As I see it, a cost-plus model gives a payer more control over pharmacy distribution and dispensing expenses. But this model could reduce incentives for generic substitution by limiting the profitability of generic prescriptions for retail and mail-order pharmacies. Payers would get new insights to the economics of Pharmacy Benefit Managers (PBMs). And as I describe below, widespread adoption of cost-plus ingredient cost reimbursement will likely lead to further pharmacy industry consolidation.
I also encourage you to check out the insightful reader comments below Monday’s CMS Approves Alabama’s Cost-Plus Plan. My article prompted a response from the always-gracious Kelli Littlejohn, Director of Pharmacy at the Alabama Medicaid Agency. I am reproducing her comments in this post below.
As always, I look forward more good debate and discussion from the Drug Channels community!
LIFE IN A COST-PLUS WORLD
Cost-plus models are a lower risk/lower return model for pharmacies. Current reimbursement models, whether based on a list price or a payer-determined maximum allowable cost (MAC), allow pharmacies to earn positive gross margins on prescriptions--on average. Sometimes a pharmacy can earn a very high margin on a prescription, but sometimes a pharmacy earns a low margin or even loses money.
Cost-plus trades this volatility for a lower average margin but less variability, i.e., lower risk and lower return.
If cost-plus models become more common, pharmacies with a combination of lower-than-average operating expenses and below average acquisition costs will be better positioned to succeed. The self-warehousing chains and mail-order pharmacies will have a natural advantage since these companies are able to acquire drugs less expensively. Larger, more active stores will benefit from cost-plus contracting because they have the lowest costs of dispensing.
However, the widespread adoption of cost-plus models faces a significant hurdle because it caps (and presumably limits) the profitability of generic drugs for pharmacies. Overall system costs could increase if the incentives for generic substitution by pharmacies, PBMs, and drug wholesalers are diminished.
Generic substitution is one of the most reliable and consistent ways for a payer to reduce expenditures for a prescription-drug plan. Cost-plus limits the potential profitability of generic drugs, thereby reducing incentives for the channel to negotiate vigorously with generic manufacturers. Cost-plus reimbursement could also reduce incentives to lower operating costs since a pharmacy would increase total gross profit dollars when paid a margin above a higher cost basis.
Payers must therefore consider a complex question before adopting cost-plus reimbursement: At what level of drug channel profits could payers still encourage rapid generic substitution while not “overpaying” for generics?
Here is a statement from Kelli Littlejohn, PharmD, Director of Pharmacy at the Alabama Medicaid Agency. Her comment originally appeared in response to BREAKING NEWS: CMS Approves Alabama’s Cost-Plus Plan.
First, thank you for bringing the AAC topic to the public. In the spirit of true transparency, please allow me to clarify some questions/comments/concerns I see from above readers.
What types of pharmacies are included in the survey? All enrolled pharmacies are surveyed, through a random selection process, once every two years. The survey process is mandatory.
Cost reporting: The surveys require providers to report invoices from all sources.
"Markup": CMS approved the Average Acquisition Cost, no markup. (ie AAC + 0%)
Dispensing Fee: CMS approved the Agency's request for a $10.64 dispensing fee, which was determined through a statistically sound, validated survey conducted by an outside contractor obtained through the RFP process. The Agency submitted both the drug ingredient and the COD modification in the same SPA; underscoring the fact that both sides of the equation need to be updated to support accurate reimbursement.
The Agency has worked extremely closely with State and national pharmacy associations throughout the entire process. Now that the AAC and the dispensing fee system have been approved, the Agency will continue its efforts to recognize additional professional services provided by pharmacists. We will continue to work closely with our provider groups as we develop the next phase to include pharmacies in creating a medical neighborhood for our patient which will include reimbursing pharmacies for other professional services. We are moving forward on that initiative now and look forward to swift approval."