Rachel Sachs: Prizing Insurance

If anyone is looking for a clear and comprehensive review of the ways in which patents can distort investment in innovation, as well as a summary of the literature on incentives "beyond IP", I highly recommend Rachel Sachs' new article Prizing Insurance: Prescription Drug Insurance as Innovation Incentive, forthcoming in the Harvard Journal of Law & Technology. Sachs' article is specific to the pharmaceutical industry but is very useful for anyone writing on the general topics of non-patent alternatives and patent-caused distortion of innovation. Sachs follows in the footsteps of IP scholars like Amy Kapczynski, along with Rebecca Eisenberg, Nicholson Price, Arti Rai, and Ben Roin–and draws on plentiful literature in the health law field that IP scholars may never see. Her analysis is far more detailed and sophisticated than this brief summary. Read more at the jump.

Patents, as well as other exclusive rights such as FDA-mandated periods of exclusivity, do not simply promote investment in innovation. They also influence which kinds of innovations will emerge to benefit society, and which will never see the light of day. This is patent-caused "distortion" of innovation. Distortion is a problem that many have observed in the patent system, alongside the better-known problem of deadweight loss caused by monopoly pricing.

Sachs identifies three main mechanisms through which patents may distort investment in innovation and in pharmaceutical innovation, in particular. First, patent term length (now 20 years) may lead firms to invest in innovations with shorter time horizons for development in order to preserve exclusivity or to invest in treatments with clear "surrogates" (end points) for non/recovery. Thus, we may see more investment, for instance, in treatments for diseases that kill people very quickly.

Second, what Sachs calls patents' "scope" can cause over or under-investment in certain classes of innovations. By "scope" Sachs does not mean the scope of an individual patent right as determined by the requirements of claiming and disclosure. Rather, she means the sphere of subject matter that is protected, or not protected, as a result of the structural framework through which patents promote innovation. So, for example, because patents operate by the mechanism of excludability, patents are not attractive for innovations that, even when patented, cannot be excluded. Or, for instance, because patents require disclosure, they may lead to underinvestment in manufacturing processes that are better kept secret.

The third way in which patents may distort investment in innovation is that patents rely on the chance for commercial success to encourage investment in research and invention. Obviously commercial success itself is not required up front to get a patent; but the hope for future commercial success is required to make patents work as incentives. As a result, patents may strongly "pull" inventors towards innovations that are likely to be highly profitable–regardless of whether these innovations have the highest possible social value, or any lasting social value at all.

Due to the limitations Sachs identifies, several scholars, such as Lisa Ouellette, Kapcynski, Peter Lee, myself, Jim Bessen, and others at various "Beyond IP" conferences, have explored alternatives to exclusive rights, ranging the gamut from tax incentives, to regulation, to philanthropy, to state venture capital, to education. But Sachs' alternative is both realistic and highly creative: prescription drug insurance.

In nations across the world, government-run health insurance programs provide all people, or certain classes of people, with significant opportunities to have the government, or a private insurer operating within a government-regulated system, pay for all or some of the cost of prescription drugs for treating, curing, or preventing medical ailments. In the United States, prescription drug insurance is now regulated under the scheme created by the Affordable Care Act. But prescription drug insurance has long been a feature of the American healthcare system, and it could, in Sachs' view, be tweaked to make it a more effective public subsidy for innovation than exclusive rights like patents.

The main problem drug insurance solves is governments' lack of information. When government wants to fund innovation directly by, say, using a prize or a research grant, it is difficult to determine which types of innovation to reward and how much to pay for them. Thus, government may end up rewarding some innovations too much and others too little; paying for the wrong kinds of innovation entirely; and generally wasting public resources on stimulating investment in dead-ends rather than the potentially superior alternatives we might otherwise have had. In other words, government funding may distort innovation and create deadweight loss for society in ways that are far more damaging than what we currently see in the patent system.

But Sachs argues that prescription drug insurance "can be structured to avoid the problem of aggregating public and private information that lies at the heart of the patents versus prizes debate. Specifically, the government only needs to be able to observe 1) the social value of a given pharmaceutical and 2) the frequency of its use. If the social value of a pharmaceutical is measured in large part by its effectiveness and the overall healthcare burden it alleviates, the government by virtue of its dual roles as pharmaceutical regulator and health insurer is in a position to observe directly those facts."

In other words, due to government's privileged position as regulator and sometimes-provider, government would be armed with all sorts of information about drugs' efficacy, cost, and frequency of use. As such, government could wield prescription drug insurance much like a prize or research grant in order to direct innovation in one direction or another.

So, for example–and this is my example, not Sachs'–government could order that "henceforth more insurance will be available for prevention of prostate cancer than for elective prostate surgery." This, in turn, should stimulate more demand for, and therefore more investment in, better preventative measures versus innovations related to prostate surgery. A real-world example of the same phenomenon: under ACA, "all new plans must cover certain preventive services such as mammograms and colonoscopies without charging a deductible, co-pay or coinsurance."  So while patents may lead drug companies to invest in highly excludable drugs to alleviate symptoms that many people won't be able to afford, ACA insurance might lead them instead to invest in preventative solutions.

That said, as Sachs observes, the current U.S. healthcare system also shares some of patent law's precise distortionary effects. For example, Medicare currently covers a whole lot of prescription drugs for people over 65, and some research suggests that, ever since prescription drug insurance for Medicare patients was enhanced in 2006, Medicare itself became responsible for increasing pharmaceutical investment into certain drug classes with higher consumption among the aging Medicare population. Prescription drug coverage for the elderly is obviously a very delicate topic, but this, I think, is an area of the current system that Sachs' proposal might help to productively change.

Sachs notes, as a caveat, that her proposal for prescription-drug-insurance-as-innovation-incentive is likely to fare better "in countries like the United Kingdom, where the health care system has been almost completely nationalized" because in these cases government–not just private insurance companies–"has precise information about the frequency of use of any particular drug. ... This allows the government to observe the frequency of use of the relevant products without relying on self-reported information from the drugmaker."

This is a significant caveat. The United States does not have a fully nationalized healthcare system like the United Kingdom. Private insurance companies still have a tremendous operational role in determining which prescription drugs are covered, and how much they should cost, even when coverage is ultimately provided through government insurance plans. But I would quibble with Sachs that the United States' hybrid public-private healthcare regime is necessarily a drawback when it comes to determining the precise social value of a pharmaceutical and the frequency of its use. Perhaps government operating in partnership with decentralized private companies operating under the discipline of (at least some) competition could do a better job at "prizing insurance" than government operating alone.

At any rate, Sachs is clearly the expert on this topic. Her work will be invaluable for distilling a complex and, to many of us, non-sensical world of medical regulations, and for introducing IP scholars and mainstream legal scholars to the health law literature.