Medco today settled its ongoing lawsuit with several state attorneys-general at the relatively modest cost of $30m. The stock rose slightly on the news, although there is an another ongoing Federal lawsuit, that TCHB has covered before. While this looks like a kind of business as usual story of “company gests caught with hand in taxpayer cookie jar, company pays fine, stock goes up as investors are happy fine isn’t bigger”, some of my more jaded readers have been poking into the details. Matt Quinn writes about a different Medco settlement with Massachusetts:

Maybe I’m missing something, but it appears that Medco only had to pay back part of what it stole from the state of Mass:

“Medco Health Solutions will pay Massachusetts $5.5 million to settle allegations that the company cheated the state while it managed prescription drug benefits for nearly 200,000 state employees and retirees, according to documents expected to be filed in US District Court today.”

“Over the course of the contract, Medco passed along about $9 million in rebates, but kept another $10 million, the state alleges.” So, steal $10, pay back $5.5… Not a bad deal.

And, of course, this plot to make Medco millions of dollars was dreamt up and executed by a few “rogue employees”:
“Medco officials have acknowledged that the company had isolated problems with “rogue employees” at a mail-order pharmacy in Tampa, but said those problems were quickly corrected and did not affect drug costs.”

Of course this is nothing to the “business opportunities” those PBMs and their rogue employees will be looking at when they get to run the Medicare drug program after 2006.

I suspect the lawyers, state AGs and the DOJ have jobs for life.

If you’ve been reading THCB for a while you’ll know that I’m not overall bullish on PBMs. But of course in any market if you win an account from your competitor that’s responsible for over 14% of the competitors’ earnings, your stock will go up and theirs will go down! So when Caremark won the Blue Cross Blue Shield Federal Employees’ contract away from Medco, forcing Medco to lower its 2004 outlook, Caremark stock went up 5%, while Medco’s stock is down 10%.

Caremark’s (and AdvancePCS) stock jumped today because (as expected) the FTC has approved their merger. Both these stocks are at significant all time highs (or at least Caremark is up 8-fold since it got out of the physician business in 1997-8, and AdvancePCS is 50% above its high of 2001 and nearly 40% above where it was immediately after when the merger’s announcement last September).

The market has drunk the kool-aid (and likes it!) regarding the conversion of the AdvancePCS lives to mail-order (to increase margins) and the big opportunities in the Medicare PDIMA drug coverage market.  No-one seems to be paying any attention to the various court cases in this market, or the inability of PBMs to control drug costs.  My suspicion is that the PBMs will find the next few years to be fairly heavy sledding as they get ready for Medicare drug coverage, and the stocks will react accordingly–it’s tough to maintain P/E ratios in the high 20s and low 30s in the health care insurance business (United’s is 20 and Wellpoint’s is 17). Even Medco, which beat profit forecasts this morning but has since sold well off its early highs, has a P-E only in the low 20s. Where the top for the sector is exactly, I don’t know, but I think it’s sometime this year.

Unless of course PBMs can really innovate in health management and reap some rewards from that, which I doubt (but they don’t) and get someone else to pay them for it.

I’ve reported before on the suits against Caremark and Medco for all kinds of alleged shenanigans in drug pricing, rebates and other activities kept away from their clients’ eyes.  There’s a bumper crop of news this week about the same topics.  The latest version of Government Health News reports that the attorney general of Ohio has jumped in with his own suit accusing Medco of slanting drug purchases towards its (former) corporate parent, Merck. Meanwhile 2 unions in New York State are accusing Express Scripts of keeping rebates that it didn’t tell them about. Finally another study in the Journal of the American Pharmacists Association reports that PBMs have been overcharging on the spread between wholesale and customer prices for generic drugs.

It’s been fairly common knowledge around the drug industry for many years that not only are PBMs getting rebates to influence which drugs end up on their formulary, but that much if not most of the rebate money doesn’t go all the way back to the clients, and in fact is a fairly substantial chunk of the PBMs’ bottom lines. As I’ve opined before, whether or not it’s a legitimate business practice as the PBMs claim, when Medicare becomes the client that type of behavior is not going to survive the scrutiny of any even half-hearted Congressional investigation.  At that point I find it hard to see how PBMs become little more than claims processors, and I’d expect their PE ratios to fall to match.  The question is whether they can increase their revenues enough by adding the volume from Medicare clients to allow their stock prices at least to tread water.  I doubt it, but it’ll be an interesting subtext in the implementation of NAIM.

As the careful regular reader will note, I’ve always been hazy on what value the PBM brings to the health care party. My old IFTF colleagues Ian Morrison and Robert Mittman were at least partially responsible for making sure some of our big pharma clients didn’t toss money away by buying PBMs in 1993-4, and while Merck eventually sold Medco for the $6bn they paid for it 10 years later, Lilly and Smithkline both took it in the shorts for their purchases of PCS (now Caremark/AdvancePCS) and DPS (Now Express Scripts). The losses for Lilly and SB were $2.4 bn and $1.6 bn respectively! (At the time Merck was not a client–Lilly and SmithKline were but ignored IFTF’s advice. If only we’d got a small share of what some of the others didn’t lose on those deals!)

The business problem in pharma’s relationships with the PBMs has always been that it’s the role of PBMs to carve-out their clients’ (employers or health plans) drug costs and reduce them. Those advocates of pharma companies buying PBMs viewed it as neutralizing the PBM’s power, and enabling it to get volume slanted towards its drugs. Many including the current plaintiffs against Medco felt that Merck was using Medco to slant business towards its drugs and also accepting pay-offs in the form of rebates, some of which were shared in a very dubious manner with its plan clients.  All of this was not exactly visible to those plan’s end customers–employers, government and consumers (and those health plans not in on the deal). 

