Maintaining the Affordability of the Prescription Drug Benefit
The purpose of this paper is to explain how managed care organizations (MCOs) are able to secure lower drug prices from pharmaceutical manufacturers as part of an effort to control drug expenditures. This paper focuses on methods MCOs use to concentrate their purchasing power to acquire the least expensive therapeutically safe and effective drugs while utilizing the discounting and contracting practices between MCOs and pharmaceutical manufacturers to achieve these ends.
What are MCOs?
MCOs include health plans, health maintenance organizations (HMOs), pharmacy benefit managers (PBMs), preferred provider organizations (PPOs), and integrated care organizations (ICOs).
An MCO is able to provide drug benefit coverage based on payments from two sources:
- Plan sponsors that pay a predetermined amount per month as a premium for drug coverage insurance or reimburse for individual prescription costs, and
- Patients who pay a portion of the cost of the benefit through copayments, co-insurance, and/or deductibles.
Plan sponsors include employers, unions, trust funds, associations and government agencies, and are also referred to as payers.
Successful efforts by MCOs to lower drug expenditures usually save money for both plan sponsors who pay the premiums and for patients. These efforts should ultimately help to ensure the affordability and sustainability of the benefit coverage.
Costs of Prescription Drugs
Pharmaceuticals play an increasingly important role in the prevention, cure and management of disease. At the same time, expenditures for drugs have been and are expected to continue to increase at rates higher than or comparable to expenditures for other health-related products and services. Prescription drug spending is projected to increase by 5.7 percent per year between 2011 and 2021.1
Increases in expenditures for prescription drugs are attributable to several broad categories: increased utilization, increased focus on quality improvement initiatives for medication adherence, higher costs of new medications and escalating prices. Increases in utilization are due to the availability of new drugs to treat diseases in which there were limited therapeutic options as well as increased use of combinations of drugs to treat a single disease. The specialty drug market is expected further increase costs over the next few years. By 2014, 25% of drug spend is expected to be attributed to specialty drugs, with the top three conditions (inflammatory conditions, multiple sclerosis, and cancer) accounting for more than 2/3 of spend.
MCOs Managing the Costs
With more than 200 million Americans currently receiving their health care through MCOs, the role of managed care pharmacy in maximizing the value of pharmaceuticals is significant. With the implementation of Medicare Part D and the upcoming health care marketplace in 2014, the number of lives affected by managed care pharmacy programs has the potential to dramatically affect both Medicare beneficiaries as well as individuals when seeking to access drug benefits.
The goal of MCOs’ drug coverage programs is to provide appropriate, affordable and accessible prescription drug benefit coverage so that positive patient outcomes are achieved. The challenges in meeting this goal, however, are numerous and complex. MCOs drug benefit coverage programs routinely use a variety of tools and strategies, frequently in tandem, to achieve the goal of managing costs for consumers and plan sponsors, including:
- Establishing formularies or preferred drug lists so that purchasing resources can be concentrated on making appropriate drugs available to most MCO members, while allowing for medically necessary alternatives for selected patients
- Negotiating volume discounts and implementing maximum allowable cost (MAC) pricing with retail and mail order pharmacies to provide MCO members with convenient access to pharmaceuticals
- Working with prescribers to ensure they are prescribing drugs appropriately based on sound scientific evidence and principles
- Promoting the use of appropriate generic products. Generic products are as safe and effective as the branded product and interchangeable with it. Most MCOs structure their prescription drug benefit design to promote the use of generics because they usually offer significant value
- Implementing disease management and medication therapy management programs designed to improve the quality and efficiency of patient care
- Implementing medication evaluation policies and systems such as drug utilization review, prior authorization, step therapy and quantity and dosage management to ensure high quality, medically safe and effective therapy and cost efficient use of prescription drugs
- Negotiating contracts with pharmaceutical manufacturers to obtain lower net drug prices
- Negotiating contracts with pharmaceutical manufacturers based on therapeutic outcomes
While most of the managed care tools identified above can be used to reduce the cost of pharmaceuticals, the focus of this paper is on contract arrangements between manufacturers and MCOs that directly result in lower costs, as well as understanding concepts related to the purchase of pharmaceuticals. (For information on other managed care pharmacy tools see AMCP’s The Value of Pharmaceuticals and Managed Pharmaceutical Care2, Principles of a Sound Drug Formulary System3, the Concepts in Managed Care Pharmacy series of Formulary Management4, Drug Use Evaluation5, Prior Authorization and the Formulary Exception Process6.)
