• <div class="header-image" style="background-image: url(/live/image/gid/4/2801_V6N8_Header.rev.1537380633.jpg);">​</div><div class="header-background-color"/>

Reference Pricing: Implementing Value Based Payment in Prescription Drugs

September 10, 2018
Public outcry at the high price of prescription drugs has reached a fever pitch. Our national focus on prescription drug costs concentrates on eye-popping, seemingly random price increases on essential drugs, and the stories reporters tell outline a simplistic “villain/victim” narrative with evil drug company executives like Martin Shkreli on one side and hapless, ill consumers on the other. One such example is the public outcry from when manufacturers tripled the price of insulin in just over a decade.[1]  While these prices frighten consumers, insurers and providers alike, pharmaceutical companies argue that they do not reflect net prices of drugs after rebates, which are harder to find and vary from payer to payer. They further argue that high prescription drug costs are necessary to finance continued innovation. One thing is certain: US prescription drug spending in dollars per capita outpaces every other OECD country, with US consumers spending roughly triple their European counterparts.[2][3]

Meanwhile, in other health care sectors, the revolution of value-based payments and accountable care organizations has made tying payments to outcomes a real possibility.[4][5] We can extend these lessons to US pharmaceuticals through a system of reference pricing which would reward pharmaceutical companies for value rather than allow companies to set prices at almost random. The result would speed the development of breakthrough therapies and decrease costs, while preserving the United States’ continued subsidization of research and development in the pharmaceutical industry.[6]

Image: Pharmaceutical Spending, Source: https://data.oecd.org/healthres/pharmaceutical-spending.htmImage: Pharmaceutical Spending, Source: https://data.oecd.org/healthres/pharmaceutical-spending.htm

How we got here (where is here anyway?)

Since the Food and Drugs Act of 1906, the United States Federal Government has played an active role in certifying the safety and legitimacy of new drugs.[7] However, drug pricing has largely been regulated not through Congress, but through anticompetitive enforcement actions. Under this system, the federal government targets price fixing and collusion and forces companies to license out medicines to other manufacturers, as they did in 1958 after companies worked together to inflate the price of the antibiotic tetracycline.[8][9] This “golden era” of drug pricing helped reduce prices for drugs like penicillin, and the Justice Department aggressively pursued price-fixing cases from antibiotics to the polio vaccine. However, changes in patent law in the 1980s increased the so called “exclusivity protections” periods of drugs which extended the time these products were protected from generic copying.[10] These protections were designed to spur development and innovation by giving drug companies a hefty prize for the creation of new therapies. Drug companies will argue that prize is critical to incentivize new drug development and recoup the 800 million - 1.2 billion dollars required to pursue FDA approval, a weak argument given the lack of correlation between research, development costs, and prices.[11]

However, drug companies make between 64 to 78% of total profits in the United States market, indicating that, at some level, drug consumption in the US is supporting research and development and subsidizing cheaper drugs internationally.[12] To phrase the same idea differently, drug companies likely take into account the assumption that drugs can be sold profitably in the United States when investing large sums in research and development and calculated expected returns – removing that assuredness could have serious consequences in the advancement of medicine. Policy solutions therefore should focus on incentivizing drug development that improves health, and leverages transparency and clarity to increase drug pricing competition.

Reference Pricing

One mechanism that could help reduce prescription drug costs while maintaining an emphasis on improving medicine is tying drug pricing to the value that drugs create by improving health. Breakthrough drugs that significantly increase quality of life are developed all of the time, and some of these drugs are expensive. For example, a new class of hepatitis C drug called direct-acting antivirals posed significant costs but was significantly more impactful than existing therapies. However, these drugs are often far outnumbered by “Me Too” drugs which are chemically similar to existing therapies and treat the same ailments.

Companies pour billions into developing “Me Too” medicines because they are more likely to be approved by the FDA, with one study saying that submitting a “Me Too” drug for FDA approval, rather than a unique drug, doubled that drug’s likelihood of acceptance.[13] This incentive structure functions as a deterrent for breakthrough therapies. If we accept the premise that high drug prices translate into research dollars (an imprecise claim), then it follows that policymakers should pay more for breakthrough therapies at the expense of “Me Too” drugs. Then, hoping to snag a sliver of the market shares, companies waste even more patient dollars marketing these drugs to patients and providers; one ProPublica analysis found that top marketed drugs in five months of 2013 were not breakthroughs or top sellers, but were largely “Me Too” drugs where older and cheaper therapies were already available.

