Price elasticities of pharmaceuticals in a value based-formulary setting

Empirical estimates of price elasticities of demand (PED) for pharmaceuticals suggest that they are relatively price inelastic. However, in many settings, a medication and its substitutes and complements face simultaneous differential changes in prices that affect the observed "composite" PED. We exploit an implementation of a value-based formulary (VBF) that utilized drug-specific incremental cost-effectiveness ratios (ICERs) to inform drug copayments, resulting in increases in copayments for some medications and decreases in copayments for others. We first show theoretically that by changing the price of a medication and its substitute in opposite directions, VBF designs can leverage cross-price effects to increase the range of composite PEDs. We then empirically estimate PED and welfare effects using a consumer surplus approach. Overall PED was -0.16, similar to the RAND Health Insurance Experiment estimate. However, there was substantial dispersion of PED across the VBF copayment tiers ranging from -0.09 to -0.87 with a statistically significant trend aligned with the levels of value as reflected by the ICER estimates (p < 0.001). The net welfare increase was $147,000 for the cohort or $28 per member over the postpolicy year. Further experimentations of VBF designs with alternative cost-effectiveness thresholds, copayment levels and value definitions could be quite promising for improving welfare.