Unintended Consequences of “Fairness”: Critically examining the idea of the US referencing EU prices
Anthony Bower, Ph.D. and Peter Kolchinsky, Ph.D.
This is the eighth in a series of articles that aim to define the biopharmaceutical industry’s social contract with America, to examine practices that deviate from that contract, and to propose refinements to healthcare policy to ensure that our continued investment in scientific progress ultimately yields affordable, effective therapeutics for future generations.
Article 1: America’s Social Contract with the Biopharmaceutical Industry
Article 2: What happens when a drug won’t go generic?
Article 3: Protecting Off-Patent Sole-source Drugs from Price-Jacking
Article 4: Why wait for Generics? In praise of me-too drugs
Article 5: False Heroes — How PBMs Add Insult to the Injury of Insurance Cost-Sharing
Op-Ed: Let’s Throw a Patent-Burning Party
Article 6: The favors they do us: Charging less in other countries makes drugs more affordable in America
Article 7: Hard Negotiating Tactics: Compulsory Licensing and Willingness to Deny
Article 8: Unintended Consequences of “Fairness”: Critically examining the idea of the US referencing EU prices
Article 9: Direct-to-Consumer (DTC) Advertising: misnamed, misunderstood, and underappreciated
Article 10: The strange and special case of epinephrine
Please see Important Disclosures for Readers at the end.
Drug companies consider many factors when determining drug prices, but at its core, their exercise is to price a (temporary) monopoly product to maximize global profits. US payers do bargain for discounts, often quite effectively if they can leverage modestly differentiated products against one another. In the US, drugs with unique benefits in life-threatening diseases tend to avoid this gauntlet. However, countries that are willing to deny their patients access to even uniquely effective drugs on the basis of price drive better bargains, often to the benefit of their taxpayers but the detriment of their patients. While European payers rarely look at US prices, mostly because US prices don’t help European countries negotiate lower rates with drug manufacturers, US payers are known to grumble about lower European prices, although they don’t have any way to leverage that in their negotiations (e.g. drug re-importation remains, for the most part, illegal). Accordingly, as part of a globally optimal strategy, US prices are generally set to maximize profit with US payers, and European prices are set to maximize European profits but with an eye to not setting them so much lower than US prices that the differential causes severe reimbursement friction in the US.
In a February 2018 report¹, the President’s Council of Economic Advisors lamented the “free-riding actions of many small countries,” which reduce companies’ worldwide profits and place a heavier burden on the US patient, and suggested unspecified trade policies that could help reduce this burden. Arguably those countries can afford to pay more, just as US payers would like to pay less.
What if America simply forced the issue of “fair” pricing by introducing regulation stating that it won’t pay more than other comparably wealthy countries? This is a practice known as reference pricing. This idea is repeatedly proposed and worth examining in detail to see how it might play out. We believe that this regulation would be much less effective than a naïve application of historical price differences would suggest, as manufacturers and payers would substantially alter their behavior to account for the new price referencing scheme in the massive US market.
It’s been done outside the US, so why not here?
It should be understood that drug reference pricing is done routinely, either formally via regulations or informally as a bargaining tool, in virtually all drug markets, including the US with its Medicaid “best price” regulation and even Medicare with its “average sale price” reimbursement model.² When Medicaid decrees that it will take a discount off the best price in the private sector, it is referencing the (US) private sector, and in particular the best negotiator’s price in the private sector, and then taking a further discount. This may be socially desirable given that Medicaid serves the poor, and prices are still well above production costs. Critics of reference pricing would be wrong to say that the general approach is unprecedented or would be highly unusual for the US. It is going on now — the question is how extensive it ought to be and whether to reference prices outside the US.
