This paper – which can be found here – conducts an empirical analysis of the impact of reference pricing on generic competition, and corresponding effects on drug prices, sales, and expenditures.

A reference pricing scheme defines a maximum price that will be reimbursed by the insurer for a set of drugs with similar therapeutic effects. Consumers can purchase a drug priced above the reference price, but will then have to pay out-of-pocket the difference between the reference price and the actual drug price. The goal of reference pricing is to curb pharmaceutical expenditures by increasing demand elasticity and stimulating price competition between drug producers.  Reference pricing has become widely used. In Europe, almost every country has now introduced reference pricing schemes for off-patent drugs. In the US, reference pricing is a well-established practice through the Maximum Allowable Cost programs that are used by Medicaid and some managed-care programs to reimburse multi-source compounds.

The impact of reference pricing on generic entry depends on the relative strength of two counteracting effects. On the one hand, reference pricing can increase demand for generic drugs due to higher brand-name co-payments, which provides the generic drug producers with an incentive to set higher prices and in turn makes generic entry more profitable. On the other hand, reference pricing pushes brand-name producers to reduce their price to counteract the (expected) reduction in demand. If the brand-name producer’s price response to reference pricing is sufficiently aggressive it may force generic drug producers to also reduce their prices and, hence, reduce to incentives to market entry. Thus, the  competitive effects of reference pricing are theoretically ambiguous.

To identify the causal effect of reference pricing on generic competition, the authors use a policy reform in Norway that introduced a reference pricing scheme called Trinnpris in 2005. The reference price, which is the maximum reimbursement rate from the National Insurance Scheme, is set at a fixed discount rate on the price cap of the original brand-name drug in the period prior to patent expiration and generic entry. The initial discount is 35 percent from the date when generic competition enters the market. After six months, the discount is increased to around 60 or 80 percent depending on the sales value of the drug. Eventually, after (at least) 18 months the regulator can increase the discount up to a maximum of 90 percent for substances with the highest sales value.

Importantly, for administrative reasons the scheme was gradually implemented and initially included only a limited set of off-patent substances. This allows for the establishment of a comparison group of drugs not subject to reference pricing, and for the use of a difference-in-difference approach to identify the effect of reference pricing on generic competition. To confirm the robustness of the results, the authors also ran a  regression discontinuity set-up focusing only on drugs that were included in the reference pricing scheme at some point during the period of observation, exploiting the fact that the exact time of inclusion was to a large extent random.

The findings of the paper are that: “the introduction of [reference pricing] substantially increased the number of generic producers and their market shares. We also found that [reference pricing]  triggered price competition, resulting in lower prices of both the brand-name and the generic drugs. Thus, our results suggest that [reference pricing]  led to a demand increase for generic drugs that outweighs the corresponding price reductions, and therefore stimulated generic entry. We also find a negative effect (albeit weakly significant) of [reference pricing]  on total drug expenditures. The  reduction in total expenditures is relatively smaller than the average price reduction, which reflects the fact that lower prices stimulate total demand for pharmaceuticals.” However, when compared with previous studies, these results “suggest that market-specific factors and the regulatory framework are important in assessing the impact of reference pricing.”

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