Should Pharmaceutical Patent Term Extensions Be Shorter?

Last month, the Federal Minister for Industry, Ian Macfarlane, stated that the government had no intention of releasing the final report of the Pharmaceutical Patents Review.  Last week, following the submission of at least one request under the Freedom of Information Act (although I understand there were others), the report was made available on IP Australia’s website.

The release of the report is described as being in response to ‘stakeholder interest’, which is true enough!  It is accompanied by the following government statement:

The Pharmaceutical Patent Review was commissioned by the previous government and conducted by an independent panel. The review panel provided its final report to the previous government in May 2013, which did not release the report.

The government notes that the report is one of a number of reviews of the pharmaceutical system conducted during the term of the previous government. The government has no plans to respond to the report at this stage but may take information in the report into account when considering future policy. The views expressed and recommendations made in the report are those of the review panel and do not necessarily reflect government policy.

In other words, ‘we did not commission it, the people who did commission it did not release it, we were not going to release it until we were forced to, and we are going to ignore it anyway!’

The report is some 234 pages in length, and I have no intention of trying to cover everything in it, particularly considering that it is unlikely to influence government policy.  However, one of the key issues addressed by the review – whether the current system for extending the term of certain pharmaceutical patents is appropriate – is certainly worthy of further discussion.  All members of the review panel recommended a reduction in the duration of extended patents.

Extensions of Patent Term

Historically, extensions of patent term, and the circumstances in which they can be granted, have fallen in and out of fashion like miniskirts or double-breasted suits.  The current provisions stem from a commitment by the Keating Labor government in 1994 to provide pharmaceutical patents with an effective term of 15 years.  Term extensions are granted to compensate the patent owners for the time required to secure regulatory approval to market a new drug, because a patent provides no practical benefit for as long as the invention cannot be sold by the patentee, or anyone else.

As a result, extensions of term are available only for patents covering pharmaceutical substances contained in products that have been approved by the Therapeutic Goods Administration (TGA) for marketing, and listed on the Australian Register of Therapeutic Goods (ARTG).  The length of an extension of term is calculated to be the period from the date of filing the patent until the date of marketing approval by the TGA, minus five years (up to a maximum of five years).  This allows for a maximum patent term of 25 years and a maximum effective market life, or period from marketing approval to patent expiry, of 15 years.

Are Australians Getting a Raw Deal?

The report cites a number of statistics relating to the current extension of term scheme, including:

1. from the commencement of the current scheme in 1999 through to October 2012 there were 599 applications for extensions and 560 (94%) of these were accepted. An effective patent life of 15 years was provided for 53% of extended patents (p 60);
2. of all the new medicines approved by the TGA for the period 2003-2010 (some of which would be expected to be eligible for an extensions and others which would not) an estimated 21-24% would have received an extension of term (p 61); and
3. Australia contributes around 2% of global revenues for pharmaceuticals, however only about 0.3% (or $1 billion) of global pharmaceutical R&D expenditure occurs in Australia.

The implication is clearly that ‘we’, as a nation, are rewarding originating pharmaceutical companies with extended patent terms and significant revenues, but they are not returning the favour by investing in Australian R&D.

What ‘Incentives’ Do Term Extensions Provide?

The review panel looked at the R&D incentive provided by the provision of extensions of patent term through the lens of a net present value (NPV) analysis.  As the report explains (p 67):

NPV analysis is used to evaluate the respective attractiveness of investment projects which builds into the analysis the idea that revenue earned in the future is worth less than revenue in the present. The basic reason for this is that the funds used to generate a new drug could instead have been invested with the expectation that they would be worth more in the future. NPV takes this into account by applying a discount rate to the future streams of money.

Now, maybe I am naïve – certainly I am not an economist – but this approach does not make much sense to me in the context of an established pharmaceutical company.  If somebody has $1 billion dollars to invest this year, and they can do so in any way they see fit, then certainly a comparison of expected NPV of the future returns for different investment options makes sense.  However, a pharmaceutical company does not make its investment decisions in this way.  It is already locked into a business model of developing and marketing new drugs.  The only investment choices it can make are between different avenues of R&D, all of which have comparable NPV.

Even setting aside this concern, the remainder of the NPV analysis offered in the report appears flawed, because the authors proceed to make the unjustified (and unrealistic) assumption that all drugs generate the same amount of revenue ($2.5 billion) over their patented lifetimes.  We know that this is not true, and that originating pharmaceutical companies have historically been highly dependent upon their so-called ‘blockbuster’ drugs.  These are products that earn well above the average revenues during the term of their patents, much of which is, by definition, during the final years of patent protection when the drug has become well-established.

Given this reality, I would presume that nobody enters the business of developing original pharmaceuticals on the basis of a standard NPV analysis.  The potential returns from a blockbuster drug are enormous – many billions of dollars per year globally – but they are a long way in the future, and the risk is, by most investment standards, astronomical.  Of course, therefore, the NPV of expected future returns on an investment today is poor!

