Drug shortages and IRA inflation rebates: Considerations for CMS

Editor’s Note: This analysis is part of the USC-Brookings Schaeffer Initiative for Health Policy, which is a partnership between the Economic Studies Program at Brookings and the USC Schaeffer Center for Health Policy & Economics. The Initiative aims to inform the national health care debate with rigorous, evidence-based analysis leading to practical recommendations using the collaborative strengths of USC and Brookings. We gratefully acknowledge financial support from Arnold Ventures.

Drug shortages of essential medicines such as amoxicillin, saline and epinephrine occur with troubling frequency – in the last few years, the Food and Drug Administration (FDA) has reported around 30 to 50 new drug shortages per year, many lasting months if not years. Due to economic, clinical, and technological factors, shortage drugs tend to be low-cost sterile injectable generics. In contrast, on-patent branded drugs have more resilient supply chains – they are less likely to end up in shortage and they recover faster when a shortage does occur.

In its concern about drug shortages and price spikes that sometimes occur with supply interruptions, Congress put forward provisions in the Inflation Reduction Act (IRA) directing the Centers for Medicare & Medicaid Services (CMS), as an agent of the Secretary, to reduce the newly required Medicare inflation rebates for drugs in shortage.  

One concern Congress wanted to address in relation to shortages appears when a low margin producer experiences an input cost increase due to a severe supply disruption. If unable to pass such an increase forward, a low margin producer may choose to exit the market. On the flipside, tying shortage status to inflation rebates creates financial incentives to keep drugs in shortage.

In recognition of the tension between the potential to prevent shortages and exacerbate them, Congress gave CMS flexibility in implementing the drug shortage provision – CMS can waive or reduce inflation rebates, with no direction on the magnitude of the reduction.

In this essay, I propose a set of considerations for setting rebate reductions so that they balance Congressional intent for inflation rebates with the potential impact of waivers and reductions on shortages. To motivate these recommendations, I describe the IRA drug shortage provisions and provide background on how FDA determines whether a shortage exists or has ended. To illustrate how the IRA drug shortage provisions work with different types of drugs, I review the current drug shortage list, before concluding with recommendations to CMS.

As I describe below, by focusing inflation rebates on single source drugs, Congress addresses inflation rebates for majority of drugs in shortage – generics. What is left for consideration under shortage provisions heavily skews towards brands, which already have strong incentives to resolve shortages. For this reason, CMS should focus its analysis on low margin drugs – the relatively rare single source Part D generics and brands with no IP protection – to the extent they are in shortage or at risk of shortage. But CMS must assess the reason for shortage to make sure it meets Congressional intent behind inflation rebates – unsubstantiated price increases.  It must also structure any reductions in a way not to prolong shortages.

IRA drug shortage provisions  

IRA Sections 11101(a) and 11102(a) directs manufacturers of single source drugs to pay Medicare inflation rebates if prices for those drugs increase faster than the consumer price index.  For Part B, the law defines single source drugs as biologics and drugs marketed and distributed under new drug applications (NDAs). For Part D, the law defines single source drugs as biologics, NDAs, and single source generics not subject to “first applicant” FDA programs such as 180-day exclusivity or competitive generic therapy. Under the new law, inflation rebate requirements only apply to single source drugs for which average Medicare annual charges per patient are more than $100. 

Rebates paid in a given year are structured to account for both past price increases and decreases. The rebate amount is equal to the total number of units sold in Medicare multiplied by the amount by which a drug’s price in a given year exceeds the inflation-adjusted price. The base year for measuring cumulative price changes relative to inflation is 2021.

For single source drugs that do pay rebates – biologics, NDAs, and Part D single source generics – IRA Sections 11101(a) and 11102(a) direct CMS to reduce or waive inflation rebates if those drugs are listed by FDA in shortage during the applicable period.

The IRA also directs CMS to reduce or waive inflation rebates for Part B biosimilars and single source Part D generics that experience “a severe supply chain disruption during the applicable period, such as that caused by a natural disaster or other unique or unexpected event.” In general, severe disruptions will cause shortages, but this language directs CMS to also account for situations where no shortage exists in the applicable period. Should CMS determine that such a disruption will likely lead to a future shortage of a generic, CMS is directed to waive or reduce the generic’s current inflation rebate.

