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How Do Drug Prices Respond to a Change from Evidence from a Danish Regulatory Reform∗ Abstract
Reference pricing is a widely used cost containment tool where the maximum reimburse- ment obtained by a patient is determined by the government using prices of similar drugs asa reference. We study the effect of a change in the design of reference price systems using aDanish regulatory reform. In 2005 the country switched from external to internal referencepricing. Previous to 2005, the reference price was calculated using average prices in otherEuropean countries. After the reform, the reference price is defined by the cheapest availableproduct in the country. We investigate the effects of the reform on three therapeutic markets:For the treatment of a chronic condition we use anti-cholesterol drugs, for a semi-chronic con-dition we use antiulcerants, and for the treatment of an acute condition we use antibiotics. Wefind that the switch from external to internal reference pricing led to a substantial reductionin pharmacy purchase prices. The effects are stronger for chronic conditions than for acuteconditions. Furthermore, the reform affects generics and parallel imports more than originalproducts. Finally, we find that the reform reinforces the effects of competition.
Keywords: pharmaceutical markets, regulation, reference pricing.
JEL Classification: I18, C23.
∗We are greatly indebted to Hannes Ullrich. Financial support from the Swiss National Science Foundation (grants 100018-135257 and PBZHP1-143346) and the Economic Policy Research Network is gratefully acknowledged.
†University of Zurich, Department of Business Administration, Plattenstr. 14, 8032 Zurich, Switzerland, ul- rich.kaiser@business.uzh.ch; Copenhagen Business School, Centre for European Economic Research, Mannheim,and Institute for the Study of Labor, Bonn ‡University of Zurich, Department of Business Administration, Plattenstr. 14, 8032 Zurich, Switzerland, su- Introduction
Reference pricing systems, where patients are reimbursed a fraction of the retail price when buying a prescription drug, constitute a particularly widely embraced tool to curb medical expenses across the world (Berndt and Dubois 2012; Esp´ın et al. 2011; L´ opez-Casasnovas and Puig-Junoy 2000).
These systems aim at benefiting patients that prefer cheaper products over more expensive ones, thus inducing more price sensitivity on consumers and more competitive pressure on firms.
There exists a large body of empirical evidence that shows that such systems indeed are effective in bringing down retail prices of prescription drugs (Aronsson et al. 2001; Brekke et al. 2007, 2009, 2011; Danzon and Liu 1998; Kanavos et al. 2008; Pavcnik 2002; Puig-Junoy 2007). It is also observed that different countries apply different rules as to how the reference price is determined. However, much less is known about the consequences of the design of such reference price systems. In April 2005, Denmark switched from external reference pricing (where the reference price was calculated as the average price of similar products in other European countries) to internal reference pricing (where the reference price is calculated as the cheapest price of a similar product in the country). A switch from an external to an internal reference price system creates incentives for patients to buy the cheapest product within a set of substitutes, since the price wedge between the cheapest substitute and a preferred products becomes larger due to the reform, unless there is only a single product in a group of substitutes. This argument is theoretically formalized by Brekke et al. (2009, 2011). We empirically study the effects on prices of a change in the design of the reference price system using a comprehensive panel set that covers around 23,600 observations of 640 unique products that we track for 59 fortnightly time periods.
We speculate that the effect of the reform on prices varies by the severity of the condition and by the type of the firm. Specifically, we distinguish between drugs that treat a chronic disease, a semi-chronic disease, and an acute disease. For the chronic condition we use anti- cholesterol drugs (statins). For the semi-chronic condition we use drugs for peptic ulcer and gastro-oesophageal reflux disease (antiulcerants). And for the acute condition we use antibiotics.
