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Salvo 10.10.2024 10 minutes

Can Healthcare Futures Save Healthcare’s Future?

Medical industry stock market graph chart

Price controls will never be able to effectively control cost.

Blood cancer is one of the disease’s most treatable forms. Thanks to decades of research, it’s become easy to eradicate through treatments like chemotherapy, radiation, and even techniques that use the body’s immune system to attack cancer cells. It’s an optimistic outlook for the more than 175,000 Americans that suffer from the disease.

Yet one might be surprised to hear that drug companies are abandoning these treatments en masse. In 2022, Eli Lilly announced they would slash a promising $40-million blood cancer drug candidate from their books. Other firms are following suit. Their reasoning? Government price regulation.

In the coming years, more price controls will take effect. Both those who oppose and those who support them know their consequences. Lower prices, while great in the short term, will affect research and development for new cures and therapies in the long term. As biotech venture capital founder Stan Fleming notes, “Lower prices and profits conflict with the reality that the cost of developing new treatments is high and will continue to rise due to increasing scientific complexity and the escalating cost of care.”

It’s not just limited to Eli Lilly. Countless early-stage biopharmaceutical firms that are responsible for 90% of new medicines have already seen a decline in necessary funding. As for future drugs, the University of Chicago’s Tomas Philipson estimates that innovative drug developers will cut their R&D investments by half a trillion dollars, resulting in 135 fewer new drugs and 331.5 million fewer life years by 2039. It’s a doomsday scenario for millions of Americans with life-threatening conditions.

This disaster is a symptom of a larger problem. Drug development, while transformative, is an incredibly risky and expensive industry. Over 90% of all drug candidates fail to make it past clinical trials, and the median trial costs $19 million. Simply cutting back on price controls will not fully address the demand for the enormous amounts of capital required to move medicines through the regulatory process. 

We need a long-term solution that stimulates more investment in healthcare, both for the innovative firms creating the cures of tomorrow and for the patients they serve. That’s why we propose creating a healthcare futures market, similar to those for industries such as energy, agriculture, metals, and currency, to satisfy market demand while keeping the relevant prices reliable for patients.

Betting on the Future

A decade of price controls on oil and gas during the 1970s amplified uncertainty in energy pricing and supply triggered by the OPEC oil embargo and the Iranian revolution. The combined effect resulted in declining investment in oil exploration, production, and alternative energy development. Price controls were removed in 1981, but investment in energy was still feeble. 

The introduction and expansion of oil futures markets in the 1980s and 1990s coincided with a period of increased exploration and technological innovation. Offshore drilling and unconventional resources like shale oil and natural gas from fracking were just a few discoveries during this period, funded thanks to the new energy futures market.

One shining example was the Barnett Shale reservoir in the late 1980s. Pioneer Natural Resources and other companies began exploring shale in Texas, an unconventional oil and gas reservoir. Thanks to oil futures contracts, Pioneer and similar companies could hedge their production, locking in prices for their future output. The sale of fixed-price contracts guaranteed a revenue flow despite the high costs and risks associated with early shale oil exploration. This innovative risk management strategy transformed the energy industry.

Similar to the oil market, healthcare futures contracts would allow biopharmaceutical innovators to lock in prices for future development programs, ensuring a more predictable revenue stream even when market prices fluctuate. This enhanced financial stability and predictability would also make the company more attractive to investors, further supporting long-term research and development projects and fostering technological innovation.

Practicing Price Discovery Instead of Price Controls

Unlike price controls, futures markets can respond rapidly to align buyers and sellers through price discovery, the dynamic and continuous process wherein the interactions of market participants and their relevant aggregated information determine a final market price. Futures contract markets start with a benchmark or standard reference price to value a specific asset or commodity. That price is based on an index reflecting the per unit cost or value of the product represented in a contract of a significantly large number of trades. 

A standard price benchmark ensures the index’s consistency, accuracy, and transparency, making it a reliable tool for market participants to gauge the value of different futures contracts. The price benchmark provides a uniform way to measure the prices of the underlying assets.

Once again, consider the energy sector. The NYMEX West Texas Intermediate (WTI) crude oil price is the standard benchmark for oil futures. It provides a consistent measure of oil prices based on standardized contract specifications. The WTI benchmark ensures that all oil futures contracts are included in the index and measured uniformly.

