Navigating the Pharmacy Benefits chcf Marketplace January 2003 Navigating the Pharmacy Benefits Marketplace Prepared for CALIFORNIA HEALTHCARE FOUNDATION by Mercer Human Resource Consulting chcf January 2003 Acknowledgments Mercer Human Resource Consulting helps clients understand, develop, implement and quantify the effectiveness of their human resource programs and policies. Our goal is to help employers create measurable business results through their people. Mercer Human Resource Consulting is a leading global consulting firm with more than 13,000 employees in some 140 cities and 40 countries. Mercer consultants work with clients to address a broad array of their most important human resource issues, both domestically and globally. This report was developed by consultants in Mercer’s Health Care & Group Benefits Consulting Practice. Employers and other plan sponsors look to Mercer as the world’s leader in the design, funding and delivery of group benefit plans, in general, and pharmacy benefits, in particular. About the Foundation The California HealthCare Foundation, based in Oakland, is an independent philanthropy committed to improving California’s health care delivery and financing systems. Formed in 1996, our goal is to ensure that all Californians have access to affordable, quality health care. CHCF’s work focuses on informing health policy decisions, advancing efficient business practices, improving the quality and efficiency of care delivery, and promoting informed health care and coverage decisions. CHCF commissions research and analysis, publishes and disseminates information, convenes stakeholders, and funds development of programs and models aimed at improving the health care delivery and financing systems. Additional copies of this report and other publications can be obtained by calling the California HealthCare Foundation’s publications line at 1-888-430-CHCF (2423) or visiting us online at www.chcf.org. ISBN 1-932064-19-2 Copyright © 2003 California HealthCare Foundation Contents 4 Executive Summary 9 I. Scope of This Report Research Materials and Methods 11 II. Who Pays for Prescription Drugs? Variations in Pharmaceutical Pricing Pricing for Public Programs Pricing for Private Plan Sponsors — Employers and Health Plans 17 III. Pricing for Private Insurers: The Flow of Money 20 IV. Pharmaceutical Manufacturers How Manufacturers and Wholesalers Determine Prices 22 V. Wholesalers 24 VI. Pharmacies Retail Pharmacies Mail-Order Pharmacies Other Pharmacies 30 VII. Pharmacy Benefit Administrators Pharmacy Benefit Managers Health Plans Third-Party Administrators 34 VIII. How Employer Plan Sponsors Can Contain Costs To Carve in or Carve Out Risk Sharing Cost Sharing Benefit Design Collective Purchasing 38 IX. An Evolving Marketplace 39 Glossary 40 Endnotes Executive Summary WITH PHARMACEUTICAL PRICES CONTINUING TO climb, cost containment will likely remain a priority for spon- sors of medical plans containing pharmacy benefits. This report is intended to help plan sponsors navigate the complex and often confusing financial arrangements that determine the ultimate cost of pharmacy benefits to employers and consumers. The report explores the multitude of forces that influence pricing — from legislation and market dynamics to the flow of money and interactions among pharmaceutical manufacturers, pharmacies, pharmacy benefit administrators, employers, and consumers. Who Pays for Prescription Drugs? There are considerable variations in pricing among the major purchasers of pharmaceuticals, not only between public and private purchasers, but also among private purchasers. Public purchasers for prescription drugs provide a variety of programs for low-income and elderly patients; veterans; mem- bers of armed forces; and federal, state, and local government employees. While public outpatient prescription drug expendi- tures constitute only about 2 percent of total U.S. health expenditures,1 the federal government exerts far more influence on pricing than do either the private sector large purchasers or individuals. In general, public programs experience the greatest level of savings off the original list price for prescription drugs because they possess tremendous concentrated purchasing power, and because legislation mandates that pharmaceutical manufacturers offer their lowest prices to public programs. For example, if a pharmaceutical manufacturer discounts a price to a particular managed care organization, then the manufacturer is legally obligated to offer that “best price” or a lower one to the entire Medicaid system nationwide. Private purchasers include health plans and pharmacy benefit managers purchasing on behalf of employers. While private spending accounts for the largest proportion of total U.S. pharmaceutical expenditures, large private purchasers enjoy less of the concentrated purchasing power and none of the favorable legislation of public programs. Consequently they have less clout than public purchasers. 4 | CALIFORNIA HEALTHCARE FOUNDATION Consumers purchase drugs from pharmacies at Pharmacies retail drugstores or by mail. Consumers who Of the money spent for prescription drugs, 64 have insurance coverage and those who are eligi- percent is channeled through retail pharmacies ble for government programs (such as Medicaid) (chains, independent pharmacies, and pharmacies typically pay less than consumers who do not within food stores); 24 percent through medical have such coverage. facilities (hospitals, nursing homes, clinics, home The act of filling a prescription represents the health care, and federal facilities); and 12 percent end point of a complex, multistage transaction through mail-order sales.2 chain that determines the ultimate cost of pharmacy benefit programs to employer plan Retail Pharmacies sponsors and consumers. This report tracks the The four largest drugstore chains account for more financial arrangements and relationships among than 60 percent of the retail pharmacy market the key players involved in purchasing share today, compared to less than 25 percent in prescription drugs. 1996.3 Some large national or regional retail chains (including pharmacy, supermarket, and mass merchandiser chains) purchase drugs in large Manufacturers and Wholesalers enough volumes so that they can bypass the Manufacturers establish a wholesale acquisition wholesaler and buy directly from the manufac- cost (WAC) as a baseline for sales to wholesalers. turer. Manufacturers offer these pharmacies both The price wholesalers pay to manufacturers for up-front discounts for purchasing their products any given product can fluctuate with the quantity and “back-end” discounts (formulary rebates) purchased. For instance, the manufacturer may for selling specific volumes of certain drugs or quote a wholesaler a price close to WAC, but this achieving a certain share of a specified market. price does not take into account volume dis- counts that occur in actual sales to wholesalers. Smaller retail entities, such as independent retail pharmacies and regional retail chains, purchase Wholesale prices are also related to public directly from wholesalers or join group purchasing program prices. Using records supplied by organizations (GPOs) in order to leverage their manufacturers of their sales to wholesalers, the combined purchasing power and negotiate Centers for Medicare and Medicaid Services discount pricing from wholesalers or even (CMS, formerly HCFA) calculate the average manufacturers. Some of these groups further manufacturer’s price (AMP) on a quarterly basis reduce their costs through direct rebate deals for all drugs. AMP is the benchmark used in offered by manufacturers. determining the Medicaid “best price,” but it is not made available to private payers, making it To obtain reimbursement from private payers, and difficult for private payers to assess the differences to have access to a greater number of customers, between AMP and WAC. retail pharmacies contract with pharmacy benefit administrators, including pharmacy benefit mana- gers (PBMs) and health plans, to join a pharmacy network — a group of independent pharmacies and pharmacy chains where members of a benefit plan have to go to get their prescriptions filled, usually for a lower cost per prescription. To be included in such a payer’s network, retail pharmacies are required to offer a guaranteed Navigating the Pharmacy Benefits Marketplace | 5 reimbursement formula for prescription drugs on its size and other factors, a PBM may perform purchased through the benefit plan. This formula some or all of the following functions: specifies how the pharmacy will calculate the cost ■ Purchase and dispense medications. Major of the drug and the dispensing fee. PBMs purchase pharmaceuticals for their mail-order pharmacies and dispense medica- Mail-Order Pharmacies tions directly to consumers. They negotiate Mail-order pharmacies, most of which are owned both purchasing agreements and rebate and operated by PBMs, are popular with employer contracts with manufacturers for the products plan sponsors, 87 percent of whom offered mail they dispense. service in 2001.4 Mail-order pharmacies can be ■ Pay claims. more cost-effective than retail pharmacies, yielding greater discounts and lower dispensing fees. By ■ Act as a financial intermediary between consolidating purchasing from consumers across pharmacies and the plan sponsor, negotiating the country, mail-order facilities can buy pharma- with retail pharmacies to contract reimburse- ceuticals in bulk and can economically dispense ment levels for prescriptions filled by plan large quantities through automated processes. members. They often create and maintain Also, mail-order pharmacists usually have a greater pharmacy networks. opportunity than retail pharmacists to focus on ■ Manage prescribing choices. PBMs can utilization management efforts and interchange influence which drugs are ultimately dispensed therapeutically equivalent products, which can at retail and mail order. They do this by significantly reduce the cost of prescriptions. developing formulary management, health and disease management, therapeutic inter- Mail-order dispensing also has the advantage change, and other education programs that of having a higher rate of correctly filled inform physicians and consumers about prescriptions than retail dispensing, because preferred drugs. mail-order pharmacies have largely automated the prescription filling process, which has led ■ Create and maintain pharmacy networks. to greater accuracy. PBMs use their relatively large customer base and ability to influence physician prescribing patterns and consumer preferences as a negotiating tool Pharmacy Benefit Administrators with manufacturers to secure formulary rebates. To administer their prescription drug benefits The U.S. Department of Health and Human program, employer plan sponsors usually Services estimates that PBMs receive direct rebates contract the services of an outside organization from manufacturers ranging from 2 to 35 percent such as a PBM, health plan, or third-party of brand-name drug sales prices and pass on administrator (TPA). about 70 to 90 percent of these direct rebates to insurers or self-insured employers.6 Pharmacy Benefit Managers PBMs are independent specialty administrators; Health Plans they focus on administering pharmacy benefits, Health plans employ varying strategies to manage and managing the purchasing, dispensing, and pharmacy benefits. They include: reimbursing of prescription drugs. About 45 ■ Outsourcing claims payments. percent of the U.S. population has pharmacy coverage provided directly by a PBM.5 Depending ■ Outsourcing elements of pharmacy benefit management. 