Our prior is that patients with a chronic condition are more price sensitive than patients for an acute condition because health expenditures are generally substantially higher, treatment time is longer and patients might be more experienced and better informed about their substitution In addition, we differentiate between three types of firms: original firms, generic firms and parallel importers. Original firms engage in R&D using intellectual property rights to protect their innovations. Generic firms produce drugs that are bioequivalent copies of original products and may only legally enter the market after the patents have expired. Parallel importers do not engage in manufacturing. Instead, they buy products in low-price countries, repackage, relabel, and sell them in high-price countries. Parallel importing is legal within the European Union and in Denmark it is permitted for both on-patent and off-patent pharmaceuticals. We explicitly allow the reform to affect each type of firm differently to account for the evidence supported by a large body of literature suggesting that generics are perceived to be different from original products.
Previous studies find that original firms keep high prices and are able to retain substantial market shares despite the presence of low-price generic substitutes. This is associated with consumers heterogeneity with respect to their price sensitivity and consumers brand-loyalty generated by first-mover advantage (Caves et al. 1991; Grabowski and Vernon 1992; Frank and Salkever 1997; Aronsson et al. 2001; Coscelli 2000).
Specifically, after generics enter the market, the price sensitive consumers switch and original producers are left with consumers that are even less price sensitive and probably brand-loyal. We expect that the switch from external to internal reference pricing affects generics more than original products, because these are consumed by more price sensitive patients. In addition, parallel imports are closer substitutes to original firms because they are not copies but exactly the same product in another package. Therefore, we expect parallel importers to react similarly to original firms.
Our paper is most closely related to the seminal work of Pavcnik (2002). She studies a switch from price cap to external reference pricing in Germany, one of the countries that first introduced this policy. She uses reduced-form pricing regressions where she maps dummy variables for the time period after the regulatory change to retail prices. The findings suggest that producers substantially reduced prices after the reform. In particular, she finds that the effects are stronger for original products, specially for those that faced generic competition. We also explore the latter finding and control for competition. We expect the reform to reinforce the effects of competition, such that prices decrease more in markets facing more competitors after the reform is introduced.
Other related work includes Brekke et al. (2009, 2011) and Kaiser et al. (2013). The first group of papers studies a switch from price cap to reference price regulation in Norway, confirming the previous results. In Kaiser et al. (2013) we conduct a welfare analysis of the Danish change from external to internal reference pricing. This analysis focuses on anti-cholesterol products only and it also includes reduced–form pricing equations similar to Pavcnik. The main finding is that the substitution from external to internal reference pricing yield a substantial decrease in prices, but opposite to Pavcnik, the effects are stronger for generics. The present analysis extends our earlier analysis by including treatments for a semi-chronic and an acute condition.
In our paper we find that the switch from external to internal reference pricing has effectively impacted pharmacy purchase prices negatively, more so for chronic conditions than for acute conditions. We also show that the reform affected prices for generics and parallel imports more than for original products. Finally, competition plays an important role and we show that the change in the design of reference pricing reinforced the effects of competition in reducing prices, inducing strongest price changes for markets with many substitute products.
This paper is organized as follows. Section 2 offers an overview of the Danish pharmaceutical market. Section 3 describes the data. Section 4 describes the empirical framework. Section 5 presents the results. Section 6 concludes.
Institutional Background
This section offers a short overview of the Danish pharmaceutical industry and describes the main regulatory framework. In Denmark the pricing of pharmaceutical products is free in the sense that firms can set any price. However these prices must be reported to the Danish Medicines DKMA makes them publicly available online under URL http://medicinpriser.dk, a website that also contains information on all authorized pharmaceuti- cal products in Denmark and was designed to ensure that prices for pharmaceuticals are identical Second, pharmacies operate in a highly regulated environment. The number and location of pharmacies, as well as their markups are regulated by the government. The regulation of the markup implicitly sets the pharmacy retail price pc, such that pc = pf + k, where pf is the price set by the firm (pharmacy purchase price) and k is the prescription fee (including value added taxes (VAT)). Moreover, Danish pharmacists are required to dispense the cheapest product among available substitutes, unless the consumer or the doctor explicitly requests another product.
