Recognizing the Power of Compound Savings in Your Pharmaceutical Costs
| By David J. Akers, President & CEO, Sourcing Alliance
For procurement professionals in education, there is a constant need to find savings. When combined with original cost savings, year over year (YOY) returns create a compound effect. This can be very valuable – especially when related to pharmacy benefits offered to your employees.
When purchasing pharmacy benefits, price is commonly regarded as the primary driver in your decision. Not paying attention to the rate of annual increase, however, will likely translate into a higher overall cost.
Looking at the Big Picture
As you select a pharmacy benefits manager, it’s important to examine the total cost of those services over the lifetime of the contract. Let’s look at how the base price in year one combined with the rate of increase YOY determines the variance in the cost – or in savings – of two contracts over time.
To begin, let’s discuss the difference between simple interest and compound interest. With simple interest, the interest earned is not added back into the principal. Instead, interest is earned month over month or year over year based on the same principal amount. Compound interest works a little differently. With compound interest, the interest accrued, or accumulated, is added back to the principal, and the interest is paid on the entire amount.
Picture opening a savings account with $100 that gains 10% interest. In the simple interest scenario, that 10% would be applied to only that $100 moving forward and the saver would only get $10 each year. At the end of three years, the saver would have $130.
On the other hand, compound interest would apply that 10% interest on the $100 initially, then on the accumulated interest YOY. So, the saver would get the same $10 in the first year but would get 10% of $110 the second year ($11), 10% on $121 the third year ($12.10) and so on. At the end of three years, the saver would have $133.10.
Translation: compounding has significant effects over time.
Applying This to Procurement
Let’s assume you’re comparing two 10-year service contracts. Contract A costs $10,000 in year one with a 15% YOY increase. Contract B costs a flat rate of $12,900 per year for the life of the contract. While Contract A is initially less expensive, by year three Contract A cost more than Contract B. Over the life of the contract, A costs a total of $ $203,037 while Contract B costs $129,000.
Contract A | Contract B
The figure above illustrates how the power of compounding drives a greater variance YOY between the two contracts. Not paying attention to the rate of annual increase, a common mistake, can cost an organization significantly.
The chart also underscores why the starting price point is so critical in determining the lifetime cost of a contract. Layered together, a lower basis and a lower annual rate of increase can mean substantial savings, especially with a major expense category such as pharmacy benefits management.
Applying This to Pharmacy Benefits
E&I offers members an agreement with SourceRx, a pharmacy benefits management (PBM) coalition created by Sourcing Alliance and Health Action Council. The coalition leverages over $1 billion in annual spend and delivers pharmacy benefits to more than three million employees and family members. The PBM contract saves self-insured employers an average of 25% in year one, while aggressive contract terms minimize annual price increases.
Let’s see how compound savings on PBM can impact E&I members:
In this example, a member is currently paying $1 million per year for pharmacy benefits with a typical average YOY increase of 10%. Under the SourceRx program, the member’s costs are reduced to $750,000 with an annual average YOY increase of 6%. The variance in the cost of the two scenarios grows over time. Under the member’s current solution, the cost in year ten is $2,357,948 while the cost of SourceRx would be $1,267,109. That is a savings of $1,090,838 – almost equal to the entire amount paid in the first year of the contract. And over the life of the contract SourceRx saves over $6,000,000 – more than six times what the member is spending today.
Not Using Program | Using SourceRx Program
As you look for the pharmacy benefits management contract that offers the lowest and best option for your organization, it is critical to look at what your costs are over time. Consider your cost in year three or four and ask yourself what you could do with a savings of $2.7 – 3.6 million over the next ten years.
About the Author
SourceRx is a revolutionary Pharmacy Benefits Management (PBM) program competitively solicited and awarded by Sourcing Alliance and Health Action Council (HAC). The longest-standing non-profit PBM and the only nationwide publicly procured PBM contract, SourceRx offers E&I members significant savings on prescription drugs from CVS Caremark and OptumRx.