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Pharmacy Benefit Managers


Pharmacy Benefit Managers (PBMs) administer nearly every prescription drug insurance plan in the U.S.
The first PBMs were created by managed care organizations in the 1980s to apply managed care principles, such as provider networks and patient co-pays, to the drug benefit portion of health care plans. Through rapid growth in the 1990s, PBMs “emerged as the national standard for the administration of prescription drug insurance in the United States.” The three largest PBMs manage drug benefits for over 200 million Americans – 95% of Americans with prescription drug coverage.2 Today’s PBMs manage all aspects of a prescription drug benefit plan, including creating formularies of preferred medicines, negotiating with drug manufacturers for discounts and rebates, negotiating with pharmacies to establish retail networks for dispensing drugs, and establishing automated processes for determining (often called “adjudicating”) coverage eligibility at the point of sale. Each of the four largest PBMs operates its own mail order
pharmacy to fill prescriptions directly.

The PBM industry is highly concentrated
Through a period of consolidations in the last decade, the PBM industry has become dominated by three large companies. The three largest PBMs - Medco, Caremark and Express Scripts - administer 80% of insured prescriptions and 90% of insured mail order prescriptions. Each of these companies has annual revenues exceeding $15 billion.

PBMs increase their profits by retaining payments from pharmaceutical companies to promote their drugs
Many opportunities and incentives for PBM practices that raise drug costs to consumers can be traced to their acceptance of payments (referred to as “rebates”) from pharmaceutical companies for increased sales of their most profitable products. As described by the Federal Trade Commission:

Pharmaceutical manufacturers recognize that having their
drugs listed on the formulary or in a preferred spot on the
formulary (as compared to competing drug products) will
likely increase the drug products’ sales. . . . [P]harmaceutical
manufacturers use “formulary payments” to obtain formulary
status, and/or they use “marketshare payments” to
encourage PBMs to dispense their drugs. Both payments
are often specified as a percentage of the drug’s wholesale
price (e.g., a percentage level of 10% means the
manufacturer will pay the PBM 10% of a measure of the
drug’s wholesale price multiplied by the quantity dispensed).
Most industry members refer to these payments as
“rebates,” and they refer to the percentage level as the
“rebate level.”

PBMs profit from rebates by retaining some or all of them instead of passing the savings on to plans and consumers. Court documents establish that Medco Managed Care, while under the ownership Merck, was paid more than $3.5 billion in rebates in 1997-99, the majority of which were not passed through to customer health plans.6 In 2004, New York Attorney General Eliot Spitzer filed suit against Express Scripts alleging that the PBM pocketed as much as $100 million in drug rebates that should have gone to the state.

Favoring Higher Priced Drugs
Higher rebates are paid on single-source brand name prescription drugs that do not have generic equivalents. Accordingly, PBMs “have an incentive to sell newer and higher priced single-source drugs, even when it may be more costly for the payer.” There is a growing body of evidence that PBMs favor single-sourced and brand name drugs over drugs with generic competition. According to estimates by the FTC, the top 25 brand drugs account for over 70% of the total payments by pharmaceutical companies to PBMs. Single-source brand drugs generally account for over 50% of the drugs dispensed to plan members by PBMs.

Playing the Spread
PBMs increase their profits by “playing the spread” between the amount that is reimbursed by the PBM to a pharmacy for a prescription and the amount reimbursed to the PBM from a plan for the same prescription. Because each amount is independently negotiated and is normally kept secret from the other, the PBM can negotiate a higher reimbursement amount for itself than it pays to a participating pharmacy to dispense the prescription. For example, in one reported case a PBM billed an employer $215 for a generic stomach medicine, Ranitidine, but paid the pharmacy only $15 for the drug, pocketing the difference.

Drug Switching
PBMs can favor higher priced drugs through drug switching. Drug switching, or
“therapeutic substitution,” occurs when a doctor prescribes one drug and the PBM requests to change the prescription to a different drug of similar therapeutic value. The PBM can profit off of the switch if the second drug has a higher rebate value or mark up than the initially prescribed drug. In May 2006, Medco took a charge of $163 million in its first quarter to cover a proposed settlement of federal charges that it defrauded customers by shorting, changing and canceling their prescriptions. In a three-month period, Medco persuaded doctors to switch more than 71,000 prescriptions from Lipitor, made by Pfizer, to Zocor, a more costly drug from Merck (then Medco’s owner). In 2002, AdvancePCS sent letters encouraging doctors to switch patients from a generic ulcer drug costing 20 cents a days to Celebrex, which cost ten times as much. Also in 2002, AstraZeneca paid ExpressScripts $500,000 to call 22,000 doctors and ask them to switch their patients to Nexium from Prilosec, after Prilosec became available in a cheaper generic form.