And yet, pharmaceutical companies do exist, and all of us in the developed world benefit from their existence through longer, healthier and more comfortable lives.  Which suggests that the mechanisms provided around the world to support their business models – including extensions of patent term in those countries that provide them – do provide an effective overall incentive for them to continue operating.

The Cost of Term Extensions

The fact remains, however, that the level of pharmaceutical R&D investment in Australia is significantly below the corresponding level of expenditure by Australia on pharmaceutical products.  There is absolutely no evidence to indicate that the availability of extended patent terms in Australia has provided any incentive for pharmaceutical companies to conduct R&D in this country, as opposed to somewhere else in the world with lower costs, or more relevant centres of research expertise.

There is also no question that reducing or eliminating extensions of term would result in cost savings to the Australian community.  For example, the report calculates (p 76) that the cost to taxpayers of PBS-subsidised drugs would be cut by around $50 million per year, for each year of reduction in the maximum available term extension, i.e. a saving of $45 million by reducing the maximum extension from five to four years, up to $244 million if extensions of term were eliminated entirely.

While this is clearly a lot of money, in the overall scheme of things it is actually not so significant.  According to the report (p 73), in 2012 the PBS expended $9.25 billion on subsidised drugs.  So the savings that would be achieved by abolishing extensions of term would be just 2.7% of the total.

The fact is that, as matters stand, the main contribution to expenditure on pharmaceuticals in Australia comes not from patented drugs, whether their patent terms have been extended or not, but from generics, as argued in a report produced last year by Stephen Duckett of The Grattan Institute.

To Change or Not?

There is a lot of data and mathematics in the report, but not much of it really helps to answer the questions at hand: should the available pharmaceutical patent term extension in Australia be reduced and, if so, by how much? 

Clearly, providing term extensions props up the business models of pharmaceutical companies and, indirectly, therefore helps to deliver the benefits we all receive from the development of new drugs, irrespective of where the R&D occurs.  On the other hand, taxpayers and consumers foot the bill by paying higher prices for longer.  When it comes right down to it, I think the equation really is that simple.  The various policy arguments about investment incentives and the like are little more than political posturing, and were never going to stand up to the scrutiny of this type of review.

The fact is that the current 15-year maximum effective term is an arbitrary number.  It was selected because, supposedly, this is a typical commercially useful term of patents in other fields of technology.  I am not aware of any good reason to believe that such a comparison provides a meaningful yardstick, and there are inconsistencies between jurisdictions, suggesting that there is no broad agreement on the most appropriate term.  The US system, for example, provides for 14 years, and I am not aware of any reason to believe that this number is any less arbitrary than ours.

The report recommends changing the manner in which the term extension is calculated, in order to ‘target’ the desired effective term, rather than the current approach which indirectly results in the 15-year maximum.  This, however, is the only aspect of the recommendation that the three panel members all agreed on.  The two economists (Mr Tony Harris, former NSW Auditor-General and Parliamentary Budget Officer, and Dr Nicholas Gruen, CEO of Lateral Economics) propose a 10 year effective patent life).  The academic member of the panel (Professor Dianne Nicol, lawyer and Associate Dean, Research, of the University of Tasmania) plumps for 12 years.  Each camp, of course, has its rationale (pp 84-85), but the respective proposals are no less arbitrary than the existing scheme.

Even if the term extension were to be reduced, it is not clear that this would result in savings to the Australian community.  If pharmaceutical companies are seeking a particular return on their R&D investment, why would they not just increase prices to compensate for a reduced period of exclusivity?  The report admits (p 78) that the projected savings from reductions in term extension do not take into account other factors that may come into play, ‘such as firm behaviour’.

Conclusion – Why Should we Extend Patent Terms?

It seems to me that Australia is becoming a pretty stingy place.  Despite being a developed country with decent levels of wealth and a high standard of living, we are more and more like the guy in the group who manages to be somewhere else whenever it is his turn to buy a round of drinks!  Our excuse is usually that we are a country of relatively small population, our little contribution is not going to make much difference in the big scheme of things, and will do us more harm than good.  So we do not want to do our bit to lower carbon emissions, to take in people who risk their lives fleeing from oppressive regimes, or to pay our share of the cost of developing new drugs.

The great thing about a system of patent term extension is that we only pay many years after the original R&D is conducted, once a drug has been approved and become established in the market.  Someone else has to take all the early risks, in the face of poor NPV!  This is not such a bad deal, although there is no good reason to think that it will lead to the growth of pharmaceutical R&D in Australia.  If that is something we want to happen, then we should be finding different incentives. 

Incidentally, one thing I would note about the report’s NPV calculations is that they provide a great argument against spending taxpayers’ money on early-stage pharmaceutical R&D (although I am sure that is not the intention, and that many researchers in the field would disagree, and probably rightly so).

If it were up to me, I would adopt the panel’s proposed method of calculation and reduce the effective term to 14 years, in line with the US.  Whatever other pros and cons there may be to extending patent terms, I can see no good reason why we should keep paying for any longer than our US counterparts.

What do you think?  Should Australians be paying the price of extended patents covering pharmaceutical products and, if so, for how long?

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Tags: Australia, Extension of patent term, Pharmaceuticals, Public policy