Adapting to the IRA: Early Lessons Learned on the IRA’s Impact on Deal-Making, Drug Economics, and Business Strategy

More than two years after the passage of the Inflation Reduction Act (“IRA”)¹ and the Centers for Medicare and Medicaid Services’ (“CMS’”) rapid implementation of the drug price negotiation program,² the life sciences industry is adapting to new economic realities. Stakeholders are adjusting their corporate and regulatory strategies, and licensing transactions are increasingly incorporating contractual provisions to address the unpredictable economic impacts of the IRA’s negotiation program.

Since our prior article published in March, 2023,³ CMS has published additional guidance for the implementation of the negotiation program,⁴ and has released a list of the first cohort of drugs selected for negotiation (the “Selected Drugs”) along with the Maximum Fair Prices (“MFPs”) that will be made available to defined categories of Medicare purchasers beginning in 2026. The agency is scheduled to imminently publish its list of the second cohort of Selected Drugs to be subject to MFPs beginning in 2027.

This article provides an update on the potential economic impact of CMS’s MFPs for the Selected Drugs, the emerging impacts of the IRA on dealmaking, corporate and regulatory strategies, and the future of the IRA amidst ongoing litigation and the potential influence of a new Trump administration.

I. Maximum Fair Prices for First Cohort of Selected Drugs

CMS published the list of MFPs on August 15, 2024 for the first cohort of Selected Drugs, with these MFPs scheduled to go into effect on January 1, 2026.⁵ These MFPs represent reductions from the 2023 list price of the Selected Drugs ranging from 38% to 79%.

Table 1: Negotiated MFPs for Selected Drugs

II. List Price Versus Net Price: Varied Impacts of the IRA’s Negotiation Program MFPs on Medicare and Broader Market Segments

1. Direct Impact of the MFP

CMS has reported an estimated $6 billion in savings in connection with the Selected Drugs, had those prices been in effect in 2023;⁶ however, recent analysis suggests that those estimates are likely overstated, particularly since many of the Selected Drugs are near the end of their life cycle and face imminent competition.⁷ Further, the analysis suggests various adverse impacts to pharmaceutical and biotechnology companies with Selected Drugs.⁸ An analysis of MFPs versus list price has significant limitations since list price does not take into account the existing net price of a given drug, including the drug’s pre-existing “rebates.”⁹ Rebates are price concessions provided by drug manufacturers to entities within the healthcare system, such as health plans, pharmacy benefit managers (“PBMs”), and other intermediaries. These rebates are typically negotiated as part of the agreement between the manufacturer and the payer or PBM and are paid after the sale of the drug, and are regarded as highly confidential and proprietary information. As recent analysis suggests, given that list prices do not take into account rebates or other price concessions, the actual economic impact on manufacturers cannot be simply estimated by evaluating the percentage discount of the MFP relative to list price detailed in Table 1.¹⁰

Put simply, the impact of the MFP on a manufacturer depends in part on a drug’s existing rebates and other price concessions. From this first round of MFPs, an emerging pattern shows that drugs with smaller pre-negotiation rebates are more likely to experience a greater impact from the MFP, and drugs with larger pre-negotiation rebates may be less affected.¹¹ This divergence suggests that certain therapeutic classes could be more impacted by selection under the IRA than others, depending upon existing market-based rebates within those classes. For instance, previous CMS analysis indicates that cardiovascular drugs, on average, carry higher rebate percentages,¹² so manufacturers of these products may be less economically impacted by the application of an MFP as compared to manufacturers of classes of drugs with lower average rebates.

Further, we do not yet have a great predictive lens of the extent to which net prices across therapeutic areas weighed into agency decision-making.¹³ Although CMS states in guidance that, in generating its initial price offer, it will take into account data on net prices of therapeutic alternatives,¹⁴ the net pricing information available to CMS may be incomplete for various reasons, including inherent limitations in the net drug pricing information available to the government.¹⁵ CMS’s recently-published MFP rationales for the first cohort of Selected Drugs provided few new insights in this regard.¹⁶

All of these factors suggest that, in life-cycle planning and in negotiating the economic provisions in licensing transactions, parties should consider a multitude of existing market-based factors as they anticipate IRA negotiation impacts on individual drugs.

