Pharmaceutical Economics and Policy SA427 ‘Bargaining over the Rate of Return VS. Value Based Pricing’ Tuesday, 3 November 2009 Faisal Latif Kyle Checchi Jessica Nicholls

Questions to address 1.How would you judge whether a new medicine is entitled to a price premium over existing therapies? 2.Does rate of return regulation, when applied to drug pricing, satisfy the objectives of health and industrial policy?

Learning Objectives To understand the principles of pharmaceutical pricing from a theoretical and empirical perspective To understand the operational requirements of regulatory approaches such as cost-effectiveness pricing and rate of return regulation and the extent to which they contribute to health and industrial policy objectives

Question 1: How would you judge whether a new medicine is entitled to a price premium over existing therapies? Kyle Checchi

Approach: Introduction to Value Based Pricing (VBP) In depth look at key elements and issues: Definition of Value How to deal with unique subgroups NICE and the mechanics of VBP Scoring and how to treat other inclusions Finding the relative competitors Information requirements Public resources How to budget total drug costs in the health system Conclusion: How to determine whether a medicine is entitled to a price premium over existing therapies

Value Based Pricing: Policy objectives: To replace PPRS price and profit controls with a value based policy To focus policy on maximizing value for NHS Drug expenditures To guide drug companies to focus their resources on new drugs that serve unmet needs

Value Based Pricing: Main Features: Max price of a product reflects the incremental benefit relative to an appropriate competitor New substances assessed “ex ante” – before they reach the market – through fast track appraisals Existing drugs assessed “ex post” through rolling assessment Risk sharing when not enough information is available to fully assess incremental value Non-linear pricing to accommodate the situations where incremental value differs by subgroup

In depth look at the key issues: “Value” – Should capture extension to life and improvement in quality of life Value should also include significant non-patient benefits, such as caretaker benefits. There is extensive debate over QALYs and how to derive them, especially focusing on how to identify and weight the quality of life parameters

In depth look at the key issues: Different value by subgroup – some medicines will have drastic improvements within specific subgroups (e.g. pregnant mothers or babies) Two potential strategies: non-linear pricing by subgroup and linear (flat) pricing

In depth look at the key issues: Non-linear pricing: different prices negotiated for specific volumes of the drug, where the volumes correspond to the amount of drug needed by subgroup secures value for the NHS encourages and rewards companies for finding improvements to subgroups does not inhibit incentives for under threshold pricing

In depth look at the key issues: Linear (flat) pricing: companies negotiate for only one price and volume (that volume can be one that addresses one, multiple, or all concerned subgroups) can include “punitive price value” component results in two scenarios: one where companies can only address one subgroup with a medication (not ideal in cases where the best drug is the best in multiple subgroups) the other where companies will struggle to price a drug with drastically different incremental values at one level to maximize its profits

In depth look at the key issues: NICE and the actual determination of value Value results can be difficult to create including all factors (3 rd party etc.) and over all subgroups Finding the relative competitors: a large challenge Does one use generics as an appropriate competitor? Information requirements – is risk sharing an effective option when the informational requirements are not met? Public Resources – Will it cost too much to do all the value and cost effectiveness assessments for every drug? reduced costs through giving less scrutiny to some clear cut assessments and focusing assessment resources for the truly complicated reviews Is this fair? Credibility – NICE is incredibly well respected and this is one of the reasons that VBP is feasible

In depth look at the key issues: How should NHS budget? Two views, cost/QALY v. total budget Should the NHS set cost/QALY values and then adjust these values to encourage or discourage increased investment in new drugs, or should a maximum ceiling (budget) for drug prices be set and maximum value recouped under that limit

Conclusion: How to judge whether a new medicine is entitled to a price premium over an existing therapy: Take into account total value of a medication, therapeutic, patient, provider, 3 rd party Calculate value including specific differences within subgroups Cost effectiveness – must compare the medication to an appropriate competing treatment, and must include generics as competing treatments Non-linear volume pricing to recognize improvements among subgroups Timing – with clear expectations for drug companies they should be able to provide enough information to assess their value ex ante (before entering market) If this is not possible than risk sharing must be arranged Must be done with a minimum of NICE resources, uncomplicated assessments must be done with limited resources leaving complicated assessments to be fully examined Use all available HTA agencies and don’t overlap (SMC, AWMSG, and NICE) Credibility and objectivity must be maintained through transparency and 3 rd party appeals. *This is an extremely high standard, can it succeed?

Q2. Does rate of return regulation, when applied to drug pricing, satisfy the objectives of health and industrial policy?

