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Why Some Large Retail Pharmacy Chains are Struggling with Reimbursement and Generic Price Inflation

I spoke with a large group of institutional investors this past Monday morning to share my view on their burning questions around why some Retail Pharmacy Chains are struggling with reimbursement and generic pharmaceutical price inflation (WAG issues) (wsj – subscription required), why is this a recent issue, whether it will continue, and if there is anything the Retailers can do about it. I’ll caveat this by sharing that this is not an exhaustive overview of the situation but rather a broad overview based upon my 25+ years industry knowledge and research I conducted recently.  Below is some background on the mechanics of reimbursement and Payer/PBM contracting and my summary of the current issues.

Background: When a pharmacy contracts with a Payer or PBM, whether Commercial Open or Preferred or Medicare Part D Open or Preferred, there is a reimbursement rate/formula for brands, generics and specialty pharmaceuticals and a differential for a 30 and 90 day script. Brands and Specialties are pretty straightforward – Average Wholesale Price (AWP) less some percentage plus a Dispensing Fee. Generics, however, may start with a similar formula but eventually the Payer/PBM is likely to move it from a formula to a specific set dollar amount. This is referred to as MAC’ing the product (Maximum Allowable Cost). The Payer/PBM can adjust the MAC for a generic class dynamically – usually downward – as price decreases are commonplace in the generic business primarily driven by competition among generic manufacturers. There are, however, price increases for generics as well, and as quickly as Payers/PBMs can be to lower reimbursement because of price decreases, they can be very slow to increase reimbursement. Typically the Payer/PBM only increases a rate on a generic class when the collective noise from retailers individually pressuring that particular Payer/PBM to adjust reimbursement reaches its crescendo.  This is conducted through the MAC appeals process which is a cumbersome process outlined in a link below.

The Issues: The first issue is reimbursement trends in general. I used to see brand, generic and specialty reimbursement rates of AWP-16.6% (brand), AWP -70% (generic), and AWP-18% (specialty). But now I’m seeing those same constructs respectively be AWP-18%, AWP-90%, and AWP-20%. And because the Plans and PBMs want to encourage use of their own Mail Order and Specialty Pharmacy arms, it’s especially low for 90 day fills and for Specialty Rates. Dispensing fees have gone from around $4 when I started paying attention to this in the late 90s to virtually nothing over the recent years in some product classes. While there are many catalysts for the declines, such as broad pressure to reduce costs and Healthcare Reform in general, the most practical to point at is the still sounding shock waves from the very public battle that Walgreens waged with Express Scripts back in 2012. If there was any question in anyone’s mind as to who has more power, the PBM or the pharmacy, that question has been answered.  Plans and PBMs are leveraging this against all Retailers.  Adding fuel to this fire is the popularity and growth of preferred network plans and in particular the growth of Preferred Medicare Part D plans.  I’m frequently asked the question “how low will it go?” – eventually the screams will turn to further consolidation of Retailers or the morphing of their business models.  We don’t see optimism for reimbursement rates.  If a Retailer walks away from a particular plan, the patients will just go to a pharmacy that accepts the plan.  Not one of our 170+ pharmaceutical manufacturer clients complained about patients not having access to product during the period in which Walgreens wouldn’t/couldn’t fill Express Scripts prescriptions.

Diving into the recent issue for pharmacy margin struggles is generic price inflation. This will seem overly simple, but the most practical reason for a pharmacy to struggle with generic price increases is the way they buy and store generics.  Generic price increases are not new.  Perhaps they are accelerating because of industry consolidation, but again, this is nothing new.  The common approach among large retailers is to buy at aggressively low rates into their own warehouse and distribute their own generics. As a rule of thumb, a warehousing chain would typically hold about 60+ days of inventory on those generics. Sometimes more like 90-120 days if there is concern for a lack of availability.  If a generic product was to realize an increase – such as some of the products that have recently gone from $10 to $100 in a single increase – at least the chain had a 60+ day buffer to begin the appeals process with the PBM/Plan/State Medicaid Office to request a modification of reimbursement for that generic class. From my understanding, in the new purchasing arrangement that Walgreens and Rite Aid  have with their wholesale distributors, the retailers no longer warehouse and instead they are serviced from the wholesale distributor’s warehouse. Part of the value disclosed when these companies announced their new relationships was to reduce working capital and increase service levels. It would appear, however, that by not holding their own inventory they lost their 60-90 day buffer. Notice that none of the other chains that still warehouse their own generics are reporting the same issue. In all fairness, while the generic increase issue appears to be prevalent at Walgreens, as they are discussing publicly, this hasn’t risen with any significance at Rite Aid yet. I suspect it to be an issue going forward however because this past quarter was not a good analog since the new pricing with their distributor went into effect July 1, 2014. In the way of a teaser, there is another and perhaps larger implication on the way regarding the challenges achieving and sustaining the low price targets they all expect.  If time permits, I intend to blog on this topic later next week.

