Pricing of Drugs with Heterogeneous Health Insurance Coverage

In this paper, we examine the role of insurance coverage in explaining the generic competition paradox in a two-stage game involving a single producer of brand-name drugs and n quantity-competing producers of generic drugs. Independently of brand loyalty, which some studies rely upon to explain the paradox, we show that heterogene- ity in insurance coverage may result in higher prices of brand-name drugs following generic entry. With market segmentation based on insurance coverage present in both the pre- and post-entry stages, the paradox can arise when the two types of drugs are highly substitutable and the market is quite pro?table but does not have to arise when the two types of drugs are highly di¤erentiated. However, with market segmentation occuring only after generic entry, the paradox can arise when the two types of drugs are weakly substituables, provided, however, that the industry is not very pro?table. In both cases, that is, when market segmentation is present in the pre-entry stage and when it is not, the paradox becomes more likely to arise as the market expands and/or insurance companies decrease deductables applied on the purchase of generic drugs.