States considering pricing drugs by how much their development costs

The latest round in the battle to cut drug prices has seen 10 US states, including California, New York and Pennsylvania, considering legislation that will force pharmaceutical companies explain the pricing structures behind their most expensive drugs, from R&D costs to levels of public grants. Last year, a Senate Finance Committee investigation concluded that the pricing of Sovaldi, Gilead Sciences’ hepatitis C drug was based on "maximising revenue, with affordability and accessibility… an afterthought". In April this year, pharmaceutical manufacturer Valeant collapsed, following a scandal which revealed it raised the prices of its drugs by up to 20 times.

At least 10 states are pondering a radical approach to putting a leash on soaring drug prices: force drug companies to explain how they arrived at the price of their costliest new drugs.

The approach is radical not in the sense that it’s a new idea, but in the sense that it hasn’t been tried before. The idea is that the prices of some blockbuster new drugs—and some hard-to-get old drugs—are opaque. The only source for the cost of research and development or acquisition in the drug business is Big Pharma itself. The industry is anything but a reliable source, as we’ve reported before.

Accordingly, California and eight other states have recently considered legislation to pull back the curtain. Most follow a common pattern. They identify the drugs that have risen in cost most sharply or represented the largest expenditure by public medical programs, and require their manufacturers to provide data justifying the price. California’s measure, which passed the Senate this month and is before the Assembly, would allow the drug makers to limit R&D disclosures to publicly available information, but also would require disclosure of the planned marketing budget and acquisition cost for a new drug. It applies to brand-name drugs whose wholesale prices have increased by more than $10,000 or 10% in a year, and to generics priced at $100 per month or more, or that have had price hikes of 25% in a year.

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The price of a drug should reflect not only an assessment of its clinical benefit...but also the effort and resources expended in its creation. — Ameet Sarpatwari, et. al., explaining the rationale of price transparency laws

Several proposals are more stringent. Colorado, New York, Oregon, and Pennsylvania would demand to know a drug’s R&D, acquisition, manufacturing, marketing and advertising costs, and the degree to which public grants helped finance the research. The drug industry has fought these measures vehemently. Several already have been put on hold, and only Vermont’s has been enacted into law.

These measures have become popular because of evidence that the prices of blockbuster brand-name drugs as well as newly-acquired generic drugs have little to do with the cost of inventing them or bringing them to market. Instead, drug makers are more likely to price them at what the market will bear.

That was the conclusion of a Senate Finance Committee investigation last December into the pricing of Sovaldi, Gilead Sciences’ blockbuster hepatitis C drug. Sovaldi, which was list-priced at $84,000 per 12-week treatment, helped set off the public uproar over drug prices; the pills were so effective as a cure of the virus that the cost threatened to bankrupt public health programs that felt bound to provide it to their hepatitis patients.

Gilead’s plan was “to maximize revenue, and affordability and accessibility was an afterthought,” said Sen. Ron Wyden (D-Oregon), who co-produced the report with Committee Chairman Chuck Grassley (R-Iowa). The company determined that revenue would keep rising up to a price of about $96,000, at which point the loss of patients would start cutting into sales. But above about $80,000, a public reaction might set in.

Valeant, another poster child for pharmaceutical profiteering, provides another clue to the impetus behind high prices. As detailed in a recent case study by David F. Larcker and Brian Tayan of Stanford’s business school, Valeant’s largest institutional investor, the hedge fund ValueAct, concluded that in-house research for new drug development was not cost-effective. Neither did J. Michael Pearson, the former McKinsey & Co. consultant who ValueAct recruited to serve as Valeant’s chief executive in 2008.

“The company also looked for situations of untapped pricing power in existing drugs,” Larcker and Tayan write. Pearson told an interviewer that “R&D on average is no longer productive.”

Pearson’s compensation was based almost exclusively on exploiting cherry-picked research projects started by others, and turbo-charged so that increases in Valeant’s stock market return yielded exponentially larger profits for Pearson.

Pearson “reduced the research and development budget, slashed corporate overhead, and launched a string of acquisitions and licensing deals to bring in new products.” The company acquired more than 30 companies for a total of more than $30 billion, including one deal for the Canadian company Biovail that was structured as an inversion to cut Valeant’s overall effective tax rate permanently from 36% to 3.1%.

But Pearson’s public-be-damned strategy and his mortgaging of Valeant’s R&D future for short-term gain was destined to end in tears. The model of charging astronomical prices for drugs that cost only a fraction of those rates to acquire and manufacture led to congressional scrutiny of its pricing methods, which involved jacking up the prices for some newly acquired drugs 20-fold. Examination of its financial disclosures and business relationships followed, then a stock crash, and Pearson’s departure in April 2016.

Valeant’s behavior has helped to turn the spotlight on even the largest brand-name drugmakers, and their assertion that high prices are necessary to recoup the billions of dollars they spend to bring new drugs to market. In 2014, researchers at Tufts University estimated this cost at $2.6 billion per drug—a big advance from the $800 million the same researchers estimated in 2003. But this estimate has provoked widespread skepticism, in part because the underlying data come from unidentified drug companies and are confidential. Moreover, the estimates don’t account for the industry’s public subsidies—tax breaks, federal grants and taxpayer-funded research at public universities.

It’s possible that “more than half of the most transformative drugs developed in recent decades had their origins in publicly funded research at nonprofit, university-affiliated centers,” observed Jerry Avorn of Harvard Medical School in an analysis last year.

More public disclosure of the real costs that go into drug research, development and marketing certainly would help policy-makers deal with drug pricing. But there may be reasons to doubt that the approach of state legislators to mandate more disclosure will work.

One is whether public agencies should even have the right to dictate whether a company should be “allowed to recoup the costs of a failed drug for Alzheimer’s disease by raising the price of a new drug for diabetes,” Avorn and two Harvard colleagues wrote in a recent article in the New England Journal of Medicine.

Nor is it settled public policy that the price of a drug should be based more on its cost of development and manufacture than on its cost-effectiveness. Sovaldi, for example, could eliminate hundreds of thousands of dollars in future medical costs for hepatitis C sufferers—far more in the long run than its one-time upfront price.

The transparency laws, in short, would certainly bring the public more information, but it’s uncertain that the data would lead to lower drug prices. The battle for the bottom line is destined to continue.

Keep up to date with Michael Hiltzik. Follow @hiltzikm on Twitter, see his Facebook page, or email michael.hiltzik@latimes.com.

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