Assessment of Pharmacy Services Funding and Retained Margin in England (2005-2009), Study notes of Pharmacy

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The Community Pharmacy Contractual

Framework and the retained medicine

margin

This report is embargoed until 00.01 30 March 2010

Contents

• Findings, conclusions and recommendations.......................................................
  • Scope of this report.....................................................................................................
  • The community pharmacy contractual framework.................................................
  • Findings and conclusions...........................................................................................
  • Recommendations
• for the drugs they dispense Part 1: How pharmacy services are funded, and how pharmacies are reimbursed
• Part 2: How the Department estimates and controls the retained margin...........
• Part 3: The overall financial impact of introducing the Framework.....................
• Annex 1: How we carried out this examination
• Annex 2: Details of fees payable for essential and advanced pharmacy services
• Annex 3: Actions taken in response to reviews of the invoice surveys

supermarkets and large chains, and are located on the high street, in communities, shopping centres and rural areas. NHS pharmaceutical services account for about 90 per cent of a typical community pharmacy’s turnover. Community pharmacies provide NHS services under a Contractual Framework which has been in operation since 1 April 2005, agreed between the Department of Health, the Pharmaceutical Services Negotiating Committee (the representative body for community pharmacy contractors), and the NHS Confederation (now NHS Employers - the employers’ organisation for the NHS).

5. The Framework provides for pharmacy contractors to be remunerated for the services they provide in three ways:

(i) About half of budgeted remuneration for pharmacies is in the form of fees and allowances that are paid from a ‘ global sum ’ budget, which over the period covered by this report was administered centrally by the Department of Health. The 2008- budget for the global sum was £1,049 million.

(ii) Pharmacies also receive further fees and allowances from their Primary Care Trusts. The main one is the ‘ practice payment ’, which takes the form of a monthly payment for smaller pharmacies, or a fee per item dispensed for pharmacies dispensing more than a threshold level of items per month. Payments for medicines use reviews and the electronic prescription service are also met by Primary Care Trusts. The 2008- budget for PCT payments was £664 million.

(iii) The third source of community pharmacies’ remuneration is the ‘ retained margin ’: the margin arising from the difference between the price at which a pharmacy purchases a medicine and the price at which the pharmacy is reimbursed by the NHS when the medicine is dispensed.

6. The Department and the Pharmaceutical Services Negotiating Committee agreed at the outset of the Framework that the target level of retained margin would be set at £500 million annually. The Department adjusts the level at which pharmacies are reimbursed for commonly dispensed items based on the level of margin achieved in the previous year. 7. In order to assess the actual total retained margin achieved each year, the Department carries out a survey of invoices, which show actual prices paid for a sample of medicines, from a sample of pharmacies. The Department uses the survey results to determine how to set the prices at which the NHS reimburses pharmacies for the

medicines they dispense. These reimbursement prices, which are published monthly in the NHS Drug Tariff, are deliberately set higher than the actual cost of medicines to pharmacies, at least for commonly dispensed generic medicines, so that globally pharmacies can earn the agreed target £500 million margin.

8. In managing the delivery of the margin by periodically adjusting reimbursement prices, therefore, the Department has to balance the risk of exceeding the target level of margin against the risk of falling short of the agreed level, and failing to meet its commitment to community pharmacies—potentially, in the longer term, affecting the availability of local community pharmacy services across the country and the supply of medicines to patients. 9. Since April 2008, when the White Paper Pharmacy in England: Building on Strengths – Delivering the Future was published, the Department has also had the related objective to provide, through the Contractual Framework, an incentive structure that will further increase the chances of achieving the Government’s aims of delivering more NHS services through community pharmacies, over and above the dispensing of medicines, and of fully utilising the skills of pharmacists and their staff in contributing to primary care and public health improvement, especially in the management of long-term conditions.

