Drug Policy in Ontario- A Cautionary Tale

As far as I know, Beatrix Potter never wrote a tale about a pharmacist, but if she were alive today there would be no shortage of material to work with based on the verbal missiles being exchanged over the distribution of prescription drugs in Ontario. This time the dispute pits retail pharmacies against the provincial government which means Ontario taxpayers. In previous rounds we witnessed the brand name companies confronting generic manufacturers, and small pharmacies their larger rivals like Shoppers Drug Mart, Zellers and Walmart.

The focus of the present clash is the higher price of many generic drugs in Ontario and Canada than in most other developed countries with the following examples provided by the Ontario Ministry of Health – the percentages show how much the average prices of four drugs are lower in five other developed countries than in Ontario.

Enalapril (blood pressure) 82% lower
Gabapentin (epilepsy) 35% lower
Metformin (diabetes) 31% lower
Ranitidine (gastrointestinal disorder) 69% lower

In order to address this differential the Ontario government proposes to abolish the 20% professional allowance payment made by drug manufacturers to pharmacists for stocking and dispensing their generic drugs, an amount which is claimed to be pocketed by pharmacists and not passed on to consumers. Other parts of the legislation propose offsetting part of the loss by pharmacists being able to charge for dispensing health advice and for pharmacies in rural areas to receive additional payments.

In order to understand the incentives and constraints affecting the players, it is useful to outline the business model and supply chain linking drug manufacture and distribution to us the patients. Healthcare and our costs by way of prices for prescription drugs and taxes will be affected by the outcome of this struggle. As Beatrix Potter describes how Jemima Puddleduck is saved by Kep the collie-dog from the foxy-whiskered gentleman who was leading her to a simmering stew pot, so we need to construct our own story to warn against misleading arguments and actions that could result in unpleasant endings. I leave the reader to decide which animal corresponds to each of the current protagonists.

There are four main activities to consider, production of the drug, distribution to the final consumer, the decision-making process of consumers including the advice they receive on what to purchase, and the money flow involving consumers, government, insurance companies, pharmacies and drug companies.

Unlike the purchase of apples where the consumer decides what type and how many to buy, chooses from a number of competing outlets, and pays for them out of his/her own pocket, prescription drugs involve a different process. Physicians prescribe on behalf of patients with payment made from some combination of direct payment, medical insurance plans and government funding out of tax revenues. The money flows back from consumers to pharmacies, wholesalers, manufacturers and those undertaking research and development. Each stage has an interest in increasing its net returns namely income less expenditures. Final consumers have only expenditures and are interested in reducing these, namely the price of prescribed drugs.

Drug Production

The central character in this tale is the prescription drug which is produced and distributed to end users, we the public as patients. The supply chain starts with the production of knowledge often in a laboratory owned by a private firm or as part of university facilities. The costs of developing and testing a new drug before it is approved for use are often extensive and time consuming. The accuracy of cost figures reported publicly is difficult to determine. Those who have an interest in showing high costs, such as the brand name companies, will highlight the drugs which were expensive to develop. Not all drugs have high development costs but many do. Tax breaks and subsidies may reduce the private outlay by companies. Those who pay for the drugs, individuals, hospitals, insurance companies and governments point to those brand name drugs which were cheaper to get to market.

An important aspect is patent protection. Brand name manufacturers argue for lengthening the duration of the patent and for protecting it against infringers at home and abroad. Consumers have an interest not in eliminating patent protection but in restricting its length. No one knows what the optimum patent length is, or exactly what would happen in the absence of some or all protection. Once the patent life is terminated, other firms, the generic manufacturers, enter as producers and using substantially the same formula produce the previously patented drug using a different name. There is also nothing to prevent the brand name manufacturers from producing a generic version of their previously patented drugs. In this respect the brand name manufacturers have an advantage in part because they can plan their promotional campaign based on their experience with distributing the patented product. An additional practice is for the brand name manufacturer to develop a new patented drug that is only slightly different from the original thereby hoping to extend the period of protection and ward off effective generic competition.

Distribution

At a certain point in the life of a drug, a generic competitor comes along and competes with the original branded version. Competition increases and prices fall, but the extent of the decrease depends on the distribution system and how the drug reaches the consumer.