The unit price of oil is tracked through continuous trading on major exchanges, with real-time data reflecting current market conditions. These price changes are aggregated and used to update the WTI index, providing a reliable benchmark for WTI crude oil price. This process ensures that the WTI index accurately reflects market dynamics, allowing market participants to make informed decisions for hedging, trading, and investment purposes.

Investors would use this same logic for the healthcare market. A standard price benchmark for units of healthcare would allow drug manufacturers to know the exact value of their future revenue streams, investors to know the value of the contracts they will be investing in, and patients to predict what their various forms of healthcare will cost. A futures market of this scope will completely eliminate the need for retroactive price controls.

We propose creating healthcare futures indexes representing per-patient costs for treating specific diseases and therapeutic areas. Up until now, determining the unit for a health futures index was difficult. There wasn’t enough data or volume to establish and accurately update benchmark prices.

Now, that has all changed. Today, electronic health data is more copious, granular, and current than in other futures markets. It’s now possible to establish a unit of care for rare diseases that reliably and consistently reflects the value of assets underlying a healthcare derivative.

Risk Management Through Derivatives

A healthcare futures market would do business through derivatives, or contracts that are based on the value of a certain asset. Risk management through derivatives makes it easier for all market participants (and particularly small biotech startups) to access capital by determining how quickly a financial asset can be converted into cash without losing value. This can be easily translated to the healthcare market. Buying and selling contracts or derivatives will add much-needed liquidity to the healthcare marketplace, facilitating easier entry and profitable exit for participants.

Financial traders will also benefit from health futures derivatives. Investors can speculate on future price changes, while other traders can hedge their risks. For instance, an investment firm with significant positions in cancer vaccine startups could buy derivatives that gain value if cancer costs fall, protecting against potential losses. Health futures would encourage investment in companies with platform technologies, such as stem cells or gene therapy, that can be used to develop cures for a broad portfolio of diseases.

For a riskier treatment like stem cell therapies or rare disease medicines, early-stage clinical trials require significant investment. Innovative developers can issue future contracts based on their treatment’s expected cost savings, and healthcare providers or insurers would buy these contracts to lock in future prices and hedge against potential cost increases.

The sale of health futures contracts creates a predictable revenue stream that helps innovators manage financial risks and ensure stable cash flows. Pre-commercial biotech companies would become more attractive to venture capital; they’d require lower returns on initial investment since the startups would have predictable future revenues secured through contracts. Similarly, institutional investors, such as pension funds or insurance companies, would be more likely to invest since they can hedge their investment risks in a liquid market. And startups can use the capital from selling futures contracts to fund late-stage clinical trials and regulatory processes.

Market Forces

Consider for example a cancer care index. It could be anchored to reflect the healthcare system’s average cost per patient ($44,000) and could include indirect costs such as quality of life and lost productivity. Suppose a biotech company wants to sell a futures contract for their new cancer drug, with one contract at $50,000 per patient sold in 100-patient increments. This $5,000,000 futures sale generates immediate revenue for the biotech firm and, simultaneously, insurers and hospitals can buy contracts to hedge against the rising costs of cancer treatment.

Returning to blood cancer, let’s say that a particular immunotherapy is found to be incredibly effective at treating leukemia. That drug will save patients from countless doctor trips, surgery costs, and overall healthcare expenditures. Here, we can see the mechanics of the futures market in action.

Demand for contracts and contract prices is likely to increase if the drug finds new uses that generate additional cost savings, like this hypothetical leukemia treatment. In a futures market, healthcare providers and insurers can hold long positions. In doing so, they profit from the increased index value while offsetting higher costs of treatment. The increased demand and higher contract prices provide revenue stability for the biotech company, encouraging continued investment in the drug’s production and distribution. That investment matters, as it can help drive down upfront costs for patients.

Indexes and futures markets can be established for various diseases and therapeutic areas, including obesity or rare genetic disorders. Each product or sector would need its own unique index to develop and trade future contracts based on expected cost savings.

Who would benefit from this newfound market? To begin with, pre-commercial biotech companies would become more attractive to venture capital, since they’d require lower returns on initial investment The startups would have predictable future revenues secured through contracts. Similarly, institutional investors, such as pension funds or insurance companies, will be more likely to invest when they can hedge their investment risks. Startups can also use the capital from selling future contracts to fund late-stage clinical trials and regulatory processes.