Drug Repackaging and Mark Ups
PBMs that own their own mail order pharmacies can profit by repackaging drugs and selling the repackaged items at higher prices than the original average wholesale price set by manufacturers. One study found, for example, “15 instances when the branded drug Celebrex was repackaged and the unit price for the repackaged drug exceeded the original manufacturer’s per unit price by more than 7% and as much as 176%.” A 2004 report of the Vermont State Auditor found that Express Scripts marked up state employee benefit drug prices by as much as 111%, costing Vermont taxpayers $1.85 million in one year.

Contract terms have not been sufficient to protect plans from excessive PBM profiteering
Some sophisticated plans negotiate contracts that include provisions for sharing rebates between the PBM and the plan sponsor and provide for audit rights that allow them to verify whether they receive the payments for which they contract. But the extent of such contract terms varies with the bargaining and power and sophistication of plans. “[A] PBM might receive a discount from a manufacturer on a particular drug and not pass any of it on to the health benefit provider, keeping the difference for itself.”

Lack of Transparency
It is often the case that buyers cannot discipline PBM profiteering because they do not know the extent to which it is practiced. In most cases, plans do not have access to PBM rebate agreements and other side deals. PMS have often claimed that these agreements are “trade secrets,” although some contracting parties have achieved access to the agreements and the First Circuit Court of Appeals has rejected trade secret claims. As the federal District Court in Maine explained, PBMs “introduce a layer of fog to the market that prevents benefits providers from fully understanding how to best minimize their net prescription drug costs.”

In 2003, Maine passed the first transparency and fiduciary duty law
The Maine law was upheld in all particulars in 2005 in a unanimous decision by the U.S. Court of Appeals for the First Circuit. The court specifically upheld the rights of states to regulate the practices of PBMs by imposing contract transparency and conflict of interest requirements, to establish a state fiduciary duty owed by PBMs to client health plans, and to require that savings based on volume discounts be passed through to client health plans and thence to consumers. On June 5, 2006, the U.S. Supreme Court rejected a request by the pharmacy benefits management industry that the Court consider the constitutionality of a Maine law. In rejecting the writ of certiorari, the Supreme Court ended the litigation over Maine’s law, which will now be enforced.

Other states have followed suit
Since the Maine law was enacted, many other states as well as the District of Columbia have passed similar laws. The D.C. statute was recently upheld (reversing an earlier decision enjoining the law) based on the 1st Circuit decision. Both the Maine and DC laws require the PBM to act as a fiduciary, require transparency and pass-through of rebates and other payments and savings, restrict drug-switching and conflicts of interest, and establish guidelines for drug-switching and other practices. Maryland passed a series of PBM reform measures in 2008 including legislation addressing transparency, registration, drug-switching, pass-through of rebates, and pharmacy contracts. Iowa, South Dakota and Vermont also have PBM laws that seek to address transparency, conflicts of interest disclosure, greater transparency on rebates and other payments, and include more limited fiduciary language (requiring “fair dealing” or “reasonable care and diligence”, “fair and truthful under the circumstances”). Several other states have more limited laws governing registration and/or payment provisions including Kansas, Mississippi, North Dakota, Rhode Island, Tennessee and Connecticut. Arkansas and Georgia have enacted a “Pharmacy Bill of Rights” which
outlines audit and payment requirements. Louisiana does not have a law, but in 2006 completed a PBM recruitment RFP process requiring fiduciary responsibility.

Potential for savings
Although the Maine PBM law was the first to be enacted, because the PBM industry was successful in halting implementation of that law for several years, there isn’t yet a track record measuring its effectiveness in cutting costs. However, in South Dakota, where the law was not challenged, well over $800,000 was saved in state health insurance costs in a single year as the direct result of the more transparent business model required by its law. In Arkansas, an audit of the PBM managing the state employee health program determined the state was overcharged almost $500,000 in just a 3 month period of time. The state ultimately issued a new transparent RFP for state business, lowering pharmacy expenses and directly saving the state over $13

Several recent reports have pointed to the value of transparency requirements in achieving savings for state government. A plan prepared for the Governor of Oregon by the Heinz Family Philanthropies recommended Oregon “require the greatest level of transparency possible” as well as annual audits of the PBMs and insurance companies the state contracts with to insure that rebates are passed through. A report to the Illinois Commission on Government Forecasting and Accountability recommended the state stop using PBMs entirely, and at a minimum require a fiduciary relationship. By
directly negotiating pharmacy benefits in its state employee health plan instead of paying a PBM $2.81 per enrollee per month to negotiate on its behalf, the report estimated savings of $1.35 per claim or about $10 million per year. The University of Michigan, in an attempt to deal with skyrocketing drug costs, dropped the five benefit managers it had been working with, hired a single new manager that has less control over how the drug plan is administered, and imposed strict new rules. These changes enabled UM to hold its drug spending to $43 million in 2003, or $8.6 million less than it
would have paid under the previous plans.

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