Politics & Policy

Obamacare vs. Drug Innovation

PhRMA’s quiescence on Obamacare badly hurt the industry — and all those who depend on medical innovation.

With the release of the president’s budget, it is now beyond dispute Beltway spin notwithstanding — that the decision by the Pharmaceutical Research and Manufacturers of America (PhRMA) to support the health-care bill was one of the worst self-inflicted wounds in the history of lobbying. For biotech and pharmaceutical companies, the president’s budget repudiates one of the most important benefits of their “deal” with the White House: the ability to market biotech drugs without generic competition for twelve years. The president would reduce that period to seven years, precisely the position of the generics industry and a position that the pharmaceutical industry had fought aggressively before it decided to make a deal with the president.

This embarrassing repudiation of the deal follows another hostile act from the Obama administration. On February 3, health and human services secretary Kathleen Sebelius released a letter to all the governors encouraging them to modify their states’ Medicaid rules so as to use more generic drugs and to make deeper price cuts for drugs purchased in Medicaid. Since the industry had already agreed, when it signed onto the health-care bill, to cut deeply their prices for Medicaid drugs, Sebelius’s inclusion of this advice in her letter to the governors was a gratuitous slap.

In fact, the best thing that could happen to the industry — and therefore to all those individuals, here and around the world, who benefit from the strides it has taken in research — would be an unraveling of PhRMA’s deal. Since the president has walked away from the deal, now is the moment for the industry to walk away from a law that will significantly weaken the all-important U.S. market for pharmaceuticals.

What will Obamacare do to America’s premier health-care research industry?

First, Obamacare inflicts a series of balance-sheet hits on pharmaceutical companies. Last year, companies scrambled to write large rebate checks to satisfy the new price controls that the law imposed in the Medicaid program. In total, the price-control provisions of Obamacare will cost the industry $38 billion over the next ten years. During 2011, pharmaceutical companies will again be required to take out their checkbooks to pay a new $2.5 billion excise tax for this year, a tax that will grow to over $4 billion by 2018; this will cost the industry another $23 billion. Also, every January 1 the drug companies will be required to provide a 50 percent price discount for seniors who have reached the “doughnut hole” (i.e., the coverage gap in Medicare Part D); this represents about $30 billion in industry revenue that will need to be recovered elsewhere.

While these hits to the balance sheet will undoubtedly weaken the industry, cost U.S. jobs, and hinder further research, Beltway lobbyists persuaded Wall Street analysts that the industry “got off easy” because these extortion payments allowed it to fend off more serious congressional threats such as imposing price controls in Medicare and permitting unrestricted drug importation.

But the lobbyists missed the forest for the trees. These taxes and fees are less important than the implications of the law’s gargantuan reordering of the pharmaceutical marketplace. Over the long term, Obamacare will cause a significant degradation of the private-sector market for pharmaceuticals, a market that has been the best in the world.

In the United States, 150 million citizens get their prescription drugs through their health insurance rather than directly from the government. Employers (and unions) contract with private health insurers to deliver the drug benefit, and the insurers negotiate with the pharmaceutical companies to decide which drugs they will cover and at what price.

Employees and retirees generally want access to the newest and best medicines, and their companies want to keep them happy and healthy. Therefore, the health plans serving employers do their best to balance cost with the need to provide high-quality medications.

Thus, the U.S. employer-provided insurance market offers the primary feature that drug companies need: a market that has incentives to reimburse for new medicines.

When Medicare Part D was created, Congress attempted, with some success, to re-create these market forces for seniors through a government-financed, but privately managed, health benefit. Under Part D, if a plan doesn’t cover the particular drugs that a senior may want, he can sign up for another plan. Seniors will seek out new medicines that work, and so plans have reason to provide them.

Combined, employer-based and Part D health plans account for over 70 percent of the U.S. market for pharmaceuticals, meaning that the overwhelming majority of the U.S. market is a healthy one, where prices are established by buyers and sellers negotiating innovation versus cost.

Obamacare would undermine this market by creating considerable incentives for employers to drop coverage for both employees and retirees. Douglas Holtz-Eakin, former director of the Congressional Budget Office, has estimated that the employer segment of the market may lose 35 million customers. The law also rescinds a tax deduction for employers who provide drug coverage to their retirees. Even those private-sector employees who keep their coverage will see their pharmaceutical benefits degraded as so-called “Cadillac plans” — the plans with the best pharmaceutical coverage — will take a huge 40 percent tax hit, giving employers significant cause to scale back drug benefits.

The law also contains two provisions that will weaken the market features of the Part D program: a Medicare payment commission that has the authority to set prices, and an “evidence-based” research institute that will tell Medicare patients (and everyone else) that they do not need all these new drugs.

While the healthy part of the pharmaceutical market will be pounded, the government-run segment of the market, Medicaid, will be expanded by 16 million patients. Medicaid has the worst pricing structure and the worst track record in paying for innovations of any sector in the United States market. Like government health-care systems around the world, Medicaid must be dragged to pay for medical advances. Unlike employers and seniors in Part D, Medicaid patients cannot vote with their feet if their health plan does not provide the new medicines they want. The incentives in Medicaid all run against paying for pharmaceutical innovations.

So, Obamacare significantly expands the worst sectors of the pharmaceutical market while degrading the best.

Despite these body blows to the pharmaceutical marketplace, Beltway business “experts” provide soothing reassurance that there will be “so many new customers” that no one should worry about the health of the industry. These new customers will appear in the so-called state exchanges that are slated to cover tens of millions of the currently uninsured. In fact, the exchanges are a market that does not yet exist and, one can surmise, will be a bad market for pharmaceuticals. Because of adverse selection and costly subsidies for lower-income participants, these exchanges will be plagued with cost overruns, as the Massachusetts exchange program currently is. Such a fiscal train wreck can only portend a market where pharmaceutical benefits are lousy, prices are controlled, and innovation is not rewarded. Many of the Medicaid bureaucrats who currently impose price controls are the very people designing the state exchanges.

So, in exchange for a Beltway “win,” PhRMA agreed to restructure the entire U.S. pharmaceutical marketplace, to its considerable disadvantage. U.S. pharmaceutical companies already face huge legal, scientific, and regulatory challenges and have shed more than 100,000 jobs in the last two years. PhRMA committed lobbying malpractice by agreeing to the Obamacare deal.

How did this happen? At the time the deal was struck, PhRMA was headed by a wheeler-dealer former congressman from Louisiana, Billy Tauzin, who was unfamiliar with the pharmaceutical business. Most of the CEOs of individual companies who might have stood up to Tauzin were either Democrats eager to please the administration, or Europeans without a sound footing in American politics.

It is not too late. The 2010 election, new leadership of PhRMA, and the movement to repeal Obamacare had already offered hope that the worst might be avoided. Now that the president has repudiated a central pillar of the deal, the industry is free to support a wholesale repeal of the law, not through clever back-room deals or partisan maneuvering, but through an open declaration that drug innovation is at stake. The pharmaceutical industry will never be popular, but if Beltway dealmaking replaces innovation, it will simultaneously court public opprobrium and commercial disaster.

— William S. Smith was formerly vice president for U.S. public affairs and policy at Pfizer, Inc. He is currently managing director at NSI, a D.C.-based consulting firm. His views are his own.

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