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5 Vaccine Supply Vaccines have eradicated smallpox and polio and prevented deadly and disabling diseases in thousands of Americans. Given their histori- cally low cost and important benefits, vaccines represent one of the out- standing bargains in health care. Nonetheless, the vaccine supply today is surprisingly fragile. lust how fragile it is was brought to national atten- tion by severe vaccine shortages in 2001 and 2002, which affected 8 of the 11 routine childhood vaccines. Such shortages have the potential to result in serious outbreaks of disease and can erode public health programs and infrastructure that have taken years to build. But the greatest threat is that the discovery and development of future vaccines, many of which are now well within reach, will be delayed or abandoned. This chapter reviews the vaccine market in the United States and the context within which it functions. Discussed in turn are the size and growth of the vaccine market, vaccine production and the associated cost structure, research and development, concentration in the vaccine indus- try, regulation of the industry, pricing, vaccine shortages, the stockpiling of vaccines, and CDC contracting. The chapter ends by describing the key barriers to a well-functioning vaccine supply system. SIZE AND GROWTH OF THE VACCINE MARKET Vaccines are a very small enterprise relative to the pharmaceutical industry overall: vaccine revenues constitute only about 1.5 percent of global pharmaceutical sales (Batson, 2001~. Global sales of all vaccines combined are roughly equivalent to the individual sales of such familiar 107

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108 FINANCING VACCINES IN THE 21ST CENTURY pharmaceutical products such as Lipitor, Prilosec, and Zocor (Marketletter, 2002~. In just three decades, the number of firms supplying routine vaccines to the United States dwindled to 5 companies that today produce all of the routinely recommended childhood and adult vaccines. U.S. vaccine sales are estimated to be about $1.5 billion per year, one- quarter of the global vaccine market (about $6 billion per year) (Mercer Management Consulting, 2002~. Most of the vaccines sold in the U.S. mar- ket are produced by four large pharmaceutical companies: Aventis Pas- teur, GlaxoSmithKline, Merck, and Wyeth. Two of these companies- Merck and Wyeth are U.S.-based; the others are based in Europe. A fifth, smaller company based in the U.K., Powderject, supplies adult influenza vaccine to the U.S. Vaccines represent a small fraction of the business of the four large companies and increasingly must compete with the com- panies' pharmaceutical divisions for internal resources (Arnould and DeBrock, 2002~. Mercer Management Consulting (2002) estimates that the global mar- ket for vaccines (childhood and adult) has grown approximately 10 per- cent per year since 1992. Globally, a significant proportion of the growth during the decade of the l990s was the result of the worldwide effort to eradicate polio. The remainder of the market grew at an annual rate of only about 1 percent (Mercer Management Consulting, 2002~. In the United States, 72 percent of the growth in revenues in the early l990s resulted from the introduction of new vaccine products and 10 percent from the increase in the measles-mumps-rubella (MMR) dosage (from one to two doses) from 1990 to 1995 (Mercer Management Consulting, 1995~. More recently, the introduction of childhood pneumococcal vac- cine in 2000 nearly doubled the U.S. vaccine market. Pediatric vaccines constitute the majority of the vaccine market (about 70 percent). Traditional childhood vaccines, such as MMR, polio, and diphtheria-tetanus-acellular pertussis (DTaP) which represent the core of the U.S. national immunization system are viewed by the vaccine industry as low-margin commodities. Projections of strong vaccine indus- try growth, however, spurred by new developments in recombinant technologies and other advances, have stimulated renewed interest in vaccines. Much of this interest is directed toward new therapeutic and cancer vaccines and adult vaccines for targeted risk groups. Some have suggested the possibility of a $10 billion market by 2010 (Hirschler, 2002~. But the ability to bring new vaccines to market still involves extraordinary technical and regulatory challenges. Maintaining producer interest and stable sources of supply of routine childhood vaccines remains a signifi- cant challenge (Arnould and DeBrock, 2002~. Large, multinational producers sell vaccines through a two-tiered pricing system. Prices in developed countries are high current prices in

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VACCINE SUPPLY 109 western Europe and the United States are comparable while a large vol- ume of vaccines is sold to the developing world at significantly lower, essentially marginal-cost prices. High-income countries generate about 82 percent of vaccine revenues but represent only 12 percent of doses (Batson, 2001~. This system serves the needs of both the multinational com- panies and the developing countries. The large volume of global sales permits the vaccine companies to exploit economies of scale in produc- tion while earning high returns on sales to developed countries. Euro- pean multinationals typically produce hundreds of millions of doses, while American companies produce tens of millions of doses (Mercer Management Consulting, 1995~. This disparity in volume has resulted in higher average production costs in the United States than in Europe. (See also the later section on cost structure.) VACCINE PRODUCTION A large number of vaccines are licensed in the United States by domestic firms and foreign suppliers, taking into account multiple combina- tions, as well as vaccines that are not routinely used (see Tables 5-1 and 5-2~. Some manufacturers are more active than others. For example, Wyeth has 16 licenses for vaccines in the United States and Merck has 13, while seven manufacturers have only 1. While many pharmaceuticals are manufactured with relatively stan- dardized chemical engineering processes, vaccine manufacturing is less standardized and less predictable. It often involves the complex transfor- mation of live biologic organisms into pure, active, safe, and stable immu- nization components. Highly sterile, temperature-controlled environ- ments are needed at each manufacturing step, and many vaccines must be maintained within a narrow temperature range during storage and deliv- ery referred to as the cold chain. Vaccines approved by the Food and Drug Administration (FDA) are subject to high standards of safety and quality assurance, including rigorous and pervasive review procedures in which each individual batch of vaccine is licensed a procedure not re- quired for pharmaceuticals (Hay and Zammit, 2002~. In addition, once in production, each batch must be tested and ap- proved prior to release. Vaccines require both a product license applica- tion (PLA) and an establishment license application (ELA), while new pharmaceutical products ("new chemical entities" or NCEs) require only the former. The ELA certifies that the facilities, equipment, and personnel involved in the manufacturing process meet FDA standards and Current Good Manufacturing Practices. Furthermore, to obtain a facility license for a vaccine, a company must first create full production capacity for that vaccine (see the discussion below) (Hay and Zammit, 2002~.

