Competitiveness of the EU Market and Industry for Pharmaceuticals

Transcription

1 Competitiveness of the EU Market and Industry for Pharmaceuticals Volume I: Welfare Implications of Regulation Final report Client: European Commission, Directorate General Enterprise & Industry Rotterdam, December 2009

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3 ECORYS Nederland BV P.O. Box AD Rotterdam Watermanweg GG Rotterdam The Netherlands T +31 (0) F +31 (0) E netherlands@ecorys.com W Registration no ECORYS Macro & Sector Policies T +31 (0) F +31 (0)

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5 Table of contents Preface 9 Executive Summary 11 1 Introduction Background of the study Political relevance of the pharmaceutical market The underlying reasons for heterogeneity in pharmaceutical regulation across the EU Member States Scope and set-up of the analysis 23 2 Main market characteristics of the EU pharmaceutical market Complex supply chain Pharmaceutical expenditure Lifecycle of drug development Size distribution Return on investment Production and value added Trade Relevance in the labour market Pricing Availability Generic medicine Parallel trade 39 3 Existing market failures in the EU pharmaceutical market Tension between the pursuit of profit and improving public health Information asymmetry and imperfect agents Moral hazard due to the existence of an insurance system Competitive features of pharmaceutical markets 47 4 Existing government actions to overcome market failure The use of patents Rationale of patents Patent regulation The use of marketing authorisations Rationale of marketing authorisations Regulation governing market authorisations Use of pricing and reimbursement policy 55

6 4.3.1 Rationale of pricing and reimbursement Regulation governing pricing & reimbursement Effect of price regulation on behaviour of pharmaceutical companies Effects pricing and reimbursement measures on public spending 67 5 Welfare implications of government interventions in the European market Framing the welfare implications Welfare effect as a result of the EU patent system Societal welfare effect of a pseudo-monopoly: dynamic versus static efficiency High administrative costs for companies due to fragmented patent system in the EU Costs of the market authorisation process for pharmaceutical companies Approval costs Delayed patient access to new medications Effects on innovation Welfare effects of pricing and reimbursement regulations Delays in the introduction of medicines Observed delays in market entry Sequencing of introduction of new medicines in the EU Welfare effects for originator pharmaceuticals Effects of pricing and reimbursement measures on R&D and innovation Welfare effects for patients Welfare effect for health care budgets Welfare effect as a result of generic entry Description Welfare implications Welfare effects as a result of parallel trade Impact on price level Impact on research and development Impact on product safety Effect on developing countries Welfare implications of regulation Minimising the side effects of regulation Proposals to improve coordination and transparency on pricing and reimbursement 102 Annex 1: Analysis of sequencing introduction of pharmaceuticals 105 Systematic sequencing of pharmaceuticals in the EU 106 Introduction 106 Methodology 107 Product Sample 108 Systematic sequencing of drug launches 111 Descriptive Analysis 113 Structural characteristics 113 System of health care financing 117

7 Regulatory characteristics 120 Factor analysis on pricing and reimbursement 123 Costs for firms 126 Appendix 129 Factor Analysis - Component Tables 129 Multivariate Analysis 130 Annex 2: Reference list 133

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9 Preface Pharmaceuticals save lives and improve the quality of life of people. The pharmaceutical industry is also a key sector for the European economy in terms of employment and production. This study investigates the functioning of the EU market of pharmaceuticals as part of the market monitoring of the pharmaceutical market in the European Union and as a follow-up to the Single Market Review. Whilst improving market functioning is essential and substantial gains can be achieved, there is a second issue which has received somewhat less attention, the regulatory system for pharmaceuticals. In this Volume I of the study particular emphasis is on the implications for economic welfare for the efficient production and effective use of pharmaceuticals in our societies- of the regulation of pharmaceuticals in the EU. In this way the study builds upon the outcomes of the Pharmaceutical Sector Inquiry carried out by the Competition Directorate General of the Commission (2009). This study also complements the evaluation of the European Medicines Agency (EMEA) (forthcoming) with its focus on the process of marketing authorisation in the EU. In a separate volume II the study describes the trends and developments in the EU pharmaceutical markets, the competitive position of the industry and the main prospects for its future development. During the study we have spoken to various people from different organisations. We would like to express our gratitude to all people who have shared their valuable insights with us. The study is carried out by an independent team of consultants from ECORYS, IDEA Consult and in cooperation with several other experts. Therefore, the views in this report represent the views of the consultants, which do not necessarily coincide with those of the European Commission. Rotterdam, November 2009 Arthur ten Have (Team Leader) Prof. Dr. M.F.M. Canoy Emmy Nelissen Nicolai van Gorp Lars Meindert Vincent Thio Nora Plaisier Vincent Duchene (IDEA Consult) Eveline Durinck (IDEA Consult) Paul Baker Prof. Dr. F.F.H. Rutten (Erasmus University Rotterdam, EUR) Prof. Dr. A.J. McGuire (London School of Economics, LSE) Wil Toenders (Toenders De Groot) 9

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11 Executive Summary Background Pharmaceuticals save lives and improve the quality of life of people. The pharmaceutical industry is also a key sector for the European economy. The sector is a major employer and it combines a large production value with high levels of innovation. It follows that the functioning of the pharmaceutical market is crucial for Europe. The examination of market functioning was the focus of the Pharmaceutical Sector Inquiry carried out by the Competition Directorate General of the Commission published in July The Inquiry concluded that improvements were possible which would add up to 3 billion in gains for European consumers. Whilst improving market functioning is essential and substantial gains can be achieved, there is a second issue which has received somewhat less attention, the impact of government regulation on the pharmaceutical markets. Hence the topic of this study is the competitiveness and functioning of the EU market of pharmaceuticals, including the role of regulation. The study is part of the market monitoring of the pharmaceutical market in the European Union and as a follow-up to the Single Market Review. Pharmaceutical markets are characterized by a number of potential market failures such as under-investment for particular diseases, free-riding behaviour concerning the use of R&D, and information asymmetry between professionals and clients on various levels. Therefore the sector is extensively regulated. The attempts to avoid the negative effects of market failures and to pursue public health goals have led to wide-ranging national policy mixes concerning regulations of pharmaceuticals. These regulations are important to maintain incentives for R&D, to prevent unsafe products from entering the market and to help reduce costs of pharmaceuticals and medical treatment. At the same time, these regulatory actions can be costly in terms of implementation, through compliance and related costs for pharmaceutical firms (e.g. by reducing incentives to innovate), purchasers of pharmaceuticals, patients, as well as society at large. Some of these costs are avoidable. Although providing exact estimates is an exercise fraught with danger, this research by ECORYS established potential gains of the order of several billions of Euros. These gains will benefit both patients (quicker access to medicines), as well as the pharmaceuticals sector (more possibilities for profitable returns) and the health budget (less efficiency losses). Thus Europe as a whole can gain not only by a better functioning of the pharmaceutical market but also by the streamlining of regulation. 11

12 The main focus of attention in this study is on various ways in which Member States deal with the pricing and reimbursement of new pharmaceutical products and with regulation considering the timing of market entry for new medicines. The motivation of this focus is that differences between Member States are vast and cannot be solely explained by history, culture or preferences. Hence it is in this field that important gains for society are achievable. In this Volume I of the study particular emphasis is on the implications for economic welfare for the efficient production and effective use of pharmaceuticals in our societies- of the regulation of pharmaceuticals in the EU. 1 In this way the study builds upon the outcomes of the Pharmaceutical Sector Inquiry. This study also complements the (forthcoming) evaluation of the European Medicines Agency (EMEA) with its focus on the process of marketing authorisation in the EU. Therefore, this study places particular emphasis on regulations governing the pricing and reimbursement of new pharmaceutical products and how these may be improved. In a separate Volume II the study describes the trends and developments in the EU pharmaceutical markets, the competitive position of the industry and the main prospects for its future development. Main characteristics of the industry The pharmaceutical industry is an industry that needs to use profit margins to pay for substantial R&D. It is a complex industry due to its complicated supply chain and the extent of government regulations in all aspects of the trade. The industry is a large and growing industry in the European Union both in terms of production figures and employment (2% of total employment in manufacturing). Developments in pharmaceutical employment in the period show an increase in employment of 5.6% for the EU27. Market failure The pharmaceutical market is characterised by several important market failures. Individual patients need to have timely access to high quality medicines to maintain a good health. But the market faces characteristics that lead to possible under-investment for particular diseases and free-riding behaviour concerning the use of R&D. Markets for pharmaceutical products are also characterised by an information asymmetry between professionals and clients on various levels, e.g. between (pharmaceutical) producers and physicians, patients and producers and patients and physicians. 1 Competitiveness of the EU Market and Industry for Pharmaceuticals Volume II: Markets, Innovation & Regulation, describes the main characteristics of the pharmaceutical industry, its overall economic performance with emphasis on innovation issues and future market prospects. 12

13 Informational imbalance between the prescriber/dispenser and the patient allows the prescriber/dispenser to influence patient s demand to his own benefit. When the costs of pharmaceuticals are fully included under health insurance coverage schemes, the level and composition of pharmaceutical expenditure may be higher because of moral hazard, which means that consumers are inclined to over-consume since they do not directly bear the costs of consumption. Finally, pharmaceutical markets are influenced by limitations to forces of competition. High initial investment (particularly in relation to R&D) can act as a barrier to entry for new firms and thus reduces competition. Large established pharmaceutical producers may also be able to lower competition through the creation of various other hurdles or barriers to entry, such as brand loyalty, market segmentation, control over key inputs and implicit collusion. Government regulation Governments try to mitigate the potential negative effects of the different types of market failures in the pharmaceutical industry through different types of regulations, including - but not limited to -patents, marketing authorisation and pricing and reimbursement. Patent protection aims to safeguard the opportunity to recover investments in innovation. A common European patent is still under development and patent protection is principally linked to national markets. Marketing authorisation aims to ensure the efficacy, safety and quality of medicines before they are allowed to enter the market and is a joint responsibility of the European Commission and Member States agencies. After having received marketing authorisation, pharmaceutical companies need to apply for a decision on the price and/or reimbursement for their product in many countries before the product can be sold or becomes part of the benefit package that citizens are entitled to. Furthermore, several measures influence the use of pharmaceuticals once they have entered the market, such as copayment schemes or rules for prescribing generic products. 13

14 Figure 1 Route from discovery to consumer access The regulation of both pricing and reimbursement and the use of pharmaceuticals once they are on the market is exercised through a wide variety of policy instruments that may either impact on the supply side for pharmaceutical production or on the demand side for consumption of pharmaceutical products. Typical supply side measures include regulation of product price, control of expenditures, industry regulation, and product reimbursement. Demand side measures contain policies aiming to influence behaviour by physicians, pharmacists and patients. An overview of policy measures used by Member States reveals a mixed pattern often combining supply side measures with demand side policies. Reimbursement policies such as international reference pricing in which countries link the price of a pharmaceutical product to prices in other countries, combined with strategies to influence the behaviour of physicians and pharmacist and linked to some form of co-payments by patients, is a quite common policy mix in a majority of Member States. The role of the EU in the regulation of pharmaceuticals is considerable, with a main focus on competition issues and marketing authorisation. Concerning pricing and reimbursement Council Directive 89/105/EEC (often referred to as the Transparency Directive ) is the main instrument. The Directive aims to ensure the transparency of the procedures established by Member States to control the prices and reimbursement of medicinal products. Welfare effects of regulation The attempts to avoid the negative effects of market failures and to pursue public health goals have led to wide-ranging national policy mixes concerning regulations of pharmaceuticals. These regulations are important as they help to maintain incentives for research & development, they prevent unsafe products from entering the market and they help to reduce costs of pharmaceuticals and medical treatment. However, these regulatory 14

15 actions are costly in terms of implementation by regulators but also directly and indirectly through compliance and related cost for pharmaceutical firms, purchasers of pharmaceuticals, patients as well as society at large. These important side effects become visible in the pharmaceutical industry s reaction to the regulations considering the substantial differences in timing of market entry for new medicines in different countries, the differences in timing of access to generic medicines and the actual wide variations in price levels of pharmaceuticals in different countries. An inventory of estimates of the costs of different types of regulation and the results of our own empirical analysis confirm that the costs of regulating pricing and reimbursement of pharmaceuticals by individual Member States are substantial, although a total figure cannot be presented due to differences in valuation and costs in the available evidence. The costs are also different for the different parties identified such as pharmaceutical firms, purchasers or reimbursers of health care, individual patients and society at large. During the lifecycle of a pharmaceutical product several forms of regulation have an impact on the timing of market entry and the price charged in the market. In this study particular attention is paid to 1) the costs of patent administration; 2) the costs associated with the process of obtaining market authorisation, 3) costs related to market entry as a result of pricing and reimbursement decisions. In the absence of a common European patent firms have to pay for obtaining and safeguarding patent protection in the different countries of the EU. Compared to other markets such as the US or Japan the cost of the fragmented European system are higher as a result of translation and litigation - it is more costly to enforce patent rights in different countries in the absence of a unified court dealing with patent disputes. Estimates of unwanted patent administration costs vary between million a year. These costs are not only costs to firms applying for patent protection, but also to purchasers of care and ultimately to consumers of pharmaceuticals as they create upward pressures on prices of pharmaceuticals. Administrative costs also play a role in the process of market authorisation. Estimates vary, but total administrative costs associated with market authorisation are expected to be at least 250 million per year for the EU. These costs may be necessary to fulfil the requirements to guarantee that only safe products are allowed to enter the market, but they represent a serious market entry barrier, particularly for SMEs. Any potential for reducing costs and simplifying procedures would thus be valuable. The impact of pricing and reimbursement regulation consists in particular of the costs of delayed entry on the market in individual Member States. Wide variations exist between Member States in the actual access to new medicines over time and the price in each individual market. Empirical analysis conducted for this study confirms existing evidence that these differences are related to a large extent to the impact of different regulatory regimens. In particular the practice of referring to other countries pricing and reimbursement decisions before taking your own decision (known as international reference pricing) seems to amplify the delays resulting from the process of estimating prices and reimbursement levels in national markets. Based on a small sample of new 15

16 innovative drugs this study estimates that the benefits of a simultaneous introduction in all 27 Member States, in terms of additional (earlier) revenues for firms alone, could add up to 35 million and 100 million per product. Whilst these costs cannot be simply extrapolated to EU27 or other drugs, they are a clear illustration of the magnitude of potential gains. The costs are significant and represent some 3.5% to 10% of the typical overall development costs of a medicine of around 1 billion. Delayed access to medicines also affects the health of patients. Whilst no EU-wide estimates of the effect of such delays on the health of patients exist, a recent study of access to 51 new medicines in the Netherlands with an average seven months delay in access has been estimated to result in 20,000 healthy life years lost which, if monetised, present a cost to society of about one billion euro s for the Netherlands alone. This inventory of welfare effects of pharmaceutical regulations indicates that substantial scope exists for improvements of the efficiency of pharmaceutical markets by making regulatory processes smarter and less time consuming. The effects will be that pharmaceutical companies will have lower costs which would help to reduce cost pressures in the provision of pharmaceuticals and health care to European citizens. The citizens would also gain by having timelier and more equal access to new pharmaceutical treatment opportunities. Minimising the side effects of regulation There are various ways in which one can reduce side-effects of regulation. The first way is geared towards the diversity of existing regulatory regimes in the Member States. This implies that different options for improvements exist for different countries. Different measures may be needed in different countries to achieve a more effective and efficient regulatory process. The second way refers to the legislatory powers of Member States vis-à-vis the European Union, which influence the feasibility of changing regulations at different levels of regulatory authority. The European Commission and Member States have different mandates in this policy area and any solution proposed should strike a balance between the existing instruments at different levels and the policy instruments to be employed. Considering pricing and reimbursement a wide variation in procedures can be observed across Member States, each with their own requirements regarding the type of information that has to be provided to the P&R authority and the way of submitting such information by the producer. Also the assessment of that information and the consequent decision making by the P&R authority vary considerably across Member States. In particular many Member States use international price referencing, owing to a lack of own assessment capacity or to other reasons. As we have observed there are major costs associated with this variation, both for producers but also for society at large. 16

17 Proposals to improve coordination and transparency on pricing and reimbursement This report proposes to build on existing coordination efforts and instruments, such as the Transparency Directive which aims to increase the transparency of pricing and reimbursement procedures, while maintaining each Member State s full control over its own decision-making processes. The Transparency Directive may serve as a vehicle for further strengthening the existing regulation and diminishing side effects by reducing transaction costs for producers and shortening the time before a product actually enters the market of the individual Member States. First, the better exchange of information among Member States could reduce unnecessary delays in pricing and reimbursement decisions and improve the quality of these decisions. Member States could co-operate more closely in the assessment of industry submissions for pricing and reimbursement of products instead of waiting for the outcome of each others individual procedures by: timely publication of price setting and reimbursement information through a common internet portal; increased information sharing on existing procedures and appraisals for pricing and reimbursement decisions in different Member States; closer technical co-operation e.g. in validating the information on cost-effectiveness or burden of disease that is submitted by the industry; closer health technology assessment co-operation between Member States. For example, some Member States with particular expertise could take the lead in the assessment of information from industry in certain disease areas. This could lead to the formation of a HTA network or the development of a common HTA body. In this regard the Joint Action on Health Technology Assessment , including work on relative effectiveness of drugs could be of interest; 2 Secondly, there is room for a greater convergence in procedures and information requirements between Member States by: exploring the room for the convergence of definitions used in pricing and reimbursement; minimising differences in information requirements for companies when applying for pricing and reimbursement in different Member States. This relates also to requirements for providing information on the criteria such as relative effectiveness for reimbursement as substantial differences exist between Member States concerning the operationalisation of these concepts; closer collaboration between Member States with comparable public health systems and/or located in a similar geographical region. Thirdly, best practices in pricing and reimbursement should be identified and used as benchmark by Member States. This would enhance procedures and serve to progressively reduce variations between Member States. Best practises can be enhanced by: 2 The Joint Action on HTA is a joint initiative by the European Commission, Member States agencies, the Pharmaceutical Forum and the European Network on Health Technology Assessment (EUnetHTA). 17

18 monitoring the actual times taken to make pricing and reimbursement decisions and setting ambitious targets for future performance; progressively moving away from the practice of International Reference Pricing that may delay market entry and create adverse launch incentives, towards greater use of health assessment-based evaluation of pharmaceuticals; collaborating closer between Member States with comparable pricing and reimbursement processes or located in a similar geographical region; ensuring greater coherence in setting reimbursement prices to ensure that the relative value-added of pharmaceuticals is fully taken into account. Finally, modifications could be considered to the Transparency Directive, which aims to obtain an overall view of national pricing arrangements and lays down a series of procedural requirements to ensure that pricing and reimbursement decisions are made in a timely and transparent manner by: requiring Member States to make an annual report including statistical information on the actual times taken to make pricing and reimbursement decisions. This would allow for easier comparison of the overall impact of the Transparency Directive by Member States; elaborating the existing obligation for Member States to take decisions on objective and verifiable criteria, including reporting on actual practices used, effective criteria applied, and the specific scientific methods employed; strengthening the appeal procedures. The Transparency Directive already specifies that Member States should have adequate judicial appeal procedures. This could be strengthened to ensure that effective and adequate judicial appeal procedures must be in place in Member States. 18

19 1 Introduction 1.1 Background of the study The first purpose of this study is to investigate the functioning of the EU market of pharmaceuticals and to provide a comprehensive, comparative and macro-level analysis as part of the market monitoring as a follow-up to the Single Market Review. As outlined in the Commission Communication "A Single Market for 21st Century Europe" and an accompanying Commission Staff Working Document "Market monitoring : State of Play and Envisaged Follow-Up" this market monitoring approach is one of the main components of the new strategy for the Single Market which aims at delivering more evidence based and impact driven policies. Following the sector screening at the Community level which was part of the Single Market Review Package, the next step consists of the implementation of the in-depth market monitoring in selected sectors. The work carried out in the pharmaceutical sector is built on the outcome of the pharmaceutical sector inquiry carried out by the Competition Directorate General of the Commission (2009). The objective of the in-depth market monitoring in this sector is to suggest measures aimed at strengthening competitiveness and improving market functioning. The second purpose of the study is to provide an analysis of factors influencing the competitiveness of the pharmaceutical industry. The market for pharmaceuticals is a key sector for Europe, and its performance is vital for Europe s competitiveness. The importance stems from several factors including the large number of people working in and for the industry, its production value, the high level of innovation, the personal and societal value of medicines and the complex systems of regulation that influence the functioning of the pharmaceutical industry. The general objective of this study on the EU market and industry for pharmaceuticals is therefore stated as to provide: a comprehensive, comparative, and macro-level analysis of the relationships between the economic performance of the pharmaceutical industry in Europe i.e. its potential for investment, economic growth, development, and employment on the one side and external factors, in particular externalities induced by European public/governmental bodies which affect this industry on the other side. This dual purpose on market monitoring and competitiveness in combination with a focus on regulation has led to a presentation of the analysis in two different volumes with volume II describing the trends and developments in the EU pharmaceutical markets, the competitive position of the industry and the main prospects for its future development. regulation 19

20 This volume I is dedicated to the welfare aspects of the regulation of pharmaceuticals in the European Union. 1.2 Political relevance of the pharmaceutical market The pharmaceutical industry has a high political relevance. National governments are faced with three overlapping and sometimes also competing regulatory tasks. First, governments must secure their public health policy objectives: protecting public health; guaranteeing patient access to safe and effective medicines; and ensuring a high quality of care. Secondly, an important healthcare policy is to contain health care budgets including pharmaceutical expenditures. Following principles of solidarity, both equity and efficiency (i.e. making best use of limited resources to increase population health) and meeting the patients needs are the prime objectives. One of the roles of government is to provide the funding and framework that score best on these objectives. 3 Thirdly, in addition to public health and health care policy, also industrial policy should be taken into account. Governments must balance health policy objectives against ensuring that the pharmaceutical sector can also perform its role in the longer term. The pharmaceutical sector is favoured by governments to stimulate their economies because they mostly rely on highly educated workforces, and production may be less likely to be outsourced to countries in which prevailing wages are lower. In addition, the pharmaceutical sector is a particularly innovation driven sector, which makes it an attractive sector to nourish. 4 The table below summarizes these three policy objectives. Table 1.1 Overview competing pharmaceutical policy interests (a simple listing; does not indicate priority) Health care policy Industrial policy Public health policy Cost containment and improving efficiency in health services and care Generic promotion and/or substitution Regulating doctor and consumer behaviour vis-à-vis medicines Promoting local research and development capacity Generating and protecting employment Promoting small and medium enterprise policies Innovative cures Patient access to medicines Efficacious treatments Ensuring access to medicines Intellectual property rights protection High-quality preparations Cost-effective medication Supporting local scientific community Safe medicines Improving prescribing Contributing to positive trade balance Sustaining the university research base Source: Permanand G, Altenstetter C, The politics of pharmaceuticals in the European Union in Mossialos E, Mrazek M, and Walley T (ed.), 2004, Regulating pharmaceuticals in Europe: striving for efficiency, equity and quality, Open University Press Pharmaceutical policy is highly politicized because of the high number of stakeholders involved (described in the next section). Given that these stakeholders often have 3 4 Permanand G, Altenstetter C, The politics of pharmaceuticals in the European Union in Mossialos E, Mrazek M, and Walley T ed.), 2004, Regulating pharmaceuticals in Europe: striving for efficiency, equity and quality, Open University Press. Sloan FA, Hsieh C-R (ed), 2007, Pharmaceutical innovation: Incentives, Competition, and Cost-Benefit Analysis in International Perspective, Cambridge University Press. 20 regulation

21 competing interests, governments find it difficult to achieve their many objectives in managing pharmaceuticals The underlying reasons for heterogeneity in pharmaceutical regulation across the EU Member States When looking at pharmaceutical regulation across EU Member States, it is very important to understand why, despite the similarity of policy objectives between the Member States (see above), pharmaceutical regulation and policies differ widely among them. A crucial element is the balance between public health and healthcare on the one hand, and industrial policy on the other. Whereas the EU holds competences over trade, competition and competitiveness, healthcare regulation (including pharmaceutical financing and reimbursement policies) is a largely exclusive competence of the EU Member States. However, separating European economic integration from national solidarity and welfare has ceased to be viable. The time of the patries de fraternité (that is of self-contained islands of national social sovereignty) is long gone and cannot be resurrected. 6 Limited literature is available on the underlying factors contributing to the large differences in pharmaceutical regulation observed across EU Member States. In terms of broad categories, however, the following factors are identified: State tradition and decision making structure: shaping of the political economy, state tradition and decision making structure (e.g. diffuse or centralist); nature of government-industrial relations; lobbying power of the industry; Culture and embedded health care system: health being directly related to individuals feelings of wellbeing and security, health regulation raises complex economic, social and ethical issues. It is deeply embedded in, and restrained by, European and national politics, and diverse views on the appropriateness of regulatory policy, which are in part based on the nations cultural heritage 7. Health care systems including the pharmaceutical subsector are influenced by the structure and culture of the societies of which they are part. 8 In particular, they reflect important values of the home country, such as the right to care, solidarity and equality 9 ; consumer behaviour and preferences (e.g. consumption of antibiotics, etc.); Market characteristics: geography, economic development, market size, population distribution (e.g. ageing). These factors interact and influence each other continuously, causing pharmaceutical policy to be a highly dynamic rather than a static process. For example, state tradition and decision making structures shape the nature of relations between government and industry Permanand G, Altenstetter C, The politics of pharmaceuticals in the European Union in Mossialos E, Mrazek M, and Walley T (ed.), 2004, Regulating pharmaceuticals in Europe: striving for efficiency, equity and quality, Open University Press. Ferrera M, 2005, The boundaries of welfare. European integration and the new spatial politics of social protection. Oxford: Oxford University Press. Payer L, 1988, Medicine and culture: varieties of treatment in the United States, England, West Germany, and France. New York: Henry Holt and Company. Ham C, 2001, Commentary: Values and Health Policy: The Case of Singapore. Journal of Health Politics, Policy and Law, 26(4), Ferrera M, 2005, The boundaries of welfare. European integration and the new spatial politics of social protection. Oxford: Oxford University Press. regulation 21

22 which may influence the set up of the healthcare system and vice versa. A certain population distribution (e.g. ageing) affects consumer behaviour and preferences and this may lead to alterations in the healthcare system. In turn, changing economic developments can affect the nature of government-industrial relations making either industrial lobbying weaker or stronger. Therefore pharmaceutical policy basically consists of various building stones which have developed through the years and are continuously re-defined, refined, re-shaped, replaced. A few examples presented below help explain the various factors at play. Although they are presented as isolated cases they should ideally be seen as part of a complex dynamic system where multiple effects influencing each other. In France the state tradition in which a centralist political approach (interventionist approach) has ruled most of its more recent history resounds in pharmaceutical regulation (e.g. for example with respect to price controls), while in other countries such as the UK historically more political emphasis has been but on market solutions (non interventionist approach) leading to for example less stringent price controls in the pharmaceutical market. An example with respect to culture and preferences is the difference in consumer behaviour and prescription patterns. In the Netherlands and Sweden research shows that the predominant coping strategy of patients is to nurse one s illness, sometimes in combination with over-the-counter medicines and home remedies while in Belgium and France, patients are much more inclined to visit their GP to ask for a prescription. This indirectly affects pharmaceutical regulations as this leads in the Netherlands to a much more significant role of pharmacies and consumer platforms in pharmaceutical policy setting than for example in France where GPs form a particularly important stakeholder to take into account. Different market characteristics play a role as countries with a strong industrial base tend to allow somewhat freer pricing (UK, Germany) France being an exception, although this is changing while those with a comparatively weak base employ a variety of price controls (Spain, Italy). Another example is that countries with national health systems (e.g. UK and Sweden) can more easily agree on control measures than countries with a social insurance system (e.g. Germany and Austria). In the latter case, the dispersal of power between the regulator and the third-party payer means that control over health care budgets and decision making becomes more complex as it involves agreements with several bodies including those beyond the public administration. Furthermore, industry cannot be seen simply as a recipient of (government-imposed) regulation. In the pharmaceutical sector where national governments and supranational authorities (like the EU) sometimes exercise strong regulatory competencies that define the prices at which drugs will be sold and where laws are set up with regard to patent protection and data exclusivity, industry lobbying is extremely relevant. Many pharmaceutical and biotechnology companies are organised in large associations based in either Brussels or Washington. This makes it more difficult to determine the lobby 22 regulation

23 positions of individual pharmaceutical companies and overall there is still limited transparency on the industries influence on national and EU policies. 10 The country specific diversity in the complex interrelationships outlined above precludes the adoption of one policy or policy combination that is right for all countries. Each EU Member State will need to meet their own objectives through policy approaches that reflect their own particular environment. However, this does not prevent EU Member States from comparing each other s policies to identify some typical best practice approaches. This is increasingly becoming common practice, stimulated for a large part by the EU. This method of best practice sharing ensures that none of the EU Member States has problems with setting up their pharmaceutical regulations due to insufficient knowledge and lack of best practice examples. 1.4 Scope and set-up of the analysis This report is Volume I: Welfare Implications of Regulations of the analysis of the Competitiveness of the EU Market and Industry for Pharmaceuticals. Volume II is a separate document and focuses on markets, innovation and regulation. 11 This study is a natural complement to the sector inquiry (2009) of the European Commission (DG Competition), of which the aim was:.to examine the reasons for observed delays in the entry of generic medicines to the market and the apparent decline in innovation as measured by the number of new medicines coming to the market Taking into account that sector inquiries are a tool under EC competition law12, the inquiry's main focus is company behaviour. 12 This study takes a broader view by focusing on how regulations in the pharmaceutical sector differ particularly with respect to pricing and reimbursement- and in what way scope exists for welfare improvements. In the subsequent chapters we will offer a short overview of the main market characteristics of the EU pharmaceutical market. 13 In chapter two we describe the existing market failures in the EU pharmaceutical market, while chapter three describes the various national and EU policy reactions to these failures. Chapter four examines the welfare implications as a result of these government interventions both at EU Member State and EU level. In chapter five an inventory is made of the welfare implications of government interventions. In the ensuing appendices the results of a detailed analysis of the relation between regulation and the availability and launch prices of new pharmaceuticals is presented Permanand G, Altenstetter C, The politics of pharmaceuticals in the European Union in Mossialos E, Mrazek M, and Walley T (ed.), 2004, Regulating pharmaceuticals in Europe: striving for efficiency, equity and quality, Open University Press. Competitiveness of the EU Market and Industry for Pharmaceuticals, Volume II: Markets, Innovation & Regulation European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. For a more elaborate overview see Volume II: Markets, Innovation & Regulation. regulation 23