Third, consumers are entitled to free and equal access to health care services. The reimburse- ment that consumers obtain when buying pharmaceuticals depends on her annual health care expenditures and the choice of the product. The final price paid by consumers pcop is given by: where pc denotes the pharmacy retail price., pr is the reference price and τ is the fraction of the reference price that will be reimbursed. Consumers in long term treatments with high prices can obtain as much as 80 percent of their cost reimbursed.
The reform affecting reference prices took effect on April 1, 2005. Denmark changed from external to internal reference pricing for all prescription-only pharmaceuticals independent of No other changes were made to the reimbursement system.
reform, the reference price for a given product was defined as the pharmacy retail price of the chosen product up to the average price of the same product in the EU-15 member states, excluding Greece, Luxembourg, Spain, and Portugal. Once the retail price exceeded the EU average price, the reference price was set equal to the EU average price.
The reimbursement reform originated from an assembly of a group of experts from the Danish Ministry of Health on September 15, 2003, who wanted to collect ideas for a reform of the existing reimbursement system to strengthen competition and cost awareness. The Danish Association of the Pharmaceutical Industry (Lægemiddel Industri Foreningen, LIF) — the Danish assembly of original drugs producers — launched the idea of using the domestic Danish price of the cheapest available product within a substitution group as the reference price instead of EU averages. In June 2004, the Danish parliament ratified the new reimbursement law making it public and These government–determined dates are important for our analysis as they define the time periods before and after the reform. Other events that may have affected drug prices include a voluntarily agreement on price ceilings that was established by LIF members between May 2001 and April 2003 and a new agreement on price ceilings that the Danish Ministry of Health and LIF ratified in October 2006. The voluntary price ceilings agreement was not respected by most LIF members, and probably neither by generic firms or parallel importers, since they are not In order to separate the reform effects from the price ceiling agreements before and after the reform, we define and focus our analysis to a base period and an implementation period.
The base period includes the time between September 15, 2003 and June 7, 2004 — the time between the working group assembly and the ratification of the reform in parliament. We choose these dates because, during that time, no reliable information about prospective changes in the reimbursement system was publicly or privately available. Moreover, the number of firms as well as prices remained stable, an issue that we discuss in more detail in Section 3. The implementation period covers the time between April 1, 2005 and September 25, 2006, the time span between the reform implementation and the beginning of the new price ceiling agreement. We discard all other time periods for our empirical analysis.
Our data set contains fortnightly prices and other characteristics of pharmaceuticals in three therapeutic markets: Anti-cholesterol drugs, drugs for acid-related gastrointestinal conditions, and antibiotics. These products are used in the treatment of diseases that vary in their severity and length of therapy with anti-cholesterol drugs constituting the longest and with more severe consequences and antibiotics constituting the shortest and least severe therapy.
We differentiate these markets because we expect the reform to have different effects in each one. Our prior is that patients with a chronic condition are more price sensitive than patients in an acute treatment, due to the fact that their health care expenditures are generally substantially higher, treatment time is longer and they might be more experienced and better informed about A product is defined by four attributes: active substance, strength, package size, and firm.
The active substance is captured by the 5-level anatomical therapeutic chemical classification code (ATC Code). Strength measures the amount of the active substance in milligram per pill.
Package size is the number of pills per package. Importantly, products with similar ATC codes are closer substitutes than products with in other ATC codes. DKMA classifies products with the same 5-level ATC code, strength, administration form, and similar package size into substitution groups. Products within a substitution group are perfect substitutes and consumers can freely choose among products in the same substitution group.
To make products from different strength or package size comparable we normalize prices and quantities using defined daily doses (DDD). This measure is proposed by the World Health Organization and widely used in the pharmaceutical industry. One DDD is defined as the average maintenance dose per day for a drug used for its main indication in adults.
Our dependent variable is the pharmacy purchase price in Danish krones (DKK) per defined daily dose (DDD), i.e. the price that is actually set by the producers for a unit of DDD. Prices are deflated using the consumer price index with the year 2005 as basis.
