Drug Pricing Part 1: Key Terms, Stakeholders, and Brand Drug Pricing Processes
Drug pricing in the United States is a complicated, controversial issue that ranges from the courtrooms and senate chambers to insurance offices and pharmacy counters. What a drug will cost is far from a simple answer and involves many different stakeholders across the pharmacy supply chain. For those looking to understand this complex topic, this series of articles by IPD Analytics will define important pricing terms, identify key players that influence drug pricing, and explain the pricing process for brand and generic drugs.
This article is the first in a two-part series on drug pricing and reimbursement. Here we will define common drug pricing terms, identify key stakeholders involved in the pharmacy supply chain, and explain the pricing process for brand drug products. The other article in this series covers the generic drug pricing process. Some of the terms we define in this article include average wholesale price, i.e. the sticker price, wholesale acquisition cost, i.e., the price provided to wholesalers, and spread pricing, i.e., the wholesale list price before any discounts provided. It also details the stakeholders involved in U.S. drug pricing, different types of pharmacies, and how pricing is determined for brand drugs.
Drug Pricing Terms
Before diving into the drug pricing process, we first have to define a few key terms around prices and costs. When it comes to drug pricing and reimbursement, there are many different price points utilized by various players in the market. The three terms that will help build an understanding of how drug pricing works are:
Average Wholesale Price
Wholesale Acquisition Cost
Spread pricing
Average Wholesale Price (AWP)
A standardized basis for the pharmaceutical cost component of pharmacy reimbursement. Historically, AWP was the generally accepted drug‐payment benchmark for many payers because it was readily available. AWP is now thought of as a “sticker price,” in that it rarely, if ever, reflects the average wholesale price actually paid after discounts have been subtracted. Reimbursement amounts are typically based on AWP minus some percentage.
Wholesale Acquisition Cost (WAC)
The list price for wholesalers, distributors, and other direct accounts before any rebates, discounts, allowances, or other price concessions that might be offered by the supplier of the product. The only drug price published by the manufacturer.
Spread Pricing (Pharmacy Network)
A common question that is asked when talking about drug pricing is, “what is spread pricing?” Spread pricing occurs when a Pharmacy Benefit Manager (PBM) contracts with a health plan for one cost while negotiating with a pharmacy for a lower cost. The “spread” is the difference between these two price points. The PBM then keeps the difference paid to them by the health plan instead of passing the full amount to the pharmacy. This practice is one of the ways PBMs generate revenue.
Stakeholders in Drug Pricing
The main players involved in U.S. drug pricing are manufacturers and wholesalers, pharmacy benefit managers, payers, and pharmacies. Before we dive into how a drug is priced, we need to discuss these stakeholders.
Manufacturers and Wholesalers
Any discussion about drug pricing cannot be complete without first mentioning drug manufacturers. Manufacturers are the ones making novel brand drugs or generic drugs, the products in question that need to be priced. When a manufacturer brings a drug to market, it will set the WAC or AWP for the drug. However, due to the negotiation process involving other pharmacy value chain stakeholders, this price will likely not be the final price for the drug.
A wholesaler is a stakeholder that purchases drugs directly from a manufacturer, and then sells those drugs to pharmacies or hospitals. Pharmacies make up the majority of the customer base for wholesalers, though wholesalers focused on professionally administered drugs will often do business with clinics and hospitals.
Pharmacy Benefit Managers (PBMs)
A Pharmacy Benefit Manager (PBM) is a third-party company that is contracted by insurers or health plans to administer the prescription drug benefit program on their behalf. PBMs negotiate drug prices with pharmacies and establish networks. PBMs also ultimately take care of the processing and payment of prescription drug claims and can be responsible for creating and updating [a] health plan’s drug formulary.
While PBMs used to be mostly independent entities, many PBMs have been acquired by insurers or must compete with new PBMs launched by the insurers themselves. The three largest PBMs—OptumRx (UnitedHealth), Express Scripts (Cigna), and Aetna (CVS Health)—are owned by health plans.
Payers
A payer is a company that pays for administered medical services and prescription drugs. Responsibilities of a payer include processing patient eligibility, enrollment, claims, and payment. The most common type of payer is an insurance company, though the U.S. government is one of the largest payers in the country through the Centers for Medicare & Medicaid Services (CMS).
Pharmacies and Pharmacy Networks
At its simplest, a pharmacy is defined as a store where pharmaceutical drugs are sold. When it comes to where drugs are dispensed, pharmacies can be broken down into three categories: retail, mail order, and specialty pharmacy.
Depending on which pharmacy is in question, the price of the drug being dispensed may be affected.
