Introduction

The Inflation Reduction Act (IRA) of 2022 will drive the biggest changes to the Medicare prescription drug benefit (Medicare Part D) since its creation. While it may be hard to imagine Medicare without drug coverage today, Medicare did not cover prescription drugs for most beneficiaries during its first 50 years. The Medicare Modernization Act (MMA), passed in 2003, created the Medicare Part D program. Even though the MMA added drug coverage, the standard benefit design still included a coverage gap (sometimes referred to as a “donut hole”) where many beneficiaries paid the full cost of the drugs. The Patient Protection and Affordable Care Act (ACA), passed in 2010, closed the “donut hole” over time, but potential beneficiary costs remained unlimited because there was no maximum-out-of-pocket (MOOP) amount. Under the IRA, starting in 2025, beneficiary cost sharing will be capped at $2,000 for prescription drugs, materially reducing the out-of-pocket costs for many beneficiaries.

While some changes to the prescription drug benefit will occur in 2023 and 2024, the most significant changes from the IRA will be seen in 2025 and later. While the MOOP may be the most visible change for Medicare beneficiaries, the following changes will also have a significant impact on beneficiaries, Part D plans, and pharmaceutical manufacturers:

• A complete redesign of the Part D benefit design in 2025, including replacement of the current Coverage Gap Discount Program (CGDP) with a new Manufacturer Discount Program (MDP)
• Government negotiation of drug prices for select drugs starting in 2026

Because many Medicare beneficiaries will pay less in out-of-pocket costs for prescription drugs starting in 2025 than they do under the 2024 “standard” Part D benefit design, one question we discuss in this paper is: Who will pay more?

While the actual impact of these changes on key participants (Part D plans, pharmaceutical manufacturers, Medicare beneficiaries, and the federal government) will play out over time, we can evaluate potential behavior changes for the key participants and their financial impact now, in anticipation of those future changes.

How will the IRA benefit redesign impact how much manufacturers pay into the Part D program?

One of the largest changes from the benefit redesign in 2025 is the change in the contribution pharmaceutical manufacturers will make directly to the Part D program due to the MDP. Under the MDP, pharmaceutical manufacturers offering brand drugs subject to the MDP (i.e., applicable drugs) will pay 10% of the allowed cost of the drug after a beneficiary has met the standard deductible and until the beneficiary reaches the MOOP and then 20% of the allowed cost of the drug once a beneficiary reaches the MOOP. This program will apply to all large pharmaceutical manufacturers initially and will be phased in for small manufacturers.

Based on modeling “an average nationwide” Medicare Part D plan,¹ we estimate the total amount manufacturers will pay under the MDP in 2025 could be double what they will pay under the CGDP in 2024, although the results will vary by manufacturer and drug. This increase in the manufacturer cost is driven by the MDP applying:

• To all beneficiaries, whereas the CGDP only applied to non-low-income (NLI) beneficiaries
• In the initial coverage corridor and above the MOOP, whereas the CGDP only applied in the coverage gap

While the average manufacturer cost due to the MDP is likely to increase, the impact will vary by manufacturer. If a manufacturer with drugs subject to the MDP has the cost for its drugs concentrated in earlier benefit phases, then the cost may actually decrease because the 2025 cost would be only 10% of the applicable drug cost in the initial coverage corridor instead of 70% of the applicable drug cost in the coverage gap for NLI individuals in 2024. The largest increase in MDP cost could occur for drugs that cost thousands of dollars per script (e.g., specialty drugs), in which costs for some manufacturers could increase fourfold (or higher) over levels in 2024.

Manufacturers that expect an increase in their Part D costs could take pricing actions such as increasing list prices for existing drugs, reducing rebates for existing drugs, and increasing launch prices for new drugs. The IRA requires manufacturers to pay inflation-based penalty payments if prices increase at a rate greater than inflation, potentially limiting the option of list price increases for existing drugs. Therefore, manufacturers could decide to reduce rebates or increase new launch prices as potential levers to mitigate the increase in their costs.

In Figure 1, we show the change in manufacturer cost and estimate the net plan cost change from 2024 to 2025 in two scenarios:

• 2025 Breakeven: A scenario in which manufacturers on average reduce overall rebates by 21% of allowed cost from 2024 to 2025 to maintain their total cost in 2025.
• 2025 No Rebate Change: A scenario in which manufacturers do not change the rebates they offer, resulting in an increase in the average total manufacturer cost from 2024 to 2025.

