No. 765

ISSUE BRIEFPharmacy Benefit Managers:A Model for Medicare?Monday, July 9, 2001Washington, DC

A discussion featuring

Bridget Eber, Pharm.D.Practice Leader, Prescription BenefitsHewitt Associates

Cynthia Kirman, Pharm.D.Director of Pharmacy, Health Care InitiativesGeneral Motors Corporation

Bruce I. TaylorDirector, Benefits Planning, Health and Welfare PlansVerizon Communications

Jeff SandersSenior Vice President, Strategic InitiativesAdvancePCS

with comments from

Lynn EtheredgeIndependent Health Care Consultant

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Analyst/Writer: Veronica V. Goff, Consultant

National Health Policy Forum2131 K Street, NW, Suite 500Washington, DC 20006202/872-1390202/862-9837 (fax)nhpf@gwu.edu (e-mail)www.nhpf.org (Web site)

Judith Miller Jones, DirectorKaren Matherlee, Co-DirectorJudith D. Moore, Co-DirectorMichele Black, Publications Director

NHPF is a nonpartisan education and informationexchange for federal health policymakers.

ISSUE BRIEF/No. 765

Pharmacy Benefit Managers

Overview—This issue brief uses large employer experi-ences with pharmacy benefit managers (PBMs) to shedlight on their potential as Medicare outpatient drugbenefit administrators. PBM management techniquesand typical employer approaches are discussed, as wellas employer perspectives on PBM strengths and weak-nesses and lessons learned. Considerations for Medi-care policy are also examined. Information is based ona literature review and conversations and telephoneinterviews with employers, PBM industry executives,and benefit consultants. This brief builds on previousNational Health Policy Forum PBM industry analysis;in particular the October 1999 forum and issue brief“The ABCs of PBMs.”1

Pharmacy benefit managers (PBMs) are central tothe debate over a Medicare prescription drug benefit.Virtually all the major proposals include PBMs toadminister the benefit, with some analysts citing themethod as an alternative to price regulation.2 But not allPBMs are alike.

The industry, which administers drug benefits formore than 200 million people nationwide, is varied andchanging.3 PBMs provide a wide array of services,employ different management strategies, and operate ina very complex pharmaceuticals market. In recent years,the PBM industry has gone through dramatic consolida-tion.4 Now, the three largest firms handle more thanthree-quarters of retail prescription drug purchases.5

Large self-insured employers turned to PBMs duringthe 1990s to administer the popular drug benefit, managecost and utilization trends, ensure appropriate use ofdrugs, and improve care quality. Although most employ-ers are satisfied with their PBM, concern is growing asdrug spending continues to climb at double-digit rates.Employer frustration over rising costs and questionsabout appropriateness of drug use are stimulating interestin PBM contractual relationships, especially financialarrangements with drug manufacturers, and the bearingthose relationships may have on PBM performance.

Amidst a growing public discourse about drugspending and affordability, Congress is considering aMedicare benefit. Whether the best practices of private-sector pharmacy benefit management are appropriatefor Medicare is uncertain. PBMs rely on utilizationcontrols, especially techniques that promote formulary

compliance, to curb spending growth. Industry support-ers argue the controls encourage appropriate drug use,but the public backlash against managed care couldspill over to PBMs if they are seen as too intrusive orindifferent to consumer needs. At the very least, aMedicare benefit would encourage closer governmentscrutiny of PBM practices, a prospect not unwelcome toprivate purchasers. At the worst, Medicare reformpolitics could involve the industry in delivering thebenefit but take the teeth out of its cost- and quality-management capabilities.

This Forum session will bring together speakersrepresenting large employers, PBM firms, industryanalysts, and health policy experts to discuss thestrengths and limitations of the pharmacy benefitmanagement model that has evolved in the privatesector and its suitability for a Medicare prescriptiondrug benefit.

INDUSTRY SNAPSHOT

PBMs administer prescription drug benefits throughcontracts with employers, managed health care organi-zations, and insurance carriers. Today, the top 20 firmsmanage more than 90 percent of retail prescription drugpurchases, and three firms—AdvancePCS, ExpressScripts, and Merck-Medco Managed Care—dominatethe market.6 The oldest began as claims administrators.

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Many newer industry members were started or acquiredby health plans, pharmaceutical manufacturers, retailpharmacy chains, or other PBMs to build specificcapabilities. Still others were established with a particu-lar niche in mind, such as mail order pharmacy.

A common strength of today’s PBMs is use ofautomated processes and information technology.Electronic communications and real-time claims pro-cessing are essential to industry operations. The mem-ber takes a prescription to a participating pharmacy,where the pharmacist uses a computer to check membereligibility, the presence of the medication on the plan’sformulary, plan rules about generic and therapeuticsubstitutions, and the member copayment. Othertechniques pioneered by PBMs, including standardizedclaim forms and mail order pharmacy, have helpedmake the industry a leader in administrative efficiency.

Contractual relationships with retail pharmacies,pharmacists, wholesalers, and pharmaceutical manufac-turers are another reason for the industry’s growth.PBMs negotiate drug price and dispensing fee discountswith retail pharmacies. They frequently provide incen-tives to pharmacists to encourage generic drugs andformulary compliance and negotiate price discountswith drug manufacturers and wholesalers for mail orderservices. The principal sources of net revenue for PBMsare retained rebates and the difference between drugacquisition cost and sales cost for mail service phar-macy, according to industry experts.

