New FDA Regs Shake Up E-Cigarette, Cigar Markets

May 17, 2016

Two weeks ago the Food and Drug Administration announced formalization of regulations designed to bring vapor products, cigars, and pipe tobacco under FDA control and review. These regulations, which have been anticipated for some time, result from the FDA deeming that these categories are under their purview with respect to the Family Smoking Prevention and Tobacco Control Act, first introduced in 2007, and signed into law by President Obama in 2009.

Dr. Michael Siegel writes in the Wall Street Journal:

… the regulations require every electronic-cigarette product on the market (the devices and the liquids that give them taste and vapor) to submit a premarket application to the FDA demonstrating that the product is beneficial to the public’s health. To do this successfully under the statute, a company must show that its e-cigarette product is safer than regular cigarettes; that it helps smokers to quit; and that the above benefits won’t be outweighed by the adoption of the product by nonsmokers, including young people.

[…]

[With these complex regulations,] the FDA seems bent on blocking what might have been one of the most substantial public-health victories of our lifetimes.

The resultant 499-page document released on May 5th details extensive application processes for new products in these categories, and comes at the end of two years of deliberation within the FDA on how these products should be reviewed. In my view, the rules failed in many ways to adequately respond to concerns voiced during the regulatory comment period, and by the FDA’s own assessment, will result in significant narrowing of the vapor market, as well as the market for premium cigars.

This matters because many health experts see vaping as a lower-risk alternative to smoking, and in the case of the UK government and the Royal College of Physicians, are trying to promote the product category as a cessation method. In addition, this narrowing will result in some notable unintended consequences, detailed below.

How the Rules Will Affect Vapor

As we wrote in our March review of taxes on vapor products, the biggest question mark had been what this new review process would look like for vapor products, which are still emerging technology and are primarily produced by smaller companies that do not have the resources to navigate a complex federal regulatory review process. From our report:

One critical conversation for the FDA is whether new vapor products will be subject to a pre-market review process as traditional tobacco products are now. Currently, any new tobacco product that does not meet “substantial equivalency” to another product currently on the market has to undergo a lengthy study process. This process is clunky; only one product in the last six years has made it through the review. Vapor products, which are in their infancy, are evolving quickly and new innovations in vapor liquid and delivery devices are frequent, meaning that new products are often not substantially similar to the rest of the market, and would have to be vetted.

A linked question is what the “predicate date” for regulation will be. This is the grandfather date after which all substantially new products must go through FDA approval. One predicate date being considered is February 2007, the current predicate date for other tobacco products, but this date would predate the invention of most vapor products currently on the market today, forcing almost the entire category to go through FDA approval to be sold.

Commenters in the vapor industry, and in fact legislators on the House Appropriations Subcommittee that oversees the FDA (here at 1:00:00 onward), had expressed concern about setting the predicated date at February 2007.

The FDA’s recent announced rule solidifies the predicate date for vapor products at February 2007, meaning that every vapor product currently sold that has been invented since 2007 (virtually every vapor product) will have to go through the more lengthy “premarket application” process, as opposed to the “substantial equivalency” process. The FDA anticipates that a premarket application will take 1,500 hours to complete on average (p. 395 here).

By the FDA’s own admission in a document from 2014, this will mean a substantial narrowing of the vapor market, as the costs associated with review “would be high enough to expect additional product exit, consolidation, and reduction in variety compared with the baseline (p. 35 here).”

In total, the FDA says “the total annual burden for submitting PMTA applications is estimated to be 1,285,550 hours (p. 434 here).” The review will apply to: “e-liquids; atomizers; batteries (with or without variable voltage); cartomizers (atomizer plus replaceable fluid-filled cartridge); digital display/lights to adjust settings; clearomisers, tank systems, flavors, vials that contain e-liquids, and programmable software.”

How the Rules Will Affect Cigars

Premium cigar manufacturers and merchants had tried to entirely exempt themselves from the FDA’s review process. They were unsuccessful, and the FDA has chosen to subject them to the most rigorous of regulatory options presented in their 2014 document. FDA estimated in 2014 that there are 11,169 cigar formulations. By their own appraisal, their new regulations would wipe out somewhere between 10 and 50 percent of these products as it will not be cost effective to put many of the products through review. The premium cigar industry is composed of some big players, but also many smaller businesses and boutique brands, many of which will likely go by the wayside.

In their 2014 analysis, the FDA anticipated that anywhere between 5 and 40 percent of the cigar market would claim a substantial equivalency exemption, meaning they would have far less paperwork to submit (FDA estimated 19.6 hours of work to navigate per product), and the rest of the cigar category would go through the substantial equivalency pathway, which requires an estimated 152 to 232 hours to navigate per product.

Going onward, they project that just 198 premium cigar applications will be submitted in a given year, likely meaning a substantial decline in variety in the cigar market. For more information on cigars, I found this timeline at Cigar Aficionado to be very informative.

What Happens Next

Products that are not grandfathered in have 24 months to comply with the review process, after which they will be pulled off the shelves.

The only way for these regulations to be changed is through Congressional action. In April, the House Appropriations Committee passed its spending bill, which includes a rider that would a change the predicate date to the effective date of the FDA’s final rule (2016) instead of 2007.

This might not matter if Congress does not pass a budget this year, which is likely, given that last year was the first time since 2009 that Congress passed a budget, and even that budget was nonbinding and was not signed by the president.

Predictions for Cigar and Vapor Markets and Tax Policy

My prediction is that these regulations will have much farther-reaching effects than the FDA anticipates, and potentially massive unintended consequences. In the vapor market, I think a substantial amount of purchasing will start to occur outside of regulatory control, as a robust online sales infrastructure already exists to sell e-liquids, vaporizers, and other devices.

These sales, of course, will skirt tax systems entirely in the few states that levy excise taxes on vapor products, and any state that enacts a vapor tax in the future. Many consumers will of course stockpile e-liquid in the next 24 months before products start to be pulled off the shelves.

Products will generally become more expensive as the regulatory compliance costs will get baked into the price producers charge consumers. Larger producers will likely be able to spread these fixed costs and have an advantage competing against smaller producers.

The premium cigar market will see some similar effects. The American premium cigar market is the largest in the world, with many boutique brands compared to other international markets, which are primarily dominated by Cuban tobacco (which has been illegal to import into the US since 1960). By the FDA’s own appraisal, many of these brands will shut down or see their offerings substantially narrowed (fewer size options, fewer blends, fewer pricing options).

I think there is some likelihood that the dearth of options in the new regulated American cigar market turns more consumers over to black market sales on the internet, specifically international sales of smuggled Cuban cigars. The irony of American consumers turning to a communist country for more market choices is, of course, hard to miss.

More on tobacco taxes.

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