Working with Pharmaceutical Manufacturers
In many ways, managing the cost of pharmaceuticals is comparable to how costs are managed by each of us as individuals in every day business and family life when securing the lowest possible net cost is typically a primary objective. The following are among the most commonly encountered examples:
- Concentration, e.g., “frequent buyer” cards and purchase commitments
- Discounts, e.g., “specials” and “sale” items at the grocery store
- Bulk purchases, e.g., purchases at large warehousetype retailers where the typical size of the product might be two or three times as large as at a more conventional retailer
- Rebates, e.g., when buying a car or electronics
Similar opportunities exist for MCOs and other purchasers of health care services and products, including pharmaceuticals. As is the case in any other business setting, MCOs routinely seek savings and lower pricing by utilizing contractual commitments that secure better prices through discounts, bulk purchasing and rebates for both goods and services.
There are three major areas where health plans negotiate contracts:
- Hospitals, physicians and clinics that provide services to their members
- Pharmacies that fill members’ prescriptions
- Pharmaceutical companies that produce the drugs used to fill members’ prescription orders
The Cost of Pharmaceuticals – Discounts and Bulk Buying
In the past, MCO members have had access to prescriptions primarily through three distribution alternatives: staff model pharmacies, mail order pharmacies and network pharmacies. Mechanisms that can be used to achieve lower drug costs within each of these avenues are outlined below.
- Staff Model Pharmacy Organization
The least common distribution alternative is a pharmacy wholly-owned and operated by an organization for use by its employees and members. Examples include health plans such as Kaiser Permanente, Group Health Cooperative and Harvard Pilgrim, and government agency programs operated by the Department of Defense and the Department of Veterans Affairs, or a private entity. Typically a pharmaceutical manufacturer or wholesaler contracts directly with the staff model pharmacy organization. All products are shipped directly to the pharmacies or in bulk to the pharmacy organization’s own warehouse. By thus reducing the cost and risk to the supplier, the MCO may qualify for a price reduction. In some cases this reduction is known as a “discount off invoice” or a reduction from the full price shown on the invoice.
- Mail order pharmacy
Mail order service facilities account for 17 percent of expenditures on outpatient prescriptions.7 Typically a pharmaceutical manufacturer or wholesaler negotiates and contracts directly with the mail order facility. All products are usually shipped directly to the facility for dispensing to patients who have chosen to use this alternative. As described in the preceding paragraph, the pharmaceutical manufacturer may provide lower pricing to the purchaser of the drugs, in this case a mail order service facility, through a "discount off invoice" arrangement.
- Network Pharmacy
MCOs that do not own or operate pharmacies, such as health plans or PBMs, provide drug products to covered members by entering into contracts with chain or independently owned pharmacies to create a network of pharmacies accessible by their members. These pharmacies are referred to as “network pharmacies.” The majority of prescriptions in this country are delivered to patients through network pharmacies. The MCO does not receive shipments of drugs or take direct ownership of them from the manufacturer.
In the case of network pharmacies, the pharmaceutical manufacturer provides any negotiated discount to the MCO through a rebate to that MCO. Rebates are the mechanism used by MCOs to drive price concessions from manufacturers since the MCO does not actually take control of the product. Rebate agreements between MCOs and pharmaceutical manufacturers help drive down the costs of prescription drugs for consumers and payers.
A fourth method of patient access to medications is administration of the drug in the physician’s office. Medications administered in such a manner are typically covered by the medical benefit rather than the pharmacy benefit. In recent years, contracting with pharmaceutical manufacturers for drugs covered by the medical benefit has become more prevalent in order to further reduce costs.
