The Impact of Managed Care on Pharmacy Practice 99

The Impact of Managed Care on

Pharmacy Practice

As prescription drug costs continue their rapid rise, managed care organizations (MCOs) are giving greater
attention to containing drug costs. This article examines the impact of managed care on pharmacy practice and
reviews types of reimbursement for managed care prescriptions. The author outlines cost-containment
measures for MCOs and pharmacy benefit management companies, including the use of mail order
pharmacies, electronic claims payment, establishment of formularies, therapeutic interchange and generic
incentives, and other measures. Cost-containment steps for pharmacies focus on identifying dispensing costs,
decreasing overhead, and reducing ingredient costs. The author recommends that pharmacists begin to
demonstrate and establish the value of their cognitive services, especially in patient counseling, in order to
obtain reimbursement for these services. Key words: cost-containment, managed care, prescription drug costs

Kenneth W. Schafermeyer, PhD

Associate Professor
Director of Graduate Studies
O NE OF THE greatest challenges fac-
ing managed care organizations
(MCOs) today is that expenditures for pre-
St. Louis College of Pharmacy scription drugs are increasing rapidly. From
St. Louis, Missouri 1995 to 1996, the average annual expendi-
ture per member increased by 22.6 percent
(from $139.56 to $171.12).1 Although drug
costs compose less than 10 percent of total
health care expenditures, they are increas-
ing more rapidly than other health care
expenditures and are a major concern of
employer groups and health insurers. As this
concern intensifies, MCOs and pharmacy
benefit management companies (PBMs) are
giving more attention to drug cost contain-
ment and utilization controls. Since Medicaid
and third-party payers accounted for 67 per-
cent of all prescriptions in 1996 (up from 64
percent in 1995),2 these cost containment
efforts are having a profound effect on the way
pharmacies are providing and being reim-
bursed for services.

Source: Reprinted from K. Schafermeyer, The Impact of

Managed Care on Pharmacy Practice, in Managed Care
Pharmacy Practice, R. Navarro, ed. pp. 451–473, © 1999.

Pharm Pract Manage Q 2000;19(4):99–116

© 2000 Aspen Publishers, Inc.
99
100 PHARMACY PRACTICE MANAGEMENT QUARTERLY/JANUARY 2000
Changes in managed care prescription
programs present both threats and opportu-
nities to pharmacy practice today. While
managed care prescription plans have con-
tributed to decreasing pharmacy margins,
they have also influenced pharmacy manag-
ers to become more efficient and to explore
new services and opportunities. This chap-
ter will describe the impact of managed
health care on community and hospital
pharmacy practice today and will outline
measures that pharmacies and MCOs can
apply to constrain increases in prescription
costs without compromising quality. To
accomplish this purpose, the chapter will
describe
• community pharmacy reimbursement
as well as costs and profits associated
with managed care prescription plans
• the objectives and some of the more
important elements of contracts be-
tween community pharmacies and
managed care prescription plans
• methods by which community phar-
macies can influence prescription utili-
zation and overall medical costs and
thereby survive or prosper in today’s
health care environment
• strategies that hospital pharmacies are
using to adapt to managed health care
IMPACT OF MANAGED CARE
PROGRAMS ON PHARMACY
The growth of managed care prescrip-
tions has changed the economics of the retail
pharmacy marketplace. For private-pay
prescriptions, retail prices are set by the
pharmacy in response to the competitive
market. Managed care prescription plans,
however, are able to demand discounts off
regular retail prescription prices through
their contractual arrangements with phar-
macies. In return for accepting these dis-
counts, pharmacies are allowed to continue
seeing members of managed care plans.
Furthermore, pharmacies often hope that
they will increase prescription volume or
create more foot traffic in the pharmacy by
being a participating health plan pharmacy.
During the last decade, retail prescription
prices have increased significantly. Third-
party and managed care dispensing fees,
however, have actually decreased. This,
along with other competitive forces, has
contributed to a shrinkage of the average
pharmacy’s gross margin from 32.2 percent
of sales in 1986 to 25.6 percent of sales in
1997—a drop of 6.6 percent.3,4 (See Table 1.)
For those pharmacies that have survived,
the average net profit has remained rela-
tively stable at about 3 percent of sales.
Pharmacies that have remained in business
have succeeded at least in part by decreasing
expenses and becoming more efficient, pri-
marily through computerization and the use
of pharmacy technicians. It also appears
that pharmacies need to maintain a net
Table 1. Changes in Pharmacy Operations,
1986–1996*
1986 1996 Change
(%) (%) (%)
Sales 100 100 0
Cost of goods sold 67.8 74.4 +6.6
Gross margin 32.2 25.6 –6.6
Expenses 29.5 22.5 –7.0
Net profit 2.7 3.1 +0.4
*Expressed as a percentage of sales
Source: Reprinted with permission from D.R. Huffman, Ed.,
Changes in Pharmacy Operations, 1986–1996, NCPA-Searle
Digest, © 1996 and 1997, National Pharmacists’ Association.
 The Impact of Managed Care on Pharmacy Practice 101

profit of about 3 percent to stay in business—
otherwise, the business’s resources could be
put to more profitable use elsewhere.
There is evidence that pharmacies with
high third-party and MCO prescription
volumes (53 percent of their total or more)
have significantly lower gross margins,
lower proprietors’ incomes, and lower net
profits as a percentage of sales than do
pharmacies with low third-party prescrip-
tion volumes (less than 23 percent)5 (see
Table 2). Lower reimbursement requires
higher volume to maintain profits. Conse-
quently, the number of pharmacies is de-
creasing (from 53,411 in 1994 to 51,579 in
19966) while the prescription volume of the
average pharmacy is increasing. This shift to
an economy of scale business requires that
pharmacies operate very efficiently and re-
duce unnecessary costs whenever possible.
Although many community pharmacy
managers may feel that dispensing fees are
too low, MCOs are not likely to increase
fees significantly as long as there is an ad-
equate network of participating pharmacies.
It is often assumed that if fees were inad-
equate, pharmacies would not accept them.
In fact, MCOs could interpret some phar-
macies’ willingness to give bids for even
lower fees in competitive bidding situations
as evidence that fees may actually be higher
than necessary.
Why then do pharmacies participate in
managed care plans while claiming that
reimbursement is inadequate? The answer
is not simple and varies from pharmacy to
pharmacy. One possible explanation is that
many pharmacy managers have not quanti-
fied the extent to which various plans affect
profitability. Even if pharmacy managers
know that they are losing money on some
managed care plans, they may not be con-
cerned if the plans are relatively small. An-
other explanation is that businesspeople
know that they can sustain losses in some
lines of business and still meet targeted
profit levels as long as there are sufficient
above-average profits on other lines of busi-
ness. Therefore, low managed care reim-
bursement can be absorbed by pharmacies
that can make additional profits from either
(1) the “front end” of the pharmacy (i.e.,

