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White Paper
Generics – The New Push For Profit!
Co-authored: Doug Wittenauer – President, Pharmacy Data Management, Inc. Rick Goebel – Vice President, Pharmacy BenefitDirect
Background
Prior to the era of full disclosure, traditional PBMs generated revenue through multiple
sources. The most significant revenue sources were manufacturer’s rebates and retained
“discount spread” (which PBMs achieved by negotiating one discount with the provider
while offering the payer a lower discount). These tactics have been widespread.
PBMs have been sharply criticized by clients/payers because of hidden rebate revenues
that have adversely impacted Rx plan cost management. In response, PBMs now claim
that they have become “transparent,” fully disclosing their dealings with others. For
evidence of this new trend, consider a recent article regarding a large PBM who was
dropping Lipitor as a preferred drug. (www.bizjournals.com – 10/24/05). The article
explains that the PBM has removed four Pfizer drugs from its preferred drug list in favor
of promoting lower cost generic alternatives. For example, the PBM will replace Pfizer’s
bestselling drug Lipitor ($11 billion revenue in 2004) with Merck’s Zocor, which is
scheduled to come off patent in 2006. In response, Pfizer has stated they will no longer
pay rebates to this PBM beginning in 2006.
Equity research analysts have viewed this as a bold move by the publicly traded PBM
demonstrating an interest to be aligned with its clients’ goals. However, we would
suggest that this article proclaims the contrary – it was not a bold move but merely a ploy
to gain positive press and a sign of the times as generics are now the focal point for new
PBM revenues.
PBMs would not walk away from an existing source of revenue until they have identified
a new revenue source to replace it. While PBMs are pressured by their clients/payers to
fully disclose all revenue streams, they are also pressured by their shareholders to
improve upon the previous quarter’s reported financials. To satisfy both interests, PBMs
have begun focusing on generic drugs as their next profit center – by doing so, they are
sending a message to clients/payers that they are serious about lowering costs with
generic substitutes; at the same time, PBMs are manipulating their obscure proprietary
maximum allowable cost (MAC) methodologies to create an increased level of spread,
thus guaranteeing higher returns for shareholders.
The brand name drug has become a loss leader for the PBM so that they can promote
deeper discounts suggesting greater savings while they make it up on inflated MAC
prices. PBMs have created the impression that they have changed and can now be trusted
as an accountable cost manager for the client/payer.
Purpose
The purpose of this paper is to expose the tactics a PBM uses to make up for the lost
revenue associated with full disclosure of rebates. We will primarily focus on two areas
– Retail Generics and Mail Order Generics – because the tactics in each area will vary.
1. Generic Drugs – PBM Retail Tactics
For traditional PBMs, retail generic drugs now drive retained revenue. A PBM uses
multiple tactics to replace rebate revenues with generic revenue while maintaining the
perception of cost management, including:
MAC “spread” pricing methodologies Single-source generic pricing Brand drug reimbursement Minimum copay In pricing retail pharmacy claims, PBMs use a “maximum allowable cost” (MAC) methodology. MACs were created by the Health Care Financing Administration (HCFA) in the 1980s to smooth generic drug cost variations and give pharmacies an incentive to purchase lowest cost products. Actual price variations among multiple generic drugs for the same original brand name drug (once off patent) can be significant. For example, consider the Ace Inhibitor drug class and the brand name drug Prinivil. The following table shows four different generic manufacturers, the respective AWP pricing, and the amount paid for a 30 days supply of Lisinopril (Tab 10mg), the generic equivalent for Prinivil: Manufacturer
AWP
Ingrd Pd
% Discount
In this example, the HCFA MAC is $17.91 ($.597 per tablet) for a 30 days supply. Under the HCFA MAC methodology, this becomes the reimbursement rate for all generics for Prinivil. HCFA created this MAC to recognize pricing differentials between drug manufacturers for the same brand name drug and to create an average across all price points. These four generic manufacturers have AWP pricing that varies as much as $10 per 30 days supply for the same generic equivalent to Prinivil. This HCFA MAC price removes provider incentives to fill the prescription with a higher cost, higher margin generic. In this way, the purchaser (client/payer) can be assured a good value. HCFA (now CMS – Centers for Medicare & Medicaid Services) created this methodology as an industry standard for price management of multiple generics to the original brand name drug. Over time, PBMs began to create proprietary MAC pricing methodologies. These proprietary MAC pricing arrangements have become an important PBM revenue channel. MAC’d Retail Generics
PBM MAC pricing methodologies negotiated with pharmacy providers vary significantly
from what the PBM actually charges the client/payer. Based on market intelligence, the
following table demonstrates the aggregate discount from average wholesale price
(AWP) for all generic drugs paid to providers and charged to client/payers:
AWP Pricing
Average Cost / Claim
Net Impact
AWP less 20%
$9.00

