Impact of Payer Policies on Pharmaceutical R&D

The Impact of Financing Policies on R&D
and Pharmaceutical Firms’ Strategies
Jorge Mestre-Ferrandiz
Office of Health Economics
Imperial College
London • 23 May 2013

The impact of financing policies on R&D and pharmaceutical firms’ strategies
• Context
• Supply Side Issues
• The R&D process and patent system
• Economics of the R&D process: dynamic competition
• R&D costs: what makes up the cost of an NME
• Interaction between the public/charitable and private sector in
medical research: complementarity vs. substitutability
• R&D incentives: ‘push’ vs. ‘pull’ (with key examples)
• Capital and the ‘market for technology’
• Final remarks
Agenda
2

Structure
3
Time
£
Supply Issues
• R&D process
• Cost of an NME
• Public/private
collaborations
• R&D incentives
• Capital market
Nature of competition
• Follow-on compounds
(dynamic)
Competition in the
off-patent segment
Demand / Regulation
• Role of HTA
• Uptake drivers
• Prescribing Incentives
• Demand vs. Supply
controls
t0
t1
t2 t3
Launch
Patent
expiry

The pharmaceutical market ‘virtuous’ cycle
4

Pharma ranks highest in R&D intensity
5

Highest R&D investment in absolute terms
6

Pharma accounts for large share
of countries’ R&D expenditure
7

• Supply is R&D intensive, which implies:
• Intellectual property rights (patents)
• Long lead times
• High risk
• Dynamic competition is as important as static competition
• Generic competition after patent expiry
• Demand is regulated – governments and social insurers are
major buyers of medicines
• Prices are regulated
Characteristics of medicines markets
8

1. R&D costs of successful new medicines (including drugs that fail to reach the market) have increased
over the last four decades
2. Drug companies have traditionally focused their evidentiary development around regulatory (i.e. FDA
and EMA) requirements
3. Decision-making power of public and private payers has grown and payers in rich and emerging
economies are becoming interested in evidence of value by using health technology assessment (HTA)
to inform health care resource allocation decisions
4. The methods being employed by companies to demonstrate evidence of product value (notably
effectiveness) to payers are moving them away from the (placebo-controlled) randomized controlled
trial traditionally used to demonstrate product efficacy and safety for regulatory approval
5. There is a significant and growing interest among both the payers and producers of medical products
for agreements that involve a “pay-for-performance” or “risk-sharing” element
9
Context for a changing R&D and
evidentiary environment

• In the US, the regulatory framework still relies on stringent placebo
controlled trials to obtain precise and reliable efficacy information.
• Comparative trials are relatively unusual in submissions to the FDA.
o But seeing a changing trend already
• The legal framework in the EU is more complex than in the US.
• Current legislation provides for the EMA to request companies to
conduct active comparator studies: “In general, clinical trials shall
be done as ‘controlled clinical trials’ if possible, randomised and as
appropriate versus placebo and versus an established medicinal
product of proven therapeutic value; any other design shall be
justified”.
Context 2: Focus on regulatory requirements
10

Context 3: Increased payer influence
11
Source: McClearn and Croisier (2011)
• Health care payers increasingly
require some level of HTA after
marketing authorization to assess
the new benefits of an
intervention including demanding
more evidence of comparative or
cost effectiveness for new drugs
• Focus on ‘value for money’ not a
new phenomenon, especially in
Europe
• But recent health care reforms
and cost containment are
probably making ‘value for
money’ even more important

• The EMA explicitly acknowledges potential disconnect between
regulatory and HTA needs: “In contrast to the benefit-risk
assessment carried out by regulators, HTA bodies compare the
relative effectiveness of medicines and take their financial cost into
account. This can lead to differences in the types of studies needed
to support the assessment carried out by regulators and HTA
bodies”.
• In addition, evidentiary needs across payers may differ. A key issue
here revolves around the choice of the appropriate comparator(s)
for assessment purposes, where the comparator in a multi-national
trial may represent standard therapy in some countries, but not in
others
Context 4. Methods
12

Taxonomy
Context 5. PBRSA
13
Source: Garrison, L. et al. (2013)

• Originally, schemes were more complex and varied in nature; now, the trend is
towards simple discounts, due to confidentiality agreements.
• Two-thirds of schemes are for cancer and one quarter for immuomodulating
biologics (mainly TNF’s).
14
Context 5. PBRSA, cont’d