Table 2. Effect of Third-Party Prescription on Pharmacy Operations, 1996*

Pharmacies with Low Pharmacies with High

Third-Party Activity (%)** Third-Party Activity (%)***

Sales 100 100

Cost of goods sold 69.8 74.4
Gross margin 30.2 25.6
Expenses 27.3 22.9
Proprietor’s salary 6.7 4.2
Net profit 2.9 2.7
Total income of self-employed proprietor 9.7 6.7

*Expressed as a percentage of sales

**Low third-party activity defined as less than 23 percent of prescriptions paid by third-party payers
***High third-party activity defined as at least 53 percent of prescriptions paid by third-party payers
Source: Reprinted with permission from NCPA-Searle Digest, D.R. Huffman, Ed., © 1996.
102 PHARMACY PRACTICE MANAGEMENT QUARTERLY/JANUARY 2000
ancillary sales) or (2) “cost shifting” third-
party losses to higher private-pay prescrip-
tion prices. In the latter case, it would make
economic sense for pharmacies to accept
reimbursement rates that cover the variable
costs of an additional prescription (i.e.,
those costs that increase with each new
prescription, such as the cost of goods sold
and the cost of prescription vials and labels)
as long as the pharmacy’s fixed costs (i.e.,
those costs that do not increase with pre-
scription volume, such as utilities and insur-
ance) can be covered by other prescriptions
that have higher reimbursement. However,
this strategy is effective only as long as the
prescriptions with low reimbursement rep-
resent a minority of a pharmacy’s business.
Given that the majority of prescriptions are
now paid for by managed care plans, such
cost shifting will not work for most pharma-
cies.
With the number of managed care pre-
scriptions increasing, pharmacy managers
must evaluate whether they can afford to
participate in each program. To do so, they
must know the pharmacy’s cost of dispens-
ing a prescription and compare the impact
of accepting to that of refusing a managed
care contract. The following sections exam-
ine managed care reimbursement and phar-
macy costs and describe some of the points
that pharmacists should consider when
evaluating managed care prescription plans.
Figure 1. Total Pharmacy Income under Capitation Reimbursement. Source: Copyright ©␣ Founda-
tion for Managed Care Pharmacy.
REIMBURSEMENT FOR
MANAGED CARE
PRESCRIPTIONS
Capitated Plans
Managed care reimbursement for pre-
scription drugs can be on either a fee-for-
service or capitation basis. A disadvantage
of fee-for-service reimbursement is the in-
herent conflict of interest that occurs when
providers have the ability, and incentive, to
increase the demand for their services.
While pharmacists do not initiate prescrip-
tions, they can influence utilization. Since
pharmacies are paid for dispensing prescrip-
tions, fee-for-service reimbursement offers
little financial incentive to control prescrip-
tion utilization, reduce costs, or provide
nondispensing services. The situation is dif-
ferent, however, under capitation. Figure 1
shows that pharmacy income from a
capitated program comes from two sources:
(1) the capitation fees paid by the MCO at
the beginning of each month for patients
assigned to receive services from that phar-
macy and (2) the copayments patients pro-
vide when they receive prescriptions. Since
the greatest portion of reimbursement is
fixed, capitation offers incentives to reduce
unnecessary prescription utilization and of-
fer nondispensing services.
Despite its theoretical advantages,
capitated reimbursement for pharmacies is

