PHARMACEUTICAL AND BIOTECHNOLOGY UPDATE

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1 Pharmaceutical and Biotechnology Update August Hogan & Hartson LLP PHARMACEUTICAL AND BIOTECHNOLOGY UPDATE Risk-Sharing and Other New Business Models for Pharmaceutical Companies in Germany. The German Federal Law to Increase Competition among Statutory Health Insurance Funds from April 1, 2007 has ushered in major changes regarding the way pharmaceutical companies do business in Germany. Statutory health insurance funds, which cover approximately 90 percent of the population in Germany, now have considerable influence on sales of pharmaceutical products. Based on greater freedom and certain incentives offered by the new law, statutory health insurance funds have started to negotiate contracts directly with pharmaceutical companies regarding drugs available to their members. Thus, these health insurance funds have become important business partners whose needs pharmaceutical companies must address when developing new distribution structures. In the first year after the new law came into force, attention was focused mainly on discount agreements for certain generics or entire lines of generic drugs on the one hand and a few innovative drugs that were affected either by the expiration of patent protection or by the elimination of health insurance funds reimbursement obligations on the other. Current discussion revolves around complex business and contractual models regarding patented drugs. For pharmaceutical companies, the thrust of such innovative contractual models lies beyond the pure negotiation of discounts and minimal sales amounts in the company s role as a service provider and system partner in the development of quality and cost efficient healthcare models. Health insurance funds are similarly interested in the creation of efficient healthcare systems because as of 2009, German law will provide one standard fixed premium for all statutory health insurance schemes. New market competition among statutory health insurance funds will center not only on financial benefits for their members but also on the quality of healthcare services provided. In this way, health insurance providers and pharmaceutical companies are joined by a common interest to cooperate closely and create market advantages based on price and quality with the help of innovative healthcare models. In addition, both parties may benefit from pioneering advantages if they are the first among their competitors in the current competition for development and implementation of new provider systems. Three contract models of a new generation have evolved out of these strategic needs and been used so far in pilot projects. These, risk-sharing agreements, added-value agreements and managed care models will be discussed in the following on the basis of concrete examples. These models can essentially be seen as precursors on the way to public private partnerships. Although this concept is relatively new in Germany, successful public private partnerships have recently been set up in the public hospital sector too. These may serve as a TAKE A CLOSER LOOK Hogan & Hartson lawyers and specialists, Meredith Manning, Elisabethann Wright, Randy Prebula, and Brian McCormick to speak at Annual RAPS Conference & Exhibition. (details) Hogan & Hartson Partner Linda Horton and Associate Hector Armengod to speak at 8th Annual EU Pharmaceutical Law Conference. (details) Hogan & Hartson Partners, Alice Valder Curran and Mitchell Lazris to speak at 13 th Annual Summit on the Medicaid Drug Rebate Program. (details)

2 Pharmaceutical and Biotechnology Update August model for future cooperation between pharmaceutical companies and statutory health insurance funds. Risk-Sharing Agreements Risk sharing agreements are based on a guarantee given by the pharmaceutical company that a certain innovative drug will be effective. The pharmaceutical company gives the guarantee by assuming part of the financial risk of an unsuccessful therapy. The obligation of the statutory health insurance fund to pay for the therapy is connected to the efficiency of the drug. The pharmaceutical company reimburses the health insurance fund for all related medication costs if the therapy does not reach a certain degree of success within a certain time period. In the case of cost-sharing agreements, a special type of risk-sharing agreement, the pharmaceutical company is obligated to reimburse the cost of medication insofar as the amount of medication given to a patient for a certain condition exceeds a certain previously agreed amount within a certain amount of time. The first risk-sharing agreements were concluded in the UK. In 2002, three pharmaceutical companies concluded a contractual agreement with the British National Health Service (NHS), pursuant to which they agreed to reimburse certain amounts to the NHS for certain drugs used to treat multiple sclerosis if such therapy remained unsuccessful. In June 2007, Johnson & Johnson closed a risk-sharing agreement with the NHS pursuant to which the pharmaceutical company was obligated to reimburse the public health care provider for the costs of Velcade, a cancer drug used in the treatment of multiple myeloma, if therapy using that drug did not prove effective (as set out in the terms of the contract) within a certain