Last week, several major drug makers marked the new year by announcing annual increases on list prices. In addition to drug maker Allergan—which pledged last year to confine price increases below 10 percent and, true to its word, reported 2018 price increases of 9.5 percent—several other companies also stuck to single-digit increases. Although list or “sticker” prices generally increased by around 9 percent for most drugs, after discounts negotiated with various health plans, the net prices that consumers and insurers actually pay will see much lower increases. For example, Allergan expects that payors will only see net price increases of 2 to 3 percent in 2018.
However, price increases won’t generate the same returns for brand drug companies that they once did. As insurers and pharmacy benefit managers consolidate and increase their market share, they have been able to capture an increasing share of the money spent on drugs for themselves. Indeed, a 2017 report found that, of the money spent on prescription drugs by patients and health plans at the point of sale, brand drug makers only realized 39 percent. Meanwhile, supply-chain participants, such as pharmacy benefit managers, realized 42 percent of these expenditures. What’s more, year-after-year, brand drug makers have seen their share of these point-of-sale expenditures decrease while supply-chain entities have kept a growing share of expenditures for themselves.
Brand drug makers have also experienced a dramatic decline in the return on their R&D investment. A recent Deloitte study reports that, for the large drug makers they’ve followed since 2010, R&D returns have dropped from over 10 percent to under 4 percent for the last two years. The ability of supply-chain entities to capture an increasing share of drug expenditures is responsible for at least part of drug makers’ decreasing R&D returns; the study reports that average peak sales for drugs have slowly dropped over time, mirroring drug maker’s decreasing share of expenditures. In addition, the decline in R&D returns can be traced to the increasing cost of bringing drugs to market; for the companies Deloitte studied, the cost to bring a drug to market has increased from just over $1.1 billion in 2010 to almost $2 billion in 2017.
Brand drug makers’ decreasing share of drug expenditures and declining R&D returns reduce incentives to innovate. As the payoff from innovation declines, fewer companies will devote the substantial resources necessary to develop innovative new drugs. In addition, innovation is threatened as brand companies increasingly face uncertainty about the patent rights of the drugs they do bring to market. As I’ve discussed in a previous post, the unbalanced inter partes review (IPR) process created under the Leahy-Smith America Invents Act in 2012 has led to significantly higher patent invalidation rates. Compared to traditional district-court litigation, several pro-challenger provisions under IPR—including a lower standard of proof, a broader claim construction standard, and the ability of patent challengers to force patent owners into duplicative litigation—have resulted in twice as many patents deemed invalid in IPR proceedings. Moreover, the lack of a standing requirement in IPR proceedings has given rise to “reverse patent trolling,” in which entities that are not litigation targets, or even participants in the same industry, threaten to file an IPR petition challenging the validity of a patent unless the patent holder agrees to specific settlement demands. Even supporters of IPR proceedings recognize the flaws with the system; as Senator Orrin Hatch stated in a 2017 speech: “Such manipulation is contrary to the intent of IPR and the very purpose of intellectual property law. . . I think Congress needs to take a look at it.” Although the constitutionality of the IPR process is currently under review by the U.S. Supreme Court, if the unbalanced process remains unchanged, the significant uncertainty it creates for drug makers’ patent rights will lead to less innovation in the pharmaceutical industry. Drug makers will have little incentive to spend billions of dollars to bring a new drug to market when they cannot be certain if the patents for that drug can withstand IPR proceedings that are clearly stacked against them.
We are likely to see a renewed push for drug pricing reforms in 2018 as access to affordable drugs remains a top policy priority. Although Congress has yet to come together in support of any specific proposal, several states are experimenting with reforms that aim to lower drug prices by requiring more pricing transparency and notice of price increases. As lawmakers consider these and other reforms, they should consider the current challenges that drug makers already face as their share of drug expenditures and R&D returns decline and patent rights remain uncertain. Reforms that further threaten drug makers’ financial incentives to innovate could reduce our access to life-saving and life-improving new drugs.