Pharmaceuticals and Refernce Drug Pricing

Background Increases in healthcare expenses have been a common theme in almost all industrialized nations for the last 30 years: ‘medical costs in Western Europe increased by an average of 4. 1% each year between 1970 and 1990, exceeding the overall rate of economic growth during the same period which increased by 2. 7% annually’ (Ioannides-Demos et al. , 2002).

Many countries have tried several techniques in an effort to reduce these astronomical increases; most interventions have been directed towards medical technology – either rationing or restricting access to new medical technology, which in most cases is pharmaceuticals (Ioannides-Demos et al. , 2002). During the period from 1975 to 1997, pharmaceutical costs rose from 8. 7% to 14. 5% of total health-care expenditures in Canada (Lindsey & West, 1999; Cassels, 2002). In British Columbia alone, drug costs were increasing at the rate of 16% per year in the early 90s (Cassels, 2002).

What is behind the increase in costs? Ioannides-Demos and colleagues provide us with a concise list of the major contributing factors (2002): (i) Price inflation, (ii) Substitution of less expensive usually older treatments by more expensive generally new therapies, (iii) Increasing number of available drug interventions particularly those for long term prevention in conditions such as osteoporosis and hyperlipidaemia, and an increasing number of drugs show to be cost effective when compared to other interventions, and.

(iv) Increases in population numbers, especially of elderly patients likely to require multiple drug therapy. In addition, Lindsey and West also attribute the rise in expenditures to increasing consumption per capita, physician prescribing habits, marketing by drug companies, and patent laws (1999). We can simplify the price of pharmaceutical products with the following relationship: drug costs are a function of prices and drug consumption. Drug consumption is defined and affected by patient demand, health professionals’ prescribing patterns, and ‘regional reimbursement regulations’ (Ess et al., 2003).

Drug Expenditures = f (drug prices, drug consumption) = f (drug prices(+), [patient demand (+), dr. prescribing patterns(+/-), reimbursement (+)]) As drug prices, patient demand, and reimbursement (to consumers) increase, drug expenditures increase. The impact of physician prescribing patterns must first be defined in order to assess its impact on drug expenditures. If physicians are more inclined (on the whole) to prescribe newer, more expensive medicines, drug expenditures will rise.

However, if physicians are encouraged to and do prescribe generic drugs instead of patented, expensive drugs, drug expenditures will decrease. The pharmaceutical market is an interesting and complex phenomenon. It is characterized by various stakeholders, all of which have certain interests and objectives in the market. According to Ess, Schneeweiss and Szucs, all stakeholders in the pharmaceutical market share the common goal of wanting ‘safe, effective and high quality drugs’ and ‘drugs that improve health, both now and in the future’ (2003).

Ess and colleagues posit that the following are the key stakeholders in the pharmaceutical market and in healthcare in general (2003): (i) Governments and their agencies (e. g. Department of Health, Department of Trade and Industry, Department of Social Affairs) (ii) Health insurance agencies – often in the form of quasi-governmental institutions, e. g. in Germany and the UK (iii) Residents in their double role as patients and taxpayers (iv) Healthcare providers (v) Pharmaceutical manufacturers.

Each group of stakeholders has different interests in regards to pharmaceutical products; pharmaceutical manufacturers want to maximize profits, residents as taxpayers typically strive for reduction of costs, residents as patients may want the newest and more expensive drugs, and governments aim to achieve a balance between optimal healthcare and economic growth (Ess et al. , 2003). Further, within the pharmaceutical market there are submarkets: the over-the-counter (OTC) submarket, the hospital submarket, and the prescription drugs submarket (Ess et al. , 2003).

Each of these markets has different traits with respect to reimbursement and demand, as well as the percentage of the market share they have. The OTC submarket usually tends to have the smallest market share, followed by the hospital market, and finally with the outpatient prescription-drug market usually having the majority of the market share (Ess et al. , 2003). Why and how do governments target the pharmaceutical drug market in an effort to reduce costs? These questions are best examined by defining the most salient features of the prescription drug market:

Unique Features of the Pharmaceutical Market Researchers have identified various aspects of the pharmaceutical market which make it a worthy candidate for price controls and regulations. The industry differs from others in that it is characterized by: (i) imperfect agency, (ii) moral hazard, (iii) information imperfections, and (iv) global, sunk, fixed costs (Lopez-Casasnovas et al. , 2000). Imperfect agency is thought to exacerbate problems already existing, resulting in high prices and large market shares for drugs even after patent expiration.