24 2 Main market characteristics of the EU pharmaceutical market This chapter provides a summary of the main market characteristics of the pharmaceutical market in general and for the EU specifically provides important background information for the subsequent chapters. It shows just how complex the pharmaceutical industry is due to its unique combination of market characteristics and the complicated interrelationships between many different stakeholders from the public and private sector. More detailed information with regard to this topic can be found in our separate report Volume II: Markets, Innovation & Regulation 2.1 Complex supply chain The supply chain of the pharmaceutical sector contains several basic features which are almost identical across all EU Member States. It is characterised by two types of suppliers: originator companies and generic companies. The distribution system of pharmaceutical products includes wholesalers, retailers and parallel traders. The wholesale channel is mostly used by community pharmacies, while hospitals buy more often directly from the pharmaceutical companies through tendering procedures. Retailers of pharmaceutical products are typically community pharmacies. Other channels are selfdispensing doctors, hospital pharmacies, and for non-prescription products (e.g. over-thecounter products) pharmacy outlets, medicine stores, supermarkets and petrol stations. The demand side consists of a complex interrelationship between, amongst others, patients, doctors, hospitals, insurance providers, and reimbursement systems. For prescription medicine a unique market feature is the fact that the consumer (e.g. the patient) differs from the decision maker (e.g. generally the prescribing doctor), and very often also from the bearer of the costs (e.g. generally the health system) Pharmaceutical expenditure Differences in pharmaceutical expenditure across EU Member States and other countries are difficult to explain, because they reflect differences in the type of pharmaceuticals consumed, the quantities of pharmaceuticals consumed and the different prices between countries. These factors are in turn influenced by many often interrelated factors such as the demographic composition of the population, life styles of patients, prescription 14 European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. 24 regulation

25 behaviour of physicians, existence and workings of a health insurance system, share of prescription drugs and over-the-counter drugs, level of self-care, level of generic entry, level of parallel trade, government regulation, level of in-country pharmaceutical production, incidence rate of diseases (e.g. cancer), share of hospital and ambulatory care in total healthcare, rate of hospital efficiency, intensity of care and use of technology, etc. 15 In the Netherlands for example, the low consumption of pharmaceuticals is partly attributed to stringent prescription behaviour of doctors combined with the cultural preference to nurse one s illness and avoid treatment as much as possible. In France quite the opposite is considered to be the situation and, in combination with a relatively high share of prescription drugs (as opposed to over-the-counter drugs) in the pharmaceutical market, leads to one of the highest real per capita pharmaceutical expenditure levels in the EU. Pharmaceutical expenditure (as share of GDP) is rather low in comparison with other components of healthcare expenditure, e.g. hospitals and ambulatory care. Overall across a group of OECD countries with consistent data, all medical goods (including pharmaceuticals) have contributed to around 20% of health spending compared with over 60% from hospital and ambulatory providers. 16 The OECD average spending on pharmaceuticals was 1.5 percent of its GDP in 2005 and The Nordic countries have the lowest share of pharmaceutical spending as part of their GDP, ranging from 0.7 percent in Norway to 1.2 percent in Finland and Sweden. Expenditures on pharmaceuticals as part of GDP are highest in Hungary (2.6 percent), followed by Portugal and the Czech Republic. With a 1.9 percent share, the US spends more than the OECD average. Table 2.1 offers an overview of total expenditure on pharmaceuticals and other medical non-durables as share of total health expenditure. The average OECD country spent approximately 17% of total healthcare expenditure 17 on pharmaceuticals in 2005 and In several OECD countries pharmaceutical expenditure plays a larger role (30% in Hungary, the Slovak Republic, Poland and Korea) than in other OECD countries (less than 10% in Denmark, Norway, and Luxembourg) Mossialos E, Oliver A, 2005, An overview of pharmaceutical policy in four countries: France, Germany, the United Kingdom, and the Netherlands in the International of Health Planning and Management, volume 20, issue 4, p ; Morgan D, Oxley, H, 2008, Improving health-system efficiency: achieving better value for money, introductory presentation: some key features of growth and cross-country differences in health-care spending, OECD and European Commission conference. Morgan D, Oxley H, 2008, Improving health-system efficiency: achieving better value for money, introductory presentation: some key features of growth and cross-country differences in health-care spending, OECD and European Commission conference. OECD Health Data 2008, December 2008 update, calculation based on data excluding incomplete series, including those with a break in series. OECD, 2008, Pharmaceutical pricing policies in a global market. regulation 25

26 Table 2.1 Total expenditure on pharmaceuticals and other medical non-durables, % total expenditure on health Average 1) 16 16,3 16,9 17,0 17,1 17,3 17,2 17,1 Austria 9,2 11,9 11,6 12,2 12,6 12,2 12,0 12,4 Belgium 16,7 17,1 b) 16,9 Czech Republic 25,1 23,4 b) 24,0 23,9 24,2 24,8 25,1 23,1 Denmark 9,1 8,8 9,2 9,8 9,1 b) 8,7 8,6 8,5 Finland 13,0 b) 15,2 15,4 15,6 15,6 15,8 15,8 14,6 France 15,0 b) 16,5 16,9 16,8 16,7 16,8 16,7 16,4 Germany 12,9 13,6 14,2 14,4 14,5 13,9 15,1 14,8 Greece 15,7 17,8 b) 16,3 16,8 17,8 19,7 18,5 17,6 Hungary 25,0 28,5 27,6 27,1 28,3 30,5 31,0 Italy 20,7 22,0 22,5 22,5 21,8 21,2 20,3 20,0 19,4 Luxembourg 12,0 b) 11,0 11,5 10,3 9,7 b) 8,9 8,4 Netherlands 11,0 11,7 11,7 11,5 Poland 28,4 30,3 29,6 28,0 27,2 Portugal 23,6 22,4 b) 23,0 23,3 21,4 21,8 21,6 21,3 Slovak Republic 34,0 34,0 37,3 38,5 31,4 b) 31,9 29,7 Spain 19,2 21,3 21,1 21,8 23,2 b) 22,7 22,4 21,7 Sweden 12,3 13,8 13,9 b) 14,0 13,7 13,8 13,7 13,3 United Kingdom 15,3 Australia 12,1 14,7 15,1 14,5 14,8 14,7 14,2 13,7 Canada 13,8 15,9 16,2 16,7 17,0 17,3 17,2 17,4 17,5 Iceland 13,4 14,5 14,1 14,0 14,5 14,6 13,4 13,1 12,9 Japan 22,3 b) 18,7 18,8 18,4 19,2 19,0 19,8 19,6 Korea 29,7 27,3 26,2 26,6 27,3 27,5 26,4 25,9 Mexico 19,4 d) 19,6 d) 21,2 b) 21,5 20,9 21,3 22,9 New Zealand 14,8 Norway 9,0 9,5 9,3 9,4 9,2 9,4 9,1 8,5 7,9 e) Switzerland 10,0 b) 10,7 10,6 10,3 10,5 10,4 10,5 Turkey 24,8 United States 8,9 11,7 12,0 12,3 12,5 12,6 12,4 12,6 Source: OECD Health Data 2008, December 2008 update, frequently requested data Explanation: 1) Own compilation excluding incomplete series, including those with a break in series; b) break in series; d) differences in methodology; e) estimate Cross-country comparisons show a positive relationship between per capita GDP and real pharmaceutical expenditure (volume of consumption), with per capita GDP explaining one quarter of the variability in per capita consumption Okunade A, Suraratdecha C, 2006, The pervasiveness of pharmaceutical expenditure inertia in the OEC countries, Social science & medicine (1982) 2006;63(1): regulation

27 In the OECD, prescription medicines 20 take up the large majority (80%) in total pharmaceutical expenditure with over-the-counter drugs accounting for approximately 19%. Large country differences occur: e.g. in Poland only 57% of pharmaceutical expenditure was spent on prescription drugs while in France prescription drugs took up approximately 87% of total spending on pharmaceuticals. 21 Hospital expenditure on pharmaceuticals takes up a relatively small share of total pharmaceutical expenditure in several countries for which evidence exist (Germany and Canada approximately 8% and in Korea 13%), but evidence lacks for a wider range of countries. In addition, it is important to note here the difficulty of making country comparisons in this case as in some countries pharmaceutical products are provided in an in-patient setting and delivered in an out-patient setting in another. 22 The private sector plays a much more significant role in pharmaceutical expenditure than in other health care expenditure. In most OECD countries, particularly out-of-pocket expenditure accounts for this. Health insurance is generally not a significant source for pharmaceuticals except in France, Canada, the Netherlands, and the USA where health insurance pays between 14% (France) to 41% (USA) of pharmaceutical expenditure. 23 Pharmaceutical expenditure has risen rapidly (e.g. 7%) across most OECD countries (particularly in the USA, Austria, Canada and Hungary) partly due to an ageing population and the diffusion of new innovative drugs. Recently a much slower growth seems to be occurring (e.g. 2% in real terms in 2006). The effect on overall healthcare spending is however not evident as the introduction of new drugs to tackle certain diseases or conditions may reduce the need for costly hospitalisation or surgical interventions This includes n some countries drugs available over-the-counter that were prescribed for use by a health-care practitioner. OECD, 2008, Pharmaceutical pricing policies in a global market. Van Mosselveld C, 2005, Pharmaceutical expenditure compared across countries, Canadian Journal of Clinical Pharmacology, 12(3), e269-e275. Morgan D, Oxley H, 2008, Improving health-system efficiency: achieving better value for money, introductory presentation: some key features of growth and cross-country differences in health-care spending, OECD and European Commission conference. Morgan D, Oxley H, 2008, Improving health-system efficiency: achieving better value for money, introductory presentation: some key features of growth and cross-country differences in health-care spending, OECD and European Commission conference. regulation 27

28 2.3 Lifecycle of drug development The figure below offers an overview of the route of a new pharmaceutical product from the discovery to patient s access. Figure 2.1 Route from discovery to consumer access Source: World Health Organisation, 2006, The pharmaceutical industry in Europe, key data, PowerPoint The figure clearly shows the importance of R&D in the lifecycle of pharmaceutical products. On a global scale the pharmaceutical sector is the highest R&D spending sector in the world. In 2006, approximately 70.5 billion was spent on pharmaceutical-related R&D 25 which led to the first launch of 25 new molecular entities and 7 biologicals worldwide. 26 On average, it takes approximately 12 to 14 years to develop a new medicine. In the preclinical phase (first years) research is done into the new molecular entity. The next phase consists of clinical trials 27 which are required by most governments to demonstrate both safety and efficacy before a drug can be approved for sale. It is these clinical trials that are one of the most costly processes in the development of a new drug. They are estimated to account for over 43% of total R&D costs. 28 Development costs of a new medicine are estimated to have grown to approximately 1 billion. In 1975 development costs amounted to 149 million in 2000 prices; in In comparison, the second sector with the largest R&D expenditure is the technological hardware and equipment with 62,5 million. Nefarma, 2007, Innovatie, EU Industrial R&D Investment Scoreboard (EC). Retrieved 2009: In the clinical phase the safety of the new molecular entities are tested on a small group of healthy volunteers. Subsequently, if this testing phase is successful the new molecular entities are tested on a small group of patients and on a larger group (between 100 tot more than 1000 patients). World Health Organisation, 2006, The pharmaceutical industry in Europe, key data, PowerPoint. 28 regulation

29 this increased to 344 million in 2000 prices; and in 2000 this increased further to 868 million. 29 It is estimated that only between 1 in 5,000 to 1 in 10,000 interesting molecular entities will eventually be further developed and sold on the market. 30 As a result, the extensive R&D costs associated with developing new medicines can only be recovered by pharmaceutical companies through price setting of the limited number of new medicines that eventually reach the market. Original pharmaceutical companies are faced with cyclical revenues as the billion blockbusters in their portfolio come off patent and they struggle to develop new medicines that can replace this income. They also have to meet short-term earnings targets that may be at odds with their long-term aspirations Size distribution The sector is characterised by the dominance of a relatively small group of big pharmaceutical companies which represents a significant part of the annual (European) turnover. Figure 2.2 on the subsequent page illustrates that in 2006 the pharmaceutical enterprises with more than 250 employees (468 companies, only 10.5% of the total number of European companies) realised approximately 73% of the total turnover. In 2006, there were 2,695 very small enterprises (< 20 employees, 60% of total), but they realised only 2% of the total turnover Di Masi JA, Hansen RW, and Grabowski HG, 2003, The Price of Innovation: New Estimates of Drug Development Costs, Journal of Health Economics, 22, Other source: Goozner M, 2004, The $800 million pill. Berkeley: University of California Press. European Federation of Pharmaceutical Industries and Associations, 2008, The pharmaceutical industry in figures. PWC, 2007, Pharma 2020: The vision, Which path will you take?, retrieved from: regulation 29

30 Figure 2.2 Overview of the size distribution of pharmaceutical firms in the EU-27 (2006) > ,5% 82,3% Number of employees per enterprise ,8% 10,8% 12,7% 17,5% < 20 2,2% 60,4% 0,0% 10,0% 20,0% 30,0% 40,0% 50,0% 60,0% 70,0% 80,0% 90,0% % of total # enterprises Turnover Source: ECORYS, based on Eurostat data, Structural business statistics, Return on investment The pharmaceutical industry is considered one of the more profitable industry sectors. In the U.S. in 2005, the pharmaceutical firms in the Fortune 500 averaged a 10.3% return on assets, compared with a median return of 4.7% for all industries in the U.S. An important fact to take into account is that the costs of capital for the drug industry are much higher than for many other industries, thus the higher returns in the pharmaceutical sector may be necessary to compensate the riskier investment environment. The standard accounting measure of profits overstates true returns of R&D intensive industries, such as pharmaceuticals as it does not treat R&D spending as a capitalised investment. 32 In the U.S, Clarkson s (1993) re-calculation taking into account the above observation- led to a drop in the rate of return on equity from 21% to 13%. The Office of Technology Assessment (OTA) calculated for the 1990s -also in the U.S. - a rate of return on investment with a profit of only 3 percentage points above the average for companies in all U.S. industries (e.g. 11%) 33. Table 2.2 offers a comprehensive overview of average accounting and corrected (economic) rates of return on assets and equity (in %) by industry sector for the period (based on Clarkson, 1996) Congress of the United States, CBO, 2006, Research and development in the pharmaceutical industry. Schweitzer SO, 2007, Pharmaceutical economics and policy, Oxford University Press, second edition. Vogel RJ, 2007, Pharmaceutical economics and public policy, the Haworth Press. 30 regulation

31 Table 2.2 Average accounting and corrected rates of return on assets and equity by industry (in %), * Accounting rate of return Corrected (economic) rate of return Assets Equity Assets Equity Chemicals Pharmaceuticals Petrol Electric Automotive Computer software Food Source: Vogel RJ, 2007, Pharmaceutical economics and public policy, the Haworth Press * This data was published in Vogel (2007) with permission of the American Enterprise Institute for Public Policy and Research Grabowski, Vernon and DiMasi (2002) examined the returns on R&D for new drug entities introduced into the U.S. market in the first half of the 1990s. Their research builds further on earlier analysis of returns on R&D for the 1970s and 1980s. For a sample of 118 NCEs they investigated R&D costs and sales and profit information. Their analysis indicates that of the sample only one-third of the new drug introductions had present values in excess of average R&D costs. The estimated mean return was 11.5%. This compares to a real cost-of-capital of 11% for this sample cohort. These results are similar to their results for the 1970s and 1980s. Namely, R&D in pharmaceuticals is characterised by a highly skewed distribution of returns towards the top deciles of new drugs (which account close to half of the overall market value) and a mean industry IRR in excess of the cost-of-capital. Their results also show a doubling of R&D investments (see also above) and an increase in the number of new introductions, average sales per introduction, and industry contribution margins compared to the period. 2.6 Production and value added Since 2002, the European Union has become the largest producer of pharmaceuticals on a global scale. It should be noted however that production figures are distorted because of the changes in the EU-USD exchange rate with considerable appreciation of the Euro since This is shown by the fact that the compound annual growth rates -based on production data in national currencies- show that in the EU growth in production was lower (3%) than in the USA (7%). 36 In the EU, the largest producers currently are France and Germany, followed by Italy and the UK. Of the smaller EU Member States, Belgium and Ireland stand out as relatively large producers, with a strong presence of multinational pharmaceutical companies. In the New Member States, Poland and Hungary are the largest producers. 37 The largest decline in growth in the period was observable in the old EU Member States except Growth rate for EU-12 is based on calculations in EUR. Eurostat, Structural business statistics, 2009 and OECD STAN Database for structural analysis, Retrieved: Eurostat, Structural business statistics, 2009 and OECD STAN Database for structural analysis, Retrieved: regulation 31

32 for the Netherlands and Belgium which experienced on the contrary the highest growth. In the New Member States Latvia and Romania experienced the highest growth and Slovakia the lowest growth Trade The European Union is the largest exporter of pharmaceutical products. It accounts for approximately 70% of world exports and almost 60% of world imports in Within the EU, Germany, Belgium, UK and France are the largest exporters. Particularly Belgium has grown in importance as an exporter in recent years. The majority of pharmaceutical trade is intra EU. Externally, EU trades the most with the USA and Switzerland. 2.8 Relevance in the labour market The pharmaceutical manufacturing industry accounts for almost 2% of total employment in EU manufacturing. In 2006 employment in the EU27 39 in the pharmaceutical sector summed up to 606,828 persons. The share of the pharmaceutical manufacturing industry is particularly high in Ireland (5.3%), Denmark (4%) and Belgium (3.6%). 40 Developments in pharmaceutical employment in the period show an increase in employment of 5.6% for the EU 27. Countries with a relatively small pharmaceutical sector have small base years and consequently growth rates generally show larger fluctuations in employment. Growth has been particularly strong in Belgium (19.7%), Ireland (18.2%), and Germany (12.5%). 41 EU labour productivity relatively low compared to the USA (only 53.5% of US productivity rate in 2003). Nevertheless, some individual EU Member States (e.g. Ireland and Sweden) outperform the USA in terms of productivity Pricing Research indicates that overall prices in the EU are converging toward a common mean. 43 However, the figure on the subsequent page shows differences continue to exist. In Europe, particularly Switzerland and Iceland have significantly higher price levels than other countries in Europe (60% and 87% higher than the EU25 average). Other countries Eurostat, Structural business statistics, 2009 and OECD STAN Database for structural analysis, Retrieved: Excluding Luxembourg, Malta and Estonia due to missing data. EUROSTAT, Structural business statistics, EUROSTAT, Structural business statistics, Pammolli F, Riccaboni, M, 2007, Innovation and industrial leadership: lessons from pharmaceuticals, John Hopkins University. Pammolli F, Riccaboni, M, 2007, Innovation and industrial leadership: lessons from pharmaceuticals, John Hopkins University. 32 regulation

33 with higher price levels than the EU average (15% to 30% higher than the EU25 average) are Denmark, Germany, Ireland, Italy and Norway. On the other side, the lowest price levels can be found in the Former Yugoslav Republic of Macedonia (58% of EU25 average), most New Member States (except Slovenia, Malta and Cyprus), Spain and Greece. 44 Figure 2.3 Price level indices for pharmaceutical products, EU25=100 Source: Konijn P, 2007, Pharmaceutical products comparative price levels in 33 European countries in 2005, Eurostat Statistics in Focus economy and finance 45/2007 Note: These prices refer to the full market price of a product, i.e. the sum of the share of the price paid by a household and the share of the price paid by the government. When making a comparison with the U.S. it becomes apparent that the average prices of branded 45 drugs in the U.S. are almost double the corresponding prices in EU countries Konijn P, 2007, Pharmaceutical products comparative price levels in 33 European countries in 2005, Eurostat, Statistics in Focus economy and finance 45/2007. The data only allow to distinguish branded products (both originator or license products and branded generics) from unbranded products, referred to as generics. regulation 33

34 EU average price for branded drugs is 50.7 percent of the U.S. level. However, generic drug prices in the EU-15 countries are percent their U.S. counterparts. 46 After having adjusted prices for PPP, average prices of branded products in the EU-15 are percent of the U.S. prices, whereas generic prices in EU-15 are percent the U.S. price. More than half of the molecules included in the sample of Pammolli and Riccaboni (2007) are priced higher in the U.S. than in any country of the EU-15.Price differences between the U.S. and EU-15 are entirely explained by differences in prices of branded drugs. In fact, prices of generic drugs in the U.S. are substantially aligned with prices in EU-15. In a few countries, such as Germany, generic prices are higher than in the U.S. 47 Price at entry of branded drugs is 43.4 percent higher in the U.S. than the prevailing average price in the market. The corresponding price gap in the EU-15 is 28.2 percent, and in Japan just 3.9 percent. U.S. generic products, by contrast, enter at prices at 60.3 percent of the average prices in the market. 48 These price differentials between the U.S. and Europe reflect differences in the extent of market regulation. 49 Prices of branded drugs in countries with free or semi-regulated prices such as the U.S. and, to a lesser extent, UK and Germany are higher than in countries where more direct forms of price regulation are in place, such as Italy and France. At the same time, the relatively unregulated markets tend to experience fierce price competition after patent expiry, since higher prices of branded drugs represent a strong incentive for generic entry and price competition. 50 Generic pharmaceutical products are sold at lower prices relative to the originator pharmaceutical products that are available on the market. Empirical evidence in the Sector Inquiry of the European Commission (2009) shows that generic medicines are sold in the EU at starting date at a price on average 25% lower than the price of the originator medicines prior to the loss of exclusivity. Two years after entry, generic pharmaceutical prices were on average 40% below the former originator price. Due to generic entry, the price levels of originator products for International Non-proprietary Names (INNs) facing generic entry also decreases somewhat. 51 These EU averages hide considerable variation between the EU Member States. Generic entry leads to the largest generic (INN) price decreases in Sweden, Finland, Denmark, Austria, Germany, Belgium, Luxemburg and the Czech Republic. In each of these countries average prices for the INNs losing exclusivity appear to drop by more than 50% Pammolli F, Riccaboni M, 2007, Innovation and industrial leadership: lessons from pharmaceuticals, John Hopkins University. However, in Germany generics are mostly branded generics rather than pure generics. These are included among the branded products. Pammolli F, Riccaboni M, 2007, Innovation and industrial leadership: lessons from pharmaceuticals, John Hopkins University. For more information on this topic see OECD (2001). Pammolli F, Riccaboni M, 2007, Innovation and industrial leadership: lessons from pharmaceuticals, John Hopkins University. However, the relationship between originator and generic price has been subject to much debate in literature. In the case of pharmaceuticals, it appears that brand-name manufacturers do not necessarily compete on price once generic competitors enter the market, despite generic prices being lower than the originator price. Instead, originator brand prices may increase rather than decline post-patent expiry. This is called the generics paradox. Source: Kanavos P, Costa-Font J, Seeley E, 2008, Competition in off-patent drug markets: issues, regulation and evidence, LSE health. 34 regulation

35 within the first two years. In Sweden, Denmark and Luxembourg this price drop is already achieved in the first year of entry. 52 Generic entry has a decreasing effect on the average price index of products sold under the INN losing exclusivity. In markets with generic entry, average prices dropped by almost 20% after the first year following the loss of exclusivity and about 25% after two years. In rare cases, for some medicines in some EU Member States, the decrease in the average price index was as high as 80-90% Availability The figure below shows the introduction lag (in months) from launch on the U.S. market. With the exception of the Netherlands, where the median launch is concomitant with the launch in the U.S., the European countries experience a time lag in the launch of new molecules. In the case of EU-15, the median launch is delayed by eight months, while the delay increases to 17 months if we look at the EU-25. Overall, the delay is larger when comparing the launch in the U.S. with the launch in New Member States. Launch in Japan is further delayed with respect to Europe, having a median delay with respect to the U.S. of more than two years. Figure 2.4 Introduction lag (in months) from launch on the U.S. market* Source: Pammolli F, Riccaboni M, 2007, Innovation and industrial leadership: lessons from pharmaceuticals, John Hopkins University European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. regulation 35

36 Other empirical research indicate that countries with lower expected prices or smaller expected market size have fewer launches and longer launch delays, controlling for per capita income and other country and firm characteristics 54. Pharmaceutical companies tend to accelerate product launches in those markets where new products can be sold at a better price, in order to obtain the highest return to R&D expenditures and other fixed costs. 55 In addition, because a low price in one market may spill-over to other markets, through parallel trade and external referencing, manufacturers may rationally prefer longer delay or non-launch to accepting a relatively low price. This finding tends to confirm the hypothesis that price regulation negatively affects the timing and occurrence of launch. 56 Also other empirical research shows that the more strongly regulated countries experience longer delay in new drug access. 57 More information on company strategies on pricing and reimbursement regulation can be found in section (Effect on behaviour of pharmaceutical companies) Generic medicine The use of generic medicines has been increasing worldwide and is being promoted through government policies worldwide. Table 2.3 below offers a regional comparison of generic penetration in the period It shows that the top three list of regions with the highest penetration rates (both in volume and value) namely China, the USA and Canada- have remained unchanged in this period. However, the EU is rapidly catching up with the highest growth rates in generic penetration shares (both in value and volume, particularly in EU-15) in the period Table 2.3 Generic penetration in main regional markets, Sales (%) Quantity (SU%) U.S.A 7,10 5,26 6,35 21,41 27,94 33,67 EU-15 3,41 4,25 8,69 7,61 8,89 16,34 EU-25 3,54 4,37 4,37 8,73 10,77 16,01 China - 33,56 23,76-41,46 33,97 Canada 10,29 13,01 14,64 16,55 22,08 28,28 India - 1,86 0,58-1,68 0,54 Japan 3,69 2,52 2,52 3,07 2,49 2,55 Source: Pammolli F, Riccaboni M, 2007, Innovation and industrial leadership: lessons from pharmaceuticals, John Hopkins University (computations on IMS Health, 2005) Danzon PM, Wang RY, and Wang L, 2003, The Impact of Price Regulation on the Launch of New Drugs in NBER Working Paper no. 9874, Cambridge, Mass.: National Bureau of Economic Research Pammolli F, Riccaboni M, 2007, Innovation and industrial leadership: lessons from pharmaceuticals, John Hopkins University. Danzon PM, Wang RY, and Wang L, 2003, The Impact of Price Regulation on the Launch of New Drugs in NBER Working Paper no. 9874, Cambridge, Mass.: National Bureau of Economic Research Pammolli F, Riccaboni M, 2007, Innovation and industrial leadership: lessons from pharmaceuticals, John Hopkins University. Pammolli F, Riccaboni M, 2007, Innovation and industrial leadership: lessons from pharmaceuticals, John Hopkins University. 36 regulation

37 Generic medicines markets have not developed to the same degree in European countries. The latest data of 2007 of the European Commission (2009) is presented in the graph below. It show that generic market shares (in value) are particularly high (between 20%- 40% and for Poland above 40%) in Poland, Portugal, Hungary, Netherlands, Germany and the UK. Generic market shares (in value) are comparatively low in Ireland, France, Finland, Belgium, Spain, Greece and Italy. Figure 2.5 Generic market shares in Europe in 2007 Source: European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report Research indicates that generic penetration is more successful in countries that permit (relatively) free pricing of medicines (e.g. Germany, the Netherlands and the UK) than in countries that have more strict pricing regulation (e.g. Austria, Belgium, France, Italy, Portugal, Spain). 59 This is because in these countries, medicine prices are generally higher, which attracts generic medicines companies to enter these markets. In regulated markets, by contrast, price regulation lowers the originator price over the life cycle of medicines, lowering the potential profit margin for a generic medicine company, discouraging their market entry. In the EU, the average time gap between the date on which the medicines lost exclusivity and the date of first generic entry was about seven months on a weighted average basis for the Sector Inquiry sample of the European Commission (2009) as a whole, whereas for the most valuable medicines it was four months, with considerable variations across EU Member States and across medicines. 60 The figure below shows that the average time to entry is relatively short in Austria, Denmark, Finland, Ireland, the Netherlands, Sweden Simoens S, De Coster S, 2006, Sustaining generic medicines markets in Europe, Research Centre for Pharmaceutical Care and Pharmaco-economics, Katholieke Universiteit Leuven, Belgium European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. regulation 37

38 and the UK, but exceeds half a year on average in Belgium, the Czech Republic, Germany, Spain, France, Greece, Hungary, Italy, Luxemburg, and Portugal. 61 Figure 2.6 Average time to entry following loss of exclusivity, by country (loss of exclusivity in , weighted by INN) Source: European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report A partial explanation for the difference in average times to entry can be found in differences in the speed of providing regulatory approval to market a generic medicine and pricing and reimbursement by authorities. For example, in the U.S. and Canada (not sampled in the Sector Inquiry sample of the European Commission, 2009) generic companies can apply for approval prior to patent expiry, while this is not the case in the EU. This basically extends the patent term of the branded originator manufacturer in the EU for the length of time it takes for bioequivalence testing and other tests needed to secure regulatory authorization. 62 With respect to pricing within the EU, the Transparency Directive 89/105/EEC specifies a 90-day limit for adopting a decision on price and a 90-day limit for reimbursement, but in practice several studies have shown that these time limits have been exceeded. According to an EGA survey (2005), price approvals in Austria and Italy surpassed 90-days; equalled 90 days in Belgium and Portugal and were shorter than 90 days in France, the Netherlands and Spain. 63 The variation in generic market shares owes, amongst other things, to differences in generic medicines policy. No single approach towards developing a generic medicine market exists. Generic medicine policy has typically grown incrementally in countries over time and reflects demographic, cultural, economic and institutional constraints. Generic medicine markets are most mature in countries that have made an effort in the European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. Kanavos P, Costa-Font, J, Seeley E, 2008, Competition in off-patent drug markets: issues, regulation and evidence, LSE health. Simoens S, De Coster S, 2006, Sustaining generic medicines markets in Europe, Research Centre for Pharmaceutical Care and Pharmaco-economics, Katholieke Universiteit Leuven, Belgium regulation

