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Tax reform law could stimulate R&D, but big life sciences organizations don’t intend to boost overall wages or headcount

Health Care Current | November 13, 2018

This weekly series explores breaking news and developments in the US health care industry, examines key issues facing life sciences and health care companies, and provides updates and insights on policy, regulatory, and legislative changes.

My Take

Tax reform law could stimulate R&D, but big life sciences firms don’t intend to boost overall wages or headcount

By David Green, partner, life sciences and health care industry leader, Deloitte Tax LLP

Nearly 80 percent of large biopharmaceutical companies and medical device manufacturers expect to benefit from the Tax Cuts and Jobs Act of 2017 (TCJA), according to a survey of chief financial officers (CFOs) conducted by the Deloitte Center for Health Solutions. Sixty-five percent of surveyed CFOs said they intend to invest in research and development (R&D), followed by general business operations (55 percent). While few CFOs expect the TCJA will lead them to boost wages or add new employees, we expect the law could stimulate overall job growth in life sciences. More about that later.

While 10 months have passed since the TCJA was signed into law, 45 percent of large biopharmaceutical companies and medical device manufacturers are trying to understand the law’s implications, or are waiting for additional guidance from the administration, according to survey respondents. Along with changes to US tax law, many company leaders are also tracking new and emerging global requirements, which could have significant implications.

Expect more guidance before year’s end

Over the past several months, the IRS and US Department of Treasury have been issuing notices and proposed regulations that begin to answer questions and clarify some of the law’s provisions. While some guidance is being released every few weeks, there is no formal schedule, so we don’t know exactly what guidance to expect, or when to expect it.

Company leaders can’t make important decisions without guidance, which is causing some stagnation in their planning efforts. L.G. “Chip” Harter, the deputy assistant secretary for international tax affairs at Treasury, recently acknowledged that seven major packages of regulations—totaling about 1,000 pages—have yet to be processed. Guidance will likely start to flow more quickly as we close in on the end of 2018.

Between Christmas and New Year’s, I expect our tax teams will be poring over these new proposed rules and interpreting them for our clients.

Despite lower tax rate, some companies could see more costs

The tax-reform law reduced the statutory corporate tax rate from 35 percent to 21 percent. However, when combined with the law’s other provisions, the lower tax rate might not lead to significant savings for companies.

While the tax-reform law contains a number of benefits for life science companies—such as the ability to repatriate previously untaxed profits from overseas—some provisions could counter those benefits. Whenever taxes increase or decrease, we should consider the two main components of the equation:

  1. The tax rate: This is the percentage amount to apply to income subject to tax TCJA reduced the tax rate.
  2. The tax base: This is the amount to which the tax rate is applied. For some companies, the new tax law expands the base, which could result in additional tax costs rather than tax savings. 

However, even if a company’s tax rate doesn’t decrease, there could be a benefit to having fixed the cost of bringing previously untaxed profits back home.

Will tax reform fuel M&A?

In July, I suggested that merger and acquisition (M&A) activity would heat up among biopharmaceutical companies and medical device manufacturers. The presidential election in 2016 and tax-reform discussions in 2017 led many life sciences companies to postpone M&A decisions. Some health care deals had been stuck in regulatory limbo. M&A activity picked up in the first half of 2018 compared to the same period in 2017. The deals were also larger. M&A deals worth approximately $141 billion were announced during the first six months of 2018. During the same period in 2017, deals totaled about $105 billion.1 Approval of some acquisitions could create opportunities for combinations that hadn’t previously been considered.

Based on the first six months of the year, we expect that the amount of activity and the value of M&A activity among biopharma and device manufacturers will be about 12 percent higher this year compared to what we saw in 2017. According to our survey results, biopharma companies are more likely than medical device companies to invest any tax reform-related savings into M&A.

Notable US deals announced during the first half of 2018 include Sanofi’s acquisition of Bioverativ for $11.6 billion,2 Celgene acquiring Impact Biosciences and Juno Therapeutics for up to $7 billion and $9 billion respectively,3,4 and Novartis acquiring AveXis for $8.7 billion.5

Nearly 40 percent of our survey respondents thought tax reform would change the way they view M&A valuations. It’s worth noting that with a lower tax rate, tax attributes are not worth as much as they have been, and that could lower the value of a deal. However, projected future earnings might increase for targets experiencing a tax-rate reduction, and that could increase target valuations.