Contracts with manufacturers are beginning tocome under closer scrutiny, however. PBMs contractwith manufacturers for rebates (after sale discounts)based on demonstrated market share utilization shifts.Rebates range between 2 and 20 percent of the drug’saverage wholesale price, according to Bridget Eber,Pharm.D., who is practice leader, prescription bene-fits, for Hewitt Associates.7 Variance is attributed tocompetition within therapeutic categories and the typeof formulary, among other factors.

Most employers contracting with PBMs receive ashare of between 50 and 100 percent of the rebate. ButPBMs often receive several forms of income frommanufacturers, including unrestricted financial grantsand fees for disease management programs, rebateadministration, and analysis of drug expenditure data.While industry experts are aware of these arrangements,few details are available because of their proprietarynature. Purchasers are beginning to question whetherthey are getting sufficient value for the price they payfor PBM services.

PBM MANAGEMENT TECHNIQUES

Basic management techniques include pharmacynetwork management, formulary management, drugutilization management, and mail service. Many PBMsalso provide disease management programs. Theextent to which these techniques are used in combina-tion with member cost-sharing affect drug cost andutilization trends. In specifying their prescription drugbenefit plans, which are administered by the PBM,employers balance cost-containment opportunitieswith employee satisfaction, convenience, and accessto affordable drug therapies.

Pharmacy NetworkPBMs offer a range of broad to narrow retail phar-

macy networks. A narrower network concentratespurchasing power by limiting the pharmacies at whichmembers are covered, thereby leveraging greaterdiscounts. Thirty-one states have “any willing provider”laws requiring PBMs to contract with any pharmacywilling to accept their reimbursement rate.8

Formulary

The formulary is a fundamental tool for the PBM.It is a list of the plan’s preferred drugs within eachtherapeutic class. Formulary options range from theleast restrictive open formulary to the most restrictiveclosed formulary. Managed formularies combinemember cost-sharing incentives with the list of pre-ferred drugs to encourage their use. Three-tier andfour-tier cost-sharing structures are becoming popularbecause they allow for an open formulary whilerequiring higher member contributions for non-preferred drugs.9

Drug Utilization Review

Prospective, concurrent, and retrospective drugutilization reviews are used to ensure safety, improve carequality, and promote compliance with the formulary. Priorauthorization is a form of prospective review, conductedbefore medications are dispensed and, ideally, before theyare prescribed. Prior authorization programs targetspecific drugs and require special authorization at thepoint of sale for coverage by the plan. Most often, theprograms apply to drugs that are high-cost and have off-label uses and a potential for misuse.

Concurrent reviews are done electronically beforemedications are dispensed. The prescription is checkedagainst the formulary as well as the member’s eligibility,prescription record for drug interaction, drug-disease

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interaction (when available), appropriate dosage, andother factors. The pharmacist may receive one of twotypes of alerts (or edits) regarding the transaction. Thefirst does not allow the transaction to proceed. Thesecond allows the transaction to be processed andprovides information to the pharmacist. Based on theinformation, the pharmacist may contact the prescribingphysician before proceeding or after the transaction isprocessed.

Retrospective reviews encourage compliance withthe formulary and promote safety by revealing inappro-priate prescribing patterns. It can also be used to assessprescribing behavior against best medical practice.Often, physicians who frequently prescribe drugs thatare not on the formulary are contacted in writing.

Generic Substitution and Drug Interchange

Substitution of generic drugs for their brand nameequivalents is common and cost-effective. Therapeuticinterchange is the substitution of one drug for anotherin the same therapeutic class. The technique encouragesformulary compliance. However, physician permissionto interchange drugs is required due to differences indrug chemical compounds.

Mail Services

Dispensing medications by mail is cost-effective formaintenance drugs because of discounts negotiated withwholesalers and manufacturers and the absence of retailpharmacy overhead. Member communications and arange of benefit design options are used to encouragemembers to use mail service when appropriate. SomePBMs own and operate their own mail order pharma-cies, while others outsource the service. Many PBMsallow members to refill maintenance medications viathe Internet.

Disease Management

Many PBMs provide disease management programsfor common and potentially high-cost conditions, suchas asthma, diabetes, heart disease, and depression.Often education and disease-specific information areavailable to members. Sometimes members are encour-aged through targeted communications to comply withtheir treatment regimens and to take an active role in themanagement of their conditions. Some PBMs arereconsidering their disease management programs dueto sensitivity about medical confidentiality; others arereassessing programs as a result of marginal success inreaching target populations.

LEADING-EDGE PBM PRACTICES

Leading-edge practices use the industry’s technol-ogy and data management competencies to put informa-tion and tools into the hands of physicians and consum-ers. One example is the recently announced RxHubLLC, a joint venture of AdvancePCS, Express Scripts,and Merck-Medco Managed Care to create an elec-tronic exchange and encourage more physicians toprescribe electronically.10

The venture addresses three major health policyconcerns: safety, quality, and consumer service. Itattempts to enhance safety by reducing errors intro-duced by reading handwritten prescriptions. Quality isaddressed by making available to physicians the PBM’sdatabase and its quick access to information such asdrug interactions. And it targets consumer inconve-nience by providing information to physicians at thepoint of care instead of catching problems, such asnoncompliance with the formulary or incorrect dosage,at the pharmacy. The program is currently being testedwith physicians. The three PBMs plan to introduce theexchange in late 2001or early 2002.

