In the face of aggressive efforts by third-party plans to reduce reimbursements for generic drugs, supermarket pharmacy directors are struggling to maintain some profitability.The profits that generic drugs once afforded supermarket pharmacies have been severely squeezed. The impact of the downward trend in reimbursements is being exacerbated by the growth of third-party business as a percentage of

In the face of aggressive efforts by third-party plans to reduce reimbursements for generic drugs, supermarket pharmacy directors are struggling to maintain some profitability.

The profits that generic drugs once afforded supermarket pharmacies have been severely squeezed. The impact of the downward trend in reimbursements is being exacerbated by the growth of third-party business as a percentage of total prescriptions dispensed -- about half of prescriptions are now filled under third-party plans.

"Generics are still a significant contributor to maintaining the pharmacy gross margin, but they are nowhere near what they used to be because of the monumental increase in third-party plans," says Dennis Beauchene, co-director of pharmacy for Hannaford Bros., Scarborough, Maine.

"Overall, generics are less profitable than they used to be because of the contracts we are now accepting and MAC [maximum allowable cost] pricing," says Wally Hays, director of pharmacy for Winn-Dixie Stores, Jacksonville, Fla.

"Some of the MAC pricing is absolutely atrocious. You would be hard-pressed to buy some of the items at the MAC price listed," adds Terry Cater, director of pharmacy for Save Mart Supermarkets, Modesto, Calif.

Third-party plans have cut reimbursements to pharmacies for generic drugs by moving to MAC pricing, and lower discounts off average wholesale prices, or AWPs. A MAC price is an average based on a market survey of what individual products typically sell for, as determined by state Medicaid programs, pharmacy benefit management companies -- known as PBMs -- and other third-party plan sponsors. AWP represents the highest price paid for a pharmaceutical, set by the manufacturer, before discounts for volume, prompt payment, etc., are factored in.

With selling prices on generics increasingly being dictated by third-party plans, supermarket pharmacies are pursuing methods other than pricing to retain generic drugs' profitability.

For one thing, supermarket pharmacy directors say they are buying generic drugs better. Prices have come down as a result of fierce competition among generic drug manufacturers and distributors. A second way in which pharmacies are attempting to protect their profits on generic drug sales has been to reject third-party plan contracts -- which typically include MAC pricing on selected generics -- that would potentially drive reimbursement rates on generics to new lows. Many pharmacy directors say they have recently rejected contracts which propose, in some cases, to drop the reimbursement on generics from AWP minus 10% to AWP minus 30% or more. In addition, dispensing fees now often come in at $1 or $1.50, vs. $3 or $3.50 a few years ago.

"I think at this point a lot of third parties are trying to find out where the bottom is," says Hays.

"My perception is that a lot of the PBMs [pharmacy benefit management companies] and insurance companies are bottom-fishing for rates," concurs Cater.

By refusing contracts that require filling prescriptions below cost, and with better buying, supermarket pharmacies have succeeded to some extent in preserving generics' profitability in the face of the steep cuts in generic reimbursements.

Farm Fresh, Norfolk, Va., with 46 pharmacies, has benefited from buying generics at better prices "across the board" from its wholesaler, says Dan Alder, pharmacy merchandiser. The better costs, he says, are the result of volume discounts the chain has received as its generic business has grown.

The growth is, in large part, the result of doing more business with third-party plans that require generic substitution. The chain also has started refusing third-party plans that have rates it deems to be too low.

"We won't sign contracts that are below cost. We've seen some recent contracts from third-party carriers that are reduced too far, and we have refused them. That has been a new development," says Alder.

However, Alder says Farm Fresh's profits on generics have held up, despite MAC pricing. "Most of the third parties are giving a reasonable reimbursement level. MAC pricing is not hurting our profitability in generics. It brings costs down to a normal level," he says.

Additionally, with the increased use of generics "you get some return from lower inventory cost." Plus, "your float money is not as drastic," he adds, with less outstanding receivables as a result of dispensing a cheaper product.

Generic drug sales have increased for Abco Markets, Phoenix, as well, allowing the chain to take advantage of volume pricing. "We are buying generics better than before," says Barrett Moravec, director of pharmacy. Moravec notes that MAC pricing provides more stability than pricing based on AWP formulas. "The MAC prices are created by market forces, not by fiat as an AWP is by the manufacturer. MAC prices may be low in some plans, but they tend to be stable from year to year. Once they get established in a formulary they tend not to go down," says Moravec.

Although a third-party plan generic may be MAC-priced, it still often yields a better return than a brand. "As a percent of each transaction, your gross is much higher on a generic drug (than a brand). And you have a lot less invested in inventory," says Moravec.

Yet, while margins may be enhanced through generic dispensing, profit dollars are not. With some drugs in some plans, it is more profitable to dispense the brand then the generic.

"It doesn't always pay for the pharmacist to dispense a generic," says Russell Fair, vice president of pharmacy operations at Giant Food, Landover, Md. "The generics will increase your margins, but the dollars you put in the bank could be less."

