Do pharmaceutical prices respond to potential patient out-of-pocket expenses?
ABSTRACT Despite the importance of patient insurance in the market for prescription pharmaceuticals, little is known about the impact of patient reimbursement on the pricing behavior of pharmaceutical firms. I examine the link between potential patient out-of-pocket expenses and pharmaceutical pricing using a unique policy experiment from Germany. Starting in 1989, a maximum reimbursement for a given medicine replaced a flat prescription fee. This change in reimbursement exposes the patient to the price of a prescribed product. Using a product-level panel data set covering several therapeutic categories before and after the policy change, I find that producers significantly decrease prices after the change in potential patient out-of-pocket expenses. Price declines are most pronounced for brand-name products. Moreover, branded products that face more generic competitors reduce prices more.
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ABSTRACT: We model demand for four cephalosporins and compute own- and cross-price elasticities between branded and generic versions of the four drugs. We model demand as a multistage budgeting problem, and we argue that such a model is appropriate to the multistage nature of the purchase of pharmaceutical products, in particular the prescribing and dispensing stages. We find quite high elasticities between generic substitutes and also significant elasticities between some therapeutic substitutes.The RAND Journal of Economics 02/1997; 28(3):426-46. · 1.49 Impact Factor
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ABSTRACT: This paper purports to explain the pricing policy of pharmaceutical companies in Germany prior and after the introduction of reference prices (RP) in 1989. First, the threat of such regulation may have kept prices finite despite a completely insured market. Next, the pricing policies of both the producer of an innovative drug and of a competing generic under RP are predicted. These predictions are then confronted with actual pricing policy for three products in the guise of case studies. Finally, the impact of modified copayment rules on pricing decisions is analyzed. Copyright 1996 by Kluwer Academic PublishersJournal of Regulatory Economics 02/1996; 10(3):257-73. · 0.84 Impact Factor
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ABSTRACT: I examine the importance of physicians in the process by which patients receive either trade-name or generic drugs. Using a dataset on physicians, their patients, and the multisource drugs prescribed, I find that almost all physicians prescribe both types of drugs to their patients, but some physicians are more likely to prescribe generic drugs while other physicians are more likely to prescribe trade-name drugs. Very little of the prescription decision can be explained by observable characteristics of individual patients, but all of the evidence indicates that physicians are indeed an important agent in determining whether patients receive either trade-name or generic drugs.The RAND Journal of Economics 02/1998; 29(1):108-36. · 1.49 Impact Factor
Do pharmaceutical prices respond to
potential patient out-of-pocket expenses?
Dartmouth College and NBER
Department of Economics
6106 Rockefeller Hall
Hanover, NH 03755
Despite the importance of patient insurance in the market for prescription pharmaceuticals, little is
known about the impact of patient reimbursement on the pricing behavior of pharmaceutical firms. This
paper examines the link between potential patient out-of-pocket expenses and pharmaceutical pricing
using a unique policy experiment from Germany.1 Starting in 1989, a maximum reimbursement for a
given medicine replaced a flat prescription fee. This change in reimbursement exposes the patient to the
price of a prescribed product. Using a product level panel dataset covering several therapeutic categories
before and after the policy change, I find that producers significantly decrease prices after the change in
potential patient out-of-pocket expenses. Price declines are most pronounced for brand name products.
Moreover, branded products that face more generic competitors reduce prices more.
Keywords: pharmaceutical industry, pricing, insurance, government regulation
JEL Classification: L11, I11, I18, L65
* I would like to thank Eric Edmonds, Gene Grossman, Penny Goldberg, Bo Honore, Uwe Reinhardt, Jon Skinner,
Doug Staiger, and seminar participants at Dartmouth, Dartmouth Medical School, EARIE, Chicago Business School,
and Federal Trade Commission for many helpful suggestions. An anonymous referee provided very useful
comments. This research was supported by the MacArthur Foundation Grant and the Center for International
Studies at Princeton University.