Findings and conclusions

10. The introduction of the new Contractual Framework in April 2005 has achieved two notable outcomes: - There has been a cost saving to the NHS of around £1.8 billion over the period 2005-06 to 2008-09 by comparison with a counterfactual scenario of retaining the pre-Framework remuneration and medicines pricing arrangements. The saving has arisen principally because, under the new Framework, the reimbursement prices paid to pharmacies for a number of commonly dispensed medicines have been reduced. - The productivity of pharmacies, with respect to core dispensing work, has also increased by 8 per cent over the four years 2005-06 to 2008-09. In 2005-06, the total volume of medicines dispensed by pharmacy contractors was 679 million items, and total payments to contractors were £1.975 billion. By 2008-09, the number of items dispensed had increased by 17 per cent, to 795 million, for an increase in total payments of 8 per cent in real terms, to

Figure 2: Payments to pharmacy contractors under the Community Pharmacy Contractual Framework, 2005-06 to 2008-

4-year total

Element of remuneration

Target^ (£m)

Outturn

(£m)

Target^ (£m)

Outturn

(£m)

Target^ (£m)

Outturn

(£m)

Target^ (£m)

Outturn

(£m)

Target^ (£m)

Outturn

(£m)

Differen^ ce(£m)

Global sum

PCT payments

Retained margin

1

2

Variance on retained margin (£m)

Total remuneration

Variance on total contract sum (£m)

Source: NAO analysis of Department of Health data

1 An extra £32 million retained margin was agreed by Ministers this year, to offset some NHS Business Services Authority underpayments to pharmacies, and stock loss. 2 Subject to final confirmation

12. The Department argues that the principal reason why the margin target has been exceeded is that the Framework incentivises individual pharmacy contractors to drive harder bargains with medicines suppliers , thereby driving down market prices for medicines. It argues that without this additional downward pressure on purchase prices, the adjustments made to reimbursement prices would have been sufficient to deliver a total margin closer to the £500 million target each year. The excess margin is due, therefore, to lower than expected prices in the medicines market, and is factored into reimbursement pricing decisions the following year, which in their turn incentivise pharmacies to drive down prices still further, as evidenced by the reduction in ex-factory prices. This cycle of 'catching up' with the previous year's excess is known as 'regulatory lag'. The Department tells us that it was an implicit part of the agreement with the Pharmaceutical Services Negotiating Committee from the outset that regulatory lag would be allowed for. The Pharmaceutical Services Negotiating Committee confirmed that pharmacies considered this to be an important element in the funding structure. 13. The £500 million target was set on the basis of limited information about community pharmacies’ actual level of medicines margin. The figure of £500 million retained margin was agreed at the outset through negotiation, based on information available at the time. The Department advise that they suspected that there would be more than £500 million margin, but that they did not have firm evidence (such as from a margin survey). The Department say that they therefore agreed to the £500 million pending firm evidence becoming available, in order to bring the Contractual Framework, and the associated margins survey, into play, which was required to affect the savings. 14. Furthermore it is questionable whether it would have been realistic to achieve the potential additional savings required to have achieved the £500 million target. It would have entailed 25% lower expenditure on community pharmacy, over four years, as compared with a counterfactual of retaining the pre-Framework arrangements, in the context of year-on-year increases in outputs. A reduction on this scale could have threatened the viability of community pharmacies and hence access to pharmaceutical services and the supply of medicines to patients, bearing in mind that not all pharmacies would have achieved the average retained medicine margin identified in the survey. 15. Uncertainty surrounding the actual level of the margin and the achievability of the target in the early period of the new Framework’s operation should, in our view, have made getting a robust assessment of actual levels of margin more of a priority for

undertaken with the Pharmaceutical Services Negotiating Committee. The Department has full access to the invoices collected, and oversees and checks a sample of the Committee’s work.

19. Over the first three years of operation of the Framework, sampled contractors were asked and encouraged through follow-up by the Pharmaceutical Services Negotiating Committee to supply the necessary information (invoices and statements). However, there was no compulsion for contractors to submit invoices. The Department realised it might have to use statutory powers to require pharmacists to take part in the survey for 2007-08, but discovered that the regulations necessary to support a statutory inquiry had inadvertently been lost as part of the implementation of the NHS Act 2006. The regulations have now been re-laid, and for the 2008-09 surveys, pharmacies were reminded that the Secretary of State has powers, under the NHS (Pharmaceutical Services) Regulations, to require them to provide the information.