Moral hazard is a result of insurance and reimbursement for drugs costs, which results in overuse and deadweight loss. In addition, the prescription drug market is a clearly defined market segment, is characteristically transparent which allows for easy evaluation, and the reduction in revenues of the drug companies does not directly affect income of healthcare providers (Ess et al. , 2003). In terms of economics, Lopez-Cassasnovas and Puig-Junoy (2000) outline the main implications of these market imperfections: (i) Reduced price sensitivity on the demand side;

(ii) A certain degree of market power on the supply side; and, (iii) Demand curves that do not reflect true social benefits. It has been proposed that the demand for prescription drugs is artificially elevated and less elastic than it might be without these imperfections. Thus all these factors combined make this segment of the healthcare market a viable target for policies by governments and other organizations which aim to reduce the costs associated with prescription medicines. Common Strategies Used to Contain Costs in the Prescription Drug Market.

As we have seen above, the pharmaceuticals market is an easy and justifiable one in which to introduce policies which attempt to curb spending. Efforts can be directed towards the pharmaceutical industry itself, wholesalers and retailers, providers/prescribers, and the patients (Ess et al. , 2003). Although naming and explaining all policies is outside of the scope of this paper, a general overview is provided below. Courses of action directed towards the pharmaceutical industries usually involve stringent licensing regulations.

Evidence of the efficacy and safety of drugs to be introduced is required by virtually all western nations. As a result, pharmaceutical companies have redirected their efforts towards researching and developing superior drugs. In terms of effects on the pharmaceutical market, this trend encourages competition among the companies to develop exceptional medicines and this in turn affects pricing as well (Ess et al. , 2003). Pricing policies are also common among countries in Europe.

Three important strategies used are: direct control of product price, indirect control of product price: reference pricing and generic substitution, and profit control (Ess et al. , 2003). Direct control involves using various criteria such as the therapeutic value of a drug or reference to existing products to determine the price of a new product. Profit controls are used less often and involve agreements between governments and pharmaceutical companies. In most cases, an agreement is made on a set amount of return allowed for a drug introduced by a company.

Generic substitution entails the encouragement of health providers to prescribe generic drugs instead of newer, more expensive drugs. Reference pricing refers to insurers covering only the price of ‘low-cost, benchmark drugs in therapeutic clusters that are deemed to be close substitutes for one another in treating specific illness’ (Kanavos & Reinhardt, 2003). Details of reference based drug pricing will be discussed in more detail below. Interventions by governments that affect wholesalers and retailers are relatively straightforward.

In the simplest of all cases, profit margins are set by the government (Ess et al. , 2003). Additionally, phenomena such as ‘parallel imports’ whereby drugs from a country in which prices are high are exported to a country where prices are low are becoming popular. Wholesalers purchase the drugs in the country where prices are low and send them back to the country where the prices are high, where they are sold below the normal price (Ess et al. , 2003). Countries may encourage such activities and thus drive down prices of drugs. Many reforms have been aimed at the consumers of prescription drugs.

Most interventions involve reducing the demand for drugs by patients: they are not reimbursed for purchases of highly price drugs or are minimally compensated (Ess et al. , 2003). Cost sharing is a very common method implemented many countries (Kanavos & Reinhardt, 2003). Below are three methods available to insurers that require patient co-payment for prescription drugs (Kanavos & Reinhardt, 2003): (i) Patients can be required to make fixed co-payments for each prescription, independent of the price of the drug, (ii) Patients can be required to pay a fixed percentage of the price of the drug, and,

(iii) Patients can be required to pay the difference between the price of the drug chosen and a ‘reference’ price set by the insurer for a group of equivalent drugs (reference pricing). Each of these methods is used either alone or in combination with each other in many systems. Each has its benefits and drawbacks, and governments usually implement these in addition to other ‘listing systems and formularies’ (Ess et al. , 2003). These policies involve listing drugs which are covered and those which are not, and various levels of reimbursement (if any) for different categories of drugs (Ess et al.

