to reduce list price growth or possibly even cut prices for many drugs on the market since they no longer profit when Medicare spending goes above inflation. The CBO also predicts that new drugs will launch at higher prices because manufacturers will factor inflation rebates and price negotiations into future pricing decisions. States, which hold significant financial liability for prescription drug spending, are particularly sensitive to manufacturer pricing decisions. The following examines how changing list price dynamics as a result of the IRA could shape state-level reform efforts.
States Will Benefit from Lower Prices, but New Drugs Might Offset Savings
States oversee health plans for their employees and retirees, as well as marketplaces for individual and family plans. States also pay for prescription drugs for the incarcerated, as well as a share of Medicaid beneficiaries’ drug spending, so lower list prices will benefit state budgets. Out-of-pocket costs for drugs are based on their list prices, so slower price growth will come as a welcome relief to state residents, including the uninsured.
Lower list prices also lower insurance premiums, benefitting the 35 percent of insured adults who worry about being unable to afford their monthly premiums. And because premiums for employer-sponsored health plans come out of taxable income, the CBO estimates that lower premiums will generate an additional $2 billion in federal tax revenue. State tax revenues are also likely to increase.
While consumers and patients benefit from lower list prices, it will have a more complicated impact on state Medicaid programs and safety-net hospitals. On one hand, negotiation can save Medicaid and safety-net hospitals money because manufacturers are required to pay rebates to Medicaid. For brand-name drugs, this includes a discount of 23.1 percent, or the best price offered to other U.S. payers, whichever is lower. Medicare-negotiated prices are included in this formula; if negotiation sets a new best price, Medicaid programs get higher rebates. Safety-net hospitals also benefit because they purchase drugs discounted using the same formula, but they are paid at list price levels for treating patients with these drugs.
On the other hand, manufacturers are also required to pay rebates to Medicaid programs for price increases exceeding inflation. CBO estimates that lower prices resulting from Medicare payment reforms will reduce Medicaid rebates by nearly $16 billion over the coming decade. Safety-net hospitals will be similarly affected. They can also expect less generous reimbursement from Medicare because of lower negotiated prices.
At the same time, the entry of new drugs at higher prices may translate to continued affordability challenges. For example, safety-net hospitals may prefer new drugs with higher list prices because they retain the difference between the list price and the statutory Medicaid discount. Over time, this could increase commercial health plan premiums, reducing or offsetting savings from lower prices on currently marketed products.
Building on the Momentum of IRA Reforms in States
A number of states have either expanded or explored expanding health care spending oversight through prescription drug affordability boards and benchmarking studies, and the impacts of the IRA’s pricing reforms could add momentum to this movement. For example, states concerned about high launch prices might consider spending restrictions, such as limiting what they will pay for certain types of care or prescription drugs. Proposals to limit how much commercial health plans pay for prescription drugs have already taken on new life, with some states considering legislation to use Medicare-negotiated prices as reimbursement limits. States could also consider preferring drugs with Medicare-negotiated prices that reduce Medicaid prices via the best-price formula, as well as any competitors offering similar levels of rebates.
The Inflation Reduction Act’s implementation coincides with state efforts to limit prescription drug spending growth, so it could become a jumping-off point for future reform efforts. If states can carry forward the momentum of the IRA, new avenues may open to control prescription drug spending.