Valuing Medical Innovation.

• Author: Hemel, Daniel J.
• Position: United States drug pricing system

Table of Contents Introduction I. How We (Mis)Value Medical Innovation A. Market Exclusivity and Its Discontents 1. Underinvestment a. Long commercialization periods b. Positive externalities c. Preventives vs. treatments 2. Overinvestment B. Problems with the U.S. Hybrid Model 1. Medicare 2. Medicaid 3. ACA coverage mandates II. Rewarding Medical Innovation Based on Social Value A. The Core of the Case for Value-Based Rewards B. Valuing Health Gains 1. The ICER value assessment framework 2. Evaluating the ICER framework a. Undervaluing QALYs and evLYGs b. Discounting future costs and benefits C. Transitioning to Value-Based Pricing 1. Timing 2. Institutional dimensions D. Applying Value-Based Pricing 1. Trikafta 2. HPV vaccines III. Alternative Drug Pricing Reforms A. "Negotiated" Drug Prices B. Cost-Based Pricing C. Why Use Ex Post Rewards? IV. Objections to Value-Based Rewards A. Cost for Patients B. Cost for Government Budgets C. Paying More than Other Countries D. Exacerbating Inequality E. Deadweight Loss of Taxation or Racing Conclusion Appendix: Calculating QALYs Introduction

The United States' drug pricing system is "broken." (1) On this point, there is broad, even bipartisan, consensus. (2) But what is less clear is how and why the system is broken, and what to do about it.

One common view--especially but not exclusively on the political leftholds that U.S. drug prices are too high. Per capita pharmaceutical spending in the United States is 42% higher than in Canada, 83% higher than in France, and 89% higher than in Australia. (3) Price disparities for certain individual drugs are even larger. For example, the retail price of a ninety-capsule package of Imbruvica, a treatment for chronic lymphocytic leukemia and other B-cell cancers, is approximately $14,000 in the United States, compared to $7,000 in Canada and $6,000 in Australia and France. (4) These high prices affect not only Americans' pocketbooks but also their health: A recent survey found that 29% of U.S. adults had taken an over-the-counter drug instead of a prescribed drug, not filled a prescription, or cut pills in half or skipped doses "because of the cost." (5)

President Biden, speaking at a community college in February 2022, cited these survey results and the Imbruvica price differential as evidence of the U.S. drug pricing system's ills. "This is the United States of America, for God's sake," an indignant Biden said. "That's just wrong." (6) But high out-of-pocket prices are not all that's wrong with the U.S. drug pricing system. Prices paid by patients and rewards received by drug developers are opposite sides of the drug price equation. And on the developer side, the system fails to provide adequate incentives for biotechnology (7) and pharmaceutical firms to invest in the medical innovations that would do the most to improve health. In other words, not only do we pay high prices for existing drugs, but we are also "missing" drugs that likely would exist under a more rational reward system. (8) The costs are quantifiable not only in dollars and cents, but also in lost years of life. (9)

Two powerful forces drive rewards for medical innovation in the United States. The first is market exclusivity: the combination of patent rights and other statutory mechanisms that allow firms to block competitors for a fixed period. (10) The second--largely overlooked by legal scholarship until recently (11)--is federally subsidized health insurance: principally Medicare, Medicaid, Veterans Health Administration coverage, and subsidized health insurance plans provided through Affordable Care Act (ACA) marketplaces. In theory, these two forces could combine to produce a healthy "innovation policy pluralism": Market exclusivity could generate powerful incentives for innovation, and federal subsidies could ensure that drugs remain affordable notwithstanding high sticker prices. (12) In practice, the promise of innovation policy pluralism has given way to a system of underpowered incentives across too many fields, resulting in crushing costs for too many patients. (13)

