Life sciences, health care reform and the new marketplace
By Sanjay Behl, Terry Hisey and Ralph Marcello
> Illustrations By Yuko Shimizu
The 2010 Patient Protection and Affordable Care Act (PPACA) will likely have far-reaching consequences across the U.S. health care industry. Yet as much as it has captured national attention, the PPACA is only the most recent, galvanizing element of a more expansive transformation of the industry driven by other state and federal reforms and, perhaps more significantly, by broader trends in the marketplace.
For life sciences companies, health care reform brings direct impacts in the form of industry taxes, rebates, comparative effectiveness data, fines and transparency requirements. However, indirect impacts related to the changing nature of their relationships to other sectors and the choice and consumption of their products could demonstrate an even greater catalyst for transformation.
While the overall effects of reform are still being debated, several implications have emerged:
Health reform will likely accelerate the transformation of the U.S. health industry. The structural impact of these changes across the industry provides a clue to the magnitude of its impact on life sciences. Reform legislation tends to focus primarily on plans, providers, employers and state governments; however it will likely have intended and unintended impacts on most participants.
Reform will roll out over several years, and there is uncertainty as to how these elements will play out over time. Some elements of reform may have benefits in the short term and not in the long. And vice versa. Without thoughtful balancing of long- and short-term goals, stakeholders may take measures that undermine the overall objectives of reform. As a critical supplier to the industry, life sciences manufacturers risk being subject to reactionary changes as other players respond to the immediate demands of reform.
Reform has the potential to change the role of life sciences companies to that of a supplier. Health reform can drive cross-sector trends that affect the way other sectors interact with and consume life sciences products and services. The impact may well be substantial. One of the most significant could be the changing role of the physician in conjunction with the larger role of medical administrators and state government entities. For life sciences companies, this could mean rethinking their business model and embracing a new cost structure in order to remain relevant and profitable.
Relevant impacts on other stakeholders
Health reform is beginning to shape other sectors in ways that can alter their relationships with life sciences. The overall effect is increased consolidation and consumer expectations along with overriding cost constraints. This suggests that it is more important than ever for life sciences companies to build the types of relationships and provide the types of data that can enable their products to gain inclusion on formularies and acceptance in major health systems.
1. Fewer plans, fewer formularies
The implementation of state exchanges and increased regulation of rates and profits will likely drive consolidation in the health insurance industry. For life sciences companies, this can mean fewer targets to influence, but the market sway could be more significant. Health plans will likely standardize around a limited number of formularies, and formulary archetypes will emerge. It will be important for life sciences companies to develop relationships and explore contracting models with the larger plans that will determine the archetypes.
Health plans are also likely to create new products and services in response to mandatory coverage requirements and significant scrutiny. This may present an opportunity for life sciences companies to develop services that align with the emerging plan products, as well as solutions for specific patient populations that will help plans manage costs and outcomes.
Although physicians in general have been leaving private practice in large numbers since at least 1996, reform will likely accelerate this trend for two reasons: policy changes that favor integrated care delivery and financial pressures.
Health plans and government payers are already focusing more on value, particularly on comparative effectiveness (CE) research. Health plans are pursuing multiple avenues to gather data from the real world, including collaborations with other sector participants. The establishment of the Patient-Centered Outcomes Research Institute (PCORI) could also bring more scrutiny and visibility to the CE of treatments. Although current legislation explicitly prevents CE from being used as a basis for formulary exclusion, payers will likely use CE findings to push preferred/leading practices to providers and set higher standards for demonstration of value, particularly for high-cost or competitive products.
In addition, health plans will need to report outcomes and justify rates based on data that is not currently collected or reported. This opens an opportunity for life sciences companies to be proactive in considering how to use and communicate product value data.
2. Physicians no longer in the driver’s seat
The impact of reform on providers will affect the basic selling relationship for life sciences companies and may alter the selection and use of products.
