Thursday, June 13, 2013

NADAC Momentum: California Abandons Average Acquisition Cost for Pharmacy Reimbursement

You may recall that California was in the process of transitioning Medi-Cal pharmacy reimbursement from the Average Wholesale Price (AWP) benchmark to an Average Acquisition Cost (AAC) benchmark. Would it be Heaven or would it be Hell? Alas, we’ll never know if a CA AAC is a lovely place, because California’s Department of Health Care Services (DHCS) just announced that the its plan is being put on hold. Click here to read the official DHCS statement.

Does this change mean slowing momentum for acquisition cost pharmaceutical benchmarks? I don’t think so. Instead, California actions implicitly endorse the National Average Drug Acquisition Cost (NADAC) data now being collected and published by the Center for Medicare and Medicaid Services (CMS). California wants CMS to take the political hits (and spend the money) to build a new U.S. pharmaceutical pricing benchmark.

The pharmacy industry may want to stab CMS’s efforts with their steely knives, but they shouldn't want to kill this beast. As I see it, they should actually be breaking out the pink champagne (on ice) for cost-based reimbursement, which essentially guarantees pharmacy profits. Read on and let me know if you agree.


By way of background, an Acquisition Cost approach to pharmacy reimbursement computes a pharmacy’s ingredient cost reimbursement based on data collected directly from pharmacies. Average Acquisition Cost (AAC) data are now being collected and published by six state Medicaid programs: Alabama, Colorado, Idaho, Iowa, Louisiana, and Oregon.

In 2012, paralleling the states’ efforts, the Center for Medicare & Medicaid Services (CMS) began collecting and publishing a National Average Drug Acquisition Cost (NADAC) to, it said, “provide a national reference file to assist state Medicaid programs in evaluating their reimbursement.” (See Transparency is Here! CMS Exposes Pharmacy Prescription Profit Margins.) Forty-four state programs had previously asked CMS to develop a single national benchmark to set Medicaid reimbursement rates. (See Coming Soon: Average Acquisition Costs for Pharmacies.)

For much more detail on cost-based reimbursement, see Chapter 5 of our 2012–13 Economic Report on Retail, Mail, and Specialty Pharmacies.


In 2011, California passed Assembly Bill 102 (Chapter 29, Statutes of 2011), which gave DHCS the authority to transition from an AWP-based pharmacy reimbursement methodology to a methodology based on actual acquisition cost for pharmacy products.

Under the law, California pharmacies would have received ingredient cost reimbursement for both brand and generic drugs at the lowest of:
  • Average Wholesale Price (AWP) minus 17 percent
  • Average Acquisition Cost
  • Federal Upper Limit
  • MAIC (Maximum Allowable Ingredient Cost)
The legislation would have eliminated AWP once AAC was up and running. However, the DCHS announcement put the transition on ice.


The pharmacy industry has opposed AAC, but I say: Relax, and be programmed to receive a big potential upside in pharmacy profits. Here's why.

When the NADAC plan was announced in 2010, a group of pharmacy trade associations—American Pharmacists Association, the Food Marketing Institute, the National Association of Chain Drug Stores, and the National Community Pharmacists Association (NCPA)—argued that CMS had no authority to collect and distribute the prices that pharmacies pay for drugs. (See DC Fracas Over CMS Transparency Proposal.) In June 2012, the NCPA offered numerous other objections to NADAC, stating: “CMS is not authorized by Congress to collect NADAC data; thus, this represents an unfunded mandate on small businesses.”

But in my opinion, cost-based models offer 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, on average, positive prescription gross margins. For generic drugs, a pharmacy can sometimes earn a very high profit on a prescription, but it can sometimes earn a low profit or even lose money on a single prescription.

A cost-based approach trades this volatility for an average margin with less variability. An AAC-based approach equates a pharmacy’s gross profit per prescription to the enhanced dispensing fee. State Medicaid programs in Alabama and Oregon have boosted the dispensing fees to $10 to $15 per prescription, based on the average cost-of-dispensing (COD). Thus,

Jon R. Roth, CEO of the California Pharmacists Association, suspects that the potential increase in California’s Medi-Cal dispensing fee would outweigh the savings from AAC. He tells Drug Channels:
“I am willing to bet the State revisited their calculations on the savings they would achieve on drug product side versus the increase in the dispensing fee that CMS would likely require them to implement. At the end of the day we estimate that those savings were not significant enough to offset the costs associated with implementing and maintaining an AAC pricing methodology.”
I find his statement odd. Among states that do not use AAC, California’s Medicaid program already has the highest dispensing fee in the country.


