Do tariffs and prices correspond with costs? A case study of orthotic braces

Abstract

Objectives: The Belgian third-party payer wishes to set reimbursement tariffs at a level that reflects the costs of orthotic braces. This article aims to calculate production and distribution costs of a prefabricated hard neck and knee brace and to explore whether Belgian tariffs and actual retail prices correspond with estimated costs of these two braces.

Methods: The cost model considered manufacturing costs, general overheads, research and development costs, warehousing costs, profit and distribution margins. Data were gathered from manufacturers, a production site visit, desk research, a decomposition of finished products and stakeholder interviews. The price year was 2007.

Results: The cost model estimated a retail price of €55–€150 for the neck brace, depending on assumptions. The estimated retail price for the neck brace was lower than the reimbursement tariff of €194 and the actual retail price of €241. The estimated retail price of €331–€694 for the knee brace was lower than the actual retail price of €948.

Conclusions: Actual retail prices and reimbursement tariffs for a neck brace and a knee brace exceeded prices based on estimated costs. Therefore, there appears to be scope for reducing tariffs.

Keywords::

• orthotic device
• brace
• orthopaedics
• costs
• reimbursement

Introduction

Orthotic devices are used by patients to support or correct human function and to render resistance to unwanted movement. There exists an extensive medical literature on orthotic devices that focuses on the biomechanical properties of devices, the effectiveness of devices in specific pathologies and the comparison of devices with other treatment approaches (e.g. physical therapy and exercise, drug treatment, surgical treatment, patient education). The market for orthotic devices is a relatively small but significant market. In Belgium, reimbursed expenditure for orthotic devices in ambulatory care amounted to €58 million (or approximately 0.3% of total public health expenditure) in 20051.

There is little evidence regarding the health economics of orthotic devices most relevant to this analysis (i.e. neck, wrist and knee braces). Two studies measured the costs of wrist braces in the treatment of distal radius fractures2,3 but, to the authors’ knowledge, no cost analyses of neck and knee braces have been conducted. Costs are an important issue from a policy-making perspective as public expenditure on braces can be significant. Orthotic braces accounted for approximately 19% of public health expenditure on orthotic devices in ambulatory care in Belgium. Prefabricated (‘off-the-shelf’) braces make up 88% of public expenditure on these three brace types1. Public expenditure on orthotic braces is expected to grow in the future as a result of the ageing population, more active lifestyles and demands for increased quality of life, constant innovation in medical technology, income growth and increasingly extensive health insurance systems that facilitate access to devices. Few economic evaluations of orthotic braces have been carried out to date4–7.

The Belgian third-party payer, the RIZIV/INAMI (the Belgian Service for Illness and Invalidity Insurance), aims to set reimbursement tariffs at a level that reflects total costs of production and distribution of orthotic braces. However, this requires insight into the cost structure of braces, information that is generally not disclosed by manufacturers. The aim of this article was to develop a model that calculates the cost of production and distribution of orthotic braces and to explore whether Belgian tariffs and actual retail prices correspond with estimated costs of braces. The findings will aid policy makers in optimising reimbursement of orthotic braces in Belgium. This study was carried out as part of a larger research project under the authority of the Belgian Healthcare Knowledge Centre which, in addition to computing costs, conducted an international comparison of prices and regulation governing national orthotic brace markets8.

Pricing and reimbursement

Regulation governing pricing and reimbursement of orthotic braces in Belgium has been described in detail elsewhere9, but a summary is provided here with a view to setting the context of this analysis of the costs and tariffs of braces.

Pricing of orthotic braces is free in Belgium. Manufacturers sell braces to distributors at the ex-manufacturer price (i.e. a price covering costs of research and development (R&D), manufacturing, warehousing, overheads and a profit margin). Distributors sell braces on to orthotists (i.e. healthcare professionals who specialise in the fabrication and delivery of, amongst other things, braces to patients) at the price to the dispenser. When the set of billing codes fixing the public reimbursement of orthotic braces (the ‘nomenclature’) was developed in 1992, the mean price to dispensers across similar products was multiplied by the ‘Walkiers coefficient’ to obtain the reimbursement tariff of each category of orthotic braces. In other words, one tariff applies to the braces of different manufacturers belonging to the same nomenclature code. The Walkiers coefficient covers a pay-off for general costs, wages, measurement and adaptation of orthotic braces, and costs of materials. The Walkiers coefficient used by the Committee of Orthotists and Health Insurance Funds of RIZIV/INAMI is currently set at 2.13 for prefabricated braces and at 4 for custom-made braces10. The retail price of orthotic braces needs to be equal to the tariff for custom-made braces, but can exceed the tariff for prefabricated braces.