, 2003). The final avenue of the pharmaceutical market that policy-makers can regulate is that of those heath practitioners that are prescribing drugs. Guidelines can be set for physicians on how much to prescribe for patients and when, as well as increasing practitioners’ knowledge of drug costs. In some cases, budgets (individual and global) have been implemented (Ess et al. , 2003). Reference Drug Programs: British Columbia The reference drug pricing scheme in British Columbia was implemented in 1995 as another method (among several) to stifle soaring drug expenditures.

Already in use in several other countries around the world (Germany, New Zealand, Australia), the plan was put into action despite fierce opposition from the pharmaceutical industry (Cassels, 2002; Ioannides-Demos et al. , 2002). The fundamental principle that provided the basis for the implementation of the program was that ‘if there was no scientific evidence that expensive drugs in the same therapeutic class had additional health benefits, then there was no basis for reimbursement beyond the reimbursement beyond the price of the less expensive, presumably equally effective, reference drugs’ (Ioannides-Demos et al.

, 2002). One of the main reasons for the popularity of reference pricing schemes is that they ‘offer(s) the possibility of limiting public reimbursement, whilst not restricting the choice of medicines available to patients and their physicians’ (Drummond, Jonsson & Rutten, 1997). The various reference pricing systems in the countries mention differ to some degree, however, there are some defining features to the strategy that are common to all programs (Lopez-Casasnovas et al. , 2000): 1.

The third-party payer (public or private insurer directly sets a ceiling for the amount reimbursable to the manufacturer for a prescribed pharmaceutical product. In this sense, RP (reference pricing) success requires the exercise of a relative purchasing power from the insurer’s side. 2. RP is equivalent to setting a co-payment which: (i) implies a variable amount depending on the price of the selected drug; and (ii) may be avoided if the drug does not exceed the reference price, 3. Identical reimbursement ceilings are defined for groups of pharmaceutical products.

‘Clusters’ of pharmaceuticals are defined in terms of their interchangeability. This may be interpreted more strictly or loosely depending on the chemical, pharmacological or therapeutic equivalence. Clusters may or may not included patented products. 4. For the reimbursement ceilings the insurer usually applies the observed domestic prices of the products included in the same cluster or group as a benchmark. 5. These reimbursement ceilings are adjusted periodically by an adjustment factor, which may or may not be previously announced.

In many cases this factor is not exogenous to the price behavior of the benchmark product(s) or to the price of new products included in the same group. The concept of interchangeability and the selection criteria for setting the [sic] reference price are reviewed every few years and changed where necessary. (Lopez-Casasnovas & Puig-Junoy, 2000) These five characteristics are, as mentioned above, common to the various reference pricing schemes throughout the world. Thus in theory, reference pricing seems to be a rational method of reducing the costs associated with drug expenditures.

However, since the program’s inception, opposition has been fierce. Opponents assert that the program has two inherent flaws, one being medical and the other economic (Cassels, 2002). The Fraser Institute, a conservative think-tank in B. C. , vehemently emphasized that the program will lead to increased illness among the population, and will lead to increased healthcare costs overall (Cassels, 2002). In order to test these assertions and make the process as transparent as possible, the British Columbia ministry of health encouraged independent researchers to examine the system and its outcomes, ultimately resulting in B.

C. ‘s RDP to be the most extensively studied reference based pricing project in the world (Cassels, 2002). The debate over the program revolved around three major issues – cost savings, health outcomes, and the effect on research and development investments by large drug companies (Cassels, 2002). In the next section we discuss these three areas of concern and how the research helped to settle (or ease) the dispute. Below is a summary table of the most important features of the program: Table 1. The reference pricing system in British Columbia Factor- Description 1. Supply conditions for medicines 1.

Price control (excessive price guidelines for new products). 2. Negative list of products not available for reimbursement. 3. Generic substitution 4. Low cost alternative (April 1994): limits reimbursement to the lowest priced drug when there are alternatives available. 2. Date of introduction October 1995 3. Product coverage 1. Drugs composed of different active ingredients in the same therapeutic category are grouped together: – H2 Antagonists – Oral and transdennal states (excluded in April 1996) – Non-steroidal anti-inflammatory – Angiotensin converting enzyme (ACE) inhibitors (included in January 1997)

– Dyhydropyridine calcium channel blockers (CCB), (included in January 1997) 2. Physicians can complete a special authorization form on behalf of the patient to be reimbursed for a non-referenced product. 4. Reference price level 1. Full price is paid for one drug in each therapeutic group and this is the maximum price that will be reimbursed for any drugs in that group. 2. Usually the reference for reimbursement is the least expensive product: Average price of 30 day supply of referenced drug. 5. Updating On going and ad hoc. 6. Immediate impact on prices and generic product market 1.

