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Drug makers recently announced their 2019 price increases on over 250 prescription drugs. As examples, AbbVie Inc. increased the price of the world’s top-selling drug Humira by 6.2 percent, and Hikma Pharmaceuticals increased the price of blood-pressure medication Enalaprilat by more than 30 percent. Allergan reported an average increase across its portfolio of drugs of 3.5 percent; although the drug maker is keeping most of its prices the same, it raised the prices on 27 drugs by 9.5 percent and on another 24 drugs by 4.9 percent. Other large drug makers, such as Novartis and Pfizer, will announce increases later this month.

So far, the number of price increases is significantly lower than last year when drug makers increased prices on more than 400 drugs.  Moreover, on the drugs for which prices did increase, the average price increase of 6.3 percent is only about half of the average increase for drugs in 2018. Nevertheless, some commentators have expressed indignation and President Trump this week summoned advisors to the White House to discuss the increases.  However, commentators and the administration should keep in mind what the price increases actually mean and the numerous players that are responsible for increasing drug prices. 

First, it is critical to emphasize the difference between drug list prices and net prices.  The drug makers recently announced increases in the list, or “sticker” prices, for many drugs.  However, the list price is usually very different from the net price that most consumers and/or their health plans actually pay, which depends on negotiated discounts and rebates.  For example, whereas drug list prices increased by an average of 6.9 percent in 2017, net drug prices after discounts and rebates increased by only 1.9 percent. The differential between the growth in list prices and net prices has persisted for years.  In 2016 list prices increased by 9 percent but net prices increased by 3.2 percent; in 2015 list prices increased by 11.9 percent but net prices increased by 2.4 percent, and in 2014 list price increases peaked at 13.5 percent but net prices increased by only 4.3 percent.

For 2019, the list price increases for many drugs will actually translate into very small increases in the net prices that consumers actually pay.  In fact, drug maker Allergan has indicated that, despite its increase in list prices, the net prices that patients actually pay will remain about the same as last year.

One might wonder why drug makers would bother to increase list prices if there’s little to no change in net prices.  First, at least 40 percent of the American prescription drug market is subject to some form of federal price control.  As I’ve previously explained, because these federal price controls generally require percentage rebates off of average drug prices, drug makers have the incentive to set list prices higher in order to offset the mandated discounts that determine what patients pay.

Further, as I discuss in a recent Article, the rebate arrangements between drug makers and pharmacy benefit managers (PBMs) under many commercial health plans create strong incentives for drug makers to increase list prices. PBMs negotiate rebates from drug manufacturers in exchange for giving the manufacturers’ drugs preferred status on a health plan’s formulary.  However, because the rebates paid to PBMs are typically a percentage of a drug’s list price, drug makers are compelled to increase list prices in order to satisfy PBMs’ demands for higher rebates. Drug makers assert that they are pressured to increase drug list prices out of fear that, if they do not, PBMs will retaliate by dropping their drugs from the formularies. The value of rebates paid to PBMs has doubled since 2012, with drug makers now paying $150 billion annually.  These rebates have grown so large that, today, the drug makers that actually invest in drug innovation and bear the risk of drug failures receive only 39 percent of the total spending on drugs, while 42 percent of the spending goes to these pharmaceutical middlemen.

Although a portion of the increasing rebate dollars may eventually find its way to patients in the form of lower co-pays, many patients still suffer from the list prices increases.  The 29 million Americans without drug plan coverage pay more for their medications when list prices increase. Even patients with insurance typically have cost-sharing obligations that require them to pay 30 to 40 percent of list prices.  Moreover, insured patients within the deductible phase of their drug plan pay the entire higher list price until they meet their deductible.  Higher list prices jeopardize patients’ health as well as their finances; as out-of-pocket costs for drugs increase, patients are less likely to adhere to their medication routine and more likely to abandon their drug regimen altogether.

Policymakers must realize that the current system of government price controls and distortive rebates creates perverse incentives for drug makers to continue increasing drug list prices. Pointing the finger at drug companies alone for increasing prices does not represent the problem at hand.

Last week, Senator Orrin Hatch, Senator Thom Tillis, and Representative Bill Flores introduced the Hatch-Waxman Integrity Act of 2018 (HWIA) in both the Senate and the House of Representatives.  If enacted, the HWIA would help to ensure that the unbalanced inter partes review (IPR) process does not stifle innovation in the drug industry and jeopardize patients’ access to life-improving drugs.

Created under the America Invents Act of 2012, IPR is a new administrative pathway for challenging patents. It was, in large part, created to fix the problem of patent trolls in the IT industry; the trolls allegedly used questionable or “low quality” patents to extort profits from innovating companies.  IPR created an expedited pathway to challenge patents of dubious quality, thus making it easier for IT companies to invalidate low quality patents.