1 Throughout the paper the term Germany refers to the states comprising the Federal Republic of Germany before
As governments worldwide try to curb their health care costs, policy debates increasingly focus
on the pricing behavior of pharmaceutical firms. Most countries constrain pharmaceutical firms through
direct price regulation. Only a few countries, such as the United States and Germany, allow for product
level price competition and rely on indirect means to reduce pharmaceutical expenditures. The
supporters of price controls justify regulation with the moral hazard problem in prescribing, as physicians
might not internalize the cost of a prescription to the patient or the patient’s insurance provider. They
argue that insurance coverage of prescription pharmaceuticals reduces the sensitivity of physicians and
patients to prices. Yet, little is known whether and how patient out-of-pocket expenses affect the pricing
behavior of pharmaceutical firms. This paper investigates this relation.
Several studies provide insights on whether insurance impacts physician and patient behavior and
thus demand for medical services. Hellerstein (1998) investigates the physician’s prescription decision
between brands and generics, motivated by the puzzle that in 1989, less than 30% of prescriptions for
multi-source drugs specified the generic version even though “generics are generally priced 30-60%
lower than their trade-name counterparts (p. 108).”2 She finds that the patient's insurance plan does not
affect the physician's choice between a brand name and a generic product. However, HMO-affiliated
physicians have a higher propensity to prescribe generics irrespective of a patient’s insurance plan. This
pattern could stem from the cost containment measures imposed on physicians by HMOs. Moreover,
studies based on data from the Rand Health Insurance Experiment document that insurance impacts
demand for health services. The experiment randomly assigned different cost-sharing plans to
individuals and found that the total expenditure (to all parties) on prescription pharmaceuticals is greater
for patients with higher insurance coverage. According to the study, the participants’ “expenditures on
drugs averaged $65 (in 1991 dollars), ranging from $82 on the free care plan to $46 on the 95 percent
2 Multi-source drugs are those that are no longer protected by a patent and are available in brand name as well as
coinsurance plan (Newhouse et.al., p. 165).”
Given the impact of patient reimbursement on physician and patient behavior, my goal is to
explore whether potential patient out-of-pocket expenses also affects the pricing behavior of
pharmaceutical firms. I use a unique policy experiment from Germany. In 1989, Germany implemented
reference pricing, a cost containment scheme that imposes a maximum reimbursable price to a patient for
a given product.3 Producers are free to set their prices, but if the retail price exceeds the reference price
(RP), the consumer pays the difference. Previously, patients paid only a fixed prescription fee regardless
of the prescribed medicine. This change in patient reimbursement directly exposes a patient to the price
of a medication. The change in insurance reimbursement modifies the demand conditions in the market
and thus alters the markup that pharmaceutical firms charge over marginal cost. I evaluate the
relationship between patient out-of-pocket expenses and pharmaceutical prices using a detailed product
level data set that spans years before and after the change in insurance and covers several therapeutic
groups. My identification relies on the comparison of prices before and after the reform. When data
permits, I additionally exploit the lag in the implementation of the reform within a therapeutic group. I
then compare the differences in the intertemporal price response of products that compete in a similar
environment, but face different timing in the changes in patient reimbursement. Finally, I investigate
whether changes in pricing behavior of pharmaceutical firms can be explained by differences in the
competitive pressures firms face.
Germany provides an excellent setting to study the link between patient out-of-pocket expenses
and the pricing by pharmaceutical firms. Unlike the US market with many insurance providers, the
German statutory health insurance covers over ninety percent of the population and always provides
coverage for prescription drugs. This setting enables me to address the question without detailed patient
level data documenting their health insurance plan. Additionally, since most people have the same
insurance coverage there is no selection problem, where people who expect higher medical expenses opt
3British Columbia, Denmark, the Netherlands, and New Zealand also introduced reference pricing.
for a more generous insurance plan. Reliance on country level data could pose a problem if prices
differed across various regions and purchasing outlets as in the United States. German retail pharmacies
are the only place permitted to dispense drugs for outpatient consumers and there is no price variation
across them. The government controls the wholesaler's and retailer's margins, and the prices of the
pharmaceuticals dispensed by pharmacies are uniform by law.