6 | CALIFORNIA HEALTHCARE FOUNDATION ■ Outsourcing pharmacy benefit management How Plan Sponsors completely to an outside PBM. Can Manage Costs ■ Owning and operating a PBM. Certain large While employers have little control over some health care plans with national or regional of the factors that determine how much the scope employ this strategy. Health plan pharmacy benefit ultimately costs, some factors PBMs typically provide service to the health can be influenced. Employers can use their plan exclusively. influence to their best advantage by carefully ■ Operating pharmacies within their outpatient evaluating the following key decisions. clinics. Some organizations with a high degree Will the benefit be administered by a health of care management, such as group-model plan or will it be managed separately by a managed care organizations (MCOs) like PBM? A health plan offers the potential for an Kaiser Permanente, offer this service. integrated health care approach, although the Most health plans have some clinical/formulary level of integrated care varies significantly among management programs that can influence health plans. While health plans can and do offer product preference in the treatment of a a range of PBM-related services, PBMs are more particular medical condition. HMOs exert likely to offer discounts and guarantees on rebate considerable control through both provider payments, provide a wider range of formulary education and plan design, including the use options, and allow the plan sponsor greater of formularies. In 1999, about 97 percent of ability to customize the program. HMOs relied on some type of formulary.7 Will the employer purchase an insured In MCOs (including HMOs) formulary pharmacy benefit, or assume financial risk compliance is generally high — approximately and self-insure? While an insured benefit 90 percent of members’ prescriptions are filled transfers the risk for the pharmacy benefit from with formulary drugs8 because (1) participating the employer to the PBM, self-insuring provides physicians agree to enforce the MCO’s utilization more opportunity to offer input on how the management programs; (2) the plan generally benefit is structured and more often allows for does not cover brand medications when generic the possibility of rebates from manufacturers. equivalents are available; and (3) the plan generally For small plan sponsors, self-insuring may pose does not cover off-formulary brand medications. too great a financial risk. These high formulary compliance rates spur What portion of the cost of prescription drugs manufacturers to offer rebate incentives in order will the employer absorb? This will vary by to successfully negotiate a place for their products employer, but can be controlled by the design of on the MCO’s formulary. the benefit plan — including how the employee’s share of the drug cost is structured (such as flat Third-Party Administrators dollar co-pay, tiered pricing, coinsurance); the Third-party administrators engage in primarily formulary (which drugs are covered); and the administrative functions; they process pharmacy actual plan design in place (for example, two-tier claims, but have no influence over what the retail versus three-tier). Employers can choose to absorb pharmacy charges, or what is dispensed. Plan anywhere from the full cost of prescription drugs sponsors rarely use TPAs to process pharmaceu- to none of the cost. tical claims without PBM support. It implies this could be a more expensive way to offer pharmacy benefits to employees. Navigating the Pharmacy Benefits Marketplace | 7 How much influence will the employer plan sponsors have over which drugs are covered in the benefit? Manufacturers’ discounts and rebates are available to plan sponsors willing to allow their PBM or other pharmacy benefit administrator to educate physicians and consu- mers about preferred drugs. This is accomplished through plan design and formulary management. Will the employer engage in collective purchasing? An employer can realize the bene- fits of collective purchasing by (1) consolidating its benefit plans with a single provider so that the sum total represents a larger group, and (2) joining together with other employers in group purchasing coalitions to collectively negotiate for even better financial as well as service arrangements. 8 | CALIFORNIA HEALTHCARE FOUNDATION I. Scope of This Report THE COST OF PROVIDING PHARMACY BENEFITS has risen significantly during the last decade, surpassing the cost increases experienced by employers for any other category of medical services. Figure 1. Pharmacy Benefit Cost Increases Continue to Outpace Overall Medical Trend Rates Rx Medical 20% 17.5 15% 16.8 15.2 10% 11.5 11.2 8.1 7.3 5% 6.2 0% 1998 1999 2000 2001 Source: Mercer/Foster Higgins National Survey of Employer-Sponsored Health Plans 1998-2001 Newer drugs are often more expensive than the ones they replace, and the utilization of drugs is growing dramatically. Multiple drugs are more often used to treat single conditions, and there is a burgeoning emphasis on using pharmaceuticals in preventive care and chronic disease management. As the growing elderly population and the emergence of new drugs to treat previously untreatable conditions continue to drive up the cost of pharmacy benefits, cost containment will likely remain a priority for prescription drug plan sponsors. In providing pharmacy benefits, an employer’s primary challenge is to secure the best pricing for the most appropriate mix of drugs and services for its employee population. Given the varied interests of the stakeholders and the sometimes complex turns and twists that characterize the flow of money and interactions through the pharmaceutical marketplace, this is no easy task. Navigating the Pharmacy Benefits Marketplace | 9 This report attempts to demystify the pricing Research Materials and Methods process by describing the following variables: Information for this report was gathered from ■ How pricing strategies vary in different sectors both primary and secondary sources. of the pharmaceutical marketplace; Primary information came largely from an ■ What principles are at work in determining extensive database of financial arrangements pricing for various purchasers; negotiated by Mercer on behalf of employer plan ■ What direct and indirect forces influence the sponsor clients with PBMs and health plans. ultimate cost of the pharmacy benefit to the Additional data were derived from Mercer’s work employer and consumer; and with pharmaceutical manufacturers to define ■ What roles and complex relationships exist the value proposition of pharmaceutical therapy among the major players in the pharmaceutical versus the cost of the prescription drug. distribution chain. Secondary sources include published articles and Employers can use this information to negotiate studies about the flow of money in the pharma- the most appropriate and cost-effective pharma- ceutical market from a variety of viewpoints. ceutical services and products. Some of these analyze or observe trends in the prescription drug industry (for example, Standard & Poor’s, PhRMA publications, and Kaiser Family Foundation’s “Prescription Drug Trends”). Others reflect a strong constituent position (for example, Human Resource Executive). To ensure that the report reflected broad-based viewpoints from all pharmaceutical market segments, we asked a spectrum of stakeholders to review it and made revisions based on their comments. Reviewers included representatives from brand-name and generic pharmaceutical companies, retail and mail-order pharmacies, PBMs, and California-based health plans, as well as industry experts. 10 | CALIFORNIA HEALTHCARE FOUNDATION II. Who Pays for Prescription Drugs? Public programs’ legislatively WITHIN THE PHARMACEUTICAL MARKETPLACE, A number of purchasers are involved in the complex flow of mandated prices influence the money and interactions that ultimately determine prescription prices that manufacturers drug prices. Each of these purchasers represents or serves a charge private purchasers. particular population or group of consumers. At the most basic level, prescription drug expenditures are funded by either private or public sources. Of the total U.S. expenditures of $99.6 billion on outpatient prescription drugs in 2000, approxi- mately 78 percent was privately funded and 22 percent was publicly funded.9 Variations in Pharmaceutical Pricing There are considerable variations in pharmaceutical pricing, not only between private and public purchasers, but also among the various private purchasers. These pricing differentials result from the interacting influences of government regulation, marketplace dynamics, and purchasing decisions. Public Purchasers Public funding for prescription drugs covers consumers participating in federal, state, and local public programs. The federal government funds multiple programs including the Department of Veterans Affairs, Department of Defense (DOD), the Coast Guard, and Medicaid (Medi-Cal in California). State and local governments sponsor programs that supplement or expand the federal programs for low- income or elderly persons. Federal and some state legislation mandates that pharma- ceutical manufacturers offer their lowest prices to public programs. The net cost for public programs is determined by a combination of legislatively mandated discounts and rebates. These legislatively mandated prices can impact the prices charged to private purchasers. Private Purchasers A large proportion of prescription drug spending is made by what might be termed “private purchasers,” or pharmacy benefit plan sponsors. These benefit plan sponsors, who pay for part or all of the cost of prescription drugs for their covered beneficiaries, include employers and health plans. Most of Navigating the Pharmacy Benefits Marketplace | 11 these plan sponsors purchase prescription drugs include both those with no prescription drug through pharmacy benefit administrators (either coverage and those who are covered by traditional health plans or pharmacy benefit management indemnity plans and must pay the full amount at companies (PBMs)) who negotiate discounts the pharmacy and later be reimbursed. Although with retail pharmacies and rebates from drug there are limited data on prescription drug manufacturers. The vast majority of such expenditures by cash-paying consumers, recent purchases tend to be outpatient drugs. estimates suggest these consumers account for approximately 21 percent of private prescription While spending by private plan sponsors drug expenditures at retail pharmacies (excluding accounts for a larger proportion of total U.S. mail order).10 pharmaceutical expenditures than public spending, these plan sponsors, lacking the Cash-paying consumers have limited, if any, favorable legislation of public programs, tend ability to negotiate for better pricing. They may to have less clout than public purchasers. comparison shop among a number of retail pharmacies and Internet pharmacy sites or join Consumers Who Make discount card programs, but still tend to pay Out-of-Pocket Payments the highest net prices of any purchasers for their There are primarily two types of consumer: prescriptions. those who have some type of pharmacy benefit Figure 2 illustrates the magnitude of cost differ- coverage and pay a portion of the cost of a drug entials among the different classes of prescription (copayment, coinsurance, deductible), and those drug purchasers. In general, public programs who have no coverage and pay the entire cost experience the greatest level of savings off the of the prescription drug at the retail pharmacy. original list price, although the cost to Medicaid Sometimes referred to as “cash-paying consumers,” is somewhat higher than for other public many of these individuals without insurance programs. MCOs, hospitals, PBMs, and other coverage are seniors who are eligible for Medicare. insurers pay a higher manufacturer price for Data collected on this type of consumer typically prescription drugs than do the public programs. Figure 2. Cost Differentials among Different Classes of Prescription Drug Purchasers 50 Federal Supply Schedule 50 Medicaid List Price (AWP) 50 Insurer/PBM 50 Cash Customer 24 40 Initial Price from Manufacturer 40 40 24 34 Net Purchase Price 37 52 $0 $10 $20 $30 $40 $50 $60 Source: Estimates based on Report to the President: Prescription Drug Coverage, Spending, Utilization, and Prices. Department of Health and Human Services, April 2000. 