HEOR Articles

Value-Based Pricing, Cost-Effectiveness Thresholds, and Affordability: Are They Compatible?

Patricia M. Danzon, PhD, The Wharton School, University of Pennsylvania, Philadelphia, PA, USA

Cost-effectiveness analysis (CEA) and value-based pricing (VBP) are tools designed to enable payers to maximize health gain for enrollees, given the payer’s budget/revenue constraints. Systematic application of CEA-VBP requires that the payer, as agent for its enrollees, defines rules for measuring the incremental cost-effectiveness (CE) of proposed new treatments, relative to current treatments, and sets a CE threshold (eg, $150,000 per quality-adjusted life year [QALY]) that reflects its willingness to pay for health gain. To gain reimbursement approval, new therapies must be priced at or below this threshold, with possible exceptions for special factors. If payers adopt this CEA approach to reimbursement, manufacturers are incentivized to adopt VBP, that is, to price a new drug based on its incremental effectiveness, valued at the payer’s CE threshold. Use of CEA-VBP by payers thus not only maximizes enrollees’ health gain from the payer’s budget, but also signals to investors that research and development is rewarded if it delivers incremental value for patients.1

"Use of cost-effectiveness analysis and value-based pricing by payers thus not only maximizes enrollees’ health gain from the payer’s budget, but also signals to investors that research and development is rewarded if it delivers incremental value for patients."

This CEA-VBP approach evaluates pricing/reimbursement decisions based on a drug’s incremental value, without considering its budget impact. Ensuring affordability of all VBP treatments requires that, in the long run, a payer’s budget and its CE threshold are simultaneously determined: the larger the budget, the higher the CE threshold can be, because a higher CE threshold implies reimbursement of more, higher-priced therapies. In the short run, the launch of new, abnormally high-price or high-volume treatments can challenge affordability, that is, the payer’s ability to pay for all VBP therapies that meet its CE threshold. This leads some payers to include “expected budget impact” in their coverage assessment for new therapies and—implicitly or explicitly—adopt a lower CE threshold and VBP if expected budget impact is “too large.” This potentially discriminates against high-volume disease classes. An alternative approach is to lower the CE threshold across the board, eliminating reimbursement for previously marginal services. However, unstable reimbursement is potentially costly for providers and patients. Thus, although affordability requires that CE thresholds and budgets are interdependent in the long run, short-run adjustment of the CE threshold to manage affordability can be inefficient and inequitable.

This paper discusses alternative tools to reconcile CEA-VBP with affordability, focusing on 3 prototypical budget challenges: (1) high-volume/high-price treatments; (2) costly “cures,” such as gene therapies; and (3) orphan drugs.

1. High-prevalence/high-price diseases   

This context arises for progressive diseases (eg, hepatitis C), which have increasing medical complications and costs over a patient’s life. Highly effective new drugs that eliminate the underlying infection and avert high, late-stage disease costs can justify high, value-based prices. Importantly, for any slowly progressing disease, the stock (prevalence) of existing patients is large, relative to the annual flow (incidence) of new patients. If a payer provides treatment for all patients as soon as an effective new treatment becomes available, total initial treatment costs would be unaffordable within current budgets and far exceed future steady-state annual treatment costs. The short-term “budget bulge” occurs because (a) the projected cost-offsets that justify the high prices accrue mostly in future years, for all early and middle-stage patients, and (b) the initial stock of patients potentially eligible for treatment far exceeds the annual flow of new patients.

Thus, high-volume/high-price challenges to affordability are greatest at the launch of highly effective treatments for slowly progressing, ultimately fatal diseases. In such contexts, immediate treatment is highly cost-effective for late-stage patients who face large, near-term medical and health costs. Immediate treatment is less cost-effective for early-stage patients with modest, near-term medical and health costs. In other words, progressive diseases imply both high patient prevalence and heterogeneity. Monitored treatment staging—treating later-stage patients immediately while deferring treatment of early-stage patients—can distribute the “budget bulge” across years and better align the incremental spending on new drugs with the accrual of cost offsets on other treatments, with minimal health risk for patients. Spreading treatment over time also allows time for entry of competing products that may offer expanded treatment options and lower prices.