Fair says that new generic incentive programs introduced by plan benefit managers will have to account in their reimbursements for the profits retailers are losing by dispensing generics instead of brands. "We need an incentive across the board, for all products we dispense [in a plan], brands and generics," says Fair.

"I don't think the money you save on lower inventory and float offsets" the profits lost from recent generic pricing, says Fair.

"We're not buying 20% better. I wish we were," says a pharmacy director of another major East Coast chain, who was recently notified by a plan that next year it is dropping its rate paid on generics from AWP minus 10% to AWP minus 30%.

The increasing prevalence of MAC lists also puts an administrative burden on the pharmacy operation to review plans in advance to ensure they will be profitable. "Each PBM or TPA [third-party plan administrator] is designing its own list. It makes it difficult to understand the components that make up your gross margins," says Cater.

Plan administrators can be expected to continue what one pharmacy director termed their "merciless rush" to obtain the best prices possible for their clients. Major PBMs, for example, are increasingly recommending MAC-base pricing.

"More and more of our clients are choosing MAC programs. It is the most cost-effective way to deliver a quality benefit," says Joyce Enterline, manager of pharmacy communications at PCS Health Systems, Phoenix. Up to 18 million of PCS's 52 million plan members are in plans with MAC prices, she says.

"We have MACs in almost every one of our contracts. It's in the payers' best interests," says Greg Madsen, manager of network operations for Diversified Pharmaceutical Services, Minneapolis. AWPs, Madsen says, are "extremely fictitious," with retailers buying generic drugs at discounts of up to 60% off AWP.

Madsen says DPS's MAC averages AWP minus 43%, which allows pharmacies to buy "some generics below the MAC price. We want them to make money on the generics," he adds.

DPS's most popular MAC plan is a "restricted" benefit plan, in which the client will pay for a brand-name of a multisource drug, less the co-pay, if the doctor wants the brand used. But if the doctor doesn't require a brand but the patient wants it, the payer will pay only for the generic, with the patient picking up the difference.

Supermarket pharmacy directors have mixed views of mandatory plans, which offer financial incentives for patients to chose a generic drug. Many are concerned that patients blame the pharmacist when faced with paying the difference.

"We don't have a lot of plans with mandatory substitution, except for state Medicaid. But when the patient has to make up the difference, the pharmacist is left there explaining it. They end up looking like the bad guys," says Jane Siebert, director of pharmacy operations at Dillons Stores, Hutchinson, Kan.

"Almost all of the plans have gone not only to mandatory generic dispensing but to MAC pricing on multisource drugs," says Alder of Farm Fresh. "There are very few left who will allow their members to take a name brand product if a generic is available. It creates a problem for the store because some patients get downright angry at the pharmacist."

When mandatory dispensing is prevalent, resulting in high levels of generic use at MAC prices, profits are threatened. At Giant Food, for example, 75% to 80% of plans have mandatory substitution, says Fair.

"I don't have a problem with mandatory substitution, because the generics are therapeutically equivalent," says R. Grant MacLean, pharmacy buyer and merchandiser at Rosauers Supermarkets, Spokane, Wash. "If there is no difference between the two products, patients should be able to use the generic."

While the substitution plans represent a "stick" approach directed at the patient to encourage generic usage, some generic incentive programs recently introduced by PBMs are "carrots" offered to the pharmacy.

Since launching its "generic performance incentive" program in July, PCS has enrolled 71 clients representing 6 million people. Target substitution rates are established by state, with awards made based on the extent to which baseline rates are exceeded, says Enterline.

Merck-Medco's PAID Prescriptions incentive plan started this year pays a flat rate of 50 cents for generics dispensed, plus a percentage of cost savings achieved when dispensing goals are met.

"Our substitution rate is 45% of all prescriptions that we fill. That is not up to a point where we can obtain more money from these plans. We are still falling 5% to 10% below where we need to be to get the minimum reimbursement," says Beauchene of Hannaford.

"We let our pharmacists know there is a possibility of a higher rate. They typically say, 'We try to substitute wherever possible,' but where patients have a choice, they chose for the brand drug," says Beauchene.

The prospect that plans will offer incentives for retailers to buy "preferred" generic drugs from specific sources holds small cheer for pharmacy directors who are already coping with the reduced profits and increased costs stemming from the growth of third-party business.

PAID's program to pay for use of generics purchased from West Point Pharma, another Merck subsidiary, many feel, is a harbinger of things to come.

"Other PBMs will try it," says Fair. "It becomes a horrendous issue for us as we will have to duplicate inventories. Dispensing [the preferred generics] is going to be a horrendous task operationally, and difficult to enforce at store level."

"Some plans reward you for higher use of formulary drugs. If a plan has a preferred generic line, I just can't worry about it. The tradeoff in inventory investment isn't worth the extra reimbursement you might get per claim," says Cater.

The issues facing retailers concerning generic drugs will only grow in magnitude as the decade progresses. A thriving generics industry undoubtedly will create opportunities for plan administrators in controlling drug costs. But it remains to be seen how much more cost-cutting retail pharmacy can absorb.