Update on Generic Dispensing Margins: Even Ahead of the CMS Final Rule, AWP is no Longer the Prevailing Medicaid Standard

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Richard Evans / Scott Hinds / Ryan Baum


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September 17, 2013

Update on Generic Dispensing Margins: Even Ahead of the CMS Final Rule, AWP is no Longer the Prevailing Medicaid Standard

  • HHS OIG* on August 30 published a survey of the benchmarks states use to determine ingredient-cost reimbursement for Medicaid prescriptions. Of the 43 states identifying their benchmarks, 30 are using the newer Average Acquisition Cost (AAC) reference; only 11 are using either (Wholesale Acquisition Cost (WAC) or Average Wholesale Price (AWP) (the outgoing ‘legacy’ references) without also using AAC
  • Thus well ahead (the survey, published last month, was mailed in January of 2012) of CMS** publication of a final rule compelling the shift from AWP to AAC, AAC is the de facto Medicaid pricing benchmark
  • The states using AAC had ingredient cost reimbursement levels that were on average 11pct lower than for states that did not use AAC; thus in addition to the practical matter of essentially having to switch as CMS shifts the benchmark, states not yet on AAC have a financial incentive to join the others
  • Why we care: With the majority of states having shifted to AAC, and the remainder almost certainly compelled to do so by the final rule (now due in January), retail pharmacy information systems across the nation must soon be loaded with the new AAC standard. This, for the first time, makes AAC practically available to commercial plan sponsors as a benchmark for their pharmacy benefit contracts. We expect these sponsors to shift their pharmacy benefit contracts to AAC as early as they can. Large sponsors have both the foresight and leverage to force AAC into renewing and even some existing contracts; smaller sponsors are likely to soon follow
  • Because AAC tracks actual generic costs closely, where AWP does not, we expect AAC to dramatically narrow the generic dispensing margins that AWP has enabled in commercial contracts – as it already has in Medicaid
  • PBMs (ESRX much more than CTRX) are most negatively affected, followed by drug retailers (CVS more so than WAG) and drug wholesalers (ABC most, followed by CAH, then MCK)

*Health and Human Services Office of Inspector General

**Centers for Medicare and Medicaid Services


State Medicaid programs use a variety of drug pricing benchmarks to determine how much a retail pharmacy is paid when a multi-source (generic, essentially) prescription is dispensed to a Medicaid beneficiary. The ‘legacy’ benchmarks are derivatives of manufacturers’ list prices, which in the case of multi-source drugs often do not bear any meaningful relationship to the actual price at which manufacturers sell to wholesalers, pharmacies, and/or PBMs[1]. These legacy benchmarks include Wholesale Acquisition Cost (WAC), and Average Wholesale Price (AWP). WAC is essentially list pricing, and AWP is simply 1.2x WAC

The Affordable Care Act (ACA) calls for these legacy benchmarks to be replaced (in Medicaid) by any of several newer benchmarks that more closely reflect true acquisition costs. These include in particular Average Acquisition Cost (AAC)[2] and Average Manufacturer Price (AMP). AAC is based on a survey of pharmacies’ acquisition costs; AMP reflects manufacturers’ actual prices received[3]

As compared to WAC and AWP, AAC and AMP are both more accurate (they’re closer to the true acquisition cost) and more precise (they have much smaller variances v. true acquisition cost). To our minds, precision is the key advantage of AAC and AMP over WAC and AWP. Reimbursements tend to be set as a fixed percentage of whatever benchmark is chosen, e.g. AWP minus 65% or AAC plus 5%. With generics, the relationship between AWP and true acquisition cost is so noisy (i.e. AWP is so imprecise) that the margins retailers (and wholesalers, and PBMs) receive varies dramatically across different drugs. Because of this noise (risk, in other words) the average generic margin (return) is set higher than it would otherwise need to be.[4],[5] Conversely, the relationship between AAC or AMP and true acquisition cost is sufficiently precise that reimbursement rates can be set much closer to the acquisition cost implied by the benchmark, i.e. average generic margins can be set much lower

Recent Developments

The HHS Office of Inspector General (OIG) recently released the results of a survey[6] in which OIG asked the states (and D.C.) to disclose their current methodologies for calculating Medicaid pharmacy reimbursement[7] for multi-source drugs, and to provide their current reimbursement rates

