Striking the right balance between value and price in pharmaceuticals

Last summer, Decree 9 of August 2019 was published in the Official Gazette, which revised the system for regulating drug pricing in Italy (Price Decree). The Italian Drug Agency (AIFA) held a public consultation, which wrapped up in September, to discuss guidelines consequent to the new legislative initiative during which drug companies submitted documentation to substantiate requests on eligibility for reimbursement and prices of their products. CERGAS (the Italian Research Center for Healthcare Management) at SDA Bocconi School of Management participated in this public consultation with a document in which, in addition to offering certain technical observations, underscored the importance of making decisions based on a structured and reproducible assessment of the value of new pharmaceuticals.

Although said evaluation is complex from a technical standpoint, we can affirm that a drug creates value for the community if on the whole it produces health, which is defined as increased life expectancy of patients and/or enhanced quality of life. The concept of value is not absolute; instead “value” is relative to the market context in which the drug is introduced. If in a given context no therapies are available to treat a certain disease, having a drug that can improve patients’ health is in itself a major step forward. If in that same context instead there are several therapeutic options, the value of the drug would be measured based on its ability to generate added value with respect to these other alternatives.

From the standpoint of people who buy pharmaceuticals and taxpayers who pay for the health of the community, drug prices must be proportionate to their value and the willingness to pay for that value. In England, for example, payers for drugs (and medical technologies in general) have set threshold values on the cost that the public healthcare system is willing to pay per unit of additional benefit (an extra year of life in perfect health). If the price that companies ask is above this limit, the drug will not be reimbursed. Other countries, including Italy, have opted not to adopt threshold values on the cost/value ratio, preferring to maintain greater flexibility; these nations have however established explicit and implicit criteria for ranking elements of value. If for example a new drug is better than another only because it is easier to administer (but there is no evidence that this improves the patient’s health), this will not justify a price premium, but should be compensated in terms of market share. Since the cost structure of pharmaceutical companies is heavy on fixed costs, in part incurred before entering the market, achieving rapid market penetration enables companies to generate revenues that cover fixed costs, with wide margins on variable costs.

Various solutions have been adopted to link price and value, but one thing is certain: if prices are regulated and negotiated by payers on the basis of value, companies will be motivated to produce this value. If instead prices are regulated on the basis of costs incurred for research, development, production and commercialization of new drugs (the cost-plus method), regardless of the value they produce in terms of health, companies will have less incentive to produce value. Added to this is the fact that a variety of costs are interconnected (an obvious example is research and development), and have a high failure rate. This complicates the process of attributing these costs specifically to the individual drugs that actually make it to the market.

Yet pricing the basis of value alone gives rise to a problem. The value of a pharmaceutical is the outcome of a long, complex process of research and development conducted at a global level, and this value is substantially analogous in the various countries where the drug is launched. If prices were set on the basis of value alone, they would be very similar from country to county. But willingness to pay can vary greatly, and depend, for instance, on available resources. Even in relatively homogeneous areas, such is the case in Europe, there are sizeable differences in per-capita income; and income level being equal, different priority is given to healthcare in the political agendas of different governments. In this case prices could differ widely depending on the willingness to pay for the same health outcome. The risk when prices diverge is that more willing payers would see lower prices, with negative fallout on companies. So the solution is to stipulate agreements for discounts or other forms of prices cuts that are not visible at an international level. This ensures that the general public has the impression that the price reflects that value of the drug, companies get the advantage of appearing to offer standard prices, and the countries that have fewer resources pay less. Clearly, all this reduces price transparency. This in turn augments the risk of opportunistic behavior by payers, who can shift the cost burden of paying for their own citizens onto other countries, and companies, which can demand higher prices while having to deal with requests for discounts that are not transparent across the board.

A final salient issue is whether the price, beyond the value of the drug and the costs incurred by producers, has to be a tool for attracting investments in activities that are considered more “noble” (research, development and production). Here too we find a deviation from the principle of value-based pricing. The choice of where to launch a new drug does not depend on the price but rather on the stability of the regulatory framework, the fiscal and financial incentives, actions aimed at making the approval of clinical studies more efficient, as well as the expected overall market size.

Beyond a doubt, pricing drugs based on costs incurred by companies (and not based on value), and utilizing the price as a means for attracting investments, which have global effects, is not correct. The new Price Decree clearly states the importance of linking the price and the therapeutic value of pharmaceuticals. However this legislation also reintroduces the cost-plus model for drugs that represent the only available therapeutic alternative, and requires companies to inform AIFA with regard to the public subsidies they receive for drug development. These last two aspects do not seem acceptable.