In 1983, Congress adopted the Orphan Drug Act (ODA) to spur investment in treatments for rare conditions. Thirty-five years later, the law is showing its age.
Because drugs to treat diseases with small patient populations can’t be sold in large volume, for-profit firms may be reluctant to develop them. To encourage investments in these “orphan drugs,” the ODA employs two policy levers: First, the law offers tax credits that defray the costs of research and development. For most of the Orphan Drug Act’s history, firms could recoup 50% of the R&D costs associated with orphan drugs; the 2017 tax cut bill halved that to 25%. Second, the ODA offers a 7-year period of market exclusivity instead of the usual 3 to 5 years given to other drugs. This allows drug makers to charge monopoly prices for an extended period, even if their patents have lapsed.
In its original form, the Orphan Drug Act required firms seeking tax credits or market exclusivity to document why a drug candidate was not economically viable. But the standard was challenging to administer and created uncertainty for investors. So Congress amended the law a year after its adoption to make benefits available for any company with a promising drug to treat a disease afflicting fewer than 200,000 people, an arbitrary ceiling based on the estimated prevalence of narcolepsy and multiple sclerosis. Perhaps as a result of the law, in the years following the amendment, investment in orphan drugs surged, yielding a raft of new therapies.
While the Orphan Drug Act has stayed the same, drug markets have changed dramatically over the past 3 ½ decades. Most significantly, the market price for orphan drugs is now remarkably high: in 2017, the average price for the top 100 orphan drugs was $147,308 a year per patient. (This is only an estimate.) Manufacturers have been accused of slicing prevalent diseases into smaller subcategories, sometimes characterized by genomic biomarkers, allowing firms to secure ODA incentives for a drug that is likely to be used in a large patient population. And the growing use of auxiliary or “surrogate” endpoints in clinical trials for orphan drugs has reduced the time and expense required for clinical research, because they set lower thresholds for indicating treatment success — e.g., slowing a tumor’s growth vs. longer survival.
As a result of these trends, the Orphan Drug Act rewards some drug manufacturers for bringing drugs to market that in all likelihood would have been produced without additional incentives. The incentive structure is an especially poor fit for orphan drugs that target such rare conditions, or are so challenging to manufacture, that the market will not support similar products from multiple firms. Because these “natural monopoly” drugs will never face meaningful competition, they may be very lucrative even without the ODA benefits.
Consider the figure below, which illustrates the extent to which orphan and non-orphan drugs face generic competition. We measure this by asking whether any manufacturer has filed an abbreviated new drug application (ANDA) to bring a generic product to market. We restrict ourselves to small-molecule drugs to allow sufficient time for generics to enter. According to our analyses, only one-third of small-molecule orphan drugs currently on the market face potential generic competition, as measured by ANDAs, compared to more than half of their non-orphan counterparts.
In other words, a substantial fraction of drugs that receive ODA incentives will enjoy effectively unlimited periods of monopoly power. For these drugs, manufacturers are unlikely to need tax breaks to encourage investment; the drugs will pay for themselves.
In Defense of the Orphan Drug Act
All that said, some common criticisms of the Orphan Drug Act should be taken with a grain of salt. It is, for example, incorrect to claim that firms seek secondary orphan indications — that is, new rare disease targets for an existing drug — simply to block generic or biosimilar competition. Orphan designation is indication-specific, so after the 7-year exclusivity period ends, companies are free to market follow-on (similar) products for that disease or condition, and doctors are free to prescribe generic or biosimilar off-label alternatives, even if the Food and Drug Administration (FDA) grants a secondary indication for the drug.
Another common criticism arises when firms secure orphan drug approval for an existing, off-patent medication, which allows them to dramatically inflate its price for the new use. A closely related concern is that firms engage in “salami-slicing” by receiving multiple orphan drug approvals for a single drug by splitting the diseases it treats into ever-smaller subgroups. Critics point out that an FDA-approved product can be prescribed off-label for any indication, suggesting that many expensive “new” orphan drugs aren’t new at all.
That’s not quite right, however. To secure orphan drug approval for a new indication, manufacturers must run clinical trials to demonstrate the drug’s efficacy for that illness. Sometimes, those trials only confirm what the medical community already knows through off-label use and clinical research. Other times, however, those trials provide clinically relevant and economically meaningful knowledge about the drug’s safety or efficacy.
Consider adalimumab (Humira®), which has been immensely successful for AbbVie — the company’s 2017 global revenues exceeded $18 billion — and is approved for several orphan indications. Below, we show the percentage of spending for Humira for approved orphan uses. (We employ data from the OptumLabs Data Warehouse, which includes de-identified claims data for privately insured and Medicare Advantage enrollees in a large private U.S. health plan.) Following the drug’s approval for most of these conditions, product usage stayed flat. That suggests the market received little new information from related clinical trials.
