The simple pricing model just described applies to cash transactions but not to those in which the retail pharmacy is paid by a group insurer, employer, or other third party at the point of sale. This section will describe mechanisms affecting the prices paid by private third parties that manage drug benefits. Again, because management by a PBM is most common, this term will be used as a shorthand for all private entities managing drug benefits.7
Because a PBM may manage the drug benefit for a large number of individuals, it can negotiate discounts at both ends of the pricing chain: from the manufacturer and from the retail pharmacy. There is little published data about the size of the discounts obtained by PBMs and private insurers, either from manufacturers or from retailers. Discounts from retailers will be estimated later in this chapter, using the MEPS and IMS Health data. Manufacturer rebates are not reflected in these data sources. Rebate agreements are highly confidential and most information about them derives from anecdotes.
The price paid to a retail pharmacy for a given drug is negotiated by the PBM and the pharmacy or pharmacy chain. Typically the PBM will take into account its estimate of the cost to the pharmacy of acquiring the drug (usually assuming that the pharmacy has paid something less than the AWP) and offer a dispensing fee above that amount. This dispensing fee is commonly a fixed dollar add-on (in the range of $2.50) that is not related to the cost of acquiring a specific drug.8 Because some PBMs cover a large share of the market, a pharmacy will often accept a price that is less than it would charge to cash customers. The PBM's negotiating power may be offset, however, by its need to assure that its enrollees have access to convenient pharmacies. It might offer a higher price to a large chain than to scattered independent pharmacies.9
Discussions with industry experts conducted during the preparation of this report have provided current information on typical PBM payments to retailers. These experts estimate that payments for brand-name drugs are in the range of AWP minus 13 to 15 percent, plus a $2.50 dispensing fee. (The range from 13 to 15 percent depends primarily on how restricted the pharmacy network is.) The example in Table 3-1 illustrates this type of discount, resulting in a price that is lower than that faced by cash customers but in this case still offers a 12 percent markup over the pharmacy's acquisition price. For some drugs, however, a pharmacy may be forced to accept reimbursement from the PBM that does not cover the pharmacy's cost of acquiring the drug (let alone its operating costs). The PBM has considerable leverage in this relationship, especially as the proportion of drugs sold through PBM-managed arrangements grows (Figure 3-1). The pharmacy is left with an option of refusing the large share of business, raising its prices for cash customers, or reducing its operating margin.
For generic drugs, about three-fourths are reimbursed using limits known as maximum allowable cost (MAC). These limits are established by PBMs, based on the lowest estimated acquisition cost for any of the generic equivalents of a given drug. The MAC tends to be 50 to 60 percent below AWP. The remaining one-fourth of generics are reportedly reimbursed, like brand-name drugs, at AWP minus 13 to 15 percent. The dispensing fee for generics tends to be the same as for brand drugs, but sometimes it is 25 or 50 cents higher, to encourage generic substitution by pharmacies.
The second type of discount that the PBM gets is a negotiated rebate paid directly from the manufacturer to the PBM. This rebate does not affect the price paid by a wholesaler to a manufacturer for the drug, the price paid by a retail pharmacy to the wholesaler, or the price paid by the PBM to the pharmacy. It is a separate transaction between the PBM and the manufacturer and thus affects the total amount spent by the PBM. To the extent that a portion of the rebate is passed along, the insurer, employer, or beneficiary may realize a part of these savings.
A key tool in determining whether rebates are available and how large they are is the use of a restrictive formulary, a list of drugs that the PBM has established as preferred for its enrollees. If there are multiple brand-name drugs available for a given condition, the PBM may include some on its formulary and not others. Enrollees who obtain a non-formulary drug may pay higher copayments, or the drug may not be covered at all. Pharmacies dealing with the PBM may be encouraged to contact physicians who have prescribed non-formulary drugs and suggest a formulary alternative.10 Physicians affiliated with the health plan using the PBM may also face pressure to prescribe formulary drugs. In addition, PBMs will commonly require or encourage substitution of generic equivalents for brand-name drugs when these are available. Again, they may charge higher copayments for brand name drugs, or limit reimbursement to the generic price even when the brand-name drug has been dispensed.