The law does not provide guidance as to how CMS should determine what level of reduction to provide.

FDA’s Drug Shortage List

Because the law specifically ties eligibility for waivers and reductions to FDA’s Drug Shortage list, it is important to understand how FDA determines whether a shortage exists.

First, it is important to understand what brings about shortages – situations where supply of a drug falls short of quantity demanded arise. Such a shortfall can happen when there is a sufficiently large supply disruption, or a demand increase, to which the supply chain cannot adjust. The shock can be exogenous (an input price increase or a hurricane that damages a facility) or endogenous (when a company does not follow good manufacturing practices causing batches of the product to be thrown away).

Whether the supply chain can withstand a shock depends on the size of the shock relative to factors such as fungibility of the manufacturing process, the level of spare capacity, and the level of inventory in the system. It also depends on availability of close substitutes and whether the shock affects a bottleneck in the system, such as closure of a single manufacturing plant for a critical product like contrast media.

To determine whether a market-wide shortage exists, FDA defines the relevant market. To do so, FDA considers the clinical implications of the supply disruption in question, for example whether a different dosage level or a different formulation could be used. Typically, the market ends up being defined on the ingredient-route level (injectable doxycycline). This is in contrast to ASHP, another prominent list of drug shortages, which defines shortages at the national drug code (NDC) level.

FDA determines whether a market-wide shortage exists using a variety of data sources. Companies must notify FDA “of a permanent discontinuance or an interruption in manufacturing of the product that is likely to lead to a meaningful disruption in supply.” The resulting lead time on potential shortages allows FDA to assess the shortfall using third party data on market share and typical use rates. It also assesses the existing potential for closing that shortfall using manufacturer-provided data on inventories, as well as the ability of the affected and competing manufacturers to restore or ramp up production.

FDA uses a range of tools to prevent impending shortages or mitigate the impact of those that do occur.  FDA will expedite the review of any company proposals to resolve the shortage, including qualifying manufacturing changes or qualifying new suppliers. Where appropriate, FDA will use regulatory flexibility, letting companies sidestep FDA requirements if doing so can mitigate a shortage without undue safety risks. For example, FDA may determine that a drug is safe to use past its expiration date or that the product can be dispensed with a filter to remove impurities in the product. FDA also allows compounding of drugs in shortage.

FDA will determine whether to delist a shortage using some of the same inputs it used to determine whether there is a shortage: historical utilization rate for the drug, ordering patterns, and existing levels of inventory.    

However, FDA’s resolution of shortages is complicated by behavioral responses to shortages. Even in situations where there is a supply disruption, a shortage tends to increase demand for the product as customers try to build up a safety stock. This demand increase exacerbates the shortage and makes it not only longer to resolve but also more difficult to assess because FDA no longer can simply rely on historical use patterns to determine the level of shortfall. Instead, it must rely on company-provided data on demand, in addition to company-supplied data on output and inventory levels.

Drugs currently in shortage

To motivate how CMS should consider implementing the IRA drug shortage provisions, it is instructive to explore drugs currently in shortage. As of January 20, 2023, FDA listed 124 such drugs. 

For this discussion, I categorize these drugs in shortage as either multiple source generics, single source generics, “505(b)(2) generics,” or branded products. These categories are useful for illustrating drug shortage vulnerability, incentives faced by manufacturers in shortage, and how CMS actions might affect shortages of those drugs.

Multiple source generics

A review of the current list suggests that 75% of these drugs have more than one manufacturer listed – an indication that they are multi-source drugs. This includes drugs like cytarabine for pediatric cancers, amoxicillin oral suspension for treatment of bacterial infections in those unable to take oral dose formulations, and something as basic as sterile water for injection.

Single source generics

Single source generics are just that – one generic drug on the market and no other direct competitors, whether branded or generic. These drugs are older drugs that experience significant exit of generic competitors, leaving just one in the market. This often happens as the market becomes unattractive because of increased availability of other therapeutic substitutes, which not only shrinks the market but also takes away pricing power as better substitutes abound. In some cases, substantive exit is a sign of a drug becoming obsolete. In other cases, this means that the use cases for the drug get narrower. 

