Wednesday, September 22, 2010

Industry Impacts of Cost-Plus Reimbursement

I want to share some of my speculations about the pharmacy industry’s evolution if cost-plus pharmacy reimbursement becomes common.

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!


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."
Thanks, Kelli!


  1. The AAC model for reimbursement of retail pharmacy claims makes sense if, similar to the model in Alabama, it is based upon random sampling of pharmacy sites and the dispensing fee represents a market-relevant value. On average, commercial third party plans yield a profit (margin $/rx) at a rate close to the $10.64 fee that has been approved by CMS. Having a predictable and uniform margin per prescription makes the process of auditing reimbursement easier.
    I don't understand that AAC plus a market-relevant fee will decrease negotiations with generic manufacturers for lower cost...average cost by definition means that some product costs will be above the norm. Additionally, the plan design can mandate generic dispensing, removing concerns for payers that retailers will not use the lowest cost alternative.
    The most significant roadblock to this type of reimbursement methodology becoming widely accepted is third-party plans not embracing full transparency, especially those that operate their own mail service facilities.

  2. This seems to be yet another central planning attempt to circumvent the marketplace. These types of ideas always begin with the flawed assumption that market behavior will remain static in the face of change. When the market reacts and the plan fails (to cut costs/save money), the planners always react with the same excuse of “unintended/unforeseen consequences” as if nobody could possibly have predicted that the market players wouldn’t simply roll over.

    In the end, either the market players will outsmart the planners (costs go up) or the market players will move their money to another industry (the public will suffer with, for example, a reduced number of pharmacies).

  3. Re: comment on the flaws of central planning, see,0,799167.story

  4. Why are there no NDC numbers on the AL drug lists?

  5. Some thoughts
    AL AAC model may be problematic as a sustainable reimbursement methodology for the following reasons;
    1) AAC is based on Wholesaler invoices excluding rebates, discounts or other negotiated cost of goods terms that truly determine actual acquisition cost to the pharmacy
    2) Chains have direct channel pricing contracts from manufacturers that would not be available to Survey process since only Wholesale Invoices probably from the big 3 players are being made available. Chains hence have an immediate competitive advantage since they will not share their manufacturer invoice prices.
    3) The AAC reimbursement appears NOT to be at the NDC level but a drug level (name, strength, dosage form).
    4) The AAC when not available for products uses a WAC+9.2% methodology; WAC is no better than AWP.
    5) There is no mechanism for AL to control invoice price inflation of the AAC.In reality it will only be a matter of time the market will transform the AAC to a hybrid of AWP through invoice price inflation.
    6) The increased dispensing fee is a negative incentive for pharmacy providers to increase their generic utilization spend. A differential dispensing fee for brand and generic may align the incentive correctly
    7) The lack of litigation for a AAC based reimbursement model that potentially reduces reimbursement to pharmacies would indicate there is sufficient spread between the AL calculated AAC and the true price paid by pharmacies to purchase pharmaceuticals.
    8) CMS intention to publish NDC based price data is likely on the other hand is potentially facing a different fate compare to (7)
    9) The reality there needs to be a time that Pharmacy transitions away from the drug commodities market and become a value added service provided independent of the drug supply chain economics. A pharmacy profession with a capitated rate should be explored.
    10) Retail AMP methodology currently would be more resilient than an AL AAC model.

  6. Adam, An Acquisition Plus (AqP) pricing model does give the payer more control over pharmacy distribution by allowing a full understanding of the cost of medication. We have seen this first hand with our AqP accounts, when a payer moves to AqP they immediately start looking for numbers they understand….What is my average cost per Rx…What is my total Rx expense per month, additionally they stop asking the irrelevant question…. what is my AWP discount. Many times after an account has moved to AqP and they become aware of the cost medications they may even ask pertinent questions…. is there a cheaper or better medication than this expensive one. Then after time they will even ask sophisticated questions: are these medications providing any benefit as a return on investment via increased employee productivity i.e. are these drugs I am paying for providing the touted disease management that they advertise and if not why not.

    Adam, yes, it is correct that under the existing traditional Mail Order and PBM business models there is a risk that the use of generics could be reduced particularly if branded AqP pricing by the traditional PBMs does not factor in the PHARMA rebates.

    When a PBM uses the AqP pricing model, bottom line savings are promoted. The AqP pricing model shows decreases in both the cost per Rx filled and total drug expenditures to the payer instead of convoluted discounts and rebates. AqP permits easily understood bottom line numbers to be produced. As of now, there is only a small handful of PBM’s like ourselves that compete on bottom line numbers. When an AqP style of PBM competes with AWP + rebates style of PBM, the numbers are forced to the BOTTOM LINE. This new found concept of looking at the bottom (sarcasm) line MANDATES not only generics, but use of therapeutic interchange, ROI, productivity, disease management, MTMs and wellness/prevention as well. To compete in the market with traditional established PBMs the AQP business model must show and does show bottom line savings immediately. To do this requires generics at a 70% dispensing rate at a minimum. Presently our 30 AqP accounts average over 75% generic use and that number increases each month as the payers SEES the savings. As can be seen when an AqP PBM competes generic usage goes up.

    On every cost analysis we have done using AqP vs. AWP the acquisition plus model has come in cheaper than Mail Order and the big three PBMs, every time. No fancy footwork here we beat mail order using networked COMMUNITY PHARMACIES AND PHARMACISTS.

    Mail order of any kind must have AWP pricing, co pay advantages and a confused payer to compete. Yes, pharmacies with lower COD and acquisition costs will make more profit and that is as should be. Mail order presently cannot lower their COD to the point where a gross margin of $10.64 per Rx is profitable, attractive to the consumer, and competitive with community pharmacy who are now on a level playing field including co pays and 90 day supply per Rx. Community pharmacies throughout the country have shown they can make a profit at this number and with the added cash flow of professional services afforded by AqP community pharmacy can flourish.

    The Free Market is already producing this new PBM business model which ironically is very similar to the original PBM business model. The original PBM model that was started back in the early 80’s by three pharmacist, what a coincidence we are three pharmacists.

    Jim Fields RPh
    Katie Fields Pharm D
    Ken Fields Pharm D

  7. There are no NDC numbers because AL is grouping like drugs together; i.e., all the ranitidine 150 mg tablets or all the bottles of a single source product. That's why it's an average.

  8. Medicaid pharmacy reimbursement that is based on a Federal AMP+ tied to the Federal rebate program would seem a logical payment model.
    What is keeping CMS from publishing Retail amps and much needed guidance for new rebate collection provisions from managed care and rebate clawback from States ?

  9. One of the anonymous posters above made the most insightful point that deserves significant thought:

    "7) The lack of litigation for a AAC based reimbursement model that potentially reduces reimbursement to pharmacies would indicate there is sufficient spread between the AL calculated AAC and the true price paid by pharmacies to purchase pharmaceuticals. " Something is fishy when NACDS, NCPA et. al are not filing lawsuit after lawsuit or organizing white coat protests in Birmingham.

  10. Why did AL NOT publish the median or average acquistion cost price at the NDC level and the medicaid weighted utilization on their website , this information would have provided greater transparency and with respect to litigation , would definitley raised alarms from NACDS AND NCPA and other from pharmacy groups.The bundled "average" is another blackbox created by the vendor and AL.The market likes the this new black box it SOON will be exposed to all the same issues as AWP

  11. Adam , we need more discussion on this issue of Cost Plus Reimbursement.Hope others contributing on this Blog Agree.