39 last years to promote generic medicine (e.g. Denmark, Germany and the Netherlands) Parallel trade Parallel trade is the legal importation of a patented drug without the authorization of the patent holder. The main driver behind parallel trade is the variation in the manufacturers drug prices across markets. Importing occurs from countries with a low drug price relative to the price of the same drug in the importing country and where the price difference is sufficient to cover the costs of transport, registration, relabeling/repackaging, creating and inserting leaflets according to national requirements. 65 In the EU it was recently estimated 66 that the standard deviation of EU prices was some 28% of average prices, making the incentives for parallel trade high. 67 While parallel trade is illegal in many parts of the world, it is legal within the EU. Within the single market, key changes in the harmonisation of regulation under the EU s mutual recognition procedure, and Articles governing the free movement of goods have fostered an environment where parallel trade can capitalise on pharmaceutical price differences across countries. Apart from EU regulations, the parallel importer has to conform to national regulations (i.e. the relevant government agency has to give its permission for sale of the re-imported product). The re-imported product must be identical to the drug registered in the importing country. In order to establish that there is no undermining of quality, the competent authority in the import country will contact its counterpart in the exporting country to receive documentation on the product in question. In several countries, there is also a specific authority governing prices on pharmaceutical products, including reimported products. 68 As the European Union is legally a single market, no formal permission from the rights holder is necessary, only a Parallel Import Product License issued by the relevant national agencies or by the European Medicines Evaluation Agency (EMEA). The legal status of parallel trade within the EU has been confirmed on several occasions by the European Court of Justice. 69 Parallel importers predominantly buy from retail vendors in other EU countries. The retailers in turn make their purchases either directly from the original manufacturers or Simoens S, De Coster S, 2006, Sustaining generic medicines markets in Europe, Research Centre for Pharmaceutical Care and Pharmaco-economics, Katholieke Universiteit Leuven, Belgium Enemark U, Pederson KM, Sørensen J, 2006, The Economic Impact of Parallel Import of Pharmaceuticals, University of Southern Denmark. Konijn P, 2007, Pharmaceutical products comparative price levels in 33 European countries in 2005, Statistics in Focus economy and finance 45/2007. In practice, the re-importer chooses a country where the target product a recent and innovative drug to ensure maximum profit sells at a low price compared to the same product sold by the original manufacturer or licensee in the import country. The parallel importer, generally a small independent wholesaling firm, must then repackage the product, sometimes replace labels and add new notices in the language of the importing country. Arfwedson J, 2003, Paralell trade in Pharmaceuticals, Centre for the New Europe. Arfwedson J, 2003, Paralell trade in Pharmaceuticals, Centre for the New Europe. regulation 39

40 from licensed resellers. In most European countries, there are several retailers that work mainly on a regional basis. Other actors, who are not directly involved in parallel trade may, nevertheless, influence the conditions under which re-importation takes place. These include physicians who may or may not choose re-imported medicines when they make prescriptions. Similarly, pharmacists may have incentives to promote re-imported products over alternatives. Finally, consumers have their own reasons for discriminating between parallel imported drugs from licensed providers. Prescription drugs are also, generally, contingent on some form of insurance scheme where the government is one influential partner. In this respect, the insurer has an incentive to make sure that expenditure is not higher than absolutely necessary and therefore to steer consumption towards cheaper alternatives when available. 70 The Pharmaceutical Sector Inquiry of the European Commission (2009) indicates that the turnover at the time of the analysis (2007) of the parallel traders of pharmaceutical products was approximately billion in EU, which is 2-3% of the overall pharmaceutical market. It is estimated in the same study that approximately 100 companies are engaged in parallel trade in the EU, employing in total between to employees. Most parallel traders with a few exceptions are SMEs. The table on the subsequent page shows that the share of parallel trade of the total prescription pharmaceutical market has increased in most parallel country destination countries in the period The reasons for this growth can mostly be traced back to legislation. Since 1996 Sweden started to allow parallel imports of pharmaceutical products and this has led to a sharp increase in parallel import in the subsequent years. In Germany, growth in parallel trade became particularly strong once a law was passed in 2000 requiring pharmacists to replace brand names with re-imported drugs when the latter are at least 10% cheaper. 71 The UK is a major destination for parallel imports, particularly due to a series of measures taken by the government that give the pharmacist an incentive to sell the generally cheaper parallel imported drugs. Also, for the UK substantial profits can be made due to exchange rate differentials between the pound and the euro. This factor appears to be a chief driving force for the growth of parallel trade. 72 In Denmark and the Netherlands the relative share of parallel imports has remained stable, particularly due to the fact that parallel trade was introduced earlier than in other countries. In the Netherlands, parallel trade is stimulated through financial benefits while in Denmark it is stimulated through a law that required pharmacists to dispense parallel traded products Arfwedson J, 2003, Paralell trade in Pharmaceuticals, Centre for the New Europe. Arfwedson J, 2003, Paralell trade in Pharmaceuticals, Centre for the New Europe. Arfwedson J, 2003, Paralell trade in Pharmaceuticals, Centre for the New Europe. 40 regulation

41 Table 2.4 Market value of pharmaceutical parallel imports and their share as a percentage of the total prescription pharmaceutical market in several EU countries, Country Sweden SEK m 270 1,012 1,402 1,732 2,011 2,309 Denmark DKK m 554,6 656,2 700,3 781,4 835,5 917,2 Germany 216,7 256,6 331, , ,30 Greece* ,7 308,1 514,3 556,7 m Netherlands UK m na ,076 1,346 Sweden 1,9% 6,2% 7,7% 8,6% 9,3% 10,1% Denmark 9,1% 10,0% 10,0% 10,2% 9,9% 9,7% Germany 1,7% 1,9% 2,30% 3,20% 4,7% 7,0% Greece* 0,9% 7,7% 10,7% 16,5% 24,4% 21,6% Netherlands % of total prescription market 14,0% 14,% 14,5% 13,5% 14,3% 14,0% UK na 9,5% 11,9% 13,6% 17,1% 19,8% Source: Kanavos P, Costa-i-Font J, 2005, Pharmaceutical parallel trade in Europe: stakeholder and competition effects, Economic Policy, 20 (44), * Data for Greece relates to pharmaceutical exports After a slow-down in 2003, parallel trade has continued to grow in the EU. In 2006, particularly Germany, the UK and the Netherlands, followed by Denmark, Norway, and lastly Sweden account for the highest proportion of parallel imports in the EU pharmaceutical market. 73 See the figure below for an overview of the estimated market value (in $ million) of parallel trade in the 6 key EU Member State Markets in 2001 and Figure 2.7 Estimated parallel trade market value in 6 key EEC markets (2001 and 2006) Source: The Global Parallel Trade Outlook : A Country-by-Country Analysis, Business Insights 73 Arfwedson J, 2003, Paralell trade in Pharmaceuticals, Centre for the New Europe. regulation 41

42 The most marked changes in the parallel import market penetration rate are observed in Germany and Sweden. In Germany, the percentage of parallel import penetration in the market fell from17.62% in 2003 to 11.22% in Conversely, Sweden demonstrated an increase in the parallel trade retail market share, growing from 8.40% in 2003 to 26.66% in Slight increases were also observed in Denmark and the UK while a slight decrease was present in the Netherlands. 74 According to IMS, at the end of 2007 Austria and Belgium have also become important parallel import markets. In 2005 the Pharmaceutical Market Access and Drug Safety Act has made it possible for parallel trade of medicines to be allowed between the US and a selected group of countries namely Australia, Canada, the EU (excluding those countries that have joined the EU since 2004), Japan, New Zealand, and Switzerland. 75 Although compared with the total volume of the US drug prescription market the proportions of parallel traded drugs is still small, being 0,39 % of the market in 2003 there has been a rapid increase in parallel trade of medicine between the United States and Canada since Recently, the supplier market has shifted towards Italy, France and even Germany. The New Member States cannot be added to this list due to export restrictions, low market volumes, and limited price differentials Kanavos P, Kowal S, Does pharmaceutical parallel trade serve the objectives of cost control in Eurohealth 2008 volume 14 number 2 Pharmaceutical policy: cost containment and its impact. Hollis A, Ibbott P, 2006, How parallel trade affects drug policies and prices in Canada and the United States, University of Calgary. 42 regulation

43 3 Existing market failures in the EU pharmaceutical market The previous chapter offered a brief description of the main market characteristics of the EU pharmaceutical market. From this it already becomes apparent that the pharmaceutical market does not meet all the criteria of a perfect market. For example, the complexity of the supply chain (involvement of insurance companies and physicians), the high R&D costs and the relevance of the pharmaceutical market for public health leads to various distortions. This chapter continues with a description of the most important market failures that are in their combination unique for the pharmaceutical industry. 76. These market failures are related to the public interest approach which presents a number of potential grounds (the market failures ) for regulation. The presence of market failure may require some form of intervention, either by the government or by means of self-regulation, for it is perceived that the market itself fails to deal with these problems, preventing an economically efficient outcome in the market. The public interest approach to regulation assumes that regulatory intervention is always directed towards gaining an improvement in social welfare. 77 The chosen government action in order to overcome these market failures will be discussed in chapter Tension between the pursuit of profit and improving public health First, the pharmaceutical market does not only serve an individual (the patient) goal, but also the public goal (e.g. increasing public health). Pharmaceuticals contribute to the provision of public goods such as public health and well-being. Therefore, positive externalities are related to the consumption of pharmaceuticals, for example in case of infectious diseases, equitable access to medicines and the information which is gathered by pharmaceutical companies in their R&D process. 78 Public goods have two special characteristics that distinguish them from private goods: non-rivalling consumption and non-exclusion. 79 If a product is a public good, the market sometimes does not or not sufficiently generate the product. Moreover, people will generally not be willing to pay for a public Sloan FA, Hsieh C-R (ed), 2007, Pharmaceutical innovation: Incentives, Competition, and Cost-Benefit Analysis in International Perspective, Cambridge University Press. Philipsen N, 2003, Regulation of and by pharmacists in the Netherlands and Belgium- an economic approach, pp. 9-45; ECORYS, 2007, Study of regulatory restrictions in the field of pharmacists. Kolassa EM, 1997, Elements of pharmaceutical pricing, The Haworth Press Inc., USA. For a brief discussion of public goods and free-riding behaviour, see, e.g., Cooter and Ulen (2004), pp , Ogus (1994), pp , and Varian (1984), pp regulation 43

44 good if they can free ride on the payment by others. According to economic theory the public good problem can be solved by production by the government or providing subsidies to public good providers. A potential conflict exists between the pursuit of profit by for-profit pharmaceutical companies and the pursuit of public health. In some cases, it may be the fact that the market does not or not sufficiently generate a certain pharmaceutical product despite its high public health advantages (for example, lack of focus on preventive medicines e.g. vaccinations 80 and medicines for the treatment of tropical diseases 81 ). In addition, a typical feature of public goods is that in the case of public goods the danger exists of free riding on the payment by others. As soon as a pharmaceutical product is launched, the product components can be traced by the competitors, and they can free-ride on the creativity and large investments of the originator company. As a result, pharmaceutical companies are less inclined to invest in R&D or they unevenly invest their R&D in disease groups benefiting profit but not (global) public health objectives Information asymmetry and imperfect agents Market failures related to information problems are also relevant in the context of the pharmaceutical industry. Markets for pharmaceutical products can be characterised by information imbalance (asymmetry) between professionals and clients on various levels, e.g. between (pharmaceutical) producers and physicians, patients and producers, patients and physicians, but also the producers and the government (reimbursers) The reimburser (the principal) cannot observe or verify the level of effort put into R&D by the company (agent). R&D is intrinsically uncertain so the outcomes are stochastic and may be reached with luck. Therefore, effort in R&D is probably related to outcome on average. This asymmetry is related to defining the appropriate level of producers surplus to be retained by the company. This surplus should give a proper incentive to engage in efficient levels of R&D, as well as trying to ensure that consumers surplus is maximised once a product is brought to market. Further, informational imbalance between the prescriber/dispenser and the patient allows the prescriber/dispenser to give misleading advice in order to increase profits. Lack of knowledge about a particular product on the part of the prescriber may be reflected in irrational prescription patterns. Some manufacturers may manipulate this lack of information by providing distorting information so as to enhance their own sales and profitability A specific example shows the full extent of the bias: Gardasil, Merck s breakthrough vaccine for cervical cancer sells for just $360 in the US, compared with an average annual wholesale price of $22,875 for Rebif and $28,400 for Tysabri, two products that modify the systems of multiple sclerosis but cannot cure or prevent it. Source: PWC, 2007, Pharma 2020: The vision, Which path will you take?, retrieved rom: Sloan FA, Hsieh C-R (ed), 2007, Pharmaceutical innovation: Incentives, Competition, and Cost-Benefit Analysis in International Perspective, Cambridge University Press. Sloan FA, Hsieh C-R (ed), 2007, Pharmaceutical innovation: Incentives, Competition, and Cost-Benefit Analysis in International Perspective, Cambridge University Press. Bennett S, Quick JD, Velasquez G, 1997, Public-private roles in the pharmaceutical sector implications for equitable access and rational drug use, WHO. 44 regulation

45 The main reason for the existence of this information asymmetry is the fact that (especially ex-ante) evaluation of the quality of the product itself may be extremely difficult for the users. Patients do not have sufficient knowledge to determine what medicine will improve their health. Further, learning by repeat buying and reputation may have only limited impact. By definition, the notion that a prescription is required before a drug can be purchased means that physicians act as front-line professional agents, making consumption decisions on behalf of patients. The underlying rationale for requiring prescriptions is that patients possess insufficient information to know when specific drugs are appropriate for treatment. Conceptually and ideally, physicians would be perfect agents for their patients, prescribing in a way that patients would if they were fully informed about treatment appropriateness. Physician prescribing may however be unduly influenced by pharmaceutical advertising. The existence of imperfect agents creates a potential conflict between pursuing health and pursuing profit: patients care about their health, but physicians may care about their financial well-being as well as their patients physical and mental well-being Moral hazard due to the existence of an insurance system A third market failure is the fact that although insurance coverage for pharmaceutical products provides a social benefit in terms of risk protection, it also imposes a moral hazard. 85 In the case of complete insurance coverage, pharmaceutical expenditure may rise to levels far higher than the optimum level (marginal social benefit equals marginal social costs). The potential effect of health insurance on the demand for health care has been studies extensively, for the first time by Arrow in He observed that, besides the cost of the illness, the cost of medical care also depended on the choices of a doctor and the willingness to use medical services. Widespread medical insurance increased the demand for medical care, according to Arrow. Barros (2008) provides an overview of the existing literature pertaining to moral hazard and the demand for health services since He states that most of the empirical literature has shown evidence of moral hazard in the health care market, but that the literature also shows that the level of moral hazard differs across health services. Some examples are: Chiappori et al (1998) tested the relation between a (change in the) copayment and the number of GP-visits. They conclude that the change in relative price did not the influence the participation rate in GP office visits or specialist s visits, but did influence the participation rate in GP home visits. This suggests that there is moral hazard in demand for some physician services, but also that Sloan FA, Hsieh C-R (ed), 2007, Pharmaceutical innovation: Incentives, Competition, and Cost-Benefit Analysis in International Perspective, Cambridge University Press. Moral hazard is the phenomena that the behaviour of people changes, when they are not fully exposed to a certain risk or do not have to pay the full costs (e.g. in case of an insurance or reimbursement of medicines). Arrow KJ, 1963, Uncertainty and the welfare economics of medical care, in: American Economic Review, volume 53-5 (1963), p regulation 45

46 when non-monetary costs are important, small changes in monetary price may not induce any major change in behaviour ; 87 ; Vera-Hernández (1999) investigated, inter alia, the implications of duplicate coverage (a compulsory medical public insurance and a purchased private one) on demand for visits to specialists (in Catalonia). She concludes that variables related to health status (acute illness disabilities, chronic illnesses,...) have an important impact in determining the number of visits to doctors, but not the insurance choice. Income and education are important in determining both demand for visits and the insurance decision choice. There is no evidence for moral hazard for heads-of-households, but exists for other house-members. 88 ; Savage and Wright (2003) investigated moral hazard in Australian private hospitals. They observed that income units purchase private hospital insurance when they expected to be heavy users of private hospital services (adverse selection). With regard to moral hazard they found substantial effects: for income units consisting of a couple with dependents, insurance increased the expected length of stay by a factor of nearly 2, while for old couples this factor was over Barros states that, despites the fact that insurance companies and governments use price incentives in order to control health-care spending, the (health) economic literature has not yet produced irrefutable evidence on the magnitude of the effect between price and demand for health care. In addition, widespread insurance coverage coupled with demographic changes like the ageing of the population may induce firms to invest more in research and development for certain types of medicines than they otherwise would, and the resulting innovation may itself be a source of increased demand. In such a dynamic context, as a consequence of pharmaceutical innovation, many new drugs are introduced into the market each year, and individuals often opt for the newest drugs, especially when they have insurance coverage. The new drugs tend to be more expensive on average, leading to increased pharmaceutical expenditures. 90 Hollis (2007) states that the choice between R&D investment strategies depend partly on the market size, which reflects both the population with a particular disease and income levels in country (especially among persons with a disease). 91 Trouiller et al (2002) examined the drug development for neglected diseases. Poor people in the developing world often lack good and affordable medicines to control infectious diseases that cause high mortality and morbidity. The study analysed outcomes of pharmaceutical R&D over a period of 25 years and current public and private initiatives aimed at correcting the imbalance in R&D that leaves diseases that occur predominantly in the developing world largely unaddressed. It appears that for the period out of 1393 new chemical entities (NCE) only 16 were for tropical diseases and tuberculosis. There is a 13-fold greater chance of a drug being brought to market for central-nervous-system disorders or cancer than for a neglected disease, Chiappori, PA., et al, 1998, Moral hazard and the demand for physician services: first lessons from a French natural experiment, European Economic Review, volume 42 (1998), p Vera-Hernández M, 1999, Duplicate coverage and demand for health care; the case of Catalonia, Health Economics, volume 8 (1999), p Savage, E, Wright, DJ, 2003, Moral hazard and adverse selection in Australian private hospitals: , Journal of health Economics, volume 22 (2003), p Sloan FA, Hsieh C-R (ed), 2007, Pharmaceutical innovation: Incentives, Competition, and Cost-Benefit Analysis in International Perspective, Cambridge University Press. Hollis A, 2007, Drugs for neglected diseases: new incentives for innovation, in: Sloan FA, Hsieh C-R (ed), 2007, Pharmaceutical innovation: Incentives, Competition, and Cost-Benefit Analysis in International Perspective, Cambridge University Press. 46 regulation

47 according to Trouiller. The main argument for the industry for this imbalance is the fact that R&D is too costly and risky to invest in low-return neglected diseases Competitive features of pharmaceutical markets The existence of market power can be a fourth market failure, which often results in a lack of competition. This has been studied in great detail in the Sector Inquiry by DG Competition. The (welfare) economic theory indicates that there should be many small and identical enterprises on the market (with homogenous product) in order to prevent that market players can have a significant influence on the price level. 93 Competition law defines market power as the ability for an enterprise to behave on the market independently from its competitors and clients. The European Court of Justice (standard cases: United Brands and Hoffmann-La Roche) defined market power as a position of economic strength enjoyed by an undertaking which enables it to prevent effective competition being maintained on the relevant market by giving it the power to behave to an appreciable extent independently from its competitors, customers and, ultimately, consumers. The existence of market power can not be determined very easily, but should be based on a variety of factors, like the concentration ratio, (potential) market entry/ entry barriers, profit margins and vertical and horizontal integration. Market concentration The pharmaceutical sector suffers substantial problems related to the failure of competition, which is inter alia linked to the existence of barriers to entry. This has resulted in a high (but not too high) 94 concentration ratio in the pharmaceutical market. However, the sector is characterised by the dominance of a relatively small group of big pharmaceutical companies which represents a significant part of the annual (European) turnover. More detailed information is provided in section 2.4. In general, several barriers can be identified, like natural, legal and strategic entry barriers. We elaborate on this below. Natural and legal entry barriers Natural barriers result from down sloping average cost curves that characterise economies of scale. Down sloping average cost curves result form sunk costs of investments and reputation effects which are seen, for example, in manufacturing, R&D, and advertisement Trouiller P, et al, 2002, Drug development for neglected diseases: a deficient market and a public-health policy, The Lancet, Volume 359 (2002), p Philipsen N, 2003, Regulation of and by pharmacists in the Netherlands and Belgium- an economic approach, pp. 9-45; ECORYS, 2007, Study of regulatory restrictions in the field of pharmacists. As is also indicated by the sector inquiry; see: European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report, consideration 69 ( there are a significant number of players in the market, from the ten blockbuster medicines belong to six different therapeutic classes and originate from ten different companies ) and consideration regulation 47

48 Legal barriers may result from different forms of regulation such as patents and market authorisation (and related to that, the approval costs). Strategic barriers Strategic barriers relate to the behaviour of other (sometimes dominant) parties which currently have a position on the market. Established pharmaceutical producers may create various hurdles. These include, but are not limited to, brand loyalty, market segmentation (especially by therapeutic subclass), cross-subsidization and vertical foreclosure. 95 Also advertisement and marketing may be used to create artificial entry barriers. It should be noted that natural and legal barriers, which may lead to a too high concentration level, are related to the (almost fundamental) main characteristics of the pharmaceutical market, while strategic behaviour is related to active behaviour of market players. Anti-competitive barriers Certain strategic behaviour by firms can be determined as anti-competitive and is therefore forbidden. The legal framework is formed by the European rules (and their national equivalents) on competition in the EC-Treaty, especially article 81 (agreements affecting competition) and article 82 (abuse dominant position). Obvious anti-competitive behaviour is strictly forbidden, like (implicit) price collusion, particular resale price maintenance (like resale price fixing and minimum resale price) and vertical clauses restricting geographical competition. Other type of behaviour may, under certain conditions, also be anti-competitive, like vertical foreclosure, (predatory) pricing, vertical tying, dumping, exclusive dealing and cross-subsidization. Research on this type of behaviour falls outside the scope of this study. The sector inquiry (2009) observed that especially patents play a key role in the sector. They make it on the one hand possible for companies to recoup their investments and make a return on their efforts. On the other hand pharmaceutical companies apply patent strategies which might block the development of a competing product. 96 Further, the sector inquiry identified strategic (and possibly anti-competitive) behaviour which might result in market access delay for generic products, like patent-clusters. 97 One of the findings of the sector inquiry is that generic entry does not always take place as early as it potentially could. An important (natural) barrier for entry are the high initial investment costs (particularly in relation to R&D), which mean that average production costs reduce only when a large quantity of a drug is produced. Research and development for prescription drugs is a lengthy and costly process. Although there is no consensus about how to calculate the cost for research and development in the pharmaceutical market and on the actual size of the cost, there is a consensus that the mean R&D cost associated with introducing a new prescription drug is in the range of hundreds of millions of dollars (see also section 2.3) Bennett S, Quick JD, Velasquez G, 1997, Public-private roles in the pharmaceutical sector implications for equitable access and rational drug use, WHO. European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report, consideration European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report, consideration 1582; Filing of a great number of patents for a single medicine in order to protect a patent; this might result a time-consuming juridical conflict with generic companies and at the end generic delay. 48 regulation

49 Furthermore there are substantial costs due to government regulation in relation to the registration (approval) of new products and pricing and reimbursement. If pharmaceutical manufacturers were to sell drugs at the marginal cost of production and distribution, they would have no way to recoup the cost of R&D and thus no incentive to develop new innovative drugs that will benefit public health Sloan FA, Hsieh C-R (ed), 2007, Pharmaceutical innovation: Incentives, Competition, and Cost-Benefit Analysis in International Perspective, Cambridge University Press. regulation 49

50 4 Existing government actions to overcome market failure Introduction As a result of the market failures described in the previous chapter, national governments interfere in the pharmaceutical market. Table 4.1links the described market failures with the government interventions, which we will describe in more detail in this chapter. Table 4.1 Overview table linking market failures with the existing regulatory framework Market failure 1. Tension between pursuit of profit and improving public health (public good characteristics) Existing government actions Patent protection (in EU 20 years) Remarks Patent protection creates temporary exclusivity right. Monopoly rents function as a reward for (risky) investments and innovation. Free-riding on investments by others is restricted. No Community patent exists; patents can be filled at national patent offices or at the EPO. In the latter case, national validation in each country is still necessary. Used criteria are based on the European Patent Convention. 2. Information asymmetry and imperfect agents Marketing authorisation Information asymmetry exists, e.g. on function & quality medicines. Before authorization the pharmaceutical products are tested extensively now, reducing the level of information asymmetry. Authorisations can be granted at Community and national level. National authorisations can be extended to other countries through a mutual recognition procedure (MRP) Directive 2001/83/EC and Regulation 726/2004 form the backbone of authorisation framework, supported by other legislation. 50 regulation

51 Market failure 3. Moral hazard due to the existence of an insurance system 4. Competitive features Existing government actions Pricing & reimbursement policies, like: Price regulation Control spending Industry regulation Product reimbursement Influencing consumption Remarks Health expenditures may rise to sub-optimal levels due to insurance system. Tools exist to influence consumption, e.g. costsharing (co-payment, co-insurance). Member States have competency to determine price and reimbursement levels on individual (national/regional) basis, given the requirements in the Transparency Directive. Patents create temporary monopolies (market power). Need to limit effect market power and/or prevent abuse dominant position. Regulatory measures exist in order to restrict the price, industrial profits, the number of prescribed medicines, etc. Member States have competency to determine price and reimbursement levels on individual (national/regional) basis, given the requirements in the Transparency Directive. Source: ECORYS, 2009 This chapter offers an overview of the rationale of the main tools used, the regulatory framework of each tool and differences in national regimes within the EU. Within the scope of this study, the regulatory framework covers only patents, marketing authorization and pricing and reimbursement policies. 99 This limited definition leaves out other legislation, for example legislation regarding medical products for veterinary use, guidelines for clinical trials, etc. 100 It should be noted that in December 2008, the Commission adopted the Pharmaceutical Package, including a communication and three legislative proposals. The latter are aimed at (i) ensuring access to reliable information on medicines, (ii) strengthening the EU system for the safety monitoring of medicines (pharmacovigilance) and (iii) strengthening EU legislation to better protect EU citizens from the serious threats posed by fake medicines Revisions to this legislation can be expected, see: The chosen scope for the regulatory framework follows the structure used in European Commission, DG Competition s Pharmaceutical Sector Inquiry A more elaborate overview of the legislation applicable to the pharmaceutical industry can be found on the European Commission, DG Enterprise & Industry website, see: < >. A more detailed overview is provided on the European Commission, DG Enterprise & Industry website: regulation 51

52 4.1 The use of patents Rationale of patents The existence of the patent system in the pharmaceutical industry is linked to the reward theory of patent protection and is presented in the classic work of Nordhaus (1969). The argument is that by generating potential monopoly power and thus patent monopoly rents- exclusivity provides remuneration for successful innovators. If the cost to generating an innovation (which is particularly high in the pharmaceutical sector, see before) is privately borne, then the anticipation of such private compensation is a necessary reward to induce innovation in a market setting with profit-maximising agents. If exclusive rights were not available to the innovator, and if the underlying knowledge is a pure public good, any party could use this information to duplicate the invention and compete with the originator company to provide it to purchasers. This kind of competition could reduce the rewards to innovation to the point where it would not be worthwhile to conduct the activity in the first place which endangers the access to new medicines for patients Patent regulation Since the nineteen-seventies, initiatives have been taken to create a kind of Community patent, which is valid in all Member States. This is not yet the case. 103 Currently, an inventor can obtain a patent either by filing a national application at each respective national patent office of the Member States or by filing a single patent application at the European Patent Office (EPO). In the latter case, which is used by the majority of pharmaceutical companies, a national validation of the European patent (granted by the EPO in each Member State where the patent owner wishes the patent to exist and to be enforceable) is still necessary. 104 In Europe, patent protection may be obtained for up to 20 years, starting from the moment the patent application is filed at the patent office of the territory concerned. 105 However this patent protection does not mean that also the product information cannot be used for over 20 years. The information protected by the patent will be publicly available and others can, given certain limitation Harhoff D, 2009, Economic Cost-Benefit Analysis of a Unified and Integrated European Patent Litigation System, final report, tender No. MARKT/2008/06/D, Ludwig-Maximilians- Universität (LMU) München, Institute for Innovation Research, Technology Management and Entrepreneurship (INNO-tec), Retrieved: Unified%20Patent%20Court%20economix%20analysis%20-% doc#_Toc For more details regarding these initiatives, see: European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report, p European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. The criteria EPO uses for granting a patent are based on the European Patent Convention (EPC) of 1973 and later amendments to the EPC. Article 52 (1) EPC 2000 determines that European patents shall be granted for any inventions, provided that they are (i) new, (ii) involve an inventive step and (iii) are susceptible of industrial application. 104 The EPO examines the request for the patent and decides whether to grant or to reject the patent. If the patent request is rejected appeal is possible, if the patent is granted third parties can start an opposition proceeding. European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. The Sector Inquiry refers to the fact that this period of 20 years reflects the assessment by the legislator that the end of this period is the point in time where the cost to society of continued patent protection (lack of competition, prices above the marginal costs, extra profits to the patent holder), starts exceeding the benefits (research, investments, etc). 52 regulation