2. Potential “Spill-over” Impacts

Of course, the true impact of the IRA negotiation program on a drug’s price is likely far more expansive than a simple comparison of MFP versus list price can reflect. The IRA’s MFP only legally applies to Medicare-defined beneficiaries, but its effects are likely to have significant “spill-over” into the private commercial market. Chief among these spill-over impacts is that the market-based incentives for PBMs and other healthcare stakeholders are likely to shift. For example, for Part D products, PBMs, in response to the adverse impact of likely-lower rebates on many IRA-selected products, may intensify competition for formulary spots and lead to more pressure on other products, including non-selected therapeutic competitors and various products subject to commercial market coverage. Early analysis has started to unpack consequences in the Medicare market,¹⁷ but commercial market spill-over is inevitable, with many anticipating repercussions for the entire US health care ecosystem.¹⁸

III. Dealmaking Trends

In response to the IRA’s negotiation program, economic adjustment provisions for licensed products that become Selected Drugs have become increasingly common. These provisions often take the form of royalty reductions, the nature of which we discussed in some detail in our prior article.¹⁹ In our experience, royalty reduction provisions have varied from detailed clauses with precise definitions to more generalized terms that reflect the parties’ desire to address the specifics of the royalty reduction at a later time.

When drafting IRA economic adjustment provisions, addressing the following points can help reduce the potential for future disagreements:

1. Timing of Adjustments

Agreements should be clear on when the economic adjustment for a licensed product that becomes a Selected Drug will take effect. In our experience, most parties agree to apply the royalty reduction only during the period when the MFP is in effect, which commences approximately two years post-selection (the “Price Applicability Period”). However, some parties may opt to apply the reduction beginning on the date of selection, perhaps anticipating potential “spill-over” pricing impacts before the actual MFP implementation. In the latter approach, the royalty adjustment would need to be specified in the agreement in advance because it cannot be based on the percentage decrease between effective price of the licensed product prior to the licensed product’s selection, as the MFP is not known at the date of selection. In other words, when royalty adjustment commences on the selection date, the adjustment must be fixed or set in some manner ex-ante and cannot be calculated off an as-of-yet-unknown MFP.

2. Scope of Reduction

Agreements should also specify (1) the territorial scope of the economic adjustment and (2) the categories of sales of the licensed product that are eligible for the reduction (e.g., sales to Medicare purchasers only or all sales). We observe that most agreements apply the royalty reduction to U.S. territory sales only, though certain licensees have negotiated reductions to apply to global sales.

Regarding the categories of eligible sales, finalized deal terms show significant variability. Some license agreements limit the reduction solely to sales associated with Medicare utilization while others apply the reduction to all net sales within the United States. The latter approach appears to be more common, perhaps due to complexity in distinguishing between Medicare from non-Medicare sales.

3. Royalty Floor and Royalty Termination

An important negotiation point in many agreements that include an IRA economic adjustment provision is the royalty floor, which is a common feature in life science licensing agreements. The royalty floor is the minimum royalty rate paid on the sales of the licensed product, regardless of any reductions or adjustments (e.g., reductions after the last to expire valid claim, generic/biosimilar entry, payments to third parties).

The negotiation often centers on whether the IRA economic adjustment is subject to the agreement’s overall royalty reduction floor or whether the IRA adjustment is exempted from that floor, allowing for further reduction in royalties beyond the existing royalty floor. Some parties have negotiated compromises where the agreement provides for a separate (but lower) royalty floor specifically for IRA reductions.

In addition, we have observed parties propose other creative solutions to mitigate IRA price negotiation risk, such as proposing that royalties could drop to zero in the United States under certain circumstances following IRA price negotiations. The market for these terms continues to evolve.

4. Type of Royalty Reduction

As we discussed in our prior article,²⁰ in structuring royalty reductions in response to the IRA’s Drug Price Negotiation Program, parties typically choose between a fixed-rate or variable-rate. Each approach has its own considerations:

1. Fixed Rate Reduction. A fixed rate reduction involves reducing the royalty by a predetermined percentage (e.g., 50%) for a Selected Drug. This method offers simplicity and predictability, making it easier to implement and calculate. However, it does not account for the variability and uncertainty of the actual MFP, as the reduction amount would be fixed in the agreement long before the MFP is known. Given the wide range of possible price reductions under the IRA, a fixed rate reduction can disproportionately affect the licensor if the hard-wired royalty reduction is lower than the reduction introduced by the MFP. This fixed-rate approach may be more suitable in scenarios where both parties prefer a straightforward and less complex agreement, accepting the risk of potential disproportionate impacts.
2. Variable Rate Reduction. A variable rate reduction adjusts royalty obligations based on the percentage decrease between the pre-IRA price (the “Medicare Price”) and the MFP. This method can more closely align the royalty reduction with the MFP’s actual economic impact (as discussed in detail in our prior article),²¹ but introduces additional complexities, particularly when considering the difference between list price and net price. By linking the reduction to the specific decrease in price based on the MFP, this approach can offer a more balanced economic impact for both licensors and licensees.

