How to Stop Medicaid from Overpaying for Drugs

A fascinating new study from the Lewin Group estimates how much Medicaid overpays for prescription drugs. You can download this lengthily-titled report for free here: Potential Federal and State-by-State Savings if Medicaid Pharmacy Programs were Optimally Managed.

Lewin estimates that Medicaid spending would drop by 14.8% ($2.5 billion) in 2011 if fee-for-service Medicaid prescriptions were “optimally managed,” which means at levels comparable to private plans. A ten-year extrapolation estimates more than $30 billion in savings.

Shocking? Not really. I’ve long been critical of the overly political nature of pharmacy reimbursement under Medicaid. Just look at the windfall to South Carolina pharmacies versus their neighbors (in A Victory for Pharmacy Profits in South Carolina) or the excessive payments to pharmacies under the old Federal Upper Limits (in Won’t get FULed again). Lewin found that higher payments to pharmacies are not even associated with higher generic dispensing rates.

The data seem clear to me. But as always, I encourage you to read the study for yourself and make up your own mind.

SHOW ME THE MONEY

The Lewin study computes the savings figure using a straightforward analytic approach:

• Compute the savings from moving Medicaid fee-for-service (FFS) plans to levels typically found in Medicaid and commercial managed care or Part D plans in four areas: dispensing fees, ingredient cost, generic fill rates, and utilization
  
  
• Add the increase in administrative costs associated with more active benefit management activities, i.e., higher costs by an internal state Medicaid program or the costs of an external Pharmacy Benefit Manager (PBM)
  

Page 8 of the report shows savings by state. Three states—New York ($402 million), California ($372 million), and Texas ($266 million)—account for 42% of the total savings. The savings figures for Alabama and Oregon are probably a bit high because both states are moving to cost-plus models to save money.

Here’s where the estimated savings come from:

One surprise is the fact that lower dispensing fees account for almost one-third of the savings. As Lewin notes: “On average, Medicaid FFS programs pay pharmacies a dispensing fee of $4.60 for brand drugs and $4.90 for generic drugs, more than twice the amount paid by private sector health plans.”

True. Compare Lewin’s computed Medicaid average dispensing fee of $4.81 with the average $1.62 fee from the PBMI's most recent survey of 372 employers (source).

Keep in mind that the dispensing fee typically accounts for only 15% to 20% of the total gross profit per prescription earned by a pharmacy from a typical third-party payer. “Spread pricing” provides retail pharmacies with most of their profits from prescriptions because pharmacies consistently acquire drugs for less than the ingredient cost reimbursement amount. Lewin found that several states are just very munificent—they are "high-end payers" to retail pharmacies for both dispensing fees and ingredient costs.

For more details on pharmacy profits, see the “Pharmacy Reimbursement by Third-Party Payers” section of The 2010-11 Economic Report on Retail and Specialty Pharmacies.

YOU HAD ME AT HELLO

I’m sure some pharmacy owners will carp about the fact that the study was commissioned by the Pharmaceutical Care Management Association (PCMA), the association that represents PBMs. There is clearly some enlightened self-interest here because PBMs would like to manage the Medicaid pharmacy benefit on behalf of states—and earn fees for doing so.

But having PBMs manage Medicaid drug trend makes sense to me as both an industry analyst and as a taxpayer, especially given historically dismal oversight of pharmacy reimbursement by state Medicaid programs. Factor in the projected growth in Medicaid enrollment (illustrated in Health Reform: Impact on Drug Channels) and there is a very compelling story here.

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What do you think? Are the study's conclusions reasonable or not?