Effect and Response of Health Insurance on Pharmaceutical demand

Fully insured health consumer enjoys the therapeutic benefit of a drug and doesn’t face the cost. If all the consumers are fully insured, only the best drugs in each therapeutic class would be consumed, irrespective of its price. No trade-offs would be made with other drugs.

Consumers without knowledge cannot substitute with lesser known drugs or generics. Drug companies spend huge amount of money in obtaining loyalty of physicians and thus influence consumption of pharmaceuticals. Pharmacists will have a limited role otherwise they too would have been targeted by the drug companies.

We can contrast this market outcome with the hypothetical case in which consumers are perfectly about the prices and therapeutic characteristics of drugs and behave as though they are paying for the drugs themselves. In this case a consumer would have an incentive to carefully trade-off a drug’s health benefits against its cost, both with respect to other competing drugs and other competing health therapies. In such a market many drugs may co-exist in the same therapeutic class, differentiated according to effectiveness and price.

Consumers would quickly substitute for cheaper bio-equivalent generics. Off-patent brand-name

drugs could not be priced higher than their marginal cost of production. Prescribing physicians, to the extent that they are involved in the process, would be acutely sensitive to cost differences between competing pharmaceutical treatments.

Pharmacists and other members of the pharmaceutical supply chain would face strong pressures to minimize their costs and provide services that consumers demand. Drug consumption would be limited to the point where the marginal benefit of the last drugs consumed was equal to the marginal cost.

Response of Health Insurance to its Effect on Demand

Health insurance can have a sizable distortionary effect on the pharmaceutical market. In the effort to offset these effects, health insurers follow regulatory, contractual and financial mechanisms to lower the quantity and price and improve the effectiveness of the mix of drugs consumed.

Health insurer applies these policies in the pharmaceutical marketplace, but this is not always the case. Insurers often purchase the provision of such services from independent agencies. In the US, these third-party agencies are known as “Pharmacy Benefit Managers” or PBMs.

PBMs seek to control drug expenditure (without compromising health outcomes) by maintaining a formulary, establishing prescription guidelines, negotiating with drug suppliers over drug prices, and maintaining a network of pharmacies. Through the use of information technology PBMs are able to monitor the purchases of pharmaceuticals, to ensure that the opportunities for generic substitution are exploited and to ensure compliance with prescribing guidelines.

Outside the US, many governments have chosen to establish specialist pharmacy management agencies which take on one or more of the functions of PBMs in the US, such as responsibility for maintaining the national formulary, negotiating prices controls, or evaluating the cost-effectiveness of new drugs. Examples include the Patented Medicine Prices Review Board in Canada and Pharmacy in New Zealand.

Pharmacy benefit management services are enhanced by the contracting out of pharmacy benefit management services, essentially depending on private rather than public agencies to implement and operate the various demand management techniques. The tendering process would ensure that the selected company had the incentive to keep pharmaceutical costs down to a minimum and to innovate in techniques for monitoring and controlling pharmaceutical expenditure.

The contractual specifications would be complex, requiring specification of the required density of pharmacies, the level of co-payments tolerated, the health care standards desired and the means by which pharmaceutical services would be integrated with the provision of other health services. Nevertheless, the practice in the US among private insurers shows that such tendering is possible. This is one of the rare cases in which responsibility for “regulatory” policies can be delegated to a private profit-maximizing agency. There seems to be merit in exploring this possibility as a tool for both controlling health care expenditures and introducing competition into the pharmaceutical market.