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110 FINANCING VACCINES IN THE 21ST CENTURY TABLE 5-1 Domestic Producers of Vaccines for the U.S. Market u.s. Company Generic Name Approval Date Bioport Corporation (Michigan Department of Public Health) Wyeth (Wyeth Laboratories, Inc.) Bioport Corporation Bioport Corporation Bioport Corporation Wyeth (Lederle-Praxis) Merck & Co. (Merck, Sharpe, and Dohme) Merck & Co. Wyeth (Praxis Biologics) Wyeth (American Cyanamid) Merck & Co. Merck & Co. Biogen Wyeth (Wyeth Laboratories) Wyeth (Wyeth Laboratories) King Pharmaceuticals (Parkedale Pharmaceuticals) Merck & Co. Merck & Co. Merck & Co. Merck & Co. Merck & Co. Bioport Corporation Greer Laboratories Wyeth (Wyeth Ayerst) Merck & Co. (Merck, Sharpe, and Dohme) Wyeth (Lederle Laboratories) Wyeth (Wyeth-Lederle) Wyeth (Wyeth-Lederle) Wyeth (Wyeth-Lederle) Wyeth (Wyeth-Lederle) Hollister-Stier Laboratories Wyeth (Wyeth-Ayerst) Chiron (Behringwerke) Bioport Corporation Merck & Co. Merck & Co. Bioport Corporation anthrax vaccine adsorbed cholera vaccine diphtheria and tetanus toxoids and pertussis vaccine adsorbed diphtheria and tetanus toxoids adsorbed diphtheria toxoid adsorbed haemophilus b conjugate vaccine haemophilus b conjugate vaccine haemophilus b conjugate vaccine and hepatitis B (recombinant) vaccine haemophilus B vaccine haemophilus vaccine hepatitis B vaccine hepatitis-A vaccine, inactivated hepatitis-B vaccine influenza virus vaccine influenza virus vaccine influenza virus vaccine measles and mumps virus vaccine live measles and rubella virus vaccine live measles virus vaccine live measles, mumps, and rubella . . . virus vaccme . eve mumps virus vaccine live pertussis vaccine adsorbed 1970 1952 1998 1970 1998 1988 1989 1996 1990 1985 1982 1996 1989 1945 1961 1998 1973 1971 1963 1971 1967 1998 plague vaccine 1994 pneumococcal 7-valent conjugate vaccine 2000 pneumococcal vaccine polyvalent 1977 pneumococcal vaccine polyvalent poliovirus vaccine live oral trivalent poliovirus vaccine live oral type I poliovirus vaccine live oral type II poliovirus vaccine live oral type III polyvalent bacterial vaccines rabies vaccine . . rabies vaccme rabies vaccine adsorbed rubella and mumps virus vaccine live rubella virus vaccine live tetanus toxoid adsorbed 1979 1963 1962 1962 1962 1999 1982 1997 1998 1970 1969 1998

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VACCINE SUPPLY TABLE 5-1 Continued 111 u.s. Approval Company Generic Name Date Wyeth (Wyeth-Lederle) typhoid vaccine 1952 Merck & Co. varicella virus vaccine live 1995 Bioport Corporation (Michigan anthrax vaccine adsorbed 1970 Department of Public Health) Wyeth (Wyeth Laboratories, Inc.) cholera vaccine 1952 NOTE: Includes vaccines with active licenses that are not in production, e.g., cholera, plague, and oral polio vaccines. SOURCE: Tufts Center for the Study of Drug Development, 2002. COST STRUCTURE1 The costs of vaccine production include research and development (R&D) costs; costs related to the regulatory approval process; ongoing regulatory costs; plant costs, including depreciation; marketing costs; vari- able costs for labor, production, equipment, and supplies; and liability costs (Arnould and DeBrock, 2002~. Although there are substantial differences between development costs for vaccines and pharmaceuticals, the latter provide a useful benchmark. It has been estimated that, between 1980 and 1984, R&D and the regula- tory approval process generated an average of 11 years of negative cash flow for NCEs introduced in the U.S. pharmaceutical industry (Grabowski and Vernon, 1997~. DiMasi et al. (1991) estimate the mean out-of-pocket cost for a successful NCE at $32 million in 1987 dollars; when discovery, clinical testing, and failure costs are included, this figure rises to $115 million, while the inclusion of time and interest costs results in an esti- mate of $231 million (more than $300 million in 1997 dollars) (Grabowski ~ Information on the costs and revenues associated with vaccine production is difficult to discern from the public record. The committee sought this information as part of its fact- finding effort by commissioning background papers on the vaccine industry (Arnould and DeBrock, 2002; Fine, 2003; Lichtenberg, 2002), corresponding with the five companies that produce recommended vaccines for the U.S. market (Aventis Pasteur, GlaxoSmithKline, Merck, Powderject, and Wyeth), inviting testimony in committee meetings from vaccine representatives, and conducting private interviews with company officials. This process yielded a substantial amount of qualitative information in support of the committee's analy- sis of the relationships among costs, revenues, returns, and investment in research and de- velopment (R&D). But verifiable, quantitative information on costs, revenues, and profits is lacking; and this lack of information represents an important limitation of this study.