In drafting the variable rate reduction, the definition of “Medicare Price” is crucial. Licensors typically favor a Medicare Price definition that reflects the drug’s net price (i.e., accounting for rebates), leading to a smaller difference between the net price and the MFP, and thus a smaller royalty reduction. Licensees, on the other hand, often seek a definition that approximates a price closer to the list price in order to maximize the reduction, or prefer to leave the concept of the pre-IRA price undefined. As noted in the discussion above, a drug’s pre-existing rebates (which can often be substantial) have the potential to create wide variability in the actual economic impact of these two alternatives.

However, imprecise language that fails to define key terms can result in issues for both licensor and licensee down the line. For example, we have seen agreements that merely provide that the royalty rate will be “reduced by a percentage equal to the price decrease resulting from selection and price negotiation,” without specifying the Medicare Price to be used in the calculation. This creates ambiguity around the meaning of the pre-IRA “Medicare Price” and thereby increases the likelihood of a future dispute over the calculation of the variable royalty rate adjustment. Clearly and thoughtfully defining these terms is likely to both parties’ benefit.

IV. Regulatory and Corporate Strategy

The IRA is broadly impacting regulatory and corporate strategy for biotechnology and pharmaceutical firms of all sizes. One of the many impacts already observed is that companies have or are planning to review and adjust their economic projections for pipeline assets, particularly for drugs with the potential to become Selected Drugs.²² Some executives have stated they expect to cancel programs or investment in planned new indications as a result of the IRA’s impact.²³ Consequently, some companies have pruned their pipelines, discontinuing programs that are no longer economically justifiable for future investment in light of expected IRA impacts.²⁴

In addition, for approved drugs, the IRA’s selection eligibility date – which CMS has defined as being benchmarked off of the date of the first FDA approval of any drug with a given active ingredient or active moiety – has reduced the incentive to invest in follow-on indications,²⁵ and industry leaders have publicly emphasized this effect.²⁶ A predictable result of this incentive is a dampening effect on investment in additional indications or formulations for already-approved drugs. This effect is further amplified for small molecule drugs, since these products are eligible for selection four years earlier than biologics under the statute.²⁷

In other ways, decisions to trim pipelines or end studies for follow-on indications have been exacerbated by CMS sub-regulatory guidance. A particular pain-point has been CMS’s decision in guidance to group all dosage forms and strengths of the drug with the same active moiety or ingredient and the same holder of a New Drug Application (NDA) or Biologics License Application (BLA) as the same product for the purposes of IRA negotiations, inclusive of products that are marketed pursuant to different NDAs (or BLAs).²⁸ Practically speaking, this means if two drugs share the same active moiety, even if they are under separate NDAs held by the same manufacturer and operate in completely distinct disease areas, both drugs would be aggregated for purposes of IRA selection, eligibility date, and applicability of the MFP. Industry players have challenged this “aggregation principle,” arguing it is at odds with the plain text of the statute.²⁹ In separate litigation challenging the law, other companies have asserted that the “aggregation principle” disincentivizes the pursuit of additional indications.³⁰ The market continues to evaluate how to respond to CMS’s aggregation guidance in connection with distinct indications or formulations of a given active ingredient or moiety.

V. Ongoing Litigation Challenges and the Incoming Trump Administration

1. Litigation

As previously mentioned, manufacturers and industry allies have filed numerous challenges to the IRA’s negotiation program, utilizing various legal approaches. These complaints have included First Amendment (compelled speech) claims, Fifth Amendment (due process and takings) claims, separation of powers claims, non-delegation, and Administrative Procedure Act claims, among others. To date, these challenges have had limited success, with most being dismissed on procedural or jurisdictional grounds, without meaningful consideration of the merits of underlying claims.

However, the 5th Circuit provided a glimmer of hope when it ruled on September 20, 2024 to reverse a district court’s dismissal of the case for lack of subject-matter jurisdiction.³¹ The court held that the industry group plaintiffs had alleged sufficient facts to have standing based on (1) the economic harm they would suffer due to the IRA’s negotiation program and (2) the procedural harm from the lack of notice-and-comment procedures in the implementation of the negotiation program.³² The court went on to hold that the plaintiffs were not required to channel their claims through HHS before bringing them to federal court and thus that there was subject-matter jurisdiction to hear the claims. The case has been remanded to the district court for consideration of the merits of the original claims.

