The U.S. prescription drug market is dominated by generics. Is that a good thing?

The U.S. market for prescription drugs is dominated by me-too products.

Just not the kind that is much maligned in the press. Pharmaceutical companies are often attacked for spinning out "me-too" drugs that are only slightly different than earlier versions, but cost as much (or more). The real story there is a bit more complicated, but let's save that argument for another day.

The real "me-too" drugs sold in the U.S. are generics, i.e. drugs that are (for the most part) exact copies of branded (patent-protected) drugs, but sold at a fraction of the price. According to a recent report by IMS health, generics account for the vast majority of all U.S. prescription drugs - a whopping 84%. IMS estimates that by 2016 this figure will rise to 87%. This is a sea change from the late 1990s, when generics only accounted for about 40 percent of the market.

Is this good for patients, and for the health care system? Yes. Is this bad for the patients, and the health care system? Yes. It depends on whether you look at the short run or long run, and what aspect of the system you want to focus on.

First a little history and some explanation: Why are generics, from a volume perspective at least, dominating the U.S. market?

The pharmaceutical industry is, as we've said many times, largely a victim of its own success. The late 1980s and 1990s saw a slew of "blockbuster" drugs launched (Prozac, Prilosec, Zocor), largely for primary care indications like depression, high cholesterol, and acid reflux. This strategy generated billions in profits for the industry, because these indications represent very large patient populations, and patients have to take some of these drugs indefinitely - perhaps for the rest of their lives.

Blockbuster has something of a pejorative connotation, but drug treatment can represent a very cost-effective way of preventing more dangerous and much more expensive complications. Harvard health economist David Cutler, for instance, has estimated that effective use of recommended antihypertensive medicines avoids 833,000 hospitalizations and 86,000 deaths annually. And if untreated hypertensive patients were effectively treated, it could prevent another 420,000 hospitalizations and 89,000 premature deaths.

Even the Congressional Budget Office (CBO), which is very conservative when it comes to estimating offsets for health care innovations, estimates that a 1 percent increase in Medicare Part D prescription drug spending saves about 0.2 percent in other Medicare costs.

But all good things must come to an end, and all patents come with an expiration date. Blockbuster drugs patented in the 1990s or early 2000s have already lost patent protection or will do so in the next few years.

This leaves industry with a pipeline problem, since they haven't produced anywhere near enough new drugs to compensate for the products going generic. And this explains the sea change: companies just aren't moving enough patients onto new drugs as patents expire. When a generic is available, patients will chose the generic 95% of the time. In fact, this year, for the first time ever, total U.S. drug spending actually declined, at least in part because of this tremendous shift towards generics (IMS suggests other factors as well).

Why have branded companies had so much trouble filling their pipelines? They've run into something of a perfect storm.

The FDA has raised the bar for approving drugs for primary care indications, and insurers are also scrutinizing new drugs more closely when it comes to reimbursement. After being stung by rare side effects linked to FDA approved drugs like Vioxx, Avandia, and Phen-Fen, the FDA wants more data from larger clinical trials for primary care indications to rule out rare side-effect problems for drugs that are likely to be used in hundreds of thousands, or maybe even millions, of American patients after the FDA grants marketing approval. This means more tests, larger trials, and closer scrutiny of the potential for rare side effects.

Arguably, this makes sense. With many good, effective drugs already approved, regulators and payers are inevitably going to look askance at new drug candidates that don't have a clear safety or efficacy advantage over existing, and very cheap, generic medicines.

But with development costs rising (due to the aforementioned FDA regulations), industry is rationally going to walk away from developing products that might have incremental benefits, but can't generate sufficient profits to justify the investment required to bring them to market. So products that might have been commercially viable - and would make a real difference to patients - a decade ago just aren't sustainable today.

Scientifically, the low hanging fruit has been picked. If you're looking, for instance, for a drug to lower the risk of heart attacks, we've got LDL cholesterol pretty clearly licked, and you're going to have to look elsewhere (scientifically) to gain a competitive position in a patient population that is taking generic atorvastatin (formerly Lipitor).

So companies find themselves chasing novel mechanisms of action where the science is less well understood. Pfizer, and other companies, got into trouble in this area when they went after drugs to raise HDL cholesterol, and found that, in cases like torcetrapib, raising HDL cholesterol actually resulted in more deaths, not fewer - which was the opposite of what the research had previously suggested.

As companies chase more novel targets they face more scientific, financial, and regulatory risks. Add to this the fact that big time investments in genomics and other new strategies haven't (yet) paid off as handsomely or as quickly as many expected, and you've got a (at least in the short term) a severe pipeline problem.

Bigger isn't necessarily better. As pipelines thinned or slowed, companies looked to restock their shelves and improve their earnings through consolidation, i.e., insourcing other people's pipelines. From a balance sheet perspective, this can make a lot of sense, but it's also a one shot strategy - financial gains from consolidation, in terms of combining sales forces and drawing in outside revenues, can only happen once. Consolidation also makes sense given the regulatory environment (which requires more sophistication) and reimbursement environment (i.e., having more products on market gives you additional bargaining leverage with large insurers and PBMs).