One tool which may reduce a firms’ interest in developing and marketing “Me Too” drugs is reference pricing, a strategy employed in many European countries to encourage substantive drug development and cut costs across the system.[14]

Reference pricing functions by requiring drug companies to submit clinical evaluations of drug effectiveness compared to existing therapies, proving not that drugs are safe and effective, but that they are more effective than therapies already on the market. If the drugs are not, in many countries such as Germany and Sweden, the payer (the government, a nonprofit insurance fund or similar) will only reimburse the cost of the new drug up to an average price (or other benchmark, such as lowest price of a drug with sufficient market share) of similar drugs. Drug companies can continue to charge whatever prices they choose to, but are forced to grapple with consumer demand if they choose to charge more than existing therapies that accomplish similar goals. In many countries, if a drug is uniquely effective, it negotiates with payers to reach an agreeable price. In Germany, in the few years after the policy launched, 63% of drugs reviewed were found to have some clinical benefit, leading to a reduction of new, expensive drugs on the market when existing therapies were just as effective.[15]

From Germany to Spain, reference pricing has been associated with significant reduction in pharmaceutical drug costs; one Harvard meta-analysis on reference pricing policies concludes, “that this strategy reduced drug prices, increased utilization of and adherence to targeted drugs, and promoted switching behavior from expensive products to alternatives at or below the reference price.” Between 2009 and 2013, German prices dropped -0.7% per year while US prices grew at 2.7% – and those very same US prices are growing at closer to five percent today. This difference between both countries amounts to tens of billions of dollars.

Image: US Drug Spending Estimates and Projections, Source: https://www.pewtrusts.org/en/research-and-analysis/fact-sheets/2018/02/a-look-at-drug-spending-in-the-usImage: US Drug Spending Estimates and Projections, Source: https://www.pewtrusts.org/en/research-and-analysis/fact-sheets/2018/02/a-look-at-drug-spending-in-the-us

Reference pricing also fits neatly into broader trends in American healthcare. By having private companies respond to market-based incentives, this rewards those companies for the value they provide and hopefully also improve efficiency in the pharmaceutical market. If lawmakers are serious about reducing prescription drug prices, they should leverage market-based incentives to cut waste and focus funds on patient wellbeing.

Student Blog Disclaimer
  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Penn Wharton Public Policy Initiative’s strategies, recommendations, or opinions.


  [1] https://www.pbs.org/newshour/health/whats-behind-skyrocketing-insulin-prices

  [2] https://data.oecd.org/healthres/pharmaceutical-spending.htm

  [3] https://healthpolicy.usc.edu/wp-content/uploads/2018/01/01.2018_Global20Burden20of20Medical20Innovation.pdf




  [7] https://www.fda.gov/AboutFDA/History/FOrgsHistory/EvolvingPowers/ucm054819.htm










