Vanessa Furhman continues her swath through the PBM industry in the WSJ. The article is called Managers of Drug Benefits Agree To More Transparency in Pricing. Apparently bullied into this by fear of losing some big clients, both Medco and Caremark are going to disclose their prescription pricing.

Responding to pressure from some of their biggest corporate clients, two big pharmacy benefit managers agreed to provide more information to employers about the way they price and administer employee drug purchases. The two PBMs, Medco Health Solutions Inc. and Caremark Rx Inc., each handles the drug benefits for tens of millions of Americans. They have agreed to participate with eight smaller PBMs in a purchasing model that would require them to pass on to clients their own costs for acquiring retail and mail-order prescriptions. They also have agreed to pass along the price rebates, rarely disclosed in the past, that they receive from drug manufacturers.

Well actually Medco was making its total rebates clear and has begun passing back to its clients a significant chunk of its rebates last year, but its profits increased anyway because it made it up on the spread on mail-order generics. So will they start disclosing what they pay for those versus what they charge? Unclear:

Medco and Caremark both started the coalition’s process to become certified when it launched last year, but dropped out along the way. A big sticking point for them, according to some people working with the coalition, was the demand for full transparency and acquisition-cost pricing on generics ordered through the mail. PBMs enjoy some of their steepest markups and profits on mail-order generic drugs.

It’s not evident that they will be doing this, although smarter employers can find out market generic prices, see what they’re paying and figure out the difference. Something not many have bothered to do–to their great cost.

But if they succeed in beating the PBMs up on rebates and on generic spreads, the enormous profitability of the PBMs (Yup, it is enormous—around 50%  net margins if you don’t look at the cost of the drugs which are mostly a pass thru) can’t continue. So does Wall Street believe the end is nigh?

Judging by the change in their stock price, not exactly.

Conundrum—It was reported in their most recent 10K that what Medco got in rebates from manufacturers went down, and that really hit profit from that sector of their business in the most recent quarter. But their overall profits went up?  How did they manage it?

Well I know (and told a private client all about it in research report) and have given you some hints before about where they make their money. But now Barbara Martinez at the WSJ has figured it out—their margins on generics are huge. And of course they control that channel by pushing their clients into mail order where they can make the generic substitutions as soon as the rebates go away. So the more generics they sell, and the more mail order they sell, the higher their margins are —even if they keep less of the rebate on the branded product.

And, as the WSJ article says, luckily for them their clients are too dumb to figure it out. (Other than Horizon Blues of New Jersey which is suing Medco)

But wait there’s a little more. Remember last year? That’s when the trade association of the big PBMs (PCMA) put out a report explaining what great savings mail order provided for purchasers of drugs. But the entire report neglected to mention that mail-order pharmacies are significantly more profitable then regular pharmacies, and it further neglected that the owners of the major mail-order houses are, of course, the big PBMs.

California Healthline had an article about PBMs role in Medicare Part D. (Hat tip Joe Paduda). Not entirely un-coincidentally, the report that I wrote with Jane Sarasohn Kahn on The Prescribing Infrastructure: Are we ready for eRx, which CHCF published last week also had a little section on PBMs.  However, for space reasons much of the research that I did for that piece didn’t make the cut. So as promised last week, here’s a longer version of what I wrote about what’s going on behind the veil of the PBM.

Pharmacy benefit management companies have become the hidden giants behind the current prescribing infrastructure. After several mergers, three dominant companies have emerged; Medco, Caremark and Express Scripts. How these companies make money has been a major source of controversy, leading to the slow emergence of the “transparent PBM movement.”  PBMs sell their services based on their ability to lower drug costs for their clients. Typically a PBM is not a risk bearing entity, but officially gets paid for providing three services to their clients, who are usually health plans or self-insured employers, and managing the pharmacy use of the “member” (the employee or insured).

The three main ways PBMs make money are via:

• Transaction processing,including managing the eligibility files, benefit information and payment transactions connected with an Rx.
• Network and formulary management, such as negotiating with both pharmaceutical companies and pharmacies over pricing, and ensuring that the most cost-effective drugs and most appropriate therapies are available to the member. This includes techniques such as generic substitution, pre-approval, step therapy and compliance programs–all of which tend to add administrative complexity to the current prescribing infrastructure.
• Mail-order pharmacies, which typically supply lower-cost 90 day supplies of chronic medications to the member

Controversy in PBMland — Channel-switching, the Spread & Rebates 

There has been considerable controversy as to how effective PBMs actually are at lowering drug costs, and how they actually make their money. Some of these issues have been raised by their competitors: retail pharmacies are losing business to mail order PBMs, and are also being forced de facto to spend a lot of unpaid time on the phone with physicians’ offices sorting out formulary issues. Many protests are also being raised by their customers -– both employers and end-user consumers/enrollees.

