The Impact of Biotechnology on the US Healthcare System

Douglas I. Kalish and Geoffrey S. Thompson

Haas School of Business, University of California at Berkeley

Introduction

The biotechnology industry has quickly grown into a large industry within the American health care system. In 2000, 377 public biotechnology companies reported $32 billion in revenue and amassed $441 billion in stock market capitalization.[1] Rapid advancements in science and technology, fueled by investor dollars, has created an endless list of business ideas and impressive sounding press releases. It has also created a list of questions, fears and public policy challenges. Biotechnology has the potential to redefine modern medicine, but it must do so within a complex, regulated and inconsistent health-industrial complex.

The American health care system has been described as the most massive, costly and complex health services system in the world. The federal government projects by 2010, health expenditures will account for 16% of GDP with annual per capita health expenditures to exceed $8,700.[2] A diverse labor force, mix of public and private payers, competing for-profit and non-profit providers and multitude of regulatory agencies has created a system replete with paradoxes and conflicting interests. Rapid advancements in biotechnology and the development of radical new gene-based diagnostics and therapies will raise difficult payment and privacy issues, challenge existing business models and create opportunities for new therapies and health services.

Identification of the specific therapies and biotechnologies which will reach the patient is hard to predict. However, a better understanding of the genetic basis of disease and the ability to genetically profile individuals suggests that biotechnology will:

· increase the number and efficacy of diagnostics – the products, tools and procedures which identify existing or potential disease in specific individuals,

· expand the number and efficacy of therapeutics – the products, usually drugs, for the treatment of specific diseases,

· result in the ability to treat the underlying causes of disease rather than just the symptoms, and

· revolutionize medical care based on an individual’s genetic profile .

These powerful trends beg the question: Will drug prices get cheaper or more expensive? While this question is impossible to predict with certainty, biotechnology will change the relationships between the existing components of the American healthcare value chain and create new and formidable social and economic pressures.

The Healthcare Value Chain

Figure 1 is a simplified picture of the value chain of the US healthcare system with four major components:

· Consumers: Individual consumers share a common need for health and a desire for the absence of illness through the demand for health care services and products.

· Service Providers: The Service Providers are organizations and professionals, like physicians, medical centers, and laboratories, who supply healthcare services to patients and/or to other healthcare providers.

· Product Providers: Healthcare products include pharmaceutical products (e.g. ethical drugs), medical devices (e.g. cardiac defibrillators) as well as medical products (e.g. surgical bandages). Retail pharmacies and pharmacists provide sales and customer support for healthcare products. Pharmaceutical wholesalers provide distribution services. Finally, pharmaceutical and medical product manufacturers are responsible for the discovery and development of healthcare products.

Payers: In many cases, payment for healthcare services and products are provided by a third-party. The majority of working-age persons have their healthcare services and products paid for by their employer. Large employers often pay for these services directly, while medium and small employers, as well as individuals, purchase private health plan products from managed care organizations. Managed care organizations (MCOs) collect premiums from employers and individuals and agree to pay for select healthcare services and products consumed by the covered member during a specified time period. For Americans aged over 65 years and certain disabled persons, the federal government program Medicare pays for the majority of hospital and physician services consumed. Low-income persons can enroll in a state-administered Medicaid program that pays for select healthcare services.

Figure 1: US Healthcare System Value Chain

The degree of dis-integration of the healthcare value chain is striking. Healthcare Product Providers can reach Consumers through Distributors, Service Providers, or directly. While many of the interactions between the value chain components are highly regulated, the many points of contact between the parties creates a huge potential for disruption.

Increase in the number and efficacy of diagnostics

Genetic data results in an explosion of diagnostic tests

An estimated $30 to $45 billion is spent annually on diagnostic laboratory services and gene-based testing growing yearly at 25%.[3] Diagnostic tests which lower short and long term health expenditures through earlier and less invasive treatment are routinely covered by Payers. Novel or premium tests often require Payer pre-approval or patient cost-sharing. While diagnostic testing services represent only a small percent of total health expenditures (2% to 4%), they influence 70% of healthcare decisions.[4]

Molecular diagnostics is the ability to identify or predict a disease based on an individual’s genetic profile. While the development of drug-based therapies from genetic information tends to usurp the headlines, the creation of molecular diagnostics to identify disease is a necessary precursor, and is subject to less stringent regulatory approvals since they are generally less invasive. If biotechnology delivers on the promise of cataloging genetically-based diseases, it will also deliver the means to discover which individuals are carrying the defective DNA.