not used often today because of a reluctance
to put pharmacies at risk for costs and
utilization over which they have only lim-
ited control. Managed care plans, however,
are experimenting with several innovations
that may make capitation arrangements
more attractive for pharmacists. These in-
clude (1) applying stop-loss provisions that
cap potential losses, (2) carving out certain
high-cost disease states (e.g., oncology, hu-
man immunodeficiency virus, acquired im-
mune deficiency syndrome) and excluding
them from the capitation arrangement, (3)
creating risk pools that include large num-
bers of pharmacies that share risk, or (4)
including physicians and pharmacies in the
same risk pool.
Although capitation reimbursement is
more common for physicians (used by
about 27 percent of all health maintenance
organizations [HMOs]), it is not the most
common method used to control utilization.
Most HMOs prefer to use financial incen-
tives or penalties as well as physician educa-
tion, drug utilization review, or prior autho-
rization.7 Although capitation is used to
control prescription utilization, it may work
best when pharmacists and physicians par-
ticipate in the same risk pool and share
responsibilities for controlling prescription
utilization and costs.
Unit Cost
Total Rx
Program
Cost
=(
Drug Ingredient
Cost + Professional
Dispensing Fee
Figure 2. Components of Fee-for-Service Prescription Costs. Source: Copyright ©␣ Foundation for
Managed Care Pharmacy.
The Impact of Managed Care on Pharmacy Practice 103
Fee-for-Service Reimbursement
As illustrated in Figure 2, three factors
influence the costs incurred in fee-for-service
prescription plans: (1) unit costs, (2) utilization
rate, and (3) administrative costs. Each of
these components is described below.
Unit Costs
Unit costs, the average amount paid by
the MCO for each prescription, consist of
two components: the cost of drug ingredi-
ents and a professional dispensing fee. The
sum is reduced by any amount that the
patient is required to pay out of pocket (i.e.,
patient cost sharing). The first component,
drug ingredient costs, represents over 74
percent of the prescription price. Figure 3
illustrates the unit cost for a fee-for-service
prescription program in more detail.
Drug Ingredient Costs.␣ Traditionally, reim-
bursement for drug ingredient costs was
based on average wholesale price (AWP)—an
artificial “list price” that is significantly higher
(often 16 percent higher, although it is highly
variable) than the actual acquisition cost
(AAC) that pharmacies pay for their inven-
tory. This difference between AWP and AAC
is known as both an “AWP differential” and
an “earned discount.” These discounts can
vary considerably depending upon the
Utilization
)× ×
– Patient Cost
Sharing
Average No. of
Rxs per Patient
Total No. of
Patients + Administrative
Costs
Intensity Population
104 PHARMACY PRACTICE MANAGEMENT QUARTERLY/JANUARY 2000
Figure 3. Unit Cost Components for a Fee-for-Service Prescription. Source: Copyright ©␣ Foundation
for Managed Care Pharmacy.
pharmacy’s purchasing volume and ability
to influence the actual products dispensed.
For this reason, discounts from AWP list
prices are often greater on generically
equivalent drug products.
Pharmacies depend on the AWP differ-
ential to provide part of a third-party
prescription’s gross margin (i.e., the portion of
reimbursement exceeding actual drug acquisi-
tion cost). By supplementing dispensing fees,
pharmacies’ earned discounts have allowed
them to participate in otherwise unprofitable
fee-for-service plans. A pharmacy’s AAC may
vary depending upon package sizes, supply
source (i.e., from a wholesaler or directly
from the manufacturer), and quantity pur-
chased. Because AAC is so variable and
difficult to determine, prescription benefit
programs usually reimburse pharmacies an
estimated acquisition cost (EAC) instead.
EAC is calculated as a percentage of AWP
(e.g., 90 percent of AWP or AWP minus 10
percent).
Dispensing Fee.␣ The second component of
unit costs illustrated in Figure 2, the profes-
sional dispensing fee, is designed to cover
the pharmacy’s overhead expenses (also
known as the “cost of dispensing”) plus a
reasonable net profit. In other words, the
dispensing fee is supposed to represent the
pharmacy’s gross margin. The dispensing
fee is a much smaller portion of the unit cost
than the ingredient cost—it represents less
than 26 percent of the average pharmacy’s
prescription price. Since the two compo-
nents of the dispensing fee (the cost of
dispensing and the net profit) are clearly
different, it has been recommended that
under fee-for-service reimbursement, the
amount of payment for these two compo-
nents should be negotiated with payers
separately.8
The U.S. Department of Health, Educa-
tion, and Welfare stated in 1975 that dis-
pensing fees should consider the cost of
professional services involved in dispensing
a drug as well as provide for a reasonable
profit for the pharmacist.9 While the dis-
pensing fees in a few Medicaid programs
vary among pharmacies according to their
costs of dispensing, most third-party and
managed care programs do not vary reim-
bursement according to the pharmacies’
levels of service or their costs of dispensing.
The more typical fixed fees have been
shown in a literature review of numerous
cost of dispensing studies to be significantly
below the average pharmacy’s cost of dis-
pensing. Some managed care plans, how-
ever, are experimenting with increased re-
imbursement as an incentive for pharmacies
to provide more cognitive services.
 The Impact of Managed Care on Pharmacy Practice
Utilization
The second component of managed care
prescription costs is utilization. As shown in
Figure 2, utilization is the product of “inten-
sity” (i.e., the average number of prescriptions
per patient) multiplied by the “population”
(i.e., the total number of patients enrolled in
the program). Program intensity is an impor-
tant benchmark used to compare managed
care prescription plans. Prescription intensity
was 8.3 prescriptions per person per year in
1996, up from 8 prescriptions in 1995 and 5.8
in 1992.10,11 Overall utilization of prescrip-
tion drugs is increasing partly due to the
growing number of members in managed
care that now have a more affordable pre-
scription drug benefit and partly due to the
growing availability of unique drug prod-
ucts. The utilization multiplied by the aver-
age unit cost is the total program reimburse-
ment for prescription drugs.
Administrative Costs
The final component of managed care
prescription costs is the administrative ex-
penses incurred in managing the prescrip-
tion benefit, including contracting with
PBMs. Over 95 percent of non–staff model
HMOs reduce administrative costs by re-
quiring pharmacies to submit claims elec-
tronically. By linking plans to pharmacies at
the time a prescription is dispensed, these
point-of-sale (POS) systems help verify
member eligibility for pharmacy services,
enforce formulary compliance, prevent
overutilization, and accumulate data
needed for studies of the effectiveness of the
prescription plan. 12 Screening pharmacy
claims and ensuring they are “clean” (com-
plete claims eligible for reimbursement)
