Walmart-Humana: An Inevitable Surprise for Pharmacies and PBMs

On Friday, Walmart (NYSE:WMT) and Humana (NYSE:HUM) announced the “Humana Walmart Preferred Rx Plan,” a new Medicare Part D prescription drug plan (PDP) with lower consumer co-payments for prescriptions filled at Walmart pharmacies. Click here to read the official press release or get full details in Humana’s 2011 Summary of Benefits document for its Prescription Drug Plans.

Well, well, well. Looks like Walmart’s appetite for the pharmacy industry has reignited after a long hibernation. The company is once again challenging the conventional wisdom about profitability and market share with a lower cost, consumer-driven plan design. Once you understand this “incentivized preferred network design” (my words), then you’ll grasp its disruptive potential for retail and mail-order pharmacies.

• The $14.80 monthly premium makes it the low-cost PDP in every U.S. state (per Kaiser’s October 2010 Fact Sheet).
• The discount retail prescription pricing will influence pharmacy choice while simultaneously undermining the economic model of the Big Three PBMs—CVS Caremark (NYSE:CVS), Express Scripts (NASDAQ:ESRX), and Medco Health Solutions (NYSE:MHS).

The announcement is also an “Inevitable Surprise”—the predictable outgrowth of Walmart’s observable actions and statements about the pharmacy and PBM industries. Exhibit A: Wal-Mart's PBM Game Plan from January 2008. (Alternative hypothesis: Nobody expects Walmart!)

Read on for more details. I include many links to older Drug Channels posts on Walmart’s strategy as background for the many new readers in 2010.

AN INCENTIVIZED PREFERRED NETWORK DESIGN

Regular readers know my perspective. If you are spending your own money, then by all means choose your own pharmacy. But if you ask someone else—such as the American taxpayer—to pay for your drugs, don’t be surprised if they want you to save them money.

Pharmacy network design is one of the possible tools to achieve such cost savings. A preferred network gives the consumer a choice of pharmacy but provides financial incentives to use the particular pharmacies that offer lower costs to the payer.

In the Humana Walmart Preferred Rx Plan, a Part D beneficiary’s out-of-pocket costs are higher at a non-preferred, i.e., non-Walmart, pharmacy. There are 4,200 preferred pharmacies (including Walmart, Sam’s Club, Neighborhood Market, and Humana’s RightSource mail-order pharmacy) and 58,000 non-preferred retail pharmacies in the Humana network for this plan.

For example, once the annual $310 deductible is met:

• The cost-share percentages for brand-name drugs are 20% to 35% at a Walmart pharmacy but 37% or 50% at non-preferred pharmacies.
• The co-payment for a 30-day supply of preferred generics at a Walmart pharmacy is $2 and $0 through Humana's RightSource mail order, but $10 at a non-Walmart pharmacy.

This arrangement hearkens back to the original Walmart-Caterpillar preferred network model announced in September 2008. (See WMT + CAT: Pharmacy's Future? although I inaccurately refer to it as a "restricted network" in the original post.) The WMT-CAT deal only focused on 2,500 generics, whereas the new program includes all Part D eligible drugs.

Note that the new program is not the so-called access-based design touted by Walmart in a June 2010 white paper. (See Walmart's Pitch for Smaller Pharmacy Networks). Payers have been reluctant to embrace highly restrictive models with the notable exception of CVS Caremark’s Maintenance Choice program. Walmart has never provided any data to justify its unsubstantiated claim of “8-12% cost savings from an access-based network with no more than 20,000 pharmacies nationwide.” Perhaps there are also Any Willing Providers (the other AWP) issues in the Part D program.

A LOSS LEADER?

I’ve been warning the pharmacy industry for years that they should prepare to compete on price, not just customer satisfaction. Excessive margins on generic prescriptions created an inevitable opportunity for Walmart and others to disrupt the pharmacy industry’s economic model. PBM mail-order pharmacy margins are next.

Walmart explained its health care strategy last year in the fascinating Health Affairs article Removing Costs From The Health Care Supply Chain: Lessons From Mass Retail. Here’s a telling quote:

“Generic drugs cost pennies per pill to produce, but drugstores have traditionally priced generics in relation to the price of their brand-name equivalent, rather than their cost of acquisition.”

Translation: Walmart is willing to accept lower (but still positive) profits on generic scripts in exchange for market share. Walgreens jumped into this game after losing significant market share to Walmart in Illinois. See CAT + WAG = More Momentum for Cost Plus.

• Does Walmart lose money on prescriptions with its discount generic program? Doubtful. I discuss the economics behind Walmart’s $4 generic program in Sloppy reporting about Wal-Mart (Dec. 2006), Wal-Mart's Gain is not Walgreen's Pain (Oct. 2007), and Pharmacy Profits and Wal-Mart (Jan 2009).
  
• Is this a cost-plus, direct-to-payer arrangement? Walmart has not publicly confirmed that Humana is reimbursing preferred Walmart pharmacies on a cost-plus basis rather than list-price or MAC-based models. As I point out in Industry Impacts of Cost-Plus Reimbursement, cost-plus models are a lower risk/lower return model for pharmacies, not a “loss leader” model.
  
• Will Humana lose money? Carl Mercurio at the Corporate Research Group cites a conversation with William Fleming, vice president of Humana Pharmacy Services, stating that the plan is expected to generate a 5% operating margin for Humana, which is the average for all Humana Part D plans.

WHAT’S NEXT?

I predict that Walmart will win significant market share in regions where it has sufficient retail coverage—primarily the Southeast, Southwest, and Midwest. Walmart will also overtake Rite-Aid (NYSE:RAD) to become the third biggest pharmacy chain in 2011.

Other payers will contemplate preferred networks, especially if Humana picks up significant share of Part D plans. At a minimum, we could see significant auto-assignment of dual eligible Low income Subsidy (LIS) enrollees to the Walmart-Humana plan.

And PBM executives on their way to the PCMA Annual Summit today should be very, very nervous. See you there!

P.S. As a reminder, Walmart's chief weapon is surprise and fear. No, wait, their two weapons are fear, surprise, and ruthless efficiency. No, no, their *three* weapons are...Wait, I'll start again...