To be sure, physician acceptance and connectivitywill be necessary for the exchange’s success. Manydoctors use the Internet now, although primarily foradministrative transactions and clinical research.11

Fewer than 5 percent prescribe electronically, accordingto the RxHub venture partners.

Yet, despite the potential for improved safety andefficiency, the venture is raising concerns among chainand independent pharmacies. They believe RxHub willshift patients from retail pharmacies to the partners’mail order and Internet services. The PBM partnersmaintain RxHub is merely a standardized electronicplatform for prescription writing. Physicians will beable to transmit prescriptions to the patient’s pharmacyof choice. Another concern of some smaller pharmaciesis a burdensome investment in information technologyin order to receive prescriptions electronically.

New PBM consumer tools can tap into the power ofthe Internet for convenient, customized access to healthand prescription drug information. Two-thirds of employ-ers with 20,000 or more employees use Internet/intranetapplications for medical benefits.12 PBMs are followingsuit by providing plan members with online informationand tools to help them effectively use their prescriptiondrug benefits and manage their health.

PBMs are also dedicating more resources to clinicalconsulting. Their pharmacists meet face-to-face with

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physicians and other health care professionals toprovide clinical information about prescription drugsand treatment protocols. Often, clinical consultants canwork from a profile of the physician’s prescribingpractices to tailor the consultation.

Finally, leading PBMs are positioning themselves ascomprehensive health management organizationsproviding a wide range of research and health improve-ment services. One example is the Center for HealthyAging and Drug Safety at AdvancePCS. The firm isdedicating staff and resources in a “holistic approach topromoting safe and cost effective health care by addingthe consumer as an active participant in his/her ownhealth care,” according to Renwyck Elder, R.Ph., vicepresident for strategic business consulting. The centerresearches aging and drug safety issues and educatesconsumers, physicians, and pharmacists. Its mission isto influence the overall cost of care by facilitatingreductions in direct and indirect costs.

EMPLOYER-SPONSORED PLANS

Forty-eight percent of employers with more than10,000 employees contract directly with a PBM,according to a recent survey by consulting firm WilliamM. Mercer.13 Each employer’s prescription drug plan isdifferent with respect to coverage and elements such asutilization controls and disease management. However,employers interviewed for this brief expressed similarexpectations of their PBMs: smooth plan administrationwith advanced use of technology and good internalcontrols; best practice clinical management programs,including provider initiatives and effective drug utiliza-tion review programs; favorable financial terms; excel-lent customer service; and PBM willingness to partneron areas of need or interest.

Contracted Services

Large employers contract with PBMs for a fairlysimilar set of pharmacy benefit management services:administrative services, pharmacy network manage-ment, formulary management, rebate services, drugutilization management, and mail service. In contrast,health plans may contract with PBMs for administrativeservices and drug utilization review but manage theirown formularies and negotiate their own discounts.

Most PBMs contracting with employers forecastexpenditures and consult with employers on plandesign. Employers make basic decisions about therestrictiveness of the formulary and the degree to which

prescription drug management techniques are used topromote formulary compliance.

Administrative services usually include maintainingeligibility files, issuing identification cards, memberservices, reporting, and processing claims consistentwith plan design by adhering to coverage rules, such asformulary and prior authorization, and member cost-sharing in the form of deductibles, copays, coinsurance,and benefit maximums.

In addition to concurrent and retrospective reviews,drug utilization management often encompasses imple-mentation of best practice clinical management pro-grams, health and disease management programs, casemanagement, physician initiatives, and member educa-tion and outreach programs.

With a growing number of breakthrough drugscoming to market and increased direct-to-consumeradvertising, more employers are asking their PBMs toprovide them a formal clinical review of new drugs.The review includes recommendations for placement inthe formulary and for encouraging appropriate utiliza-tion through controls such as prior authorization, retailedits, quantity limitations, and member cost-sharing.

Typically, large employers contract with only onePBM because discounts and administrative fees arebased on projected group utilization. Generally, they optfor a broad pharmacy network, and contracts usuallycover a three-year term. The various criteria employersconsider in choosing a PBM are summarized in Table 1.

Table 1Choosing a PBM:

Employers’ Administrative, Service,and Financial Criteria

� Bidding requirements (e.g., eligibility filemaintenance)

� Firm profile and stability

� Operational and administrative procedures

� Network management

� Utilization and cost management

� Financial terms

� Performance guarantees

� Miscellaneous administrative requirements

� References

Source: Bridget Eber, Hewitt Associates

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Financial Terms

The typical payment arrangement for employerscontracting with PBMs is a fee-per-claim basis. Admin-istrative fees have been declining in recent years,averaging between 10 cents and 60 cents per claim.Financial terms considered during the bid processinclude administrative and dispensing fees, rebates, andprice discounts on drug average wholesale price andmaximum allowable cost, a reimbursement schedule forgeneric drugs. Base rate administrative fees often do notinclude fees for customized programming of systemsadministering utilization controls such as prior authori-zation programs. Contracts often contain provisionsprohibiting employers from discussing negotiated feesand discounts with other employers.