Unlike in Part B, Part D single source generics are subject to inflation rebates. Based on an analysis of FDA’s current shortage list, the Part D Drug Spending Dashboard, and Drugs@FDA, there appear three such drugs currently in shortage: amoxapine tablets, chlorothiazide oral suspension, and methyldopa tables. These kinds of drugs will require attention from CMS.

Single source drugs will also require attention from CMS for another reason – the legislation specifies that single source Part D generics not on the shortage list may be subject to shortage rebate reductions if the manufacturer experienced a severe supply disruption and the disruption has not yet resulted in a shortage but may do so in a future period. An example of a disruption outside of the control of the manufacturer – the kind that the law describes through examples – would be a significant increase in the cost of an input. If margins are sufficiently small, which they might be if the drug faces competition from other molecules, then the manufacturer would need to pass on the cost increases to stay on the market. 

505(b)(2) generics

505(b)(2) generics is not a formal term, but an apt description of drugs that that have the same dosage form and active ingredient as the reference brand but could not pursue the standard generic Abbreviated New Drug Application (ANDA) pathway because of differences in inactive ingredients.  Generic manufacturers may need to use different inactive ingredients to get around patents. In these situations, FDA recommends a manufacturer files a type of an NDA called 505(b)(2).

From CMS’s perspective, the defining feature of a multiple source drug is not whether a drug is approved under an ANDA but whether it has a therapeutic equivalence code listed in  FDA’s Orange Book. CMS recently issued guidance stating that 505(b)(2) drugs without therapeutic equivalence codes are single source drugs and therefore will be issued separate HCPCS codes. Notably, the drugs listed in that guidance are the low-margin sterile injectable generics that are prone to shortages. Many of those drugs have been or are currently in shortage.

Reviewing the list of drugs currently in shortage, five include 505(b)(2) generics among the set of same-molecule competitors: calcium gluconate injection, chloroprocaine hydrochloride injection, epinephrine injection, midazolam injection, and morphine sulfate injection. Review of the CMS Part B dashboard reveals that all five had average spending per beneficiary below $100. However, there is no assurance that other 505(b)(2) drugs will not cross the $100 threshold, thereby rising to CMS’s attention.

Yet unlike with single source generics, this group of drugs may not need to be a concern to CMS but rather to FDA. Qualified drugs can obtain therapeutic equivalent codes if they request them through citizen petitions to the FDA. Currently FDA has a backlog of these petitions but is now required to resolve those petitions within 180 days. FDA may need to dedicate extra resources to resolving the backlog, which might increase if having a therapeutic equivalence code absolves the 505(b)(2) generic from inflation requirements.  

Branded products

The current drug shortage list includes 23 drugs marketed under an NDA or BLA, in addition to the five 505(b)(2) generics described above. All 23 brands would appear subject to inflation rebates and therefore eligible for rebate reductions. In contrast, only three generics currently in shortage, all single source Part D generics, would be subject to rebates and therefore potentially eligible for rebate reductions. 

In general, brands have more resilient supply chains because high margins earned by their products provide a countervailing incentive to prevent production disruptions. Brands have a greater incentive to invest in systems that minimize production disruption, to have alternate supply sources, and to maintain spare capacity in case production unexpectedly has to be shut down. When production disruptions occur, they tend to be resolved faster.

But not all brands may have the margins and sales that incentivize fast recovery from shortages. Just as with single-source generics, some brands may not face generic competition because they are unattractive through a combination of size, relative efficacy and safety to other drugs, and sometimes formulation challenges. Of the 23 brands in the current shortage list, 14 appear to have no more IP protection.  An analysis of 2020 CMS suggests significant variation of per unit costs for these drugs. 

To the extent these old brands provide important benefits to special populations and have low margins, they warrant similar consideration to single source Part D generics. For both groups, the law allows such rebate reductions while the drugs are in shortage but not if the branded drug, even if low margin and low volume, might experience a shortage in a future period. 

