The pharmaceutical industry: structure, regulation, and innovation

Pharmaceutical Industry

The purpose of this work is to research the pharmaceutical industry and to answer the question of whether the costs of pharmaceuticals in the United States are too high and whether the cost of pharmaceuticals should be regulated. Further this work will attempt to answer the question of whether the Federal Drug Administration (FDA) is adequately protecting U.S. citizens from unsafe drugs and whether the U.S. Congress has bee co-opted by the pharmaceutical industry. Finally this work will address the affordability of the new pharmaceutical benefit that was recently enacted under the Medicare Modernization Act.

The rising costs of prescription medication has been at the forefront of the business, political, prescribing physician and the legal mind for some time now due to the shifts in the industry on many levels both medically, legally and within recent legislation changes. Further, with the recent knowledge concerning the mediation Vioxx public confidence is a concern for the pharmaceutical industries but it is certain that is not reflected in the pricing schemes of the drugs companies. In terms of costs the question of to regulate or not to regulate is a big one at this time as well as the ability of the Food and Drug Administration (FDA) in terms of providing protection to the public from unsafe medication. There are those who believe that the U.S. Congress acts on behalf of the large pharmaceutical companies in its formation of regulations and indeed the list is endless of the many problems that present themselves in relation to the affects in terms of health, liability, reliability, legalities and costs that are associated with the industry.

Literature Review:

According to the Economist in its November 27, 2004 issue: " Serious allegations about the behavior of America's Food and Drug Administration are adding to the mounting woes of big drug firms." State regulators have plagued many American industries here of late which only serves to fuel the fire of what the economist terms to be: "A hostile business press, political scrutiny and the unwanted attentions of the plaintiff's lawyers." The Economist further states, "The drug firm crisis has appeared to morph into something uniquely dark and dangerous." So it appears that if there wasn't enough already enough complications facing the pharmaceutical industry the Food and Drug Administration (FDA) is under the gun after letting Vioxx slip past and the possibility of the public confidence failing in view of the FDA surely will affect the industry in an extremely negative manner. The possibility that Vioxx may have damaged the hearts of more than 100,000 Americans since its' FDA approval in 1999 was on the Agenda of a November 18, 2004 committee as David Graham, a safety scientist at the FDA testified that "the FDA overvalues the benefits of drugs and seriously undervalues, disregards and disrespects drug safety." (the Economist, 2004) Furthermore, Merck's Vioxx is not the only drug at issue as the following companies and their drugs are on the same list with Vioxx:

Crestor made by AstraZeneca

Serevent made by GloxoSmithKline

Bextra made by Pfizer

Meridia made by Abbott Laboratories; and Accutane made by Roche Laboratories.

Resulting was a 10% fall in AstraZeneca's share price and Glaxo*****hKline share fell by 6% with Merck's share steady but $40 billion of the firm's value being sheared by traders between the announcement about Vioxx and 2 months later. These effects have been witnessed industry-wide.

Parallel Trading - Arbitrage of Pharmaceuticals

One factor in driving the high-costs of pharmaceutical products is the practice of parallel trading or arbitrage, which is the practice of buying in low-price markets and selling in high-price markets. This practice in the pharma industry is becoming increasingly common and lucrative to a fault for those involved in this type of buying and selling. (Morais, 2004) According to Forbes Magazine writer Richard C. Morais, "No one really knows the size of this drug arbitrage business since much of it take place in the shadows. Where it is legal, few in the pharma industry-neither the arbs nor the manufacturers, nor big wholesalers want to talk about it on the record. But this much is clear. The business of arbitraging drugs is huge, fast-growing an constantly morphing around the globe according to locals laws and customs." The business of legal arbitrage of pharmaceuticals is an astounding $12 billion dollar business in Europe and $1.1 billion in U.S. dollars on the border of Canada and the United States. Worldwide the U.N. estimates it to be a $20 billion business. In terms of the legal aspect the most rigid laws are found in the United States concerning drug reimportation and "strictly forbid the wholesale importation of drugs intended for distribution in other countries." (Morais, 2004)

Case Study of Prescription Drug Movement by FDA and U.S. Customs study was conducted by the Food and Drug Administration and U.S. Customs in 2001, tracking the movement of legal prescription drugs across seven of the U.S. borders crossings. Detected were 586 individuals carrying 1,120 drugs across borders in a four-hour period. Only half of these individuals were carrying valid prescriptions that were either U.S. Or Mexican prescriptions. Politicians from Montgomery, Alabama and Springfield, Massachusetts also arbitrate drugs from Canada for their municipal employees and New England U.S. Department of Health and Human Services intends to provision 100,000 residents with arbitraged prescription medications. (Morais, 2004)