• Context
• Final remarks
Agenda
15

Understanding the R&D process
16
Phase
IV
REGULATION
TIME (YEARS)
PHASES OF
DRUG
DEVELOPMENT
Phase III
Development research
Final patent
application
Marketing
application
Post-mktg
research
2002-7
Discovery research
Investigational new
drug application (US)
1999
Phase Phase IISynthesis
Biological testing &
pharmacologic
screening
2008
Marketing
approval/
product launch
2010
Regulatory
review
Basic
research
Short-term animal testing
Long-term animal testing
Toxicology and pharmacokinetic studies
Chemical development
Pharmaceutical development
ATTRITION
RATES
COST

• A patent is a set of exclusive rights granted by a state
(national government) to an inventor or their assignee for a
limited period of time in exchange for a public disclosure of an
invention.
• Patents have a dual function:
1. To put information in the public domain
2. To incentivise research by conferring time-limited
exclusive rights to exploitation of inventions.
• For pharmaceuticals: high R&D costs, but low production
costs. Patents prevent copies from competing on the marginal
cost of production; no incentive otherwise to develop new
drugs.
• Thus, patents aid dynamic efficiency.
Dual role of patents
17

• A patent provides the right to exclude others from
making, using, selling, offering for sale, or importing the
patented invention for the term of the patent.
• Incentives depend on respect of intellectual property
rights.
• Under the World Trade Organization's (WTO) Agreement
on Trade-Related Aspects of Intellectual Property Rights
(TRIPS), patents should be available in WTO member
states for any inventions, in all fields of technology.
• The term of protection available should be minimum 20
years.
The patent system generally
18

• Applies to pharmaceuticals
• But ‘effective patent life’ for pharmaceuticals is shorter due to
the lengthy R&D and regulatory (market authorisation)
process required before a new medicine can be made
available
• Protection time can be increased by a further maximum
period of five years in the US, Japan and Europe
• Europe: Supplementary Protection Certificates (SPCs)
introduced in 1993 in some countries, and later extended to
all of them. SPCs cannot come into force until the relevant
patent has expired. SPCs were designed to compensate for
the lengthy R&D process.
The patent system and medicines
19

• Most new medicines are developed by the private sector.
• Patents do not guarantee monopoly power.
• The “innovation race” produces competition between
patent-protected medicines treating the same, or
overlapping, patient groups.
• Being the first in class does not imply being the best in
class.
• Efficient R&D and achieving the right mix and quantity of
R&D depend on the right rewards being available for
successful innovation.
Economics of the R&D process:
monopoly and competition
20

Development of follow-on and first-in-class drugs often occurs almost simultaneously.
Since much R&D in the pharmaceutical industry is simultaneous, is difficult to
meaningfully distinguish between R&D that is directed to the first available treatment
for any particular indication and follow-on products.
The innovation race
Percentage of follow-on drugs approved in the US from 1960 to 2003 that were first tested in humans anywhere
in the world or had an IND filed prior to that for their first-in-class compound (for therapeutic classes where the
first-in-class drug was approved in the US from 1960 to 1998).
In a substantial number of
cases in recent periods, the
first drug in a class to reach
the US marketplace was not
the first to enter clinical
testing either in the US or
anywhere in the world.
21
Source: DiMasi and Paquette (2004)

Periods of marketing exclusivity have been shrinking for first-in-class medicines as a
result of therapeutic competition from follow-on medicines.
Innovation race brings competition
Average period of marketing exclusivity for first entrants to a therapeutic class (time from first-in-class approval to first
follow-on drug approval) by period of first-in-class US marketing approval.
The data show a sharp decline
in the period of marketing
exclusivity for first entrants
since the 1970s. The mean
length of the marketing
exclusivity period fell 78%
from the 1970s to 1995-8
(from 8.2 to 1.8 years).
22

Consider the therapeutic ratings that the US FDA has assigned to follow-on drugs.
Approximately one-third of all follow-on drugs have received a priority rating from the
US FDA. In addition, 57% of all therapeutic subclasses have at least one follow-on drug
that received FDA priority rating.
First in class ≠ Best in class
FDA therapeutic ratings for follow-on drugs Sub-classes with at least one follow-on with a priority rating
23

• Pharma has high fixed R&D costs (and associated costs of
capital) and relatively low marginal costs (MC) of production.
• Therefore, MC pricing would not enable break-even.
• Patents enable price > MC, if competition from other
molecules is weak.
• Hence price/profit regulation imposed to control the price on
the assumption that competition is ineffective in doing so.
• Defining an appropriate margin is theoretically and empirically
problematic.
• R&D is a global joint sunk cost—it is the same whatever the
number of users internationally. Hence, it is practically
impossible to attribute R&D costs to particular users, or even
to particular national markets.
R&D costs
24