Orthotic braces are reimbursed by the RIZIV/INAMI if they are delivered to ambulatory patients by an officially recognised orthotist who works for a company or a medical equipment shop that is affiliated to a health insurance fund. The distribution margin is determined by the Walkiers coefficient and the possible difference between the public price and the reimbursement tariff of the brace.

Methods

To estimate the costs of orthotic braces, a cost model was created following the principles of cost analysis in health economics11–13. Development of the cost model consisted of four steps. The first step determined the scope of orthotic braces to be included in the analysis. The production process was represented schematically in the second step, thus enabling all relevant cost drivers to be identified. In the third step, the model was populated with data. Finally, the cost model generated an estimate of the ex-manufacturer price of orthotic braces, taking into account uncertainty in estimates of cost drivers, as well as an estimate of the retail price, taking into account distribution margins. The various steps involved in developing the cost model are described in the following sections.

Scope of analysis

The cost model focused on two selected braces (i.e. a prefabricated hard neck brace and a prefabricated hard knee brace). Prefabricated braces were selected as these made up more than 80% of public expenditure on neck and knee braces in 20051 and prefabricated braces are internationally standardised products readily lending themselves to product research. Hard neck and knee braces were chosen because a review of the medical literature demonstrated the effectiveness of these braces in multiple pathologies8. Also, the nomenclature code of the selected type of hard knee braces accounted for 63% of public expenditure on prefabricated knee braces in Belgium. Similarly, the code of the type of hard neck braces made up 19% of public expenditure on prefabricated neck braces1. Finally, based on the market share of the different brands within each nomenclature code, the DonJoy 4-titude hard knee brace and the Jerome Miami hard neck brace were selected with a view to estimating costs.

Production process

The production steps in the manufacturing process were used to identify cost drivers. Manufacturing costs incurred in subsequent production steps involve: raw materials; direct labour arising from, for example, operating and packaging; indirect labour related to engineering and quality assurance; and machine costs. In addition to these manufacturing costs, the analysis accounted for general overheads (relating to administration, accounting, insurance and security), R&D, warehousing and a profit margin.

Data sources

Data on volume and unit costs of cost drivers were extracted from a variety of sources. Eight international manufacturers active on the Belgian market were solicited to provide information about the production and cost structure of prefabricated hard neck and knee braces, with responses being received from one German manufacturer. The research team visited a production site where hard knee braces are manufactured. The questionnaire filled in by the German manufacturer and an analysis of annual reports of the eight manufacturers yielded data regarding the amount of investments in R&D of neck and knee braces and in machinery. Information was also gathered from disassembling and studying finished samples of the two selected products. Three experts in materials were contacted to learn more about the raw materials involved in the production process. Information was received from machine constructors regarding the purchase, operational and maintenance costs of machines typically used in the production process. Finally, an extensive desk research was carried out with a view to gathering data from catalogues, brochures, internet websites, annual reports and other financial information from manufacturers.

Cost estimates of raw materials were based on information from the metal industry (i.e. from a sheet metal stamping manufacturer and a manufacturer specialised in injection moulding processes, which supply the medical devices industry). The weight of raw materials was determined from actual product samples. Waste of raw materials during production was determined during a visit to a production site for every production step and was taken into account to determine the cost.

Labour costs depend on the wage level in the country of production. As the eight manufacturers have production facilities in various European countries, a European industry average cost was considered14–17. Direct labour costs amounted to €25 per hour for operators and maintenance technicians, and indirect labour costs were estimated at €40 per hour for quality assurance and engineering.

The cost of machinery was determined in terms of the cost per hour (total investment cost for machinery/total hours of production capacity). The total hours of production capacity are documented in the model. This capacity is related to the number of hours a machine is active over 1 year (one or two shifts) and the lifetime of a machine. A full utilisation rate (100%) was hypothesised for machinery because all machinery used in the production process is multipurpose machinery. An exception was made for specialised cutting and welding machinery used for the protection material applied in the knee brace. As the market only needs a limited numbers of knee braces, the concept of mass production and a full utilisation rate is not applicable. For this machinery, the research team used a 50% utilisation rate (one full shift capacity).

The mark-up for warehousing was fixed at 2% of manufacturing costs based on a report on the medical devices industry18. The mark-up added to the sum of manufacturing and warehouse costs was set at 8% for general overheads. A mark-up of 10% for R&D was added to the total manufacturing, warehousing and overhead costs. Finally, the mark-up for profits was set at 15% of the sum of manufacturing, warehousing, overhead and R&D costs. Estimates of mark-ups for overheads, R&D and profits were derived from an analysis of the annual reports of 2005 and 2006 of the eight manufacturers. Based on discussions with industry representatives, an overall cost of filing patents and certificates of €100,000 was also taken into account for each of the two selected products. This cost is a fixed cost divided over the total production volume over the lifecycle of the product.

