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No Easy Prescription to Lower U.S. Drug Prices

publication date: Nov 18, 2015
No Easy Prescription to Lower U.S. Drug Prices

…and why biotech investors should not be so worried

Turing Pharmaceuticals, in what has to be defined as a tone deaf move of outrageous behavior in light of the growing debate over high drug prices, raised the price of Daraprim, a drug used to treat infections commonly acquired by HIV patients, from about $13 a pill to over $750 a pill overnight.  This moved sparked outrage in social media and was the basis of a tweet by Presidential candidate Hillary Clinton who was just about to announce a “drug prices” proposal as part of her Presidential campaign.

Clinton tweeted, “

“The Tweet” caused a volatile selling event in biotech stocks.

Daraprim was approved in 1953!  So it’s pretty hard to defend whatever rationale Turing is coming up with to suggest this breakthrough-one of-a-kind-patent-protected type price.  Indeed CEO Martin Shkreli was portrayed in the media as a profiteering jerk.  In my opinion he earned every bit of it in terms of public relations responses.

In a joint letter to Turing, the Infectious Diseases Society of America and the HIV Medicine Association addressed the price move as “unjustifiable for a medically vulnerable patient population” and “unsustainable for the health care system.”  It is fair to say that the move by Turing is not really defensible even though it is “legal”.

Perhaps Turing got caught up in an easy money game being played when acquiring specialty drugs.  Antibiotic Doxycycline moved from $20 to $1800 a bottle.  The drug cyclserine, used in drug resistant TB, rocketed from $500 to $10,000.  Valeant is also a part of the price raising party hiking prices on heart medications it acquired from Marathon some 500%. 

All of these seemingly unwarranted (at least from an R&D argument) marketplace price spikes are now under congressional scrutiny.  In some sense the price gouging on old drugs will probably allow legislators to do something there without focusing much on new drugs.  But given the ability of congress to magically do nothing at the urging of special interest lobbyists even this “acquisition to price piracy pipeline” element of the debate may find no actual action.

Unfortunately drugs in these specialty market examples sometimes lack ready generic equivalents.  But help will be on the way for patients when drugs are not new.

Old drugs versus new branded drugs

Our concern with the issue is that it bleeds over into the branded drug market in a destructive way.  While this market has pricing issues of its own, the public is much more understanding when new drugs cost more.  Patient advocacy groups have seen much anticipated new treatments bomb in final leg of clinical trials and even understand the high costs of R&D with potential failure.  New and greater benefits can actually accrue great savings in the health care system by avoiding chronic care costs that lead to surgeries, transplants, amputations and death.

Still, as biotech investors it probably pays to watch this issue unfold as a potential to disrupt the profit potential of companies developing new drugs.  For example, portfolio stock Gilead (GILD) is also under some scrutiny for its high prices of Hepatitis C drugs.
Nature of Market complicates Pricing

When one looks at the issue of prescription drug prices there is both good news and bad news or patients and companies.  For patients there is a robust competitive generic drug market that dramatically lowers just about every drug that becomes generic.  A similar thing will begin happening in the biosimilar market for monoclonal antibodies due to provisions of “Obamacare”.  The cost saving or generics are roughly 80% of their branded name counterparts.  To the degree there is a success story in the prescription drug pricing world, the market for generics is it.

The branded market is another story and recent “gouging” examples notwithstanding, is typically at the center of the high drug cost issue.   Branded cancer drugs carrying a $100,000 treatment course price tag are not uncommon today.  The branded drugs are protected by patent and enjoy the sort of exclusivity and profits that inventions can bring to investors and to inventors. 

Not a consumer choice market

Of course drugs are different sort of inventions; much different from a fancy patent in TV displays or smartphones.   After all “needing” a drug that magically eases or cures a burden in patients is not really like “wanting” a fancy new smartphone.  And waiting for the drug to drop in price due to the robust generic competition market is not a feasible response, though some actually argue it is.  Patients don’t like the idea of extraordinary profits coning at their expense from a patented product they “need”.  At minimum they don’t like the idea of facing severe financial hardship to get what they need.  At the time of their consumer decision there is considerable focus on health over cost or inferior choices. 

Investors on the other hand like the idea of a blockbuster drug that creates substantial patient benefit and positive societal cost benefits… and yes profits.  It is an endeavor that should and does attract capital.  Personally, I think that a cure for heart disease or liver cancer should bring those that risk the capital and high rates of failure in pursuing such endeavors a profit commensurate with the achievement, marketability of discovery and risk.