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2 FINANCING VACCINES IN THE 21ST CENTURY TABLE 5-2 Foreign Producers of Vaccines for the U.S. Market u.s. Approval Company Country Generic Name Date Statens SerumInstitut Denmark diphtheria toxoid 1998 Statens SerumInstitut Denmark tetanus and diphtheria toxoids 1998 Statens Serum Institut Denmark tetanus toxoid 1998 Aventis (Pasteur Merieux France acellularpertussis DTP 1992 Connaught) Aventis (Aventis Pasteur) France Bacillus Calmette-Guerin 1990 (BCG) live vaccine Aventis (Aventis Pasteur)) France BCG vaccine 1998 Aventis (Aventis Pasteur) France conjugated haemophilus 1993 influenza b and diphtheria, tetanus, and acellular pertussis vaccine Aventis (Aventis Pasteur) France tetanus, diphtheria,polio and 2002 pertussis (cPDT) vaccine Aventis (Aventis Pasteur) France diphtheria and tetanus toxoids and pertussis vaccine adsorbed 1978 Aventis (Aventis Pasteur) France diphtheria and tetanus 1984 toxoids adsorbed Aventis (Aventis Pasteur) France diphtheria and tetanus 1997 toxoids adsorbed Aventis (Aventis Pasteur) France diphtheria and tetanus toxoids 1978 adsorbed, for adult use Aventis (Aventis Pasteur) France haemophilus B conjugate vaccine 1987 Aventis (Aventis Pasteur) France haemophilusb conjugate 1993 vaccine (tetanus toxoid conjugate) Aventis (Aventis Pasteur) France haemophilusb conjugate 1996 vaccine/diphtheria, tetanus toxoids, acellular pertussis vaccine in combination Aventis (Aventis Pasteur) France influenza virus vaccine 1978 Aventis (Aventis Pasteur) France meningococcalpolysaccharide 1978 vaccine, group A Aventis (Aventis Pasteur) France meningococcalpolysaccharide 1978 vaccine, group C Aventis (Aventis Pasteur) France meningococcalpolysaccharide 1981 vaccine, groups A, C, Y and W-135 combined Aventis (Aventis Pasteur) France pertussis vaccine 1978 Aventis (Aventis Pasteur) France poliovirus vaccine inactivated 1987 Aventis (Aventis Pasteur) France poliovirus vaccine inactivated 1990 Aventis (Aventis Pasteur) France rabies vaccine 1980 Aventis (Aventis Pasteur) France rabies vaccine 1991 Aventis (Aventis Pasteur) France smallpox vaccine 1978 Aventis (Aventis Pasteur) France tetanus toxoid 1943

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VACCINE SUPPLY TABLE 5-2 Continued 113 U.S. Approval Company Country Generic Name Date Aventis (Aventis Pasteur) Aventis (Aventis Pasteur) Aventis (Aventis Pasteur) Takeda Chemical Industries, Ltd. Research Foundation for Microbial Diseases Akzo Nobel (Organon Teknika Corp.) Cheil Jedang Berna Sa (Swiss Serum and Vaccine Institute) Berna Sa (Swiss Serum and Vaccine Institute) GlaxoSmithKline (Smith Kline Beecham Biologicals) France France France Japan tetanus toxoid tetanus toxoid adsorbed yellow fever vaccine acellular pertussis vaccine concentrate Japan Japanese encephalitis virus vacine inactivated Netherlands BCG vaccine South Korea hepatitis-B vaccine Switzerland tetanus toxoid adsorbed Switzerland typhoid vaccine live oral 1978 1978 1978 1991 1992 1989 1988 1970 1989 UK diphtheria and tetanus toxoids 1997 and acellular pertussis vaccine adsorbed GlaxoSmithKline (Smith UK hepatitis AInactivated and 2001 Kline Beecham Biologicals) Hepatitis B (recombinant) vaccine GlaxoSmithKline (Smith UK hepatitis B vaccine (recombinant) 1989 Kline Beecham Biologicals) GlaxoSmithKline (Smith UK hepatitis-a vaccine, inactivated 1995 Kline Beecham Biologicals) Powderject Pharmaceuticals UK influenza virus vaccine 1998 (Medva Pharma) Statens SerumInstitut Denmark diphtheria toxoid 1998 Statens SerumInstitut Denmark tetanus and diphtheria toxoids 1998 Statens Serum Institut Denmark tetanus toxoid 1998 Aventis (Pasteur Merieux France acellularpertussis DTP 1992 Connaught) NOTE: Includes vaccines with active licenses that are not in production, e.g., pertussis monovalent and hepatitis B-Cheil Jedang vaccines. SOURCE: Tufts Center for the Study of Drug Development, 2002. and Vernon, 1997~. A more recent study by DiMasi indicates that the out- of-pocket cost of an NCE has escalated to $403-$802 million (2000 dollars) when the time lag between investment and market release is capitalized (DiMasi et al., 2003~. Total development costs of bringing a vaccine to market are roughly similar to those for drugs and can be higher (Grabowski and Vernon, 1997~. As part of the initial approval process, the FDA requires that the

