PharmExec Blog

Sequestration: What Does it Mean for Pharma?

You may have read horror stories about the looming Sequestration Act, but what exactly is it? And what does it mean for US pharma? Tom Norton reports.

Lurking in the shadows of the US General Elections is something called The Sequestration Transparency Act of 2011. Of late, you may have read the occasional article that breathlessly reports that “US defense will be halved by Sequestration” or “Air Traffic Controllers will be drastically reduced under Sequestration”, and even “Sequestration will lead to the next Great Recession if enacted”. All pretty dire stuff, for sure, and if you begin slicing and dicing these stories, there does appear to be some truth in all of them…if the Act goes into effect.

So, with near Armageddon apparently on the horizon, what in the world is this Sequestration Act and more importantly, what impact, if any, will it have an on the US Pharma? Read on, and I think you will be surprised at the answers. I was.

First of all, what the heck is a “sequestration”? According to dictionary.com, as a legal term, sequestration means “confiscation” or “seizure”. So, this law is designed to confiscate, or seize money out of the existing US budget. Interesting that we have to pass a law to take back our own money…

Anyway, this 2011 act of Congress mandates that the President and Congress must:
“Revise the discretionary spending limits and reduce the discretionary appropriations and direct spending specified in the 1985 Gramm-Rudman-Hollings Act unless a joint committee bill achieving an amount greater than $1.2 trillion in deficit reduction would be enacted by January 15, 2012.” (http://tinyurl.com/9cdqp88)

Further, this $1.2 trillion dollars in federal spending will be ‘seized’ over a nine-year period. If you appreciate that the total US budget, or rather ‘expenditures’ for 2012, are now estimated to come in at approximately $3.8 trillion, and you divide this out by nine, it means in 2013, for example, about $110 billion dollars will have to be cut from the federal budget. Is this a bad thing?

Where it becomes particularly interesting is that under the law the so-called ‘mandated spending’ — Medicare, Social Security, Medicaid (For 2012, it’s $2.25 trillion) — is exempt, and not ‘Sequesterable’ during this nine year mandate. Indeed, all the Sequester cuts will be coming from only the remaining ‘discretionary’ spending, which totals approximately $1.6 trillion in 2012.

And so, under the theoretical Sequester for 2013, US ‘discretionary spending’ will be reduced by about $110 billion and go from $1.6 trillion to $1.5 trillion. These cuts will be spread across the bureaucracy at rates that are set at 7.6% to 9.6%, plus a 2% cut to Medicare provider.
That’s it. Armageddon? Obviously not. And really, who among us has not had to deal with somewhere around 10% in business cutbacks over the last nine years?

But let’s get back to my original question. How could this impact the US Pharmaceutical industry? There’s an interesting list of effects that are being projected. And by the way—as a point of transparency — the estimates for these cuts are all over the place given the many unknowns that surround the actual implementation of the Sequester. I purposely have included those that appear to be on the ‘conservative’ side of the many guesstimates that are out there.

FDA
For starters, let’s take a look at what the Sequester could mean at the FDA. According to the 2012 OMB report, the ‘sequesterable’ budget authority (BA) for FDA is $3.873 billion. Therefore, for FY 2013, according to OMB, 8.2 percent of this amount (or $318 million) is liable to be ‘sequestered’. So what? Well, first, if this interpretation by OMB is correct, one thing that could result would be a reduction in the user fees paid to FDA. Why is this not good? Well, for starters, if industry doesn’t actually pay user fees in the amount that FDA is supposed to receive them, there are ‘legal beagles’ in DC wondering if FDA is relieved of its obligation to perform drug approvals at the rate that the FDA User Fee Law originally mandated. Really! (See above ref.)

A mess, to be sure. So if nothing else, such an action could slow down the 2013 FDA drug approval process…and clearly not good for the Rx industry.

National Institutes of Health (NIH)
Another major Sequester impact point for the Rx industry would be at NIH. An awful lot of basic research and development on new drug entities is done by the NIH, frequently in cooperation and under partial sponsorship of the pharmaceutical industry. There’s no doubt the Sequester would put a crimp on this work. According to United for Medical Research, the collective impact around the nation at specific NIH research sites would be substantial. For example, UMR estimates that 1,840 NIH awards, valued at $1.85 billion, would be ‘seized’ under the 2013 Sequester. This same summary also suggests that the total NIH related employment loss from the Sequester would total more than 33,000 scientists and lab workers. Given what’s happened to industry R&D centers over the last decade, clearly not a good outcome for research & lab professionals.

