How do pharmaceutical companies price drugs?

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Companies price drugs to be at a competitive value compared to the current standard of care. Most nations use a Value-Based Pricing approach

Consider a cholesterol-lowering Statin like Lipitor. Consider a patient who isn’t taking Lipitor. That patient has an X% chance of getting a nasty heart attack and dying, a Y% chance of requiring a bypass. If Lipitor reduces the rate of death of heart attacks a bypass by Z%, then the economic and medical benefit of Lipitor should be proportional to Z.

In healthcare terms, companies use Quality-adjusted life year (QALY) which assigns a value of 0 to 1 for the quality and quantity of life lived. A healthy year would be 1. However, if the patient were to become blind or incapacitated then the QALY would be less than 1. What then happens is that the insurer puts a value on what 1 QALY is worth. That value is used to set the prices for every procedure/treatment/pill. Where things get interesting is that QALY is worth differently in different countries; drugs aren’t worth more in the US because companies price them higher, it’s because the QALY is worth more.

From the perspective of healthcare insurers, this has economic value. If a company spends $400,000 on a procedure which has a 1/4 chance of occurring a year, it would make sense to suggest to a patient that they should be paying $100,000 or less for their pills.

Where things get tricky is the impact of side effects and drug adherence. Obviously, if patients don’t take their drugs then the medical benefit goes away. Furthermore, the benefit of taking the drug has to outweigh the risk of side effects. This in turn reduces the “value added” of the pill and reduces the costs. Alternatively, if you have a drug that is better than other drugs, then you can increase the price.

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The price is largely set by the negotiating insurer and is determined by what the going rate is for competing therapies The NHS/NICE, has a fairly straightforward and transparent approach using the Pharmaceutical Price Regulation Scheme.[1] This describes a combination of a Value-Based Pricing with QALY but NICE will also assess whether or not the drug provides sufficient value to the network. The common example is for rare diseases which have a small overall cost to the network but are often overpriced compared to their QALY value.

Part of that system allows for flexible pricing. If new indications of a drug are identified or the evidence of the efficacy of the drug changes, then the price would be adjusted accordingly. However, there is also a monetary cap on how quickly those prices can rise. Another aspect is the concept of Patient Acccess Schemes where things like rebates and discounts are incorporated.

It also defines the criteria of pricing

  1. the price of other presentations of the same medicine or comparable products
  2. forecast sales and the effect on the NHS drugs bill
  3. the clinical need for the medicine
  4. any exceptional costs.

If you’re an economist, I would highly recommend reading these reference documents on drug pricing.

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