Although not the sole cause of high prescription drug costs, abusive practices that distort competition contribute to the problem. Too many companies exclude competition through a variety of anticompetitive tactics, including rebate traps, product hopping, and pay-for-delay patent settlements.

Editor’s note: The following is based on testimony given before the US Senate Committee on the Judiciary, Subcommittee on Competition Policy, Antitrust, and Consumer Rights on July 13.

Anticompetitive conduct in prescription drug markets is both prevalent and persistent. Even in areas where antitrust enforcement has had moderate success, such as with pay-for-delay settlements, it has taken more than a decade, the success is fragile, and it requires substantial resources. In other areas, antitrust enforcement has been less successful at stopping anticompetitive conduct at all.

The problems in the pharmaceutical industry reflect deeper problems in antitrust laws. Over the last four decades, judicial interpretations of antitrust law in general have undermined antitrust enforcement, making it unnecessarily difficult for plaintiffs to prevail in meritorious cases. In a sense, the pharmaceutical industry was the canary in the coal mine. The cost of the judiciary’s evisceration of the antitrust laws appeared first in pharmaceutical markets but, without new legislation, will continue to spread to other areas in the US economy.

The list of anticompetitive conduct in pharmaceutical markets is large; here, I discuss three types of common practices.

Rebate Traps

A rebate trap can effectively deter competition or limit its impact in pharmaceutical markets. Pharmaceutical companies give pharmacy benefit managers (PBM), companies that manage drug benefits for insurers, rebates for a preferred status on the formulary. It might seem like a larger rebate means lower prices. Sometimes it does, but not always. Facing biosimilar competition, the incumbent company can raise its list price, increase its rebate, and make it dependent on market share (say, 95 percent). If the share of the incumbent biologic falls below that, the PBM receives no rebate and must reimburse the incumbent based on the list price for all units. Alternatively, the incumbent can offer a bundled discount across a range of products, which the new entrant cannot match.

Questionable rebates are common in prescription drug markets. According to a Senate staff report, rebating “appears to be contributing to both increasing insulin [wholesale acquisition cost] prices and limited uptake of lower-priced products.” Mylan Pharmaceuticals used rebating to combat lower-prices competition to its Epipen product, which treats severe allergic reactions.

Notably, courts have struggled with this rebate trap. In the Epipen antitrust case, for example, the District Court granted the defendant’s summary judgment motion and dismissed the antitrust case. It did so, even though it agreed that the plaintiff could prove the following at trial: Epipen had a monopoly. Mylan Pharmaceuticals, the manufacturer of Epipen, and Sanofi, the manufacturer of the competing product, both expected Sanofi’s product to gain 30 percent or more of the market within three years. Instead, Mylan, through a rebate trap, prevented Sanofi’s success while increasing both Epipen’s net price and profits. If proven, those facts are the very definition of exclusionary conduct.

Product Hopping

Product hopping is another anticompetitive tactic used to prevent or delay competition. A branded company makes a small change to its product shortly before a generic competitor enters. It then takes a range of actions to move the franchise from the old product to the new, tweaked product. This strategy blunts competition from the generic because it cannot be substituted for the new product. According to one study, product hopping on just five products increased prescription drug costs by $4.7 billion a year.

In an industry that prides itself on taking risks to develop life-saving drugs, product hopping is the opposite. The modifications are minor and involve little risk of failure, but they provide little value to the patients. One need look no further than Asacol, a product used to treat ulcerative colitis, a chronic disease of the colon. As part of a product hop, Allergan, the manufacturer, put an Asacol tablet inside of a capsule and obtained approval for a new product, Delzicol. That is not innovation; it is just anticompetitive gaming of the system.

Pay-for-delay Patent Settlements

Even when antitrust enforcement has had success, it is incomplete. A pay-for-delay patent settlement occurs when a branded company pays the generic or biosimilar company to delay launching its competitive product. The settlement eliminates the potential for competition. Both the branded and generic company profit at the expense of consumers.