Gene-based testing will propel the diagnostics industry as diagnostics and therapy converge. Many drug therapies today are effective for only a subset of the population. For example, Genentech has developed a therapy (Herceptin) specifically for women with breast cancer who over-produce a gene product called HER-2. Treatment with Herceptin will have no effect on women whose breast cancer is due to other causes and in fact could have dangerous side effects. In December 2001, the Food and Drug Administration voted to recommend to physicians the use of the gene-detection test FISH (fluorescence in situ hybridization) which identifies women with the HER-2 gene who could benefit from Herceptin therapy, thus targeting a therapy to a specific genetic profile.[5] The benefits of gene-based testing to patients will be unambiguous and create a huge market for clinical diagnostic tests.

At-home (and at-the-mall) testing and diagnosis becomes an important new market

As the market for clinical testing explodes, the growing sophistication of health consumers, due in large part to the rapid expansion of health information available on the Internet, has spawned a growing market in providing diagnostic laboratory services directly to patients. The success of home testing kits for HIV and Hepatitis C, along with a patient’s ability to retrieve lab results directly over the Internet are models for new products and services from diagnostic laboratories companies.

The direct-to-consumer model will provide new markets for manufacturers of medical and surgical devices. The baby-boomer generation has significant financial resources and a desire to stay young and healthy. Baby-boomers are more educated, more sophisticated purchasers, and more wired than previous generations and are unlikely to take no for an answer when it relates to a new therapy guaranteed to improve their health or simply improve their quality of life. This attitude will represent a boon to suppliers of new diagnostic and therapeutic solutions. It is not surprising to find companies directly offering Magnetic Resonance Imaging services to patients, many with facilities located in shopping malls. For fees in the range of hundreds of dollars, these operators are offering services like full-torso MRI scans to affluent, health-conscious consumers.

Pharmacies expand direct pharmacist-consumer relationships

Retail chain drug stores, independent pharmacies, and their web-based counterparts often represent the final step in the delivery of healthcare products. Though the number of pharmacies has remained relatively constant, there has been considerable growth in the number of prescriptions filled and prescription revenues. Prescriptions filled have grown by 150% since 1992 while revenues have grown 270%.[6] The job responsibilities of pharmacists are also expanding. In addition to the traditional role of verifying the prescription, checking drug-interactions and ensuring proper dosage, pharmacists are asked to help administer the patient’s complex pharmacy benefits and in some cases directly help the patient manage their disease.

With a high demand for their services and the introduction of more at-home diagnostics and therapies, pharmacists have the opportunity to move up the value chain, offering higher value services and demanding a larger share of the profits. The pharmaceutical companies will accelerate the process through their aggressive Direct-To-Consumer (DTC) marketing. Since 1997, when the government relaxed restrictions on drug advertising, billions of dollars have been spent by pharmaceutical companies to help Americans “discover” their untreated ailments and to encourage them to try their latest drug. In 1999, $1.8 billion was spent on DTC television, magazine and newspaper advertising, with the Internet being an important medium of the future.[7]

Genetic data will require greater pharmaceutical expertise by physicians

Even with the growth in DTC pharmaceutical therapies, personal physicians will remain the critical decision-maker in the health care system. Physicians retain very specialized knowledge in diagnosing and treating diseases, while the patient is typically poorly informed about diagnosis, alternatives, efficacy and price. This historical information asymmetry has created an agency relationship, where the physician is trusted to act on behalf of the patient.[8] Though MCOs and other forces have encroached on the patient-physician relationship, licensure, tradition, and patient preference keep the majority of healthcare decisions within the domain of physicians. Patients will still look to their personal physician as a trusted source for treatment decisions. However, the growing complexity and availability of pharmaceutical therapies will require a greater degree of pharmaceutical expertise and knowledge by physicians as patients become more informed of alternative therapies and huge numbers of new therapies reach the market.