Unsurprisingly, the most pressing affordability challenges have arisen from such highly effective new treatments for high-prevalence, progressive diseases, notably hepatitis C. Most payers managed the high-price/high-volume “budget bulge” by spreading treatment of the initial patient stock across years and by exploiting the entry of competitor products to negotiate price discounts. Going forward, the annual cost of treating new patients is more modest. The key to affordability thus lies in (a) recognizing that the initial “budget bulge” is temporary, because disease prevalence exceeds annual incidence; (b) understanding disease progression, to optimally manage treatment staging; and (c) creative contracting to exploit competitive entry and achieve lower prices.

2. High-priced “cures”

“Cures” are single treatments that promise lifetime reductions in medical costs and/or improvement in quality of life, such as gene therapy. The value-based price of such a treatment is potentially very high, because it reflects the present value of cost savings and QALYs gained over the patient’s expected life. Budget impact can thus be large for the initial payer who pays for treatment, while medical cost offsets and health gains are spread over the patient’s life and future payers. This misalignment of payment with benefits has prompted analogies with home mortgages and proposals for novel mechanisms that pay instalments over time, possibly contingent on actual cost-savings and QALYs realized.

A major advantage of such pay-as-you-go mechanisms is that payment can be contingent on actual outcomes, to share risks as to long-term benefits of novel therapies and align producer incentives. Short-term, outcome-based contracts are increasingly being used by payers to appropriately tailor payments to outcomes realized. However, outcomes-contingent contracts entail monitoring and administrative costs, hence are most practical for treatments with readily observable outcomes in the short-term (eg, cholesterol reduction over 1 to 2 years). However, for long-duration “cures,” monitoring outcomes and attributing cause becomes increasingly problematic as time elapses.

In practice, installment-payment proposals for “cures” ignore key differences between medical care and home mortgages. Most medical care is covered by public or private insurance, and patients typically switch insurers over their lifetime, especially in the United States. The payer that agrees to administer and pay the first installment for a “cure” cannot legally commit future payers to make future payments. Granting such power would undermine the first payer’s incentive to be diligent in negotiating the total prices and fairly sharing payment with future payers, especially Medicare, which covers most patients after age 65. Future payers might litigate or default on their “liabilities,” with some justification if their formulary does not cover the treatment or if they incur unexpected treatment-related complications. Further, patients who carry with them a contractual liability for past treatment would likely encounter rejection and/or high premiums in private insurance markets, unless all health plans are subject to guaranteed issue/community rating requirements that mandate payment for prior treatment liabilities. From the producer’s perspective, if future payers default, no collateral/repossession remedy exists, analogous to repossessing a house if the buyer defaults on payment.

"A major advantage of such pay-as-you-go mechanisms is that payment can be contingent on actual outcomes to share risks as to long-term benefits of novel therapies and align producer incentives."

In fact, gene therapies and other “cures” are not unique in offering long-term medical benefits. Arguments for installment payment could be applied to many existing drugs and medical services with long-lived benefits, including many surgeries, vaccines, and other long-lived treatments. Over time, any large payer pays for some long-lived treatments but benefits from others. Such diversification across patients undermines the affordability case for installment-based payments for long-lived treatments, although the risk-sharing and incentive alignment arguments for installment payments remain valid. However, the feasibility of measuring and attributing outcomes to treatments are key to making such contingent, value-based payment systems practical. Applying such contracts to long-term cures requires further research on outcomes measurement and attribution, and on the management of multi-insurer liabilities.

3. Orphan drugs

Rare diseases were traditionally of concern because they were neglected as unprofitable by R&D departments. This neglect led, in 1983, to the Orphan Drug Act (ODA), to incentivize R&D for rare indications, defined as less than 200,000 patients in the United States. The ODA provides special R&D tax credits and grants, user-fee waivers, and 7 years of market exclusivity. Although the ODA does not explicitly address pricing, higher prices for orphan drugs, both absolutely and per unit health gain (eg, price-per-QALY) have been rationalized on grounds that: (1) patient volume and hence budget impact is low for each orphan drug; and (2) high prices are needed to offset low volumes to cover fixed R&D costs and yield a competitive return on investment. Although high prices are also sometimes rationalized by high “unmet medical need,” a lack of other effective treatments enhances the incremental value of an effective new treatment and hence would normally justify a high price within the standard CE threshold. Thus “unmet medical need” alone cannot support the use—implicit or explicit—of an abnormally high CE threshold for pricing any drug, orphan or nonorphan.

