By Dennis Purcell, founder and senior advisor, Aisling Capital LLC
Back in the 1840s, when the U.S. was primarily an agrarian society, the concept of a futures market for commodities was introduced. At the end of harvest season, when farmers brought their agricultural or meat products to Kansas City and Chicago, the supply of goods coming to the market at the same time put a downward pressure on prices and made it challenging for producers to obtain reasonable prices and achieve a satisfactory lifestyle. There needed to be a mechanism whereby the producers could attain some certainty over future prices for their products. The producers wanted some stability, while plenty of investors and speculators sought opportunity. A two-sided futures market was created.
Fast forward to the 1970s. The oil shock created by OPEC threatened the U.S. with an impossible future of ever-rising prices and chronic shortages. Consumers waited for hours to put gasoline in their cars. The price of a barrel of oil went from $20 in July 1973 to $50 in July 1974. The government was at a loss as to how to handle the demand/supply imbalance. The answer to the problem, once again, came in the form of a futures market that was created in energy, allowing for industry participants to sell their products for future delivery and for buyers of fuel to lock in supply. Even though the price of a barrel jumped from $15 in 1998 to nearly $150 in 2012, the price of gasoline at the pump only went from $1.06 to $3.64.
Why? The natural participants and the investors/ speculators were able to come together and create both stability and opportunity in that market. Once future demand was evidenced by this trading, the industry was able to ramp up exploration and production knowing that the product that would be created was already sold. Instead of needing high -risk venture capital to finance expansion, the industry was able to borrow against future demand. Airlines began to manage their cost of fuel, and oil producers could manage their future profitability by locking in a fixed price. Today the price of a barrel of oil ranges between $40 and $50 per barrel. The United States consumes approximately 7 billion barrels of oil per year, implying a market size of approximately $300 billion annually. The futures market in oil has matured significantly.
Most other industries have followed suit. Today there is a futures market for virtually every sector of the economy. There are equity, bond, currency, precious metals, and industrial metals futures. In many industries, the products are organized on a vertical basis, whereby there is a futures market available for those who are interested in a particular type of product. There is no metals future; rather, you buy futures in gold, silver, aluminum, copper, etc. There is no agricultural future; rather, you buy futures in corn, soybeans, wheat, or cotton.
HEALTHCARE NEEDS TO EVOLVE INTO VERTICAL SEGMENTATION
Healthcare is one of the few industries organized in a horizontal manner. Let’s look at two recent events concerning immuno-oncology and Alzheimer’s disease. Bristol-Myers Squibb (BMS) shed nearly $28 billion in market value recently after the surprise failure of its immuno-oncology drug Opdivo, yet the company has many other products on the market and in its pipeline. Considering this was just a trial result, the marketplace reaction wasn’t related to the profitability of BMS, but rather the disappointment of the failure of a potential new cancer treatment.
BMS is not a pure play in immuno-oncology, much like Biogen is not a pure play in Alzheimer’s disease. After announcing positive Phase 2 results for its compound aducanumab, Biogen’s market value increased by $12 billion, or more than 10 percent. Its stock price came right back down a few days later because the results were only interim results, years away from commercialization. Investors really did not want to invest in Biogen; they wanted to invest in Alzheimer’s treatments, but currently there is no financial instrument representing Alzheimer’s treatment.
Again, this is because the industry is organized horizontally. All Big Pharmas have products across the entire spectrum of healthcare. The financial tools are also organized horizontally. There are funds that invest in Big Pharma, biotech, diagnostics, generics, and medical devices. All of these cover all sectors. But the patients (i.e., customers) are consuming goods vertically. A cancer patient is given the cancer diagnostic, pharmaceutical, device, and generic.
So why hasn’t the healthcare industry evolved into vertical segmentation like other industries? Until now, it’s because there has been no systematic way to hedge/ transfer either institutional or operating risk in the healthcare system because information gathering and delivery are generally limited and poorly organized. So, without a way to hedge, anticipated cost volatility must be built into operating margins (as a cushion against cost fluctuations). This has generally contributed to inefficiencies, perverse incentives, high barriers to entry, and reduced competition, all of which have led to higher costs. Healthcare today requires a capital market that recognizes these trends and provides its industry participants and investors the opportunity to hedge against future price fluctuations. In an industry that is 10 times larger than the oil industry, we must adapt like other industries.
A SOLUTION THAT STARTS WITH THE DIABETES MARK
I believe it is time for healthcare to become organized on a vertical level, and the first thing to do is systematize risk in the diabetes market by using futures contracts. The aggregate cost of treating diabetes and its comorbidities is estimated to be in excess of $400 billion on an annual basis just in the United States. I propose to use per-patient cost data (much like a “spot price”), delivered on a consistent and timely basis, verified by an independent and reputable third party, to create market-based methods and financial vehicles to hedge and transfer risk. In other words, it’s a futures market based on the cost of treating diabetes.
Who would benefit from such a market? First, payers of diabetes care, such as insurance companies, self-insured corporations, and governments and individuals who consume diabetes care, could utilize a futures market to cushion against future pricing shocks and thereby employ a more uniform and consistent standard of care. Second, suppliers of diabetes care, such as treatment centers, dialysis providers, hospitals, and other medical professionals, could protect operating margins, obsolescence, and patent expirations through hedging mechanisms. Third, patients who are looking for greater efficiency in the system could own financial vehicles that reflect the economic performance of their disease. And, fourth, investors, banks, and asset managers could obtain exposure to a new asset class that has limited correlation with existing products.
Think of our recent experience in treating hepatitis C. The cost of direct treatment and associated comorbidities was rising during the last decade as more people contracted the disease. The approval of Harvoni and Sovaldi became game changers. The cost of treatment has gone up in the short term as new drugs are adopted, but in the long term, the cost will decrease, as we now have potentially a long-term cure for this debilitating disease.
New hedging techniques in the healthcare industry will be positive for us all. A more efficient allocation of costs and better and more predictable price discovery will offer the ability to expand services efficiently. In addition, Medicare and Medicaid will have a privatemarket counterpoint to help them manage their patient needs.
After proving that diabetes is a disease that can be effectively hedged, we can create other products that address serious disease states (e.g., Alzheimer’s disease, asthma). We thereby begin to bend the cost curve of the relentless increases in today’s healthcare system. It is time to shift healthcare from being solely a cost to the system to becoming an asset.