53 by the patent right, use this information for improvements and further research. Further, in order to protect the originator companies during the period between the filing of a patent application and the authorisation for market launch, the European Commission (Council regulation 1768/92) created a supplementary protection certificate (SPC) for medicinal products. It was determined that the holder of both a patent and a certificate should be able to enjoy an overall maximum of 15 years of exclusivity from the time the medicinal product in question first obtains authorization to be placed on the market in the Community. The fact that the exclusivity right is only temporary and that the information will be publicly available gives the patent holder incentives to invest and innovate further. 4.2 The use of marketing authorisations Rationale of marketing authorisations The market for pharmaceutical products (like many other markets) can be characterised by information asymmetry on various levels between professionals and clients. The information asymmetry (for example regarding the quality and function of the product) may lead to irrational prescription patterns (the prescriber may have lack of knowledge) and misleading advice and information (this may be in the interest of the manufacturers). The difficulty to determine the quality of a product is the main reason for the existence of the information asymmetry. This was described in more detail in paragraph 3.2. To solve this information asymmetry and increase and protect public health, producers of pharmaceutical products are only allowed to enter the market after market authorisation. Before the market authorisation is granted all pharmaceutical products are tested extensively in order to check the quality, safety and efficacy of medicinal products. This procedure reduces to some extent the information asymmetry (claims by manufacturers are checked, the medical effects are tested, etc.). It should be noted that marketing authorisation is not specific to the pharmaceutical market. Also in the food and feed sector marketing authorisation is necessary requirement Regulation governing market authorisations Some fundamental changes were made regarding the regulatory framework after the adoption of the Review Package in Pertaining to medical products for human use, two main legal documents form the backbone of the authorisation framework, namely Directive 2001/83/EC (as amended) and Regulation 726/2004 (as amended) For more information, see for example: EFSA, European Food Safety Authority, European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. These two documents are: (i) Directive 2001/83/EC on the Community Code relating to medical products for human use and (ii) Regulation (EC) No 726/2004 laying down Community procedures for the authorisation and supervision of medicinal regulation 53

54 Authorisations at Community level Article 3 of Regulation 726/2004 (as amended) determines that no medicinal product which appears in the Annex of the Regulation may be placed on the market within the Community unless a marketing authorisation has been granted by the Community. This means that a Community authorisation is compulsory for medicinal products developed by means of certain biotechnological processes, advanced therapy medicinal products, medical products containing a new active substance for which the therapeutic indication is the treatment of specific diseases, and orphan medicinal products. For medicinal products not appearing in the Annex the Community authorisation is optional. The European Medicine Agency (EMEA) is responsible for the examination of the applications and for the granting of the authorisations at Community level. In principle a marketing authorisation is valid for five years throughout the Community and can be renewed (article 13 and 14 of the Regulation). Authorisations at national level Directive 2001/83/EC (as amended) determines that no medicinal product may be placed on the market of a EU Member State unless a marketing authorisation has been issued by the competent national authorities or unless a Community authorisation has been granted (article 6). 109 A granted national authorisation can be extended to other EU Member States by using a mutual recognition procedure (MRP), this is: other Member States will recognize the (national) marketing authorisation granted by the Reference Member State (RMS). Recognition is realised through approving the assessment report, the summary of product characteristics and the labelling and package leaflet (by the EU Member States). Moreover, in case where no national marketing authorisation has yet been granted, the decentralised procedure (DCP) allows for the submission of an application in several Member States at the same time and for the choice of one Member State to act as Reference Member State. 110 The applicant shall request the RMS to prepare the documents (assessment report, the summary of product characteristics and the labelling and package leaflet) and the other Member States have to approve these (decentralised procedure) products for human and veterinary use and establishing a European Medicines Agency. See also: European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report, p Of course, this backbone is underpinned with other regulations. A more elaborate overview of the applicable legislation can be found on the European Commission, DG Enterprise & Industry website, see: >. The marketing authorisation shall be refused if (i) the risk-benefit balance 109 is not considered to be favourable, (ii) its therapeutic efficacy is insufficiently substantiated by the applicant, or (iii) its qualitative and quantitative composition is not as declared (article 26). European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report; see also article in Directive 2001/83/EC of the European Parliament and of the Council of 6 November 2001 on the community code relating to medicinal products for human use, official journal L 311, 28/11/2004, p regulation

55 Data and marketing protection Related to the marketing authorization are the data and marketing protection of originator products. The main rules are laid down in article 10 Directive 2001/83/EC (as amended) and article 14 Regulation 726/2004 (as amended). These rules can be summarized as follows: 111 For a generic product of a reference medicinal product, an abridged application is possible after eight years from the initial marketing authorisation (data exclusivity period) ; The original MA holder benefits from a ten-year period of marketing exclusivity for the reference medicinal product. This means that a generic product authorised on the basis of an abridged application cannot be placed on the market until ten years have elapsed from the date of the MA for the reference product. 112 Transitional provisions exist for marketing authorisation applications submitted before 20 November This report did not investigate the impact of MA in detail as this is in the realm of ongoing evaluation of EMEA. 4.3 Use of pricing and reimbursement policy Rationale of pricing and reimbursement The patent regime gives originator companies a temporary monopoly in order to have the possibility to commercialise their invention and realise a sufficient profit margin. However, these patents also create a situation of market power: companies might abuse their dominant position and set excessively high prices, which (according to economic literature) harms the level of social welfare. Price regulation and reimbursement schemes should limit this market power to a level acceptable for society Regulation governing pricing & reimbursement Council Directive 89/105/EEC, commonly referred to as the Transparency Directive, is the main legal instrument in the area of pharmaceutical pricing and reimbursement in the European Union. 114 The Transparency Directive does not affect national policies on price setting and on the determination of social security schemes, but it does require any national measure to control the prices of medicinal products for human use or to restrict European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report, p The Sector Inquiry continues: When the ten-year period of marketing exclusivity has elapsed, the generic product can be launched on the market, provided that no new therapeutic indication with a significant clinical benefit has been approved for the reference product during the first eight years following the MA. If there is such an approval, the reference product obtains a non-cumulative period of one year of additional marketing exclusivity. Council Directive 89/105/EEC of 21 December 1988 relating to the transparency of measures regulating the prices of medicinal products for human use and their inclusion in the scope of national health insurance systems; European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report, nr Council Directive 89/105/EEC of 21 December 1988 relating to the transparency of measures regulating the prices of medicinal products for human use and their inclusion in the scope of national health insurance systems. regulation 55

56 the range of medicinal products covered by their national health insurance systems to comply with the framework laid down in the Directive. The Directive aims to ensure the transparency of the procedures established by Member States to control the prices and reimbursements of medicinal products. It guarantees public access to information on pricing, profit control and reimbursement, in particular for participants in the medicinal product market. The Directive spells out four main types of requirements with respect to pricing and reimbursement: Decisions must be adopted within a limited timeframe; Decisions must be based on objective and verifiable criteria; Decisions must be notified to the applicant and the rationale behind them must be published; Adequate judicial procedures must be in place to appeal the decisions 115. Member States have the competency to determine the prices and reimbursement levels for medicines on an individual (national or regional) basis. As a result, pricing and reimbursement policies vary significantly within the EU. In practice, national pricing and reimbursement regulation mainly focuses on the price level ex-factory 116, the reimbursement level 117 and restrictions on stakeholders (doctors, pharmacists, patients 118 ). 119 Three types of practices can be identified which affect pricing decisions: (i) supply side practices (focus on pricing and reimbursement levels), (ii) demand side practices (use of medicine), and (iii) mixed policies (supply and demand side practices). 120 These will be discussed below. Supply side practices The following table summarizes the variety in supply side measures. The initial price regulation tool focuses on the price setting of the pharmaceutical products when the product is marketed, while after the initial pricing decision, pharmaceutical companies and the authorities negotiate additional conditions (control of expenditures and specific industry regulation). Product reimbursement restricts the number of (prescribed) medicines at the expense of the national social health insurance or national health service or limits the maximum reimbursement price European Commission, Enterprise and Industry, Transparency Directive. Retrieved 2009: The price ex-factory determines the main cost factor for the medicine. To arrive at the retail price level, the margins for the wholesalers and pharmacists as well as the VAT are added. The reimbursement level, expressed as a percentage of the retail price. This will determine how much of the retail price is paid by public funds. The remaining part, also referred to as co-payment, is paid by the patient or his private supplementary insurance. Stakeholders such as doctors or pharmacists will determine how often and under what conditions a medicine can be prescribed, dispensed and used. European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. 56 regulation

57 Table 4.2 Summarizing the supply side measures I. Supply side measures Description I-A Product price regulation Free pricing Specific assessments, like (i) economic evaluation, (ii) cost comparison of similar/ existing treatment, (iii) assessment of clinical performance Cross-border price comparisons Cost plus calculation Controlled price updates I-B Control of expenditures Discounts/ rebates Price freezes/ cuts Payback Price-volume agreements Free price setting of the pharmaceutical products when the product is marketed. Economic evaluations compare the new treatment with existing therapies, based on cost-effectiveness analysis (comparison cost-per-unit in order to identify the most efficient one) and other forms of economic evaluation. Cost comparison focuses on the cost of similar treatments for the same indication (internal price referencing). It compares prices of pharmaceuticals in one country with the price of identical pharmaceuticals (ATC 5 level) or similar products (ATC 4 level) or even with therapeutically equivalent treatment (not necessarily a pharmaceutical) in another country. Cross-border price comparison (or external/cross-country price referencing) takes into account the proposed wholesale price in comparison to the prices of the same product in other countries. Most of the Member States use a particular selection of other countries to compare with, varying from three to 14 reference countries. Five Member States (AT, BE, GR, LV and PL) compare the price to the average EU-price (EU as one country). The price is determined on the basis of the production costs, other costs (like promotional expenses) and a certain profit margin for fixation of the price. Allowed controlled price updates of already launched pharmaceutical products. Discounts refer to mandatory or negotiated reductions in the medicines final price for certain institutional payers, while rebates are returns of a specified proportion of the sales made by a manufacturer to an institutional purchaser over a given time period. The national authorities might also use price freezes in order to regulate the price after the launch of the product and influence the expenditures. In general, the price of a pharmaceutical is fixed at a given level, mostly for a predetermined period of time. Price freezes are sometimes based on agreements between the pharmaceutical industry and authorities, but in most cases it is done by law. Payback is a risk-sharing mechanism that requires manufacturers (either individually or collectively, e.g. via their industry association) to return a certain part of their excess revenue to a purchaser if sales exceed a previously determined target. A price-volume agreement refers to a contract between public authorities and a manufacturer regarding the price of a pharmaceutical based on a forecast of its sales volume. If the actual sales volume exceeds the forecast, the price of the pharmaceutical is usually revised downwards. I-C Industry regulation Profit control Tax benefits I-D Product reimbursement Positive list Negative list Agreements between the companies and the authorities in which companies refund (part of) the profit earned above a pre-agreed limit Investments in R&D or in manufacturing capacity List of pharmaceuticals that may be prescribed more or less without further conditions at the expense of the national social health insurance or national health service (positive list). A negative list determines the non-reimbursable regulation 57

58 I. Supply side measures Description medicines. Reference price system Based on economic evaluation Not all medicines products can be fully reimbursed. A reference price system, determines a maximum price for reimbursement. When an insured person purchases a pharmaceutical product for which a fixed price has been established (the reimbursement price), he or she must pay the difference between the fixed price and the actual pharmacy retail price of the product in question. The reimbursement decision can be supported by economic evaluations. Sources: (i) Andalusian School of Public Health, 2007, Analysis of differences and commonalities in pricing and reimbursement systems in Europe; (ii) European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report Table 4.3 shows that EU Member States use a wide variety of supply side measures. Differences in (initial) price regulation are seen as very important distinctions between the EU Member States. 121 Table 4.3 Overview use of supply side measures I. Supply side measures BE DE ES FR HU IT PL SE UK EU-24 I-A Product price regulation Free pricing x x x 5 Assessment of clinical performance x x x x x 11 Economic evaluation x x x 11 Cost comparison existing treatment x x x x x 11 Cross-border price comparisons x x x x x 17 Cost plus calculation x 2 Controlled price updates x x x x 12 I-B Control of expenditures Discounts/ rebates x x x x x 9 Price freezes/ cuts x x x x x 11 Payback x x x x x 7 Price-volume agreements x x x 7 I-C Industry regulation Profit control x x 4 Tax benefits x x x x 6 I-D Product reimbursement Positive list x x x x x x x 20 Negative list x x x x 4 Reference price system x x x x x x 16 Based on economic evaluation x x x x x 18 Source: Andalusian School of Public Health, 2007, Analysis of differences and commonalities in pricing and reimbursement systems in Europe; Note: situation in 2006; the study covers only 24 Member States. 121 The target of price regulation differs per country. Some have focused their price regulation on reimbursable pharmaceuticals (AT, FI, FR, IE, IT, LV, LT, PL, SL and ES), while others include all products (BE, CY, HU, GR, SK) or all products excluding OTC (PT, RO). 58 regulation

59 In 2006, only Denmark (DK), Germany (DE), Malta (MT), Sweden (SE) and the UK used a system of free product price setting by pharmaceutical companies); while also had some form of free pricing. 122 These EU Member States use the free price setting in combination with other tools. In the UK for example free price setting is combined with price freezes, payback and profit control, and while in Germany negotiations are made about the discount and rebate factor. In Denmark pharmaceutical companies are free to set their prices, but reimbursement may be denied if the price is found to be too high in comparison to other pharmaceuticals or alternative treatments for the same disease. In most EU Member States however there is a separate pricing decision. A lot of EU Member States focus on the value added of medicine compared to the price asked for by the producer. They use specific assessments, like clinical performance assessments, economic evaluations and cost comparison to existing treatments, in order to determine this value added and the price. 123 Often, the requested price is compared to the prices of the same medicine in a selection of other countries (cross-border referencing). 124 Demand side practices Demand-side practices mainly focus on influencing the decisions of different types of actors, namely (i) physicians, (ii) pharmacists, and (iii) patients. Table 4.4 summarizes the main demand side tools Table 4.4 Summarizing the demand side measures II. Demand side measures II-A Influencing physicians Prescription guidelines Some countries developed prescription guidelines and inform doctors on efficient prescribing practices. Sometimes, countries make certain prescribing behaviour Education and information Monitoring of prescriptions mandatory, or establish strict criteria and conditions for more expensive products. Some Member States monitor (and sometimes reward) individual prescribing behaviour, sometimes in combination with prescription quota or a specific budget. Prescription quotas For example: doctors are asked to respect a budget or a prescribe quota or target percentage of cheaper medicines and can get a financial bonus if they respect Pharmaceutical budgets Financial incentives this budget, quota or target. Some Member States use (personal) financial incentives in order to stimulate well thought prescription behaviour. II-B Influencing pharmacists (Generic) substitution Some Member States explicitly lay down the right for pharmacies to substitute a medicine with a cheaper (i.e. often a generic) version with the same quality in their legislation, while make it mandatory for pharmacies. Financial incentives Traditionally, in a lot of Member States the pharmacists receive a pharmacy mark Andalusian School of Public Health, 2007, Analysis of differences and commonalities in pricing and reimbursement systems in Europe; European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report; in a country with free price setting, the medicines are often only reimbursed up to a certain amount or on condition that the price is considered acceptable. In 2006, 11 Member States used a form of clinical performance assessment as well as economic evaluation or cost comparison (not necessary the same countries; seven Member States use all three assessment types). Cross-border price comparison (or external/cross-country price referencing) takes into account the proposed wholesale price in comparison to the prices of the same product in other countries. Most of the Member States use a particular selection of other countries to compare with, varying from three to 14 reference countries. regulation 59

60 II. Demand side measures up, a fixed pharmacy margin or a bonus (discount). However, this system might provide undesirable financial incentives to sell higher-priced medicines. Therefore, some Member States align financial incentives for pharmacies to prescribe a cheaper generic version, like lump sum, capitation, dispensing fee, differential mark-ups, e.g. higher mark-up for generics or lower-priced products. Claw back II-C Influencing patients Information/ education Cost-sharing (e.g. copayment, co-insurance, deductible) This tool allows third party payers to recoup (part of the) discounts/rebates granted in a reimbursement system involving various stakeholders, e.g. wholesalers and pharmacists. In fact it refers to discounts of pharmacies dispensing fees (pharmacists payment of fees for the service of dispensing a pharmaceutical) that accrue to the third party payer (UK) or discounts on pharmacy purchase costs of drugs (The Netherlands). Member States have created several incentives for patients to become (more) cost-sensitive. These incentives focus on awareness rising information campaigns, and cost-sharing (e.g. co-payment, co-insurance). In the latter, individual patients have to cover (directly) at least a part of the costs for the health care they use, which gives an incentive to limit their use. There are several types of cost sharing and often Member States use a mixture of these tools. Sources: (i) Andalusian School of Public Health, 2007, Analysis of differences and commonalities in pricing and reimbursement systems in Europe; (ii) European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report These demand side measures are used in many EU Member States (see Table 4.5). EU Member States try to guide and influence the physicians who prescribe the medicine and who often have a choice between competing products. Also pharmacists have a significant impact on the cost of treating certain diseases when they are entitled to substitute a medicine with a cheaper (i.e. often a generic) version with the same quality. Table 4.5 Overview demand side measures II. Demand side measures BE DE ES FR HU IT PL SE UK EU-24 II-A Influencing physicians Prescription guidelines x x X x x x x x 19 Education and information x x X x x x x x 18 Monitoring of prescriptions x x X x x x x x 19 Prescription quotas x x X 4 Pharmaceutical budgets X x x 5 Financial incentives x x X x x 7 II-B Influencing pharmacists (Generic) substitution x X x x x x x 17 Financial incentives x x x 5 Claw back x x x x 6 II-C Influencing patients Information/ education x x X x x x x x 17 Cost-sharing* x x X x x x x x 20 Andalusian School of Public Health, 2007, Analysis of differences and commonalities in pricing and reimbursement systems in Europe; * E.g. co-payment, co-insurance, deductible 60 regulation

61 Mixed pricing & reimbursement measures EU Member States also use a mix of supply and demand practices, focusing on relatively low prices for medicines and relatively frequent use of lower-priced medicines. The Sector Inquiry of the European Commission (2009) indicates that the combination of demand- and supply-side practices is a concept often found in generic policies. These policies might for example focuses on the (fast) introduction of generic medicine in a market or increased use of available generic pharmaceuticals in order to limit total health expenditures. Often these policies are a mixture of tools, for example (i) encouraged or mandatory prescribing of (certain) generics by physicians, (ii) generic substitution by pharmacists, (iii) information and incentives for generic utilization to prescribers, pharmacists and consumers, (iv) selective financing of generics in positive lists, reference price systems, procurement by tendering, IPR policies, and (v) pricing policies: prices of generics might be free, under the assumption that price control is not necessary, as generics generate competition. 125 Promoting generic medicine Policies to encourage generic use can be divided into supply- and demand-side policies. Supply-side measures relate to market entry and penetration of generic medicines, prices and reimbursement prices and reimbursement product lists. Demand policies impact behaviour of prescribing physicians, dispending pharmacists and/or purchases of patients. The combination of both types of measures lead to the best result 126. Table 4.6 offers a short non-exclusive overview of available generic medicine policies. Several descriptions of these policy tools and their interrelationships with other policy tools are described in the subsequent text. Table 4.6 Overview policy tools to improve generic medicine use Type Supply-side Demand-side Policy tools Price cap Reference pricing (low, high, narrow, broad) Protection first generic entrant for a limited exclusivity period Free pricing of medicines Promoting generic prescribing (INN prescribing, budgets, non-financial incentives) Compulsory generic prescribing Generic substitution Flat or regressive margin for pharmacists Discounting allowed officially Claw back Patient co-payments (setting differentials per type of medicine) Information campaign Source: Kanavos P, Costa-Font J, Seeley E, 2008, Competition in off-patent drug markets: issues, regulation and evidence, LSE health; Simoens S, de Coster S, 2006, Sustaining generic medicines markets in Europe, Research centre for pharmaceutical care and pharmaco-economics Andalusian School of Public Health, 2007, Analysis of differences and commonalities in pricing and reimbursement systems in Europe. Kanavos P, Costa-Font J, Seeley E, 2008, Competition in off-patent drug markets: issues, regulation and evidence, LSE health; Simoens S, De Coster S, 2006, Sustaining generic medicines markets in Europe, Research Centre for Pharmaceutical Care and Pharmaco-economics, Katholieke Universiteit Leuven, Belgium regulation 61

62 A large number of countries have included reference pricing to contain public pharmaceutical expenditure. Reference pricing may aid generic market penetration because originator medicines priced above the level of the reference price are likely to lose market share as a result of an additional patient co-payment. However, this is only the case when originator companies do not lower their prices accordingly as they have done in France and Italy. It is mentioned that reference pricing is particularly successful in mature generic medicine markets with substantial price differences between medicines within a group 127 and a high level of medicine prices. 128 INN prescribing policies have been implemented in Denmark and the UK, where students are taught to prescribe by INN in medical schools; in the Netherlands where physicians are stimulated to engage in INN prescribing; and in Portugal where physicians are required to prescribe reimbursed medicines for which generic equivalents exist by INN. In Belgium and France, INN prescribing policies have not led to success and are thus limited, because physicians in these countries have a tradition to prescribe brand-name medicines and highly value their prescribing freedom. In addition, stimulating INN prescribing does not lead to any effect if it is not combined with INN dispensing regulation for the pharmacist and remunerations of pharmacists to favour generic medicines. In the Netherlands, pharmacists are encouraged to dispense medicines that are priced below the reference price by being able to retain a percentage of the difference between the medicine price and the reference price. In France, pharmacists are entitled to higher discounts (from pharmaceutical companies on generic medicines than on originator medicines. Not many countries are yet influencing patients to stimulate generic medicine consumption. A lower percentage co-payment on generic medicines appears to have stimulated the Portuguese generic medicine market. In Poland, the consciousness of the level of patient co-payments has stimulated physicians to prescribe generic medicines. Implementing co-payments do not always work, if for example they are covered by private insurance of patients such as in France Effect of price regulation on behaviour of pharmaceutical companies After describing the main government interventions in the pharmaceutical market, this section looks at the main effects of price regulation. Effect on first launch behaviour Pharmaceutical companies often aim to launch their products first in the largest EU Member States. Despite being larger pharmaceutical markets, the UK and Germany are also popular because these two countries allow pharmaceutical companies to freely set By therapeutic class, active substance or pharmacological class, different per country Simoens S, De Coster S, 2006, Sustaining generic medicines markets in Europe, Research Centre for Pharmaceutical Care and Pharmaco-economics, Katholieke Universiteit Leuven, Belgium Simoens S, De Coster S, 2006, Sustaining generic medicines markets in Europe, Research Centre for Pharmaceutical Care and Pharmaco-economics, Katholieke Universiteit Leuven, Belgium regulation

63 (higher) prices without prior price approval, influencing the price of their products upwards in markets with price control. 130 Germany is particularly interesting as a first launch country, because the free price setting usually results in a relatively high price, offering a relatively high point of reference for cross-border referencing. Empirical evidence shows that the use of price controls has a statistically and quantitatively important effect on the extent and timing of the launch of new drugs. Firms headquartered in countries that regulate price reach fewer markets than those in countries without price controls. Companies avoid price-controlled markets, and are less likely to introduce products in additional markets after entering a price-controlled country. The results suggest that price regulation in one country affects entry into other countries, and may affect the strategies of domestic firms. 131 Research indicates that price regulation (that it will dissuade market entry) appears to have more relevance among the high-income countries. For these countries the extensive price control is always found to lower the probability of market entry, and moderate regulation appears to do likewise, even in the long run. For poorer countries price regulation makes it less likely that new drugs will be available quickly, but it does not appear to prevent new products from being launched eventually. 132 The Sector Inquiry of the European Commission (2009) reports that France, Italy, the Netherlands and Sweden are also among the top first launch countries because pharmaceutical companies may submit in these countries a pricing and reimbursement dossier before the marketing authorisation is officially granted. In these countries, the only condition is a positive CHMP (Committee for Human Medicinal Products at the EMEA) opinion. In most other EU Member States, a submission for pricing and/or reimbursement can only be made after the marketing authorisation has been granted. 133 Figure 4.1 on the subsequent page provides an overview of the EU Member States ranked according to their popularity amongst companies to apply early for a pricing and/or reimbursement status. As can be seen, some of the free-price countries (United Kingdom, Germany, Sweden) and/or the countries with so-called positive CHMP opinion (Italy and Sweden) form the top four countries to start a pricing and/or reimbursement application when taking into account the reference pricing system that many other Member States apply. Empirical evidence shows that countries with lower expected prices or smaller expected market size have fewer launches and longer launch delays, controlling for per capita income and other country and firm characteristics. Controlling for expected price and volume, country effects for the likely parallel export countries are significantly Kyle MK, 2007, Pharmaceutical price control and entry strategies in The review of economics and statistics, February 2007, 89 (1), p Kyle MK, 2007, Pharmaceutical price controls and entry strategies in The review of economics and statistics, February 2007, 89 (1),, p ; Danzon PM, Furukawa MF, 2008, International Prices And Availability Of Pharmaceuticals in Health Affairs, volume 27 (2008), p Lanjouw, JO, 2005, Patents, Price Controls and Access to New Drugs: How Policy Affects Global Market Entry, Center for global development, Working Paper Number 61 June European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. regulation 63

64 negative 134. The overview in figure 4.1 shows that EU Member States with small markets (Cyprus, Malta) and countries with less per capita purchasing power (Poland, Bulgaria, Lithuania, Latvia, Estonia, Hungary, Romania) are generally not taken as reference countries. Originator companies are reluctant to make first price applications in these last countries as a generally lower price level might lead to low prices elsewhere via crossborder referencing. In anticipation of known lengthy P&R procedures companies may also decide to file applications early in those countries which explain the ranking of e.g. Italy in the figure below compared to other rankings in which Italy typically ranks much lower in terms of delays for actual market access. Figure 4.1 Ranking of Member States according to filing for pricing and/or reimbursement status Source: European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report Note: The ranking above is based on respondent companies' replies to the question which requested them to provide information on the first five most recently launched INNs and to order chronologically the first ten EU27 Member States in which they approached the pricing/reimbursement body. In constructing the ranking, a Member State to which the pricing/reimbursement body a company had turned to first received 10 points, second 9 points, third 8 points, and so forth. Unfortunately there is lack of data to separate out the authorization delay from the price/reimbursement delay and, within the price/reimbursement delay, the component that is due strictly to the administrative process versus the component that is related to disagreement over the price. The availability of such data might shed light on the sequential game underlying new drug price and launch decisions Danzon PM, Wang YR, Wang L, 2005, The impact of price regulation on the launch delay of new drugs-evidence from twenty-five major markets in the 1990s in Health Economics, 14(3), Remark: this study was funded by 135 AstraZeneca Pharmaceuticals. Danzon PM, Wang YR, Wang L, 2005, The impact of price regulation on the launch delay of new drugs-evidence from twenty-five major markets in the 1990s in Health Economics, 14(3), Remark: this study was funded by AstraZeneca Pharmaceuticals. 64 regulation

65 Effect on price strategies The previous section offers some insights into the launch strategies of pharmaceutical companies as a result of differences in pricing and reimbursement systems. It shows that pharmaceutical companies are aware that the interaction of prices between different markets is increasing (due to price referencing and parallel trade, the latter particularly an issue in the EU). They cannot limit themselves to setting the price on a market-by-market approach. Instead they must comprehensively understand the interactions prevailing between country prices. 136 The link between regulatory regimes and pharmaceutical firms pricing strategies has however received surprisingly little attention in the literature IMS Health (2008) observed that in the US the pharmaceutical companies mainly use premium pricing strategies, while in the EU a balance of strategies (premium pricing, parity pricing and discount pricing) is employed. 138 Empirical results of a policy experiment in Norway, which in 2003 introduced a system called index pricing (IP) for a sub-sample of off-patent pharmaceuticals, replacing the existing price cap (PC) regulation, show that regulatory pricing significantly reduces both brand-name and generic prices within the reference group, with the effect being stronger for brand-names. A negative cross-price effect on therapeutic substitutes not included in the IP system was also identified. In terms of policy implications, the results suggest that IP is more effective than PC regulation in lowering drug prices, while the cross-price effect raises a concern about patent protection 139. Another study shows that under the minimum policy (reference price as the minimum of the observed prices in the market) firms are not able to coordinate on higher prices while the linear policy (reference price as a linear combination of firms prices), implicitly, provides a coordination device. 140 Effects on innovation While the previous sections focused on the effects of the pricing and reimbursement framework on launch times and pricing, this sections look at the effect on R&D and innovation. Basic economic theory predicts that firms invest in capital up to the point where the expected marginal efficiency of investment in R&D (MER, in fact the demand for investment) is just equal to the firm's marginal cost of capital (MCC, in fact the supply of Seget S, 2003, Pharmaceutical pricing strategies: Optimising returns throughout R&D and marketing, Reuters. Brekke KR, Grasdal AL and Holms TH, 2009, Regulation and pricing of pharmaceuticals: reference pricing or price cap? in European Economic Review 53 (2009) IMS Healthcare, 2008, Pricing and Market Access Review , IMS Healthcare Brekke KR, Grasdal AL and Holms TH, 2009, Regulation and pricing of pharmaceuticals: reference pricing or price cap? in European Economic Review 53 (2009) Brekke et al refer to other sources which provide a mixed experience. Danzon (2001) and Puig-Junoy (2005) doubt whether a reference pricing system really results in additional competition. Other studies, like Aronssonetal (2001), Pavcnik (2002), Bergmanand Rudholm (2003) and Dalenetal (2006) report positive effects of the price reference system (lower prices, higher generic market shares). Miraldo M, 2009, Reference pricing and firms pricing strategies in Journal of Health Economics, volume 28 (2009) p regulation 65