Figure 1 shows the increase in manufacturer cost due to the new MDP (i.e., from 7% of allowed cost under the CGDP in 2024 to 13% of allowed cost under the MDP in 2025 for an average nationwide plan). The actual impact on net plan cost in 2025 from changes in manufacturer behavior likely is between these scenarios. However, because the MDP is concentrated in high-cost products with lower rebates, the actual impact will likely be closer to the “No Rebate Change” scenario.

Medicare plans share a portion of rebates with the federal government and use the remaining rebates to lower their net plan cost. The amount of shared rebates is proportional to the federal reinsurance amount, which is 80% of allowed cost after a beneficiary reaches the true out-of-pocket (TrOOP) amount through 2024. However, the benefit redesign in 2025 decreases the federal reinsurance to 20% of allowed cost for applicable drugs and 40% for non-applicable drugs with a MOOP amount of $2,000. Plans will therefore retain a greater portion of rebates in 2025, due to lower federal reinsurance.

As illustrated in Figure 1, for each dollar of rebates plans are estimated to keep $0.62 in 2024, whereas in 2025 plans are estimated to keep $0.83. Hence, even if manufacturers, on average, were to lower rebates to maintain their same cost from 2024 to 2025 (i.e., Breakeven scenario), plans could still see the same total net rebates which they use to lower premiums, due to the increase in the share of rebates they keep.

How will the value of rebates to Part D plans change?

To reflect the impact of the changes in the Part D benefit design, Figure 2 illustrates how prescription drug costs are allocated among the beneficiary, the Part D plan, the pharmaceutical manufacturers, and the federal government. We have provided examples for both applicable drugs and non-applicable alternatives and illustrate how that allocation changes from 2024 to 2025 for a single NLI beneficiary. The key assumptions in this comparison are:

• The Part D plan offers the standard benefit design in 2024 and 2025 as opposed to an enhanced plan.
• For the applicable drug scenarios, the beneficiary currently takes four applicable prescriptions per month that are eligible for the CGDP or MDP.
• The allowed cost of each applicable drug taken by the beneficiary is $400, so the total cost per year is $19,200.
• Manufacturer rebates are 35% of the allowed cost of applicable drugs.
• For the non-applicable scenarios, alternative non-applicable drugs are available for the applicable drugs the beneficiary currently takes. Each non-applicable drug has an allowed cost of $150, so the total cost per year of the non-applicable drugs is $7,200.

Figure 2 is an illustrative example that shows how, under the 2024 Part D benefit, the net cost to the Part D plan for an NLI beneficiary taking applicable drugs is significantly less than the net cost if the beneficiary took non-applicable drugs due to the rebates. This is largely because the net cost to the Part D plan is $0 or negative in the coverage gap and catastrophic phases in 2024 for applicable drugs since the Part D plan is receiving rebates equal to 35% of the cost of the drug in these phases while plan is only paying 5% of the allowed cost in the coverage gap and 20% in the catastrophic phase. Hence, the rebates could be greater than the portion of the cost to the Part D plan overall. Starting in 2025, the Part D plan will be responsible for a significantly larger portion of applicable drug costs (from 60% to 65%), resulting in a large increase in net plan cost even after accounting for rebates. Overall, the net plan cost for this illustrative beneficiary increases from roughly $100 per year under the 2024 benefit design to $5,200 per year under the 2025 benefit design, if the beneficiary continues to take the applicable drugs, while the net plan cost if the beneficiary takes the non-applicable drugs decreases slightly, assuming no change in drug prices or rebates.

Because the material increase in plan cost will not happen until 2025, Part D plans should be reviewing their rebate contracts and potential non-applicable alternatives before the end of 2024. Beneficiary disruption and other Centers for Medicare and Medicaid Services (CMS) requirements such as limits on the changes to total beneficiary cost (TBC) will need to be taken into account in developing the 2025 bids.

What are the potential impacts of price negotiation?

Another key component of the IRA allows CMS to negotiate drug prices for select Part D drugs starting in 2026 and Part B drugs starting in 2028. The first set of 10 Part D drugs selected for price negotiation was published on August 29, 2023, and the negotiated prices will go into effect in January 2026. Drugs will be ranked on total expenditures from June 1, 2022, through May 31, 2023, with the U.S. Department of Health and Human Services (HHS) selecting drugs from the top of the list.² Price negotiations between the Secretary of HHS and manufacturers will occur from October 1, 2023, to August 1, 2024. This process will continue in future years with more drugs added to the list each year.

The IRA states that the “maximum fair price” for selected drugs will at a minimum reflect the greater of the average price concessions, including the average rebates negotiated by Part D plans, and minimum discount levels, for different drugs based on their existing time on the market, as defined by the IRA. However, HHS could negotiate a lower maximum fair price using deeper discounts beyond these predefined minimum discounts. It is currently unclear how much they are expected to differ.