period of time. In Germany, the first risk-sharing agreements were made in fall 2007 among Novartis and the two statutory health insurance funds German Employee Fund (DAK) and Barmer Fund (BEK). According to the terms of the contracts, Novartis is obligated to reimburse pharmaceutical costs to the health insurance funds if within twelve months of treatment for osteoporosis with Aclasta, the patient experiences bone breakage or in case of a kidney transplant using Sandimmun Optoral, Myfortic and/or Certican, the organs are rejected. Roche offered insurance companies a cost-sharing agreement entailing full or partial reimbursement by the pharmaceutical company in case treatment for breast cancer or renal cell carcinoma using the drug Avastin exceeded a certain total dosage over a certain period of time. While participating health insurance funds look for competitive advantages by offering their insurance takers access to innovative drugs, pharmaceutical companies are interested in increased market share due to higher sales. However, reaching and sustaining higher sales volumes with risk-sharing agreements is tricky. It may help to fit physicians into the equation by combining these contracts with other innovative healthcare models. A further difficulty in connection with these contracts is clearly defining the condition which would trigger the pharmaceutical company s obligation to assume or reimburse costs (i.e. unsuccessful therapy). Above all, the contract must protect the pharmaceutical company from payment obligations if the therapy is unsuccessful not because the drug was ineffective, but for other reasons like non-compliance or as a result of some other risk-increasing behavior on the part of persons involved in the treatment. Risk-sharing agreements are therefore primarily interesting for those medical conditions for which the success or failure of the treatment is relatively easy to assess.

3 Pharmaceutical and Biotechnology Update August Since statutory health insurance funds fulfill their legal mandate by concluding risk-sharing agreements, these are legally only admissible as supplemental agreements in connection with discount agreements pursuant to Art. 130 a para. 8 German Social Code part V (Sozialgesetzbuch V/ SGB V ). For this reason, they may be concluded only if they fulfill the conditions set out for discount arrangements. Among other things, health insurance funds must adhere to strict bidding process requirements. Civil courts uphold that contracts exceeding a value of 211,000 must adhere to the restrictions for awarding contracts under Sections 97 et. seq. German Act against Restraints of Competition (Gesetz gegen Wettbewerbsbeschränkungen/ GWB ) as well as under the Contracting Rules for Services Provided (Verdingungsordnung für Leistungen/ VOL/A ). Added-Value Contracts Added-value contracts are best implemented regarding chronic diseases such as diabetes, rheumatism, high blood pressure or respiratory illnesses. Here, pharmaceutical companies offer lower discounts, but also provide health insurance funds with additional services to ensure optimal medical treatment. In this way, pharmaceuticals compete to offer the best treatment concepts rather than simply the lowest prices. Of central importance are system solutions comprising the actual product, but also advisory services, training and further services which allow for added value by way of overreaching treatment concepts. Such additional services whose value is taken into account when calculating discount amounts include, for instance, nutritionist services, seminars on how to quit smoking, the development of therapy guidelines or treatment methods, laboratory tests or services to improve patient compliance. As in the case of risk-sharing agreements, the inclusion of the physician in charge is of central importance. It thus makes sense to combine these contracts with other innovative healthcare models. An example of a value-added contract can be found in the German Initiative for the General Medical Treatment of Dementia, in which the National General German Health Fund (AOK), the Regional Bavarian General Health Fund (AOK Bayern), Pfizer and Eisei work together to develop an indication-based treatment concept. The initiative aims to defer admittal into nursing homes as long as possible by improving the treatment given to dementia patients by general physicians and relatives caring for them at home. Services provided by pharmaceutical companies to improve treatment by developing and implementing care management include comprehensive informational services for participating physicians as well as affected patients and their families. A further example of a value-added contract can be found in the cooperation between the German Company Health Fund (BKK) and Sanofi-Aventis which covers thyroid hormone drugs grouped together under the brand name Henning. In addition to discounts and other measures, this agreement provides for an informational campaign by the pharmaceutical company for the early detection of abnormal changes in the thyroid gland. Similar to risk-sharing agreements, added-value contracts legally qualify as supplemental agreements in connection with discount arrangements pursuant to Art. 130 a para. 8 SGB V. Thus, the same bidding procedures as described above are legally required.