Recommendations

2 0. The Department is carrying out a new inquiry to determine what would be a reasonable cost for the NHS to pay for the level of pharmacy services likely to be required in future. In the context of this inquiry, and the subsequent negotiations to implement its findings within the Contractual Framework, there is an opportunity to improve further the margin survey and funding arrangements. We recommend that the Department should:

ƒ Be more timely in making adjustments to reimbursement prices for generic medicines

to manage the level of retained margin. We understand that the Department’s intention is to move to a process of rolling invoice surveys, which should facilitate this. However, the Department should also use evidence from other sources, such as average ex-factory prices, to make adjustments if necessary.

ƒ Continue to work with recognised experts in survey design and analysis to maintain

and improve the invoice survey. In particular, whilst the response rate has improved considerably since the inception of the Framework, the Department should take steps to ensure high response rates continue in future.

ƒ Present the arrangements for funding the Framework more explicitly. If the

Department believes that the target level of margin is likely to be exceeded every year

due to the operation of ‘regulatory lag’, this should be made clear, and the implications for expenditure on pharmacy services and medicines should be set out.

21. Furthermore, notwithstanding the expertise that the Pharmaceutical Services Negotiating Committee has in interpreting invoices for the margins survey, we recommend that the administration and processing of the survey should be carried out by an independent organisation. This would remove any potential or perceived conflict of interest.

How pharmacy services are funded

1.4 In 2003, prior to the introduction of the current Framework, the Department carried out a ‘cost-of-service’ enquiry, in conjunction with the Pharmaceutical Services Negotiating Committee, to establish a fair estimate of the cost of providing pharmacy services. The Department agreed with the Committee that over time, the fees and allowances that had previously formed the basis of Government funding of pharmacy services had ceased to be sufficient to cover pharmacy costs. At the same time, growth in the market for generic medicines had led to pharmacies making an increasing proportion of their income from margin earned from medicines purchases, since reimbursement prices were often considerably higher than actual average manufacturers’ or wholesalers’ prices.

1 .5 The Framework recognises three principal sources of remuneration for community pharmacies:

• About half of budgeted remuneration for community pharmacies comes from the ‘ global sum ’, which over the period covered by this report was administered centrally by the Department of Health. Following the Health and Social Care Act in 2008, the global sum is being devolved to Primary Care Trusts from April 2010.
• Community pharmacies receive ‘ practice payments ’ from their Primary Care Trusts, in the form of a monthly payment for smaller pharmacies, or a fee per item dispensed for pharmacies dispensing more than a threshold level of items per month. Primary Care Trusts also fund payments for the electronic prescription service and medicines use reviews.
• The third source of community pharmacies’ remuneration is the ‘ retained margin ’: the margin arising from the difference between the price for which a pharmacy can purchase a medicine and the price at which the pharmacy is reimbursed when the medicine is dispensed. The Department and the Pharmaceutical Services Negotiating Committee agreed at the outset of the Framework that the total target level of retained margin would be set at £500 million annually.

1.6 In 2008-09 community pharmacies received a total of £2.418 billion under the Framework. Figure 3 shows the breakdown of this figure.

Figure 3: Structure of community pharmacies’ remuneration through the Framework in 2008-

1053 43%

595 25%

770 32% Global sum (£m) PCT payments Retained margin

Source: NAO analysis of Department of Health data

1 .7 The Department of Health and the Pharmaceutical Services Negotiating Committee agreed that they would re-negotiate the target sum for the total remuneration each year, to take into account:

ƒ inflation, as measured by the GDP deflator;

ƒ increases in the volume of dispensing at marginal cost;

ƒ increases in staff salaries in excess of GDP deflator levels; and

ƒ an efficiency assumption, which assumes some ability to make annual efficiencies

and is consistent with efficiency targets in the NHS as a whole.

