Released under the GIC Framework
The following paper was written by a student at the Saint Louis University, Madrid. It focuses on the "pay for delay" activities of the pharmaceutical industry.
In 2003, the United States Congress passed the Medicare Prescription Drug, Improvement, and Modernization Act. This extensive overhaul of the medical assistance program for senior citizens was in part intended to make vital prescription drugs more affordable, particularly for those participating in the government-funded program. The original cost estimate of the bill was $400 billion, but it soon became apparent that the actual cost would be much higher. This discrepancy can be explained in part by political motivations of the original estimate and the difficulty of predicting seniors’ future health care choices; however, a large portion of the program’s massive price tag is due to prescription drugs’ high prices. These may seem unavoidable, but in fact the price of drugs is influenced by several practices within the pharmaceutical industry that artificially inflate prices at the expense of consumers.
Prescription drugs, like all goods, are subject to the market forces of supply and demand. When a pharmaceutical company releases a brand name drug for which it holds a patent, the supply of the drug is limited to the single company’s production. Additionally, the lack of legal competition allows the patent-holding company to set the price much higher than consumers would otherwise pay. Because of the high prices of patented drugs, a strong generic industry has attempted to lower prices through competition. However, no generics may be produced until the expiration of a drug’s patent, or so it would seem. This turns out not to be entirely true because of deals made between patent-holding companies and generic manufacturers as the patents near expiration, a period referred to as the “patent cliff”.
Under the Hatch-Waxman Act, generic drugs may enter the market before patent expiration if the manufacturer can prove in court that the generic drug does not infringe on a valid patent. The first generic to file with the FDA for early entry gets the added benefit of 180 days of exclusivity before other generics may enter. The profits from the drug during this period are essentially divided between the two companies, with the patent-holding company dropping their price to, typically, 60% of the original while the exclusive generic costs 40% of the original. This is beneficial for consumers because prices have gone down. Faced with a significant loss in brand name revenue from a generic entering the market, patent-holding companies resort to “pay-for-delay” deals following the patent litigation process. The patent-holding company pays the exclusive generic manufacturer and in return receives a promise that the generic drug’s release will be substantially delayed, keeping the brand name price at 100% for longer. The Federal Trade Commission found that between 2004 and 2009, 66 such deals were made.
The existence of these deals can be explained by simple economic principles. First, it is widely known that people and corporations respond to incentives. The exclusivity deals authorized under the Hatch-Waxman Act benefit both the exclusive generic and consumers, but negatively impact brand names. Pay-for-delay deals, though they have been ruled illegal under antitrust law, are mutually beneficial for the two companies and damaging to consumers. The benefit of pay-for-delay is most obvious for the patent-holding company, because its prices do not drop as early, maintaining profits as high as possible. The incentive is less clear for the generic manufacturer in this case because it does not get as much exclusive early market access. It benefits instead from either monetary compensation, or a promise that the brand name will not introduce a competing “authorized generic” to drain from its exclusive profits. This also illustrates the principle of thinking at the margin. The patent-holding company’s marginal profit on all the drugs it can continue to sell at 100% price exceeds the amount it must pay out to the generic, or the profit that it would earn from an authorized generic. Similarly, the payment received by the generic manufacturer in return for delay, or additional profits it will earn from the absence of authorized generic competition exceeds the marginal profit it would earn from entering the market as early as it had planned.
As we have already seen in the example of Medicare, the implications of this practice in the pharmaceutical industry are serious, not only for individual consumers but for the government as well. The recent FTC study previously cited estimated the deals’ cost to consumers at $35 billion dollars between 2010 and 2020. Most damagingly, patent-holding companies have a greater incentive to maintain high prices on their most popular, widely-prescribed drugs, making them the most likely targets for pay-for-delay deals that impose unnecessary and illegal costs on the greatest number of consumers.
The issue of prescription drug prices will continue to grow, as even greater drug benefits were created under the Patient Protection and Affordable Care Act. For both Medicare and public option patients, the government emphasizes low-cost options to minimize the programs’ budget impacts. However, the high costs of prescription drugs under pay-for-delay deals increase both consumer and government opportunity costs of buying drugs, limiting consumers’ ability to purchase other goods and reducing the amount of the federal budget that can be spent on discretionary projects. The government interest has increased attempts to regulate the industry, including an FTC recommendation for legislation banning the deals. Without definite action declaring pay-for-delay a violation of antitrust law and imposing penalties, the incentives are too great for companies to voluntarily cease this anti-consumer activity.
Alazraki, Melly. “The 10 Biggest-Selling Drugs That Are About to Lose Their Patent”. AOL Daily Finance. 27 Feb. 2010. Accessed 23 March 2011. http://www.dailyfinance.com/story/ investing/top-selling-drugs-are-about-to-lose-patent-protection-ready/19830027/
Kemper, Vicki. “Medicare Drug Benefit Plan to Far Exceed Cost Estimate”. The Los Angeles Times. 30 Jan. 2004. Accessed 3 April 2011. http://articles.latimes.com/2004/jan/30/nation/na-medicare30
Saftlas, Herman. “Generics look to impending branded patent cliff”. Standard & Poor’s Industry Surveys. 25 Nov. 2010. Accessed 23 March 2011. http://www.netadvantage. standardandpoors.com.ezp.slu.edu/NASApp/NetAdvantage/showIndustrySurvey.do?code=hep
Other background information provided by: M∙CAM, Inc., Charlottesville, Virginia.