This NICE Deal Could Foreshadow 2011

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There's no doubt that the topic of health-care reform ruled 2010 for health-care stocks -- and 2009, for that matter. This article alone had 284 comments and nearly 150 recommendations

Fortunately, 2010 wasn't the year that health reform sank drugmakers. The industry basically got through the reform with a slap on the wrist, especially considering the potential for a knockout uppercut.

In the next round of reform -- I don't know when, but there will be one -- drugmakers might not be so lucky.

Value-based pricing
In pretty much every other industry, products are priced based on their features. The 64GB iPad costs more than the 16GB one, because it offers the consumer more.

Drugs don't really work that way. They're often not compared to each other, and when you factor in cheap generics, it's easy to make an argument that brand-name drugs aren't worth their higher cost.

Yet most consumers don't really know what the cost of their medication is -- a $20 co-pay is a $20 co-pay. The only way to encourage lower drug costs is to get the end user to pay the cost directly.

I'm guessing that health insurance will likely look more like house insurance in the future. We expect insurance to protect us through a major issue, but minor issues with the house -- a leaking roof or a stopped-up toilet -- aren't covered. Health insurance will be the same way: Actual catastrophes will be covered, but consumers will be expected to pick up the tab for routine issues.

With consumers more in tune with the cost of health care, there will be more demands for value-based pricing.

You just have to look at the UK's National Institute for Health and Clinical Excellence (NICE) to see an extreme example of where we're headed. The agency isn't convinced that GlaxoSmithKline's (NYSE: GSK  ) new kidney-cancer drug Votrient is as good as Pfizer's (NYSE: PFE  ) Sutent, so it's made a deal with Glaxo to pay for the drug at the same price as Sutent. And it gets better; if a clinical trial comparing the two, which is scheduled to come out in mid-2012, doesn't show equivalent efficacy between Votrient and Sutent, Glaxo has will issue a rebate back to the National Health Service (NHS), which runs the U.K.'s publicly funded health-care system.

This type of value-based pricing is where the U.S. is headed -- perhaps not in 2011, but someday soon.

How to benefit
To avoid getting caught up in the value-pricing wars when that day arrives, investors need to look for innovation and avoid duplication.

Simply put, innovative drugs treat unmet needs. And by definition, there's no competition, so much of the value-based pricing becomes somewhat moot. We're talking about drugs like Vertex Pharmaceuticals' (Nasdaq: VRTX  ) hepatitis C drug telaprevir, or Human Genome Sciences' (Nasdaq: HGSI  ) lupus treatment, Benlysta. Current hepatitis C treatments cure only about half of their patients, and there hasn't been a new drug to treat lupus in more than 50 years. Do you really think HGS will have a problem getting Benlysta paid for?

At the other extreme, avoid me-too drugs that duplicate what's already out there. Take Bristol-Myers Squibb's (NYSE: BMY  ) and AstraZeneca's (NYSE: AZN  ) diabetes drug Onglyza, which is in the same class as Merck's (NYSE: MRK  ) Januvia. The former drug offers no real advantage that I can see over the latter.

Another area I'd avoid is treatments with a lot of generic competitors, such as depression mediations. The cheap competition works so well that there's limited opportunity for brand-name contenders. If a new drug is 10% better than the current standard, does that mean it'll be priced 10% higher than the generic?

Slippery slope
The decision to move toward value-based pricing isn't cut and dry. The cries of nonexistent "death panels" will certainly come roaring back. But when Americans realize that they can't have an all-you-can-eat buffet of health care at reasonable prices -- this isn't Vegas, after all -- they may be willing to make purchases off the a la carte menu to reduce costs.

Investors need to be prepared, and act accordingly.

Buffett thinks this "picks and shovels" company should profit, regardless of Congress' health-care reforms.

Pfizer is a Motley Fool Inside Value selection. Vertex Pharmaceuticals is a Motley Fool Rule Breakers recommendation. GlaxoSmithKline is a Motley Fool Global Gains pick. The Fool owns shares of and has written covered calls on GlaxoSmithKline. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. The Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (2)

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  • Report this Comment On December 30, 2010, at 4:02 PM, medicalquack wrote:

    I think you are right that this coming year pharma may face more pressure to reduce the cost of drugs.

    Right now so much has been moved over to the physicians to prescribe drugs, especially chemo therapy drugs that cost less and the doctors are overloaded with business intelligence software for their decisions so something need to come along here and take the pressure off. If drug pricing were handled better aligned with what insurers will be, then we would not be needing to place oncologists on pay for performance programs, agree? Here's a couple examples below with the emphasis on the "payer" relations.

    This one is from United Healthcare who also wrote to the oncologists last year telling them they didn't do a very good job with following recommendations with drug prescribing and I had one oncologist dispute as he said he can't hardly even get Avastin approved if he wanted to with some carriers.

    United might be interested in more value based drugs from China with this acquisition they made last year about 3 links down the subsidiary chain.

  • Report this Comment On December 31, 2010, at 1:16 PM, djr37 wrote:

    I fear that Brian is being too optimistic.

    Targeting unmet need is only half the story. Particularly in Europe, to be successful, a new drug needs to offer meaningful improvement over other treatments in areas that payers, physicians (and ideally also patients) consider to be important.

    GSK's problem with Votrient is not that kidney cancer is a trivial condition that is well treated by other agents. Rather their problem is that they are yet to demonstrate that Votrient is any better than Sutent. Furthermore, there is a risk they will never achieve this (hence NICE's demand for a potential rebate).

    In answer to the question, "Do you really think HGS will have a problem getting Benlysta paid for?", there absolutely is a chance that they will struggle. As I understand it, the phase III results show superiority of Benlysta + standard of care versus placebo + standard of care. However, whilst statistically significant that improvement may not be very meaningful in clinical practice. Regulators (FDA / EMEA) care about the former, but the later is what matters to European payers and likely US ones in future.

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