Monday, September 20, 2010

BREAKING NEWS: CMS Approves Alabama’s Cost-Plus Plan

The Alabama Medicaid Agency just announced that the Centers for Medicare and Medicaid Services (CMS) has approved a new pharmacy reimbursement program using Actual Acquisition Cost (AAC) instead of published benchmark or Maximum Allowable Cost (MAC) lists. Read the official announcement on the AAC Program Implementation page. The changes will be effective for outpatient pharmacy claims on September 22, 2010.

Fans of transparency will be pleased to know that Alabama will now publish pharmacy acquisition costs for both brand-name and generic drugs (by product name and package size) on this free public website: Alabama AAC List.

My $0.02: The post-Average Wholesale Price (AWP) future just became a little clearer. While alternative list price benchmarks, such as Wholesale Acquisition Cost (WAC), are becoming more common, I expect computed transactional benchmarks to become the norm for pharmaceutical reimbursement. The Alabama Medicaid Agency now officially becomes the leading innovator of alternative benchmarks.

I describe Alabama’s proposal and its potential market impact in Alabama: More Momentum for Cost-Plus. Key questions:
  • Will other states follow Alabama's lead? (I hear at least one state is very close.)
  • Will private payers adopt Alabama's methodology and/or use the public AAC data?
  • What will happen to pharmacy and wholesaler profits?
Post your best guesses in the comments below. You can comment anonymously, if you want.


Judge Patti Saris, who has overseen a lot of the litigation related to AWP, is quite clear about her views on AWP as a pharmacy reimbursement benchmark:
“AWP has been exposed as a faux inflated price unrelated to actual drug prices. Reliance on AWP is a trap for unwary and unsophisticated TPP (third-party payors) purchasers and results in consumers paying unwarranted co-payments.” (Order Granting Final Approval of Settlement–March 17, 2009, page 13)
I’ve written a lot about AWP over the years. Here are two especially relevant articles to catch you up:
There has also been an interesting discussion in the Life Sciences Reimbursement Group over on Linkedin around the question: “What do you think is going to replace AWP, when the time comes?” (This link should work if you are part of this group.)

The question is a bit misleading because Average Wholesale Price (AWP) will not be going away. Wolters Kluwer Health intends to keep publishing AWP for its Medi-Span customers (per their Pricing Policy Update website). WAC, another list price benchmark, will also remain available in the market.

The search for alternatives will continue, especially given payer perception that reimbursement models based on list prices can provide inappropriately high profits for retail and mail-order pharmacies on certain prescriptions. AAC and cost-plus models seem to be likely alternatives.


I broke the news that CMS wants to gather data on the prices paid by pharmacies to drug wholesalers or manufacturers and then post these data on its website. See CMS Wants Public Transparency to Pharmacy Profits.

A group of pharmacy associations—The American Pharmacists Association, the Food Marketing Institute, the National Association of Chain Drug Stores, and the National Community Pharmacists Association—are protesting CMS’ plan to conduct a national survey of pharmacy acquisition cost. An August 6, 2010, letter to CMS from these groups states: “We have identified no legal authority for CMS to collect and distribute pharmacy acquisition cost data.” See DC Fracas Over CMS Transparency Proposal for more details.

As far as I know, the Alabama Medicaid agency has the statutory authority to implement this program. Does it also have sufficient legal resources to defend the inevitable challenge to their AAC program?


  1. Do you have any sense as to the types of pharmacies Alabama is including in its survey? I would imagine these prices would conform more closely to the old definition of AMP than to the new one.

  2. Thanks for the info. I'm interested in your take on what this "clarity" will do for the channel overall. As always, love reading your posts.

  3. King Solomon wrote in Ecclesiastes that there is nothing new under the sun. Industry veterans such as this writer will recall that in the 70's some payors attempted to use AAC as a reimbursement base. It will be interesting to see how well this attempt works -- and if it works any better now than it did then. The earlier effort failed because it required providers to submit their own actual costs, which created all sorts of problems, and was ultimately abandoned. This new idea is based on the Plan creating an average cost.

    It is most instructive to note that the cost information that Alabama's consultants is requesting does not include the value of rebates, prompt payment discounts, promotional allowances and the like. One also assumes that providers will not report costs from secondary sources. So the costs will not be the true costs to the providers. It will also be interesting to see if these 'average' costs will disadvantage smaller retailers who, at least in theory, don’t buy as well as the very large corporate providers.

    Let's also see how sellers will 'map' their costs to these new AAC lists. Try to imagine a marketing plan base on AAC minus 5%, or the like.


  4. Pharmacy reimbursement formulas have two components: an ingredient and a dispensing fee. AAC only addresses the former. How will the dispensing fee be adjusted to ensure that it recognizes changes in the operating costs incurred by pharmacies to dispense prescriptions?

