Why Are Reimbursement Rates Such a Trouble For Walgreen And Other Drugstore Chains?

by Trefis Team
Walgreen Co.
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“Reimbursement pressure” has been the buzz word in the pharmacy retail industry for a while now. Not even the largest operators in this field, using scale to their advantage, could avoid a hit to their bottom lines in the last four quarters or more. For example, Walgreen (NASDAQ:WBA) has successfully posted healthy monthly sales advances in the last 12 months, but hasn’t been able to carry the same momentum into bottom line growth. While their fiscal 2014 revenues grew about 6% year-over-year, gross profit grew by a paltry 2%. In Q1’15 alone, gross margin was down by 120 basis points year over year and the management expects the negative factors impacting pharmacy margins to intensify in the second quarter. More often than not, the reason for this margin pressure has been reimbursement rates, combined with generic price inflation. In fact, “cost” and “margin” were the most frequently used words during the company’s Q1’15 earnings release (after “quarter”, “year” and “thank”) [1]. Walgreen’s top competitors,  CVS Health (NYSE:CVS) and Rite Aid (NYSE: RAD) aren’t immune to this pressure either. However, the fact that they have PBM services divisions of their own, puts them in a better position to manage these headwinds (Note: Rite Aid got into PBM services very recently through an acquisition and is yet to integrate operations).

Due to this very reason, Walgreen might end up having a greater exposure to risks arising from low reimbursement rates. In this article, we try to dig deeper into the causes of this issue and understand why the industry hasn’t been able to find a solution yet.

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What Causes The Decrease in Reimbursement Rates?

When a pharmacy retailer enters into a contract with a Payer or PBM (both referred to as “Payer” in the rest of the article), there is a reimbursement rate/formula for brands, generics and specialty pharmaceuticals that both sides agree on. For brands and specialties, the reimbursement is pretty straightforward, i.e. the average wholesale price (AWP) less some percentage plus a dispensing fee. However, for generics, the payer is likely to move it from a formula to a fixed amount, called the MAC (Maximum Allowable Cost), which is the maximum amount that a plan will pay for generic drugs. The payer can adjust the MAC for a generic class (usually downward), as prices of generics tend to go down primarily driven by competition among generic drug manufacturers. However, the industry has been in a phase of generic price inflation, as seen in the past few years. While payers are quick to act on a price decrease, they can be very slow to readjusting the reimbursement levels when the prices go up. This is the root cause of the problem.

But, the main reason for a pharmacy to be affected by generic price increases is the way they purchase and stock generics. As scale plays an important role in determining the price at which a retailer will be able to procure drugs, large retailers usually buy in large quantities (based on sales estimates) at lower rates. They use their own warehouses to stock these drugs and then distribute them using their own channels. Typically, a pharmacy chain operating a warehouse holds an inventory of generics amounting up to 60+ days [2]. If it were to face a price increase of a generic product, the chain would have a 60+ day buffer during which they could initiate the appeals process with the PBM/Plan and request a revision in terms of reimbursement. But lately, as product costs have risen, retailers have been putting efforts into reducing costs elsewhere. For example, Walgreen had entered into a distribution agreement with Amerisourcebergen (ABC) for distribution of branded and generic pharmaceuticals to Walgreen’s retail stores, mail order and specialty pharmacies. This enabled them to both reduce working capital requirements and increase service levels due to the partner’s expertise in distribution. However, there is also a downside to this. As retailers no longer stock inventory on their own and are serviced from the wholesale distributor’s warehouse, they have lost the 60+ day window which acted as a buffer to initiate appeals processes. This would lead to increased costs for the retailer, as they’d still be reimbursed at rates corresponding to the pre-inflation drug costs.

Why is it Difficult to Readjust (Increase) Reimbursement Rates?

In situations like the one discussed above, the pharmacy petitions the specific plan for an increase in reimbursement, though plans are not under any obligation to do so. This is where the type of retail pharmacy comes into play. Independent pharmacies have the ability to see the difference between the cost at which they acquire a product and the amount they get reimbursed for it. If the prescription is a loss-making one, they can turn away the patient making an excuse that they’re out of stock. (Note: pharmacies can refuse to fill a perscription, but not because the pharmacy loses money on a particular prescription.) However, retail chain pharmacists at the store level don’t enjoy the same level of visibility into product economics and will fill the same prescription, even if it is a loss-making one. As a result, pharmacy chains accumulate losses in reimbursement  more often than independent ones.  Only ex post facto can they then initiate an appeals process with the plan. This is conducted through the MAC appeals process.

Following an appeal, payers look for unanimity in the retailer community before they approve an increase in reimbursement on a generic class. But, as independent pharmacies are naturally shielded from these losses, appeals come in only from a limited number of retailers such as pharmacy chains. Hence, the payer offices aren’t compelled to change reimbursement rates and eventually, the rates end up being at the same pre-appeal levels.


While regulatory bodies try to resolve this issue, Walgreen is doing its part by working out more favorable contract terms with manufacturers. Also, top players in the market are making investments in the form of distribution agreements and acquisitions in an effort to develop their own way of combating industry headwinds. With all of this, the competition is set to get more fierce in the pharmacy retail industry. But, the good news is that the market is growing at a healthy pace and  will tend to offset the more severe effects of heightened competition.

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Other Sources:

  • Walgreen Investor Relations
  • Seeking Alpha Earnings Call Transcripts
  1. Walgreen’s Q1’15 Earnings Transcript, Seeking Alpha, December 13, 2014 []
  2. Finsights Report, Blue Fin Group, October 14, 2014 []
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  • commented 6 years ago
  • tags: CVS RAD WAG
  • Good article, but it's missing a key factor regarding low reimbursement rates. Pharmacy benefits managers (PBM) increase their margins through spread pricing, a process where the plan sponsor is over charged for a drug, the pharmacy is reimbursed a low rate and the PBM keeps what is left in the middle as profit. PBMs' cut of transactions can double drug costs for consumers or employers. A month's supply of a 20 milligram dose of Lipitor cost consumers or their employers $21.60, according to an audit of a PBM contract done by Pharmacy Outcomes Specialists, which represents companies, managed care organizations, unions and government agencies. The drugstore was reimbursed $10.83, so the PBM kept $10.77.