Since the ODA was enacted in 1983, the environments for orphan drug approval and reimbursement have changed dramatically. A recent study found that of the top 100 drugs in the United States, the average cost per patient/per year was $140,443 for orphans versus $27,756 for nonorphan drugs, with the highest-price orphan drug costing over $500,000 per patient/per year. These large differences strongly suggest that orphan drugs receive a higher price-per-QALY than nonorphan drugs, on average, although unfortunately no systematic comparison exists of price-per-QALY for orphan versus nonorphan drugs.

The combined effects on R&D of the ODA incentives, easing of regulatory requirements through breakthrough status and high prices, have been dramatic. Since 1983, over 600 orphan indications have been approved2 and orphan drugs now account for over one-third of new drugs approved by the US Food and Drug Administration (FDA) per year, with 30 to 50 new approvals annually since 2013. This surge in R&D targeting orphan drugs suggests that adding abnormally high pricing to the significant R&D incentives provided by the ODA and lower regulatory burdens, has made orphan indications more profitable than nonorphan indications, potentially biasing R&D towards orphan indications. Consistent with this, recent research found that phase III R&D cost was 50% lower for orphan conditions, and 75% lower after tax credits. Many orphan drugs are approved for multiple indications, including some nonorphan indications, and off-label use is common, such that patient treatment volume exceeds the orphan drug threshold for many orphan drugs. Overall, the expected return on investment was 1.14 times greater for orphan versus nonorphan drugs.3 Sales forecasts for pipeline orphan drugs now account for over a third of total R&D pipeline sales through to 2024.4 Thus orphan drugs in aggregate now pose an affordability concern for payers, and even individual, high-priced orphan drugs can have significant budget impact.

This growing share of new drugs and sales that target orphan conditions strongly suggests that pricing of orphan drugs using a higher CE threshold—implicit or explicit—is unnecessary to stimulate orphan R&D, given the statutory provisions of ODA (tax credits, market exclusivity, and fee forgiveness), supplemented by the FDA’s breakthrough status and other favorable regulatory provisions that apply to most orphan candidates.

This analysis suggests that payers should apply the same value-based pricing criteria and CE thresholds to orphan drugs as to nonorphan drugs. Those orphan drugs that provide highly effective treatments for unmet medical need will still qualify for high prices, while those that offer only modest benefit will receive a price that reflects their modest value. Pricing orphan drugs using the standard CE threshold would reduce the orphan drug affordability challenge and provide more appropriate allocation of current health budgets and incentives for future R&D. Whether certain ultra-orphan conditions can justify special CE thresholds or other VBP considerations remains a subject for future research.


Although in the long run, payers who use VBP must consider their budgets in setting CEA thresholds to assure affordability, in the short run other tools can offer remedies that are better tailored to deal with specific affordability challenges. High-volume/high-price treatments for progressive diseases can be managed by staging treatment of the initial patient stock over several years, after which annual treatment costs are modest. High-priced “cures” may be amenable to short-term, outcomes-contingent payments, but long-term installment payment is problematic and unwarranted. Pricing orphan drugs using standard CE thresholds would eliminate the orphan drug affordability challenge for payers, while preserving ODA and FDA provisions that mitigate R&D costs for orphan drugs. 


1. Danzon PM, Towse A., Mestre-Ferrandiz J. Value-based differential pricing: efficient prices for drugs in a global context. Health Economics. 2015;24(3): 294-301. DOI: 10.1002/hec.3021.

2. Lanthier M. Insights Into Rare Disease Drug Approval: Trends and Recent Developments. http://www.fda.gov/downloads/forindustry/developingproductsforrarediseasesconditions/ucm581335.pdf. Accessed May 31, 2020.

3. Evaluate Pharma. Orphan Drug Report 2015. 3rd edition - October 2015. http://info.evaluategroup.com/rs/607-YGS-364/images/EPOD15.pdf. Accessed May 31, 2020.

4. Evaluate Pharma. Orphan Drug Report 2018. 5th edition – May 2018. https://www.evaluate.com/thought-leadership/pharma/evaluatepharma-orphan-drug-report-2019. Accessed May 31, 2020.

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