dynamic efficiency and value-based differential pricing: setting optimal prices for pharmaceuticals...

Adrian TowseDirector of the Office of Health Economics, LondonVisiting Professor, London School of EconomicsPresentation at EuHEA 16th July 2016

Dynamic Efficiency and Value-Based Differential Pricing: Setting Optimal Prices for Pharmaceuticals Cross-Nationally, with particular reference to the Single European Market

Dynamic efficiency and value-based differential pricing

Based on two papers…

• Danzon, Patricia M., Adrian K. Towse, and Jorge Mestre-Ferrandiz. 2015. “Value-Based Differential Pricing: Efficient Prices for Drugs in a Global Context.” Health Economics 24: 294–301

• Towse, Adrian, Michele Pistollato, Jorge Mestre-Ferrandiz, Zeba Khan, Satyin Kaura and Lou Garrison (2015). “European Union Pharmaceutical Markets: A Case for Differential Pricing?” International Journal of the Economics of Business 22:2, 263-275


• High level of R&D and other fixed costs means that pricing at marginal cost, which is the norm for efficient use of drugs (static efficiency), will not cover total costs

• Patents enable companies to price above marginal cost for the patent period and potentially recoup their R&D investment. This is “second best” if pricing above marginal cost foregoes some utilization efficiency.

• Universal insurance coverage protects consumers from financial risk and make health services affordable for low-income consumers. However, it makes patient demand highly price-inelastic, manufacturers have incentives to charge prices above the second best optimal level that would result from patents alone.

• Public and private insurers use various strategies to control drug prices but these are generally not well-designed with a view to efficiency.

• R&D is a global joint cost that benefits consumers worldwide, appropriate global pricing requires appropriate relative contributions from different countries to this joint cost.

• Economic models of price discrimination imply that price discrimination across countries is likely to be welfare superior to uniform pricing, if differential pricing increases utilization which is plausible in the case of drug.

Challenges in pricing pharmaceuticals


Theory of Differential PricingFive different pricing rules for pharmaceuticals:1. “Ramsey Prices”: pricing in inverse relation to the demand

elasticity in each country or MS [Ramsey (1927); Jack and Lanjouw (2005)]

2. Value Based Differential Pricing (VBDP): the use of an incremental cost-effectiveness ratio threshold based on populations “willingness-to-pay” for health gains [Danzon, Towse and Mestre-Ferrandiz (2015)]

3. Adaptation of the Peak Load Pricing model [Boiteux (1949); Schweitzer and Comanor (2011)]

4. Two-part pricing structure of consumer co-payment and payer top-up payment. [Garber, Jones and Romer (2006); Jena and Philipson (2008); Lakdawalla and Sood (2013)]

5. Patent buyout, HIF, prizes [Kremer, 1998; Hay, (2005); Banerjee, Hollis, and Pogge (2010); Wilson and Palriwala, (2011)]

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Features of the optimal pricing rules:• All agree upon the fact that maximal welfare is

achieved when the pricing scheme allows access in all markets where the willingness to pay is at least equal to the marginal cost of producing and distributing a medicine

• Differ as to whether:• they achieve first best or second best static efficiency• prices should enable the company to earn a normal

return on R&D investment, or to earn the social surplus during the period of patent protection

• Differ in practical complexity, political feasibility

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Value based differential pricing• Builds on Garber and Phelps (1997) derivation

of an ICER using a welfare economics framework

• Builds on Ramsey optimal pricing (ROP) differential pricing approach, but unlike ROP:

• derived from consumer willingness to pay for medical care which is key to dynamic efficiency prices, and

• designed to derive optimal absolute price levels rather than only relative prices, for optimal investment in R&D (dynamic efficiency)


• Following Garber and Phelps (1997) a representative individual has income Y which is constant in real terms across time periods

• Expected utility in period 0 can be written:

• Where:• Income is spent on medical care (a,b) and other goods. • Consumption of medical care in period 0 affects the probability

of survival P and the quality of life k in future periods.• The expected benefits of medical care can thus be expressed

in terms of QALYs

Deriving an ICER for an individual


• Two available medical interventions a and b, with prices wa, wb

• The optimal utilization of health technology a defined by the first order condition can be written:

• Optimal utilization thus implies equating the marginal utility cost of spending on in period 0, , to the marginal expected utility of future discounted QALYs gained from using , .Rewriting:

• The LHS is technology a’s ICER. The RHS is equal to the ratio of future period-specific utility to marginal utility in the base period, or willingness to pay for medical care

Deriving an ICER for an individual (2)


• Garber and Phelps (1997) state that “The optimal CE criterion is equivalent to determining optimal coverage for an actuarially fair insurance policy, under perfect information.” (p27)

• Assume each country operates a universal insurance system that covers drugs and other treatments for all citizens

• Assume that each country can be represented by a representative individual

• Assume that the system is financed efficiently, including the raising of the subsidies necessary to achieve such access to health care as society has deemed socially equitable

• The we might expect the system ICER to reflect that of the representative consumer.

