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Are Generics Killing Drug Innovation?

|Includes:Allergan plc (AGN)
The pharmaceutical industry has created highly innovative medicines, and in years past, was one of the most profitable industries in the world. It has lost that status as the costs of developing a drug have grown, with the FDA demanding ever-higher standards for approval. Fewer than one in ten compounds entering the clinic are approved by the FDA- even then only one in three marketed drugs generate enough revenue to recoup the cost of their development.
Much of this is due to the increased competition from generics companies. Passage of the Hatch-Waxman Act in 1984 helped create a robust generics industry in the US by allowing companies to introduce low-cost versions of drugs once their patents expire by submitting data to the FDA showing their drugs are bioequivalent to the originals; no clinical trials were necessary. A second portion of the Act allowed generics companies to conduct court challenges of the legitimacy of drug patents before their expiration. Successful litigation provides 180 days of exclusivity to the challenger.
So successful have has this strategy been that the president of generics company Watson Pharmaceuticals, Paul Bisaro, warned their industry was locked in a “death spiral” which would potentially cut off future income as pharmaceutical companies forgo research into the development of novel small molecule drugs. Yet he has also lead Watson to become increasingly aggressive, arguing that if Watson didn’t do this, someone else will.
In a bid to confront the threat of a successful patent challenge, pharmaceutical companies have increasingly turned to authorized generics. When a patent has been overturned and a drug goes generic, the challenger has 180 days of exclusivity from other generics makers, but the original manufacturer remains free to continue selling the drug. Under the authorized generics scheme, brand name drug makers sell a generic version of their drug during that same 180 day period of exclusivity, leading to substantially lower prices and profits for the generics company.
With this leverage, a generics company may be willing to defer the launch of it copycat drug in return for a promise that the brand name manufacturer does not launch an authorized generic. According to the FTC, from 2004 to 2008, 25% of patent settlements resulted in brands agreeing to withhold authorized generic competition, leading to an average of 34.7 months of additional market exclusivity beyond the settlement date.
But patent litigation is not the only challenge to drug innovation. Another major problem is government policies in the US and abroad. Drug price controls in Europe are now starving the continent of innovative R&D. In the 1960s and 1970s, 65% of innovative drugs came from Europe; today, that number is below 40%. The US is now seen as the clear innovator in pharmaceuticals. R&D efforts are focused on the US and drugs are approved here on average one year before in the EU.
Price controls have indeed reduced the costs of brand name medicines in the EU, but at what cost? The region is losing its R&D competitiveness and access to cutting edge medicines is delayed. Moreover, price controls may not even be a money-saver. While branded drug prices in the EU are lower than in the US, those for generics are significantly higher with comparatively lower utilization rates. The US
Department of Commerce, International Trade Administration has estimated that increased generics utilization in the EU can lead to savings that can potentially offset an increase in EU drug prices to US levels.
Not withstanding studies showing the detrimental effects of drug price controls, the US government is contemplating price controls of its own. The idea has been tossed around for some time but has yet to be implemented. Any type of price controls should be carefully considered. If the US is no longer seen as the best place for innovation, it will flow elsewhere.

Disclosure: No position
Stocks: AGN