Changing economics in an era of healthcare reform

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Under these pressures and because of the growing sophistication of animal toxicology and clinical research techniques, pre-marketing requirements have become increasingly detailed over time. The resulting system has provided important information on the safety and efficacy of new drugs, but it also has considerably lengthened the pre-marketing development process. The tension between increasingly thorough pre-marketing evaluations and early product availability becomes urgent in the case of life-threatening disease.

In the early s this tension led the FDA to create a category of regulatory exceptions for cancer drugs so-called group C drugs to allow desperately ill patients to use promising but still experimental drugs before they are officially approved. However, it is only with the advent of the human immunodeficiency virus HIV epidemic and the activism of patient advocacy groups for acquired immune deficiency syndrome AIDS that the need to streamline the drug approval process for life-threatening diseases has come into the national spotlight and has further transformed regulatory practice.

This procedure shortens the pre-marketing evaluation stage by merging Phase II and Phase III trials into more definitive Phase II trials, and it emphasizes more strongly the post-marketing evaluation stage Phase IV for providing safety and effectiveness information.

There are medical and economic reasons to expect that some of these changes will be extended to other disease categories. First, despite increasingly detailed pre-marketing trials, there are no zero-risk drug approval decisions.

For example, the detection of delayed or rare adverse effects less than 1 in 10, would require extremely long periods of testing or the exposure of many thousands of patients. Furthermore, valuable therapeutic information on the risks and benefits of a drug may emerge only after its diffusion into the often uncontrolled environment of general use; for example, side effects may be influenced by differing pharmacogenetic profiles of patients, comorbidities, environmental influences, and other factors.

These side effects may go unnoticed in carefully controlled and selected pre-marketing studies; their detection requires post-marketing evaluation.

Second, there is an economic argument that favors more emphasis on post-marketing research, especially if the pre-marketing evaluation period can be shortened. The increasing duration of pre-marketing development has made the process more costly and has reduced the effective patent life of new pharmaceuticals.

The need to halt the continuing erosion of patent protection was recognized in the Drug Price Competition and Patent Term Restoration Act of Under its terms, manufacturers can have their patent term extended for up to 5 years to compensate for time that passes while waiting for approval.

Instead of the extensive animal and clinical data for a full NDA, this simplified application merely requires demonstrating that the active ingredient is bioequivalent to an already-approved drug whose patent is about to expire.

The loss of market share to much-lower-priced generic drugs has been exacerbated by the more stringent payment policies of the s. Historically, drugs have been the least expensive of all medical technologies; with higher patient coinsurance rates and out-of-pocket fees, they were not main targets for cost savings.

Except in the Medicare program a major exception , prescriptions were generally reimbursed liberally. In the s payers came under increased pressures to contain costs, and with improvements in computerized insurance claims systems and utilization review, they began to scrutinize claims for medications more critically. As Mortenson indicates Chapter 4 , three issues permeate recent policy debates: a payment for experimental drugs and the care of patients in clinical trials, as well as payment for experimental drugs used outside of clinical trials compassionate use ; b payment for the use of approved drugs for non-approved purposes off-label use ; and c the coverage of new drugs under formularies and the passage of generic substitution laws Until recently, this clause, especially with respect to medications, was not strictly enforced.

Medications in Phase I, II, or III trials now are categorically denied reimbursement, however, and payers are starting to deny the associated costs of hospital care.

The hesitancy to pay for the often higher costs of care associated with experimental drugs is understandable. Mortenson argues that this approach would be especially attractive to the treatment of solid tumors, where standard medical regimens are not very effective and experimental therapies offer the best chance for a clinical response The second issue concerns reimbursement for drugs used for conditions that have not been specified on their label.

As mentioned, drug development occurs not only before a drug is introduced into practice but also continues afterwards as additional indications emerge during its use in clinical practice. As Mortenson indicates, roughly 50 percent of chemotherapy regimens, which represent state-of-the-art oncological practice, are officially off-label Reimbursement of off-label use has become controversial, for many payers interpreting their contracts restrictively have designated off-label drugs as investigational and excluded them from coverage.