  • <h3>USDA Nutrition Assistance Data</h3><p><img width="180" height="124" alt="" src="/live/image/gid/4/width/180/height/124/485_usda_logo.rev.1407789238.jpg" class="lw_image lw_image485 lw_align_right" srcset="/live/image/scale/2x/gid/4/width/180/height/124/485_usda_logo.rev.1407789238.jpg 2x, /live/image/scale/3x/gid/4/width/180/height/124/485_usda_logo.rev.1407789238.jpg 3x" data-max-w="1233" data-max-h="850"/>Data and research regarding the following <strong>USDA Nutrition Assistance</strong> programs are available through this site:</p><ul><li>Supplemental Nutrition Assistance Program (SNAP) </li><li>Food Distribution Programs </li><li>School Meals </li><li>Women, Infants and Children </li></ul><p> Quick link: <a href="http://www.fns.usda.gov/data-and-statistics" target="_blank">http://www.fns.usda.gov/data-and-statistics</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>HUD State of the Cities Data Systems</h3><p><strong><img width="200" height="200" alt="" src="/live/image/gid/4/width/200/height/200/482_hud_logo.rev.1407788472.jpg" class="lw_image lw_image482 lw_align_left" srcset="/live/image/scale/2x/gid/4/width/200/height/200/482_hud_logo.rev.1407788472.jpg 2x, /live/image/scale/3x/gid/4/width/200/height/200/482_hud_logo.rev.1407788472.jpg 3x" data-max-w="612" data-max-h="613"/>The SOCDS provides data for individual Metropolitan Areas, Central Cities, and Suburbs.</strong> It is a portal for non-national data made available through a number of outside institutions (e.g. Census, BLS, FBI and others).</p><p> Quick link: <a href="http://www.huduser.org/portal/datasets/socds.html" target="_blank">http://www.huduser.org/portal/datasets/socds.html</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>Congressional Budget Office</h3><p><img width="180" height="180" alt="" src="/live/image/gid/4/width/180/height/180/380_cbo-logo.rev.1406822035.jpg" class="lw_image lw_image380 lw_align_right" data-max-w="180" data-max-h="180"/>Since its founding in 1974, the Congressional Budget Office (CBO) has produced independent analyses of budgetary and economic issues to support the Congressional budget process.</p><p> The agency is strictly nonpartisan and conducts objective, impartial analysis, which is evident in each of the dozens of reports and hundreds of cost estimates that its economists and policy analysts produce each year. CBO does not make policy recommendations, and each report and cost estimate discloses the agency’s assumptions and methodologies. <strong>CBO provides budgetary and economic information in a variety of ways and at various points in the legislative process.</strong> Products include baseline budget projections and economic forecasts, analysis of the President’s budget, cost estimates, analysis of federal mandates, working papers, and more.</p><p> Quick link to Products page: <a href="http://www.cbo.gov/about/our-products" target="_blank">http://www.cbo.gov/about/our-products</a></p><p> Quick link to Topics: <a href="http://www.cbo.gov/topics" target="_blank">http://www.cbo.gov/topics</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>Federal Reserve Economic Data (FRED®)</h3><p><strong><img width="180" height="79" alt="" src="/live/image/gid/4/width/180/height/79/481_fred-logo.rev.1407788243.jpg" class="lw_image lw_image481 lw_align_right" data-max-w="222" data-max-h="97"/>An online database consisting of more than 72,000 economic data time series from 54 national, international, public, and private sources.</strong> FRED®, created and maintained by Research Department at the Federal Reserve Bank of St. Louis, goes far beyond simply providing data: It combines data with a powerful mix of tools that help the user understand, interact with, display, and disseminate the data.</p><p> Quick link to data page: <a href="http://research.stlouisfed.org/fred2/tags/series" target="_blank">http://research.stlouisfed.org/fred2/tags/series</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>The World Bank Data (U.S.)</h3><p><img width="130" height="118" alt="" src="/live/image/gid/4/width/130/height/118/484_world-bank-logo.rev.1407788945.jpg" class="lw_image lw_image484 lw_align_left" srcset="/live/image/scale/2x/gid/4/width/130/height/118/484_world-bank-logo.rev.1407788945.jpg 2x, /live/image/scale/3x/gid/4/width/130/height/118/484_world-bank-logo.rev.1407788945.jpg 3x" data-max-w="1406" data-max-h="1275"/>The <strong>World Bank</strong> provides World Development Indicators, Surveys, and data on Finances and Climate Change.</p><p> Quick link: <a href="http://data.worldbank.org/country/united-states" target="_blank">http://data.worldbank.org/country/united-states</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>National Center for Education Statistics</h3><p><strong><img width="400" height="80" alt="" src="/live/image/gid/4/width/400/height/80/479_nces.rev.1407787656.jpg" class="lw_image lw_image479 lw_align_right" data-max-w="400" data-max-h="80"/>The National Center for Education Statistics (NCES) is the primary federal entity for collecting and analyzing data related to education in the U.S. and other nations.</strong> NCES is located within the U.S. Department of Education and the Institute of Education Sciences. NCES has an extensive Statistical Standards Program that consults and advises on methodological and statistical aspects involved in the design, collection, and analysis of data collections in the Center. To learn more about the NCES, <a href="http://nces.ed.gov/about/" target="_blank">click here</a>.