4 Pharmaceutical and Biotechnology Update August Managed Care Models Managed care models are integrated systems to coordinate the provision of health care for health insurance members in which statutory health insurance funds, healthcare service providers and pharmaceutical companies may participate. These new healthcare models are designed to improve the quality and economic efficiency of medical services by coordinating processes and structures. In Germany, pharmaceutical companies may participate primarily in the following managed care models which can be combined with risk-sharing or added-value contracts: integrated healthcare, general physician-based healthcare and disease management programs. Integrated Healthcare In the scope of integrated healthcare models which were introduced in Germany in 2000 with the new legislation contained in Arts. 140 a et.seq. SGB V and further developed with a major health care reform in 2004 individual sectors of medical care are integrated into a network. This integration serves to improve coordination among general physicians, specialized doctors, clinics, physical therapy centers, home health aids, and other healthcare providers. These parties cooperate in treating each patient and share a common budget. This type of organized treatment enables cross-sector exchange of patient-related information, eliminates redundancy and enables statutory health insurance funds to offer their insurance takers one high-quality and economical healthcare service package. These healthcare models usually operate regionally and can either be indication-oriented (to treat widespread diseases such as diabetes, strokes or intervertebral disk-related injuries and illnesses) or be geared to supply a certain population with fully integrated healthcare. Statutory health insurance funds may enter into integrated healthcare model contracts with certain parties set forth in Art. 140b SGB V. This list enumerates several healthcare service providers and management companies (who offer an integrated care package of such healthcare service providers). Pharmacies and pharmaceutical companies are explicitly excluded from this list. While the inclusion of pharmacies into integrated healthcare models is covered by Art. 129 para. 5b SGB V, Art. 140 a para. 1 SGB provides that pharmaceutical companies may only participate in integrated healthcare models and supply necessary medication for related out-patient treatment by entering into discount arrangements pursuant to Art. 130a para. 8 SGB V. The industry is thus precluded from directly participating in contracts to provide integrated healthcare. Pharmaceutical companies may, however, participate in such models indirectly, not only via added-value or risk-sharing agreements on the basis of discount contracts, but also by participation in management companies which assume coordination of these new healthcare structures. As for compensation, Art. 140c SGB V allows integrated healthcare participants a great deal of leeway. In cases of complex healthcare structures, existing compensation methods such as the uniform valuation standard and diagnosis-related groups may be complemented by surcharges for certain additional services and participation in savings potential. Currently, over 5,000 contracts regarding integrated healthcare exist in Germany. Of these, most are indication-related. For example, the German Company Health Fund (BKK), together

5 Pharmaceutical and Biotechnology Update August with the regional doctors network alliance in southern Lower Saxony and an additional regional medical association, has developed a treatment method for patients with reflux and concluded integrated healthcare contracts to this end. These contracts are set up on the basis of a discount arrangement concluded with AstraZeneca for its patented stomach drug, Nexium. In the Kinzigtal region in the German state of Baden-Wuerttemberg, a population-based fully integrated healthcare system was put into place. It is notable that this model, known as "Healthy Kinzigtal," includes the participation of pharmaceutical companies. In November 2005, the regional statutory health insurance fund AOK Baden-Wuerttemberg and the Agrarian Health Fund (LKK) set up a cross-sector fully integrated healthcare for around 30,000 AOK and 2,000 LKK members for a nine-year term. For this, two other parties, Optimedis AG, a private company specialized in integrated healthcare and a local doctor's organization (Ärztenetz Medizinisches Qualitätsnetz Ärzteinitiative Kinzigtal e.v.) founded Healthy Kingzigtal GmbH as a management company pursuant to Arts. 140a et.seq. SGB V. After an initial start-up financing, the company is now funded solely by the amount of costs saved as compared to normal costs of healthcare for the total population of AOK's insurance policy holders in that one defined region. On the basis of a long term savings contracting, all parties involved have an interest in maintaining maximal efficient healthcare for the term of the contract. Central components of the pilot project comprise specific programs developed by pharmaceutical companies for certain risk groups and the systematic implementation of preventive medicine, whereby the physicians responsible play an active and central role. For instance, Pfizer has developed a program to quit smoking, and Berlin-Chemie developed a regime to prevent diabetes. Although the pharmaceutical companies participate on the basis of discount contracts with the management company which concludes such contract on behalf of the statutory health insurance funds pursuant to Art. 130 a para. 8 SGB V, they do so not purely as a drugs supplier, but rather as a provider of long term system solutions, including such services as doctor and patient training and communication of research results. Similar models