The OECD countries use a variety of pharmaceutical cost control approaches. The most common tactic in Germany is reference pricing, while France and Canada utilize product price controls and the UK uses profit regulation (Bloom and van Reenen, OECD, 1999; Dickson 1992). The most direct method of controlling drug costs is product price control whereby the government negotiates directly with each manufacturer to determine the reimbursement level for individual products. In a typical system the price is established after the drug product obtains marketing approval but prior to market introduction. The government or a government-sanctioned body reviews the manufacturer's price application and determines whether the requested price is "fair." If the price is not acceptable, the government can set a lower price. If the government-determined price is lower than the manufacturer requested, the company can appeal the decision. The price setting process usually takes one of two forms: internal, which primarily focuses on the manufacturer's price justification, or external, which examines the prices charged for the same or similar product in other countries (Dickson 1992; Earl-Slater 1997). When conducting an internal evaluation of a manufacturer’s price justification, governments take into account a myriad of factors such as the anticipated therapeutic benefit of the new product, anticipated sales volumes, and the company’s contribution to the economy (Le Pen 1996; Earl-Slater 1997). In setting a low price for a particular product, the government may take advantage of the fact that research and development expenses were incurred in another country (like the US) where the selling price is higher. This, in turn, creates an incentive for "parallel trade" in drug products, where drugs from a "low price" country are imported and resold in other countries where they command a higher price (GAO 1994b, Bloor 1996).
Regulatory systems that employ external price justifications for new drug products use different pricing criteria. Where the product under review is already marketed in other countries, these systems compare prices directly based on dose, strength, and pack size considerations. Where the product is not widely marketed elsewhere, countries develop comparative “market baskets” of drugs with the same therapeutic indication. The contents of these market baskets vary from system to system depending on which comparator drugs are included and whether generics are part of the package. The result is that the “fair” price for a given drug product will vary from country to country (Bloor 1996; Anis and Wen, 1998).
By whatever means a country sets the initial drug price, there is also the question of subsequent price changes. All governments that use direct drug price controls require approval for any product price increases after market introduction. (Le Pen 1996; Earl-Slater 1997; Anis and Wen ,1998)
In place of direct product-by-product price controls, some regulatory systems use a method known as “reference pricing”. In such a system, drug prices are compared by three different approaches: the same drug chemical, the same drug class, or therapeutically equivalent drugs that work via different mechanisms of action.2 Dickson and Redwood (1998) define reference pricing as the maximum reimbursement ceiling (reference price) set by the insurer for defined drugs. If the drug costs more than the reference price, the patient or supplementary private insurers are responsible for the difference (Dickson and Redwood 1998). Reference pricing differs from direct price controls in that the pharmaceutical firm can sell the product above the reference price if it believes that the patient is willing to pay the cost difference. The selling price is not strictly regulated on a product-by-product basis. Rather, reference pricing regulates groups of identical or similar drugs. Although reference-pricing systems differ greatly across countries they share four common objectives:
- Modify physicians' prescribing patterns to prescribe less expensive drugs.
- Influence patients to accept cheaper drugs or higher copayments.
- Pressure the pharmaceutical industry to lower prices in order to remain competitive.
- Control expenditures of the payer's drug budget. (Dickson and Redwood 1998; López-Casasnovas and Puig-Junoy 1999)
Reference pricing has been enacted in countries throughout the world, including Germany and British Columbia, Canada. It has become increasingly popular among private payers and Medicaid programs in the United States. The maximum allowable cost (MAC) pricing approach, used by many private insurers and Medicaid, uses reference pricing for drugs that are chemically identical. The effectiveness of reference pricing in influencing market prices depends upon several factors, including:
- The purchasing power of the buyer
- The scope of drugs covered under the reference pricing system
- Consumer's willingness to purchase the product at a given price
- The availability of substitutes for drug therapy, such as surgery or physical therapy (López-Casasnovas and Puig-Junoy 1999).
The general consensus is that reference pricing is effective in controlling drug costs, but the financial savings are short-term and subject to the law of diminishing returns. Initially, a significant reduction occurs in prices for referenced products resulting in short term savings for the insurer. Over time, the cost saving effect diminishes as pharmaceutical companies, physicians, and patients alter prescription consumption towards greater use of the reference-priced product (Dickson and Redwood 1998; Dickson 1992; Bloor 1996; López-Casasnovas and Puig-Junoy, 1999).
Some countries regulate the profits of pharmaceutical manufactures rather than the prices they may charge for their products. Britain and Spain both use this approach. Profit is defined by different methods including the rate of return on capital attributable to sales in that country or negotiated profit margins for each company (Bloor 1996). At regular intervals, a target profit rate is negotiated between each pharmaceutical company and the government. Profit regulation permits companies to price products at their discretion. If a company’s profits are above the negotiated profit rate, the excess is either remitted to the government or prices are reduced (Dickson 1992; Towse 1996; Lecomte and Paris 1998).
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