The antitrust battle over these settlements has raged for roughly two decades. In a series of decisions that began in 2003, various courts concluded that this practice was acceptable. In these courts’ view, the fact that the branded company’s patent might exclude the generic meant that the branded company could pay the generic not to compete for any period of time until the patent expired.

These rulings had a devastating impact on generic competition. The number of potential pay-for-delay deals with significant payments increased from zero in fiscal year 2004 to a high of 33 in fiscal year 2012. The deals increased prescription drug costs by $63 billion.

In 2013, in the Androgel case (FTC v. Actavis), the Supreme Court rejected the lenient view that patent holders could simply pay potential infringers to stay off the market. According to the Supreme Court, an agreement in which the branded and generic companies eliminate potential competition and share the resulting monopoly profits likely violates the antitrust laws, absent some justification. The Supreme Court’s decision has limited pay-for-delay deals. In the fiscal year 2017, the most recent year of reported data, the number of potential pay-for-delay deals with significant payments fell to three.

That success has been incomplete, and it overlooks the cost of enforcement. The Supreme Court approach requires a case-by-case analysis of a practice that virtually always is anticompetitive. That allows companies to find new ways to hide compensation or offer a plethora of alternative justifications for their conduct. Based on the past mistakes and some open hostility to the Supreme Court’s decision, courts could accept one of these defenses and create a costly loophole.

Further, the approach is resource-intensive. Indeed, the Federal Trade Commission (FTC) resolved the Androgel case itself almost six years after the Supreme Court decision allowing the case to go forward and more than a decade after the case was filed. The FTC continues to litigate multiple cases against the same parties over the same product.

“In a sense, the pharmaceutical industry was the canary in the coal mine. The cost of the judiciary’s evisceration of the antitrust laws appeared first in pharmaceutical markets but, without new legislation, will continue to spread to other areas in the US economy.”

Failure of Antitrust Law

Anticompetitive conduct in prescription drug markets has been occurring for decades and has flourished despite the FTC having devoted substantial resources to trying to stop the conduct. It regularly litigates to judgment to stop egregious anticompetitive conduct with only limited success.

We are in this situation because “antitrust enforcement faces a serious deterrence problem, if not a crisis.” Judicial decisions have contributed to this problem. They “have thrown up inappropriate hurdles that limit the practical scope of the antitrust laws’ application to anticompetitive exclusionary conduct, including monopolization, and to anticompetitive mergers.”

1. Hostility to direct evidence of market power

In most antitrust cases, the plaintiff must prove that the defendant had market or monopoly power. A plaintiff can infer it by proving the relevant market and establishing that the defendant has a high market share. The alternative is to prove the actual anticompetitive effect of the conduct—such as higher prices, lower quality, and lower output. As the Supreme Court explains, “proof of actual detrimental effects, such as a reduction of output can obviate the need for an inquiry into market power, which is but a surrogate for detrimental effects.”

Courts, however, increasingly shy away from direct effects evidence, making plaintiffs go through the often pedantic process of defining markets, particularly in pharmaceutical cases. Invariably, the impact of delaying or limiting competition is obvious. Delaying a generic or biosimilar competitor prevents prices from falling. That should end the market power inquiry. Courts, however, reject the obvious direct evidence for the less reliable market definition evidence.

In Mylan Pharms. Inc. v. Warner Chilcott, the court ignored the substantial impact generic competition would have on pricing. Instead, it relied on its own assessment of the qualitative similarities between the product at issue and other branded products. It defined the relevant market to include many products and found that the defendant’s market share was too small to establish market power. Even when the court reaches the right result using the wrong methodology, it unnecessarily complicates the case and increases the cost of litigation.

2. Leniency toward dominant firms

In various ways, courts over the past four decades have limited the role of antitrust law in regulating conduct by dominant firms. A series of policy judgments have driven this development. Courts too often believe that monopolies spur innovation and discount the value of potential competition. Judicial doctrine reflects these policy choices. Courts are highly skeptical of antitrust cases based challenging refusals to deal and predatory pricing, even though modern economics establishes that such conduct can be successful in limiting competition and profitable. Exacerbating this tendency, courts often focus on the wrong facts.