But from an innovation perspective, this approach may not be effective. It's not clear that when you take two different R&D teams, with different cultures and approaches to doing research, each of which might be successful independently, and cram them together - along with the associated layoffs - you're really better off. You just might be more schizophrenic.

Where does that leave industry and patients? Increasingly, companies are focusing on "unmet medical needs" - in therapeutic areas like cancer, multiple sclerosis, cystic fibrosis, and other orphan diseases where there are few good treatment options and less generic competition. This is good for patients, who literally face life and death challenges, and it also gives industry some (frankly) much needed revenues to fund ongoing R&D.

The FDA approved 39 new drugs last year, a record, but 19 of those were for either cancer or orphan diseases. IMS also notes that out of the 28 drugs launched from last year's approvals (a number were approved late in the year, and weren't launched until 2013), representing $10.8 billion in new drug spending, specialty drugs accounted for $7 billion. That gives you a pretty good picture of where the industry's growth strategy is pointed, at least for the time being.

So are we headed to a two tiered market, where generics dominate (at least by volume) for primary care indications, and pharma/biotech focuses on specialty indications? And if that is the industry division of labor, is it sustainable?

Some of the new specialty treatments, like Kalydeco, are also truly game changers for patients. Although Kalydeco helps just 4% of cystic fibrosis patients, the drug seems to be an effective cure for those patients. That's tremendous science, and should be applauded. Cancer is another area where the industry is poised to make tremendous gains.

But all of these medicines are tremendously expensive, because of the "numbers" problem: With a smaller patient population, companies have far fewer (i.e., thousands or even hundreds) patients over which to spread their development costs and generate profits, especially since effective patent times have been flat or declining. Kalydeco, for instance, costs $294,000 annually.

As more expensive products push into the rare disease space, insurers and government payers are eventually going to balk at paying those prices, and they already are to some extent - requiring much higher co-pays from patients for some drugs.

On the other hand, the shift away from primary care indications is deeply troubling because of the enormous impact of chronic disease on patient health and the economy (through both direct and indirect costs, like lost productivity). Diabetes, heart disease, stroke and drug resistant pathogens all require much better treatments.

Burden of chronic disease.png

Without a different approach from the FDA, and a reimbursement environment that rewards incremental and breakthrough innovations in these disease areas, to say nothing of Alzheimer's, we're looking at a tsunami of health care costs and expensive complications from these diseases as the population ages.

The Solution: Broaden Innovative Pathways to Market for All Indications

Policymakers are apt to cheer cheaper generics today without thinking deeply about the implications for innovation tomorrow. Fundamentally, there is a very clear tradeoff between lower drug prices today, and less innovation for patients tomorrow.

The Obama Administration, for instance, seems blissfully untroubled by the implications of imposing Medicaid price controls on Part D, or reducing exclusivity for biologic medicines down from 12 years to 7. The former would save an estimated $123 billion over 10 years, and the latter would save $3 billion over the same time period--but the lost revenues would clearly reduce the industry's capacity to invest in innovation. And research suggests that future innovation has far higher returns to society than lower drug prices today - something on the order of 3-1 - but current policy debates are much more short-sighted than economics suggests that they should be.

What can we do to change the equation? Policymakers should encourage innovation across many different disease areas, both primary care and specialty.

For starters, we should revisit Hatch-Waxman, and slow the erosion in effective patent times so as to encourage more innovation. Companies should get back all of the patent time they lose in FDA mandated clinical trials and drug reviews. This won't prevent a single drug from going generic, but it will allow drug makers to spread their costs over more years, and help reduce short term pricing pressures.

Second, we should expedite pathways for new or repurposed drugs targeted at subgroups of patients. Drugs that come to market with companion diagnostics could be granted short patent extensions, say six months. Taking old generics and developing new uses for them, including conducting the clinical trials required for FDA approval, should be rewarded with new patent or marketing exclusivity. Repurposing old drugs is less expensive than developing new drugs, given that significant data already exists on their safety profile and mechanism of action. Encouraging more co-development of drugs and companion diagnostics will increase their cost-effectiveness, and help energizing the diagnostics industry. (Here, the MODDERN Cures Act is a great step in the right direction.)

Finally, FDA approval pathways - like accelerated approval or the new Breakthrough Therapies designation - need to be opened other classes of drugs beyond cancer, orphan drugs, and HIV. Here, the Obama Administration can heed the excellent report from the President's council of scientific advisors on doubling drug innovation in the U.S. over the next decade.

The agency and its stakeholders should develop standards for using novel biomarkers and adaptive clinical trial designs to approve drugs for targeted populations for primary care indications and antibiotics as well as specialty and orphan drugs. This would help industry, as well as society, replenish our supply of new medicines in these vital areas.

In the short run, the triumph of generics may seem like financial a windfall to payers and consumers. And largely, it is. But with an aging population, these gains will be short lived and will be far outweighed by the human and economic cost of lost or foregone innovations tomorrow.

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