The impact of financing policies on R&D and pharmaceutical firms’ strategies 25
Mestre-Ferrandiz, J., Sussex, J. and Towse, A. (2012) The R&D Cost of a New Medicine. London: Office of
Health Economics. [Available at: www.ohe.org]

• How much it costs to research and develop a successful
new medicine has been an important policy issue at
least since the 1960s.
• Cost estimates matter not just because of intellectual
curiosity or for industry understanding of its
performance, but because they are a key aspect of the
international debate about the reasonableness of
pharmaceutical prices and the magnitude of the long-
term investments involved.
• Moreover, a related debate continues about whether the
research and development (R&D) productivity of the
biopharmaceutical industry has fallen.
R&D costs – why important?
26

• Published estimates of the mean (average) cost of R&D per
new medicine that is launched on the market suggest an
increase in cost over the last decade -- from the estimate of
US$1.0bn (£600m) by DiMasi et al. (2003), expressed in 2011
price terms, to US$1.9bn (£1.2bn) by Paul et al. (2010).
• Our new estimate is US$1.5bn (£900m) and therefore lies
between the DiMasi and Paul estimates.
• Estimates of mean R&D costs per new medicine, and
comparisons between such estimates, must be treated with
caution: studies differ in both methodology and data used.
Key studies
27

The cost of an NME is rising
28
Source: Mestre-Ferrandiz, Sussex and Towse (2012)

Key studies
29

• Out-of-pocket costs
• Discovery research and preclinical development
costs
• Clinical
• Clinical success and phase attrition rates
• Capitalisation costs
• Development times (long)
• Cost of capital (high)
Determinants of the cost of an NME
30

Out-of-pocket costs
• Out-of-pocket
development
costs, before
adjusting for
failures, appear
to have increased
over time. Similar
estimates for
total out-of-
pocket devel-
opment costs but
less consistent
across clinical
trial phases
Success rates
• Cumulative
clinical success
rates appear to
have decreased
over time. The
probability is
shrinking that a
candidate
entering Phase I
clinical trials will
in due course be
authorised to be
launched onto
the market
Development times
• The total time
taken to progress
through all
phases of clinical
trials and market
authorisation
appears to have
remained rela-
tively unchanged
since the early
2000s
Cost of capital
• The long time-
scales of pharma-
ceutical R&D
mean that the
cost of capital has
a major impact
on the final cost
per drug and so
the estimated
development cost
per successful
drug is highly
sensitive to the
cost of capital
applied. An 11%
real annual cost is
commonly used.
Determinants of the cost of an NME: evolution
31

• Commercial reasons have been increasingly important
for discontinuing projects.
• Since 2000, companies have been focusing more on high
risk, high premium areas with a lower ‘expected
probability of success’ (POS), such as:
• Chronic diseases (Alzheimer’s disease, diabetes, obesity,
rheumatoid arthritis) compared to acute diseases (6.9% vs
8.8%)*
• Potentially lethal diseases, mostly cancer and some
infectious diseases (5.5% vs. 9.7%)*.
Attrition rates: reasons for failure
32
*Source: Pammolli, F., Magazzini, L. and Riccaboni, M. (2011)

Criticisms Rebuttals
Data – confidential, comes from companies
directly and cannot be replicated
Other recent studies have either used publicly
available information or have used different
confidential data (like ours)
Only self-originated compounds are included and
these represent a small proportion of new drugs –
and the most expensive ones
Decreasing importance of self-originated
compounds relative to licensed-in compounds is
valid, but has become so perhaps only recently.
More recent estimates cannot differentiate so
apply also to a wider universe of compounds, not
just self-originated compounds
Estimates should not be capitalised, given that
companies are not investment houses and have no
choice but to spend money on R&D
Out-of-pocket costs are merely one part of the
total cost. Capitalised costs are real costs.
Investors require a return that reflects alternative
potential uses of their investment
Estimates are pre-tax, so they do not reflect the
fact that R&D expenses are deductible
Societal perspective when thinking about the costs
of R&D of new medicines: total cost of developing
a new drug will be the same no matter who pays --
tax rebates affect who bears the costs, but not the
total amount
Estimated costs of an NME are controversial
33

• Published estimates, including ours, that refer to the
mean cost of R&D per new medicine are just that:
averages
• The literature shows that the costs of R&D vary with
the subgroup of drugs included in the analysis
• Costs vary according to therapeutic area, firm size
and whether the molecule is a ‘traditional’ chemical
compound or a biologic
Warning: mean costs may hide important fifferences
34