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4 FINANCING VACCINES IN THE 21ST CENTURY vaccines used in Phase III clinical trials be produced in a facility that will be used for commercial production if the vaccine is approved. As a result, manufacturers must frequently invest more than $30 million in the pro- duction facility prior to product approval (Grabowski and Vernon, 1997~. Vaccine development costs have also risen as a result of the increased time it takes to achieve licensure, as well as larger FDA-required Phase III clinical trials for many recent vaccines (see Box 5-1~. The size of clinical trials depends on a number of variables (Foulkes and Ellenberg, 2002), including the rates of disease and anticipated adverse events. The average size of clinical trials has increased over time (as has been the case for drugs) to provide an adequate base for identifying rare adverse effects during vaccine development. One industry expert estimates that a new vaccine costs $700 million from initial research to commercial production (Clarke, 2002~. In addition to the requirement for early facility invest- ments, production facilities for vaccines tend to be more capital-intensive than those for pharmaceuticals. On the other hand, vaccines tend to have higher success rates than pharmaceuticals and may be characterized by faster development times (Grabowski and Vernon, 1997~. Once a vaccine has been approved, the production process involves high fixed costs relative to variable costs. Fixed production costs, exclu- sive of up-front R&D and sales labor, represent 60 percent of total produc- tion costs for vaccines (Mercer Management Consulting, 2002~. These fixed costs are not affected by changes in production volume. They are associ- ated primarily with quality assurance activities, administrative labor, de- preciation, and other manufacturing overhead. Industry representatives have indicated that increased regulatory requirements have resulted in increased costs for quality assurance employees relative to production employees. Semivariable costs make up 25 percent of total costs, exclud- ing R&D and sales labor. Semivariable costs are batch costs that are con- stant per batch regardless of the number of batches (Mercer Management Consulting, 2002~. Specific examples of batch costs are test animals and labor for production and testing. The remaining, variable, costs account for only 15 percent of total costs; examples of such costs are vials, stop- pers, labels, packaging, and in-source components. The costs of producing licensed vaccines have increased over the last decade as a result of several factors: mandatory removal of the mercury- containing preservative thimerosal, increased burdens associated with regulatory enforcement, a variety of improvements in vaccines that have been incorporated into existing products, both voluntary and mandated upgrading of production facilities, and increased direct provider shipment costs under new CDC contract arrangements (Hay and Zammit, 2002~. Modern vaccines are also subject to constant updating and improvement, such as new stabilizers and new production technologies, as a result of

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VACCINE SUPPLY 115

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116 FINANCING VACCINES IN THE 21ST CENTURY scientific advances. The MMR vaccine that is currently produced for the U.S. market is far different from the version produced in 1971, having been subject to an array of technical improvements (Arnould and DeBrock, 2002~. While the costs of producing vaccines have generally been increasing, the revenues from vaccine sales have remained relatively constant. The revenue potential of vaccines is limited by the small number of vaccina- tions usually required. Many prescription drugs are taken by patients for years; most vaccines are administered between one and four times over a lifetime. Furthermore, vaccine production costs do not necessarily decline over time. A key factor that contributes to higher production costs is the rigid batch inspection process, which makes it difficult for companies to achieve more efficiency through a learning curve and to enjoy cost reduc- tions related to process improvements (Grabowski and Vernon, 1997~. Pressures on revenues have resulted from CDC's ability to negotiate dis- counted federal contract prices, federal price caps on certain vaccines since 1993, the gradually increasing public share of vaccine purchases (at dis- counted prices), and the addition of price competition to the government contracting process. The principal exceptions to this revenue picture re- late to two fairly new vaccines varicella and pneumococcal conjugate- which are priced higher than earlier vaccines. RESEARCH AND DEVELOPMENT In 2000, the leading global vaccine companies spent about $750 mil- lion on R&D (Mercer Management Consulting, 2002~. This figure is sig- nificantly smaller than the $26.4 billion allocated to pharmaceutical R&D worldwide (Arnould and DeBrock, 2002~. The United States has been responsible for the discovery and development of two-thirds of the world's new vaccines in the last 20 years. The major contributors to vaccine re- search in the United States are companies conducting industrial research, government agencies (the National Institutes of Health [NIH] and the Department of Defense [DoD]), and the academic institutions they fund. There were 285 vaccine R&D projects ongoing in 1996 (not including HIV vaccine efforts), of which 133 were in the clinical trials phase (Grabowski and Vernon, 1997~. Mercer Management Consulting (2002) reports that this activity had increased by 2000 to nearly 350 R&D projects 188 in the pre-clinical trial phase and 158 in clinical trials. The rate of U.S. approval of vaccine licenses has also been increasing. Between 1997 and 1999, 17 new licenses were approved, compared with 8 licenses between 1990 and 1992 (Mercer Management Consulting, 2002~. A recent IOM study identifies additional vaccines that are expected to be devel- oped by 2010 (IOM, 2000b) (see Box 5-3~.

