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Health and Benefits

Pharmacy Benefit Management and Prescription Formulary

Selection of a pharmacy benefit manager (PBM) and management of the prescription formulary are important elements of the cost containment strategy in a self-insured health plan.

Cost of Prescription Medications

Prescription medications represent a large percentage of the total cost of employer-sponsored health insurance.  In self-insured plans, prescriptions are often responsible for 30% or more of total claims costs.  However, there are strategies available to minimize these expenses without sacrificing the level of care expected by the plan sponsor and plan participants.

Prescription medications generally fall into three classifications:

1. Brand Name

Brand name medications are expensive because the original manufacturers desire to recoup the cost of research and development, as well as the cost of marketing efforts.  They are often prescribed due to name recognition, even when more cost-effective generic equivalents are available.  Original manufacturers are often granted exclusive production and marketing rights for a certain period of time in order to recoup the expenses of bringing the medication to market.  This exclusivity eliminates competition which would otherwise reduce the cost to consumers.

2. Generics

Generic medications are lower-cost alternatives that are functionally equivalent to brand name medications.  Generics are less expensive because they are produced by manufacturers who did not participate in the original research, development and marketing efforts, and therefore do not carry the associated cost burden.  Generics can often be substituted for brand name medications at the counter when requested by the insured.  Generics may not be available for newer medications, or when the prescribing physician includes “dispense as prescribed”, or equivalent language, in the prescription.

3. Specialty

The term “specialty” refers to a range of medications that may have any of the following characteristics: derived from living cells, treat potentially debilitating or fatal conditions, treat rare diseases, injectable or infusible, have unique storage and/or shipment requirements, not commonly stocked in pharmacies.  Specialty medications may be either brand name or generic and are often very expensive.

While profit is the primary motivator for progress and innovation in the pharmaceutical field, it can lead to situations where the cost of medication becomes misaligned with its clinical value.  Many medications are available at a range of prices and there may be no clinical difference between the most expensive version and another that is available at a fraction of the cost.

Where no clinical difference between two medications exists, any extra money spent on a more expensive version is money that is wasted by the plan sponsor and plan participant.  Careful review of the medications being utilized by plan participants can reveal opportunities for cost containment through provision of more economical substitutes.

Pharmacy Benefit Manager

The pharmacy benefit manager (PBM) performs the administrative functions that a commercial insurer would perform in a fully-insured health plan with respect to prescription medication access.  These functions include drafting the prescription formulary document, negotiating medication costs with manufacturers, confirming coverage, and processing claims.

PBMs generate revenue through spread pricing, manufacturer rebates and administrative fees.  Spread pricing means that the PBM charges the plan sponsor a markup over the price it pays the manufacturer.  This generally leads to the utilization of higher cost medications.  Low administrative fees may signal that the PBM generates its revenue by retaining more of the rebates it receives from manufacturers.  Though it may be possible for the PBM to pass all rebates back to the plan sponsor by charging higher administration fees, this is not necessarily in the plan sponsor’s interest.  When the PBM shares in rebate revenue, they are incentivized to consistently negotiate the best rebate terms with manufacturers.

Where the PBM relies on static administrative fee income regardless of performance, the PBM may not work as diligently to negotiate rebate terms on the plan sponsor’s behalf.  Incentives can also become misaligned where the PBM focuses primarily on potential rebate revenue without regard for ultimate cost of medication to the plan sponsor or plan participant.  These factors should all be considered when evaluating PBM vendors.

Prescription Formulary

The prescription formulary is the plan specific document that lists the medications that are covered under the health insurance plan and the pricing structure that applies to them.  The formulary is a function of the PBM that is chosen to administer pharmacy benefits.  The formulary generally classifies medications into four tiers.  The pricing structure and cost-sharing between the plan sponsor and plan participant depends upon the tier to which the subject medication belongs.

  • Tier 1 – Generics: Generally, the most cost-effective option, where available.
  • Tier 2 – Preferred Brands: Brand name medications available at favorable pricing.
  • Tier 3 – Non-Preferred Brands: Brand name medications available at less favorable pricing.
  • Tier 4 – Specialty: Generally, the most expensive category of medications.

Plan sponsors often choose a broad default formulary offered by the PBM in hopes that the majority of medications desired by plan participants will be covered.  While this may appear to be the safest route to provide a smooth experience for plan participants, it often leads to wasteful spending by both plan sponsors and plan participants.  By working actively with PBM’s to remove high cost medications from the formulary and providing avenues for plan participants to access more economical equivalents, wasteful spending can be drastically reduced.