Performance Evaluation andFinancial Guarantees

Contracts usually specify performance on severalfactors. For example, dispensing indicators may addressmail service rate, timeliness, accuracy, and generic drugrate. Customer service indicators may include telephoneaccessibility, response time on written inquiries, andtimely and accurate issuance of identification cards.

Employers typically approach PBM performanceevaluation in a three-step process. First, they identifyareas of importance, such as customer service, genericrate, or mail service timeliness and accuracy. Next, theyconsider financial incentives. Usually a percentage ofthe administrative fee (20 to 50 percent) guaranteesperformance. Sometimes a limited risk-sharing arrange-ment is used so that PBMs and employers share anysavings. Finally, they structure the financial guaranteeby establishing targets and defining measures andincentive/penalty arrangements.

Audits

Audits are used to formally verify PBM performance.The audit provides oversight, ensuring that the PBMmeets its contractual agreements, as well as informationon utilization and PBM operations and performance. Arecent survey found that 68 percent of employers haveaudit rights in their contracts, but only 30 percent audittheir PBMs.14 PBM audits are becoming more frequent,however, and employers are incorporating more detailedaudit language into their contracts. New provisions moreclearly define audit rights, such as choice of auditor,time frame for responding to requests, and ownershipand use of data. As part of the process, PBMs must auditparticipating pharmacies at their own cost.

EMPLOYER PERSPECTIVES ANDLESSONS LEARNED

A recent survey of employers by the InternationalSociety of Employee Benefits Specialists reported that91 percent of respondents said they were satisfied orvery satisfied with their PBMs.15 Discussions withemployers and benefit consultants provide more detailon employer perspectives about PBM strengths, areasfor improvement, and lessons learned. Although em-ployers acknowledge PBMs have different managementstrategies and strengths, they articulate some commonthemes about performance.

Strengths

Administrative Services. Employers report PBMsefficiently and economically manage a high volume ofclaims with relatively few problems for beneficiaries. Forexample, one large employer interviewed for this briefreports that 400,000 prescription drug claims are pro-cessed annually. AdvancePCS, one of the three largestfirms, manages 450 million pharmacy claims annually,representing $18 billion in drug expenditures.16 Nowhereelse in the health care delivery system is such a largevolume of claims processed in real time so efficiently.

Negotiated Discount Pricing on Drugs and Net-works. PBMs are effective at negotiating rebates frommanufacturers and lower prices from retail pharmacies(drugs and dispensing fees) for plan members than areavailable to cash-paying customers.

Drug Utilization Review. PBM databases are com-prehensive. They provide real-time safety controls andthe potential to continually improve efficiency andcare quality.

Mail Service. Audits of mail order services reveal theyare efficient and secure. Plan members, rather thansponsors, are usually the primary beneficiaries ofsavings associated with mail service due to the deepdiscounts offered to encourage their use. For example,the retiree drug plan might have a 20 percent coinsur-ance for a 30-day supply at retail and $10 generic/$20brand copays for a 90-day supply by mail. Employersare reexamining plan design to ensure it does notoveremphasize mail service and result in wastage ofmedications and unnecessary spending. They want toavoid problems such as a beneficiary’s buying a 90-daysupply of a maintenance drug only to have problemswith side effects and never finish the course of medica-tion. Some employers require at least two prescriptionfills through retail before allowing or requiring theprescription to be processed by mail.

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Areas for Improvement

Client-Focused Infrastructure and Reporting. Anumber of employers express dissatisfaction with PBMreporting, saying they have difficulty understanding thedata. Employers also want reports tailored to specificinterventions. Generally, PBMs will not customizereports without charging additional fees. For theirlargest clients, the cost of customized systems andreporting is usually included in the bidding process.

A related issue employers raise is member service.Especially during the first quarter of a plan year withnew coverage rules, employers report that members arefrequently directed back to them rather than havingissues resolved by the PBM. As large corporationsreduce the size of their benefits staff, the problem isbecoming more pronounced. Employers want PBMs touse more sophisticated information and reportingsystems so that member service representatives canreadily reference coverage rules and reports can becustomized. They also want better handling of memberinquiries, especially when delivering unwelcomemessages, and better execution of appeals processes.

Industry leaders are aware of employer concerns andare responding in a variety of ways. For instance, somePBMs are experimenting with electronic venues tocustomize reports. Employer-clients would have adatabase available to them and could customize theirown reports. PBMs are also distilling data into action-able information and creating reports consistent withplan objectives, rather than reporting a lot of data thatmay be meaningless to the client. PBMs and theirclients are continuing to work together to improvereporting and customer service.

Proactive Programs. Employers want PBMs to moreactively address physician prescribing patterns andpharmacy performance to encourage best clinicalpractice. The lack of proactive account managementrelative to cost management and quality improvementopportunities is a common employer complaint.

