Have we tipped the pendulum too far in favor of generics?
On March 25, the Supreme Court heard oral argument in a closely watched case, FTC v. Actavis, Inc. The case involves a branded drug company's settlement with a generic patent challenger in which the patent-holding company paid the challenger not to launch a generic version of the branded drug until an agreed-upon date. Generics are much cheaper than branded drugs and the Federal Trade Commission objects when competitors agree to delay competition in return for cash. Consumers, private insurers and the government pay higher drug prices for the remaining duration of the drug's patent.
The FTC's concern is understandable, but it overlooks a broader issue for health consumers: the importance of striking a balance between incentives for innovation on the one hand, and encouraging faster access to more affordable medicines on the other.
Evidence suggests we've tipped the scales too far in favor of generics, resulting in less innovation and poorer health. The pharmaceutical industry is by definition somewhat monopolistic. Patents are necessary to promote innovation in research-and-development-intensive industries with enormous sunk costs and very high regulatory barriers to market entry. Shorten patent life and you also diminish incentives for new research.
With the Hatch-Waxman Act of 1984, Congress encouraged generic drug companies to challenge drug patents. Under the law, the first generic company to successfully file an "abbreviated new drug application" with the Food and Drug Administration gains duopoly rights to sell its drug as the sole competitor with the branded product for the first six months after the application is filed, or after the patent is overturned or expires. Hatch-Waxman exclusivity can be worth hundreds of millions, or even billions of dollars, depending on the market for the original drug. In 2012, for instance, three generic drugs were in the top 30 for total sales (worth about $6.47 billion).
Generic companies have little to lose from challenging patents of top-selling medicines and lots to gain. Innovator companies must robustly defend against every patent challenge, and losing a single case can result in billions of dollars in lost revenues.
When a branded company faces high litigation costs and uncertain outcomes and the generic one has relatively little to lose, settlements become a rational option. In effect, both parties agree to split the monopoly profits remaining under the patent rather than litigate the case to an uncertain conclusion.
The FTC's concern is that reverse payments protect some weak patent claims. Outlawing reverse settlements, however, might lead to fewer patent challenges or longer patents (if the patent is upheld) the opposite of what Hatch-Waxman intends. In fact, in the majority of "pay for delay" cases (most of which have been upheld by the courts) generics still come to market years earlier than they would have if the patent were upheld.
By any objective standard, Hatch-Waxman has been fabulously successful perhaps too successful.
Generic drugs account for about eight in 10 of all medicines sold in the United States today, up from 47 percent in 1999. Patent expirations through 2015 are expected to open $250 billion in branded drugs to generic competition. Several generic companies, such as Teva Pharmaceuticals, have become large multinational corporations in their own right.
The problem is that the Food and Drug Administration has become more risk-averse in approving medicines for primary care indications like diabetes, requiring companies to complete longer, more complex and thus, more expensive clinical trials. Longer clinical trials and increased generic patent challenges both have the effect of reducing effective patent life, lowering expected profits from pharmaceutical research and development.
The result: the drug industry has laid off tens of thousands of employees and decreased research budgets or terminated research into indications (like antibiotics or neurological diseases) where the costs are high and the outcomes uncertain. In March, for instance, Astra Zeneca announced that it was cutting funding for its anti-infectives research.
In theory, drug companies have 20-year patents for their products. In practice, they have about 10 years. Hatch-Waxman allows companies to recoup some of the time that companies spend in mandated clinical trials, but only up to five years. This means some products will never be developed because other drugs provide greater revenue though these may not be the drugs with the greatest social need, like antibiotics.
Whatever the court decides in Actavis, it's time to revisit Hatch-Waxman. One solution would be to allow companies to recoup the entire time they remain in trials to a maximum of 14 or 15 years of patent life. This would provide a powerful incentive for continued innovation, with enormous social benefits. If the court sides with the FTC, Congress should legalize reverse-payment settlements, provided that the settlement does not extend the full expected patent life.
Striking the right balance between innovation and affordability is difficult. While patents are, by definition, anticompetitive, they are also indispensable to biomedical research. We have many cheap generics today. Policymakers should start worrying more about how many new drugs we're going to be missing tomorrow.
Paul Howard is director of the Center for Medical Progress at the Manhattan Institute.