For one orphan disease, however — the skin disorder hidradenitis suppurativa — Humira use surged after its approval for this indication. That suggests the clinical trials provided new and useful information to the market. That information may or may not be valuable enough to outweigh the incentives that AbbVie received under the Orphan Drug Act. But the Humira example suggests that claims of gamesmanship must be evaluated empirically.
Three Proposals for Improving the Orphan Drug Act
There’s no doubt that orphan medicines have helped countless patients. According to the National Institutes of Health, there are nearly 7,000 rare diseases affecting more than 25 million Americans and their families. Nonetheless, the law incentivizing orphan drug development is outdated. We have three interrelated proposals to improve the Orphan Drug Act.
First, incentives should be provided only in the form of tax credits, not a mix of tax credits and market exclusivity. Because many orphan drugs are economically viable, the 7 years of exclusivity is unnecessary. Less well understood is that the cost of relying on exclusivity is unevenly borne by society in undesirable ways and should not be relied on to induce innovation. Exclusivity gives firms more time to charge higher prices, shifting costs to insurers and to patients, who often face the financial burden of high out-of-pocket costs for drugs and, in the long term, higher premiums. In contrast, a broad tax base funds the tax credits.
Second, the tax credits should be subject to a “clawback” provision for drugs that earn enough to suggest, ex post, that they could have been developed without such incentives. In Japan, for example, manufacturers must begin to repay R&D subsidies for drugs with annual sales that exceed 100 million yen. A similar threshold could be adapted for the U.S. market. In addition, the FDA could require manufacturers to demonstrate both that a drug candidate will serve fewer than 200,000 patients and that it would not be economically viable without the tax breaks. Applying these standards would present administrative challenges, but it would focus government assistance on drugs that would not otherwise be brought to market and limit rewards to natural monopolies.
Third, firms receiving R&D tax credits for developing an orphan drug should agree to some form of price regulation on the drug after its patent expires, if there is no generic or biosimilar competition. At that point, firms would be able to charge only a prespecified margin above the production costs. Even large errors in determining production costs would yield much lower prices than what we currently see. While broad rate-of-return regulation in the pharmaceutical sector would discourage innovation, drugs that have already enjoyed their patent protection have received the financial reward that society has deemed appropriate. Settings in which firms face little threat of competition arise when the market cannot profitably support multiple competitors, and when that happens, regulation becomes an appropriate means of increasing efficiency.
(Another alternative: Force manufacturers to put the intellectual property associated with a particular orphan drug into the public domain so other manufacturers could market it when the patent expires. However, this option won’t work for drugs with exceptionally small markets, because the primary barrier to entry is the inability for multiple firms to earn profits — not access to intellectual property.)
A Focused Approach
The pharmaceutical industry might oppose these proposals, but the intensity of potential resistance shouldn’t be overstated. First, our proposals are relatively modest; they apply only to firms that benefit from the ODA’s provisions. Manufacturers concerned about future price regulation would remain free to set any price that maximizes profits, as long as they did not take taxpayer-funded R&D credits. Second, our proposal leaves intact genuine orphan innovation — the development of drugs that serve a small population and are not economically viable without public assistance. Only firms that received tax credits that ultimately proved unnecessary would be affected. Third, Congress recently reduced the magnitude of the orphan drug tax credit from 50% to 25%. Although the policy change failed to account for the ODA’s underlying economic problems, the fact that such a policy passed suggests that reforms in this area are possible.
Our proposals are not intended to address all pricing issues in either the orphan drug or overall pharmaceutical market. For example, an attempt to shift the contract structure in pharmaceuticals to “value-based pricing” is a potentially worthwhile but different enterprise. We are focusing on a clear and distinct problem in the Orphan Drug Act: excessive incentives for innovation. Ensuring a well-functioning pharmaceutical market where all prices reflect value is an important goal, but beyond the scope of our current work.
Another potential objection to our proposals might be that some firms will increase prices even more in anticipation of having to return the R&D tax credit. This would further shift costs onto patients and insurers. But such claims imply that drug makers don’t already charge the highest price possible — which does not square with the profit-maximizing behavior of these firms, and a large literature in economics has never found evidence for these so-called claims. Higher prices are unlikely to result from our proposals.
It is long past time to reform the Orphan Drug Act for the 21st century, and to evaluate current policies to assure that benefits are targeted at those orphan drugs that otherwise would not come to market.