Last week, the pharmaceutical giant Merck filed a lawsuit against the U.S. Department of Health and Human Services (HHS) and the Centers for Medicare and Medicaid Services (CMS). The complaint characterizes the provision detailing the process of Medicare drug price negotiations established by the Inflation Reduction Act (IRA) as “tantamount to extortion.” In addition, the company asserts that the "singular purpose of this scheme is for Medicare to obtain prescription drugs without paying fair market value.” Almost immediately following Merck, the Chamber of Commerce also sued HHS and CMS on similar grounds of purported government overreach.
Merck seeks to maintain the status quo in which drugs are priced in accordance with supposedly “fair market value.” On the other hand, Medicare wants to establish what it calls “fair” prices for drugs it now has the authority to negotiate over with drug makers. Which prices are fair? Well, neither. Because of a suboptimally functioning market, the current prices negotiated between drug makers and private entities contracting with Medicare aren’t fair. And due to the arbitrary nature of the maximum upper limits (or minimum discounts), the future prices negotiated between drug manufacturers and Medicare as a collective unit aren’t fair. In both instances, the opposing stakeholders rely on problematic conceptions of fairness in pharmaceutical pricing. The alternative, a cost-effectiveness- or outcomes-based price, isn’t (yet) on the table. This is too bad, as it stands a better chance of establishing a consensus fair price.
Both Merck and the Chamber of Commerce want to halt implementation of the first-ever round of Medicare drug price negotiations for a limited subset of single-source prescription drugs. The Dayton (Ohio) Chamber of Commerce doesn’t mince words: “This illegal and arbitrary attempt to impose government price controls is a dangerous precedent that must be blocked.”
The lawsuits argue against the process of Medicare drug price negotiations on the basis of supposed non-adherence to the Constitution. Referencing the First Amendment, the complaints allege that any negotiated agreement on price will constitute “compelled speech,” because they deem the process of negotiation as envisioned by the law as a price control, not a negotiation. Further, Merck argues that the looming Medicare’s drug price negotiations violate the Fifth Amendment’s “takings” clause, which prohibits private property to be “taken for public use, without just compensation.” The Chamber of Commerce’s complaint includes what it views is a violation of the Eighth Amendment’s “excessive fines” clause, as well as of due process and separation of powers.
Given my lack of legal expertise I won’t comment on the constitutionality of the drug pricing provisions contained in the IRA.
However, what I can opine about are the notions of fairness made explicit in Merck’s complaint and implicit in the Chamber of Commerce’s brief, as well as in the text of the IRA.
Medicare drug price negotiations
One of the main drug pricing provisions contained in the IRA allows Medicare as a collective entity to negotiate prices with drug makers for a limited subset of outpatient (Part D) and physician-administered (Part B) drugs. Starting in 2026, 10 Medicare Part D drugs will have a Medicare-negotiated price. This number will rise to 15 Part D drugs in 2027, 15 Part B and D drugs in 2028, and 20 Part B and D drugs in 2029 and beyond.
To be selected for negotiation, small molecule drugs must be 9 years post launch and not face generic competition, and large molecule biologics must be 13 years post launch and not have biosimilar competition.* Furthermore, the pharmaceuticals chosen will be from the top 50 list of drugs with the highest gross Medicare Part D expenditures, and later, beginning in 2028, from the top 50 list of drugs with the highest total Medicare Part B spending.
CMS will announce which drugs it has selected for negotiation two years prior to the actual implementation of negotiated prices. A one-year long negotiation process will ensue.
Imposed by CMS functioning as a monopsonist, or single purchaser, pharmaceutical manufacturers whose branded, single-source drugs are selected for negotiation face stiff penalties in the form of a 65% excise tax for sales during the first 90 days of “non-compliance,” escalating to 95% by the end of the first year. Here, non-compliance implies not entering negotiations with CMS. In the end, firms have no realistic recourse. They can exit the Medicare market, but that’s highly unlikely, given how important this segment is to most pharmaceutical firms.
Proponents of the legislation call it a process by which fair prices are established through negotiations. They say changes are long overdue in a system in which, until now, drug makers were too often “unilaterally calling the shots.”
Critics, on the other hand, suggest that a monopsonist can extract maximum discounts. The pharmaceutical industry and investor community, in particular, worry that the tail end of a drug’s life cycle will be drastically reduced in terms of revenues.
As a reminder, in Europe and elsewhere, government purchasers intervene, both in terms of pricing and reimbursement, at every stage in the lifecycle of a drug. Evidence is mixed as to how much of a discount government purchasers are able to achieve. For newly approved drugs, a 20% discount off of the list price is typical at launch. However, there have been several high-profile instances, in which price cuts of up to 60% were imposed by government payers; for example, when bluebird bio wanted to launch its newly approved drug Zynteglo (betibeglogene autotemcel)—indicated for beta thalassemia—the German reimbursement authority demanded a 60% price reduction.