• Important variations around the mean cost per NME for
different types of medicines are observable
• Significant differences are evident in the cost of R&D for new
medicines across therapeutic areas – can be more than
twofold
• Licensed-in compounds tend to be more successful than self-
originated NMEs
• Drugs with a more validated target and more objective
endpoints are more successful than drugs with more novel
mechanisms of action and less clear cut endpoints
• Total capitalised costs for biologics appear to be higher than
for other pharmaceuticals
Key findings – variations around the mean
35

• On-going debate: does public and charitable funded
research crowd-out private (commercial) research that
would otherwise have taken place, or does it stimulate
additional private research to take place, or neither?
• Evidence from published literature: supports the result
that public research is complementary to private sector
research and development (R&D) activity. That is,
public/charitable research stimulates additional private
R&D that would otherwise not have been carried out.
Public and private funding of medical R&D
36

Two estimates of how much private R&D is
stimulated by public medical research
Toole (2007): Distinction between basic and clinical research
↑ $1 public research Additional private R&D After how many years?
Basic $8.38 8
Clinical $2.35 3
Ward and Dranove (1995)
↑ 1% public basic research in a particular therapeutic area (by US NIH)
↑ 0.76% in private R&D in same
therapeutic category over 7 years
↑ 1.71% in private R&D in other
therapeutic category over 7 years
In total, a 1% increase in public basic research across the board will generate up
to a 2.5% increase in total private pharmaceutical R&D spend
37

• Mechanisms facilitating the transmission of
knowledge from the public to the private sector:
• Universities (taken to represent publicly funded research)
• Networking and social interactions
• ‘Absorptive capacity’ (the ability of firms to assimilate and
exploit existing information to create new knowledge).
• These different channels through which public
research can affect (positively) industrial R&D are
even more important in the pharmaceutical sector
than in other sectors.
Medical research spillovers
38

• What is the case for specific incentives for biomedical R&D?
• ‘Market failures’ – public-good nature (‘externalities’); lack of effective
demand/low expected return in some cases (e.g. neglected diseases,
orphan drugs)
• High level of uncertainty due to significant scientific challenge at early
stage (basic research and pre-clinical) and recurrent risk of failure at
clinical phases
• Large investment required (vs. other sectors)
• Role for ‘public’ intervention/additional incentives
• Broadly speaking, incentives can be ‘push’ or ‘pull’
The case for R&D incentives
39

R&D incentives: ‘push’ and ‘pull’
Key distinction Whether or not the reward is conditional on having
a successful product on the market
Push incentives fund or reward R&D effort ex ante, i.e. regardless of
outcome
Pull provides rewards for R&D effort ex post if the outputs of R&D
achieve health gain
Hybrid approaches:
Push funding can be partly conditional on outcome as well as effort
Pull funding may be staged and reward intermediate outcomes prior to
delivery of a product
40

‘Push’ incentives
Push initiatives: pay as you go
• US National Institutes of Health: funding for specific trials or discovery
programmes within broad portfolio objectives
• Product Development Partnerships (PDPs): funding for specific trials or
development /discovery programmes within a portfolio to achieve
licensed products
• Tax incentives to subsidise the costs of R&D: three possible forms: (1)
tax credits, (2) tax allowances and (3) tax deferrals
• Low interest finance for development
41

‘Pull’ incentives
Pull initiatives: pay for final deliverable
• Advance Market Commitment (AMC): funding to purchase products not
yet completed development. The funding includes a return on R&D
• GAVI Fund: funding to purchase products already on the market through a
supply contract
• US Priority Review Vouchers: priority FDA Review as a reward for a
neglected disease product
• Transferable/roaming intellectual property rights (TIPR): Company is
awarded additional IP on a product of its choice in exchange for developing
a given (neglected) disease product
• Prizes: create a prize equal to the social value of innovation through a
system of patent buyouts
42

• US Orphan Drug Act (1983)
Contains two main incentives:
• Income tax credit = 50% of
clinical trial expenses (lowers
cost)
• 7 year market exclusivity
(addresses low demand)
• ODA is regarded as very successful
at stimulating R&D and delivering
products for orphan diseases
• Impact of tax credits not enough
in markets with small revenue
potential (Yin, 2009)
Orphan drug legislation:
hybrid ‘push’ and ‘pull’
• EU Orphan Drug Legislation (1999)
Inspired by US ODA
• Mainly ‘pull’ incentive: provides 10-
year market exclusivity for approved
orphan products
• Additional ‘push’ support:
• Easier (and cheaper) marketing
approval process
• Provides possibility for a single,
EU-wide marketing
authorisation
• Deemed also as a good starting
point
43