As a bonus to pharmacies, the AAC may be inflated and/or manipulated, per my comments on NADAC when it was launched. Since NADAC excludes “discounts or rebates that are not listed on the invoice,” a wholesaler could raise invoice prices—while simultaneously increasing off-invoice, end-of-quarter rebates.

Of course, I’ve never, ever heard of a wholesaler doing something to increase a pharmacy reimbursement benchmark. Well, okay, there was that one time…

Those of us who spend time in the drug reimbursement hotel already know the truth: You can check-out any time you like, but you can never leave.


  1. I
    agree this release of cost of medications by CMS will be of benefit to pharmacy and indepedents pharmacy the most benfited. Cost plus may/will adversely effect,
    Mail Order, Traditional PBMs, Group Purchasing Organization (GPOs) , to a
    lesser degree Chain and mass merchandizers, and least of all independents
    because they traditionally have paid the highest rates to wholesalers for all classes of drugs
    and will/should have more negotiating power by having this new knowledge.

  2. Oh but Adam - you left off the other half of my statement. California's own dispensing fee studies, as well as private independent studies, have demonstrated repeatedly that while you may think our pharmacies are basking in the profits of their generous $7.25 dispensing fee (tongue firmly planted in cheek), the actual cost to dispense is shown to be between $12-$14 (as of 2010). California is one of, if not THE most expensive states to run a business. So while it may seem odd that we would complain about a $7.25 dispense fee, its all relative my friend. Even Alabama, where I would think the costs of doing business are significantly lower, raised to their dispensing fee under AAC to nearly $10.50. If the state and feds want to get to the actual cost of drugs, then fine let's go there. But the state and feds then need to be willing to get to the actual cost to dispense.

  3. Jon,

    I did not intend to imply anyone is "basking" in profits. Let me clarify the economic realities.

    Under traditional reimbursement models, a retail pharmacy earns the majority of its gross profits from spreads between (1) third-party ingredient reimbursement and (2) net acquisition costs. The dispensing fee does not cover the pharmacy’s cost of dispensing, due to presence of the additional spread profits.

    Under an acquisition-cost approach, ingredient cost reimbursement approximates actual drug acquisition costs. Thus, the dispensing fee must be increased to account for the elimination of spreads.

    Alabama's switch to an AAC-based reimbursement model also led to an increase in its Medicaid pharmacy dispensing fee, from $5.40 to $10.64. When AAC was launched, Alabama projected first-year savings of $30.5 million, equal to 6.1% of its $500
    million fee-for-service drug expenditures. In other words, the higher dispensing fee was offset by reductions in pharmacies' spread profits from the Medicaid program.

    Under cost-based reimbursement, a pharmacy trades the volatility of spread-based profits for more-stable fee-based profits. While pharmacy profits may drop slightly, AAC certainly seems more consistent with pharmacists' desire to be treated as providers, rather than buy-low/sell-high retail merchants..


  4. Adam,

    I agree that a cost-based pharmacy reimbursement model is inevitable. Moreover, I don’t dispute your contention that it could actually be in the best long-term interests of all involved, including community pharmacy. But I think the operative word is here is ‘if’.

    IF the ingredient component of reimbursement is based on acquisition
    costs that are widely and consistently available to both independent and chain pharmacies; and IF the dispensing fee accurately reflects the operating costs incurred by pharmacies to process and dispense prescriptions in full compliance with all applicable laws, regulations and professional obligations; and IF the price paid to pharmacies provides a predictable (albeit modest) profit margin then, perhaps, we have the basis for an equitable and sustainable model that ensures consumers have continuing access to convenient and affordable pharmaceutical

    In 2007 I wrote viewpoint in Drug Topics in which I called for an overhaul of our pharmacy reimbursement system. In addition to the above elements
    I included one additional component to the proposed reimbursement formula: performance incentives linked to the pharmacies’ ability to move key outcome metrics desired and valued by payers. That is, a reimbursement model that is cost-based but outcomes-adjusted. In
    such a model, community pharmacies would be fairly compensated for their costs of providing conventional (read: commodity) prescription care but would be incentivized to do more.
    Pharmacies that wished to play the high-volume, low-service game could do so. However, those pharmacies and performance-based networks that are willing and able to meet key metrics established by payers would be recognized and rewarded for adding value. Patients, payers and plan sponsors would vote with their feet - which is the way it should be - and everyone would know what they’re getting.

  5. Thanks, Mike. Great comment.

    For the benefit of Drug Channels readers, here is a link to Mike's 2007 article: Viewpoint: It's time to overhaul our drug reimbursement system.