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The economics of alternative payment models for pharmaceuticals

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Abstract

Pharmaceuticals are priced uniformly by convention, but vary in their degree of effectiveness for different disease indications. As more high-cost therapies have launched, the demand for alternative payment models (APMs) has been increasing in many advanced markets, despite their well-documented limitations and challenges to implementation. Among policy justifications for such contracts is the maximization of value given scarce resources. We show that while uniform pricing rules can handle variable effectiveness in efficient markets, market inefficiencies of other kinds create a role for different value-based pricing structures. We first present a stylized theoretical model of efficient interaction among drug manufacturers, payers, and beneficiaries. In this stylized setting, uniform pricing works well, even when treatment effects are variable. We then use this framework to define market failures that result in obstacles to uniform pricing. The market failures we identify include: (1) uncertainty of patient distribution, (2) asymmetric beliefs, (3) agency imperfection by payer, (4) agency imperfection by provider, and (5) patient behavior and treatment adherence. We then apply our insights to real-world examples of alternative payment models, and highlight challenges related to contract implementation.

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Notes

  1. By uniform pricing, we refer to a lack of price variation occuring between most individual payers and drug manufacturers for the majority of products they trade with.

  2. Our argument builds on the insight that price-bargaining can mitigate or eliminate monopoly losses in healthcare [18].

  3. It is straightforward to show that all our results obtain with positive marginal costs.

  4. The assumption of Nash-bargaining is not entirely innocuous. For example, Nash-bargaining fails to cover cases in which one or both players find it optimal to walk away from the negotiation without a deal [19]. More complex sequential bargaining models are needed to study such contexts.

  5. Notice there are no copayments in this model. This is without loss of generality, as we can simply redefine \({P}_{i}\) as the price net of the copayment.

  6. Note that a risk-neutral payer focuses only on expected consumer surplus and does not care independently about the actual realization of variance in the treatment effect. This is why the expression is independent of \({\epsilon }_{i}\).

  7. If the drug were costly to manufacture, this production cost would appear within the left-hand side expression for profits.

  8. It is not obvious that bargaining will always make consumers better off. While price-bargaining increases the total amount of gross consumer surplus, \(\sum_{i=1}^{{i}^{*}}n(i){G}_{i}\left({\Delta }_{i},{\sigma }_{i}^{2}\right)\), insurers with market power may extract these gains in the form of higher premiums. Governments may wish to return some surplus to consumers via taxes on firms and transfers to consumers. We leave the analysis of optimal redistribution policy to future work.

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Funding

This study was supported by a grant from NIH under Award Number R01AG062277. The content is solely the responsibility of the authors and does not necessarily represent the official views of the National Institutes of Health.

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Authors and Affiliations

  1. Leonard D. Schaeffer Center for Health Policy and Economics, University of Southern California, Los Angeles, CA, USA

    Jakub P. Hlávka, Jeffrey C. Yu, Dana P. Goldman & Darius N. Lakdawalla

  2. Sol Price School of Public Policy, University of Southern California, Los Angeles, CA, USA

    Jakub P. Hlávka, Dana P. Goldman & Darius N. Lakdawalla

  3. USC School of Pharmacy, University of Southern California, Los Angeles, CA, USA

    Jeffrey C. Yu, Dana P. Goldman & Darius N. Lakdawalla

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  1. Jakub P. Hlávka
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Correspondence to Jakub P. Hlávka.

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Conflict of interest

Dr. Hlávka does not report any conflicts of interest. Mr. Yu reports personal fees from Boston Health Economics. Dr. Darius Lakdawalla has received consulting fees from Amgen, Genentech, GRAIL, Novartis, Otsuka, and Pfizer. Darius Lakdawalla also holds equity in Precision Medicine Group, which provides consulting services to firms in the pharmaceutical and biotechnology industries. Dr. Goldman reports honoraria from Amgen, The Aspen Institute, and Celgene. Until March 2020, Dr. Goldman served as a scientific advisor to Precision Medicine Group, and owns < 1% equity in the company. Until November 2019, Dr. Goldman served on the scientific advisory board of ACADIA Pharmaceuticals. He currently serves on the scientific advisory board of GRAIL.

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Hlávka, J.P., Yu, J.C., Goldman, D.P. et al. The economics of alternative payment models for pharmaceuticals. Eur J Health Econ 22, 559–569 (2021). https://doi.org/10.1007/s10198-021-01274-4

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