European Affairs

Many different techniques are used (sometimes in the same country) to help control drug spending and they often differ by the category of drug. Drugs may be categorized into brand name (i.e. on-patent) versus generic drugs or in other cases as drugs available from only a single source (i.e. single-source drugs) versus those available from multiple sources. (Multiple source drugs are drugs for which there is at least one other therapeutic equivalent or bioequivalent drug.) Drugs may also be categorized into “innovative” drugs versus those that are only marginal improvements over drugs already on the market (i.e. “me-too” drugs). In all these different categories, the techniques used by countries to control spending practices may or may not reflect a “societal valuation” about a type of drug the country wishes to financially support the most.


Like some western European nations, the United States has a health care system involving a combination of private and public payers adopting a variety of pharmaceutical reimbursement policies. The private insurance companies may negotiate drug prices, rebates, and drug-volume discounts with pharmaceutical manufacturers. The three largest U.S. government purchasers of pharmaceuticals – Medicare, Medicaid, and the Department of Veterans Affairs (VA) – use a mixture of methods, including reimbursement-rate setting, price ceilings, negotiated prices, discounts, and rebates, as well as other cost and utilization-management tools. 2

Western European nations also use many different methods to mitigate increases in pharmaceutical expenditures, including reference pricing, parallel trade, profit controls, and value-based pricing. These pricing policies are used not just to price drugs, but also to determine reimbursement rates and to manage utilization. Governments may rely on more than one of these methods and may also, along with private insurers, negotiate prices, discounts, and rebates, and use other cost and utilization-management tools to help mitigate price increases.

This article defines and provides a brief overview of each of these payment methods used by the U.S. government, western European nations and private health insurers. A description of the health system or program in which the payment method is currently implemented is provided to help explain each method. Payment methods are often used by more programs and health systems than simply the example provided. A closing summary of the academic literature on cross-national differences in pharmaceutical prices provides an idea of the state of our knowledge on these methods.

U.S. Government Methods

Reimbursement Rate Setting. This technique can apply when a payer acts as a price setter and dictates the amount it will pay. To be successful, reimbursement rate setting requires the payer to have significant buyer leverage. Reimbursement rate setting is not used solely by the U.S. government; some western European countries also use the payment method. An example of this approach involves drugs covered in part B of the U.S. Medicare program. The Medicare program in the U.S. is a publicly funded, federal government administered program for persons aged 65 and over and certain disabled persons. Part B of the program covers the cost of a limited number of prescription drugs and some forms of care. In addition, in the U.S., some physicians, such as cancer specialists, may purchase select drugs from a wholesaler or other distributor, administer the drug to a patient and subsequently be reimbursed for the drug by the payer – at a rate that may or may not be the same as the purchase price. Part B of the U.S. Medicare program sets the rate at which it will reimburse providers for such drugs that are furnished incident to a physician’s service.

Price Ceilings. This is the maximum reimbursement rate a health system will pay. Price ceilings are used by the U.S. government as well as other governments. For example, the U.S. sets price ceilings for certain pharmaceuticals, which are called the federal upper payment (FUL) levels, for Medicaid, which is a State-based program covering the cost of healthcare for certain low-income individuals. Each of the 50 States operates independently under broad federal guidelines, and the federal government and the States share the cost of the program. The FULs are calculated consistent with a statutory formula and based on data submitted by pharmaceutical manufacturers. With few exceptions, these upper limits, plus “reasonable” dispensing fees, are the maximum amount the States can pay for multiple-source drugs.

Western Europe Government Methods

Parallel Trade. Reselling pharmaceuticals to people in other nations commonly occurs in Europe and is termed parallel trade. It implies importing foreign pharmaceutical prices as well as the products and allows countries to tacitly use other countries’ pricing systems. Manufacturers cannot prevent the movement of pharmaceuticals from one European country to another due to the absence of trade barriers in the EU single market. On this issue, U.S. legislation uses the term “reimportation” in recognition of the fact that the U.S. is the largest exporter of pharmaceuticals, so importing pharmaceuticals into the U.S. would be, for the most part, tantamount to re-importing them.

