The Thread Holding Generic Dispensing Margins

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Plan sponsors’ (e.g. employers’) contracts with PBMs specify how much the sponsor pays for each prescription handled; plan sponsors’ payments to PBMs typically are determined as a function of the average wholesale price (AWP) of each prescription

For brand drugs, AWP bears a consistent relationship with the drug trades’ actual cost of acquiring the prescription, i.e. brand dispensing margins are a consistent percentage of the brand’s acquisition cost. We estimate average brand dispensing margins of roughly $5.77 / Rx

For generic drugs, AWP and actual acquisition costs are essentially un-related, thus plan sponsors’ payments to PBMs bear little relation to the drug trades’ actual cost of acquiring generic drugs. We estimate average generic dispensing margins of roughly $9.01 / Rx, 56% higher than for brands

Plan sponsors can see AWP directly, but not the trades’ acquisition costs. Because brand AWP is tightly correlated to brand acquisition costs, plan sponsors can accurately infer acquisition costs, so no information asymmetry exists in the brand reimbursement negotiation. Not so for generics; plan sponsors cannot infer the trades’ generic acquisition costs using AWP, thus an information asymmetry does exist in the generic reimbursement negotiation

Despite this asymmetry we might assume that plan sponsors, realizing the trades make more on generics, will simply lower their (AWP-based) payments for generic prescriptions, perhaps to a level at which brand and generic dispensing margins are equivalent. We show that because of an AWP-related artifact, plan sponsors cannot lower AWP-based generic reimbursement much (if any) further

Because AWP and generic acquisition costs are largely un-related, a portfolio of generic prescriptions will have a great diversity of dispensing margins. Included in this dispersion are a few prescriptions that lose money, and a lot that nearly do. As we force AWP-based generic reimbursement lower, we find that the trades quickly begin losing money on such a large percentage of generic prescriptions that they cannot both accept the lowered payment terms and agree to make all approved generic molecules readily available. As long as AWP is the benchmark, plan sponsors cannot simultaneously lower generic dispensing margins and expect that all necessary generics will be stocked and dispensed

Conversely, once AWP is replaced by a benchmark that reflects acquisition costs, both of these effects (information asymmetry and the existence of any negative generic dispensing margins) evaporate, and generic dispensing margins should fall to the brand level. Two such benchmarks are forthcoming; the first to be available by late this year. Presumably plan sponsors will not convert PBM contracts from AWP to an acquisition cost benchmark until they’re sure the new benchmark will remain in place (i.e. survive judicial challenges); we believe plan sponsors will have this confidence by 2012

We conclude that generic dispensing premiums (relative to brands) are almost wholly a consequence of AWP-related artifacts, and that this premium will be lost – most likely all at once – when AWP is replaced

PBMs (e.g. MHS, ESRX, CVS) are most negatively affected, especially those with greater exposure to mail order dispensing. Drug retailers (e.g. WAG, CVS, RAD) are next most negatively affected; PBMs have extracted some of the AWP-related arbitrage from retailers, thus retailers have somewhat less margin to lose when AWP is replaced. Drug Wholesalers (e.g. CAH, MCK, ABC) are the least negatively affected; our concern is that the collapse of generic dispensing margins at retail leads to a loss of independent pharmacies, who are wholesalers’ highest margin customers

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