International reference pricing is used among European countries — though it doesn’t work as one might think and it certainly has no relationship to any notion of global fairness. A study of orphan drug list prices and affordability across a dozen countries showed that, while the nominal list price did indeed stay about the same, these drugs were far more expensive for poorer countries (Greece, Hungary, Poland) than the wealthier ones (Germany, Sweden, France) once adjusted for wages, purchasing power parity, and other wealth-normalizing methods.³ But even those prices aren’t the real prices those countries pay. In fact, we don’t actually know the real net prices of drugs in each country; whereas reference prices standardize their published list prices across countries, many countries then negotiate their own confidential discounts to arrive at a net price they are willing to pay, which means that reference pricing does more to standardize the upper limit on what a drug might cost in any European country that subscribes to the reference price.
Let’s play it out anyways — the folly of a global price
If the US forced list prices to be the same as in other countries, the end result would very likely be differential net prices coming from private discounts, just as we have today but even more so. But let’s just imagine that the US could magically mandate globally uniform net prices. We make the case that in a scenario where a biopharmaceutical company had to set a single, global net price, that price would likely be closer to the current US net price than the lower prices in other countries. Let’s play it out to see how we come to this conclusion.
Germany is a plausible and “fair” candidate for a US reference price, as it is a large and wealthy economy with prices for many branded drugs lower, let’s say, by about 20% than in the US (the precise difference is actually hard to calculate because we don’t know net prices in either country and the same drugs aren’t used and approved in both countries; price differences for individual prices vary significantly⁴). There would be large savings for US payers if they could simply reference the current German prices. But this is highly likely to be an overestimate of the long-term savings because manufacturers would increase their foreign prices to account for the knock-on effects in the US of the price referencing. (This may be difficult with current drugs in Germany, but not with new drug applications).
Take a simple example in which the US requires a drug company to sell in the US at the German price. And for simplicity, let’s assume that a single company controls the global commercialization of the drug (as it often does) and that it is launching the drug in both markets at about the same time (although the US usually is first). Any price concession to Germany to gain access will, under these regulations, flow through to the US. The company now sets a single price that maximizes the sum of the profits from the two markets.
Because the US is price insensitive and is the largest market in the world, the profit-maximizing global price is a high price that mostly extracts value from the US. To obtain this high price, manufacturers will accept that the high price in Germany will imply restricting access only to the sickest German patients. The decision is regrettable from the company’s perspective but is especially clear because there are four times as many potential patients in the US. Still, even if Germany were the same size as the US, as long as the US is fundamentally unwilling to deny access based on price, the optimal pricing strategy in certain circumstances might be to just charge a very high price in the US and forget about the German market entirely.
Note that the Germans (or whichever is the reference country) are worse off in this referencing scenario, having to face a higher price and fewer treated patients — and, depending on a drug’s anticipated demand at this higher price, it might not make sense for the manufacturer to promote the drug there at all other than to be able to claim to US payers that they are, technically, paying the same as the German price. In that case, referencing results in zero benefit for US patients and zero access for German patients. And absurd as it may seem, pricing parity could assuage those drug pricing critics driven by “international fairness” rather than absolute cost to the US and patients, possibly reducing payers’ efforts to manage drug prices by other, more effective means.
Forcing companies to standardize their European prices with those in the US will tend to mean exporting higher US list prices to Europe. The microeconomics on this point are quite clear and company pricing departments are well aware of the global dynamics and highly incentivized to stay ahead of the game. Therefore, advocates of referencing US prices to those in Europe who think that this would lower prices substantially in the US would be disappointed.
A few realities about numerous unintended side effects
A little more thought reveals an alarmingly formidable array of unintended side effects of US price referencing. Some of the biggest side effects are touched on below.
Incentivizing unverifiable private discounts
Since no law is without its loopholes, one can expect that Germany (or, again, any other US reference pricing candidate) would attempt to access the drug at a more reasonable cost by exploring ways of effecting confidential discounts or rebates that the US would have a hard time accounting for. This is already occurring in the UK, with its euphemistic private “patient access schemes” providing discounts to the UK NHS that cannot be price referenced on the European continent.