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VACCINE SUPPLY 117 Industrial Research The National Vaccine Advisory Committee (NVAC) estimates that vaccine sales financed 46 percent of the $1.4 billion spent on vaccine R&D in 1995 (CDC, 1997~. Vaccine R&D is conducted by both large and small companies. Large companies spent an estimated 15 to 20 percent of their product sales about $650 million on R&D in 1995. Many small biotech- nology firms, ranging in size from 36 employees (Antex Biologics, Inc.) to over 1,600 employees (Immunex Corporation), are also involved in vac- cine research. Their total sales range as well, from $500,000 (AVAX Tech- nologies, Inc.) to almost $1 billion (Immunex Corporation). In 1995, small companies invested $250 million in vaccine R&D (CDC, 1997~. Some biotechnology firms receive funding directly from the govern- ment to develop vaccines for the military, such as vaccines against diar- rhea and gastroenteritis. Other firms are subsidiaries of larger pharma- ceutical companies or may be partially owned by another firm. Many small vaccine start-up companies receive a significant portion of their funding through venture capital (Arnould and DeBrock, 2002~. Some firms focus solely on vaccine research, while others emphasize multiple approaches to a single type of disease. Major targets of current research include respiratory diseases, viral hepatitis, sexually transmitted diseases (STDs), herpes virus diseases, parasitic diseases, fungal infec- tions, and cancer vaccines. A recent breakthrough in research on the hu- man papilloma virus (HPV) holds the promise of eliminating cervical can- cer (Schultz, 2003~. Vaccines in the pipeline, including recombinant vaccines for HIV, herpes simplex, diabetes, and infertility (see Box 5-2), are increasingly complex (Mercer Management Consulting, 2002~. One of the major areas of recent research is vaccines for STDs and vaccines that can be effective in children. Extensive effort has been fo- cused on finding a vaccine for HIV to stop the worldwide spread of the virus. Scientists have learned a great deal about how the immune system works through this research. This knowledge has spurred research on can- cer vaccines, and the market for such vaccines is projected to grow signifi- cantly through 2007. R&D projects are frequently aimed at diseases for which vaccines are not yet available (see Table 5-3~. But a substantial amount of research is also directed toward vaccines that would be improvements upon or com- binations of existing licensed vaccines, as well as directly competing vac- cines. Considerable research is also directed toward new methods for ad- ministering vaccines, such as the recently FDA-approved nasal spray form of influenza vaccine (FDA, 2003~. Despite these signs of commercial interest, product development is increasingly costly relative to the market potential of vaccines. The ab-

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VACCINE SUPPLY TABLE 5-7 Vaccine Supply Status in 2001-2002 135 Supply Problems No Supply Problems Tetanus-diphtheria DTaP MMR Varicella (chickenpox) . Pneumococcal 7 valent (PCV- 7) Haemophilus influenzue type b (Hib) Hepatitis B IPV Hepatitis A Meningococcal polysaccharide Influenza Adult pneumococcal SOURCE: Orenstein, 2002c. ended; supplies of pneumococcal conjugate vaccine are expected to re- turn to normal in 2003 (CDC, 2003h). No reports of regional outbreaks of preventable infectious diseases occurred during this period of vaccine shortages. However, shortages place stress on the fragile public-private partnership that delivers vac- cines to the public. Public compliance with the recommended schedule can be threatened by the lack of vaccines and sudden changes in the sched- ule resulting from shortages. CDC reports that, as a result of the tetanus vaccine shortage, 52 percent of states suspended school immunization laws (Orenstein, 2002a). Given the recent intensity of antivaccine rhetoric, school administrators find themselves in an uncomfortable role as en- forcers of laws that they themselves may not adequately understand. In a recent poll of school nurses, the majority of respondents indicated their belief that children may be receiving too many vaccines (Lett,2002~. These trends may make it difficult to reinstate school laws that are suspended as a result of shortages. It is too soon to determine whether the recent shortages were a one- time event or an early sign of a recurring pattern. An important structural risk factor in supply disruption the limited number of suppliers has not changed. With only four suppliers for all universal childhood vac- cines and monopoly suppliers of four of those vaccines, the United States remains highly vulnerable to disruptions in manufacturer production. Vaccine shortages appear to result from specific and apparently unre- lated causes rather than a single overriding factor (GAO, 2002; NVAC, 2003) (see Table 5-8~. Vaccines affected by the shortages are both new, such as pneumococcal conjugate, and long-standing, such as MMR; and shortages have affected both sole-supplier and multiple-supplier vaccines. Some explanations for the shortages that have been advanced by the in- dustry include problems associated with removing thimerosal from the production process, compliance with increasingly stringent Current Good

