Patents are a fixture in many industries, and they are characterized by high research and development costs. In the United States, a utility patent can cover “any new and useful process, machine, manufacture or composition of matter, or any new and useful improvement thereof” (35 USC § 101)1 and provides the patent owner with exclusive commercial rights to produce and use the covered technology for up to 20 years. Recently, there have been prominent patent infringement battles regarding genetically modified plants, virus scan software, children’s toys and smartphones, among other things.
The function of patents within the pharmaceutical industry has garnered specific attention. Well-reported examples have highlighted pharmaceutical patent holders using exclusivity in ways that may stretch a common understanding of patents, and these sometimes have been correlated with price increases and potentially anticompetitive market dynamics. This article explains how patents function in the pharmaceutical industry.
Intellectual Property Protection in the Pharmaceutical Industry
The pharmaceutical industry includes two similar but distinct types of intellectual property protection for pharmaceutical inventions. Patent exclusivity is a system shared with other industries. Unique to the pharmaceutical industry, however, the Food and Drug Administration (FDA) (separate from patent protection) grants newly approved drugs a period of time during which they will not approve competitor drugs—this is known as regulatory exclusivity.2
A successful patent grant requires demonstration of three elements:
- Usefulness (the invention accomplishes its intended purposes)
- Novelty (the invention was not publicly known before the patent applicant invented it)
- Non-obviousness (the invention is not an obvious development to an expert in the invention’s field)
Pharmaceutical patents can include a wide variety of claims about a single drug, including formulation, indications for treating particular diseases, technology for administration, methods of manufacturing and chemistry related to active ingredients. Patents can be applied for and issued at any time during the development of a drug. Patents that cover new aspects of or improvements to a drug already covered by a patent are referred to secondary patents. A single drug may be covered by more than 100 patents due to secondary patents covering many unique aspects of a drug.3 Each new patent, whether a first or secondary patent, grants commercial exclusivity for 20 years.
Regulatory exclusivity is unique to the pharmaceutical industry and refers to prohibitions granted to new drug applications that prevent the FDA from approving competitor drugs. Unlike patents, regulatory exclusivity varies in term depending on which of seven types of exclusivity are issued. For example, orphan drugs are eligible for the longest period of exclusivity at seven years, while new generic entrants are eligible for the shortest period of exclusivity at 180 days.4
Patents and regulatory exclusivity operate separately, and drugs may have both, just one or neither type of protection. The two types of protection may or may not run concurrently and can cover similar or different aspects of the drug product. Concerns about exclusivity abuses and potential reform usually focus on patents because the patent exclusivity term is longer and can be lengthened through secondary patents, whereas regulatory exclusivity grants are provided only to new drug applicants.
The FDA publishes lists and information about approved pharmacological products in the Orange Book and Purple Book. The Orange Book contains information about drug products while the Purple Book contains information on biologic products. Drug products typically are manufactured through chemical synthesis and therefore have well-defined chemical structures that can be analyzed for safety, efficacy and patent novelty purposes. Biologics, on the other hand, are manufactured in a living system, such as a plant or animal cell, and typically are large and complex molecules that are difficult if not impossible to characterize analytically. As a result, the process of producing a biologic and the consistency of that process is the subject of the patent analysis, not just the composition of the final product.
Another key difference between the Orange Book and the Purple Book is the type of information each contains. The Orange Book contains specific information about patent and regulatory exclusivity data in addition to other key information such as a drug’s proprietary name, active ingredients, dosage form, route and strength, and therapeutic equivalence to other drugs. The Purple Book, on the other hand, contains information about regulatory exclusivity, proprietary name and biosimilar status; notably, it does not contain information about patents. The presence of patent information in the Orange Book can make it easier for potential generic competitors to understand if infringement claims could be brought and what the content of the patents are.
