Human Capital & Careers

Drug Discount Peddlers

Uncontainable drug costs have spurred employers to take a fresh look at how their pharmacy benefit managers might be hiding revenue.
David KatzOctober 28, 2005

Earlier this month Express Scripts Inc., one of the top three managers of employer-sponsored prescription-drug benefits, made headlines by announcing that it would erase Lipitor from its list of preferred drugs. The move marked a sea change in relations between the pharmacy benefit managers (PBMs) and the big drug companies, according to some observers. If they’re right, that change is being driven by employers’ growing awareness about where their drug-benefit dollars are going.

In brief, Express Scripts (ESI) removed Lipitor, Pfizer’s huge-selling cholesterol-cutting drug, in favor of Zocor, according to published reports. The reason? Merck, which manufactures Zocor, will lose its patent-protected rights to produce it in June 2006. Once generic-drug makers begin selling their own versions of Zocor, ESI would be able to recommend the much cheaper generics. That option wouldn’t be available for Lipitor, which doesn’t come off-patent until 2011.

From its point of view, ESI was only proceeding on a well-worn path, according to press accounts. By replacing brand-name drugs with generics, it would be doing just what employers have long hired PBMs to do: provide deep discounts in pharmaceutical costs while administering employers’ prescription-drug programs. At the same time, PBMs make out handsomely by recommending generics, which offer wider profit margins than brand-name drugs for their manufacturers. Those wider margins enable the PBMs to get a bigger piece of the “spread” between what a drugstore chain charges for a prescription and what an employer pays for it.

The arrangement, even PBM critics agree, has largely served both employers and employees well. According to a 2003 report by the Government Accountability Office that examined three drug-benefit managers, PBMs were able to bargain down retail pharmacies by 18 percent below the average cash price that customers would pay at pharmacies for 14 name-brand drugs — and by 47 percent for four generic drugs. The GAO did caution that its findings might be read to overstate that bargaining success; if companies had no access to PBMs, observed the watchdog agency, companies would likely try to negotiate discounts on their own.

Even so, by gathering and automating huge amounts of pharmacy pricing data and making it widely known, PBMs have certainly exerted a strong downward pressure on retail drug costs. And they have helped employer drug programs fit nicely into managed-care plans, bringing the co-payment features typical of health maintenance organizations into the pharmaceutical-benefits arena — in turn, providing an incentive that’s valuable in hiring and retaining employees. At the same time, many employers have gained negotiating efficiency by “carving out” drug benefits from HMOs and broader health insurance programs, then dealing directly with PBMs.

Despite such advantages, however, employers’ image of PBMs has taken on some tarnish — and, perhaps, influenced ESI’s switch from Lipitor to Zocor. ESI and the other two pharmacy-benefit giants, Caremark Rx and Medco, have suffered through lawsuits and bad press regarding rebates they receive from drug manufacturers. Pharmaceutical companies dole out those payments to PBMs that add the companies’ name-brand drugs to the PBMs’ formularies, or preferred lists.

In one case, New York Attorney General Eliot Spitzer charged ESI in August 2004 with hiding and pocketing “millions of dollars in rebates and other payments from pharmaceutical manufacturers” that rightfully belonged to the Empire Plan, the state’s main employee health program. ESI masked much of the rebate money under such rubrics as “administrative fees,” “data fees,” and “formulary compliancy fees,” according to Spitzer. Another of his charges was that ESI schemed to boost generic drug prices to enrich itself at the expense of the plan. ESI has filed a motion to dismiss the complaint. (An ESI spokesperson didn’t return phone calls requesting comment on the Lipitor decision and on Spitzer’s lawsuit.)

Caremark and Medco have likewise had their days in court. In September, Caremark agreed to pay the federal government $137.5 million to settle charges made in 1999 that its AdvancePCS subsidiary asked for and got kickbacks from pharmaceutical makers and paid kickbacks to potential customers. Under the terms of the settlement, Advance PCS, which was acquired by Caremark in 2004, denied all wrongdoing.

For its part, Medco is still contesting portions of a lawsuit filed by the U.S. Attorney’s Office for the Eastern District of Pennsylvania in 2003. Among other things, the suit alleged that the company accepted payments from Merck and other drug makers to favor their products even though other drugs were cheaper or more effective. Merck spun off Medco in 2003.

Complaints against PBMs have also included allegations of manipulated price spreads and cloudy reporting of arrangements with drug companies and employers.