My results suggest that, at least in this case, the pricing behavior of pharmaceutical firms is very
sensitive to potential patient out-of-pocket expenses. This finding is robust to different identification
strategies and therapeutic markets. The estimates of price adjustment to exogenous change in insurance
reimbursement range from 10 to 26%. Brand name products experience the biggest price decline. The
price responses by pharmaceutical firms are partially explained with variation in their exposure to
competition. The drop in prices is sharper for those brand name products that face more generic
competition. Policy implications and generalization of these results are discussed in the conclusion of
The next section presents institutional background on the German pharmaceutical market and the
reference pricing scheme. Section 3 provides theoretical motivation on how changes in patient out-of-
pocket expenses might affect the pricing of pharmaceutical products. Section 4 looks at the data and
descriptive statistics. Section 5 introduces the empirical strategy and discusses the estimation results.
Section 6 concludes.
2. Institutional Background on the German pharmaceutical market
In Germany, the retail pharmacies dispense all outpatient care prescription drugs. These retail
pharmacies are the last stage in the distribution of pharmaceuticals from the manufacturer to the patient.
Pharmaceutical manufacturers sell their products to the wholesaler. Manufacturers are free to set their
prices without government approval before and after the implementation of reference pricing. However,
producers need government approval to launch a new product and must obtain a permit to produce it.
Imported drugs must be licensed and can only be handled by a licensed importer. Moreover, a
manufacturer must sell the product for the same price in a given time period to all wholesalers. The
wholesalers then sell the product to retail pharmacies that deliver it to the patient. The government
controls the wholesaler's and retailer's margins. Thus, by law retail pharmacy prices are uniform across
the country. 4
Insurance plays an important role in the transaction between a patient and the retail pharmacist.
Over ninety percent of the population is covered by statutory health insurance that always includes
coverage for prescription pharmaceuticals. Prior to 1989, patients paid only a fixed prescription fee
when purchasing a pharmaceutical product regardless of the retail price. The 1989 reference pricing
scheme imposes the maximum reimbursable amount (i.e. reference price) for a given product. If the
retail price exceeds the maximum reimbursement, the patient bears the excess cost. Otherwise, the
patient does not need to copay. The consumer continues to pay a DM3 prescription fee only for the
products not subject to a reference price.5 The retail pharmacist is reimbursed directly by the insurance
based on the prescription obtained from the patient. Unlike in the United States, the pharmacist is not
allowed to substitute to a generic product unless the doctor explicitly permits it on the prescription pad.
The dispensed product must match the strength of the active ingredient, the size, and the dosage of the
physician's prescription (Sitzius, pp. 245). I describe how reference prices might affect a physician’s
prescribing behavior in detail in section 3.
The Federal Commission of Physicians and the Statutory Health Insurance Committee determine
reference prices in two stages. In the first stage, they jointly specify the therapeutic groups that should be
under the reference price system. Thereafter, the insurance committee selects the level of the reference
price for the most common package size in a given active ingredient or therapeutic group. The reference
4 The hospital market is completely separate from the retail pharmacy market. Hospitals provide pharmaceuticals
only for inpatient care. They purchase either from the wholesaler or directly from the manufacturer, in which case
they often receive discounts and rebates. For all these reasons, I do not include them in my analysis.
5 In 1993, the prescription fee was extended to all products and it depended on the price of a package: DM3 if retail
price is less than DM30, DM5 if retail price is between DM30 and DM50, and DM7 if retail price exceeds DM50.
Since 1994, prescription fee depends on package size: DM3 for small package, DM5 for medium package, DM7 for