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Drug price hikes spark investor demand for socially responsible innovation

Just over a year after President Donald Trump said pharmaceutical companies are "getting away with murder," the political risk around drug pricing is adding fuel to increasing investor concern that price hikes could hide unsustainable business models.

The White House's Council of Economic Advisers released a paper on Feb. 9 outlining a range of goals to reform the industry's pricing model. Lawmakers have explored drug pricing actions and even discussed regulations with the White House, but no concrete moves have been made.

Drug pricing practices now play into analyst recommendations on different investments, said Chris Delpi, healthcare analyst and vice president at 1919 Investment Counsel, an asset management group and sustainability-focused subsidiary of Stifel Financial Corp.

"It's up to us to do that, because from a society perspective it's the right thing to do," Delpi said in an interview.

It is also smart investing, he said. "From a cost perspective, you really risk sticking your head up and getting it lopped off by some sort of congressional action."

While there is no legislation on the table yet, many investors have already joined the chorus of patients and politicians complaining about rising drug prices. The investors are concerned that the frequency and magnitude of some increases masks a lack of innovation, which could endanger the longer-term sustainability of these businesses.

"You can see that it's going to be a question that healthcare companies are going to have to answer," said Les Funtleyder, healthcare portfolio manager at asset manager E Squared Capital LLC and author of Healthcare Investing: Profiting from the New World of Pharma, Biotech, and Health Care Services. "It's also driven in part by the new investors. Millennials are starting to have more investable assets, and they're demanding products like this."

Influential investors are catching on. Toward the end of 2017, the chairman and CEO of asset management giant BlackRock Inc. issued a letter to companies in the group's multitrillion-dollar portfolio urging them to make positive contributions to society.

Vanguard Group Inc., the largest mutual fund manager in the U.S., has also scaled up efforts to address issues in board structure, compensation and long-term value. The group's investment stewardship team — those focusing on these issues — has doubled since 2015, spokesperson Carolyn Wegemann said. Vanguard also voted for two climate change-related shareholder proposals last year, a first for the company and a move that led both Exxon Mobil Corp. and Occidental Petroleum Corp. to disclose more climate risk information.

Shareholders: Price hikes mask slow innovation

Price hikes accounted for at least 100% of net income growth for seven pharmaceutical companies in 2016 and a significant chunk of revenue at a range of other drugmakers, according to an April 2017 report by Credit Suisse analysts. While these increases mitigated the impact of drug patent expirations in 2012 and 2013, companies continue to rely on them for sales growth, Credit Suisse said.

That has some investors demanding that companies invest more in developing new medicines, which would boost profits and meet patients' needs. The Interfaith Center on Corporate Responsibility, a shareholder coalition also known as ICCR, is delivering resolutions targeting executive pay to five of the seven companies mentioned in the Credit Suisse report: AbbVie Inc., Amgen Inc., Biogen Inc., Bristol-Myers Squibb Co. and Eli Lilly and Co.

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The group is also requesting pricing strategy reports from Pfizer Inc. and Vertex Pharmaceuticals Inc., but not linking those resolutions to executive compensation packages. Except for Vertex, the targeted companies are among the 10 biggest U.S. drugmakers by market value.

ICCR counts about 300 institutional investors among its members and had an endowment of more than $1.2 billion in 2017, with contributions from J&J, Abbott Laboratories, Merck & Co. Inc. and Pfizer in that year. In the 2017 proxy season, ICCR filed 283 resolutions with 165 companies, ultimately withdrawing 28 of those as they struck agreements tied to their goals, such as Exxon's appointment of a climate scientists to their board and Wells Fargo & Co.'s split of the CEO and board chair roles.

"It really concerned us that companies were raising their drug prices, sometimes twice a year, 10% at a time," said Cathy Rowan, director of socially responsible investments for Trinity Health, a Catholic hospital network and member of the ICCR shareholder initiative. "If a company is making its money that way, what does it say about its sustainability over the long haul?"

It is not always a price hike that can put a pharmaceutical company in the line of fire. Allergan plc, which had just a year earlier pledged to cap annual price increases, drew criticism last summer after an unprecedented deal with the St. Regis Mohawk tribe put its patents for the blockbuster dry eye drug Restasis behind the tribe's sovereign immunity shield.

The attempt to ward off generic competition that would dent the product's price ultimately did not succeed, but it did attract public notice and criticism.

"These are the types of things that really give the industry not just a black eye, but really hurt the multiples of the industry, from an investment standpoint," Delpi said.

By focusing on management pay, the ICCR-led shareholders' coalition hopes not just to highlight drug price increases, but companies' allocation strategies and governance as a whole. Revenue gains should be invested in research and development, said Donna Meyer, director of shareholder advocacy for coalition member Mercy Investment Services, an asset manager for the international order of nuns known as the Sisters of Mercy.

"It is too great a risk for all of the shareholders if all of the increased revenue goes towards compensation instead of reinvestment in the company," said Meyer, who also led a recent shareholder campaign on opioid controls. "If they are depending on all their increase in revenue to come from price increases, that is not a sign of good health for these companies."

While Vanguard does not comment on sector-specific issues, Wegemann said it does see performance-based executive compensation as one of its general priorities even outside of ESG.

R&D and access to drugs

Sustainable, innovative research and development is a critical factor in the biannual pharma ranking by the Amsterdam-based Access to Medicine Foundation, a nonprofit that evaluates 20 international drugmakers on pricing, product accessibility and progress on unmet medical needs.

In R&D specifically, two of the shareholder coalition's targeted companies, Lilly and Bristol-Myers, scored low on foundation's Access to Medicines Index, ranking 18th and last in a group that included a range of U.S., European and Japanese pharma companies.

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"The thing that distinguishes between a leader and a laggard in this particular area is how much a company targets priority gaps," Jayasree Iyer, the foundation's executive director, said in an interview. These gaps are highlighted needs, such as infectious disease vaccines and treatments, in low- and middle-income countries; in the next year, the foundation is also looking to add prevalent cancers to its calculations.

Bristol-Myers has a small portfolio when it comes to these high-need areas, with just 16 relevant products and a pipeline of five R&D projects that fit into the index's scope, according to a November 2016 analysis. The majority of its focus is in non-communicable diseases, which could help in later ratings, but the foundation's R&D ranking also factors in research partnerships and openness on clinical data, areas where Bristol-Myers also scored poorly.

Meanwhile, Lilly has the smallest relevant pipeline according to foundation's calculations, with just one R&D project during the report's time period that fit low- and middle-income countries' needs: the diabetes medicine Trulicity. While Lilly is strong when it comes to sharing data, the company actually fell in the ranking this year with no clear R&D targets in the high-need areas.

The list of pharma investors pledging support to index has grown steadily each year, topping 60 organizations managing $5.5 trillion in the latest count, which includes coalition members such as Mercy and the ICCR, a range of asset managers and a few major corporations such as luxury retailer Hermes.

"Investors are interested in emerging market behavior and emerging market incentive, and are also looking at more business-related initiatives that also have a social impact," Iyer said. "You see that the companies are following."

The argument from a social standpoint is clear, Mercy Investment's Donna Meyer said: People need affordable drugs.

"But then if you look at this from a financial standpoint, we want these companies to be successful five, 10, 15 years from now," she said. "And the only way they're going to sustain themselves is if they develop new products and new markets."