EVENTS

Date:	Monday, October 31, 2005
Time:	10:00 AM -- 12:00 PM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

October 2005

Authorized Generics: Part of the Solution or Part of the Problem?

When drug patents expire, cheap generic equivalents usually enter the market, drastically reducing prices and costs. Generic competition has arrived for many blockbuster drugs in the past few years, and much more is on the way. Sometimes, the manufacturer of a branded drug offers its own “authorized generic” to compete with the first outside generic to enter the market. Whether authorized generics promote or inhibit competition has been vigorously debated by health care experts. At an October 31 AEI panel discussion, Ernst R. Berndt and Andrew Parece discussed the conclusion of their new study, “Authorized Generic Drugs, Price Competition and Consumers’ Welfare” (coauthored with Richard Mortiner, Ashoke Bhattacharjya, and Edward Tuttle), that authorized generics tend to enhance competition and work to the benefit of patients.

Ernst Berndt
MIT Sloan School of Management        

Andrew Parece
Analysis Group, Inc.

The Hatch-Waxman Act of 1984 was a grand compromise designed to reward innovation, yet encourage competition. The act extended the effective patent life of drugs in recognition of the increased time and resources involved in drug development. However, it also facilitated generic entry by not requiring generic manufacturers to replicate clinical studies originally performed by the brand drug manufacturer. As a result of this legislation, a generic entrant has the option of filing a paragraph IV certification in conjunction with an abbreviated new drug application (ANDA) submitted to the FDA. In doing so, the generic manufacturer either directly challenges or claims non-infringement of the branded patent. If successful in the court system, the FDA grants the independent generic entry a 180-day exclusivity period. An authorized generic is marketed under the brand manufacturer’s new drug application (NDA), and thereby can enter this period as a competitor.

Does this potential for short-run competition from authorized generics deter traditional generic manufacturers from filing paragraph IV ANDAs, and thus delay generic entry that could benefit consumers? In answering this question, it should be noted that authorized generics lower prices by increasing generic competition during and after the exclusivity period. In addition, they provide patients with a cheaper yet identical alternative to the brand drug. Interestingly, only approximately 20 percent of drugs face a paragraph IV certification in the first place. If authorized generics were to decrease incentives for paragraph IV filings, they would do so only for those cases with the least likelihood of success. Reducing speculative patent challenges averts wasteful litigation expenses. These savings may in turn increase a manufacturer’s expected profits and lead to the development of more innovative drugs. In the short run, authorized generics have no appreciable impact on paragraph IV certifications and clearly benefit consumers by lowering prices through enhanced competition.

An equally important question to ask is whether authorized generics decrease price competition for a given product in the long run. For most drugs, the incentives behind independent generic entry would remain intact, since generic manufacturers would anticipate intense competition regardless of whether or not an authorized generic entered the market. Evidence suggests that the addition of a generic entrant beyond the first four or five generics has a negligible effect on generic-to-brand relative prices or shares. Therefore, in a market where the majority of drugs face substantial generic penetration, the reduction in long-run generics due to the presence of an authorized generic is unlikely to impact long-run generic prices. This conclusion is consistent with the finding that an appreciable number of generics enter the market and reduce prices relative to the brand, even when no paragraph IV certifications have been successful. Overall, any potential harm posed by authorized generics is greatly outweighed by the benefits they provide consumers.
       
Anna Cook
Congressional Budget Office

In the long run, authorized generics would likely have no effect on generic prices, particularly when the market is rife with competition. But, in the short run, the impact of authorized generics on patent challenges and the timing of generic entry is still disputed. In order to settle this debate, policymakers need to understand why brand manufacturers offer authorized generics in the first place.

During the patent challenge period, the generic market is fairly lucrative due to limited generic competition. Having an authorized generic allows a brand manufacturer to capture an additional segment of the market that would otherwise be off limits. If a pharmaceutical benefits manager automatically switches from a brand to a generic as soon as one is available, a brand manufacturer can share in these sales by offering its own generic. In most situations, an authorized generic enhances welfare by generating more competition at an earlier point along the generic timeline.