Few CFOs expect to add headcount

Lawmakers expected TCJA would prompt companies to increase wages and add more employees.6 But companies that have a stabilized operating model might not want to add significant numbers of new jobs. However, bigger investments in R&D, business operations, and capital projects could create different types of jobs. Companies that automate certain tasks and use data to improve efficiencies, for example, might need to hire talent to help leverage new technology to achieve their goals. Indirectly, companies that find themselves with additional operating cash flow might direct those funds to emerging areas—such as oncology or genomics—which could lead to new jobs. Moreover, a growing number of newly formed start-ups in the life sciences space could result in more jobs for the sector overall. 

While US tax reform will not impact all companies the same way, all life sciences companies are likely to face some level of strategic uncertainty. We recommend that CFOs consider the following:

  • Create or re-evaluate a tax-efficient operating model: Companies should reassess their manufacturing footprint and supply chain operations and determine if business, supply chain, and tax objectives are aligned.
  • Look to technology: Analytics, artificial intelligence (AI), data management, and enterprise resource planning system enhancements can bring greater efficiencies and insight to help enhance operational and financial models.7 Our survey suggests that many life sciences companies are already planning to invest in these areas.
  • Bring all the necessary stakeholders to the table: Our survey found that although R&D was one of the biggest areas of investment with the greatest likelihood of moving to the United States, just 35 percent of the companies surveyed involve R&D heads in strategic tax decisions. Involving relevant stakeholders can result in more effective decision-making.8
  • Plan for uncertainty: As global tax policies continue to take shape, companies should continue to adapt and strategically pivot. Companies should build scenario-planning capabilities leveraging newly available technologies to proactively address business risk and uncertainty.

For biopharma companies and medical device manufacturers, the tax landscape is shifting—both in the US and globally. While the US lowered corporate tax rates, some European countries might bring their tax rates down further—even while adding new taxes to income derived from intellectual property. In addition, some European countries are considering imposing minimum taxes for the right to sell products to patients in various geographic areas. Fifty-five percent of survey respondents see TCJA as just one of many new global requirements that they need to prepare for (and allocate resources to) as part of their long-term strategy.

PS: We’re hosting a webcast on November 19 where we’ll dive deeper into the tax law, the potential impacts from the mid-term elections, and developments in global trade policy. I hope you can join us!

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1 Deloitte analysis based on EvaluatePharma Data
2 Sanofi, Sanofi to Acquire Bioverativ for $11.6 Billion, January 22, 2018
3 Reuters, Celgene to buy Impact Biomedicines for up to $7 billion, January 7, 2018
4 Celgene, Celgene Corporation to Acquire Juno Therapeutics, Inc., January 22, 2018
5 Novartis, Novartis enters agreement to acquire AveXis Inc. for $ 8.7billion to transform care in SMA and expand position as a gene therapy and Neuroscience leader, April 9, 2018
6 The White House, The Wages of Tax Reform Are Going to America’s Workers, April 18, 2018
7 Maggie Zellers, Bob Norton, and Scott Shafer, The data dilemma: Tax reform’s new demands on life sciences, Deloitte, 2018
8 Deloitte CFO Insights, “Finance’s role in a collaborative life sciences industry,” Wall Street Journal, July 16, 2018


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In the News

Election results: Voters approve Medicaid expansion in three states

Several states had ballot measures to increase Medicaid eligibility. On September 6, voters in Idaho, Nebraska, and Utah approved expanding their states’ programs, while voters in Montana voted against a financing proposal for their existing expansion.

In states that have not expanded Medicaid eligibility, people with incomes up to 138 percent of the federal poverty level (FPL)—an annual income of approximately $17,000 for an individual or $25,000 for a family of four—do not qualify for coverage. In these expansion states, the state will pay 10 percent of the costs to expand eligibility, and the federal government will cover the remaining 90 percent—as called for by the Affordable Care Act (ACA).