Increase in number and efficacy of therapeutics

Shift from labor-intensive (doctors, nurses) to capital-intensive (pharmaceuticals) healthcare

In a study of insured persons from 1997 to 2000, the number of prescriptions for the elderly grew 7.1% while their total drug spending increased 18.5% and for the non-elderly the number of prescriptions grew 4.7% with their total drug spending increasing by 15.6%. Those growth rates contrast with average general inflation during that time period of only 2.3%.[9] The high growth rates in pharmaceutical spending will continue as the population ages. Elderly persons spend over three times as much on pharmaceuticals as the non-elderly, and have over three times the number of prescriptions. In 2000, 65% of the insured population under age 65 years had at least one prescription, while 84% of the insured elderly population had at least one prescription.[10]

New medical products and technologies have been identified as drivers of America’s rapid healthcare inflation. J.D. Kleinke describes it as “a major structural shift from traditional medical services to the consumption of medical products, a systemic rotation from labor to capital.”[11] This shift has generated serious questions over the cost-benefit comparisons of these medical technologies and whether there are proper incentives in place to ensure that only cost-effective technologies are adopted and used.[12]

New drug development increases the load on regulators, but little will be done about it

The Food and Drug Administration (FDA) is the regulatory body charged with maintaining the safety and efficacy of pharmaceutical products on behalf of the customer. Since a new therapy cannot be sold before FDA approval, the speed, efficiency and expertise of the FDA has often been scrutinized. Thanks to the 1992 Prescription Drug User Fee Act and 1997 FDA Modernization Act, the FDA has instituted a faster, more efficient drug approval process. Mean approval times have decreased from 30.3 months in 1991 to 12.6 months in 1999. However, 2000 saw a reversal of that trend with an increase to 17.6 months.[13] The recent uptick in approval times has generated concern among manufacturers since recent biotechnology discoveries are expected to dramatically increase the number of drugs that need approval. User fees paid by pharmaceutical companies seeking drug approval has enabled the FDA to add 600 additional reviewers[14]. However, if even only a small fraction of the 30,000 to 50,000 genes in the human genome yield candidates for therapeutics and diagnostic tests requiring approval, the current process will be overwhelmed. The actual approval process is a small portion of the entire drug discovery and development process under the control of the FDA. Getting the average drug from laboratory to patient requires fourteen years and costs in excess of $500 million dollars.[15] Henry Miller of the Hoover Institution describes it as “inefficient and excessive regulation” or more poignantly “overkill”.[16] Defenders of the current FDA process point to the agency’s success in ensuring the safety of American’s health products and that any inefficiency is the price for that safety. The high costs of drug development and regulatory approval have been identified as a major limitation to innovation. The rigidity and high cost of FDA regulation discriminates against smaller companies, and ensures the industry’s focus on ‘blockbuster’ drugs. While the welfare consequences of stifling innovation and perpetuating monopolists are understood by many, the FDA development and approval process remains arcane and obscure to most. For this reason, radical reform of the FDA is unlikely to be supported by society at large, particularly if such reform in anyway benefits large pharmaceutical companies even if it benefits smaller companies. Unless an alarming crisis emerges in the drug approval process, the FDA will likely continue to remain a large, powerful regulatory agency.

New drug development increases the load on clinical testers, a boon for AMCs

In addition to increasing the burden on regulators, the projected increase in new therapeutics will stress the drug developers’ capacity to test the efficacy and safety of new drugs. Most clinical research is performed in Academic Medical Centers (AMCs), a special subset of medical centers affiliated with medical schools and having resources dedicated to clinical research. AMCs have been financially strained because they are usually higher-cost providers in an environment of declining reimbursement. AMCs have criticized the utilization management tactics used by MCOs as inhibiting valuable clinical trial activities that limit the discovery of new therapies. This inhibition can be direct through the restriction of possible patients to participate in clinical trials (i.e. MCOs steering patients to lower cost hospitals for treatment) and refusal to reimburse providers for the unproven therapies.

AMCs will face strong competitive pressure as MCOs continue to steer patients to lower cost community providers for general hospital services. However, AMCs are in an envious position to exploit the growing business opportunities presented by an increased demand for clinical trials. With the huge potential for new therapies generated by biotechnology, AMCs will be better positioned to replace their money-losing operations on primary care and secondary services with drug development services. A survey by Richard Retting of the RAND Corporation found that the ability of AMCs to conduct clinical trials hinges on a systematic process to identify possible patients for trials and a sophisticated data collection patient tracking system.[17]

Success for AMCs will require the adoption of a cost-effective patient data collection system and the recruitment and retention of high profile clinicians. As consumers more aggressively search out and clamor for the payment of groundbreaking therapies and clinical expertise, AMCs could benefit from a specialization of their services.