Manufacturers of brand-name drugs that treat conditions for which an alternative brand-name treatment is available thus have a strong incentive to grant discounts to the PBM in return for the inclusion of their drugs in the formulary. If generic equivalents are available, the manufacturer may also grant a discount to make the price of its brand-name product more competitive. These discounts usually take the form of direct rebates from the manufacturer to the PBM. For example, in the simplest rebate arrangement, the PBM may report periodically to a manufacturer the number of prescriptions for a given drug that the PBM's enrollees have filled; the manufacturer then pays the PBM an agreed-upon amount for each prescription. In addition or as an alternative to a per-prescription rebate, manufacturers and PBMs also negotiate arrangements where the PBM is reimbursed for moving market share -- causing a significant increase in the number of prescriptions for the manufacturer's drug.
One study by the General Accounting Office attempted to quantify the value of rebates obtained by PBMs contracting with plans participating in the Federal Employees Health Benefits Program (FEHBP). Blue Cross/Blue Shield paid about $1.4 billion for FEHBP pharmacy benefits in 1995 and estimated that its PBM had saved $505 million, of which 21.2 percent was attributable to manufacturer discounts or rebates and 52.3 percent to discounts from retail and mail-order pharmacies.11 If costs in the absence of the PBM would have been $1.9 billion, this suggests retail or mail-order discounts of 14 percent (consistent with the estimates cited above) and manufacturer rebates of 5 to 6 percent (or slightly more, assuming the PBM did not pass all rebates fully to Blue Cross). Overall FEHBP plans estimated that their savings from manufacturer rebates ranged from 2 to 21 percent of total savings. Industry representatives report that rebate savings can be much higher (35 percent) on selected drugs.12
Table 3-1 uses a range of rebate amounts to show the net effect on the price if the unmeasured rebates were taken into account. This amounts to a hypothetical retail price of $30 to $44 (compared to the total $46 price that the pharmacy receives from the customer and the insurer) if the discounts were applied at the pharmacy instead of through rebates to the PBMs. An alternative way to display this discount would be to reduce the manufacturer's price by the rebate or by some portion of it. Because rebates cannot be measured, the analysis reported later in the chapter does not reflect this additional discount.
PBMs that operate under contract to an insurer or self-insured employer are required to pass on most of the rebates. Industry sources report that the insurer or employer typically receives 70 to 90 percent of the rebates. In addition, the PBM will often guarantee a minimum per-prescription rebate, in case actual rebates received from manufacturers are lower than expected. While estimates differ, industry experts report that the value of rebates passed on to insurers or employers may average about $1.00 per claim.13
In addition to cash rebates, industry analysts have reported that PBMs may receive noncash benefits from manufacturers or cash rebates that are not tied to a particular drug. For example, PBMs may receive rebates from manufacturers in return for agreements with regard to the content of their communications with physicians about the use of certain drugs (sometimes called counter-detailing). PBMs that operate their own mail-order pharmacies may receive extra discounts on drugs purchased by those pharmacies. Other PBMs may receive support for development of disease management systems or other research activities. Some industry analysts believe that the value of these other considerations may exceed the amount of cash rebates. The PBM may not be obligated to pass these benefits on to plan sponsors.
Finally, a PBM can realize further savings by encouraging enrollees to use a mail-order pharmacy. (Some PBMs operate their own mail-order pharmacies.) Enrollees may pay a lower copayment when using a mail-order pharmacy or may be required to use mail-order for drugs to be taken over a long period, such as maintenance drugs for chronic conditions. Mail-order pharmacies can operate with a smaller markup than other retail pharmacies, because of economies of scale and lower overhead. They may also be more successful in encouraging prescribing physicians to agree to substitute formulary for non-formulary drugs, because they have more time to contact a physician before filling a prescription.
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