Generic drugs may seem cheap, at least in comparison to brand name drugs. But Canadians pay more for generic drugs than people who live in many other countries. Last summer, the premiers of several provinces announced that they would attempt to take advantage of competition between generic manufacturers to drive down prices. The generic manufacturers’ association responded by commissioning a report focused on the risks of adopting such an approach. Do the benefits that the premiers see outweigh the risks?

How much does Canada pay for generic drugs?

For several decades, the increasing use of prescription drugs has been a major driver of increasing health care expenditure in Canada. Recently the growth in prescription drug spending has slowed, due in part to the fact that patents of some of the most commonly prescribed drugs, like Lipitor, have expired. Once a drug’s patent expires, other companies develop generic versions of these drugs, which are sold at lower prices than the brand-name versions. With generic drugs making up a progressively larger share of the Canadian pharmaceutical marketplace, provincial governments have turned their attention to generic drug pricing as a way to control health care costs.

Over the past two decades, Ontario has taken a number of steps to reduce the price of generic drugs. In 1993, Ontario declared that generic drugs could be sold for no more than 75% of the price of the branded version. This price was lowered to 70% in 1998, and then to 50% in 2006. In 2010, Ontario went further and lowered the maximum price to 25% of the branded drug. Other provinces have followed Ontario’s lead and taken similar steps.

However, while Ontario’s prices are among the lowest in Canada, a number of other countries pay substantially less for generic drugs.  Many generic drug manufacturers are international corporations, who sell their products in multiple countries. Rather than sell their products for the same price everywhere, there is ample evidence that manufacturers adjust their prices based on a country’s policies and economy.

In an effort to try to get the same sort of deal other countries are getting, the Premier’s Health Care Innovation Working Group has recommended that the Canadian provinces and territories experiment with a competitive bidding process for generic drugs, known as “tendering”.  Under a tendering system, provinces would ask generic drug companies to compete against one another for the business of provincial drug plans.

Competition in Canada’s generic marketplace

According to a report from the Federal Competition Bureau, while Canada’s generic drug industry is currently competitive, generic manufacturers are competing for the business of pharmacies, rather than provincial drug plans.

In order to convince pharmacies to stock their own products rather than their competitors, generic manufacturers offer pharmacies significant discounts. These discounts obviously improve the pharmacies’ bottom line. However, a Competition Bureau report states, they “have typically not resulted in lower prices to consumers [or] to public and private drug plans.” This is because neither pharmacies nor manufacturers currently have any incentive to compete with one another for the business of provincial drug plans.  As a result, rebates offered to pharmacies are not passed along, so prices charged to drug plans tend to reflect the maximum allowed under provincial regulations.

At the same time, pegging generic drug prices to 25% of the price of the brand-name drug upon which they are based does not necessarily reflect the cost of producing a generic equivalent.  According to research by Aidan Hollis, a professor of economics at the University of Calgary, “there are many products with production costs either far below or far above 25% of the brand’s price.” As a result, “price will be excessive for many products, relative to cost,” he writes in a 2010 discussion paper on generic drug prices.

Benefits of tendering

“We’re leaving money on the table,” says Michael Law, an assistant professor at the University of British Columbia’s School of Population and Public Health. “Instead of leveraging competition to get better prices, we’re stuck on this old, arbitrary formula.” The bottom line, he says, “is that Canadians are paying too much for generic drugs.”

Law believes that tendering for generic drugs would drive the prices paid by provincial drug plans down, by making manufacturers compete for the business of drug plans, rather than the business of pharmacies.  “If you look at what public drugs plans in countries that use tendering – like the United States and New Zealand – are paying for generic drugs, they are a lot lower in nearly every case,” he says.  If Ontario were able to use tendering to achieve prices comparable to those in these other countries, Law estimates that that Ontario would save over $125 million a year.

Risks of tendering

While tendering would likely result in significant savings for provincial drug plans, at least in the short term, it is not without risks. These risks are laid out in detail by Aidan Hollis and Paul Grootendorst in a report paid for by the Canadian Generic Pharmaceutical Association. The report raises a number of risks, including concerns about possible drug shortages that can result when drugs are sole sourced, an issue Healthy Debate delved into earlier this year.

The biggest risk raised by this report is that tendering might remove the incentive for generic manufacturers to challenge patents on brand name drugs.

In Canada, patent protection on the active molecule in a new drug lasts for 20 years.  When the patent expires, competitors may legally bring generic drugs based on that molecule to market.  However, Canadian intellectual property law allows companies to file multiple patents on different parts of a product.  For example, in addition to patenting the molecule that is the active ingredient in a drug, companies may also file patents on different elements of the manufacturing process and particular formulations of the drug.  Moreover, these patents may be filed at any point, so drug companies often file them in order to extend patent protection for their drug beyond 20 years.  According to Hollis and Grootendorst, in Canada these additional patents sometimes number in the hundreds for a single drug.

If a manufacturer wishes to bring a generic version of a drug to market, Canadian regulations require them to resolve any and all remaining patents before the drug is approved by Health Canada. This means the generic manufacturer must engage in a lengthy and risky legal process to prove that their drug either does not violate the additional patents (e.g., because it uses a different manufacturing process) or because the patents are invalid (e.g., because they were for processes that were “obvious” under Canadian law).

Hollis and Grootendorst worry that under a tendering system, the incentive to challenge patents would be removed, because they believe there would be no guarantee that the company who successfully challenges the patents would be the same company who wins the tendering contract.  Especially since the company who has challenged the patents in court will need to recover their legal costs by charging a higher price, which will make them unlikely to win a tendering contract against companies who can charge a lower price.

This is a serious risk, because if no generic companies were to challenge patents, public drug plans would be forced to keep buying brand name drugs, which are four times more expensive than generics.  This could quickly wipe out any savings from tendering.

Managing the risks of tendering

Law agrees that there must be incentives for generic companies to challenge patents, but argues that these incentives are entirely compatible with tendering. “Generic drug pricing is more competitive in the United States,” he says, “their approach is to give the generic company who challenges a patent six months of exclusivity.” Six months with no competition allows generic companies to make a significant profit, while also allowing them to develop efficiencies in their manufacturing that may help them when it comes time to bid on a tendered contract.

Another approach would be for the provinces to require generic manufacturers to pay royalties to whichever company successfully challenged a patent.  This would ensure that even if the company who challenged a patent did not win the tender, they would still benefit financially from paving the way for others.

The simplest way to manage this risk is probably for the government to wait for a period of time after the first generic enters the market before issuing a tender. Hollis agrees, explaining in an interview with Healthy Debate that “definitely if you delay [the tender] for a while, to allow the challenging generic to earn some money, then it clearly reduces the problem of whether there’s enough incentive for the generics to enter at all. That’s fairly straightforward.” He cautions, however, that “this delay should probably be for several years… the benefits from being first play out over quite a long period.  If the period is too short, you hurt the incentive.”

Looking ahead

Governments are understandably eager to reduce the price of generic drugs. Tendering is an appealing way to do this but is not entirely without risk. In addition to the risks associated with removing the incentive to challenge patents, public drug plans may also become overly reliant on single suppliers. If the provinces do purse a policy of tendering generic contracts, they need to take steps to manage these risks.