This is a perfect solution to the threat of price controls for all parties, as a futures market allows for the stabilization of prices while ensuring a consistent revenue stream for healthcare companies and their investors.

A health futures market also sustains a virtuous cycle for innovation through transparent, market-based product valuations over time. Unlike arbitrarily negotiating price controls, a futures market sets competitive and realistic, market-based benchmark prices. In turn, these stable prices build investor confidence, leading to more investment in high-risk/high-reward research and development and improved cures and therapies.

These conditions will ensure there are always buyers and sellers for futures contracts. The added investor confidence and market liquidity will also reduce the cost of capital, making it more affordable for startups to fund their operations and growth. That’s critical, as 60% of all novel medicines come from small companies. Early-stage VC investors can sell futures contracts based on the expected success of a developmental cellular or gene therapy, attracting further investment into the biotech sector.

Healthcare Futures in Practice

Let’s say a company (we’ll call it CelFix) successfully raised $100 million by selling futures contracts tied to the future cost savings and health outcomes of their experimental stem cell therapy. Institutional investors, confident in the transparent valuations and liquidity of the health futures market, invest an added $50 million in equity. With $150 million in funding, CelFix can more rapidly complete late-stage clinical trials, obtain regulatory approval, and scale production. By providing tools to manage financial risk and ensure revenue stability, a derivatives market enhances attractiveness to investors, enabling biotech companies to secure the necessary funding for projects at a lower cost.

By comparison, price controls generate revenue uncertainty through Medicare’s “take it or else” price-setting process. In this scenario, CelFix will have a lower valuation because future cash flows are constrained, making it more difficult and expensive to raise significant capital. The additional risk premium increases the cost of capital, which makes raising funds for research, development, and commercialization more costly, uncertain, and less attractive to investors.

A healthcare futures market could also open up new avenues to medication access. Access to life-saving drugs in poor communities and developing countries remains a significant global challenge. Financial barriers, unpredictable costs, and inadequate funding often prevent these populations from receiving essential treatments.

Take diabetes. GLIP-1 diabetes drugs like Ozempic have taken the U.S. by storm and could have incredibly positive effects on those in developing nations. The issue is access. An Obesity Treatment Cost Index (OTCI) could be used to create and market “access futures contracts” (AFCs) that would lock in the price of a new diabetes treatment over a long period of time, ensuring enhanced and protected affordability. 

Healthcare providers and governments can use these contracts to forecast and plan their budgets more accurately, ensuring funds are available to purchase necessary drugs without financial shocks. Non-governmental organizations (NGOs) and international health agencies can buy call options on futures contracts. This would allow them to secure future drug supplies at a predetermined price, taking unpredictability out of the equation and putting their patients first.

For instance, healthcare NGOs in Low- and Middle-Income Countries (LMICs) could be awarded grants to buy futures contracts at $300 per dose, securing the price for the next two years. Similarly, a government can subsidize an NGO covering 50% of the futures contract cost, effectively securing GLP-1 agonist drugs at $150 per dose.

As mentioned, the Food and Drug Administration recently approved a GLP-1 drug as a treatment to reduce cardiovascular death, heart attack, and stroke in adults who have heart disease and obesity. Additionally, studies are being conducted to determine GLP-1 receptor agonists to treat nonalcoholic fatty liver disease (NAFLD), Parkinson’s disease, Alzheimer’s disease, osteoarthritis, and chemical dependency. Since new uses for GLP-1 are being developed, long positions on futures contracts could produce sizable returns.

As Swedish economist Assar Lindbeck remarked in his seminal paper, “Rent Control as an Instrument of Housing Policy,” “Rent control appears to be the most efficient technique presently known to destroy a city: except bombing.” Similarly, there is nothing more effective at demolishing medical innovation than price controls on new medicines. The outdated practices of the past are insufficient for the challenges we face today. It is time to give up the fantasy that price controls can control cost and embrace the dynamic potential of a healthcare futures market.

The American Mind presents a range of perspectives. Views are writers’ own and do not necessarily represent those of The Claremont Institute.

The American Mind is a publication of the Claremont Institute, a non-profit 501(c)(3) organization, dedicated to restoring the principles of the American Founding to their rightful, preeminent authority in our national life. Interested in supporting our work? Gifts to the Claremont Institute are tax-deductible.

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