ESRX, MHS, and the PBM Bear Case

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We update and summarize our PBM bear case in light of ESRX’ bid for MHS

Generic dispensing margins (est. $9.01 / Rx) should fall toward brand levels (est. $5.77 / Rx) if average wholesale price (AWP) is replaced by a benchmark that more closely reflects true generic acquisition costs. Two candidate benchmarks are emerging: average acquisition cost (AAC, essentially a survey of retail prices), and average manufacturer price (AMP, essentially a more reasonable proxy for manufacturers’ net selling price). AAC should be nationally available as soon as late this year, AMP by the end of 2012

As mix shifts away from highly interchangeable small molecule brands, fewer rebate dollars are available. We estimate that three-quarters of dollar sales attributable to highly interchangeable small molecule brands will be lost to generics within three years

As mix shifts toward specialty products, management of the drug benefit tends to be reintegrated into the medical benefit, i.e. taken away from PBMs. Patients taking specialty brands tend to be more closely and actively managed by medical plans, thus favoring reintegration of the drug and medical benefits. We suspect this at least partially explains UNH’s decision not to renew the MHS contract

Because of the two preceding points, the large PBMs’ infrastructure (call centers, mail-order) is less essential, thus the large PBMs are a less and less cohesive oligopoly

The emergence of co-pay cards further limits PBMs’ ability to extract large brand rebates from manufacturers, especially for specialty drugs; this in turn further limits PBMs’ ability to offer an (absolutely or relatively) attractive value proposition in specialty pharmacy management

The declining relevance of call center and mail-order infrastructure, the increasing relevance of generic dispensing spreads to total potential savings, and the ability of smaller ‘b-list’ PBMs to offer tight generically oriented formularies, all point to share gains by b-list PBMs, even as the total market for PBM services may narrow

The high likelihood of employers shifting subsidy-eligible employees out of employer sponsored insurance (ESI), and onto health insurance exchanges (HIEs), means potential PBM beneficiaries will be shifted from employers (where PBMs have relatively high odds of capturing beneficiaries at relatively healthy margins) to HMOs (where both the odds of capturing beneficiaries and service margins are far lower)

We recognize that consolidation of ESRX and MHS would tend to lessen the tendency for price competition among the a-list PBMs; however, we would emphasize that CVS is still motivated to price compete because it enjoys marginal retail volume gains that ESRX and MHS do not; and, that the majority of threats to the large PBMs tie to issues other than price competition

The prospect of an ESRX/MHS combination does not change our view of the PBM industry, nor would we view ESRX/MHS together as significantly more able to react to these changes than either PBM on its own

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