1.8 In addition, the target sum may be uprated to reflect costs necessitated by significant additional regulatory burdens on contractors. Regulatory burdens and the uplift are assessed on a retrospective basis.

1.9 While the total target sum is adjusted each year in accordance with these factors, the target level of retained margin remains at £500 million each year, and hence represents a decreasing proportion of total remuneration over time. Any excess retained margin, above the agreed £500 million, is considered in the negotiations between the Department and the Pharmaceutical Services Negotiating Committee, and may lead, for example, to reductions in other elements of remuneration such as practice payments.

Other sources of remuneration for pharmacies

1 .12 In addition to reimbursement for drugs, the NHS Business Services Authority also administers the fees and other payments that are made to community pharmacies under the terms of the Framework. These cover a range of essential and advanced services, set at fixed rates in some instances, and on sliding scales in others. For example:

ƒ A professional fee of 90p per item is payable on all items dispensed.

ƒ Practice payments (34.5p per item for April 2008 to September 2008) are paid for

each item dispensed, over a threshold (2,120 items per month for April 2008 to September 2008). Payment is conditional on demonstration that the pharmacy has sufficient dispensing staff levels to support the number of items dispensed each month and other essential services (for example, a pharmacy dispensing 5,000 to 6, items per month should have a minimum of 75 hours of dispensing staff time per week). Below the threshold, pharmacies are paid a monthly payment according to the band of prescription items per month into which they fall. For April 2008 to September 2008, pharmacies dispensing fewer than 1,100 items per month received one-sixth of £300 per month; one-sixth of £1,750 per month if they dispensed between 1,100 and 1,599 items per month; and one-sixth of £2,450 per month if they dispensed 1,600 to 2,119 items. Further details of fees and payments are given in Annex 2.

1.13 A further cash flow to pharmacies arises from prescription charges which are paid directly to pharmacies by members of the public who are not entitled to free prescriptions. Pharmacies retain the income from these charges and it is offset against the overall reimbursement calculated by the NHS Business Services Authority. However, cash flow benefit from prescription charges is small by comparison with the total reimbursements to pharmacies, since by far the majority of prescriptions are dispensed free of the prescription charge.

Reimbursement prices and the NHS Drugs Tariff

1.14 There are two main types of drugs – branded and generic. Branded drugs are initially patent protected and produced by a single manufacturer, while generic drugs are produced by multiple manufacturers.

1.15 Branded drugs represent about three-quarters of total NHS expenditure on prescription drugs in primary care. The prices manufacturers charge for branded drugs are regulated by the Pharmaceutical Price Regulation Scheme, an agreement between the Department of Health, acting on behalf of the Health Departments for England, Scotland, Wales and Northern Ireland, and the Association of the British Pharmaceutical Industry, that is re-negotiated at regular intervals. The reimbursement price for branded medicines is calculated with reference to the manufacturers’ list price.

1.16 Although branded drugs account for 74 per cent of NHS expenditure on drugs by value, they only account for about 35 per cent of the total volume of items dispensed. Most of the items that pharmacies dispense are generic drugs, and there is greater scope for pharmacies to earn a margin on generics, as there is price competition between manufacturers, wholesalers and other suppliers. Reimbursement prices for generic medicines are determined centrally by the Department of Health, and published monthly in the NHS Drug Tariff. Pharmacies are reimbursed for the generic items they dispense each month at the prevailing Tariff prices.

1.17 Generic drugs are divided into five ‘categories’ for the purposes of the Drug Tariff, as shown in Figure 5.

Figure 5: Categories of medicines in NHS Drugs Tariff

Category A —Drugs which are readily available. The Tariff price is set each month as a weighted average of the prices listed by the following manufacturers and suppliers: AAH, Alliance Healthcare (Distribution) Ltd, Teva UK and Actavis.

Category B —Drugs whose usage has declined over time. The Tariff price is set by considering price lists from the following manufacturers or suppliers: Alliance Healthcare (Distribution) Ltd, AAH, UCB Pharma and Thornton & Ross. Price lists are considered in the order listed and the Tariff price is set as the list price in the first price list that contains a price for the product.

