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Drug Benefit News brings us this fascinating story: Caterpillar/Wal-Mart Rx Drug Pilot Scraps Use of Average Wholesale Price, Uses Drug Cost-Plus Pricing.

Readers of this blog know that we are prone to getting on a soapbox about the flawed “Average Wholesale Price” (AWP) system that health plans and many government programs (like Medicaid) use to decide how much to pay pharmacies for prescription drugs. In fact, a number of members of our coalition have brought class action lawsuits against drug companies, drug pricing publishers and major drug wholesalers for allegedly inflating the Average Wholesale Prices of prescription drugs.

In a nutshell, pharmacies generally are very protective of the details of how much they pay to drug companies and wholesalers for the drugs that they then sell to consumers and health plans. They argue that revealing those prices would put them at a competitive disadvantage. So, health plans and governments are forced to decide how much to pay for drugs without knowing what the pharmacy paid. The Average Wholesale Price was intended to approximate what pharmacies in general were paying for a drug. The health plan would then agree in a contract with a pharmacy that they’d pay them an amount based on the AWP of each drug — say, AWP minus 5%. The idea was that a health plan would pay a pharmacy an amount that would be a modest amount higher than than what the pharmacy paid – the “actual acquisition cost.”

But AWPs no longer have any basis in any reality — the joke is that AWP stands for “Ain’t What’s Paid.” In the lawsuits mentioned above, there are examples cited where the AWP was many times, even tens or hundreds of times, higher than what pharmacies were actually paying. This meant that health plans were overpaying pharmacies — often massively – for prescription drugs.

First Databank and Medispan, two of the defendants in a class action lawsuit on this issue, have voluntarily agreed to stop publishing AWPs within approximately the next two years. Since these two companies are pretty much the only ones who publish AWPs anymore, this information is going to cease to be available pretty soon. That means that health plans, pharmacies and government programs are going to have to figure out an alternative. And that’s a major question still up in the air — what are they going to use instead of AWP?

Well, it looks as though WalMart (NYSE:WMT) and Caterpillar (NYSE:CAT) are already thinking about that, and have come up with an alternative — at least for those two companies. As Drug Benefit News explains:

A new pharmacy benefit pilot program involving Caterpillar Inc. and Wal-Mart Stores, Inc. cuts “significant waste” out of the pharmaceutical supply chain and scraps the long-maligned average wholesale price (AWP) discount methodology in favor of an Rx cost-plus model, say those involved in the program…

When Caterpillar approached Wal-Mart, the first thing the parties did was address the question of AWP, which Bisping describes as a “flawed methodology.” Typically, PBMs negotiate discounts off AWP, which can be wildly inflated and bear little resemblance to the true cost of the drug.

To address this concern, Caterpillar developed a new pricing methodology based on Wal-Mart’s actual invoice prices on drugs, Bisping says, adding that AWP doesn’t appear at all in the contract. “For all of the drugs that we purchase now from Wal-Mart, the core basis is on the real invoice price, of course, plus some money for their overhead and any margin they have to make,” he explains.

The article doesn’t go into very much detail about what this “new pricing methodology” actually means. We’re willing to bet that there are heavy-duty confidentiality provisions in the contract to prohibit Caterpillar from revealing the “real invoice prices” that Wal-Mart pays for drugs.

What’s most intriguing about this new model, as scant as the details are, is that it’s based on actual prices, instead of inherently unreliable and unverifiable “benchmark” prices. Basing drug reimbursements on actual costs is something we’ve supported for a long time, including in an article that ran several years ago in the BNA Pharmaceutical Law & Industry Report.

Another interesting aspect of this agreement is that it basically cuts out the traditional middleman between an employer (or health plan) and a pharmacy: the Pharmacy Benefit Manager (PBM). The PBM industry grew massively in the 90s to save employers and health plans from the hassle of having to engage in such negotiations. Now, Caterpillar is quite a large company, so don’t expect to see small- or even medium-size companies or health plans negotiating directly with pharmacies anytime soon. And Caterpillar’s PBM doesn’t seem that worried:

For their part, RESTAT [Caterpillar’s PBM] executives say they are more than happy to assist Caterpillar with the program. The Wal-Mart agreement doesn’t do anything to change RESTAT’s basic relationship with Caterpillar, except for some negotiating relationships on acquisition costs at the pharmacy level, says David Kwasny, vice president of sales and marketing.

“We’re very flexible,” he tells DBN, adding that RESTAT is a highly transparent PBM that doesn’t make any spread on pharmacy utilization. “It’s not a conflict for us.”

Is this a sign of things to come? Can we expect to see other large employers and insurers moving away from AWP? With the coming demise of AWP, it’s inevitable. Let’s hope that other employers and health plans follow suit in the near future, rather than waiting until AWP is on its way out the door.