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Rising cost of medicines: fixing the free-trade bungle

By: Luigi Palombi – Adjunct Professor, Murdoch University
19 November, 2014

Ten years on from the Australia-US Free Trade Agreement, Australia is entering another round of negotiations towards the new and controversial Trans-Pacific Partnership.

Negotiations for the Trans-Pacific Partnership present an opportunity to correct a mistake made a decade in the Australia-US Free Trade Agreement, which led to Australia paying higher prices for pharmaceuticals.

In July 2004, Tony Abbott, then health minister in the Howard government, issued this statement:

"The price of pharmaceuticals will not rise as a result of the AUSFTA…"

Contrast this to what the Abbott government's first budget, in May this year, which told Australians:

"Over the past decade the cost of the Pharmaceutical Benefits Schedule (PBS) has increased by 80 per cent…"

To be sure, the "price of pharmaceuticals" is not the same thing as "the cost of the PBS". But since the PBS is responsible for providing medicines to the vast majority of Australians, it is reasonable to infer that a contributing factor has been a rise in the price of pharmaceuticals. It is also reasonable to infer that the AUSFTA is partially to blame for that rise.

The legislative instrument through which the AUSFTA was implemented is the US Free Trade Agreement Act 2004. The Therapeutics Goods Act 1984 was also amended to require companies seeking marketing approval for a pharmaceutical to provide a patent certificate as part of the Therapeutic Goods Administration's (TGA) regulatory assessment process.

The patent certificate must say if the sponsored medicine will "infringe a valid claim of a patent that has been granted in relation to the therapeutic good (being the patented medicine)" in question. It must also notify the patent holder.

Otherwise known as "patent linkage", the application for regulatory approval creates a link between a patented medicine and a possible generic substitute.

The patented medicines are categorised as F1 formulary medicines, which means there is no approved substitute.

When a generic medicine comes onto the market, these drugs are contained in the F2 formulary. Generic medicines contain the same active ingredient or have the method of production to the patented drug, or they may be similar in terms of its administration, dosage, method of treatment or indication.

How does 'patent linkage' play out in Australia?

"Patent linkage" provides advance warning to a patent owner, usually the manufacturer of a patented medicine, that a generic medicines' manufacturer is about to enter the market with a competing and cheaper substitute medicine.

With the knowledge that a generic medicine will trigger an automatic 16 per cent price drop for the patented medicine – and result in its transfer from the F1 formulary to the F2 formulary – the patent owner applies to the Federal Court of Australia for a preliminary injunction.

The injunction is normally granted and as a result, the marketing of the generic medicine is delayed by an average of three years.

This means that the patented medicine stays in the F1 formulary. This affects the pricing of that medicine not only because the price is higher, but also because medicines in the F2 formulary are subject to mandatory price disclosure. This tends to exert downward price pressure on all medicines within the F2 formulary.

For a generic manufacturer to defeat the injunction, it must mount a challenge to the validity of the allegedly infringed patent. The average cost of patent litigation is about A$5 million and requires a team of specialist patent lawyers, patent attorneys and highly skilled experts.

In addition to the legal cost, the generic manufacturer is, by effect of the injunction, denied sales revenue for the duration of the injunction – not to mention the opportunity cost it incurs as its workforce diverts attention to the patent litigation.

In Australia, legal costs follow the event, meaning that should the generic manufacturer lose, it will also be required to pay a significant percentage of the legal costs incurred by the patent owner in defending its patent.

So, it is critical that a generic company carefully assess any patent that puts at risk a proposed generic medicine launch. This assessment costs money. And unfortunately, because of differences in patent law around the world, it is impossible for a generic manufacturer to extrapolate the results of a patent challenge in one country to that in another.

How does it affect medicine prices?

The longer a medicine remains in the F1 formulary, the higher the cost of that medicine to the PBS. This, combined with the consequences on price once that medicine moves into the F2 formulary, creates a significant incentive for patent owners to stop generic competition.

Patent owners encircle a valuable patented medicine with a series of "evergreening" patents. These usually apply after the patent (for the active ingredient) has or is about to expire. This can extend patent protection beyond the normal 20 to 25 year period to a period closer to 40 to 50 years.

Unfortunately, the profit margin for generic manufacturers has fallen significantly due to the price disclosure mechanism, while the cost of patent litigation has risen significantly. Consequently, the capacity of generic manufacturers to assume the risks involved in risky and expensive patent litigation has fallen dramatically.

In the absence of any serious intervention by the Australian Competition and Consumer Commission, it is likely that fewer "evergreening" patents will be challenged in the future. This means that more medicines will remain in the F1 formulary and for a longer period and the costs of medicines will rise.

A consequence of price rises, particularly at a time of economic austerity, is that newer medicines are not being listing on the PBS. The Pharmaceutical Benefits Advisory Committee, which decides which drugs will be subsidised through the PBS, for instance, recently rejected the costly drug Sovaldi, despite effectively treating hepatitis C virus infection.

If the Abbott government wishes to limit the annual cost increase of the PBS to 4 per cent, it is critical that only medicines that are truly innovative and deserving of patent protection remain in the F1 formulary. If room in the PBS is to be made for medicines such as Solvadi, then it is essential for more of the older F1 medicines be moved into the F2 formulary more quickly.

The cost of the PBS has risen by 80 per cent in the past ten years. It's likely that without the AUSFTA, the cost of the PBS, and by inference the cost of medicines, would have risen by much less.

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