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Medical Device Regulation Revisited

Changes in regulation are casting shadows over the medical device industry.

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A little over a year ago, we wrote about several independent, grassroots forces that were agitating for more stringent Food and Drug Administration oversight in the medical device industry. Now that some of those potential changes have started to take shape, we wanted to revisit the topic and provide some perspective on the key issues that have gained momentum over the last year.

Standard Geographical Strategy May Change
The geographical strategy that device makers have historically relied upon may change now that we're seeing greater regulatory convergence among the three major markets for device makers: the European Union, the United States, and Japan. In the past, device manufacturers have aimed to roll their new products out first in the EU, where the regulatory pathway was less rigorous (compared with the U.S.). Roughly 1.5-2.5 years later, the new device would receive FDA approval and roll out domestically, followed by launch in Japan approximately three years after the U.S. introduction. However, last spring the regulatory hurdles in the EU became substantially higher, and we now expect device makers will face a longer clinical process and higher development costs in that geographical area. Starting this year, device makers must demonstrate the risk/benefit ratio of devices based on clinical data. Previously, the manufacturers only had to show the safety of the device at the time of implant and there were no requirements on effectiveness. Postmarketing registries to track patients are also now mandatory. With the newly raised regulatory bar, we think it could take longer to get devices on the European market, and this could lessen the incentive to head for Europe first.

Changes Under Way at the FDA
Over the last 18 months, it's become quite clear that the Food and Drug Administration will also be raising the regulatory bar for medical devices. Thanks to a series of high-profile product recalls that have highlighted coziness with the Center for Devices and Radiological Health (CDRH), some questionable approval decisions, and the inadequacy of some clinical data, there is now external and internal momentum to shift CDRH further away from the industry's sphere of influence. It also helps that the FDA, under the direction of new commissioner Margaret Hamburg, has already moved to clean house in the CDRH unit and install new personnel with fewer ties to the industry.

Thus far, there is still much uncertainty surrounding tightening regulatory standards of the abbreviated 510(k) process. Considering over 85% of medical device approvals are handled through the expedited 510(k) process, versus the more rigorous premarket approval pathway, we can see why the medical device companies are sitting on pins and needles to see how the dust settles. There is one potential change that could definitely change the regulatory landscape--the creation of a new Class IIb grouping for devices. This proposed Class IIb designation would require clinical data in addition to laboratory data for submission. This new development, if implemented, could add substantially to development costs for device makers. Unfortunately, it is not yet clear which devices should be labeled with this new designation. The 510(k) working group has suggested that potential candidates could include some implantable, life-sustaining or life-supporting devices because they present greater risks than run-of-the-mill Class II devices.

Implications for Clinical Trials
In the past, we've noted the FDA has become more risk-averse following the Vioxx situation. We think the CDRH unit has also leaned in this direction after the huge Guidant implantable defibrillator recall in 2005 and the discovery of very late stent thrombosis related to drug-coated stents in 2006. We have already seen pharmaceutical clinical trials grow much bigger to include more patients, and there has been much discussion about the need for larger clinical trials for medical devices. However, this desire comes up against the reality that it is extremely difficult and expensive to conduct trials that are sufficiently large enough to catch low-incidence issues, such as very late stent thrombosis, or for robust analysis of patient subgroups. We think it is unlikely that medical device companies will conduct 10,000 patient trials on each product, and we believe going forward we will have to rely more heavily on postmarketing registries to track the performance of devices over the longer term. There seems to growing recognition and acceptance that statistical models are less and less able to provide reassurance about how the device will perform over the longer term. We've already seen the EU make registries mandatory for approved devices, and the orthopedic implant makers are also going down this path.

Device Firms to Watch
We think the uncertainty around regulatory changes is one factor that has cast a cloud over some of the medical device companies we cover. While the specific changes to regulation have not yet been determined, all the potential changes we've heard discussed will likely raise development and commercialization costs, and we are building in higher R&D costs for these companies going forward. Having said that, we still think there are some moaty device companies that are trading at compelling discounts to our fair value estimates, including cardiac company  Medtronic (MDT) and orthopedic implant makers  Stryker (SYK) and  Zimmer (ZMH).

Debbie Wang does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.