These developments help explain why antitrust enforcement has struggled to stop anticompetitive conduct in prescription drug cases. In loyalty rebate cases, courts focus on issues such as whether the rebates increased and whether the practice eliminated competition completely, not whether the rebates allow the defendant to maintain its monopoly power by limiting competition. In the pay-for-delay context, the fact that the eliminated competition was potential or uncertain led many courts to discount the harm.

“Courts are highly skeptical of antitrust cases based challenging refusals to deal and predatory pricing, even though modern economics establishes that such conduct can be successful in limiting competition and profitable.”

One doctrine, refusals to deal, or when a firm refuses to deal with its competitor, deserves special mention. According to some courts, a refusal to deal can violate the antitrust laws only if the defendant has terminated an existing relationship. Under that standard, it is at least questionable whether the government would have been successful in breaking up AT&T’s phone monopoly in the 1980s. This development should shock anyone who supports free markets and competition.

It also helps explain the rise of an anticompetitive strategy in prescription drugs. Some branded companies would prevent their potential generic competitors from obtaining samples of the branded product. Without those branded samples, the generic company could not conduct the tests necessary for approval. Members of the Senate Judiciary Committee identified the problem and introduced legislation, the CREATES Act, to solve the problem, which it did. If the courts had not whittled away the restrictions on monopolists’ refusing to deal with competitors, however, the practice may have never arisen.

3. Weaker deterrence

Federal government antitrust enforcers have limited options to address the harm caused by anticompetitive activity, which is particularly problematic in prescription drug markets. The rewards are large. Delaying competition by a single year can generate hundreds of millions (and potentially billions) of dollars in additional revenue. If the government’s only remedy is an order forbidding the defendant from repeating the conduct, violating the law has little downside.

A recent Supreme Court decision exacerbated this dynamic. The Court determined that the FTC lacks the authority to seek monetary remedies for violations of the law. The FTC can not seek to compensate victims or deprive companies of the profits they earned by violating the law. This development will simply encourage pharmaceutical companies to adopt profitable, anticompetitive tactics that will further increase prescription drug costs.

Proposals to Restore Effective Antitrust Enforcement

The courts have made antitrust enforcement too difficult, although not impossible, and prescription drug markets are a prime example. Congress can correct these errors, restore the vitality of the antitrust laws, and deter anticompetitive conduct, which would inject competition into prescription drug markets. Two types of reforms exist: general antitrust proposals and laws tailored specifically to prescription drug markets.

1. General antitrust reforms

There are broad principles Congress should enshrine to improve antitrust enforcement. First, direct evidence of anticompetitive effect should be sufficient for an antitrust case. Second, Congress can correct courts’ willingness to defer to dominant firms’ conduct by changing legal standards to stress that the risk of eliminating potential competition can violate the antitrust law. Congress should establish legal rules that, in appropriate cases and based on sound economics, require defendants to prove their conduct does not harm competition, and new legislation should nullify existing precedents that inappropriately limit antitrust law, such as precedents on refusal to deal and predation. Finally, Congress should restore the FTC’s authority to seek monetary remedies and give the government the ability to obtain civil fines for antitrust violations.

Existing legislative proposals would address these issues. The Competition and Antitrust Law Enforcement Reform Act takes precisely this approach and would dramatically improve competition in prescription drug markets in particular, and throughout the economy generally. Although more limited, the Tougher Enforcement Against Monopolists Act would increase penalties, limit courts’ ability to rely on speculative justifications, and would require courts to find a violation where there is direct evidence of intent to harm competition.

2. Pharmaceutical-specific reforms

As the CREATES Act establishes, targeted solutions can be effective. A number legislative proposals are pending. Although the current Supreme Court rule on pay-for-delay settlements protects competition better than the lower courts had, it still has required the FTC to spend substantial resources to prevent clearly anticompetitive conduct and there is risk that future court decisions could undermine the current rule. Congress should pass legislation that creates a strong presumption against pay-for-delay deals such as the Preserve Access to Affordable Generics Act.