Economic Justification of Patents
Patents are a regulatory tool that can solve inefficient outcomes related to knowledge-based innovation. They address an economic reality for industries dominated by research and development costs where the cost of generating a new product is extremely high and the new product can be copied easily by competitors who did not participate in those initial costs but can now participate in the subsequent profits. Patents allow the entity that generated the new product to exclude competitors from enjoying subsequent profits for a period of time.
Patents are public documents that contain thorough documentation on the nature of the invention. This allows for new research to be done that uses the findings documented in the patent, so a well-functioning patent system can fuel further innovation by incenting public distribution of research findings without attaching financial penalties.
For example, Coca-Cola’s famously secret recipe is not patented, as doing so would mean disclosing the ingredients to the public via the patent application and losing exclusive rights to that formulation at the expiration of the patent. The recipe’s protection as a trade secret benefits from relatively little regulatory assistance, unlike patents, which are enforced with significant regulatory muscle.
Drug products generally cannot be protected as trade secrets because their molecular composition can be readily determined by chemical analysis—a competitor would need only to obtain a sample of a drug to recreate it. This is not necessarily true for biologic products, as their chemical structures are not easily analyzed and looking at the chemical structure of the product does not necessarily help inform which biological processes led to its creation.
Finally, patents can be “rented” through payment of royalties. They also can be sold or acquired. This creates opportunities for competitor firms to produce products that would otherwise infringe on patent rights, subject to an agreement with the patent holder. This allows the patent to be treated as a somewhat liquid asset in a market-based economy. It also allows for the creation of products that not only partially rely on patented inventions but also introduce novel and unpatented inventions. Patents do not guarantee an innovator a profitable monopoly. For example, a competitor may produce a new and innovative product that consumers prefer, but then consumer needs may shift or the manufacturing and distributing of the product may not be profitable.
Financial Analysis of Patents in the Pharmaceutical Industry
A numeric financial analysis of the impact of patents on the pharmaceutical industry is complex and often debated. The costs of bringing new drugs to the market are indisputably high, but published estimates can be very different from each other. These costs are subject to considerable risk and volatility, and thus they can be misleading indicators of a pharmaceutical company’s financial stability.
A commonly cited study by the Tufts Center for the Study of Drug Development5 points to $2.558 billion in costs (2013 U.S. dollars) to bring a single drug to market. A more recent study6 puts the price tag at $757 million (2017 U.S. dollars). A 2010 study published in Nature7 pegged costs at US$1.8 billion. Methodological differences contribute to the large variation in cost estimates in addition to difficulty in obtaining robust and common data.
Many factors add to the high costs of bringing a drug to market. Drug discovery can take a team of scientists between three and 20 years, with good fortune perhaps the most powerful force in steering toward the low end of that range. The FDA’s three-phase clinical trial testing process can cost millions per phase, and only a fraction of products tested in clinical trials succeed—so a company must cover the costs of many failed drugs among those that succeed. The discovery and clinical trial steps are prominent contributors to the considerable volatility in costs that pharmaceutical developers incur, and the gap between when costs and profits are realized. Some commentators note that pharmaceutical companies are rarely flush with cash, while others suggest misaligned corporate interests are the cause rather than true pharmaceutical development. The only clear conclusion seems to be that there is not an easy answer.
Previous Reforms of Pharmaceutical Patents
Two notable pieces of legislation, the Drug Price Competition and Patent Term Restoration Act of 19848 (popularly known as the Hatch-Waxman Act and the America Invents Act of 20119 (also known as the Leahy-Smith America Invents Act or AIA), are landmarks in the current patent landscape and provide a reference for future reforms.
The Hatch-Waxman Act fueled exponential growth in the generic drug market. Prior to the approval of the Act, less than 20 percent of prescriptions were for generics; today, more than 80 percent of prescriptions are for generics and nearly all brand drugs not covered by in-force patents have a generic competitor.10
The bill introduced an abbreviated FDA approval process for generic drugs called the Abbreviated New Drug Application (ANDA). Generic products utilizing the ANDA no longer need to prove safety and efficacy but can alternatively prove bioequivalence to a designated reference drug (i.e., the approved brand the generic mirrors). Bioequivalence means that there is no significant difference in the “rate and extent that an active ingredient is in contact with the site of the drug’s action.” In practice, generic manufacturers seeking approval test the generic and brand-name drug in patients, draw timed blood samples and demonstrate that the drug’s bioavailability in those samples is not clinically different. This abbreviated process significantly reduces the requirements and uncertainty associated with gaining approval of generic drugs.
