Regulation and Innovation
Ian McCarthy | Emory University
Innovation
What is innovation?
How would you define “innovation” in pharma?
- Should not just mean a new drug, but a new drug that is better than existing treatments
- Not clear this is always the argument made in the media
What governs innovation?
- Strong empirical evidence that firms internalize future profits of a drug when making R&D decisions
- Investment decision can be modeled as:
- Ranking of expected returns to potential new drugs, including costs of manufacturing, packaging, marketing, and distribution. This is the Marginal Efficiency of Investment (MEI)
- Comparison of MEI to cost of capital
- Investment in the drugs to the point where MEI=cost of capital
How to influence innovation?
- If firms are maximizing profits, then the only way to influence innovation is to change the MEI or the cost of capital
- Shift MEI outward via:
- Changing marketing regulations (DTC advertising)
- Increasing demand for a drug (market exclusivity, coverage under public insurance)
- Shift cost of capital down via:
- Easier access to funding (tax credits, grants, etc.)
How to influence innovation?
- Which approach is “best”?
- Politically, these are NOT identical policies
- Pull incentives require no up-front costs
- Pull incentives tend to place R&D burden onto pharma customers
- Push incentives require up-front government investment
- Push incentives place burden on taxpayers
Regulation
Key areas of regulation in this market
- Price regulation (reference pricing, direct price caps, etc.)
- In general, lower prices discourages innovation by shifting MEI inward
- How much? Some estimates of price elasticity of R&D at 0.6
- 10% price cut reduces R&D by 6%
- But what innovations are “lost”? Hard to say
Paper Discussion 1
The High Cost of Prescription Drugs in the United States: Origins and Prospects for Reform
1. High Spending
- Higher spending in the U.S. compared to peer countries
- Faster spending growth in the U.S. compared to peer countries
But…
- Spending on even very high cost drugs can still be cost-effective
- Sovaldi (hepatitis C) found to be cost-effective despite $84,000 per 12-week course
Research Questions
- What factors seem to contribute to pharma price increases?
- What policies can help ensure prices match value and that drugs are available in an equitable way?
Brand name vs generic
- Annual cost of highly specialized brand name drugs exceeds $250,000 per patient!
- High brand-name prices now extend to drugs with some substitutes (not just rare conditions)
- Generic drugs generally lower priced, but some examples of high price increases
- Daraprim, 63-year old treatment for toxoplasmosis, increases 5500% (from $13.50 to $750) in 2015
- A few hundred generic drugs experienced price increases of more than 1000% from 2008 to 2015
- Why? Monopoly products, despite no patent protection
Why such high prices?
- Prices set by manufacturers, PBMs, insurers, and pharmacies
- Little direct price regulation
- Conversely, the UK specifically requires cost-effectiveness thresholds before allowing coverage
Competition
- Patent protection usually lasts around 20 years (starts before drug is officially approved)
- Companies can apply for extended patent protection for 5 years (max of 14 years in the market)
- Additional 6 months if testing products in children
- On average, 12.5 years of post-market exclusivity for widely used drugs and 14.5 years for highly innovative drugs (first-in-class)
Limited competition even for brand name drugs with some substitutes. Why?
- Fragmentation
- Information problems
- Physician agency
Firms can also deter generic entry, via:
- Additional patents on coating, method of administration, etc.
- Example: Nexium is derivative of Prilosec (omeprazole), sold for 600% markup over generic omeprazole
- Significant settlements to generic drug companies
- Delays in approval for generic drugs (FDA delays of 3-4 years, now closer to 1-2 years)
Barriers to substituting brand name drugs with generic drugs even after generic entry:
- Drug product selection laws in 30 states that allow but do not require pharmacists to substitute generics
- 26 states that require patient consent when replacing brand name with generic drugs
- All states allow “dispense-as-written”, which restricts pharmacists’ ability to substitute brand name drugs
Other barriers to competition in among generics and brand name:
- PBMs often paid based on insurer spending on specific drugs, therefore little incentive to intensely negotiate prices
- From US House Committee on Oversight and Government reform:
“The investigation revealed, for example, that Turing received ‘no pushback from payors’ when it increased ‘Chenodal price 5x… [Thiola] price 21x… [and Daraprim] price 43x.’
Justification for high prices
Industry argument that significant R&D costs necessitate higher prices
But…
- Half of the “most transformative drugs” developed (or started) in academic centers
- Many drugs also started in small companies later acquired by larger manufacturer
- “Innovation” means more than just another drug
- Current price growth simply not sustainable
What can we do?
Federal Policies:
- Limit secondary patents for minor changes
- Combat anticompetitive practices like pay-for-delay
- Allow negotiation of prices and formulary exclusions by Medicare
- Faster time to market for generics
State Policies:
- Drug product selection laws
- Allow negotiation of prices and formulary exclusions by Medicaid
Paper Discussion 2
US Subsidizing ROW
- US clearly pays higher prices than other countries
- Strong evidence that US contribution to profit for future innovation is higher than it should be
- That said, the ROW contribution is meaningful (all other countries do not force prices to marginal costs)
- Authors urge a more international view of spending, suggesting better policy is to advocate for higher prices elsewhere rather than directly for lower prices in the US