  • Supporters of Idaho’s Medicaid expansion say the program will extend coverage to about 62,000 Idahoans. The state’s incumbent governor, Butch Otter (R) endorsed the expansion measure.
  • In Nebraska, an anticipated 90,000 people will now be eligible for coverage. Several pro-expansion advocacy groups supported Nebraska’s initiative to expand Medicaid. Nebraska Governor Pete Ricketts (R), who won re-election, campaigned against expansion.
  • Utah voters approved raising the state’s sales tax to fund the expansion, which supporters say will extend coverage to about 150,000 individuals.

Montana’s Medicaid expansion ballot initiative—which focused on how to finance the state’s share of the expansion cost—was not approved. The measure proposed raising taxes on all tobacco, including vaping products and e-cigarettes, and dedicating a portion of that tax revenue to Montana’s Medicaid program. The initiative also sought to eliminate the June 30, 2019 sunset date for the state’s Medicaid expansion. Although voters did not approve the measure, Montana lawmakers could act to continue the state’s Medicaid expansion beyond the sunset date.

CMS proposed rule would change Medicaid managed care network adequacy and other requirements

On November 8, the US Centers for Medicare and Medicaid Services (CMS) proposed revisions to the federal Medicaid managed care regulations, which were intended to relieve administrative burden and give states more flexibility. CMS collaborated with the National Association of Medicaid Directors (NAMD) on the proposed regulations.

Key updates proposed to the 2016 final rule focus on the following areas for improvement:

  • Promoting flexibility. The proposed changes would allow states to set network adequacy standards that incorporate new service delivery models, such as telehealth. It would give states greater flexibility to develop a payment rate for specific conditions, require a three-year transition period for states that want to move new services and populations into managed care, and make it easier for Medicaid managed care plans to communicate electronically with beneficiaries. It would also allow states to set network adequacy standards that incorporate new service delivery models, such as telehealth.
  • Increasing accountability. CMS said it intends to issue guidance to help states more seamlessly move through the federal rate-review process and reduce document submissions when appropriate.

CMS would maintain aspects of the programs’ existing regulatory framework, which includes provisions for determining the soundness of rate setting, provider screening and standards for enrollment, and medical loss ratio (MLR) standards. To protect taxpayers from cost-shifting, the agency proposes prohibiting states from retroactively adding or modifying risk-sharing mechanisms.

(Source: CMS, CMS Proposes Changes to Streamline and Strengthen Medicaid and CHIP Managed Care Regulations, November 8, 2018)

CMS proposes rule to strengthen oversight of insurance exchanges

On November 7, CMS released a proposed rule aimed at improving eligibility and enrollment processes in, state-based exchanges (SBEs), and states that use the federal exchange platform. The proposed rule would implement recommendations from the Office of Inspector General (OIG) and the Government Accountability Office (GAO), which audited the exchanges. The agencies, for example, identified weaknesses in the process used to determine eligibility for advance premium tax credits (APTCs) and cost-sharing reduction (CSR) payments. CMS says it wants to be sure enrollees are eligible for the subsidies they receive. Under the proposed rule, SBEs would be required to report annually. The agency would audit exchanges to make sure they comply with eligibility and enrollment processes.

CMS also intends to improve its data-matching processes around enrollment. These improvements would, for example, flag consumers who are enrolled in both Medicare and an exchange-based health plan.

(Source: CMS, CMS releases proposed rule to improve the integrity of the Exchange, November 7, 2018)

Specialty drug tiers are becoming more common among large employers

More than half (52 percent) of people who work for large organizations are enrolled in a health plan that includes a separate tier for specialty drugs—up from 43 percent in 2016, according to an analysis of the 2018 Kaiser Family Foundation’s (KFF) Annual Health Benefits Survey. The analysis, released November 6, was conducted by the online newsletter, Drug Channels. The analysis also determined that 51 percent of employer-sponsored plans had four or more tiers for drugs in 2018—up from 44 percent a year ago. Prescription drug plans give enrollees a financial incentive to choose less-expensive, lower-tier drugs. Members pay progressively higher copayments or coinsurance for drugs on higher tiers.