12 | CALIFORNIA HEALTHCARE FOUNDATION A closer look at how drug prices are determined Medicaid for each of these purchasing groups will enable Of all the public programs, Medicaid may have employer plan sponsors to understand some of the most significant impact on prescription drug the dynamics of pharmaceutical pricing and the pricing. This program, jointly financed through extent to which employer plan sponsors and federal and state funds, is designed to aid certain private insurers indirectly influence pricing for low-income people, and covers more than 36 private purchasers. million individuals. Pricing for Public Programs As previously noted, public (government) In the years after the Medicaid outpatient prescription drug expenditures best-price regulation took effect, constitute a relatively small proportion of total discounts beyond the specified U.S. health care expenditures. There are two primary reasons that the government exerts 15.1 percent to any entity, public far more influence on pricing than do other or private, became less generous prescription drug purchasers: and less common. 1. Legislation regulates the amount paid for prescriptions under public programs. 2. Public purchasers can realize greater Pharmaceutical pricing for the Medicaid drug economies of scale because of the size rebate program is primarily regulated through the of the populations they include. Omnibus Budget Reconciliation Act (OBRA) of Unlike many other countries around the world, the 1990. OBRA 1990 is administered by the Centers United States does not impose price controls on for Medicare and Medicaid Services (CMS, pharmaceutical products. Manufacturers are free formerly HCFA) an agency within the federal to price their products as they see fit, seemingly Department of Health and Human Services constrained only by the demand for each particular (HHS). OBRA 1990 specifies that pharmaceu- product. However, legislation mandates discount tical manufacturers whose products are listed on levels for prescription drugs in order for them to the Medicaid formulary must give state Medicaid be covered under the public programs. programs the lesser of: The following is a brief overview of the public ■ The “best price” offered to any purchasing programs that fund prescription drugs. For a entity, including wholesalers, retailers, more detailed analysis, see von Oehsen’s nonprofit entities, or governmental entities “Pharmaceutical Discounts Under Federal within the states (but excluding specific Law: State Program Opportunities.”11 federal agencies), OR ■ The average manufacturer price (AMP) charged to wholesalers with a 15.1 percent discount for brand drugs or an 11 percent discount for generic drugs. Navigating the Pharmacy Benefits Marketplace | 13 Regulations Governing Pharmaceutical Pricing for Non-Medicaid Public Programs Section 340B FSS prices are typically more deeply discounted Enacted in 1992, Section 340B of the Public than even Medicaid best prices because manu- Health Service Act requires pharmaceutical facturers and wholesalers can offer prices for manufacturers to provide reduced price the FSS list without considering the Medicaid outpatient drugs to eligible federally funded best price. This creates a critical advantage for grantees, including federally qualified health the VA in its negotiations with pharmaceutical centers, safety net hospitals, and clinics. The manufacturers. statute sets the maximum price that cannot be exceeded for certain outpatient and over- Section 603 and the “Big Four” the-counter drugs, called the ceiling price. Section 603 also mandates minimum drug The ceiling price must be at least as low as discounts for the “big four” federal agencies the price that state Medicaid programs pay that procure pharmaceuticals: VA, DOD, (lower prices may be negotiated). According portions of HHS, and the Coast Guard. Even to recent information available from the Office though these agencies benefit from FFS of Pharmacy Affairs, there are more than pricing, Section 603 sets a minimum discount 8,600 eligible covered facilities participating to protect these purchasers from large fluctua- in the 340B program.* tions that can occur in prices on the FSS schedule. This price cap is set at 24 percent Section 603 and the Federal less than AMP to nonfederal purchasers (also Supply Schedule known as non-FAMP, the nonfederal average The federal supply schedule (FSS) is a list of manufacturer’s price is the weighted average prices that assists federal departments, of the prices paid by all wholesalers and the agencies, and institutions in purchasing specific lower prices paid by manufacturers’ largest products and services. Individual agencies can purchasers). These prices reflect manufacturers’ take advantage of public programs’ combined discounts and rebates, but exclude the purchasing power to extract greater discounts discounted prices paid by the VA and other from various suppliers, including pharmaceutical federal agencies, and rebates paid to state manufacturers. The VA is in charge of collective Medicaid programs. The manufacturer faces pharmaceutical purchasing; it negotiates, a penalty if the non-FAMP rises faster than awards, administers, and maintains contracts inflation (as measured by the consumer price under two VA federal supply schedule programs index). As with the federal supply schedule, for pharmaceuticals.† The VA negotiates with pharmaceutical manufacturers must agree to each manufacturer for its "most favored custo- these price caps for the “big four” in order mer" price, which is a discount equal to or to be a supplier to Medicaid programs.‡ greater than what that manufacturer currently * Health Resources and Services Administration, Office of offers a comparable customer. Pharmacy Affairs (http://www.hrsa.gov/odpp) † “How the Medicaid Rebate on Prescription Drugs Affects Section 603 of the Veterans Health Care Act of Pricing in the Pharmacy Industry,” Congressional Budget 1992 makes participation in FSS a requirement Office Papers, January 1996. for manufacturers who wish to participate in ‡ The Federal Supply Service the Medicaid program. Other rules require any (http://www.fss.gsa.gov/aboutUs.cfm) manufacturer wishing to contract with the VA to disclose discounts and pricing information for other customers. This allows the VA to analyze and compare pricing and to target particular drugs for negotiation. 14 | CALIFORNIA HEALTHCARE FOUNDATION OBRA 1990 legally obligates participating program’s immense purchasing power creates a pharmaceutical manufacturers to give the Medicaid compelling incentive for participating manufac- program the best price available in the private turers to conform to the best price regulations; marketplace. In other words, if a pharmaceutical otherwise they will be barred from all Medicaid company discounts a price to a particular MCO programs — that is, their products will not be or other insurer, it is mandated to offer that price listed on, or covered by, the Medicaid formularies or lower to all Medicaid programs nationwide. nationwide. While specific information on AMP is not available, reports from the Congressional Budget If a pharmaceutical company Office have shown that in the years after the discounts a price to a particular Medicaid best price regulation took effect, discounts beyond the specified 15.1 percent to any entity, insurer, it has to offer that price or public or private, became less generous and less a lower one to the entire Medicaid common.13 Discounts to private purchasers that were on average the equivalent of 36 percent off system nationwide. AMP in 1991 diminished to 19 percent in 1994.14 The reduction is understandable from the manu- facturers’ point of view: If discounts in excess The price paid by a state Medicaid program is of 15.1 percent are given to any commercial not determined at the time the prescription is purchasers, a commensurate discount must be filled. The final cost of the prescription drug given to Medicaid purchasers. is determined retroactively on a quarterly basis. After OBRA 1990, when non-Medicaid discounts Manufacturers are legally required to supply became less generous, pharmaceutical costs went CMS with records of the prices charged to whole- up for other government purchasers as well as salers, and using these records, CMS computes private purchasers. A cascade of legislation ensued. the average manufacturer price (AMP) for all The resulting regulations specified that in order for drugs. The state Medicaid programs pay the a pharmaceutical manufacturer to participate in pharmaceutical manufacturer for the cost of the Medicaid programs, the manufacturer must agree medication, taking into account both the up- to the legislatively mandated price specified for the front discounts offered by the manufacturers other governmental programs, which are generally and rebates “owed” on the basis of the volume at least as low as the Medicaid best price. of medications sold to Medicaid participants. These rebates help bring the costs down to the level specified by OBRA 1990. The final price that Medicaid pays the manufac- turer remains confidential. Information about AMP is not publicly available, so a private plan sponsor cannot determine how its pricing compares to best price. Forty-nine states and the District of Columbia cover drugs under the Medicaid program and approximately 520 pharmaceutical companies participate in this program.12 The Medicaid Navigating the Pharmacy Benefits Marketplace | 15 Pricing for Private Plan Sponsors: Employers and Health Plans The purchasing experience is more complex Private plan sponsors typically for private plan sponsors than for government entities. The price paid by public programs is do not have the same access legislatively mandated and directly negotiated to pricing information as with the manufacturer, whereas the price paid by the private plan sponsor is a combination government purchasers. of discounts, fees, and rebates negotiated with intermediaries (such as PBMs and health plans). Moreover, private plan sponsors typically do not have the same access to pricing information as government purchasers. Later sections of this report explain the intertwined relationships and transactions that ultimately determine the employer’s net cost for pharmaceuticals. 