when transmitted reduces costs incurred by
105
both pharmacies and PBMs associated with
claims rejections and resubmissions. Phar-
macies usually have to pay a small transac-
tion charge that varies from plan to plan
depending upon their claim volume (usu-
ally $0.05 to $0.10 per claim).
ADMINISTRATION OF MANAGED
CARE PRESCRIPTION
CONTRACTS
Because the administration of managed
care pharmacy programs is rather complex
and requires a large prescription volume to
be conducted efficiently, MCOs often carve
out prescription benefits and arrange to
have them managed by PBMs. Using a
PBM helps the MCO isolate cost centers
and concentrate a workforce of prescription
benefit experts to manage the prescription
program. (See Chapter 10 for a complete
description of PBM services.) The adminis-
trative services provided by PBMs include
• contracting with pharmacies to pro-
vide specified services
• communicating with both patients and
providers to explain and update ad-
ministrative policies
• providing reports to plan sponsors
• identifying eligible beneficiaries
• processing claims submitted by phar-
macies
• reimbursing pharmacies
• auditing pharmacies
• controlling utilization
• ensuring program quality13
In carved-out programs, the extent to
which MCOs can integrate prescription
data with data for medical, hospital, labora-
tory, and other health care services is often
limited. Unless all medical data are inte-
grated, it is difficult to assess the impact of
106 PHARMACY PRACTICE MANAGEMENT QUARTERLY/JANUARY 2000
pharmacy services on overall health care
costs. Nevertheless, PBMs can employ nu-
merous strategies to control costs and qual-
ity. The extent to which pharmacies are
involved in these efforts is determined con-
tractually.
PBMs recruit pharmacies that are willing
to sign a participating pharmacy agree-
ment—a contract that stipulates the phar-
macy services that will be provided in ex-
change for a specified, discounted
reimbursement. The network of participat-
ing pharmacies may be an “open panel,” in
which all community pharmacies are in-
vited to sign participating pharmacy agree-
ments, or it may be a “closed panel,” in
which only selected or “preferred” pharma-
cies may participate. These preferred phar-
macies are often selected because they be-
long to a chain willing to accept lower
reimbursement or share some of the MCOs’
administrative costs. Carried to an extreme,
the closed network could contract with a
very limited number of pharmacies (some-
times only one chain) and become what is
known as an “exclusive provider organiza-
tion” (EPO).
Some HMOs develop a network of phar-
macies that they own and operate. Twenty-
nine percent of HMO prescriptions were
dispensed through on-site pharmacies in
1996, up from 17 percent in 1995. This
strategy is employed more commonly by
staff model HMOs; 80 percent of them had
an in-house pharmacy in 1996.14
Closed panels and EPOs can devastate
pharmacies that are not allowed to partici-
pate. When faced with the possibility of
losing a major portion of their clientele,
many pharmacies see no option but to ac-
cept very low reimbursement. Even phar-
macies willing to accept the terms of a closed
panel or EPO contract may find themselves
locked out from participation.
Mail Order
Participation of community pharmacies
in managed care plans can also be limited by
the use of mail-order pharmacies. One of the
ironies of today’s turbulent prescription
marketplace is that pharmacies and PBMs
are often partners for some prescriptions
and competitors for others. Most plans con-
tracting with pharmacies also offer prescrip-
tion mail services to beneficiaries; 72 per-
cent of HMOs offered mail service in 1996,
up from 58 percent in 1995. Utilization of
the mail service benefit by enrollees, how-
ever, was modest; HMO plans dispensed an
average of only 6.2 percent of their prescrip-
tions through mail service in 1997, repre-
senting approximately 11 percent of their
prescription budgets.15 Although patients
may have incentives, such as a lower
copayment, to use mail-order plans, ap-
proximately 75 percent of consumers re-
sponding to a survey reported that they had
no experience with prescription mail ser-
vice. Among the 25 percent who had used
mail service, a sizable minority (22 percent)
expressed dissatisfaction with the experi-
ence.16 By emphasizing personalized ser-
vices, community pharmacies may be able
to retain some prescription volume that may
otherwise be lost to mail service.
Eligibility
The participating pharmacy agreement
specifies how covered employees and de-
pendents will be identified. Although the
PBM usually issues identification cards,
these cards are difficult to retrieve when
employees terminate employment and,
therefore, are usually not sufficient evi-
 The Impact of Managed Care on Pharmacy Practice
dence of eligibility. Pharmacies are usually
required to verify patient eligibility through
an on-line POS verification system that also
indicates the portion of the cost of the pre-
scription the patient must pay (i.e., the
amount of patient cost sharing).
Claims Payment
Participating pharmacies dispense pre-
scriptions to eligible beneficiaries and then
send electronic claims through the
pharmacy’s computer at the time the pre-
scription is dispensed. This is referred to as
“on-line, real-time claims adjudication” and
is usually a contract requirement for partici-
pation with managed care plans. The PBM
processes these claims and reimburses phar-
macies according to the guidelines in the
participating pharmacy agreement, usually
once or twice a month. Although pharma-
cies usually incur a nominal fee for transmit-
ting the claims electronically, the cost is
usually exceeded by savings from reduced
claims processing errors, faster payment,
and fewer bad debts.
The arrangement in which the phar-
macy, rather than the patient, submits
claims to the PBM is known as assignment
of claims. In return, the pharmacy accepts
the PBM’s payment as payment in full—the
pharmacy may not collect additional pay-
ment from the patient except for any patient
cost sharing amounts specified in the con-
tract, or if the patient specifically requests a
prescription benefit that is not covered by
the health plan.
Some insurance programs, however, re-
quire patients to pay pharmacies for pre-
scriptions received and then submit claims
for reimbursement. This arrangement is
known as an indemnification program. Al-
though indemnification has been common
107
in major medical programs, most third-
party plans now have an assignment of
claims provision.
Reimbursement
Reimbursement by prescription benefit
programs is usually substantially below pri-
vate-pay prescription prices established in
the competitive marketplace. The average
HMO reimbursement to network pharma-
cies in 1997 was AWP minus 14.2 percent
plus $2.38.17 The easiest and most common
way to lower costs has been to restrict
pharmacy dispensing fees. But since dis-
pensing fees represent just over one-fourth
of prescription costs, the potential savings to
be achieved by controlling the other three-
fourths of the prescription costs (i.e., drug
ingredient costs) are much greater.
Formularies
PBMs establish formularies—lists of drug
products that are covered (i.e., a positive
