Reference Pricing with Elastic Demand for Pharmaceuticals

• Published date: 01 January 2018
• Date: 01 January 2018
• Author: Ricardo Gonçalves,Vasco Rodrigues
• DOI: http://doi.org/10.1111/sjoe.12207

©The editors of The Scandinavian Journal of Economics 2016.

Scand. J. of Economics 120(1), 159–182, 2018

DOI: 10.1111/sjoe.12207

Reference Pricing with Elastic Demand for

Pharmaceuticals*

Ricardo Gon¸calves†

Universidade Cat´olica Portuguesa, 4169-005 Porto, Portugal

rgoncalves@porto.ucp.pt

Vasco Rodrigues

Universidade Cat´olica Portuguesa, 4169-005 Porto, Portugal

vrodrigues@porto.ucp.pt

Abstract

In this paper, we re-examine the properties of two commonly adopted government

reimbursement schemes for pharmaceuticals: reference pricing and fixed percentage

reimbursement. We depart from the previous literature by assuming that the individual

demand is price-sensitive and depends on the copayment rate (i.e., the part paid by each

consumer). We obtain two novel results under reference pricing: first, as the copayment

rate increases, so do pharmaceutical prices; second, this increase in pharmaceutical

prices reduces social welfare. Whilst reference pricing does emerge as a preferable

reimbursement scheme, demand elasticities and the copayment rate interact in complex

ways. This leads (unexpectedly) to the possibility that a higher copayment rate (lower

reimbursement rate) results in higher government expenditure.

Keywords: Copayment rates; pharmaceutical reimbursement schemes

JEL classification:I18; L13

I. Introduction

Purchasing pharmaceuticals is different from purchasing other goods:

demand is often relatively inelastic and, in a large number of countries,

individuals only pay a fraction of the price of the prescription

pharmaceuticals they consume, whilst the government (or other third-party

payers) are responsible for the remainder. Two widely adopted schemes to

determine their relative contributions are fixed percentage reimbursement

(FPR) and reference pricing (RP). Under FPR, the government pays a fixed

†Both authors are affiliated with Cat´olica Porto Business School and CEGE.

*Financial support from Funda ¸c˜ao Ciˆencia e Tecnologia (projects PTDC/EGE-

ECO/100296/2008 and PEst-OE/EGE/UI0731/2011) is gratefully acknowledged. We thank

H´elder Vasconcelos, Ricardo Ribeiro, Odd Rune Straume, two referees, and participants of

the 2012 European Conference in Health Economics (Zurich), 6th Portuguese Economic

Journal Meeting (2012, Porto), and 13th Portuguese Health Economics Conference (2013,

Braga) for helpful comments and suggestions.

160 Reference pricing with elastic demand for pharmaceuticals

percentage of the pharmaceutical’s price and the patient is responsible for

the remainder (also known as the copayment rate). By contrast, under RP,

within each cluster of pharmaceuticals,1one is chosen as the “reference”

and the government only pays a fixed fraction of the “reference”

pharmaceutical’s price, even if the consumer buys a more expensive

alternative.2

In the last decades, RP has become a widely used scheme for price

and (public) expenditure control in pharmaceutical markets. It has attracted

significant attention in the literature, and a large consensus has emerged

regarding its merits. Most models in the literature on RP share two

common features: first, they assume pharmaceuticals are differentiated;

second, they typically make the assumption of unit demand (i.e., each

consumer is assumed to purchase exactly one unit of a pharmaceutical

variety or none). Under the assumption of unit demand with full market

coverage (e.g., Brekke et al., 2007), it should not be surprising that social

welfare is equal across reimbursement regimes as there are no quantity

effects. Reimbursement regimes merely determine who captures the surplus

created, but not its amount.

In this paper, our main aim is to analyze the impact of considering

that each individual consumer’s demand depends on prices – a clear

departure from the previous literature, which commonly assumes individual

unit demand – under reimbursement schemes such as FPR and RP,

in a full market coverage setting with differentiated pharmaceuticals.

This strikes us as a realistic assumption, at least for some health

conditions. For instance, in the treatment of health conditions that

result in recurring episodes of symptoms of variable intensity, such as

sleeping disorders, muscular pain, and migraines, pharmaceuticals might

be prescribed during a significant period of time (e.g., under long-

term prescriptions). It is entirely plausible that the patient might react

to the price of the prescribed pharmaceutical when deciding whether

to take it on a specific occasion.3Even in the treatment of chronic

diseases and conditions, such as hypertension, high cholesterol, and

asthma, treatment adherence has been shown to depend on patients’

1Several criteria could be used to cluster pharmaceuticals: chemical, pharmacological, and

therapeutic (Miraldo, 2009).

2Naturally, RP is only viable if more than one pharmaceutical is available for the treatment

of a condition, and it is especially used when low-price generic competition exists. For more

detailed reviews of RP, see L´opez-Casasnovas and Puig-Junoy (2000) and Galizzi et al. (2011).

3It is important to note that the most obvious candidate to satisfy this assumption is the

over-the-counter (OTC) market for pharmaceuticals. However, OTC pharmaceuticals are not

subject to prescription and, hence, typically fall outside the scope of reimbursement schemes.

©The editors of The Scandinavian Journal of Economics 2016.