Typically drugs are distributed from the manufacturer to a wholesaler who then supplies retail pharmacists and institutions such as hospitals. In turn, the drugs are supplied to consumers who have only limited input regarding these purchases. Leaving aside hospitals where physicians choose what to prescribe and the only real choice for the patient is to accept or decline the medication, other consumers receive prescriptions from a doctor and take them to a pharmacist for fulfillment. The pharmacist decides which particular drug to dispense depending on the availability of generic drugs and how payment is made.

This is where it gets tricky because of the types of drugs, brand name and generic and the alternative payment mechanisms, consumer, private insurance and government or some combination of these three.

An example may help to clarify the main alternatives.
A patient receives a prescription from a doctor for:
1. A brand name drug for which there is no generic alternative
2. A brand name drug for which there are one or more generic alternatives
3. A generic drug for which there are one or more alternatives

Payment can be:
A. By the patient
B. By an insurance company in whole or in part with the patient paying the balance
C. By the government in whole or in part with the patient paying the balance or with the insurance company paying the balance, or some combination of the above.

At this point we need to move from the stages of drug distribution to the payment of monies, although it is difficult to separate the two.

Follow the money

Like Kep the collie who tracked Jemima to find out where the foxy whiskered gentleman had taken her, it is necessary to follow the money trail to find out who is getting what. The money for drugs comes from a combination of user payments, insurance company financed health plans which in turn have been paid for by consumer premiums, and by government with monies from tax revenues or borrowing. Regardless of the institutional arrangement, consumers/taxpayers are on the hook for the cost of prescription drugs.

When the current Ontario battle is described as one between the provincial government and retail pharmacies, it distracts from the fact that the public pays either out of pocket, or with premium financed insurance plans or out of tax revenues. The protagonists are really retail pharmacies and consumer/taxpayers with drug manufacturers, insurance companies and governments having a variety of interests and involvement in the outcome.

Over the course of a year my prescription drugs are paid for by a combination of cash, the Ontario government, and an insurance plan with Great-West Life. In each case I pay, with cash, with my taxes which help to fund the government portion and with my premiums to the insurance company. I have a direct interest in the final price of the prescription regardless of the source of the payment. Thus, when the price of generic drugs are higher in Ontario than in other jurisdictions, I and other consumers should be as concerned as when the prices of gas, food and clothing are higher.

Consider the above cases. In 1. where there is only a brand name drug, there are no choices for the pharmacist to make and the supplier can determine the price, unless the government decides that an alternative cheaper drug is satisfactory even if it is not a direct substitute. The patient may have the choice of the cheaper drug paid for by the government or insurance company or pay directly for the prescribed branded drug.

In cases 2. and 3. where there are generic substitutes, especially more than one substitute, a choice is made as to which drug to use to fill the prescription. Here the pharmacy has input into the transaction, since the pharmacist may not carry all the available generic substitutes and may carry only those drugs for which professional allowances are received. The allowance is an incentive. Some refer to it as a kick-back for the pharmacist to carry a particular drug but with no incentive to pass any or all of this benefit on to the consumer. It is similar in many but not all ways to a rebate given by an automobile company to a car dealer that is taken by the dealer and not handed on to car buyers.

One reason why car dealers would have difficulty in pocketing a rebate is because retail competition is much more intense for cars than for generic drugs. The nature of the two markets do differ, but it is not just this comparison that matters but the fact that prescription drug prices for generic drugs are substantially higher in Ontario than in the markets of other developed economies as outlined above.

Response from pharmacists

Pharmacists have organised a spirited rebuttal to the proposed legislation that I outline here. More detailed arguments are found on the website of the Ontario Pharmacists’ Association:
1. Pharmacy profits will be reduced to such an extent that some pharmacies will go out of business and others will be forced to reduce services such as opening or dispensing hours. Pharmacy staff will be reduced and less time will be given to customers regarding their prescriptions.
2. Pharmacies in rural areas will be forced out of business due to the loss of revenues from removal of the professional allowances.
3. Patients will suffer from the reduced pharmacy services.

Issues to consider in evaluating the opposing positions relate to the business model for pharmacists. Small specialized pharmacies exist alongside and compete with big stores like Walmart, Shoppers Drug Mart and Rexall. Pharmacies are either part of larger stores selling a wide range of goods that often have slim margins but allow money to be made on volume, while higher margins are earned on a lower volume of prescription drugs; or the stores specialize more in prescription drugs and health related products only and have a smaller turnover with higher margins for what they sell.

