The NYT story is based on the AARP’s latest analysis of prescription drug list prices: Rx Watchdog Report: Drug Prices Continue to Climb Despite Lack of Growth in General Inflation Rate.
Comparing list prices for a single product category to a computed, non-list price index for a broad basket of goods (CPI-U) is mathematically illogical. After all, the CPI-U for prescription drugs increased at a rate less than half the rate of list prices. But we all know appropriate comparisons don't get you on the front page of the New York Times.
Anyway, let’s assume the AARP computations are mathematically accurate and consider the following Drug Channels-related question:
Have pharmacy profits from brand drug prescriptions gone up, gone down, or stayed the same as average list prices have increased?
The answer may surprise you.
PHARMACY MARGIN MATH
Pharmacies earn the majority of their gross profits on a prescription from “spread pricing”—the difference between (a) the “ingredient cost” reimbursement a pharmacy gets from a third-party payer or consumer minus (b) the pharmacy’s net acquisition cost for purchasing the product. Pharmacies also collect a fixed per prescription payment, a.k.a., a dispensing fee. See pages 16-20 of my pharmacy report for more details.
Most private and government third-party payers use the Average Wholesale Price (AWP) benchmark to estimate a pharmacy’s ingredient costs for a drug and compute a reimbursement amount. For instance, private employers in 2009 used an average discount of 16.4% from AWP, i.e., “AWP minus 16.4%,” as the ingredient cost reimbursement. AWP has a mathematical relationship to Wholesale Acquisition Cost (WAC), the list price used in the AARP study.
THE SURPRISING RESULT
The AARP study shows the average WAC (and hence AWP) for a brand prescription increasing. So what happened to pharmacy profits as the reimbursement benchmark rose?
To find out, I translated the AARP computations into a crude monthly per-script AWP estimate. I’m keeping things simple by ignoring the AWP rollback issue.
The table below shows my computations for the average gross profit and gross margin per brand prescription. These are averages, so YMMV. Click the chart to enlarge it.
- Pharmacies now receive a smaller percentage of a bigger number. The average AWP discount has increased. PMBI’s 2009-2010 Prescription Drug Benefit Cost and Plan Design Report, which survey employers (not PBMs) on benefit plan design, shows the average discount off AWP increasing from -14.1% in 2002 to -16.4% in 2009. Despite bigger AWP discounts, average pharmacy reimbursement per script has increased from $91 in 2002 to $144 in 2009—an annual average growth rate of 6.7%.
- Gross profits per brand prescription have grown very slowly. A retail pharmacy’s acquisition cost for a brand-name drug can be reasonably approximated using AWP/WAC benchmarks due to the pricing structure for single-source brand-name drugs. hus, average gross profits per brand drug prescription have increased very slightly and average gross margins per brand prescription have declined. Note that these computations are sensitive to the particular assumptions for column [E].
- Efficient, low-cost dispensing fulfillment is crucial to a pharmacy’s economic survival. You may be surprised to see average gross profits per prescription remaining fairly consistent over the 2002 to 2009 period. However, it does reconfirm my belief in the challenges facing a retail dispensing model. Wal-Mart agrees, as I note in Wal-Mart Explains Its Healthcare Strategy. These pressures are one reason the average daily number of prescriptions per pharmacy has been increasing steadily across all dispensing formats. See exhibit 8 of the pharmacy report.
- Profits from generic drug prescriptions have saved the day for pharmacies. The retail generic dispensing rate has gone from about 40% in 2002 to about 70% in 2009. Generic prescriptions yield higher profits per prescription for pharmacies than brand-name prescriptions. This superior profitability is being threatened as healthcare payers implement new payment benchmarks and pharmacies engage in a generic prescription price war.
The AARP report was co-authored by Stephen W. Schondelmeyer, a professor at the University of Minnesota. He is quoted in the New York Times article as saying: “When we have major legislation anticipated, we see a run-up in price increases.”
My web searching finds that tuition at the University of Minnesota increased by 7.3% this year (source) and by 7.5% last year (source).
Golly, those increases are quite a bit higher than the CPI-U, too.
I look forward to learning what major legislation is causing a run-up in tuition increases by the University of Minnesota.