More importantly, there was no overall visibility behind how much the PBMs were getting in rebates for switching how much business between different drug products. Now that PBMs are going to have the same role in Medicare, enquiring minds have wanted to know what they are and how big a role they’ll play–and of course how hard the PBMs are trying to reduce drug costs if a big chunk of their revenue comes from their suppliers. The most enquiring of those minds is dotcom millionaire Senator Maria Cantwell from Washington state who’s amendment to make PBM’s rebates transparent in Medicare drug coverage was in the Senate bill but of course disappeared from the final version.

However, even though her amendment didn’t make it into the deal, the heat is still on the PBMs over the rebate issue. Even the New York Times has sat up and taken notice, although to be fair to Milt Fredunheim he’s been writing about this for years now. The change now is that a combination of prosecutors who’ve been investigating the PBMs for years, and very upset clients like Ford and Verizon are actively demanding to know what’s going on under the hood. The PBMs of course are squawking that if their deals became public, prices would rise because their suppliers wouldn’t give them the best deal because then everyone would want it. But of course you can go all the way back to Adam Smith to discover collusion between those with more information meaning higher prices to those with less.  Of course, the proof in the pudding is that while PBMs have been around drug prices have been the fastest growing component of health care costs.  When you start making the argument that your actions saved a bad situation from getting worse (as the PBMs must if they are to justify their earnings for the last 10 years) then you’re going to be looking hard for sympathetic ears. Mind you, since the "end of managed care", health plans need to brush up the same argument.

In a New England Journal of Medicine article called The Effect of Incentive-Based Formularies on Prescription-Drug Utilization and Spending a team from Harvard found that three-tier formularies work.  Three tier formularies are what PBMs and health plans introduced in response to rising drug uilization and prices in the late 1990s. In essence the PBM puts generics, and the branded drugs for which it has negotiated the best rebates, into the cheap first and second tiers ($5 or $10 co-pays) and charges huge co-pays for the others. Amazingly enough this means that people switch.  In this study:

Among the enrollees who were initially taking tier-3 statins, more enrollees in the intervention group than in the comparison group switched to tier-1 or tier-2 medications (49 percent vs. 17 percent, P<0.001) or stopped taking statins entirely (21 percent vs. 11 percent, P=0.04).

While the only press article I could find on this in the Boston Globe, plays up the fear that patients will stop taking their drugs, my guess is that some of those people would have given up anyway.  The key stat is that half the people switched. Presumably switching to another statin doesn’t make much difference on health. Medpundit has some interesting things to say about the clinical impacts of this switching (and, Sydney, we agree in this case!)

This is what Ian Morrison calls "the Ross Perot effect"–you can move people around for $10. (Apparently in 1992 Ross Perot spent $10 for each vote he got). Actually it’s a little more than $10 in this case, but it shows that therapeutic substitution based on money is very powerful.

My sense is that this shows that the power of the PBM has been underused. The PBMs have been mostly the handmaiden of the pharmas. For their health plans and employer clients they have in general been unwilling to really move people away from branded drugs, unable to get too many of their clients to move to very aggressive formularies, and unable to get doctors to prescribe according to the formulary.  However, this study shows that the opportunity to move people between products is very real, and with Medicare formularies on the way (in the new PBM-managed formularies) they may become even more important.

Well I told you last week that I’d had a small bet on the PBMs losing value this week as investors realized that the Medicare legislation wasn’t guaranteed to pass.  It happened for random reasons that I bought put options last week on AdvancePCS, which trades in lockstep with Caremark, which is acquiring it. (In case you don’t know, put options go up if the underlying stock goes down). Did it go down because of the delay in passing the Medicare bill? Heck no, so I was wondering what to do as the options expire tomorrow.  Then midday today the news comes out that Caremark is being sued by whistleblowers who:

allege that Caremark resold returned drugs, failed to credit the state employees’ health plan for copayments on returned drugs and falsified and destroyed documents to make it appear as if the company had complied with contractual time limits for processing and delivering prescriptions.

Interestingly enough, the state of Florida which was the client and who supposedly was defrauded, did not join the suit. So it probably has no legs. 

Nonetheless the news was enough to push AdvancePCS stock down $2 and to make my options to be worth 3 times what I paid for them.  As the traders say, "it’s good to be good and it’s good to be lucky, but it’s better to be lucky than good!" Pity that it was only a small bet.

Despite my doubts as to whether we’re going to get a Medicare drug bill, the market has decided a) that we will and b) that the PBMs are going to benefit the most from it. The last two days have seen a 10% rise in the PBMs stock price, and in the last 2 months they’ve gone up above their all time highs of 2 years ago. Somewhere a little north of here, I feel a pullback is imminent–perhaps I can just get word to Ted Kennedy and we can split a short position together?

I noticed that the PBM stocks took off like a rocket at the end of the trading day yesterday. The news was that a tentative deal Medicare has been reached by the committee negotiating a compromise Medicare bill. PBMs are likely to add millions of members under the version of the bill that may be passed. However, of course this slight optimism is tempered by the fact that neither the hard-core Democrats like Ted Kennedy nor the fiscally-conservative Republicans are likely to sign on to this compromised version of the bill, because it either will lead to the death of Medicare as we know it, or the bankrupting of the Federal government–depending on your point of view.

In any event, I’m not sure that adding a large number of members via a government-funded program which may make them low-margin contractors is the best solution for fast future growth for PBM bottom lines.