Pharmaceutical R&D: Costs, Risks, and Rewards February 1993 OTA-H-522 NTIS order #PB93-163376 GPO stock #052-003-01315-1 Recommended Citation: U.S. Congress, Office of Technology Assessment, PhurrnaceuficaZ R&D: Costs, Ris/u and Rewards, OTA-H-522 (Washington, DC: U.S. Government Printing Office, February 1993). [:or ,L,lc ~, I]W 11. s. (;()~cnln]cn[ Pnntlng OI!ICC Supt. I IIIIL.IIdCI)[ (II [)ocumcnl.. ?Iiill Slop: SSOP. W.i.hlngl(m, 1)(’ ?(M()? -[)32X ISBN 0-16 -041658-2 Foreword harmaceutical costs are among the fastest growing components of health care costs today. Although increases in the inflation-adjusted prices of ethical drugs and perceived high prices of new drugs have been a con- P cern of congressional committees for over 30 years, the growing Federal role in paying for prescription drugs has increased the concern over the appro- priateness of prices relative to the costs of bringing new drugs to market. Specific policies of U.S. and other governments can alter the delicate balance between costs and returns to pharmaceutical R&D, with ramifications for the future health of Americans, for health care costs, and for the future of the U.S. pharmaceutical industry. OTA’s report focuses mainly on the economic side of the R&D process. Pharmaceutical R&D is an investment, and the principal characteristic of an investment is that money is spent today in the hopes of generating even more money in the future. Pharmaceutical R&D is a risky investment; therefore, high financial returns are necessary to induce companies to invest in researching new chemical entities. Changes in Federal policy that affect the cost, uncertainty and returns of pharmaceutical R&D may have dramatic effects on the investment patterns of the industry. Given this sensitivity to policy changes, careful consid- eration of the effects on R&D is needed. The specific request for this study came from the House Committee on Energy and Commerce and its Subcommittee on Health and the Environment. The Senate Committee on the Judiciary’s Subcommittee on Antitrust, Monopolies, and Business Rights endorsed the study. OTA was assisted in this study by an advisory panel of business, con- sumer, and academic leaders chaired by Frederick M. Scherer, Ph. D., Professor of Economics, John F. Kennedy School of Government at Harvard University. OTA gratefully acknowledges the contribution of each of these individ- uals. As with all OTA reports, the final responsibility for the content of the assessment rests with OTA. Roger Herdman, Acting Director . Ill Advisory Panel Frederick M. Scherer, Chair Lewis A. Engman Judy C. Lewent Professor of Economics Partner Senior Vice President and Chief John F. Kennedy School of Winston & Strawn Financial Officer Government Washington, DC Merck & Company, Inc. Harvard University Whitehouse Station, NJ Cambridge, MA Thomas Q. Garvey, Ill President George B. Rathmann Jerome Avorn Garvey Associates Inc. Chairman of the Board Director Potomac, MD ICOS program for Analysis of Clinical Bothell, WA Strategies Frederic Greenberg School of Medicine Partner Shyam Sunder Harvard University EGS Partners Professor of Management and Boston, MA New York, NY Economics School of Industrial Administration Nancy L. Buc Robert Helms Carnegie-Mellon University Partner Resident Scholar Pittsburgh, PA Weil Gotshal & Manges American Enterprise Institute Washington, DC Washington, DC Jacob C. Stucki Retired Vice President for Martin Neil Baily Gene Kimmelman Pharmaceutical Research Professor of Economics Legislative Director The Upjohn Company University of Maryland Consumer Federation of America Kalamazoo, MI College Park, MD Washington, DC W. Leigh Thompson William S. Comanor Jeffrey Levi Executive Vice President Professor of Economics Director of Government Affairs Eli Lilly & Company University of California AIDS Action Council Indianapolis, IN Santa Barbara, CA Washington, DC NOTE: OTA appreciates and is grateful for the valuable assistance and thoughtful critiques provided by the advisory panel members. The panel does not, however, necessarily approve, disapprove, or endorse this report. OTA assumes fill responsi- bility for the qort and the accuracy of its contents, iv Project Staff Roger C. Herdman PRINCIPAL STAFF OTHER CONTRIBUTING STAFF Assistant Director JUDITH L. WAGNER Jacqueline C. Corrigan OTA Health and Life Sciences Project Director Senior Analyst Division Philip T. Polishuk Clyde J. Behney Michael E. Gluck Research Assistant Health Program Manager Senior Analyst Penelope Pollard ADMINISTRATIVE STAFF Senior Analystl Beckie Erickson Office Administrator Timothy W. Brogan Research Assistant2 Eileen Murphy P.C. Specialist Lara Jakubowski Research Assistant3 Carolyn Martin Secretary David J. Kaufman Research Assistant Arna M. Lane Research Analyst PRINCIPAL CONTRACTORS Roseanne Altshuler Richard Frank Stephen W. Schondelmeyer Rutgers University The Johns Hopkins University University of Minnesota William R. Baber Alan Garber Gordon Sick George Washington University Palo Alto Department of Veteran Affairs University