One frequently heard complaint is that PBMs are restricting consumer choice by forcing members to receive their drugs only from their own mail order pharmacies. In fact, the creation of SureScripts by the largest pharmacy chains was in direct reaction to the initial creation of RxHub by the PBMs, which the pharmacies thought was an attempt to turbo-charge this channel switching by controlling access to online pharmacy channels. These fears were somewhat overblown, and the two networks are working in cooperation together. The truth is that this channel restriction is done with the approval of the benefit plan sponsor (usually the employer), and may actually be a rational method of controlling costs and increasing efficiency. Mail order drug operations are highly automated and require substantially fewer pharmacists per Rx than traditional retail pharmacy.

But the major accusations are that PBMs are withholding information from their clients about the “spread” and their “rebates.”

The spread is the difference between the price the PBM tells its client that it is paying for the drug (or in effect the price its client is charged) and what it actually is paying the pharmacy. Critics accuse PBMs of paying much lower actual prices to pharmacies than they reveal to their clients, and also of giving clients only a small fraction of the extra profit they make when they dispense a drug via mail order. For more on this see Robert Garis, et al Shining The Light On Non-Transparent PBM Cash Flows in America’s Pharmacist, November 2004

The rebate is a payment from a pharmaceutical company to a PBM for driving more volume to its branded product by putting it higher on formulary. There are two separate controversies about the rebates.

• First, while the revenue from the rebates are officially passed back to the end client, the accounting behind that process is extremely opaque and has been very difficult for customers to audit. PBMs have been commonly accused of either short-changing their clients, or colluding with health plans to keep rebates back from their customers. For instance, Medco paid Oxford Health Plans $87m allegedly for data, but this was widely presumed to be connected to hiding the rebates from its customers, including the government. (As reported in Barbara Martinez U.S. Maintains Medco Offered Insurer a Kickback Wall Street Journal December 3, 2004) –in effect keeping drug prices higher than they need to be. Michael J. Rudolph, Pharm.D., of the University of Southern California School of Pharmacy, noted that one of the three largest PBMs (Medco) admitted in its annual report that of about $3 billion in rebates garnered in 2004, it passed only $1.7 billion to health plan providers. "This is the story that is not being told, and I venture to say most of the plan sponsors do not understand this," he said’. (source is Frank Celia Chains ponder responses to mandatory mail order Drug Topics Apr 18, 2005)

• The second controversy is that the rebate agreements have been “bribes” that have resulted in the PBMs creating formulary incentives, or campaigns that in fact favor branded products over cheaper generic equivalents. For example, the Detroit Free Press reported that the University Michigan concluded that PBMs working with the university often steered customers towards more expensive brand name drugs and accepted payments from drug companies to promote their products. As a result, the University has moved to a single PBM and is tightly monitoring drug spending. The school has saved $8.6 million as a result. I found this info in Katie Merx U-M’s changes cut drug expense: Pharmacy benefit managers who drove up costs are replaced Detroit Free Press May 18, 2005 (Article is no longer online, although I have a copy if anyone is really interested)

When Sen. Maria Cantwell (D-Washington) suggested that, in order to participate in Medicare Part D, PBMs should be forced to reveal information about these contracting arrangements, their opposition was very vocal, and it was supported by a GAO report. While the PBMs said that this disclosure would prevent their ability to contract on behalf of their clients, cynics drew a different conclusion.

Some studies are now starting to support some of these accusations, and it may be that the tide is slowly turning against PBMs. One survey showed that over 47% of their customers thought that PBMs did not get them the best drug costs Hewitt Associates “Health Care Expectations: Future Strategy and Direction 2005” Executive Summary of Hewitt Teleconference November 17, 2004) but several interviewees we spoke to in the course of this report suggested that PBMs’ customers had in general been slow to try to do anything about these practices. There is though an ongoing legal suit in Illinois (Melissa David "Loyalty Strained at Caremark" The Street.com 2/1/2005), and the slow emergence of the “transparent” PBM movement, such as the breakaway group of employers lead by Hewitt Associates, (Melissa David "Medco and Its Peers Brace for a Flank Attack" The Street.com 8/16/2004).

Overall the trend towards transparency will will probably push PBMs away from looking to rebates and other games with pharma clients. Instead they will try to drive more revenue by switching fulfillment to their mail order businesses, and by more aggressively moving to generic substitution. But it’s still a business that requires more aggressive customers overseeing what’s going on behind the curtain.