Over-the-counter and lifestyle therapeutics proliferate

The demand for over-the-counter (OTC) therapies will grow considerably as the population ages. More than eight out of every ten Americans takes an OTC pain reliever during a 6-month period and over one-third take pain relievers more than 8 times a month.[18] Pharmaceutical companies recognize this growth in self-treatment and are increasing the availability of OTC therapies that should lead to additional expenditures and higher utilization. Pharmacia’s CEO stated “Our new OTC business strategy will rely on increased emphasis on moving selected prescription drugs from Pharmacia Corporation into the consumer market.”[19] The major pharmaceutical firms may find that close alliances with – or even outright acquisition of – retail pharmacy networks or distributors will give them more control over the OTC value chain.

As with OTC therapies, “lifestyle” drugs will grow in demand as the baby-boomer generation yearns to stay young. Drugs to cure baldness generated $180 million in sales in 1998, facial anti-wrinkle drug Botox earned $90 million in sales in 1997, and Viagra, a drug to correct erectile dysfunction, reached $788 million in sales in only its first year.[20] An industry report projected $11 billion in annual sales of lifestyle drugs; while over $20 billion is currently being invested in developing drugs for lifestyle conditions.[21] While most lifestyle drugs remain available only through prescription and their coverage by insurance is problematical, a large portion of the discretionary healthcare dollar will be directed towards them.

Treatment of underlying disease cause instead of symptoms results in an aging population

Over the last century, there has been a profound shift in the causes of death and ill health from infectious origins to chronic causes. Of the leading causes of death in America, seven of the top 10, representing over 71% of deaths, can be attributed to chronic disease. Even deaths that are attributed to an infectious disease are often the result of an underlying chronic condition that makes the person more susceptible.[22]

The growing prevalence in chronic disease can be explained by the fact that Americans are living longer. Life expectancy has increased dramatically from 63 years in 1940 to over 75 years in 1990[23], so that elderly adults represent a greater percentage of the population. Currently 33.9 million adults are aged 65 years or older. That number is expected to jump to 70 million by 2030, or one in every five Americans.[24]

The promise of biotechnology is to treat the underlying disease and not just the symptoms. For example, cystic fibrosis is a devastating disease caused by a single genetic defect which affects the operation of ion pumps in particular cells, resulting in gastric and respiratory symptoms. Today, therapy for cystic fibrosis treats only the symptoms of the disease. Individuals with cystic fibrosis today usually succumb in their early 20’s to the cumulative effects of the disease and its therapies. Genetic therapies under development will deliver normal copies of the defective gene to the appropriate cells enabling them to make working versions of the ion pumps, effectively curing the disease. The benefit to the patient is that all symptoms of the underlying disease are eliminated, not just the most obvious or easily treated. Of course, not all diseases are the result of defects in single genes, and the promise of gene replacement therapy has yet to be realized, but the knowledge gained from understanding the operation of gene products holds tremendous promise for actually curing illness. Cancer and heart disease, the two leading causes of death in the US, will be particularly amenable to genetic-based diagnosis and treatment as we begin to understand the genetic basis of tumor formation and high cholesterol.

The result will be a decrease in genetically-treatable chronic illness and a concomitant increase in life expectancy. With earlier detection and more effective treatment of chronic illnesses, survival rates should increase. A patient who is cured of cancer through an innovative gene-based therapy will be more likely to die of another chronic disease or a non-chronic cause later in life, and may require a longer period of assisted living in the later stages of life.

The social and economic impacts of a rapidly aging population are the subject of much discussion.[25] The revolution in biotechnology will place a huge burden on our healthcare system to support a population much older than the one of today.

