29 April 2014

Pharmaceutical Regulation, Costs and Torts

‘Liability risk in the pharmaceutical industry: Tort law in the US and UK’ by Kristina Lybecker and Lachlan Watkins in (2014) Social Science Journal examines
the extent to which product liability risk contributes to the high costs of pharmaceuticals in the United States relative to prices in the United Kingdom. Research on pharmaceutical prices rarely accounts for the impact of liability risk, and none that we are aware of compares the United States and United Kingdom. Drawing on a dataset of 77 brand name drugs sold in both the US and the UK, we analyze relative manufacturers’ factory prices in each nation. We utilize several proxies for liability risk including drug litigation history, the percentage of plaintiff wins, and controlled substance classification. Importantly, under US law there are no caps on the amount that can be awarded to a plaintiff claiming economic losses in the US. However, payouts in the UK are limited. Accounting for market differences and regulatory environments, we find liability risk can account for a portion of the price differential that exists between the US and UK, warranting further investigation.
The authors conclude -
Few studies account for differences in product liability environments between countries, and none to our knowledge account for non-tort liability in the form of civil litigation. This study demonstrates the potential impact that product liability risk, under tort law, plays in the pricing of pharmaceuticals in the United States. Our findings suggest that it may be wise to investigate how product liability environments contribute to drug price differentials across nations. Further study is clearly warranted to comprehensively investigate how a wide range of liability risk, including non-tort law, can affect drug prices. Using the data from a GAO study comparing the prices of pharmaceuticals in the U.S. and U.K., this study controls for a portion of liability risk under tort law in the U.S., demonstrating the important role liability risk plays across markets. 
Our results indicate that some portion of the high observed drug price differential between the U.S. and U.K. is derived from the potential litigation costs that firms face when selling pharmaceuticals in the U.S. market. The high potential liability costs are directly associated with the legal structure of state and federal tort law in the U.S. U.S. tort law is stricter than in the U.K., as well as most other industrialized nations, helping to explain why U.S. pharmaceutical prices are the highest in the world. 
With the passing of the Patient Protection and Affordable Care Act (PPACA), comparisons of the costs of pharmaceuticals and healthcare across nations will become even more important. The PPACA, as well as the Healthcare and Education Reconciliation Act of 2010, will make drastic changes to the healthcare system of the United States beginning in 2014. Continued concern for escalating healthcare costs will ensure that policymakers will look to the pharmaceutical industry for reform. This study demonstrates that high pharmaceutical prices are, in part, derived from the prospective costs of litigation in the U.S. As such, future studies should focus on the impact of tort law reform as a potential means of reining in the high costs of pharmaceuticals in the United States.
They note that
Few studies consider the impact of tort reform on pharmaceutical prices. The first work on this topic was done by Manning (1994, 1997, 2001) who examined how the liability environment may impact prices and whether reducing liability costs can lead to lower prices for both prescription drugs and vaccinations. Helland, Lakdawalla, Malani, and Seabury (2011) confirms that liability risk increases drug prices but that it also reduces medical side effects. Their analysis shows that liability reduces supply but enhances expected safety and thus increases demand. Overall their results suggest that tort liability improves social welfare.  Beyond the impact on pharmaceutical prices, Garber (2013) analyzes the economic effects of several kinds of legal liability for pharmaceutical companies, focusing on three forms of economic efficiency: increasing the population-level health benefits, reducing the social costs of drug-related injuries, and decreasing the transaction costs of legal disputes. Garber examines product liability as well as three other types of litigation related to safety, efficacy, and marketing and promotion. Safety and product liability risk are described by Offit (2005) as reasons why pharmaceutical manufacturers are abandoning vaccine production. 
More generally, other studies find that tort law reform actually decreases both the number of lawsuits and amount of damages awarded in tort liability cases. Rubin and Shepherd (2007) argue that tort reform could decrease expected liability costs for firms thus resulting in lower prices allowing consumers to purchase more risk-reducing products like pharmaceuticals. According to Rubin and Shepherd, as the prices for goods covered by tort law increase, consumers will be less willing to pay for these goods. Thus reform that increases tort liability may increase risk and keep the prices of pharmaceuticals high. Alternatively, they argue that tort reform that decreases tort liability may make pharmaceuticals and other risk-reducing products more affordable and available to consumers. 