Retail Pharmacy
A retail pharmacy is what most people traditionally associate with a pharmacy: a physical store where patients can walk in to receive both prescriptions and over-the-counter medications. CVS and Walgreens are perhaps the two most common retail pharmacies, though food and retail corporations such as Publix and Walmart have their own retail pharmacies located within their stores.
Retail pharmacies see a massive amount of prescriptions filled each year. According to data from Statista, 4.55 billion prescriptions were filled at retail pharmacies in 2020 alone. Those prescription numbers are projected to approach 5 billion in 2025.
Mail-Order Pharmacy
Not surprisingly, mail-order pharmacies are pharmacies that deliver prescription drugs to patients via mail. Patients order their prescriptions over the phone or online versus walking to their local retail pharmacy.
Mail-order pharmacies usually operate through a PBM and require patients to have a certain kind of insurance. This is an important distinction from online pharmacies, which operate more like traditional online stores and may not accept insurance. Most of the largest mail-order pharmacies are run by PBMs such as Caremark and Express Scripts (and in turn, by their payer parent companies), though there are competitors such as Amazon’s PillPack.
Specialty Pharmacy
Specialty pharmacies are pharmacies that usually dispense medications for patients with serious health conditions that require complex therapies, although sometimes they do carry less complex medications that are simply limited distribution by the manufacturer.
Medications that would fall under the category of “complex therapy” often have the following characteristics, as defined by the American Pharmacists Association:
Because of the complex nature of therapies indicated to treat serious health conditions, many specialty pharmacies do more than just dispense medication. Specialty pharmacies offer patient care services that include adherence management, training caregivers on medication administration, treatment assessment, and patient monitoring.
With the rare disease drug pipeline yielding many FDA approvals for high-cost therapies, specialty pharmacies have been in the spotlight as the main dispenser of these complex, expensive, and sometimes controversial medications. Like their PBM and mail-order pharmacy counterparts, most specialty pharmacies are owned by payers.
Pharmacy Networks
A pharmacy network is a group of pharmacies that have contracted with a payer or PBM to provide covered services to patients. Patients covered under a payer looking to receive their prescriptions must go to a pharmacy within the pharmacy network covered by their plan or PBM, otherwise their claim will be considered out of network..
Pharmacy networks may also be referred to as “preferred pharmacy networks.” Competition among pharmacies is fierce, so contracting with a PBM or health plan and entering that entity’s preferred pharmacy network stands as a viable business strategy decision. Pharmacies who join these networks get a greater volume of patients from the payer, and, in return, payers can negotiate for lower reimbursement rates.
Pricing for Brand Drugs
Now that we have covered key terms and stakeholders, we can explain the brand drug pricing model.
Pharmacies and other providers obtain drugs from either wholesalers or directly from manufacturers at a discounted rate based off of WAC price.
Payers or PBMs pay pharmacies for drugs at a negotiated rate based on AWP.
Payers reimburse PBMs (if the PBM is independent of the payer) for the cost of drugs as well as for an administration fee.
Importantly, the rate negotiation process for brand drugs is different from the process for generic drugs, so we will cover each process separately.
Pricing by Pharmacy Type
The price of a brand drug will vary depending on where the medication is dispensed out of the three kinds of pharmacies: Retail, mail-order, and specialty.
For drugs dispensed at retail pharmacies, prices are based off of an equation using AWP and then factoring in rates negotiated by payers or PBMs. The current rates for brand drugs at retail pharmacies range from AWP minus 15%–18%. Most payers will negotiate a 30-day supply fill rate and a 90-day supply fill rate, and the 90-day fill rates are usually approximately 1%–2% less than the 30-day rates.
For drugs dispensed via mail-order pharmacies, the negotiated brand rates sit at AWP minus 21%–24%. These rates are based on 90-day supply only. Brand drugs usually carry lower prices at mail order pharmacies due to the large quantity of medications delivered, which allow for prescriptions to be less expensive. If a PBM owns a mail-order pharmacy, drug costs can be lower as well.
Drugs dispensed at specialty pharmacies have a more complicated pricing process. Since medications for rare diseases carry high costs and complex reimbursement, prices are set in one of three of ways:
Flat AWP minus for all medications
Separate negotiated rate by specific drug
Set flat rate for most drugs, with separate negotiated rate for certain other drugs
Additionally, most payers either own specialty pharmacies or contract with a very small network of specialty pharmacies.
Understanding the Basics of Drug Pricing
In the complex world of the pharmacy value chain, understanding the various terms, stakeholders, and pricing processes is essential to formulating a winning payer strategy.
To learn more about how IPD Analytics helps payers, providers, and suppliers navigate the pharmacy value chain, take a look at our Payer and Provider Insights and CODESOURxCE solution.
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