Pharmacy benefit managers (PBMs) develop formularies seeking to optimize net cost for plan sponsors. Key components of formulary development include reviewing drug list prices, manufacturer rebates, and different subsidies and offsets (e.g., manufacturer discounts and federal reinsurance). Historically, manufacturer rebates have been more valuable than list price discounts because plans share a greater portion of list price discounts with other stakeholders. For this reason, plans have often favored high list price, high-rebate products over low list price, low-rebate products. With the benefit redesign in 2025, these dynamics could shift as mentioned previously, where the value of list price discounts may be closer to the value of rebates for plan sponsors than in prior years.

For drugs selected for price negotiation, manufacturers may offer significantly lower rebates in 2026 than they currently do or eliminate rebates altogether because the point-of-sale manufacturer discounts will likely be materially higher than they are currently. In addition, drugs selected for price negotiation will be required to be covered on a plan’s formulary unless they are substituted with non-applicable equivalents. The drugs selected for price negotiation will no longer be subject to the new MDP.

Figure 3 shows an illustrative example of net plan cost for a beneficiary taking 12 scripts of a drug priced at $1,000 per month (Drug X) that offers rebates at 35% of allowed cost before any effects of the IRA take place. Figure 3 shows the cost distribution to several different participants under the following scenarios:

• Scenario 1: If the drug is selected for price negotiation and has a 35% negotiated discount:
• The manufacturer has a net reduction in cost of approximately $1,700 due to not having to pay the manufacturer discount.
• The federal government pays about $450 more in federal reinsurance net of rebates and other subsidies.
• The plan pays approximately $1,300 more than without negotiation.
• Scenario 2: If the drug is selected for price negotiation and has a 49% negotiated discount (breakeven for the manufacturer):
• The beneficiary pays $60 less than if the drug had a 35% rebate.
• The federal government pays about $150 less in federal reinsurance net of rebates and other subsidies.
• The plan pays approximately $200 more than without negotiation.
• Scenario 3: If the drug is selected for price negotiation and has a 52% negotiated discount (breakeven for the plan)
• The beneficiary pays approximately $150 less than if the drug had a 35% rebate.
• The federal government pays about $200 less in federal reinsurance net of rebates and other subsidies.
• The manufacturer has a net increase in cost of about $350 more than without negotiation.

These scenarios highlight some of the intended (and potentially unintended) dynamics introduced by price negotiation. Depending on the ultimate level of discount negotiated, plans could see an increase or decrease to their net plan cost for selected drugs. Manufacturers could still offer rebates to secure preferred formulary placement for selected drugs, but they could face lower net revenue if Medicare negotiates materially higher discounts. Some of the scenarios illustrated above lead to reduced beneficiary cost sharing, which could incentivize beneficiaries to choose the selected drugs. However, there may be some cases where the beneficiary’s out-of-pocket cost sharing remains unchanged due to the application of the MOOP for beneficiaries with higher drug spending. It is unclear how competitors to selected drugs will respond, but they may have an advantage if they are willing to offer rebates.

While the impact of this provision of the IRA will not take effect for a couple of years, plans should be aware of the potential upcoming list of drugs subject to negotiation when setting their formularies in 2025 to avoid significant drug coverage changes and disruption at the beginning of 2026.

Additional considerations

While this paper highlights a few key changes in the Part D program that will occur in 2025 and beyond, there are likely to be other provisions that impact the key participants as CMS releases future guidance on the changes for 2025 and later. While many of the changes can be measured independently, plans should also consider interactions among the changes and how they could offset each other (e.g., higher retained rebates vs. higher plan cost before rebates under the 2025 benefit design). With all changes occurring, it is more important than ever for health plans and other key participants to ask the right questions and receive clear guidance from CMS, PBMs, consultants, and other external partners.

¹ An average nationwide plan is a Medicare Part D plan with the following characteristics using Milliman internal research: average allowed cost across Medicare Advantage Prescription Drug (MAPD) plans and Prescription Drug Plans (PDPs), market average LI/NLI distribution, representative benefit design from basic and enhanced benefits in the market, formulary reflecting actual experience, and anticipated average contracting and rebate terms.

² CMS (January 11, 2023). Medicare Drug Price Negotiation Program: Next Steps in Implementation for Initial Price Applicability Year 2026. Retrieved August 28, 2023, from https://www.cms.gov/files/document/medicare-drug-price-negotiation-program-next-steps-implementation-2026.pdf.