Generic applicants using the ANDA need to certify one of four categories of patent coverage:
- That the generic drug does not overlap with any patents ever approved
- That the generic drug overlaps with patents that have expired
- That the generic manufacturer will not market the drug until overlapping patents have expired
- That the generic manufacturer believes overlapping patents are not relevant or invalid
The Hatch-Waxman Act created safe harbor protection for generic applicants asserting the third option (will not market the drug until overlapping patents have expired). This allows generic producers to prepare manufacturing processes and gain FDA approval for generic drugs while the brand patent is still in effect so that generic drugs can become available immediately after an overlapping patent expires. In nonpharmaceutical applications, this type of preparatory work likely could constitute patent infringement.
Likewise, the Hatch-Waxman Act established that the fourth option (belief that overlapping patents are not relevant or invalid) is an “artificial” act of patent infringement. This encourages brand manufacturers to bring an early patent challenge; in fact, a patent owner must bring suit within 45 days of an ANDA filing or the right to bring action is lost. This further expedites the generic approval processes and insulates generic manufacturers from potentially costly patent infringement findings late in a generic product’s launch process. A patent challenge puts a 30-month stay on the approval of the ANDA to resolve the legal dispute.
Litigation under the Hatch-Waxman Act can be brought only regarding patents that are reported to the FDA through the Orange Book. The Purple Book, relating to biologic drugs, does not contain patent information—and even for drug products contained in the Orange Book, there may be patents that are not required to be reported to the FDA that still impact potential generic entrants. As a result, there are potential patent challenges that lie outside of Hatch-Waxman’s purview.
The AIA enacted another route toward challenging the validity of a patent through the inter partes review (IPR) procedure. Petitioners applying for IPR may challenge a patent under Sections 102 or 103 of Title 35 of the U.S. Code. Section 10211, which pertains to “prior art” that is a patent, printed publication or public use that existed prior to and is identical to a claimed invention—the existence of prior art eliminates eligibility of a patent. Section 10312 says that a patent may not be obtained if a claimed invention is “obviously similar” to prior art for an expert in the field.
IPR cases are heard by the Patent Trial and Appeal Board (PTAB) and appealed to the U.S. Court of Appeals for the Federal Circuit. The AIA created the PTAB to reduce costs and time to litigating parties—a jury trial can be significantly more expensive and time-consuming than an IPR before the PTAB. IPR has eliminated about half of challenged pharmaceutical patents that have received final written decision (i.e., not settled, dismissed, etc.). This has led to dubbing the PTAB the “death squad,”13 while some technology firms have voiced support for the procedure as it has enabled quicker resolution to what they see as annoying patent disputes.
IPR, unlike ANDA-derived litigation, may challenge any patent, including patents that were not required to be reported to the FDA in the Orange Book or the Purple Book. A 2015 proposal that would have similarly exempted pharmaceutical patents from IPR was estimated14 by the Congressional Budget Office (CBO) to cost the federal government $1.3 billion over 10 years due to delayed generic entrance, illustrating the impact IPR has.
Patents and regulatory exclusivity occupy an increasingly prominent role in the pharmaceutical industry and in societal conversation about how to ensure the pharmaceutical industry meets patients’ needs, fosters innovation and promotes long-term stability. Intellectual property rights are but one of many interwoven and complex factors that impact the prices consumers pay for drugs.
Actuaries can play an important role in the societal conversation by providing perspective on ways to balance financial volatility embedded in the process of bringing a drug to market, health system costs and patient health.
Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.
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