Rate of return regulation (RRR) “A form of regulation in which prices are limited to levels that give ‘acceptable profits’” (Morris et al., 2007) TR = TVC + rK Form of monopoly regulation Central idea: firms charge price that would prevail in a competitive market Dominant in US for years but different systems in other countries Limitations/criticism due to profit accumulation by companies (Averch-Johnson effect)

The Pharmaceutical Price Regulation Scheme (PPRS) NHS spends about £11bn a year on various treatments - £8bn on branded drugs PPRS is main instrument to control NHS expenditure PPRS broadly has two components: Profit controls Maximum level of profit company may earn Exceeding level requires repayment to DH Price controls Gives companies freedom to set initial price of New Active Substance (NAS)

PPRS Objectives Deliver value for money Encourage innovation Promote access and uptake of new medicines Provide stability, sustainability and predictability Scheme must strike balance to ensure that the interests of patients, the NHS, industry and taxpayer are promoted for each other’s mutual benefit

PPRS 2009 – rate of return regulation Return On Capital (ROC) Based on historical average of capital employed Target of 21% per year Margin of Tolerance (MOT) Members will be able to retain profits of up to 140% of ROC target If profits in excess of 140% of MOT, DH will negotiate one of following: Repayments of amount of profit exceeding MOT Price reductions Delay/restriction of price increase

PPRS 2009 – rate of return regulation (cont.) R&D allowance Maximum allowed is 22% of NHS home sales for assessing price increases 30% of NHS home sales for assessing AFRs Marketing allowance 2-4% of home sales of NHS medicines Fixed elements of £0.5m - £1m Information allowance

Timeline

Office of Fair Trading (OFT) Published a market study in 2007 Response to PPRS 2005 Key recommendation – replace profit and price controls with value-based pricing (VBP) Rationale: Value for money for NHS Better incentive to invest Stable, sustainable system Ensure the price of drugs reflect their clinical and therapeutic value to patients and the broader NHS

Case for independent pricing body Figure 1. Medicines Pricing Commission model (OFT Report, 2007)

Case for independent pricing body (cont.) Remove political influence from technocratic decision making on pricing Pre-launch centralised price setting body Could credibly commit to paying reasonable prices Government has successfully set up independent bodies in variety of fields Effective use of resources and expertise of HTA bodies Framework is long-term possibility

Evaluation of VBP as replacement to PPRS OFT report created widespread debate Misconceptions of OFT recommendations Is current PPRS a sustainable model? Choice facing companies – between OFT proposals and status quo Companies producing most cost-effective products will lose out Compelling paper – pro-VBP by Simon Thornton (Health Economics, 2007)

Interim government response to OFT report “Government should reform the PPRS, replacing current profit and price controls with a value-based approach to pricing” (OFT recommendation) Response in context of PPRS objectives Conceded that need better mechanisms to deliver fair prices and value to the NHS Accepted that there is scope for further improvement in the uptake of cost-effective new drugs

What are we trying to achieve? Efficient use of medicines currently available – static efficiency (Towse, 2007) Are we achieving productive efficiency? Are we treating conditions and patients society most cares about? To stimulate development of new cost-effective medicines – dynamic efficiency. Combination of: Revenues for current medicines Incentives

Final govt response – June 2009 “2009 PPRS ensures that value is better reflected, delivers value for money, assists the uptake of innovative cost-effective treatments, rewards innovation and provides stability, sustainability and predictability” New pricing mechanisms introduced: Flexible pricing arrangements Patient access schemes However, government admits there is still scope to improve the way in which prices reflect value - still employing ROC & MOT mechanisms...

Does RRR, when applied to drug pricing, satisfy the objectives of health and industrial policy? PPRS objectives Deliver value for money Encourage innovation Promote access and uptake of new medicines Provide stability, sustainability and predictability Current PPRS profit controls do not effectively satisfy these objectives In order to achieve balance between value for money and pharmaceutical industry incentives, government must ultimately move towards VBP system

References Department of Health (UK) (2009). The Pharmaceutical Price Regulation Scheme. Department for Business, Enterprise and Regulatory Reform Pharmaceutical Price Regulation Scheme: Interim Government Response to OFT Report. BERR, London, 2 August 2007 Department for Business Innovation & Skills Pharmaceutical Price Regulation Scheme: Final Government Response to OFT Report. BIS, London, June 2009 Morris, S., Devlin, N. & Parkin, D. (2007). Economic Analysis in Health Care. John Wiley & Sons. Office of Fair Trading (2007). The Pharmaceutical Price Regulation Scheme, London

References (cont.) Sorenson C, Drummond, M, Kanavos, P. Ensuring value for money in health care: The role of health technology assessment in the European Union, European Observatory, Thornton, S. (2007). Drug Price Reform In The UK: Debunking The Myths. Health Economics 16: Towse, A. (2007). If it ain’t broke don’t fix it: the OFT and PPRS. Health Economics 16(7):

Thank you for listening. Any Questions...?