16 | CALIFORNIA HEALTHCARE FOUNDATION III. Pricing for Private Insurers: The Flow of Money Securing the best pricing for A PRESCRIPTION DRUG GETS FROM THE pharmaceutical manufacturer to the privately insured the right goods and services individual via a multifaceted distribution and pricing system can be a daunting task for the and a range of stakeholders. The complex relationships among employer in a pharmaceutical key players in this multistage transaction chain directly and indirectly determine the ultimate cost of the prescription drug marketplace where the price to employers and consumers. determination process is less The distribution of products through the pharmaceutical chain transparent than that for to the consumer is generally carried out by manufacturers, wholesale distributors, and pharmacies. The key players in the other employee benefits. pharmaceutical marketplace can be seen in Figure 3. Figure 3. Pharmaceutical Product Flow Source: Market share estimates based on data from IMS Health, 2001. Navigating the Pharmacy Benefits Marketplace | 17 While the flow of products through the pharma- Because of the number of players involved in the ceutical chain is relatively straightforward, the flow of money, the price paid to the pharmaceu- flow of money involves a wider range of players tical manufacturer for a given drug is rarely the and complex financial relationships (see Figure 4). same as the price paid by the consumer. In 2001, the average estimated retail prescription cost of Figure 4. Pharmaceutical Money Flow: Carve In 18 | CALIFORNIA HEALTHCARE FOUNDATION a drug to the consumer was $50.17. Of this prescription dollar sale at a retail pharmacy, amount, the manufacturer received $37.93; the 76 percent went to the manufacturer, 3 percent wholesaler received $1.67; and the retail phar- went to the wholesaler, and 21 percent went to macy received $10.57. In other words, for every the pharmacy.15 Figure 5. Pharmaceutical Money Flow: PBM Carve Out Navigating the Pharmacy Benefits Marketplace | 19 IV. Pharmaceutical Manufacturers PHARMACEUTICAL MANUFACTURERS HAVE BEEN under increasing scrutiny as the cost of prescriptions drugs continues to rise and consume a greater share of the U.S. health care dollar. In 2000, according to IMS, U.S. prescription drug sales (based on wholesale prices) totaled $145 billion, an increase of 15 percent from the previous year.16 The pharmaceu- tical industry points to demographic changes in the population and the rapid introduction of life-extending medications and procedures as the primary reasons for this increase. Increased utilization accounts for approximately 9 percent; price increases for 4 percent; and new medicines for 2 percent of the rise in prescription drug costs.17 Pharmaceutical manufacturers fulfill various roles, including In 2000, U.S. prescription (1) research and development of new drug therapies, (2) drug sales totaled $145 manufacturing products, and (3) marketing to inform the medical community and consumers. Not all pharmaceutical billion, an increase of manufacturers assume all these roles. A number of lesser- 15 percent from the known companies do not develop new therapies, but instead previous year. manufacture generic compounds — drugs that are no longer protected by patents. After a drug’s patent has expired, generic versions of the same compound can be introduced into the market to compete with the original branded version. The pharmaceutical industry maintains that development costs are the key drivers of escalating prices for patented prescription drugs. The Tufts Center for the Study of Drug Development estimates that the average cost of developing a new drug is $802 million.18 Another Tufts study reports that the time from initial drug creation to market approval has increased from around eight years in the 1960s to approxi- mately 14.2 years in the 1990s.19 Added to the high cost and increasing amount of time required to bring a drug to market is the fact that only a relatively small number of drugs ever attain commercial success. Manufacturers’ primary customers are wholesalers, retail pharmacy chains, mail-order pharmacies, hospital chains, and some health plans. Occasionally an employer with an on-site pharmacy will purchase drugs directly from the manufacturer, but the typical employer plan sponsor does not. Wholesalers are manufacturers’ largest group of purchasers, and wholesale prices depend partially on volume purchased. 20 | CALIFORNIA HEALTHCARE FOUNDATION Manufacturers offer up-front discounts to retail price; that is, the price that manufacturers pharmacies for purchasing their products, and recommend that wholesalers use to resell a drug rebates (back-end discounts) to wholesalers and to retail pharmacies.20 PBMs that sell specific volumes of certain drugs To complicate matters, wholesale prices are or achieve a target market. Purchasers who are indirectly related to public program prices; able to more closely manage the pharmacy benefit that is, WAC is loosely related to the average or influence the market share of a specific drug manufacturer’s price, the benchmark used to are likely to receive greater formulary rebates than determine the Medicaid “best price.” AMP is those who do not. the average price paid by wholesalers for a drug, as calculated quarterly by CMS with records How Manufacturers and supplied by manufacturers of their transactions Wholesalers Determine Prices with wholesalers. While this information is the Manufacturers and wholesalers use several pricing benchmark used in determining the price to standards to arrive at their pricing arrangements. governmental purchasers, it is not made available To develop introductory drug prices within the to private payers. This makes it difficult for United States, manufacturers use “employed private payers to assess the differences between financial modeling,” which takes into account AMP, AWP, and WAC. research and development costs, launch and marketing costs, competitor prices, and estimates of consumer and physician demand. Once an introductory price has been set, the manufacturer establishes a wholesale acquisition cost (WAC), which it uses as a baseline for sales to wholesalers. Purchasers who are able to manage the pharmacy benefit more closely or influence the market share of a specific drug are likely to receive greater formulary rebates than those who do not. In addition, the manufacturer establishes the benchmark price known as the average wholesale price (AWP), which is published in recognized sources such as FirstData Bank and its supple- ments or other nationally recognized pricing sources. Until recently, there has been no standardized definition of AWP. A commonly accepted one is the manufacturer’s suggested Navigating the Pharmacy Benefits Marketplace | 21 V. Wholesalers LIKE MOST OTHER TYPES OF WHOLESALERS, pharmaceutical wholesalers purchase goods from manufacturers and then resell them to other businesses. Wholesalers, whose main customers are retail and mail-order pharmacies, buy pharmaceuticals in bulk, sort them by customer needs, and disperse them in usable quantities, selling them at a profit. They offer their customers either a full line of pharmaceutical products or a narrow, more specialized line, such as oncology The top five wholesalers now drugs or biotech products. Some wholesalers sell to a wide account for approximately variety of customers; others distribute pharmaceutical products to a narrower customer base, such as physician offices or 90 percent of the entire diagnostic labs. wholesale drug market. Pharmaceutical wholesalers have undergone significant consolidation during the past 25 years, with the number of firms declining from approximately 200 in 1975 to fewer than 50 by 2000.21 The top five wholesalers now account for more than 90 percent of the entire wholesale drug market.22 While wholesalers have experienced lower operation margins over the past several years, larger wholesalers are in a better position to negotiate prices with manufacturers. Figure 6. Wholesalers’ Market Share, 2000 Others Bindley Western McKesson 6% HBOC, Inc. Drug Co. 9% 33% 11% AmeriSource Corp. 20% 21% Bergen Cardinal Brunswig Drug Co. Health, Inc. Source: Profile of the Prescription Drug Wholesaling Industry, Eastern Research Group, Inc., 2001 22 | CALIFORNIA HEALTHCARE FOUNDATION Although some of the largest drugstore chains find it more advantageous to assume the role of wholesaler for their own retail operations than to outsource that role, wholesalers continue to play an important role in the pharmaceutical distribu- tion chain. Their ability to buy drugs in large quantities creates efficiency in the marketplace that is reflected in the discounted pricing they receive. Wholesalers alleviate the need for manu- facturers to negotiate and distribute products to numerous pharmacies, and they pass along the savings of economy of scale to pharmacies by supplying smaller purchasers with products at a lower price than they would pay manufacturers. While wholesalers do not generally interact directly with employer plan sponsors, one major wholesaler, AmeriSourceBergen (formerly Bergen-Brunswig), has recently offered PBM- type services to employers. Whether or not this direct wholesaler-to-employer connection will provide additional savings to employer plan sponsors remains to be seen. Navigating the Pharmacy Benefits Marketplace | 23 VI. Pharmacies ALL PHARMACIES — INCLUDING RETAIL CHAINS, food stores, mass merchandisers such as Target and Wal-Mart, independently owned pharmacies, and mail-order facilities — play a pivotal role in the distribution chain. They fill prescrip- tions for consumers and serve as a link between prescription drug benefit administrators and manufacturers/wholesalers. Among their key functions, pharmacies: ■ Maintain adequate stock to provide products on an as-needed basis to consumers in a convenient way, ■ Provide meaningful information to consumers to ensure safe and effective use of prescription drugs, and ■ Facilitate billing and payment for consumers participating in group benefit plans. As Figure 7 shows, the majority of dollars spent for prescription drugs flow through retail pharmacies. In 2000, 64 percent of sales were channeled through retail pharmacies (chains, indepen- dent pharmacies, and food stores with pharmacies), 12 percent through mail-order sales, and 24 percent through medical facilities (hospitals, nursing homes, clinics, home health care, and a number of federal facilities).23 Figure 7. U.S. Prescription Market Share by Distribution Channel Home