Genetic profiling means individualized health care

The complexity of personalized therapy regimens will encourage wholesalers and drug companies to diversify to disease management

The growing complexity and information collection requirements of more personalized diagnostics and therapies will encourage wholesalers and pharmaceutical manufacturers to diversify their business models. In addition to manufacturing and distributing therapies, many will expand their offerings to include individualized health content, disease management and information technology services. For example, Pfizer, a large pharmaceutical company, hosts a website www.pfizerforliving.com providing interactive health tools and healthcare information on various topics like diet and exercise, allergies, high cholesterol, diabetes, high blood pressure, and osteoporosis. The site includes software tools for calculating target body weight and heart rate, a nutrition analyzer and a personalized medication log. Biogen, another pharmaceutical company, recently signed a deal with Salu to create a clinical information website to reach neurologists and their patients with multiple sclerosis, providing them with educational information and programs, new study information, drug updates, research information, online continuing medical education courses, and patient education materials. Roche Diagnostics, a large diagnostics company, offers stand-alone diabetes management software for use between patients and their physicians. These companies are moving toward a one-stop-shopping location for individualized disease information, patient support and management, and health products and supplies.

Genetic Information Enables Discrimination between Healthy and Sick Individuals

Third-party payers (Payers) insulate insured consumers from the direct cost of health services and products through the pooling of expenses in group coverage. Payers allocate limited resources among a given population for a specified time. They are less interested in knowing the expected healthcare costs of an individual, compared to the expected costs for the group. Biotechnology, specifically genetic testing and tailored therapies, disrupts the insurance paradigm because it injects much more reliable information on the propensity of disease and cure at the individual level. Such information should benefit Payers in two ways.

First, knowing the genetic profile of a patient should allow the Payer to determine the most clinically effective and the most cost effective course of treatment. More targeted and effective pharmaceutical therapies for diseases like cancer or diabetes will prevent or delay the onset of complications that require costly hospital visits or surgery. Where the cost benefit inures to the Payer, they will include these therapies as part of the health benefit package. However, therapies and treatments where the cost savings are uncertain or have many years to materialize are less likely to be included even if there is a clear clinical benefit. Payers will develop sophisticated cost-effective analyses, known as pharmacoeconomics, to justify payment for specific therapies. Preventative therapies are even less likely to be covered. Because of the turnover of employees at an employer, and the turnover of employers within a Payer’s plan, the cost savings of a preventative therapy will almost never flow to the paying party, so there is no economic incentive to extend this coverage.

Second, genetic testing, would allow private MCOs to charge a higher premium to those who are shown to be likely to develop a disease during the period they are insured, or to avoid insuring those persons altogether. In theory, MCOs could more closely determine profitability on a per-patient basis, not just the entire group, because they can more accurately predict who is a “bad” risk versus a “good” risk and can establish premiums that reflect that risk level. Uncovering an individual’s genetic propensity to illness poses a real threat to the consumer surplus enjoyed by sick members in the group coverage model. In the absence of strong legislation or social pressure to solidify community and average premium rating, the availability of personal genetic information will increase the spread of health insurance premiums that are much closer to an individual’s direct cost.

Individualized medical care requires the sharing of personal health data

The enthusiasm for genetic testing as a vehicle to discover biological causes of disease and advance individualized therapies has been tempered with ethical and practical concerns over personal genetic privacy. Paul Starr of Princeton University summarized the conflicting interests of most Americans over personal genetic information:

“Patients have a strong interest in preserving the privacy of their personal health information, but they also have an interest in medical research and other efforts by health care organizations to improve the medical care they receive. As members of the wider community, they have an interest in public health measures that require the collection of personal data.”[26]

Starr further explains that the controversy over the use of personal health information diverges from the original definition of “the right to privacy”, but rather focuses on how that information is collected and used (or misused) by the health care organizations we rely upon for medical care. Starr points out that the mistrust of the healthcare system is the result of its sheer scale and complexity. The frequent flows of data among all the organizations in the industry require a complex structure of legal and technical provisions, the volume and complexity of which make it “impossible for individual patients or citizens to know whether these systems actually safeguard their data.”[27] It is the potential that personal health information will be used to exclude them from the wider community that threatens the exchange of personal genetic information.

Dr. Francis Collins, Director of the National Human Genome Research Institute, states: “Because genetic information is personal, powerful, and potentially predictive, it can be used to stigmatize and discriminate against people.”[28] A 1998 study by the National Center for Genome Resources reported that 85% of adults believed employers should not have access to a patient’s genetic information and 63% indicated they would not undergo genetic testing if they knew that insurers or employers could discover the results.[29] In the United Kingdom, a five-year moratorium on the use of genetic information by insurance companies was recently enacted.[30]

In 1996, Congress passed the Health Insurance Portability and Accountability Act (HIPAA), which introduced new standards on the use and transmission of patient-specific health information. The goal of the regulations was to prevent abuse of such information and instill confidence and security in the public on the use of digital and genetic health data. HIPAA prohibits insurance companies from using genetic information to deny or limit insurance coverage for individuals enrolled in a group plan, prohibits charging a higher premium to an individual than to others in the group and prohibits patient’s genetic information to be considered a pre-existing condition without a supporting diagnosis.