Mechanisms that can be used to achieve lower drug costs
Just as there are several ways that MCOs purchase, deliver and pay for drugs for their members, there are several contract mechanisms that are available to MCOs to secure lower prices for drugs; they are related to the distribution alternatives described above.
Discounts direct from the manufacturer, often called “discount off invoice” or “bulk discounts”
As explained in the discussion of staff model pharmacies above, some MCOs own and operate their own pharmacies that dispense prescriptions to their plan members. In these situations, the MCO negotiates with the pharmaceutical manufacturer to obtain a lower purchase price for a drug. Typically the negotiated price is based on the market share that drug realizes within the MCO’s covered population. The MCO is billed by the manufacturer for the drug it purchases, based on the negotiated price for the drug including any discount off invoice, and then the MCO pays the manufacturer directly for the product it receives. This is similar to any purchase from a manufacturer that a business may make whether it is for office supplies, laboratory equipment or drugs.
In some situations, pharmaceutical manufacturers may also offer “bulk discounts,” an added discount given when MCOs purchase an extraordinarily large amount of product.
A rebate is broadly defined as a discount that occurs following a purchase wherein the manufacturer of the product returns some of the money that was paid for the product to the purchaser. When drugs are purchased by MCOs, rebates are determined based upon volume, market share and other parameters (see description below). Rebates are provided by pharmaceutical manufacturers to MCOs. Rebate discounts are the most common mechanism that pharmaceutical manufacturers use to provide lower pricing to MCOs, because most prescriptions are dispensed to plan members through network pharmacies.
The MCO/pharmacy network/pharmaceutical manufacturer relationship is comparable to what occurs when a parent buys a computer for a child and the computer manufacturer offers a rebate on the purchase. In this example, the parents are the purchasers, but the child gets the computer. The parents receive a rebate check from the computer manufacturer when proof of purchase is submitted.
In the MCO/pharmacy network/pharmaceutical manufacturer arrangement, when a plan member’s prescription is filled by a network pharmacy, a similar transaction occurs. The member receives the prescription. The MCO, as the purchaser, sends the proof of purchase to the pharmaceutical manufacturer and earns the rebate for purchase of the drug.
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The following summarizes how the rebate process works when a health plan negotiates a rebate contract with a pharmaceutical manufacturer to provide savings to consumers and plan sponsors:
- The health plan develops a network of chain and independent pharmacies that agree to fill prescriptions for the health plan’s members.
- The health plan negotiates a rebate with the manufacturer of a drug, based on potential volume, preferred positioning in the formulary, or some other basis that justifies a rebate.
- The network pharmacy purchases drugs either directly from the manufacturer or through a wholesaler, so it has a supply available when patients present prescriptions.
- The manufacturer or wholesaler bills the pharmacy for the drugs that were shipped to the pharmacy, and the pharmacy pays the invoice for these shipments. These bills do not reflect any rebate arrangements that may have been negotiated between the manufacturer and health plan.
- A health plan member goes to the network pharmacy with a prescription for the drug for which the health plan has negotiated a rebate.
- The pharmacy fills the prescription and provides the drug to the member. The pharmacy also bills the health plan for the cost of the prescription, as allowed in the pharmacy’s contract with the health plan. This bill is based on the price the pharmacy paid for the drug, not the discounted price the manufacturer has negotiated with the health plan.
- The health plan reimburses the pharmacy for the cost of the prescription.
- The health plan also sends a report to the manufacturer indicating that its member received the drug and that it is requesting the rebate that was negotiated for the drug. This request is basically an invoice to the manufacturer for the difference between the amount reimbursed to the pharmacy and the discounted price negotiated with the manufacturer.
- The manufacturer pays the health plan the rebate amount.
