Inflation reduction act impact on pharmaceutical investment: insights from investor interviews

Abstract

Introduction

There is limited direct measurement of whether the Inflation Reduction Act (IRA) is beginning to influence investment strategy and decisions.

Methods

Using a standardized guide, we interviewed life science investors from a range of stages, investment sizes, and fund types to explore how incentives under the IRA have impacted investment decisions.

Results

We interviewed 31 active investors. Over 90% had discussed the law within their firm. While 71% reported a lack of firm-wide consensus as to the IRA's precise potential impacts, 87% reported that the IRA was making it more challenging to bring innovative new medicines to market. All but one investor reported they were more likely to consider a larger launch indication for products they invest in, and 77% reported the IRA influenced small molecule investing.

Conclusion

Early signals of IRA impact on investor strategy include favoring a larger population launch and reduced small molecule investing. Noting stated preference and other study limitations, investors signaled continued interest in certain high Medicare utilization drugs. Buy-side investment impacts remain understudied.

Introduction

The Inflation Reduction Act (IRA) significantly reshapes the landscape of drug pricing in the United States, introducing new mechanisms of government price regulation and a cap on out-of-pocket drug costs for Medicare patients. The law's impact on pharmaceutical innovation has been fiercely debated.^1,2 A main concern is whether the IRA's Drug Price Negotiation Program (DPNP), which directs the Centers for Medicare and Medicaid Services (CMS) to set “maximum fair prices” (MFPs) for high-expenditure Medicare drugs, reduces manufacturers’ incentives to invest in new and ongoing drug development. It has been argued that the anticipated reduction of returns due to MFPs might: reduce the number of subsequent indications pursued,³ bias investment decisions away from small molecule drugs given the shorter timeline toward DPNP eligibility (ie, 7 years) relative to biologic drugs (ie, 11 years),⁴ disincentivize the development of drugs with populations with heavy Medicare representation, and influence the selection of the initial indication.⁵

Estimates of the impact of this legislation have varied widely. Initial estimates of potential reductions in new drug approvals range from 15 fewer new drugs over 30 years⁶ to 79 fewer small molecule drugs and 109 fewer post-approval indications over 20 years.⁴ In addition to impacts on the number of new approvals, recent research suggests possible impacts on venture investing,^7,8 and on the net present value^9,10 of pipeline medicines. The extent to which these impacts may be offset by capital shifts to smaller firms or strategic resource re-allocation is debated.¹¹

Though 2 years have passed since the IRA became law, direct measurement of its impact on investment decisions is limited. Investors decide daily which companies to fund, technologies to license, and programs to prioritize. This work aims to explore whether the IRA is already affecting investor strategy.

Methods

We performed a series of interviews with life science investors and decision-makers. We used a grounded theory approach, allowing themes and insights to come directly from our interviewees rather than starting with a pre-existing framework or theory to validate. After each interview, we looked for common themes. This method is commonly used to develop new ideas from conversations and observations, and it allowed us to learn more about areas not previously considered.¹² All work was done in alignment with best practices as outlined in the Standards for Reporting Qualitative Research (SRQR) framework.¹³ We targeted three categories of investors: traditional, corporate, and search and evaluation. Each category has different corporate structures, incentives, and levels of independence from manufacturers. Traditional investors (TVC) work in venture capital firms where a number of limited partners seek higher risk­–higher return investments to complement their portfolio. Pharmaceutical manufacturers might be one of the limited partners in a fund, but they wouldn’t have control over investment decisions, and the TVC optimizes for return. Corporate investors (CVC) make venture capital investments but from within a pharmaceutical company. These investors have some independence and necessarily seek market rate returns but have themes for investing directed by the parent company. Search and evaluation (S&E) professionals identify partnerships or assets to fill pharmaceutical pipelines. S&E professionals are the most responsive to direction and strategy from the manufacturer.

Interview design

We conducted semi-structured interviews using tailored guides for each investor type. An example guide for traditional investors is available in the Appendix. Interview questions were in three categories: awareness of the IRA and DPNP; influence of the DPNP on product development strategies; and changes to overall strategy. Questions and themes for the interview were drawn from literature. Questions were designed to be open-ended and prompt conversation.¹⁴ The interview was designed to be covered in roughly 30 minutes. Interview guides were piloted with cognitive interviews with a participant familiar with venture investing but not included in our sample.