As another example, to avoid giving the impression that it was heavily discounting a rare disease drug in particular countries, a company could ask less wealthy countries to pay full or nearly full price for some patients and give away drug for free to the rest. If that means that the country pays for 25% of patients and the other 75% get free drug, that’s the same as offering a 75% discount per patient, and yet terminology shapes perception — who can fault a company for giving away free drug? These free-drug schemes must be reported in the US (e.g., in calculating the Medicaid Best Price), but the US government lacks jurisdiction over foreign payers, who would have no incentive to provide such information as doing so would infringe on their sovereignty and their ability to get a good deal.
Complicating global partnerships
Often, different companies market a drug in different countries, such as when a biotech company licenses out ex-US rights to a foreign pharmaceutical company during development in exchange for funding and help with developing the drug. Where rights are split, US law requiring reference pricing might only apply to the company commercializing the drug in the US, leaving the partner with foreign-rights free to set price in Germany to maximize their own profits. If the reference pricing law were instead applied without making exceptions for such international partnerships, then odds are that the US would enjoy German prices for many partnered drugs, but the benefits would be short-lived because companies would stop splitting commercialization rights in this way, creating friction for innovation and commercialization but doing nothing to reduce US drug prices. The bottom line is that the industry would adapt to preserve its ability to maximize profits in the US, which is the one large market that it counts on today to put the needs of patients above cost.
Introducing timing issues that don’t have to do with getting to market quickly to treat ill patients
Another limitation of reference pricing stems from the fact that most drugs become available in the US before they launch in Europe. Therefore, US pricing would be set first, making it difficult to eventually set a lower price in Germany that would, at the same time, force the US price lower to match and immediately erode the drug’s US profits. Far easier to launch the drug in Germany at the same price as in the US, preserving US sales, and hoping for some incremental sales in Germany despite their willingness to restrict access based on price.
Management consultancies currently offer intricate and sophisticated launch-timing pricing models, which are generally used for ex-US launch timing exercises. It would be easy for those models to incorporate the US market. Our point here is that the whole market has the tools to move quickly to a new pricing equilibrium.
US prices might increase to make up for lost profits abroad
Perturbing the global pricing system with reference pricing might create further inefficiencies that raise US prices. Since odds are that companies, if required to set a single uniform price, would set one close to what they charge in the US (if not even higher), we have to assume that some countries would consider this price unaffordable for them and deny their patients access by shutting the drug out of their market. The US manufacturer might have to compensate for these lost markets with higher US prices to preserve acceptable profitability levels, and they may become less sensitive to social outrage given that they could claim parity with European prices.
Clinical trials would take longer and cost more
In the event of global reference pricing, it is possible, even likely, that countries that restrict access to marketed drugs they consider too expensive would be unwilling to participate in clinical testing of new drug candidates, nor would companies feel comfortable leading patients on. It’s arguably unethical to experiment on patients and then not give them a chance to benefit from the drug if it actually works and is approved. Shifting more of the work of drug development and trial enrollment to the US would mean that trials would take longer to enroll and cost much more to complete (clinical trial costs in the US are higher than in many other countries). The end result might be that companies would feel further incentivized to charge yet higher prices in the US to generate a return on this greater investment. Having priced other countries out by exporting its drug prices to them, America would be left shouldering ever more of the burden to fund and incentivize drug testing in patients and innovation, which is hardly the intended effect of reference pricing.
Inducing desperate compulsory licensing by countries that refuse to let their patients go without
Finally, we speculate that over time, more countries, especially the less wealthy ones in Europe with nationalist governments, might opt for compulsory licensing, breaking patents to make branded drugs for their own patients and those of other countries unwilling to pay the uniform price; the end result for companies would be lost ex-US profits, protracted disputes before international bodies, and a lot of bad press.
