It looks like regulators are once again trying to solve a problem caused by overregulation with more regulation. The news does not look good for drug companies anywhere from privately funded startups all the way to Big Pharma.
FierceBiotech reported last week that FDA commissioner Dr. Scott Gottlieb is sick and tired of rising drug rebates to benefits managers that pharmaceutical companies use to inflate their list prices. He suggested that rebates be considered kickbacks and therefore be illegal. Since insurance deductibles are based on list prices rather than the discounted prices paid by benefits managers, the strategy enables drug companies to take more from the end consumer while increasing demand for drugs through rebates from the benefit manager middlemen.
At first sniff the strategy smells bad, and it seems justified that Gottlieb would want to have it considered a kickback. Doing so would force drug companies to lower their list prices, meaning patients would pay less, and problem solved, right?
Except for the fact that outlawing rebates would not affect in the slightest the rising costs of drug development. In the end, pharmaceutical companies would make less on the drugs they sell, which will discourage future drug development by big companies and bankrupt the smaller ones that still haven’t recouped their losses. Not to mention the damage to benefits managers like Express Scripts (ESRX, Financial).
But the rebate/list price discrepancy is not really the point. It’s nothing but a financial engineering smokescreen. Any given financial engineering scheme is designed to navigate the regulatory framework in which an industry exists. The current framework is conducive to a high rebate/list price discrepancy, but it really doesn’t matter what the scheme is or how it works. In the end, drug companies both big and small need to be reasonably assured that they can make their money back in whatever way and profit on a given project before they proceed. Whether they make their money through inflated list prices that are rebated, or just straight out high prices across the board, makes no practical difference.
A case in point happening now on the pricing front is Vertex (VRTX, Financial), which specializes in one of the most expensive drug niches in the world, cystic fibrosis. And this case is not even directly related to the rebate controversy, but illustrates the point of pressure coming from different directions. Despite the sky-high list price for Vertex’s suite of CF drugs including Kalydeco, Orkambi and Symdeko at nearly $300,000 a year for each, the company is still $4.9 billion in the hole.
Yes, Vertex is finally profitable after a prohibitively long and expensive development process, but now a think tank called the Institute for Clinical and Economic Review (ICER) is insisting that the prices of these drugs be reduced by more than 75%. This is in order to “bring the prices into alignment with their clinical value to patients,” in the words of ICER’s chief science officer.
But clinical value to patients cannot be measured in dollars, but only through action. If patients buy the drug, then it is obviously of clinical value to them, and who is ICER to say otherwise? Its chief science officer does not suffer from CF.
One could argue that a reduction of 75% would make the drugs more affordable, and perhaps it would in the short run, but not in the long run. In the long run, it would shatter development efforts for next-generation CF drugs and hurt patients.
Such a forced massive price reduction would be an existential danger to Vertex. It would cut its top line by 75% without denting its expenses at all and easily knock the company down to being unprofitable again. The deeper question is this: Had investors known from the beginning that Vertex’s drugs would be forced to take a 75% haircut on pricing, would they have invested in the first place? The answer is almost certainly no. These drugs would never exist, and therefore the next big CF breakthrough in a private lab will probably not be picked up and financed through approval, knowing the risks have effectively quadrupled.
If ICER wants a 75% reduction in Vertex’s CF suite, fine. If Dr. Gottlieb of the FDA wants to consider rebates kickbacks, that’s fine, too. That’s not the problem. Find a way to cut drug development costs by the same percentage, and that would enable drug companies to cut prices by the same on future drugs going forward without endangering the flow of future research and development.
There is one quick and easy way to accomplish this. The vast majority of drug development costs are in late stage efficacy testing. Safety testing is relatively short and cheap by comparison. If late phase II and phase III trials are eliminated from regulatory requirements and the FDA is limited to testing safety alone, that would greatly shorten the time to approval and the chances of approval for all drugs. Efficacy could be tested in the market itself, and if a drug proves efficacious, then private insurance companies could decide to cover it through their own market-oriented efficacy requirements. Ultimately, efficacious drugs would be cheaper for patients and win out in the market over duds that would never be covered.
Disclosure: No positions.