However, The National Human Genome Research Institute points out many gaps remain.[31] HIPAA does not:

· Prohibit the use of genetic information as a basis for charging more for health insurance.

· Limit the collection of genetic information by insurers and prohibit insurers from requiring an individual to take a genetic test.

· Limit the disclosure of genetic information by insurers.

· Apply to individual health insurers except if covered by the portability provision.

A solution to the privacy debate put forth in HIPAA is the use of personal consent, where the individual, not government, dictates whom and for what purpose their genetic information can be viewed. Individuals can give consent to genetic testing when it offers a legitimate health benefit, but can prohibit that information being used by others for any other purpose. Patients can opt-in to therapy and opt-out of discrimination at the same time. Criticism of this compromise is that most requests for genetic testing are at a point when the patient finds it nearly impossible to say no (say when applying for health coverage) and that it will limit the ability of clinical researchers to conduct medical research because of the additional expense of getting consent after the initial encounter.[32] The knowledge and debate over genetic testing is in its infancy, but any American solution will likely include some mixture of government oversight and individual self-control.

HIPAA privacy rules allow the right to control the release of their personal information, but do little to increase an individual’s ability. Patients will have little or no choice but to agree to genetic testing when asked. While the concern over genetic privacy is growing in momentum, it still remains largely unorganized and dispersed compared to the concentrated might and highly tuned political clout of the organizations that support the increased availability of genetic information. The collection and use of personal of genetic information will be slow at the start as the ethical and logistical safeguards are reinforced, but powerful industry interests will prevent the adoption of legislation that jeopardizes its future availability. The potential for misuse of information will dissuade some people from pursuing gene testing and therapy until the provision of personal information produces clear personal and tangible benefits.

So, will drugs get cheaper or more expensive?

Biotechnology holds the possibility of decreased cost of drug development, not lower prices

Pharmaceuticals product manufacturers have been the most profitable industry in the American economy. In 1999, Fortune magazine ranked pharmaceutical companies as the most profitable with a net profit margin of 18.6%, compared with the Fortune 500 median of 5.0[33] The pharmaceutical industry has long defended its profitability as a method for financing the risky and expensive process of discovering, developing and commercializing new therapies.

Research-based pharmaceutical companies are projected to spend over $30.5 billion, or 18.5% of sales revenue, on Research and Development (R&D) in 2001, compared with an average of 3.9% across all industries.[34]The large outlays in R&D correspond with a quintupling of the total costs to discover and develop new drugs. The high costs of R&D include the costs of discoveries that never actually become medicines. Fewer than 2% of pharmaceuticals in development actually become commercial medicines and those that do take an average of 13 years.[35]

Biotechnology will increase the number and availability of new drugs. Whether it will translate into cheaper drug prices is a tougher question. At first, new information on genes and biology will do little to reduce the number of “failed” discoveries and expenditures on R&D activities will continue to escalate, perpetuating the justification for high prices. Eventually the promise of biotechnology is to increase the productivity of drug discovery and development efforts and lower the economic return requirements of individual drugs and products for manufacturers. To date, though, no company has claimed a decreased cost of drug development due to the tools of biotechnology.

However, prices are not established based on their R&D expenses (though they are justified that way) but rather are set by the ability of manufacturers to get their price in the market. Without legislated price controls or a dramatic increase in the negotiating power of payers or consumers, manufacturers will be able to ask for premium prices on new pharmaceuticals and artificial organs regardless of any lower development costs incurred, thanks to biotechnology.

