Thursday, July 15, 2010

Alabama: More Momentum for Cost-Plus

Tuesday’s post about South Carolina' pharmacy profit boost connected me with Kelli D. Littlejohn, R.Ph., Pharm. D., Director, Pharmacy Services at the Alabama Medicaid Agency. Subject to approval by the Centers for Medicare and Medicaid Services (CMS), Alabama’s Medicaid program will soon implement a new pharmacy reimbursement program using Actual Acquisition Cost (AAC) instead of published benchmarks or Maximum Allowable Cost (MAC) lists.

Does AAC sound familiar? Yup, it’s our old friend cost-plus pharmacy reimbursement. As far as I know, Alabama is the first state to move to a cost-plus model. Some implications:
  • The cost-plus revolution continues. Interest in cost-plus models stems from payer perception that reimbursement models based on list prices can provide inappropriately high pharmacy profits on certain prescriptions.

  • Pharmacy profits will decline. Alabama estimates that Medicaid pharmacy costs will drop by $30.5 million in the first year—more than 6% of total drug spending and about $4 per prescription. Say goodbye to mega-spreads on generic prescriptions.

  • Get ready for transparency. The State publishes AAC survey data by product name and package size. Check out the cost of your favorite brand or generic drug by downloading the most recent AAC list.

  • Other payers will follow. Since the AAC data are on a public website for all to see, I see no reason why Pharmacy Benefit Managers (PBMs) or Medicare Part D Prescription Drug Plans (PDPs) will not start using the data in Alabama.
Alabama has posted a lot of useful background information on its AAC Program Implementation web page. Here are three highlights, which I encourage you to read for yourself:

I predict the growth of cost-plus reimbursement and discuss its likely impact in The U.S. Pharmacy Industry: 2009 Economic Report and Outlook. Here’s some high-level background in case you (gasp) don’t have a copy of the report.

Cost-plus reimbursement models represent a different revenue and profit model for a retail pharmacy. Instead of being compensated relative to a list price or based on a fixed price determined by the payer, the pharmacy receives reimbursement based on its actual acquisition cost of a drug plus an additional amount to cover the pharmacy’s overhead and profit margin. Prior to Alabama, these models have been primarily adopted in private contracts such as the Walmart-Walgreens-Caterpillar deal or by Walmart’s other alleged access-based network design customers. (Yes, Walmart, that’s a hint.)


The Alabama situation got started with Average Wholesale Price (AWP) lawsuits. Ultimately, the Alabama Supreme Court ruled that three manufacturers—GlaxoSmithKline, Novartis, and AstraZeneca—did not defraud the state in pricing Medicaid prescription drugs. This makes sense to me. After all, the manufacturers simply published (inaptly named) list prices.

The Alabama Medicaid Agency, like most states, apparently neglected to look at actual pharmacy acquisition costs when setting reimbursement rates. Result: “Alabama pharmacists were paid millions in excess of their actual drug costs.” The brand drug overpayments averaged 20% and generic drug overpayments averaged 84.5%.

As the presentation indicates, the Court criticized the state (correctly, IMHO) for not changing the reimbursement system even though everyone knew it was inaccurate. Judge Patti Saris has made the same point in her rulings. See Farewell, AWP.


The National Association of Chain Drug Stores posted a comment on Thursday’s post, writing:
“In addition, you mention the cost of dispensing in South Carolina, but you fail to mention that Medicaid pays dispensing fees that are well below those costs. The fact that other states may pay even less does not justify paying pharmacies below their costs in South Carolina.”
This is misleading and disingenuous nonsense. The dispensing fee must cover costs ONLY when ingredient cost reimbursement is equal to actual drug acquisition costs.

I presume (hope?) NACDS knows more about actual pharmacy economics. In addition to a dispensing fee, retail pharmacies earn spreads between (a) the ingredient cost reimbursement that a pharmacy gets from a third-party payer or consumer, and (b) the pharmacy’s net acquisition cost for purchasing the product.

This “spread pricing” provides retail pharmacies with more than 80% of their profits from prescriptions because pharmacies consistently acquire drugs for less than the ingredient cost reimbursement amount. The average dispensing fee from an employer-sponsored pharmacy benefit plan was only $1.57 (source), which obviously wouldn’t cover an average dispensing costs of $10 per prescription.

Pharmacies maintain spreads by keeping drug acquisition costs hidden from third-party payers. This lack of transparency creates opportunities for higher pharmacy profits by enabling the pharmacy to earn larger dollar spreads between the payer’s reimbursement and the acquisition cost. Spreads are largest for pharmacies that receive undisclosed rebates and hidden discounts from wholesalers or a pharmacy buying group. See this January 2008 OIG report for the facts.

A deep irony of the Drug Channel universe: Pharmacy owners complain loudly about spread pricing reimbursement and transparency from payers to PBMs, yet profit by spread pricing themselves. Yeah, whatever.