Healthcare (1%) HMOs (1%) Federal Facilities (1.5%) Prisons, Universities, Long Term Care (3%) etc. (0.5%) Mass 7% Merchandisers 8% 30% Clinics Chain Food Stores 9% 10% 17% Non-Federal 12% Hospitals Independent Mail Service Source: IMS Health, Retail and Provider Perspective™, 2002 24 | CALIFORNIA HEALTHCARE FOUNDATION Retail Pharmacies cost on to plan sponsors, these higher dispensing For many Americans, the local retail drugstore fees translate into potentially higher prescription remains the primary distribution channel for drug benefit costs for employers. prescription drugs, although other channels such as mail order are growing in popularity.24 Accord- ing to the National Association of Chain Drug Stores, there are approximately 50,000 retail pharmacies in the United States (20,000 are independent and 30,000 are operated by chains, One by-product of retail pharmacy supermarkets, and the like).25 consolidation may be less Retail pharmacy chains have merged to gain buy- competition among the retail ing power from manufacturers and wholesalers and to broaden and strengthen the regional pharmacies and potentially higher presence of their stores. In 2001, the top four costs for employer plan sponsors. drugstore chains accounted for 51 percent of market share compared to less than 25 percent in 1996.26 Retail pharmacies obtain prescription drugs from Figure 8. Market Concentration of Top Four manufacturers or wholesalers. Some large national Retail Chain Pharmacies or regional chains (including pharmacies, food stores, and mass merchandiser chains) purchase in large enough volumes that they can bypass the 40% wholesaler and buy directly from the manufacturer, negotiating discounts equivalent to those that a 30% 32.2 wholesaler would obtain from a manufacturer. 30.6 These organizations already have the operational 20% infrastructure necessary to bypass wholesalers — 21 such as warehousing facilities, distribution 10% vehicles, and inventory control systems. Smaller retail stores, such as independent retail 0% pharmacies and smaller retail chains, purchase 1996 1997 1998 directly from wholesalers or join group purchasing Source: Standard & Poor’s Industry Surveys: Supermarkets & Drugstores, Aug. 2, 2001 organizations. As members of a GPO, smaller and Prescription Drug Trends, Kaiser Family Foundation, July 2000 entities receive the benefits of volume purchasing by leveraging their combined purchasing power Ironically, one by-product of retail pharmacy to negotiate discount pricing from wholesalers or consolidation may be higher costs for employer even manufacturers. plan sponsors. As retail chains grow in size and Additionally, some retail pharmacies reduce their regional and national presence, many are able to costs through rebate deals for selling selected command higher dispensing fees (fees paid to the drugs or achieving market share targets for selected pharmacist for filling the prescription) as a condi- manufacturers’ drugs. These rebates provide an tion for continued participation in a PBM’s or incentive for pharmacists to switch interchangeable MCO’s network. As PBMs and MCOs pass the medications in favor of the one that has a rebate. Navigating the Pharmacy Benefits Marketplace | 25 Although rebate payments to pharmacists are This reimbursement formula specifies how the generally confined to prescriptions for cash- pharmacy will calculate the cost of the drug — paying customers, pharmacists sometimes use including the discount — and the dispensing fee. this substitution approach to fill prescriptions For a brand-name medication, the drug cost is from PBM and health plan members whose usually determined by subtracting a negotiated plans cover all medications. percentage from the drug’s AWP. For a generic While mail order may offer the same level of drug, reimbursement may be determined in the service, the opportunity to establish a personal same way as for a brand drug, but is more often relationship with a pharmacist is a priority to based on an amount specified as the maximum some consumers. allowable cost (MAC) per unit (such as tablet or capsule) dispensed. MAC Pricing Retail pharmacies offer consumers To stabilize the cost variance of different generic convenience and the opportunity to products of the same compound, pharmacy benefit administrators calculate a maximum establish a personal relationship allowable cost based upon the listed average with a pharmacist. wholesale prices of competing generic drug manufacturers. The resulting proprietary price list varies from PBM to PBM. CMS also issues a MAC list, but only for generic products that Retail pharmacies generally do not have the have three or more manufacturers or distributors economies of scale that large mail-order on the market. Because of this limitation, not pharmacies have; therefore their costs are higher all generics have a corresponding CMS MAC. than those of mail-order pharmacies. Retail PBMs often utilize this government issued MAC pharmacies can compete by offering a high as the basis of their MAC list and supplement it level of service and convenience to consumers. with other generic products. They may, for example, ■ Stock a large and varied inventory of Mail-Order Pharmacies pharmaceuticals at convenient locations; Mail-order pharmacies are typically available to ■ Offer an opportunity for face-to-face consumers whose plan sponsor includes them in consultations with pharmacists; and the benefit. Consumers send their prescriptions ■ Obtain payments from PBMs and by mail, fax, phone, or Internet to a central other payers. location where the prescriptions are filled and mailed back to the consumer. Mail-order To be included in a pharmacy benefit admini- pharmacies are popular with employer plan strator’s network, retail pharmacies are required sponsors, 87 percent of whom offered mail to offer a guaranteed reimbursement formula service in 2001.27 While the majority of mail- for prescription drugs purchased through the order facilities are owned and operated by PBMs, benefit plans. a number of retail pharmacy chains also own mail-order facilities. 26 | CALIFORNIA HEALTHCARE FOUNDATION Mail order is best suited for maintenance brand-name drug sales prices. PBMs pass on medications when treatment is predictable and about 70 to 90 percent of these rebates to medication can be ordered in advance of need. insurers or self-insured employers.28 Mail order is not appropriate for consumers Mail-order pharmacists can substitute generic or with acute conditions, such as an infection that less expensive brand medications for high-cost requires antibiotics, in which the treatment must brand medications more frequently than retail be started as soon as possible. pharmacies because the pharmacist has more time between when the prescription is received and when it is filled to contact the prescribing physician and request a change. The cost difference between the generic drug and the brand-name drug can lead to significant savings. Mail-order pharmacies are popular These factors combine to make mail-order with plan sponsors, 87 percent of pharmacies potentially more cost-effective than whom offered mail service in 2001. retail pharmacies. Industry sources with a stake in the mail-order business estimate that plan sponsors using a relatively high percentage of mail order can achieve approximately 10 percent Cost Savings in additional savings over retail.29 However, One of the advantages promoted by mail-order the cost-effectiveness of mail order relative to facilities is their dispensing accuracy. Because retail depends largely on the plan design — mail-order pharmacies have largely automated for example, the amount of copayments or the prescription filling process, they typically coinsurance — to ensure that the members’ cost operate with less than a .01 percent error rate. sharing properly reflects the larger prescriptions (for example, 90-days supply) at mail order. Mail-order pharmacies generally offer cost savings over retail pharmacies. By consolidating purchasing from consumers across the country, mail-order facilities can buy pharmaceuticals in According to some mail-order bulk and dispense them economically through providers, plan sponsors using a automated processes. As high-volume purchasers, these pharmacies can choose the most cost- relatively high percentage of mail effective source for products by negotiating order can potentially achieve up to directly with manufacturers, or negotiating volume discounts with wholesalers. 10 percent in additional savings PBMs that use mail-order pharmacies also have over retail. a greater opportunity than retail pharmacists to earn rebates by interchanging therapeutically equivalent products. When they are passed along to employer plan sponsors, rebates can signifi- cantly reduce the cost of prescriptions. HHS estimates that PBMs receive rebates from manu- facturers ranging from 2 to 35 percent of certain Navigating the Pharmacy Benefits Marketplace | 27 Other Pharmacies In general, an Internet pharmacy constitutes a Though not as widespread and accessible as retail different contact interface for mail-order and mail-order pharmacies, other pharmacies open distribution. From a cost perspective, the unique opportunities for plan sponsors whose efficiencies of mail-order purchasing apply needs fit within these pharmacies’ special niche. equally to Internet pharmacies, with the added advantage of decreased administrative costs resulting from the efficiency of the Internet interface. However, Internet pharmacies generally do not provide the level of service offered at retail pharmacies or through a PBM-operated mail- order pharmacy. An Internet pharmacy constitutes a different contact interface for mail- order distribution. According to one manager of Internet Pharmacies worksite corporate health programs, Stand-alone Internet-based “drugstores” were first employers who offer worksite developed in the late 1990s to offer consumers the convenience of ordering prescription drugs online. pharmacies can save up to 20 For the most part, these businesses have failed to percent on their prescription drug attract the number of customers initially antici- pated. Part of the reason may be that PBMs and coverage costs. other providers built their own Internet pharma- cies, making it unnecessary for plan members to use the stand-alone Internet pharmacies. Employer-Sponsored Worksite Pharmacies Also, in response to the Internet pharmacies, When employees are concentrated almost retail pharmacies developed their own Internet exclusively in one or more work locations, as in capabilities. Some retail chains allow consumers the case of workers at a large manufacturing to order refill prescriptions via the Internet and plant, employers sometimes find it cost-effective then either pick them up at a nearby chain store to operate a worksite pharmacy exclusively for or have them delivered to the home. This their employees. This allows employers to offer increases the number of options available to all of the advantages of retail purchasing with the consumers. They may choose to transmit the added convenience of not having to leave the original signed prescription from their physician work site, while reducing costs. The employer, to the pharmacy via traditional means (fax, mail, who is financially at risk for the operation of the or bring it to the store), or they may send the pharmacy, usually hires a managing agency that information through the Internet. The availability specializes in worksite health facilities (such as of these options varies by state. clinics or nurse stations) to oversee the operation. 