British Columbia had the highest generic substitution rate in Canada before implementing reference pricing. 2. The effect on generics has been minimal. 3. There are indications of greater price competition in the market. 7. Impact on total market shares 1. Increased market share for referenced products. 2. Increased number of prescriptions. 3. December 1995: generics = 45% of all prescribed drugs. 8. Expected third party savings Government claims to have saved $30 million in the first year and $44 million in the second year. However, – $15 million additional funding given to Gps and an extra $250 million to pharmacists.

-Administrative costs in just 7 months for special authorizations estimated at $3. 7m 9. Actual impact on total drug expenditures 1. Total drug expenditures: 1995/96: C $406 m 1996/97: C $396 m 1997/98: C $430 m 2. RP is saving the province about $44 million per year, according to data from the Minister of Health. Impacts of the Reference Drug Program The three major areas of concern for policy makers in B. C. with regard to the Reference Drug Program were as follows (Cassels, 2002): (i) Does the policy save money, either by reducing the rate of spending or keeping spending constant?

This question must be examined with respect to health outcomes: with health outcomes remaining the same, do we still save money? (ii) What is the effect of the program on health outcomes? Do we want to implement a system which just shifts costs to other sectors of the healthcare system? Does the money saved by the RDP outweigh the increases in physician and hospital visits, if that is indeed the case? (iii) Since the program reduces profits for pharmaceutical companies, will research and development investments be withdrawn from British Columbia?

What effects will the program have on the investment climate of the province, and what are the implications for the people of B. C.? These and many other questions were asked by numerous researchers from Canada and the United States in order to get to the bottom of the debate. Below is a summary of the findings with respect to these concerns. Effect on Pharmacare spending. According to the B. C. Ministry of Health, the program saves British Columbian taxpayers on the order of $44 million per year (Cassels, 2002; Lopez-Casasnovas & Puig-Junoy, 2000).

In the first year alone, spending on referenced medications went from $42 million before to $23. 7 million after (Cassels, 2002). Conservative estimates put first year savings at $30 million, with some estimates as high as $74 million for the first two years (Ioannides-Demos et al. , 2002). Savings such as these are paralleled in other countries which have adopted this program (or variations thereof), such as New Zealand and Australia (Ioannides-Demos et al. , 2002; Drummond et al. , 1997; Dickson & Redwood, 1998).

An exhaustive amount of literature on the effects of the program on spending is in agreement that the program has led to significant savings in the area of pharmaceutical drugs (Menon, 2001; Cassels, 2002). Effects of the RDP on health outcomes. Independent researchers are in agreement that, on the whole, there has not been a significant ‘increase in rates of physician visits, hospitalizations, and long-term care admissions’ (Schneeweiss, Soumerai, Maclure, Dormuth, Walker & Glynn, 2003). Evaluations have been carried out for each group of drugs in the RDP, and the trends observed are the same throughout (Cassels, 2002).

Thus there has not been a ‘shift’ of costs from the pharmaceutical sector to other sectors of the health care system. Effect on investments by pharmaceutical companies. Alan Cassels addresses this issue head-on in his analysis of the Reference Drug Program in B. C. The pharmaceutical industry threatened to withdraw funding for research and development of drugs from B. C. if the program was implemented; Cassels argues that there was not a significant amount of money invested in the province to begin with, and that it did not change as a result of the RDP (Cassels, 2002).

According to him, ‘B. C. has roughly 13% of Canada’s population, yet receives only 3. 3 percent of pharmaceutical R&D spending, an amount that has not changed in percentage terms since 1988’ (Cassels, 2002). As a result, Cassels asserts that the impact on investment in B. C. is minimal, as is its effect on the average British Columbian. Conclusion Increases in expenditures in all areas of the health sector have led governments and regulatory bodies to respond in many ways. Different strategies have been tried in an attempt to cut costs wherever possible.

