How The FDA Created “Hedge Fund Bro” Martin Shkreli
Everyone knows the story — “hedge fund bro” Martin Shkreli purchased the rights to Daraprim, a drug used mostly by HIV patients, and heartlessly raised the price by 5,500%. Pretty horrible situation all around. So why should we condemn anyone other than Shkreli?
Because this is a wildly incomplete version of an even larger, sadder story. Yes, what he did was terrible, but focusing our anger on one man completely misses the real opportunity to reform the system that allowed it in the first place.
The Daraprim price increase is not a unique story
We shouldn’t be directing our anger at one specific drug price increase. Many drugs, both generic and brand-name, are getting increasingly more expensive. Daraprim has not been the only drug to go through a massive price hike in the United States recently — 100 pills of the asthma drug albuterol sulfate went from $11 to $434 in only six months, 500 pills of generic antibiotic doxycycline hyclate went from $20 to $1,849 also in six months, and tetracycline went from $0.035 to $2.36-per-pill within a year.
Between November 2013 and 2014, 17 generic drugs increased in price by over 1000%.
If you actually care about improving drug affordability in America, focusing on how our system allowed Shkreli to act the way he did, as well as understanding what’s causing this larger trend should be our focus. In order to achieve good policy reform, we need a good diagnosis of the situation before arriving at any conclusions.
The Daraprim Story And The Underlying Issues
Here’s a more thorough overview of the entire situation —
In August 2015, Turing Pharmaceuticals, lead by Founder & CEO Martin Shkreli, purchased the rights to Daraprim (pyrimethamine) from Impax Laboratories for $55 million dollars. Shortly after securing those rights, Turing Pharmaceutical raised the price of one pill of Daraprim from $13.50 to $750.
In America, drug companies are allowed to charge high prices by protecting their new drugs from competitors in two ways — with a patent and with FDA exclusivity. These protections can last between 180 days to 20 years.
Daraprim has been an FDA-approved drug since 1953, meaning it’s patent and exclusivity have long expired. Without an active patent, generic drug manufacturers are completely free to sell a cheaper generic version of Daraprim in the United States.
So why isn’t there a cheap generic version of Daraprim available in the United States to compete with Shkreli? This is the question we should be discussing. Seems like a no-brainer for generic drug manufacturers since it would be easy to grab market share from such a wildly overpriced drug.
When one or more generic versions of a drug hits the market, the price of that drug drops dramatically. This is why pyrimethamine, the active drug in Daraprim, is so cheap in other countries — $0.66-per-pill in the UK, $0.18-per-pill in Australia, and $0.10-per-pill in India. All it would take is one generic pyrimethamine in the United States to see prices fall dramatically.
So why hasn’t that happened?
The FDA forces Americans to overpay for prescription drugs
Two specific FDA policies play a rather significant role with the trend of increasing drug prices in the United States — exclusivity periods, and the barriers to entry for new drugs.
First, exclusivity periods. The FDA uses an interesting phrase to describe the goal of exclusivity periods — to allow drug companies to “recover the development costs” of new drugs. Translation — since it’s easy to overcharge for something when there’s no competition, exclusivity periods essentially encourage drug companies to legally price gouge.
There’s actually logic behind this — Scientific America estimates that between research and development costs and FDA regulations, it now costs $2.5 billion to bring a new drug to market, double the amount it took ten years ago. If a drug was immediately met with cheap generic competition, drug companies would never be able to recoup this initial $2.5B+ investment and therefore wouldn’t invest as much money into the development of new drugs in the first place.
By allowing drug companies to bring new drugs to market without competition for a set period of time, drug companies can charge much more than would otherwise be possible and recoup their investment quicker. This is great for the pipeline of innovative new drugs, and great for people who need innovative new treatments, but not so great for the people paying for those drugs while they’re in their exclusivity periods. But this is a good compromise to ensure that drug companies have the incentives necessary to continue to develop new drugs that drastically improve our quality of life. Until someone comes up with a better system to balance the need to incentivize new drug development with the desire to have affordable drugs, this is the best system we’ve got.
And this is what Martin Shkreli took advantage of — he dramatically increased the price of Daraprim because there were no competitors to keep him in check.