66 investments).price regulation influences this ideal R&D investment decision on several places: 141 Regulatory influence like price regulation will lower a firm's expected returns to R&D and reduce the demand for R&D investments; Product launch delays (e.g. caused by price and reimbursement negotiations) reduce the expected present value of cash flows from product sales by delaying cash flows (through delayed launches) and reducing their size and duration (through reduced periods of market exclusivity and patent protection); Reduced pharmaceutical profitability (due to price regulation) reduces firm cash flows, which limits low-cost financing, an important determinant of R&D investment in this industry. Empirical evidence from the USA shows that expected returns and cash flow are important determinants of pharmaceutical R&D. Government interventions like price and reimbursement controls (but also pre-market regulatory controls, product formularies, tax policy, patents, technology transfer policies) affect R&D returns and the supply of funds to undertake pharmaceutical R&D. 142 A simulation of price regulation in the largely unregulated US market shows that, given certain caveats, such an introduction will lead to a decline in industry R&D by between 23.4 and 32.7%. From a social welfare perspective, it is important to note that the model s predictions have only limited value due to the model limitations. 143 Summary The next table summarizes the observations we have made pertaining to the effect of price regulation on the behaviour of pharmaceutical companies. Table 4.7 Summary table effects price regulation on behaviour pharmaceutical companies Effect price regulation on Main observations... first launch behaviour Price regulation does influence launch behaviour as pharmaceutical companies are aware of the interaction of prices between markets. Launch often in largest Member States. UK and Germany are popular first launch countries, due to the system of free pricing. This results in (relatively) high point of reference for cross-border reference. According to the literature, the existence of strict price regulation seems to influence the extent and the timing of the launch of new drugs negatively. Extensive price control may result in the fact that new drugs are not launched in a country or much later. Other popular first launch countries: France, Italy, the Netherlands and Sweden, due to fact that pricing and reimbursement dossier can be submitted before granting market authorisation Vernon JA, Golect JH and Hughen WK, 2006, The Economics of Pharmaceutical Price Regulation and Importation: Refocusing the Debate in American journal of law and medicine, Volume: 32, Issue: 2/3 (June 1, 2006), p Grabowski HG, Vernon JM, 2000, The determinants of pharmaceutical research and development expenditures in Journal of Evolutionary Economics, volume 10 (2000), p Vernon, JA, 2005, Examining the link between price regulation and pharmaceutical R&D investment in Health Economics 14 (2005), p regulation

67 Effect price regulation on Main observations... price strategies Literature somewhat limited; issue related to first launch behaviour. Free price setting can be used to influence the cross-border reference pricing.... innovation Expected profitability and cash flow are important factors relating to R&D investment decisions. Price regulation influences the ideal R&D investment decision (e.g. creation of launch delays, lower expected profitability and cash flow) Source: ECORYS, Effects pricing and reimbursement measures on public spending In section we presented the existing toolkit of supply and demand side measures in order to decrease the use of health care and limit health care expenditures. The effects of price regulation have been discussed extensively. There are however other tools, like generic substitution, positive (and negative) reimbursement lists and cost-sharing. These measures have been investigated in economic literature, but the results are not easy to interpret, as studies often focus on one country or one specific measure. Here we present a short illustration of observed results. Generic substitution Haas et al. (2005) estimated the potential savings on public health care expenditure in relation to generic drugs substitution in the US. They concluded that although broad substitution of generic drugs would affect only a modest percentage of drug expenditures, it could result in substantial absolute savings: If a generic had been substituted for all corresponding brand-name outpatient drugs in 2000, the national median annual savings in drug expenditures would have been $5.9 billion, representing approximately 11% of total drug expenditures. 144 Simoens and De Coster (2006) investigated (as an illustration to their study) the potential savings from increased substitution of generic for originator medicines in a number of EU-countries. They found that increased substitution of generic for originator medicines can yield substantial savings: for the top 10 active substances by expenditure of originator medicines, generic substitution would reduce public expenditure on the originator medicines containing these active substances by at least 20% in selected countries, with the proportional reduction varying between 21% in Poland (11.2 million) and 48% in Denmark ( 60.1 million). 145 Buzzeli et al (2006) examined the impact of generic substitution on pharmaceutical prices and expenditures in OECD countries. Their empirical results indicate that the average reduction of prices after the implementation of the policy is 3.1%. However, we were Haas J, et al, 2005, Potential Savings from Substituting Generic Drugs for Brand-Name Drugs: Medical Expenditure Panel Survey, in Annals of internal medicine, volume (2005), p Simoens S, De Coster S, 2006, Sustaining generic medicines markets in Europe, Research Centre for Pharmaceutical Care and Pharmaco-economics, Katholieke Universiteit Leuven, Belgium regulation 67

68 not able to show that the policy would have a statistically significant impact on pharmaceutical expenditures. The point estimate refers to a 1.6 reduction in expenditures. These results suggest that the consumption of pharmaceuticals increases as response to lower prices. 146 Use of positive reimbursement lists Yfantopoulos (2007) assessed the effectiveness of the positive reimbursement list which was introduced in Greece in His results showed that the measures proved to be ineffective since pharmaceutical expenditure, after a short-term reduction, continued to increase at similar rates to those before the introduction of price control mechanisms. New legislation in 2006 included the abolition of the positive list and the establishment of a rebate system. 147 Cost-sharing Grabka et al (2006) investigated the effect of the introduction in 2004 of a 10 copayment per quarter for the first contact at a physician s or a dentist s office. The results show that physician contacts declined in the year 2004 compared to 2003, but the share of those patients who had at least one physician contact in both years remained stable. The results also point out that necessary physician contacts still take place, e. g., in case of disabled persons and persons with poor health. According to Grabka it seems plausible that the introduction of this co-payment has contributed to a reduction of unnecessary and redundant physician visits. 148 Hsu et al (2006) investigated the effect of emergency department copayment levels on emergency department use and unfavourable clinical events. They found that relatively modest levels of patient cost-sharing for emergency department care decreased emergency department visit rates without increasing the rate of unfavourable clinical events. 149 Martikainen et al (2007) investigated the effect of changes in copayment level on the adoption of 2 antiglaucoma drugs in Finland. The results show that a decrease in the copayment of a new antiglaucoma drug to the same level as the copayments of alternative drugs accelerated the adoption of these new products in Finland: One year after the change, the observed consumption of dorzolamide was 109% higher and that of latanoprost was 21% higher than if the copayment had remained the same. 150 Li et al (2006) evaluated, inter alia, the impact of deductible/co-payment policy changes for prescription drugs on the use of drugs and physician visits among seniors with rheumatoid arthritis (RA) in Canada. The study shows that when cost sharing for Buzzelli A, et al, 2006, Impact of generic substitution on pharmaceuticals prices and expenditures in OECD countries in Journal of Pharmaceutical Finance, Economics and Policy, volume 15 (2006), p Yfantopoulos J, 2008, Pharmaceutical pricing and reimbursement reforms in Greece in European journal of health economics, volume 9-1 (2008), p Grabka M, et al, 2006, The Impact of Co-Payments on Patient Behaviour: Evidence from a Natural Experiment, Medizinische Klinik, volume (2006), p Hsu J, 2006, Cost-Sharing for Emergency Care and Unfavourable Clinical Events: Findings from the Safety and Financial Ramifications of ED Copayments Study in Health services research, volume: 41-5 (2006), p: Martikainen JE, 2007, Adoption of new antiglaucoma drugs in Finland: Impact of changes in copayment in Clinical therapeutics, volume (2007), p regulation

69 prescription drugs increased, the demand for prescription drugs decreased and the demand for physician visits increased. 151 Summary The next table summarizes the observations we have made pertaining to the effect of some selected measures on public spending. As mentioned above, several measures have been investigated in economic literature, but the results are not easy to interpret, as studies often focus on one country or one specific measure. Table 4.8 Summary table effects pricing and reimbursement measures on public spending Selected measures Main observations Generic substitution Literature (only two sources) indicates that generic drug substitution has the potential to realise significant savings on the public health care expenditures. Examples from literature: 11% ($ 6 bn) decrease in the US in 2000 and approximately 20% decrease in some selected EU countries. Another source indicates however that generic substitution may reduce the prices, but that these lower prices also increase the consumption. Use of positive reimbursement lists One scientific source showed that in Greece this measure had only a short term effect on public expenditures. Cost-sharing Regarding cost-sharing measures (e.g. co-payment) scientific sources show some mixed results concerning the reduction of public spending (including drugs, physician visits, etc). Probably the success factor depends on the design of the measure. Source: ECORYS, Li X, 2007, The impact of cost sharing of prescription drug expenditures on health care utilization by the elderly: Own- and cross-price elasticities in Health policy, volume 82-3 (2007), p regulation 69

70 5 Welfare implications of government interventions in the European market From the previous chapters we can infer that government interventions across Europe differ substantially, especially with respect to pricing and reimbursement. Some of these differences reflect differences in history, culture or preferences. But other differences point at inefficiencies. This chapter aims to get a feel for the nature and order of magnitude of the welfare implications involved with these differences. A number of caveats are in place. First of all, on the methodological side, little research has yet been done on a number of welfare dimensions. This is to our knowledge- one of the first few attempts to offer a complete overview. As such this chapter should be read as exploratory in nature. Second, a considerable amount of research publications in the pharmaceutical sector has been sponsored by the pharmaceutical market and thus can be biased. Third, it is impossible to be comprehensive in the sense of covering all government interventions in all EU Member States and their welfare implications. Indeed, the idea of this chapter is not to offer a complete inventory of welfare implications but instead to gain a better understanding of the scope for potential improvements. Furthermore, - a related point - even for interventions in EU Member States that have been researched in economic literature, often precise data lack. As a result, our order of magnitude exercise sometimes particularly relies on qualitative and less on quantitative information. To illustrate the high complexity of the institutional setting in Europe, Figure 5.1 provides an overview of the levels of governance at which decisions regarding pricing and reimbursement are taken. As is clear from the figure there is a proliferation across the EU of models that determine the price and reimbursement level of a new drug. Important to note here is that also within one country, decisions regarding pricing, reimbursement, budget available for the new drug and listing of the new drug can be taken at different governance levels. For example, pricing and reimbursement levels could be determined at the national level, whereas budget and listing could be fixed by regional authorities (see country 3 in Figure 5.1). Listing decisions can be even taken at the local level, by e.g. hospital groupings. This distribution of regulatory decisions across different governance levels within one country is also different across the EU Member States. 70 regulation

71 Figure 5.1 Levels of the regulation chain in the EU Source: IDEA Consult, Framing the welfare implications The welfare implications of regulation are closely linked to the different stages of the product life cycle, in which each stage is characterised by different types of regulation. This whole process may cover years or more. Table 5.1 Regulation and the pharmaceutical product life cycle Phases Remarks Phase 5: Patent expiry & generic entry End of legal monopoly Level of competition increases Phase 4: Commercial sales (after MA) - introduction - growth - maturity - decline Period for regaining investments High marketing investments/ approach of pharmacists, physicians Continued safety monitoring Phase 3: Filing - Application market authorisation (MA)(Community/national) - Pricing & reimbursement negotiations & decisions (cross-border price comparisons, economic evaluation, etc.) Details described in chapter 4 EPO-procedure: 3,5 years Marketing exclusivity: 10 years Data exclusivity: 8 years Phase 2: Clinical development Pre-clinical investigations: initial laboratory regulation 71

72 Phases Phase 1: Discovery research - Patent application (later?) Remarks experiments, studies to determine whether product is safe and effective; Clinical studies: during the process patients will be involved Patent expiry: 20 years after patent application (option: 5 additional years with the SPC [supplementary protection certificate]) Source: ECORYS, 2009 As such, the two main players in these product markets, companies and regulators, can be seen as interacting agents, directly or indirectly influencing each others decisions. A company starting research into new molecules or having to decide which research trajectory to continue and which one to stop, will theoretically base its decision on the perceived net present value of the molecule which is influenced by effective patent protection, approval procedures, pricing and reimbursement decisions, regulation to promote generic entry, etc. The long time frame between the individual firm s R&D decisions and the changing policy and regulatory environment give rise to considerable uncertainty which lead the company to request a further premium or restrict its R&D activities as compared to the hypothetical situation in which a company would have full knowledge about the impact of regulations during the full product life cycle. Within the more realistic setting of a multi-product firm with a substantial R&D portfolio and ongoing sales the pursuit of profit maximisation by the firm will give rise to strategic behaviour during the product life-cycle when faced with changes and differences in and between regulatory regimens. From the perspective of regulation alone, companies will have preference to enter those markets with highest available prices, minimal delays in market approval and entry, and weak (generic) competition. The main welfare impacts of regulation can be categorised in price levels, the timing of availability of medicines in (different) markets, and the subsequent impact through health effects for consumers, efficiency gains in health systems, and ultimately the incentive to innovate. In addition, the compliance costs of regulation have a direct welfare effect. Regulators trying to obtain the best commercial deal have an impact on all these other parameters as well. 5.2 Welfare effect as a result of the EU patent system The patent system described in the previous chapter is a double-edged sword: it preserves the incentive for R&D on one hand, but on the other, it also creates a negative societal welfare effect due to the creation of a pseudo-monopoly and administrative burden. A crucial regulatory problem is therefore to determine the optimal length of market protection so that drug companies are still willing to take costly risks to develop lifesaving drugs, while on the other hand prices are not driven up too high due to excessive monopoly rents. 72 regulation

73 5.2.1 Societal welfare effect of a pseudo-monopoly: dynamic versus static efficiency As mentioned above, the patent system stimulates the incentive for R&D (and innovation) but the creation of a pseudo-economy also leads to allocative inefficiencies due to higher prices as a result of monopoly rents. Recent literature on estimating the overall welfare effect, balancing these effects against each other, is fairly limited. Most literature on the measurement of allocative inefficiency as a result of monopoly pricing uses a partialequilibrium model shown in figure 5.2 below. The creation of a monopoly market leads to a deadweight loss equal to the size of the shaded area 152. The existence of patents creates a barrier to entry for the non-patent holders to enter in the pharmaceutical market. This creates a pseudo-monopoly, stifling healthy competition (acting as a barrier for entry) and enabling the patent-holders to set a (higher) monopoly price (Pm) and a (lower) monopoly quantity (Qm) with a high profit margin for the monopolist. Figure 5.2 Deadweight loss in a monopolistic market Source: Rockett K, 2008, Property rights and invention, discussion paper series no 663, University of Essex; Kelton CML, Rebelein RP, 2005, Social welfare loss in antidepressant and antipsychotic pharmaceutical markets, University of Cincinnati, Vassar College Poughkeepsie. The partial equilibrium model is not ideal to estimate allocative inefficiency since effects outside the pharmaceutical market are not included. A general-equilibrium model leads to a less pessimistic estimate of allocative inefficiency due to monopoly profits in the pharmaceutical sector as it takes into account the increased utility from increased consumption in other parts of the health sector (e.g. number of therapeutic treatments, etc.). 153 With the use of a general-equilibrium model, Kelton and Rebelein (2005) found out that using U.S. data- a patented monopoly has a nontrivial effect on U.S. social welfare. In Rockett K, 2008, Property rights and invention, discussion paper series no 663, University of Essex; Kelton CML, Rebelein RP, 2005, Social welfare loss in antidepressant and antipsychotic pharmaceutical markets, University of Cincinnati, Vassar College Poughkeepsie. Kelton CML, Rebelein RP, 2005, Social welfare loss in antidepressant and antipsychotic pharmaceutical markets, University of Cincinnati, Vassar College Poughkeepsie. regulation 73

74 2003, monopolistic production of each of the examined (nine) drugs caused at least $60 million in social welfare loss. Two of the drugs exhibited over $600 million in allocative inefficiency 154. Due to the fact that it is often not the drug user paying for the medicines, this allocative inefficiency often has a particular negative distributional impact of monopoly on taxpayers. It is important to keep in mind that the societal benefits of the stimulation of R&D as a result of the patent system are not taken into account in this exercise. In the study results described below, stimulation of R&D has been taken into account. Hughes, Moor and Snyder (2002) 155 attempted to specify the overall societal welfare effect in case all patent rights on branded prescription drugs would be eliminated for both existing and future prescription drugs without compensation to the patent holders. They reason that while accelerating generic entry will yield substantial gains in consumer surplus associated with greater access to the current stock of pharmaceuticals, future consumers will be harmed by the reduced flow of new pharmaceuticals to the market. They have based their estimates of the consumer surpluses on the stylized facts concerning how generic entry has affected prices, outputs, and market shares. They found that providing greater access to the current stock of prescription drugs would yield large benefits to existing consumers in absolute terms. However, realizing those benefits has a substantially greater cost in terms of lost consumer benefits from reductions in the flow of new drugs. Gains to existing consumers from full access would be considerable, on the order of $1 trillion dollars. At the same time, the lost opportunities to develop new drugs to address currently untreated illnesses, or to improve upon existing drugs, carry a considerably larger price tag. According to their demand analysis, $3 in present value terms would be lost for every dollar gained due to easier access. They ve obtained this result even accounting for the stylized fact that after generic entry branded drugs continue to earn significant price premia over generic products. Nevertheless, the absence of an extended period of market exclusivity reduces incentives to innovate and ultimately denies future consumers benefits that far exceed the gains to current consumers from lower prices on the stock of drugs already on the market High administrative costs for companies due to fragmented patent system in the EU Administrative costs The patent system brings along administrative costs for pharmaceutical originator producers in terms of (opportunity) time and funding spent on acquiring the patent. This increases the costs of production of an innovative medicine. If pharmaceutical originator producers cannot pass on these administrative costs in demanding higher price for their products (ultimately reducing consumer welfare), the patent system acts as a barrier for pharmaceutical originator companies to innovate, counteracting the very raison d être of the existence of the patent system. In this section, we show how fragmentation in the Kelton CML, Rebelein RP, 2005, Social welfare loss in antidepressant and antipsychotic pharmaceutical markets, University of Cincinnati, Vassar College Poughkeepsie. This research as many other research publication in the pharmaceutical sector- has been sponsored by the pharmaceutical market. Hughes JW, Moore MJ, Snyder EA, 2002, Napsterizing pharmaceuticals: access, innovation and consumer welfare. Retrieved: 74 regulation

75 EU patent system leads to relatively high patent costs in the EU in comparison with other countries like Japan and the US. In the European Union, an inventor can only obtain a patent by filing a national application at each respective national patent office of individual the EU Member States or by filing a single patent application at the European Patent Office (EPO). In the latter case, national validation of the European patent granted by the EPO in each Member State where the patent owner wishes the patent to exist and to be enforceable is still necessary. 157 In general the EPO procedure therefore takes three and a half years (starting from the moment the patent application is filed at the patent office) before the patent is granted or rejected 158. This fragmentation makes it cumbersome and a lengthy procedure for pharmaceutical companies to apply for an EU-wide patent coverage. 159 The total cost of validating and maintaining a patent in the EU is, according to pharmaceutical originator companies due to this fragmentation high, when compared to other countries like the USA or Japan. This is due in part to litigation costs (see further below) and the fact that the patent must be translated into the official languages of each country in which the patentee wants protection. The European Patent Office estimates (in 2007) that the cost of obtaining a European Patent via a Euro-direct application and maintaining the patent for a 10 year term is approximately The cost of a Euro-PCT patent is about 50% higher than those of a patent obtained via a Euro-direct application. In fact, all cost components are higher in the Euro-PCT patent due to the (typically) higher number of pages and larger number of countries of validation. 161 In addition to costs associated with payments to external parties, the patentee might also incur in-house costs, with estimates ranging from for a Euro-direct to for a Euro-PCT patent. The table below offers a breakdown of estimates into detailed cost categories (in ). Table.5.2 The cost of a sample European patent breakdown of estimates into detailed cost categories (in ) Cost category Euro-direct Euro-PCT Professional representation before the EPO Pre-filing Processing Translation (claims only) EPO fees and international fees (PCT) Translation and related cost Translation Attorney: validation Publication fees Renewal fees (paid to national offices) and related cost European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. Barton S, Zacca F, 2007, the European Patent Office, EPO, PowerPoint hand-out. Euro-direct: 18 pages (11 pages description, 3 pages claims, 4 pages drawings), 10 claims, patent validated in 6 countries (DE, UK, FR, IT, ES, CH) ; Euro-PCT: 26 pages (18 pages description, 5 pages claims, 3 pages drawings), 15 claims, patent validated in 8 countries (DE, UK, FR, IT, ES, CH, NL, AT). regulation 75

76 Cost category Euro-direct Euro-PCT Renewal fees (years 5-10) Attorney: payment of renewal fees Total, excluding in-house cost ~ ~ In-house cost to the applicant Pre-filing Processing Total, including in-house cost ~ ~ Source: The cost of a sample European patent - new estimates, Czech technical university in Prague. Retrieved 2009: It is important to mention that the above information dates from before 2008 and therefore does not include the London Agreement (Article 65 EPC) which became into force in May This agreement waives, entirely or largely- in those EU Member States which have ratified or acceded to the Agreement the requirement for translations of European patents: A state which has an official language in common with one of the official languages of the EPO (French, English, German) shall dispense entirely with the translation requirements provided for in Article 65(1) EPC; A state which does not have an official language in common with one of the official languages of the EPO (English, German, French) shall dispense with the translation requirements provided for in Article 65(1) EPC if the European patent has been granted in the official language of the EPO prescribed by that State (English, German or French), or translated into that language and supplied under the conditions provided for in Article 65(1) EPC. These states may however require that a translation of the claims into one of their official languages be supplied 163. This Agreement will cut translation costs dramatically. The Chartered Institute for Patent Attorneys (CIPA) for example states that on average patents are translated into seven languages, at a cost of 1000 per language. Since this Agreement eliminates this need, patent applicants can reduce their costs on average with 7000 (approximately 22% of their total patent costs excluding in-house costs) to approximately The table below offers a comparison of costs and fees (in ) payable for obtaining patents in the EU (in eight Member States), the USA, and Japan. The estimated costs for obtaining an EU patent are estimated somewhat higher ( instead of ) than the previous table indicating the difficulty of obtaining an exact estimate. The table does clearly illustrate though that the cost of the European patent was approximately three to five times higher in 2000 than that of patent in Japan or the USA Currently 15 EU Member States including the 3 where the most European patents took effect in 1999, that is, France, Germany and the United Kingdom. European Patent Office, Agreement on the application of Article 65 EPC London Agreement. Retrieved 2009: The register, cost of pan-european patent protection may plummet in May, Retrieved 2009: 76 regulation

77 Even a reduction of the translation costs in the EU to 2200 (estimated to be the case in case a Community Patent would be set up 165 and somewhat comparable to the situation under the London Agreement) would still mean that the cost of a European patent remains two and a half to four times as high than that of a Japanese or US patent. Table 5.3 Cost comparison of costs and fees (in ) payable for obtaining patents in the EU (in eight Member States), the USA and in Japan in 2000 Filing and search fees Examination fees Grant fees Renewal fees Translation costs Agent's fees Total EPC (typical application, Member States) US n/a Japan n/a Source: Europa, Communiqués de press rapid, 2000, Commission proposes the creation of a Community Patent. Retrieved: The cost of national validation and national renewal could in the EU, according to the originator pharmaceutical companies, be eliminated if a granted patent automatically applied to the entire EU. 167 This statement is confirmed by the European Commission who stated that a European patent designating only 13 out of the 27 Member States is about nine times more expensive than a USA or a Japanese patent, if total costs are considered. Particularly innovative SME may not be able to access the EU market due to the high patent application costs. 168 This could stifle innovation in the EU pharmaceutical market. Generic companies stress that the fact that European patents granted by the EPO are subsequently transformed into a bundle of national patents is a major problem, as these national patents are then enforced (or have to be challenged) in each Member State separately. As patents are often covered by multiple patents, trying to obtain market entry for a generic product can become very costly and time-consuming. Litigation costs In this section we explore to what extent fragmentation in the EU patent system causes high litigation costs which can be overcome by setting up a more unified system. An EPO patent is, in fact, a bundle of national patents (in the countries Europa, Communiqués de press rapid, 2000, Commission proposes the creation of a Community Patent. Retrieved: =fr. According to Oppedahl Patent Law Firm LLC In the US, a patent application for more complicated cases costs between $8000 or $10000 (between ) or more to be filed with the U.S Patent Office. Sources: Oppedahl Patent Law Firm LLC, What things cost. Retrieved and Currency site. Retrieved: European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. regulation 77

78 designated by the applicant). National laws apply to these patents, with any legal challenges being pursued at the national level. In other words, there is no unified court to deal with patent disputes for the whole of Europe. This can make for multiple litigations in many European jurisdictions with potentially contradictory outcomes. This causes on the one hand, patent-holders to be faced with considerable judicial costs as they have to enforce their patent rights in multiple EU Member State courts. On the other hand, third parties interested in showing that particular parent rights have been granted erroneously are disadvantaged by having to initiate revocation proceedings in multiple jurisdictions 169. The overcoming of this duplication of infringement and revocation cases is likely to generate large benefits for the European economy. Recent study results suggest that currently, between 146 and 311 infringement cases are being duplicated annually in the EU Member States. By 2013, this number is likely to increase to between 202 and 431 duplicated cases. Total private savings from having access to a unified Patent Court in 2013 would span the interval between EUR 148 and 289 million. 170 An assessment of the operating costs of a European unified Patent Court is obviously subject to a large number of caveats. Based on data from earlier efforts (in particular the EPO's Working Party on Litigation), an upper-bound estimate for the operating costs of a court with a capacity of 940 cases indicates that the Court would cause operating costs of EUR 27.5 million. Hence, the cost-benefit assessment focusing on avoided duplication leads to a highly positive evaluation of the proposal. Even if the low estimate of savings (EUR 148 million) is taken, the new system would create substantial benefits and reach a benefit-cost ratio of 5.4. However, this view may be unduly conservative, and the benefitcost ratio could be as high as The above estimates and considerations are based on the assumption that the unified Patent Court will offer litigation at roughly the same cost level as the three largest low-cost national systems. In a robustness check, the report explores to what extent the gains from saved duplication would be dissipated if the cost level were higher. The computations show that even with a substantial average cost increase, benefit-cost ratios remain above one, and for most scenarios considerably above one. Particularly strong positive welfare contributions can be expected if an effective and rapid, low-cost revocation procedure is available. The latter feature should provide an effective means against strategic and (possibly) frivolous litigation activity which could be mounted in the future by patent trolls Harhoff D, 2009, Economic Cost-Benefit Analysis of a Unified and Integrated European Patent Litigation System, final report, tender No. MARKT/2008/06/D, Ludwig-Maximilians- Universität (LMU) München, Institute for Innovation Research, Technology Management and Entrepreneurship (INNO-tec), Retrieved: Unified%20Patent%20Court%20economix%20analysis%20- % doc#_Toc Harhoff D, 2009, Economic Cost-Benefit Analysis of a Unified and Integrated European Patent Litigation System, final report, tender No. MARKT/2008/06/D, Ludwig-Maximilians- Universität (LMU) München, Institute for Innovation Research, Technology Management and Entrepreneurship (INNO-tec), Retrieved: Unified%20Patent%20Court%20economix%20analysis%20-% doc#_Toc regulation

79 Additional benefits could flow in case of additional litigation activity, be it in terms of infringement or revocation actions. The availability of a low-cost litigation path offered by a unified Patent Court is likely to lead to additional activity from parties in countries which currently do not use the European patent system extensively Costs of the market authorisation process for pharmaceutical companies The use of market authorisations described in the previous chapter is on the one hand a necessary tool to protect public health by overcoming information asymmetry. On the other hand however, it also entails an administrative task for pharmaceutical companies and any delays in market authorisation may lead to profit loss for pharmaceutical companies and delayed patient access to new medications Approval costs The application for market authorisation at Community level is necessary for medicinal products that appear in the Annex of the Regulation (see chapter four for more details). The application costs are a burden on pharmaceutical companies. The full basic fee of applying for market authorisation at EMEA amounts to and covers a single strength associated with one pharmaceutical form and one presentation. Additional fees of and are demanded to cover respectively 1) one additional strength or pharmaceutical form and one presentation, submitted at the same time as the initial application for authorisation, and 2) for each additional presentation of the same strength and pharmaceutical form, submitted at the same time as the initial application for authorisation. A reduced fee is applicable when a full dossier is not necessary (according to Directive 2001/83/EC as amended). The basic fees drops in this case to or and the additional fees to or An extension of the market authorisation is necessary in case of changes to the active substance(s); and changes to the strength, pharmaceutical form and route of administration. The full fee for an extension of market authorisation is and the additional fee is for each additional presentation of the same extension submitted at the time as the initial extension application. A reduced fee is application in case the use focuses on the paediatric population and in case no new clinical data are submitted by the MAH. 171 Harhoff D, 2009, Economic Cost-Benefit Analysis of a Unified and Integrated European Patent Litigation System, final report, tender No. MARKT/2008/06/D, Ludwig-Maximilians- Universität (LMU) München, Institute for Innovation Research, Technology Management and Entrepreneurship (INNO-tec), Retrieved: Unified%20Patent%20Court%20economix%20analysis%20-% doc#_Toc regulation 79