In this example, for all generic drugs that are MAC’d the PBM retains $9.00 per claim as
revenue. It is assumed that 85% of all generic drugs are MAC’d with multiple generics
for a brand name drug. In this case, 85% of all generics return $9.00 per claim to the
PBM as revenue. PBMs contractually may guarantee to the client/payer a 40% to 50%
AWP aggregate discount for MAC’d generic drugs. Market intelligence on these MAC’d
generic drugs indicates the aggregate discount the PBM negotiates with the provider
pharmacy is in the 60% to 70% range.
Non-MAC’d Retail Generics
For the 15% of generic drugs dispensed without a MAC price, PBMs also negotiate a
deeper reimbursement than they pass through to the client. A common practice among
PBMs for non-MAC’d generics is to default to the negotiated discount level for the brand
name drug even though the actual negotiations with the pharmacy have netted a much
deeper discount. By retaining the difference, or “spread,” the PBM continues to generate
revenue. The following example represents this tactic:
AWP Pricing
Average Cost / Claim
PBM Net Revenue
16% of AWP
$9.60
In this example, the PBM retains an average of $9.60 per claim for the 15% of generic claims that are not MAC’d. Single-source generic drugs when they are first offered to the market do not compete with other generic drug manufacturers and therefore hold a six-month to one-year monopoly as the first generic drug in the marketplace. For example, consider the first-source generic for Prilosec in the Proton Pump Inhibitor drug class. The single-source drug was “omeprazole,” approved by the FDA in June 2003. While the brand drug Prilosec averaged $135 for a 30 days supply, omeprazole was introduced at $120 for the same days supply. This is problematic for the client/payer: Under the Rx plan benefit design members may pay a generic copay of $10 for omeprazole compared to the $45 copay for Prilosec, the brand name drug. There is no MAC established for the drug and the client is reimbursing at the
The plan picks up a higher share of the cost on a generic drug that is priced at a
comparable level to the brand name drug that is being substituted. Until multiple generic
drugs have been introduced and a MAC price is set, the client/payer bears the brunt of the
cost while the PBM continues to retain revenue.
Brand Name Drugs – PBM Tactics
The brand discount is the most visible area for drug ingredient costs today because
generic MAC prices are not understood or published. In the past, the brand discount
“spread” between the provider’s negotiated price and the client/payer’s actual discount
was retained as revenue by the PBM. Today, the brand discount can be a loss leader. In
this way, the PBM offers a brand discount at a higher level than they may have
negotiated with the pharmacy. For example, many PBMs offer prospective clients brand
discounts as high as AWP less 16% even though many large chains refuse to contract at
this discount level.
In the following example, the PBM offers a branded AWP less 16% discount but they can
only secure an AWP less 15.5% aggregate discount from all pharmacies based on
negotiations and actual utilization. The net impact is a loss to the PBM of .5% in brand-
level discount:
AWP Pricing
Average Cost / Claim
Net Impact
AWP less .5%
($1.00)

The traditional PBM has actually lost $1 per claim but fully intends to increase generic
substitution to make up for this loss through the generic spread. This tactic enables the
PBM to show a prospective client/payer a superior discount and then offset the loss
through the increased spread that has been built into the generic MAC methodology.
Retail Minimum Copay
Traditional PBMs negotiate “minimum copay” and “zero balance” copay arrangements
with pharmacy providers. Under these terms, when the actual charge is less than the
copay as stated in the benefit design, the pharmacy is allowed to collect the stated copay
or the allowed copay minimum. For example, a PBM negotiates a minimum copay of $8
in the base provider contract and the generic drug Loratadine tab 10mg, with a total
negotiated cost of $5.28 (ingredient cost plus $2 dispensing fee), is dispensed. If the
PBM contracts a “minimum copay” deal with the pharmacy, the negotiated cost of $5.28
is not recognized and the pharmacy collects the $8 minimum from the member.
Traditional PBMs allow pharmacies to charge “up to” the copay when the member’s
discounted charge is actually below the copay. By allowing this language, the PBM can
negotiate better terms with the pharmacy chain. These improved terms are not passed
through to the client/payer but are retained by the PBM to increase the spread. Another
downside is that many client/payers and members are unaware of this practice, which can
result in member dissatisfaction; under a union Rx plan this practice may also violate a
commitment that the union makes to its member.
Retail Summary
This information was developed to offer insight into the new direction traditional PBMs
are taking to counter today’s client/payer demand for full disclosure of rebates and to
replace lost revenue. Using the examples shared in this article, the following table
summarizes the net impact for the traditional PBM:
Drug Spend
% Mix Provider
$ Spread Per Claim
Total
100%
$60.74
$64.79
$4.05*