The third issue is when and how a pharmacy finds out about the increase and what is done about it. The quick answer is that when the pharmacy is faced with a situation when the reimbursement rate is lower than the acquisition cost of the drug, the pharmacy petitions the specific plan for an increase in reimbursement. It is up to the plan to adjust, although they are under no obligation to do so. A little background on the business issues – pharmacies are not allowed to turn away patients just because the pharmacy loses money on a particular prescription. The pharmacy can refuse to fill but not for this reason. This is where we have to pay attention to the type of retail pharmacy. Independent pharmacies have the ability to see in real time what they pay for a product and what they are reimbursed. I have seen them use the “we don’t have that in stock right now” excuse for not filling a prescription that loses them money – followed by “you may want to try the [chain] down the road.” Chain pharmacists at the store level however do not have that visibility to product economics so they fill blind to whether they are making or losing money on a particular prescription. And the chain corporate office can’t mandate their outlets not fill based upon economic impact. So losses in reimbursement initiate the pharmacy’s appeals process with the plans – but there are many plans – Medicaid and the array of Commercial and Medicare D plans. But as these appeals come in from the pharmacies, the plans may not hear the same issue across all of retail. Every Retail Chain typically has a different price – literally – one chain could buy a product for $10 and another for $100. So where should the Payer/PBM set reimbursement? So the Plans, PBMs and State Medicaid offices aren’t necessarily in a rush to change reimbursement. And why should they? Why should they accommodate what is usually poor business decisions when others have not made the same mistake? Here is a link to the results of a survey from the National Community Pharmacy Association (NCPA) regarding this issue highlighting how profoundly dismal the pharmacies feel as it relates to the MAC appeals process.

What is being done:
There are several efforts through efforts by the NCPA and the National Chain Drug Stores (NACDS) for MAC transparency and structure within Plans and PBMs like they have pushed for within the State Medicaid plans.  But these are being met with mixed results.  One of the more popular, H.R. 4215 (112th): Medicare Pharmacy Transparency and Fair Auditing Act, was introduced with fanfare and died quietly.

Some modest and indirect help appears to be on the way to combat these generic increases in general. I ran my channel checks last week and confirmed that payers are indeed beginning to design a split of Tier 1 (the tier usually reserved for generics with minimal patient copays) into a Tier 1a and 1b. Tier 1a would be for “lower” priced generics. Tier 1b would be for “higher” priced generics and would result in a higher out of pocket copay for the patient. Definitions are not clear at this point and the whole concept is in the early stages of development. As of today, I have not heard of a clear time frame as to when these will be operationalized as the 2015 contracts are close to being finalized now–so perhaps 2016?

There are, however, chains out there that will not struggle with these issues because of their strategies and structures. As Adam Fein pointed out in his blog from Thursday October 2nd, Walgreens plans on changing their contract terms with manufacturers. I believe that while this seems like an obvious place to go, it will be met with resistance by the generic manufacturers. If it has any chance of being effective, it will take time and likely some changes to their physical operation. Perhaps not enough time to recover during the suppressed contract period ahead. And predicting which generic products will increase when and to what degree is extremely difficult as there is no rhyme or rhythm yet to the increases.  I hope to blog again shortly on when and how generic manufacturers take price increases. It’s a pretty interesting phenomenon – primarily driven by the rules around supply and demand, but it’s counterintuitive based on what most of us would suspect.

Oh the tangled webs we weave.

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