80 These are not the only applicable fees: In case of a small or large variation to the marketing authorisation, fees need to be paid between and ; In case of a renewal, a fee of is demanded; In case of inspection, a fee of is demanded (travel expenses are extra in case this is outside the Community); In case of a transfer of the marketing authorisation; a fee of is demanded; In case of maintenance (annual fee); a fee is demanded of ; and In case of referral; a fee of is demanded. 172 Theses fees are one-time fees and avoid litigation costs that might arise from a lawsuit concerning unsafe drugs Delayed patient access to new medications In the 1980s and 1990s discussions about access to newly approved drugs focused particularly on the time lag between the application for approval and granting of market authorisation. This delay was identified as the first barrier to patient access to new medications. It refers to the traditional three hurdles: safety, efficacy, and quality of manufacturing practices. 174 The EC published a study on the impact and effectiveness of the single market and one of their conclusions was that the time taken to grant marketing authorisation for pharmaceuticals has been substantially reduced thanks to the new centralised procedure at the EMEA. According to the EC, the authorisation procedure took up to one year after 1996, while it cost five years per country before In another study it was observed that the time of approval by the EMEA was seven to fifteen month, depending whether clock stops in the procedure were included. 176 However, respondents on the Sector Inquiry of the European Commission (2009) find the continued fragmentation of the different regulatory agencies in the EU problematic. Despite the European regulatory framework, companies reported the increasing volume of data requested during the evaluation procedure and the need for duplicative assessments for certain national agencies. More coordination between the agencies or EU-wide consolidation of the requirements in the design of clinical trials could save time and effort of pharmaceutical companies to gain EU-wide market authorisation. 177 Despite the reduction of approval time since EMEA, the results of the Sector Inquiry of the European Commission (2009) also indicates that European pharmaceutical companies EMEA, 2009, Explanatory note on fees payable to the EMEA. Findlay SM, Frost, Sullivan, 2009, Drug approval trends in Europe, Life Science Leader. Cohen J, Faden L, Predaris S, Young B, 2007, Patient access to pharmaceuticals: an international comparison in Eur J Health Econ (2007) 8: European Commission, the EU single market. Retrieved 2009: Garattini and Betele (2004) European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. 80 regulation

81 are currently negatively affected by a growing backlog as regards the treatment of applications for marketing authorisations. This problem is particularly reported to exist in the four EU Member States (Germany, Denmark, United Kingdom and the Netherlands) which are often chosen as Reference Member State. Comments by pharmaceutical companies in response to the Sector Inquiry of the European Commission (2008) mainly related to delays in the procedures and lack of accessibility of application slots due to insufficient resources in the authorities to turnover all the necessary paperwork in a timely matter. 178 Unfortunately no further details are provided with respect to the size of the backlogs. Empirical evidence in relation to anti-cancer drugs shows that EU authorisation took on average of 418 days. Almost 30 percent of this time was used for administration, not related to the approval process itself. By comparison average review time for all standard drugs in the US in 2004 was in the same study period 387 days, and 180 days for priority drugs Effects on innovation The main trend in the marketing authorization process is that the requirements that a new drug has to satisfy in order to have a positive evaluation by the EMEA and/or FDA are becoming more and more stringent and complex: this is a worldwide phenomenon and not only applicable to the EU. These stringent demands have increased the timeline for product development substantially. Also the clinical trials have to include more patients and cover more countries and are more stringent with regard to the side-effects of certain drugs. These above-mentioned findings that were obtained from interviews with large pharmaceutical multinationals, were confirmed by the Impact on Clinical Research of European Legislation ( ICREL ) 180 study that was launched by the European Commission as part of the 7th Framework Programme. The ICREL study aimed to assess the impact of the Clinical Trials Directive (CTD) 181 on the number, size and nature of clinical trials, on workload, required resources, costs and performance. ICREL concluded that performing clinical trials has become considerably more difficult and costly. More specifically, the ICREL study examined by means of a survey among commercial sponsors of clinical trials (i.e. pharmaceutical companies), the impact of the CTD on subject recruitment and workload of commercial sponsors. With regard to subject recruitment, it was noted in the study that this is the most critical element for time lines and budget of a clinical trial. The ICREL survey showed that commercial sponsors could not increase their recruitment rates despite an increase of involved countries by about European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. Wilking N, Jönsson B, Högberg D, Justo N, 2009, Comparator report on patient access to cancer drugs in Europe, Karolinska Institutet, Stockholm, Stockholm School of Economics, Stockholm, i3 Innovus, Stockholm. EFGCP (European Forum for Good Clinical Practice), 2008, Impact on clinical research of European legislation (ICREL) - Answers from the Commercial Sponsors. European Commission, DG Enterprise and Industry, Pharmaceuticals Unit, 9 October 2009, Assessment of the functioning of the clinical trials directive (CTD), 2001/20/EC Public Consultation Paper, p 8 and 9. regulation 81

82 30% and of involved centres by nearly 60%. Thus, companies had to increase their number of sites because fewer sites were able to provide the expected number of patients. As regards the impact of the CTD on the workload related to conducting clinical trials, the survey indicated that more staff was needed to cope with the CTD requirements in preparation and execution of clinical trials. The vast majority of companies responded that they need more personnel than before to prepare and perform clinical trials. Finally, the ICREL study noted that with the implementation of the SUSAR (Suspected Unexpected Serious Adverse Reaction) definition, the new CTD aimed at reducing the workload of expedited safety reporting. However, according to the results of the ICREL survey the contrary was achieved: the required number of FTEs in pharmaceutical companies increased by 85%. Despite considerable investments in resources and technology only half of the respondents were of the opinion that this new process has increased the safety of study participants. The increase in the development timeline of new drugs and in the costs of conducting clinical trials has two potential effects on the R&D spending by the pharmaceutical industry. First of all, the time to regain the investment costs (which are limited by the fixed duration of patent protection) is shortened. Secondly, in the business model of the pharmaceutical industry, the R&D costs are financed by sales. These sales also diminish due to the amplified development time of a new drug and the increased costs related to conducting clinical trials, leading to less money being available to invest in R&D. Although the US are evolving in the same direction as the EU (stricter regulation), in the US, the focus lies on the improvement of a product once it is on the market: e.g. if it is a lifesaving drug, it will already be able to access the market after phase IIb of the clinical trials. Finally the tightening of regulation in the US is mainly concentrated in the premarketing stages whereas in the EU the regulatory environment has become more complex in the post-marketing stages. This means that in the US, the demands with regard to clinical trials are becoming more stringent while in the EU, the requirements made in the perspective of pricing and reimbursement decisions by national and regional authorities are becoming more complex. In this context, it is interesting to observe that EMEA already demands the commitment of the pharmaceutical companies to carry out extra studies upon authorization of a new drug. More specifically, in the EMEA Notice to Applicants Guide on the procedures for market authorization, it is stated that for all opinions of the CHMP (whether or not for conditional approval or under exceptional circumstances) Follow-Up Measures (FUMs) can be requested at the initial CHMP opinion or further to the CHMP assessment of any submitted additional data/applications European Commission, DG Enterprise and Industry, Notice to applicants, volume 2A, Procedures for marketing authorization, chapter 4, centralised procedure (April 2006), ENTR/F2/BL D (2006). 82 regulation

83 5.4 Welfare effects of pricing and reimbursement regulations Because the patent regime gives originator pharmaceutical companies a temporary monopoly, pricing and reimbursement regulations have been put in place to limit this market power to a level acceptable for society. Delays with respect to pricing and reimbursement decisions can however influence the profitability of pharmaceutical companies, the health situation of patients, and affect health care budgets Delays in the introduction of medicines In some Member States, new drugs are launched systematically at a later date. 183 As explained in section launch behaviour is influenced by price and reimbursement regulation as a result of administrative procedures and strategic behaviour of pharmaceutical firms.. First, delay may be the result of differences in the duration of administrative procedures related to pricing and reimbursement decisions. In the Sector Inquiry of the European Commission (2009), both originator and generic companies complain that in several Member States the deadlines for pricing and reimbursement decisions laid down in the Transparency Directive (89/105/EEC) namely 90/180 days- are not respected and that they face delays (ranging from a few months to several years) with respect to the pricing and reimbursement decision. This is confirmed in the interviews for this study, where it was stated that some countries administrations bring out an automatic negative advice after 180 days, forcing the pharmaceutical applicant company to resubmit its pricing and reimbursement application. This way, the countries comply with the Transparency Directive, but stall the procedure by giving a negative evaluation to the application. Second, the delays may be the result of strategic launch price differences. The delays may result from strategic behaviour by pharmaceutical firms who, in the presence of parallel trade, postpone launches in lower priced countries allowing the company to (temporarily) price discriminate between different groups (countries) with different willingness to pay. Consequently, countries with low prices for pharmaceuticals generally have fewer launches and longer launch delays. 184 Besides the pharmaceutical firm s motives to (temporarily) price discriminate between countries, strategic launch, delays may also result from the specifics of pricing and Inter alia, Cambridge Pharma Consulting, 2002, Delays in market access, Cambridge, UK,; Danzon PM, Wang YR, Wang L, 2005, The impact of price regulation on the launch delay of new drugs-evidence from twenty-five major marketing in the 1990s in Health Economics, 14 (3), ; Wilking N, Jönsson B, 2005, A pan-european comparison of patient access to cancer drugs. Karolinska Institutet, Stockholm; IMS Healthcare, 2008, Pricing and Market Access Review , IMS Healthcare Danzon and Epstein (2008). Cambridge Pharma Consulting, 2002, Delays in market access, Cambridge, UK; Danzon PM, Wang YR, Wang L, 2005, The impact of price regulation on the launch delay of new drugs-evidence from twenty-five major marketing in the 1990s in Health Economics, 14 (3), ; Wilking N, Jönsson B, 2005, A pan-european comparison of patient access to cancer drugs. Karolinska Institutet, Stockholm;. regulation 83

84 reimbursement policies. Notably the use of international price referencing as a pricing and reimbursement tool may cause companies to postpone launches Observed delays in market entry In 2004, the European Federation of Pharmaceutical Industries and Associations commissioned IMS Health to produce a bi-annual study of delays between marketing authorization and effective patient access to new medicines in different EU Member States. 186 The resulting "Patients' W.A.I.T. Indicator Report" (Waiting to Access Innovative Therapies) reveals substantial differences in patient access to new medicines across the European Union. 187 The W.A.I.T. indicator does, however, not reveal which factors cause exactly the delay, such as national pricing and reimbursement systems, administrative practices, business strategies or decisions of the marketing authorisation holders. 188 In the 2007 edition of the Patients' W.A.I.T. Indicator Report, analysis shows that for 18 of the 20 European countries covered in the report, 20 to 94% of the medicines that received a marketing authorisation between 1 January 2003 and 31 December 2006 were still not available to patients six months later on 30 June Table 5.4 below offers an overview for all new medicines (retail and hospital combined) with marketing authorisation (EMEA and Mutual Recognition Procedure) from 1 January 2003 to 31 December The following observations can be made: The average time to access (delay in days) is the highest in Belgium followed by Slovakia, Austria, Italy and France. The average time to access (delay in days) is the lowest in the US 190, UK 191, Germany and Denmark; The highest difference between the minimum and maximum delay in days is observable in Slovakia, Switzerland, Belgium and Czech Republic. The lowest difference is observable in the USA, UK, Germany, Estonia and Ireland Seget S, 2003, Pharmaceutical pricing strategies: Optimising returns throughout R&D and marketing, Reuters; Danzon PM, Wang YR, Wang L, 2005, The impact of price regulation on the launch delay of new drugs-evidence from twenty-five major markets in the 1990s, Health Economics, 14(3), ; Andalusian School of Public Health, 2007; Danzon and Epstein, The IMS database does not take into account delays because of launch delays. European Federation of Pharmaceutical Industries and Associations, Delays and inequalities in patient access to new medicines. Retrieved 2009: European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. IMS, 2007, Patients W.A.I.T. Indicator Phase 8 Report, Retrieved from: According to Cohen J, Faden L, Predaris S, Young B, 2007, Patient access to pharmaceuticals: an international comparison in Eur J Health Econ (2007) 8: IMS reports no time delay in the US because at least one of the hundreds of third party payers will reimburse a drug immediately after marketing approval. Anecdotic evidence indicates however that US insurers routinely exclude from coverage for up to 6 months new brand-name drugs that are therapeutically similar to existing drugs. The Centres for Medicare and Medicaid Services (CMS) are moreover known to delay reimbursement of certain newly approved products, including pharmaceuticals, by as much as 270 days after launch. According to Cohen J, Faden L, Predaris S, Young B, 2007, Patient access to pharmaceuticals: an international comparison in Eur J Health Econ (2007) 8: IMS reports no delay in the UK because when a drug is licensed in the UK it is, by default, reimbursable. For a small number of drugs, however, there is well-documented evidence of so-call NICE blight- delays in reimbursement by NHS primary care trusts during the period of appraisal by NICE.. It takes on average approximately 13 months for NICE to complete its assessment of drugs selected for appraisal. Cohen et al. (2007) even found an average delay of 32 months in their sample analysis. 84 regulation

85 Table 5.4 Molecule availability and delay statistics between marketing authorisation and market access (retail and hospital combined) Country Number of Number of Average time Minimum Maximum medicines medicines to access delay (days) delay (days) with market accessible to (days) authorisation patients Belgium Slovakia Austria Italy France Hungary Spain Slovenia Czech Republic Greece Estonia Poland Portugal Switzerland Netherlands Sweden Finland Norway Ireland Denmark Germany UK US Source: IMS, 2007, Patients W.A.I.T. Indicator Phase 8 Report, Retrieved from: Note: All new medicines with marketing authorisation (EMEA and Mutual Recognition Procedure) from 1 January 2003 to 31 December 2006 ordered by decreasing average time to access (in days) A separate analysis has been made distinguishing between EMEA and Mutual Recognition Procedure separately. The overall observations with regard to the highest average time to access (delay in days); and the highest and lowest difference between minimum and maximum delay in days does not deviate from the observations made above. In addition it is observed that: o More EU Member States are experiencing higher average times for patients to access medicine (in days) with respect to EMEA market authorisation than with MRP market authorisation; o More EU Member States are experiencing higher maximum delays (in days) with regard to EMEA market authorisations than with respect to MRP market authorisation. However, more EU Member States are experiencing higher regulation 85

86 minimum delays (in days) with regard to MRP market authorisations than with respect to EMEA market authorisation Table 5.5 EMEA and Mutual Recognition Procedure (MRP molecule availability and delay statistics between marketing authorisation and market access (retail and hospital combined) All new EMEA and MRP medicines with marketing from 1 January 2003 to 31 December 2006 Country Number of Number of Average time Minimum Maximum medicines with medicines to delay (days) delay (days) market accessible to access (days) authorisation patients EMEA MRP EMEA MRP EMEA MRP EMEA MRP EMEA MRP Austria Belgium Czech R Denmark Estonia Finland France Germany Greece Hungary Ireland Italy Netherlands Norway Portugal Slovakia Slovenia Spain Sweden Switzerland UK Source: IMS, 2007, Patients W.A.I.T. Indicator Phase 8 Report, Retrieved from: The Patients' W.A.I.T. Indicator Report also shows the average time delay between marketing authorisation and market access for retail and hospital based use. The country results indicate that overall hospital based use is generally accessible earlier, compared to drugs used in outpatient setting. Still, the delays from marketing authorisation to accessibility in hospital are very long in Belgium, France, Greece, Italy and Spain. In Greece the delay is actually even longer for hospital based use than for drugs used in outpatient setting Wilking N, Jönsson B, Högberg D, Justo N, 2009, Comparator report on patient access to cancer drugs in Europe, Karolinska Institutet, Stockholm, Stockholm School of Economics, Stockholm, i3 Innovus, Stockholm. 86 regulation

87 5.4.3 Sequencing of introduction of new medicines in the EU As stated, the W.A.I.T. statistics measure average delays for introduction of new medicines in countries but do not explain the different reasons that may cause the delays. There are some indications that launch delays result from strategic choices. If this is the case, one may find a relation between pricing and reimbursement policies of national authorities and observed launch delays. A separate statistical analysis carried out for this report (see Annex A for a detailed analysis) supports this notion. The analysis examines the relationship between launch dates of non-replaceable, or unique, medicines and a number of structural and regulatory characteristics of Member States. By this, the analysis tries to determine if there is a systematic sequencing of pharmaceuticals in the EU and if this sequencing can be attributed to country-specific indicators. The main difference between our analysis and previous studies on this topic is that it considers only such drugs, which are classified as non-replaceable, or unique, and therefore cannot be grouped together with other drugs. This allows the manufacturer to obtain a premium price on his product, which again potentially enhances his decision to pursue strategic launch behaviour in order to benefit most from a country s structural and regulatory characteristics. As such, strategic behaviour is more likely to be expected for unique pharmaceuticals. The analysis in annex A shows that pricing and reimbursement decisions of national authorities (partially) explain the observed different launch dates. The analysis examines the observed differences in launch dates for a group of innovative medicines on the basis of three different sets of explanatory variables: structural characteristics, financing mechanisms and different regulatory measures. Below we show the main results from the analysis. The analysis follows two steps: a descriptive analysis and a multivariate analysis. Because of the relative small sample size and the possible correlation between explanatory variables, it is not possible by means of a descriptive analysis alone to identify highly significant relationships. The value of the descriptive analysis is then mainly to provide a first check of what we intuitively expect in a form that is understandable for most. In order to correct for the possible interrelations between explanatory variables and to find relations with a higher significance value we subsequently perform a more advanced (and for many less understandable) technique: the multivariate analysis. The descriptive analysis of structural characteristics reveals that there is a general negative relationship between per capita GDP and launching dates and between per capita expenditure and launching dates. Given the limitations of the analysis these relations are relatively significant (with R 2 of around 0,5). The relationship between age structure and launch dates seems less strong. All in all, however, sequencing of drug launches cannot be fully explained by its observed relationships with structural characteristics; The descriptive analysis of financing mechanisms indicates that countries that have tax-funded health care financing system tend to have a higher probability for an early launch of a new medicine, than MS where financing is mainly organized on the basis regulation 87

88 of social security contributions. However, this relation is not very strong as there are quite a few exceptions to this case. Furthermore, the analysis illustrates that there is a slightly positive relationship between Out-Of-Pocket payments (OOP) and delay in launch dates. Again this relationship is not very strong; The multivariate analysis of regulatory measures shows that pricing and reimbursement policies in general and international reference pricing practices in particular, are related to the sequencing of launch dates of innovative drugs studied. The data analysis shows a positive relationship between initial pricing regulation and launching dates. This means that drugs are launched generally later in Member States that have more initial pricing regulation. International Reference Pricing (IRP) makes this relation substantially stronger, which indicates the crucial role that IRP plays for the strategic launching of innovative pharmaceuticals. Furthermore, the relationship between expenditure control measures and sequencing of pharmaceutical launches were not clear and seem a less important factor for the sequencing of innovative drugs than initial pricing regulation measures. Delay in launching a product in a country has adverse consequences for both the country itself (e.g. welfare loss because of health gains foregone) as well as for the industry (e.g. shorter period to recoup R&D costs). In the following sections these welfare implications are further specified Welfare effects for originator pharmaceuticals The delay to gain access to the market gives rise to opportunity costs for the originator companies in the form of a loss of operational profits for that period of delay. 193 It basically shortens the period for originator companies (e.g. also referred to as effective patent life) to recoup their extensive R&D costs (e.g. before generic companies enter the market). 194 Because firms rely heavily on cash flows from sales to fund their R&D efforts, fewer sales may imply less R&D spending (and thus fewer pharmaceutical innovations). Research indicates that increasing regulatory delays in approving new drugs decreases the number of new chemical entities discovered per year. 195 The extent of the impact of delays for companies are analysed in annex 1. It is shown that for products that are non-replaceable, the loss of delayed entry vary from 35 million up to over 100 million (in terms of present value of cash flows). It should be said, however, that (potential) higher sales lead to an incentive to launch early because of higher opportunity costs (the analysis in annex 1 shows a strong negative relationship between sales volumes and launch delays) In this respect it goes without saying that the effective exclusivity period is only shortened if the LoE is based on patents/spc.if it is based on data exclusivity the protection period only starts running as of the granting of the MA, i.e. the duration of the grant procedure is irrelevant. European Commission, DG Competition, 2009, Pharmaceutical Sector Inquiry, final report. Hughes JW, Moore MJ, Snyder EA, 2002, Napsterizing pharmaceuticals: access, innovation and consumer welfare. Retrieved: Hughes JW, Moore MJ, Snyder EA, 2002, Napsterizing pharmaceuticals: access, innovation and consumer welfare. Retrieved: 88 regulation

89 A U.S. study estimated that in the US a one-year acceleration of FDA review would, on average, yield an increase of the present value of returns to a typical pharmaceutical product of $22 million (an additional year of patent protection would only yield $13 million). 196 A similar effect is caused by generic entry. Grawbowski and Vernon (1992) estimated that the adverse cash flow effect of an increase in generic penetration in the US on incentives to innovate can be offset by a one-year reduction in the regulatory approval process (or a three-year extension in patent life). These figures are considerable as the development costs of a new medicine are estimated to be approximately 1 billion (see section 2.5 for more details). Reductions in regulatory approval times are more effective than extensions of patent life because they add cash flows during the less heavily discounted beginning of the product lifecycle, rather than the end Effects of pricing and reimbursement measures on R&D and innovation Pricing and reimbursement decisions are taken by the national and/or local authorities within the EU. These decisions can be based on several different mechanisms, differing from country to country. This complex regulatory setting with regard to pricing and reimbursement is an important determinant for pharmaceutical R&D investments within the EU. Trends in the pricing and regulatory frameworks include a tendency for health authorities to move away from crude cost-cutting policies towards cost-effectiveness considerations. This movement towards the cost-effectiveness leads to more rational, evidence based and predictable regulatory decision making. A second trend that we need to highlight is the movement away from national policies towards local responsibilities. In our survey it became clear that each of these mechanisms potentially induces costs to the pharmaceutical industry and could pose delays in the market access of a new drug, which could induce a shortening of the time span to regain R&D investment costs. The direct link between pricing and reimbursement regulation and innovation by pharmaceutical companies appears to have received little (academic) attention. In a study commissioned by the pharmaceutical industry in 2009, the different interlinkages between the various price mechanisms on the one hand and R&D behaviour on the other hand are elaborated in detail and analysed by means of a decision-theoretic model. 198 When looking at two common forms of pricing and reimbursement measures i.e. International Reference Pricing and Internal Reference Pricing, the study distinguish different effects Congress of the United States, Congressional Budget Office, 2006, Research and development in the pharmaceutical industry. Retrieved 2009: Hughes JW, Moore MJ, Snyder EA, 2002, Napsterizing pharmaceuticals: access, innovation and consumer welfare. Retrieved: In ESMT, 2009, a decision-theoretic model is developed that allows to quantitatively evaluate the effects of the main existing pricing and reimbursement schemes on the value of the product portfolio of a representative pharmaceutical firm and to assess the interaction between the different pricing and reimbursement schemes in this evaluation exercise. In the model, pharmaceutical firms evaluate a portfolio of new drug candidates on the basis of a ranking according to the drug candidates Expected Net Present Value (ENPV) and Expected Profitability Index (EPI). regulation 89

90 of these two types of price setting and reimbursement mechanisms on the R&D and innovation behaviour of pharmaceutical companies. 199 Effect of International Reference Pricing on R&D and innovation International reference pricing may lead to a delay in the launch of a new drug in countries with a lower willingness to pay. There is a second-round effect attached to this differentiated launching behaviour: if firms only or firstly launch new drugs in countries with a higher willingness to pay, they will direct their R&D attention towards drugs that address the specific needs of these countries for example diseases that are more prevalent in high-income countries (ESMT, 2009). This could push R&D towards niche markets we refer here as well to the evolution towards customized therapies. Another response to international reference pricing might be to differentiate the new drug across different countries with regard to the drug s characteristics, so that the price cannot be directly compared across two countries (ESMT, 2009). This differentiation across the same product demands financial resources that therefore might not be spent on R&D. More generally, international reference pricing has an effect on availability of funds reserved for R&D investments, as this mechanism reduces the possibility for pharmaceutical companies to sell products at a high price in countries with a high willingness to pay and at a lower price over the entire lifecycle of a product in countries with a lower willingness to pay and thus to gain the maximum amount of sales of a new drug. The dilemma the pharmaceutical firm faces is that if it launches its product in a low willingness-to-pay country, this could also cause a lower price in a country that implements the international reference pricing scheme even if this country has a higher willingness to pay. In a world where nearly one fourth of the regions use the system of international reference pricing, the value of the selected portfolio is calculated to be reduced by approximately 6%. This may consequently lead to a reduction in the number of selected projects and an increased bias against highly innovative and risky projects. Effects of Internal reference pricing on R&D and innovation Internal reference pricing can occur under two forms, one where patented drugs are excluded from the reference system and one where they are included and thus can also be compared to generics. A response of pharmaceutical companies to internal reference pricing could be that projects in later stages of the development process will be cancelled once the company discovers that a competitor will probably reach the market earlier with a similar product. This means that otherwise successful projects might be stopped: the sunk costs related to these abandoned projects increase the R&D costs per product that effectively reaches the market (EMST, 2009). This hypothesis is confirmed by the high attrition rates described in the literature by Pammolli and Ricaboni (2007). Based on various surveys conducted among large pharmaceutical companies in both the EU and the US, Pammolli and Ricaboni (2007) calculated the number of R&D projects passing with success to the next stage of a R&D trajectory and the number of project 199 In international reference pricing, the price of a drug in a country is compared to and determined by the price of the same drug in a reference country or in a basket of reference countries. Internal reference pricing determines the price of a new drug on the basis of a similar drug in the same country. 90 regulation

91 discontinued. Their findings suggest that during the 1990s attrition rates of pharmaceutical R&D projects increased. Especially in clinical phases II and III, the probability of success of R&D projects dropped significantly between 1990 and 2000: from about 50% success ratio to ca. 30% on average in clinical phase II and from ca. 80% to 50% on average during clinical phase III (Pammolli et al. (2007): 116). Using results from the Bain Drugs Economics Model (2003), Mertens (2005) comes to a similar conclusion. While in the early nineties, 1 out of 8 drug candidates launched at the preclinical stage passed successfully all subsequent stages and got commercially launched. In , this ratio had dropped to 1 out of 13 (Mertens (2005): 37) Welfare effects for patients For patients, the delay in access to (innovative) medicines can have a negative effect on their health. It can lead to a lower quality of life or even shorter life expectancy. Many researchers have calculated the considerable welfare gains that can be gained if patients get access to innovative new medicines to replace their consumption of older medicines. Wilking and Jönsson (2005) for example show in their research that an increase in the number of available drugs is associated with an increase in both the 1-year and the 5-year survival rates of cancer patients. 200 In another study it was found that approximately $ in medical expenditures is required to gain one life-year, while only $1345 in pharmaceutical research and development is needed to yield the same benefit. 201 However, almost no research has been undertaken to estimate the welfare effect due to the delays described above to access to (innovative) medicines for patient welfare. One way of estimating this welfare effect is the use of quality-adjusted life years (QALY s) which put a monetary value on the increase in quantity and quality of life lived as a result of a medical intervention. It is based on the number of years of life that would be added by the medical intervention. Each year in perfect health is assigned the value of 1.0 down to a value of 0.0 for death. If the extra years would not be lived in full health, then the extra life-years are given a value between 0 and 1 to account for this. The monetary value attached to a QALY differs per country and the concept of a QALY is sometimes criticized because it is based on a utilitarian principle and it does not reflect important values such as equity and societal preferences. Additionally, the QALY estimates depend on the viewpoint by which they are approached. Different viewpoints such as from the side of patient groups, taxpayers, average citizens, or even epidemiologists and health economists frequently result in different QALY estimates Wilking N, Jönsson B, 2005, A pan-european comparison of patient access to cancer drugs. Karolinska Institutet, Stockholm. Tsjachristas A, Goudriaan R, Groot W, 2008, The welfare effects of innovative pharmaceuticals a pilot study for the Netherlands, APE BV, Maastricht University. McGregor & Caro, regulation 91

92 In a recent Dutch study 203 it is estimated that in the benchmark scenario (with a QUALY equal to ) that the welfare effect of having access to new innovative medicines was 1.7 billion in 2006 in the Netherlands. Since the average delay in the introduction of a medicine in the market after registration was 7 months in that year in the Netherlands, it is estimated that this delay resulted in 2006 to 970 million (= 1.7 billion *7/12) foregone welfare gains. In the case of their lower scenario (QUALY = ) they estimated that there would be no foregone welfare gains 204 and in the case of the upper scenario (QUALY = ) they estimated 2 million in foregone welfare gains. 205 Although we can not extrapolate the Dutch result to the other EU Member States, the estimate of 970 million in one year (2006) in one country (the Netherlands) of foregone welfare gains as a result of the delay between market authorization and market access (in this case 7 months) gives a first indication of the considerable order of magnitude of the welfare effect for the EU as a whole which could be achieved if the earlier described delays would be shortened. One could even argue that the negative welfare effect caused by the delay is in reality even considerably higher because R&D costs are not immediately responsive to the length of the delay and thus could be seen as sunk costs Welfare effect for health care budgets For health care budgets, the delay in access to (innovative) medicines can reduce the gains in total costs of treating a disease as a result of a new drug. According to Lichtenberg (2001) on average a new drug resulted in a reduction of $71.09 in non-drug spending and an $18 increase in prescription costs. In absolute number, Lichtenberg (2002) estimates that a one year reduction in the age of drugs utilized reduces non-drug expenditure 7.2 times as much as the increase in drug expenditure. In another study (2006), Lichtenberg shows that in 2003 the reduction of hospital and nursing home expenditures outweighs the increase in drug expenditure as a result of new drug introductions in the period Welfare effect as a result of generic entry Description Generic entry into the pharmaceutical market has a profound effect as it changes the market from a monopolist to multiple sellers. One of the most important observed effects of this change is the drop of the average prices. The Sector Inquiry of the European Commission (2009) deals in-depth with this particular topic. As a consequence, we keep The authors have analyzed the data of 16 studies from CVZ, 26 studies of NICE/CADTH and 13 from their own literature review (3 studies are common in the CVZ and NICE/CADTH samples). Their selected sample concerned 52 innovative medicines of 24 different pharmaceutical companies in the Netherlands. The authors Tsiachristas, Goudriaan and Groot (2008) warn that one has to be careful in interpreting the negative overall results in the lower alternative scenario as this is almost entirely based on the NICE/CADTH sample. Tsjachristas A, Goudriaan R, Groot W, 2008, The welfare effects of innovative pharmaceuticals a pilot study for the Netherlands, APE BV, Maastricht University. Tsjachristas A, Goudriaan R, Groot W, 2008, The welfare effects of innovative pharmaceuticals a pilot study for the Netherlands, APE BV, Maastricht University. 92 regulation

