Historic drug pricing reform will not hinder biotech innovation

by | Oct 7, 2022

By Marek Poszepczynski and Ailsa Craig, co-investment managers of the International Biotechnology Trust

The elevated cost of prescription drugs has been the subject of numerous policy debates in America, where government support has historically been limited in comparison with single payer systems such as the UK’s. However, the potential impact of introducing legislative controls on prescription drug pricing has sparked debate within the healthcare sector, due to the risk of it disincentivising investment into the space and inhibiting innovation.

The Inflation Reduction Act of 2022, which was approved by the US Senate last month, has finally brought some drug pricing reforms into law. The new legislation will allow Medicare – the US national health insurance programme for elderly patients – to negotiate lower prices for certain best-selling drugs starting in 2027. However, it contains many caveats, which will affect the extent to which it impacts the biotech sector.

The bill will apply only to commercially successful treatments that have been on the market for nine or more years – depending on the drug class – and that lack effective generic competition. The legislation will also prevent above inflation price increases for marketed drugs, and aims to lower the price of medications for major diseases, such as heart disease and diabetes.

Reshaping R&D

The industry consensus around the legislation is it could lead to a single-digit percentage revenue fall for certain large pharma companies, with one sell-side analysis from a major US bank finding approximately 11% of drug sales could be subject to price negotiations. The eco-system of the healthcare sector is such that the most commercially successful products tend to end up in the hands of companies with sizeable distribution networks and marketing machines, such as large pharmaceutical players, as opposed to the smaller, more innovative biotech companies.

We may see biopharma companies increase their focus on biological products, pivoting away from small molecule products. Under the new legislation, small molecule treatments will be protected from drug price negotiations for nine years post launch, whereas large biological molecules will receive 13 years’ protection. Companies may also spend less time focusing on treatments for the most common chronic US ailments, such as heart disease and diabetes, which have been singled out by the regulations.

Innovation not inhibited

While the long-term implications of the reform must be carefully considered, since the legislation passed, there has been little impact on valuations across the biopharmaceutical and biotechnology sectors – particularly those of innovative small and mid-cap players who may well pioneer future breakthrough treatments. Several factors are likely responsible for this.

Firstly, the legislation has exemptions for certain types of drugs, namely treatments produced by small biotech companies, drugs for rare diseases or so called ‘orphan’ conditions, those with generic competition, and those for blood-derived products such as cell therapies – one of the more exciting areas of current innovation. Big pharma may also choose to spin out certain products with the aim of them being reclassified as small biotech, and thus falling outside of the new legislation.

Perhaps most importantly, drug price negotiations will only apply to the 20 best-selling drugs each year, only take effect nine to 12 years after launch, and will only impact drugs purchased via Medicare. While the percentage of revenues this represents varies from company to company, the overwhelming majority of US drug revenues will subsequently avoid drug price negotiations.

Moreover, given the measures will only apply to the best-selling drugs after a set number of years on the market, by definition, a product must have been commercially successful for a considerable timeframe to be impacted. Earlier stage biotech companies will likely view this as a nice problem to have, as their products will only be subject to price negotiation should they prove highly commercially successful.

Besides, with innovation accelerating rapidly in the biotech and biopharma sectors, driven by structural tailwinds on both the demand and supply sides, many products are likely to be superseded by new, more effective treatments before their patent expires. The fact price negotiations will only come into effect after nine to twelve years therefore makes the new legislation somewhat irrelevant.

We share the view of the US Congressional Budget Office, whose analysis suggests very few future drugs will be lost as a result of this legislation, and, critically, the high levels of innovation propelling biotech and biopharma should largely be unaffected.  The market also appears to share this view, with biotech company valuations seeming to shrug off the news. Importantly, the legislation will also provide some relief for those suffering from the most common types of diseases in America.

With mid-term elections looming, we hope the pre-emptive strike of this new legislation will reduce the political noise around drug pricing in the run up to the election, which usually causes extra volatility in the biotech sector.

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