Vaccines are one area where the failures of the U.S. drug pricing system are acute. The lightning-fast development of safe and effective vaccines against Covid-19--accelerated by an $18 billion investment from the federal government's Operation Warp Speed (14)--illustrated the pharmaceutical sector's capabilities given sufficient resources and high-powered incentives. (15) But outside the Covid-19 context, efforts to develop vaccines against common infectious diseases have struggled to attract financial support. (16) According to one pre-Covid estimate, manufacturers spent less than three cents on vaccine research and development (R&D) for every dollar directed at other drugs. (17) Such low levels of investment in vaccine-related R&D are a predictable result of a reward structure based on market exclusivity. Vaccines generate large positive externalities by providing herd immunity, but in a market-based system, vaccine manufacturers can typically charge only the patients who receive their vaccines, not the other members of the population who benefit from herd immunity. (18) Moreover, the benefits of risk-reducing products such as vaccines often vary from person to person, but vaccine manufacturers generally can't tailor their prices to individual risk. (19) So although vaccines are hugely valuable to society, our market-exclusivity-based reward structure allows vaccine makers to capture only a tiny sliver of their products' social value--with the consequence that firms invest less in vaccines than in other drugs that yield larger profits but smaller social benefits.

Cancer prevention provides another vivid illustration of the failures of the U.S. drug pricing system. Since the 1970s, drugs designed to prevent cancer have accounted for only around 1% of all cancer-drug clinical trials, and drugs designed to treat cancer before it spreads to surrounding tissues have accounted for an even smaller share. (20) One likely source of this skew is the shorter period of effective market exclusivity for preventives and early-stage treatments. In clinical trials, drugs that seek to prevent cancer entirely, or target cancer at an early stage, typically take longer to demonstrate efficacy. This is because patients in both the treatment and control groups generally will not experience adverse outcomes for several years. (21) Researchers file for drug patents before they begin clinical trials, so clinical trials eat into the fixed twenty-year patent term. (22) Preventives and early-stage treatments thus enjoy fewer years of patent protection following approval by the Food and Drug Administration (FDA), which means fewer years of monopoly profits. In effect, U.S. patent law provides smaller rewards for preventives and early-stage treatments than for late-stage treatments. Unsurprisingly, pharmaceutical-industry investments reflect this incentive structure. (23)

The same pathologies of market exclusivity affect drugs for cardiovascular disease. The number of new cardiovascular-disease drugs starting at all clinicaltrial stages declined between 1990 and 2012, (24) even as cardiovascular disease continues to be the leading cause of death in the United States (25) and worldwide. (26) Such quantitative indicators align with the qualitative impressions of professionals in the field. The title of a 2014 meeting of leading scientists from the federal government, academia, and industry captures the sentiment: "Cardiovascular Drug Development: Is it Dead or Just Hibernating?" (27) Researchers point to low return on investment as a key driver of the decline. (28) And again, market exclusivity bears much of the blame. As with cancer preventives and early-stage cancer treatments, cardiovascular-disease drugs typically require long clinical trials that eat into the fixed period of market exclusivity under U.S. law. (29) In the case of cardiovascular-disease drugs, federal health insurance policies further undercut incentives for R&D: The Medicare Act gives pharmaceutical firms less pricing power with respect to cardiovascular drugs than to other common drug classes. (30) In effect, the U.S. drug pricing system has deprioritized drugs that target the number one killer in the country.

The slow pace of progress in areas such as vaccines, cancer prevention and early-stage cancer treatment, and cardiovascular drugs may seem distinct from the scourge of high pharmaceutical prices. Yet these seemingly separate problems are really two different manifestations of the same problem: a U.S. drug pricing system in which rewards for medical innovation bear little relation to the social value of the drugs in question. Instead of rewarding firms based on the health gains generated by their drugs, Medicare's Part B program and Medicaid reimburse firms and providers based on how much they charge other customers for the same drugs--higher prices for other customers mean larger reimbursements from Medicare and Medicaid. (31) The result, from a consumer-welfare perspective, can be even worse than a pure monopoly: Drugmakers in the United States sometimes charge more than the monopolist's profit-maximizing price so they can extract extra federal-reimbursement dollars. (32) Those exorbitant prices may put drugs out of reach for lower- and middle-income patients who aren't covered by Medicare, Medicaid, or other federally subsidized health insurance programs.

The failures of the U.S. system for rewarding medical innovation not only impose harms on the broader population, but also force certain demographic groups to bear disproportionate costs. African Americans experience significantly higher rates of fatal cardiovascular disease than do whites, and the difference in cardiovascular-disease death rates explains a large portion of the Black-white life-expectancy gap. (33) Underinvestment in cardiovascular-disease drugs is thus...