are currently planned for other regions in Germany. The European Court of Justice will, hopefully before the end of this year, decide on the basis of a motion made by the German District Court of Duesseldorf whether or not statutory health insurance funds award a public contract in the sense of Sec. 99 GWB as a public company in the sense of Sec. 98 GWB when concluding integrated health care contracts. Until the European Court of Justice delivers its opinion, there is legal uncertainty. There is a risk that integration contracts concluded without first holding a formal bidding procedure may be considered null and void or subject to termination and that statutory health insurance funds may be liable for damages. General Physician-Based Healthcare Since April 1, 2007, all German statutory health insurance funds have to offer the general physician-based healthcare set out in Art. 73b SGB V. It may be coupled with risk-sharing or added value contracts on the basis of discount contracts. This is a single-sector model subject to public bidding procedures based on individual contracts between statutory health insurance funds and registered doctors. The model is designed to achieve increased efficiency and quality of health care by using standards tailored to general physicians like guidelines especially designed for general physicians or training and implementation of quality management. Insurance policy holders may voluntarily participate in a general physician

6 Pharmaceutical and Biotechnology Update August model. In return for lower premiums, the policy holder is, in case of illness, obligated to consult first only one specific certain general physician chosen by the patient, and not a specialist. In May 2008, after initial bidding procedures, the AOK Baden-Wuerttemberg signed an agreement for general physician-based healthcare with the regional general physicians' association, a further medical association (MEDI), and individual participating general physicians. There are plans to consolidate this model with further tailored health care forms and elements such as integrated health care and discount contracts. Disease Management Programs Disease management programs are cross sector treatment programs supported by general guidelines regarding chronic widespread diseases (such as diabetes, breast cancer, coronary heart disease, asthma, chronic obstructive pulmonary disease) whose qualitative prerequisites are legally determined in a regulation by the German Federal Ministry of Health on the basis of general recommendations made by the Federal Joint Committee which includes representatives of healthcare service providers and health insurance funds. The concrete structure of each program is the subject of negotiation for any given region between statutory health insurance funds and healthcare service providers. They can be combined with models of integrated healthcare and the types of discount contracts described above. In the scope of the North German Heart Network, a cooperation between different statutory health insurance funds and over 200 registered general physicians, specialists, clinics, physical therapy centers and other healthcare service providers for the improvement of healthcare for patients suffering heart diseases, all therapists work on the basis of coordinated therapy and treatment concepts whereby a combination of disease management programs and integrated health care is available. Public Private Partnerships When analyzing these new contract models for cooperation between pharmaceutical companies and statutory health insurance funds, certain parallels to public private partnerships (PPPs) come to light. These are especially prevalent in the area of public infrastructure projects (building construction, transportation, public supply and waste management). Over the past few years, public private partnerships in the area of healthcare have also been developed and implemented in Germany. In this field, PPP models have been created in which medical device and instruments manufacturers have actively participated not only as suppliers, but as a system providers. In this way, a company in which both construction company Bilfinger Berger and Siemens are shareholders received a contract from the German state of Schleswig- Holstein to plan, finance, build and operate over a period of 25 years a state of the art particle therapy center in Kiel with a total investment volume of 250 million. The essential characteristics of public private partnerships in the area of infrastructure are: (i) cooperation among public and private partners for the fulfillment of a public mandate with the common goal of saving costs by increasing efficiency, (ii) coordination by way of a project company of the different resources needed to complete the project contributed by the partners, (iii) the allocation of risks associated with the project to those partners who can best assess and influence them and (iv) the long term nature of the cooperation among the partners