formulary) or excluded from coverage (i.e.,
a negative formulary) to promote the most
cost-effective drugs and reduce ingredient
costs. Formularies are also described as
either open (i.e., prescribed products are
reimbursed whether or not they are listed)
or closed (i.e., reimbursement is limited to
selected drugs in each therapeutic class).
Since most formularies have restrictions on
some—but not all—therapeutic classes, they
fall somewhere along the continuum be-
tween “open” and “closed.” The tendency,
however, is for formularies to become more
restrictive.18 PBMs commonly exclude cer-
tain classes of drugs such as oral contracep-
tives, products used primarily for cosmetic
purposes, weight control products, experi-
mental drugs, parenteral drugs (other than
108 PHARMACY PRACTICE MANAGEMENT QUARTERLY/JANUARY 2000
insulin), and certain compounded drugs.19
They may also establish a lifetime limit (or
cap) for some drug products, such as one
course of nicotine patches.
Financial incentives to physicians and
pharmacists (through reimbursement) and
patients (through higher copayments) are
used to ensure formulary compliance. The
impact on the pharmacist can be substantial.
While adhering to formularies requires time
and effort on the part of the pharmacist to
effect a change to the preferred medication,
some formulary systems create incentives
by reimbursing pharmacists for their time
and cognitive abilities.20 Receiving proper
reimbursement requires pharmacy person-
nel to be aware of and compliant with
formulary restrictions.
Therapeutic Interchange
Some PBMs use provider incentives to
encourage interchange of drug products
that are therapeutically (rather than generi-
cally) equivalent. Since pharmacists must
contact the prescriber to authorize a thera-
peutic switch, PBMs may include an addi-
tional fee to cover the extra cost and to give
the pharmacist an incentive. Therapeutic
interchange works more smoothly in closed
panel programs, such as staff model HMOs,
that have more control over physician pre-
scribing. Therapeutic interchange also
works well in mail service, when the phar-
macist has time (usually a month or more) to
contact the physician by phone or fax, be-
cause the prescription is not an acute care
medication.
Generic Incentives
PBMs use two approaches to encourage
the use of equivalent generic drug products:
(1) provider incentives or sanctions and (2)
patient incentives or sanctions. Pharmacist
incentives may consist of a small bonus
added to the dispensing fee or an additional
percentage added to ingredient costs when-
ever a generic equivalent is dispensed. The
expectation is that the cost savings will more
than offset the additional payment. A sanc-
tion commonly imposed on pharmacists is a
maximum allowable cost (MAC) provision
in which payers limit reimbursement for
drug ingredient costs to a generic price
when a multiple-source drug is prescribed—
whether or not a brand-name drug is actu-
ally dispensed. Some programs have provi-
sions for overriding the MAC price when
the physician insists on brand-name drugs.
As described in the next section, patients are
given financial incentives to accept generic
equivalents.
Physicians can be encouraged to allow
the use of generics through risk sharing
arrangements that create financial rewards
or penalties based on costs of prescribed
medications.
Patient Cost Sharing
MCOs commonly require beneficiaries
to pay a portion of the cost of their prescrip-
tions. This patient cost sharing is designed
to control utilization of health services by
discouraging patients from seeking care for
insignificant problems while not impeding
them from obtaining care for problems that
are significant.21
Patient cost sharing takes one of three
forms: copayments, deductibles, and coin-
surance. Copayment, the most common
form of patient cost sharing for prescription
benefits, requires patients to pay a specified
dollar amount for every prescription received
(e.g., $5 per prescription). Deductibles require
patients to pay for all of their prescription
 The Impact of Managed Care on Pharmacy Practice
expenses until a specified dollar amount has
been paid out of pocket. For example, the
prescription plan may cover prescriptions
only after the patient has paid the first $200 of
prescription expenses within any given year.
With the expansion of on-line computerized
claims processing, more programs are includ-
ing deductibles as the pharmacist is informed
by the computer of the amount of cost sharing
the patient is responsible for. Coinsurance
requires patients to pay a specified percentage
(usually 20 percent) of the prescription cost
while the payer covers the remainder.
The pharmacy is supposed to collect the
patient’s share of the prescription cost at the
time the prescription is dispensed; this
amount is then deducted from the PBM’s
reimbursement. PBMs often use tiered
copayments that are lower for generic or
preferred drug products and higher for
brand-name or nonpreferred drug prod-
ucts, as described in Chapter 2. Patient cost
sharing, therefore, serves multiple func-
tions: it decreases the PBM’s unit cost, helps
control utilization, and channels patients
and providers toward using less expensive
products. Pharmacies help the PBM modify
patient behavior by collecting copayments
but also by helping patients minimize their
copayments.
Prior Authorization
PBMs sometimes specify policies that de-
termine the specific situations in which certain
high-cost drugs may be used. Usually the
prescriber must explain the reasons why a
particular drug product is superior to a pre-
ferred formulary product and obtain authori-
zation from the PBM before the pharmacy
may dispense the drug and obtain reimburse-
ment. Pharmacies receiving a prescription for
a drug restricted by a prior authorization
109
program may have to contact the physician or
the PBM to make sure the proper authoriza-
tion is obtained before the drug can be dis-
pensed. Although this can be inconvenient for
the patient, pharmacist, and physician, it does
reduce expenditures without unnecessarily
denying access to medications when they are
needed. Although 81 percent of HMOs use
prior authorization,22 the administrative ex-
penses associated with operating prior autho-
rization programs usually require that PBMs
apply this restriction to relatively few drug
products.
Step-Care Protocols
Step care is an adaptation of prior autho-
rization in which use of more expensive
agents is reserved for cases in which less
expensive treatment has been tried unsuc-
cessfully. Although protocols are com-
monly used for inpatient care, community
pharmacists are not yet extensively in-
volved in step therapy programs.23 Phar-
macy POS on-line adjudication systems
support step-care protocols in community
pharmacies. The pharmacist will be in-
formed through the POS system if the pa-
tient has satisfied the step-care protocol re-
quirement of using a less expensive agent
and will be given approval on line to dis-
pense the more expensive product.
Drug Utilization Review
Controlling program intensity, or the
average number of prescriptions per pa-
tient, can save more money than restricting
expenditures for drug ingredients or dis-