Recommendations for implementing drug shortage provisions

In considering how CMS should apply its authority to adjust rebate reduction levels according to market conditions, it is important to assess the purpose of giving CMS the ability to waive inflation rebates.   One clear rationale is that Congress was seeking to minimize unintended consequences of inflation rebates as they relate to shortages and, in appreciation for the possible unintended consequences, afforded CMS with flexibility on how to deploy the adjustments.

A key unintended consequence of inflation rebates in relation to shortages appears when a low margin producer experiences an input cost increase. To maintain positive margins, the manufacturer would need to pass on those cost increases, but then those cost increases would then have to be rebated back to Medicare. Depending on the level of needed passthrough and share of the drug’s sales in Medicare, the manufacturer may not find it feasible to continue marketing the product.

This scenario would not, however, occur with high margin products, whose prices are less tied to marginal cost of production and more to the demand for the product. 

On the flipside, attaching potentially sizable dollars to shortages may have unintended consequences. 

First, shortages often occur for reasons that are in control of the manufacturer—be it not following good manufacturing practices (GMPs) or not vetting suppliers properly. Providing extra relief in the short term is undoubtedly beneficial but it sends the wrong signal to the manufacturer. 

Second, and perhaps more concerning, drug manufacturers control capacity and have superior access to information on market conditions. Sizable rebate reductions would incentivize high margin manufacturers to ramp up production just short of what FDA would consider necessary to close the supply-demand gap.  

With these considerations in mind, I propose the following set of recommendations.

Default to minimal reductions

CMS should default to minimal reductions and then ask companies to provide information supporting their request for a greater reduction. This has an additional benefit as such a default can unlock access to FDA information, much of which is proprietary. To obtain higher reductions, companies can authorize FDA to release relevant data to CMS for the sole purpose of determining inflation rebate reductions. 

Distinguish between low margin and high margin products

As discussed above, inflation rebates do not adversely affect the high margin manufacturers’ ability to stay in the market and they do not lower the incentives of the single-source manufacturer to resolve a shortage. On the other hand, low margin manufacturers closer to a cost-plus pricing structure may be adversely affected by inflation rebates. For this reason, CMS should consider market size, spending per claim, and manufacturing complexity when assessing whether the manufacturer should have inflation rebates significantly reduced.

Consider the reason behind the price increase

Drug supply shocks can cause increases in the cost of goods sold. If a manufacturer is closer to a cost-plus pricing model, it may need to pass through such increases to keep the drug on the market. On the other hand, exercising market power as in the case of the IP-expired brand Daraprim appears as to be exactly the kind of price increases targeted by Congress. Similarly, the clockwork January price increases by many brands are also for what Congress intended inflation rebates. To help assess the role of supply shocks, CMS should distinguish between current period increases versus pre-existing price increases.

Minimize potential gaming of shortage end date

Should CMS decide to offer reductions, it should be wary of tying the reduction to a discrete end of shortage. As described above, manufacturers control the output level and have superior information about demand. If CMS were to abruptly turn off reductions, it could incentivize companies to increase production to just under the level that would close off a shortage. Such an adverse incentive could be mitigated, to some extent, by reducing the rebate reduction as the gap between supply and demand shrinks. Doing so would necessarily require a lot more coordination with the FDA and access to proprietary data. Because much of the data would be company-provided, CMS would have to set up audit processes to verify the veracity of provided information, as needed.

Consult with FDA’s Drug Shortage Staff

The FDA Drug Shortage team has intimate knowledge of the relevant drug markets. FDA also does assessments of medical necessity and close substitutes. All these data may be useful in determining when and how CMS should engage.

Conclusion

In its concern of the impact of inflation rebates on drug shortages, Congress responded in two ways.  First, it exempted the majority of drugs at risk of shortage by limiting inflation rebates to single source drugs. Second, it granted CMS the ability to reduce inflation rebates for brands and single source Part D generics. However, in recognition of perverse incentives that tying shortages to rebates might yield, Congress also granted CMS flexibility in determining appropriate reductions. CMS would be wise to leverage this flexibility in focusing on low margin products and assessing their reason for price increases.

Acknowledgements: I would like to thank Erin Fox, Richard Frank and Rena Conti for providing useful comments. I would also like to thank Erin Fox, Robin King and Amalis Cordova-Mustafa for their help in characterizing drugs currently in shortage. 

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