    The language of the State Plan Amendment states that the dispensing fee will be set by the Agency and "reviewed periodically for reasonableness". How, exactly, will that be done? Will an annual cost-of-dispensing analysis be performed? If so, will some across-the-board median COD value be used to represent all pharmacies that dispense prescription drugs to Medicaid patients in Alabama, irrespective of the breathtaking differences among business models as you move from mail order to mass merchants to food stores to traditional chains to independents?

    Alternatively, will the Agency use some convenient benchmark of inflation like the CPI, thereby virtually guaranteeing that the dispensing fee will fail to keep up with pharmacy operating costs?

    I'm on record as an advocate for cost-plus reimbursement models in community pharmacy. But to be equitable and sustainable it has to be done right and I'm not convinced Alabama has it right.

  5. Mike,

    The dispensing fee has been increased to $10.64.

    I presume there will still be ingredient cost spread opportunities whenever market prices for generics decline more quickly than the AAC data are updated. This occurs in the Medicare Part B program with ASP. See Generic Drug Profits: Too High or Appropriate Incentive?.


  6. Yes, other States will follow Alabama when they see the positive impact it has on in State pharmacies and the decreased cost to State Tax payers.

    Private payers will follow and be amazed how much they save over the traditional PBM model.

    Pharmacy profits will stay the same or increase slightly due to increased volume

    Wholesaler profit margins will fall but may see a slight increase in volume.

    Buying groups (GPO’s) could have their purposed diminished and their profits if AAC pricing would start to include generic rebates given to pharmacies.

    PBM profits will be significantly impacted as pricing becomes understood by governments and private payers. A traditional PBM cannot pay a pharmacy for distribution and make a profit at $10.64 per Rx. A PBM would be acting as an adjudicator only for the payer capable of only charging $00.50 to $2.00 per Rx above the $10.64 fixed margin, dependent upon how the question of rebates are resolved inside of AAC.

    Rebates will diminish further hurting PBM and TPA's whose profits are tied to PBM admin fees.

    Mail order profits will fall through a combination of decreased use and decreased profit margins.

    Theoretically AAC or any Acquisition plus plan is a win for providers ,plans, and payers with the only big losers being the PBMs. However, I am sure there will be many attempts to change acquisition plus pricing to something as convoluted as AWP.

  7. Is there any way that they can look at AAC + A PERCENTAGE (say 6-7%) PLUS the dispensing fee? If it goes the way I see it, that means pharmacies will only get $10-12 on average when dispensing Oxycontin 80mg at over $1000 cost! How can anyone stay in business that way?

  8. Adam,

    That is precisely my point. If there will continue to be ingredient cost spread opportunities then this is not a true cost-plus model.

    As for the dispensing fee, it comes from a Myers & Stauffer study that was completed a couple years ago so it's already out of date. Moreover, the value they selected ($10.64) is the median which means that 50% of the pharmacies surveyed had a higher COD. If the ingredient really were priced at AAC then that would guarantee that half of the participating pharmacies would lose money on every Medicaid prescription.

    The Alabama program is a bold step but cost-plus can be done better.

  9. Mike,

    I'm not saying that Alabama's cost-plus program is the best. However, it does appear to be the first.


  10. Hi Adam -

    I am really (literally) scared about this new AAC methodology. On the one hand, we'd gain on cheap generics if the TPs do it as proposed; however, we'd lose (big time) on huge acquisition cost item if all we are making is $10-15 per rx regardless of cost. I see this move as a death sentence for all independents! I am already struggling to pay my bills now due to slow cash flow (let alone already low reimbursements, and in some cases under cost as well). I haven't paid myself a salary in months...

    What do you think? Can independents survive (with business as usual)?


  11. Adam,

    I believe Mr. Fields needs to go back and look at the numbers. If the business model moves to this it will impact the bottom line in a negative way. Branded prescriptions will be reimbursed $3-$4 less and the generic profits will not make up for that loss as they do now. AAC is fine but the model needs to move to AAC plus a gross margin , not a dispensing fee. The dispensing fee used to be called a"professional" fee and look what happened. Pharmacy is a business first and it needs to be operated as such , instead of this make believe calling ourselves a profession.

  12. I agree with David's comment. Here's two possible (albeit, partial) solutions:

    First, include an inventory carrying cost (ICC) component in the annual COD analysis to recognize the cost of carrying expensive Rx inventory. Second, identify pharmacies (mostly independents) that are the sole provider to underserved and/or geographically isolated populations and adjust their dispensing fee to reflect their dispensing costs (i.e., not the median).