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There are several types of rebate agreements that are used by pharmaceutical manufacturers and MCOs. Manufacturers offer rebates for specific medications based upon plan and formulary design decided upon and updated by a Pharmacy and Therapeutics (P&T) committee. Once a P&T committee determines the clinical value of adding a drug to the formulary, the MCO will negotiate the most advantageous arrangements, including rebates. (For additional information on formulary development, see AMCP’s Concepts in Managed Care Pharmacy – Formulary Management.8 The reader should also refer to AMCP’s Principles of a Sound Drug Formulary System.9)
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A formulary or preferred drug list is a quality assurance and cost management tool that lists medications that are preferred by the plan. MCOs develop formularies that are continually updated by pharmacy and therapeutics (P&T) committees to stay up-to-date with new medications and new medical information. P&T committees consist of knowledgeable pharmacists, physicians and other health care professionals who evaluate medications based on safety, efficacy and clinical merit of the drug. A P&T committee meets on a regular basis to determine which medications should be placed on the formulary. The most important information that a P&T committee will consider is the safety and efficacy of medications.
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Different types of rebates include:
Market share rebates
Market share rebates are often called “incentive formulary rebates.” They are used when a pharmaceutical manufacturer is interested in increasing the percentage of market share of its drug versus competitors’ drugs by a particular MCO’s members. The manufacturer will offer a rebate to the MCO if the MCO is able to increase the use of its drug versus the competitor’s drug. The MCO reduces costs by moving market share, capturing higher rebates and passing the savings through to consumers and employers. Such arrangements are put in place once the P&T committee has evaluated all competing drugs and has determined that the competing drugs in question are clinically equivalent and are appropriate for members. Market share rebate arrangements offer a variable percentage of rebate dollars based upon the market share level a drug captures compared with other similar drugs in the same class.
This type of rebate is considered for use depending on the following factors:
- Number of drugs within a class of medications
- Utilization levels of a particular drug
- The utilization management strategy (Prior Authorization, Step Therapy, etc.) put in place for a certain medication/class of medications
- Ability to increase a drug’s market share in the class of medications beyond what direct-to-consumer advertising or the manufacturer’s sales force could potentially achieve.
There are two types of rebates related to formulary placement that can be used:
- Formulary access rebate: A manufacturer may offer a formulary access rebate to an MCO for placement of a drug on a formulary once the drug has been judged clinically appropriate by a P&T committee.
- Rebates based on formulary type: There are different types of formularies — for example, open, closed and tiered. An MCO with a closed formulary will cover a member’s medication only if it is on the formulary or otherwise authorized. Under a tiered formulary, more medications are usually eligible for coverage, but the amount that a member pays is usually higher if that drug is non-preferred. With an open formulary, the member pays the same copay whether or not the drug is preferred. (See AMCP’s Concepts in Managed Care Pharmacy – Formulary Management.10)
In general, a pharmaceutical manufacturer will negotiate a more generous rebate if competing drugs are either kept off the formulary or placed in a non-preferred status such as at a higher copayment tier or with utilization management restrictions (i.e., prior approval or step therapy).
A drug’s position on a formulary can have a significant impact on the rebates that can be negotiated with manufacturers. For example, a P&T committee may review drug A, a higher-cost drug that is clinically superior to a lower-cost drug B (see Table 1). Drug A is placed on formulary in a preferred position. Drug B is placed on formulary in a non-preferred position. An MCO can pass on money generated from rebates for Drug A through to members in the form of lower co-payments. Therefore, members may receive quality, clinically superior, medications with a higher non-rebated cost at a lower out-of-pocket co-payment amount. This will subsequently increase market share of Drug A and increase the amount of rebate earned. In addition to being able to offer lower co-payments for preferred drugs, the use of rebated and preferred drugs may help the MCO reduce the cost of drug benefit premiums.
Table 1. Cost Analysis of Market Share Rebate of Drug A vs. Drug B
Cost of the Prescription
Drug Cost after Rebate
Therapeutic outcome-based rebates
These rebates are based on the utilization of evidence-based medicine and the ability to measure total medical outcomes and costs may help determine the effectiveness of new drugs in the marketplace. The implementation of these rebates allows patients to be seen in a holistic manner and followed throughout therapy, including medication adherence and emergency room (ER)/hospital visits. Discounts/rebates from manufacturers can be based on these measures as well as other health outcomes.
