Tuesday, October 20, 2009

Healthcare Reform: Bullish for PBMs, but Not Pharmacies

"a brand-new market for Medco to serve”

That’s the view on the Senate’s health reform proposal from David Snow, CEO of Medco Health Solutions (NYSE:MHS) as reported yesterday in CEOs Tally Health-Bill Score.

Right now, it looks like healthcare reform will benefit Pharmacy Benefit Managers (PBMs) by expanding coverage. Retail pharmacies would benefit from increased prescription volume but will likely see gross margins drop as the uninsured get the advantage of third-party bargaining power.

The Bullish Case for PBMs

If you believe the CBO’s October 7 analysis of the America’s Healthy Future Act of 2009, then the total non-elderly insured population will grow by 50 million people by 2019. The number of uninsured will drop by 29 million people while the number covered by Medicaid/CHIP will grow by 14 million.

Here’s the breakdown of coverage that I derived from page 14 of CBO’s letter to Senator Baucus. (Click the chart to enlarge it.)

The net effect will be an overall increase in the number of people covered by prescription drug insurance. I assume that most plans sold through health insurance “exchanges” will include some type of drug coverage. (Click here for a helpful overview of the insurance exchange concept from the Kaiser Family Foundation.)

Pharmacy Benefit Managers (PBMs) are the likely administrators of these plans, regardless of coverage guidelines or the government’s involvement. T
his brand-new market won't appear until 2014, which is when the CBO expects the number of uninsured to start dropping significantly.

The Less-Bullish Case for Retail Pharmacies

Prescription drug insurance is a double-edged estoque for retail pharmacies.

The good news for pharmacies is that overall prescription utilization would grow, benefiting brick-and-mortar pharmacies. This is exactly what happened in 2006 when the Medicare Part D benefit was introduced.

At the same time, greater insurance coverage would also depress pharmacy margins. As I show in Exhibit 13 of my new pharmacy report, pharmacies earn much higher margins from uninsured and underinsured individuals, a.k.a. “cash customers.” In contrast, the pooled negotiating power of third-party payers limits the profitability of pharmacy prescriptions for consumers with third-party insurance.

You may not appreciate that this margin decline also occurred when Part D started. Here’s a quote from CVS Caremark’s 2007 10-K filing:
“The Medicare Drug Benefit became effective on January 1, 2006. Since its inception the program has resulted in increased utilization and decreased pharmacy gross margin rates as higher margin business (such as cash and state Medicaid customers) migrated to the new Medicare Part D coverage.”
There are other aspects of the proposal that will benefit pharmacies. Everything could change as the proposal gets turned into law. So, my comments only represent the first stage in the coming bullfight.


  1. I can't disagree with your comments on the impact of cash pay customers dropping out. However, I think the benefits of the increased utilization more than swamp the impact. In the Part D example, CVS' Gross Margins went from 26.8% in 2005 to 27.2% in '06, 29.1% in '07 and 30.1% in '08. There is a lot of other stuff going on in those numbers (simvastatin, the acquisition of Caremark and Savon Osco) but they were able to increase margins by over 300 bps while getting less cash pay. I think utilization will carry the day.

  2. Yes, I agree that utilization will be a big benefit especially in combination with the big wave of generics on the way.

    I just want to highlight an oft-ignored downside to greater coverage. I also see substantial risks to the future profitability of generics for pharmacies with greater third-party insurance. See Trend #3 in my new pharmacy report.

    For the benefit of other readers, keep in mind that CVS Caremark does not disclose gross margins for the prescription portion of their pharmacy business, so the margin figures cited above include many offsetting effects.


  3. Adam is right on with today's post. It's murky times in the retail pharmacy industry. Maybe not today, and maybe not tomorrow. But slowly, over time, we'll see even more increased margin pressure from PBM's and the payer sources behind them.

    New generics are indeed on the way and though they help with the GM %, again it's the dollars that the drug stores take to the bank. With newer pricing mechanisms, pass through savings, and some sort of "AMP" pricing in front of us, the GM $ will be heading south.

    Those chains which have initiated "club pricing" will have little flexibility in adjusting generic pricing as it will all be handled for them by the PBM's and payer sources.

    Chairs up!

    Thx Adam.

  4. Dr. Fein,

    You need to go one step further in your analysis. A big cause for all of our health care dollars is chronic disease. Pharamcists need reasonable compensation to provide services to the patients that drive so much of healthcare spending. We also need to stay in business.

    If you are correct, then I can look forward to reimbursement getting cut to the bone. If healthcare reform means more margin pressure for those of us on the front lines of patient care, then we will all end up paying more. Does that make sense to you?

  5. Tom, The '57 Civil Rights Act was proposed by a Republican President to a Democratic Congress, and passed both houses by huge margins. The Civil Rights Act of 1964 took considerably more effort on behalf of progressives, but also had hundreds of thousands of people marching in the street, carrying out sit-down strikes, and anything else to disrupt daily life and call attention to a noble cause.

    Whether I'm for it or not, I really can't see that kind of broad support happening for healthcare reform, be it now or 7 years from now.