In addition, many new indications are found late in the life cycle of a drug, often near the time of generic competition, at which time manufacturers have little financial or marketing incentive to invest in further clinical trials. The use of such medical compendia as the U. Finally, coverage policy for new FDA-approved drugs is undergoing pro found change.

A case in point is the rapid growth of formularies in both the public and private sectors. At the same time payers have started to enforce generic and therapeutic substitution more stringently. The recent introduction of biotechnology drugs with thousand-dollar price tags has galvanized the HCFA and the U.

Congress to look more closely into how manufacturers make pricing decisions. He finds that the average compound earns a real annual return of 9 percent. However, if prices had not increased during the s, then an average drug would not have broken even within its expected market life.

Close scrutiny of drug pricing policies by government and an increase in the number of large, sophisticated institutional buyers will make it difficult for the drug industry to continue its price increases Current trends will place a heavier burden on the industry to develop breakthrough drugs or second- and third-generation drugs that lead to important improvements in clinical outcomes and efficiency.

For example, many innovators are focusing on drugs that require less frequent dosing and have less expensive costs of administration.

Furthermore, because economic arguments have become central to the case for formulary acceptance, the development of new pharmaceuticals is increasingly supported by cost-effectiveness studies. Finally, as Spiegel states Appendix B , there is a strong trend toward industry mergers and consolidation to create economies of scale in research and marketing. The policy environments differ considerably for drugs and for devices, as can be expected given differences in the two industries and the nature of innovation.

The device industry is younger, less concentrated, and comprises mostly smaller firms. There is much greater heterogeneity of medical devices in terms of design, purpose, and use and in the firms that manufacture them.

Foote Chapter 5 estimates the industry—7, manufacturers—to produce roughly 1, different types of medical devices Because a device for a specific application often can be designed in a number of different ways, patents are less significant for device than for drug innovation. For example, the first lithotripter—invented and developed by Dornier—used shock waves generated by spark gap technology. However, Dornier's patent was not a significant entry barrier for competitors, who could easily design around the patent by generating shock waves electromagnetically, piezoelectrically, and by microexplosive technology Furthermore, a high level of incremental innovation characterizes the development of new medical devices.

Also, the product life of a device usually is much shorter than that for drugs; competitors may rapidly introduce a slightly modified version. Finally, the ultimate effectiveness and benefit of the device is often crucially dependent on the skills of the practitioner using or implanting the device. These elements of device heterogeneity, incremental innovation, and dependence on users can help explain some of the differences in the way medical devices are regulated. The history of medical device regulation is shorter and less complicated than that of drugs.

Although the FDA had some jurisdiction over medical devices as early as , not until the Medical Device Amendments to the Food, Drug and Cosmetic Act were all medical devices required to be reviewed by the FDA before marketing. The law classifies devices in two ways: by level of risk Class I, II, or III and by descriptive category pre-amendment, post-amendment, substantially equivalent, implant, custom, investigational, and transitional.

The underlying principle is that the more potentially dangerous the device, the more stringent the regulatory scrutiny. Device manufacturers obtain FDA approval for marketing their products in two basic ways. Since device innovation is predominantly incremental, this provision was intended to reduce the regulatory burden for technologies that were not significantly different from those already marketed. The other main route is more comparable to drug regulation and involves full pre-market testing and approval.

The differences between these two FDA approval routes are significant. Because a k application requires much less time and effort on the part of a manufacturer, the average FDA response time to pre-marketing notification in one study took one-fifth the time taken to approve a pre-marketing application PMA. This dramatic difference has not been overlooked by the industry—approximately 55 substantially equivalent k s are filed for each PMA filed Foote reviews the trade-offs and conflicts among the various policies that affect device innovation She refers to recent concerns about the implementation of the device amendments.