I’m so fond of analyzing "research" by AHIP that I’ve missed some from PCMA, the trade group of the PBMs. But if you go to their site you’ll learn that you, the consumer, are about to save $1.3 trillion over the next ten years because of our brave PBMs.

Well at least they haven’t taken to AHIPs trick of claiming savings for their consumers when their costs were going through the roof.  I mean, who can dispute that the presence of PBMs is saving their consumers money? Well some people might but they can’t tell us what will happen in the future can they!  After all, who knows what will happen in the future? No one! So what they say can’t be challenged!

You may guess that I’ll have a little more about this coming up. For now, hunt about in the section on PBMs in the CHCF report that came out yesterday, before I introduce you to some folks who’ve been overturning the rocks in the PBMs’ backyard.

There’s an interesting article in AISHealth.com’s Business News of the Week called Why the Plans of a Major Drug Purchasing Coalition Did Not Work. The quick story is that a group of employers got together in late 2004 and made an attempt to negotiate pricing direct with the pharma companies.  The pharma companies, who are quite happy with the way they work with the PBMs, and who also realized that this coalition was too small (only 53 companies and 5 million lives) to matter, and that they could easily face them down. And that’s what happened.

But instead the companies involved were rounded up by their benefit consultant (Hewitt) and demanded a more transparent approach from their PBMs. So they have got that with some smaller PBMs (Medimpact, Aetna & Walgreens) offering to supply "transparent" services.  That is, tell them what rebates they are getting and therefore the true price they are paying for drugs. Now this is very very early days. No one has actually switched over to using these plans yet and won’t until next year. Plus more importantly given the buying power of the big 3 (Medco, Caremark and Express Scripts) it’s very likely that the transparent PBM will still have a price disadvantage overall. And that is before the big 3 target the transparent guys in a price war for their clients.

However, we may be seeing a bigger sea change as a Federal Appeals court yesterday upheld a Maine state law that said that PBMs must reveal to their Maine customers what rebates they get, and must have the best interests of their clients at heart when they negotiate with drug companies. (Stop and think about what that last sentence says about the PBMs’ behavior thus far!!)

Now this information does not have to be made public (and I’m sure PBMs will design contracts banning their clients from revealing that information). The PBMs of course will fight this to the Supreme Court and fight it state by state. And of course if you believe their public statements, all this fuss about them making money off rebates and price gouging their clients (not to mention bribing health plans) can’t possibly be true. No sir, No way. Here’s what Express Scripts’ CEO Barrett Toan said about these accusations in Health Affairs earlier this year.

Atlas: Let’s turn to some challenges to the PBM business model. Critics of PBMs assert that PBMs’ way of doing business is inherently at odds with the interests of their customers. Recent actions by various state governments and others seem to bear out this concern. Practices that at minimum raise eyebrows are (1) accepting rebates and administrative fees from drug manufacturers whose products PBMs give preferential status in their formularies, and then retaining unspecified portions of these sums rather than passing them along to customers; (2) paying health plans, ostensibly for data on plan members’ prescription drug usage, in return for securing the health plans’ business; and (3) leveraging the purchaser relationship to steer business away from retail pharmacies to mail-service pharmacies that the PBMs themselves own and that in fact generate large percentages of PBMs’ profits. How do you respond to these critics?Toan: Those are theories. To understand the actual PBM practices, you need to know the details. Those kinds of concerns are overblown because the actual marketplace will not allow those practices to exist.First, the rebates. Express Scripts will not accept any other form of revenue from a manufacturer except in the form of rebates, which are actually discounts from their prices plus administrative fees that are associated with those rebates. We negotiate at arm’s length through a closed bid process run on a two-year cycle. Those bids are opened, and we essentially have our rebates defined. We make those rebate offers known to our customers; that helps them shape their formularies. We pass on a majority of the rebate dollars to the plan sponsor, which can audit the actual payments made by the manufacturers. There’s a great degree of transparency in the rebating process. The idea that these are secret deals, black boxes, is a canard coming from people who oppose what we’re doing—which is making drugs more affordable and a little bit safer.On the issue of whether PBMs should pay plan sponsors for data, we have a very strict policy on that, and I would assume other PBMs have similar policies. First, the amount of money that’s paid to help a group implement its program—for instance, if it has to issue new ID cards or send around new formularies—is reimbursed at fair value. Each of our clients certifies that these are legitimate costs, so that we can be sure that we’re reimbursing for services that had to be provided. Paying data fees is not a practice we would be comfortable with unless there were a very big direct benefit. We do some research that requires an integrated database, so having de-identified medical records can be useful in performing important research. But again, any consideration that might be given for something should be strictly justified based on the actual value to the PBM.