But, targeted populations for drug therapies means development, manufacturing and marketing costs must be amortized over smaller populations

Even if biotechnology results in highly efficient drug discovery and targeting, the specificity of new therapies may work against their profitability. Advances in molecular diagnostics will allow for the specific targeting of pharmaceutical therapies, which will increase their clinical effectiveness and market value. However, molecular diagnostics will reduce the overall demand for drugs by shrinking the pool of patients for whom the chemical has been proven effective. Brian O’ Reilly provides an example:

“…the typical gene-based medicine is likely to benefit a far smaller number of patients. A new medicine might not be for all 50 million people with high cholesterol, for example; it might be just for the 50,000 of 500,000 people whose cholesterol is high because they have an aberrant gene producing a faulty liver enzyme, which is different from the enzyme afflicting some other group that also has bad cholesterol.”[36]

Pharmaceutical company profits over the past decades can be partially attributed to sales of drugs where the perceived benefit was high but the actual clinical benefit might have been much lower. Molecular diagnostics could unleash information that could substantially reduce who should receive a prescription so that drug development costs will have to be amortized over smaller patient populations.

Drug manufacturers wring more dollars out of each drug

At the same time as pharmaceutical companies hope to lower the costs of drug development and testing, they will be aggressively pursuing strategies to protect and extend their product portfolios. Typically, the time involved for development and clinical testing of a new drug takes up a significant portion of the time on which the company maintains a patent monopoly. Patents are awarded for a total of 20 years, but the average period of a useful patent life of a new drug in the 1990s was only 11 to 12 years.[37]

Every month of an extended monopoly on a blockbuster drug can be worth hundreds of millions of dollars in revenue. Since drug patents are granted for a particular use, drug companies are actively looking for new uses of their existing drugs. Under current law, drug companies can get three years of additional exclusive marketing when they demonstrate that a drug can be used to treat another disease. An additional 6 months of exclusivity can be gained if the manufacturer agrees to test the product on children.

One of the benefits expected from the human genome project will a more complete understanding of the interactions of gene products. One drug, perhaps in combination with other therapies, could be used to treat a variety of diseases. Expect the pharmaceutical firms to use biotechnology at both ends of the manufacturing process: to decrease cost and increase the number of candidate drugs, and to find novel uses which will extend their monopolies over drugs in production. In any economic model, extension of the monopoly serves to support the manufacturers’ ability to set prices and thus will contribute to higher drug costs

The government continues pressure on drug costs

Another factor which complicates the prediction of the direction of drug costs is the perturbation of the free market by governmental insurance programs. For Americans over the age of 65 and for certain disabled persons, the federal government pays for pharmaceutical products received as a part of a hospital service through the Medicare Part A program. Medicaid, which is partially financed by the federal government but administered by individual states, pays for healthcare services and products for the indigent. Each state can establish eligibility criteria and offer additional services in the program. Many states cover prescription drugs for Medicaid eligibles. In 1999, 39 million persons were enrolled in Medicare and another 32 million were enrolled in a Medicaid program.[38]

In countries with universal national health insurance, the governments have been able to leverage their huge spending volume by exacting discounts from pharmaceutical manufacturers as well as enacting legislative price limits. The ability to price their products at a premium in the US has helped the pharmaceutical industry remain the most profitable industry. If the federal government limits the ability to extract those profits, the manufacturing industry will lose that position.

Despite promises made during the 2000 presidential campaign, the unlikelihood of drug coverage at the federal level helped spawn a collection of state legislative initiatives to control spending on pharmaceuticals. Soaring Medicaid drug costs and heightened media attention to pharmaceutical prices helped many state and local legislators enact purchasing legislation that will lower total drug expenditures. In Florida, the third largest Medicaid program behind New York and California, facing a $650 million deficit in its Medicaid budget and feeding off a sensation that prescription prices are spiraling out-of-control, enacted an extremely restrictive formulary (list of approved drugs). To make the list, drug manufacturers had to promise price cuts of 6% in addition to a mandated 19%.[39] Drugs from manufacturers unwilling to lower their prices were excluded from reimbursement by the program.

The Florida action has reverberated throughout the country with several other states, including Louisiana, Maine and Michigan, enacting similar legislation. The pharmaceutical industry has legally challenged the cost-containment legislation, claiming that state programs do not have the authority to restrict patient access to prescription drugs.[40] Most drug price controls have been limited to lowering prices for Medicaid eligibles and the uninsured. However, the baby-boomer generation, who have a history of voting in high numbers and prolific use of pharmaceuticals will likely support legislators who pursue price control measures.

