Nova Scotia should allow competition to determine generic drug prices - commentary

Nova Scotia’s minister of health Maureen McDonald has announced her government’s intentions of introducing legislation this spring aimed at getting ‘fairer’ drug prices. It appears that minister McDonald will likely be following Ontario and Quebec’s mistakes by arbitrarily regulating prices.

The health minister is rightly concerned about the high cost of generic drugs in Canada relative to other markets. In currency-equivalent terms, Canadian retail prices for generic prescription drugs in 2008 were 90 per cent higher on average than retail prices in the United States for identical drugs. However, further regulation of drug prices is the wrong approach. Inflated prices for generic drugs are caused by the flawed reimbursement policies of public drug plans across Canada. The minister should treat the cause, not the symptoms of the problem and reform Nova Scotia’s PharmaCare reimbursement policies.

There are two main problems with PharmaCare’s reimbursement policies which are common in other provinces. First, the prices of generic drugs reimbursed by public drug programs are set as a fixed percentage of the original patented, or ‘brand-name’ drug. Second, PharmaCare reimburses pharmacies for the cost of drugs dispensed, instead of reimbursing patients directly for the cost of drugs purchased.

Fixed percentage reimbursement is a problem because retail pharmacies have no incentive to compete on prices to win sales. Every pharmacy charges the maximum price allowable under the public reimbursement scheme which in turn creates a single price in the market for publicly reimbursed products. In 2010, both Ontario and Quebec reduced the public reimbursement price of generic drugs to 25 per cent of the original brand-name drug. This was down from the previous levels of 50 per cent (Ontario) and 54 per cent (Quebec). In the short-run, these changes are saving taxpayers billions annually. But in the long-run, there are consequences when governments regulate prices.

Regulators are mistaken if they think that businesses will continue to supply drugs to the market at any price determined by government. Prices must provide a competitive economic return to drug producers, relative to alternative uses of invested capital. If prices are set below levels that produce a competitive rate of return in the drug business, investors will react by shifting capital into alternative businesses that offer higher rates of return. Although it is still too early to tell, reduced pharmacy services and a more limited drug supply could be some of the negative consequences of further regulating generic drug prices. The data confirms that Ontario and Quebec have overpaid for generic drugs relative to competitive market prices for a long time, wasting billions in unnecessary public expenditures in the meantime. Now the provinces might be underpaying, which could distort supply. Nobody really knows, because only a competitive market can strike the right balance on prices, supply and demand.

The other problem with PharmaCare is that the program reimburses pharmacies rather than patients. Consequently, any price discounts that are normally produced by the competition for sales between generic drug manufacturers are kept by retail pharmacies as windfall profits instead of being passed on to consumers. In other words, because of direct-to-pharmacy reimbursement, patients are unable to realize the benefits of any price competition between drug manufacturers who supply the pharmacies.

The policy objective of provincial governments should not be to impose ‘fair’ prices through arbitrary regulation. Government policies should simply stop preventing organic market forces from achieving competitive prices. Nova Scotia’s PharmaCare program could realize this objective by reimbursing public drug plan recipients directly and requiring consumers to pay a portion of the cost of their prescription drugs through a flat percentage co-insurance payment.

Under this scenario, PharmaCare recipients would be responsible for paying the full price of the prescription up front, then later submitting receipts to the government plan for partial public reimbursement. Because they would be exposed to a proportional part of the cost, PharmaCare recipients would become sensitive to price and be motivated to shop around, creating incentives for pharmacy retailers to compete on prices. There would no longer be a single price in the market because competition for retail sales would force pharmacies to pass any rebates received from generic manufacturers down to consumers in the form of discounted prices.

This reform would also remove the need for regulators to make decisions about which drugs should be covered under provincial formularies. Drug decisions would become consumer choices instead of political choices. Patients and taxpayers would benefit from choice and savings, while the most competitive drug makers and pharmacy retailers would win increased sales.

Rather than simply following the lead of other provinces in reducing generic drug prices, Nova Scotia’s health minister should take this opportunity to introduce a more economically rational approach and allow market dynamics to naturally produce competitive drug prices.