National Science Foundation (NSF)
This independent federal agency, created in 1950, was designed to support outstanding “science” being generated in academic centers around the nation. Today, 20% of federally sponsored academic research is underwritten by the NSF including biologic research into plant and animal genomic characteristics. Given the prescription drug revolution in genomic medicine that is currently underway, it hardly needs saying that slashing the NSF would not seem wise thing to do at this point. According to the LA Times, about $450 million in NSF funding is slated for the chopping block over the next five years of sequestering. No guess here on science lab employment losses, but you would have to surmise, it would be significant.

Medicare 2% cut in Reimbursement to Providers
In my mind, probably the biggest “sleeper impact” of the Sequester on the RX industry, and really this entire Sequester, will come in the form to the proposed 2% cut in reimbursement fees to Medicare providers. Why? Well, consider the following: An interesting study commissioned by the AMA, the AHA, and the ANA, not exactly DC allies on most days, has found that in the first year of the Sequester, about 500,000 jobs would be lost at medical institutions around the country due to the 2% Medicare reimbursement cuts. And get this: An estimated $10 billion of the first year’s Sequester savings would come out of Medicare (See above p. 7). Right. That’s about 10% of the total Sequester from Medicare. This seems to be lost in a lot of the reporting I have read.

Further of those being laid off, in the first year, 40,000 would be physicians, dentists, and other practitioners.

Why all the employment impact? The study reasons that the delivery of Medicare services flows downstream, through many professional and support sectors in each medical institution that receives Medicare funding. When a provider cut like this occurs, the business operations of these organizations take over. Services are reduced or stopped; procedures curtailed or eliminated; and staffs laid off. End result? Diminished care to patients.

Oh, and have any of you been through one of these Medicare health center cut backs? I have experienced many, and among the first things to go is access to Rx pharmaceuticals. So it doesn’t take too much imagination to figure out how major teaching hospitals in large cities around the US will respond to their Medicare cuts. In their pharmacy services area, say good bye to brand name products, and say ‘hello’ to therapeutic substitution, using all generic formularies…

Overview
So let’s step back and take a look at all of this for a moment. Unless Congress gets it act together “H.R. 5872: The Sequestration Transparency Act of 2012” will go into effect on January 2, 2013. The impact of $110 billion being cut from the federal budget could no doubt lead to major losses in public and private employment, and a likely reduction of industrial capacity in many areas of the economy. All dire, and all very serious, especially at this time.
But from the standpoint of the Rx industry, think about a few of the variables floating around this issue, too.

· For instance, if the proposed cuts to the military (about 40% of the total Sequester) become a political hot potato and the sentiment begins to shift against defense cuts, think about how “Congressional reconfiguration” of the law’s percentages could work against the Rx industry…Maybe a 3% cut in Medicare Provider fees?

· Or let’s say you’re an Rx R & D director who is trying to move forward with NIH research in a critical cancer project. If the National Cancer Institute, one of the NIH’s largest, stands in line to be one of those drastically cut in the Sequester, do you, or even can you…continue your project partnership with NIH? Do you simply stop the project? What happens to your research and the promise it holds for cancer patients around the world?

· And finally, what if you are a CEO, or the SVP of sales & marketing at a US Pharma company? How do you plan for 2% cuts to Medicare provider reimbursements, slowed FDA new drug approvals, reduced NSF support for key company research, and promising NIH projects that may simply evaporate? Answer: You do what this industry always does when markets contract: Cut overhead, close plant, fire employees, and hunker down until this passes, if it does.

So, I would suggest it definitely could be tough sledding for the Rx business if the Sequester comes on line. For every employee of the Rx industry, it bears careful study. Given all the other challenges facing the US Pharma business right now, being shot in the foot by our own Congressional Sequestration Law just doesn’t seem to be the best thing to do. But it seems, unless our better spirits rise up here, this is where we could come out on January 2, 2013. Those are my thoughts on the Great Sequester of 2013. I’d be interested to hear what you think about this situation, too.

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2 Comments

  1. John Suedbeck
    Posted October 4, 2012 at 8:59 am | Permalink

    The reduction in the development of new drugs and a focus on dietary supplements, generics and personalized medicine is in-line with the Pharma Model 3.0 that was presented to the industry by Ernst & Young in 2010. They communicated the need for change quite well. Start with the question – who are your customers? The largest single customer is the US Goverment, and they pretty much have to buy generics when one is available. I have been planning my career accordingly.

  2. M. Jones
    Posted October 18, 2012 at 9:00 am | Permalink

    Deep dive into sequestration and FDA user fees: http://www.faegrebdc.com/webfiles/FDA_Bloomberg.pdf

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