Life sciences eyes give-and-take with IRA and upcoming ‘patent cliff’

The Inflation Reduction Act of 2022 (IRA) represents a monumental change to drug pricing by mandating pricing negotiations between the federal government and the makers of the highest-spend Medicare Part B and D drugs. This change could reduce Medicare spending by an estimated $100 billion by 2030, according to the Congressional Budget Office, potentially resulting in greater hits to large pharmaceutical company earnings. It could also indirectly challenge middle market life sciences companies that often rely on large pharmaceutical companies for research funding and collaboration.

At the same time, the life sciences industry and the biopharma sector are facing an unprecedented expiration of patents through 2030, which, while challenging for large pharmaceutical companies, could bolster investment in the middle market as those large companies renew their patent pipelines.

This outlook refers to these two developing events, the IRA and the “patent cliff,” as a give-and-take for middle market life sciences companies, representing both challenges and opportunities in the coming months.

The IRA and its effect on the middle market

With Medicare spending nearing $1 trillion annually, drug pricing under Medicare Parts B and D has come under scrutiny. Historically, biopharma manufacturers have set their own Medicare Part B and D prices. This is because previous noninterference clauses under the Social Security Act prevented the government from mandating or setting prices. The IRA has changed this and various other aspects of Medicare spending. Under the new guidance, manufacturers of the highest-spend Medicare Part B and D drugs will be required to negotiate prices with the secretary of the U.S. Department of Health and Human Services annually. While the Congressional Budget Office has forecasted Medicare savings totaling roughly $100 billion by 2030, the actual impact to life sciences companies, including those in the biopharma sector, may be larger.

Based on 2021 Medicare Part D spending data from the Centers for Medicare & Medicaid Services (CMS), approximately 90% of the more than $200 billion of Medicare Part D annual spending is on drugs manufactured by 75 large pharmaceutical companies. Of the approximately 3,400 unique drugs purchased by Medicare Part D, these manufacturers sell approximately 2,100 of them. The median and average valuations of these companies are $11 billion and $63 billion, respectively.

Because of the significant concentration of high-spend drugs produced by large pharmaceutical companies, the middle market may not see a direct impact; however, this is only one part of the story. There is significant uncertainty surrounding the indirect impact the IRA may have on the middle market and other companies in the life sciences ecosystem.

Several questions remain:

• Will large pharmaceutical companies choose to absorb the price reductions enforced by CMS? Alternatively, will the industry pass the cost of price reductions on to other companies, such as pharmacy benefit managers?
• Could published Medicare prices affect non-Medicare pricing of the same drugs?
• Will a loss of large pharmaceutical company revenue translate directly to a loss of investment funds to support research and development, licensing, and mergers and acquisitions for middle market life sciences companies
• Will biopharmas change their development and new drug application strategies to delay less lucrative indications in favor of more lucrative ones, thereby delaying the start of the negotiation timeline? Alternatively, will companies favor biologics over small molecule drugs due to the longer negotiation timeline for biologics? Factors at play include:
  • Eligible drug products are only eligible for negotiation seven years after the date of U.S. Food and Drug Administration (FDA) approval.
  • Eligible biological products are only eligible for negotiation 11 years after the date of FDA approval.

While it may be several years before the impact of the IRA becomes apparent, we expect that large pharmaceutical companies will begin planning and revising forecasts now. In the end, time will tell whether the rapidly growing list of drugs slated for pricing negotiation, and the resulting loss of large pharmaceutical company revenue, have a lasting effect on middle market biopharmas.

The patent cliff could bolster middle market investment

From 2023 to 2030, the 18 largest pharmaceutical companies will face the expiration of patents for 169 commercialized drugs, according to Bloomberg data. That will put nearly $400 million of revenue at risk of erosion by new market entrants, Bloomberg said. In addition, 66 of these drugs are biologics and 103 are small molecule drugs; however, as a percentage of annual revenue, biologics constitute 66% of exposed revenue, compared to 34% for small molecule drugs.

A large, concentrated group of patent expirations presents several opportunities for middle market companies in the biopharma space. The most obvious is the chance to bring a generic or biosimilar drug to market and compete for market share with branded drugs.

The industry has faced similar circumstances in the past, most recently from 2000 to 2002 and 2010 to 2012. In both periods, a significant number of generic drugs were brought to market at lower price points, which proved costly for large pharmaceutical companies, with revenue for certain drugs experiencing 90% declines, according to The Wall Street Journal. 

The majority of drugs affected by these historical patent cliffs were small molecule. As such, the significance of biologics in the current population of expiries could yield different results than previous periods. 

A  2021 study by the National Institutes of Health indicated that the average time from patent expiration to launch of the first generic drug is approximately 1.5 years, compared to the timeline for a biosimilar of 2.5 to three years. To date, far more biosimilars have been approved for marketing in Europe than in the United States. This is partially driven by the fact that the European Medicines Agency does not require animal studies as part of the biosimilar approval process, but the FDA does.

Additionally, companies seeking FDA approval typically commission human trials of larger and longer duration than their European counterparts. Since 2017, biosimilar approvals in Europe have outpaced U.S. approvals by nearly 2 to 1. This indicates that opportunity for further biosimilar development already exists in the U.S.; with the impending patent expirations, demand will continue to grow, potentially creating opportunity for early-stage biotech companies. 

An additional upside for middle market companies will be increased appetite among large pharmaceutical companies to enter licensing deals to solidify their pipelines with the hope of recovering earnings lost to generics and biosimilars. According to Bloomberg data, the volume of such deals hit historic highs in 2020 and 2021 but decreased significantly in early 2022. The third quarter of 2023 saw a large increase in such deals, and we expect deal volume will continue to accelerate in coming quarters.

Similar to their pursuit of licensing deals, large pharmaceuticals will likely begin to target later-stage biotech companies for acquisitions. This is driven by a desire to bolster drug pipelines in the wake of patent expirations. Moreover, biotech valuations remain down more than 50% from peaks in early 2021, and larger firms may seek to capitalize on this before the public biotech markets turn more positive.

The takeaway

While the IRA represents challenges to the industry, patent expirations could provide opportunities for middle market biopharmas and others in the life sciences space through renewed investment and innovation. The industry will see some give-and-take, but its fundamental need will remain the same: a focus on clinical success to drive investment.