October 29, 2010 – Why Generic Dispensing Margins (Eventually) Must Fall

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October 29, 2010 – Why Generic Dispensing Margins (Eventually) Must Fall

For both drug retail and PBM mail-order we estimate that per-Rx generic dispensing margins are $5 higher for generics than brands, and show that this premium results from: 1) payors’ uncertainty w/ respect to pharmacies’ generic acquisition costs (uncertainty premium), and 2) payors’ current need to ‘bias’ pharmacies in favor of generic dispensing (incentive premium)

The uncertainty premium fades as payors’ knowledge of generic acquisition costs improves: suddenly if HHS publishes acquisition costs (average manufacturer price or AMP) in January; or if not, then more gradually as states shift Medicaid Rx re-imbursement closer to generic acquisition costs. Alabama is making this shift (and is making generic acquisition costs public); other states likely will follow

Commercial payors’ need for pharmacies to earn more on generics (i.e. the incentive premium) fades as consumers’ out-of-pocket exposure to brand v. generic differentials grows, and this differential is growing exponentially

Quite apart from these separate pressures on the uncertainty and incentive premiums, the entire generic dispensing premium is under competitive attack.  By forgoing large generic mark-ups, Wal-Mart / Humana’s Medicare Part-D plan offers a monthly premium less than 1/2 the national average

This competitive assault should accelerate. As generics represent a growing % of Rx’s dispensed, generic dispensing premia grow in absolute importance as an ever larger cost of delivering a drug benefit.  And, the relative importance of generic dispensing premia grow as well; as brands are lost to patents, drug rebates fall in importance as a source of drug benefit cost savings.  More simply: competition to deliver low cost drug benefits is shifting from the negotiation of brand drug rebates to the lowering of generic dispensing premia

Timing the collapse of the generic dispensing premium is difficult; we’re convinced it’s gone by 2015/’16, and see substantial odds that it’s gone much sooner.  We’re desperately aware of how useful it would be to time things more accurately, particularly in light of patent losses in 2011 – ‘13

We recommend reducing exposure to the drug trades (PBMs (MHS, ESRX, CVS), drug retail (WAG, CVS, RAD), and distributors (CAH, ABC, MCK)), even ahead of the generic wave.  PBMs are particularly at risk, with both higher valuations and higher gross profit exposure than other trades

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