In the May 2016 issue of Health Affairs, Amy Kapezynski and Aaron Kesselheim propose that the federal government invoke its patent use authority under Section 1498 to lower drug prices and increase access for breakthrough medicines in government-funded health care programs. Section 1498 allows the government eminent domain-type powers to circumvent an inventor’s patent exclusivity rights in exchange for “reasonable and entire compensation” — in effect a royalty on sales which would be determined through negotiation or by the courts.
To date, application of Section 1498 has been limited to selective military and national security related purchases. Kapezynski and Kesselheim advocate expanding its use to force down prices in health care programs like Medicare, Medicaid, and the Veterans Administration (VA), “where there is a large disconnect between risk-adjusted cost of research and development (R&D) and the price commanded by a breakthrough drug product.”
Kapezynski and Kesselheim assert that Section 1498 can be administered in such a way as to achieve significant drug cost savings to payers and patients without any adverse consequences for R&D incentives and drug innovation. However, the devil is in the details, and it is fanciful to believe this would be the case.
An Eminent Domain Policy Will Discourage R&D and Innovation
Kapezynski and Kesselheim suggest a patent holder could be given a reasonable royalty on sales to provide a return on its R&D investment, commensurate with its risk-adjusted cost of capital, so as to avoid disincentives to R&D. However, a royalty determined after a breakthrough product is developed and approved for marketing would subject the patent holder to the hold-up problem and other likely downward biases in the level of compensation received. Underinvestment occurs in this situation because of investor concerns that the government could “hold them up” and extract most of the product’s value, once R&D expenditures are committed and become sunk costs.
Expropriating patent rights in this way also raises many other questions and issues for policymakers. For example, who will determine objectively which products are subject to Section 1498 administration and which are not? By what metric can a reasonable royalty on sales be computed before a market even evolves, with subsequent new entrants competing on quality and price? And, to what unintended consequences will Section 1498 administration give rise as firms engage in strategic behavior to increase their royalties?
Even if these problematic issues can be addressed, the reasonable royalty approach outlined by Kapezynski and Kesselheim would still have highly disruptive consequences for future drug innovation. The pharmaceutical R&D process is long and costly, with highly variable and uncertain outcomes. Scholarly studies find that returns on R&D for new drug product introductions are characterized by a skewed distribution — one with long tails in which a few entities account for a disproportionate amount of the sales and profits.
The top ranked 10 percent of new drugs generally account for more than half of all the sales and profits of the introductions in particular periods. Furthermore, the majority of new drug introductions do not cover the average cost of R&D, when one also takes account of the high risks of failure and the lengthy times associated with the biopharmaceutical R&D process. Companies are therefore dependent on the high returns from a few successfully marketed products to sustain the R&D process.
The Kapezynski and Kesselheim proposal would result in particularly adverse consequences for R&D funding for early-stage R&D startup firms. Over the past three decades, hundreds of startup firms, typically backed by venture capital funding, have been launched in the biopharmaceutical industry. A robust market for innovation has emerged. Patents play an essential role for early-stage funding of new technologies in this economic ecosystem of boutique research firms, where many of the key breakthrough drugs have originated.
The prospect that the government would use Section 1498 to countermand the patent rights of important new drug discoveries would severely limit biopharmaceutical R&D funding opportunities by venture capital firms who target high-risk, high-reward projects and depend on few big winners to compensate for many projects that lose money. Venture capital firms do not restrict their activities to investments in new drugs and technologies, but also invest in competing opportunities (such as web-based internet applications, advanced scientific investments, improved energy sources, etc.) that would not be subject to uncertain compensation based on negotiating or litigating a reasonable royalty with the federal government.
Under Section 1498 patent expropriation, if a company or venture firm makes large bets on potential breakthrough new drugs and loses, it would bear all the losses, whereas if it succeeds, the government would appropriate much of the expected returns. The billions that were lost by the industry in the last development round of Alzheimer’s Disease drug candidates a few years ago are illustrative of how widespread losses can be. Many research-intensive biotechnology companies completely disappear when their investments in new technologies and products fail to pan out in clinical trial testing.
A recent analysis by Berndt and colleagues found that industry returns on R&D declined in the first decade of the 21st century, and a negative value was observed for the most recent cohort they analyzed, spanning the years 2005 to 2009. They also observed high variability across products and over time in R&D returns. Consequently, it is not unusual for both young and mature drug companies to experience significant ups and downs in their earned profits levels, driven by R&D project successes and failures.
Economic Analyses also Points toward Adverse Impact on R&D
The Kapezynski and Kesselheim proposal has similarities to a provision in the Clinton Administration’s Health Care Reform Plan that would have established an Advisory Council on Breakthrough Drugs to monitor their prices and potentially subject them to government price regulation. In a simulation analysis motivated by that proposal, John Vernon and I examined how industry profitability from R&D would be affected if the top decile of sales-ranked drug products were constrained to a risk-adjusted rate of return, whereas other drugs were left unregulated. We found this would cause a decline in realized revenues of more than 30 percent and would result in average revenues per new drug introduction being less than average R&D costs.