The welfare question becomes more controversial when a brand manufacturer introduces an authorized generic after losing a patent challenge. In this case, the presence of an authorized generic reduces the profits the generic manufacturer had expected to gain when it filed suit. If this becomes the customary response of brand companies, generic manufacturers may find it unprofitable to pursue further paragraph IV certifications.

Once two generics become available, the manufacturers must compete for a single space on a pharmacy shelf. Rebates are consistently used to win over retailers and are generally not picked up by those who monitor drug pricing. Therefore, the generic market may be even more competitive than the authors perceive. When assessing the welfare implications of authorized generics, it would be helpful to know what percentage of the generic price is making it to the final purchaser.

The authors found that authorized generics are priced slightly higher than independent generics. But does the practice of authorized generics lead to lower overall prices throughout the entire generic market? Probably so, but it is important to bear in mind that the manufacturer of an authorized generic--particularly if it is a subsidiary of the brand company--will consider the impact of its price on the sales of the brand drug. Does this behavior thwart competition? An independent generic that is not compelled by brand interests would provide more intense competition needed to drive down price.

Tomas Philipson
University of Chicago

While this study clearly describes the relationship between authorized generics and paragraph IV filings, it fails to explain the puzzling behavior of brand manufacturers. Based on the evidence presented, one cannot firmly conclude whether this behavior is pro- or anti-competitive. If paragraph IV certifications were never employed, few would object to post-patent competition brought forth by a brand manufacturer. But in this market, regulations lure monopolists into creating duopolies to stave off further competitors during the exclusivity period. Why else would a drug manufacturer sell off its license to another manufacturer only to start competing with it? Why not compete on price and take advantage of consumer preference for brands?

Some argue that exploiting authorized generics is a discreet way of paying off generic manufacturers to prevent unwanted competition. This troublesome point is substantiated by the fact that the price of authorized generics falls between the price of the brand and that of other generics. If a brand manufacturer had to choose a competitor, a wise choice would be a competitor who offers a relatively high price. To better understand these market dynamics, one could assess the relative change in the established price of authorized generics throughout, and particularly at the end of, the exclusivity period.

The question at the forefront of this debate is whether authorized generics should be banned. If Congress implemented this change, the logical response of a brand manufacturer would be to lower the branded price, rather than contract a competitor to deter generic entry. In order to create prudent policy, more research must be undertaken to reveal the benefits manufacturers foresee when bringing an authorized generic to market.

Christine Simmons
Generic Pharmaceutical Association

The Generic Pharmaceutical Association (GPHA), which includes 85 percent of generic manufacturers, takes the position that authorized generics are simply brand products masquerading as generics. Many of our manufacturers do engage in this practice, yet the industry consensus is that authorized generics should be banned since they devalue the incentives underlying the 180-day exclusivity period. Manufacturers have a duty to shareholders to increase profits through all available and legal means. Therefore, the use of authorized generics remains a legal practice, but our members and consumer welfare would greatly benefit from its prohibition.

The Food and Drug Administration considers authorized generics as brand products for purposes of product approval. As part of the NDA, authorized generics are not precluded from the 180-day exclusivity period, and they act to discourage patent challenges. By contrast, the Centers for Medicare and Medicaid Services recognizes authorized generics as generic products for purposes of best price calculation. This policy allows brand companies to get quite a windfall by not including an authorized generic in their best price calculation. The corollary is that state and federal healthcare programs are spending more money than necessary.

In respect to this study, GPHA disagrees with the final conclusion. In the short term, the added presence of an authorized generic can increase competition and potentially lower prices of generic drugs. However, in the long run, the practice of authorized generics diminishes the exclusivity period, which was designed to encourage generic companies to challenge the questionable pharmaceutical patent.

There is evidence to support both sides of the issue, but GPHA members maintain that authorized generics are negatively impacting the way they do business. Early generic challenge to patents significantly increases consumer savings by accelerating consumer access to affordable medicine. It is these numbers that will suffer from authorized generics. One can frame this as a brand versus generic battle, but ultimately this is a consumer health care issue and if not resolved, consumers will be the losers.

AEI research assistant Elizabeth DuPre prepared this summary.