However, IPR is available for patents in any industry, not just the IT industry.  In the market for drugs, IPR offers an alternative to the litigation pathway that Congress created over three decades ago in the Hatch-Waxman Act. Although IPR seemingly fixed a problem that threatened innovation in the IT industry, it created a new problem that directly threatened innovation in the drug industry. I’ve previously published an article explaining why IPR jeopardizes drug innovation and consumers’ access to life-improving drugs. With Hatch-Waxman, Congress sought to achieve a delicate balance between stimulating innovation from brand drug companies, who hold patents, and facilitating market entry from generic drug companies, who challenge the patents.  However, IPR disrupts this balance as critical differences between IPR proceedings and Hatch-Waxman litigation clearly tilt the balance in the patent challengers’ favor. In fact, IPR has produced noticeably anti-patent results; patents are twice as likely to be found invalid in IPR challenges as they are in Hatch-Waxman litigation.

The Patent Trial and Appeal Board (PTAB) applies a lower standard of proof for invalidity in IPR proceedings than do federal courts in Hatch-Waxman proceedings. In federal court, patents are presumed valid and challengers must prove each patent claim invalid by “clear and convincing evidence.” In IPR proceedings, no such presumption of validity applies and challengers must only prove patent claims invalid by the “preponderance of the evidence.”

Moreover, whereas patent challengers in district court must establish sufficient Article III standing, IPR proceedings do not have a standing requirement.  This 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 pre-filing settlement demands.  The lack of a standing requirement has also led to the  exploitation of the IPR process by entities that would never be granted standing in traditional patent litigation—hedge funds betting against a company by filing an IPR challenge in hopes of crashing the stock and profiting from the bet.

Finally, patent owners are often forced into duplicative litigation in both IPR proceedings and federal court litigation, leading to persistent uncertainty about the validity of their patents.  Many patent challengers that are unsuccessful in invalidating a patent in district court may pursue subsequent IPR proceedings challenging the same patent, essentially giving patent challengers “two bites at the apple.”  And if the challenger prevails in the IPR proceedings (which is easier to do given the lower standard of proof), the PTAB’s decision to invalidate a patent can often “undo” a prior district court decision.  Further, although both district court judgments and PTAB decisions are appealable to the Federal Circuit, the court applies a more deferential standard of review to PTAB decisions, increasing the likelihood that they will be upheld compared to the district court decision.

The pro-challenger bias in IPR creates significant uncertainty for patent rights in the drug industry.  As an example, just last week patent claims for drugs generating $6.5 billion for drug company Sanofi were invalidated in an IPR proceeding.  Uncertain patent rights will lead to less innovation because drug companies will not spend the billions of dollars it typically costs 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.   And, if IPR causes drug innovation to decline, a significant body of research predicts that patients’ health outcomes will suffer as a result.

The HWIA, which applies only to the drug industry, is designed to return the balance established by Hatch-Waxman between branded drug innovators and generic drug challengers. It eliminates challengers’ ability to file duplicative claims in both federal court and through the IPR process. Instead, they must choose between either Hatch-Waxman litigation (which saves considerable costs by allowing generics to rely on the brand company’s safety and efficacy studies for FDA approval) and IPR (which is faster and provides certain pro-challenger provisions). In addition to eliminating generic challengers’ “second bite of the apple,” the HWIA would also eliminate the ability of hedge funds and similar entities to file IPR claims while shorting the stock.

Thus, if enacted, the HWIA would create incentives that reestablish Hatch-Waxman litigation as the standard pathway for generic challenges to brand patents.  Yet, it would preserve IPR proceedings as an option when speed of resolution is a primary concern.  Ultimately, it will restore balance to the drug industry to safeguard competition, innovation, and patients’ access to life-improving drugs.

The two-year budget plan passed last week makes important changes to payment obligations in the Medicare Part D coverage gap, also known as the donut hole.  While the new plan produces a one-year benefit for seniors by reducing what they pay a year earlier than was already mandated, it permanently shifts much of the drug costs insurance companies were paying to drug makers.  It’s far from clear whether this windfall for insurers will result in lower drug costs for Medicare beneficiaries.

Medicare Part D is voluntary prescription drug insurance for seniors and the permanently disabled provided by private insurance plans that are approved by the Medicare program.  Last year, more than 42 million people enrolled in Medicare Part D plans. Payment for prescription drugs under Medicare Part D depends on how much enrollees spend on drugs.  In 2018, after hitting a deductible that varies by plan, enrollees pay 25% of their drug costs while the Part D plans pay 75%.  However, once the individual and the plan have spent a total of $3,750, enrollees hit the coverage gap that lasts until $8,418 has been spent.  In the coverage gap, enrollees pay 35% of brand drug costs, the Part D plans pay 15%, and drug makers are required to offer 50% discounts on brand drugs to cover the rest.  Once total spending reaches $8,418, enrollees enter catastrophic coverage in which they pay only 5% of drug costs, the Part D plans pay 15%, and the Medicare program pays the other 80%.

The Affordable Care Act (ACA) included provisions to phase out the coverage gap by 2020, so that enrollees will pay only 25% of drug costs from the time they meet the deductible until they hit the catastrophic coverage level.  The budget plan passed last week speeds up this phase out by one year, so enrollees will start paying only 25% in 2019 instead of 2020.  The ACA anticipated that with enrollees paying 25% of drug costs and drug maker discounts of 50%, the Part D plans would pay the other 25%.  However, last week’s budget plan drastically redistributed the payment responsibilities from the Part D insurance plans to drug makers. Under the new plan drug makers are required to offer 70% discounts so that the plans only have to pay 5% of the total drug costs.  That is, the new plan shifts 20% of total drug costs in the coverage gap from insurers to drug makers.