For example, studies by the General Accounting Office GAO found weaknesses in pre-marketing review broad use of k applications as well as failures of post-marketing surveillance 11 These reforms will address some of the weaknesses in current device evaluation. This recommendation is especially relevant, because the vast majority of device companies are small and do not have the resources manpower, money, or time to deal with an elaborate regulatory process.

Liability law also intends to deter the diffusion of unsafe products, as well as to permit compensation for injured users. Devices like drugs are caught up in an increasingly litigious society.

The legal environment is complex and relatively unpredictable, and it can have serious negative effects on innovation. Consequently, there is a growing recognition that reform of the liability system is in order and that unnecessary overlap between regulation and liability in their pursuit of device safety should be eliminated Expensive medical devices were seen as the personification of rising costs in the s; as a result, they have been the focus of cost-containment efforts for a longer time than have drugs.

For a new device the increasingly restrictive payment circumstances often became manifest first in the form of the HCFA coverage decision for the Medicare program. Coverage decisions usually are made locally by HCFA fiscal intermediaries. Public Health Service. Following a Medicare coverage decision, a technology must be assigned to a certain DRG category. Although the price system is intended to be neutral under PPS, this is not always the case.

By contrast, cochlear implants were placed in a DRG that covered only a fraction of the cost of the device. For example, innovators developing second- and third-generation implants were unable to attract venture capital or to interest larger manufacturers to further pursue development.

In general, hospitals have a strong financial incentive to provide the least resource-intensive treatment under PPS although competition, patient demand, and malpractice concerns may provide countervailing forces. The system promotes a significantly lower level of growth in service intensity than traditionally has been the case. Recalibration of DRGs could mitigate disincentives to use costly new technologies, but readjustments often considerably lag changes in medical practice Furthermore, as Neumann and Weinstein point out 1 , because PPS applies only to inpatient hospital services Medicare Part A , hospitals have an incentive to provide more services in the outpatient setting even if they could be provided more efficiently in inpatient care and to use only those technologies that are cost effective over the short term of hospitalization.

Hospitals may have little financial incentive to use technologies with long-term benefits, even though those technologies may ultimately have a greater impact on the efficiency of the system as a whole.

Because HMOs receive a fixed amount per enrollee and also deliver outpatient care, they have less incentive to inappropriately shift to outpatient care, and decision making is more likely to reflect concern with long-term cost effectiveness. This long-term perspective, however, may be tempered by the fact that HMOs may not pay for all patient services such as long-term nursing home care as well as by the significant number of HMO enrollees who leave the system 1.

The change toward a more stringent payment policy seems to have exerted a strong effect on medical device innovation. For example, incentives to avoid restrictive Medicare Part A reimbursement controls have done more than change the locus of care; they have also stimulated the development of a whole range of new devices to be used exclusively in the outpatient setting.

These include everything from smaller, lighter, and less expensive versions of hospital machines which are more amenable to office use to new, user-friendly, computerized infusion devices for the growing number of home health care applications. A proposed HCFA rule change would require that device manufacturers have not only FDA approval attesting to safety and efficacy but also data showing that their technology improves outcomes or lowers resource use relative to existing alternatives.

Yet the very essence of a new device is that its costs and benefits are uncertain until applied more widely and subject to considerable change thereafter. Foote discusses interim coverage as a more appropriate payment alternative—that is, covering costly devices for a designated period of time during which providers can gather information on costs and effectiveness.

Although surgical procedures typically involve the use of drugs and devices, their defining characteristics may be the special combination of surgical skills and abilities they entail. The dynamics for those procedures that do not center on a new product e. According to Chang and Luft Chapter 7 , incremental innovation often occurs in everyday practice, but major surgical procedures generally are developed by specialists in academic centers Surgical procedures cannot be patented; although surgical innovators may gain higher fees and more patients, they receive no licensing fees for procedures performed by others.

Motivating factors may include the need to offer patients improved surgical technology, the thrill of being first, and the attainment of national reputation and academic prestige. Finally, if a new procedure is not centered on the use of a new product, no formal government regulatory system exists to evaluate it prior to diffusion.