Case study: impact of EU orphan drug
legislation (1)
3
5 5
6
3
13
14
7
12
0
2
4
6
8
10
12
14
16
2001 2002 2003 2004 2005 2006 2007 2008 2009
Number of orphan medicinal products in the community register of medicinal products
for human use, 2001-2009
Source: European Commission (2013).
NB This is the situation as of 17 June 2010 – by this date, three OMPs had been included in the Community Register in 2010.
44

Influence of EU OMP legislation in shaping company’s
strategic decision-making in the EU
Key features of the EU OMP legislation (ranked ‘Most important’ to
‘Third most important’)
Average growth in R&D expenditure
Case study: impact of EU orphan drug
legislation (2)
Source: Mestre-Ferrandiz, et al. (2010) for OHE Consulting
45

Capital markets: cost of capital is high
Study Real annual cost of capital
Hansen, 1979 8%
Wiggins, 1987 8%
DiMasi et al., 1991 9%
OTA, 1993
10% and 14% down
to 10% ‘staircase’
DiMasi et al., 2003 11%
Adams and Brantner,
2006
11%
DiMasi and Grabowski,
2007
11.5%
Vernon et al., 2009 14.36%
Paul et al., 2010 11%
46

Capital market imperfections
• Limited availability of funding for high risk or small
projects
• Squeezed cash resources – both venture capital and equity
• Large pharma seen as major source for funding
beyond the start-up phase
• Hence the growth of numerous joint working
arrangements from licensing to strategic alliances
• Known as the ‘market for technology’
47

• Context
• Final remarks
Agenda
48

Reduced incentives for innovation
means less innovation
• Policy makers understand this for neglected diseases
and orphan drugs
• ‘Push’ incentives for R&D
• R&D tax credits
• Grants
• Fast-track approval
• Subsidised capital
• ‘Pull’ incentives:
• Purchase funds
• Prizes
• Roaming exclusivity
• So why not for all medicines?
49

References
DiMasi, J. et al. (2003) The price of innovation: New estimates of drug development costs. Journal of Health Economics. 22(2),
151-185.
DiMasi, J.A. and Paquette, C. (2004)The economics of follow-on drug R&D: Trends in entry rates and the timing of development.
PharmacoEconomics. 22(Suppl 2), 1-14.
European Commission. (2013) Register of designated Orphan Medicinal Products (by number). Available at:
http://ec.europa.eu/health/documents/community-register/html/orphreg.htm
Garrison, L. et al. (2013) Performance-based risk-sharing arrangements—good practices for design, implementation, and
evaluation. An ISPOR Task Force Report. 16(5): forthcoming.
McClearn, C. and Croisier, T. (2011) Big pharma’s market access mission. Cambridge, MA: Monitor Company Group.
Mestre-Ferrandiz, J., Garau, M., O'Neill, P. and Sussex, J. (2010) Assessment of the impact of orphan medicinal products in the
European economy and society. OHE Consulting Report. London: Office of Health Economics. [Available at: www.ohe.org]
Mestre-Ferrandiz, J., Sussex, J. and Towse, A. (2012) The R&D Cost of a New Medicine. London: Office of Health Economics.
[Available at: www.ohe.org]
Pammolli, F., Magazzini, L. and Riccaboni, M. (2011) The productivity crisis in pharmaceutical R&D. Nature Reviews Drug
Discovery. 10(6), 428-438
Paul, S.M. et al. (2010) How to improve R&D productivity: The pharmaceutical industry's grand challenge. Nature Reviews Drug
Discovery. 9(3), 203-214.
Toole, A. (2007)Does public scientific research complement private investment in research and development in the
pharmaceutical industry? Journal of Law and Economics. 50, 81–104
Ward, M.R. and Dranove, D. (1995) The vertical chain of research and development in the pharmaceutical industry. Economic
Inquiry. 33(1), 70-87.
Yin, W. (2009) R&D policy, agency costs and innovation in personalized medicine. Journal of Health Economics. 28(5), 950-962

To enquire about additional information and analyses, please contact Dr.
Jorge Mestre-Ferrandiz at jmestre-ferrandiz@ohe.org
To keep up with the latest news and research, subscribe to our blog, OHE News
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Impact of Payer Policies on Pharmaceutical R&D

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