RWJF Investigator Award Winner Takes Close Look at Market Incentives Provided to Pharmaceutical Industry

    • January 5, 2011

In 2009, the top five pharmaceutical companies in the United States reported profits of more than $41 billion, on revenues in excess of $191 billion. The rest of the industry does well, too, regularly ranking near the top of the Fortune 500 annual list of most profitable industries, coming in third in 2008, with profits representing 19 percent of revenue.

Given that profit margin, some might be surprised to discover that much of the industry’s revenues are built on market incentives provided by the federal government. The purpose of those incentives—which include tax credits and research grants, full control of intellectual property discovered with government resources and extended periods of market exclusivity for their prescription drugs—is to encourage pharmaceutical companies to develop new drugs to combat particular types of diseases or to conduct research aimed at expanding the approved uses of existing drugs.

But a November article in the New England Journal of Medicine by Aaron Kesselheim, M.D., J.D., M.P.H., a 2009 recipient of a Robert Wood Johnson Foundation Investigator Award in Health Policy Research, raises questions about whether such incentives are cost-effective or actually work as intended. Kesselheim notes that the number of new drugs coming onto the U.S. market has hit a low point, with the average number of new drugs approved each year by the Food & Drug Administration (FDA) now running about 40 percent lower than a decade ago. The decline in the development of new drugs is not a reflection of any shortage of demand for new products, Kesselheim writes, but it has triggered calls to further expand government-sponsored financial incentives for the pharmaceutical industry.

After winning FDA approval for a new drug, pharmaceutical companies are rewarded with a multi-year period of market exclusivity, meaning that no other company may compete with the developer by marketing a copy of it. That exclusivity allows manufacturers to set the price point for their product, which can help them recoup the upfront investment in research and development and earn a profit. Once the exclusive period expires, their competitors may market generic versions, and often do so at much lower prices closer to the cost of production.

Extensions of that period of exclusivity can be worth billions of dollars to the industry, and, as Kesselheim writes, they “are politically attractive because they offer support for drug innovation without direct allocation of taxpayer funds.” But, he continues, “Patients (or their insurers) bear the costs by paying higher prices for the products during market-exclusivity periods. These programs may also be subject to misuse if they are implemented in a way that permits the incentives to be earned for marginal innovations or in contexts beyond the intended scope of the legislation.”

Taking a Closer Look

Kesselheim’s article explores five major legislative schemes that have used market exclusivity incentives to encourage research and development of drugs, taking a careful look at their impact, including their unintended consequences.

  • The Bayh-Dole Act of 1980 was intended to encourage commercial development of research funded by the government, and it encouraged private control of inventions funded by federal grants. It is typically credited with paving the way for cooperation between industry and university-based researchers in product development.
  • The Orphan Drug Act of 1983 was designed to create incentives to industry to develop drugs to treat rare diseases. The small numbers of patients requiring such drugs could otherwise make it difficult for the pharmaceutical companies to recover the costs of development, so the law provided grants for research, a tax credit for clinical trials and a seven-year period of exclusive marketing for FDA-approved orphan drugs.
  • The Waxman-Hatch Act of 1984 extended market exclusivity to account for patent time manufacturers lost during the FDA’s review. The law also used market incentives to encourage companies to develop generic drugs, granting the first manufacturer of a given generic six months’ exclusivity before other generic companies could sell their versions.
  • The Prescription Drug User Fee Act (PDUFA) of 1992 was a response to concerns about the length of FDA’s approval process. It allowed FDA to collect user fees from companies seeking drug approval, and use the fees to speed up its review.
  • The Pediatric Exclusivity Extension, a provision of a larger 1997 law, took aim at the lack of research on the pediatric applications of drugs. Children’s physiology is different than adults’, so only by conducting additional research can manufacturers establish the efficacy and safety of their products for children. But because children are infrequent consumers of drugs, industry had little economic incentive to conduct that research. The law allowed a half-year extension of exclusivity for new drugs if the manufacturer studied their use in children.

By virtue of these and other pieces of legislation, market exclusivity incentives have become a mainstay of public policy around drug development. But Kesselheim wanted to know if these five programs have really worked as intended. “My goal,” Kesselheim said in an interview, “was to dig down into each of these federal legislative programs, and find out what evidence there is in the literature of their impact.”

A ‘Mixed Bag’

His conclusion: “It’s a bit of a mixed bag. For example, there’s a myth that the Bayh-Dole Act was an incredibly important piece of legislation, without which there wouldn’t be drug development. There’s a similar myth about the Orphan Drug Act—that it was a leading force behind a bunch of new drugs. But when you look at the data, the record is not so clear.”

One area of particular focus for Kesselheim is possible abuses by industry of the exclusivity policies. “Incentives can be very powerful,” he explains, “and there are definitely examples where they’ve worked as anticipated. But there are too many examples where drug developers have taken advantage of the system, or where the incentives have provided undeserved windfalls for work that would have happened anyway. So, in general terms, what we’re doing is creating relatively inefficient programs that can be easily gamed. We see a lot of unanticipated consequences, because the legislation as written didn’t anticipate these collateral effects.”

Such abuses might include a manufacturer seeking FDA approval of a specific drug for a rare form of cancer, thus qualifying for special exclusivity under the Orphan Drug Act, even though the drug is clearly effective for uses beyond that particular cancer. “Manufacturers may predict that the drug will be used more widely after it’s approved,” Kesselheim says, referring to post-approval use of a drug for off-label purposes. Physicians often prescribe drugs off-label, particularly if they have reason to believe the drug will be safe and effective. As a result, the incentives might allow a manufacturer to benefit from extended marketing exclusivity, while still reaching the broader market. But the limited pre-market testing of the drug, as well as the higher price that results from the absence of a generic competitor, can harm patients and the health care system.

Similarly, Kesselheim notes, the Pediatric Exclusivity Extension “doesn’t require an optimal study with maximal public health benefit, just a study.” So a “poorly designed pediatric trial, or a trial that is performed as a patent is close to expiring,” can nevertheless earn a six-month extension of market exclusivity, he says.

In addition, he writes that the accelerated FDA review of drugs encouraged by PDUFA may also have contributed to some of the regulatory failures in the drug market of the last decade, such as the cholesterol-lowering agent cerivastatin (Baycol) and the anti-inflammatory drug rofecoxib (Vioxx), both of which were withdrawn from the market after they were shown to pose safety hazards to patients. Studies have shown that drugs authorized by the FDA close to an arbitrary regulatory deadline demonstrated important safety issues after approval.

Future Incentives?

One lesson that Kesselheim draws from his work is that future policy decisions ought to better account for such potential inefficiencies and collateral effects. “[I]incentive programs should be implemented in a way that encourages fairness and more closely links the incentive to the desired outcome,” he writes. “For example, in Europe, orphan drug legislation includes a reduced exclusivity period once use of the product expands.”

“Another way to prevent manufacturers from taking undue advantage of incentive programs would be for them to return the government's initial investment with a reasonable rate of return if an orphan drug becomes exceedingly profitable,” he continues. “In the case of pediatric exclusivity, direct federal grant support (and perhaps a small bonus) could be provided to encourage researchers to conduct needed trials. Another possibility would be to calibrate the value of the incentive on the basis of the actual public health outcomes among pediatric patients.”

“My paper was an effort to encourage a more systematic review of these statutes when they come up for reauthorization, or a more measured prospective analysis of similar legislative proposals” Kesselheim says. “We’re not seeing the kind of rational policymaking we need in this area.”

Kesselheim’s work on the subject was supported by the RWJF Public Health Law Research Program and his 2009 RWJF Investigator Award in Health Policy Research.