Politicizing Gilead’s Research and Development Costs for Sovaldi is a Reckless and Dangerous MisadventureCommentary by John R. Graham
July 25, 2014
Gilead (NASDAQ: GILD) has become the whipping boy du jour for the forthcoming Obamacare-driven cost explosion in government and private health spending. Apparently, everything was going swimmingly until Gilead – right out the blue! – dropped a cure for Hepatitis C on the market and threw everyone’s spending projections into a tizzy.
Politicians and the health-insurance industry have embarked on a high-profile campaign to shame Gilead for the price of its new wonder-drug, Sovaldi, which can add up to $84,000 for a course of treatment. If successful, this campaign will have terrible long-term consequences for medical innovation.
Thursday’s earnings report by Gilead confirms that Sovaldi is blowing the doors off. 70,000 patients have already received treatment in the U.S., and a further 10,000 in Europe. Worldwide, sales for the first half have amounted to $5.75 billion, almost half the company’s revenue. That revenue comes from health insurers and governments, so it is not surprising that they are scrutinizing the issue.
Senators Wyden and Grassley have requested documents from Gilead respecting its acquisition of Pharmasset, the company which originally developed the medicine that was to become Sovaldi. This is a fishing expedition that purports to have the objective of determining exactly how much Pharmasset and Gilead spent on researching and developing Sovaldi. However, this question cannot be answered. Further, it is irrelevant to the value Sovaldi delivers.
In its latest 10-Q, reporting the first quarter’s results, Gilead confirmed that:
We do not track total R&D expenses by product candidate, therapeutic area or development phase. However, we manage our R&D expenses by identifying the R&D activities we anticipate will be performed during a given period and then prioritizing efforts based on scientific data, probability of successful development, market potential, available human and capital resources and other considerations. We continually review our R&D pipeline and the status of development and, as necessary, reallocate resources among the R&D portfolio that we believe will best support the future growth of our business.
In plain English: Gilead’s management sees how things are going in the research portfolio and moves money around based a lot of business factors. To be sure, Gilead does not want to expose the details of its R&D budget to politicians and the public. However, it probably could not even if it wanted to.
Lessons learned from a failed drug candidate are useful for another compound. A molecule is forgotten about for a couple of years until a new scientist decides to have another look at it. Some research may be applicable to more than one candidate in the portfolio. If a drug-maker’s board tasked two different executives to calculate the historical R&D spending on a successful medicine, those executives would probably arrive at very different measurements.
The brand-name pharmaceutical industry’s trade association points out that only one in ten thousand new compounds will be approved by the Food and Drug Administration, and only two or three of them will make enough profit to justify the investment. Forbes’ Matthew Herper has estimated that it now costs $5 billion to invent a new medicine, which includes the cost of the tens of thousands of molecules that fail. The government cannot simply dictate that a pharmaceutical company shall earn a politically acceptable rate of return only on a specific medicine’s R&D costs, without taking failed R&D spending into account.
The Wall Street Journal has exposed the role of the health-insurance industry. Its trade association, apparently, has funded an effort by John Rother of the National Coalition on Health Care to criticize Gilead for the price of Sovaldi. Health insurers are now quasi-public utilities whose income statements are regulated by the federal government. This is done via the medical-loss ratio (MLR) which dictates health insurers’ profit margins. Further changes in premiums are regulated (but not fixed) and must be accepted by state regulators months before taking effect. On the other hand, they have to pay for prescription drugs, for which there is no price regulation in the U.S. private market.
So, an asymmetry exists. Still, are we meant to believe that health insurers have no clue which drugs are coming down the pipeline, and how much they will cost? On the contrary, pharmaceutical companies have highly skilled people calling on payers, proposing the value proposition of their products.
Gilead’s critics are not very clear about what they want. Karen Ignagni, CEO of America’s Health Insurance Plans, calls for “balance“. That sounds reasonable, but that should not require an expensive public-affairs campaign. Drug makers and health insurers have done business for decades without politicizing and exposing their differences.
Perhaps Obamacare has consolidated the government-healthcare complex to the point where it is no longer possible for these two industries to negotiate in a businesslike manner. Mr. Rother simply asserts that Sovaldi’s price is “unsustainable“. However, he does not suggest a more “sustainable” price. At a recent panel discussion in Washington, DC, Mr. Rother insisted that Gilead be more transparent about its costs to research and develop Sovaldi.
It looks suspiciously like Gilead’s critics are trying to develop a pathway for the government to regulate drug-makers’ margins based on R&D spending. Innovative drug-makers would have to expose their most sensitive business practices to government scrutiny, worry about the government’s response to a change in R&D priorities, and perhaps even get the government’s permission to change the R&D budget.
The research and development process, especially in the clinical-trial phase, is already highly regulated. This has added significantly to the cost of new drugs. Government oversight and regulation of pharmaceutical budgets and margins would be a catastrophe for innovation.