Wednesday, August 16, 2017

Diplomat Sees Declining DIR Fee Impact—and Perhaps Readies a PBM Strategy

Last week, Diplomat Pharmacy released its quarterly earnings, which included new details about the financial impact of Direct and Indirect Remuneration (DIR) fees. I provide some background on DIR fees below.

Diplomat, as a public company, is the only entity that is obligated to publish truthful information about DIR fees. While reviewing its data, let’s recall our Drug Channels philosophy, courtesy of the late senator Daniel Patrick Moynihan: "Everyone is entitled to his own opinion, but not his own facts."

As you will see below, Diplomat’s exposure to DIR fees remains relatively modest. DIR fees as a share of its gross profit has even declined since last year. This shift is driven by an evolving business mix along with better accounting of and management control over DIR fees.

In part to counter DIR fees and other payer pressures, Diplomat is signaling its intention to play a more significant role in the pharmacy benefit management (PBM) business. Let the rumors begin!

THE LATEST NUMBERS

As always, I encourage you to read the original source material for yourself. Here are links to Diplomat’s financial results for the second quarter of 2017:
DIRTY WORK

Direct and Indirect Remuneration (DIR) fees have been problematic for specialty pharmacies. Specialty pharmacies have two key concerns with these fees:
  • Some DIR fees are computed as a percentage of a drug’s ingredient cost. When computed in this manner, a DIR fee can absorb a significant portion of a prescription’s gross profit.
  • DIR fees may be computed using quantitative performance criteria that are irrelevant to specialty pharmacies. For example, a specialty pharmacy’s DIR fee could be based on generic dispensing rates or adherence to non-specialty hypertension medications.
Note that performance-based DIR fees must be computed retroactively. For example, the period from January through April could be used to measure a pharmacy’s activities. The plan would analyze the data over two months (May and June), and then assess the DIR fees in July. Consequently, pharmacies would feel the financial impact in the third calendar quarter.

In response, wholesalers have unveiled tools to help independent pharmacies project the financial impact of DIR fees. McKesson offers a DIR Estimator as part of its myHealthMart platform. AmerisourceBergen’s Good Neighbor Pharmacy has also launched its own DIR Fee Estimator.

DIR fees are now a major source of controversy and confusion in the pharmacy industry. Here are two recent examples:
There is a scarcity of hard facts behind these disputes. For example, at least 90% of DIR fees comprise rebates paid by manufacturers to Medicare Part D plans. Payments from pharmacies to plans constitute a small portion of DIR fees. However, rhetoric from pharmacy associations often conflates all DIR fees with the specific subset of DIR fees paid by pharmacies to plans. Some groups have made unverified, hard-to-believe statements about the magnitude and impact of DIR fees on pharmacy economics. For more context, see my comments in DIR Fees, Rebates, Pharmacy Economics, and the Future of Medicare Part D.

DIPLOMAT’S DIR DISCLOSURES

Last fall, it seemed like Diplomat had not properly projected its inevitable DIR expenses. This apparent oversight spooked investors and led to a nasty stock decline. See
Behind Diplomat Pharmacy’s Plunge: A Primer on DIR Fees in Medicare Part D
.

Diplomat has clearly learned from that fiasco. In its press release, Diplomat noted that DIR fees were responsible for only a slight decline in gross margin, from 7.6% in the second quarter of 2016 to 7.5% in the second quarter of 2017. On last week’s earnings call, management confidently projected DIR fees of $20 to $25 million for 2017. In 2016, these fees were about $16 million.

The chart below assesses the magnitude of these DIR fees by comparing them with revenues and gross profits. As you can see, annualized DIR fees have grown slightly as a share of Diplomat’s revenues. But they have declined as a share of Diplomat’s gross profits.

[Click to Enlarge]

These figures understate the impact of DIR fees on individual prescriptions. Only 25% of Diplomat’s total business is subject to DIR fees for Medicare Part D plans. For Part D scripts with a DIR fee, we estimate that Diplomat's DIR fees were about 2% of prescription revenues and about 15% of gross profits. While significant, these amounts are not catastrophic. Note that more than one-third of its Part D business also has no DIR fees.

Diplomat is also benefiting from a changing business mix. Diplomat’s revenues from such other businesses as specialty infusion, managed market, and hub services have no DIR fees. The company’s revenue from these businesses is growing more quickly than traditional specialty pharmacy dispensing.

ET TU, PBM?

In The State of Specialty Pharmacy 2017: Reflections from #Asembia17, I observed:
"DIR fees are embedded in contracts between a PBM and a pharmacy or the pharmacy’s PSAO. From what I heard, many manufacturers expressed a belief that the solution should therefore be negotiated by the relevant parties in the transaction: pharmacies and PBMs."
Consider this concept when reading Diplomat Pharmacy CEO Phil Hagerman’s comments last week about Diplomat’s likely evolution:
"Industry dynamics and the push towards value based care may potentially accelerate our long-term plan of adding PBM-like services to our managed market strategy. As examples, our managed care customers are asking us to expand our existing capabilities in the highly customized services including formulary management, prior authorization management, and rebate aggregation."
This strategy is evident in this week's announcement of a medical benefit drug management partnership between Diplomat’s EnvoyHealth business and PharMedQuest.

You may have also noticed that the company has added two executives with extensive PBM experience:
If you can’t beat ‘em…

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