:: Reflecting On The Delaware Battle of the Titans – Are The Pharmarcy Benefit Managers Really Helping Health Plans?

A Delaware corporate law judge Friday refused to stand in the way of a shareholder vote on the proposed combination of Caremark Rx Inc. and drug store operator CVS Corp. . . .

With a $26.8 billion rival offer already on the table from Express Scripts Inc. Caremark’s rival in the business of pharmacy-benefits management, the threat of an appraisal lawsuit from Caremark shareholders who say the CVS deal is too cheap could be a potent factor in the three-way takeover fight.

Wall Street Journal, Judge Refuses to Halt Deal Between Caremark-CVS (February 26, 2007)

Pharmacy benefit managers, or “PBM’s”, continue the path of consolidation which led to the dominance of the major players in the early 1990’s. The three way fight described in the WSJ represents yet another step in consolidation of the industry. In essence, the struggle is over Express Scripts Inc. competition with CVS Corporation in an attempt to acquire Caremark Rx Inc.

While the Delaware judge refused to halt the sale, the court did require Caremark to hold up on a vote until advised shareholders more about factors that may sway their decision.

PBM’s promise to deliver cost savings to health plans through plan design, effective purchases of appropriate pharmaceuticals, disease management and various ancillary services. The PBM’s dictate the formularies that drive traffic toward certain drugs and away from others based on reimbursements that the PBM’s specify. Inasmuch as the big are posed to get even bigger, these current events present an occasion to reflect on the utility and effect of the PBM mechanism in the American health care system.

Do The PBM’s Make Good On Their Promises?

Virtually all health plans have contracts with one of the major PBM’s and the contracts are rarely scrutinized. Do the PBM’s really accomplish all that they promise? Consider the findings in this report on drug costs in the United States:

In analyzing the volume of drugs consumed per person (standard drug units per capita) for the nine major therapeutic areas in Germany, Canada, the United States, and the United Kingdom, we found that US patients consume approximately 20 percent less prescription drugs than patients in these other nations. As both drug costs and volumes determine total spending in the system, we determine that drug costs to the US health care system are, through this measure,70 percent higher in the United States than in peer nations. . . .

We also analyzed the drug distribution and retail pharmacy system in the United States and peer countries. We found that distribution systems are overall quite similar, except for two distinctions. The first is the use of pharmacy benefit managers (PBMs), an entity unique to the United States, which adds 1 to 3 percent to the total cost of drugs to the system. The second is the use of rebates negotiated between pharmaceutical companies and payors or PBMs. Although in extreme situations rebates can reach 50 percent, they generally average 10 percent. Taking all this into account, we find that overall US drug costs to the system are 50 to 70 percent higher than in peer countries, even after PPP and wealth (GDP) adjustments.

McKinsey Global Institute, Accounting for the Cost of Health Care in the United States (January 2007) pp 14-15 (emphasis added)

The rebate scandals have drawn scrutiny from many quarters and the details of those transactions will not be recounted here. In view of such excesses and the foregoing statistics, employers must question to what extent PBM’s do anything other than add an additional layer of costs in pharmaceutical purchases.

Recall that the recent case Chicago Dist. Council of Carpenters Welfare Fund v. Caremark, Inc., — F.3d —-, 2007 WL 120794 (7th Cir) (January 19, 2007) stands for the proposition that PBM’s do not act as fiduciaries. Since PBM’s view their dealings with health plans as arms-length transactions, employers should govern themselves accordingly, i.e., caveat emptor. See :: “Absolute Discretion” Provision Key To PBM’s Avoidance of ERISA Fiduciary Status

Mail Order Savings?

What about those mail order savings that are so heavily promoted? An innovation that promised much, some are now coming around to the idea that mail order prescription services may not be delivering the savings after all. Consider:

A recent study by The Ohio State University College of Pharmacy found a 3.4% increase in drug utilization among members of the Ohio Public Employees Retirement System (OPERS) who filled their prescriptions via mail order.

While mail order provides convenience to some members, it may not necessarily be less expensive to health plans, Streator said. “The real study is does 90-day supply save more than 30-days supply,” he said, adding that The Ohio State University study shows that OPERS has a 3.4% increase in days supply of mail versus community pharmacy. “Some plans could actually lose money if discounts are not steep enough at mail to account for this increased utilization,” Streator said.

Rick Goebel, vice president at Pharmacy BenefitDirect, a PBM that promises full transparency, says mail order is actually “really expensive to the payer.” One reason for this is that most health plans, in order to entice the use of mail, allow members to drop a co-payment.

