A radical plan to lower drug costs

What would happen to the pharmaceutical industry if patents were replaced with one-time prizes?

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(Fortune) -- What to do about the high cost of drugs? A cadre of academics and economists has a radical new answer: Take away the exclusive product patents the government grants a new drug and replace them with cash awards to the innovating company.

Not surprisingly, this is one prize Big Pharma says it doesn't want. Even so, the idea of "prizes not patents" is gaining support and sparking a heated debate over the price of medical innovation.

Here's how the so-called "prizes not patents" scheme would work, according to its supporters: The federal government would set up an $80 billion innovation fund, and rather than grant exclusive patents, officials would use the pot of cash to reward each company's new drug discovery with a one-time prize. Regulators would then take the new drug's formula and place it in the public domain, where any other drugmaker can copy it, make a duplicate medicine, and rush it to market. The hope is that the ensuing market competition would generate dramatically lower prices for new medications.

Such policy notions would have little traction if not for the overwhelming feeling that drugs are too costly. Drug treatments are becoming an increasingly larger part of the U.S. healthcare budget. And as baby-boomers begin to sign up for Medicare's new prescription drug benefit, taxpayers and politicians are fretting the costs. Americans spent $274 billion on prescription drugs in 2006, an increase of 82% over spending in 2000. Medicine prices have risen faster than the rate of inflation in each year of this decade.

According to a study by the AARP Policy Institute, the average senior citizen taking four brand name medications saw a cumulative increase of $1,461 to fill prescriptions between 2000 and 2006. Reform advocates fear that increasing costs can limit patients' access to life-saving drugs. Some of the most expensive drugs, in fact, are those for cancer treatment.

Moreover, some policymakers believe prizes would solve more than just high prices. They say the plan would create an incentive for companies to research and develop medicines diseases that are more prevalent in developing countries - ailments drugmakers currently considered to be less lucrative.

If the new patent scheme sounds downright Soviet, that's because it is. Actually, the old Soviet Union tried awarding prizes for innovation, but according to most Russian policy experts, the system failed to generate scientific creativity. Supporters of this new plan point out, however, that the Soviet's were too stingy, and didn't offer large enough prizes.

The prize plan is gaining new clout in recent months. Nobel laureate economist Joseph Stiglitz advocated the idea in a recent syndicated column. "[T]he patent system with all of its distortions has failed in so many ways," Stiglitz lamented. Last month, Vermont Senator Bernie Sanders introduced the idea in the form of the Medical Innovation Prize Act of 2007.

Earlier this month on the presidential campaign trail, John Edwards promised to make drug patent reform a part of his healthcare agenda. The former North Carolina senator told a gathering in New Hampshire that the plan would "create a different dynamic for drug companies and particularly for breakthrough drugs in big areas like Alzheimer's, cancer, etc." "We'd offer a cash prize for research and development of these drugs, but they don't the patent," Edwards explained. "So, we eliminate the monopoly."

Big drugmakers shudder at the idea of more government involvement in their business. "A prize system could interrupt the flow of funding needed to guarantee research success and could inject the government into decisions about research priorities," says Ken Johnson, senior vice president of PhRMA, the drug industry's main lobbying organization. Johnson insists out that the current patent system hardly grants the lucrative monopolies critics describe.

While it's true, for instance, that patents last 17.5 years, unlike other industries, drugmakers conduct an average of about 12.5 years of research on medicines before they can gain FDA approval. That leaves roughly five years of patent exclusivity for a drug company to recoup its industry average $800 million investment. "We believe that any weakening of the current patent system could be potentially devastating for patients," Johnson says.

The idea of government prizes for drug innovation is the brainchild of James Love, an economist who is director of Knowledge Ecology International, a Washington, D.C.-based think tank. Love has made a name for himself in the nation's capital as a consumer advocate, lobbying and working to pass legislation in areas including technology, intellectual property and health care. He is often criticized for being anti-business, but he believes his prescription for drug companies couldn't be more pro-industry.

"We're saying we want to give $80 billion a year to biotechs, Big Pharma," says Love. "Is that really anti-business? To me, it's a market-oriented alternative to an unproductive, ethically challenged system. Patients prefer a free market, but they don't like monopolies where you pay $100,000 a year for cancer medicines."

So where does the $80 billion come from? Love explains that the federal government spends more than $100 billion each year on pharmaceuticals via the Medicare prescription drug benefit, the Veterans Administration and the federal workers insurance plans. He says the prize plan "would easily pay for itself" with the savings achieved through lower prices for new drugs.

Under the Sanders bill, which Love co-authored, the innovation fund would have a board of trustees determining which innovations deserve prizes. As imagined by Sanders and Love, the board would be comprised of 13 members, including the administrator of the Centers for Medicare and Medicaid, the commissioner of the FDA, the director of the Centers for Disease Control and Prevention, nine presidential appointees (three representatives from the business sector, three private medical researchers, and three consumer advocates).

For every drug approved by the FDA, the board would determine whether and in what amount to award it's designers. Award payments could be staggered over as much as ten years, with no single drug being granted more than 5% (or $4 billion) of the fund in any given year. An 18% portion of each year's fund would be set aside to award research in neglected diseases, AIDS vaccines, and medicines for responding to bioterrorism.

Love's proposal is grand, but he believes that Big Pharma is facing a strong headwind as government grapples with ways to pay for its health programs. "It's either going to be price controls or prizes," he says. "Prizes are more market driven." Clearly, if industry wants to avoid this scenario, they had better start fashioning some new ideas of their own.