Table 1 provides information on turnover, reimbursement, the number of patients in treatment and sales for each therapeutic group. This information is not based on the product-level data that we use in our econometric analysis but was downloaded from www.medstat.dk, a website that contains yearly statistics on consumption and utilization of pharmaceuticals in Denmark. The table shows that turnover (pharmacy retail price × DDDs sold) is relatively similar to all products but slightly higher for antiulcerants. However, the chronic conditions account for a higher share of reimbursement than the acute condition. Moreover, the number of patients differs enormously between the treatments. In 2005 almost 1.7 million patients were treated with antibiotics. In the same year the number of patient treated with antiulcerants was around 380,000 and 307,000 patients were treated with anti-cholesterol drugs. The increase in the number of patient using anti-cholesterol drugs is remarkable (170 percent from 2002 to 2006). Utilization per patient (sales in DDD relative to number of patients) is much higher for anti-ulcerant and anti-cholesterol drugs Finally, Table 1 also gives an estimate of the duration of treatment indicated by the measure at the bottom of the table. If we convert it into sales in DDD per inhabitant per year, the measure constitutes an estimate of the number of days for which each resident is annually treated on average. If each person in Denmark were treated with anti-cholesterol drugs, the treatment length in 2006 would be around 22 days. The treatment for antiulcerants would be between 11 and 14 days, and the treatment with antibiotics would only take five days. These figures are approximations and are just meant to illustrate differences in treatment durations. Actual treatment with anti-cholesterol drugs can be lifelong, while a treatment with antiulcerants lasts Our data is consists of information on 253 antiulcerants, 228 statins, and 157 antibiotics that we observe for 58 fortnightly time periods.1 Table 2 displays descriptive statistics on prices and variables that mirror the respective competitive situation. Reported are fortnightly average prices for a DDD in DKK. A DDD of antibiotics costs on average more than a DDD of anti-cholesterol products or antiulcerants. Note that average reference prices are higher than average pharmacy purchase prices, because the latter do not include prescription fees or VAT.
Furthermore, the average number of products and average number of firms is relatively stable and very similar for all groups, which helps us mitigate attributing effects to the reform that could have arisen from entry and exit. In contrast, the average number of substitution groups and the average number of products in a substitution group differs significantly. For anti-cholesterol drugs there are on average 40 substitution groups, each with around five to seven products to choose from. In the case of anti-ulcerants there are only around three products in each substitution group, and in the antibiotics group, there are only two products in each substitution group. We expect the reform to have stronger effects on the chronic condition, since this is the therapy that Finally, the table presents the share of original products, generic products, and parallel imports 1Appendix A displays the exact classification of the products in terms of their ATC code.
in each group. The share of generics in the chronic and semi-chronic condition is higher than the share of original products. Parallel imports are also well represented in these groups (28 percent of anti-cholesterol drugs and 12 percent of antiulcerants) but not in the group of antibiotics, where they only make one percent of all observations. Antibiotics is a group dominated by original Empirical Approach
This section describes our empirical framework. Our aim is to identify the effect of the reimburse- ment reform on pharmacy purchase prices. To this end, and like Pavcnik (2002), we estimate standard fixed effects regressions of dummy variables for the reform and variables that represent competition on the natural logarithm of pharmacy purchase prices. Our regression equation take 1R ∗ dop + α2R ∗ dpi + γ1zj + γ2R ∗ zj + β1R ∗ zj ∗ dop + β2R ∗ zj ∗ dpi + µj + νt + ϵjt, where pf is the pharmacy purchase price of a product j in time t. R denotes a dummy variable that is coded one for the implementation and zero for the base period. It is our variable of main interest and its corresponding parameter ρ is to be interpreted as the approximate percentage difference between the pharmacy purchase price before and after the reform. dop and dpi are dummy variables equal to one if the product is an original product (op) or if the product is a parallel import (pi) respectively. We interact these dummy variables with the reform dummy to allow for different impacts in different types of firms. The variable zj is the number of products in a substitution group and measures the the current competitive situation of product j. We interact zj with the reform dummy to allow competition to have different effects on prices before and after the reform and in addition, we permit these effects to differ for each firm type by interacting them with the firm type dummy variables. The term µj lumps together all product-specific time- invariant characteristics of product j. Since all drug characteristics — strength, active ingredient, package size and substitution group — are time-invariant, we do not need to additionally account for them. Finally, we include a full set of time dummy variable νt and the term ϵjt is an iid This section reports our empirical findings from a change in the design of reference pricing. The results are summarized separately for each therapeutic treatment. Table 3 presents the results for anti-cholesterol drugs, Table 4 the results for antiulcerants, and Table 5 the results for antibiotics.
