pharmaceuticals

Pharmaceutical Trends

Industry Insight

Date June 2019

Projected Values - Pharmaceuticals

 

Current Trends

  • Branded and generic pharmaceutical industry revenues are forecasted to increase at annualized rates of 2.6% and 2.3%, respectively, over the next five years, despite attempts by the federal government to regulate drug pricing
  • Recent pricing pressure has resulted in scrutiny on price hikes and a general margin compression, especially in the generic sector. Pharmaceutical pricing in the United States increased by an average of 6.2% over the past 10 years, but by just 2.6% through April 2019, representing a substantial reduction in the rate of price increases
  • Several legal actions have been filed against distributors of opioids resulting in two major settlements between the U.S. Drug Enforcement Agency and two large regional distributors, as well as an ongoing criminal case involving a major drug manufacturer

By the numbers

Synopsis

USMCA provision may benefit drug companies: The Trump administration’s United States-Mexico-Canada Agreement (USMCA), includes a provision for intellectual property (IP) protections for new products that stands to benefit drug manufactures, in turn potentially making it harder to keep drug prices down in the future. The agreement, which has yet to be ratified by the U.S. Congress, includes a new provision allowing drug companies extended protections against other companies’ ability to provide cheaper alternatives on biopharmaceuticals (also known as a biological medical products or biologics). Biologics are drug products manufactured in, extracted from, or semi-synthesized from biological sources rather than synthetic chemicals, which are used in drugs targeting specific therapeutic classes including diabetes and oncology, among others. Industry research projects generic biologic drugs to revamp the industry in the next few years. IBISWorld notes that, in response to mounting external competition, brand name pharmaceutical manufacturers are anticipated to incorporate biologic and biosimilar production to diversify their product portfolios. Obtaining approvals for biologics requires expensive and time-consuming clinical trials and other extensive research and development. The USMCA provision would give biologic drug makers in Canada and Mexico 10 years of protections against other products that would rely on the same data that they used to win approval, which would raise the limit in Canada, where the industry currently has only eight years of protection, and would create a timeline in Mexico, which technically has no established IP protection for drug manufacturers currently. The new provision would not change U.S. policy, which allows for 12 years of IP protection. After the 10- to 12-year protection period, competing drug companies would be allowed to rely on the original manufacturer’s clinical trial data to obtain product approvals for their own drugs, providing they could show that they have produced an equivalent drug. Congressional Democrats have objected to the provision out of fear that formalizing the extended protection period in a trade agreement could create an impediment to efforts to lower health care costs through legislation going forward. Lawmakers also argue that other provisions of the trade pact could hinder development of generic drugs. It will be important for drug wholesalers and retailers as well as insurance companies to monitor how the new agreement, if ratified, would impact alternative drug and generic manufacturing and industry pricing.
 

Pharmaceuticals remain exempt from China tariffs: Pharmaceuticals remain one of the few products that have not been impacted to some extent by tariffs in the U.S./China trade war. Pharmaceuticals were exempted from the most recent list of proposed tariffs on approximately $300 billion of Chinese imports announced in May 2019. The U.S. Trade Representative’s Office will hold public hearings in June 2019 regarding the list of over 3,800 product categories that could be subject to tariffs of up to 25 percent. The proposed list would cover nearly every consumer product left untouched by previous tariffs on $250 billion worth of Chinese imports, including cellphones, laptops, and tablets, as well as a wide variety of consumer products ranging from clothing and shoes to fresh produce and meat, among many others. The current list excludes Chinese-made pharmaceuticals as well as inputs for pharmaceuticals and select medical products. To the extent that future tariffs touch this category, the U.S. could be facing higher prices and/or potential shortages of these critical products and inputs.
 

Increased pricing pressures: There continues to be a major focus on controlling pharmaceutical prices. Pharmaceutical pricing in the U.S. for the past 10 years has increased by an average of 6.2 percent. For year-to-date 2019, pharmaceutical pricing has increased by an average of 2.6 percent, representing a substantial reduction in the rate of price increases. The rate drop is the result of scrutiny on the sector as well as several proposals by the current administration to implement policy changes such as allowing drugs to be imported directly from other countries, including Canada, as well as a proposal to effectively adopt foreign price controls on Medicare Part B drugs by implementing an international pricing index. In addition, there have been suggestions to reign in the use of Pharmacy Benefit Managers (PBM), which are third-party administrators of prescription drug programs. Other current pricing initiatives fall into several different areas:
 

