New Prescription Drug Regulations Proposed in Ontario

Government legislation can have a big impact on the operations of business firms. In April 2010, the government of Ontario proposed new regulations for prescription drugs in that province. These proposed changes have caused great debate because it looks like some individuals and companies will benefit from the changes, and others will not. Here’s the story.

Each year, Canada spends about $25 billion on prescription drugs. About half of the prescriptions are filled with name-brand drugs, and about half with generic drugs. Approximately 47 percent of the total cost of prescription drugs is paid by provincial drug programs, 37 percent by private-sector workplace drug plans, and 16 percent by individuals out of pocket.

During the next few years, the patents on several brand-name prescription drugs are going to expire. The drugs whose patents are expiring include Lipitor (cholesterol reduction), Advair (asthma treatment), Nexium (acid reflux), and Crestor (cholesterol reduction). The expiration of patents on these name-brand drugs means that lower-priced generic drugs with the same ingredients will be increasingly available to consumers. This means, for example, that companies covering employee prescription drugs through their health plans should see substantial savings as a result of these patent expirations. In the short run, they could save somewhere between $25 and $45 per employee, and as more patents expire on brand-name drugs in the future, companies might save up to $100 per employee. In percentage terms, this means an 8 percent reduction in costs immediately and a 16 percent reduction over the next few years. The changes are particularly helpful to companies in the automobile industry, since their health care costs are so high. The Canadian Vehicle Manufacturers Association has indicated its approval of the changes, saying that they will make automobile manufacturers more competitive.

The expiration of patents on name-brand drugs also presents an opportunity for provincial governments to cut their prescription drug costs; they are highly motivated to do this because of rapidly increasing provincial budget deficits. The Ontario provincial government has proposed two key changes to its prescription drug regulations that are designed to save the province $500 million. First, the province will now reimburse pharmacies for generic drugs at only 25 percent of the price of the name-brand equivalent (the government formerly paid 50 percent). This change will reduce by half the costs incurred for generic drugs by government, and reduce by more than half the cost incurred for individuals who pay for their drugs out of pocket or through insurance plans (currently, generic drugs cost about 70 percent as much as name-brand drugs). This change is being proposed because generic drugs in Canada cost significantly more than generic drugs in the U.S. and the U.K.

Second, the new regulations ban professional allowances that generic drug manufacturers pay pharmacies to carry their drugs (in 2009 generic drug manufacturers paid Ontario pharmacies a total of $750 million dollars in professional allowances). The ban is being proposed because the Competition Bureau is concerned that consumers are not benefiting enough from the competition that currently exists among generic drug makers. In a speech on April 8, 2010, Ontario Health Minister Deb Matthews noted that pharmacies are supposed to use professional allowances to improve patient care, but instead they have been using the money for salaries, bonuses, and fringe benefits. She also said that many individual pharmacies have failed to file required reports indicating how they are using professional allowance money they have received from generic drug makers. Matthews says she is committed to reducing the price of generic drugs, and to reforming a system that has been open to abuse. Other critics argue that professional allowances are really nothing more than kickbacks which don't help consumers (because the cost of the allowances is simply added to the price of generic drugs). Barbara Martinez, an analyst with Mercer Canada Ltd., was formerly a sales representative with a generic drug company. She says that the paying of professional allowances has caused the price of generic drugs to increase because pharmacies were always putting pressure on generic drug companies to pay more professional allowances than their competitor was paying. This increased the cost structure of the generic drug manufacturers and caused generic drug prices to increase.

To soften the impact of these two changes, the government proposes to increase the dispensing fees that the government pays to pharmacies, and to increase financial support for pharmacies in rural areas. As well, the proposed changes will initially apply only to drugs that are made available through the Ontario Drug Benefit Plan, which provides drugs to elderly and disabled people. The changes would be phased in over time for drugs that are sold to people covered by private insurance programs and for people who have no coverage.

These changes should reduce health care costs for consumers, for the government, and for companies that fund employee drug costs. So, everyone should be happy, right? Wrong. Drug chains (like Shoppers Drug Mart and Rexall) and grocery chains (like Loblaw and Sobeys) that have pharmacies in their stores are unhappy because the changes will substantially reduce their revenues. After the plan was announced, the shares of Shoppers Drug Mart dropped 15 percent in value. Financial analyst Keith Howell of Desjardins Securities said that the changes are detrimental to Shoppers Drug Mart, and he downgraded his recommendation on the stock from "hold" to "sell." Smaller drug stores may suffer even more than the big drug chains because they rely more on prescription drug sales for their profits. Overall, it is estimated that the industry will lose about $1 billion in revenue. Mark Dickson, the chairman of the Canadian Association of Chain Drug Stores, characterized the changes as a huge cut in funding for pharmacies. He said that many small pharmacies cannot possibly cope with these changes.