Participant selection

Participants were drawn from an author's professional network. W.J.C. is a current life science investor with over 10 years of experience. We used stratified sampling and targeted 20 traditional investors, 5 corporate investors, and 5 S&E professionals. We targeted a larger group of traditional investors because we believed that this group would have the greatest diversity in perspective. Additionally, within traditional investors, we stratified our recruitment by the firm's stage focus (pre-seed/seed, Series A or later, or stage agnostic) and fund size. To protect anonymity, the final list of interviewees was anonymized, and each participant was assigned a unique and randomly selected ID number.

Data collection and processing

Given that interviewees were geographically spread across North America and Europe, all interviews were performed virtually. All interviews were performed by a single interviewer and included verbal informed consent. If interviewees agreed to have the interview recorded, we used the audio recording function of Zoom. Background firm characteristics not covered in the interview were drawn from the organization's website and pitchbook.com.

Audio recordings were transcribed using Notta, an AI platform that uses proprietary algorithms (not publicly available LLMs) to convert audio to text. Notta is SOC2 Type II, ISO 27001, GDPR, CCPA, and HIPAA compliant. All transcripts were reviewed by the interviewer for quality of transcription compared to the original recording. Any information that could identify an interviewee was redacted from the transcript to ensure anonymity.

Data analysis

Following transcription, each interview was coded to the relevant section of the interview guide. When possible, responses were categorized as ordinal values based on whether they believed they were more likely or less likely to make decisions based on incentives of the IRA. Additionally, quotes were identified from each transcript to capture sentiment from the interview that could not be captured in an ordinal scale.

Results

From an initial sample of 75 potential interviewees that met our criteria, we contacted 43 and ultimately interviewed 31, for an overall response rate of 72%. All 31 participants completed the full interview. S&E professionals were harder to recruit; we only interviewed 4, one below our target. Full response rate information is available in Appendix Table S1. We reached data saturation on feedback from our interviewees in each of our subgroups, validating our choice of sample size.

Interviewee characteristics

Full review of interviewee characteristics can be found in Table 1. Our interviewees were focused on life sciences, with representation across stages. Our sample skewed toward larger fund size, with over half of investors coming from funds larger than $250 million. Our respondents were largely in the middle tiers of the organization, with 84% being either partner, principal, or director level.

Table 1.

Interviewee characteristics.

Parameter	Corporate	S&E	Traditional	Total
(n)	5	4	22	31
% Exclusively life sciences	100%	100%	68%	77%
Stage
N/A		100%		13%
Pre-seed/seed			27%	19%
Series A or later	40%		27%	26%
Cross stage	60%		45%	42%
Fund size
N/A		100%		13%
<$25M			5%	3%
$25-99M			9%	6%
$100-249M			36%	26%
$250-499M	60%		23%	26%
>$500M	40%		27%	26%
Assets under management
N/A		100%		13%
$25-99M			14%	10%
$100-249M			14%	10%
$250M-1B	60%		27%	29%
>$1B	40%		45%	39%
Position
MD/GP	20%		5%	6%
Partner/principal/director	80%	100%	82%	84%
Sr. associate/associate			14%	10%

Awareness of the IRA and DPNP

Most of our interviewees (54%) expressed a moderate level of knowledge of the IRA and DPNP. Over 90% reported that the IRA and its potential impact had explicitly been discussed at their firm. While 71% reported a lack of firm-wide consensus as to the IRA's precise potential impacts, nearly 9 in 10 (87%) said that the IRA was making it more challenging to bring innovative new medicines to market. Approximately half stated it had already impacted deal value (45.5%), exit values (45.5%), and/or companies raising capital (56.5%). Full categorical results can be found in Table 2. Some had very strong opinions about the law. This is exemplified by one VC:

The consensus is it's terrible. And we all hope it gets repealed, or at least modified and still alive because not only is it an existential threat to investment in small molecule medicines, it represents that the federal governments or the powers that pass this fundamentally do not understand drug making.

Table 2.

Interviewee responses.