93 this section brief and refer in the text below to the conclusions of the Sector Inquiry. We want to emphasise that this does not mean that the welfare effect as a result of generic entry is any less relevant than other welfare effects more elaborately explained in this report. In the Sector Inquiry (2009), the European Commission estimates an average drop in price by almost 20% after the first year following loss of exclusivity and about 25% after two years. In rare cases, for some medicines in some Member States, the decrease in the average price index was as high as 80-90%. This price reduction is of benefit for the consumers of care and the payers of care (e.g. national governments). If generic entry would be instant after loss of exclusivity these benefits would be reaped to the maximum level possible. This is however not the case. In the Sector Inquiry the European Commission (2009) estimates that the average time for a generic medicine to enter the market after loss of exclusivity is about 12 months in absolute terms, whereas it is about seven months in weighted value terms Welfare implications In the Sector Inquiry (2009) the European Commission has made an estimate of the loss of potential savings (for the payers of care) that would have been attainable in case generic entry had taken place immediately upon loss of exclusivity of the originator medicine. They have estimated that taking the volumes in the year prior to expiry as a benchmark the cost of the average time to entry on their E75 sample under consideration can for the entire period be roughly estimated at 3 billion (at retail prices). 208 Of course, generic entry also imposes a welfare loss for the originating firms. As an illustration of the scope of this welfare loss, some drugs, the so-called blockbusters, have sales of well over US$ 1 billion per year. Yet after the expiration of a patent, revenues can quickly diminish and companies may be forced to lower their profit margins because of generic competition. For example, in 2003 the quarterly sales revenue of its three medicines Glucophage IR, Taxol and Serzone of Bristol-Meyers Squibb dropped by 90% after patent protection expired. 5.6 Welfare effects as a result of parallel trade The welfare effects of parallel trade are ambiguous. The main argumentation in favour of parallel trade is that it results in lower drug prices benefiting national governments and consumers. Other authors however argument that parallel trade puts pressure on the profit The sales in the year before expiry have been approximated by taking 12 times the sales in the month of expiry. This estimate is based on 17 Member States only, where sufficient observations were available. regulation 93

94 margin of drug manufacturers. 209 Both viewpoints are analysed from a welfare point of view below Impact on price level Theoretical framework Because parallel importing in countries with higher drug prices can lead in the short and medium term to a savings benefit theoretically speaking parallel trade can be welfare enhancing. 211 The savings benefit is the result of two effects 212.: First, direct saving (welfare effect) will be the result as the same quantity of drugs will be consumed as before, but a certain quantity (parallel imports) will now be sold at a lower price. The assumption is made that overall demand does not change when the prices decrease; Secondly, if price competition results in a downward pressure on the price of the originator products then indirect savings (price effect) will also occur on the remaining quantity consumed as the originator price will be lower than it otherwise would have been without parallel importing. 213 In relation to the indirect price effect, once a parallel product occurs within a market theoretically- some price convergence is expected. Price convergence depends on consumers valuing the original and the parallel imported drug equally, otherwise some level of price difference that reflects the differences in consumer preferences and willingness/ability to pay will always persist. 214 However, it is disputed that this welfare effect is achieved through superior production efficiency. Instead, it is mentioned that countries achieve low pharmaceutical prices and become parallel exporters usually through stringent price regulation or weak patent protection. Since pharmaceutical production must conform to regulated good manufacturing practice (GMP) in all countries, production techniques are uniform throughout the EU. The only possible source of savings is lower labour cost of packaging and processing which is a tiny fraction of total costs. In fact, because parallel trade exploits regulated price differences that do not reflect real cost differences, parallel trade can actually increase societal costs because of additional transportation and administrative costs, and yet still be profitable for the trader. 215 Moreover, in the short term, the net distributive effect of parallel trade is largely to transfer revenues from manufacturers to intermediaries who capture most of the margin between the low export price and the higher regulated price in the importing country. Consumers and payers benefit only to the extent that payers reduce distribution margins to reflect the lower Ganslandt M, Maskus KE, 2004, Parallel imports and the pricing of pharmaceutical products: evidence from the European Union, Journal of Health Economics, 23(5), Kyle MK, 2008, Strategic response to parallel trade, London Business School, NBER and CEPR Enemark U, Pederson KM, Sørensen J, 2006, The Economic Impact of Parallel Import of Pharmaceuticals, University of Southern Denmark. Enemark U, Pederson KM, Sørensen J, 2006, The Economic Impact of Parallel Import of Pharmaceuticals, University of Southern Denmark. Enemark U, Pederson KM, Sørensen J, 2006, The Economic Impact of Parallel Import of Pharmaceuticals, University of Southern Denmark. Ganslandt M, Maskus KE, 2001, Parallel Imports of Pharmaceutical products in the European Union Danzon PM, 1998, The Economics of Parallel Trade in PharmacoEconomics, 13(3), regulation

95 prices of parallel imports as in the UK and the Netherlands. 216 Another point, is that any cost savings (for the government and consumers) from parallel trade are often minimal as a result of the phenomenon of price shadowing where the parallel traders will seek to maximize their profits by offering pharmaceutical products that are priced only marginally below domestically sourced products. 217 Danzon (1998) and Enemark et al. (2006) suggest that through the pressure of parallel trade, pharmaceutical manufacturers will eventually be forced to follow a uniform pricing strategy (same prices for all markets). For countries with higher drug prices this is beneficial as the uniform price will be below the original price, but in countries with lower drug prices (generally also less wealthy countries) the uniform price will end up above the original 218. Arfwedson (2003) is less worried about this effect because, in practice, the European Union is a highly fragmented market. National governments have their own control over the healthcare and reimbursement policies, which widely differ across the European Union. This makes it impossible for pharmaceutical manufacturers to set drug prices at their own free will. Government of countries with low drug prices can perform some level of price control, for example by setting a maximum price level on certain pharmaceutical products. 219 Empirical studies Several studies have investigated the amount of direct (welfare effects and indirect savings, e.g. price effect) credited to parallel trade. See for an overview of the various study results the table on the subsequent page. 220 The two largest studies the York study (2003) 221 and the LSE study (2004) have dominated the debate on parallel trade in recent years and considerable differences between the methods used and the results obtained especially for Germany, Sweden, and the UK (see also overview table) are observed. 223 Due to these and other drawbacks, Enemark, Pederson and Sørensen (2006) conclude that the methodology applied for estimating direct savings on drug expenditures by the York study is the most appropriate and have used their methodology also in their own research (see bottom of the table and Danzon PM, 1998, The Economics of Parallel Trade in PharmacoEconomics, 13(3), Maclean N, 2004, Parallel Trade in Medicines, The Social Market Foundation. 218 Danzon PM, 1998, The Economics of Parallel Trade in PharmacoEconomics, 13(3), ; Enemark U, Pederson KM, Sørensen J, 2006, The Economic Impact of Parallel Import of Pharmaceuticals, University of Southern Denmark. 219 Arfwedson J, 2003, Parallel Trade in Pharmaceuticals, Centre for the New Europe. 220 Enemark U, Pederson KM, Sørensen J, 2006, The Economic Impact of Parallel Import of Pharmaceuticals, University of Southern Denmark. 221 West P, Mahon J, 2003, Benefits to payers and patients from parallel trade, York, York Health Economics Consortium. 222 Kanavos P, Costa-i-Font J, Merkur S, Gemmill M. The economic impact of pharmaceutical parallel trade in European Union member states: A Stakeholder analysis LSE Health and Social Care, London School of Economics and Political Science. 223 The York study has been carried out by the York Health Consortium at the University of York and was sponsored by the European Association of Euro-Pharmaceutical Companies while the LSE study has been carried out by LSE Health and Social Care at the London School of Economics and was sponsored by Johnson & Johnson. According to Enemark, Pederson and Sørensen (2006) the two different sponsors clearly had an effect on the study results. While the LSE report concludes that the benefits to patients and healthcare systems are negligible, the York study estimates that parallel trade generates significant savings. The York study concluded that parallel trading gives significant direct savings with signs of indirect competitive effects while the LSE study found only very modest savings and no signs of competitive effects. The York study pointed to direct benefits to patients as well as indirect savings in the national health system, while the LSE study found limited direct benefits to patients and concluded that the main beneficiaries of parallel trade are the parallel traders 223. regulation 95

96 subsequent text). Their study estimates considerable savings in the four countries, although lower than the York study. A comparison made with previous results from the York Study (notably based on 2001 data) shows decreasing savings over time and most notably in Germany and UK. In Germany direct savings declined by 32%, while in the UK the estimated direct savings were reduced by approximately 20%. According to Enemark et al. (2006) regulatory changes that have taken place in recent years have contributed to this decline in savings, e.g. the strict price control in Sweden and the change in PI quotas and mandatory rebates to sickness funds in Germany. Thus, for Germany the savings are exceptionally low in 2004 due to the temporary but significant increase in the mandatory discounts to sickness funds, which led to withdrawal of about one-third of the PI products. Estimated savings for Germany in 2003 amounted to 213 million and the 2005 figures will be higher than for Other explanations for the apparent decrease in savings offered by Enemark et al. (2006) are that prices have converged so that the savings per quantity sold are lower, or that supplies have been increasingly restricted and therefore sales have gone down. Table 5.6 Summary results of selected studies Year of Direct savings of indirect savings/price Study research Country parallel trade effect Selection York 2002 study 224 UK 342 m* Germany 194 m Limited price effect: decreasing price for on- Top-selling products + Sweden 47 m patent drugs with random sample Netherlands 32 m competition. Increasing of 150 products. Denmark 16 m price for on-patent drugs without competition. Competitive price effects have occurred in the pharmaceuticals markets of Denmark, Sweden, Germany and the United Kingdom as a result of parallel trade. In the Dutch pharmaceutical market the Total 635 m** evidence was inconclusive LSE study 225 UK Germany 6,9 m 17,7 m No price effects 6 product categories.19 Sweden 3,8 m products Netherlands 12,8 m covering 21% of Denmark 3 m brand market West P, Mahon J. Benefits to payers and patients from parallel trade York, York Health Economics Consortium. Kanavos P, Costa-i-Font J, Merkur S, Gemmill M, 2004, The Economic Impact of Pharmaceutical Parallel Trade in European Union Member States: A Stakeholder Analysis, LSE Health and Social Care, London School of Economics and Political Science. 96 regulation

97 Year of Direct savings of indirect savings/price Study research Country parallel trade effect Selection Norway 6 m Total 44,8 m** Persson et Sweden SEK 110 m al mi 108 million SEK (13 million ) 6 selected products with 2-3 sub categories. Additional pharmacy costs estimated to be 2%-133% of realised savings. Riksförsäkri 1999 Sweden SEK m n.a. Estimates based ngs- 5 m + pharmacy on pharmacy verket 227 price margin purchase price, so this should be added. Ganslandt & Sweden n.a. Significant price effects. Maskus 228 Price reduction of 4% for goods subject to competition by parallel trade. Taking market contestability into account: 50 highest selling products in 164 forms. For a subset also detailed prices for exporting countries Linnosmaa 2001 Finland 4.9 m (incl. et al. 229 indirect savings) originator prices cut up to 19%. no price effects found Assumes that all price changes after parallel trade are caused by parallel trade Enemark et 2004 for Direct Indirect This study uses the same The 50 products al. 230 direct effect Denmark 14,2 8,3 methodology as the York that were the Persson U, Anell A, Persson M, 2001, Parallelhandel med läkemedel i Sverige en ekonomisk analys, Lund, Sverige, IHE Institutet för Hälso- Och sjukvårdsekonomi. Riksförsäkringsverket, 2000, Parallelimporterade läkemedel - inte till vilket pris som helst, Report no. 2000:6, Redovisar. Ganslandt M, Maskus KE, 2004, Parallel imports and the pricing of pharmaceutical products: evidence from the European Union, Journal of Health Economics, 23(5), Linnosmaa I, Karhunen T, Vohlonen I, 2003, Parallel importation of pharmaceuticals in Finland: effects on markets and expenditures. Pharmaceutical Development and Regulation, 1(1), Enemark U, Pederson KM, Sørensen J, 2006, The Economic Impact of Parallel Import of Pharmaceuticals, University of Southern Denmark. regulation 97

98 Year of Direct savings of indirect savings/price Study research Country parallel trade effect Selection and Germany 45,3 16,4 study. Considerable highest selling 2004 for Sweden 145,0 n.a. savings although lower products in indirect effects UK 237,0 n.a. 441,5 Total 24,7 than the York study (due to regulatory changes according to the authors, see subsequent text for more details) Source: Enemark U, Pederson KM, Sørensen J, 2006, The Economic Impact of Parallel Import of Pharmaceuticals, University of Southern Denmark. * Includes claw back collects by the NHS ( 134m) as well as an estimated saving from discounts that accrue to pharmacists. ** An explanation of the large difference between both study results is given in the text above the table. A follow-up study of Kanavos and Costa-i- Font (2005) of the LSE study based on IMS data examines the indirect (price) effect of parallel trade in the six EU countries receiving the highest shares of parallel import in the EU in the period Their results indicate that generic competition has an impact on prices of locally sourced originals more so than competition from parallel imports. This is explained in a number of ways. First, prices of locally sourced pharmaceutical products are not sensitive to the presence of parallel-distributed products and, therefore, maintain their structure over time, despite the loss of market share to equivalent imported drugs. The economic rationale in this case is that if prices were driven downwards, revenues would also suffer due to both smaller market shares and lower prices. Second, by reducing prices, local manufacturers would accept that parallel trade poses a threat to their commercial interests; instead, locally sourced products can still maintain market share by offering the so-called price equalization deals to their own distributors and, by extension, to pharmacists. This implies that whereas the list price remains as is, there can be significant discounts to pharmacists. In this case, the latter may also benefit financially but these benefits are invisible. Third, manufacturers are aware that there may be exogenous pressures affecting product supply to parallel distributors, and, therefore, affecting their ability to operate successfully over time. These pressures may relate to the intensity of the regulatory procedure, the coverage of the market by the parallel distributor, the overall market size for certain products, transportation costs, product availability in source countries, and transaction costs where they apply, such as repackaging, relabeling, re-boxing and inserting new patient leaflets. 231 Perhaps the most significant factor influencing the behaviour of parallel distributors is product availability. It is not always guaranteed that a product will be available, or that it will become available from the cheapest possible source; in fact, there is evidence of product shortages in some countries that parallel-export intensively. 231 Kanavos P, Costa-i-Font J, Merkur S, Gemmill M, 2004, The Economic Impact of Pharmaceutical Parallel Trade in European Union Member States: A Stakeholder Analysis, LSE Health and Social Care, London School of Economics and Political Science. 98 regulation

99 Conceptually, therefore, it is questionable whether parallel trade leads to (downward) price convergence over time; by decomposing the available product sample into in-patent and off-patent drugs and examining the effect of parallel trade in each group, the authors have shown that generic competition leads to a downward price adjustment, whereas the effect of price competition from parallel trade is ambiguous Impact on research and development The theoretical argument goes that parallel trade will reduce the (marginal) profits of research and development, which results in cut-backs in R&D. At the same time, the transfer of revenue and profits from manufacturers to parallel importers may also reduce investments in research and development, because parallel importers typically do not invest in R&D. 233 However, till now no empirical studies exist that show how lower manufacturer revenues from parallel trade negatively affects pharmaceutical R&D and new drug development, either in the countries with parallel trade or in the EU overall. Specifically, it is not known whether parallel trade leads to lower R&D spending by manufacturers, nor whether changes in pharmaceutical R&D affect the development of innovative drug treatments versus development of product extensions of existing products. Some EU countries that engage in parallel trade notably the UK and Sweden are home to some of the world s most successful pharmaceutical manufacturers. 234 In addition, the effects of parallel trade on profits in the research-based pharmaceutical industry may not necessarily translate into cuts in research and development, but might equally likely affect other cost areas, e.g. marketing or administration. 235 Then Gyldmark (2000) also remarks that as a result of parallel trade some degree of scarcity of funds for R&D, combined with the increased use of health economic analysis by governments when considering appropriate prices for new pharmaceuticals, may lead to welfare gain as R&D funds may be refocused away from me-too products and minor improvements and towards potential break-through products. 236 The evidence found with regard to the effects of parallel trade on research & development is at best circumstantial. In a study by Danzon (1998) 237 the hypothesis was tested that, in markets that can be separated, differential pricing will be used and new drugs launched promptly, while in non-separable markets prices will converge and delays in the launch of Kanavos P, Costa-i-Font J, Merkur S, Gemmill M, 2004, The Economic Impact of Pharmaceutical Parallel Trade in European Union Member States: A Stakeholder Analysis, LSE Health and Social Care, London School of Economics and Political Science. Enemark U, Pederson KM, Sørensen J, 2006, The Economic Impact of Parallel Import of Pharmaceuticals, University of Southern Denmark. Kanavos P, Gross D and Taylor D, 2005, Parallel trading in medicines: Europe s Experience and Its Implications for Commercial Drug Importation in the United States, AARP. Enemark U, Pederson KM, Sørensen J, 2006, The Economic Impact of Parallel Import of Pharmaceuticals, University of Southern Denmark. Glydmark M, 2006, The economics of parallel trade revisited: possible implications for the social welfare in Europe. Retrieved 2009: Danzon PM, Wang YR, Wang L. The impact of price regulation on the launch delay of new drugs -evidence from twenty-five major markets in the 1990s.Health Economics 2005; 14(3): regulation 99

100 new products will occur in low-price countries. The data analysis suggested that within the EU, the likely parallel-exporting countries in Southern Europe have fewer launches of new chemical entities and a longer average delay in the launch of new products. Furthermore, launch delay appeared to decrease with increased market size and expected price. Controlling for national income the effects were smaller but still significant. These results are, however, merely indicative and do not address the issue of the effects of parallel importing on research and development Impact on product safety Until recently, the arguments surrounding the safety and quality of parallel traded medicines were unproven. The theoretical risk existed that so long as parallel traded medicines could be re-packaged and re-boxed, this could lead to counterfeiting. Yet, parallel distributors are obliged to notify the regulatory authorities as well as the manufacturer of any changes made to the product concerned, thus, making themselves liable in case counterfeit medicines enter the distribution chain from this source. So far limited evidence exists that counterfeit medicines only in a number of cases have entered the supply chain via a parallel distributor, although it remains a general area of concern Effect on developing countries The main problem with allowing parallel trade between first- and third world countries is that pharmaceuticals products that are offered at a much lower price in developing countries due to humanitarian and economical reasons, are re-imported back to first world countries to compete with the higher priced manufacturers product. There is also the danger that illegal imports of medicines will be sold at a large discount or given away to developing countries, but subsequently smuggled back into Europe Welfare implications of regulation The attempts to avoid the negative effects of market failures and to pursue public health goals have led to wide-ranging national policy mixes concerning regulations of pharmaceuticals. These regulations are important as they help to maintain incentives for research & development, they prevent unsafe products from entering the market and they help to reduce costs of pharmaceuticals and medical treatment. However, these regulatory actions are costly in terms of implementation by regulators but also directly and indirectly through compliance and related cost for pharmaceutical firms, purchasers of pharmaceuticals, patients as well as society at large. These important side effects become visible in the pharmaceutical industry s reaction to the regulations considering the Enemark U, Pederson KM, Sørensen J, 2006, The Economic Impact of Parallel Import of Pharmaceuticals, University of Southern Denmark. Kanavos P, Kowal S, Does pharmaceutical parallel trade serve the objectives of cost control in Eurohealth 2008 volume 14 number 2 Pharmaceutical policy: cost containment and its impact. Arfwedson J, 2003, Parallel Trade in Pharmaceuticals, Centre for the New Europe. 100 regulation

101 substantial differences in timing of market entry for new medicines in different countries, the differences in timing of access to generic medicines and the actual wide variations in price levels of pharmaceuticals in different countries. An inventory of known estimates of the cost of different types of regulation and the results of our own empirical analysis confirm that the costs of regulating pricing and reimbursement of pharmaceuticals by individual Member States are substantial, although a total figure cannot be presented due to differences in valuation and costs in the available evidence. The costs are also different for the different parties identified such as pharmaceutical firms, purchasers or reimbursers of health care, individual patients and society at large. During the lifecycle of a pharmaceutical product several forms of regulation have an impact on the timing of market entry and the price charged in the market. In this study particular attention is paid to 1) the costs of patent administration; 2) the costs associated with the process of obtaining market authorisation, 3) costs related to market entry as a result of pricing and reimbursement decisions. In the absence of a common European patent firms have to pay for obtaining and safeguarding patent protection in the different countries of the EU. Compared to other markets such as the USA or Japan the cost of the fragmented European system are higher as a result of translation and due to litigation because it is more costly to enforce patent rights in different countries in the absence of a unified court dealing with patent disputes. Estimates of unwanted patent administration costs vary between EUR million a year. These cost are not only cost to firms applying for patent protection, but also to purchasers of care and ultimately to consumers of pharmaceuticals as they increase upward pressures on prices of pharmaceuticals. Administrative cost also play a role in the process of market authorisation. Estimates vary but total administrative costs associated with market authorisation are expected to be at least EUR 250 million. These cost may be necessary to fulfil the requirements to guarantee that only safe products are allowed to enter the market, but they represent a serious market entry barrier, particularly for SMEs. Any potential for reducing costs and simplifying procedures would thus be valuable. The impact of pricing and reimbursement regulation consists in particular of the costs of delayed entry on the market in individual Member States. Wide variations exist between Member States in the actual access to new medicines over time and the price in each individual market. Empirical analysis conducted for this study confirms existing evidence that these differences are to a large extent related to the impact of different regulatory regimens. In particular the practice of referring to other countries pricing and reimbursement decisions before taking your own decision (known as international reference pricing) seems to amplify the delays resulting from the process of estimating prices and reimbursement levels in national markets. Based on a small sample of new innovative drugs this study estimates that the benefits of a simultaneous introduction in all 27 Member States, in terms of additional (earlier) revenues for firms alone, could add up to EUR 35 million and EUR 100 million per product. Delayed access to medicines also affects the health of patients Whilst no EU-wide estimates of the effect of such regulation 101

102 delays on the health of patients exist, a recent study of access to 51 new medicines in the Netherlands with an average seven months delay in access has been estimated to result in 20,000 healthy life years lost which, if monetised, present a cost to society of about one billion for the Netherlands alone. This inventory of welfare effects of pharmaceutical regulations indicates that substantial scope exists to improve the efficiency of pharmaceutical markets by making regulatory processes smarter and less time consuming. The effects would be that pharmaceutical companies have lower cost which would help reduce cost pressures in the provision of pharmaceuticals and health care to European citizens, who would also gain by having timelier and more equal access to new pharmaceutical treatment opportunities Minimising the side effects of regulation There are various ways in which one can reduce these side-effects. The first way is geared towards the diversity of existing regulatory regimes in the Member States. This implies that different options for improvements exist for different countries. Different measures may be needed in different countries to achieve a more effective and efficient regulatory process. The second way refers to the legislatory powers of Member States vis-à-vis the European Union, which impact on the feasibility of changing regulations at different levels of regulatory authority. The European Commission and Member States have different mandates in this policy area and any solution proposed should strike a balance between the existing instruments at different levels and the policy instruments to be employed. Considering pricing and reimbursement a wide variation in procedures can be observed across Member States, each with their own requirements regarding the type of information that has to be provided to the P&R authority and the way of submitting such information by the producer. Also the assessment of that information and the consequent decision making by the P&R authority vary considerably across Member States. In particular many Member States use international price referencing, owing to a lack of own assessment capacity or other reasons. As we have observed there are major costs associated with this variation, both for producers but also for society at large Proposals to improve coordination and transparency on pricing and reimbursement It is proposed to build on existing coordination efforts and instruments, such as the Transparency Directive which aims to increase the transparency of pricing and reimbursement procedures, while maintaining each Member State s full control over its own decision-making processes. The Transparency Directive may serve as a vehicle for further strengthening the existing regulation and diminishing side effects by reducing transaction costs for producers and shortening the time before a product actually enters the market of the individual Member States. 102 regulation

103 First, better exchange of information among Member States could reduce unnecessary delays in pricing and reimbursement decisions and improve the quality of these decisions. Member States could co-operate more closely in the assessment of industry submissions for pricing and reimbursement of products instead of waiting for the outcome of each others individual procedures by: timely publication of price setting and reimbursement information through a common internet portal; increased information sharing on existing procedures and appraisals for pricing and reimbursement decisions in different Member States; closer technical co-operation e.g. in validating the information on cost-effectiveness or burden of disease that is submitted by the industry; closer health technology assessment co-operation between Member States. For example, some Member States with particular expertise could take the lead in the assessment of information from industry in certain disease areas. This could lead to the formation of a HTA network or the development of a common HTA body. In this regard the Joint Action on Health Technology Assessment , including work on relative effectiveness of drugs could be of interest; 241 Secondly, there is room for a greater convergence in procedures and information requirements between Member States by: exploring the room for the convergence of definitions used in pricing and reimbursement; minimising differences in information requirements for companies when applying for pricing and reimbursement in different Member States. This relates also to requirements for providing information on the criteria such as relative effectiveness for reimbursement as substantial differences exist between Member States concerning the operationalisation of these concepts; closer collaboration between Member States with comparable public health systems and/or located in a similar geographical region. Thirdly, best practices in pricing and reimbursement should be identified and used as benchmark by Member States. This would enhance procedures and serve to progressively reduce variations between Member States. Best practises can be enhanced by: monitoring the actual times taken to make pricing and reimbursement decisions and setting ambitious targets for future performance; progressively moving away from the practice of International Reference Pricing that may delay market entry and create adverse launch incentives, towards greater use of health assessment-based evaluation of pharmaceuticals; collaborating closer between Member States with comparable pricing and reimbursement processes or located in a similar geographical region; ensuring greater coherence in setting reimbursement prices to ensure that the relative value-added of pharmaceuticals is fully taken into account. 241 The Joint Action on HTA is a joint initiative by the European Commission, Member States agencies, the Pharmaceutical Forum and the European Network on Health Technology Assessment (EUnetHTA). regulation 103

104 Finally, modifications could be considered to the Transparency Directive, which aims to obtain an overall view of national pricing arrangements and lays down a series of procedural requirements to ensure that pricing and reimbursement decisions are made in a timely and transparent manner by: requiring Member States to make an annual report including statistical information on the actual times taken to make pricing and reimbursement decisions. This would allow for easier comparison of the overall impact of the Transparency Directive by Member States; elaborating the existing obligation for Member States to take decisions on objective and verifiable criteria, including reporting on actual practices used, effective criteria applied, and the specific scientific methods employed; strengthening the appeal procedures. The Transparency Directive already specifies that Member States should have adequate judicial appeal procedures. This could be strengthened to ensure that effective and adequate judicial appeal procedures must be in place in Member States. 104 regulation

105 Annex 1: Analysis of sequencing introduction of pharmaceuticals regulation 105

106 Systematic sequencing of pharmaceuticals in the EU Introduction This part of the study examines the relationship between launch dates and a number of structural and regulatory characteristics that allow for a differentiation between Member States. The main objective of the analysis is therefore to determine if there is a systematic sequencing of pharmaceuticals in the EU, and if this sequencing can be attributed to country-specific indicators. Delay in launching a product in a country has adverse consequences for both the country itself (e.g. negative welfare effect because of health gains foregone) as well as for the industry (e.g. shorter period to recoup R&D costs). First, a set of structural characteristics is taken into consideration, such as GDP per capita, age composition of the population, health and pharmaceutical expenditure. A second set of structural characteristics includes the financing mode of the health care system. Finally, the analysis addresses the question of whether or not pricing and reimbursement policies affect launching dates and therefore the availability of drugs in the Member States. In particular the practice of International Reference Pricing (IRP) is examined as a factor that plays a role for the sequencing of drugs. The main research questions of the analysis are therefore formulated as follows: Can we identify a systematic sequencing of drug launches in the EU Member States? Can we identify certain countries in which drugs are structurally launched at an earlier or later date? Can we identify a relationship between pricing and reimbursement policies, and specifically between IRP and the sequencing of drug launches? The main difference between our analysis and previous studies on this topic is that it considers only such drugs, which are classified as non-replaceable, or unique, and therefore cannot be grouped together with other drugs. This allows the manufacturer to obtain a premium price on his product, which again potentially enhances his decision to pursue strategic launch behaviour in order to benefit most from a country s structural and regulatory characteristics. This is why strategic behaviour is more likely to be expected for unique pharmaceuticals. The launch pattern of non-replaceable drugs could be crucial with regard to evaluating the role of IRP, as manufactures would prefer launching in such a country first, to which most countries refer later. 106 regulation