Conclusion
Since the problem facing patients is that some drugs seem unaffordable to them, we believe the solution has nothing to do with counterproductive international price referencing but rather making drugs affordable by actually covering them. The US has the highest number of patients who say they have to forego treatment on account of cost because the US has the worst cost-sharing practices of any wealthy country.⁵ The US market is already very efficient at utilitizing generics (excepting some highly publicized case of price-jacking, which, however outrageous, add up to only a few percent of drug spending). At the margins, there could be societal savings worth pursuing by giving US payers more freedom and incentives to bargain for lower prices for “lower” value branded products (e.g. a branded once-daily version of a drug that is already available as a twice-daily generic), playing me-too drugs off one another to get deeper discounts, and streamline payer administrative costs, which are far higher than in Europe. And, if the US wants to get other countries to shoulder what some may think is a fairer share of pharmaceutical innovation cost, the best option may be to inspire them with the idea that genericizable drugs are, in the long run, a cost effective investment in healthcare for current and future generations and then, when that doesn’t work, negotiate with them through trade agreement, as we have in the past (e.g. Canada more consistently honored patents on American drugs after signing onto NAFTA⁶).
Acknowledgements: We’re grateful to Chris Morrison for his invaluable and substantive thought-partnership and drafting/editing, to everyone who engaged with us in the constructive debates that led up to these articles, and to Erin Clutter and the RA Capital graphics team for creating artwork that so astutely captures the essence of each core concept.
Sources
¹ https://www.whitehouse.gov/wp-content/uploads/2017/11/CEA-Rx-White-Paper-Final2.pdf
³ https://www.tandfonline.com/doi/full/10.1080/20016689.2017.1369817
⁴ https://www.commonwealthfund.org/publications/issue-briefs/2017/oct/paying-prescription-drugs-around-world-why-us-outlier ; https://www.commonwealthfund.org/publications/journal-article/2013/apr/higher-us-branded-drug-prices-and-spending-compared-other?redirect_source=/publications/in-the-literature/2013/apr/higher-us-branded-drug-prices-and-spending
⁶ https://www.ictsd.org/downloads/2008/06/cs_reichman_hasenzahl.pdf
Anthony Bower, Ph.D.
Tony Bower, Ph.D. is President of BRG LLC, a management consultancy dedicated to growing biotech and pharma companies by improving commercial effectiveness and market access, including pricing, positioning, and health economics. Prior to BRG, Dr. Bower held commercial and global market access leadership positions at Synageva, Amgen, ALZA and SmithKline Beecham. Most recently he was Vice President (Head) of Global Pricing, Reimbursement and Health Economics at Synageva BioPharma. His doctorate is in economics from the Stanford Graduate School of Business.
Peter Kolchinsky, Ph.D.
Peter Kolchinsky is a founder, Portfolio Manager, and Managing Director at RA Capital Management, LLC, a multi-stage investment manager dedicated to evidence-based investing in healthcare and life sciences. Peter is active in both public and private investments in companies developing drugs, medical devices, diagnostics, and research tools, and serves as a Board Member for various public and privately held companies, including Dicerna Pharmaceuticals, Inc. and Wave Life Sciences Ltd. Peter also leads the firm’s outreach and publishing efforts, which aim to make a positive social impact and spark collaboration among healthcare stakeholders, including patients, physicians, researchers, policy makers, and industry. He authored “The Entrepreneur’s Guide to a Biotech Startup”, written on the biotech social contract, and served on the Board of Global Science and Technology for the National Academy of Sciences. Peter holds a BS from Cornell University and a Ph.D. in Virology from Harvard University.
Important Disclosures for Readers
The contents of this publication are intended for informational and educational purposes. The views and opinions expressed are those of the author and are subject to change. They do not necessarily reflect the views or opinions of RA Capital Management® or any other person the author is affiliated with.
Nothing of the content should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security or product. The author and/or RA Capital Management® may hold or trade securities of the companies named in this publication or that manufacture the drugs discussed.
Designations used by companies to distinguish their products are often claimed as trademarks. All brand names and product names used in this article are trade names, service marks, trademarks or registered trademarks of their respective owners.
The author’s opinions are based upon information he considers reliable, and there is no obligation to update or correct any information provided.
© 2018 Peter Kolchinsky, Ph.D.
