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Outside the Box: Investors in drug stocks should ignore dubious valuations based on rigged methodologies

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The investment firm Morningstar has announced that it will now pick drug stocks based upon each company’s vulnerability to poor reviews of their prices by the Institute for Clinical and Economic Review (ICER). Morningstar thinks “cost-effectiveness analysis will have a growing influence on drug-pricing policy and negotiations, putting firms with unjustified prices for their top-selling drugs at risk.”

Investors study the past to predict the future. So, what would have resulted from this advice in the past few years? I’ll cite one example for concision:

Consider the Boston-based biotech company Vertex
VRTX,
+0.96%
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ICER has been a longtime critic of the prices for Vertex’s cystic fibrosis drugs called CFTR modulators. In June 2018, ICER wrote a report critical of Vertex’s prices on three CFTR modulators. Then, in October 2019, Vertex launched a new CFTR modulator called Trikafta, which was priced comparably to Vertex’s older products. Because Trikafta was such an effective drug, Vertex’s stock price skyrocketed from $195.48 in October 2019 to $290.31 by June 2020. 

Missed opportunity

Had Morningstar been picking stocks based upon ICER’s pricing reports and recommended that investors steer clear of Vertex, investors would have missed this enormous opportunity to profit from Vertex stock.

So, yes, investors may want to avoid Morningstar’s advice on drug stocks.

The problems with the use of ICER reports doesn’t end there. 

ICER uses a methodology to review drug prices called the quality adjusted life year (QALY). The QALY is a methodology imported from European countries with socialized medicine systems that helps to put a fig leaf on their denials of access to breakthrough drugs for their citizens. When these countries deny their citizens access to new drugs, they need to argue that they are using an “objective” method to rate those drugs, hence the use of the QALY. 

However, the QALY is a subjective methodology that places an arbitrary monetary value on the value of a year’s life spent in good health. Postulate that a year of life spent in good health is worth $1 billion, and every drug will be rated as cost effective. Postulate that a year of life spent in good health is worth only $100, and no drug will meet the requirement. 

By manipulating the threshold value of a human life, the QALY can spit out any conclusion about drug cost effectiveness that is desired by a government or private sector insurer.

Investors are wiser to pick drug stocks based upon a company’s ability to discover products that meet unmet medical needs rather than Morningstar’s dependence on rigged QALY ratings.

ICER’s influence is not growing

Morningstar might also want to rethink its risky prediction that ICER ratings “will have a growing influence.”  

In a 2019 report, the National Council on Disability dropped this bombshell on ICER and methodologies employing QALY: “QALY-based programs have been found to violate the Americans with Disabilities Act.” Government and commercial payers using the QALY now can become the target of litigation on behalf of groups representing people living with disabilities. So much for their “growing influence.” 

Powerful evidence of the tide’s turning against ICER can be found in a 2021 report to the White House on how to address drug prices, which distances the Biden administration from the use of the QALY in rating drugs purchased by Medicare. 

In it, U.S. Health and Human Services Secretary Xavier Becerra wrote: “there are important concerns about the equity implications of certain methodologies, such as Quality Adjusted Life Years (QALYs), for people of all ages with disabilities and chronic conditions. Drug pricing reforms should avoid utilization of methodologies that adversely impact access to needed medications for vulnerable populations.”

On the opposite side of the aisle, conservative House Republicans have introduced legislation to ban the use of the QALY in all federal programs, which they label as a “health-care rationing formula.” These Republicans are loath to adopt a tool used by socialized health-care systems to ration treatments to patients. 

If the Republicans take the House in the midterm elections, it’s likely legislation will follow banning the use of the QALY in all federal programs, legislation that President Joe Biden seems positioned to sign. 

Morningstar’s prediction that ICER is having “growing influence” is simply wrong. 

Morningstar’s assertion that the QALY should be used as a screen to help pick stocks is hopelessly misguided. Investment firms should be analyzing biopharmaceutical companies based on the tried-and-true common-sense standard: Is the company likely to bring valuable cures to market for patients?

William Smith, PhD, is senior fellow and director of the Life Sciences Initiative at Pioneer Institute in Boston. Pioneer Institute is an independent, nonpartisan, privately funded research organization that seeks to improve the quality of life in Massachusetts through civic discourse and intellectually rigorous, data-driven public policy solutions based on free-market principles, individual liberty and responsibility, and the ideal of effective, limited and accountable government.

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