For example, Verizon Communications, workingwith Omnicare, Inc., a geriatrics health care company,found a significant number of Verizon’s Medicare-eligible retirees were being prescribed cisapride, agastroesophageal reflux disease medication withadverse side effects for many seniors.17 They also foundtheir PBM did not have a drug utilization reviewprotocol to caution against cisapride use in seniors,even though there are alternatives with significantly lessrisk. Omnicare pharmacists consulted with prescribingphysicians in an effort to reduce the risk of cisapride-

associated problems in plan members with medical anddrug risk factors. The effort resulted in cisapride beingdiscontinued in 78 percent of identified cases.

Another example is an effort led by General Motors(GM) to improve treatment compliance and drug effectthrough dosing optimization. GM’s director of phar-macy, health care initiatives, Cynthia Kirman, PharmD.,has met with hospitals, health plans, PBMs, medicalsocieties, employers, and drug manufacturers to stimu-late awareness and education about the quality and costimplications of once- versus twice-daily dosing. GM isworking with Merck-Medco Managed Care on develop-ing a pilot program to improve optimal dosing formaintenance drugs obtained through mail service.

Employers recognize that payment on a per claimbasis does not provide PBMs an incentive to improveclinical practice. Some are exploring more aggressiverisk-sharing arrangements such as performance-basedpharmacy networks. Others are excluding rebateguarantees from their contracts to reduce incentivesdriving utilization toward specific drugs.

Lessons Learned

Employers interviewed for this issue brief generallyagree that they would offer the following advice toothers considering contracting with PBMs.

Recognize that not all PBMs are alike. Most PBMsevolved with a focus on a particular market segmentand therefore developed specific management strategiesand strengths. For example, a PBM may present excel-lent financial terms but not have a strong reputation forservice to pharmacists and physicians. Open reportingof rebate agreements and processes may be a manage-ment approach for one firm, but not another. One PBMmay have successful disease management programs,while another is relatively ineffective in demonstratingparticipation by target populations. Although there is afairly uniform level of administrative services providedby industry members, employers must consider anumber of financial, operational, and special programissues during the bidding and selection process.

Clearly define objectives and contract terms. Asemployers gain more experience with PBMs, they areless likely to use standard PBM contracts. Many em-ployers are undergoing a comprehensive review ofcontract terms to improve clarity. For example, newcontracts clearly define how measures will be calculatedand reported and how penalties will be assessed. Theythoroughly describe audit rights and what constitutes arebate. Financial terms are being renegotiated with

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greater use of incentive/penalty arrangements. Moreemployers are working with consultants familiar withPBM operations in order to improve their knowledgeand position prior to contracting.

Formally review performance. Although it can beexpensive, more employers are auditing their PBMs.Occasionally, audits find errors such as incorrect fees ordiscounts programmed at set-up that result in financialcharges to the PBM. Some employers report that anaudit revealed a PBM practice they did not track inroutine reports, such as therapeutic substitutions at mailservice. The Segal Company, an actuarial and consult-ing firm, finds formal PBM reviews and audits often“provide encouraging news about PBMs,” such ashigher than expected generic substitution rates andlarger discounts than required by the contract.18

Actively communicate with plan members. Leadingemployers believe the more informed employees andretirees are about their prescription drug benefit, theless likely they will have problems. At a minimum,members should understand the objectives of theprescription drug plan and know what drugs are on theformulary and what techniques are used to promoteformulary compliance.

Changes in coverage or processes present specialcommunication challenges. Drug price changes are espe-cially difficult to communicate in a timely way.Employers devote significant resources to benefitscommunication. They actively educate employees andretirees through a variety of venues about their benefitplans, navigating the health care system, and healthpromotion/disease management. PBMs, through con-tractual agreements, are also responsible for educatingplan members. They use multiple media to reach out tomembers and respond to their inquiries. They also preparenetwork pharmacies to answer plan member questions.

Growing Concerns about ManufacturerRelationships

As prescription drug spending continues to climb atdouble-digit rates, more employers have questionsabout the effects of PBM/manufacturer relationships.Speaking candidly, they worry that manufacturerpricing and rebate agreements may inappropriatelydrive formulary and drug switching decisions andexcessive use of drugs. There is no objective evidencelinking rebates to inappropriate volume increases ordrug substitutions to consumer harm or benefit. ButPBMs do not disclose details of rebate negotiations andother revenue from manufacturers, fueling speculation

about the actual effects of those agreements. JimAstuto, regional manager with the healthcare manage-ment group at Verizon Communications, speaks formany employers when he asks, “Are we getting dis-count prices while driving increased volume?”

Until recently, few employers were interested indrug formulary management. Employers are reluctant toinvolve themselves in areas where they have littleexpertise. After making basic decisions about formularyrestrictiveness and enrollee cost-sharing, they rely onthe PBM and its pharmacy and therapeutics (P&T)committee to recommend a quality formulary. The P&Tcommittee usually comprises physicians and clinicalpharmacists and is often independent of the PBM. Theirrecommendations are based on evaluations of drugefficacy, safety, and relative cost. Drug side effects andtheir relationship to physician visits, clinical monitor-ing, and patient functioning are considered whendetermining relative cost.