Perhaps spurred by lawsuits if not complaints, the big PBMs might be beating a hasty retreat from the special relationships they’ve had with big drug makers. “What we’re seeing is PBMs walking away from rebate revenues,” says Sean Brandle, prescription-drug consulting practice leader of The Segal Company in New York. Increasingly, the drug-benefit managers will try to make money by pushing rebate-less generics, he predicts.

A Caremark spokesperson said, however, that she didn’t know if the company planned to seek less of its revenue through rebates. Even so, when asked whether ESI’s move might portend a broader change in the business model of the major PBMs, she said, “Caremark is a generics-first company; we would promote generics if appropriate.” A Medco spokesperson was more definitive. As to whether the company might move to a rebate-less business model, she said the PBM “has no plans for any change of that kind at the moment.”

But if such changes do occur, they will likely be initiated by increasing employer efforts to penetrate the fog surrounding PBM contracts. Indeed, both on their own and collectively, employers have begun a quest for more-transparent drug plans. EMC Corp. benefits director Delia Vetter, for instance, says that since her company joined the Health Policy Association’s 52-member drug purchasing coalition, she’s learned a great deal about PBMs’ potential to hide revenues from clients.

For many employers, however, knowledge of such matters is still in its infancy. “That’s one of the reasons we joined the coalition,” says Vetter. “We don’t know what we don’t know.”

Alpine Drug Costs

The main impetus for companies’ new scrutiny of PBMs, of course, is the long, steep rise in drug-benefit costs. As of 2004, those expenses soared 83.4 percent during the previous half-decade, according to Mercer Health & Benefits figures cited in June by the The Wall Street Journal.

To be sure, the rise can be linked largely to macro-trends like the aging of the population and the surge of direct-to-consumer drug advertising. But corporate benefit executives are also wondering whether their relationships with intermediaries are also playing a role, as they look at cost drivers they can do something about themselves. “To retain quality and control cost, benefit managers need to look at every possible avenue where we can have an impact,” says Vetter. Hence the recent interest in the arrangements between their companies and PBMs.

Indeed, it was skyrocketing drug costs that led the University of Michigan to shift PBMs twice in three years. In the late 1990s the university began to see 15 percent to 20 percent yearly increases in pharmaceutical costs at its three health-maintenance-organization plans and 20 percent to 30 percent increases at its two self-insured, traditional major-medical benefit plans. Between 2002 and 2003, total prescription drug outlays jumped 34 percent, from $33 million to $44 million.

A big part of the problem was the university’s hands-off relationship with its five PBMs. Michigan officials learned of the drug-cost hikes only at annual coverage-renewal meetings with the HMOs and the major-medical plans, since those insurers had delegated management of the drug programs to the PBMs. However, the university’s benefits staff wasn’t privy to information about the insurer-PBM relationships, recalls Keith Bruhnsen, the school’s assistant director of benefits and prescription plan manager.

Alarmed by the price increases, university officials started to demand that the insurers provide details of how the money was being spent. One thing they learned is that the HMOs had little incentive to push hard for cuts in drug spending, since benefit cutbacks might drive university employees to seek more generous coverage elsewhere, according to Bruhnsen.

In 2003, the university carved out responsibility for the drug plans from its overall health-insurance programs, replaced the five PBMs, and began to deal directly with a single one, Caremark’s Advance PCS. By cutting red tape and its attendant costs, the change has helped Michigan to hold drug increases to no more than 10 percent per year, says Bruhnsen.

Drawing on the considerable expertise of its medical school faculty, the university also took the unusual step of assuming control of its plan’s formulary and taking on the decision of picking the listed drugs. (Bruhnsen acknowledges, in something of an understatement, that “not every company has the expertise” to take a step like that.) Even further change is afoot: In 2006, Michigan will shed Caremark’s full-service administrative approach for a stripped-down plan coordinated with SXC Health Solutions and Walgreens Mail Service, and requiring more involvement by the university.

Like other internal benefits managers, Bruhnsen has been poring over rebate arrangements. In many of those deals, the PBM agrees that the employer will ultimately receive most or all of the rebates that pharmaceutical makers pay out when their brand-name drugs appear in employers’ formularies. Sometimes a rebate can be as much as 50 percent off a drug’s average wholesale price, according to Creighton University pharmacy professor Robert Garis. He notes, however, that since that wholesale price is assigned by the manufacturer, it tends to be “tremendously elevated” above the price that the pharmaceutical company actually charges and that the employers pay.

Rebates can be a mixed blessing: They tend to align the interests of PBMs with those of drug makers rather than those of companies that sponsor the benefit plans. A whopping rebate, for instance, might prompt a PBM to recommend that an employer add a hot but costly brand-name drug to its formulary, says Bruhnsen. Even if the employer gets a big chunk of the rebate, a company that approves an employees’ use of such a drug could well find that “five months later, a generic comes out,” says Bruhnsen. A few months of rebates, he explains, wouldn’t make up for the expense of a brand-name drug that an employee might take for many years.

