Bill Brooks

As is well-known, longevity increases throughout the world. This is mainly due to the advance of medical technology, which also includes prescription drugs. Now, this is an interesting category from an economic point of view. Given that drugs can make the difference between alive or dead or, somewhat less extreme, a life without too much pains and one with chronic pains, they can have very large value added. Moreover, they sometimes allow for reduced spending on other types of medical services. Hence, no wonder that prescription drugs are highly priced. In turn, high prices ensure that firms are willing to supply what consumers demand.

 

Obviously, we know that this outcome is not the most desirable one. High drugs prices mean that large parts of the population will be unable to buy them if needed. And that’s where health insurance steps in. Insurance can make drugs accessible for the entire population, which is considered a great virtue in most cases. In addition, if the insurance industry is sufficiently competitive, profits made will be modest.

 

If money does not matter, drugs producers can raise drugs prices with several percent

However, not all is that well. Due to problems of adverse selection, markets for health insurance may fail to develop. In addition, competition within the health insurance sector may be far from perfect. Indeed, if a few insurers dominate the market, the sector may be more akin to a monopoly than to a case of perfect competition. And there is another problem that is maybe even more important. That is that the protection that insurance offers makes the insured passive. Due to insurance, the insured do not need to compare prices of different providers (if there are more than one) nor do they have to spend energy asking whether a certain drug is worth the fee. Rather, they can make their decision whether to buy a drug purely on medical grounds. This may sound well to many: after all, what is more important than your health? Well, that may be the case, but there is an economic side effect. If money does not matter, drug producers can raise drug prices with several percent. Or double them. Or even more. As long as patients (and their doctors) make their decisions on medical grounds only and send the bill to the health insurer, price increases will mean virtually no loss of demand. Good news for the profits of pharmaceutical firms, which means that due to health insurance these firms have an incentive to set drugs prices sky-high – without any relation to production cost. Supply will still meet demand, but at the cost of high health insurance premiums.

 

This may help to reduce drugs prices, thereby avoiding very high health insurance premiums

Hence, one can understand that countries define policies to lower prices. These include policies that determine whether a certain drug is allowed to enter the country’s market or policies that induce pharmacists to substitute low-priced generic drugs for high-priced branded drugs as in the Netherlands. Another type of policies is to use co-payments. Co-payments, whether in the form of deductibles, co-pays or co-insurance, may help patients becoming more active and foster that decisions whether or not to buy a drug are based on financial conditions as well. This may help to reduce drugs prices, thereby avoiding very high health insurance premiums.

 

Now, it is a practical issue how large should be the co-pays on typical products. If they are set too low, opportunities to benefit from low insurance premiums will be partly lost. If they are set too high, society will give up too much in terms of accessibility of health care. In a recent research, Einav, Finkelstein and Polyakova show that in the case of US Medicare insurance for prescription drugs, private health insurers use co-payment policies quite efficiently. Particularly, these health insurers set the level of co-pays high in those cases in which drugs can be easily substituted for other drugs and low in those cases where substitution is not possible or very difficult. In the case investigated, health insurers thus seem to fine-tune the balance between health care accessibility and moral hazard to the characteristics of typical drugs. On the other hand, public insurers seldom differentiate their co-pay policies between different drugs. Rather, these insurers typically apply uniform policies.

 

think of the future drug that will let mankind live until eternity but that is too expensive for many of us

This line of research is novel and also important. Indeed, current levels of health care spending are so high that we must have a clear view on what typical policy instruments can and cannot achieve. Moreover, due to population ageing, spending levels will only increase further in the future and the role of pharmaceuticals will likely get only bigger. And to those who are not convinced, I invite you to think of the future drug that will let mankind live until eternity but that is too expensive for many of us. Agree it is important?