“PBM Mail Order Rx Services Are Expanding, But The Cost Savings Are Not Clear”, AIS Health Services, (Reprinted from the November 17, 2006, issue of DRUG BENEFIT NEWS)

AWP as a Fictional Construct

When health plans sign up for services through a PBM, the contract prices have historically been stated in terms of some percentage off average wholesale prices (”AWP”). The preeminent list for drug prices is published by a Hearst Corporation subsidiary, First DataBank. The list was purportedly based upon a survey of wholesaler prices. (The WSJ article noted below cites an industry joke that AWP stands for “ain’t what’s paid”).

For background on the controversy surrounding that pricing mechanism, see the article “First DataBank Agrees To Tentative Settlement In Suit Over Prescription Drug Average Wholesale Prices”.

The article, from Medical News Today, carries several links of interest, including one to the website of the law firm that filed suit against First DataBank, where links are provided to the WSJ article about the litigation and the settlement agreement.

Other pricing mechanisms purporting to establish a norm have suffered similar debunking. For example, PBM’s use a maximum allowable cost (MAC) as the base price for generic drugs instead of AWP. Since MAC lists are generated by a variety of different entities, critics have noted that a PBM could use one MAC list to charge clients and another MAC list to reimburse pharmacies. This too has led to litigation and a call for transparency in pricing and billing strategies.

Medco Holding Its Own

Medco Health Solutions, Inc., the PBM titan notably absent from the battle of the giants for Caremark, actually predicts gains from the consolidation. In the recent article “As Rivals Tussle, Medco Sees Gains” (WSJ, February 22, 2007), the WSJ reports that a Medco spokemans says Medco is seeing better collaboration and pricing “from [a] large constellation of non-CVS retailers than we have seen in the past . . ” Medco credits its business model as giving a competitive edge and “organic growth”.

Medco’s confidence in its business model is based upon more than a string of non-CVS retailers. Its history includes a bumpy period in the 90’s when a Merck-Medco merger created a vertical integration model that only foundered under a Federal Trade Commission challenge.

According to the FTC, when Merck acquired Medco in late 1993, it became the first pharmaceutical manufacturer to vertically integrate into the then relatively-new business of pharmacy benefit management. Since then, several other pharmaceutical companies have joined with PBMs. In 1995, the FTC challenged Eli Lilly and Company’s acquisition of PCS, another PBM, from the McKesson Corporation, alleging violation of the antitrust laws. At that time, the Commission pledged to monitor the industry carefully and cautioned that it might take future action if it concluded there were signs of anticompetitive conduct in the industry. Federal Trade Commission Press Release (August 27, 1998)

And so Merck retreated by divestiture. The foray into vertical integration was stymied, at least for a time. A window into this retrenchment is provided by the following excerpt:

The divestiture of Merck-Medco completes the retreat of the pharmaceutical industry from its earlier foray into pharmacy benefit management. Eli Lilly & Co. shed PCS Health Systems for a $2.4 billion loss in 1997, and the then SmithKline Beecham took a $1.6 billion loss to dump DPS in 1999. The original acquisitions led to charges that the PBMs would boost the sales of the products of their parent companies at the expense of other drugs. The Federal Trade Commission then forced the drug companies to build firewalls around their PBMs. “Merck-Medco to become stand-alone PBM”, Drug Topics (professional magazine for pharmacists) (February 18, 2002)

Nonetheless, what one cannot do by acquisition may still be accomplished by contract and business alliance. Interesting commentary on this phenomenon may be found on the site, Oligopoly Watch. An oligopoly:

denotes a situation where there are few sellers for a product or service. The members of an oligopoly change the nature of a free market. While they can’t dictate price and availability like a monopoly can, they often turn into friendly competitors, since it is in all the members’ interest to maintain a stable market and profitable prices. The new oligopoly is made up of multinational corporations that have chosen specific product or service categories to dominate. In each category, over time, only two to four major players prosper. Starting a new company in that market segment is difficult, and the few that do succeed are often gobbled up or run out of business by the oligopolies.

Implications For U.S. Health Care System

The seeds for the growth of the PBM giants have germinated and flourished in soil fertilized with public dollars. The problem is a complex one, but by no means will a single payer plan solve it since the PBM’s have been hard-wired into the reimbursement system. Thus, it is unlikely that proposals such as that of Senator Kennedy cause any concern in PBM boardrooms – actually, the proposal could be welcome.

For example, a 2004 press release by the U.S. Office of Personnel Management stated that Federal Employees Health Benefits enrollees obtained medicines totaling $6 billion through PBMs in 2003. The public funding running through PBM’s has only gone up since then. Thus, through contracts with Medicaid programs and the federal government, the PBM’s have a claim already staked out with the public payer system.

For the average employer, the best practice will be to undertake a careful review of contractual arrangements and any PBM promises of savings. In a separate article, a checklist of points to consider will be presented in a practical guide to financial self-defense when dealing with Big Pharma. In the meantime, barring regulatory intervention, the PBM playing field is likely to involve even fewer players in the very near future.

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