Ex-manufacturer price

Aggregating manufacturing costs and costs of overheads, R&D, warehousing and profits produces an estimate of the production cost of the brace as it leaves the factory of the manufacturer. This estimate is referred to as the ex-manufacturer price. Such an estimate needs to take account of the total number of products than can be produced over the lifecycle of a product (i.e. the lifecycle production volume) and the volume of production per batch. To incorporate this volume aspect, the model generates estimates of the ex-manufacturer price that reflect a low- and a high-volume scenario. The low-volume scenario referred to a total lifecycle production volume of 18,000 and a production batch volume of 300. The high-volume scenario was based on volumes of 180,000 and 3,000, respectively. These scenarios were based on information provided by the German manufacturer of orthotic braces, a sheet metal stamping manufacturer and a manufacturer specialised in injection moulding processes.

Retail price

Distribution costs need to be added to production costs to generate an estimate of the retail price (i.e. third-party reimbursement and patient co-payment) of the two orthotic braces. The ex-manufacturer price was multiplied by a mark-up for distributors/importers. Interviews with several distributors indicated that this mark-up was estimated to be 1.66, but could be as high as 2.2. Therefore, an estimate of 1.66 was used in the base case analysis and a value of 2.2 was applied in a sensitivity analysis. In addition, the price to orthotists (= ex-manufacturer price × 1.66 or 2.2) was multiplied by 2.13 (i.e. the mark-up for orthotists as determined by the Walkiers coefficient) to obtain an estimate of the retail price. Retail prices (value-added tax of 6% included) and tariffs were expressed in 2007 values. Actual retail prices applying to the Belgian market were gathered through a survey among retailers, with 21 respondents providing information about prices.

Results

Table 1 summarises estimated manufacturing costs and ex-manufacturer prices for the prefabricated hard neck brace. The cost model generated estimated ex-manufacturer prices for the neck brace of €15.48 or €32.03 depending on assumptions surrounding the volume of total lifecycle production and production per batch. Manufacturing costs accounted for 68% or 54% of ex-manufacturer prices of the neck brace in the high- and low-volume scenario, respectively. The most important cost drivers were labour (25% or 20% of ex-manufacturer price), raw materials (31% or 15% of ex-manufacturer price), profit (13% of ex-manufacturer price) and machines (11% or 13% of ex-manufacturer price).

Table 1.  Breakdown of estimated ex-manufacturer prices of a prefabricated hard neck brace.

	Low-volume scenario		High-volume scenario
	Absolute costs(€)	Relative costs (%)	Absolute costs (€)	Relative costs (%)
Cost of moulds	1.95	6	0.19	1
Cost of raw materials	4.82	15	4.82	31
Cost of machines	4.11	13	1.69	11
Cost of labour	6.55	20	3.85	25
Manufacturing costs	17.43		10.55
Patent costs	5.56	17	0.56	4
Warehousing costs	0.46	1	0.22	1
General overheads	1.88	6	0.91	6
R&D costs	2.53	8	1.22	8
Profit	4.18	13	2.02	13
Ex-manufacturer price	32.03	100	15.48	100

R&D, research and development.

Estimates of manufacturing costs and ex-manufacturer prices for the prefabricated hard knee brace are presented in Table 2. Estimated ex-manufacturer prices for the knee brace were equal to €93.71 or €148.03 depending on assumptions. Approximately 70% of the ex-manufacturer price could be attributed to manufacturing costs. The ex-manufacturer price was primarily made up of the cost of machines (22% of ex-manufacturer price), raw materials (27% or 17% of ex-manufacturer price), labour (15% or 12% of ex-manufacturer price) and profit (13% of ex-manufacturer price).

Table 2.  Breakdown of estimated ex-manufacturer prices of a prefabricated hard knee brace.

	Low-volume scenario		High-volume scenario
	Absolute costs (€)	Relative costs (%)	Absolute costs (€)	Relative costs (%)
Cost of moulds	19.03	13	1.90	2
Cost of raw materials	25.25	17	25.25	27
Cost of machines	33.26	22	20.61	22
Cost of labour	18.15	12	13.95	15
Cost of coating	5.00	3	5.00	5
Manufacturing costs	100.69		66.71
Patent costs	5.56	4	0.56	1
Warehousing costs	2.12	1	1.34	1
General overheads	8.66	6	5.48	6
R&D costs	11.70	8	7.40	8
Profit	19.30	13	12.22	13
Ex-manufacturer price	148.03	100	93.71	100

R&D, research and development.

Adding distribution to production costs yielded an estimated retail price for the neck brace of €55 or €113 when a distribution mark-up of 1.66 is used, and €72 or €150 when a distribution mark-up of 2.2 is applied. The estimated retail price for the knee brace amounts to €331 or €523 with a mark-up of 1.66, and €439 or €694 with a mark-up of 2.2. Estimated retail prices obtained from the cost model were compared with reimbursement tariffs and actual retail prices (see Table 3). Table 3 indicates that the tariff for the neck brace was substantially higher than the estimated retail price. With respect to the knee brace, the tariff was close to the estimated retail price under the assumption of a low production volume. Actual retail prices exceeded estimated retail prices by a factor of 2–4 for the neck brace and by a factor of 2–3 for the knee brace.