The U.S. Federal Food, Drug, and Cosmetic Act (FFDCA) prohibits anyone from importing prescription drugs into the United States unless they are the original manufacturer of the drugs. The Medicare Prescription Drug, Improvement, and Modernization Act (MMA) includes a provision that partially circumvents the FFDC: it authorizes the U.S. Food and Drug Administration (FDA) to allow drug reimportation from Canada if the Secretary of Health and Human Services (HHS) certifies that importation of prescription drugs is both safe and cost-saving. The incumbent Secretary has chosen not to exercise this option.3 Consequently, it is illegal for someone to import a drug from a pharmacy in another country, even if the drug was originally manufactured in the United States. All drugs sold in the U.S. must be manufactured and packaged for U.S. sale. The rationale for prohibiting reimportation is that the FDA can not guarantee the safety of the drug once it has left the agency’s regulatory control. Moreover, the version produced by U.S. drug manufacturers for foreign markets may not meet all of the requirements for U.S. sales and marketing approval.

Profit Controls. Another drug-pricing method that may be used by payers is profit controls, whereby manufacturers share all or part of the profits that are predetermined to be in “excess.” This type of pricing-method operates well in systems where pharmaceutical manufacturers can accurately ascertain what portion of the profits is obtained from the payer, such as a government-financed healthcare system. The largest challenge in profit control is defining the “appropriate” profit limit. One example of profit controls is the Pharmaceutical Price Regulation Scheme (PPRS)4 in the United Kingdom. The PPRS regulates the pharmaceutical prices and profits of branded drugs in the UK for the National Health Service (NHS). Price and profit agreements are arrived at through negotiations every five years between the pharmaceutical industry, represented by the Association of the British Pharmaceutical Industry, and the UK Department of Health. Individual manufacturers can choose whether or not to participate in the negotiated agreement, but non-participants do not have their drugs covered by NHS. The UK system does not dictate the manufacturers’ drug prices. Rather, pharmaceutical manufacturers can set any price for their product at the beginning of an agreement term, but the UK Department of Health must agree to any price increases during the term.

The profit control agreement specifies that any profits in excess of the agreed upon return-on-capital threshold must either be repaid to NHS, or the company must lower existing and future prices. This type of agreement provides a strong incentive for manufacturers to set their prices so that profits do not exceed the return-on-capital threshold. To help enforce the return-on-capital limits, the current agreement creates a tiered system of profit reporting and financial transparency requirement that vary with the manufacturer’s sales.

Reference Pricing involves either comparing the prices for similar products or comparing prices for the same product in other countries or settings. Germany and the Netherlands5 are examples of countries in which reference pricing is used for pharmaceuticals.6 Prices are often determined by clustering drugs by drug class and setting a uniform rate for all drugs in the cluster. The reimbursement rates are determined through cross-country (or jurisdiction) comparisons or within country comparisons of similar therapies. The cross-country comparisons result in regulation prices in one country directly affecting prices in another country. The drug clusters are controversial because they may ignore differences in safety profiles, efficacy, and application forms across drugs.7 For example, a manufacturer may argue that its drug is an improvement over others in the same cluster because it causes fewer side effects and can be administered as a pill rather than an injection; however, the value of these improvements may not be fully captured by pricing drugs in clusters. To deal with such nuances, new or innovative products may be excluded from clusters.

Value-Based Pricing sets drug prices using a relative value metric, where each drug is compared to other drugs to assess whether the improved safety-profile or efficacy is worth the additional cost. Cost-effectiveness8 and cost-benefit9 analysis are both examples of relative value metrics. Value-based pricing is not traditionally used as a method of pricing drugs, and instead has primarily been used as a way to determine the status of a drug (i.e., preferred, restricted use, excluded) in the health coverage and reimbursement scheme of a country or private health insurer. Drug prices are typically set prior to evaluating a drug’s status on a formulary.

The crux of the problem in value-based pricing is that the definition of “value” can be subjective. It requires establishing how much a payer is willing to pay for improvements in health and drug safety profiles. It also requires defining an “appropriate” comparison drug. For example, a cancer drug that costs US $35,000 per patient per year would appear to be a bargain if compared to the drugs costing US $50,000 per patient per year. Would this be an “appropriate” comparison? How many additional years of life would have to be provided by the US $50,000 drug in order to justify its cost?