Although the drug spending in each individual’s coverage gap is less than $5,000, with over 42 million people covered, the total spending, and the 20% of spending shifted from insurers to drug makers, is significant.  CMS has estimated that when drug makers’ discounts were only covering 50% of drug spending in the gap, the annual total discounts amounted to over $5.6 billion.  Requiring drug makers to cover another 20% of drug spending will add several billion dollars more to this total.

A government intervention that forces suppliers to cover 70% of the spending in a market is a surprising move for Republicans—supposed advocates of free markets.  Moreover, although reducing prescription drug costs has become a national priority, it’s unclear whether shifting costs from insurers to drug makers will benefit individuals at all.  Theoretically, as the individual Part D plans pay less of their enrollees’ drug costs, they should pass on the savings to enrollees in the form of lower premiums.  However, several studies suggest that enrollees may not experience a net decrease in drug spending.  The Centers for Medicare and Medicaid Services (CMS) has determined that under Medicare Part D, drug makers increase list prices to offset other concessions and to more quickly move enrollees out of the coverage gap where drug makers are required to offer price discounts.  Higher list prices mean that enrollees’ total out-of-pocket drug spending increases; even a 5% cost-sharing obligation in the catastrophic coverage for a high-priced drug can be a significant expense. Higher list prices that push enrollees out of the coverage gap also shift more costs onto the Medicare program that pays 80% of drug costs in the catastrophic coverage phase.

A better, more direct way to reduce Medicare Part D enrollees’ out-of-pocket drug spending is to require point-of-sale rebates.  Currently, drug makers offer rebates to Part D plans in order to improve their access to the millions of individuals covered by the plans.  However, the rebates, which total over $16 billion annually, are paid after the point-of-sale, and evidence shows that only a portion of these rebates get passed through to beneficiaries in the form of reduced insurance premiums.  Moreover, a reduction in premiums does little to benefit those enrolled individuals who have the highest aggregate out-of-pocket spending on drugs. (As an aside, in contrast to the typical insurance subsidization of high-cost enrollees by low-cost enrollees, high-spending enrollees under Medicare Part D generate greater rebates for their plans, but then the rebates are spread across all enrollees in the form of lower premiums).

Drug maker rebates will more directly benefit Medicare Part D enrollees if rebates are passed through at the point-of-sale to reduce drug copays.  Point-of-sale rebates would ensure that enrollees see immediate savings as they meet their cost-sharing obligations.  Moreover, the enrollees with the highest aggregate out-of-pocket spending would be the ones to realize the greatest savings.  CMS has recently solicited comments on a plan to require some portion of drug makers’ rebates to be applied at the point of sale, and the President’s budget plan released yesterday proposes point-of-sale rebates to lower Medicare Part D enrollees’ out-of-pocket spending.  Ultimately, targeting rebates to consumers at the point-of-sale will more effectively lower drug spending than reducing insurance plans’ payment obligations in hopes that they pass on the savings to enrollees.

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.

It’s been six weeks since drug maker Allergan announced that it had assigned to the Saint Regis Mohawk Tribe the patents on Restasis, an Allergan drug challenged both in IPR proceedings and in Hatch-Waxman proceedings in federal district court.  The unorthodox agreement was intended to shield the patents from IPR proceedings (and thus restrict the challenge to district court) as the Mohawks would seek to dismiss the IPR proceedings based on the tribe’s sovereign immunity.  Although Allergan  suffered a setback last week when the federal court invalidated the Restasis patents and, in dicta, expressed concern about the Allergan/Mohawk arrangement, several other entities are following Allergan’s lead and assigning patents to sovereigns in hopes of avoiding IPR proceedings.

As an example, in August, SRC Labs assigned about 40 computer technology patents to the Saint Regis Mohawk Tribe.  Last week, the tribe, with SRC as co-plaintiff, filed lawsuits against Microsoft and Amazon for infringement of its data processing patents; the assignment of the SRC patents to the tribe could prevent a counter-challenge from Microsoft and Amazon in IPR proceedings.  Similarly, Prowire LLC, who has sued Apple for infringement, has assigned the patent in question to MEC Resources, a company affiliated with three tribes in North Dakota.  And state universities (whom the PTAB considers to be arms of the sovereign states, and thus immune to IPR challenges) are in discussions with lawyers about offering their sovereign immunity to patent owners as a way to shield patents in IPR proceedings.

These arrangements that attempt to avoid the IPR process and force patent challenges into federal courts are no surprise given the current unbalance in the IPR system.  Critical differences exist between IPR proceedings and Hatch-Waxman litigation that have created a significant deviation in patent invalidation rates under the two pathways; compared to district court challenges, patents are twice as likely to be found invalid in IPR challenges.