But the difference between what Shkreli did and what the FDA encourages is that Daraprim was not a new drug and should have had generic competitors by now to prevent this price increase from ever happening.
Why hasn’t a generic Daraprim been introduced in the United States? This leads to the second way the FDA is forcing American people to pay more for drugs — crazy barriers to entry for new drugs.
In the United States — and most developed nations — you can’t launch a new drug without obtaining the proper approvals. This costs time and money. In America, it takes a lot of time and money, which causes two problems —
First, a drug manufacturer must charge a higher price for their drugs in order to recoup their initial research and development costs.
Second, if the market for a new drug is small, the costly barriers to entry may outweigh the potential profits and the drug won’t be brought to market in the first place.
With Daraprim, the latter scenario has prevented a generic from entering the market. Let’s go through the numbers —
According to the Infectious Disease Society of America, at $750-per-pill, Daraprim would cost $336,000 for someone under 60kg and $634,500 for someone over 60kg, implying a patient needs between 448 and 846 pills of Daraprim annually (however, according to the CDC, a course of Daraprim is comprised of about 88 pills — I’m not a doctor so we will use the IDSA’s numbers, but they may be significantly overstated). About 2,000 people per year need Daraprim to treat toxoplasmosis. At $750-per-pill, the annual market for Daraprim is somewhere between $672M and $1.27B. At the old price of $13.50-per-pill, the market was only $12.1M to $22.8M annually.
With no generic competition, Turing Pharmaceutical feels no business pressure to lower the price. But if a generic popped up, competition would drive the price down. Let’s say Daraprim sold at $0.66 per pill, the same price in the UK. This would make the annual market for pyrimethamine between $591,000 and $1.12 million — a very small market.
But if another company besides Turing sold pyrimethamine and the market was split equally, each would see annual revenues of about $295,500 to $558,000. Under the most optimistic circumstances, each company could expect to earn a 40% net margin on that and earn at least $118,200 in profit annually.
So how much would it cost for a generic manufacturer to enter this market? According to the Washington Post, it costs between $1 million and $5 million and takes about 3 to 5 years. To reiterate that, a company would have to spend between $1 million and $5 million and wait 3 to 5 years before they could optimistically earn $118,200 annually. Doesn’t sound like a very good deal.
If the FDA didn’t force a new generic drug to cost so much and take so long to develop, there would probably be a cheap generic Daraprim in the United States today and Shkreli wouldn’t have been able to raise the price of Daraprim so dramatically without having his business suffer.
Something needs to change, but not all reforms are good
We can all agree that affordable access to drugs for anyone that needs them is a positive goal — the question is how to achieve that.
It comes down to a balancing act between making it worthwhile for drug companies to develop new drugs versus making drugs affordable.
Unfortunately, many people are calling for reforms that would not only do little to fix the current underlying issues, but would actually make matters worse.
Enter Bernie Sanders.
Bernie Sanders has been a vocal advocate for lowering the cost of prescription drugs. And to be honest, not all of his ideas are bad — but some are horrible.
Sanders released a six-point plan, but it lacks any sort of substance so it’s impossible to analyze. Not once does he discuss the true underlying issues — FDA red tape and the high cost of bringing drugs to market.
Better solutions to be considered
A few politicians have tossed around ideas, but no one has released an in-depth plan or displayed a more holistic understanding of the issues than Hillary Clinton. Despite her populist rhetoric and a few questionable proposals, Hillary Clinton actually has an impressive wonk-level grasp of the issues and has a good plan overall to address drug affordability in America —
Stop direct-to-consumer drug company advertising subsidies, and reinvest funds in research
Clinton wants to “ban or severely restrict” direct-to-consumer marketing for prescription drugs. Nothing wrong with this idea — drug companies can still market their drugs to doctors. This is how it should be. Marketing directly to non-medically trained consumers is reckless and just a way to make a quick buck at the expense of our federal budget. But regarding the details, it’d be easier and cheaper for the government to simply ban direct-to-consumer ads altogether rather than “severely restrict” them. We’ve done it before for cigarettes to protect our population.
Require drug companies that benefit from taxpayers’ support to invest in research, not marketing or profits
This is another one where the details matter. If a company is benefiting from publicly-funded research, they should not be granted exclusive rights to the drug. How Clinton plans to achieve this will determine if it’s a net positive or net negative, but it’s certainly a debate we should be having.