107 Methodology The analysis is conducted on two different levels, namely on the level of the Member States, and on the drug level. For the investigation of the above-state questions, the following steps and methods are developed and applied. Ranking The question of whether or not there is a pattern of sequencing of drug launches for the products that we observed was approached on the basis of a ranking of launch dates across Member States. Additionally, for each drug the countries were classified as early, middle, or late launchers, in order to allow for a more differentiated picture. Descriptive Analysis The descriptive analysis examines the relationship between the Member States (as ranked at the country level) and relevant structural, financial and regulatory characteristics in order to identify if the observed launch pattern is determined by such factors. The results are presented mostly in the form of scatter plots, as it best visualizes possible relationships between the variables examined. A line of best fit that indicates the relationship trend is also added. Factor Analysis We have a number of characteristics available that describe the regulatory system in each of the EU Member States. The following three groups were distinguished: the way the initial drugs prices are set; what measures Member States use to control expenditures; what systems Member States use for drug reimbursement. For the descriptive analysis we use a factor analysis technique. Hereby we construct a single measure for each group whereby various indicators are combined. Advantages of this technique are that the number of variables is reduced. This is particularly interesting since we only have information from a limited number of Member States. Besides it allows identification of groups of interrelated variables. A disadvantage is that the measure that is constructed is based on statistical properties. Hence the (economic) interpretation needs to be given specific attention to. Multivariate Analysis Because of the relative small sample size and the possible correlation between explanatory variables, it is not possible by means of a descriptive analysis to identify relationships that are very significant (this is also clear from the relatively low R 2 s in the scatter plots below). The value of the descriptive analysis is then mainly to provide a first check of what we intuitively expect in a form that is understandable for most. In order to correct for the possible interrelations between explanatory variables and to find relations with a higher significance value we subsequently perform a more advanced (and for many less understandable) technique: the multivariate analysis. The multivariate analysis relates launch dates of individual drugs to the various characteristics that were included in the descriptive analysis. Hereto the following regulation 107

108 approach is used. Firstly, for each of the drugs we divide the Member States in four groups: Firstly, the group where the drug is launched early and a second and third group where the drug are being launched later. Finally, we have a fourth group where the drugs have not yet been launched. Based on these four groups we have done multivariate analysis in which we explain the probability of being among the Member States where drugs are launched early. In the model we include characteristics reflecting the structural characteristics, characteristics of the health care system and regulatory characteristics. In particular, we will look at the impact of international reference pricing on the probability to be among the early launching Member States. The analysis can be formulated as follows: (1) Pr(drug launch is early) = f 1 (SC, HC, RC) SC HC RC = structural characteristics = health care characteristics = regulatory characteristics The model is estimated using a logit model. In the analysis countries in which a specific drug has not been launched are left out. Product Sample Criteria for selecting product sample The first and main criterion is that the research sample should consist of products that are differentiated from other products, such that large enough price differences are to be expected. In other words, these types of drugs should be more cost-effective then other drugs and add considerable therapeutic value, such that the manufacturer can obtain a premium price. The higher the premium (or monopolistic) price, the more is there to gain from strategic launch behaviour. Second, the products should preferably be based on various technologies (biotechnology, gen technology, synthetic, nano, etc.) and address diseases that fall in different classes of severity: e.g. cancer (heavy), hepatitis (light). The first criterion should be given a heavier weight in the product selection. As a consequence, it remains to be seen to what extent the second criterion can be fully met. Starting point for sample selection As a starting point for the product selection we used medicines that were listed in the socalled 1b-annex of the Dutch Regulation on health insurance (Regeling zorgverzekering). The medicines on this list are considered non-replaceable (unique) drugs with differences in properties such that they cannot be clustered with other drugs The Regulation on health insurance regulates, amongst other things, which medicines are to be reimbursed by the insurer. These medicines are included in annex 1 of the regulation. The annex contains two lists. List 1-a consists of medicines that are not differentiated enough from existing medicines (with mostly similar indications, routes of administration, targeted age groups and for which no clinically relevant differences in outcomes apply), such that the price equals the group s weighted average price. List 1-b contains products that cannot be clustered because they have unique properties. The price of these medicines is not subject to a maximum; however, in order to be added to the 1-b list (and thus to be reimbursed), the College of Health Insurances estimates the therapeutic value and the efficiency (the latter is a function of the market price 108 regulation

109 The medicines on this list have been granted this status based on an extensive evaluation by experts of various public and non-public reports. While selecting a product sample based on the 1-b list in annex 1 of the Dutch Regulation on health insurance, a few exceptional categories of products on this list should be considered carefully and should (potentially) be eliminated: A first exceptional category of medicines are the antiviral HIV medicines. These medicines are considered non-replaceable by default, although this is (in practice) not always the case, for example, most protease inhibitors. There are, however, also HIV medicines that are unique. 243 ; Another class of medicines are combination medicines that combine several existing (already marketed) medicines into one medicine. If one of the existing medicines is on the 1-b list, the combined medicine is automatically placed on 1-b as well. Combination medicines are to be excluded from our sample by definition. Final selection A first selection of products is based on the medicines that have applied for a 1-b status between 2004 and This concerns the following list. Table 1 Medicines that have been applied for a 1-b status between 2004 and 2008 Trade mark ATC Trade mark ATC Aptivus J05AE09 Prezista J05AE10 Atripla J05AR06 Procoralan C01EB17 Carbaglu A16AA05 Protelos M05BX03 Celsentri J05AX09 Raptiva L04AA21 Emend A04AD12 Revlimid L04AX04 Emtriva J05AF09 Reyataz J05AE08 Exjade V03AC03 Stalevo N04BA03 Faslodex L02BA03 Sutent L01XE04 Ferriprox V03AC02 Tarceva L01XE03 Inspra C03DA04 Telzir J05AE07 Isentress J05AX08 Xagrid L01XX35 Mimpara H05BX01 Cystadane A16AA06 Nexavar L01XE05 Pradaxa B01AE07 Orfadin A16AX04 Wilzin A16AX05 From this list we eliminate Stalevo because it combines Levodopa and Carbidopa with the 1-b drug Entacapone. Stalevo is thus not unique. This also goes for Atripla, which is a HIV medicine that combines Efavirenz, Emtricitabine and Tenofovir, and for Emtriva, 243 suggested by the pharmaceutical company). Based on this assessment, the Minister will decide whether or not to add the medicine to the 1-b list, and thus, whether it will be reimbursed at the price that the manufacturer suggests. See also the Dutch text: College voor zorgverzekeringen, 2004, Aanscherping berekeningssystematiek GVS-vergoedingslimieten Eerste rapportage uitvoeringstoets modernisering GVS, retrieved 2009: GVS_tcm pdf. For example: Celsentri, which is an entry or fusion inhibitors that does not know any alternative (yet!). regulation 109

110 which is a HIV medicine belonging to the group Nucleoside Reverse Transcriptase Inhibitors (NRTIs) and has multiple alternatives. Furthermore, we should be careful in the analysis with Aptivus, Prezista, Reyataz and Telzir because these are protease inhibitors that are in principle mutually inter-changeable with each other and with other existing protease inhibitors. However, the guidelines of HIV specialists specifically prefer Telzir (also knows as Fosamprenavir) as the preferred protease inhibitor. Finally, it should be mentioned that in 2009 EMEA has retracted the market authorisation for Raptiva. This does not affect the analysis because 2009 is not included; however, it may give reason to pay special attention to Raptiva in the analysis. The final set of products is presented in the table below. The table also shows the disease that the product treats. Table 2 Finale product sample Trade mark Product name ATC Disease Raptiva Efalizumab L04AA21 Plaque psoriasis Procoralan Ivabradine C01EB17 Angina pectoris Revlimid Lenalidomide L04AX04 Multiple myeloom / myelodysplastic syndromes (MDS) Celsentri Maraviroc J05AX09 HIV Exjade Deferasirox V03AC03 Chronic iron overload due to frequent blood transfusions Tarceva Erlotinib L01XE03 Non-small cell lung cancer (NSCLC) Xagrid Anagrelide L01XX35 Essential thrombocythaemia patients Emend Aprepitant A04AD12 Chemotherapy-induced nausea and vomiting (CINV) Sutent Sunitinib L01XE04 Carbaglu Carglumic Acid A16AA05 Gastrointestinal stromal tumour (GIST) And Metastatic renal cell carcinoma (MRCC) Hyperammonaemia in patients with N-acetylglutamate synthase deficiency Ferriprox Deferipron V03AC02 Treatment of iron overload in patients with thalassaemia major Isentress Raltegravir J05AX08 HIV Mimpara Cinacalcet H05BX01 Secondary hyperparathyroidism (HPT) in patients with end-stage renal disease (ESRD) on maintenance dialysis therapy. Cystadane Trimethylglycine A16AA06 High homocysteine levels Orfadin Nitison A16AX04 Hereditary tyrosinemia type 1 Wilzin Zinc_Acetate A16AX05 Wilson's disease Inspra Eplerenon C03DA04 Chronic heart failure Nexavar Sorafenib L01XE05 Hepatocellular carcinoma and Treatment of patients with advanced renal cell carcinoma (MRCC) who have failed prior interferon-alpha or interleukin-2 based therapy or are considered unsuitable for such therapy Protelos Strontium M05BX03 Postmenopausal osteoporsis 110 regulation

111 Trade mark Product name ATC Disease Ranelate Faslodex Fulvestrant L02BA03 Metastatic breast cancer in postmenopausal women Pradaxa Dabigatran B01AE07 Anticoagulant, i.e. it stops blood from clotting Telzir Fosamprenavir J05AE07 HIV Systematic sequencing of drug launches Ranking at the country level In a first step, Member States are ranked according to their average launch dates. There were 18 countries used for the ranking, namely Austria (AT), Belgium (BE), Germany (DE), Denmark (DK), Estonia (EE), Greece (EL), Spain (ES), Finland (FI), France (FR), Hungary (HU, Ireland (IE), Italy (IT), Netherlands (NL), Portugal (PT), Sweden (SE), Slovakia (SK), Slovenia (SL) and United Kingdom (UK). Considering the fact that almost no information on launch dates is available for Italy and Belgium, these two countries are not taken into account in the analysis. The ranking was based on the available information on launching dates for the following drugs: Procoralan, Mimpara, Raptiva, Tarceva, Sutent, Inspra, Nexavar, Protelos, Faslodex, Exjade, Pradaxa. 244 For each MS, a rank is given according to its relative positioning for the introduction of each of the pharmaceuticals mentioned above (the MS that introduces the drug first is given rank 1). The rank scores are then added up and divided by the number of drugs that were actually introduced on the respective market. Based on the score they obtained, the Member States were then assigned an overall ranking. Chart 1 provides an overview of the ranking that will be used in the analysis (Method 2). In the Appendix a table is shown that gives an overview of the score and the ranking of each Member State. Method 1 includes all the pharmaceuticals, whereas Method 2 includes only those that were introduced in most Member States. For the analysis, Method 2 was chosen. 244 The following drugs were excluded for the ranking, as they were introduced only in a few of the member states: Emend, Ferriprox, Xagrid, Telzir, Revlimid, Isentress, Cystadane, Celsentri, Wilzin, Orfadin, Carbaglu. regulation 111

112 Chart 1 Ranking according to Method 2 Launch Data ranking According to Method 2 14,0 12,0 10,0 8,0 6,0 Score_2 4,0 2,0 0,0 DE AT IE UK DK SE EL FI NL SK HU ES SI FR PT EE Ranking at the drug level At the drug level, all 22 pharmaceuticals were considered. For each of those, specific launch dates were examined and launch groups were constructed. In the general case, MS that launched a drug within 6 months of the first introduction date were classified as early launchers, and the MS that were within the last six months of the time span were defined as latecomers. However, given the very big differences for the launching period between drugs, in a number of cases this definition was adapted for the specific case, as launching dates were either too close to each other, or too far apart. The following table provides an overview of launching groups on the drug level, indicating what percentage of the countries taken into consideration rank within a certain group. 112 regulation

113 Table 3 Grouping of countries according to launch dates at the drug level Trademark Launch group Not Early Middle Late launched Cystadane 6,3% 37,5% 18,8% 37,5% Emend 12,5% 43,8% 31,3% 12,5% Exjade 6,3% 37,5% 50,0% 6,3% Faslodex 43,8% 31,3% 25,0% Ferriprox 18,8% 18,8% 37,5% 25,0% Inspra 37,5% 25,0% 37,5% Isentress 43,8% 12,5% 6,3% 37,5% Mimpara 25,0% 25,0% 43,8% 6,3% Nexavar 25,0% 37,5% 37,5% Pradaxa 25,0% 12,5% 56,3% 6,3% Procoralan 50,0% 25,0% 25,0% Protelos 18,8% 31,3% 43,8% 6,3% Raptiva 37,5% 31,3% 31,3% Revlimid 25,0% 18,8% 25,0% 31,3% Sutent 31,3% 37,5% 31,3% Tarceva 37,5% 31,3% 31,3% Telzir 37,5% 12,5% 18,8% 31,3% Xagrid 18,8% 31,3% 25,0% 25,0% Total 27,8% 27,8% 31,9% 12,5% Descriptive Analysis Structural characteristics In order to find if there is a systematic sequencing of drug launches in EU MS, several structural characteristics, such as GDP and GDP per capita, health and pharmaceutical expenditure, as well as age structure of the population are taken into consideration. GDP and GDP per capita are indicative of the market size and the ability of a country s population to pay for a new product. Health care expenditures tend to rapidly increase with age. Therefore pharmaceutical companies might seek to first launch new products in countries where the proportion of old-age population (and thus the necessity for pharmaceuticals) is higher (OECD 2006). Finally, pharmaceutical expenditure is an indicator of the willingness of a certain country s population to pay for pharmaceuticals. Differences in this respect are driven not only by affordability considerations, but also by cultural and social factors regarding the use of medicines (Okunade and Suraratdecha, 2005). By that, pharmaceutical companies are likely to consider such structural characteristics for their launching decision. regulation 113

114 The graphs shown in this section represent the relationship between the score each MS has achieved according to its average launching dates (X-axis), and a range of structural characteristics (Y-axis). The better the score on launching dates, the closer the country is to the origin. The upper part of the graphs contains the countries that score highest in terms of structural characteristics. GDP and GDP per capita Germany and UK have the highest GDP in absolute terms and are also among the forerunners in the launch dates ranking. However, among the other countries, apart from a cluster of countries with comparable GDP and similar ranking scores (Austria, Sweden, Denmark, Ireland), there seems to be no clear link between GDP and sequence of launch dates. Therefore we cannot conclude that market size alone determines the launch pattern that we observe. Per capita GDP could shed further light on the relationship between drug sequencing and structural characteristics, as it indicates the affordability of drugs for the population of a certain country. The second part of Graph 1 illustrates that there is a general negative relationship between per capita GDP and launching dates (i.e., the higher the GDP per capita is, the more we observed a timely launch). Also, a cluster of Southand East European countries (EL, AL, PT, SK, HU, EE), which have the lowest GDP per capita are found in the bottom end of the launch dates ranking. However, there are still substantial exceptions from this trend. Most notably - despite similar per capita GDP levels to the ones of the forerunners - Finland, The Netherlands and France score substantially worse in terms of launching dates. This indicates that market size and ability to pay are not the only factors that pharmaceutical companies take into account for their decision where to launch a certain drug first. 114 regulation

115 Graph 1 Ranking of Member States by launching dates of innovative drugs versus GDP and GDP per capita, 2006 Data: Eurostat (2006). Age structure of the population The age structure of the population, measured in terms of proportions of different age groups (0-5, 65+, 80+) were examined in order to see if there is a relationship between countries that have a higher share of population in a particular age class and their corresponding launch dates pattern. The reasoning behind such a relation is connected with the increased need for pharmaceuticals for certain age groups, like newborns and very old people. By this, pharmaceutical companies could seek to launch their products first in such countries, where those groups form a higher share of the overall population. However, given the fact that the age structure of the MS is rather similar and there are no substantial differences in the shares of population in the age classes between countries, a conclusion that manufacturers base their strategic behaviour on age structure of the population cannot be drawn. Not surprisingly, the most distinct relationship that could be observed was connected to the proportion of very-old aged population (80+) in the total population (Graph 2). Apart from Ireland and Slovakia, there seems to be a negative relationship between launching dates and share of population aged 80 or above. As mentioned above, this result can be explained by the fact that health needs and expenses grow significantly in the final years of life. regulation 115

116 Graph 2 Ranking of member states by launching dates of innovative drugs versus share of population above 80 years, 2006 Source: Eurostat (2006). Per capita health and pharmaceutical expenditure Per capita health and pharmaceutical expenditures could be considered by drug producers as an indicator for the observed ability and willingness to pay for pharmaceuticals in a society. Graph 4 illustrates the relationship between per capita health and per capita pharmaceutical expenditure and the ranking scores the Member States received according to their respective launch dates for the drugs we examined. 116 regulation

117 Graph 3 Ranking of member states by launching dates of innovative drugs versus health and pharmaceutical expenditures per capita, 2006 Source: WHO (2006) Despite very similar per capita health expenditures, Member States perform very differently in terms of launch dates, which is why overall health expenditure per capita does not seem to be of particular relevance for strategic behaviour from the drug producers. The pharmaceutical expenditures per capita do show a clear trend towards better performance for such countries that spend more on drugs, with Germany having both the highest per capita expenditure on pharmaceuticals and the best observed score in terms of timely launching of drugs. An exception from this trend is Ireland, which does not spend more on drugs than a number of other Member States (The Netherlands, France, Spain), but where drugs are launched significantly earlier. The analysis of structural characteristics reveals that sequencing of drug launches cannot be fully explained by its observed relationships between GDP, expenditure and age structure. A number of further factors contribute to the explanation of the launch pattern. System of health care financing A second cluster of characteristics that could hold explanatory value for a specific sequencing of pharmaceuticals is connected to the mode of financing of the healthcare system. In the European context, there are two main forms of financing, namely through regulation 117

118 taxes, and through earmarked contributions. With respect to pharmaceuticals, the mode of financing is crucial insofar as there are differences between the two types in terms of explicitness of the definition of the benefit package, as well as in the scope for costsharing (WHO 2009). Systems that are predominantly financed through social security contributions usually have more explicitly defined benefit packages, even though there are substantial differences between countries in terms of what is covered. It could be assumed that pharmaceutical companies would seek to launch first in such countries, where the benefit package is less specific and thus there is more potential for a certain drug to fall under the coverage of the benefit package. On the other hand social insurance systems are thought to be more generous as revenues are earmarked for health care expenditure. The level of out-of-pocket payments (OOP) is indicative of the cost-sharing in the system, which is most commonly applied for pharmaceuticals. Chart 1 represents a breakdown of the percentage of total expenditure on health by main contribution mechanism for each MS for The numbers do not add up to 100, as other forms of financing, most notably out-of-pocket payments, as well as private voluntary insurance are not taken into account. Chart 1 Breakdown of financing mechanisms as a % of total expenditure Breakdown of financing mechanisms as % of total expenditure 100% 80% 60% 40% 20% Out-of-Pocket Payments Contributions Tax Funding 0% AT BE DE DK EE EL ES FI FR HU IE IT NL PT SE SK SI UK Source: WHO (2009), data for 2005 Degree of tax-financing vs. degree of social insurance contributions-funding Graph 4 illustrates that MS that are predominantly tax-funded score better in terms of timely launching of pharmaceuticals than MS where financing is mainly organized on the basis of social security contributions. One reason for this might be the above-mentioned variance in the definition of benefit packages, which might induce producers to launch first in such countries, where the drugs have a better chance of falling among the coverage of the health insurance. The significant exceptions from this observation are Germany and Austria, where the health care systems are mainly financed through contributions, but which fall into the group of countries with the best scores on launching dates of innovative drugs. 118 regulation

119 Graph 4 Ranking of member states by launching dates of innovative drugs versus degree of tax financing, 2006 Source: WHO (2009), data for Degree of out-of-pocket payments Levels of out-of-pocket payments (OOP) vary significantly across MS. Graph 5 illustrates that there is a slightly positive relationship between OOP and delay in launch dates. This means that countries with higher OOP score in general worse on timely launching of drugs compared to countries where the OOP share is lower. Graph 5 Ranking of Member States by launching dates of innovative drugs versus share of out-of pocket costs, 2006 Source: WHO (2009), data for regulation 119

120 Regulatory characteristics The sequencing of drug launches in MS may also be related to the type and intensity of existing pricing and reimbursement policies. This means that apart from strategic behaviour of the pharmaceutical behaviour in terms of given structural characteristics, specific attention could be paid to the regulatory process in the Member States. We have information available related to the following elements of the pricing of drugs within MS: Basis for initial price decision; Control of expenditure; Product reimbursement. Supply side measures initial price decision For each MS the following information is available regarding initial pricing regulation: Initial price decision based on clinical performance; Initial price decision based on economic evaluation; Initial price decision based on cost of existing treatments; Initial price decision based on cost-plus calculations; Initial price decision based on international prices; Controlled price updates; Other. Table 4 below shows average score on the ranking for launching dates versus the existing initial pricing regulation types. It shows that the presence of whatever type of initial pricing regulation is associated with a worse ranking score in terms of launch dates. Therefore, initial pricing regulation and its impacts on launch delays should be assessed in more detail. Table 4. Ranking of Member States by launching dates of innovative drugs versus initial pricing regulation, 2006 Clinical performance Economic evaluation Cost of existing treatments Cost-plus calculations International prices Controlled price updates No Yes No Yes No Yes No Yes No yes No Yes Average score 6,6 9,1 6,7 8,8 5,8 9,5 7,8 8,5 5,3 8,8 6,2 6,6 Average ranking Supply side measures control of expenditures For each Member State the following information is available regarding control of expenditures: Use of discounts / rebates; Payback; Price-volume agreements; Use of price-freezes and cuts; Other. Table 5 shows that the presence of expenditure control measures is also associated with later average ranking score, even though the difference is not as high as for supply side measures based on initial pricing decisions. 120 regulation

121 Table 5 Ranking of member states by launching dates of innovative drugs versus control of expenditure, 2006 Use of discounts / Price-volume Use of price-freezes rebates Payback agreements and cuts No Yes No Yes No Yes No Yes Average score 8,3 7,3 6,6 10,4 7,1 9,3 6,6 8,9 Average ranking Demand side measures product reimbursement For each Member State the following information is available regarding product reimbursement: Reference Price System; Positive lists; Negative lists; Based on economic evaluation; Other. Table 6 refers to the ranking of countries by launching dates of innovative drugs that do or do not display different product reimbursement policies. Here, the same observation is concluded, namely that such types of regulation are associated with later launch of pharmaceuticals. Table 6 Ranking of Member States by launching dates of innovative drugs versus product of reimbursement, 2006 Based on Reference Price System Positive lists Negative lists economic evaluation Other No Yes No Yes No Yes No Yes No yes Average score 5,3 9,1 5,4 8,6 8,5 5,4 6,4 8,4 7,5 10,4 Average ranking International Reference Pricing (IRP) As a special case of product and pricing regulation, International Reference Pricing (IRP) policies might represent a further factor for the decision of pharmaceutical companies to strategically launch their products. Successful introduction of a certain drug in a country that does not refer to others for the price-setting, but is in a later stage referred to by many other countries for the determination of the drug price there, enables the producers to obtain a higher price on their product in these other countries. We have developed a measure (IRP factor) that reflects the number of countries a Member State refers to relative to the number of countries it is referred to. MS that do not refer to others and/or are referred to by many have the lowest scores on the IRP factor. The chart below illustrates that those MS are also those that are to be most commonly found in the early or middle group of launching countries for the drugs examined. The X- axis shows the ranking of the Member States according to their score on the IRP factor, with the corresponding score indicated in brackets. The stacks on the Y-axis show for what percentage of the cases reviewed a MS has been placed in a certain group with regulation 121

122 regard to launch dates. Germany, which has the best score on the IRP factor, and is referred to by 11, has been among the early comers in terms of drug launches in almost 80% of the cases. Moreover, the MS that refer most to other MS for the price setting of a drug, also have not launched at least 10% of the drugs examined here. Chart 3 International reference pricing scores and launch groups Table 7 100% 80% 60% 40% 20% 0% Ranking of MS according to IRPfactor with corresponding group placement DE (0,09) UK (0,13) AT (0,13) DK (0,17) SE (0,25) EL (0,25) EE (0,5) FR (0,56) ES (0,63) NL (1,25) PT (1,5) SK (1,8) SI (2) IE (2,5) HU (3,25) FI (4,67) Table 7 provides a precise overview of the IRP factor for each MS and the percentage of cases in which they have launched a certain drug early, middle, late, or not at all. The order of the Member States corresponds to the IRP factor, with countries not referring to others (Germany, UK, Austria, Denmark), being placed first. IRP factor and launch groups on the drug level IRP Factor Early Group Middle Group Late Group Not launched DE 0,09 77,8% 16,7% 5,6% UK 0,13 66,7% 27,8% 5,6% AT 0,13 50,0% 33,3% 5,6% 11,1% DK 0,17 61,1% 22,2% 16,7% SE 0,25 33,3% 27,8% 38,9% EL 0,25 27,8% 16,7% 27,8% 27,8% EE 0,5 5,6% 11,1% 55,6% 27,8% FR 0,56 5,6% 33,3% 44,4% 16,7% ES 0,63 33,3% 33,3% 33,3% NL 1,25 22,2% 38,9% 38,9% PT 1,5 5,6% 22,2% 61,1% 11,1% SK 1,8 5,6% 44,4% 38,9% 11,1% SI 2 11,1% 22,2% 50,0% 16,7% IE 2,5 44,4% 27,8% 16,7% 11,1% HU 3,25 11,1% 27,8% 38,9% 22,2% FI 4,67 16,7% 38,9% 33,3% 11,1% Not launched Late group Middle group Early group 122 regulation

123 Graph 4 shows the relationship between the IRP factor and the general ranking of the countries described in the methodology. With the exception of Ireland and Finland, there is a clear link between minimized utilization of international reference pricing as a pricing and reimbursement tool, and better overall performance of a country in terms of launching dates. Graph 4 Ranking of Member States by launching dates of innovative drugs vs. IRP factor score Factor analysis on pricing and reimbursement The previous section showed that pricing and reimbursement policies in general, and international reference pricing practices in particular, are related to the sequencing of launching dates of innovative drugs studied here. Therefore, this section will review such policies in more detail on the basis of a factor analysis, which combines the different categories of supply- and demand side instruments into single measures. The corresponding component matrixes that provide information on the weights of the different policies onto the single factor can be found in the Appendix. Initial pricing and reimbursement regulation In order to examine the overall relationship of initial pricing and reimbursement regulation (P&R) policies and launch dates ranking of countries, a factor score was computed based on the following IPR measures: Initial price/reimbursement decision based on clinical performance; Initial price/reimbursement decision based on economic evaluation; Initial price/reimbursement decision based on cost of existing treatments; Initial price/reimbursement decision based on cost-plus calculations; Controlled price updates; Other. Even though International Reference Pricing also falls into the group of IPR measures, given its above-examined specific relevance for the launch dates pattern that we observe, regulation 123

124 it will also be reviewed as a separate factor. Graph 5 shows the relationship between the factor score obtained from IPR measures, and the ranking of Member States according to launching dates for innovative drugs. The left-hand graph does not consider International Reference Pricing, whereas the factor score in the right-hand graph includes its impact. Graph 5 Ranking of Member States by launching dates of innovative drugs vs. Initial Pricing Regulation factor scores Graph 5 shows that in both cases (with or without international reference pricing included in the set of initial pricing regulation characteristics), there is a positive relationship between initial pricing regulation and launching dates. This means that the more initial pricing regulation there is in a given member state, the worse it scores on launching dates. In the second case, where we consider IRP in the factor analysis, we observe a substantially stronger relationship, which again indicates the crucial role that IRP plays for the strategic launching of innovative pharmaceuticals. Control of expenditures Expenditure control measures were as well combined in a single measure through factor analysis. The measures that were used were: Use of discounts / rebates; Payback; Price-volume agreements; Use of price-freezes and cuts; Others. 124 regulation

125 Graph 6 illustrates the relationship between the ranking of Member States by launching dates and the combined factor score computed for control of expenditure measures. However, the relationship between expenditure control measures and sequencing of pharmaceutical launches is not clear. For instance, despite very similar scores in the launch ranking, UK and Sweden vary substantially with regard to their expenditure control measures. Also, a range of countries with similar factor scores on expenditure control perform very differently in terms of launching dates. This suggests that control of expenditure policies are a less important factor for the sequencing of innovative drugs than initial pricing regulation measures. Graph 6 Ranking of Member States by launching dates of innovative drugs vs. control of expenditure factor score Reimbursement policies Reimbursement policies aim at deciding on the inclusion of the product in the insurance package in a more or less formalized process. In some countries reimbursement is closely linked to price decisions like in Sweden where the decision to reimburse the drug coincides with negotiation about its price. A special case is the reference price system which limits reimbursement to a certain price for a whole cluster of drugs. The remaining part of the price above this limit is usually paid by the patient in the form of OOP. Consequently, pharmaceutical companies might seek to launch their products first in such Member States, where there are fewer restrictions on product reimbursement. The latter suggestion is partially confirmed by Graph 7. It shows that indeed for Germany and the UK, where product reimbursement factor scores are low, performance in terms of timely launching is better. A second cluster of countries with good results on drug sequencing (Denmark, Austria, Ireland, Sweden) however does not exhibit less product reimbursement regulation than many Member States, which score worse in the launch dates ranking. A plausible explanation for this observation arises from the fact that most of the Member States in the right-hand bottom part of Graph 7 have high factor scores on the two other forms on the pricing regulation factors. regulation 125

126 Graph 7 Ranking of member states by launching dates of innovative drugs vs. product reimbursement factor score Costs for firms We have strong indications that pricing and reimbursement policies affect launch delays. This imposes costs on firms that reduce incentives to innovate. Below we illustrate on the basis of four examples how large this effect can be for non-replaceable drugs. The present value (PV) of the forgone revenues under patent life due to delayed launch dates serve as a proxy for the costs of delayed access. Graphically, this is equal to the PV of the area between the pink and blue dotted lines in Figure below. Where the blue dots are the observed sales volumes of product i in country n, launched at t in ; the pink dots are the sales volumes of product i in country n had it been launched at t i1, where t i1 is the date of product i s first launch in a Member State. Figure 1 Sales volume of product i in country n t i1 t in t ix Pink dots from t ix onward are forecasts based on the best fitted (logarithmic or polynomial) trend of the observed sales volumes. We have calculated the PV of the forgone revenues for four products in our sample that we have selected on the basis of the EU wide sales volumes in the last quarter of regulation