Vaccine options

The recent headlines regarding the flu are ominous: The available vaccine lacks the Fujian strain, there may be a vaccine shortage and the illness is hitting earlier and harder than predicted. To add fuel to the fire, the vaccine industry is in trouble. Thirty years ago, there were over 25 vaccine manufacturers in the U.S.; today, there are five. The Institute of Medicine recently issued a report calling for a “clear and deliberate strategy that the government can use to stabilize and assure adequate rates of return on future private investments in vaccine development.”

Several factors have brought us to where we are today: an increase in government purchases of vaccines (the government buys over half of children’s vaccines, wielding considerable market power), liability concerns and the fact that vaccines are less profitable than other pharmaceutical investments.

The flu vaccine is unique. The decision of which strains to include must be made early in the year. This must occur with the collaboration of researchers worldwide and be subject to the best science available at the time. The vaccine requires months of production. So, even if we decided today to produce additional vaccine, it wouldn’t be ready for months. Any glitches in strain selection and production can spell disaster.

Manufacturers are faced with a classic economic problem: investment under uncertainty. As happened this year, a strain not included in the final vaccine may emerge and demand may increase or decrease. In past years, manufacturers overproduced vaccine and had to eat the losses. Purchasers face uncertainty as well; the vaccine expires within the year, so purchasing excess vaccine that goes unused is essentially throwing money down the drain.

Several strategies have been discussed in policy circles, including vaccine stockpiling, guaranteed purchase by the government, and incentives for developing better flu vaccines.

An alternative approach involves the application of option theory to ensure adequate supply of vaccine. Financial options are widely used to address uncertainty in markets. Call options give the holder the right, but not the obligation, to purchase a particular asset (the underlying asset, in this case, being additional vaccine doses) at a predetermined price, on or before a given date. Here’s how it could work:

A purchaser places an annual order for 5 million doses at $X a dose and buys options to purchase 1 million additional doses for $Y by a predetermined date. The price of the call option would vary, based on the underlying asset’s current price, the exercise price and the expiration date. Accordingly, purchasers who wait until the last moment to decide whether to purchase additional vaccine would pay more for later-expiring options.

If the flu is mild or demand is low, the purchaser would not exercise the option and only loses the cost of the option. If the flu is severe, a new strain emerges or demand increases, the purchaser would exercise the option. The total cost in this case is the option price plus the cost of the additional vaccine.

Will this approach provide an incentive for investment in capacity? Options, purchased before capacity decisions have to be made, and covering the risk taken on by firms to produce extra vaccine, may do just that. From the manufacturer’s perspective, if the flu season is mild, the sale of options would cover the marginal cost of production plus some additional fixed costs associated with capacity investment; if the season is severe, they have the excess supply to fill orders from purchasers exercising their options.

The mechanics of vaccine options have to be worked out. An advantage to this approach is that it uses a well-known financial mechanism to address an important market failure. Other approaches in this vein, such as the use of derivatives, may provide more sophisticated solutions. Further, experimenting now may lead to a stronger vaccine industry with substantial social benefits. Recent shortages in childhood vaccines have concerned parents and policy-makers alike, and trace their origins to the frailty of the vaccine industry. A healthier vaccine industry may spur innovation and shore up supply.

A looming threat is a re-play of the 1918 Spanish flu, which killed an estimated 40 million people worldwide. Experts predict that a completely novel strain of the flu is bound to arrive sometime, and if this year is any indication, we may be very poorly prepared. Each year the flu kills upwards of 36,000 Americans and results in the loss of billions of dollars through effects on worker productivity and medical costs. Public health leaders and health care providers try to make this clear to us, and now it seems we are listening. In most years, intense immunization campaigns are required to convince people to get the shot. This year is atypical, with individuals demanding the vaccine. Perhaps this convergence of factors, bringing the challenge to the fore, will prompt creative strategies.

Erica Seiguer is pursuing a medical degree at Harvard Medical School and a doctoral degree in health policy/economics at Harvard University.

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