Table 3.  Comparison of retail price and tariff.

Brace	Estimated retail price (€)	Tariff (€)	Actual retail price (€)
Hard neck brace—high volume scenario	55	194	241
Hard neck brace—low volume scenario	113	194	241
Hard knee brace—high volume scenario	331	580	948
Hard knee brace—low volume scenario	523	580	948

Discussion

The cost structure of orthotic braces tends to be a black box and has not been investigated in the international literature to date. Moreover, little information is available about the relationship between pricing and reimbursement of orthotic braces. This study has developed a model to gain insight into the cost of production and distribution of a prefabricated hard neck brace and a prefabricated hard knee brace and has examined whether tariffs and actual retail prices reflect the estimated costs of these braces.

The cost analysis has highlighted that the retail price of orthotic braces in Belgium is largely determined by the margins for distributors/importers and orthotists. Discussions with distributors revealed that the ex-manufacturer price needs to be multiplied by (at least) 3.5 to obtain an estimate of the retail price. In other words, distribution costs account for a minimum of 70% of the retail price and production costs make up a maximum of 30%.

This model estimated total costs of production and distribution of orthotic braces. With respect to production, costs were estimated from European sources as there are no Belgian manufacturers of braces. This implies that the same production process and costs were assumed for every manufacturer. This appears to be a reasonable assumption because the analysis focused on two selected braces (i.e. a prefabricated hard neck brace and a prefabricated hard knee brace) and production processes for each of these braces are unlikely to vary to a great extent between manufacturers. With respect to distribution, the margin for distributors/importers and orthotists specifically applied to Belgium.

Ideally, RIZIV/INAMI, the Belgian third-party payer, would like to set tariffs at a level that reflects total costs of production and distribution of orthotic braces. The analysis shows that estimated retail prices derived from the cost model are lower than tariffs of the selected neck and knee brace. This appears to suggest that Belgian tariffs are set at a generous level. The fact that Belgian tariffs do not reflect estimated retail prices is not surprising given that reimbursement of each category of braces is based on prices fixed in 1992 and adjusted on the basis of the evolution of the Belgian consumer price index over time. Thus, the analysis indicates that the tariffs set in 1992 no longer reflect the current value of orthotic braces sold on the Belgian market. The difference between tariffs and estimated retail prices needs to be further investigated by the Committee of Orthotists and Health Insurance Funds of RIZIV/INAMI, which is responsible for setting tariffs for orthotic braces in Belgium.

The analysis also indicated that actual retail prices of the selected neck and knee braces substantially exceeded estimated retail prices. An international price comparison showed that actual Belgian retail prices of the selected neck and knee braces were considerably higher than prices in England, France, The Netherlands and Ontario (Canada)8. Higher prices in Belgium may result from the fact that pricing is free and that there are no mechanisms based on public procurement (such as in Sweden) or maximum prices (such as in France and Ontario) that regulate price setting.

As few details on the cost structure of orthotic braces are publicly disclosed, a number of assumptions had to be made. As a result, the findings give an idea of the order of magnitude of cost drivers but do not represent exact cost data. The added value of the analysis lies in the quantification of the relative importance of the various cost drivers. Whenever possible, an effort was made to base assumptions on published figures and on a decomposition of finished products by experts. In addition, the research team contacted various stakeholders to gain insight into the manufacturing process and product lifecycle. This constitutes a valuable approach in a domain where cost information is deemed confidential by manufacturers.

It may be possible to generalise the results to other countries taking into account local regulation governing distribution margins. This is because the estimates of ex-manufacturer prices were based on the products and annual reports of international manufacturers. Production tends to be centralised in one country and braces are then exported to various national markets. Adding the distribution margin that is used in a country to the estimates of ex-manufacturer prices would allow national reimbursement agencies to attain an approximation of the retail price of the prefabricated hard neck and knee braces. Such an exercise could be carried out, for instance, for England, where the distribution margin of community pharmacies for braces consists of a fee per prescription.

Further research needs to be undertaken to refine and validate the methodology for estimating production and distribution costs. Also, this analysis needs to be applied to types of orthotic braces other than prefabricated hard neck and knee braces. Such an exercise may aid policy makers in setting tariffs closer to real costs, thereby containing public expenditure on orthotic braces and optimising the allocation of scarce resources.

Acknowledgements

Declaration of interest: Financial support for this research was received from the Belgian Healthcare Knowledge Centre, a state-funded research institution. The authors have no conflicts of interest that are directly relevant to the content of this manuscript.