ICERs in a universal coverage system


• There are ways in which heterogeneity can be accommodated, even in universal systems with a single payer or a mandated minimum coverage by competing insurers, to provide opportunity for both “voice” and “exit:• In a pluralist health care system such as the USA, different health

plans could choose different ICERs, implying different drug prices and patient access, subject to minimum compulsory coverage requirements. Individuals could choose a health plan that best reflects their income and preferences

• National and social insurance systems can vary ICERs by condition to address social preferences e.g. “end of life”

• If some patients who are deemed ineligible for a given product under the social insurance are willing to pay out of pocket, they could be permitted to do so

ICERs in a universal coverage system: accommodating preference heterogeneity


• Assume the optimal ICER is K. • Each country makes its ICER choice K unilaterally• Differentiate the RHS of equation (3) with respect to

income:

• Where:• is the elasticity of utility with respect to income () and is

expected to be positive• is the elasticity of marginal utility with respect to income

(), also known as relative risk-aversion

Differences Across Countries in Optimal ICERs


• In terms of equation (4)

• If , individuals are risk neutral and K rises in proportion to income

• If , individuals are risk-averse and the optimal ICER K, rises more than in proportion to income

• If two countries differ in per capita income but are otherwise similar, ICER thresholds and price levels will likely be higher in the higher income country

• The precise relationship to income cannot be predicted a priori.

Differences Across Countries in Optimal ICERs


• If two countries differ in per capita income but otherwise have similar preferences for medical care, the optimal ICER or willingness to pay for medical care will be higher in the country with the higher income per capita.

• If each country chooses its own ICER threshold(s) based on its citizens’ willingness-to-pay for medical care, countries with higher income per capita are likely to choose higher ICERs

• Manufacturers can set higher prices in these countries.• There will not be exact proportionality of prices with income - other factors play a

role, including preferences, disease burdens, income distribution and health system design.

• These prices should differ appropriately across countries and in aggregate should add up to an appropriate incentive for manufacturers to invest in R&D.

• External Reference Pricing (ERP) is a form of informational arbitrage, whereby one country sets its price for a drug based on the average or lowest price of the same drug in a basket of other countries undermines price discrimination across countries.

• Parallel Trade (PT) is a form of physical arbitrage, legal in the EU, similarly undermines differential pricing

• Both ERP and PT lead manufacturers to rationally seek the same prices across linked markets, accepting launch delays and non-launch in low price low volume countries

Achieving Appropriate Price Differentials Across Countries with ICERs


Per capita Income Differentials in the EU

PolandSlovak Republic

EstoniaCzech Republic

PortugalGreece

SloveniaSpain

ItalyUnited Kingdom

France (2012)GermanyBelgium

NetherlandsIrelandAustria

SwedenDenmark

Luxembourg

0 20,000 40,000 60,000 80,000 100,000 120,00013,566

17,70018,35418,712

20,51321,276

22,46229,498

35,02039,62739,907

44,84245,384

47,48548,53748,993

58,05859,266

111,121

GDP per capita (US$ exchange rate) for selected EU countries, 2013

GDP per capita (US$ exchange rate)

Source: OECD Health Database (Accessed 05 March 2015).


Member State use of ERP

Source: Tuomi, Mondher, Cécile Rémuzat, Anne-Lise Vataire, and Duccio Urbinati. 2013. External Reference Pricing of Medicinal Products: Simulation-Based Considerations for Cross-Country Coordination.


Parallel Trade (PT): economic consequences

• Empirical and theoretical work on PT concludes:• The gains of the parallel trade accrue mostly to the distribution chain

of parallel imported medicines: parallel distributors and wholesalers and not to health insurers

• PT reduces the global welfare by creating an environment where the manufacturers have no incentive to serve countries with lower drug prices

• Lower investments in R&D by firms involve long term welfare losses• There are short term welfare loss from medicine shortages in

exporting countries (Greece, Spain)

• Sources Kanavos and Costa-Font, 2005, Gandslandt and Maskus, 2004, Szymanski and Valleti, 2005; Kanavos et al., 2011•


..some recognition of the problem………….