Many P&T committees use what Joanne Sica,assistant vice president of Aon Consulting, refers to asa “bucket strategy.”19 The first bucket contains “musthave medications.” The second bucket contains “noneed to have medications.” These drugs either have noclinical advantage over others in the same therapeuticclass or have safety or efficacy profiles that are notcomparable to others in the class and/or have a higherprice. The third bucket contains “could have medica-tions.” These have similar safety, efficacy, and relativecost as other drugs in the therapeutic class and are goodclinical alternatives for many patients.

Once determinations are made on “must have” and“no need to have” drugs, the committee may provideguidance on the “could have medications” and thenumber of choices physicians should have within atherapeutic class. Otherwise, their work is complete. ThePBM then negotiates price and rebate agreements on the“could have medications.” Whether those drugs end upon the formulary may be due more to the capabilities ofthe PBM’s rebate contracting department than to clinicalsignificance, according to some industry experts.

Some PBMs report a somewhat different P&Tcommittee process. Among others, the Merck-MedcoManaged Care P&T committee does not use cost as afactor in its considerations. Drug price is negotiated bythe PBM based on its ability to move market share. Itdoes not enter into P&T committee deliberations.

Rebate negotiations seem to be getting more com-plex. Negotiating a rebate for one drug often necessi-tates having other of the manufacturer’s drugs on the

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Copayments 78%

Coinsurance 17%

Both 5%

None <1%

Source: International Society of Employee Benefit Specialists, Survey Results,December 2000.

formulary. Manufacturers may also require demon-strated market shifts to qualify for rebates. The PBM’suse of the formulary to shift utilization gives thembetter leverage to negotiate prices and rebates frommanufacturers. But there are numerous questions aboutthat strategy, such as whether drug switching decisionsare in the best interest of individual consumers and howphysicians view therapeutic substitution requests andother, perhaps numerous, PBM formulary advisories.

Employers play a part in the problem by acceptingdiscounts and using rebate performance guarantees. Inthis competitive environment, however, most employersare reluctant to give up rebates when everyone elsebenefits from them and there is no hard evidence ofdetrimental utilization effects.

CONSIDERATIONS FOR MEDICARE

As Congress considers expanding Medicare benefitsto include outpatient prescription drugs, large employerexperiences highlight important considerations forMedicare policy.

Expenditure Trends andPatient Affordability

Prescription drug costs as a percentage of total healthcare expenditures will continue to rise and older Ameri-cans will continue to account for a disproportionateshare of drug spending. In 2000, drug spending rose by19 percent to almost $132 billion. A recent study by theHealth Care Financing Administration predicts prescrip-tion drugs will be a major driver of annual health carespending increases averaging 13 percent over the nextdecade.20 Medicare beneficiaries will spend an estimated$686 out-of-pocket on drugs in 2001, and 20 percent ofthem will spend more than $1,100.21

Employer experiences bear out these data. The drugbenefit is the fastest rising component of retiree medicalplan costs. A survey of large employers predicts retireedrug costs will increase 23 percent in 2001, comparedto a 13 percent rise in total retiree medical plan expen-ditures.22 One employer interviewed for this briefreports that Medicare-eligible retirees use an average of34 prescriptions per year, while the average for activeenrollees is 11 percent.

More work is needed to understand PBMs’ capabil-ity to affect drug prices, expenditures, and trends. A1997 U.S. General Accounting Office study of theFederal Employees Health Benefits Plan estimatedsignificant savings from PBMs, although much of the

savings came from “lower prices paid to pharmaciesrather than rebates offered by drug manufacturers.”23

Private employer experiences show PBMs exertmore control over expenditures and trends than anunmanaged system does, but on the whole are unsuc-cessful in slowing spending growth. PBMs counter theycould further slow spending if permitted to use moreaggressive pharmacy management strategies, butemployers are unwilling to do so.

Nevertheless, after almost a decade of annualdouble-digit growth in prescription drug expenditures,employers are increasing copays for brand and genericdrugs. And more employers are considering shiftingconsumer cost-sharing from a copay to a coinsurancedesign. As shown in Figure 1, copayment accounts formore than three-quarters of current cost-sharing struc-tures. The copay design, a flat fee paid by plan mem-bers for a prescription, such as $5 for generic and $10for brand drugs, has resulted in employers’ paying anincreasing share of drug costs as prices have increased.The coinsurance design requires plan members to paya percentage, usually 20 percent, of the prescriptioncost. Coinsurance designs automatically index memberout-of-pocket spending to the drug’s cost and may makeconsumers more aware of prices for different brand andgeneric drugs.

Figure 1Employer/Employee Cost-Sharing Structures

The Role of the PBM

The way the PBMs’ role is defined and the flexibil-ity they are given to use techniques such as formularymanagement and drug utilization review will likely

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determine their effectiveness in containing costs andimproving the way patients use and physicians prescribedrugs. However, just as there is a public backlashagainst managed care, there may be problems if PBMsare perceived by consumers and physicians as being toointrusive.