Empirical Finding 1 (Price Effect) A switch from external to internal reference pricing yields
a substantial reduction in pharmacy purchase prices. The effects are stronger for chronic condi- Importantly, the effects of the reform are stronger the more severe the condition is. We find that prices decrease by 47 percent (= exp(−0.633) − 1) for statins, by 22.9 percent for anti- ulcerants and 5.3 percent for antibiotics. These are the results from a specification that includes only a dummy variable for the reform and product-specific fixed effects (see Specification (1) in all tables). This pattern is robust to the inclusion of more explanatory variables. These results support the view that consumers with a chronic condition are more price sensitive than those with an acute condition and as expected, the reaction to the reform in chronic groups is stronger.
We additionally study differences in reform effects for each type of firm. In Specification (2) we introduce two variables that measure the effect of the reform on original products and the effect of the reform on parallel imports. Generics constitute the base category and the coefficient on the reform dummy corresponds to the reform effect on generics.
Empirical Finding 2 (Effects by Type of Firm) A switch from external to internal refer-
ence pricing affects generic firms and parallel importers stronger than original firms. The effects on generics and parallel imports is stronger than for original products in all ther- apeutic groups. Specially in the group of statins, where the negative effect on original products (-0.23 = exp(−0.907+0.648)−1) is substantially lower than the effects on generics (-59.6 percent) or parallel imports (-60 percent). Furthermore, in all therapeutic groups, the differences in effects between generics and parallel imports are small and not statistically significant. Contrary to our findings, Pavcnik (2002), Granlund (2010), and Brekke et al. (2011) find stronger price decreases for original products. However, these studies analyze the introduction of reference pricing, while in our setting, a policy of reference pricing was already in place and we expect patients to be Next, we use the number of products in a substitution group as a measure for competitiveness and allow it to affect prices differently before and after the reform.
Empirical Finding 3 (Effects of competition) A switch from external to internal reference
pricing reinforces the effects of competition. Specially for generic products and chronic conditions. The results correspond to Specification (3) and indicate that it is ambiguous how more prod- ucts in a substitution group affect prices. The effects for statins is almost zero, for antiulcerants is negative, while the effect for antibiotics is positive. However, we show that the reform reinforces the expected effect of competition and this result is consistent in all three markets. The coefficient of Reform × # of products in substitution group is negative and significant for all therapeutic groups, suggesting that more competition after the reform is associated with lower prices. This result also holds if we further allow the reform effects to be different for products from different types of firms (Specification (4)). These findings reflect the differences in the structure of the therapeutical markets. Products in the same substitution group are closer substitutes to each other, than products outside the substitution group. While for antibiotics there are many substi- tution groups each with few products, the structure for statins is the opposite: few substitution groups each with more products (as reported in Table 2). The reform reinforces the effects of competition more for chronic conditions, where there are many substitution options, than for acute conditions, where there are fewer substitution options. Furthermore, in Specification (5) we allow competition to have a different effect, not only before and after the reform, but also for different types of firms. The results suggest that the reform reinforces competition effects To summarize our results, we find that the switch from external to internal reference pricing has effectively impacted pharmacy purchase prices negatively, mostly so for chronic conditions than for acute conditions. We also show that the reform affected prices for generics and parallel imports more than for original products. Finally, competition plays an important role and we show that the change in the design of reference pricing reinforced competitive pressure, inducing strongest price changes for markets with many substitute products.