Because of certain defining features, the pharmaceuticals market has proven to be a popular candidate for cost-reducing reforms. Interventions targeting pharmaceutical companies, wholesalers and retailers, prescribers, and patients have been implemented, but their ultimate effect is debatable: money spent on drugs is continually increasing. Reference drug pricing systems have proven to be popular and effective overall (Lopez-Casasnovas & Puig-Junoy, 2000; Dickson & Redwood, 1998). Although skeptics abound, it is hard to ignore the facts: as of 2002, reference drug pricing had saved British Columbians $161 million (Cassels, 2002).

The reduction in costs is significant and there has not been a resultant shift in costs to other sectors of the healthcare system, as opponents had once argued so fervently. It is widely held that reference systems have two main weaknesses: ‘it is difficult to apply them to innovative drugs because of a lack of comparable ‘reference drugs’, and they imply criteria for defining the therapeutic equivalence of drugs, often based on weak data (Ess et al. , 2003). These weaknesses contribute to the limited savings possible with reference pricing and its applicability to only part of the problem.

Another major criticism of reference pricing is ‘its potential to act as a disincentive to pharmaceutical innovation’ (Ess et al. , 2002). Large pharmaceutical companies operate with a bottom line of making profit; reducing the profits earned by these companies reduces the incentive to research and develop newer drugs, which usually require huge amounts of capital investment. This complication from reference based pricing is real, and must be taken into account by governments and regulatory bodies. The fact remains that drug costs are still on the rise: in 2000/2001, total Pharmacare expenditures amounted to $657 million (Cassels, 2002).

The figures would undoubtedly be higher without the RDP; however, according to many researchers and critics, the fight to contain costs cannot end here. Menon argues that although the current measures have proven effective, they are not enough and we must find other innovative ways to tackle the problem (2001). This sentiment is shared by many, but it is proving to be a difficult undertaking. In the meantime, reference based drug pricing has proven to be an effective way to limit drug costs to a certain extent.

Although there will always be opposition by various parties to programs which strive to achieve these ends, those interested in providing healthcare to all in an equitable and effective manner must do their best to support such programs. Ultimately it may be a combination of such rational schemes which control healthcare costs. For now, the Reference Drug Program is a step in the right direction towards keeping our national healthcare system sustainable and viable in the years to come. References Cassels, A. (2002). Paying for what works: BC’s experience with the Reference.

Drug Program as a model for rational policy making. Canadian Centre for Policy Alternatives, March 2002. Accessed on April 4th, 2004 from: http://www. policyalternatives. ca/ Dickson, M. & Redwood, H. (1998). Pharmaceutical reference prices: How do they work in practice? Pharmacoeconomics, 14(5), 471 – 479. Drummond, M. , Jonsson, B. & Rutten, F. (1997). The role of economic evaluation in the pricing and reimbursement of medicines. Health Policy, 40, 199 – 215. Ess, S. M. , Schneeweiss, S. & Szucs, T. D. (2003). European healthcare policies for controlling drug expenditures. Pharmacoeconomics, 21(2), 89 – 103.

Ioannides-Demos, L. L. , Ibrahim, J. E. and McNeil, J. J. (2002). Reference-based pricing schemes: Effect on pharmaceutical expenditure, resource utilization and health outcomes. Pharmacoeconomics, 20(9), 577 – 591. Kanavos, P. & Reinhardt, U. (2003). Reference pricing for drugs: Is it compatible with US health care? Health Affairs, 22(3), 16 – 30. Lindsey, R. & West, D. S. (1999). National Pharmacare, reference-based pricing, and drug R&D: A critique of the National Forum on Health’s Recommendations for Pharmaceutical Policy. Canadian Public Policy, 25(1). Lopez-Casasnovas, G. & Puig-Junoy, J.(2000).

Review of the literature on reference pricing. Health Policy, 54, 87 – 123. Menon, D. (2001). Pharmaceutical cost control in Canada: Does it work? Health Affairs, 20(3), 92 – 103. Schneeweiss, S. , Soumerai, S. B. , Maclure, M. , Dormuth, C, Walker, A. M. & Glynn, R. J. (2003). Clinical and economic consequences of reference pricing for dihydropyridine calcium channel blockers. Clinical Pharmacology & Therapeutics, 74(4), 388 – 400. Woodfield, A. (2001). Augmenting reference pricing of pharmaceuticals in New Zealand with strategic cross-product agreements. Pharmacoeconomics, 19(4), 365 – 377.

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