When the cost to provide prescription-drug coverage to employees at SRA International increased 8 percent during the company’s fall 2004 insurance renewal, Wayne Grubbs was delighted. An odd response from SRA’s corporate controller and treasurer? Not at all: for other customers of insurer Unicare in the Washington, D.C., metropolitan area, where SRA’s employees are concentrated, the cost was going up an average of 17.5 percent. Grubbs credits close attention to pharmacy costs and changes to the company’s plan design for an annual savings of more than $350,000.

One key change came in January 2004 when SRA, an IT-services firm with $756 million in revenues and 3,800 employees, adopted a preauthorization program for some types of common drugs. The program requires employees and their doctors to first try cheaper medication options for certain ailments, such as arthritis or common allergies, and move to more-expensive medications only when necessary. That had an immediate effect on costs, recalls Ann W. Denison, vice president and director of human resources at SRA.

“As soon as we started asking the [medical] providers to verify that they had tried over-the-counter or other nonprescription solutions before they went to the prescription, we saved money on drugs,” says Denison. Other efforts also helped to moderate cost increases, according to Grubbs, including the use of nurses on staff to help manage large medical claims.

SRA isn’t alone in rethinking the way it structures prescription-drug benefits, which now account for about 18 percent of active employees’ health-care costs. Companies everywhere are looking for new ways to manage their drug spend, from redefining which drugs or drug classes are considered “preferred” to adopting reference-based pricing (where employees pay the difference for more expensive drugs in the same class) or consumer-driven health plans. (One strategy they won’t try: buying drugs from Canada. “It’s technically illegal,” observes Sean Brandle, vice president at The Segal Co.)

In Towers Perrin’s health-care cost survey for 2005, more than 60 percent of employers responding said they are considering new approaches to the prescription-drug benefits they offer. Like Wayne Grubbs and Ann Denison, they are trying to at least slow down this alarmingly fast growing expense. According to an October 2004 report from the Kaiser Family Foundation, $162.4 billion was spent on prescription drugs in the United States in 2002—four times the amount spent in 1990. “We have seen double-digit trends in prescription-drug costs for most of our employer clients dating back to 1999,” says Ron Fontanetta, a principal in the health and welfare practice at Towers Perrin.

What’s behind the rapid escalation of costs? Kaiser estimates that 42 percent of the increase between 1997 and 2002 was due to increased use of prescription drugs; about a third to shifts to newer, higher-cost drugs; and a quarter to manufacturers’ price increases. (It’s important to note that in some cases, higher drug costs may be balanced by reduced health-care costs elsewhere, as when drug treatment replaces surgery. Changing medical guidelines for treating such conditions as high cholesterol also, arguably, reduce the long-term cost of heart disease.)

Moreover, marketing and advertising by pharmaceutical companies have also contributed to higher drug prices. According to Fontanetta, there has been a “very direct correlation between the increased spend that employers are witnessing and the promotional efforts” of the pharmaceutical manufacturing industry. A study prepared for Kaiser by researchers at Harvard and MIT estimates that direct-to-consumer advertising accounted for 12 percent of the growth in spending on prescription drugs between 1999 and 2000.

Price Check

The biggest obstacle to managing drug costs is that neither employers nor consumers have a handle on the real prices of drugs. That lack of pricing transparency presents challenges as employers go beyond the flat co-payment approach to plan design. If employers are asking employees to pay a percentage of a drug’s price through a co-insurance arrangement, or all of it through a health reimbursement account or health savings account, “we have to be comfortable [that we know] the real cost,” says Kenneth Sperling, health-care market leader at Hewitt Associates. The problem is, “nobody really knows what drugs cost,” adds Sperling.

One reason is that the most common compensation model for pharmacy-benefit managers (PBMs, third parties that administer prescription-drug plans for large employers and for insurers) can complicate drug pricing. The PBMs often don’t charge large employers a fee for administering their pharmacy benefits, but instead are compensated by drug rebates from drug makers.

For some employers, that model raises doubts about whether the financial incentives of the PBM and the plan-sponsoring employer are aligned, says Sperling. “There’s a question as to whether PBMs are driving toward the lowest net cost to the employer and the employee, or whether they’re chasing the largest rebates,” he says.

Greg Folley, director of compensation and benefits at Caterpillar Inc., estimates that the Peoria, Illinois-based manufacturer spends about $150 million per year on prescription drugs. Like many employers, Caterpillar has been adjusting its pharmacy-benefit plan design. Folley says the company has raised co-payments for salaried and management employees (and for retirees). Also, Caterpillar has introduced a plan design that requires employees and their doctors to try less-expensive treatments for some ailments—to use over-the-counter treatments for heartburn, say, before moving to prescription drugs like Prilosec or Nexium.