Although physicians in general have been leaving private practice in large numbers since at least 1996,1 reform will likely accelerate this trend for two reasons: policy changes that favor integrated care delivery and financial pressures. Private practice physicians will be hit by the combination of declining reimbursement rates and an increasing need for capital investments to keep up with health information technology (HIT) mandates. Taken together with the new care delivery and payment models, the expected result is that more private physicians will join large practices and that there could be further consolidation among providers.
States will simultaneously be responsible for coverage for a larger number of people and also for implementing health information exchanges and health insurance exchanges, mostly during a time of budget shortfalls.
Some decision-making authority may also be taken out of the physician’s hands as providers take greater responsibility for medical cost management. Provider organizations could exert greater influence over physician preferences as the pressure to reduce costs and demonstrate value heats up. Prescription patterns will depend, at least in part, on therapies’ formulary placement. Medical device use, if the device is not highly differentiated or if substitutes exist, may depend on the procurement process rather than physician preference. Once formularies and reimbursement rates are locked down, product negotiations could move into the realm of the medical administrator or other institutional purchaser, a non-caregiver who becomes the gatekeeper into the provider organization. Not only will account-based selling replace the one-on-one relationships of influence, but providers may also look for risk-sharing models and other forms of support for achieving cost and quality objectives.
Providers are also likely to explore new models of care to align services with the most cost-effective modes and sites for delivering care, offering opportunities for products and services aimed specifically at these care environments.
3. Employers pushing decisions, and costs, down to patients
With even more incentive to control costs and usage, employers can stoke the consumerism trend and invest more in comprehensive wellness programs and solutions that can reduce costs while effectively managing chronic conditions and improving employee health. They could also pass more of the cost to their employees. As a result, employee patients will become more invested in health care decisions, including those involving drugs and medical devices.
4. State governments wielding new influence
States will assume a larger role in setting policies, negotiating reimbursements and executing formulary decisions. States will simultaneously be responsible for coverage for a larger number of people and also for implementing health information exchanges and health insurance exchanges, mostly during a time of budget shortfalls.
Execution of federal reforms will vary by state. Increased standardization and transparency is likely, but winning formulary approval and meeting effectiveness and cost data requirements may proceed state-by-state. Life sciences companies that do not secure formulary approval may lose a large portion of their market in a state.
Although there is national guidance around information sharing and reporting, states have varying needs, capabilities and some latitude in executing the provisions of reform. Additionally, the majority of recently elected governors campaigned against reform, and many are suing to seek its repeal. Life sciences companies may need to treat each state as a separate account and dedicate resources to meeting the particular and specific needs of those large accounts. States may require more creative contracting and bundling strategies, data for decision support and risk sharing arrangements.
Regulatory scrutiny will also increase significantly, potentially creating greater burden for the life sciences companies’ legal and compliance groups. In order to mitigate the risks of fines and penalties for violations of new regulations (e.g., “sunshine” provisions, Anti-Kickback Statue, False Claims Act and overpayment recovery provisions), life sciences companies will need to effectuate changes or implement new compliance programs and controls.
The effects of cross-sector mega-trends
Reform and the shifting power within the industry are also spurring pervasive cross-sector trends that will likely have profound repercussions for life sciences:
Transparency and measurement. Expect a change in how data are collected, shared and analyzed. For life sciences companies, increased emphasis on value will require changes in how data can be used to present and position products. Regulators will likely use the new large data sets to mine for indications of fraud, waste and abuse. Such sweeping changes will require different strategies for data collection and testing, resources, as well as increased scrutiny of the relationships with physicians and group practices.
Shifting payment models. Changes to payment will likely affect all participants: policy mandates new payment models; plans and government develop new models and procedures to implement them; providers and patients become aware of the changes and possibly modify processes or behaviors to accommodate the new payment models. Each step of the way has the potential to affect the eventual decision to prescribe or use a life sciences product as well as to determine how the product is acquired and paid for.