Kudos to Alabama for being first in the nation to get serious about the post-AWP future. They are embarking on a fascinating experiment to transform Medicaid reimbursement to pharmacies. Everyone in the drug channel—pharmaceutical manufacturers, wholesalers, pharmacies, PBMs, and private payers—should pay close attention these developments.

I’ll close with a direct quote from page 33 of the "Pricing Drugs" slide deck:
Concern: It was determined that the reimbursement modification would be an overall cut to pharmacies; some would be forced out of business

Response: As determined through the AWP litigation discovery process, the Agency has been overpaying for drugs based on an inaccurate, flawed drug pricing model. It is time for the State to move to an accurate, fair, reimbursement process based on the actual cost of dispensing, and the actual drug ingredient cost.
You know you want hear it now. Click here if you can't see the video.


  1. Great post Adam. You are an important and valued resource. I agree with you that AAC or AC Plus is where the payor world needs to be. We may just jump ASP or AMP altogether. Thank God for an unfettered Internet that can distribute information that would otherwise be filtered or supressed by competing interests.

  2. Hey Adam,
    Not to temper your unbridled enthusiasm for cost-plus reimbursement but . . . assuming Alabama has found a valid (magical?) method for determining pharmacies' actual acquisition costs AND assuming HID's weighted median cost of dispensing is accurate at $10.64, that still leaves us with a problem. If we use AAC, thereby removing all margin from the ingredient and then take HID's recommendation to set the dispensing fee at $10.64, the resulting reimbursement still just represents dead net (no profit margin). Moreover, it only represents dead net or better for 50% of pharmacies. The rest are actually guaranteed to lose money. That's the way the median works. While it may be reasonable to assume that some of the pharmacies at the high end of the COD analysis could be a bit more efficient, it seems unreasonable to assume that 50% are profligate spendthrifts in how they run their operations. Bottom line: Cost-plus will only work if there is a reasonable margin available for pharmacies that agree to participate in the program. That, in turn, will require (1) valid and continuously updated information on the AACs being paid by pharmacies, (2) annual cost-of-dispensing (COD) analyses to determine the operating costs incurred by pharmacies to dispense prescriptions, and (3) a mutually acceptable negotiated margin. If Alabama is prepared to do that then I applaud them. Thanks for the post and keep up the good work.
    - Mike Rupp

  3. David Schwed RPhJuly 15, 2010

    Glad you picked up and ran with AAC comment. You earn points for your well structured navigation links to Alabama's information, as well as well earned self-gratification when you recognized that there are similarities to directed contracting posts you had made previously.
    However, I would appreciate a response to my query about the sustainability of the NJ formula. The truth is that many payers now pay well below the AAC + the cost to dispense on average; ditto for many state Medicaid programs. I know we have a market-based system, but many payers and intermediaries game the system by relying on providers considering them marginal (not core) business and accepting sub-par compensation. That model is not only unfair to the provider, but penalizes fair paying Medicaid programs and the uninsured, as well as other private and public payers who play fair. Again, the water balloon model pushes both payers and providers. NCPA and NACDS cannot be blamed alone for trying to help members survive in the current failed system. It would be encouraging to see you bash both payers and providers equally for creating and profiting from that system. Gaming should quickly come to an end as AAC models evolve and networks shrink through business failure and contract attrition. Once lost pharmacy access will be hard to rebuild. Alabama is to be commended for recognizing that pharmacy access must be preserved and working together with pharmacy providers in developing their model. Additionally, they are poised to recognize and rewarded enhanced clinical models.

    In answer to Mike Rupp: investigate the Alabama model. They have at least addressed the questions you bring. You will have to judge for yourself whether their solutions met your expectations.

  4. AnonymousJuly 15, 2010

    Mr. Fein

    The state of Missouri (Mo Health Net) has been using WAC (Wholesale Acquisition Cost) plus a percentage plus a fee for many years. We find very few problems.

  5. Thanks for the constructive and thoughtful comments. My $0.02:

    Roy: Thank you! I don’t want and expect everyone to agree with me--I just try to educate and challenge people in a fact-based way.

    Mike: Good points. I spoke to Kelli Littlejohn before writing this post. She told me that pharmacists had a lot of input into the new system, so presumably these issues will be resolved. Stay tuned.

    David: I'm not intimately familiar with the NJ situation. I'm merely pointing out that new reimbursement models are emerging; the transparency associated with the data will have big implications for pharmacies, PBMs, wholesalers, payers, and (eventually) manufacturers. And while you assert "many payers now pay well below the AAC + the cost to dispense on average," numerous unbiased studies have come to very different conclusions. I have discussed and analyzed most of these studies over the years. Of course, YMMV.

    Shy Guy (anonymous): WAC is not the same as AAC. Since WAC is not a computed transactional price, it suffers the same conceptual criticisms and problems as the AWP benchmark. WAC is simply an alternative published price and does not necessarily represent the price paid by any entity within the distribution system. Any critiques of AWP could potentially be leveled against WAC, too.