  • Study Bills – establish a task force or authorize a study focused on various aspects of drug costs and pricing
  • Reporting Bills – require some or all drug manufacturers to report certain information regarding their drug prices and company costs to state governing bodies. In addition, some legislation may require pharmacy PBMs or health plans to report information to states regarding their prescription drug costs and/or rebate agreements with manufacturers
  • Notification Bills – require certain manufacturers planning to launch or increase the price of a high-cost drug to notify states and other payers of price increases
  • Marketing/Advertising Bills – add requirements and/or restrictions to pharmaceutical marketing and advertising activity
  • Price Control Bills – establish limits on the prices of certain drugs
  • Pharmacist Disclosure Bills – prevent PBMs and plans from prohibiting pharmacists from informing patients about drug prices and lower-cost options
  • Manufacturer Cost-Sharing Assistance Bills – limit or prohibit manufacturers from offering discounts or reductions in an individual’s out-of-pocket costs, or require reporting on such discounts  

All of these bills threaten to severely restrict and limit future pharmaceutical price increases. The rate of drug inflation has declined significantly in the face of these proposals and the general scrutiny on the sector.
 

Opioid legal action surmounts: Not unlike the groundbreaking legal action taken against the tobacco industry in the 1990s, the prescription drug industry has been hit hard by lawsuits and settlement payouts over the past decade. In June 2019, a team of lawyers representing thousands of municipal plaintiffs in over 1,200 counties unveiled the framework for a nationwide settlement in the U.S. District Court for the Northern District of Ohio against a collection of pharmaceutical companies related to opioid abuse. The motion for class certification did not include settlement amounts nor a formula for who would pay them; however, it did outline a deal where roughly 24,000 local governments would be consolidated into a single entity that could settle with drug companies as a group. Those communities would get to vote (weighted by population) on any proposed payout and could also opt out of the arrangements altogether. In April 2019, the DEA announced criminal charges as well as an agreement between the agency and Rochester Drug Cooperative Inc. (RDC) for unlawfully distributing oxycodone and fentanyl and conspiring to defraud the agency. Under the agreement and consent decree, the RDC agreed to accept responsibility for its conduct by making admissions and stipulating to the accuracy of extensive fact statements, pay a $20 million penalty, reform and enhance its Controlled Substances Act compliance program, and submit to supervision by an independent monitor.
 

Similarly, after years of investigations and lawsuits over the marketing of the highly addictive opioid painkiller OxyContin, Purdue Pharma and its controlling owners the Sackler family pleaded guilty to a federal felony and paid over $600 million in criminal and civil penalties in 2007. More recently, a group of more than 500 counties, cities, and Native American tribes named the Sacklers in a case in the Southern District of New York, bringing the family into the Ohio-based bundle of cases. As recently as March 2019, Purdue Pharma settled with the state of Oklahoma for approximately $270 million in damages. In all, NPR reports that more than 1,800 lawsuits have been filed so far against drug makers like Johnson & Johnson, distributors like McKesson, and pharmacies including CVS and Walmart. Plaintiffs claim companies across the supply chain earned billions in profits by aggressively marketing and selling prescription opioids, for which they are now being made to pay funds to support the government and public health agencies responsible for treatment.

Pharmaceutical chargebacks discounted in liquidation: Large hospital buying groups and retail pharmacies typically negotiate purchase prices for pharmaceutical drugs directly with manufacturers based on volume. Pharmaceutical chargebacks help to remedy differences in purchase prices charged to various types of buyers and typically are instituted in the following situation: when a wholesaler sells a product to customers at a price lower than its purchase price from the manufacturer, the wholesaler is allowed to contractually charge back the manufacturer for the difference and normal margin. Drug manufacturers often do not reimburse this chargeback in cash; rather, they are generally issued as a credit to be applied against future purchases. Thus, at any point in time, there are always payables due to the wholesaler for chargebacks as well as payables due to the manufacturer for the original inventory purchase. Gordon Brothers typically assumes that a wholesaler (and in turn the secured party) won’t receive the chargebacks in a liquidation, as they would be offset against other account payables owed; in essence this means that, in a liquidation scenario, the company wouldn’t realize the full contracted margins usually generated.
 

Fifteen years ago, chargebacks fell in the range of 5 to 6 percent of total sales; now it is not uncommon for chargebacks, especially on generic products, to be as high as 30 to 40 percent of total sales. In addition, previously, chargebacks were not tracked at the lot level, and competitors would buy pharmaceuticals in a liquidation below cost and recover the chargeback when they sold the product, thus minimizing the impact of chargebacks in a liquidation. Now, due primarily to gray market pharmaceutical concerns and cross border sales issues, chargebacks are tracked at the specific lot level and can only be recovered by the parties involved in the original purchase. Competitors that buy pharmaceuticals in a liquidation will not consider the benefit of a chargeback into what they pay for the product.
 

Government contracts pose risk: Some wholesalers sell a significant portion of their inventory under government contracts, which are negotiated between the manufacturer and the contracting agency. These contracts typically enable government bodies to purchase products at significantly discounted rates. In a liquidation, it is unlikely that inventory would continue to be sold to the government at those prices, which could pose a problem if the government is a significant buyer. In this scenario, liquidators would likely need to find alternate buyers and, depending on the volume, that could be challenging. Lenders should be aware of how much inventory is typically sold under government contracts and the impact it could have on recovery values.
 

Limited distribution increases desirability of some inventory in liquidation: The Drug Quality and Security Act (DQSA), signed into law in 2013, aims to improve identification and traceability of all prescription drugs distributed in the United States. To control distribution, manufacturers often strictly limit the number of wholesalers authorized to sell particular products. This means that no one other than a potentially short list of wholesalers is authorized to buy that product from the manufacturer. If one of those authorized wholesalers were to go into liquidation, some wholesalers that were previously unable to acquire the product directly from the manufacturer may be willing to pay a premium for the product. Thus, lenders may wish to consider how exclusive the wholesalers’ contracts are.
 

Gray market pharmaceutical issues: Title II of DQSA, the Drug Supply Chain Security Act (DSCSA), outlines steps to build an electronic, inter-operable system to identify and trace certain prescription drugs as they are distributed in the United States. The DSCSA requires wholesale distributors and third-party logistics providers to report licensure and other information annually to the Food and Drug Administration (FDA). Additionally, to further enhance the security of the drug supply chain, manufacturers, re-packagers, wholesale distributors, and dispensers are required to notify the FDA and other trading partners within 24 hours after determining a product is illegitimate. This legislation has evolved in order to limit the secondary sale of pharmaceuticals from wholesaler to wholesaler and shrink the so called “gray market” for these products; as a result, the secondary market for pharmaceuticals is not what it once was. The issue for pharmaceutical manufacturers was not so much safety as protecting margins. There has historically been a significant variation in the price charged for what is ostensibly the same product in various countries and regions of the world. As a result, with the advent of the internet as a major retail sales channel, online pharmacies started filling pharmaceutical sales across government borders. In order to protect regional and national margins (as well as protect against burgeoning counterfeit operations), pharmaceutical manufacturers and governments began to crack down on pharmaceuticals being sold outside of the intended national sales channel. This stifling of the gray market and the control of out-of-channel purchases has also had a negative effect on the secondary market for pharmaceuticals in a liquidation as there are fewer entities willing to purchase pharmaceuticals out of channel.
 

Aging an important consideration: All pharmaceuticals have expiration dates. Many retailers will not accept inventory that is within a year of its expiration date. Thus, lenders should inquire about the aging of inventory and beware of lending against any product that has a shelf life of less than one year. Often, wholesalers will return inventory with a shelf life of less than six months because of this concern. Lenders should inquire about inventory management procedures and stock rotation programs in place.
 

Exit strategies must be coordinated with government agencies: The FDA is the primary agency responsible for the regulation of pharmaceutical manufacturers and distributors. Manufacturers and distributors are required to register for permits and licenses and comply with certain regulatory controls of the FDA, the U.S. Drug Enforcement Administration and various state boards of pharmacy or comparable agencies. In addition, pharmaceutical manufacturers and distributors are subject to the requirements of the Controlled Substances Act and the Prescription Drug Marketing Act of 1987, an amendment to the Food, Drug and Cosmetic Act, which requires each state to regulate the purchase and distribution of prescription drugs under prescribed minimum standards. These laws regulate the manufacture, shipping, storage, sale, and use of such products and product samples. In addition, the FDA, Federal Trade Commission, and state authorities (regulations vary by state) regulate the advertising of prescription and over-the-counter products and enforce rules and licenses regarding filling, compounding, and dispensing prescription products.
 

Gordon Brothers has discussed hypothetical exit strategies with the FDA and has been advised that the agency would work with a responsible party in this type of event, assuming the party was acting in good faith, with transparency, and expressed an interest in protecting the public health. The FDA has advised that any such action in relation to a company’s inventory would best be taken under the direction of the existing company that would likely be currently licensed to distribute the regulated products. This being said, for distribution entities, there is no FDA license or FDA authority required for a liquidation; however, there are state distribution licenses typically regulated and administered by a state pharmacology board. In addition, if the liquidation were to involve any dispensing of prescription products, a licensed pharmacist would likely need to be engaged to handle and oversee these activities. In all cases, the selling entity would need to be licensed by the appropriate federal and state authorities as applicable under the situation. Lenders should be aware of these complexities in taking possession of pharmaceutical inventory and comply with the proper and legal processes for liquidating it.