Report to the President: Prescription Drug Coverage, Spending, Utilization, and Prices.. 3.3 Drug Pricing

04/01/2000

The pricing for prescription drugs is complex and varies greatly depending on who is the payer and who is the seller. The following is a summary of three major measures of prescription prices: the Producer Price Index, the Average Wholesale Price and the retail pharmacy charge.

The Producer Price Index (PPI) for pharmaceutical drugs measures inflation at the earlier stage of the production and marketing process. It is based on the prices of almost 50 therapeutic classes and indicates the prices paid at the wholesale level. The PPI is often used to determine whether the annual growth rate in drug prices exceeds those of other goods and services. The pharmaceutical manufacturer industry has long criticized the PPI as not properly assessing the impact of new medicines and thus overstating true drug inflation. (PhRMA, 1995)

The average wholesale price of a prescription drug (AWP) is undoubtedly the best known of the pricing terms. It is comparable to a sticker price on an automobile where the manufacturer suggests a certain price but almost everyone pays something different from that price. It tends to be a reliable price reference for brand name drugs but can be misleading with generic drugs since each manufacturer establishes its own AWP for the same product (Cohen, 1995). It is very important to have some reference point for pricing, negotiations, reimbursement, etc., and AWP serves effectively in this role. Unfortunately, the AWP does not really capture actual transaction prices including discounts and rebates (Schweitzer, 1997). The average wholesale price is referenced to some extent in most Medicaid and other third-party programs, but it is virtually unheard of for a plan of any size to pay AWP without extracting some discount from the retailer. Historically, pharmacists used AWP as their basis for pricing. However, they would usually purchase the drugs from wholesalers or manufacturers at some percentage discount from AWP and could thus retain the difference between what they paid for the drug and the cost basis for reimbursement as additional profit. As drugs became more of a commodity at the retail level, third-party payers including Medicaid programs and others, sought to share if not completely capture this "additional" profit. In effect, this substantially eroded the gross margins of pharmacies and thereby created friction between pharmacies and PBMs or other third-party payers. Using state Medicaid programs as an example, some states would reimburse pharmacists at AWP minus 10 percent plus a dispensing fee that varies depending upon the state. The AWP compares to the average manufacturer price (AMP) which is defined as the average price paid by wholesalers for products distributed to retailers (Cohen, 1995). This is obviously one step removed from the retail sector. This term gained widespread public notice with the passage of OBRA 90 where it was used as the reference point for calculating the rebates that drug manufacturers would have to provide to state Medicaid programs (NPC, 1998). Today, it is still used as the primary reference point for determining drug rebates in a variety of prescription drug plans.

The most common method of pricing in a retail pharmacy is to start with a cost basis for the drug and then add a pharmacy-dispensing fee to arrive at a selling price. For mechanical purposes, let us assume that an AWP for a particular prescription is $100 and the dispensing fee is $3. If there were no discounts from AWP included in this particular example, the prescription would be priced at $103. If the pharmacist paid AWP for this product then the pharmacist would gross $3 on that particular prescription. Now let us assume that the pharmacist is being reimbursed at AWP minus ten percent plus the $3 dispensing fee. In this case, the drug cost would be $100 dollars minus $10 (ten percent) or $90. Adding the dispensing fee of $3, the reimbursement price for this particular prescription would be $93. In this case, the pharmacist would need to be able to purchase the product for at least AWP minus 10 percent.

Retail prescription charges are frequently quoted in the lay press but they are difficult to interpret across different types of pharmacies. Drug Topics reports the average value per prescription-drugstore acquisition cost for 1998 at $36.79 per prescription (Glaser, 1999). For 1997, this cost is reported as $32.87 (Gebhart, 1998). However, the average prescription charge for 1997 for independent pharmacies ranged from $24.97 to $34.44 depending on overall sales volume, and was actually higher for pharmacies with high third party activity (NCPA, 1998). A Consumer Reports survey examined retail prices for five commonly prescribed drugs at 26 pharmacies, including chains, independents, supermarkets, mass merchandisers and online/mail order. In general, online pharmacies provided the best prices and independent the highest, although the authors note that the extra service provided by independent pharmacies may be worth it (Consumer Reports, 1999). In general, individual consumers pay more out-of-pocket for prescription drugs than do other more favored purchasers such as HMOs or the federal government (Bettehheim, 1999). The marketplace, as it currently exists, has created a wide range of prices for the exact same product.

One of the thorniest issues surrounding prescription drug prices is rebates. When a PBM is considering adding to or deleting drugs from the formulary, it will negotiate with individual drug manufacturers about providing incentives since the inclusion or exclusion will ultimately mean large dollars to the manufacturer. Generally, these incentives constitute a manufacturer’s rebate calculated as a percentage of the product that flows through the PBM to the plan. The rebate is often set in advance and based on the market share that a manufacturer expects to see for its product within a plan. As an example, assume that a manufacturer and PBM agree that sales of drug X for one year, at average manufacturer price (AMP), will be $5 million. Based on this, the manufacturer agrees to “rebate” back to the PBM 10 percent of the AMP for products dispensed though the particular plan represented by the PBM. The PBM would ultimately receive $500,000 from the manufacturer. The PBM, which is acting on behalf of a client such as a large employer, would receive some of this as a fee for services and the remainder remitted back to the client. The concept of a drug rebate was first widely applied when Congress passed the Omnibus Budget Reconciliation Act of 1990 (OBRA 1990) requiring drug manufacturers to provide rebates back to State Medicaid programs (NPC, 1998). Rebates have revolutionized the prescription drug marketplace. In 1994, rebates to all Medicaid programs totaled $1.8 billion out of total Medicaid outpatient drug payments of $9.5 billion (Lyles, 1999).

Rebates do not directly affect the retail sector, per se. While rebates have a substantial effect on the overall cost of drugs to a particular program, they are negotiated between the manufacturer and PBM or other third-party payer. Thus, when pharmacists dispense a prescription drug to a patient, they are essentially ignorant of any rebate arrangements made for that particular product. This is not to say that the retail sector is totally unaffected. For example, if a plan were not able to obtain the percentage rebates necessary to operate profitably, it may attempt to extract additional from the retail sector.

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