Thus we get to the fundamental “problem”:

How much should a drug company be able to charge for a drug that has a captive customer demanding to use a product

The problem is actually more or less unique to health care industry that  doesn’t use the free market notion of people voting with their feet (i.e. non-captive consumer choice) when costs seem out of bounds.  But enough of the moral sophistry on consumer choice, neither the drug companies nor society wants to tell people to “wait until it’s generic”  before you can treat your Hepatitis C, cancer, Rheumatoid arthritis, debilitating pain or rare disease that just got a new drug in the treatment arsenal.

Some fundamental problems

Analyzing the issue we come to some basic problems in the way that drug prices are determined in an insurance driven world.  I’ll summarize 4 fundamental problems as, aside from not wanting to see companies make big profits in healthcare (a view shared by many), these 4 issues are central to the debate in our view.
  1. Price control is a potential disaster.
  2. Pricing is “unfair” to U.S. patients in particular
  3. Insurers are not really good price negotiators
  4. Some can negotiate price and others cannot shifting costs to those that cannot
Price control is a potential disaster

The impact of capping price (i.e. profits) is to drive away capital and innovation.  Not many would argue the point but it is worth highlighting.  If for example drug development were treated like a regulated utility model you can bet that safe targets with lots of potential customers would likely be the end result of “innovation”.  Why would you risk a long FDA process with potential failure on hundreds of millions of dollars when all you can do if successful is break even or a little better?  And any regime that allowed for the consideration of all failed drug development costs to be factored in would fare no better at lowering costs of successful drugs.  In fact such a system would encourage taking extraordinary risks in development.

It doesn’t take a whole lot of analysis to predict that a price/profit control regime spells trouble for patients as well as investors and society looking or new medicines.

Thankfully none of the proposals being floated by Hillary Clinton or Senator Sanders actually rise to true price control.  But each is fraught with plenty of impractical cost shifting nonetheless.

What is not really talked about in the “price control is bad” camp is that that price control is essentially what you have from Europe and Canada to some degree as their government programs negotiate the costs of drugs with the Pharma companies.  The result is even higher prices in the U.S.  But the bottom line argument that true price control would be bad (or simply politically impossible) is likely born out in the fact that most proposals stop short of proposing that in any real sense.

Pricing is “unfair” to U.S. patients in particular

One of the ideas that gets floated repeatedly is that U.S. patients should be able to import drugs from other countries.  I’m not talking here about some novel drug that has yet to be approved stateside.  The simple concept is to import an identical approved drug rom Canada or Europe that for whatever reason is much cheaper than it is in the U.S. 

In the U.S. the largest system Medicare cannot negotiate drug prices.  What this means in practice is that the non-negotiated markets like Medicare Advantage simply pay more and subsidize markets with the lower prices.

Cost of Imatinib (Gleevec) in selected markets 2013

When looking at the large disparity in drug prices it’s hard to imagine U.S. taxpayers will not eventually get agitated enough to demand something be done to correct serious “unfair” imbalances.  After all it’s not like the UK and Germany are third world countries needing a big discount for humanitarian considerations. 

It is worth noting also however that the prices in this specific graph for Gleevec are likely to come down about 80% when Gleevec becomes broadly generic in 2016.

Healthcare Costs will cripple government funded reimbursement programs

With some sense of national debt survival, it makes sense for there to be a level playing field for bringing U.S. costs down.  Balancing the playing field on negotiated versus non negotiated markets makes some sense.  Whether that would result in lower costs for the U.S. and higher costs elsewhere currently negotiated is debatable but logical.  Unless there is some rationalization of these discrepancies, the U.S. citizen/taxpayer/patient is going to eventually demand price control legislation or drug imports allowing them to shop around for a better price.

As biotech investors we don’t like the talk of profiteering and holdup but will not defend it either.  But new lifesaving drugs are probably not the real problem.  Gleevec has probably added so many survival years to the patient community that it’s hardly the drug to take aim at.  For CML patients the drug has been a near miracle of lifesaving.  And it’s about to become generic also bringing that patient life year improvement to the market in a permanently cheaper way. 

What free market?

Cries of let the “free market handle it!” as pure in principle as they may be, are not really a solution in drug prices either.  This is primarily because it does not operate as a free market in consumer behavior, pockets of price regulation, reliance on insurance/formularies and monopoly power.  In drug pricing, myriad non free market forces are at play.  That is to say the model looks nothing much like a supply/demand commodity market (until there is a shortage of a drug of course).