Of the 43 states (plus DC) that identified the pricing benchmarks currently used to determine reimbursement, 30 reported use of Average Acquisition Cost (AAC), and one state (included in the 30 using AAC) reported using Average Manufacturer Price (AMP). Only 11 states continue to rely on either Wholesale Acquisition Cost (WAC) or Average Wholesale Price (AWP), without also using either AAC or AMP

OIG calculated what all states’ Medicaid ingredient cost reimbursement[8] will be after the provisions of the Affordable Care Act (ACA) are fully implemented (these require use of AAC or AMP instead of WAC or AWP), and compared these ‘post-ACA’ values to each state’s current Medicaid ingredient cost reimbursement. Of the states currently using AAC who provided drug pricing data, the OIG calculates that post-ACA Medicaid ingredient cost reimbursement payments will be on average 17pct lower than they are today. Of the states providing pricing data that are not currently using AAC, the OIG calculated that post-ACA Medicaid ingredient cost reimbursement will be 32pct lower than it is today (Exhibit 1)

The Inspector’s findings support several conclusions:

  1. More states are using AAC than not;
  2. States using AAC are paying less than states that are not; and,
  3. All states (including those already using AAC) have a significant economic incentive to fully adopt the ACA’s Medicaid pricing provisions when these are finally in place

Why We Care

Commercial drug benefit contracts currently are benchmarked to AWP. It would be to plan sponsors’ (generally, employers) advantage to benchmark their contracts to either AAC or AMP, however this cannot practically be done until and unless AAC and AMP pricing values are ‘resident’ in essentially all retail pharmacies’ point-of-sale systems. Medicaid is a sufficiently large percentage of total retail drug volumes to essentially force retailers’ systems to be able to price prescriptions using whichever benchmark(s) Medicaid chooses. Thus as Medicaid completes its switch to AAC and/or AMP, these pricing data become resident in retail pharmacy point-of-sale systems, and by extension these more accurate pricing benchmarks become viable options for commercial contracts. Replacing AWP with AAC or AMP is likely to compress generic dispensing margins in the commercial setting (as it has plainly done in the Medicaid setting); and, since generic dispensing margins are an outsized component of total gross margin for the drug trades (PBMs, retailers, wholesalers), we expect gross margins to come under pressure across the drug trades as these new benchmarks are adopted by commercial plan sponsors

  1. Multi-source manufacturers must negotiate with wholesalers, retailers, and PBMs (the ‘drug trades’), since the trades have the option of buying a given multi-source product from any of several manufacturers. As a result, true acquisition costs for multi-source drugs are almost always less than these drugs’ list prices. This is not the case for single-source brands; with the exception of a standard 2pct discount for prompt payment, these manufacturers do not discount below list price to the trades, since the trades by definition have no other source for these products
  2. There is also a National Average Drug Acquisition Cost (NADAC), which is simply the national version of the state-level AAC
  3. The various indices are evaluated in depth in: “Detailed Comparison of the AWP Replacements” SSR Health, October 3, 2011; and again in: “PBM Bear Thesis Update” SSR Health, May 28, 2013
  4. For more on why an imprecise pricing benchmark leads to higher average margins, please see: “The Thread Holding Generic Dispensing Margins” SSR Health, May 5, 2011
  5. For a detailed view of where generic dispensing margins for PBMs appear to be, and where we believe they will go after AWP is replaced, please see: “PBM Pricing Post-AWP: An Estimate of Sustainable Earnings Power” SSR Health, November 14, 2011
  6. “Medicaid Drug Pricing in State Maximum Allowable Cost Programs”, HHS Office of the Inspector General, OEI-03-11-00640
  7. Specifically, Maximum Allowable Cost or ‘MAC’ rates. These are ceiling prices set by states on a per-drug basis when reimbursing pharmacies for Medicaid prescriptions
  8. That is, reimbursement excluding dispensing fees. States generally pay pharmacy two fees for each multi-source prescription dispensed: 1) a fixed dispensing fee that is independent of the cost of the ingredient; and 2) a reimbursement for the ingredient costs of the prescription


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