The mechanisms of the PPRS

The revised PPRS, applying from October 1999, covers the supply of all branded NHS medicines. This includes items such as blood products, vaccines and dialysis fluids. It will stay in force for at least five years. In the event of major changes affecting the supply of medicines to the NHS either industry or the Department of Health may request an interim review after not less than 2 1/2 years of the scheme.

Companies do not have to be members of the ABPI to be members of the Scheme. Any company can elect not to be a member, or may be excluded from the PPRS because it has not complied with requirements. In such circumstances the Secretary of State for Health has power to invoke a statutory scheme under the Health Act 1999.

Annual Financial Returns

For companies with NHS sales of £25 million or more the core reporting mechanism of the PPRS is known as the Annual Financial Return, or AFR. This is a set of accounts drawn up in an agreed format identifying a company's NHS sales, costs and trading profit. Companies must submit their AFRs within set periods after the ends of their financial years. The AFR has two main elements:

1. Sales, costs and profit. This details actual and projected operating costs and profits, and requires reconciliation of the data provided with audited accounts. The latter must be supplied by all companies, except (in permitted cases) those with NHS sales of less than £1 million a year. The parent companies of subsidiary concerns based in the UK must also submit their accounts, so that a full picture can be established 2. Capital employed. This details the capital employed by each company supplying medicines, and allows an appropriate proportion of it to be allocated to home NHS use as opposed to other business, such as exports.

1. Sales, costs and profit. This details actual and projected operating costs and profits, and requires reconciliation of the data provided with audited accounts. The latter must be supplied by all companies, except (in permitted cases) those with NHS sales of less than £1 million a year. The parent companies of subsidiary concerns based in the UK must also submit their accounts, so that a full picture can be established
2. Capital employed. This details the capital employed by each company supplying medicines, and allows an appropriate proportion of it to be allocated to home NHS use as opposed to other business, such as exports.

The above figures are then used in assessing the overall profitability of a company within the PPRS scheme or to assess an application for a price increase.

Measuring profits

The PPRS sets a ceiling on companies' profits, but does not guarantee them.

Companies within the Scheme have an allowable profit (or cap) of 21 per cent, measured as a return on average historic capital employed. That is building, plant, land and other relevant items valued at the time they were purchased or constructed, rather than at current prices.

Pharmaceutical suppliers that do not have major capital investments in the UK can work on a return on sale (ROS) basis.

A company, which, through efficiency gains, exceeds its target return, can retain up to 40 per cent over the originally permitted return. i.e. up to 29 per cent return on capital - but only if it has not received a price increase for any product in that same year.

Profits beyond this margin of tolerance must be reduced by:

• Cutting prices
• Repaying the excess profit to the Department of Health or
• Delaying or restricting previously agreed future price increases.

Price changes

The 1999 Scheme imposed an immediate cut in the price of medicines covered by the PPRS leading to £200 million worth of savings for the NHS. However, it permitted manufacturers flexibility in applying price cuts to individual NHS medicines subject to an overall reduction of 4.5 per cent across each supplier's product range. No price increases will be allowed before January 2001.

Even then, no price increase will be allowed unless a company's profit level has fallen to below 8.5 per cent, as measured by its return on capital.

No PPRS member can increase the price of any NHS medicine without prior approval from the Department of Health. There is mounting evidence that competition is effective in controlling prices, and changes to the thresholds for price increases within the scheme will mean that they are even less likely to occur than in the past.

Allowances

In calculating a company's costs many expense categories, including research and development and sales promotion are restricted to allowed percentages of turnover. Where a cost, as reported in the annual financial return, exceeds the allowance, the excess is added back and treated as profit.

Research and development allowance

Each company's R&D allowance comprises up to 20 per cent of total home NHS turnover (when assessing profits) or 17 per cent (when considering a price increase). In addition, companies are permitted up to 3 per cent more depending on the number of patented products they sell in the UK.

UK fixed costs

Non-R&D fixed assets and manufacturing infrastructure costs are apportioned between Home and Export sales. To take full account of the assets and costs necessary to supply the NHS, 7.5 per cent is allocated to Home NHS before the balance is divided according to the proportion of a company's Home and Export sales.

Sales promotion allowance

When assessing a company's profits the formula used to determine permissible sales promotion spending involves a basic allocation of 6 per cent of NHS sales. The figure is reduced to 3 per cent when considering a price increase. In both cases there is also a fixed element of £464,000 (which assists smaller turnover companies) and tiered cash allowances relating to the numbers of products a company has with sales above £100,000 to the NHS.

Enforcing the scheme

Other aspects of the recent PPRS agreement made between the Department of Health - acting on behalf of Ministers and the NHS in all the UK nations - and the Association of the British Pharmaceutical Industry included arbitration, consultation and Parliamentary reporting arrangements.

A further relevant innovation is that the powers granted to the Secretary of State in the Health Act 1999 allow for special statutory penalties to be imposed on companies supplying medicines to the NHS if they fail to comply with the terms of the PPRS. The Secretary of State also has the option to control prices of a company in the event that it does not sign up to the PPRS Scheme and reserve powers to set up a statutory scheme.

A failure to provide, say, financial information or to respect price restraints may attract a single penalty of £100,000, and/or a cumulative daily fine of £10,000.