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136 FINANCING VACCINES IN THE 21ST CENTURY TABLE 5-8 Vaccine Shortages and Their Causes Vaccine Immediate Cause of Shortage Shortage Period DTaP Two producers withdrew in 2000: Baxter 4th quarter 2000 to acquired North American Vaccine and 3rd quarter 2002 withdrew its DTaP product. Wyeth withdrew as of January 2001. The two remaining suppliers, GSK and AvP, had insufficient capacity to supply full demand. AvP experienced production slowdowns due to the removal of thimerosal. Td In January 2000, Wyeth withdrew from 4th quarter 2000 to production of tetanus vaccine. 3rd quarter 2002 MMR Merck, the sole producer, interrupted January 2001 to production to address issues related to July 2002 Current Good Manufacturing Practices. 700,000 doses were borrowed from the stockpile. Varicella Production ceased from September 2001 to 4th quarter 2001 to November 2001 because of scheduled 2nd quarter 2002 modifications to production facilities, which took longer than expected. Pneumococcal Unexpectedly strong demand overwhelmed October 2001 to conjugate supply, combined with a January 2002 present production bottleneck. Influenza Multiple manufacturers had difficulty growing one of the flu strains, combined with increased demand due to a recommendation change (reduction in the age of the primary target group from 65 to 50) and quality control issues at Parkdale and Wyeth. 2000-2001 flu season Vaccine production was delayed; only two-thirds 2001-2002 of the supply was available by October. flu season SOURCES: DTaP and Td: Fine, 2003; other: Mason, 2002. Manufacturing Practices, disruptions due to plant renovations, unantici- pated high demand for new vaccines, and sudden withdrawals from the market by producers. The FDA licensure process may create a structural barrier to rapid adjustment of output to address sudden shortfalls in sup- plies. The agency's requirement for full-scale production capacity before

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VACCINE SUPPLY 137 licensure is granted may tend to fix minimal excess capacity at start-up. Combined with the stringent entry requirements and lead times for licen- sure, little flexibility to adjust production remains (Arnould and DeBrock, 2002~. There is also evidence that other developed countries, while not experiencing the critical shortages of the United States, are characterized by capacity constraints that could lead to shortages (Mercer Management Consulting, 2002~. Some have sought a relationship between vaccine pricing and short- ages (Orenstein, 2002c). As shown in Table 5-9, however, short-run corre- lations between vaccine prices and shortages are not apparent. Prices for vaccines with supply problems are generally higher than those for vac- cines without such problems. A more meaningful relationship would in- volve profit margins, yet even this relationship may be confounded by other variables. STOCKPILES The vaccine stockpile program consists of an inventory system of stor- age and rotation contracts negotiated with manufacturers. Initiated in 1983 to establish a 6-month strategic reserve of each universally recommended vaccine, the program was initially funded with Section 317 funds. By 1988, stockpiles had been developed for six important vaccines and combina- tions (DTP, tetanus toxoid [TT], Td, oral poliovirus [OPV], IPV, and MMR). The Omnibus Budget Reconciliation Act (OBRA) of 1993 allowed VFC federal entitlement funds to be used for stockpile purchases, but ap- proval from the Office of Management and Budget (OMB) is required for this purpose. CDC began to target purchases toward vaccines with sole suppliers to minimize financial risk. Multiple withdrawals from the stock- piles occurred between 1984 and 2002, mainly as a result of temporary TABLE 5-9 Vaccines With and Without Supply Problems (2002) With Supply Problems Without Supply Problems Contract Catalog Contract Catalog Vaccine Price Price Vaccine Price Price Td a $7.50 avg. state IPV $8.25 $15.42 DTaP $10.58-$10.65 $17.12 Hib $5.75-$8.00 $15.25-$18.95 MMR $15.53 $28.35 Hep. B $9.00 $21.40-$24.20 Varicella $39.14 $49.13 PCV-7 $45.99 $58.75 aPrice capped at $0.144; no contract could be negotiated. SOURCE: Orenstein, 2002c.

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138 FINANCING VACCINES IN THE 21ST CENTURY manufacturing problems. The most recent drawdown was 700,000 units of MMR in 2001 (see the discussion of shortages, above). Of ten vaccines that CDC has targeted for stockpiling, only three were stockpiled in 2002 (Lane, 2002~. Building up the stockpiles to full strength and possibly increasing their capacity could help alleviate the shortages discussed earlier (GAO, 2002~. Rebuilding the stockpiles would require substantial investment and OMB clearance. GAO has also recommended legislation that could autho- rize the use of VFC stockpiles for non-VFC-eligible recipients in cases of national shortage. But even at full strength, the stockpile program pro- vides only a temporary buffer in cases of serious supply disruption. Given the time required for licensing a new facility and ramping up production, the stockpiles would be inadequate in the face of a total manufacturer withdrawal. No government contingency plan exists for this prospect. Stockpiles are also costly. Moreover CDC has been conservative about developing stockpiles to minimize financial risk from, for example, a change in vaccine recommendations that could render a stockpile useless. Examples of such changes include the switch from OPV to IPV, the elimi- nation of thimerosal from certain vaccines, and the future replacement of individual and exisiting combination vaccines with new combinations. CDC CONTRACTING Each year, CDC negotiates a federal contract for the purchase of ACIP- recommended childhood vaccines. CDC does not directly purchase vac- cines; state and local grantees are each given a vaccine budget for the purchase of vaccines at the negotiated contract prices. With that budget, states can purchase, store, and redistribute these vaccines from their own depots or through contracts with pharmaceutical distribution companies. Some states allow clinicians to choose among competing vaccine prod- ucts. States can also purchase vaccines under the CDC contract for non- VFC vaccines for other federally authorized state programs. Of the 52 per- cent of vaccines purchased under the federal contact, 35 percent are for the VFC program, while the remaining 17 percent are purchased by states using both Section 317 funding (10 percent) and state funds (7 percent) (Orenstein, 2002b). Several factors in addition to negotiating leverage determine the con- tract prices. For some vaccines (OPV, IPV, Haemophilus influenza type b, Hib, MMR, DTP, DTaP, Td, adult pneumococcal, and hepatitis B), there are statutory price caps that were imposed at the time VFC was enacted to prevent rapid escalation of prices. The price caps hold vaccines to their price on May 1,1993, plus an annual inflation adjustment. DTaP and hepa- titis B are no longer subject to the cap. Vaccines that were approved after