of Calgary and Stanford University Lester Chadwick Ellen S. Smith University of Delaware Elizabeth Jensen consultant Hamilton College Robert Cook-Deegan Steven J. Wiggins consultant Albert Link Texas A&M University University of North Carolina at Greensboro Joseph DIMasi Tufts University Stewart C. Myers Massachusetts Institute of Technology 1 From September 1989 to September 1991. W. Gary Flamm 2 From Feb~q 1991 to Febw 1992. SRS International, Inc. Lynn Powers 3 From Auwst 1989 to JUIY 1991. Editorial Consultant v contents 1 Summary, 1 Summary of Findings, 1 Introduction, 3 Origins and Scope of OTA’s Study, 3 Issues Beyond the Scope of This Study, 4 The Nature of Pharmaceutical R&D Investments, 4 R&D Costs: The Evidence, 10 Returns on R&D: The Evidence, 19 Total Pharmaceutical Industry Returns, 23 Industry Response: Increasing R&D, 24 Payment Policy and Returns on R&D, 26 The Regulation of Pharmaceutical R&D, 32 Federal Tax Policies Affecting Pharmaceutical R&D, 33 Federal Support for Pharmaceutical R&D, 34 2 Research and Development Expenditures, 39 How to Measure R&D Spending, 39 Trends in Domestic R&D Spending, 42 Trends in Worldwide Pharmaceutical R&D , 4 Expenditures, 43 Directions of Pharmaceutical R&D, 44 Interpreting Aggregate Trends, 46 3 The Costs of Pharmaceutical R&D, 47 A Framework for Estimating R&D Costs, 47 Existing Studies of R&D Costs, 48 Validity of R&D Costs Estimates, 54 Other Factors Affecting Validity, 66 Tax Savings From R&D, 67 Recent Trends in the Cost of R&D, 69 Conclusions, 72 J vii 4 Returns on Pharmaceutical R&D, 73 Returns on R&D: The Evidence, 76 Total Pharmaceutical Industry Returns, 95 Findings and Conclusions, 104 5 Trends in Science, Technology and Drug Discovery, 105 Drugs and Receptors, 106 Protein Analysis and Proteins as Pharmaceutical Agents, 113 Genetics in Biomedical Research, 119 DNA as a Therapeutic Agent, 127 Discovery Increasingly Driven by Biomedical Research, 131 Implications for Future Pharmaceutical R&D Cost, 132 6 Government Regulation and Pharmaceutical R&D, 135 The Impact of Pharmaceutical Regulation on R&D Costs and Output, 136 The U.S. Regulatory Review Process for New Drugs, 138 Efforts to Expedite FDA New Product Regulations, 151 Trends in the R&D and Regulatory Review Processes, 158 Trends in the Regulation of Pharmaceuticals in Other Countries, 163 Conclusions, 167 7 Product Liability and the Pharmaceutical Industry, 169 Product Liability and Pharmaceutical R&D, 169 Pharmaceuticals and Product Liability Law, 170 Product Liability Insurance, 172 Product Liability Claims and R&D, 173 Government Policy and product Liability, 180 Conclusions, 182 . Vlll 8 Federal Tax Policy and Drug Research and Development, 183 Analyzing Tax Policy, 183 Tax Deductions and Taxable Income, 184 Tax Credits, 186 Other Nations’ R&D Tax Incentives, 197 Conclusions, 198 9 Federal Support for Pharmaceutical Research and Development, 201 Federal Support for Life Sciences, 203 Collaboration Between Pharmaceutical Firms and Academia, 206 Targeted Federal Pharmaceutical R&D Programs, 210 Industry Collaboration With Federal Research Laboratories, 217 Orphan Drugs, 225 Medicare and Medicaid Support for Clinical Drug R&D, 232 Conclusions, 233 10 Trends in Payment for Prescription Drugs, 237 Health Insurance for Prescription Drugs in the United States, 238 Prescription Drug Benefits in Other Countries, 250 Conclusions, 262 APPENDIXES A Method of Study, 265 B Acknowledgments, 269 C The Cost of Capital, 276 D Congressional Access to Proprietary Pharmaceutical Industry Data, 284 ix E Patent Protection of Pharmaceuticals in the United States, 290 F Summary of Methods Used to Analyze Trends in Postpatent Revenues, 294 G Estimating the Cost of Producing and Selling New Chemical Entities, 302 H Methods of OTA’s Survey of Clinical Trial Size, 308 I Methods Used in OTA's Study of Success Rates for New Molecular Entities, 309 J Estimates by OTA and JCT of Federal Tax Credits Attributable to Pharmaceuticals, 310 K Federal Programs Dedicated to Pharmaceutical R&D, 311 L Acronyms and Glossary of Terms, 316 REFERENCES, 323 INDEX, 347 n this assessment, the Office of Technology Assessment examined the costs of pharmaceutical research and development (R&D), the economic rewards from that investment, and the impact of public policies on both costsI and returns. Below is a brief synopsis of the study’s major conclusions: SUMMARY OF FINDINGS . Pharmaceutical R&D is a costly and risky business, but in recent years the financial rewards from R&D have more than offset its costs and risks. The average aftertax R&D cash outlay for each new drug that reached the market in the 1980s was about $65 million (in 1990 dollars). The R&D process took 12 years on average. The full aftertax cost of these outlays, compounded to their value on the day of market approval, was roughly $194 million (1990 dollars). The cost of bringing a new drug to market is very sensitive to changes in science and technology, shifts in the kinds of drugs under development and changes in the regula- tory environment.