Folley sees increased drug-pricing transparency as a necessary step to making employees savvier consumers. Pricing in the drug-purchasing arena is “kind of a black box now,” says Folley, and people don’t understand how the pricing arrangements work among the pharmaceutical companies, the PBMs, and the consumer, he says.

To shed more light on pricing, Caterpillar and other large employers have joined a coalition to explore the possibility of direct pharmaceutical purchasing, under the umbrella of the HR Policy Association. The coalition consists of 53 large firms that together spend about $3.7 billion per year on prescription drugs, says Sperling. As a group, the coalition intends to evaluate its aggregate usage data and negotiate drug prices, net of rebates, with pharmaceutical companies, according to Sperling. Ultimately, the group hopes to develop a model in which drug prices are more transparent to the company and the patient.

Towers Perrin, meanwhile, is coordinating another employer collaborative that is seeking price transparency and full pass-through of rebates from drug manufacturers. Fontanetta says the group, which consists of about 30 employers, has negotiated agreements with Medco Health Solutions, a large PBM, in which Medco will be paid by the employers on a fee basis. In turn, Medco will pass along the drug rebates it receives from manufacturers to the employers. Tim Wentworth, Medco group president for national accounts, points out that this approach isn’t for everybody. Some employer plans, he says, still prefer to share the rebates rather than pay an administrative fee.

A Dose of Data

Experts say any strategy for controlling prescription-drug costs requires an understanding of the company’s usage data. “Really take a look at where your costs are coming from,” advises The Segal Co.’s Brandle. Employers need to know the drug categories and specific drugs that drive cost increases.

At SRA, analysis of usage data has played a critical role in containing both prescription-drug and other health-care costs. Overall, according to Denison, the company’s health-care cost increases have been below the national average in recent years.

As it happens, SRA has in-house data-mining capabilities that it can apply to its medical-claims data without identifying information about individuals. Grubbs and Denison attend quarterly meetings with, among others, CFO Stephen Hughes and COO David Kriegman to review trends revealed through this process and determine whether the drug-benefit plan design can be improved. For example, Denison explains, when the company learned that one of the top 25 drugs used by employees is for lowering cholesterol, it developed a voluntary health-promotion campaign to educate workers about lowering cholesterol, eating right, and exercising (see “Belt-tightening“).

Because SRA’s HR and finance staffs have been working closely together on a benefit-plan structure for a number of years, says Grubbs, their viewpoints have influenced each other. He says the finance team has become much more sensitive to how employees view plan-design changes, while he credits the HR team with having developed a better appreciation for the financial analysis of benefits decisions. As a result, says Grubbs, “at the end of the day, we end up with something better.”

Martha E. Mangelsdorf is a freelance business writer in Boston.

Rx for Curbing Pharmacy Costs

Co-Insurance.

A typical pharmacy-benefit plan design these days might include three or four tiers of set co-payment levels. But with a co-insurance model, a company defines the percentage of the cost an employee will typically pay for a given type of drug. According to a recent survey by Hewitt Associates, 45 percent of employers are now offering a co-insurance option, up from about 20 percent during the past several years.

Set Employer Contributions For Certain Conditions.


For some classes of commonly used drugs in which there is a wide price differential among various drugs that are all within established medical-treatment guidelines—such as those to lower cholesterol—employers may offer to reimburse up to a set amount per day for an employee’s prescription. With such a plan model, employees who use one of the more inexpensive medications may find that all of their costs are covered, while an employee whose physician prescribes a costlier drug option would face out-of-pocket costs.

Step Therapy.

Employees and their doctors are required to start with more inexpensive treatments for certain conditions. “If something that’s simple and cheap can take care of you, then they won’t pay for something that’s less simple and more expensive,” explains Gary Claxton, director of the Healthcare Marketplace Project at the Kaiser Family Foundation.

Fixed Benefit.

Starting in July 2003, Humana, a Louisville-based health insurer, offered its employees the option of a pharmacy benefit that divides drugs into four classes based on how likely the drug is to offset other medical expenses, explains vice president of pharmacy and clinical integration William Fleming. Then, instead of fixing the employee’s contribution through a co-payment, Humana contributes a fixed amount for each prescription that varies with the class of the drug. For all but the drugs in the lowest tier of reimbursement, which includes those that treat hair loss and sexual dysfunction, the company caps an employee’s out-of-pocket costs per prescription.

Consumer-Driven Plans.


The trend toward consumer-driven health-care plans, in the form of health savings accounts and health reimbursement arrangements, may also curb drug costs. Prescription drugs are one of the areas where such plans can have the greatest impact on consumer behavior.—M.M.