Parameter	Corporate	S&E	Traditional	Total
Awareness of IRA
Low	20.00%	25.00%	27.27%	25.81%
Moderate	60.00%	50.00%	54.55%	54.84%
High	20.00%	25.00%	18.18%	19.35%
Impact discussed at firm (%Y)	100.00%	100.00%	86.36%	90.32%
Consensus on impact at firm (%Y)	20.00%	25.00%	31.82%	29.03%
IRA part of an individual decision (%Y)	0.00%	75.00%	36.36%	35.48%
Impact on SMD investing
No impact	40.00%	0.00%	22.73%	22.58%
Some impact	60.00%	100.00%	54.55%	61.29%
Large impact	0.00%	0.00%	22.73%	16.13%
Less likely to choose Medicare pop (%Y)	0.00%	25.00%	18.18%	16.13%
Impact on indication sequencing (%Y)	100.00%	100.00%	61.29%	90.32%
Impact on accelerated approval (%Y)	20.00%	75.00%	18.18%	25.81%
Incorporated into financial projections (%Y)	60.00%	25.00%	31.82%	35.48%
Invest in rare/orphan
Less likely	50.00%	0.00%	22.22%	24.00%
No impact	50.00%	66.67%	77.78%	72.00%
More likely	0.00%	33.33%	0.00%	4.00%
Launch with larger indication
Less likely	0.00%	0.00%	0.00%	0.00%
No impact	0.00%	0.00%	5.00%	3.45%
More likely	100.00%	100.00%	95.00%	96.55%
Launch with multiple indication
Less likely	0.00%	0.00%	0.00%	0.00%
No Impact	20.00%	25.00%	69.23%	50.00%
More likely	80.00%	75.00%	30.77%	50.00%
Launch with orphan
Less likely	0.00%	0.00%	38.46%	25.00%
No impact	66.67%	100.00%	53.85%	65.00%
More likely	33.33%	0.00%	7.69%	10.00%
Launch outside the United States
Less likely	0.00%	0.00%	0.00%	0.00%
No impact	100.00%	75.00%	87.50%	85.71%
More likely	0.00%	25.00%	12.50%	14.29%
Impacted deal value
Yes	60.00%	0.00%	43.75%	45.45%
Uncertain	20.00%	100.00%	37.50%	36.36%
No	20.00%	0.00%	18.75%	18.18%
Impacted companies raising capital
Yes	50.00%		57.89%	56.52%
Uncertain	0.00%		0.00%	0.00%
No	50.00%		42.11%	43.48%
Impacted fund
Yes	0.00%		20.00%	16.67%
Uncertain	0.00%		0.00%	0.00%
No	100.00%		80.00%	83.33%
Impacted exit values
Yes	100.00%	0.00%	44.44%	45.45%
Uncertain	0.00%	0.00%	22.22%	18.18%
No	0.00%	100.00%	33.33%	36.36%
Earlier HEOR
No impact	33.33%	0.00%	33.33%	27.78%
Already do HEOR	66.67%	0.00%	33.33%	33.33%
More likely	0.00%	100.00%	33.33%	38.89%
IRA making innovation more or less challenging
More	80.00%	0.00%	86.36%	87.10%
Uncertain	20.00%	100.00%	13.64%	12.90%
Less	0.00%	0.00%	0.00%	0.00%

However, most expressed a “wait and see” approach to strategy changes given uncertainty in the law's implementation. As one respondent put it:

It feels like a lot of these regulatory boogeymen that have popped up in the past haven't really been born out. So the attitude, we generally err on the side of like, well, let's wait and see what actually gets implemented versus what everybody's talking about right in this moment.

When the IRA was first passed, many respondents said it was one of several factors considered for individual investments. A third (35%) could report a specific investment where the law was considered as part of the decision to invest or not. Although not all interviewees gave details on specific investments where the IRA was considered, those that provided examples consistently referred to decisions around companies focused on small molecules or small indications. Several investors, and all S&E interviewees, indicated that the IRA was more of a factor in how they structured an investment rather than whether or not they made that investment. In particular, these included both a shift to earlier milestones that would happen before any potential DPNP selection and the inclusion of IRA riders allowing for proportional reduction of royalty payments if drug was selected for the DPNP.

DPNP impact on specific investing strategies

Small molecules

Over three-fourths (77%) of respondents reported that the IRA had created a disincentive away from investing in small molecules. All but one investor was still investing in small molecule companies, but several mentioned that there was now a higher standard for investing there. As one interviewee summarized:

Bars are higher for small molecules and justification has to be deeper.

Many highlighted that this is building on a trend of preferential investment in biologics given that it is much harder to genericize biologics and therefore lose market exclusivity.

Specific investment strategies around small molecule drugs varied by investor stage and had often evolved over time. Early-stage investors were uniformly less reluctant around investing in small molecules than later stage investors investing in clinical stage companies closer to DPNP eligibility. Many respondents suggested that they had completely paused small molecule investing within their firm until the first round of MFPs came out, but they had since evolved their position. As one explained:

I would say in 2022 and early 2023, I was very reluctant to look at anything that was a small molecule focused company. I've softened on that since and I don't know if that's a smart thing though.