Some actors that distort free market principles are:
  • Customers don’t vote but demand access.
  • Patents confer monopoly pricing for an extended period.
  • Some markets negotiate on National Health Care plans and others do not
  • There is no actual cost benefit formulation in drug pricing although the in formulating prices companies takes savings and avoided system costs into account.
The lack of true supply/demand dynamics creates a problem at the start.

Insurers are not really good price negotiators

The drug price negotiation in the U.S. is very different than in Europe with governments negotiating price.  Basically the insurers non-collectively negotiate the price in the U.S.   But U.S. insurers have little incentive to lose customers because they refuse to carry new pricy drugs.  A combination of bad publicity and lost customers would result.  So in the end the U.S. insurers just don’t negotiate anywhere close to what the governmental agencies outside the U.S. get away with.

The bad deal that the insures gets carries through to other U.S. systems like Medicaid and the VA as these programs use some formulas that begin with poorly negotiated prices.

Some can negotiate price and others cannot shifting costs to those that cannot

We pretty much highlighted this end result with the explanations in the prior issues.  High costs of prescription drugs are shifted to those without insurance and those in Medicare insurance coverage plans.  Better rates are obtained in negotiated areas. 

The U.S. patient pool basically subsidizes the cost of drugs in other parts of the world which is the dirty little secret that should concern the industry overall.

The bottom line is until there is rethinking on how prices are arrived in various markets, the U.S. will always be carrying the burden for other nations.  And Medicare Advantage will also carry the burden for other insurance markets as a pace setter to some degree. 

We Need High Prices for R&D
The issue that companies spout is that they need to pay for research and development.  They do especially as you include acquisition of innovative small drug developers in biotech.  But biopharma companies spend quite a bit more on advertising and marketing in reality. 

Part of the reason for this is they need to get all the customers as quickly as they can before generic competition.  It is a beat the clock game. 
Proposals to eliminate tax breaks for marketing are part of the Clinton proposal but are unlikely to have desired impacts as getting the patient number high “pre-generic competition” is crucial.  Imagine what the branded price would be with only 60% of the current penetration before generics come on board?

Politics says….

In reality everything short of price limiting is messing around the edges and requires political moves unlikely to occur.  Still some balance between overall fairness of negotiated prices needs to be on the table or it is unlikely this problem will go away or U.S. patients.  It is also a real issue that will impact national budgets and cut across party lines.

On the other hand calls or fixing the system short of true price control regimes are probably less of a concern for investors than the market would have you believe.  In our estimation most of the solution is likely to come in the form of balance shifting in new drug markets.  Attempts to streamline the regulatory approval process can also assist in the long run.

…so what will be done about the problem?

Eventually there will be reckoning in the U.S.  However that day does not appear close in branded drugs.

Quite simply the solution involves onerous attempts at government price controls, cost based approvals in Medicare reimbursement (not currently acceptable), price negotiation in Medicare part D (not legal) etc.  Getting around these legislative hurdles with big Pharma and “death panel” lobbying is just unlikely if not dead on arrival.

There are some rational ideas to speed the approval process, make reasonable considerations on how extraordinary marketing dollars are treated, providing some patient safeguards to prevent financial ruin especially in chronic conditions, and incorporate types of catastrophic coverage to account or extremely expensive new drugs.  The latter of these ideas is likely the simplest solution closest to a free market approach with lower system-wide or unintended consequences.
But the fundamental reality is that in the two tiered system (generic versus branded) there is a short time for grabbing high profits which exacerbates the pricing.  Calls to shorten the time to generic status of new drugs would only make prices rise in the pre-generic period.


Gilead is one of our portfolio stocks and is in the middle of the pricing debate.  Gilead has taken a lot of heat over prices for its Hepatitis C drugs.   With the ability to cure the condition in 80% to 90% of patients Gilead is armed with all sorts of system avoidance costs.  Costs to treat Hep C consequences like chronic pain, hospitalization, liver cancer and liver transplants are all considerations.  That is, their drugs are a big deal and demand a good profit. 

But with a patient population as large as Hep C are they also greedy?  It’s a good question and the answer is probably a qualified yes given the dramatic system savings in liver transplants the company can point to in its pricing analysis.  Savings aside, assuming companies in the drug product development space cannot have a profit/greed incentive like Apple can in the consumer product space is fraught with a lot of long term problems likely to diminish the quality of drug development and patient outcome long term.  And providing a utility model to those profits is likely to either bring in lots of failed development accounting or push specialty and rare disease research to the dustbin of history or university/government research.

