Published

The Center for Medicare and Medicaid Services’ (CMS) final rule replacing average wholesale price (AWP) as a basis for reimbursing pharmacies for generic drugs dispensed to Medicaid beneficiaries will be published this August. The rule will be effective as early as this September, but no later than December of 2014. Our best guess is that the rule takes effect in either January or June of 2014

To process Medicaid prescriptions, pharmacies nationwide will have to include the AWP alternatives (average manufacturer price or ‘AMP’; and/or national average drug acquisition cost or ‘NADAC’) in their information systems – thus making AMP and NADAC available for commercial (e.g. employer-sponsored) drug benefit contracts

AWP bears no consistent relationship to pharmacies’ costs of acquiring generics; two government studies cited herein show that AWP-based reimbursement tends to exceed true acquisition cost by roughly 400 pct. AMP and NADAC both are closely related to true acquisition costs; these same studies show AMP-based pharmacy reimbursement exceeds true acquisition cost by only about 35 pct

We’re convinced commercial plan sponsors will insist on AMP or NADAC as reimbursement benchmarks once these are available in pharmacy information systems, that this will reduce generic dispensing margins throughout the drug trades (PBMs, retail, wholesale), and that PBMs will be most negatively affected

A common counter-thesis is that PBMs will simply shift to the new benchmark but price at a level that maintains to total gross margin. We believe this is unlikely for several reasons, primary among these being the tendency of AMP or NADAC to eliminate much of what makes newly launched generics so particularly profitable

Because AWP is not tied to acquisition costs, as acquisition costs fall in the first months and quarters following the new generic’s launch, pharmacy margins rise (the AWP-based reimbursement remains constant, even while the cost of the generic to pharmacies is falling). AMP and NADAC are tied to acquisition costs, thus as the cost of a generic to pharmacies falls (as it tends to do dramatically early in the new generic’s life), the AMP or NADAC based pharmacy payment also falls, narrowing the opportunity for outsized generic margins in the months and quarters following launch of a new generic

For our full research notes, please visit our published research site

We expect 2.9% (nominal) y/y growth in US health services demand during 2Q13, the product of 1.5% growth in unit demand, and 1.4% price growth. Unit demand growth remains very slow; the projected 1.4% rate is below the inherent rate of demand growth (1.5%) attributable to population growth and aging alone, and well below our long-term expectation of 2.8%

We expect nominal pricing to decelerate 50 bps, from 1.9% to 1.4%; this is a direct consequence of the 2% decline in Medicare payment rates brought about by the ‘fiscal cliff’ sequester. Dental services are significantly less affected by the sequester, and appear able to maintain steady price growth of roughly 3.7%

Independent of our quarterly growth rate models, we handicap the odds of a trend break, i.e. a significant acceleration or deceleration in demand. The trend-break model indicates near zero probability – <2% – of accelerating demand in 2Q13

Our models correctly anticipated that the downward trend in unit demand would persist during 1Q13 – however the fall was even more dramatic than our pessimistic view. This is directionally consistent with company reported results from the quarter – where surprises to the downside of sell-side analyst revenue consensus estimates far exceeded positive surprises

We believe demand is weak primarily because of low employment, which translates into a smaller percentage of households having the benefit of the most generous source (employer-sponsored) of health coverage. Employment gains, expansion of Medicaid eligibility, and the initiation of state health insurance exchanges all are likely to expand the availability of health coverage in the relatively near-term

We recommend a pro-US / pro-cyclical tilt to healthcare portfolios; this translates into overweight positions for Hospitals, select Non-Rx Consumables (especially more US-focused names such as CFN and OMI), and select Dental names (emphasize more US-focused names with product lines that include higher-mix items, such as XRAY and PDCO). We recommend underweight positions in Large-cap Pharmaceuticals (on US real pricing power concerns), drug trades (Retail, Wholesale, PBM)(on the loss of AWP pricing, and risks of PBM disintermediation), and Research Tools / Services (implied revenue growth exceeds R&D spending growth)

For our full research notes, please visit our published research site

For most households, the marginal costs of acquiring health coverage on an exchange are within shouting distance of the annual cost of a new car (Exhibit 1); and, the odds of health costs (if uninsured) exceeding costs of coverage (if insured) are less than 50 pct (Exhibit 3). Among subsidy-eligible households, in many cases net premium costs are higher for younger (and presumably healthier) than for older (and presumably sicker) beneficiaries with similar incomes (Exhibit 4). It follows that many households – especially younger and healthier – may choose not to purchase coverage