The UK’s National Institute for Clinical Excellence (NICE) addressed the challenge of defining the “appropriate” comparison drug by allowing committees, which are comprised of academic and NHS experts, to determine the comparison drugs.10 NICE is a quasi-independent organization that assesses the cost-effectiveness of treatments in the UK, and provides guidance on treatments for patients using the NHS. Drugs receiving positive recommendations tend to have cost-effectiveness ratios below US $46,000 per quality adjusted life year (QALY), but NICE has not defined a strict cut-off ratio for distinguishing drugs that add “value” from those that do not. Instead, NICE recommendations use cost-effectiveness as one factor in their recommendations. Even though NICE recommendations weigh the drug costs compared to the benefits, the recommendations do not explicitly factor in affordability and NHS budget constraints. Thus, a drug costing US $50,000 may receive a positive NICE recommendation if it provides enough benefit to produce a favorable ratio. NICE only recommends, and does not determine, whether the treatments should be included in the NHS formulary. Regardless of the NICE recommendation, treatments can not be denied to UK patients who are shown to need them.

One of the goals noted by the UK PPRS is to promote the uptake of effective new medicines that have received a positive recommendation from NICE; however, non-positive appraisals for a drug do not explicitly result in punitive actions, such as exclusion from the NHS formulary.

Private Health Insurance Methods

Since they do not have the authority to set the prices of drugs in the U.S. and Western Europe, private health insurers often try to limit drug expenditures by managing the quantity of drugs purchased. Private health insurers, as well as government health systems, use their formulary as leverage in negotiating prices, rebates, and discounts with drug manufacturers and distributors. (A formulary, as mentioned above, is a set of drugs for which a health system or insurer has agreed to pay a portion of the costs; the formulary may also specify contingencies for payment.) A drug manufacturer or distributor may be willing to negotiate these concessions in exchange for favorable placement of their drug on the formulary (i.e. few restrictions on when and how much of the drug may be used and limited or no cost-sharing required for patients).

International Comparisons of Drug Prices

The majority of researchers believe that people in the U.S. pay more for some pharmaceuticals than people in some western European countries, yet how much more and why are matters of contention. One of the more frequently cited studies, authored by Danzon and Chao, compared drug prices in the U.S., France, Germany, Italy, and the UK11 and found that price differences in 1992 reflected differences in product characteristics and the regulatory regime.12 The authors found that U.S. drug prices were lower than Germany’s, but higher than France, Italy, and the UK. France had the lowest prices of the group, followed by the UK and Italy. Additionally, for a subset of drugs available globally, Danzon and Chao concluded that the prices did not vary much among countries.

Another frequently cited study, authored by Danzon and Furukawa, found that, in 1999, U.S. prices were higher than prices in western Europe, specifically Germany, Italy, UK, and France.13 France again had the lowest prices of the European countries, followed by Italy, Germany, and UK. The authors also found that the number of manufacturers and presentations (e.g. tablet, syrup, or pill) per multiple source product was highest in the U.S. and Germany.

Since differences in average disposable income across countries may contribute to the observed differences in drug prices, the authors adjusted the results for health “purchasing power parity” (PPP), as defined by the Organization for Economic Cooperation and Development (OECD). This adjustment had a strong effect on the results. After accounting for PPP, Germany, Italy, and the UK appeared to have lower drug prices than the U.S., and France was on par with the U.S. The authors interpreted this finding to suggest that differences in drug prices may reflect differences in cost-of-living across countries.

A third frequently cited study, authored by Anderson et al., compared the average prices of the 30 drugs with the greatest total U.S. spending in 2003 to the prices of the same drugs in the UK and France. The authors concluded that the U.S. paid more for these drugs than the UK, and the UK paid more than France.