The realm of surgical procedure evaluation has been left to the medical profession in the spirit of clinical autonomy. This takes place largely through peer review, the activities of medical societies, and Institutional Review Boards IRBs. Although IRBS are responsible for reviewing university-based research, they are interested primarily in protecting the rights of human subjects and not in issues of evaluation.

As a result, new surgical procedures generally are not systematically evaluated for safety and efficacy, and controlled clinical trials are often undertaken only after their diffusion. In this context payment policies take on a quasi-regulatory rigor. Coverage and reimbursement decisions represent crucial determinations that limit or expedite the adoption and use of new procedures.

Some commentators argue that they have become the rate-limiting step in diffusion—the true technological gatekeeper The proliferation of managed care policies, such as surgical second opinion, pre-certification, concurrent review, and case management, signals a new level of scrutiny of surgery by payers. However, as mentioned, other factors affect the adoption of new technology as well.

For example, Chang and Luft 27 call attention to the powerful influence that competitive forces can have on the adoption of new technologies. Sometimes, the presence of a new technology or a surgical team capable of performing an experimental operation has such cachet that it helps an institution portray itself as a modern facility that uses breakthrough technology to provide high-quality care.

Changes occurring in the payment situation appear to affect surgical development and diffusion considerably, although empirical research is scarce. Chang and Luft point out that new procedures are identified chiefly through the coding system for insurance claims or hospital discharge summaries. In most cases an innovator seeks payment for an innovation by pursuing a new billing code or an additional code descriptor.

Payment systems are very sensitive to the experimental versus accepted status of a procedure just as they are for drugs and devices. Weaknesses in data and methods for assessing the value of new operations often are at the center of disputes about whether payers should reimburse practitioners or hospitals for a given procedure. More rigorous coverage criteria are forcing clinicians to improve their evaluation of the safety and efficacy of new procedures; however, the very nature of surgical innovation poses several challenges to traditional modes of evaluation that need to be addressed.

Chang and Luft describe how PPS has—and the implementation of the new RBRVS for physician payment will—affect the diffusion and development of surgical interventions The underlying principle is that a good outcome from a complex, risky operation is highly dependent on the talents of a stable, experienced, well-run surgery team.

As a prerequisite for bidding on a selective contract, an institution must demonstrate experience with the procedure, good success rates, and institutional commitment to maintaining the program in question. More recently, the nature of selective contracting has changed.

It is more common to select only a few institutions among those that have met certain minimum standards. This has resulted in price competition among large institutions; for example, institutions have started to offer a package rate for coronary artery bypass grafting.

Thus, selective contracting has become a way for large insurers to bargain for certain high-cost procedures with a center that has high-quality outcomes. These payment changes are creating incentives to encourage the efficient use of resources, and they may limit the premature diffusion of costly surgical procedures.

One drawback is that the mortality and morbidity data used to evaluate outcomes are relatively limited; insofar as this is true, selective contracting may focus on price because it has no adequate measure of quality. Changes in payment schemes also provide greater incentives for surgeons to develop more efficient variations of operations.

Reducing operating room time is the most direct way of reducing the costs of surgery itself and of complications and their associated costs. Furthermore, interest is growing in developing less invasive operative procedures, such as laparoscopic gynecological surgery, cholecystectomy, and herniorrhaphy The downside of payment reforms, however, may be to reduce the financial ability of hospitals to fund developmental activity and to evaluate and document the utility and costs of new procedures.

Proposals that might remedy this situation include interim coverage and modifiable selective reimbursement; they require serious consideration if we want to continue incentives for innovation. The United States, Europe, and Japan provide large-scale natural experiments as to the impact of public policies on medical innovation.

In general, European governments are more heavily involved in the delivery, financing, and regulation of health care than is the United States, although considerable differences among European countries exist. Burstall Chapter 8 provides an in-depth discussion of the European environment for pharmaceutical innovation In comparison with American firms, European companies face several distinct disadvantages.