28 | CALIFORNIA HEALTHCARE FOUNDATION Aside from the convenience to employees, a Managed Care Organization worksite pharmacy offers the financial advantage On-Site Pharmacies of eliminating the middlemen. According to Primarily located in MCO-owned outpatient CHD Meridian Healthcare, a developer and facilities, which house physicians’ offices as well manager of worksite corporate health programs, as some diagnostic facilities, MCO on-site employers who offer worksite pharmacies can pharmacies are for the exclusive use of the save up to 20 percent on their prescription drug MCO’s plan members, and are typically staffed coverage costs.30 The managing agent (e.g., CHD by MCO employees. For plan members, this Meridian HealthCare) is able to take advantage type of pharmacy offers all of the services of a of volume purchasing from manufacturers and retail pharmacy plus the unique convenience wholesalers by pooling orders from all the facilities of being able to fill a prescription at the same it operates. Likewise, it is able to obtain rebates facility as their physician’s office. While the to the extent that its pharmacists are able to number of customers for this type of pharmacy influence which medications are dispensed. is limited to the participants in the MCO, this However, these rebates are frequently not shared arrangement presents some distinct advantages. with the employer. MCOs with on-site pharmacies can negotiate Given the specific circumstances needed to make lower prices because, compared to almost any the employer-sponsored worksite pharmacy other pharmacy, they have the ability to influence option viable, this arrangement is not often the prescribing behavior of physicians through utilized. There are at most 40 worksite pharmacies the use of their formularies. Moreover, to the currently in operation in the United States.31 extent that managed care organizations directly purchase and distribute prescription drugs, some data indicate that MCOs are able to achieve lower acquisition costs than other privately funded pharmacies.32 Some MCOs with on-site pharmacies can negotiate lower prices because they have greater ability to influence the prescribing behavior of in-house physicians. Navigating the Pharmacy Benefits Marketplace | 29 VII. Pharmacy Benefit Administrators IN PROVIDING PRESCRIPTION DRUG BENEFITS, employers usually contract for the services of a PBM, health plan, or third-party administrator to administer the program. Some of these TPAs pay claims and exert some level of control over dispensing; others only pay claims. Some are willing to bear risk; others are not. Pharmacy Benefit Managers PBMs are independent administrators that focus exclusively on pharmacy benefit administration. They manage drug purchasing, dispensing, and reimbursement for prescription drug benefit plans. It is estimated that about 45 percent of the U.S. population has pharmacy coverage directly through a PBM.33 The PBM industry has undergone significant consolidation The number of PBMs over the past several years, with clear industry leaders now operating in the United States emerging. The number of PBMs operating in the United States has shrunk from more than 100 companies in 1998, has shrunk from more than to 80 in 1999, to fewer than 60 in 2000.34 According to a 100 companies in 1998, to first-quarter 2001 market survey, there are approximately 55 distinct PBM companies currently in existence.35 This 80 in 1999, to fewer than industry consolidation could affect employer plan sponsors 60 in 2000. by supplying them with fewer PBMs to choose from but potentially more competitive financial deals as PBMs compete to capture market share from each other. A PBM may do the following: ■ Purchase and dispense medications. PBMs purchase pharmaceuticals for their pharmacies — mail-order facilities — and dispense medications directly to consumers. They negotiate purchasing agreements and rebate contracts with manufacturers for the products they dispense. ■ Pay claims. ■ Act as a financial intermediary between pharmacies and the plan sponsor, negotiating with retail pharmacies to contract reimbursement levels for prescriptions filled by plan members. They often create and maintain pharmacy networks. ■ Manage prescribing choices. PBMs have the opportunity to influence which drugs are ultimately dispensed at retail and mail order, thereby leveraging their negotiating power. 30 | CALIFORNIA HEALTHCARE FOUNDATION They do this through formulary management, steer physicians and patients toward preferred health and disease management, therapeutic drugs. interchange, and educational programs that can To o l s t o M a n a g e P r e s c r i b i n g C h o i c e s The Formulary Examples of PBM Gross Revenue per Transaction PBMs develop a formulary (a list of prescrip- ADMINISTRATIVE FEES : $0.20 – 1.00 tion drugs that members are encouraged to DRUG SALE TO RETAIL PHARMACY request and participating pharmacies are NETWORK ( SPREAD ): $0.10 – 0.35 encouraged to dispense) as the foundation MAIL ORDER PRESCRIPTION SALES : of their pharmacy management approach. $50 –150 This list is issued to inform physicians which DISEASE MANAGEMENT: $5 PMPM medications are the most cost-effective and clinically efficacious, and therefore preferred, REBATES (% OF BRAND - NAME in a particular therapeutic class. When deciding DRUG SPENDING ): 5 – 25% whether to add or delete particular drugs from Source: FAC/Equities, Research Report-Caremark Rx, its formulary, a PBM looks at both the clinical October 2001 and financial impact. Health and Disease Management Programs From a clinical perspective, the PBM’s phar- macy and therapeutics committee evaluates Some PBMs offer clinical programs that maintain the efficacy of the drug and determines wellness; provide case management services whether or not it should be included in the for particular conditions, such as asthma and PBM’s list of formulary drugs. diabetes; and disseminate educational informa- tion to patients and physicians. Manufacturers On the financial side, a PBM negotiates with often subsidize development and management individual pharmaceutical manufacturers for of these programs by the PBM, believing that rebates or incentive payments for including they will help achieve greater product recogni- their drugs in the formulary. The inclusion or tion and influence physicians and consumers exclusion of a drug can significantly impact toward a preferred therapy. the manufacturer’s sales volume. Rebates may be based on the sales or market share Pharmacy Claims Data targets for the manufacturer’s drugs sold through the PBM. Pharmaceutical manufacturers often pay PBMs and health plans to supply them with Manufacturers pay substantial rebates to sanitized claims data detailing the volume PBMs for increasing their market share. Some and types of drugs sold. These data provide sources estimate PBM rebate revenues to be valuable information for manufacturers about between 5 and 25 percent of brand-name drug drug utilization. spending; other sources estimate the figure as high as 35 percent. Therapeutic Interchange Programs These programs are employed by PBMs to substitute generic or less expensive brand medications for higher-cost brand drugs when available and appropriate. The ability to make such changes is often dependent on the physi- cian’s willingness to modify prescriptions (has not indicated "dispense as written"), as well as the patient’s willingness to change medications. Navigating the Pharmacy Benefits Marketplace | 31 For plan sponsors, the PBM’s volume discounts, PBMs eventually become a service of the health rebate savings opportunities, and therapeutic plan that can be purchased on a stand-alone interchanges can yield significant cost savings. basis. MCOs extend the integration of pharmacy and medical administration to include purchase and distribution of pharmaceuticals, and even operate pharmacies within their outpatient For plan sponsors, the PBM’s clinics. For some organizations with a high volume discounts, rebate savings degree of care management, such as group model opportunities, and therapeutic MCOs like Kaiser Permanente, it makes sense to maintain control over pharmacy procurement interchanges can yield significant and utilization. Kaiser procures its own pharma- cost savings. ceuticals from manufacturers and dispenses to members at on-site pharmacies. Given the range of administrative strategies that health plans use, the cost of pharmaceutical Health Plans coverage can vary considerably from plan to plan. Health plans adopt a range of strategies in admini- For plan sponsors with fewer than 5,000 members, stering outpatient pharmacy benefits. A few health a pharmacy benefit program provided through a plans reimburse patients for prescriptions on a fee- health plan is likely to provide a better financial for-service basis, but health plans rarely use this arrangement than direct negotiation with a PBM method to process pharmaceutical claims because because the health plan essentially offers the it allows no opportunities to reduce costs or con- smaller plan sponsor a vehicle for aggregate trol utilization. More commonly, health plans pharmaceutical purchasing. employ one of the following strategies: ■ Outsource claims payment to a Third-Party Administrator. There may be more efficiencies National and regional health and greater savings to be gained through out- sourcing if the claims processing is centralized plans obtain perhaps the most and performed by an expert in that area. advantageous pricing of any ■ Outsource pharmacy benefit management to nongovernmental entity. an external PBM. With their primary focus on inpatient and outpatient medical care, some health plans prefer to use a specialist for outpatient pharmaceuticals. Health plans such as nationally and regionally based MCOs tend to negotiate fairly competitive ■ Operate their own PBMs. Certain large arrangements with pharmacy networks because health plans with national or regional scope they are able to ensure that a relatively large own PBMs. These PBMs typically provide group of members will be using a relatively dedicated service to the health plan. Examples concentrated number of pharmacies. Most health include CIGNA, operating Rx Prime; plans further reduce drug costs through formulary PacifiCare, operating Prescriptions Solutions; management programs that influence medication and Wellpoint, operating Wellpoint Pharmacy preference in the treatment of a particular medical Management. In some cases, these internal 32 | CALIFORNIA HEALTHCARE FOUNDATION condition. In 1999, about 97 percent of MCOs federal facilities such as VA hospitals achieve acqui- relied on some type of formulary.36 sition costs of 40 percent below retail.38 Among privately funded pharmacies, MCOs are able to MCO Advantage achieve some of the lowest acquisition costs. Among health plans, national and regional managed care organizations obtain perhaps