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The Trump administration has proposed using international pricing of drugs to establish ceilings on what Medicare will pay for therapies administered by physicians in their offices or in hospital outpatient clinics (these drugs are covered under Part B of the program; drugs dispensed to Medicare patients through retail pharmacies are covered under Part D). 

The administration’s proposal has precipitated a debate over whether international reference pricing (IRP) would be appropriate in the U.S. market in general, and Medicare in particular, and also over whether such a tool would produce the intended price reductions. Some background information and analysis might be helpful as policymakers consider their options.

Reference Pricing vs. International Reference Pricing (IRP). Reference pricing refers to the practice of using prices from differing suppliers of medical products and services to limit payments by an insurer (public or private). For instance, governments in many European countries use reference pricing to limit what they pay in their nationalized systems of health insurance for off-patent drugs by setting the reference price at what is charged for a competing generic version of the same therapy.  

International reference pricing (IRP), which is sometimes called external reference pricing, has a different focus. Governments use IRP to ascertain what other countries are paying for pharmaceutical products. That information is then used to set or influence pricing decisions for those products. IRP is used most often (but not always) to set or influence pricing for products that remain under patent protection.

The Use of IRP Has Grown Rapidly Over the Past Thirty Years. Germany adopted a form of reference pricing in 1989, which then led to the spread of IRP in the 1990’s. Today, 29 European countries use some form of IRP to set or influence the pricing of prescription drugs. The governments in Australia, Brazil, Canada, Japan, New Zealand, and South Africa also use IRP schemes to help them set prices for covered drugs.

IRP Schemes Are Associated with Lower Prices, But Their Effects on Global Drug Revenue Is Less Clear. Studies show IRP has worked for the countries that have implemented it, although these analyses are not able to track global revenue streams for drug companies. One analysis found IRP reduces prices by an average of 11.5 percent.   It is possible that drug companies are able to offset lower list prices through shifting sales to higher-priced countries and other business adjustments.

The Number of Referenced Countries in an IRP Can Vary Greatly. Some countries look to a handful of other countries when developing an IRP, while others include a large number of countries in their reference basket. For instance, the Netherlands looks at pricing in four other countries while Belgium includes 24 countries in its IRP tool.

Some Countries Are Referenced More Than Others. Some countries are particularly popular reference points for drug pricing in other countries. A review of IRP policies in Europe found that Germany and Spain were referenced by 13 countries in IRP schemes.  France and the U.K. were referenced 11 times each.

Many Countries Use IRP Tools to Influence Rather Than Set Prices. Canada, Germany, Japan, and others collect and examine the pricing of drugs in other countries but that is not the only basis for setting prices in these countries. They also look at other information, including clinical data, and engage in direct negotiations with the manufacturers of the products.

IRP Only Works If Some Countries Use Other Criteria When Setting Prices. IRP would descend into a circular farce if there were no other basis for setting prices other than the pricing that is observed elsewhere. Somewhere along the way, a country must set a price for a covered drug on a basis other than the prices that were set for the same drug by other countries.

The U.K. and Germany are popular reference countries because their pricing systems are not tied exclusively to the prevailing prices in other countries. In fact, the U.K. doesn’t use IRP at all. Instead, it sets prices based in part on assessments of the clinical value of the products as well as on agreed-upon rates of return for drug manufacturers. For new therapies, Germany uses a process designed to set prices based on how valuable those products will be to the improvement of the health of German patients. The government directly negotiates prices with the drug manufacturers based on that information, and uses an arbitration system when negotiation fails to produce a pricing agreement. 

There Are Now Global Ripple Effects from Drug Pricing Decisions. The complex web of IRP schemes in high-income countries means that pricing decisions in one country will affect prices paid in many other countries as well. Both drug manufacturers and governments are now aware of these effects when making decisions about prices. In particular, drug companies understand that price negotiations and pricing decisions in certain key countries (the U.K, Germany) will have an effect on the prices they will be paid for their products in other countries as well. One study found that a 1.00 euro drop in price for a drug in Germany would lead to a 0.28 euro drop in the Netherlands, and to a 0.22 euro drop in price in Ireland.

Drugs Companies Are Delaying the Introduction of New Therapies in Some Countries to Avoid Adverse Pricing Consequences. IRP is leading drug companies to delay the launch of some of their products in certain countries to keep low prices out of global IRP schemes. An analysis of product introduction dates for drugs in Europe found that elimination of IRP schemes would speed up product launches by an average of 14 months in several eastern European countries. As noted, the German government sets prices for drugs through a process involving clinical evaluations, direct negotiations with the manufacturers, and then an arbitration system to settle pricing disputes when negotiations do not produce an agreement. Of the 186 drugs that went through this process from 2011 to 2017, 35 ended up in arbitration, and in 30 of those cases, the drug companies chose to withdraw their drugs from the German market rather than accept the arbitration price.

Price Evasion Strategies. Drug companies have tools at their disposal to evade IRP schemes. They can offer concessions to countries that do not show up in the official list prices that other countries see. These concessions can be in the form of rebates and other financial payments that appear to be separate from list prices but in fact are discounts that are considered private transaction within the countries in which they occur and not visible internationally. Another tactic would be to work with a government to maintain a high list price for a product, and then to offer that product for free to a sizeable segment of the population. The average price across the entire population would be close to the net price that is acceptable to the government, but the price that gets fed into IRP schemes internationally would be the official list price paid by the government for only a subset of the population getting the therapy.

Drug Companies See the U.S. as Their Most Important Market, and Will Act Accordingly. The U.S. drug market is much more important to drug manufacturers than are the markets in other countries. In 2018, drug spending in Germany was only 11 percent of what it was in the U.S., and spending in France was even lower, at 7 percent.  If the U.S. were to adopt IRP in any form, drug companies would respond as necessary to protect as much of their global revenue as possible from price erosion. One could expect more delays in product launches in certain countries, and the use of non-price concessions to keep the prices included in the U.S.-sponsored IRP scheme as high as possible.

Even if one assumes no evasion of a U.S.-based IRP, it is not certain that it would lead to lower overall revenue for drug companies. A recent study modeled the effects of using just Canadian prices to establish pricing throughout the U.S. market. Because Canada is so much smaller than the U.S., drug companies would have strong incentives to prevent their U.S. prices from falling to levels found in Canada. The end result of this policy wouldn’t be lower prices in both countries but rather something close to the status quo in the U.S., higher prices in Canada, and higher overall revenue for the drug companies.

U.S. prices for drugs are well above those found in other high-income countries. That is an understandable source of frustration. However, it will not be easy to lower prices in the U.S. by referencing prices in other countries. Drug companies see the U.S. as their most important market because it is critical to reaching their global revenue goals. A U.S.-based IRP scheme is more likely to lead to delays in product launches elsewhere, and to more creative price evasion schemes, than to lower prices for U.S. consumers or taxpayers.

James C. Capretta is a RealClearPolicy Contributor and a resident fellow at the American Enterprise Institute.

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