WhatIF

What if: A sliding scale were used to reimburse generic drugs to effectively drive down prices?

Aidan Hollis, Department of Economics, University of Calgary

The policy option presented here was chosen to stimulate discussion, but is only one of several options examined by the author in the reportManaging Pharmaceutical Expenditure: An Overview and Options for Canada”.

Summary

About the presenter

Aidan Hollis is professor in economics at the University of Calgary, and vicepresident of Incentives for Global Health; a U.S.-based non-governmental organization focused on the development of the Health Impact Fund proposal to pay for pharmaceutical innovation. Hollis studied at Cambridge University and the University of Toronto, where he obtained a PhD in economics. His research focuses on innovation and competition in pharmaceutical markets. He has published widely in economics. In 2003-2004 he served as the T.D. MacDonald Chair in Industrial Economics at the Competition Bureau of Canada.

Main concern/problem

Because generics offer no quality advantages over their branded counterparts, generic drugs compete for market share by offering low prices. The Ontario Drug Benefit (ODB) program, the largest drug plan in Canada, plays an important role in determining generic drug reimbursement prices. The ODB has set its generic drug reimbursement at 25% of the price of the reference branded drug. This has created unwanted consequences. In general, the price will be either too high or too low for any given drug, since this price-setting mechanism is arbitrary. If too high, payers are paying too much, and the excess profits will be divided between the pharmacies and the manufacturers. Excessive prices may also drive excessive entry. If 25% of the brand price is below the cost of manufacturing, then generic manufacturers either won’t enter the market, leading to sustained brand monopolies, or there will be a regulatory proceeding to allow for higher reimbursements.

Proposed Option

The reimbursement rate for drugs with interchangeable generic products would depend on the number of generics. For example, with only one generic, the reimbursement rate could be 50% of the brand price. With two generics, the rate could be 35%; with three, 25%; with four, 20%; with five, 15%; etc.

Benefits

This system mimics competitive outcomes by using the knowledge firms have about their own costs of production in order to generate lower prices for payers. Firms would continue to enter the market as long as their costs were lower than the price.

This system would increase productive efficiency, since, as additional firms enter the market, the price is driven down, forcing higher-cost producers out.

This system also “rewards” early entrants, who would benefit from higher prices initially, and typically larger market shares over time. This is appealing because it would reduce litigation expenses—early entrants are generally the generic firms that engage in costly litigation to enable competition.

Experience/evidence of success

Ontario used the sliding scale mechanism for many years, but set the levels at 70% for one generic and 63% for multiple generics. This approach was administratively successful but didn’t require prices to fall beyond the 63% ceiling.

Challenges and Limitations

In order to drive prices down successfully, provinces will need to coordinate their pricing. To ensure market forces drive down prices as quickly as possible, a steep price scale should be used. Some critics have suggested that this system is administratively complicated, but this could be resolved through computer technology.

Considerations for Canada

Public drug plans seek to price generic drug prices as low as possible without discouraging generic entry. A firm that competes under the sliding scale model would have to be willing to supply as much as the market demanded in order to have its product accepted in the provincial formulary at the new price.

Presentation