Question

Drug manufacturers compete with each other with prices to attract insurers. The government imposes the following rule. All manufactures must charge Medicare the lowest price that they charge other insurance providers. Using the ideas of strategic moves, explain why this policy results in higher average drug prices.

Answer 1

The abundance of pharmaceutical manufacturers makes it difficult for pharmacies to purchase drug products directly from the factory where the drug is produced. The supply of pharmaceuticals involves a chain of wholesalers that help distribute drugs to pharmacies before they reach the patient. The business model for wholesalers relies on the ability to purchase large orders of drug products from manufacturers and sell them to pharmacies at a higher price. The pharmacies benefit from not having to coordinate with all of the manufacturers, and they enjoy reduced inventory carrying costs. This supply chain dynamic has created three transaction areas of particular interest: from manufacturer to wholesaler, from wholesaler to pharmacy, and from pharmacy to patient.

The first transaction in the supply chain between the manufacturer and wholesaler or pharmacy as a direct purchaser produces several different measurements for drug costs. The average manufacturer price (AMP) is a measurement of the price wholesalers pay to purchase drug products from the pharmaceutical manufacturer. The AMP was originally mandated as a part of the Omnibus Budget Reconciliation Act of 1990 (OBRA ’90), and the actual definition continues to evolve. AMP is meant to calculate the cost of a drug directly from a manufacturer after any rebate or discount is included. The wholesale acquisition cost (WAC) is an estimate of the manufacturer’s list price for a drug to wholesalers or direct purchasers, but does not include discounts or rebates. Without including rebates and other incentives provided by manufacturers, it is hard to estimate the actual cost of the drug. The average sales price (ASP) is derived from the sales from manufacturers to all purchasers and includes practically all discounts, but is limited in that it is only available for Medicare Part B covered drugs

The next transaction, between the wholesaler and the pharmacy, is another area of interest for drug cost calculation. The average wholesale price (AWP) is a measurement of the price paid by pharmacies to purchase drug products from wholesalers in the supply chain. The most common source for AWP data for drug pricing comes from the compendia produced by Medi-Span and First Data Bank. The estimated acquisition cost (EAC) is an estimated price that state Medicaid programs use to reimburse pharmacies for the cost of the drug plus a “reasonable” dispensing fee. The EAC is meant to reflect the cost of the drug to the provider from the wholesaler, but is not a published figure. The average actual cost (AAC) is considered the final cost paid by pharmacies to their wholesalers after all discounts have been deducted and is derived from actual audits of pharmacy invoices. Currently, two states are using the AAC for pharmacy reimbursement

In most markets, consumers see a price for a good or service and make a decision to purchase if the benefit of the good or service outweighs the cost. In the prescription-drug market, most patients are enrolled with a third-party plan (government and/or insurance company) that utilizes a pharmacy benefits manager (PBM) to help manage this process. The patient pays the third party in the form of premiums along with a contribution from the government or the patient’s employer as a part of the total work compensation to the PBM. At the point of sale when patients pick up their prescription from the pharmacy, they usually pay a smaller portion of the transaction and the PBM reimburses the pharmacy for the balance. Low copays disguise the actual cost of medications, increasing patients’ demand for prescriptions. For example, a patient may be prescribed a medication with a U&C price of $100 for a month’s supply, but with a contracted third-party plan the patient may only be responsible for a $20 copayment to the pharmacy. This reduction in price helps drive consumer demand for this prescription medication. When patients are responsible for a larger proportion of the cost, they are less likely to utilize the health care service