Alberta’s drug reimbursement policy needs re-thinking

The Alberta government has just released the second phase of the provincial Pharmaceutical Strategy. The plan calls for decreasing public reimbursement rates for new generic drugs from 75 per cent of the price of the previously patented brand-name drug to 45 per cent. In addition, the government intends to negotiate lower prices for current generic drugs.  The annual savings are projected to be up to $50 million for new generic drugs and $150 million for generic drugs already on the market.

The province considers generic prices to be too high, and the available evidence suggests that they are correct. We conduct research, published annually by the Fraser Institute, which confirms that generic prices in Canada tend to be significantly higher than prices for identical drugs in other comparable countries. Our most recent study from 2008 compared US and Canadian prices for the 100 most commonly prescribed generics in Canada. The study found that on average Canadian prices were roughly twice as high as commonly available US prices for identical drugs.

Bear in mind that public drug programs account for about half the market for prescription drug spending in Canada. For instance, data from the Canadian Institute for Health Information shows that about 44 per cent of total drug expenditures in Alberta were publicly financed in 2008. This means that consumers and taxpayers alike are affected by inflated prices for generic drugs, making efficient drug pricing a matter of public interest.

However, the Alberta government could potentially save consumers and taxpayers a lot more money if generic drug prices were determined by genuine market forces instead of an arbitrary benchmark imposed by government.

Our research found that artificial inflation in generic prices in Canada is caused by government interference with competitive market dynamics. Many provincial public drug programs use fixed-percentage reimbursement rates for generic drugs, like the approach used in Alberta. Under this policy, the government offers to pay pharmacies a guaranteed price for generics, set at a fixed percentage of the price of the previously patented brand-name drug. This policy removes the incentive for either generic manufacturers or retail pharmacies to compete on price. All manufacturers and retailers universally charge the guaranteed price, which is not only a price ceiling (maximum), but also a price floor (minimum).

Generic manufacturers are also known to exchange bulk discounts for exclusive distribution rights with pharmacy retailers. This is a legitimate business strategy for the manufacturers, which is not much different from soft-drink companies sponsoring a sporting event on the condition that only their products are sold at the event.

However, because government drug programs reimburse retail pharmacies for the drugs they dispense, instead of individual consumers for the drug expenses they personally incur, any discounts that are negotiated between drug manufacturers and retail pharmacies are not passed on in the final price. The discounts end up as windfall profits for retailers, because the retailer can still charge the full public reimbursement rate directly to the provincial payer, which is guaranteed at a fixed price.

To address this problem, the Alberta government’s strategy is to simply reduce the reimbursement rate for generic drugs. Despite good intentions, this approach is misguided; it attempts to fix a problem created by government intervention in the market, with a blunt solution based on more government intervention. If the goal is to achieve the most efficient drug pricing, Alberta should instead adopt market-oriented reimbursement policies.

Barring comprehensive health and drug insurance reforms (a conversation for another day), the province should implement direct-to-consumer reimbursement for provincial drug plan recipients. Recipients of public drug plans should buy their prescriptions directly, and submit receipts to the province for reimbursement. The province should retroactively reimburse 75 per cent of the drug costs to the consumer. Consumers would therefore be exposed to a 25 per cent co-insurance charge for any drug they purchase. Cumulative co-insurance costs could be capped at five per cent of income.

The co-insurance charge would work as a price signal to encourage efficient drug choices. Consumers would have real economic incentives to shop around, both between pharmacies and between drug brands. The resulting price competition would lead to more efficient prices over time.

Alberta’s currently proposed pharmaceutical reimbursement strategy needs re-thinking. Economic evidence suggests that the best way to make public drug spending more efficient is to allow prices be determined in a competitive marketplace.