pensing fees. For example, patients who
continue taking H2 antagonists beyond the
time recommended for acute treatment of
ulcers cause significant and unnecessary
costs for the program. By limiting medica-
110 PHARMACY PRACTICE MANAGEMENT QUARTERLY/JANUARY 2000
tion use to the recommended dosage and
duration, the MCO can save hundreds of
dollars for just one patient. To control inten-
sity, about 80 percent of MCOs employ
some form of drug utilization review
(DUR).24
DUR may be prospective or retrospec-
tive. Retrospective DUR involves review of
prescription claims databases to study pre-
scribing, dispensing, and drug use patterns
to detect problems with inappropriate pre-
scribing and over- and underuse of medica-
tions. The review occurs well after the pre-
scriptions have been dispensed. Since these
programs are educational, the focus is on
alerting physicians and pharmacists to po-
tential problems with the hope that they will
be able to improve future prescribing and
dispensing practice, thereby leading to more
effective and less costly drug usage.
Prospective DUR, on the other hand,
occurs before the prescription is dispensed
and results in alert messages being sent to
the pharmacy’s computer when problems
are detected with the following:
• duplication of therapy
• dosage out of normal range
• contraindications
• drug interactions (categorized accord-
ing to severity)
• improper duration of therapy
• unusual or unexpected patterns of pre-
scription refills
Pharmacists respond to the alert mes-
sages by (1) contacting the prescriber, who
may cancel the prescription or select a differ-
ent medication or (2) overriding the alert by
dispensing the medication when it is deter-
mined that no potential problem exists. The
most common alert message, early refill, is
often overridden by pharmacists because
the physician may have told the patient to
increase the dosage or because the patient
needs an early refill for vacation or to pre-
vent an extra trip to the pharmacy a few
days later.
Although some DUR alert messages are
little more than an inconvenience, many
help pharmacists provide professional ser-
vices. Prospective DUR programs that use
real-time computer alerts allow pharmacists
to counsel even those patients who patron-
ize more than one pharmacy.
Provider Education
Many MCOs encourage cost-effective
prescribing and dispensing practices
through various types of provider educa-
tion programs. Retrospective DUR, for ex-
ample, is essentially an educational pro-
gram. Another example is performance
profiles or reports, sometimes referred to as
“report cards.” A physician profile is a set of
reports designed to monitor the prescribing
practices of a given physician and provide
information that can be used as the basis for
various types of interventions devised to
improve these prescribing practices. These
interventions can range from simply mail-
ing prescribers copies of their report cards to
conducting personal visits with physicians
to discuss how their prescribing practices
compare with program averages or speci-
fied benchmarks and how performance can
be improved. 25 These personal visits,
known as counterdetailing or academic de-
tailing, usually are conducted by a pharma-
cist working for the MCO or PBM.
Prescription claims data can also be used
to generate report cards for pharmacies. By
determining how a given pharmacy com-
pares to averages and preestablished bench-
marks, a pharmacy manager can learn the
level of performance that is expected regard-
 The Impact of Managed Care on Pharmacy Practice
ing use of generics, formulary compliance,
response to alert messages, and therapeutic
interchange.26 PBMs could use this informa-
tion in the future to select preferred pharma-
cies for their networks.
Disease State Management
By definition, managed care should focus
on maximizing the effectiveness of health
care services to enhance the probability of
positive patient outcomes. This concept
implies that health care providers will col-
laborate to manage patients’ health and,
consequently, their disease states. For phar-
macists, this means not only dispensing
drugs but also educating patients, encourag-
ing compliance, monitoring patient
progress, and intervening when necessary
to ensure positive outcomes. Disease man-
agement programs offer clinical opportuni-
ties for pharmacists to become more in-
volved as pharmacotherapy managers.
However, except in limited pilot projects,
managed care is not yet comfortable with
providing a separate cognitive skills fee re-
imbursement to pharmacists for their in-
volvement in disease state management.
MANAGED CARE STRATEGIES
FOR PHARMACISTS
Pharmacy managers must be both good
managers and good clinicians to survive or
prosper in the managed care environment.
Specifically, pharmacists must be able to
• identify their costs of dispensing
• decrease overhead costs by managing
as efficiently as possible
• reduce drug ingredient costs
• document clinical services that en-
hance patient outcomes
111
• know what payers need and be able to
satisfy those needs
Identifying Cost of Dispensing
For a pharmacy to be viable, its revenues
must exceed its associated expenses. Devel-
oping an understanding of a firm’s cost of
doing business is among the most basic and
vital business functions. The cost of doing
business should be assessed and used for
pricing prescriptions as well as in contract
negotiations, cost management, and other
decisions.
To price prescriptions competitively and
yet realize a fair profit, prescription pricing
decisions and decisions regarding participa-
tion in managed care contracts must be
based on accurate measurements of costs.
Because pharmacies make thousands of
transactions, each having a relatively small
dollar value, minor miscalculations in de-
ciding price relative to cost are multiplied
thousands of times in the course of a year.
As stated previously, the components of
a retail prescription drug price include the
cost of drugs, cost of dispensing (COD)
prescriptions, and a reasonable return on
investment. The COD is calculated by total-
ing all prescription department expenses
over a given period and dividing by the
number of prescriptions dispensed during
that time. A COD analysis can be as simple
or as detailed as needed. The simplest ap-
proach would be to classify all expenses into
two categories, direct costs and indirect
costs. Direct costs would be applied 100
percent to the prescription department,
while indirect costs could be allocated in
proportion to the percentage of total store
sales generated from the prescription de-
partment. Further refinements may be
112 PHARMACY PRACTICE MANAGEMENT QUARTERLY/JANUARY 2000
made to satisfy the internal management
needs of the firm conducting a COD analy-
sis. (Two examples are allocating fixed costs
in proportion to the amount of store area
occupied by the prescription department
and allocating personnel costs in proportion
to the percentage of each employee’s time
spent working in the prescription depart-
ment.) Although it may be important to
apply the same cost accounting procedures
to all pharmacies participating in
industrywide COD surveys, this unifor-
mity is not necessary or even desirable for
individual companies that are interested in