Even contracts stating that “100 percent of rebates” will be returned to the employer provide no guarantee that the PBMs aren’t getting paid by drug companies, experts say. That’s because “rebates” usually refers solely to payments based on how often employees use certain drugs, notes Matthew Gibbs, national pharmacy practice leader at Hewitt Associates. Gibbs notes that many other payments, including data-aggregation fees, data-sales fees, and other administrative outlays, might still flow from drug companies into PBMs’ pockets. Adds Bruhnsen: “There are a lot of rocks they can hide sources of revenue under.”

Betting Against the Spread

Another target of scrutiny is how PBMs can unduly profit from price spreads. In a typical arrangement, the manager at the PBM agrees with a corporate client on a guaranteed price that the client will pay for a drug. If the manager can hash out a lower price with the drugstore chain, the PBM pockets the difference.

When it comes to generics, the spread should work to the advantage of both the employer and the PBM. Since pharmaceutical companies earn bigger profits on generics than on brand-name drugs, the PBM has more room to bargain for bigger discounts, thereby cutting costs for its corporate client while earning more revenue for itself. “That’s a good incentive,” says Joseph Paduda, the principal of Health Strategy Associates, a Madison, Connecticut-based workers’ compensation and managed-care consulting firm. “How pharmacy benefit managers get paid saves employers money when they shift to generics.”

But sometimes the spread can be gaping. For instance, according to a recent study by Garis and his Creighton colleague Bartholomew Clark, one PBM billed an employer $200 for rantidine, a generic stomach medicine, but shelled out just $15 to the pharmaceutical company, and charged $80 for the generic blood-pressure drug atenolol while paying just $7. Closer scrutiny by the internal benefits manager might have delivered some of that spread to the employer.

At times, PBMs allegedly benefit from using different price lists with different clients. According to Spitzer’s as-yet-untried charges against Express Scripts, the company generated “huge profits” by parlaying price differences between spread-based plans and “pass-through” plans. Under the latter arrangement, the PBM charges the employer the same amount that it was charged by the drugstore chain. Rather than profiting from a price spread, the PBM receives a fixed fee from the employer for every prescription it processes.

In the Express Scripts case, Spitzer alleged that ESI paid inflated prices for generic drugs to a number of drugstore chains, then passed through those inflated prices to the Empire health plans and their members. Because of those inflated payments, the attorney general explained, the chains “accepted lower prices from ESI for the same drugs dispensed to members of ESI’s ‘spread’ plans.” ESI charged higher prices to the employers with spread-based arrangements and made hay on the difference, according to Spitzer.

Exquisite Detail

To avoid being caught on the wrong end of such a situation, employers are beginning to demand much more clarity from their PBMs about how rebates and spreads are divvied up. Garis, who also advises clients on choosing PBMs, maintains that with each invoice from the PBM, the client company should receive a digital copy of the prescription-drug transaction, including the cost of the drug, the pharmacy’s filing fee, and the amount of the employee’s co-payment.

Currently, however, CFOs and their benefits teams receive surprisingly little data, according to Garis. Typically they get a statement that says only “pay this amount” or that merely provides information on a broad group of pharmaceuticals — like payouts out for “the bellyache drugs,” Nexium, Prevacid, and Protonix. Adds Garis, “The exquisite detail that has to be present [for the] pharmacy benefit to work is noticeably absent.”

Getting those details has been hard for individual employers, so many are banding into consultant-run collectives to push for closer audits and clearer pass-through arrangements. In addition to the Health Policy Association, run by Hewitt Associates, the Rx Collaborative also boasts more than 50 members; it is administered by Towers Perrin.

Seeking to push PBM incentives into line with employer goals, the Rx Collaborative pledges that members will seek financial and contractual protections in their drug-benefit agreements, according to a Towers Perrin publication. Among them are price transparency via “full disclosure” of PBM revenue sources; “100 percent pass-through of rebates, discounts, and dispensing fees”; and enough information to audit the PBM.

With all the criticism of pharmacy benefit managers, it’s fair to ask whether they’re still needed at all. Handling drug benefits in house, however, is not in the cards. “Somebody’s got to adjudicate the claims,” says Ron Lyon, national pharmacy practice leader with Towers Perrin, adding that PBMs do still provide substantial discounts. The problem, he adds, is that while PBMs still provide considerable value to employers, they’re not providing “as much value as they could.”

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