The IRA’s negotiation program is likely to persist alongside ongoing litigation for years to come as this case and others are processed through the courts.

2. Political Landscape and Potential Amendments

As we transition into the second Trump administration, with Republican majorities in both houses of Congress, changes to the IRA itself may be possible. Incoming President Trump has not made clear his plans for the program, but Republicans in Congress have expressed their disfavor.³³ Commentators have noted that a complete repeal of the IRA (or even the drug price negotiation portion of the IRA) is unlikely;³⁴ however, a Republican Congress may pave the way for amendments to the law.

Several provisions of the IRA’s negotiation program have been discussed by commentators as potential candidates for amendment under the new Congress.

1. Orphan Drug Exclusion. The “Orphan Drug Exclusion,” one of the more controversial areas of the law, excludes from negotiation orphan drugs designated as a drug for only one rare disease or condition and for which the only approved indication (or indications) is for such disease or condition.³⁵ Critics argue that limiting the exclusion to orphan drugs in this manner disincentivizes companies from seeking additional indications for orphan drugs, leading to fewer treatment options for patients.³⁶ As referenced in our prior article,³⁷ industry players have responded to these incentives by discontinuing trials to expand the label for certain orphan drugs.³⁸ The Orphan Cures Act³⁹ was introduced into Congress on September 18, 2023, and aimed to provide a fix to this issue (i.e., expand the exclusion for orphan drugs under the IRA to include orphan drugs with more than one approved indication). The bill would have to be taken up with the new Congress, but has strong support from rare disease advocates and industry.⁴⁰
2. Small Molecule and Biologic Timelines. Another area of the IRA that has triggered pushback from industry and commentators is the disparity in treatment between small molecule drugs and biologics. Under the IRA, small molecule drugs are eligible for selection nine years after FDA approval, which is four years before initial selection eligibility for biologics. Industry and commentators have criticized this so-called “pill penalty,” arguing that this reduced timeline disincentivizes small molecule (e.g., pill and capsule) development, reducing patient access to these medicines.⁴¹ A bipartisan bill introduced to Congress, called the Ensuring Pathways to Innovative Cures (EPIC) Act, aimed to address this disparity by increasing the time before selection for small molecule drugs to match biologics.⁴² It remains to be seen whether a new Congress would decide to consider a similar bill.

In light of ongoing litigation and the incoming Trump administration, the future of the IRA’s drug price negotiation program remains somewhat uncertain; however, as noted above, a full repeal is unlikely.

VI. Final Takeaways

Following the publication of the first ten Selected Drugs and their MFPs, significant uncertainty remains regarding the ultimate impact of the IRA’s drug price negotiation program on the pharmaceutical and biotech industries. Nonetheless, there are some key takeaways:

1. Impact of MFPs. The MFPs represent substantial reductions from list prices. However, the actual economic impact varies due to differences between list and net prices, among other factors, and recent analysis suggests that drugs with lower pre-negotiation rebates could be more affected.
2. Economic Adjustment Provisions. In response to the IRA, economic adjustment provisions, such as royalty reductions, are increasingly common in licensing transactions. Important considerations include the timing of such adjustments, the scope of the reduction, the type of royalty reduction (fixed versus variable), and the precise calculation method for variable adjustments.
3. Corporate and Regulatory Strategy. Pharmaceutical and biotech companies are responding to incentives introduced by the IRA, including by trimming their existing pipelines and reducing investment in follow-on indications.
4. Ongoing Political and Legal Challenges. The IRA continues to face legal challenges from industry stakeholders and advocacy groups, as well as political opposition from certain lawmakers in Congress. These efforts in the courts and Congress may influence the future of the drug price negotiation program, though a full repeal is unlikely. With the transition to a new Congress and the Trump administration, changes to certain provisions and CMS guidance are possible, potentially altering the program’s implementation and impact.
5. The Landscape is Evolving in Real-Time. As the legal landscape around the IRA evolves and the true economic impacts of the drug price negotiation program become better understood, pharmaceutical companies and other stakeholders will continue to adjust their approaches to deal-making and their general business strategy accordingly. This shifting environment means that there is no one-size-fits-all approach to responding to the negotiation program. As the law continues to develop, parties should pay close attention to how the IRA may impact their business.

We will continue to monitor the evolving IRA legal landscape and the impacts of the IRA. Please contact the authors or the Ropes & Gray attorneys with whom you work to discuss specific regulatory or transaction needs.

This article is informational only and should not be relied on as legal advice in relation to a particular transaction or situation.