Such sentiment is evident in New Jersey, wherenew regulations effective July 1, 2001, prohibit healthmaintenance organizations from using a closed formu-lary or denying coverage for drugs not on their pre-ferred list. The new rules also limit plan member andphysician incentives to choose preferred drugs.24

Citing such examples, policy experts speculate aboutthe appropriateness of the current private-sector modelfor Medicare. Coverage decisions and processes in aMedicare benefit would need to be more public andsubject to greater scrutiny. Some industry expertspropose a fairly regulated approach to PBMs adminis-tering Medicare benefits, with open formularies,reference (or incentive) drug pricing, and periodicbidding for regional monopoly contracts. Others recom-mend a more competitive model, whereby seniorswould choose among approved PBMs in their market.

Still others, such as the National Association ofChain Drug Stores (NACDS), question the scope ofpatient care and cost management responsibilitiesassigned to PBMs in Medicare drug proposals underconsideration. NACDS would limit the PBM role toadministrative functions, saying they have not beeneffective care managers and actually add cost to thesystem.25

Depending on the structure of a Medicare PBMmarket, the formulary itself could be a critical stickingpoint in designing a workable benefit. Private employ-ers make important decisions regarding the restrictive-ness of the formulary and member cost sharing. WillMedicare play a similar role? If so, how will formularydecisions be made, and what are the implications ofexcluding drugs from the Medicare formulary? On theother hand, formulary design and compliance incentivesare the key tools for containing costs. How wouldprogram spending be managed with an open formularyand few rules or incentives for preferred drugs?

PBMs and Financial Risk

Typically, PBMs contracting with employers arepaid by a fee-for-service arrangement. They generallydo not guarantee drug spending trend or take capitatedrisk. They do, however, negotiate financial guaranteesfor certain aspects of the plan, such as generic dispens-

ing rates and rebates. In recent years, PBMs experi-mented with capitated arrangements. These werequickly abandoned for a variety of reasons: PBMs arenot insurers, they have not been able to accuratelyproject cost trends, and they do not have contractualrelationships with physicians and therefore have littleability to influence prescribing. Generally, proposals toshift Medicare’s insurance risk for pharmacy to thePBM industry through full capitation have met with acool reception. But, since the Medicare prescriptiondrug bill passed by the House last year was based oncapitation, the issue of risk assumption by PBMs hascontinued significance.

Marketplace Relationships and Dynamics

Finally, Congress must consider how a Medicarebenefit administered by PBMs affects marketplacerelationships and dynamics. For example, retail pharma-cies say increased PBM market share disproportionatelytargets them for cost containment through low reim-bursement rates. Another competitive issue they raise isthe redirection of consumers to mail order and Web-based pharmacy services. While mail order and onlinepharmacies may be a convenience for consumers, thelong-term impact on retail pharmacies is unknown.

THIS FORUM SESSION

Speakers

Bridget Eber, Pharm.D., who leads Hewitt Associ-ates’ national prescription drug consulting practice, willbegin with an overview of the PBM industry and a dis-cussion of the principles and “rules of the road” thatgenerally guide large-employer contracting decisions.Before joining Hewitt, Eber was a regional pharmacydirector for a large national HMO, where she was res-ponsible for administrative and cost management pro-grams. She has also practiced as a clinical pharmacist.

Cynthia Kirman, Pharm.D., director of pharmacy,health care initiatives, at General Motors, will discussGM’s experience with pharmacy benefit managementand outline current GM pharmacy initiatives, with afocus on retiree issues. In her role at GM, Kirman, aregistered pharmacist, works with insurance carriers,unions, and community leaders to improve prescriptiondrug value and quality. Her previous professionalexperience includes serving as director of pharmacyprograms for a health maintenance organization and asdirector of clinical information services for a pharmacybenefit management company.

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1. For more information on industry evolution and a glossaryof terms, see Robin J. Strongin, “The ABCs of PBMs,” IssueBrief No. 749, National Health Policy Forum, October 27,1999.

2. Mark McClellan, Ian D. Spatz, and Stacie Carney,“Designing a Medicare Prescription Drug Benefit: Issues,Obstacles, and Opportunities,” Health Affairs, 19, no. 2(March/April 2000): 26-41.

3. Anna Cook, Thomas Kornfield, and Marsha Gold, “TheRole of PBMs in Managing Drug Costs: Implications for aMedicare Drug Benefit,” a report by Mathematica PolicyResearch, Inc., for the Henry J. Kaiser Family Foundation,January 2000.

4. Strongin, “ABCs of PBMs,” and Lynn Etheredge,“Pharmacy Benefit Management: The Right Rx?” HealthInsurance Reform Project at the George Washington Univer-sity, April 1995.

5. Cook et al., “Role of PBMs.”

6. For a detailed overview of PBM origins and ownership,see Cook et al., “Role of PBMs.”

7. Bridget Eber, “The Employer/Purchaser PBM Perspec-tive,” presentation for Hewitt Associates at the NationalHealth Care Purchasing Institute Advanced PurchaserWorkshop, Academy for Health Services Research andHealth Policy, November 17, 2000.

8. Cook et al., “Role of PBMs.”

9. A three-tier structure has different copayments forgeneric, brand, and nonpreferred brand drugs. In 2000, 29percent of large employers used a three-tier plan with an

Bruce I. Taylor, director, benefits planning, healthand welfare plans, at Verizon Communications, willdiscuss the firm’s experience with pharmacy benefitmanagement as well as important considerations forMedicare’s use of PBMs. At Verizon, Taylor is respon-sible for the strategy and management of the firm’shealth care and other welfare employee benefit plans.He is actively involved in national health care issuesand holds leadership positions in the WashingtonBusiness Group on Health, the Employer’s ManagedHealth Care Association, and the Leapfrog Group forPatient Safety, among others.