analyzing their own costs. Because it is
possible that expenses that are variable in
one pharmacy may be fixed in another, it
would be best if costs could be assigned by
someone familiar with each pharmacy’s
operation.
The potential profitability of a particular
managed care contract depends in part on
the proportion of beneficiaries that are new
customers relative to the proportion that
were private-pay customers but converted
to the plan. A well-known accounting text
states that “present business should be
charged with all present costs [in other
words, the cost of dispensing], and addi-
tional business should be charged only with
incremental or differential costs [in other
words, only variable costs—costs that in-
crease with prescription costs].” 27(p. 899)
Therefore, for current patients who are
converted from private pay to the managed
care plan, the pharmacy will make a profit
only if the gross margin from the plan (i.e.,
the dispensing fee plus the AWP differen-
tial) exceeds the pharmacy’s COD. For new
patients, the gross margin earned from the
plan must exceed only the variable CODs
for the new prescriptions—provided, of
course, there are a sufficient number of
higher-paying prescriptions to cover the
pharmacy’s fixed costs.
Decreasing Overhead Costs
Pharmacies in today’s health care mar-
ketplace face the difficult task of trying to
reduce overhead costs to the extent possible
while at the same time expanding pharma-
ceutical care services. To accomplish these
seemingly opposing objectives, pharmacies
must (1) minimize pharmacists’ roles in
drug distribution by delegating these func-
tions to technicians and (2) use automation
and technology to increase efficiency.
Delegating dispensing functions to techni-
cians requires that pharmacies alter their work
flow so that pharmacists are free to counsel
patients, monitor drug therapy, and intervene
with patients when necessary. This modified
work flow, in turn, may require some remod-
eling of the pharmacy so that technicians
receive prescriptions, type labels, and count or
pour medications while pharmacists work
closer to the “out window” to check pre-
scriptions processed by the technicians, re-
view computerized patient records, and in-
teract with patients. A counseling area that
offers patients privacy must be close to the
pharmacist’s workstation. For technicians
to be of optimal use, they must be well
trained. Many pharmacies are encouraging
or requiring technicians to improve skills by
participating in a nationally recognized cer-
tification program.
Pharmacies are also finding that comput-
erization and automation enhance effi-
ciency—especially in high-volume pharma-
cies. Using up-to-date computer equipment
and software also helps pharmacists make
maximum use of available patient informa-
tion so that they can provide patient case
 The Impact of Managed Care on Pharmacy Practice
management. Pharmacies have been rela-
tively successful at decreasing overhead
costs, but increasing financial pressures re-
quire a continuing commitment to creating
additional efficiencies.
Reducing Drug Ingredient Costs
Pharmacy managers must reduce the cost
of goods sold by purchasing inventory as
efficiently as possible (usually through
large-volume purchasing cooperatives) and
using generics as much as possible. Com-
munity pharmacies often participate in buy-
ing groups to obtain volume discounts.
Eventually, groups of community pharma-
cists, in collaboration with physicians, may
be able to establish community formularies
to more efficiently select therapeutic equiva-
lents and alter therapeutic regimens.
Documenting Patient Outcomes
Pharmacists must demonstrate that phar-
maceutical care services have value. For
example, patient counseling can improve
patient compliance, which, hopefully, will
result in more favorable patient outcomes
(e.g., cure for or alleviation of symptoms, or
reduced expenses for other health care ser-
vices such as physician office visits, lab tests,
hospitalization, and nursing home admis-
sions). Pharmacies that provide pharmaceu-
tical care services and document positive
outcomes will make themselves indispens-
able (no pun intended) to MCOs.
Pharmacists’ survival and prosperity in
the managed care market depend in part on
their ability to justify and obtain reimburse-
ment for cognitive services. According to
Rupp, the steps involved in developing a
reimbursement strategy for cognitive ser-
vices include (1) identifying key participants
in the reimbursement decision, (2) demon-
113
strating patient need for the service, (3)
marketing to establish payer demand, (4)
documenting the service–outcome link, and
(5) setting prices to reflect value to the
payer.28 Reimbursement will not be easy to
achieve. MCOs will pay for these services
only if they are convinced that doing so
helps them accomplish their goals. Several
pharmacy organizations, computer compa-
nies, and third-party programs are trying to
develop standardized methods to pay for
pharmacy interventions.29
Providing cognitive services requires that
pharmacists excel at counseling patients,
monitoring therapy, conducting utilization
review, ensuring compliance, and maximiz-
ing therapeutic outcomes. Ultimately, phar-
macists will provide disease state manage-
ment, focusing first on those disease states
that lend themselves most readily to im-
provement through pharmacists’ interven-
tions, such as diabetes, asthma, allergies,
hypercholesterolemia, anticoagulation
therapy, and chronic obstructive pulmo-
nary disease. Pharmacies concentrating on
managing one or more of these diseases are
already creating market niches.30 Later op-
portunities may include mental health, nu-
trition, oncology, geriatrics, pediatrics, hy-
pertension, depression, gastric disorders,
digestive diseases, respiratory problems,
cardiac disorders, and circulatory prob-
lems. The focus on cost-effectiveness will
encourage even more specialized pharma-
ceutical care services in the future.31
EFFECT OF MANAGED CARE ON
HOSPITAL PHARMACIES
Background
The rapid rise in hospital costs during the
last several decades has been fueled by an
114 PHARMACY PRACTICE MANAGEMENT QUARTERLY/JANUARY 2000
oversupply of hospital beds, lack of price
competition among hospitals, and generous
reimbursement methods. With the passage
of the Hill-Burton Act in 1946, the federal
government provided money to build new
hospitals in many communities throughout
the country. The growth of hospital beds
created a Field of Dreams phenomenon (“if we
build it, they will come”): the number of
hospital admissions increased significantly,
as did the average length of stay. Hospitals
were also reimbursed on a “cost-plus” basis
that created few incentives to contain costs.
As a result of this generous fee-for-service
reimbursement, it was not necessary for
hospitals to compete on price. Instead, hos-
pitals competed with each other to attract
physicians who could fill the beds. The most
effective way of attracting physicians was to
provide the latest medical technology—a
very costly but effective strategy.
Effective restraints on hospital costs were
finally introduced in 1983 with a form of
prospective reimbursement known as diag-
nosis-related groups (DRGs). Under