Therapeutic area choice

Very few (16%) interviewees reported that the incentives of the DPNP made them less likely to consider indications with heavily Medicare representation like oncology or neurodegeneration. In this context, the DPNP was framed as the cost of doing business, and the Medicare-eligible population was simply too large to ignore.

I think at the end of the day, almost every indication is going to have some form of government payment and CMS negotiating is just going to be part of the game that's played.

I feel like we actually skew more toward diseases that do affect the aging population just because the population is getting older and there are like well-defined diseases where you could drastically improve quality of life …that we feel like are very attractive because the market size is so large.

The focus of investors is often on pursuing the largest possible market. Given the high failure rate of drug development, commercially viable drugs in sizable populations, including Medicare populations with anticipated price reductions, remain attractive relative to alternative outcomes that include pre-clinical, clinical, or commercial failure. As one respondent succinctly framed it:

I think it's slightly disincentivizes you, but ultimately you always swing for the fences regardless.

The IRA's orphan drug exclusion was discussed with our interviewees. The current structure of the exclusion was not enough to mitigate the move away from smaller indications that might start the clock on DPNP selection sooner. A quarter of interviewees reported that they were less likely to invest in orphan indications since the law was passed. Only 10% reported that they were more likely to launch in orphan indications.

Indication sequencing

Investors reported the clearest signaling of IRA impacts in indication sequencing. All but one interviewee reported that they were now planning to launch with the largest potential indication and that they may wait longer to enter clinical development to have a better chance of success with a larger indication rather than start sooner with a smaller indication.

We definitely think about ensuring the biggest indications are the ones that are going to come online first or doing multiple simultaneous indications.

I think we definitely think about what is the largest patient population that we can address and how do we get …there as soon as soon as we can…I think it'd be harder to sell an opportunity that is starting in a small tumor type with… an accelerated approval, and then expanding then going to lung cancer, I think it's all about how do you find your largest indication and get there as expeditiously as possible.

Many also highlighted that this push for larger indications sooner makes it much more challenging for smaller biotechnology companies that now have to raise larger investments for larger clinical trial sizes:

Traditionally, what a biotech would do is on little dollars, invest in kind of the smaller indication cause you need to recruit less patients [because] effect sizes tend to be larger. And then pharma would buy you and then develop you in the big indication that takes a, you know, a thousand person clinical trial and the trials are a lot longer and more expensive. I think it's a lot less attractive to pharma. If, you know, the clock starts ticking too early.

Investors closely affiliated with manufacturers additionally try to increase market size at launch by running multiple trials simultaneously or by launching trials for subsequent indications closer to or in parallel with the launch indication. Eighty percent and 75% of CVC and S&E interviewees, respectively, said they were more likely to launch with more indications post-IRA. This was much less likely for traditional investors whose portfolio companies can typically only afford one large trial. Only 40% of traditional investors said they would be more likely to launch with multiple indications.

Discussion

Several past analyses on the potential impacts of the IRA have theorized potential impacts¹ or predicted the impact via modeling.^4,9-11 Despite uncertainties in IRA implementation, more direct methods are needed to assess its impact on investment strategy in the 2 years since the law's passage. The hypothesis-generating nature of questions about early investor responses, combined with limited literature directly engaging investors, suggests this topic is well suited for an interview-based approach.

Interviews provide early signals that the IRA is influencing investor strategy. Broadly, nearly all investors (90%) had discussed the potential impact of the IRA at their firm, and most (87%) reported that the IRA was making it more challenging to bring innovative new medicines to market.

We identified several specific changes in investor strategy. First, most investors reported that the IRA had disincentivized investing in small molecules. While they are still looking for opportunities to invest in small molecules, many hold them to a higher evidentiary standard. Next, most investors were not categorically avoiding Medicare-heavy indications. Rather, the truncation of market-based pricing has incentivized launching with larger indications and waiting longer to start clinical development.

Finally, investors have responded swiftly to the time frame of the “clock” towards DPNP eligibility, benchmarking a company's value mostly on the first indication of the lead asset rather than truncated follow-on indications. The push to launch with larger indications creates a need for companies to raise more capital since larger populations typically have smaller effect sizes.¹⁵ This matches observations of companies raising so-called mega-rounds to support larger trials.⁸ This shift also disincentivizes the development of drugs for medium or small indications. Both observations could be corroborated with further analysis of clinical trials and regulatory submissions before and after the IRA.