Regarding drugs that fit the profile of the ones whose prices CMS will be negotiating, there is evidence from tender offers in Europe that discounts can be considerable: At least 40% off of the list price. So, for example, public hospital systems and other large purchasers in the U.K. often procure drugs through competitive bidding when there is more than one drug in a therapeutic class. Where this occurs, competing manufacturers must lower their prices to retain market share.
While in the U.S. there won’t be nationwide tender offers for drugs in the late stages of their lifecycle, for one segment of the market, Medicare, the government will act as a monopsonist for a small number of drugs. Here, the legislation establishes an arbitrary upper limit or minimum discount for the negotiated price (the “maximum fair price”), equal to a percentage of the non-federal average manufacturer price: 75% for small-molecule drugs which are more than nine years but less than 12 years removed from their first date of marketing; 65% for drugs between 12 and 16 years after launch; and 40% for drugs more than 16 years after coming to market.
Though there is an arbitrarily designated minimum discount there is no floor, which in theory means the government could leverage its monopsony power to the fullest. But conspicuously, the IRA lays out explicit criteria with which drug makers may justify their counteroffers to the price CMS determines is a benchmark maximum fair price.
For the purposes of negotiating, the Secretary of HHS shall consider, among others, the following factors:
- Research and development (R&D) costs of the drug, and the extent to which the manufacturer has recouped R&D costs;
- The degree to which a drug meets unmet medical needs for a condition for which treatment or diagnosis is not addressed adequately by available therapeutics;
- Comparative clinical effectiveness of the drug in question, taking into consideration the effects on specific populations, including the disabled, the elderly, and the terminally ill.
During the period of negotiations following a drug’s selection by Medicare an exchange of information between CMS and drug manufacturers will occur in multiple meetings in which drug makers can provide supporting documentation regarding their counteroffers.
Which process results in fair pricing?
Medicare is trying to lower drug prices below the level that would otherwise be determined. Indeed, why else would Congress pass a law to allow for Medicare to negotiate prices?
The question becomes, which price is fair? Is it the fair market value price Merck refers to, or Medicare’s maximum fair price?
Merck maintains that it is being coerced into selling its products to Medicare at “below‐market prices,” which isn’t fair in its view. The coercion part refers to the excise tax the government levies on those who don’t take part in the negotiation with Medicare once their drug has been selected for negotiation.
The company describes the prices it presently receives from Medicare for its products as reflecting “fair market value,” and Medicare’s current drug‐pricing rules as “a free‐market approach based on market‐driven prices.”
As a rule, the fair market value of a good or commodity is the price at which it would change hands between a willing and informed buyer and seller. But this presumes an optimally functioning market. And that is far from being the case with respect to prescription drugs.
The pharmaceutical market is characterized by numerous violations of assumptions governing a competitive market: Asymmetry and lack of completeness of information, substantial regulatory barriers to entry which include monopolies and oligopolies, third party payments, and a system riddled with anti-competitive practices on both the payer and drug manufacturer sides. As signals, current drug prices therefore provide incentives that don’t reflect either “underlying costs or consumer preferences.”
However, just as it’s unfortunate Merck uses language to describe the status quo as resulting in fair market value, it’s similarly problematic for the Inflation Reduction Act and CMS to call the end-result of its negotiation process a “fair price.” Perhaps better to just call it the price of doing business with Medicare, a social program that must allocate finite resources to meet the needs of all beneficiaries, elderly and disabled alike. Seen in this light, prescription drugs as a Medicare benefit are not ordinary goods. There is a societal imperative for government policymakers to make each dollar go as far as it can in terms of producing health outcomes for the population as a whole.
In this context, possibly a better tack for Medicare to have taken would be to point to the suboptimality of markets in which prices and value do not necessarily align. Medicare should then pay more for high value pharmaceuticals and less for low value drugs. In a circumscribed way, several of the criteria outlined in the IRA—factors that will be part of the offer and counteroffer negotiation process—denote a very rough value assessment.
But, to do this much more effectively, Medicare would have to explicitly calculate a proxy of value based on comparative cost-effectiveness data. The incremental cost per Quality-Adjusted Life Year (QALY) concept can do this. However, in a concession to drug makers and certain patient advocacy groups, the use of cost-per-QALYs and really any cost-effectiveness measure is prohibited in Medicare.
A comprehensive method for value- or outcomes-based pricing, which doesn’t necessarily have to depend on QALYs, could get all stakeholders closer to a consensus on what is a fair price. Surely, prices and value would be better aligned than they are now. But at least in the short term Medicare is unlikely to embrace cost-effectiveness in price negotiations.
And so we’re left with a situation in which both Merck and Medicare deploy faulty notions of fairness. Moreover, there isn’t a shared language of what constitutes fairness. Drug manufacturers wrongly presuppose an optimally functioning market, while Medicare, by way of the IRA, introduces an arbitrary conception of fairness that isn’t properly tethered to value.
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