First, Burstall argues that Europe cannot compete with the United States in basic science, partly because of Europe's smaller government support for academic and related research. Second, legislation to restore effective patent life has not yet been enacted in Europe. On the other hand, European firms enjoy certain advantages In contrast to the United States, for example, generics are not as actively promoted; they account for no more than 5 percent of the market.

Furthermore, the procedures to bring a drug through regulatory review seem to be more flexible and less time consuming in Europe. Finally, structural differences in the liability system contribute to making Europe significantly less litigious.

This situation will change with the creation of a truly common European market in EEC proposals to lengthen effective patent life will, if implemented, put Europe in an advantageous position relative to the United States. The harmonization of product-licensing procedures could either reduce or lengthen approval times, depending on the policies followed, and pricing issues still need to be resolved. Burstall surmises that American companies as they are large and innovative stand to benefit from the unification of the European market, but that it is difficult to be as optimistic about the European drug companies.

Hutton Chapter 9 reviews the European policy environment for device innovation. In Europe was estimated to represent 25 percent of the world market for devices Pre-marketing regulatory policies are less stringent in Europe; most nations tend to confine themselves to safety and technical performance criteria and do not include efficacy. Hutton contends that changes in payment policies, such as a growth in hospital budgeting systems, have had a greater impact on device innovation than regulatory policies.

Neimeth Chapter 10 describes how the Japanese government used a combination of policies to rebuild a pharmaceutical industry whose manufacturing facilities were virtually destroyed during World War II Furthermore, in a system of pre-marketing approval was enacted that had pre-clinical and clinical requirements different from those in other industrialized nations and that required clinical research to be undertaken in Japan.

In response to these patent and payment policies, Japanese firms focused on the development and manufacturing of me-too products. At the same time, the act established an entry barrier to foreign firms. Furthermore, the financial incentives embodied in the payment system formidably increased demand; by , 40 percent of the overall health bill in Japan was spent on drugs by contrast, in the United States the share of national health care expenditures for drugs was 6 to 8 percent In the s significant downward adjustment of prices occurred, and pre-marketing approval requirements were harmonized with international standards, allowing international competition.

As a result of increased competition and decreased profitability, Japanese companies increased their investment in research and their globalization efforts. Neimeth thus shows how patent, regulatory, and payment policies have combined to create a strong industry. This growth, however, has come at a price. First of all is the likely inappropriate use of drugs reflected in the immense share of total health care expenditures.

Moreover, some observers believe that Japan's innovative capacity might have developed sooner if policies had allowed more foreign competition and if patent protection had been in place earlier. This society generally values technological innovation in medicine. Over time, a set of public policies has evolved to encourage the development of new medical technology.

At the same time, in our pursuit of other policy objectives—such as enhancing safety, access, or cost-effective care—we may inhibit innovation. This volume discusses the complex interdependencies and trade-offs in public policy that affect the nature and rate of technological change.

In contrast to other sectors of the economy, research on the economics of innovation in medicine is just emerging, and this volume tends to pose more questions than it answers. This is especially true when one takes into account the influences that motivate innovation in the small device firm, the new biotechnology firm, or the surgeon innovator.

Obviously, improved understanding of the basic mechanisms that underlie technological change is necessary if government interventions are to be successful in encouraging not only the diffusion, but also the development, of cost-effective technology.

We hope that this volume stimulates much-needed empirical research on the economics of medical innovation and contributes to a better understanding of the critical issues in public policy during the s. Coverage refers to the decision to pay or not pay for a technology and under what circumstances. The reimbursement decision involves how much to pay for the technological intervention and how. Patents provide a restricted period of monopoly power to an inventor to make, use, and sell an innovation.

Effective patent life refers to the period between approval of the product and the patent expiration date. Officially, a U. In most European countries patent terms are 20 years, and they commence at time of filing. He and his wife live in Atlanta, Georgia, taking advantage of the opportunities they now have to spend more time with their nearby children and grandchildren. Brief content visible, double tap to read full content. Full content visible, double tap to read brief content.

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