DRGs, hospitals were paid a specified
amount for each admission based on patient
diagnosis. This new reimbursement
method encouraged hospitals to become
more efficient and to improve effectiveness
of treatment to reduce patient length of stay.
While DRGs are still used by some MCOs,
many MCOs now negotiate with hospitals
to establish per diem rates that include all
services.
Through prospective reimbursement
systems, MCOs have profoundly changed
the way hospitals operate. Hospitals now
have strong incentives to eliminate unneces-
sary services and to promote efficiency.
Some hospitals have closed, and others have
eliminated, some of their licensed beds.
Most hospitals have either consolidated into
large hospital corporations or developed
affiliations with other hospitals to benefit
from economies of scale in their purchasing,
advertising, and central administration.
Implications for Hospital Pharmacies
The advent of prospective reimburse-
ment transformed hospital pharmacies
from profit centers into cost centers and
created incentives to eliminate unnecessary
services and promote efficiency. The pri-
mary cost-cutting targets for hospital phar-
macies have been the two areas that contrib-
ute the most to costs: (1) inventory and (2)
personnel. Almost all hospital pharmacies
have reduced inventory costs by working
with the medical staff to adopt extensive
formulary systems. They have also reduced
the cost of goods by joining with other
hospitals to form volume purchasing
groups that solicit competitive bids from
pharmaceutical manufacturers.
Personnel costs have been reduced by
delegating routine functions to pharmacy
technicians and by automating dispensing
procedures. Automated dispensing ma-
chines and robots reduce personnel time
and enhance accountability by delivering
medications to the nursing staff on demand.
Many hospital pharmacy departments have
increased the extent of their on-the-job train-
ing programs, and some have encouraged
or required pharmacy technicians to en-
hance their knowledge and skills by passing
the Pharmacy Technician Certification
Board exam. Automation and extended use
of pharmacy technicians, however, have
not always reduced pharmacy staff. In
many cases, pharmacists have become more
involved with patient-focused care, dosage
recommendations, discharge counseling,
 The Impact of Managed Care on Pharmacy Practice
and case management. By working with the
medical staff to achieve positive patient out-
comes, hospital pharmacists can help re-
duce patients’ length of stay and, conse-
quently, minimize overall hospital costs.
CONCLUSION
Pharmacists will continue to play a
greater role in managed care. Managerial
skills will be needed to control costs and to
develop new initiatives. Clinical and com-
munication skills will be needed to work
with other health care professionals and to
help patients achieve positive outcomes.
Finally, pharmacists need a clear under-
standing of the current and future demands
of the health care environment so that they
REFERENCES
1. R.P. Navarro, Novartis Pharmacy Benefit Report: 1997 Facts
& Figures (East Hanover, NJ: Novartis Pharmaceuticals
Corporation, 1997), 4.
2. “Independent Pharmacy Sales Soar by 14.3 Percent,”
America’s Pharmacist 120, no. 11 (1998): 31.
3. D.C. Huffman, Jr., ed., 1996 NCPA-Searle Digest (Alex-
andria, VA: National Community Pharmacists Associa-
tion, 1997), 32.
4. “Independent Pharmacy Sales,” 31–32.
5. Huffman, 1996 NCPA-Searle Digest, 37.
6. Navarro, Novartis Pharmacy Benefit Report: 1997.
7. R.P. Navarro, Novartis Pharmacy Benefit Report: 1998 Facts
and Figures (East Hanover, NJ: Novartis Pharmaceuti-
cals Corporation, 1998), 7.
8. K.A. Proctor and K.W. Kirk, “The Forgotten Compo-
nent of Third-Party Reimbursement: Net Profit,” Ameri-
can Pharmacy NS27 no. 4 (1987): 52–55.
9. “HEW Recognizes the Need for Equity in Pharmacists’
Dispensing Fees,” Weekly Pharmacy Reports 24 (1975): 4.
10. Navarro, Novartis Pharmacy Benefit Report: 1997, 12.
11. Marion Merrell Dow, Inc., Managed Care Digest, HMO
Edition (Kansas City, MO: 1994), 5.
12. K.W. Schafermeyer, “Basics of Managed Care Claims
Processing: From Claims Payment to Outcomes Man-
115
can continue to provide pharmaceutical
care services that are valuable components
of managed health care.
While managing the prescription benefit
to optimize patient outcomes may increase
prescription expenditures, this should be
acceptable if it can be shown that other,
more expensive health care costs are pre-
vented. MCOs and pharmacists, therefore,
need to work together to provide care that is
truly managed rather than just controlled.
All pharmacists—staff or management,
community or institutional—are affected by
the problems and opportunities presented
by managed care prescription programs.
Pharmacists’ ability to use their skills to
minimize problems and take advantage of
opportunities will determine to a large ex-
tent the profession’s future success.
agement,” Journal of Managed Care Pharmacy 1, no. 6
(1995): 201–202.
13. K.W. Schafermeyer, “Managed Prescription Drug Pro-
grams,” in Managed Care Contracting: A Guide for Health
Care Professionals, ed. W. Knight (Gaithersburg, MD:
Aspen Publishers, 1997), 229–242.
14. Navarro, Novartis Pharmacy Benefit Report: 1997, 24.
15. Navarro, Novartis Pharmacy Benefit Report: 1998, 6.
16. Navarro, Novartis Pharmacy Benefit Report: 1997, 24.
17. Navarro, Novartis Pharmacy Benefit Report: 1998, 8.
18. Navarro, Novartis Pharmacy Benefit Report: 1997, 13.
19. K.W. Schafermeyer and S.D. McCann, “Medicaid
Task Force Recommends Policies on Prior Authoriza-
tion,” Missouri Pharmacist 66, no. 1 (1992): 7–9.
20. R.B. Goldberg, “Managing the Pharmacy Benefit: The
Formulary System,” Journal of Managed Care Pharmacy 3,
no. 5 (1997): 565–573.
21. E.W. Brian and S.F. Gibbens, “California’s Medi-Cal
Co-Payment Experiment,” Medical Care 12 (1974): 54.
22. Navarro, Novartis Pharmacy Benefit Report: 1998, 7.
23. B.R. Motheral et al., “Pharmacy Benefit Management:
Factors Influencing Utilization and Costs in a Pharmacy
Benefit Program,” Drug Benefit Trends, October 1996, 16.
24. Navarro, Novartis Pharmacy Benefit Report: 1997, 12.
116 PHARMACY PRACTICE MANAGEMENT QUARTERLY/JANUARY 2000
25. E.A. Balas et al., “The Effect of Physician Profiling on
Utilization,” Journal of General Internal Medicine 11 (1996):
584–590.
26. J.A. Marcille, “Contracting: How Will You Measure
Up?” Managed Care Pharmacy Practice 3 (1995): 19.
27. W.W. Pyle and K.D. Larson, Fundamental Accounting
Principles, 9th ed. (Homewood, IL: Richard D. Irwin,
Inc., 1981), 899.
28. M.T. Rupp, “Strategies for Reimbursement,” American
SUGGESTED READING
Blissenbach, H.F., and P.M. Penna, 1996. Pharmaceutical
Services in Managed Care. In The Managed Care Hand-
book, 3rd ed., ed. P.R. Kongstvedt, 367–387. Gaithers-
burg, MD: Aspen Publishers, Inc.
Pharmacy NS32, no. 4 (1992): 79–85.
29. C. Winkler, “Closer to Pay Day?” American Druggist,
February 1994, 37–38, 40.
30. V. Meade, “Pharmaceutical Care in a Changing Health
Care System,” American Pharmacy NS34, no. 8 (1994): 43–
46.
31. K.K. Knapp and D.L. Sroby, “Directions for Specializa-
tion in Pharmacy Practice, Part 2,” American Journal of
Hospital Pharmacy 48, no. 4 (1991): 691–700.