We believe our results are consistent with other research and industry observations on VC investments following the IRA's passage. While early evidence suggests the total amount of VC investment into therapeutics companies has corrected back to pre-pandemic levels after a significant increase in 2021,^8,16 industry reports have observed that this investment has gone into fewer investments of larger size.^17,18 A larger deal size may reflect shifts towards investing in larger initial indications, consistent with strategies discussed by our interviewees. Additionally, our finding that investors may be employing a higher standard for small molecule investing is consistent with analyses reporting a disproportionately greater slowdown in VC funding for small molecules.¹⁶

Our respondents at times communicated seemingly discordant perspectives, likely reflecting the risk and reward in venture capital and ongoing uncertainty around IRA implementation. On one hand, most respondents reported that the IRA is making innovation more challenging. At the same time, many framed IRA-related risks as a new cost of doing business, with continued intention to invest in Medicare-heavy indications they felt are too big to ignore. This is not surprising given the economics of the industry. VC is an industry built on outliers. Many funds will have most of their return come from one or two companies. Accordingly, investors need large returns from a few companies to recoup investments in the majority of companies which will fail to provide any returns. Our respondents seem to be balancing an ongoing need to identify companies with the potential for market success amidst IRA-related uncertainty, including the likelihood of selection and the extent to which the IRA will reduce net prices.

This study provides additional evidence on the IRA's impact but also has methodological limitations. First, interviews focus on stated rather than revealed preferences, the limitations of which are well documented.¹⁹ We attempted to mitigate this by asking for specific examples of decisions. Another potential limitation is the relatively small sample size. We worked to mitigate this by sampling from known groups of investor subtypes and by interviewing a larger sample than has been recommended for data saturation,²⁰ which we reached before finishing enrollment. Longitudinal research will further bolster hypothesis tests of IRA impacts given ongoing health policy dynamics including recent changes to orphan drug exemptions.

Our work raises questions which merit further study. First, investors discussed the IRA-related incentive towards larger populations for initial indications. It remains unclear how this IRA-related incentive will interplay with competing changes to clinical trial landscapes and incentives, including competitive pressures after a first-in-class drug gains FDA approval and begins its timeline towards DPNP eligibility as well as pre-IRA trends in more personalized medicine investments. Second, many interviewees suggested that they are very responsive to the signals from manufacturers who acquire smaller companies or public market investors that provide liquidity to early investors. Future investigation is warranted into how buy-side investors have adjusted their strategies or modified methods for company valuations. Next, the stated preferences summarized here should be followed up with observed transactions (eg, revealed preferences), though causality may still be challenged by other changes to the market access environment.²¹ Finally, given time constraints, we were not able to probe additional potential changes to investor strategies and prioritization, including the relative attractiveness of first-in-class versus follow-on drugs or personalized medicines.

The IRA introduced significant changes to the incentives of drug development. While prediction and simulation are valuable policy tools, directly engaging decision-makers improves understanding of how market incentives influence real-time investment choices. Our study addressed this through interviews, adding hypothesis-generating richness to the data that suggests promising areas for future investigation. Our results suggest that the IRA has both influenced investor strategies and directly impacted deal values, exit values, and/or companies raising capital. Specifically, investor strategies post-IRA have shifted towards larger initial launch indications—with Medicare-heavy indications remaining attractive—while disincentivizing small molecule investments.

As IRA implementation proceeds, it will be increasingly important to continue engaging these stakeholders and conduct empirical research to understand how drug development is changing.

Supplementary material

Supplementary material is available at Health Affairs Scholar online.

Funding

This research was supported by funding from the National Pharmaceutical Council.

Conflicts of interest

Please see ICMJE form(s) for author conflicts of interest. These have been provided as supplementary materials.

W.J.C. reports research funding for the present manuscript from the National Pharmaceutical Council, consulting fees from C2N Diagnostics, RebootRx, MARAbio, Bodyport Inc., and Eurofins/Transplant Genomics Inc. (all unrelated to this work) and stock options in Accipiter Biosciences which is unrelated to the current project. J.A.P. and J.D.C. are both employed by the National Pharmaceutical Council; neither reports any financial relationships, consulting fees, stock or stock options, or other relevant interests beyond this employment. All authors affirm that they have disclosed all potential conflicts of interest in compliance with ICMJE guidelines.