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VACCINE SUPPLY 139 the enactment of the VFC program have never been subject to a cap. These include hepatitis A, influenza, varicella, and pneumococcal conjugate (CDC, 2002m). Vaccine companies do not always bid the maximum price of the cap. For example, Merck has always bid the maximum for MMR, while Aventis Pasteur has consistently bid below the cap for IPV, despite its monopoly on that product (CDC, 2002m). CDC has also introduced competition into the contract design. The original "winner take all" contracts were initially replaced with a mul- tiple-supplier contract that guaranteed the largest market share to the low- est bidder (all Section 317 and half of VFC purchases). In 1998, CDC intro- duced the current competitive approach, under which states can purchase from the supplier of their choice at the federal contract price. Manufactur- ers can attempt to increase their market share by lowering their price sev- eral times during the contract period. Private-sector buyers purchase vaccines through both wholesale dis- tributors and direct customer sales. Clinicians typically pay high prices to distributors, but they are able to make small purchases when needed and benefit from business relationships with local distributors (Mercer Man- agement Consulting, 1995~. In contrast with childhood vaccines, the public sector purchases a very limited share of adult vaccines. For example, only about 2 percent of the 90 million doses of trivalent influenza vaccine sold in the United States in a single year is purchased through federal contracts Johnson, 2002~. The two U.S.-based manufacturers of influenza vaccine emphasize direct sales to end users instead of to distributors.7 The third manufacturer is based in the United Kingdom and relies on U.S. distributors. Also, bulk-purchase arrangements are common with adult vaccines. Many employers offer mass vaccination services in the workplace. One large mass vaccinator recently reported administering over 1 million doses during the 2001- 2002 influenza season. Premier, a group purchasing association represent- ing about one-third of the hospital beds in the United States, contracts for several million doses of influenza vaccine for its members each year (CDC, 2002n). BARRIERS TO A WELL-FUNCTIONING VACCINE SUPPLY SYSTEM This chapter has identified a number of barriers to a well-functioning vaccine supply system. These barriers are reviewed in turn below. 70ne of the two domestic producers recently dropped out of the influenza vaccine market.

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140 FINANCING VACCINES IN THE 21ST CENTURY Exit and Concentration Concerns about the possibility of a total loss of supply of a critical vaccine are widespread. These concerns have spawned national debate and research on the reasons for the apparent fragility of vaccine supplies. For example, NVAC has held numerous discussions of and recently re- leased a report on vaccine supply (NVAC, 2003~. The Council of the IOM also issued a statement in 2001 calling for the creation of a national vac- cine authority to address this problem (IOM, 2001~. However, exit of manufacturers from vaccine production and the re- sultant concentration of supply cannot, by themselves, be considered a system failure. For example, substantial economies of scale combined with a limited U.S. market may mean that only one efficient producer can sur- vive for each vaccine. But recent vaccine shortages suggest that the indus- try may not be able to produce a stable supply under current conditions. Research and Development Maintaining a vital R&D enterprise has been a cornerstone of U.S. vaccine policy and the basis for patent regulations and NIH research fund- ing. Yet research has suggested that significant disparities exist between private incentives to invest in R&D and the social benefits of vaccines (Kremer, 2000a,b). Additional public support may be necessary to address these disparities if the full potential of vaccines as valuable tools of dis- ease prevention is to be achieved. As Kremer further points out, however, R&D depends on the expectation of firms that they will be adequately rewarded for their investment. Too many aspects of vaccine policy in the United States including government pricing polices, licensure require- ments, and regulation send negative signals to companies. While regu- lation and reasonable pricing are each important, achieving national policy goals requires that they be balanced and coordinated. There are many indications that the opposite is in fact the case. Barriers to Entry Perhaps the most important long-run solution to the fragility of vac- cine supplies is to ensure that multiple companies have access to the U.S. market. Although a large number of small domestic R&D firms and for- eign companies have applications pending for vaccine licenses in the United States, regulatory and cost barriers may inhibit the entry of many of these producers. For example, a company that has had a successful vaccine product in use for many years in Europe and Canada must con- duct full clinical trials as part of its U.S. license application rather than