    Medicare currently recognizes about 1,300 hospitals that provide care to underserved rural populations (i.e., "critical access hospitals") and adjusts their reimbursement upward. Similarly, each state should recognize critical access pharmacies (CAPs) that serve vulnerable populations. A side benefit of this would be to encourage new pharmacies to open in rural and underserved areas.

  13. Adam,
    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.
    -Kelli Littlejohn, PharmD
    Director of Pharmacy
    Alabama Medicaid Agency

  14. First COD numbers assume all pharmacies are working at capacity. Most pharmacy are no where near capacity.

    Secondly, and most important, is that we should not try and build professional charges inside a DISTRIBUTION charge. $10.64 per Rx is a fair number to pay for DISTRIBUTION even when factoring in the cost of having to carry in excess of $300,000.00 in inventory. It is not a fair charge, however, if professional services are mandated as an inclusion in the distribution charge.

    One the advantages of an “Acquisition Plus” (AqP) business model is that the model permits and encourages the opportunity for a professional Pharmacist service charges as a separate fee. This allows pharmacists an opening to have similar professional charges to that of Physicians, PA’s, NP’s and other “Health Care Providers.” Specifically Pharmacists would be charging for Wellness, Disease Management and MTM services. In our business model we have several business using pharmacy services under an AqP business model. This model started in our pharmacies and we have expanded it to many pharmacies in three state using our HIT as an adjudication service that eliminates traditional PBMs and their mail order pharmacies.

    Simply put, PBMs and Mail Order Pharmacies cannot make sufficient profits for their stock holder at $10.64 gross margin per Rx filled using AqP. To accept $10.64 per Rx gross margin PBMs and Mail Order would experience a 40% reduction in profits. This 40% reduction is not something that stock holders would accept and they would sell in mass. Forcing PBMs back to their orginal businss model of adjudication only.

    Speaking as an independent pharmacist we can not only make a profit at $10.64 per Rx for distribution, but with the opportunity for professional services made available by AqP pricing, pharmacist would flourish and do flourish with AqP.

    Regarding the distribution fee itself:
    Of the pharmacies here in Ohio and Kentucky that I have visited, few have margins greater than $10.64 per Rx as a yearly average when based on Acquisition Price from their wholesalers.
    My year to date (9months) numbers based on ~60,000 Rx filled is $10.59, to that number you could add another $00.64 cents for the rebates received via our buying group for a cumulative total of $11.23 per Rx gross margin including Ohio Medicaid prescriptions.

    Ohio Medicaid as a standalone number provides only $ 9.22 gross margin per Rx filled for our pharmacies. Meaning that $10.64 per Rx would be a vast improvement over the present Ohio system and would add business certainty to an uncertain government reimbursement system that we now endure. With the upcoming possibility of Medicaid expansion through PPACA this improved pricing and elimination of uncertainty would make all pharmacists not only more profitable but allow some peace of mind as well.
    Jim Fields RPh
    CFO ApproRx

  15. I've been giving a lot of thought to the development in Alabama. Seems to me that a big part of the 'story' is that Alabama Medicaid understands that a pharmacy needs adequate per Rx revenue to sustain operations. As we know, one of the dirty little secrets in our industry is that pharmacies can't make a living on $2.50 dispensing fees. In fact, their major source of profit is the spread between reimbursed and net cost.

    So, since the Alabama AAC pricing will reduce the cost side of the equation, they offset that cut with a dispensing fee of over $10.00. Not a bad trade-off. I also feel that pharmacies, Medicaid, PBMs and the other stake holders in our industry will be well served by bringing all of this into the open.

    There is at least one major downside: If a pharmacy gets most of its revenue from a flat dispensing fee, there will be less incentive to promote generics. The math is simple: Assume that, since Alabama AAC won't be true cost, the spread between AAC and true acquisition cost will be about 4%. So, an average spread to the pharmacy on a brand Rx will be about $5.00. For a generic, it will be only about $1.50. It wont take long before retailers figure this out!

    Best regards


  16. I was unneccessarily vague in my reference to "another state" above.

    The Oregon Health Authority has submitted a plan to use AAC starting in January 2011. The plan differs from Alabama because it has a tiered dispensing fee based on a pharmacy’s total claims volume (per site).

    For details, see


  17. Adam - as I compare the AAC lists for AL and OR, I was surprised to find a wide difference in reported AAC on some very high volume generic drugs.  

    Do you have any sense on whether this is a function of selection bias in the surveying, which drug wholesaler is controlling the market share in the state, an overall drug wholesaler price strategy segmentation by state, or other?Have you done research by chance on drug wholesaler market share by state? I'd think perhaps with knowledge of top customers, one may be able to back into something respectable?  Easier said than done!Regards, Andy