Financing around a health care bottleneck

What good is discovering a potential cure for cancer if there’s no money to make it happen? Scientists understand more about diseases now than ever before, says MIT Sloan professor Andrew W. Lo, but investment in drug development has stalled at a critical moment. Lo, the director of the MIT Laboratory for Financial Engineering, believes a little creativity will go a long way when it comes to delivering new treatments and cures to patients.

Starting next semester, students across campus can enroll in a new course, Healthcare Finance, to team up and try to solve the problem. We spoke with with Lo to ask him why now is the perfect time, and why MIT Sloan is the perfect place, to bust up the clog.

Why is the drug development pipeline experiencing a bottleneck?
Well, one reason it’s happening is increasing risk. The fact that we’ve gotten smarter about the underlying science of various diseases like cancer has ironically meant that the risk of drug discovery and development has actually increased. Usually, when we get smarter about something, the risks go down — that’s certainly true in finance. When you learn more about a company, the risk to you as an investor should decrease. But the more we know about human biology, the more we realize there are so many ways diseases can emerge—and so many options for dealing with them — it becomes harder to pin down how biomedical investments are going to perform.

So the biopharma industry is challenged right now in terms of funding. There’s a so-called “valley of death” at the early stages of drug discovery, between the preclinical and phase I/II stages. A lot of great new science is being done, but we don’t have enough funding to bring these ideas from the laboratory into the clinic. We have to be more creative about how we finance biomedical innovation, otherwise we aren’t going to be able to maintain the current pace of innovation.

Cancer is a good example. We now know it’s not one disease but more like 200 different diseases. There are all sorts of different ways of treating cancer: starving a tumor by restricting the growth of its blood vessels, using the body’s immune system to fight cancer cells, radiation, surgery, and so on. The more possibilities we have, the more difficult it is to predict how an investment in a particular approach is going to turn out.

We seem to be at an inflection point in biomedicine right now. We’ve had an incredible series of breakthroughs over the last 10 years, and in certain fields, just in the last couple of years. For example, scientists and clinicians have developed what looks like a cure for melanoma, an immunotherapy called pembrolizumab that exploits a cancer patient’s own immune system to fight tumors. In August 2015 former president Jimmy Carter was diagnosed with stage IV melanoma, with tumors in his liver and brain, and by January 2016, President Carter reported he was tumor-free. In March 2016, his doctors discontinued all treatments and declared that he was cured. These are the kinds of breakthroughs that are happening every day, yet funding for early stage biomedical R&D is harder and harder to come by. Finance seems to be at the center of these challenges.

Is there capital out there?
Yes. There’s a tremendous amount of capital in the global investment community just waiting to be deployed. World population has grown, savings have increased, and all that money needs to be earning a reasonable rate of return. Sovereign wealth funds, pension funds, banks, and insurance companies all have huge pools of capital that aren’t generating very attractive returns in the current low-yield environment. Recent stock market performance has been relatively disappointing, and most experts feel that bond markets aren’t the answer either.

Health care offers a wonderful set of opportunities for investors, but they need to understand the risks and rewards. That’s why it’s critical to be able to combine the expertise of financial analysts with the scientific expertise of drug developers. We have to collaborate to make the ecosystem work better.

How can finance help?
Financial engineers know how to manage risk by combining many investments into a single portfolio to take “multiple shots on goal.” With drug development, only one or two successes will more than pay for all the rest of the trials.

Imagine financing a large portfolio of drug development projects using debt. We could issue “cancer bonds” to fund these projects, just like we issued war bonds during World War II to finance the war effort. There are a lot more bond holders than equity holders, and the amount of capital invested in bond markets is one or two orders of magnitude larger than in biotech venture capital.

Derivative securities like credit default swaps can also play a valuable role in helping the biopharma industry manage risk. Imagine financial institutions issuing “FDA swaps” that pay investors a fixed sum if the FDA doesn’t approve a particular drug. Such contracts are essentially FDA approval insurance and could greatly reduce the risk of the drug development project, which could attract more capital to this industry.

But your new course, Healthcare Finance, isn’t just for students of finance, right?
Right. The course is for anybody who has an interest in health care, and in applying ideas in financial engineering to biomedical innovation. By bringing together budding entrepreneurs and biomedical experts in this course, we’re hoping to build bridges between finance and the life sciences.

How will you structure the course?
It will be a combination of lectures on health care finance by me and class discussions with practitioners involved in current applications. The lectures will cover conceptual material on various financing methods and the practitioners will provide industry-specific context for these methods. Then, students will work on projects in which they’ll have a chance to apply these ideas to their own challenges, which will be the ultimate test of whether or not finance can have an impact on biomedical innovation.

So the time is right. What about the place?
MIT is absolutely the perfect place to offer this course for several reasons. First, MIT was where financial engineering was born, thanks to [Nobel laureate] Bob Merton and the many other giants of modern finance who were and are faculty here. MIT and the Cambridge/Boston area are also home to many incredible breakthroughs pioneered by biologists, clinicians, biotech entrepreneurs and VCs, and big pharma — we’re at the epicenter of this incredible industry. We also have some of the world’s best hospitals within a five-mile radius of MIT. And finally, Boston happens to be one of the mutual fund capitals of the world. What could be more perfect than to combine finance and biomedicine here at MIT? I feel very privileged to be able to draw on all of these resources for my health care finance course and can’t wait to get started.