New Analysis Takes Issue with CBO Patent Settlement Legislation Cost Estimate

By Kurt R. Karst –   

A recent analysis of the Congressional Budget Office’s (“CBO’s”) cost estimate of legislation intended to curb patent settlements (or what opponents call “pay-for-delay” or “reverse payment” agreements) criticizes the estimated savings as “significantly overstated.”  As we recently reported, in late July, the U.S. Senate Committee on Appropriations approved the inclusion of the “Preserve Access to Affordable Generics Act” in the report (Senate Report No. 111-238; pages 144-148 & 150-151) accompanying the Fiscal Year 2011 Financial Services and General Government Appropriations Bill (S. 3677).  The version of the “Preserve Access to Affordable Generics Act” in Senate Report No. 111-238 is modeled after S. 369, which would make patent settlements, if challenged by the Federal Trade Commission (“FTC”), presumptively anticompetitive and unlawful unless it can be demonstrated “by clear and convincing evidence that the procompetitive benefits of the agreement outweigh the anticompetitive effects of the agreement.”  In addition, under the pending legislation (as in S. 369), a violation can lead to “a civil penalty of not more than 3 times the gross revenue of the NDA holder from sales of the drug product that is the subject of the patent infringement claim for the period of the violation, starting with the date of the agreement.”  In June 2010, the CBO updated its previous cost estimate for S. 369, estimating that the bill, if enacted, would save the Federal government $0.9 billion (net) between 2010-2015 and $2.7 billion between 2010-2020 period.

According to the August 2010 analysis, which was suported by funding from PhRMA, the CBO’s cost estimate is “flawed,” and depends critically on at least three assumptions:

• First, based on an earlier “study” by the FTC, the CBO assumed that the bill would accelerate entry of generic drugs affected by the bill by an average of 17 months.

• Second, the CBO appears to have implicitly assumed that restrictions on reverse payment settlements in existing law will be entirely ineffective over the next 10 years and that anticompetitive settlements can only be prevented by the further restrictions in S. 369.

• Third, the CBO assumed that substantial restrictions on reverse payment settlements would decrease generic manufacturers’ incentives to challenge branded patents and as a result reduce generic entry in some cases.

As an initial matter, the analysis concludes that the 17-month delay settled on by the FTC in its January 2010 study, which is “critical to the CBO’s cost estimate,” is unreliable:

As a matter of economics, there is no sound rationale for assuming that the inclusion of a payment from the branded to the generic manufacturer as part of the settlement agreement caused the observed differences in entry dates by the generic manufacturers. . . . [I]f settlements with reverse payments occur more often when the branded manufacturer possesses a stronger patent than in settlements without reverse payments, later entry under the reverse payment settlements may just reflect the average difference in patent strengths rather than any payment for delay. Similarly, patent settlements with and without reverse payments may differ in the average patent life remaining or the point in time after an initial challenge at which the settlement is reached. Such differences would render invalid the comparison of entry delay between the two types of settlements.  By ignoring the fact that the universe of settlements that involved a reverse payment may differ in important respects from the universe of settlements without such payments, the FTC study (and thus, the CBO cost estimate) has oversimplified the analysis in a way that has material bearing on its utility and reliability for predicting generic entry or estimating costs under alternative rules.

Moreover, according to the study authors, “[t]he FTC study (and therefore the CBO cost estimate, when relying on it) ignores the fact that patent settlements with reverse payments may actually accelerate generic competition for numerous drugs.”  That is, “[t]o the extent that a reverse payment is essential to enable the parties to settle litigation, it can lead to generic drugs entering years before they would at the end of a protracted litigation.”  Thus, restricting patent settlements “would in fact cost the Federal government billions of dollars in increased expenditures on prescription drugs, in contrast to the billions of dollars in savings estimated by the CBO.” 

Second, according to the study authors:

the CBO’s cost estimate depends importantly on accurately estimating the extent to which patent settlement agreements that would be undeterred under the current legal environment would be prevented by the additional restrictions in S. 369. . . . . [T]he CBO appears to attribute all savings from reducing reverse payment settlements to the additional restrictions – implicitly assuming that none of these settlements would be caught or deterred under existing law.  Because existing law will catch or deter at least some anticompetitive reverse payment settlements, this assumption is inappropriate and is another reason why the CBO overstates savings from S. 369.

Finally, apparently agreeing with the CBO cost estimate, the study authors note that a decrease in patent challenges as the result of the enactment of an effective ban on patent settlement agreements will significantly increase Federal expenditures by slowing generic competition:

To the extent that further restrictions on reverse payment settlements reduce such expected rewards (e.g., by denying the generic manufacturer one option for exiting lengthy, costly litigation), then generic manufacturers would have reduced incentives to challenge branded patents in the future.  Patent challengers can be small pharmaceutical firms that may lack the capital to withstand a long, drawn-out patent fight in court.  Faced with a greater likelihood of expensive and protracted litigation, these firms may just forgo the challenge.  Well-resourced generic companies may also have different business assessments of challenging patents in the face of protracted litigation with little possibility of an out-of-court resolution.

This would lead to fewer generic entrants and, all else equal, higher drug prices.  Even if the effect on a particular generic manufacturer’s decision were relatively small, the collective impact on future generic competition could be substantial.

Several Senators raised similar general concerns a letter sent to Senate Majority Leader Harry Reid (D-NV) objecting to the inclusion of the “Preserve Access to Affordable Generics Act” in any Fiscal Year 2011 appropriations bill.