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VACCINE SUPPLY 141 drawing on efficacy and safety data from its current product experience. GAO (2002) has recommended expedited FDA review procedures. Imple- menting this recommendation would accelerate approval of new and com- petitive vaccines in the case of shortages and also reduce the total cost of bringing a vaccine to market. Regulation FDA product and facility regulations are important to the safety of the vaccine supply and the viability of the industry. According to industry experts, however, the impact of regulation has been costly, without clear evidence of corresponding improvements in quality (GlaxoSmithKline, 2002; Merck, 2002~. A government planning authority does not exist at a high enough level that can balance national objectives of safety, as em- bodied in the FDA's regulation of production, and availability, which depends in part on the regulatory burden faced by vaccine producers. Undervaluation of Vaccines Industry representatives frequently allude to the role of federal pric- ing policies as evidence of the undervaluation of vaccines. They suggest that the elimination of vaccine-preventable diseases has reduced the per- ceived threat of those illnesses and also decreased the perceived value of vaccines. Although substantial research has demonstrated the social ben- efits of vaccines, economic analysis suggests that vaccines are persistently undervalued (IOM, 2000b; Kremer, 2000a). The increased costs of newer vaccines such as pneumococcal conjugate at $176,000 per quality-ad- justed life-year saved has changed the picture dramatically. As a result, it is no longer possible to generalize across all vaccines in discussing so- cial valuation. Several proposals have been offered to reduce the gap between the social value and price of vaccines. McGuire (2003) proposes a method for setting an administered price of a vaccine according to its social benefit (see Box 6-2 in Chapter 6~. In McGuire's formulation, a preset price is determined that maximizes consumer surplus subject to profit maximiza- tion of the producing firm, based on an estimate of the social benefit of the vaccine. Putting this approach into practice would depend on the exist- ence of estimates of the average benefit of a vaccine. A recent IOM report (IOM, 2000b) presents a cost-effectiveness analysis of 26 candidate vac- cines, applying a common analytical framework for measuring the costs and effects of vaccine development and administration. Other authors have used a similar framework. Kremer (2000a) estimates that in the developing world, a vaccine against malaria would be cost-effective at

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42 FINANCING VACCINES IN THE 21ST CENTURY $41 per dose; but that under the current purchasing system for develop- ing countries, producers would probably receive only around $2 per dose, which is too low to stimulate appropriate investment. On the other hand, it is clear that the prices of newer vaccines, such as pneumococcal conjugate and varicella, are considerably higher than those of their predecessors. This situation may reflect higher costs, higher prof- its, or both. Given the vaccine industry's recent pricing trends, under- valuation is a phenomenon that applies principally to older, routine vac- cines. FINDINGS The amount that the nation spends on vaccines appears to be insig- nificant compared with that spent on other medical and social interven- tions that may have lesser social benefits. While federal and state govern- ments must address the vaccine line item as an expense to be managed, a commitment of resources substantially higher than current levels may be justified to address persistent breakdowns in the vaccine system. The relationship between financial returns to the vaccine industry and future investment in production capacity and R&D is a fundamental con- cern addressed by this study. While proprietary industry information was not available to the committee, a large body of indirect and secondary evidence suggests that high development and production costs and stable revenues have constrained investments in new products within the vac- cine industry as a whole. While many new candidate vaccines are in early stages of development, the overall level of investment in vaccine products is too low to support the level of R&D that is desirable in light of the social benefits of immunization. The committee finds that The U.S. vaccine market is small relative to total expenditures on personal health services and pharmaceuticals. The entire global market for vaccines is roughly equivalent to the sales of certain individual block- buster drugs. The supply of U.S. vaccines is becoming highly concentrated, re- sulting in limited backup capacity in the event of supply disruptions. Inadequate build-up of vaccine stockpiles has limited their reme- dial effect on recent shortages. The development of 6-month stockpiles would help avert short-term disruptions in supply but would not address more fundamental concerns, such as the continuing loss of suppliers from the industry. The risks and costs to manufacturers associated with vaccine pro- duction have increased. Key factors include regulation, removal of the preservative thimerosal, and an increase in vaccine injury lawsuits.

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VACCINE SUPPLY 143 FDA resources for vaccine regulation have not kept pace with the growth and complexity of vaccine products. FDA regulation has shifted from a focus on science to a focus on enforcement. This shift may increase the risks and costs associated with vaccine production without increasing safety. The pace of vaccine R&D, particularly in the discovery stage, is currently high, but commercial development is impeded by pricing and industry returns. Investment in production capacity for existing vaccines is especially problematic. FDA licensure requirements including the increasing size of clini- cal trials, the requirement that companies build full production capacity before licensure, and the inadmissibility of clinical data from outside the United States for U.S. licensure create substantial barriers to entry. The requirement for building full plant capacity in advance of ap- proval may limit fixed capacity and increase the chances of shortages. Vaccine company investments in R&D on new vaccines are sensi- tive to prices and expected returns on investment. Ensuring socially de- sirable levels of R&D may necessitate prices that are substantially higher than current prices for most routine childhood vaccines. By using its bargaining power to achieve substantial discounts in federal contracts, CDC may substantially undervalue vaccines and reduce industry incentives for investment in both R&D and short-run production capacity.

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