In this example, the traditional PBM retains an average of $4 on every claim dispensed.
The PBM now has a clear incentive to continue to increase generic substitution ratios to
increase retained revenue. Additionally, to secure the very best rates from the retail
pharmacy, the traditional PBM will allow minimum and zero copay arrangements so
members have higher cost exposure under the Rx benefit plan.
2. Generic Drugs – PBM Mail Tactics
In November, the CEO for a large PBM made a presentation at the Reuters Health
Summit and was quoted as saying that most of the PBM’s profit is “derived from generic
drugs delivered by mail.” In this presentation he further stated that “drugs worth more
than $9 billion in annual sales will be exposed to generic competition in the United States
in 2006, including Merck & Co.’s Zocor cholesterol fighter and Bristol-Myers Squibb
Co.’s Pravachol.”
Did you ever wonder why mail order companies do not offer “maximum allowable cost”
(MAC) pricing? Through owned mail order operations, PBMs have learned that they are
much better off eliminating a MAC methodology in favor of straight AWP generic
discounts. Remember … the PBM owns the mail order operation and is better served to
have latitude over which generic drug manufacturer’s products are dispensed. As stated
earlier, each generic drug price varies and the respective profit margin to the mail order
service subsequently varies based on the product that is filled against the order. The mail
order provider has an incentive to fill higher priced products if the outcome is higher
profit margin to their bottom line.
Under the retail pharmacy program, the PBM does not own the retail pharmacy where the
drug is dispensed, so they benefit from the use of a proprietary MAC program by
retaining the “spread.” With their owned mail order program they are adversely affected by MAC programs that restrict product margin opportunities. The following table compares the generic drug alternative (Citalopram tab 20mg) for the brand name drug Celexa dispensed at a straight AWP less 55% discount compared to the retail HCFA MAC reimbursement for the same drug: Brand
90 Days Supply
Name
Generic Manufacturer
Ingredient
Drug
(Citalopram tab 20mg)
Discount
Celexa
Mail Generic #1
$230.64
$103.79
55%

In this example, the mail order provider’s AWP price is comparable to the retail generic
drugs dispensed but the PBM is not obligated to a MAC pricing methodology and takes a
straight AWP less 55% discount. The Rx plan spends an additional $48.44 ($103.79 mail
vs. $55.35 retail) on one mail order claim while the retail provider would have been
obligated to fill according to the established HCFA MAC. The savings for the Rx plan is
significantly higher in the retail setting.
The following example focuses on the difference in generic reimbursement for two
different mail order reimbursement programs offered by two different PBMs:
Mail Order Plan 1
Mail Order Plan 2
In the above examples, it appears that Mail Order Plan 1 is a higher cost option than Mail Order Plan 2. In fact, Mail Order Plan 1 may actually be the lower cost option as the following table demonstrates for the stated generic drugs: 90 Day Supply
Net Ingredient
Generic Drug
Dispensed
Totals
$645.93
$135.38
$290.67
The lesser of the HCFA MAC or AWP methodology keeps the mail order provider
honest and ensures that the Rx plan’s cost management expectations are met. In the
above example for these four generic drugs, Plan 1 was a better value even though the
AWP discount was lower. The HCFA MAC methodology generates savings and keeps
the PBM honest by reimbursing at the same level for all generics dispensed when a
generic drug is MAC’d. This takes away the mail order provider incentive to fill using a
higher cost generic drug option.
Summary
A true transparent model should not stop at the disclosure of manufacturer rebate
contracts but should extend to all aspects of the PBM’s operation. The model should also
include the contractual relationship with the provider base and the awareness that
“spread” exists between provider-negotiated rates and Rx plan-applied rates. A published
and industry accepted MAC methodology should be applied and the existence of
undisclosed proprietary PBM MACs should be eliminated. A MAC standard should
apply to both retail and mail order pharmacy claims. As a client/payer who is at risk for
the cost of pharmacy benefits under the plan, it is important to understand and guard
against these PBM tactics in the marketplace.
The traditional PBM who owns the mail order service becomes both cost manager and
provider to the Rx plan. These PBMs are not able to play an objective role in cost
management because they profit more from mismanagement. They serve two masters –
plan clients/payers and shareholders – and cost management will always be a secondary
goal. A new non-traditional model in pharmacy benefit management is taking hold
among informed client/payers. This option by separating itself from provider ownership
distinguishes itself from the traditional model aligning its business practices to work for
the Rx plan as the only customer.
This paper is presented by Pharmacy BenefitDirect, a privately held program that offers health
plans proprietary approaches for managing their pharmacy benefits. This Rx benefit model
removes all conflicts between what’s right for the plan versus increased revenue for the benefit
manager. The article is authored by Doug Wittenauer, President of Pharmacy Data
Management, Inc. (PDMI), and Rick Goebel, Vice President of Marketing and Sales for
Pharmacy BenefitDirect. Doug and Rick have combined over 50 years of experience in managed
care/pharmacy benefit management and have dedicated their efforts over the past 5 years to
offering solutions in pharmacy benefit management. For more information, please visit
www.pharmacybenefitdirect.com or contact Rick at 800-774-0890.

Source: http://benefitslink.com/articles/generics_push_for_profit.pdf