A large diversified store can afford to have its margins squeezed on the more profitable prescription drugs without being forced out of business. A small pharmacy more dependent on its prescription drug business will experience a relatively larger negative impact on its profitability, and may have to close down or restructure its operations so as to diversify its sources of revenues and profits.

In recognition of this, the Ontario legislation includes two other provisions, one to pay pharmacists for the health advice that they give clients and the other is to provide a higher prescription dispensing fee for pharmacies in rural areas that have lower turnover. How payment for advice will be structured is unclear at this stage but may require customers to make appointments for a consultation with the pharmacist. Issues may also arise regarding the liability associated with a pharmacist’s advice for which payment is made.

Another factor to consider is the extent of the alleged loss of service to consumers as patients if some pharmacies are forced to reorganize. This has to be looked at in the context of mail-order distribution of drugs where there is already reduced opportunity for dispensing advice but increased sources of retail supply.

Conclusion

Complexity can be added to the above discussion by describing the role of drug formularies, the catalogues that list available drugs and are used by the industry to determine those that can be dispensed under different conditions. The foregoing discussion tries to identify the main factors influencing the supply and pricing of prescription drugs in Ontario in order to assess the likely impact of changing policies.

The final costs of the measures introduced by the Ontario government are uncertain, until the principal players in the supply chain adjust their transactions to the new policies. The economic effects will be found in the prices to consumers, both direct payments and indirect payments in the form of insurance premiums and taxes, and in the type of service received.

The initial response of some pharmacies to reduce hours of service for dispensing drugs, and thereby limiting revenues seems to be masochistic behavior, but perhaps generates some non-pecuniary satisfaction especially when undertaken in the riding of the Minister of Health. It’s hard for consumers to be unsympathetic to a policy which is trying to reduce the prices of drugs that are substantially lower in other developed countries, facts that are not contested. Perhaps Beatrix Potter could construct a happy ending for this tale.

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2 Responses to “Drug Policy in Ontario- A Cautionary Tale”

  1. Miles Keenleyside Says:

    Your detailed description of the way in which prescription drugs are produced, distributed and paid for is very helpful. However, I am still puzzled by one central feature of the Ontario government’s proposal. How will removing the “professional allowances” – i.e., money paid by generic drug manufacturers to pharmacies to encourage them to sell their products – how will this save the government any money?

    I understand the province’s wish to slow down the rate of increase in healthcare costs. But preventing pharmacies from receiving “kickbacks” from generic drug producers should, I would think, encourage the pharmacies to raise, not lower their prices to consumers. Please help.

    • cmaule Says:

      Good question.

      As you indicate drug costs are an increasing share of health care costs, and the latter are an increasing share of total government expenditures. Removing the professional allowances occurs in conjunction with capping the prices of generic grugs which is the only way to reduce these costs. If the legislation is passed, this will be done as follows:

      1. If the Ontario government is paying for the drugs then reimbursement will be capped at 25% of the price of the original drug that is replaced by the generic drug in the formulary (catalogue of drugs for which reimbursement occurs). Publicly funded programs account for 45% of monies spent on prescription drugs in Ontario – 2.8 million people receive $3.8bn in drug benefits.

      2. If private insurers pay for the drugs (in whole or in part), they will pay the same price as the government. Presumably insurance premiums will then decline. I am unclear how the government will ensure that they pay the lower prices and lower premium benefits are passed on. At present my drugs are paid for by the government, a private insurer and myself. Sometimes I end up paying nothing and sometimes $6.11 which is amount presumably not covered by either the public or private plans

      3.If individuals pay for the drugs out of their own pocket, they may receive the price paid by the Ontario government but again some enforcement mechanism would be required for this to happen.

      There is another wrinkle to consider. Part of the prescription price is for the drug and part for the dispensing fee. The proposed legislation allows this fee to rise from $7 to $8 now and higher in future years. Rural pharmacies will be able to charge higher fees than city pharmacies. Also the government will fund payment for advice given by pharmacists to patients. How this will work is unclear. Do you make an appointment with a pharmacist? What liability does the pharmacist have for advice given?

      As I get clarification of these details I will post them.
      Hope this provides some clarification.

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