Proposals to extend prescription drug coverage to Medicare, the largest single payer for health services, could have huge ramifications on pharmaceutical product demand, prices and profits. The drug manufacturer’s biggest concern is the de-facto price controls Medicare would place on existing and new therapies if it were to extend coverage. Medicare could exact severe price discounts from manufacturers due to large volume purchases which would likely lead to generally lower prices. If pharmaceutical manufacturers lose the ability to set the prices for their new drugs then their industry-leading profit margins will likely disappear.

Another serious concern of the drug companies is that benefit coverage, payment and delivery decisions could become vulnerable to political attitudes and bureaucratic forces. Getting a new therapy approved is a decade-long process costing millions of dollars. Getting a new therapy approved for payment and at what price and in what delivery situations could add several more years before the first pill is ever sold. For these reasons, pharmaceutical companies will oppose any Medicare drug coverage and get their allies, like the MCOs, to follow suit. They will be helped greatly by the looming insolvency of Medicare.

MCOs provide health coverage to millions of persons and have a strong financial interest in lowering pharmaceutical expenditures. Their cost control strategies and benefit coverage decisions can have a significant impact on the type, price and quantity of therapies that are provided. Up to this point the managed care industry has been relatively unsuccessful in reining in the soaring pharmaceutical costs. The managed care and pharmaceutical industries have often joined forces to limit government regulation in the health care system. However, based on more frequent signs of tension and “beginning signs of outright conflict”, Donald Moran hypothesizes, “the ‘free-market detente’ that has characterized the development of U.S. health policy since at least the early 1980s may, alas, be poised to break down in the face of the business and political pressure now facing the for-profit sector in health care”[41]

If MCOs support legislated price controls or some other sort of government intervention in the market for prescription drugs, they run the risk of creating a monster. As for-profit companies whose return is dependent on setting their own premiums, they have a vested interest in keeping the healthcare free-market alive and well. MCOs face a difficult balancing act of supporting legislative reforms that will benefit their business while maintaining the belief that the private market can handle its own inflationary problems. MCOs will quietly support certain legislation aimed to curb pharmaceutical spending, but will refrain from supporting any permanent government encroachment in the health care market.

MCOs will be the ‘bad guys’ in the drug price battle

Prescription drugs are popular and expensive. Payers have the undesirable position of making decisions of what pharmaceuticals will be covered and which ones will not be covered. MCOs will increase their efforts to slow their expanding drug bills through adjusting health benefit designs to shift costs of prescriptions to patients, stepping up efforts to extract discounts from manufacturers and traditional service providers and adopting more sophisticated and defensible economic arguments for non-payment. DTC advertising and the historically strained relationships MCOs have with physicians will force MCOs to wear the black-hat in the financing of health care for the immediate future. Lobbying efforts, legal actions and heated negotiations will be more common as MCOs fight against the high prices of new pharmaceutical products.

Conclusion

The biotechnology revolution will have profound effects on the on the American healthcare system. Genetic data will generate opportunities for new diagnostics and therapies, many of them administered at home, in the physician’s clinic, or at the mall. Regulators will be weighed down with new demands to approve these new, soon-to-be-popular pharmaceutical products and could represent a real stumbling block to the introduction of life-saving therapies. Biotechnology will enable scientists, physicians and patients to treat the underlying causes of disease, resulting in actual cures where we once treated only symptoms.

Health care will become individualized, with traditional product providers becoming more active in providing disease treatment and health information. Genetic information will also allow a greater distinction between the healthy and the sick, to the detriment of the latter. The rise of individual therapies will put a stress on the insurance group risk model. Identification of individual propensity for disease promises huge clinical benefits, but at a necessary cost to individual privacy.

Biotechnology will have little immediate impact on drug prices. While drug development costs might go down in the future, other market forces will continue to determine drug prices. As molecular diagnostics target “appropriate” patients, drug manufacturers will battle to keep prices high for those patients. Government will continue to ratchet down on the shrinking drug budgets while MCOs continue to battle member relations problems over limiting drug choice. Sales for OTC and lifestyle drugs will soar.

The interactions between drug manufacturers and doctors, and doctors and patients will evolve as biotechnology and information technology reduce the information asymmetry on which the relationships are currently based. Drug distributors and pharmacies have an opportunity to use their close client relationships to increase the value and breadth of their services. . The opportunities for realignment in the healthcare industry as a result of the biotechnology revolution are no less significant than the realignment in the computer industry as a result of the information revolution.