Acquisition Gouging is in the crosshairs

The overall issue of high drug prices is a real dilemma for policy makers and eventually the taxpayer and patient community.  But right now the political will to campaign on the issue is probably a lot greater than the political ability to really change things very much in the branded drug arena.  

The situation in the “old drug” arena where companies are simply acquiring drugs then pushing through eye popping (or is it eye gouging?) price increases is another matter.  In fact a Senate panel has no taken up that specific portion of this overall debate.

“Some of the recent actions we’ve seen in the pharmaceutical industry—with corporate acquisitions followed by dramatic increases in the prices of pre-existing drugs—have looked like little more than price gouging,” said McCaskill, former Missouri State Auditor and courtroom prosecutor. “We need to get to the bottom of why we’re seeing huge spikes in drug prices that seemingly have no relationship to research and development costs. I’m proud to help lead this bipartisan investigation so that we can find some answers the public wants and deserves.”

Branded drugs are just too tough a nut to crack right now.  And in a real sense generics and a combination of catastrophic coverage can probably go a long way to solution already.  But the Turing-type price gouging incidents might give politicians and the media something to carry away as a victory pelt in patient advocacy. 
The problem with the Hillary Clinton Plan…the balloon effect

In simple terms the drug companies will need to secure profit and growth rates to satisfy investors.  Thus any attempt to push on one end of the price control balloon has the impact of inflating the other end.  This is known as the balloon effect.

As described in Wikipedia
changes made in one area of a business lead to unforeseen and adverse effects in other parts of a business.

Unless you have an actual regime that restricts pricing (profit) the balloon effect is basically what occurs in practice.  In fact it’s one of the reasons we have price distortion today to the degree we do between negotiated and non-negotiated markets.
By way of example let’s look at the 5 basic principles of the Clinton plan for the obvious balloon effect response.
  1. Eliminate the ability of drug companies to treat direct-to-consumer advertising as a tax-deductible business expense, as other companies can.
That’s fine, but if you increase expenses (i.e. remove tax treatment on expenses) I either have to charge more to make the bottom line or… (there is no or)
  1. Shorten the patent life of innovative drugs.
If I have to gain all the profits of monopoly (patent-branded) price in 5 versus 7 years, I can predict a general branded drug price rise of roughly a 7/5 (40%).
  1. Prevent insurance companies from passing more than $250 of drug spending to consumers in the form of out-of-pocket costs.
I got a car insurance plan to sell you.  So… you think the $750 deductible, the $250 deductible or the $0 deductible plan is costliest for me to insure? It’s a no-brainer of course.

So who is going to then eat these higher insurance costs?  As Medicare Advantage is a prime market price setter, look for increased premiums there and to employer plans.  Capping catastrophic costs can be done but doing it globally in this way is counterproductive via the balloon effect.
  1. Allow the U.S. to import drugs from other countries where price controls are in place.
This one would at least bring some balance to the current “stick to the U.S. patients” status quo system.  It is likely that ex-U.S. costs would increase however bringing only marginal benefit to the U.S. and marginal detriment abroad. “The balloon effect”
  1. Allow Medicare to negotiate prescription drug prices.
This proposal specifically is likely the politically dead on arrival proposal.  It is worth noting that government negotiation was not only proposed (and killed) in Medicare Advantage but prohibited.  The proponents of the status quo argue and lobby hard for keeping Medicare Part D as an amalgam of private insurance rates.  The trouble is the arguments fall apart as in general U.S. patients pay so much more than negotiated actors in Europe or in Veterans and Medicaid programs.

Time for biopharma to take the issue seriously

What biopharma has to realize is that when the U.S. taxpayer begins delivering a lot of the profits to the bottom line by way of tax supported programs like Advantage, some degree of reasonableness is probably in order to ensure that the method used to secure innovation, research and profits is not disproportionately borne on the backs of U.S. citizens and patients. 

While we fundamentally believe the industry has a pretty strong grip on politicians in general, ignoring the large discrepancies paid by U.S. versus foreign consumers for the exact same drugs is something the biopharma industry does at its long term peril.  After all in the current Presidential sweepstakes there is a likely candidate on the Democratic side proposing taking action while the poll leader on the GOP side declares the U.S. negotiates “like chumps” for its Medicare Advantage prices and everything else for that matter. Long term something has to give or the issue will move from simply attacking gouging to one of popular support for price control over time.