Category C —Drugs which are not readily available as a generic, where the Tariff price is based on the price of a particular proprietary product, or as listed by the manufacturer or, as the case may be, supplier.

Category E —Extemporaneously prepared items, made up of two or more products listed elsewhere in the Tariff. The Tariff price is the sum of the Tariff prices of the components.

Part 2: How the Department estimates and

controls the retained margin

2.1 The Department of Health calculates the annual total retained margin on the basis of a survey of invoices, which show actual prices paid for medicines, from a sample of pharmacies. These prices act as the benchmark for the Department to gauge by how much to adjust reimbursement payments to pharmacies periodically, so that globally the target income of £500 million from medicines margin is achieved.

2.2 The average margin achieved on a given prescription item in a given month is the difference between the average purchase price and the average reimbursement price for that item in that month. The total retained margin achieved in a year, therefore, can be calculated by multiplying the monthly average margin for each item by the monthly volume of that item dispensed, and summing the result across all items and months.

2.3 The difficulty with performing this calculation in practice is that while there is good information available on the volumes of items dispensed (since each item is recorded by the NHS Business Services Authority), and good information on reimbursement prices (since these are set by the Department of Health), there is no single source of data on the prices pharmacies actually pay suppliers for medicines. These vary from pharmacy to pharmacy, and depend on factors such as which suppliers are used and the levels of discount pharmacies can negotiate.

2 .4 There are two possible sources of information that can be used to estimate purchase prices:

• suppliers’ trade price lists and data on volumes sold and sales income generated, as well as lists of ex-factory prices; and
• invoices from pharmacies showing which items have been purchased and how much pharmacies paid for them.

2.5 An advantage of estimating average purchase prices on the basis of price lists is that this information is logistically easy to obtain, provided appropriate safeguards are put in place to maintain commercial confidentiality. However, suppliers’ list prices do not necessarily reflect the prices paid by pharmacies, and stock may not be available in practice to contractors at the prices shown in price lists. Average ex-factory prices are collected by the Department for Category M and generic medicines (although these do

not include wholesaler distribution costs). A disadvantage of using price lists is that it does not have the ‘face validity’ of using evidence gathered from physical checking of invoices. The Pharmaceutical Services Negotiating Committee and the pharmacy owners it represents would find it difficult to accept an estimate of the retained margin that was not based on a review of evidence from invoices.

2.6 A disadvantage of estimating the margin on the basis of evidence from invoices, however, is that obtaining the data requires considerably more time and resources than obtaining sales information from suppliers, and the resulting estimate is necessarily retrospective, based on a sample of prescription items and of pharmacies, and subject to sampling and non-sampling error.

The invoice surveys

2.7 At the time the Framework commenced in April 2005, it had been agreed that medicine margins would be monitored by periodic surveys of pharmacy invoices. The Department and the Pharmaceutical Services Negotiating Committee entered discussions in June 2005 on the detailed methodology for assessing the level of medicine margin achieved.

2.8 The Department has developed and refined the methodology for its surveys each year to improve the accuracy with which it assesses the levels of medicine margin. We describe below the surveys carried out since the Framework came into force, and describe the steps the Department has taken to strengthen the survey methodology.

2.9 Performing a robust survey requires detailed planning and the application of complex statistical methods together with a thorough knowledge of the pricing and reimbursement system and how medicines costs are documented on invoices. The Department argues that the imperative to gather survey evidence in the time remaining in 2005-06, in order to identify the excess margin it suspected was in the system, meant that there would necessarily be some technical and logistic limitations in the first surveys. They told us that both they and the Pharmaceutical Services Negotiating Committee considered that developing the surveys would be a learning process.

2.10 The Department performed the first surveys in 2005-06. Independent pharmacies were surveyed for two months: in October 2005 and February 2006. The October survey was of a sample of 42 pharmacies (from a total of over 10,000, of which over 4,000 are independent pharmacies) and 126 medicines (105 generic and 21 branded), and covered