Shifting risk and health care consumerism. Together with new payment models, shifting risk and consumerism could alter the notion of what opportunities are attractive to life sciences companies. Previously less attractive areas, such as dermatology, may become more attractive precisely because they are not reimbursable and proceed outside the tight controls and standardization of the insured market.
Traditional life sciences innovation models will also be challenged as the returns for development of new therapies may not be sufficient for the investment risk. The trends may well favor an innovation model based as much on adaptability as on pure science.
Monumental impacts on Life Sciences
The impact of the aforementioned factors could be as much as a 14 percent decrease in revenues and a permanent shift toward a less profitable, lower-margin business for life sciences manufacturers.2 Medical device manufacturers could experience similar declines due to changing patterns of influence and increasing pricing pressures.3
Life sciences manufacturers will be subject to pricing and, increasingly, formulary pressures, particularly on nonspecialty products. While the volume of covered individuals will grow, emphasis on controlling costs, availability of generic substitutes and scrutiny of cost effectiveness of products will increase pricing pressures. Life sciences, as well as providers and payers, will need to reduce the cost to serve.
U.S. branded pharmaceuticals market could decline by 14 percent
In order to quantify the impact of health care reform on the U.S. branded pharmaceutical market, Deloitte* modeled both direct and indirect impacts on branded pharmaceutical revenues. Based on this analysis, the direct impact of health care reform provisions may cost the industry ~$52 billion in lost revenue over a 10-year period.4 However these impacts are minimal compared to the indirect impacts of reform, which could cost the industry ~$266 billion in lost revenue.
Direct impacts include:
Coverage expansion: The expanded access from PPACA is expected to increase the total volume and velocity of drug use and contribute ~$26 billion in additional revenue to the U.S. branded pharmaceutical market over 10 years.5
Medicaid drug rebate program: The Medicaid drug rebates called for by the PPACA combined with the projected increase in the Medicaid population could cost the industry ~ $32 billion in lost revenue over 10 years.
Part D “donut hole” relief: The 50 percent discount on branded drugs
for Medicare beneficiaries with Part D coverage who hit the “donut hole”—the coverage gap between the $2,800 drug payment cap and the yearly out-of-pocket spending limit of $4,550—translates to ~$18 billion in lost revenue over 10 years.6
Industry tax: The industry fee, levied as a percentage of profit on manufacturers, will result in ~$28 billion of lost revenue to the branded market.
Indirect impacts could include:
Formulary pressures: Deloitte estimated the potential impact of formulary pressures on branded revenue by analyzing three cost-constrained systems where formulary tightening and rejection of blockbuster drugs has already occurred – the United Kingdom, Germany and Kaiser Permanente. At Kaiser Permanente, for example, the formulary includes only two statins.7 Other statins are approved for use in the much smaller subset of patients where the approved drug proves ineffective. Based on a weighted analysis of factors such as risk of therapeutic substitution, disease area, pricing, patent expiration and known formulary tightening in the markets studied, Deloitte estimated revenue contraction for each of the top 300 branded products in the U.S. and applied these scores to product- and company-level revenue projections. Our analysis indicates that the U.S. branded pharmaceutical market may lose ~$236 billion in revenue over a 10-year period as a result of formulary pressures.
Risk of biosimilars: Deloitte modeled the potential erosion in revenue to branded biologics in nine major drug markets and aggregated the impacts to the industry.8 Although revenue from branded biologics will continue to grow, total volume will likely remain well below pre-reform projections. Biosimilar introduction is expected to cost the industry ~$29 billion in lost revenue over the next 10 years.9
In addition, pharmaceutical companies may experience implications for the portfolio mix. To understand the impact on the pharmaceutical portfolio, consider branded drugs sold in the U.S. Figure 4 shows the total drug portfolio categorized based on what job the drug does (x-axis) and where it is administered (y-axis). The top 300 revenue generating drugs in the U.S. make up 82 percent of the U.S. market by revenue. Currently, 67 percent of that revenue comes from drugs that fall within the highlighted area, the mass market.10
The impact of reform is likely to be felt differently in each category. For instance, as employers reduce coverage and pass more costs along to employees, employers will likely still pay for drugs that treat disruptive morbidity (e.g., migraines) but may no longer pay for drugs that treat nondisruptive morbidity (e.g., heartburn). Likewise, there could be differences between coverage of drugs that treat life-threatening conditions, depending on whether the condition is fast-acting (e.g., heart attack) or slow-acting (e.g., hypertension).