The PTAB applies a lower standard of proof for invalidity in IPR proceedings than do federal courts in Hatch-Waxman proceedings. In federal court, patents are presumed valid and challengers must prove each patent claim invalid by “clear and convincing evidence.” In IPR proceedings, no such presumption of validity applies and challengers must only prove patent claims invalid by the “preponderance of the evidence.” In addition to the lower burden, it is also easier for challengers to meet the standard of proof in IPR proceedings.  In federal court, patent claims are construed according to their “ordinary and customary meaning” to a person of ordinary skill in the art.  In contrast, the PTAB uses the more lenient “broadest reasonable interpretation” standard; this more lenient standard can result in the PTAB interpreting patent claims as “claiming too much” (using their broader standard), resulting in the invalidation of more patents.

Moreover, whereas patent challengers in district court must establish sufficient Article III standing, IPR proceedings do not have a standing requirement.  This 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 pre-filing settlement demands.  The lack of a standing requirement has also led to the  exploitation of the IPR process by entities that would never be granted standing in traditional patent litigation—hedge funds betting against a company by filing an IPR challenge in hopes of crashing the stock and profiting from the bet.

Finally, patent owners are often forced into duplicative litigation in both IPR proceedings and federal court litigation, leading to persistent uncertainty about the validity of their patents.  Many patent challengers that are unsuccessful in invalidating a patent in district court may pursue subsequent IPR proceedings challenging the same patent, essentially giving patent challengers “two bites at the apple.”  And if the challenger prevails in the IPR proceedings (which is easier to do given the lower standard of proof and broader claim construction standard), the PTAB’s decision to invalidate a patent can often “undo” a prior district court decision.  Further, although both district court judgments and PTAB decisions are appealable to the Federal Circuit, the court applies a more deferential standard of review to PTAB decisions, increasing the likelihood that they will be upheld compared to the district court decision.

Courts are increasingly recognizing that certain PTAB practices are biased against patent owners, and, in some cases, violations of underlying law.  The U.S. Supreme Court in Cuozzo Speed Technologies v. Lee concluded that the broadest reasonable interpretation claim construction standard in IPR “increases the possibility that the examiner will find the claim too broad (and deny it)” and that the different claim construction standards in PTAB trials and federal court “may produce inconsistent results and cause added confusion.”  However, the Court concluded that only Congress could mandate a different standard.  Earlier this month, in Aqua Products, Inc. v. Matal, the Federal Circuit held that “[d]espite repeated recognition of the importance of the patent owner’s right to amend [patent claims] during IPR proceedings— by Congress, courts, and the PTO alike—patent owners largely have been prevented from amending claims in the context of IPRs.”   And the Supreme Court has agreed to hear Oil States Energy Services v. Greene’s Energy Group, which questions whether IPR proceedings are even constitutional because they extinguish private property rights through a non-Article III forum without a jury. 

As Courts and lawmakers continue to question the legality and wisdom of IPR to review pharmaceutical patents, they should remember that the relationship between drug companies and patients resembles a social contract. Under this social contract, patients have the right to reasonably-priced, innovative drugs and sufficient access to alternative drug choices, while drug companies have the right to earn profits that compensate for the risk inherent in developing new products and to a stable environment that gives the companies the incentive and ability to innovate.  This social contract requires a balancing of prices (not too high to gouge consumers but not too low to insufficiently compensate drug companies), competition law (not so lenient that it ignores anticompetitive behavior that restricts patients’ access to alternative drugs, but not so strict that it prevents companies from intensely competing for profits), and most importantly in the context of IPR, patent law (not so weak that it fails to incentivize innovation and drug development, but not so strong that it enables drug companies to monopolize the market for an unreasonable amount of time).  The unbalanced IPR process threatens this balance by creating significant uncertainty in pharmaceutical intellectual property rights.  Uncertain patent rights will lead to less innovation in the pharmaceutical industry because drug companies will not spend the billions of dollars it typically costs 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.  Indeed, last week former Federal Circuit Chief Judge Paul Redmond Michel acknowledged that IPR has contributed to “hobbling” our nation’s patent system, “discourag[ing] investment, R&D and commercialization.” And if IPR causes drug innovation to decline, a significant body of research predicts that consumers’ health outcomes will suffer as a result.

Last Friday, drug maker Allergan and the Saint Regis Mohawk Tribe announced that they had reached an agreement under which Allergan assigned the patents on its top-selling drug Restasis to the tribe and, in return, Allergan was given the exclusive license on the Restasis patents so that it can continue producing and distributing the drug.  Allergan agreed to pay $13.75 million to the tribe for the deal, and up to $15 million annually in royalties as long as the patents remain valid.

Why would a large drug maker assign the patents on a leading drug to a sovereign Indian nation?  This unorthodox agreement may actually be a brilliant strategy that enables patent owners to avoid the unbalanced inter partes review (IPR) process.  The validity of the Restasis patents is currently being challenged both in IPR proceedings before the Patent Trial and Appeal Board (PTAB) and in federal district court in Texas.  However, the Allergan-Mohawk deal may lead to the dismissal of the IPR proceedings as, under the terms of the deal, the Mohawks will file a motion to dismiss the IPR proceedings based on the tribe’s sovereign immunity.  Earlier this year, in Covidien v. University of Florida Research Foundation, the PTAB determined that sovereign immunity shields state universities holding patents from IPR proceedings, and the same reasoning should certainly apply to sovereign Indian nations.

