Pharmacy benefit managers, the companies that manage prescription drug benefits for 200 million Americans, are coming under increased scrutiny. On the surface, the issue involves who should get the money that PBMs generate. Benefit managers sit at the center of a complex web of relationships. They get retail pharmacies to agree to discounted prices, negotiate rebates with drug manufacturers and perform other tasks aimed at saving money. Because health plans hire the PBMs, they feel that nearly all the rebate money should be passed through to them.

Often, however, PBMs keep the rebates, which apparently have become their primary source of revenue. Health plans are crying foul, but they ultimately bear much of the responsibility. A flawed system of copayments and a 1990 federal Medicaid law brought about this state of affairs.

Copays are a flat dollar amount, as distinct from a coinsurance percentage. Today, a typical drug benefit might have a $10 copay for generic drugs and a $20 copay for brand-name drugs. By shielding consumers from the price differences between drugs, copays allow other factors, such as advertising, to have outsized influence on consumer preferences, and they do nothing to control costs.

Health plans attempt to compensate for this flaw in benefit design by having PBMs administer drug formularies, which are lists of drugs that are presumably the most cost-effective, based on price and efficacy. The formularies are determined by committees, and therein lies the problem.

According to a Heritage Foundation paper, authored by physicians Susan Horn, Frederick Goodwin and Robert Goldberg, formulary committees "ignore individual differences in response to treatment and medicines." Moreover, "the primary concern of such committees typically is neither the total cost of disease treatment, nor the long-term well-being of the patient, but rather the price and cost of the medicines."

This overemphasis on price, far from controlling drug costs, tends to increase them. Horn led a research team that studied 13,000 patients from six HMOs and "found that more restrictive drug formularies were correlated with an increase in patients' use of more expensive medical services, treatment in emergency rooms and hospitals and visits to doctors' offices."

Unfortunately, many health plans continue to refine this flawed process of copays. The new wrinkle uses formularies as part of a three-tiered copay system. One example of such a benefit would be a $10 copay for generic drugs, a $20 copay for brand-name drugs on the formulary, and a $40 copay for nonformulary brand-name drugs.

The trend has been accompanied by a general rise in copay amounts, shifting costs from insurer to patient. But cost shifting is not the same as cost containment. Higher copays don't promote price competition and, at best, only temporarily restrain insurance costs.

Rather than competing for consumers' business by reducing prices, drug manufacturers compete to get their drugs listed on formularies. The preferred method of getting on a formulary is to offer rebates to the PBMs. This is the consequence of a federal law that requires drug manufacturers to give state Medicaid programs the "best price" that they have offered any other plan. Thus, manufacturers have a built-in incentive to keep drug prices high, or else lose revenue on their Medicaid business.

A compliance guide issued by HHS' inspector general is now calling the legality of formulary rebates into question. The guide states, "Any rebates or other payments by drug manufacturers to PBMs that are based on, or otherwise related to, the PBM's customers' purchases potentially implicate the antikickback statute." For rebates to avoid antikickback violations, the rebates must "be authorized in advance by the PBM's customer (the health plan) and . . . all amounts actually paid to the PBM on account of the customer's purchases (must) be disclosed in writing at least annually to the customer."

Such disclosure obviously strengthens the position of health plans and allows them to get their hands on more of the rebates. But continued reliance on a system of copays, formularies and rebates won't make healthcare any more affordable. Medicaid reform will be necessary to tackle the rebate issue. But private sector plans looking to control their overall costs can act now and consign copays to the junkyard of healthcare fads.

Health plans should abandon the use of copays and return to a coinsurance model or, even better, a new consumer-driven model that allows consumers to see the full price differences between drugs. Once consumers are armed with this knowledge, formularies can be given the boot and decisions now made by formulary committees can be returned to the doctor-patient relationship where they belong.

Sally Pipes is president and chief executive officer of the San Francisco-based Pacific Research Institute. She can be contacted at spipes@pacificresearch.org.
Chris Middleton is a senior policy analyst for healthcare studies at Pacific Research Institute. He can be contacted at http://pri.eresources.ws/cmsadmin/internet/publications/cmiddleton@pacificresearch.org.