Assuming households that do purchase coverage do so optimally, +/- 80 pct of households would buy the cheapest (Bronze) coverage and the remainder (+/- 20 pct) the most expensive (Platinum) coverage. By purchasing the cheapest plan, healthy households (the 80 pct on Bronze) minimize their payment of excess premiums (premiums above their costs of care), and thus minimize the extent to which they subsidize households (the 20 pct on Platinum) whose medical costs exceed premiums paid

Small employers with younger and healthier employees can almost certainly save by self-funding, i.e. by avoiding the exchanges entirely. Stop-loss policies to self-funding employers can be priced to reflect a specific employer’s health risks, where fully-insured policies on the public exchanges cannot. This is likely to result in small group exchanges consisting of significantly worse-than-average health risks

We believe that the Affordable Care Act’s (ACA’s) provisions for limiting adverse selection are too weak (e.g. penalties for being uninsured are too low), or even counter-productive (higher effective premiums for younger than for older subsidy-eligible beneficiaries at a given level of income). The Act’s provisions for risk sharing are relatively strong; however these only serve to ensure equivalent relative exposure to unsustainably high absolute risks

Conclusion: Enrollment in individual and small group exchanges will be much less than originally (and perhaps even currently) expected; sellers of alternatives to full risk policies (ASO services, medical stop-loss insurance) in the small group markets will see accelerating demand; and, additional legislation and/or regulatory rule-making (i.e. further reforms) may be necessary soon after the exchanges begin operating

Cigna (CI) is a notable beneficiary of rising demand for ASO services and medical stop-loss in the small group market. Health Net (HNT) and Aetna (AET) are relatively exposed to small group risk, and stand to lose from a shift by employers (with healthier workers) to self-funding. AET’s acquisition of Coventry, completed last week, increases their exposure

Risks to other insurers have less to do with adverse selection (you can see it coming and price for it; and, the ACA ensures the risks are more or less equally shared), and more to do with the high likelihood that adverse selection forces new – and potentially adverse – legislation and/or rule-making

For our full research notes, please visit our published research site.

PFE announced direct to consumer sales of Viagra; orders placed on Viagra.com will require a legitimate US prescription, and will be filled by CVS

Viagra is a perennial favorite of drug counterfeiters. The National Association of Boards of Pharmacy (NABP) counts more than 10,000 online pharmacies dispensing to US customers but operating outside of state and/or federal regulatory compliance; more than 8,000 of these will either issue prescriptions or dispense prescription products without one. Thus patients too embarrassed to ask for a prescription, and/or those with off-label plans, can avoid physicians

Beyond being shy and/or misbehaving, men are cheap. Years ago when Levitra and Cialis ended Viagra’s ED monopoly, we asked men to ‘build’ an optimal ED drug by allocating 100 points among their preferred drug attributes, with more points given to the more important features. Men gave as many points to low price as to speed of onset, and twice as many points to low price as to duration of effect. Price matters – a lot

The typical Viagra Rx is $160 – $190 at retail (6 to 7 pills at about $27 each). Viagra is not covered by Part D, so not many men over 65 have coverage. A little more than two-thirds of commercial plans cover ED treatments, but most require co-payments well above the prevailing tier-2 $30 for ‘preferred’ brands. Counterfeits are available for $1 to $3 / pill – cheaper than the best co-pay

For all of these reasons ‘online pharmacies’ will remain attractive to men who are cheap, shy, or misbehaving. PFE’s online service can only cater to men with legitimate prescriptions that are willing to pay either retail, or their applicable co-pay. Notably, most commercial drug benefits will not pay for drugs received by mail, unless the prescription is filled by the payor’s own mail order operation. Thus outside of CVS (who administers PFE’s program) there may be many men with drug benefits that cover Viagra, but that will not cover prescriptions sourced from Viagra.com

Thus on net, the marginal utility of Viagra.com is that it serves men who are: 1) sufficiently self-confident to talk to their doctors (and thus get legitimate US prescriptions); 2) willing to pay either retail or their share of retail; 3) if covered, belong to a commercial plan that will cover a mail Rx dispensed out of network; AND, either: 4) too shy to have the Rx filled at retail; and/or who prefer the convenience of Viagra.com over any mail alternative their plan may offer. The initiative makes total sense – but offers very little answer to men’s motives for buying counterfeits – so the counterfeits will continue

For our full research notes, please visit our published research site