There are three scenarios that may take place:
- If it can be shown that the member has a beneficial health outcome (e.g., with good adherence there has been a positive response to therapy) then the MCO will cover the necessary therapy. This is a win for the MCO as well as the manufacturer because decreasing poor health outcomes such as ER visits overall decreases cost more than the cost of the drug therapy.
- If the member’s medication is found to be ineffective, then the manufacturer may agree to refund the entire cost of the drug, provide a matching amount of drug therapy free for another patient, or even reduce the price in the future.
- A third scenario, which is much less common, is when the manufacturer will actually increase rebates to the MCO if patients show improvement in health outcomes. This would be a “win-win” for both stake holders as well.
In each of these scenarios there is risk-sharing taking place between the MCO and the manufacturer with an overall goal of improving patient outcomes.
The cost for medications continues to rise year after year and is likely to escalate at levels greater than the Consumer Price Index, especially with the numerous specialty drugs in the pipeline.
To get the best price, purchasers of pharmaceuticals use mechanisms similar to and universally available to purchasers of any commodity.
Purchasing and contracting options of MCOs benefit plan sponsors and patients by lowering costs.
The goal of the various mechanisms used in pharmaceutical contracting is to drive down net costs while maintaining high quality, appropriate, affordable and accessible health care benefits.
A patient's ability to obtain medical care determined by the availability of medical services, their acceptability to the patient, the location of health care facilities, transportation, hours of operation and cost of care.
Brand Name Drug
A drug that has a trade name and is protected by a patent (may be produced and sold only by the company holding the patent).
A type of formulary that limits the number of prescription drugs reimbursed by the plan.
Consumer Price Index (CPI)
A governmental program that produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.
An agreement between parties (individuals or corporate) who have the legal capacity to agree and who entered into the agreement voluntarily, in which the obligations set forth in the agreement are legally enforceable and the purpose of the agreement is not illegal or contrary to public policy.
An amount insured members must pay each time they receive a prescription or medical care using their benefit. A fee charged to an insured member to offset costs of paperwork and administration for each office visit or pharmacy prescription filled. A cost-sharing arrangement in which a covered person pays a specified charge for a specific service, such as a fixed dollar amount for each prescription received; (e.g., $5.00 per generic prescription, $10.00 per preferred brand name prescription, and a higher charge such as $25.00 for a non-formulary product).
A specific list of drugs that are included with a given plan for a client. A continually updated list of medications, related products and information, representing the clinical judgment of physicians, pharmacists and other experts in the diagnosis and/or treatment of disease and promotion of health. Types include closed formulary, negative formulary and open formulary. Also referred to as a “Preferred Drug List.”
An organization that finances and either directly provides health care to its enrolled members, through its own facilities and staff, or indirectly through contracted providers of care (physicians, hospitals, pharmacies, etc.).
HMO - Health Maintenance Organization
A form of health insurance in which members prepay a premium for the HMO's health services, which generally include inpatient and ambulatory care. For the patient, it means reduced out-of-pocket costs (i.e., no deductible), no paperwork (i.e., insurance forms), and only a small co-payment for each office visit to cover the paperwork handled by the HMO. There are several different types of HMOs.
Integrated Care Organizations (ICOs)
A specific type of MCO where various types of providers, e.g. physicians, hospitals, pharmacies, etc., are part of one organization that either includes a health plan or that contract together with one or more health plans, i.e. the care is “integrated.”
MAC - Maximum Allowable Cost
A cost management program that sets upper limits on the payment for equivalent drugs available from multiple manufacturers. It is the highest unit price that will be paid for a drug and is designed to increase generic dispensing, to ensure the pharmacy dispenses economically, and to control future cost increases.