</p><p> Quick link to NCES Data Tools: <a href="http://nces.ed.gov/datatools/index.asp?DataToolSectionID=4" target="_blank">http://nces.ed.gov/datatools/index.asp?DataToolSectionID=4</a></p><p> Quick link to Quick Tables and Figures: <a href="http://nces.ed.gov/quicktables/" target="_blank">http://nces.ed.gov/quicktables/</a></p><p> Quick link to NCES Fast Facts (Note: The primary purpose of the Fast Facts website is to provide users with concise information on a range of educational issues, from early childhood to adult learning.): <a href="http://nces.ed.gov/fastfacts/" target="_blank">http://nces.ed.gov/fastfacts/#</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>Internal Revenue Service: Tax Statistics</h3><p><img width="155" height="200" alt="" src="/live/image/gid/4/width/155/height/200/486_irs_logo.rev.1407789424.jpg" class="lw_image lw_image486 lw_align_left" srcset="/live/image/scale/2x/gid/4/width/155/height/200/486_irs_logo.rev.1407789424.jpg 2x" data-max-w="463" data-max-h="596"/>Find statistics on business tax, individual tax, charitable and exempt organizations, IRS operations and budget, and income (SOI), as well as statistics by form, products, publications, papers, and other IRS data.</p><p> Quick link to <strong>Tax Statistics, where you will find a wide range of tables, articles, and data</strong> that describe and measure elements of the U.S. tax system: <a href="http://www.irs.gov/uac/Tax-Stats-2" target="_blank">http://www.irs.gov/uac/Tax-Stats-2</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>Federal Aviation Administration: Accident & Incident Data</h3><p><img width="100" height="100" alt="" src="/live/image/gid/4/width/100/height/100/80_faa-logo.rev.1402681347.jpg" class="lw_image lw_image80 lw_align_left" srcset="/live/image/scale/2x/gid/4/width/100/height/100/80_faa-logo.rev.1402681347.jpg 2x, /live/image/scale/3x/gid/4/width/100/height/100/80_faa-logo.rev.1402681347.jpg 3x" data-max-w="550" data-max-h="550"/>The NTSB issues an accident report following each investigation. These reports are available online for reports issued since 1996, with older reports coming online soon. The reports listing is sortable by the event date, report date, city, and state.</p><p> Quick link: <a href="http://www.faa.gov/data_research/accident_incident/" target="_blank">http://www.faa.gov/data_research/accident_incident/</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>MapStats</h3><p> A feature of FedStats, MapStats allows users to search for <strong>state, county, city, congressional district, or Federal judicial district data</strong> (demographic, economic, and geographic).</p><p> Quick link: <a href="http://www.fedstats.gov/mapstats/" target="_blank">http://www.fedstats.gov/mapstats/</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>The Penn World Table</h3><p> The Penn World Table provides purchasing power parity and national income accounts converted to international prices for 189 countries/territories for some or all of the years 1950-2010.</p><p><a href="https://pwt.sas.upenn.edu/php_site/pwt71/pwt71_form.php" target="_blank">Quick link.</a> </p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>National Bureau of Economic Research (Public Use Data Archive)</h3><p><img width="180" height="43" alt="" src="/live/image/gid/4/width/180/height/43/478_nber.rev.1407530465.jpg" class="lw_image lw_image478 lw_align_right" data-max-w="329" data-max-h="79"/>Founded in 1920, the <strong>National Bureau of Economic Research</strong> is a private, nonprofit, nonpartisan research organization dedicated to promoting a greater understanding of how the economy works. The NBER is committed to undertaking and disseminating unbiased economic research among public policymakers, business professionals, and the academic community.</p><p> Quick Link to <strong>Public Use Data Archive</strong>: <a href="http://www.nber.org/data/" target="_blank">http://www.nber.org/data/</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>NOAA National Climatic Data Center</h3><p><img width="200" height="198" alt="" src="/live/image/gid/4/width/200/height/198/483_noaa_logo.rev.1407788692.jpg" class="lw_image lw_image483 lw_align_left" srcset="/live/image/scale/2x/gid/4/width/200/height/198/483_noaa_logo.rev.1407788692.jpg 2x, /live/image/scale/3x/gid/4/width/200/height/198/483_noaa_logo.rev.1407788692.jpg 3x" data-max-w="954" data-max-h="945"/>NOAA’s National Climatic Data Center (NCDC) is responsible for preserving, monitoring, assessing, and providing public access to the Nation’s treasure of <strong>climate and historical weather data and information</strong>.</p><p> Quick link to home page: <a href="http://www.ncdc.noaa.gov/" target="_blank">http://www.ncdc.noaa.gov/</a></p><p> Quick link to NCDC’s climate and weather datasets, products, and various web pages and resources: <a href="http://www.ncdc.noaa.gov/data-access/quick-links" target="_blank">http://www.ncdc.noaa.gov/data-access/quick-links</a></p><p> Quick link to Text & Map Search: <a href="http://www.ncdc.noaa.gov/cdo-web/" target="_blank">http://www.ncdc.noaa.gov/cdo-web/</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>