U.S. medical device market could decline by 10.2 percent
The impact of health reform on medical devices comes primarily from pricing pressure as physicians lose purchase decision-making power especially over devices that are more readily substituted. Hospitals and patients will increasingly make the decisions about these products. The industry’s system of influence, which was directed at physicians, will no longer be relevant except in the most highly clinically differentiated devices. Instead, hospitals will likely shift more decisions to a procurement model or, in cases where the patient bears the cost, to the patient. Stents, hip and knee implants, and pacemakers are just a few examples of devices that will be the focus of extreme spending reduction.
Direct impacts of health reform on the medical devices sector are likely to be felt due to increased utilization as coverage is extended to more individuals and through increased excise taxes. Both factors add up to a slight negative impact (-0.2 percent) on projected revenue in 2015. Additional revenue pressures from the changing influences within the ecosystem, which Deloitte modeled qualitatively by analyzing factors such as payor type, physician preference, technological maturity, procedural complexity, disease severity and spend targets, however, will result in a much higher impact, a revenue reduction of approximately 10 percent.
A response of similar magnitude is needed
Historically, when regulations substantially changed an industry, suppliers experienced significant downstream impacts. They underwent an array of changes, including consolidation, alignment to targeted models, increased cross-border trade, lower-cost operating models, and more significant standardization. They learned, sometimes too late, that major changes to their business and operating models seemed to be necessary to remain relevant and profitable.
Reform legislation is taking effect in an industry and market environment already grappling with other long-term trends, including the “patent cliff”; the opportunities and challenges of offshoring and participating in developing markets; increased consumer demand for non-allopathic therapies; and the growth in personalized medicine. The impact of health reform and the options available for transformation should be viewed in this context.
While the direct impact of reform as written into legislation is small enough to be absorbed, the indirect negative impact will hit top-line revenue in the range of 12 to 14 percent, according to our estimates.
A transformed life sciences business model is likely to look very different from today’s approach – outcomes rather than products will drive the new model. The cost-constrained, outcomes-orientation of health reform will require flexibility in everything from the industry structure to the innovation model to the supply chain and information technology (IT).
From suppliers of products to providers of solutions
As their products get more commoditized, life sciences companies can soon be dealing with the procurement department and the medical administrator. However, most manufacturers may not be structured to compete on price.
One strategy for life sciences manufacturers is to continue to appeal to doctors and other care providers by using services to enhance their product offerings and retain differentiation, as well as offering valuable support associated with the provision of care. This approach has been effective to varying degrees in other industries, but it comes with challenges for life sciences executives. Adopting a service-focused model may mean going from a 90 percent gross margin business to a 40 percent gross margin business. Life sciences executives can face a difficult task in reducing cost structures enough to be profitable while selling services.
As the industry changes, the path to retain margin and influence is to become adept at developing and selling entire “solutions,” not just individual products. It is not obvious at this juncture how manufacturers could implement a solutions-oriented model. The way forward raises questions for each subsector, which may include:
Cross-sector consolidation. A solutions focus will change the industry structure. Pharmaceuticals companies are already consolidating and looking for other opportunities to achieve scale. How can you use consolidation to develop wrap-around services or to target specific types of needs? What other capabilities will you need to help derive value from an acquired collection of pharma, generic and medical device companies?
Increased scope of treatment. What type of specialization (disease-type or physician-type) will be most effective for your company – or should you specialize at all? For example, a company might focus on the treatment of diabetes and build a portfolio that integrates the drugs and the delivery systems, supplies and monitoring equipment.