Mail-Service Drug Program (Mail Order Pharmacy)
A growing number of Health Maintenance Organizations (HMOs) and Pharmacy Benefit Management (PBM) companies affiliated with corporations or federal contracts use mail-service drug programs to ensure their members have timely access to discount rate drugs. A Mail Order pharmacy is a pharmacy whose primary business is to dispense prescription drugs or devices under prescription drug orders and to deliver the drugs or devices, usually to patients’ homes, by US mail, a common carrier, or a delivery service.
MCO - Managed Care Organization
A generic term applied to a managed care plan; also called Health Maintenance Organization (HMO), Preferred Provider Organization (PPO) or Exclusive Provider Organization (EPO), although the MCO may not conform exactly to any of these formats.
A participant in a health plan who makes up the plan's enrollment.
The group of physicians, hospitals and other medical care professionals with which a managed care organization has contracted to deliver medical services to its members.
Pharmacy and Therapeutics (P&T) Committee
An advisory committee responsible for developing, managing, updating and administering the drug formulary system. P&T Committees are comprised of primary care and specialty physicians, pharmacists and other health care professionals. Committees may also include nurses, legal experts and administrators.
Pharmacy Benefit Management Companies (PBMs)
Organizations that manage pharmaceutical benefits for managed care organizations, other medical providers or employers. PBMs contract with clients interested in optimizing the clinical and economic performance of their pharmacy benefit. PBM activities may include some or all of the following: benefit plan design, creation/administration of retail and mail service networks, claims processing and managed prescription drug care services such as drug utilization review, formulary management, generic dispensing, prior authorization and disease and health management.
A company that assumes financial responsibility for an insured group. Plan sponsors include employers, unions, associations and government agencies, and are also referred to as payors.
Preferred Provider Organization (PPOs)
PPO-based health plans usually experience wider provider choice for their members as compared to HMO plans. Members in PPO-based plans may choose out-of-network providers if they are willing to accept less financial protection from the plan. These organizations contract with entities that bear insurance risk to provide access to a network of providers and cost containment through discounted fees for network providers. Unlike HMOs, PPOs are only one part of a health plan that also includes an insurer or self-insured employer, actuary and benefits design consultant, claims administrator, utilization management company, and other MCO functions.
Preferred Drug List
Broadly defined as a discount that occurs following a purchase wherein the manufacturer of the product returns some of the money that was paid for the product to the purchaser. A monetary amount returned to a payer from a prescription drug manufacturer based on use by a covered person or purchases by a provider.
1 Health Affairs. “Health spending projections through 2013. Feb 11, 2004. at www. healthaffairs.org.
2 The Value of Pharmaceuticals and Managed Pharmaceutical Care, http://www.amcp.org/data/nav_content/index%5Fvalue%2Epdf, accessed March 6, 2006.
3 Principles of a Sound Drug Formulary System, October 2000. http://www.amcp.org/data/nav_content/drugformulary%2Epdf, accessed March 6, 2006.
4 Academy of Managed Care Pharmacy. Concepts in Managed Care Pharmacy – Formulary Management. 1998.
5 Academy of Managed Care Pharmacy. Concepts in Managed Care Pharmacy – Drug Use Evaluation. 1999.
6 Academy of Managed Care Pharmacy. Concepts in Managed Care Pharmacy – Prior Authorization and the Formulary Exception Process. 2005.
7 The Lewin Group, Mail-Service Pharmacy Savings: A Ten-Year Outlook for Public and Private Purchasers, prepared for: Pharmaceutical Care Management Association, August 2, 2005. p. ES-2. http://www.pcmanet.org/newsroom/pr_08/Lewin_Study.pdf, accessed March 6, 2006.
8 Academy of Managed Care Pharmacy. Concepts in Managed Care Pharmacy – Formulary Management. 1998.
9 Principles of a Sound Drug Formulary System, October 2000. http://www.amcp.org/data/nav_content/drugformulary%2Epdf, accessed March 6, 2006.
10 Academy of Managed Care Pharmacy. Concepts in Managed Care Pharmacy – Formulary Management. 1998.