Alabama: More Momentum for Cost-Plus

Tuesday’s post about South Carolina' pharmacy profit boost connected me with Kelli D. Littlejohn, R.Ph., Pharm. D., Director, Pharmacy Services at the Alabama Medicaid Agency. Subject to approval by the Centers for Medicare and Medicaid Services (CMS), Alabama’s Medicaid program will soon implement a new pharmacy reimbursement program using Actual Acquisition Cost (AAC) instead of published benchmarks or Maximum Allowable Cost (MAC) lists.

Does AAC sound familiar? Yup, it’s our old friend cost-plus pharmacy reimbursement. As far as I know, Alabama is the first state to move to a cost-plus model. Some implications:

• The cost-plus revolution continues. Interest in cost-plus models stems from payer perception that reimbursement models based on list prices can provide inappropriately high pharmacy profits on certain prescriptions.
  
  
• Pharmacy profits will decline. Alabama estimates that Medicaid pharmacy costs will drop by $30.5 million in the first year—more than 6% of total drug spending and about $4 per prescription. Say goodbye to mega-spreads on generic prescriptions.
  
  
• Get ready for transparency. The State publishes AAC survey data by product name and package size. Check out the cost of your favorite brand or generic drug by downloading the most recent AAC list.
  
  
• Other payers will follow. Since the AAC data are on a public website for all to see, I see no reason why Pharmacy Benefit Managers (PBMs) or Medicare Part D Prescription Drug Plans (PDPs) will not start using the data in Alabama.

Alabama has posted a lot of useful background information on its AAC Program Implementation web page. Here are three highlights, which I encourage you to read for yourself:

• Issue Summary—a succinct summary of the program and its implementation
  
  
• Pricing Drugs in the Public Interest—a useful (albeit somewhat self-serving) primer on drug pricing by manufacturers and reimbursement to pharmacies
  
  
• Cost of Dispensing Prescription Drugs in Alabama—results of a study conducted by Health Information Design, Inc., which recommends the cost to dispense a prescription in the State of Alabama be established at $10.64.

ADAM’S QUICK PRIMER ON COST-PLUS

I predict the growth of cost-plus reimbursement and discuss its likely impact in The U.S. Pharmacy Industry: 2009 Economic Report and Outlook. Here’s some high-level background in case you (gasp) don’t have a copy of the report.

Cost-plus reimbursement models represent a different revenue and profit model for a retail pharmacy. Instead of being compensated relative to a list price or based on a fixed price determined by the payer, the pharmacy receives reimbursement based on its actual acquisition cost of a drug plus an additional amount to cover the pharmacy’s overhead and profit margin. Prior to Alabama, these models have been primarily adopted in private contracts such as the Walmart-Walgreens-Caterpillar deal or by Walmart’s other alleged access-based network design customers. (Yes, Walmart, that’s a hint.)

SWEET HOME REIMBURSEMENT

The Alabama situation got started with Average Wholesale Price (AWP) lawsuits. Ultimately, the Alabama Supreme Court ruled that three manufacturers—GlaxoSmithKline, Novartis, and AstraZeneca—did not defraud the state in pricing Medicaid prescription drugs. This makes sense to me. After all, the manufacturers simply published (inaptly named) list prices.

The Alabama Medicaid Agency, like most states, apparently neglected to look at actual pharmacy acquisition costs when setting reimbursement rates. Result: “Alabama pharmacists were paid millions in excess of their actual drug costs.” The brand drug overpayments averaged 20% and generic drug overpayments averaged 84.5%.

As the presentation indicates, the Court criticized the state (correctly, IMHO) for not changing the reimbursement system even though everyone knew it was inaccurate. Judge Patti Saris has made the same point in her rulings. See Farewell, AWP.

WHERE THE SPREADS ARE SO TRUE

The National Association of Chain Drug Stores posted a comment on Thursday’s post, writing:

“In addition, you mention the cost of dispensing in South Carolina, but you fail to mention that Medicaid pays dispensing fees that are well below those costs. The fact that other states may pay even less does not justify paying pharmacies below their costs in South Carolina.”

This is misleading and disingenuous nonsense. The dispensing fee must cover costs ONLY when ingredient cost reimbursement is equal to actual drug acquisition costs.

I presume (hope?) NACDS knows more about actual pharmacy economics. In addition to a dispensing fee, retail pharmacies earn spreads between (a) the ingredient cost reimbursement that a pharmacy gets from a third-party payer or consumer, and (b) the pharmacy’s net acquisition cost for purchasing the product.

This “spread pricing” provides retail pharmacies with more than 80% of their profits from prescriptions because pharmacies consistently acquire drugs for less than the ingredient cost reimbursement amount. The average dispensing fee from an employer-sponsored pharmacy benefit plan was only $1.57 (source), which obviously wouldn’t cover an average dispensing costs of $10 per prescription.

Pharmacies maintain spreads by keeping drug acquisition costs hidden from third-party payers. This lack of transparency creates opportunities for higher pharmacy profits by enabling the pharmacy to earn larger dollar spreads between the payer’s reimbursement and the acquisition cost. Spreads are largest for pharmacies that receive undisclosed rebates and hidden discounts from wholesalers or a pharmacy buying group. See this January 2008 OIG report for the facts.

A deep irony of the Drug Channel universe: Pharmacy owners complain loudly about spread pricing reimbursement and transparency from payers to PBMs, yet profit by spread pricing themselves. Yeah, whatever.

I’M COMING HOME TO YOU

Kudos to Alabama for being first in the nation to get serious about the post-AWP future. They are embarking on a fascinating experiment to transform Medicaid reimbursement to pharmacies. Everyone in the drug channel—pharmaceutical manufacturers, wholesalers, pharmacies, PBMs, and private payers—should pay close attention these developments.

I’ll close with a direct quote from page 33 of the "Pricing Drugs" slide deck:

Concern: It was determined that the reimbursement modification would be an overall cut to pharmacies; some would be forced out of business

Response: As determined through the AWP litigation discovery process, the Agency has been overpaying for drugs based on an inaccurate, flawed drug pricing model. It is time for the State to move to an accurate, fair, reimbursement process based on the actual cost of dispensing, and the actual drug ingredient cost.

You know you want hear it now. Click here if you can't see the video.