I’ve published a previous article explaining why pharmaceutical companies have legitimate reasons to avoid IPR proceedings–critical differences between district court litigation and IPR proceedings jeopardize the delicate balance Hatch-Waxman sought to achieve between patent owners and patent challengers. In addition to forcing patent owners into duplicative litigation in district courts and the PTAB, depriving them of the ability to achieve finality in one proceeding, the PTAB also applies a lower standard of proof for invalidity than do district courts in Hatch-Waxman litigation.  It is also easier to meet the standard of proof in a PTAB trial because of a more lenient claim construction standard.  Moreover, on appeal, PTAB decisions in IPR proceedings are given more deference than lower district court decisions.  Finally, while patent challengers in district court must establish sufficient Article III standing, IPR proceedings do not have a standing requirement.  This has led to the exploitation of the IPR process by entities that would never be granted standing in traditional patent litigation—hedge funds betting against a company by filing an IPR challenge in hopes of crashing the stock and profiting from the bet.

The differences between district court litigation and IPR proceedings have created a significant deviation in patent invalidation rates under the two pathways; compared to district court challenges, patents are twice as likely to be found invalid in IPR challenges.  Although the U.S. Supreme Court in Cuozzo Speed Technologies v. Lee concluded that the anti-patentee claim construction standard in IPR “increases the possibility that the examiner will find the claim too broad (and deny it)”, the Court concluded that only Congress could mandate a different standard.  So far, Congress has done nothing to reduce the disparities between IPR proceedings and Hatch-Waxman litigation. But, while we wait, the high patent invalidation rate in IPR proceedings creates significant uncertainty for patent owners’ intellectual property rights.   Uncertain patent rights, in turn, lead to less innovation in the pharmaceutical industry.  Put simply, drug companies will not spend the billions of dollars it typically costs to bring a new drug to market when they can’t be certain if the patents for that drug can withstand IPR proceedings that are clearly stacked against them (for an excellent discussion of how the PTAB threatens innovation, see Alden Abbot’s recent TOTM post).  Thus, deals between brand companies and sovereigns, such as Indian nations, that insulate patents from IPR proceedings should improve the certainty around intellectual property rights and protect drug innovation.

Yet, the response to the Allergan-Mohawk deal among some scholars and generic drug companies has been one of panic and speculative doom.  Critics have questioned the deal largely on the grounds that, in addition to insulating Restasis from IPR proceedings, tribal sovereignty might also shield the patents in standard Hatch-Waxman district court litigation.  If this were true and brand companies began to routinely house their patents with sovereign Indian nations, then the venues in which generic companies could challenge patents would be restricted and generic companies would have less incentive to produce and market cheaper drugs.

However, it is far from clear that these deals could shield patents in standard Hatch-Waxman district court litigation.  Hatch-Waxman litigation typically follows a familiar pattern: a generic company files a Paragraph IV ANDA alleging patent owner’s patents are invalid or will not be infringed, the patent owner then sues the generic for infringement, and then the generic company files a counterclaim for invalidity.  Critics of the Allergan-Mohawk deal allege that tribal sovereignty could insulate patent owners from the counterclaim.  However, courts have held that state universities waive sovereign immunity for counterclaims when they file the initial patent infringement suit.  Although, in non-infringement contexts, tribes have been found to not waive sovereign immunity for counterclaims merely by filing an action as a plaintiff, this has never been tested in patent litigation.  Moreover, even if sovereign immunity could be used to prevent the counterclaim, invalidity can still be raised as an affirmative defense in the patent owner’s infringement suit (although it has been asserted that requiring generics to assert invalidity as an affirmative defense instead of a counterclaim may still tilt the playing field toward patent owners).  Finally, many patent owners that are sovereigns may choose to voluntarily waive sovereign immunity to head off any criticism or congressional meddling. Given the uncertainty of the effects of tribal sovereignty in Hatch-Waxman litigation, Allergan has concluded that their deal with the Mohawks won’t affect the pending district court litigation involving the validity of the Restasis patents.  However, if tribes in future cases were to cloud the viability of Hatch-Waxman by asserting sovereign immunity in district court litigation, Congress could always respond by altering the Hatch-Waxman rules to preclude this.

For now, we should all take a deep breath and put the fearmongering on hold.  Whether deals like the Allergan-Mohawk arrangement could affect Hatch-Waxman litigation is simply a matter of speculation, and there are many reasons to believe that they won’t. In the meantime, the deal between Allergan and the Saint Regis Mohawk Tribe is an ingenious strategy to avoid the unbalanced IPR process.   This move is the natural extension of the PTAB’s ruling on state university sovereign immunity, and state universities are likely incorporating the advantage into their own licensing and litigation strategies.  The Supreme Court will soon hear a case questioning the constitutionality of the IPR process.  Until the courts or Congress act to reduce the disparities between IPR proceedings and Hatch-Waxman litigation, we can hardly blame patent owners from taking clever legal steps to avoid the unbalanced IPR process.

Today, the Senate Committee on Health, Education, Labor, and Pensions (HELP) enters the drug pricing debate with a hearing on “The Cost of Prescription Drugs: How the Drug Delivery System Affects What Patients Pay.”  By questioning the role of the drug delivery system in pricing, the hearing goes beyond the more narrow focus of recent hearings that have explored how drug companies set prices.  Instead, today’s hearing will explore how pharmacy benefit managers, insurers, providers, and others influence the amounts that patients pay.