the Third-Party Administrators (TPA) most advantageous pricing of any nongovern- mental entity not only because of their volume TPAs may process pharmacy claims but are not of purchases but, more importantly, because involved with dispensing drugs or controlling these organizations are uniquely positioned to utilization. Their approach can vary, with some control the prescribing behavior of their staff TPAs subcontracting the pharmacy benefit physicians and members through the use of administration to a PBM. In other cases, plan their formularies. sponsors require the employee to pay the full cost of the prescription at the pharmacy and submit a claim form to the TPA for reimburse- ment. Whatever the approach, the TPA has no Among MCOs with formularies, influence over what the retail pharmacy charges approximately 90 percent of or what is dispensed. members’ prescriptions are filled with formulary drugs. For many MCOs, formulary compliance is generally high because (1) the plan will not readily pay for more expensive medications when less expensive equivalents are available, and (2) parti- cipating physicians agree to enforce the plan’s utilization management programs, allowing the plan to influence the physician’s behavior before the prescription is written rather than after the fact. For the most part, physicians are cognizant of the formulary and prescribe accordingly. As a result, among MCOs with formularies, approxi- mately 90 percent of members’ prescriptions are filled with formulary drugs.37 A Congressional Budget Office study showed that for MCOs that directly purchase and distribute prescription drugs, acquisition costs are, on average, 18 percent below retail pharmacy acquisition costs, whereas hospitals’ acquisition costs are only 9 percent below. By comparison, Navigating the Pharmacy Benefits Marketplace | 33 VIII. How Employer Plan Sponsors Can Contain Costs EMPLOYER PLAN SPONSORS FACE A NUMBER OF challenges, not the least of which is balancing cost containment against the pressure to provide adequate pharmacy benefit coverage for employees and their dependents. How much the pharmacy benefit ultimately costs each employer is the result of many factors involving numerous parties and a chain of financial transactions, many of which are played out behind the scenes. While employers have no control over some of these factors (such as government regulations), others are open to their influence (for example, the choice between a health plan and a PBM). Employers can use this influence to their best advantage by carefully evaluating how the following key decisions will affect the goals of their benefit program. To Carve in or Carve Out Will the benefit be administered by a health plan or will it be carved out and managed by a PBM? A health plan offers the potential for an integrated health care approach, combining information from both medical and prescription drug data to identify at-risk members and implement disease and health management programs. In practice, however, there is significant variation in the level of integrated care offered by health plans. For smaller plan sponsors, health plans often offer more aggressive pricing terms leveraged by their ability to purchase large quantities. On the other hand, they tend to limit the employer’s flexibility to modify the benefit, and tend to offer a limited range of formulary options. PBMs focus solely on the prescription drug benefit; therefore, they can work with employer plan sponsors to develop an effective combination of appropriate employee access and pharmacy management. Many PBMs have also developed programs to identify and manage the care of at-risk members. While these programs utilize pharmacy data only, lacking the potential to integrate clinical and pharmaceutical care, some use sophisticated methods to effectively use pharmacy data to identify members with chronic conditions. 34 | CALIFORNIA HEALTHCARE FOUNDATION PBMs regularly provide a range of formulary Cost Sharing options. They are also likely to offer guarantees What portion of the cost of prescription drugs on financial and service performance, and are will the employer pay? The proportion the typically more flexible with plan design and employer pays will depend on how the benefit program management customization. On the plan is structured — that is, the amount of other hand, a PBM’s financial arrangements may the employee’s share of cost (in copayment, be complex and difficult to understand, and coinsurance, and deductibles); how many and some PBMs tend to be unwilling to disclose key which drugs are covered and which are not; and information about their pharmaceutical whether and how the formulary is tiered. Most agreements. PBMs and some health plans offer more than one formulary for plan sponsors to choose from, Risk Sharing with some formularies being more restrictive than others. A restrictive formulary is believed Will the employer to result in greater cost savings. It may, however, purchase an insured lead to member dissatisfaction over coverage pharmacy benefit, or limitations or higher co-pays for a larger percen- assume financial risk and tage of drugs. self-insure? Many employers purchase an Some plan sponsors also introduce various insured benefit so as to utilization management strategies that can vary avoid the greater risk and potentially higher costs the level of coverage based on clinically related of providing prescription drug coverage. However, rules or prescribing guidelines. Plan sponsors also some employers prefer to self-insure, seeing this use more narrow retail networks to contain their as a way to provide greater input on how the portion of costs. benefit is structured and provide greater likelihood of rebates from pharmacy providers. Benefit Design For some plan sponsors, especially smaller How much influence will the employer have over employers, limiting financial exposure by which drugs consumers use? Manufacturer purchasing an insured benefit may be more discounts and rebates potentially are available to advantageous than choosing unlimited exposure plan sponsors willing to allow their pharmacy along with the guarantee of rebates. However, the administrator to steer consumers and physicians insured arrangement often subjects the employer toward one drug rather than a competing drug. to mandated benefits, premium increases, and This is accomplished through plan design and specific plan design, which may make the formulary management decisions. employer more reliant on the health plan to control costs. Self-insuring allows the employer greater flexi- bility in plan design, formulary, and pharmacy management, and can be of particular advantage to national employers because it avoids coverage mandates that differ by state. However, self- insuring imposes a greater burden on the sponsor to implement programs to control costs. Navigating the Pharmacy Benefits Marketplace | 35 Plan Design this management strategy can pose difficulties in An employer can use plan design to influence certain employer situations, as when benefits are which drugs its employees use. By implementing determined by union negotiation. different cost-sharing structures, employers can help move employees from higher- to lower-cost Collective Purchasing drugs. Examples of plan design include: Will the employer engage in collective purchasing? ■ Two-tier co-pays, which favor purchase Almost every player in the pharmaceutical distri- of generic over brand medications; bution chain seeks the benefits of economies of ■ Multi-tiered or percent co-pays; and scale and enhanced bargaining power offered by ■ Programs such as prior authorization, aggregate or group purchasing. Wholesalers mandatory generics, or mail-order and purchase in large volume from manufacturers on Internet reordering incentives. behalf of numerous smaller entities. Institutional purchasers such as hospitals and independent Employers moving from open formularies to pharmacies form group purchasing organizations, a two- or three-tier plan design can negotiate or GPOs, to obtain advantageous pricing from higher rebate payments because manufacturers manufacturers and wholesalers. National chains typically provide PBMs and health plans with (including pharmacies, supermarkets, and mass improved rebates for formulary designs that merchandisers) centralize purchasing on behalf include incentives for members to utilize drugs of all stores in the chain. Mail-order facilities on preferred lists. amass the purchasing volume of plan members throughout the country, enabling them to receive discounted pricing. Some national and regional Plan sponsors receive a greater share MCOs purchase in large volume for their affiliated pharmacies, clinics, and hospitals. PBMs leverage of formulary rebate earnings if they their nationwide presence to negotiate with allow their PBM or health plan to pharmacies and manufacturers. Finally, public intervene more intensively with programs secure highly favorable pricing by using both legislative mandates and their own enormous physicians and consumers. advantages in aggregate purchasing and ability to steer participants toward preferred drugs. Employer plan sponsors indirectly share in the Formulary Management Decisions financial advantages of aggregate pharmacy Formulary lists can be more or less inclusive, and purchasing when discounted prices or rebates efforts to achieve compliance can be more or less are passed on to them. They can also directly intrusive. Plan sponsors receive a greater share participate in group purchasing through benefit of formulary rebate earnings if they allow more plan consolidation and employer coalitions. intensive intervention efforts, including therapeutic Benefit plan consolidation. When feasible, interchange programs and targeted communica- employers can decrease the number of distinct tions to patients and physicians. While more benefit plans offered to their employees so that restrictive formulary management can result in each plan represents a larger group. This consoli- increased rebate earnings from the administrator, dation often increases bargaining potential. 