    Bonus points to Roy, Mike, and David for being bold enough to provide non-anonymous perspectives!


  6. AnonymousJuly 15, 2010

    Cost Plus a Pharmacist’s best hope and it provides the Quality Assurance and Preventive care needed under PPACA

    The Way for pharmacy and pharmacists to thrive into the future is to download a New Business Model into their collective mindset using cost plus as the program. Cost Plus is a business model that both circumvents and uses existing market forces to yield long term profits for retail pharmacy and fair prices for payers.

    We feel certain that the competition in the generic drug market has opened a natural path benefiting to retail independent pharmacy. And we here state and insists that the existing generic retail competition, including $4.00 generic prescriptions, is not retail enemy but rather an ally.
    If retail pharmacy will intelligently use this “ally” by leveraging with a new cost plus pricing model and the use of new “Health Information Technologies” together with adjudication capabilities. Then cost plus will to provide the path to accessible, high quality, cost-effective professional pharmacy care and profitable reimbursement for these services.

    The Professional services allowances with-in the medical package will be derived from the savings the plan is accorded via generic cost plus program. The current pharmacy business model does not fund nor provide a feasible way forward to fund pharmacist professional services, cost plus could show the way.

    These professional allowances will be paid to pharmacists to provide
    pharmacy professional services such as continuing education programs; clinic days including flu shot, asthma clinics and diabetes management clinics; public education days for health protection and marketing/promotion activities; compliance packaging and adherence counseling that assists patients with complicated medication regimes; disease management and prevention initiatives such as patient information material and services, blood pressure monitoring, blood glucose meter training, asthma management and smoking cessation; private counseling areas; and hospital in-patient or long-term care home resident clinical pharmacy and most importantly therapeutic interchanges.

    Currently, the funding for pharmacy distribution services received from public drug plans and some private plans is lower than the cost for providing these distribution services. The only way pharmacy can continue to provide distribution services below fixed cost is to create new cash streams during the fill process.

    The current framework for the compensation of pharmacy services is neither sustainable, nor reliable and needs to be modernized.

    WE feel that a properly run cost plus prescription plan will enable retail pharmacists to maintain profitability, continue to provide the best distribution services available and the best healthcare possible for patients.

    Jim Fields RPh

  7. Adam -- thank you for the review of the work being done by Alabama Medicaid and Alabama Pharmacists. One component that wasn't mentioned was our Stage III work (Stage I - AAC, State II - COD). Stage III will develop a plan of action to include pharmacists and their professional services into the Medical Home program we have in place, called Patient First. This will create a true Medical Neighborhood. There are signficiant peer-reviewed studies showing that involvement of pharmacists in the care of patients improves outcomes and lowers costs. We are working with all of our pharmacy and primary care providers to develop this program. Given the budget crises we are experiencing we are looking at creative ways to implement the program -- by implementing shared savings for pharmacists (we already have shared savings for primary care providers), linking with care coordination systems and other innovative ways to provide appropriate and cost-effective services to our recipients.

  8. In response to Shy Guy: our discovery process in our AWP lawsuits did indeed find that the WAC was almost as inaccurate as the AWP. It is our belief that paying based on WAC still creates a situation where you are "overpaying" for ingredient costs.

    In response to Mike: currently the budget argument goes like this: "pharmacy costs are increasing by 15 - 17%, the highest percentage of any component of the Medicaid program" What the Governor and the Legislature hear is "Pharmacists are costing us too much money" when in fact we all know it is "drug manufacturers are raising their prices". By separating the ingredient costs from the Cost of Dispensing the issue of profit margin (and at what %age) is a cleaner argument for the pharmcists. We then are talking about a 15% increase in ingredient costs (for which Medicaid has little or no control over) and a 3% increase in COD, which includes a reasonable profit margin.

  9. AnonymousJuly 16, 2010

    I agree with many of the benefits of cost plus, but I do have some reservations about the long term economic impact of transparency in generic pharmaceutical pricing. As weighted average AACs are published, there will initially be a significant drop in AACs as pharmacies especially the larger buyers push manufacturers to offer better than average prices. Once we pass through the initial phases of implementation, I believe the variation in generic drug prices will narrow and an artificial floor may be created. Manufacturers will know that a narrow band of prices exist and where that price floor is. They will not have the incentive to offer lower prices to gain volume because the market will follow the average published price. Volume gains will be short lived. The published AAC will be a "best price" barrier that no manufacturer will want to cross. In the end, there will be less aggressive generic pricing, thus reducing the cost saving of generics to the overall healthcare system. Generics will be still be a better deal than brands, but the competitive market forces that drive down prices will be reduced. I would appreciate your perspective on this public health angle.

  10. AnonymousJuly 16, 2010

    Will the publishing of AAC have a long term negative impact on the cost of generic drugs to the overall healthcare system? It may narrow the range of prices and create a barrier that manufacturers will not want to cross. Please comment on the potential long term economic impact of AAC. Will published ACC reduce competitive forces?

  11. Roll Tide!!!