In 2016, net U.S. drug spending increased by 4.8% to $323 billion (after adjusting for rebates and off-invoice discounts).  This rate of growth slowed to less than half the rates of 2014 and 2015, when net drug spending grew at rates of 10% and 8.9% respectively.  Yet despite the slowing in drug spending, the public outcry over the cost of prescription drugs continues.

In today’s hearing, there will be testimony both on the various causes of drug spending increases and on various proposals that could reduce the cost of drugs.  Several of the proposals will focus on ways to increase competition in the pharmaceutical industry, and in turn, reduce drug prices.  I have previously explained several ways that the government could reduce prices through enhanced competition, including reducing the backlog of generic drugs awaiting FDA approval and expediting the approval and acceptance of biosimilars.  Other proposals today will likely call for regulatory reforms to enable innovative contractual arrangements that allow for outcome- or indication-based pricing and other novel reimbursement designs.

However, some proposals will undoubtedly return to the familiar call for more government negotiation of drug prices, especially drugs covered under Medicare Part D.  As I’ve discussed in a previous post, in order for government negotiation to significantly lower drug prices, the government must be able to put pressure on drug makers to secure price concessions. This could be achieved if the government could set prices administratively, penalize manufacturers that don’t offer price reductions, or establish a formulary.  Setting prices or penalizing drug makers that don’t reduce prices would produce the same disastrous effects as price controls: drug shortages in certain markets, increased prices for non-Medicare patients, and reduced incentives for innovation. A government formulary for Medicare Part D coverage would provide leverage to obtain discounts from manufacturers, but it would mean that many patients could no longer access some of their optimal drugs.

As lawmakers seriously consider changes that would produce these negative consequences, industry would do well to voluntarily constrain prices.  Indeed, in the last year, many drug makers have pledged to limit price increases to keep drug spending under control.  Allergan was first, with its “social contract” introduced last September that promised to keep price increases below 10 percent. Since then, Novo Nordisk, AbbVie, and Takeda, have also voluntarily committed to single-digit price increases.

So far, the evidence shows the drug makers are sticking to their promises. Allergan has raised the price of U.S. branded products by an average of 6.7% in 2017, and no drug’s list price has increased by more than single digits.  In contrast, Pfizer, who has made no pricing commitment, has raised the price of many of its drugs by 20%.

If more drug makers brought about meaningful change by committing to voluntary pricing restraints, the industry could prevent the market-distorting consequences of government intervention while helping patients afford the drugs they need.   Moreover, avoiding intrusive government mandates and price controls would preserve drug innovation that has brought life-saving and life-enhancing drugs to millions of Americans.

 

 

 

Joanna Shepherd is Professor of Law at Emory University School of Law.

Today, three of the largest proposed mergers — Bayer/Monsanto, Dow/Dupont, and ChemChina/Syngenta — face scrutiny in both the U.S. and Europe over concerns that the mergers will slow innovation in crop biotechnology and crop protection.   The incorporation of innovation effects in the antitrust analysis of these agricultural/biotech mergers is quickly becoming more mainstream in both the U.S. and E.U. The concerns are premised on the idea that, by merging existing competitors into one firm, consolidation will reduce incentives to develop new products in the future.  Since 2015, the Department of Justice has opposed proposed mergers between Applied Materials/Tokyo Electron, Comcast/Time Warner Cable, and Halliburton/Baker Hughes at least partly based on innovation concerns. Similarly, the European Commission has raised innovation concerns in its analyses of several mergers since 2015, including Biomet/Zimmer Holdings, GlaxoSmithKline/Novartis, and BASE/ Liberty Global.

Although most of these contested deals are not based exclusively on innovation markets, fear of harms to innovation often result in the required divestiture of innovation-related assets.  For example, both the FTC and European Commission allowed the 2014 merger between Medtronic/Covidien only on the condition that Covidien divest its drug-coated balloon catheter business to protect innovation in that market. And just this week, Dupont agreed to divest a large part of its existing pesticide business, including its global R&D organization, to secure approval for the Dow/Dupont merger in the EU.

Certainly the incorporation of innovation effects in antitrust analysis could be relevant in specific mergers or acquisitions if the consolidating firms are the primary innovators in the area, the firms innovate internally, and there are limited sources of external innovation. However, in many industries, this model simply doesn’t apply.  Take, for example, the pharmaceutical industry; as I explain in a recent Article, concerns about consolidation’s impact on drug innovation are largely based on an outdated understanding of the innovation ecosystem in the pharmaceutical industry.

Today, most drug innovation originates not in traditional pharmaceutical companies, but in biotech companies and smaller firms, where a culture of nimble decision-making and risk-taking facilitates discovery and innovation.  In fact, about two-thirds of New Molecular Entities approved by the FDA originate in biotech and small pharmaceutical companies, and these companies account for almost 70 percent of the current global pipeline of drugs under development.

