A system to save on drugs falters

Posted: February 10, 2003

To cut their prescription drug costs, America's health insurance plans sought a decade ago to win price breaks based on volume discounts.

For a while, the strategy worked. Middleman companies, called pharmacy benefit managers, played drug companies off against one another by promising them millions of the health plans' customers in return for the lowest possible prices.

By pressuring doctors to prescribe only drugs on which they had gotten the best deals, pharmacy benefit managers, also known as PBMs, cut pharmaceutical costs up to 30 percent for some health plans.

In short order, PBMs managed the prescription drug choices of more than 200 million Americans. Independence Blue Cross, the largest health insurer in Southeastern Pennsylvania, uses Medco Health Solutions Inc. as its PBM. Aetna, the second-largest health insurer locally, does not use an outside PBM.

But the big savings have dwindled. Today, prescription drug spending is the fastest-growing sector of U.S. medical outlays. And critics now regard PBMs, the supposed cost cutters, as part of the problem.

Many PBMs that once earned most of their revenue by holding down drug costs for health plans now earn a large portion of their money from drug companies that pay them undisclosed rebates and other financial incentives for promoting certain medications. Critics charge that sometimes those medications aren't the most cost-effective for the PBMs' clients.

"That's the crux of the issue," said Gerry Purcell, a pharmacy benefits consultant in Atlanta and a former PBM executive. "They're negotiating hidden deals for their own benefit, while at the same time telling employers: 'We're here to represent you.' "

The side deals and undisclosed payments may account for as much as 10 percent of the $161 billion that Americans are estimated to have spent on prescription drugs in 2002, said Purcell, who has worked as a consultant for plaintiffs in several lawsuits against PBMs.

The legality of drug-company payments to PBMs and other PBM industry practices is in dispute and probably will be decided in court. The U.S. Attorney's Office in Philadelphia has been investigating PBMs' business practices since 1998. The probe focuses on the cost and health effects of rebates on patients, "and the broader cost effect on [employer health] plans," according to Assistant U.S. Attorney James Sheehan, who is leading the investigation.

One of the PBMs being investigated, AdvancePCS Inc., of Irving, Texas, wrote in a Securities and Exchange Commission filing last year that Sheehan's case centered on whether rebates and other drug-company payments to PBMs, or payments that PBMs make to retail pharmacies or others, "may violate the anti-kickback laws or other federal laws."

The SEC document says Advance believes its practices comply with all applicable federal laws and regulations. After initially challenging investigators' requests for documents and employee interviews, company officials are cooperating with the probe.

Officials of Medco Health, of Franklin Lakes, N.J., another focus of the investigation, wrote in similar SEC filings last year that they also believed they were complying with federal laws. But "different interpretations and enforcement of these laws could require us to make significant changes to our operations," the company wrote.

In numerous lawsuits across the country, health plan representatives want PBMs to repay millions of dollars in rebates and other financial incentives that they claim should have been passed on to their health plans. Some of the lawsuits accuse PBMs of steering clients to higher-priced drugs for their own profit and of failing to act in their plans' best financial interests.

A suit filed by the West Virginia Public Employees Insurance Agency accuses Medco, its former PBM, of, among other things, hiding drug company rebates by listing them as various fees.

"They were calling them 'data fees,' 'management fees' and 'administration fees.' Anything but rebates," agency director Tom Susman said.

Medco denies hiding any rebates, and has sued the agency for nonpayment of $2 million. The company also denies Susman's assertion that it improperly withheld about $12 million in rebates from 2000 to 2002.

Without admitting any wrongdoing, Medco and plaintiffs in five other lawsuits have agreed to a settlement that, among other things, calls for Medco to pay $42.5 million. A sixth plaintiff, represented by New Orleans lawyer Russ Herman, rejected the offer as inadequate. In court, Herman said analysts he hired to review Medco financial documents concluded that Medco withheld $2.85 billion in rebates from clients from 1995 to 1999.

Medco, which reported nearly $2 billion in rebates in 2000 and $2.5 billion in 2001, denies wrongfully withholding any funds from clients.

In response to clients' concerns about rebates, many PBMs, including Medco, now share a portion of the rebates with their clients, said LaVarne Burton, president of the Pharmaceutical Care Management Association, a trade group that represents the PBM industry.

PBM industry officials continue to say, however, that undisclosed rebates are legitimate and should remain confidential if they aren't covered in their clients' contracts.

"We have to make some money," said David Machlowitz, senior vice president and general counsel for Medco, the country's second-largest PBM. "I don't understand why they're asking us to be totally transparent. . . . We don't claim to be not-for-profit. . . . We're a business. We're not a charity hospital."

PBMs have resisted clients' attempts to audit those undisclosed rebates. "If it is not part of our deal with them, and they're getting what they contracted for, and it's not something we've done on their behalf, why would they be auditing that?" Machlowitz said.

More than 100 PBMs operate in the United States, but the industry is dominated by four: AdvancePCS (75 million people covered), Medco (65 million), Express Scripts Inc., of St. Louis (40 million), and Caremark Rx Inc., of Birmingham, Ala. (20 million).

Purcell, the pharmacy benefits consultant, said that, with those numbers, PBMs can essentially tell drugmakers: " 'If you want to market your drug, you have to do business with us or we're going to shut you out of 40, 50 or 60 million lives.' They have amassed so much power, you have to deal with them."

When the first PBMs appeared in 1969, they simply processed drug claims for health plans in return for a few cents per prescription. As drug spending soared in the '90s, PBMs began negotiating lower prices with drug companies for their clients. The drugs on which they got the best deals were placed on a list of "preferred" drugs that the plans provided the highest level of coverage for, called a formulary. For medications that weren't on the formulary, the coverage level generally was lower or even nonexistent, depending on the plan.

Drug companies, hoping to increase sales, often offered rebates and other incentives to PBMs in return for placing their medications on drug plan formularies. PBMs also can receive rebates when drug sales increase due to greater usage by health plan members. In addition, drugmakers sometimes pay PBMs to promote certain medications to doctors and patients.

In time, these incentives rivaled clients' fees as the prime revenue source for many PBMs. Drug companies, seeking to control the middleman, began buying PBMs in the early '90s. The Federal Trade Commission, concerned that PBMs owned by drug companies would favor medications made by their parent companies, acted to discourage the acquisitions. Today, Merck & Co. Inc., of Whitehouse Station, N.J., Medco's owner, is the only drug company that owns a PBM.

The Bush administration wants to restrict the financial incentives that drug companies give PBMs for promoting their products. The drug industry is fighting the measure, saying the changes would disrupt a time-honored system that isn't broken and doesn't need fixing.

Despite all the criticism, PBMs may be in for a new federal windfall. President Bush and congressional Republicans are keen to pass some kind of prescription drug coverage for 39 million Medicare recipients early next year. If they succeed, they want PBMs to administer the program.

Staff writer Josh Goldstein contributed to this article.

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