Innovation. How can you continue to innovate scientifically if the odds of failure are greater and the potential payoff lower? Where is the opportunity when the needs of the mass market have largely been met and the threshold for effectiveness for a new product is high? Will you innovate in novelty or specialty markets where the market size is much smaller? Or can you find innovative ways to share risk for the high cost of discovery and development? In times of industry upheaval, innovation needs to encompass not just science, but ways of serving the customer and orchestrating the supply chain.
Research and development. If reform changes the attractiveness of the U.S. market, how will the pattern of product development and launch change? Will global R&D emerge based on projections in a global marketplace comprising particular markets with widely varying needs and characteristics? How will you accommodate the need to provide comparative effectiveness and outcomes data?
Supply chain. Just as the pattern for drug development and release is expected to change, so will the supply chain that feeds markets. How can your supply chain most effectively support fragmented markets and a smaller population for each offering? Do the same factors that led to offshoring still hold for pharma manufacturing? Is your primary focus still to serve an entire global market?
Legal and compliance. Increased regulatory requirements are changing the interaction model with providers, increasing the cost of compliance especially of traditionally outsourced functions (e.g., CROs, manufacturing and sales forces) and in turn causing companies to re-evaluate the use of third parties. How do you mitigate the risks of civil fines and penalties while managing costs? Do you adopt compliance controls early to address recent regulatory changes?
The way forward
The impact of U.S. health care reform on the life sciences industry will be significant and pervasive. While the direct impact of reform as written into legislation is small enough to be absorbed, the indirect negative impact will hit top-line revenue in the range of 12 to 14 percent, according to our estimates. Facing such monumental changes, life sciences companies cannot continue to engage in the piecemeal changes of the past.
Some life sciences organizations already conduct significant, scalable and profitable business with large managed care organizations. They may not be affected. However, most may have difficulty adjusting to new service-oriented business models that cut gross margins in half.
So where will innovative life sciences companies find opportunities? As health care reform unfolds and permanently alters the life sciences business model, how can the industry not only survive increased cost pressures, constrained reimbursement and the constantly changing regulatory environment, but actually transform itself to take advantage of short- and long-term opportunities? The answers to these questions are not readily apparent. What is clear, however, is that these companies should be aggressive in their attempts to analyze possible future operating models, explore new areas of innovation, and get a jump on competitors in what promises to be a dramatically transformed industry in the years ahead. DR
Sanjay Behl and Ralph Marcello are principals with Deloitte Consulting LLP.
Terry Hisey is vice chairman and U.S. Life Sciences leader with Deloitte LLP.
The authors wish to thank the following collaborators for their contributions to the authors’ thinking on health care reform in the life sciences industry: Yogesh Bahl, Deloitte Financial Advisory Services LLP; Ted Hoffman, Rob Jacoby, Rob Kennedy, Adit Mané and Krithika Ramamoorthy, all with Deloitte Consulting LLP.
1. HSC 2008 Health Tracking Physician Survey. In 2008, 44 percent of physicians were employees or contractors while the remaining 56 percent were either full or partial owners of their business. This represented a significant decline from 1996 when 62 percent of physicians held an ownership stake but was about the same as it was in 2004.
2. Based on Deloitte Consulting LLP analysis.
5. Projections from external data (52 state summary) and an actuarial analysis of a variety of scenarios for potential changes to insurance coverage for the period 2010-2020.
6. Using AARP, Kaiser Family Foundation and CBO estimates for the distribution of Medicare beneficiaries with Part D coverage, Deloitte Consulting LLP modeled the size of the donut hole and the branded revenue impact.
7. Based on Deloitte Consulting LLP analysis.
8. Insulin, growth hormones, HIV, anemia, neutropenia, multiple sclerosis, hepetitis C, rheumatoid arthritis and oncology MAB.
9. Based on Deloitte Consulting LLP analysis.
* As used in this article, “Deloitte” means Deloitte Consulting LLP. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries.