Market Analysis

Prescription Drug Price Politics and Pharmaceuticals/Biotech Stocks

Capping prescription drug prices would be a negative for the industry, but even if the idea became legislation, it isn't likely to pass through the political gauntlet.

Editors' Note: Our discussion of politics is focused purely on potential market impact and is designed to be nonpartisan. Stocks don't favor any party, and partisan ideology invites bias-dangerous in investing.

Are drug prices running rampant? After The New York Times reported on Sunday that a small private Pharmaceuticals firm, Turing Pharmaceuticals, jacked up the price of a 62-year-old drug by 5,000-ish percent, that question has sparked a media firestorm.[i] Monday, partly in reaction to the news, Democratic Presidential front-runner Hillary Clinton fueled further debate by vowing to "deal with skyrocketing out-of-pocket health costs and particularly, runaway prescription drug prices." All week, media articles aplenty have focused on the issue and wondered whether Federal price controls are necessary to put a lid on the rise. But whatever your opinion of the sociological merits of this plan or drug prices, price controls in general have a long history of causing more harmful unintended consequences-including dinging stock prices-than any positive they may bring. That being said, pharmaceutical price controls seem unlikely to come to fruition any time soon.

For those interested in the details of Mrs. Clinton's plan, here are the major proposals:

  • Establish a $250 monthly cap on prescription drug co-payments for patients with chronic or serious medical conditions.
  • Allow Medicare to directly negotiate prices with drug companies, as opposed to relying on private health insurance companies to do so (e.g., United Healthcare, Anthem), as is the current status quo.
  • Allow consumers to purchase drugs from other countries where prices are lower.
  • Mandate a percentage of revenue that drug companies must spend on R&D.
  • Shorten patent life for biotech drugs.
  • End drug companies' ability to write off consumer-directed advertising as an expense, on the notion the practice encourages more expensive branded drug use as opposed to lower-cost generics.
  • End "pay-for-delay agreements"-deals under which a branded drug company pays a generic company to hold off on production after the patent is expired.

The first three points would force down drug prices and likely impact stocks the most (ironically enough, the last four would arguably push prices up). Interestingly, Vermont Senator Bernie Sanders, Clinton's rival in the Democratic primary race, unveiled similar proposals two weeks ago, which garnered almost no media attention. And some state-level legislators in Massachusetts and elsewhere argue for government oversight and controls.

At first glance, the issue gaining steam politically seems understandable, considering US spending on prescription drugs jumped 13% in 2014 to $374 billion.

As with most data however, the devil is in the details. 2014 appears to likely be a unique case with over half of the branded spending growth coming from a drug that cures Hepatitis C in over 90% of patients. The Hepatitis C drug Sovaldi (made by biotech firm Gilead Sciences), debuted with an $84,000 price tag for a full treatment, triggering a similar level of media consternation when it launched. However, Solvadi's price is down by nearly 50% in 2015, largely because the largest pharmacy benefits firm Express Scripts refused to buy the drug. In a last minute scramble, Gilead cut the drug price in order to not lose the number two player, CVS Pharmacies, as a customer. The market's invisible hand at work, no regulation necessary!

Before 2014's seemingly one-off jump, prescription drugs made up just 9% of total US healthcare spending in 2013 (Exhibit 1-2014 data not yet available). Hospitals, clinics and physician pay make up the vast majority of US healthcare spending. (Some suggest this is tied to the ease and prevalence of malpractice lawsuits as a key driver, but that's a topic for another day.)

Exhibit 1: Share of Health Care Spending

Source: Centers for Medicare and Medicaid Services, Office of the Actuary, National Health Statistics Group.

Overall, price increases over the last couple of years have come from previously difficult or impossible to treat diseases (e.g., cancer, Multiple Sclerosis, etc.). R&D for these new drugs isn't cheap, with some estimating it costs up to $2.6 billion to develop and gain FDA approval for a new drug. This is why new, innovative drugs carry such steep price tags. Pharmaceuticals and Biotech companies need the incentive and the ability to cover huge R&D costs-taking away the incentive risks taking away the innovation.

That's Pharmaceuticals' business model: Spend big; have a few blockbuster successes to cover your failures; and then lose the vast majority of your successful drugs' revenues roughly a decade down the road when your patent expires. Patent expirations, a constant industry headwind, can knock off 60% to 90% of revenues from a single drug. Lather, rinse, repeat. Installing price controls on certain drugs would negatively impact this and hamper Pharmaceuticals' and Biotech firms' profitability-a negative for both stocks in the industry and likely new healthcare innovation. However, the most important question from an investing standpoint is, what is the probability price controls are enacted?

In my view, the answer is, low. First, a politician championing price controls must win the nomination and the Presidential election. Next, they would need to actually do what they say (rare for politicians of any stripe). Finally, and here is the kicker, one or more of these proposals would have to clear Congress. Since these proposals are currently championed by Democratic candidates, this last part could prove hard, as 2016's election structure is unlikely to yield a Democratic majority in Congress. Hence, gridlock could ice the plan, presuming it made it that far. It's possible that legislation could survive this, but it doesn't seem all that likely given the current political environment. It is a matter worth watching and analyzing, but at this point there are few signs national prescription drug price controls are likely to become a reality.

In the end, this is likely just normal campaign trail behavior: Make big promises to garner votes, then if elected, all the huffing and puffing dissipates and the new politician goes right back to being ... just another politician that gets very little done.

[i] Turing's CEO adamantly defended his actions earlier in the week, before backpedaling and promising to lower the price.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.