• The EU Commission Access to Medicine initiative:• From the countries’ perspective, the main problems cited

were: lack of marketing authorisation, shortages of supply, no effective availability, unaffordable prices and marketing delays. Economic operators cited the following key factors: low profitability at allowed prices/margins, local language requirements, price spillovers through international reference pricing, and/or risk of parallel trade. (European Commission 2014)

• Belgian Presidency report to the European Commission proposed a centrally agreed system of price differentiation within the EU to enable better access to new treatments in all the Member States (Annemans et al. 2010)


Implementing differential pricing in Europe

Options for differential pricing in the EU

Degree of centralisation

Europe wide agreement on Ramseypricing, or VBDP

Maximum

Two-tier Europe (a form of peak load pricing)

Medium

Increased confidentiality leading to Ramsey pricing or VBDP

Minimum


A minimum centralised option• Differential pricing systems based on VBDP complemented with:

• confidential discounts• or confidential voluntary contractual agreements

• This approach requires limitations to price transparency• It is politically feasible

• It would allow price differences to be agreed at member state level which could remain confidential

• This would limit the ability of countries who did not accept the principle of differential pricing to undermine low prices obtained by others.

• May not be stable due to the economic value of the hidden information


Conclusion and policy implications• Third party payers in each country should use ICER

thresholds reflecting their enrolees WTP for health gain, and raise funds efficiently – VBDP

• This will lead to optimal dynamic and second best static efficient relative and absolute prices for pharmaceuticals

• ERP and PT mean EU price differences are suboptimal • Low per capita income markets suffer from shortages of supply,

unaffordable prices and marketing delays• Dynamic incentives for optimal R&D for EU patients are reduced

• Two feasible solutions:• “Two-blocks” Europe, with parallel trade and IRP only allowed within

and not between blocks (equivalent to “peak” and “off peak” users).• Confidential discounts perhaps linked to the use of voluntary

contractual agreements. Could be used to implement VBDP


References (1) • Banerjee A, Hollis A, Pogge T. 2010. The health impact fund: incentives for improving access to

medicines. Lancet 375:166–169

• Boiteux, Marcel P. 1949. “La tarification des demandes en pointe: Application de la theorie

• Danzon, Patricia M., Adrian K. Towse, and Jorge Mestre-Ferrandiz. 2015. “Value-Based Differential Pricing: Efficient Prices for Drugs in a Global Context.” Health Economics 24: 294–301

• Ganslandt, Mattias, and Keith E. Maskus. 2004. “Parallel Imports and the Pricing of Pharmaceutical Products: Evidence from the European Union.” Journal of Health Economics 23 (5): 1035–58.

• Garber, Alan M, Charles I. Jones, and Paul Michael Romer. 2006. “Insurance and Incentives for Medical Innovation.” Forum for Health Economics & Policy 9 (2): 1–27. http://econpapers.repec.org/article/bpjfhecpo/v_3abiomedical_5fresearch_3ay_3a2006_3an_3a4.htm.

• Hay Joel W. 2005.“Application of Cost Effectiveness and Cost Benefit Analysis to Pharmaceuticals.” Chapter 14 in Santoro M, Gorrie T, eds. The Grand Bargain: Ethics and the Pharmaceutical Industry In the 21st Century. Cambridge University Press, New York NY, 2005:225-248

• Jack, William, and Jean O. Lanjouw. 2005. “Financing Pharmaceutical Innovation: How Much Should Poor Countries Contribute?” The World Bank Economic Review 19 (1): 45–67. http://wber.oxfordjournals.org/content/19/1/45.short.

• Jena, Anupam B., and Tomas J. Philipson. 2008. “Cost-Effectiveness Analysis and Innovation.” Journal of Health Economics 27 (5): 1224–36. doi:10.1016/j.jhealeco.2008.05.010.


References (2) • Kaló, Zoltán. 2014. “Differential Pricing Across Europe - Addressing Central-Eastern European Country

Needs.” presented at the ISPOR 17th Annual European Congress, Amsterdam, November 10.