In a similar vein, Browne and Puelz (1999) analyze the effects of tort reform on total claim severity as well as on reducing the likelihood that an injured party will seek litigation. Their study suggests that tort reform has a statistically significant effect in reducing economic and non-economic damage awards. In contrast, in an analysis of the effect of noneconomic damage caps for awards in the U.S., Durrance (2009) finds no evidence that these caps would decrease malpractice litigation frequency. Danzon (1986) finds that tort reforms capping awards reduced the severity of awards by 23%, while two additional studies (Thorpe, 2004; Viscusi & Born, 2004) show that states that enacted damage award caps experienced a significant decrease in loss ratios – the ratio of losses to insurance premiums – and the costs of insurance premiums. Yoon (2001) also finds that several types of tort reform decreased the number of lawsuits filed as well as the damages awarded by actually lowering liability costs. This is echoed in a study by Viscusi, Zeckhauser, Born, and Blackmon (1993) which analyzes the impacts of 1980s tort reforms, finding that states that enacted tort reforms between 1985 and 1988 restrained the growth of liability costs. The study also finds that tort reforms also reduce the cost of insurance premiums. Finally, Lasker and Womeldorf (2013) analyze the consequences of pharmaceutical firm risk in potentially massive punitive damages sanctions in prescription drug product liability litigation for conduct taken in full compliance with FDA regulations. They describe a recent Supreme Court Decision in which the court “laid the groundwork for significant protections for FDA-compliant companies, both by strengthening the hands of individual state legislators to establish the scope of punitive damages liability for pharmaceutical companies located in their states and by highlighting the reasons why the imposition of punitive damages for FDA-compliant conduct improvidently intrudes upon FDA’s plenary enforcement authority” (p. 35). 
In the context of liability risk in other healthcare settings, several studies examine the effect of liability reform on physician behavior and costs (Helland, Lakdawalla, Malani, & Seabury (n.d.); Kessler & McClellan, 1996, 2002a, 2002b; Shapiro, McGarity, Vidargas, & Goodwin, 2012). Helland et al. (n.d.) examine product liability risk and show that while liability reform does not change the safety of drugs produced by global firms, it does reduce liability faced by doctors who respond by prescribing more drugs. Kessler and McClellan have written several papers on liability and tort reform. In a 1996 study, they analyze the effects of malpractice liability reforms and find that they directly reduce provider liability, resulting in reductions of 5–9% in medical expenditures without substantial effects on mortality or medical complications. Another Kessler and McClellan study (2002a) considers elderly Medicare beneficiaries and establishes that liability reducing tort reforms reduce defensive practices in areas with high and low managed care enrollment. This work is extended in another 2002 study in which they find that direct tort reforms improve medical productivity through reduced malpractice claim rates and a reduction in the time spent defending such claims. Finally, in contrast, Shapiro et al. (2012) argue against malpractice reform, claiming that torts have little impact on medical decisions or medical practice costs. 
While pharmaceutical liability risk is largely overlooked by existing studies, other forms of pharmaceutical regulations, specifically market regulations, feature prominently in recent examinations of international price differentials. Sood et al. (2009) analyze pharmaceutical regulations in nineteen developed countries from 1992 to 2004, focusing on how different regulations impact pharmaceutical revenues. They find both that there has been a trend toward increased regulation and the majority of regulations result in reduced pharmaceutical revenues. Moreover, in the context of a largely unregulated market such as the United States, the introduction of new regulations could significantly reduce pharmaceutical revenues. Their analysis demonstrates that if the United States implemented price controls and negotiations similar to those in other developed countries, U.S. pharmaceutical revenues would fall by as much as 20.3%. Their results show that the introduction of price controls and other regulations in largely unregulated markets will significantly reduce costs, but perhaps at the cost of future innovation.
