Financial Accruals in the Specialty Pharmaceutical Industry: The Case for Automating the Process

As payers and providers are required to provide real-world outcomes data, there is high demand for the detailed financial reporting that an automated financial accruals process can produce. Here's what stakeholders need to know about the process.

Traditionally, rare drug development has fallen into the territory of smaller biotechnology and specialty pharmaceutical companies. Only about 55% of total drug spending, or $170 billion out of $300 billion, went to primary care medicines according to a 2011 review from the IMS Institute of Healthcare Informatics. The specialty trend is being driven by breakthroughs in genomics, accelerated development of targeted therapeutics, and improvements in genetic testing.¹

Another key reason for an increased interest is that rare drugs cost less to develop and have higher prices than conventional drugs. Also, health care reform and the rise in personalized medicine have paved the way for the concept that no market is too small to develop. Today, payers are compelled to reimburse for new therapies based on legislative mandates and patient access responsibilities.

Most treatments for rare diseases are costly, ranging from $200,000 to $500,000 per patient.² But the regulatory risks associated with these products tend to be lower because clinical trials may require fewer enrollees and fast-track regulatory review may allow for quick speed to commercialization. Profit margins for rare drugs are generally higher compared with traditional drugs, as manufacturing demands are low and outputs yield higher prices per dose. These characteristics—coupled with growing generic competition, the emergence of biosimilars, faltering drug development pipelines, and the demise of the blockbuster drug model—have forced the pharmaceutical industry to consider commercial opportunities in the rare drug space.²

In this climate, specialty pharmaceutical companies are facing increasing pressure to deliver effective treatments for rare diseases with smaller populations to treat, and strengthened requirements by payers and providers to provide real-world outcomes data. This has generated high demand for flawless financial reporting. Achieving this is an enormous challenge, given the involvement of hundreds of pharmaceuticals with varying formularies that are being reimbursed under a wealth of payer contracts, with varying rates and contract terms.

REDUCING CALCULATION ERRORS WITH AUTOMATED FINANCIAL ACCRUALS

One approach is to take a look at the financial accruals process, which has become a major headache for corporate finance teams in the specialty pharmaceutical industry because they are increasingly difficult to manage, and can lead to major business issues if calculated incorrectly.

These accruals are an important part of compliance with generally accepted accounting principles (GAAP). Funds are set aside to cover the financial obligations associated with sales, from promotional programs, rebates, and discounts. They are hard to manage due to the fact that the data for each type of program are captured in different places within an organization. The data associated with copay programs, direct rebates, and chargebacks must be gathered, and then amounts to set aside must be determined based on past and future projections.

The problem is that most companies don’t have an automated way of pulling all the data together and calculating the appropriate accrual rate. Manufacturers do the calculations manually or in an offline tool. Depending on the company and the kinds of promotional programs they offer, calculations can range from the complex to the extremely complex.

Any calculation errors can have a significant impact. If the accrual percentage is too high for rebates and promotions, funds are essentially being taken away from other areas of the business, such as research and product development, which can help grow revenue. But if enough isn’t reserved, manufacturers could find themselves in a cash crunch, and money will need to be borrowed to cover obligations. If the amounts get to be too large, it can also be considered a “material impact” item for earnings reports.

There’s another aspect that companies are missing. Many organizations are spending more time and money on the mechanics of the accruals—the number crunching—than on understanding what the data are telling them. They’re missing an opportunity to analyze the accruals to see what promotions and programs are really driving the business, helping them to expand market share and drive revenue.

STAYING ON TOP OF UNFORESEEN CIRCUMSTANCES

Most companies have a consistent set of issues to address. Compliance is first and foremost on everyone’s mind. The accrual methodology has to align with GAAP, and then ultimately, a system should be in place that has the right process controls and audit capabilities. The methodology must be documented, that is, how you came up with your calculations, and it must be reconcilable to your auditors. But the formula can’t be static or locked down. The accrual rates need to evolve over time based on actual business results. Sometimes they may need to adjust to the rates in real time, so the process has to be flexible enough to accommodate “human intervention.”

The calculations may need to be adjusted when unforeseen events occur—shortages, business interruptions, and other unplanned circumstances. Here’s an example from the generics pharmaceutical world: Imagine that you are one of only 3 companies producing a certain compound. You learn that the FDA has shut down one of your competitor’s plants, so you know that your sales are going to increase. If you have volume-dependent pricing, or rebate programs that incorporate that product, you will need to increase your accrual rate to accommodate higher sales projections. It’s an unpredicted circumstance, but you have to deal with it immediately.

KEY CONSIDERATIONS AND RECOMMENDATIONS

Some of the key success factors are to consolidate the incentive program data into a central system, apply systematic accrual rate calculations, and evolve them based on real results over time.

Depending on the situation, it might not be possible to automate 100% of the transactions, but it can still be valuable to automate as many as possible, while allowing the flexibility for human intervention when needed as a means of controlling the process without constraining the process.

Finally, one shouldn’t simply focus on getting the calculations right. Analyze the data to see which promotional programs are having the greatest impact on the results. Fine-tune the mix of programs, so that results are being continually optimized. SPT

References

1. Pines N. Specialty pharma: niches to riches. Med Marketing Media. www.mmm-online.com/specialty-pharma-niches-to-riches/article/228656/. Published March 1, 2012. Accessed July 9, 2013.

2. Mintz C. Orphan drugs: big pharma’s next act? Life Sci Leader. www.lifescienceleader.com/magazine/past-issues3/item/3561-orphan-drugs-big-pharma%E2%80%99s-next-act. Published October 2010. Accessed November 18, 2010.

About the Author

Jim Burke, as senior vice president of contracting and pricing solutions, is ultimately responsible for the planning and delivery of all projects within Alliance’s contract strategy, operations, and compliance practice. Since his launch of the practice in 2004, Alliance has helped life sciences companies optimize their revenue management environments by providing strategic guidance, automated solutions, advanced analytics, and operational support. This practice has successfully delivered these services to several leading biotechnology/specialty pharmacy manufacturers, as well as primary care pharmaceutical manufacturers both large and small.