Conclusion
While it is undisputed that reference pricing effectively brings down prices of pharmaceutical products, much less is known how a reference price system should ideally be designed. We focus our analysis with one particularly design question: should reference prices be externally determined 2Appendix B presents the results from specification (5) separately for each type of firm, in each therapeutic or internally determined? To provide an answer, we use a Danish reform for reimbursement of expenditures for pharmaceuticals. Where Denmark switched from external to internal reference As Pavcnik (2002) we estimate reduced-form pricing equations where we linked the reform to pharmaceutical purchase prices for three types of therapeutic groups that differ in the severity of the condition: anti-cholesterol drugs, that treat a chronic condition, antiulcerants, that treat a semi-chronic condition, and antibiotics for the treatment of an acute condition. We allow for different effects in these groups because consumers differ in their price sensitivity by the type of condition. Consumers with a more prevalent disease face regular and higher expenditures, thus we expect them to be better informed with regard to their substitution alternatives, than consumers that are treated occasionally and for a short period of time, as is usually the case of antibiotics.
We find that the switch from external to internal reference prices substantially reduced phar- macy purchase prices. The effects are stronger for chronic conditions and for generics products and parallel imports. Furthermore, the reform reinforces the effects of competition.
Market Overview
Source: www.medstat.dk
Table 2: Summary statistics
Notes: Table 2 reports summary statistics for all variables in each therapeutic group. Prices are fortnightly averages fora defined daily dose in Danish krones. All figures deflated using consumer prices index with June 2005 as basis.DDD Table 3: Estimation Results – Anti-Cholesterol
Reform × # Products in subs. group Reform × # Products in subs. group × Original Reform × # Products in subs. group × PI Notes: Table 3 reports linear regression estimates of the coefficients in our pricing equation for the therapeuticmarket of anti-cholesterol products. The variable PI stands for parallel import, the variable Original standsfor original product. Robust standard errors in parentheses. The estimation sample contains only the baseand the implementation period. Statistical significance: *** p < 0.01, ** p < 0.05, * p < 0.1 Table 4: Estimation Results – Antiulcerants
Reform × # Products in subs. group Reform × # Products in subs. group × Original Reform × # Products in subs. group × PI Notes: Table 4 reports linear regression estimates of the coefficients in our pricing equation for the therapeuticmarket for antiulcerants. PI stands for parallel import, Original stands for original products. Robust stan-dard errors in parentheses. The estimation sample contains only the base and the implementation period.
Statistical significance: *** p < 0.01, ** p < 0.05, * p < 0.1 Table 5: Estimation Results – Antibiotics
Reform × # Products in subs. group Reform × # Products in subs. group × Original Reform × # Products in subs. group × PI Notes: Table 5 reports linear regression estimates of the coefficients in our pricing equation for the therapeuticmarket for antibiotics. PI stands for parallel import, Original stands for original products. Robust standarderrors in parentheses. The estimation sample contains only the base and the implementation period. Statisti-cal significance: *** p < 0.01, ** p < 0.05, * p < 0.1 Characterization of Products in Terms of Their ATC Code
Notes: Appendix A displays a detailed classification of the products considered in the analysis in termsof their Anatomical Therapeutical Chemical classification code and the average number of products for aperiod of 14-days in each molecule group for the base and the implementation period. Source for classifi-cation: WHO Collaborating Centre for Drug Statistics Methodology.
Estimation Results by Product Type
Notes: Table B reports linear regression estimates of the coeffi-cients in our pricing equation and summarizes the results by thetherapeutic market. Robust standard errors in parentheses. Theestimation sample contains only the base and the implementa-tion period. Statistical significance: *** p < 0.01, ** p < 0.05, References
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