7 Pharmaceutical and Biotechnology Update August involved. PPPs are most often motivated by public budget restrictions connected with increased competition among affected public companies. These characteristics present a strong argument that the PPP concept may prove a feasible model to help statutory health insurance funds improve and innovate the way in which they fulfill their public mandate. The new models of cooperation between the pharmaceutical industry and health insurance funds described above fulfill several of, and in the case of integrated healthcare virtually all of the characteristics of a PPP. In the "Healthy Kinzigtal" pilot project, statutory health insurance funds work together as public companies with non-public healthcare service providers and pharmaceutical manufacturers to fulfill their public duties (planning, financing, building and operation of structures to provide medical care to its members) while benefiting from synergies in order to provide more efficient service and earn profits by rationalization. The resources contributed by each party are coordinated through a management company, the project risks are shared among the partners and the cooperation is of a long term nature. The reasons for developing the new healthcare models (necessity to improve the statutory health insurance funds' competitiveness due to increased cost pressure) are similar to those which motivated classic public private partnerships, for instance in the public hospital sector. If these new models of integrated healthcare are combined with risk-sharing agreements, pharmaceutical manufacturers can give a quality guarantee for the effectiveness of their drugs and in so doing assume the risk that they can best assess and influence. If pharmaceutical companies also become shareholders in a management company, all the characteristics of a classic PPP are given. The drug manufacturer will then not participate on the basis of a mere discount contract, but rather as a shareholder involved in the strategic development, design, chances and risks of the entire project. Thus, pharmaceutical companies can increase their part in developing integrated healthcare models to include know-how in project management and financial participation. The management company can then assume the role of a project company whose shareholders each carry out a certain area of the project contract with the statutory health insurance fund themselves. One typical PPP model which may prove useful in further developing innovative cooperation models between statutory health insurance funds and pharmaceutical companies is the contracting model used routinely in the area of energy supply. Here, a private project company provides the public contractor with planning, financing, and implementation of energy-efficient supply and receives in turn at least a portion of the costs saved in addition to a fee for the supply of energy and related services. Like all PPP arrangements, the contracting model can also be structured as a company model, meaning that the public contractor may also be a shareholder in the project company. When structuring a cooperation between pharmaceutical companies and statutory health insurance funds in the form of a PPP in Germany, there are as in the cooperation models described above, numerous legal provisions that require attention. These influence the contents of the individual contracts and can restrict contractual freedom. Aside from general contractual, company law and liability issues, labor law and tax aspects, there are provisions of German social law (SGB V), competition and anti-trust law, laws restricting medical advertising, drug laws, pharmacy regulations and data protection laws to consider. Of special importance for the legal structuring are those laws which include limitations on the cooperation among

8 Pharmaceutical and Biotechnology Update August pharmaceutical companies, doctors and health insurance funds. In addition to the doctor's professional code of conduct, the German anti-corruption law must be taken into account. Also, the code for all members of the association for voluntary self-control of the drug industry in Germany may apply. Finally, pharmaceutical companies with connections to the US must always keep the provisions of the US Foreign Corrupt Practices Act in mind. For instance, Arts. 32, 34 of the German doctor's professional code of conduct which are designed to protect the doctors` independence require that any payments to doctors such as bonus payments, discount arrangements or participation in cost savings must be structured so that the doctor receives them only from the health insurance fund or from the management company acting on its behalf but not from the pharmaceutical company, and not for the prescription of a certain medication, but rather only for the doctor's economic efficiency. Doctors must at all times have the freedom to prescribe any drug, even those not included in the contractual arrangement. To the extent doctors participate as shareholders in the management company or may in any other way exercise influence on the management company's business, contracts between the management company and the pharmaceutical company may not contain any provision which may be construed as a benefit granted by the drug manufacturer to the management company for the promotion of sales of a certain drug vis-à-vis any doctor. If doctors and pharmaceutical companies are shareholders of a management company, it may prove sensible - from a professional point of view and due to liability issues - to limit its responsibilities to a purely coordination and documentation function. Mutual obligations to perform services between each of the management company, doctors and pharmaceutical company on the one side and the health insurance fund on the other should be addressed, on the basis of a common framework agreement, in legally separate and direct contractual relationships exclusively between the respective participating parties. For further information please contact: HENNING MENNENOEH hmennenoeh@hhlaw.com Munich, Germany This Update is for informational purposes only and is not intended as basis for decisions in specific situations. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Copyright 2008 Hogan & Hartson LLP. All rights reserved. Hogan & Hartson LLP is a District of Columbia limited liability partnership with offices across the United States and around the world. Some of the offices outside of the United States are operated through affiliated partnerships, all of which are referred to herein collectively as Hogan & Hartson or the firm.