Rexall responded to the changes saying that they would have to start charging for delivering prescriptions, and that they would freeze hiring at their corporate headquarters. The company also said that it would eliminate pharmacy student and intern programs in Ontario, and assess it future investment plans in the province.

Shoppers Drug Mart had already recognized the possibility that the Ontario government might introduce changes to the provincial drug program. In one of its recent financial statements, for example, it noted that it faced two risks: changes to the pharmacy reimbursement program, and the availability of manufacturer allowances. Both of these risks have now materialized with the government's changes. The company said it was looking at closing some stores, laying off some staff, reducing hours of store operation, and reassessing their operations in Ontario.

The changes introduced by Ontario will be closely examined by other provinces, and they may follow suit because they, too, are facing increasing health care costs and large provincial budget deficits. The drug chain stores and grocery stores with pharmacies are concerned that if this becomes a national trend, their profitability prospects will be negatively affected.

Questions for Discussion

1. What are the various roles that governments play in Canada's mixed economic system? What is the primary role the Ontario provincial government is playing in the situation described above? Give examples that illustrate your conclusion.
2. When new government regulations are implemented, some individuals and groups benefit and others do not. Identify those who will benefit and those who won't as a result of the proposed new prescription drug rules in Ontario.
3. Consider the following statement: The changes proposed by the government of Ontario will not have the intended effect. They will simply motivate pharmacies to protect their financial bottom line by doing things like discontinuing some services, or starting to charge for services that are now free. So, the overall benefit will be minimal. Do you agree or disagree with the statement? Explain your reasoning.

Sources: www.health.gov.on.ca/en/public/programs/drugreforms/speeches/speech_201004088.aspx, accessed April 27, 2010; Tom Blackwell, "Pharmacy Fight; Ontario’s Drug Reforms Being Closely Watched Across Country," National Post, April 17, 2010, p. A4; Tom Blackwell, "Going Behind the Counter," National Post, April 17, 2010, p. A4; Brent Skinner and Mark Rovere, "Fix the System, Not Prices; Ontario has Slashed and Fixed Prices for Generic Drugs. A Better Idea is to Overhaul the System and Let Consumers Rule," National Post, April 17, 2010, p. FP19; Fabrice Taylor, "Shoppers Picks A Fight That It Will Not Win," The Globe and Mail, April 15, 2010, p. B12; Andre Picard, "Cheap Drugs? There’s a Cost," The Globe and Mail, April 15, 2010, p. L1; "Rexall Replies to Ontario With Cuts Of Its Own; Will Freeze Hiring, Charge To Deliver Prescriptions," National Post, April 14, 2010, p. FP14; Grant Robertson, "Ontario Offers Glimpse Of Future Drug Savings," The Globe and Mail, April 13, 2010, p. B5; Marina Strauss and Karen Howlett, "Shoppers Faces Pitfalls And Opportunities In Wake Of Ontario Drug Rule Changes," The Globe and Mail, April 10, 2010, p. B3; Clare Dear, "Shoppers Shares Tumble; Ontario Rules To Cost Pharmacists $1 Billion," National Post, April 9, 2010, p. FP1; "Professional Allowances and the Price of Generic Drugs," CBC News-Health, April 9, 2010, www.cbc.ca/health/story/2010/04/09/f-generic-drugs-professional-allowances; Adam Radwanski, "Ontario to Prescribe a Bitter Pill for Pharmacies," The Globe and Mail, April 8, 2010, p. A9.

Answers to Questions for Discussion

1. What are the various roles that governments play in Canada's mixed economic system? What is the primary role the Ontario provincial government is playing in the situation described above? Give examples that illustrate your conclusion.

The federal, provincial, and municipal governments in Canada play a variety of roles, including those of customer (governments buy thousands of different products and services from business firms), competitor (governments compete with businesses through Crown corporations), regulator (governments regulate business activity through an array of legislative requirements for business conduct), taxation agent (governments collect taxes from business firms), provider of incentives (governments offer incentive programs which are designed to stimulate business activity), and provider of essential services (highways, education, the postal service, police, firefighters, etc.).