Sood et al is 'The Effect Of Regulation On Pharmaceutical Revenues: Experience In Nineteen Countries' by Neeraj Sood, Han de Vries, Italo Gutierrez, Darius N. Lakdawalla and Dana P. Goldman in (2009) 28(1) Health Affairs w125-w137.

The authors comment
 We describe pharmaceutical regulations in nineteen developed countries from 1992 to 2004 and analyze how different regulations affect pharmaceutical revenues. First, there has been a trend toward increased regulation. Second, most regulations reduce pharmaceutical revenues significantly. Third, since 1994, most countries adopting new regulations already had some regulation in place. We find that incremental regulation of this kind had a smaller impact on costs. However, introducing new regulations in a largely unregulated market, such as the United States, could greatly reduce pharmaceutical revenues. Finally, we show that the cost-reducing effects of price controls increase the longer they remain in place. 
If the United States implemented price controls and negotiations similar to those in other developed countries, U.S. revenues would fall by as much as 20.3%. 
Rapid growth in pharmaceutical spending is a worldwide phenomenon. According to a recent study, spending on pharmaceuticals in Organization for Economic Cooperation and Development (OECD) countries has increased by an average of 32% in real terms since 1998, reaching more than U.S.$450 billion in 2003. However, there is wide variation in the growth of pharmaceutical spending across countries. For example, during this period, the annual growth rate of pharmaceutical spending in the United States (9.6%) was nearly triple the growth rate of spending (3.5%) in Germany. 
This growth in pharmaceutical spending has increased demands for regulating pharmaceutical markets by imposing limits on prices, profits, or total spending on pharmaceuticals. The likely effect of such regulations on social welfare is a contentious and much-debated public policy issue. On the one hand, regulations curb expenditures and thus potentially improve the welfare of the current generation. On the other hand, such regulations limit incentives for research and development (R&D) and thus might hurt future generations by reducing the pace of innovation. In addition, some argue that pharmaceutical regulations might also have negative consequences for consumers today. For example, price regulation can lead to less competition in markets for generic drugs, delay launch and limit availability of new drugs, and could lead firms to follow costly strategies to “game” regulations. 
Pharmaceutical regulation thus involves a potential trade-off between curbing costs today and having fewer drugs to treat current and future generations. Thus, the first step in examining this trade-off is estimating the effect of regulations on pharmaceutical revenues. However, there is little consensus about whether or not real-world pharmaceutical regulations have any impact on revenues. Some believe that these regulations have little “bite,” especially over time, as pharmaceutical firms learn to work their way around them. Others believe that regulations have big impacts on revenues and consequently limit the pace of innovation. 
The lack of consensus is driven in part by the lack of systematic information about current trends in pharmaceutical regulation and its effect on revenues. One strand of existing studies compares pharmaceutical prices or spending across regulated and unregulated markets. For example, a recent study by the U.S. Department of Commerce reviewed pricing in eleven OECD countries and found that for patented drugs that were best sellers in the United States, the prices in other OECD countries were 18–67% less than U.S. prices, depending on the country. The study concluded that price deregulation in these countries would increase pharmaceutical revenues by 25–38%. In general, these studies are limited by their reliance on cross-sectional variation in revenues or prices and by their resulting vulnerability to heterogeneity across countries in type of regulation and other determinants of prices. 
There are some studies that address the heterogeneity problem by analyzing longitudinal data and comparing pharmaceutical spending before and after policies take effect. For example, Nina Pavcnik estimated a 10–26% decrease in drug prices as a result of a reference pricing policy introduced in Germany after 1989. However, most of these studies only examine the effects of a limited range of regulations in one country or a small group of countries. 
In this paper we attempt to fill this gap in the literature by characterizing the pharmaceutical regulatory environment in nineteen developed countries over a thirteen-year period. We take advantage of the substantial variation in pharmaceutical policies within a country to identify the causal effect of a wide variety of pharmaceutical regulations on revenues. We also examine the extent to which different regulations complement or substitute for each other. For example, to what extent are the effects of a particular policy on drug revenues determined by other regulations that were already in place before the new policy was introduced? Finally, we examine whether the effects of regulations change over time.