The $3 Billion Incentive: How IRA Redesign Fuels Misaligned Drug Spending

The central investor question is not whether drug spending is rising, but why it is rising so unevenly. The $3 billion in extra Part D spending is a symptom of a misaligned incentive system, not a cyclical blip. The divergence between low-income (LI) and non-low-income (NLI) populations reveals a structural shift in how benefits are used, with profound implications for plan economics.

The data shows a stark and growing gap. Total gross drug costs PMPM rose 16% in the first half of 2025, but this aggregate figure masks a fundamental split. The NLI population drove the surge, with costs climbing 27% between 1H2024 and 1H2025, more than double the 11% increase for the LI population over the same period. This divergence is the core story. It points to a behavioral change, not a broad-based medical trend, and is strongly linked to the IRA benefit redesign that altered cost-sharing for higher-income beneficiaries.

This shift is most acute in specialty drugs, where the cost gap between populations is narrowing. In early 2024, LI specialty costs were 2.6 times greater than those of NLI members. By mid-2025, that ratio had fallen to 1.8 times. The reason is clear: NLI specialty trends have outpaced LI trends, with NLI specialty costs increasing by 18% between Q1 and Q2 2025 compared to a 7% rise for LI. This convergence signals that the NLI population is now driving the highest-cost utilization, a new dynamic for the Part D market.

The concentration in specific drug classes underscores the structural nature of this spending. Several therapeutic areas are seeing gross cost PMPM trends exceeding 50%, with Atopic Dermatitis Biologics leading at 100%. This isn't random; it's a predictable response to benefit changes. When cost-sharing is lower, utilization for expensive, non-essential treatments rises. The sustainability of this pattern is questionable. It relies on continued behavioral response to the current benefit design, which could be altered by future policy or plan design changes. For now, however, the system is funneling billions into high-cost classes, creating a new, higher-cost baseline for NLI populations that threatens the actuarial balance of Part D plans.

The PBM and Plan Incentive Trap: Financial Disconnects

The Medicare Part D payment structure creates a powerful financial disconnect between gross drug costs and net plan liability, a dynamic that incentivizes plans and PBMs to favor high-priced drugs with lucrative rebates. The math is stark. From 2014 to 2016, gross expenditures grew 20% to $145.1 billion, but rebates and other price concessions increased 66% to $29 billion. This means net expenditures, the actual cost to the plan after rebates, rose only 13%. The system funnels the bulk of these rebates directly to reduce plan liability, effectively shifting the financial burden of high drug prices onto beneficiaries and the federal government.

This creates a perverse incentive. Plans are motivated to select drugs that command high rebates, even if they have high list prices. The reason is structural: the catastrophic phase of the Part D benefit, where Medicare liability is capped at around 80%, is the primary destination for this spend. High-priced drugs, paired with high rebates, accelerate beneficiaries through the initial coverage and coverage gap phases, pushing more of the total drug spend into the catastrophic phase where plan risk is lowest. In this phase, Part D plans are responsible for only 15 percent of costs. The system rewards plans for managing spend in a way that minimizes their own exposure, regardless of the total program cost.

The disconnect is most visible in premiums. Despite a 16% gross cost PMPM growth in recent years, the average monthly premium for stand-alone PDPs is projected to be $45 in 2025, a modest increase from $42. This minimal premium growth is a direct result of the rebate system. PBMs, who manage the vast majority of Part D drug benefits, earn revenue primarily from fees and by passing through the vast majority of rebates to plans. The system allows plans to control premiums for beneficiaries while absorbing the financial risk of high drug costs in a way that is structurally advantageous to them.

The bottom line is a misaligned incentive system. The Part D structure amplifies spending by rewarding plans for shifting costs into the catastrophic phase, where their liability is minimal. This creates a financial trap where gross costs can surge, but net plan liability and premiums remain relatively stable. The burden, however, is not borne by the plans. It is passed through to beneficiaries in the form of higher cost-sharing at the pharmacy counter and to the federal government through increased subsidies for low-income enrollees. The system is efficient for plan sponsors but creates a significant and growing disconnect between the true cost of drugs and the financial risk they are designed to manage.

The Risk Spine: Funding, Reimbursement, and Policy Uncertainty

The structural growth story for Medicare Part D is built on a foundation of rising drug costs, but that foundation is cracking under the weight of a widening actuarial gap. The core of the problem is a mismatch between the model used to fund the program and the reality of where costs are rising. The 2025 RxHCC model is calibrated using lagged Part D claim data from CY2022, a baseline that predates the Inflation Reduction Act's benefit redesign. That redesign has created a stark divergence: while total year-over-year allowed PMPM trend for NLI members is more than two times the LI trend, the funding model assumes a more stable relationship between these populations. This creates a fundamental mispricing risk, where plans are effectively bidding on a 2022 cost structure for a 2025 reality, threatening their financial viability.

The mispricing is amplified by the mechanics of the Part D payment system. The program relies on a complex web of post-point-of-sale compensation, known as Direct and Indirect Remuneration (DIR). While these rebates and concessions can lower a plan's net liability, they have a perverse effect on the program's economics. They shift more of the drug spend into the catastrophic phase, where Part D plans are responsible for only 15 percent of costs. This shrinks plan liability, which in turn caps premium growth. The result is a system where Medicare's costs for these beneficiaries also grow as beneficiary cost-sharing increases, but the program's subsidy burden is rising while plan financial responsibility is shrinking. The widening gap between NLI and LI costs threatens to overwhelm this delicate actuarial balance.

The final layer of risk is political. The entire system is under increasing scrutiny, with both administrations targeting the powerful Pharmacy Benefit Managers (PBMs) that control these flows. The Trump administration has directed a reevaluation of PBM practices, while the Biden administration's Inflation Reduction Act has already authorized Medicare to negotiate drug prices. This creates a high-stakes policy uncertainty. Any major legislative or regulatory intervention aimed at capping rebates, changing how DIR is allocated, or altering the benefit design itself would directly attack the profit margins of plans and PBMs. The recent House GOP legislation, for example, includes provisions targeting PBM practices that could have a "relatively modest impact on the federal deficit," but the real cost would be to the operational model of managing Part D. The bottom line is that the current model is a high-wire act, sustained by a lagging funding model, distorted by DIR mechanics, and vulnerable to a policy shift that could rewrite the rules overnight.