Cost-effectiveness thresholds (CETs) can be used to identify what is good value for money for reimbursement decisions. In practice countries and jurisdictions have increasingly used CETs as a benchmark to guide price agreements. Only those with a price which correspond to an incremental cost effectiveness ratios (ICER) below the accepted CET, get covered in the national health system. Although the mechanism (which we call “ICER pricing”) is well defined, there is a lack of theoretical economic models exploring the allocation of consumer and producer surplus and social welfare generation under it.

In this paper we propose a general supply and demand model based on economic theory, Nash bargaining solution and evidence from real-world functioning of pharmaceutical pricing. We propose a baseline model based on existing approaches in the literature and we explore the implications of relaxing some key assumptions on the optimal CET and the distribution of the consumer and producer surpluses.

Results show that when the payer has effective bargaining power, the CET can be set at a level above the supply-side threshold without involving a net health loss for the system. The same implication draws from the case of flexible /increasing health budgets. However, for the latter, both players obtain additional surplus due to the extra funding, while in the former, the benefit comes from transferring some of the surplus of the developer to the payer via a price effect. The incorporation of R&D cost contributes to move the CET upwards in order to create incentives to developers to invest in pharmaceutical innovation for the future. Finally, if reserve ICERs of the industry concentrate around a range of threshold values, then the optimal threshold, or alternatively the threshold that equates the surpluses of the payer and the developer might increase depending on the shape skewness of the distribution.