To complete the development process and commercialize their drugs, biotech companies regularly collaborate with large pharmaceutical companies that push drugs through the grueling late-stage clinical trials and regulatory hurdles of the FDA, organize their manufacturing and distribution capabilities to bring the drugs to market, and mobilize their vast sales force to quickly achieve peak sales.  In this current ecosystem, biotech and pharmaceutical firms are each able to specialize in what they do best, bringing expertise and efficiencies to the innovation process.

This specialization has dramatically changed the share of internally-developed versus externally-developed drugs in the pharmaceutical industry. Whereas in the 1970s and early 1980s, almost all drug discovery and early stage development took place inside traditional pharmaceutical companies, today, the companies increasingly shift resources away from internal R&D expenditures and projects and towards external sources of innovation.  Externally-sourced drugs now account for an incredible 74 percent of new drugs registered with the FDA for sale in the U.S.  Internal R&D is no longer the primary source of drug innovation in large pharmaceutical companies.

As a result, antitrust analyses that focus on pharmaceutical mergers’ impacts on internal R&D and innovation largely miss the point.  In the current innovation ecosystem, where little drug innovation originates internally, a merger’s impact on internal R&D expenditures or development projects is oftentimes immaterial to aggregate drug innovation. In many consolidated firms, increases in efficiency and streamlining of operations free up money and resources to source external innovation. To improve their future revenue streams and market share, consolidated firms can be expected to use at least some of the extra resources to acquire external innovation. This increase in demand for externally-sourced innovation increases the prices paid for external assets, which, in turn, incentivizes more early-stage innovation in small firms and biotech companies.   Aggregate innovation increases in the process!

Thus, proper antitrust analyses must take into account the innovation ecosystem in the merging firms’ industries.  In industries in which most innovation originates externally, as in the pharmaceutical industry, analyses should be less concerned with mergers’ impacts on internal innovation, and more focused on whether consolidation will increase demand for externally-sourced innovation and, ultimately, increase aggregate drug innovation.

In a weekend interview with the Washington Post, Donald Trump vowed to force drug companies to negotiate directly with the government on prices in Medicare and Medicaid.  It’s unclear what, if anything, Trump intends for Medicaid; drug makers are already required to sell drugs to Medicaid at the lowest price they negotiate with any other buyer.  For Medicare, Trump didn’t offer any more details about the intended negotiations, but he’s referring to his campaign proposals to allow the Department of Health and Human Services (HHS) to negotiate directly with manufacturers the prices of drugs covered under Medicare Part D.

Such proposals have been around for quite a while.  As soon as the Medicare Modernization Act (MMA) of 2003 was enacted, creating the Medicare Part D prescription drug benefit, many lawmakers began advocating for government negotiation of drug prices. Both Hillary Clinton and Bernie Sanders favored this approach during their campaigns, and the Obama Administration’s proposed budget for fiscal years 2016 and 2017 included a provision that would have allowed the HHS to negotiate prices for a subset of drugs: biologics and certain high-cost prescription drugs.

However, federal law would have to change if there is to be any government negotiation of drug prices under Medicare Part D. Congress explicitly included a “noninterference” clause in the MMA that stipulates that HHS “may not interfere with the negotiations between drug manufacturers and pharmacies and PDP sponsors, and may not require a particular formulary or institute a price structure for the reimbursement of covered part D drugs.”

Most people don’t understand what it means for the government to “negotiate” drug prices and the implications of the various options.  Some proposals would simply eliminate the MMA’s noninterference clause and allow HHS to negotiate prices for a broad set of drugs on behalf of Medicare beneficiaries.  However, the Congressional Budget Office has already concluded that such a plan would have “a negligible effect on federal spending” because it is unlikely that HHS could achieve deeper discounts than the current private Part D plans (there are 746 such plans in 2017).  The private plans are currently able to negotiate significant discounts from drug manufacturers by offering preferred formulary status for their drugs and channeling enrollees to the formulary drugs with lower cost-sharing incentives. In most drug classes, manufacturers compete intensely for formulary status and offer considerable discounts to be included.

The private Part D plans are required to provide only two drugs in each of several drug classes, giving the plans significant bargaining power over manufacturers by threatening to exclude their drugs.  However, in six protected classes (immunosuppressant, anti-cancer, anti-retroviral, antidepressant, antipsychotic and anticonvulsant drugs), private Part D plans must include “all or substantially all” drugs, thereby eliminating their bargaining power and ability to achieve significant discounts.  Although the purpose of the limitation is to prevent plans from cherry-picking customers by denying coverage of certain high cost drugs, giving the private Part D plans more ability to exclude drugs in the protected classes should increase competition among manufacturers for formulary status and, in turn, lower prices.  And it’s important to note that these price reductions would not involve any government negotiation or intervention in Medicare Part D.  However, as discussed below, excluding more drugs in the protected classes would reduce the value of the Part D plans to many patients by limiting access to preferred drugs.

For government negotiation to make any real difference on Medicare drug prices, HHS must have the ability to not only negotiate prices, but also to put some pressure on drug makers to secure price concessions.  This could be achieved by allowing HHS to also establish a formulary, set prices administratively, or take other regulatory actions against manufacturers that don’t offer price reductions.  Setting prices administratively or penalizing manufacturers that don’t offer satisfactory reductions would be tantamount to a price control.  I’ve previously explained that price controls—whether direct or indirect—are a bad idea for prescription drugs for several reasons. Evidence shows that price controls lead to higher initial launch prices for drugs, increased drug prices for consumers with private insurance coverage,  drug shortages in certain markets, and reduced incentives for innovation.

