Sunday, October 25, 2015

Valeant and Health Economics (1)

The guys at Valeant must really hate the guys at Turing.  It was Turing's decision to jack up the price of Daraprim which brought the whole pricing strategy thing out into the open, prompting blog posts like this one from Derek Lowe, and news articles like this one from the Financial Post and this one from the Globe and Mail, along with claims from a short seller that Valeant had a somewhat unhealthy (for the payer) relation with a specialty pharmacy.  Valeant is apparently denying that there's anything improper in their business relations with Philidor, and they may well be able to make their case, although the whole thing's going to leave a bad odour for a long time.

This post is not about the legalities or the accounting rules involved - plenty of other people are posting about those.  I'm interested in how I could use the Valeant example to teach health economics (and my view on that has changed over recent days - I see a wider gap between Valeant and Turing than others do).

It comes down to two well known pieces of economic analysis of the US (and to lesser but increasing extent Canadian) market for pharmaceuticals.

The one I'll deal with in this post is the well known fact that most people don't pay the full cost of their prescriptions.  Their insurance pays most of it (unless they're uninsured, which is a matter for yet a different post).  The cost of the prescription to the insurer depends on the price set by the pharmaceutical company.  When a drug is under patent, with no on-patent competitors (and if you don't think that on-patent competition matters, see this paper by Lichtenberg and Philipson) the insurer basically just pays the price set by the supplier.  When the drug goes off patent, generic competitors can come on the market.

We used to speak as if a generic was automatically a lot cheaper than an on-patent drug: Turing has punctured that illusion.  the price set by a generic company will depend on the degree of competition it faces.  No competition means monopoly, which means monopoly price.  But for the moment let's assume that the old assumption holds and that generics are cheaper than their brand-name counterparts.  Insurers want to shift as many of their insured across to the generic as possible, for obvious reasons.

Sometimes they do it through mandatory generic substitution.  When one of my meds went off patent, my pharmacist shifted me across to the generic with my next refill (I was relieved, by the way, to see that he gets his generics from Teva and not from one of those generic manufacturers whose quality control has been shown to be, shall we say, less than sterling recently - seems brand name matters even in the case of generic drugs).  Alternatively, if the insurance plan operates using co-payment (a flat patient charge per refill, as distinct from co-insurance under which the patient pays a percentage of the price of the drug) the insurer will put the brand name drug in a high co-pay tier and the generics in a low co-pay tier, and count on the patient's elasticity of demand with regards to out-of-pocket payment to induce him to shift from the brand name to the generic drug.

What's been happening recently (and Valeant is by no means the only firm doing this, so too are a number of brand name companies - take a look at what happened when Lipitor went off patent) is that manufacturers have been offering to cover the co-pay for any patient who has his or her doctor specify no substitution - i.e. has their doctor insist that the patient get the brand name drug.  The patient pays next to nothing out of pocket, the brand name company makes the sale and the insurer has to pay the price which the brand name company set (unless the insurer chooses to refuse to cover the brand name drug at all, which some insurers decided to do in the case of Lipitor).

So it looks as if part of what Valeant might be doing is using a specialty pharmacy to cut the price to the person in the prescription chain who has a big say in the buying decision and who is likely to be pretty sensitive to price - i.e. the patient.   If so, they're doing it differently, if they are indeed using a specialty pharmacy to do it rather than sending out co-pay credit cards, but it may well be exactly the same pricing strategy as a number of brand name drug companies have engaged in in recent times. Basically, they are making it very convenient for patients to order their prescriptions through one distributor, who can pay the co-pay on behalf of the patient, and so keep those patients loyal to Valeant's products.

As I say, the legalities and accounting rules re Valeant's relation with its specialty pharmacy are way outside my competence, but from the perspective of teaching health economics, it's not impossible that Valeant is actually engaging in a variant of a now pretty well established pricing policy.

There's more health economics theory to be invoked here, but that'll wait for another post.