Investors have had an on-again, off-again love affair with biotechnology for decades now. The reason for this dysfunctional relationship is not entirely clear, but it probably has something to do with the nature of the field, which holds great promise and yet requires enormous risk-taking. Depending on the prevailing sentiment, the investing public has found itself at turns either entranced by, or dubious of, biotech's prospects. As I have noted previously, these mood swings have created periodic boom-and-bust cycles since Genentech (NYSE:DNA) went public back in 1982.
These cycles may never end, but they could be moderating, primarily because biotechnology is maturing. While the segment is still dwarfed by traditional pharmaceutical giants, biotech's contribution is large and growing. According to Bio, the biotechnology industry's trade organization, more than 160 biotech drugs have hit the market in the last 10 years, and there are now roughly 370 biopharmaceuticals and vaccines in human trials.
G. Steven Burrill, the head of life sciences merchant bank Burrill & Co. and a longtime deal-maker in biotech, recently remarked, "In the history of the biotechnology industry, the prospects for long-term success have never been greater." This is music to the ears of investors, who welcome stability. Unfortunately, though, maturity also has a downside.
Biotech's premium price
Large-molecule, or biologic, drugs have long been expensive, in part because these therapies are costly to produce. Genzyme's (NASDAQ:GENZ) Ceredase, for Gaucher Disease, stirred controversy for its high price tag back in 1992. At that time, though, biotech's influence on America's total drug bill was fairly minimal, since so few of these medicines were on the market and many of them, including Ceredase, were "orphan drugs" targeted at very small populations.
Now, however, biologics are a much bigger factor in health care because there are more of them and they are being used to treat more common conditions, including cancer, rheumatoid arthritis, psoriasis, and asthma. As a result, the societal cost of biotech has become a subject of debate. The recent New England Journal of Medicine editorial expressing alarm about the high price of new biotech cancer drugs reflects this trend.
Concern about biotech's cost already is widespread among the managed care companies, government programs, and corporations that foot much of the drug bill for Americans. These payers are working hard to clamp down on biotech expenses associated with their members (those covered by insurance plans). The cost containment is likely to become more intense, and could have a significant impact on the sales of some therapies.
Drug delivery, doctors, and managing costs
Biologics' delivery mechanism can be a significant component of their overall cost to payers. Most must be delivered into the body via injection or intravenous infusion, unlike some of their small-molecule counterparts, which can be taken orally. This is significant because unlike pills and tablets that members pick up at a pharmacy and take at home, infusions are generally administered by doctors, who charge for their services. Further, when members buy pharmacy drugs, insurers receive near-real-time, highly detailed claims data on these purchases. By contrast, doctors' claims for specialty treatments can be so vague that they may not even include the type of medicine used.
Lacking detailed information, payers have had scant control over how much and which types of drugs physicians use. As a result, cost control has been a challenge. Joshua Golden, a consultant with Mercer Human Resources Consulting, a division of Marsh & McLennan (NYSE:MMC), notes that insurers typically pay a discount to wholesale price for pharmacy drugs, while historically they have reimbursed physicians full wholesale price plus a premium for in-office treatments such as infusions.
Payers are now moving to change this dynamic. Medicare, for instance, is planning on simply cutting the amount oncologists receive for providing chemotherapy. The private sector is likewise taking steps to more aggressively manage the use and expense of these therapies. Specialty pharmacy services providers, such as Express Scripts' (NASDAQ:ESRX) CuraScript, and Aetna (NYSE:AET) and Priority Healthcare's (NASDAQ:PHCC) recently announced specialty pharmacy service venture, are using new measures to achieve savings and to drive down utilization where clinically appropriate.
One clear way that payers believe they can save is by cutting doctors out of the equation, and the easiest means of accomplishing this appears to be by discouraging the use of infusion treatments when possible. The growing aversion to infusion could have a measurable dampening effect on some therapies' sales. For example, insurance companies may charge higher co-payments or simply not cover Johnson & Johnson's (NYSE:JNJ) Remicade, a rheumatoid arthritis drug administered by infusion, and instead direct members to Abbott Laboratories' Humira, Amgen's and Wyeth's Enbrel, or other therapies that can be self-injected by patients at home.
Sharing the burden, controlling utilization
The most significant change in insurance coverage, though, could be for conditions that are neither life-threatening nor crippling. Both Golden and Tom Baker, a vice president at The Zitter Group, cite psoriasis as a major concern among payers. Baker notes that a small number of insurance entities already require patients to shoulder more of the cost burden for this category, and beginning on January 1, he expects more to adopt these practices. For his part, Golden is advising many of his self-insured clients to create a separate specialty pharmaceuticals coverage tier that institutes higher co-pays.
The effect of these tactics is the same: whereas before patients might have paid a small fee of $15 or $30 for treatment, under these new schemes they will have to cover as much as 20% of the drug's price. The newest biotech treatments for psoriasis, many of which also target rheumatoid arthritis, are priced at $1,000 to $1,500 per month, meaning patients' out-of-pocket expense could range from $200 to $300. Many payers will likely include a cap on these payments, but it seems reasonable to assume that more patients will forgo pricier biotech psoriasis therapies as their charges grow. In addition, the infusion stigma still applies, so drugs like Biogen Idec's Amevive and Johnson & Johnson's Remicade, both of which are delivered by infusion, may be even more expensive for consumers, or may not be covered by insurance at all.
Do the research
Biotechnology remains an exciting field with plenty of opportunity for savvy investors. Now, though, innovative technology and success in clinical trials will no longer be guarantees of a drug's success, because biotech companies will be challenged more than ever before on pricing and convenience. Investors, then, will have to do more homework on pipelines and consider reimbursement as a factor when valuing drug candidates. This due diligence will be difficult, but the payoff should be well worth the extra effort.
More Fool biotech commentary:
- Are Biotechs Worth the Risk?
- Avoiding Biotech Land Mines
- Biotech Is Back
- The Psoriasis Wars
- Biotech's Full Monte
- A Foolish Checklist for Biotech Investing
Fool contributor Brian Gorman is a freelance writer living in Chicago, Ill. He does not own shares of any companies mentioned here. The Fool has a disclosure policy.