• Kaló, Zoltán, Lieven Annemans, and Louis P Garrison. 2013. “Differential Pricing of New Pharmaceuticals in Lower Income European Countries.” Expert Review of Pharmacoeconomics & Outcomes Research 13 (6): 735–41. doi:10.1586/14737167.2013.847367.

• Kanavos, Panos, and Joan Costa-Font. 2005. “Pharmaceutical Parallel Trade in Europe: Stakeholder and Competition Effects.” Economic Policy, 20(44): 751–98.

• Kanavos, Panos, Willemien Schurer, and Sabine Vogler. 2011. “The Pharmaceutical Distribution Chain in the European Union: Structure and Impact on Pharmaceutical Prices.” EMIN€T Report, Austria. http://whocc.goeg.at/Literaturliste/Dokumente/FurtherReading/Pharmaceutical%20Distribution%20Chain%20in%20the%20EU.pdf.

• Kanavos Panos and Stacey Kowal. 2008. “Does pharmaceutical parallel trade serve the objectives of cost control?” Vol 14 No 2 22-26, Eurohealth. http://www.lse.ac.uk/LSEHealthAndSocialCare/pdf/eurohealth/VOL14N2/Kanavos%20and%20Kowal.pdf

• Kremer M, “Patent Buyouts: A Mechanism for Encouraging Innovation.” Quarterly Journal of Economics, 1998, November: 1137–7

• Lakdawalla, Darius, and Neeraj Sood. 2013. “Health Insurance as a Two-Part Pricing Contract.” Journal of Public Economics 102 (C): 1–12. https://ideas.repec.org/a/eee/pubeco/v102y2013icp1-12.html.

http://whocc.goeg.at/Literaturliste/Dokumente/FurtherReading/Pharmaceutical%20Distribution%20Chain%20in%20the%20EU.pdf

http://whocc.goeg.at/Literaturliste/Dokumente/FurtherReading/Pharmaceutical%20Distribution%20Chain%20in%20the%20EU.pdf

http://www.lse.ac.uk/LSEHealthAndSocialCare/pdf/eurohealth/VOL14N2/Kanavos%20and%20Kowal.pdf

http://www.lse.ac.uk/LSEHealthAndSocialCare/pdf/eurohealth/VOL14N2/Kanavos%20and%20Kowal.pdf

https://ideas.repec.org/a/eee/pubeco/v102y2013icp1-12.html


References (3)• Ramsey, F.P. 1927. “A Contribution to the Theory of Taxation.” The Economic Journal 37 (145):

47–60. http://darp.lse.ac.uk/papersdb/Ramsey_(EJ_27).pdf.

• Schweitzer, Stuart O., and William S. Comanor. 2011. “Prices of Pharmaceuticals in Poor Countries Are Much Lower than in Wealthy Countries.” Health Affairs (Project Hope) 30 (8): 1553–61. doi:10.1377/hlthaff.2009.0923.

• Szymanski, Stefan, and Tommaso Valletti. 2005. “Parallel Trade, Price Discrimination, Investment and Price Caps.” Economic Policy 20 (44): 705–49. http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0327.2005.00149.x/full.

• Towse, Adrian, Michele Pistollato, Jorge Mestre-Ferrandiz, Zeba Khan, Satyin Kaura and Lou Garrison (2015). “European Union Pharmaceutical Markets: A Case for Differential Pricing?” International Journal of the Economics of Business 22:2, 263-275

• Tuomi, Mondher, Cécile Rémuzat, Anne-Lise Vataire, and Duccio Urbinati. 2013. External Reference Pricing of Medicinal Products: Simulation-Based Considerations for Cross-Country Coordination.

• West P, Mahon J. 2003. Benefits to Payers and Patients from Parallel Trade. York: York Health Economics Consortium, University of York.

• Wilson Paul and Amrita Palriwala. 2011. Prizes for Global Health Technologies. The Results for Development Institute (R4D). http://resultsfordevelopment.org/sites/resultsfordevelopment.org/files/resources/R4D-PrizesReport.pdf

http://darp.lse.ac.uk/papersdb/Ramsey_(EJ_27).pdf

http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0327.2005.00149.x/full

http://resultsfordevelopment.org/sites/resultsfordevelopment.org/files/resources/R4D-PrizesReport.pdf

http://resultsfordevelopment.org/sites/resultsfordevelopment.org/files/resources/R4D-PrizesReport.pdf

dynamic efficiency and value-based differential pricing: setting optimal prices for pharmaceuticals...

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