Revenue Recognition Accounting Policy
Product net revenues consist principally of sales of prescription drugs to clients and members, either through Medco’s networks of contractually affiliated retail pharmacies or through Medco’s mail-order pharmacies. The majority of Medco’s product net revenues are derived on a fee-for-service basis. Medco’s product net revenues also include revenues from the sale of diabetes supplies by PolyMedica. Specialty pharmacy product net revenues represent revenues from the sale of primarily biopharmaceutical drugs and are reported at the net amount billed to third-party payors and patients. Medco recognizes product revenues when the prescriptions are dispensed through retail pharmacies in Medco’s networks of contractually affiliated retail pharmacies or Medco’s mail-order pharmacies and received by members and patients. Medco evaluates client contracts using the indicators of Authoritative Guidance to determine whether Medco acts as a principal or as an agent in the fulfillment of prescriptions through the retail pharmacy network. Medco acts as a principal in most of its transactions with clients and revenues are recognized at the prescription price (ingredient cost plus dispensing fee) negotiated with clients, including the portion of the price allocated by the client to be settled directly by the member (co-payment), as well as Medco’s administrative fees (“Gross Reporting”). Gross reporting is appropriate because Medco (a) has separate contractual relationships with clients and with pharmacies, (b) is responsible to validate and economically manage a claim through its claims adjudication process, (c) commits to set prescription prices for the pharmacy, including instructing the pharmacy as to how that price is to be settled (co-payment requirements), (d) manages the overall prescription drug relationship with the patients, who are members of clients’ plans, and (e) has credit risk for the price due from the client. In limited instances where Medco adjudicates prescriptions at pharmacies that are under contract directly with the client and there are no financial risks to Medco, such revenue is recorded at the amount of the administrative fee earned by Medco for processing the claim.
Medco’s product net revenues also include premiums associated with Medco’s Medicare PDP risk-based product offerings. These products involve prescription dispensing for beneficiaries enrolled in the CMS-sponsored Medicare Part D prescription drug benefit. Medco’s two insurance company subsidiaries have been operating under contracts with CMS since 2006, and currently offer several Medicare PDP options. The products involve underwriting the benefit, charging enrollees applicable premiums, providing covered prescription drugs and administering the benefit as filed with CMS. Medco provides two Medicare drug benefit plan options for beneficiaries, including a “standard Part D” benefit plan as mandated by statute, and a benefit plan with enhanced coverage that exceeds the standard Part D benefit plan, available for an additional premium. Medco also offers numerous customized benefit plan designs to employer group retiree plans under the Medicare Part D prescription drug benefit.
The PDP premiums are determined based on Medco’s annual bid and related contractual arrangements with CMS. The PDP premiums are primarily comprised of amounts received from CMS as part of a direct subsidy and an additional subsidy from CMS for low-income member premiums, as well as premium payments received from members. These premiums are recognized ratably to product net revenues over the period in which members are entitled to receive benefits. Premiums received in advance of the applicable benefit period are deferred and recorded in accrued expenses and other current liabilities on the consolidated balance sheets. There is a possibility that the annual costs of drugs may be higher or lower than premium revenues. As a result, CMS provides a risk corridor adjustment for the standard drug benefit that compares Medco’s actual annual drug costs incurred to the targeted premiums in Medco’s CMS-approved bid. Based on specific collars in the risk corridor, Medco will receive from CMS additional premium amounts or be required to refund to CMS previously received premium amounts. Medco calculates the risk corridor adjustment on a quarterly basis based on drug cost experience to date and records an adjustment to product net revenues with a corresponding account receivable from or payable to CMS reflected on the consolidated balance sheets.
In addition to PDP premiums, there are certain co-payments and deductibles (the “cost share”) due by members based on prescription orders by those members, some of which are subsidized by CMS in cases of low-income membership. For subsidies received in advance, the amount is deferred and recorded in accrued expenses and other current liabilities on the consolidated balance sheets. If there is cost share due from members or CMS, the amount is accrued and recorded in client accounts receivable, net, on the consolidated balance sheets. After the end of the contract year and based on actual annual drug costs incurred, cost share amounts are reconciled with CMS and the corresponding receivable or payable is settled. The cost share is treated consistently as other co-payments derived from providing PBM services, as a component of product net revenues on the consolidated statements of income. Premium revenues for Medco's PDP products, which exclude member cost share, were $687 million, or 1% of total net revenues, in 2010, $543 million, or less than 1% of total net revenues, in 2009, and $317 million, or less than 1% of total net revenues, in 2008.
Medco’s agreements with CMS, as well as applicable Medicare Part D regulations and federal and state laws, require Medco to, among other obligations: (i) comply with certain disclosure, filing, record-keeping and marketing rules; (ii) operate quality assurance, drug utilization management and medication therapy management programs; (iii) support e-prescribing initiatives; (iv) implement grievance, appeals and formulary exception processes; (v) comply with payment protocols, which include the return of overpayments to CMS and, in certain circumstances, coordination with state pharmacy assistance programs; (vi) use approved networks and formularies, and provide access to such networks to any willing pharmacy; (vii) provide emergency out-of-network coverage; and (viii) adopt a comprehensive Medicare and Fraud, Waste and Abuse compliance program. Medco has various contractual and regulatory compliance requirements associated with participating in Medicare Part D. Similar to Medco’s requirements with other clients, Medco’s policies and practices associated with executing its PDP are subject to audit. If material contractual or regulatory non-compliance was to be identified, monetary penalties and/or applicable sanctions, including suspension of enrollment and marketing or debarment from participation in Medicare programs, may be imposed. Additionally, each calendar year, payment will vary based on the annual benchmark that applies as a result of Medicare Part D plan bids for the applicable year, as well as for changes in the CMS methodology for calculating risk adjustment factors.
Rebates and guarantees regarding the level of service Medco will provide to the client or member or the minimum level of rebates or discounts the client will receive are deducted from product net revenues as they are earned by the client. Rebates are generally credited or paid to clients subsequent to collections from pharmaceutical manufacturers, although there are certain instances where rebates are paid to clients on a more accelerated basis. Other contractual payments made to clients are generally made upon initiation of contracts as implementation allowances, which may, for example, be designated by clients as funding for their costs to transition their plans to Medco. Medco considers these payments to be an integral part of Medco’s pricing of a contract and believes that they represent variability in the timing of cash flows that does not change the underlying economics of the contract. Accordingly, these payments are capitalized and amortized as a reduction of product net revenues, generally on a straight-line basis, over the life of the contract where the payments are refundable upon cancellation of the contract or relate to noncancelable contracts. Amounts capitalized are assessed periodically for recoverability based on the profitability of the contract.
Service revenues consist principally of administrative fees and clinical program fees earned from clients, sales of prescription services to pharmaceutical manufacturers, performance-oriented fees paid by Specialty Pharmacy manufacturers, revenues from data analytics and research associated with the September 2010 acquisition of UBC, and other non-product-related revenues. Service revenues are recorded by Medco when performance occurs and collectibility is assured.
Source: Medco Health Solutions Inc., Annual Report
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