Many other studies have also examined this question, yet there remains disagreement on how large the price differences are between countries and why. Part of the lack of definitiveness lies in the variability of methods and data used in comparisons. Studies have been criticized as biased due to unrepresentative or small samples, unweighted indexes14, or exclusion of generic drugs from the analysis. Also, price comparisons are often difficult because comparisons should include the active ingredient, formulation, route of administration, dosage form, strength, package size, and manufacturer.15 Since the exact same drug is often not available in all countries, only a subset of drugs can be compared in this manner. Also, there is a delicate, if near impossible, balance between comparing the drugs that may matter most to a country (i.e. the drugs with the highest sales revenues) and adequately accounting for generic availability within countries. Specifically, a sample of the top-selling drugs may be biased towards inclusion of brand name drugs with no therapeutic equivalent. Ideally, prices should also account for any rebates and discounts given to the payer, although these amounts are rarely available to researchers.

The relative contribution of payment policies to differences in pharmaceutical prices is unknown due to many other observable and unobservable differences in the utilization of pharmaceuticals across countries. Future research will hopefully help elucidate this issue and the effect of different pharmaceutical utilization patterns across countries.

Gretchen Jacobson, Ph.D. is a health economist and analyst with the Congressional Research Service which provides legislative research and analysis to the U.S. Congress. The statements in this article are those of the author and do not reflect the views of the Congressional Research Service.

1From 2002 to 2006, the compounded annual growth rate for prescription drugs was greater than the growth rate for any other health-spending category.

2 For more information, see Congressional Research Service (CRS) Report RL33802, Pharmaceutical Costs: A Comparison of Department of Veterans Affairs (VA), Medicaid, and Medicare Policies, by Gretchen A. Jacobson, Sidath Viranga Panangala, and Jean Hearne. See also Congressional Research Service (CRS) Report RL31419, Medicare: Payments for Covered Part B Drugs, by Jennifer O’Sullivan.

3If the Secretary were to allow reimportation from Canada, Canadian residents may encounter drug supply limits. In the past, pharmaceutical manufacturers have threatened to limit the supply of drugs available to Canadian distributors and pharmacies if reimportation of drugs from Canada was legalized. For more information, see Ceci Connolly, Pfizer Cuts Supplies to Canadian Drugstores, Washington Post, February 19, 2004, A10. Also see Theresa Agovino, GlaxoSmithKline Threatens to Cut Off Drug Sales to Canada, The Associated Press, January 10, 2003.

4 For additional details on the PPRS, see the UK Department of Health, The Pharmaceutical Price Regulation Scheme, November 2004. Available at]. Accessed June 15, 2007.

5Note that these countries use a mixture of pricing mechanisms and reference pricing is only one of the mechanisms used by these countries. For more information, see Christine Huttin, “Drug Price vDivergence in Europe: Regulatory Aspects,” Health Affairs, vol. 18, no. 3 (May/June 1999), p. 245-249.

6 France, Italy, Portugal and Spain are also among the many European countries that use reference pricing, especially in patent-expired products.

7For more information, see Christine Huttin, op. cit.

8Cost-effectiveness is typically assessed by dividing the additional dollars a drug costs by the additional quality adjusted life years (QALYs) a drug provides, to arrive at a $/QALY ratio.

9Cost-benefit is assessed by first determining the monetary value of the “benefits” gained from the drug and then subtracting the costs of the drug from the “benefits.”

10For more information about NICE and its responsibilities, see Wilhelmine Miller, “Value-Based Coverage Policy in the United States and the United Kingdom: Different Paths to a Common Goal,” National Health Policy Forum, November 29, 2006.

11The authors also compared the prices to those in Canada and Japan.

12For more information, see Patricia M. Danzon and Li-Wei Chao, “Cross-national price differences for pharmaceuticals: how large, and why?” Journal of Health Economics, vol. 19 (2000), p. 159-195.

13The study also compared the prices to those in Canada, Chile, Japan, and Mexico. For more information, see Patricia M. Danzon and Michael F. Furukawa, “Prices and Availability of Pharmaceuticals: Evidence From Nine Countries,” Health Affairs, vol. W3 (October 29, 2003), p. 521-536.

14 Danzon and Chao found that the results were very sensitive to the index measure used. Specifically, the drug prices of each country appear cheaper when its own-weighted index is used.

15For more information, see Judith L. Wagner and Elizabeth McCarthy, “International Differences in Drug Prices,” Annual Reviews of Public Health, vol. 25 (2004), p. 475-495.


This article was published in European Affairs: Volume number 8, Issue number 2-3 in the Summer/Fall of 2007.