Medicaid's Prescription Plan - Passed April 2004

Congress passed a Medicare prescription benefit plan law, which will not take effect until 2004, but covers seniors in the interim who are uninsured with discount cards endorsed by Medicare. The bill that was passed is one that ensures more affordable access to drugs for seniors. Critics of the bill "assert that its injection of private competition into Medicare will undermine the program." According to Senator Edward Kennedy (D. Mass), the legislation results will "force senior citizens into the cold arms of the HMOs." (Chain Drug Review, 2004) the bill sets out the procedure whereby premiums that average between $35 a month and $275 deductible are paid then after that initial payment of 25% of a years drugs costs Medicare would pay the remaining 75% on costs from $276 to $2,200 each year. however costs after $2,200 up to $3, 600 would have Medicare paying absolutely nothing while from $3,600 upward the beneficiary would pay only 5% of the cost of each prescription in the form of a co-payment of approximately $5 to $10.

Putting Two and Two Together:

Washington study reported by Families USA stated that "while inflation rose 2.7% from January 200 to January 2001, prices of the 50 top prescription drugs used by Americans age 65 and older increased an average of 6.1%. It also found that drugs used to treat chronic conditions such as heart failure and diabetes have experienced the greatest price hikes. The average annual costs of the 50 prescriptions studied was the amount of $956' according to the report. The lack of prescription drug coverage in the Medicare bill is the stated reason that so many individuals are "forced to go to Canada or Mexico to buy cheaper drugs." (Krupin, 2001)

Case Study in Relation to Costs-Markup by Medicare:

Stated is that there exists a bias against full reimbursement of high-cost pharmaceuticals. This study developed a model of the relationship between products costs and charge markup. Stated further is that, "The logarithmic model shows that an increase in the acquisition cost per episode can be expected to lead to a reduction in the charge markup multiple. When markups for pharmaceuticals decline as acquisition cost increases, a rate-setting methodology that assumes a constant markup results in reimbursement for higher cost products that can be far below acquisition cost. The incentives in the payment system could affect site of care choices and beneficiary access." (Braid, et al., 2004) study performed states that, "We used the hospital ownership type reported by the hospitals on the Medicare cost report found on the healthcare cost report information system (HCRIS). We collapsed the reported ownership type to three categories: (1) for profit; (2) not-for profit; and government... We tested this hypothesis using the drug as the unit of analysis. We calculated the median charge per unit recorded in the OPPS claims data. Also from the OPPS claims data, we calculated the average units per claims line. The median charge per unit multiplied by the average units per claims line results in the median charge per administration. The acquisition cost per administration was obtained using the unit acquisition cost obtained from the hospitals and multiplying this by the average units per line obtained from the OPPS claims data." (Braid et al., 2004)

This study found that the compression in terms of constant markup is real stating that,." We found that the relationship between acquisition cost and markup is logarithmic and that the charge markup declines as acquisition cost per administration increases. When the model is estimated taking into account hospital ownership type, the same relationship between markup and acquisition cost is shown for each category of ownership. This relationship has an effect on the payment rates that CMS sets. Higher cost pharmaceutical therapies are systematically reimbursed below acquisition cost (i.e., the payment system is biased against full reimbursement for higher cost therapies). Reimbursement compared to acquisition cost for the top IO pharmaceuticals by total expenditures indicates that 9 of the 10 are significantly under reimbursed."

Clinical Trials Report:

Congress established Medicare beneficiaries numbering 40 million with a prescription drug coverage, which has been called a "vast expansion of federal support for and control of expenditures on medicines. Even in its early stages, this program is focusing public attention on prescription drug prices, marketing, utilization, and effectiveness." (Weschler, 2004) Further stated in the Clinical Trials report is that, " the Medicare drug benefit is expected to boost prescription drug use by seniors and provide incentives to develop therapies needed by elderly patients such as arthritis, cardiovascular conditions, and Alzheimer's disease. But it also may squeeze prices and profit margins of pharmaceutical companies that sponsor research. A new payment system for oncology treatments and other therapies administered by physicians may alter incentives for R&D in these areas, while the Medicare outpatient pharmacy benefit will establish model formularies, post negotiated prices, promote treatment protocols, and track adverse events and outcomes more thoroughly -- all likely to shape prescribing practices and new product utilization. These developments will require sponsors to incorporate outcomes measures into studies earlier in the development process, and may cause earlier abandonment of unpromising research."

The fall of 2004 was replete with the pharmaceutical industry experiencing one crisis after another as well as for the federal regulators which together managed to raise questions of serious import and "pre and post approval safety testing of new products." (Weschler, 2004) According to the report congress blamed FDA "oversight, accusing agency officials of trying to squelch staff warnings on drug safety issues and of ignoring signs of trouble at Chiron. One response was to call for full disclosure of all clinical trial results by sponsors and FDA -- including those studies that rail to demonstrate efficacy. Investigations were launched into the possibility of manufacturer ethics in behavior and the following issues were considered by government officials and industry leaders":