21 March 2013

Patents Not to Blame for High Cost of Drugs in Australia

Drugs and money An article in the Fairfax media this week contends that ‘Australia is wasting more than a billion dollars a year by paying up to 64 times too much for some prescription drugs’.

The claim derives from a report (wittily entitled Australia’s Bad Drug Deal) prepared by Stephen Duckett, former secretary of the Australian Commonwealth Health Department, for the non-aligned think tank The Grattan Institute.

Casual readers skimming over this news might well be inclined to assume that the usual suspects are to blame for high drug prices, i.e. ‘big pharma’, and its pushing of patented ‘blockbuster’ drugs.  However, the report makes for very interesting reading, and tells a very different story.

In reality, according to Duckett, patents pay only a minimal role in the excessive prices being paid, in comparative terms, by the Australian people, mostly by way of the government support provided by the federal government under the Pharmaceutical Benefits Scheme (PBS).  Most of the A$1.3 billion annual savings identified in the report would be made on generics, not patented original drugs.

The real culprits, according to Duckett, are the government itself – for failing to compel more substantial price reductions when drugs go off-patent – and retail pharmacies – for cosy arrangements with both the government and the generic suppliers, which net the industry A$105 million per year in government subsidies, along with an unknown amount resulting from manufacturer discounts.  Duckett describes these discounts, which put money directly into the pockets of pharmacists, as ‘windfall income [that] was not intended when PBS prices were agreed.’  A more recent price disclosure policy has gone some way towards reining in excess profits resulting from discounts, although there appears to be evidence that pharmacists and suppliers are finding creative ways around this policy.

Mandated Price Reductions

In Australia, once a generic version of a patented drug becomes available, there is an immediate and irreversible 16% drop in the price that the government will pay for the product under the PBS.  If prices remain higher than this (as they often do in the case of the original ‘brand name’ product), the end consumer must make up the difference.  However, in most cases there is little incentive for generic manufacturers to compete to push prices below the PBS level, and the price ‘premium’ for the established brand is often set such that many consumers are willing to pay for the peace of mind of having a familiar and trusted product.

The Duckett report points out that in many comparable economies, the mandated price reduction is 30% or more, and that:

This year Canadian provinces have gone the furthest by requiring the price of six generic drugs … to fall to at least 82 per cent below the price of the original, patented drug. The provinces expect to expand the rule to more drugs in the future. The change follows the example of provinces such as Ontario, which increased mandatory price reductions for all new generic drugs to 75 per cent in 2010.

Duckett is recommending a price reduction for Australia of 50%.

Patents and Injunctions

It is worth noting that the mandated price reduction is a primary reason why pharmaceutical patentees are generally able to obtain preliminary injunctions when generic manufacturers threaten (alleged) infringement of an (allegedly) valid patent.  If an injunctions is not granted, and a generic product is launched – even if only temporarily, if the patent is ultimately found valid and infringed – the harm to the patentee is irreversible, since the price reduction is itself irreversible.  On the other hand, this situation enables patent-holders to maintain profit margins for an extended period, pending a final determination (usually in an appeal), even if the patent is invalid and/or not infringed.

This circumstance is not addressed in the report, however it is clearly an area in which there is some scope for further reform.  Perhaps, for example, the original manufacturer should be required to undertake to repay the 16% (or 50%, if Duckett’s recommendation is implemented) ‘premium’ accrued during the period of the interlocutory injunction in the event that the generics prevail in a given case?

What We Can Learn from New Zealand

Much has been made in the past, by proponents of reform, of the different approach adopted in New Zealand, where generic drug suppliers are selected by a periodic tender process.  In other words, New Zealand has a ‘sole supplier’ policy, whereby its Pharmaceutical Management Agency, PHARMAC, creates competition amongst generic manufacturers to become the single supplier of a drug.  Once the tender has been awarded, however, there is typically only a single brand available for the contract period.  Possibly, the New Zealand market is too small to sustain effective price competition through normal retail market forces.

Opponents of the New Zealand sole supplier model (including pharmacists) have pointed out that it denies choice to consumers, and that even where the underlying active ingredient is identical, differences in formulation can lead to differences in efficacy across individual patients.

In any event, Duckett does not recommend that Australia follow the sole supplier model.  What he does recommend taking from New Zealand, however, is the creating of an independent statutory body responsible for negotiating pharmaceutical prices, which should be constrained by a fixed annual budget with which to achieve its function.  The existing process in Australia involves decision making at high levels within government, and places no cap on annual costs.  Duckett believes that this is a major cause of the high prices being paid for drugs in Australia.


In 2008, Australians paid some of the lowest prices in the word for pharmaceuticals.  According to recent OECD data, we now pay more than most other developed nations.

Contrary to popular perception, the high cost of drugs being borne by the Australian people (mostly as taxpayers, rather than as direct consumers) is not primarily in relation to patented products, where we compare favourably with other markets.  Rather, it is in the area of generic products that Australians are losing out.  By applying the prices paid in New Zealand, in all cases where these are cheaper than Australia, Duckett estimates savings of A$1.3 billion may be made.

Duckett also addresses the other common arguments in favour of existing policy: availability of drugs; impact on local research and development; and impact on retail pharmacies.  If these areas are of particular interest to you, I recommend you read the full report, and Chapter 6 in particular.

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