It is 5:43pm on Saturday, May 16, 2020. COVID-19 continues to be the topic du jour. My personal objectives today included eating breakfast, power-washing our deck, helping Holger with elementary reading, and attempting to develop some insights on the structure of the pharmaceutical industry.
Introductory and meandering thoughts
I have been working in the insurance business since I was twenty years old. Insurance is an interesting field of study in an academic sense; On average, insurers should benefit from the law of large numbers and learning curves and create economic value by selling products to help customers manage risk. Insurers function like a casino, in many respects, but with an additional financial attribute called “float.”
Much of my career has been in the employee benefits field. This field, which encompasses group medical, dental, and vision benefits, as well as life and disability coverages, is also quite interesting, as the direct and indirect customers include employers (direct) as well as the employees and their families (indirect). Within this space, one area that has been of particular interest to me has been the pharmacy component of group health plans.
I was wrestling with the question one evening this week about “how a firm might price a cell” in the context of a novel therapy and thought I would look for analogs. In particular, I was curious about the pricing of Gilead’s Sovaldi and Novartis’ Kymyriah. As I ran through old 10Q filings and press releases last night, I found myself thinking about the more traditional nuances embedded in the structure of the American benefits system.
A few years ago, I wrestled a bit on a similar weekend afternoon and jotted my vision of the value chain. I was able to find it this morning.
In addition to the increasing significance of the benefit to individuals, and therefore employers, there is also innovation and disruption occurring at multiple levels of the value chains: new (high cost) therapies (e.g. new cures for disease, such as SMA via Zolgensma,) new specialty pharmaceutical providers, and integration across the value chain by incumbents in other spaces (e.g. CVS acquiring Aetna, United acquiring Optum, and Rite Aid standing up EnvisionRx.)
In writing this post, I wanted to confirm the proper use of acronyms dealing with pricing of drugs (e.g. wholesale acquisition cost => WAC, average wholesale price => AWP, average manufacturers price => AMP, etc.) and found the following two slides from a 1/30/09 presentation to CBO by Anna Cook, Julie Somers, and Julia Christiansen:
I also came across the following very strong article on this topic at US Pharmacist.
I invested some time this morning to look a bit deeper into some of the nuances of these relationships. A few thoughts:
Who is the client?
Well, it depends on where you are on the value chain! Insurers and Third-Party Administrators consider employers their customers. Retail pharmacies think in terms of patients walking through their doors. I imagine this section of Gilead’s 10Q, reflecting the high concentration of sales to the largest three American wholesalers, and Novartis’ 2019 20F demonstrate that, in addition to patients, there is important consideration of other extra-patient relationships within the value chain. AmerisourceBergen, Cardinal, and McKesson think about retail pharmacies as their direct customer.
We offer rebates to key managed healthcare and private plans in an effort to sustain and increase the market share of our products, and to ensure patient access to our products. These programs provide a rebate after the plans have demonstrated they have met all terms and conditions set forth in their contract with us. These rebates are estimated based on the terms of individual agreements, historical experience, product pricing and projected product growth rates, and are recorded as a deduction from revenue at the time the related revenues are recorded. Novartis Form 20F, Page 89
Who is capturing value?
Well, this work is incomplete. But, I spent a few hours working through statements of some firms in the manufacturer, wholesale, and retail aspects of the value chain. My hypothesis was that returns are disproportionately held by the manufacturers with some good economic returns around the periphery of the ecosystem (e.g. perhaps PBM). Specifically, thinking about the earlier quote from the Novartis Form 20F, I wonder how ROIC for firms along the value chain are influenced by the “fluff” (technical accounting term) built in by manufacturers (i.e. rebates) for distribution? I imagine that, notwithstanding arguably unattractive distortions in the marketplace, the ROIC for Novartis would be essentially unchanged if they changed this pricing model and passed through the net pricing, holding other factors constant (e.g. formulary impacts). ASIDE – I find the treatment of future rebates as “contra-revenue” rather than under SG&A counterintuitive. (Perhaps this is a topic for future consideration and another blog post…)
My efforts have not evaluated the return-on-invested-capital of PBM, insurer, or other provider in the prescription drug value chain. I was admittedly bit confounded by some analytical nuance on a few financial statements, such as a surprising magnitude of tax expense in the retail pharmacy, as well as a substantial amount of net income attributed to discontinued operations within the manufacturer during the applicable period. Directionally, though, these results all pointed in the direction I initially expected.
Conclusory remarks
Breakfast was had. My deck has been washed. Holger learned about the letter “O” and offered input into why “the cat is sick and the cat is sad.” (Stomachache.) And I completed this post. In the words of the inimitable Ice Cube, “Today was a good day.”