The new prescription drug rules in Ontario clearly show the provincial government acting primarily in the role of regulator. That role really has four distinct parts: promoting competition (regulating business to ensure that healthy competition exists among business firms), protecting consumers (regulating business products so that consumers are protected), advancing social goals (promoting the well-being of Canadians), and protecting the environment (developing legislation to protect our air, land, and water).

Three of these four parts of the government's regulator role are evident in the prescription drug case. The most obvious is promoting competition. For example, the new rules outlaw professional allowances, since the government feels that while these allowances may increase competition among generic drug manufacturers, they do so in a way that increases the prices of generic drugs, rather than decreasing them. Consumer protection is also evident because the changes are designed to reduce the prices that consumers have to pay for prescription drugs. The changes also illustrate the government role of trying to achieve social goals (in this case, better access to prescription drugs for Canadians).

2. When new government regulations are implemented, some individuals and groups benefit and others do not. Identify those who will benefit and those who won't as a result of the proposed new prescription drug rules in Ontario.

There are three groups that will presumably benefit as a result of the new rules: the provincial government (because it will now pay out smaller amounts for drug reimbursement), individuals living in the province of Ontario (who will pay lower prices for drugs if they decide to buy generic versions), and many different business firms (who will pay out smaller amounts of money to support employee health care benefits). Whether these groups will actually benefit remains to be seen (see question #3 below).

The most obvious group that is likely to be hurt by these changes is pharmacies. They will have to cope with two significant problems: reduced reimbursements from the government for generic drugs (from 50 percent of the cost to 25 percent of the cost), and the loss of revenue from professional allowances that they have historically received from the generic drug companies (because these allowances are no longer allowed).

3. Consider the following statement: The changes proposed by the government of Ontario will not have the intended effect. They will simply motivate pharmacies to protect their financial bottom line by doing things like discontinuing some services, or starting to charge for services that are now free. So, the overall benefit will be minimal. Do you agree or disagree with the statement? Explain your reasoning.

Students who agree with the statement will probably make one (or both) of the following arguments. First, every business organization has an incentive to protect its bottom line. When a company is faced with some major threat (like a new government regulation), it will be motivated to adjust the way it does business so that it will continue to survive and prosper. In the case of pharmacies, these changes might include the following: reducing services, starting to charge for services that were formerly provided for free, reducing store hours, canceling pharmacy student intern programs, and laying off staff. Students who use this line of reasoning will argue that the overall benefit will be minimal because these changes will have a negative impact on various Canadians. For example, laying off staff will obviously hurt individuals who are currently employed in pharmacies. Reducing store hours will be inconvenient for customers. Starting to charge for services that formerly were provided for free will obviously raise the price of the service for some consumers. Canceling intern programs will hurt pharmacy students. In other words, the proposed changes to Ontario's rules will simply mean that a different configuration of activities and costs will develop with respect to prescription drugs.

This argument leads directly to the second reason that some students may agree with the statement, namely that determining whether the new configuration is superior to the old one is a very complex question, and it will be difficult to get agreement about whether the new system is really better, all things considered. There are many elements to this argument, but consider just one: costs. The government argues that companies will see their health care bills decline under the new rules. But will they? Predictions about cost savings may or may not be accurate. Two recent articles that examine the complexity of the issue as follows: Andre Picard, "Cheap Drugs? There's A Cost," The Globe and Mail, April 15, 2010, p. L1; also Brent Skinner and Mark Rovere, "Fix the System, Not Prices; Ontario has Slashed and Fixed Prices for Generic Drugs; A Better Idea is to Overhaul the System and Let Consumers Rule," National Post, April 17, 2010, p. FP19. Skinner and Rovere, for example, argue that provincial drug plans distort the prices that would result if the market would just be left to work naturally. His solution is to have the Drug Benefit Program reimburse consumers directly (and require consumers to pay a portion of the cost). Then, consumers can shop around for the best drug prices, and this will motivate pharmacies to lower their prices. Picard argues that the promised cost savings of the proposed changes are largely illusory, and notes that past attempts to reduce prescription drug costs in Ontario have failed. He believes that consumers will not really see much in the way of reduced prices, and that they will receive fewer services from pharmacies.

Students who disagree with the statement will likely argue that the key element in this situation is the price that is charged for prescription drugs, and if the government reduces the amount it will reimburse for generic drugs, the overall benefit will be positive. They may also point out that if there is one thing we can count on with human beings, it is that they will try to get things for the lowest price possible. This means, for example, that companies will seize the opportunity stipulate in their health care plans that generic drugs must be purchased. To the extent that company policies are strictly enforced, this should indeed mean lower costs for companies.