Giving HHS the authority to establish a formulary for Medicare Part D coverage would provide leverage to obtain discounts from manufacturers, but it would produce other negative consequences.  Currently, private Medicare Part D plans cover an average of 85% of the 200 most popular drugs, with some plans covering as much as 93%.  In contrast, the drug benefit offered by the Department of Veterans Affairs (VA), one government program that is able to set its own formulary to achieve leverage over drug companies, covers only 59% of the 200 most popular drugs.  The VA’s ability to exclude drugs from the formulary has generated significant price reductions. Indeed, estimates suggest that if the Medicare Part D formulary was restricted to the VA offerings and obtained similar price reductions, it would save Medicare Part D $510 per beneficiary.  However, the loss of access to so many popular drugs would reduce the value of the Part D plans by $405 per enrollee, greatly narrowing the net gains.

History has shown that consumers don’t like their access to drugs reduced.  In 2014, Medicare proposed to take antidepressants, antipsychotic and immunosuppressant drugs off the protected list, thereby allowing the private Part D plans to reduce offerings of these drugs on the formulary and, in turn, reduce prices.  However, patients and their advocates were outraged at the possibility of losing access to their preferred drugs, and the proposal was quickly withdrawn.

Thus, allowing the government to negotiate prices under Medicare Part D could carry important negative consequences.  Policy-makers must fully understand what it means for government to negotiate directly with drug makers, and what the potential consequences are for price reductions, access to popular drugs, drug innovation, and drug prices for other consumers.

On November 9, pharmaceutical stocks soared as Donald Trump’s election victory eased concerns about government intervention in drug pricing. Shares of Pfizer rose 8.5%, Allergan PLC was up 8%, and biotech Celgene jumped 10.4%. Drug distributors also gained, with McKesson up 6.4% and Express Scripts climbing 3.4%. Throughout the campaign, Clinton had vowed to take on the pharmaceutical industry and proposed various reforms to reign in drug prices, from levying fines on drug companies that imposed unjustified price increases to capping patients’ annual expenditures on drugs. Pharmaceutical stocks had generally underperformed this year as the market, like much of America, awaited a Clinton victory.

In contrast, Trump generally had less to say on the subject of drug pricing, hence the market’s favorable response to his unexpected victory. Yet, as the end of the first post-election month draws near, we are still uncertain whether Trump is friend or foe to the pharmaceutical industry. Trump’s only proposal that directly impacts the industry would allow the government to negotiate the prices of Medicare Part D drugs with drug makers. Although this proposal would likely have little impact on prices because existing Part D plans already negotiate prices with drug makers, there is a risk that this “negotiation” could ultimately lead to price controls imposed on the industry. And as I have previously discussed, price controls—whether direct or indirect—are a bad idea for prescription drugs: they lead to higher initial launch prices for drugs, increased drug prices for consumers with private insurance coverage, drug shortages in certain markets, and reduced incentives for innovation.

Several of Trump’s other health proposals have mixed implications for the industry. For example, a repeal or overhaul of the Affordable Care Act could eliminate the current tax on drug makers and loosen requirements for Medicaid drug rebates and Medicare part D discounts. On the other hand, if repealing the ACA reduces the number of people insured, spending on pharmaceuticals would fall. Similarly, if Trump renegotiates international trade deals, pharmaceutical firms could benefit from stronger markets or longer patent exclusivity rights, or they could suffer if foreign countries abandon trade agreements altogether or retaliate with disadvantageous terms.

Yet, with drug spending up 8.5 percent last year and recent pricing scandals launched by 500+ percentage increases in individual drugs (i.e., Martin Shkreli, Valeant Pharmaceuticals, Mylan), the current debate over drug pricing is unlikely to fade. Even a Republican-led Congress and White House is likely to heed the public outcry and do something about drug prices.

Drug makers would be wise to stave off any government-imposed price restrictions by voluntarily limiting price increases on important drugs. Major pharmaceutical company Allergan has recently done just this by issuing a “social contract with patients” that made several drug pricing commitments to its customers. Among other assurances, Allergan has promised to limit price increases to single-digit percentage increases and no longer engage in the common industry tactic of dramatically increasing prices for branded drugs nearing patent expiry. Last year throughout the pharmaceutical industry, the prices of the most commonly-used brand drugs increased by over 16 percent and, in the last two years before patent expiry, drug makers increased the list prices of drugs by an average of 35 percent. Thus, Allergan’s commitment will produce significant savings over the life of a product, creating hundreds of millions of dollars in savings to health plans, patients, and the health care system.

If Allergan can make this commitment for its entire drug inventory—over 80+ drugs—why haven’t other companies done the same? Similar commitments by other drug makers might be enough to prevent lawmakers from turning to market-distorting reforms, such as price controls, that could end up doing more harm than good for consumers, the pharmaceutical industry, and long-term innovation.