F.M. Scherer, an eminent scholar in the economics of innovation, concurred that regulation designed to control the prices and profits of breakthrough drugs with large unit sales, without concern for the many not-so-profitable entities, is a particularly perverse type of regulation for biopharmaceutical R&D incentives. In a parallel analysis to the one undertaken by John Vernon and myself, he also investigated the effects of subjecting pharmaceutical firms to public utility style regulation, in which prices and profits are set to produce a targeted return on a company’s total R&D investment. He also found this type of price regulation would lower overall expected R&D returns and would have particularly negative effects on smaller firms with fewer drug candidates under development, as opposed to larger firms that can balance R&D project successes and failures.
An earlier policy of the U.S. government designed to promote fair drug prices is instructive in the current context. In the 1990s, the National Institutes of Health (NIH) adopted reasonable or fair pricing clauses in its Cooperative Research and Development Agreements (CRADAs) between NIH intramural labs and industry development partners. The fact that NIH could invoke these fair pricing clauses many years after the R&D investment by its industrial partners created substantial uncertainty about the value of any resulting intellectual property rights.
Following public hearings in 1995, Harold Varmus, then-director of NIH, determined the clause should be removed, finding that “the pricing clause has driven industry away from potentially beneficial scientific collaborations with (NIH) scientists without providing an offsetting benefit to the public.” A Congressional Research Service analysis found the “effect of abandoning the clause was immediate. Subsequent to rescission of the clause in April 1995, the number of CRADAs executed by NIH increased substantially.”
Sovaldi and the New Anti-viral Drug Therapies to Treat Hepatitis C
Kapezynski and Kesselheim specifically point to Sovaldi and the class of powerful new anti-viral agents to treat hepatitis C as expensive drug therapies where application of Section 1498 could yield significant public health benefits. They indicate that several state Medicaid agencies have constrained use of these drugs to the most severe hepatitis C cases and imposed other restrictions on their use, in part to moderate impacts on the Medicaid drug budget.
At the same time, recent publications by Chhatwel and colleagues and Najafzadeh and colleagues indicate that Sovaldi is a highly cost-effective medicine for its approved indications for hepatitis C patients. This reflects the expected benefits associated with reductions in liver cancer cases and liver transplant patients from its use.
Sovaldi was launched in December 2013 at an initial price of $84,000 for a 12-week course of treatment. The price to Medicaid is lower since it is entitled to a mandatory rebate of at least 23.1 percent, or the best price offered to any purchaser. Furthermore, as new competitive entrants entered the market in 2014, the level of rebates significantly increased.
In particular, Gilead has indicated that after Viekira Pak and Harvoni entered in 2014, average rebates to Medicaid and the VA increased to more than 50 percent on Sovaldi and Harvoni gross sales. This price competition helps to moderate the initial budget impacts on Medicaid and other government programs and make the cost effectiveness of these drugs more compelling. Several states also have negotiated supplementary rebates as a criterion for a manufacturer’s products being listed on the state’s formulary of preferred drugs.
While it can be challenging for government programs such as Medicaid to fund breakthrough drugs for large patient populations, a number of policies can be employed to encourage their more optimal utilization without curtailing the inventors’ patent rights and discouraging future R&D investments. These include contracting deals that would spread the costs over longer time horizons, as well as value-based pricing contracts that provide higher future discounts if the drug does not achieve benefit expectations.
A more integrated approach to health care budgets that considers drug and other health care expenditures together, rather than as separate “silos,” could result in increased utilization of the most cost-effective medical therapies. A program of directed subsidies earmarked to infectious diseases like hepatitis C from federal and state funds also could be justified, given the contagious nature of this disease.
Given that the FDA and Congress are currently focusing on policies to increase the availability of breakthrough drugs, it would be counterproductive to adopt the policy approach advocated by Kapezynski and Kesselheim. Many economic studies have confirmed the central role that new drug innovations have played in increased longevity, enhanced quality of life, and improved labor force participation and productivity.
For example, Cutler and McClellan concluded that the benefits patients derive from access to new medications are far greater than their costs in the major disease areas they examined. Murphy and Topel found the societal benefits from the increases in U.S. longevity experienced between 1970 and 2000 were enormous, adding about $3.2 trillion per year to national wealth. Other studies show that new drugs have played a large contributing role to medical progress in several high burden disease areas like AIDS, with a large share of the benefits occurring to patients.
This underscores the importance of maintaining strong incentives for R&D investment in the search for innovative new drug therapies. One can lower the current price of breakthrough drugs by adopting an eminent domain policy and annexing the patents of drug inventors as proposed by Kapezynski and Kesselheim, but there will be a large expected cost for future patient populations with respect to the availability of new drug innovations.
from Health Affairs BlogHealth Affairs Blog http://ift.tt/28Jxpf1
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