Increase competition for prescription drugs, including specialty drugs, to drive down prices and give consumers more choices
This is the key provision here. She breaks this into two goals: Clear out the FDA generic backlog, and increase competition for new specialty drugs. Regarding the generic backlog, while the overall goal is ideal, her website says she would accomplish this by giving the FDA more funding to clear their backlog as fast as possible. However, the issue isn’t that the FDA is lacking funding — the issue is that there is so much red tape for the FDA to manage in the first place, which is also the reason for the expensive barrier-to-entry we discussed earlier. If all she’s doing here is providing more funding for the FDA, this is a useless provision and her plan becomes a net negative. But if she’s actually going to eliminate the expensive barriers-to-entry for new drugs, this is a great reform.
Ban “pay for delay” arrangements preventing generic competition
Sometimes drug companies pay generic drug manufacturers to delay their development of competing generic drugs so they can have more time to price gouge the public. This should already be illegal as it sounds like it would be breaking some sort of antitrust law, but apparently it’s currently legal. Fixing this is a very good pro-market reform.
Demand higher rebates for prescription drugs in Medicare
This is a zero-sum provision, but as long as we recognize that it helps low-income seniors, it should be considered. Clinton requires that drug manufacturers provide the same rebates to low-income seniors in Medicare that they provide to people in Medicaid. The drug companies will surely make up for this loss of revenue somewhere else, so this really does nothing to address the true cost issue, but it does improve drug access where it’s needed most.
Allow Medicare to negotiate drug and biologic prices
Right now, individual benefits managers negotiate drug pricing instead of the entire Medicare system negotiating as one for their 40 million enrollees. While I have serious problems with relying on political appointees to negotiate with the private sector, the fact is that they are the ones paying for these drugs and probably could negotiate a better deal than individual providers, so it’s only fair they are the ones agreeing on price. However, we need to keep an eye on the numbers to make sure that costs are going down and there’s no crony capitalism going on behind closed doors.
If the plan stopped here, it’d be damn near perfect at improving the system we currently have in place. However she adds a few extra ideas that do more harm than good —
Cap out-of-pocket costs for prescription drugs
This is another zero-sum provision, however it doesn’t help those in need as much as it may seem. By capping out-of-pocket expenses, insurance plans will simply cost more to make up for the increased expenses. We need to be careful not to add on too many provisions that raise the cost of insurance coverage, because it leads to a phenomenon in the insurance industry where healthy people opt-out, leaving behind a pool of enrollees sicker and more expensive to cover. Insurance costs then go up even more, leading to another exodus of healthy enrollees. And this happens again and again until coverage is insanely expensive and no one opts to enroll anymore.
Allow Americans to import drugs from abroad — with careful protections for safety and quality
This is a reform that Bernie Sanders also supports, and it’s a really bad one. Free trade is an overwhelmingly positive reform, however only when there’s a level playing field. Unfortunately with American drug manufacturers, the field is far from level — it’s much more expensive to bring a drug to market in the United States than in other country. This gives foreign drug companies a competitive advantage over US-based manufacturers. Of course American drug manufacturers would lower their prices to try and compete, but because of expensive barriers to entry the FDA has in place, prices can only go so low before they cannot go any lower, yet are still overpriced compared to their international peers. Once this point is reached, American consumers would still opt to purchase from across the border. This would cause many American drug manufacturers to move overseas or go out of business. If international standards could be agreed upon in order to keep regulatory costs identical between nations, this would be a great reform, but unfortunately there’s been no such talk from either Clinton or Sanders.
Ensure American consumers are getting value for their drugs
This provision sounds more like political posturing rather than real reform. What does this even mean? I’d prefer my doctor determine if a drug is “valuable” to me, not the government. How will this be enforced? What does she propose the government do to drugs that they deem are “not valuable”? As with all of these reforms, the devil is in the details, but here it seems like there is no benefit at all.
There are no easy answers, but there are incremental fixes
Anyone that says there’s an easy way to make prescription drugs affordable without disrupting the development of new drugs is kidding themselves. Not even single-payer universal healthcare can address these issues. But there are many pro-market reforms, as mentioned above, that allow us to improve access and affordability to life-saving drugs without disrupting the pipeline.
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