In addition to more drug tiers, enrollment in high-deductible health plans (HDHPs) with a savings option continues to grow among employer-sponsored plans, according to Drug Channels. In 2018, 29 percent of employees were enrolled in an HDHP—up from 4 percent in 2006. According to the analysis, 46 percent of employees who are enrolled in an HDHP have coinsurance for fourth-tier drugs, compared to 36 percent of those enrolled in other plans, meaning that they have much higher exposure to out-of-pocket spending.

KFF’s 2018 survey provides benchmarking data for 2,160 public and private employers, such as premiums and employee contributions, enrollment, and cost-sharing, among other topics (see the October 9, 2018 Health Care Current).

(Source: KFF, Premiums for Employer-Sponsored Family Health Coverage Rise 5 percent to Average $19,616; Single Premiums Rise 3 percent to $6,896, October 3, 2018; Drug Channels, Employer Pharmacy Benefits in 2018: More Tiers, Greater Coinsurance, and Lots of High-Deductible Plans, November 6, 2018)

FDA launches a new, open-source app to help researchers gather real-world data

On November 7, the US Food and Drug Administration (FDA) launched a new app, MyStudies, to gather patient data for use in clinical trials. FDA released the MyStudies app to the public so researchers can tailor it to their research needs. Using a mobile device, patients can upload their data into the app. Researchers can then link those data to other electronic health information to support clinical trials and observational studies. The app runs on multiple operating systems.

According to Deloitte’s 2018 survey on real-world evidence benchmarking survey, data generated from patient wearables or health apps could provide new, helpful insights into disease progression, treatments, and patient benefit.

(Source: FDA, FDA’s MyStudies Application (App), November 2018)

Breaking Boundaries

Machine learning and the hunt for new viruses

Whether it’s the yearly battle to figure out which influenza strains might be circulating, or determining how to contain potential global outbreaks of infectious diseases like Ebola and Zika, scientists and public health officials are constantly trying to stay ahead of emerging viral threats. Thousands of viruses exist in the wild, circulating in animal hosts—and gaining attention if they make the leap to humans. An article in the November issue of Science shows how machine learning is helping scientists identify patterns in the genomes of viruses that could help predict which viruses might become dangerous to humans.

The machine-learning system can offer clues about a virus’ origin—and whether it could spread to humans. The researchers created datasets based on genomic information from viruses with known vectors and reservoirs. Using those datasets, the researchers built a machine-learning model to better understand virus-host patterns. If scientists discover a new virus, they can sequence its genetic information and use the model to hypothesize what kind of host it might seek. If the virus relies on a vector to spread, the model can help identify the type of vector needed.

The machine-learning system is still in the early stages of development. To be most effective, the system will need to identify potential hosts with more specificity. But, the system’s developers say they expect scientists will improve their ability to learn more about—and respond faster to—emerging viruses.

Each year, scientists uncover a few new viruses that could threaten human health. As human populations and cities grow, more frequent encounters between humans and wildlife might lead to a viral spillover. Understanding more about which animals can spread emerging viruses is important for surveillance and prevention.

Analysis: Speed and efficiency are also critical for diagnosing infectious diseases in clinical settings. Physicians typically must go through a long list of symptoms before zeroing in on a diagnosis. But machine learning is enabling real-time, automated infectious-disease detection and diagnosis. By analyzing electronic health records, nursing triage forms, and lab results, machine-learning systems can be used to alert physicians to possible or confirmed cases of many illnesses.

Along with helping to improve analyses and interventions, machine learning also has the potential to improve population health by identifying illnesses and patterns of behavior. Over the past several years, interest in machine learning—and other types of artificial intelligence (AI)—has surged inside and outside of the health care industry. Venture capital investments in companies that are developing and commercializing AI-related products and technology are growing. During the past five years, total AI startup funding reached $12.5 billion. The future of machine learning in health care will likely move to the consumer in the form of mobile apps that can diagnose certain ailments conditions, such as skin conditions or insect bites, by analyzing digital photos.

(Source: Simon A. Babayan, Richard J. Orton, and Daniel G. Streicker, Predicting reservoir hosts and arthropod vectors from evolutionary signatures in RNA virus genomes, Science, November 2, 2018)

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