Jeff Sanders, senior vice president, strategic initia-tives, at AdvancePCS, will focus on the operational issuesPBMs face in providing services to large-employercustomers and how these issues would play out in aMedicare environment. Before joining PCS in 1993,Sanders served three years as director of the Office ofLegislation and Policy at the Health Care FinancingAdministration; he has also held posts with the Congressand the Office of Management and Budget.

Independent health policy consultant LynnEtheredge will conclude with reactions to the speakers’presentations, raising key questions about the use ofPBMs to implement a Medicare prescription drugbenefit. Etheredge’s career includes several stints at theOffice of Management and Budget; he currently workswith the Health Insurance Reform Project at the GeorgeWashington University and has authored numerouspolicy studies about Medicare reform and prescriptiondrug coverage.

Key Questions

Among the questions to be considered by thespeakers are the following:

� How effective are rebates for cost containment? Andto what extent do purchasers actually pay the aver-age wholesale price? If PBMs manage most ofprescription drug purchases, can they all be gettingdiscounts from the “average” price?

� What would be the role of PBMs in a Medicarebenefit? By what process will Medicare as the buyermake cost containment, utilization management, andformulary decisions? If PBMs were given littlelatitude to apply utilization management techniques,how would costs be managed?

� How should the Medicare PBM marketplace bestructured, that is, one PBM per area or competingPBMs?

� How would a Medicare benefit administered byPBMs affect marketplace dynamics and relation-ships among PBMs, retail pharmacies, manufactur-ers, and health plans? How would the benefit affectcompetition for PBM services, considering there areother companies with similar management capabili-ties, such as the Blues plans and EDS?

� What are the Medicare specific concerns, such asimplementation and administrative challengesrelated to Medicare population characteristics (forexample, older, sicker, lower average income;integration of Part A and B systems with PBMoperations; and restructuring of medigap options)?

� In designing the benefit, how can Congress capital-ize on industry information management capabilitiesto improve drug safety and efficiency?

ENDNOTES

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average copayment of $29.00 for nonpreferred brand drugs,according to consulting firm William M. Mercer. Some of thenew four-tier structures are based on cost and efficacy ratherthan whether the drug is a generic or brand. For example, ahigh-cost generic may be in tier two, while a low-cost brandname drug may be in tier one. Self-injectables, gene therapydrugs, and new biotech products are placed in tier four, withthe highest copay or no coverage provided by the plan,although consumers may benefit from a price discount due togroup purchasing.

10. Ann Carrns, “Trio of Big Pharmacy-Benefit ManagersAnnounce Plans for Electronic Exchange,” Wall StreetJournal, February 23, 2001.

11. Jerome P. Kassirer, “Patients, Physicians, and theInternet,” Health Affairs, 19, no. 6 (November/December2000): 115-123.

12. William M. Mercer, Inc., “Accelerating Health BenefitCost in 2000 has Employers Bracing for Double-Digit Rise in2001,” press release, December 12, 2000.

13. Blaine Bos, briefing for Capitol Hill staff and media,based on Mercer/Foster Higgins National Survey ofEmployer-Sponsored Health Plans: Key Findings for 2000,April 18, 2001.

14. International Society of Certified Employee BenefitSpecialists (ISCEBS), “Employer-Sponsored PrescriptionDrug Benefits—A Closer Look: Survey Results,” Brookfield,Wis., December 2000.

15. ISCEBS, “Survey Results.”

16. AdvancePCS, Fact Sheet, January 2001.

17. Jim Astuto, Regional Manager, Healthcare ManagementGroup, Verizon Communications, Inc., telephone conversa-tion with author, April 16, 2001, and National Health CarePurchaser Award Nomination Form, National Health CarePurchasing Institute.

18. The Segal Company, “A Prescription for Treating theHigh Cost of Drug Coverage: PBM Reviews and Follow-up,”Government Employees Benefits Update, June 2000.

19. Joanne Sica, telephone conversation with author, May 30,2001.

20. Stephen Heffler et al., “Health Spending Growth Up in1999; Faster Growth Expected in the Future,” Health Affairs,20, no. 2 (March/April 2001): 193-203.

21. Kaiser Family Foundation., “Medicare and PrescriptionDrugs,” Fact Sheet, March 2000; accessed January 30, 2001,at http://www.kff.org/content/2000.

22. Watson Wyatt Worldwide and Washington BusinessGroup on Health, “Projected Employer Health Care Spendingin 2001,” survey, 2000.

23. U.S. General Accounting Office, “Pharmacy BenefitManagers: FEHBP Plans Satisfied with Savings and Services,but Retail Pharmacies Have Concerns,” GAO/HEHS-97-47,February 21, 1997.

24. “New Jersey Fiddles with Formularies,” Business andHealth, March 2001, 22.

25. National Association of Chain Drug Stores, “Assuring aQuality, Cost-effective Pharmacy Benefit for America’sSeniors,” Issue Brief, April 2001.