I’ll have more to say about this when the piece Jane Sarasohn-Kahn and I have written on The Prescribing Infrastructure comes out soon, but suffice it to say that "he would say that wouldn’t ‘e". (For those of you who don’t know the quote, go read your early ’60s British scandal history) But in some senses, this battle is part of the last war.  The bigger PBMs are slowly turning to making their money via their mail order services and doing more generic substitution. And of course they now have the Medicare program to mine. Although eventually, I think that will hurt their margins….but eventually is a long time!

Friday’s news that Caremark was settling with the Feds over a whistle-blower over rebates at AdvancePCS gave me some pause for thought. For a start, the number is $135m, and for a relatively low margin business like a PBM, that’s not nothing — especially as this was just for Federal employees and there are a hell of a lot more state employees than Federal ones (not to mention private sector employees) waiting in the wings with their lawsuits. AdvancePCS (which Caremark bought after the bad deeds were already done) was taking rebates — or what the rest of us might call bribes — from pharmaceutical companies to move volume from one branded product to another, and then hiding those rebates as administrative charges rather than passing them on to their clients. When the client is the Federal government, that effectively becomes fraudulent in a way that a smart whistle-blower (or in this case three of them) can can file a Qui Tam suit about it and become millionaires. But many similar suits are pending and many private clients of the big PBMs may start wondering how much of the rebates that the PBMs got were they passing along.  And the answer is not much.

It gets worse, in that a recent study by the University of Michigan found that their PBM was not only taking rebates to move market share from one branded product to another, but was working with big pharma to move share to branded products from generics! In other words although they were supposed to be acting as the University’s agent to reduce its drug costs, the PBM was taking money from pharma and the result was that their client ended up paying more.

I’ve been working on a piece that highlights some more of these cases and which has some numbers (all publicly available) to back them up. I’ll let that do most of the talking when it’s out in a few months. However, many of the games that the PBMs have been playing to make money are being found out.  Of course they still have the advantage of being able to buy drugs in great bulk and they still run highly efficient and profitable mail-order facilities, to which their clients are captive (even if their clients don’t understand quite why their that profitable).  Meanwhile the transparent PBM movement is in its infancy, so I’m not exactly sure that their gravy train is running off the tracks. But I think this settlement marks a big change in how PBMs have to behave, especially as come next year they’ll be working for the government a whole lot more.  Watch this space.

On a day when Caremark’s stock continues up into the stratosphere, and the earnings machines that are PBMs seem unstoppable even before they get their hands on all that lovely government money next year, a report came out yesterday about mail order pharmacy. The full report from the Lewin Group is here (PDF) and a exec sum press release is here.

The report says what is fairly obvious. Mail order drug distribution is cheaper, probably safer (in terms of error reduction) and probably doesn’t really impact negatively on the patients outcome or experience — despite a lot of guff from pharmacists about the value their in-person counseling brings to patients. And Lewin, which has the reputation of being the arbiter of all public policy budget analysis, while being available to paying clients (a kind of private sector CBO), says that mail order will be 23% of Medicare drugs and that this will save the government money, as we sit around watching baseball and eating apple pie with our mothers.

But there’s a somewhat odd thing about this press release. While it’s clear that the PBMs’ trade association paid for the study, and that those paying the tab for drug costs, who you might think would include the PBMs, would be better off using mail order, it isn’t exactly explicit about the relationship between PBMs and mail order pharmacies. In fact it doesn’t even mention it once in all 11 pages.

Of course it’s no secret that PBMs are in general not at risk for the pharmaceutical benefit they administer for their clients. So, whatever they say, it doesn’t matter to them if their clients drug costs go up — in the last five to eight years or so drug costs have exploded and so have PBMs’ profits and stock prices. It’s also no secret, despite the complete absence of its acknowledgment in this report, that the combination of greater efficiency and bulk-purchasing makes mail-order pharmacy operations much more profitable than their retail equivalents despite the lower prices they charge. So if the recommendations from learned reports like this one from consultants working for people claiming to be pharmaceutical purchasers are followed, then mail order pharmacies will be making even more money.

And who runs the biggest mail order pharmacies?  Well you can work that one out on your own.

(Note. A piece I’m working on that will be publicly available in the Fall reviews PBMs’ role in much greater detail, so I’ll let THCB readers know about it when it’s out)