Wal-Mart Takes Bite Out of Drug Costs

After a decade of scrutiny and more than $100 million in settlements, the pharmacy benefit manager industry isn’t out of the woods just yet.

Gerry Purcell, who first exposed the lucrative and often questionable profit taking by PBMs in 1998, said the expansion of $4 generic drug offerings by Wal-Mart Stores Inc. to 90-day supplies for $10 is another shot to the middlemen who control prescription drug benefits for more than 210 million Americans.

“They should be very nervous,” said Purcell, managing partner of Pharmacy Partners Inc. in Atlanta, who negotiates with PBMs for employers.

MedCo, Express Scripts and Caremark together control 70 percent of the PBM market, setting prices with manufacturers, reimbursements from insurance companies and premiums from employees.

The excessive spreads between prices along with rebates from drug manufacturers wrongfully pocketed by PBMs – standard practices revealed by Purcell – led to lawsuits by attorneys general in more than 20 states and several multi-million dollar settlements.

MedCo paid $42 million in 2002 to settle several suits, including one in Florida where court filings showed the company kept $2.8 billion in drug rebates from 1995-1999.

No industry in America was more profitable than the prescription drugs from 1995-2002, and in 2006 it ranked second, with a return on sales of 19.6 percent compared to the 6.3 percent average for all Fortune 500 companies.

In the 1990s, prescription costs rose at an average annual rate of 12 percent and continued the double-digit inflation until 2003.

“I believe a substantial part of that – as much as a third to a half – was taken in PBM margins,” Purcell said.

Cutting out intermediaries has long been a pillar of Wal-Mart’s low-cost model. PBMs miss out every time a patient pays the “street price” rather than the insurance co-pay triggering the reimbursements from which PBMs take a cut.

“It’s very good in terms of keeping PBM margins compressed,” Purcell said. “It’s good for employers, good for insurance companies and a good thing for consumers if [insurers] will pass the savings along in rates.

“And it’s very good for senior citizens. They benefit the most.”

Wal-Mart, whose generic pricing has been matched by competitors Kroger and Target, estimates the program has saved its customers – many of whom are uninsured – more than $1.1 billion since 2006.

“We welcome our competitors,” said Wal-Mart spokeswoman Deisha Galberth. “Health care has its own problems and issues. We realize we can do our part, but we can’t fix it ourselves. Between the government and private sectors, we’re happy when they come behind us to make it more affordable for communities we serve.”

Leveraging its massive pricing power has been good for Wal-Mart customers but bad for independent pharmacies, the main negative of the program in Purcell’s eyes. He expressed his support for an anti-trust exemption approved by the U.S. House of Representatives judiciary committee in February and opposed by PBMs that would allow independents to negotiate en masse with drug manufacturers.

Costly Care

American health care costs are staggering, but just as dramatic are measures of the impact of the Wal-Mart program and its imitators.

In 2005, Americans spent nearly a quarter of a trillion dollars on prescription and over-the-counter drugs. Health care spending has increased as a percent of GDP from 8.8 percent in 1980 to 16 percent in 2007 and is projected to increase to $4.2 trillion by 2016, or 20 percent of GDP.

Since 2000, employment-based health insurance premiums have increased 100 percent, compared to cumulative inflation of 24 percent and cumulative wage growth of 21 percent during the same period, according to the Kaiser Family Foundation.

Now consider the rate of inflation in drug prices since the PBM transparency movement ignited by Purcell, the introduction of Medicare Part D in early 2006 and Wal-Mart’s generic program launched in the fourth quarter of that year.

The annual increase in prescription costs was 4.4 percent in 2005, according to the U.S. Bureau of Labor Statistics and declined to 1.9 percent in 2006.

The BLS cited lower prices for Part D beneficiaries and the introduction of retail generic programs for the lowest cost increase in the category seen since 1973.

From September 2006 to September 2007, the BLS reported an increase of 1 percent, the lowest rate since 1961.

The fourth quarter of 2006 was the first period in decades that drug prices declined for three consecutive months, and the use of generic drugs skyrocketed from 13 percent of all prescriptions in 2005 to 63 percent in 2006.

A study published by the University of Michigan in February estimated that 70 million people bought $4 generic drugs since 2006.

Of those, two thirds of adults who purchased generics were covered either by private insurers or Medicare. With an average generic price of $30 in 2006, the total savings to insurers multiplies rapidly.

If the 47 percent of adults with private insurance – 32.9 million – purchased just one prescription for $4 rather than making a $10 co-pay (requiring an average reimbursement of $20 by the insurer) the savings to the companies would be $658 million.

Multiple prescriptions filled multiple times makes the potential cost benefit to insurers clear. Purcell said it is still too early for any studies quantifying benefits to insurers but said there is no doubt those numbers are being monitored closely within the industry.

Dr. Adam Fein of Pembroke Consulting in Philadelphia has written extensively on the Wal-Mart program and said state governors “love” the effort because Medicaid must only reimburse the cash price of any prescription to retailers, further reducing health care costs.

“We have removed unnecessary dollars from the health care system,” Galberth said. “That frees up time and money for other things and to improve it.”

Minding Margins

The dramatic reduction in pricing by Wal-Mart was scoffed at in 2006 alternately as hype or an attempt by the company to use generics as a “loss leader” to increase store traffic. After the introduction of Phase III in May, which also includes a slew of women’s medicines for $9 and a cut in many private label, or “store brand,” over-the-counter drugs to $4, few are discrediting Wal-Mart now.

Generics are the greatest source of profits for pharmacies, and when Walgreens – who along with CVS has not matched Wal-Mart’s offerings – posted its first quarterly net income decline in 10 years last September it cited the dearth of new generics entering the market in 2007.

Fein estimates Wal-Mart’s average gross margin even on $4 drugs is still 24 percent, and the company has insisted all along that it would make money.

“We’re not in business for gimmicks and promotions,” Galberth said. “We make money on every prescription we sell.”

Purcell said Wal-Mart has used the allure of exclusive distribution to leverage prices down from manufacturers. Citing Pravachol, a generic statin that lowers cholesterol, Purcell noted the price a year ago was $23 to $25 but now it is on the $4 list.

“It’s amazing,” Purcell said. “How do you do that? What I’ve been told is they went to the manufacturer and said, ‘We’ll give you an exclusive if in exchange you will sell it for close to cost.’ Now generic manufacturers have to become more competitive.

“You can fairly say that Wal-Mart was a catalyst in that.”

For a company that measures data obsessively, Wal-Mart is using at least one non-scientific metric to judge the effect of its generic program when a gallon of gasoline is now more expensive than a 30-day supply of medication.

“The best evidence of our work is the stories we hear,” Galberth said. “Customers who tear up when the pharmacist brings a script for [generic] Coreg at $4 that may have been $160 before we added it.

“We hear every day from our customers that it is helping.”