36 | CALIFORNIA HEALTHCARE FOUNDATION Employer coalitions. Although both national and regional employer health coalitions have existed for many years, collective purchasing appears to be more widespread for prescription drug benefit administration services than for other health care benefits. The reason is that PBMs offer aggressive financial terms to coalitions or GPOs, such as deeper discounts (particularly at mail order) and more competitive administrative fees and rebates. It is possible for an employer plan sponsor to reduce prescription drug benefit costs simply by joining a coalition, without necessarily changing plan design. It is possible for an employer plan sponsor to reduce prescription drug benefit costs simply by joining a coalition, without necessarily changing plan design. Collective purchasing does have its potential drawbacks. Collective purchasing can limit a participating plan sponsor’s ability to customize its plan design, and may require compromise to achieve group consensus. Although a single plan sponsor may be offered less aggressive financial terms than could be gained through collective purchasing, the plan sponsor is able to negotiate directly with a PBM to meet individual needs and it retains independent decision making. For an in-depth look at the number of choices open to plan sponsors and the type of questions they may want to ask their pharmacy benefit vendors to ensure they are taking advantage of all factors available to them in the purchase of prescription drug benefits, see Prescription Drug Benefit Plans: A Buyer’s Guide. Navigating the Pharmacy Benefits Marketplace | 37 IX. An Evolving Marketplace PRICING ARRANGEMENTS WITHIN THE PHARMA- ceutical marketplace are constantly evolving and the regulatory environment is continually changing. While the future is uncertain, some forces are likely to continue to drive prescription drug prices higher: ■ Advances in science and technology will continue to generate new agents (including biotech) that replace older drugs; fill voids where no drug treatment previously existed; and generate more preventive drugs. ■ Consumer demand for prescription drugs can be expected to grow as the baby boomers age and need more medical care. ■ Direct-to-consumer advertising and manufacturers’ sales representative activity with physicians will likely continue to create greater demand for certain drugs while increasing manufacturers’ advertising and promotion costs. New opportunities are surfacing as plan sponsors and other purchasers attempt to cope with these persistent cost increases. For instance, we can expect to see the following: ■ Rapid growth of cost-effective means of dispensing pharma- ceuticals, such as mail-order and Internet pharmacies; ■ Tactics that influence physician and consumer drug choices, such as tiered formularies, more restrictive formularies, generic incentives, and therapeutic interchange programs; ■ More extensive use of alternatives like employer-sponsored worksite pharmacies, supplemental discount card programs, and defined contribution initiatives; ■ Pressures for more legislation to contain drug costs for some consumer groups — especially in response to the burgeoning Medicare beneficiary population; and ■ More MCOs and physician groups taking steps to limit drug representatives’ access to physicians. In the coming decade, employers with successful pharmacy benefit plans will have a clear understanding of the relation- ships among the key players, keep a vigilant eye on the ever- shifting transactions that determine pharmaceutical pricing, and seize innovative solutions. 38 | CALIFORNIA HEALTHCARE FOUNDATION Glossary Average wholesale price (AWP) — A list of bench- pricing for generic medications in the Medicaid mark prices set by averaging across the spectrum program as a mechanism to lower costs. The CMS of prices charged to pharmacies by wholesalers for issues a MAC price list for generic products that both brand-name and generic drugs. The current have three or more manufacturers or distributors list price is published in recognized sources, on the market. Because of this limitation, not all including Medi-Span, FirstData Bank and its generics have a corresponding CMS MAC price. supplements, and Medical Economics’ Red Book. PBMs often utilize this government issued MAC as the basis of their MAC list and supplement the list Collective purchasing group — Also known as group with other generic products. purchasing organizations or GPOs, these are groups of retail entities that join together to leverage their Pharmacy benefit managers (PBMs) — Organizations combined purchasing power to negotiate discount that help manage the purchasing, reimbursement, pricing from wholesalers or manufacturers. and dispensing of prescription drugs for employer plan sponsors or health plans. PBMs create and Formulary rebates — Remuneration received from maintain pharmacy networks. They also create certain drug manufacturers as a result of inclusion formularies that influence physician prescribing of those manufacturers’ products in the formulary. patterns and dispensing. Through formulary Formulary — A list of preferred prescription drugs guidelines and their large customer base, PBMs chosen by a pharmacy benefit manager on the basis can secure substantial manufacturer rebates. of quality and cost. Retrospective Drug Utilization Review (DUR) — Generic dispensing rate — The percentage of generic Retrospective DUR is a program designed to drugs within the total of prescription drugs measure and assess utilization, quality, medical dispensed under a program in a contract year. appropriateness, and appropriate selection and Generic drug — A medication that is the chemical cost of prescribed drugs. It involves evaluating equivalent of a brand-name drug with an expired pharmaceutical therapies after the medications patent. When a brand-name drug’s patent expires, have been dispensed. other pharmaceutical companies can produce the Therapeutic interchange programs — These programs same active chemical compound and sell the drug are employed by PBMs to substitute generic or less under its generic name, typically at a lower price. expensive brand medications for higher-cost brand Generic substitution rate — The total number of drugs when available and appropriate. The ability prescriptions dispensed under a program in a con- to make such changes is often dependent on the tract year that consists of generic drugs, divided by physician’s willingness to modify prescriptions (has the total number of prescriptions dispensed under not indicated “dispense as written”), as well as the the program in the same contract year for which a patient’s willingness to change medications. generic is available on the market. Third party administrators (TPAs) — Organizations Health and disease management programs — that process pharmacy claims, but have no influence Some PBMs offer clinical programs that maintain over what the retail pharmacy charges, nor what is wellness, provide case management services for dispensed. Plan sponsors rarely use TPAs to process particular conditions, such as asthma and diabetes, pharmacy claims without PBM support as it greatly and disseminate educational information to increases expense. patients and physicians. Manufacturers often subsidize development and management of these programs by the PBM, believing that they will help achieve greater product recognition and influence physicians and consumers toward a preferred therapy. Maximum allowable cost (MAC) pricing — MAC prices are a schedule of pricing for generically equivalent drugs based upon the listed average wholesale prices (AWPs) of competing generic drug manufacturers. The federal govern- ment originally introduced the concept of MAC Navigating the Pharmacy Benefits Marketplace | 39 Endnotes 1. Centers for Medicare and Medicaid Services, Office of 19. Testimony before the House Committee on Commerce, the Actuary, National Health Statistics Group. “Table Subcommittee on Health and the Environment, 105th 3: National Health Expenditures, by Source of Funds Con., 1st Session. April 23, 1997. Statement of Joseph and Type of Expenditure: Calendar Years 1995–2000.” A. DiMasi, Director of Economic Analysis, Tufts Center 2. Based on IMS Health. U.S. Mail Order Market, for the Study of Drug Development, Tufts University, March 2000. Boston, MA. 3. Standard & Poor’s Industry Surveys: Supermarkets & 20. “Profile of the Prescription Drug Wholesaling Industry.” Drugstores, August 2, 2001 and Prescription Drug February 12, 2001. http://www.fda.gov/oc/pdma/ Trends, Kaiser Family Foundation, July 2000. report2001/attachmentg/toc.html 4. Mercer/Foster Higgins. National Survey of Employer- 21. Lehman Brothers. “Macro Shock: How Wholesale sponsored Health Plans. 2001. Distribution Industries Are Being Revolutionized.” June 22, 1999 (http://www.nawpubs.org). 5. MCO & PBM Strategies for Pharmacy Benefits: Recent Results, Current Practices, Future Plans. Third edition. 22. 2001 Healthcare Distribution Management Association Atlantic Information Services, Inc., 2001. HMO & Industry Profile and Healthcare Factbook, p. 9. PBM Strategies for Pharmacy Benefits: Recent Results, 23. Based on IMS Health, Retail and Provider Perspective™. Current Practices, Future Plans. Third edition. Atlantic 2002. Information Services, Inc., 2001. 24. IMS Health. “IMS Health Reports 14.9 Percent Growth 6. U.S. Department of Health and Human Services. in U.S. Prescription Sales to $145 Billion in 2000.” Report to the President: Prescription Drug Coverage, News Release, May 31, 2001. www.imshealth.com Spending, Utilization, and Prices. April 2000. 25. National Association of Chain Drug Stores, 2000. 7. Aventis Pharmaceuticals. Managed Care Digest Series: www.nacds.org HMO-PPO/ Medicare-Medicaid Digest. 2000. 26. Standard & Poor’s Industry Surveys: Supermarkets & 8. Aventis Pharmaceuticals. Managed Care Digest Series: Drugstores, August 2, 2001, and Prescription Drug MCO-PPO/ Medicare-Medicaid Digest. 2000. Trends, Kaiser Family Foundation, July 2000. 9. Centers for Medicare and Medicaid Services, Office of 27. Mercer/Foster Higgins. National Survey of Employer- the Actuary, National Health Statistics Group. “Table sponsored Health Plans. 2001 3: National Health Expenditures, by Source of Funds 28. Department of Health and Human Services. Report to and Type of Expenditure: Calendar Years 1995–2000.” the President: Prescription Drug Coverage, Spending, 10. Estimate based on IMS Health data as cited in Utilization, and Prices. April 2000. Novartis Pharmacy Benefit Report, 2000. 29. Merck-Medco Managed Care, L.L.C. Managing 11. Von Oeshen, William H., III. “Pharmaceutical Discounts Pharmacy Benefit Costs, 2000 edition. Under Federal Law: State Program Opportunities.” 30. “On-site Pharmacies Save Money.” Human Resource Public Health Institute, Pharmaceuticals and Indigent Executive Magazine, March 2001. Care Program, May 2001. 31. Personal communication from Stuart Clark at CHD 12. Centers for Medicare and Medicaid Services, Medicaid Meridian, December 2001. Drug Rebate Program, accessed 9/19/02 (http://www.hcfa.gov/medicaid/drugs/drughmpg.htm). 32. Congressional Budget Office Study, “How Increased Competition from Generic Drugs Has Affected Prices 13. “How the Medicaid Rebate on Prescription Drugs and Returns in the Pharmaceutical Industry.” July 1998. Affects Pricing in the Pharmacy Industry,” Congressional Budget Office Papers, January 1996. 33. HMO & PBM Strategies for Pharmacy Benefits: Recent Results, Current Practices, Future Plans. Third edition. 14. Ibid. Atlantic Information Services, Inc., 2001. 15. National Association of Chain Drug Stores (NACDS), 34. Ibid. Industry Statistics, 2000. 35. Ibid. 16. IMS Health, News Release: “IMS Health Reports 14.9 Percent Growth in U.S. Prescription Sales to $145 36. Aventis Pharmaceuticals. Managed Care Digest Series: Billion in 2000.” May 31, 2001 (www.imshealth.com). HMO&PPO/ Medicare-Medicaid Digest. 2000. 17. Ibid. 37. Aventis Pharmaceuticals. Managed Care Digest Series: MCO-PPO/ Medicare-Medicaid Digest. 2000. 18. Tufts Center for the Study of Drug Development News Release 11/30/01, accessed 9/19/02 38. Congressional Budget Office Study, “How Increased (http://csdd.tufts.edu/newsevents/recentnews.asp? Competition from Generic Drugs has Affected Prices newsid=6). and Returns in the Pharmaceutical Industry.” July 1998. 40 | CALIFORNIA HEALTHCARE FOUNDATION