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Will Amazon’s Online Pharmacy Display Therapeutic Equivalents?

Lawrence W. Abrams No Comments

Postscript (12/2/2017)  

Amazon is now the best hope for a consumer-directed pharmacy benefits website that “crosses the chasm” by suggesting lower cost therapeutic equivalents.

It has been ten years since we wrote a paper on The Future of Consumer-Directed Pharmacy Benefits .  The possibility of consumer-directed health care got a new life in the mid-2000s with Web 2.0.  We thought that the likes of Google, Microsoft, or a Steve Case funded startup might soon launch a consumer-directed pharmacy benefit website that might “cross the chasm” by presenting therapeutic interchange informed by “wisdom of the crowd.”

Since then, websites like GoodRx and Blink Health have advanced the cause of drug price transparency, but have failed to “cross the chasm”.  In fact, these so-called disruptive startups have sold out to PBMs by receiving PBM-negotiated brand drug rebates in return for unstated “sins of omission” of not suggesting lower cost therapeutic equivalents when consumers are viewing information about PBM-favored brands.

For us, the surest sign that an online pharmacy is not aligned with the best interests of consumers is the appearance of ads for expensive new brands showing up alongside search results for another drug.

Consider this example of an ad for the very expensive autoimmune drug Imbruvica that showed up while we were searching on GoodRx for pricing of a generic diabetes drug called Acarbose.

Note to ad platform used by GoodRx:  if you are going to allow this kind of c**p, at least you should be serving an ad for a drug that may be of interest to a diabetic, not an ad for some drug based on cookies indicating prior visits to websites with information about autoimmune drugs.

Summary of Original Paper (8/10/07)

Pharmacy benefits present the best opportunity for consumer-directed healthcare (CDHC) to outperform traditional managed care.

This is due to the fact that drugs are commodity purchases with little quality issues. Also, drug price transparency does not require any government intervention because there is a group of “outsider” pharmacies like Costco showing a willingness to compete on price.  

Pharmacy benefits also presents the best entry point for new healthcare intermediaries. The role of new intermediaries will be to link user-created “scrapbooks” of health data to rankings of treatment options based on the “wisdom of crowds” and, in turn,  to price competitive pharmacies.

The following diagram summarizes our view of the future of consumer-directed pharmacy benefits.

                

The Wellness Information Branch

Consumer-directed healthcare (CDHC) is about presenting consumers with information about price and treatment options so that they can pursue cost-saving opportunities.  It is not surprising then that the vanguard this movement is found online.  There are actually two basic branches of the CDHC movement. One branch is what we call the wellness information branch while the other is what we call the purchasing information branch.  

The wellness information branch traces its roots back to the early 1970s and is marked, in our minds, by the publication of Our Body Ourselves in 1973.  There are plenty of websites today with information about wellness and treatment options, but few are directly linked up to prices displayed on provider websites.  

The wellness information branch can evolve in several fundamentally different directions.  One fundamental split will be over the evaluation of treatment options.  One branch will feature options ranked by experts.  This branch is the domain of traditional healthcare intermediaries – insurance companies with captive pharmacy benefit managers (PBMs) and independent PBMs.   The other branch will feature options ranked by au courant social networks. This branch will be the domain of new intermediaries.

The other fundamental split will be over the business model chosen by these new intermediaries.  

The two major options are a fee-based business model, with fees paid by customers or their insurance plan, and an advertising-based business model.  There are early signs that an advertising-based business model will dominate. This is not unexpected as the dominant business model for search and information websites today is advertising-based.

 Furthermore, there are signs that banner ads will dominate. The drugs now featured on television – brand name drugs in blockbuster therapeutic classes facing competition from other brand and generic therapeutic equivalents – will be the very same ones that will dominate online advertising.  This includes such drugs as Lipitor, Crestor, Vytorin, Nexium, Lunesta, and Clarinex.

The website developed by the Mayo Clinic, www.mayoclinic.com, is an outstanding example of the treatment options representing the “wisdom of an elite”. The website is free, but the business model is heavily dependent on advertising of brand name “me too” drugs in oligopolistic therapeutic classes.   

Search for information on insomnia and up pops up advertisement for Lunesta. Search for information how to reduce cholesterol and up pop up ad for Vytorin. These ads are not some minimalist Google-style hyperlink, but full color Flash ads that dominate the right third of the page.  While the Mayo Clinic makes it clear that their editorial staff is isolated from marketing pressures, one always must be wary of content supported by advertising.  

It is interesting to compare the drug treatment recommendations on the Mayo Clinic website with those presented in a Consumer Reports based on recommendations of the Drug Effectiveness Review Project – a 15 state initiative to help guide Medicaid drug coverage.   

The Consumer Reports repeatedly recommends generics and OTC drugs as substitutes for more costly “me too” brands, whereas the Mayo Clinic is non-committal about therapeutic interchange.  Compare the recommendations of each site for the proton pump inhibitor therapeutic class:

Mayo Clinic: 1

Prescription-strength proton pump inhibitors. These are long-acting and are the most effective medications for suppressing acid production. They’re safe and have few side effects for long-term treatment. To prevent possible side effects, such as diarrhea or headaches, your doctor will likely prescribe the lowest effective dose. Prescription-strength proton pump inhibitors include esomeprazole (Nexium), lansoprazole (Prevacid), omeprazole (Prilosec), pantoprazole (Protonix) and rabeprazole (Aciphex).

Consumer Reports:2

The five available PPI medicines are roughly equal in effectiveness and safety, but differ in cost. One – omeprazole (Prilosec OTC) – is available as a prescription and nonprescription generic drug.

Taking the evidence for effectiveness, safety, cost, and other factors into account, Prilosec OTC is our choice as a Consumer Reports Best Buy Drug if you need a PPI. You could save $100 to $200 a month by choosing this medicine over more expensive prescription PPIs

Could the differences in recommendations be due to differences in business models?

There is another approach to the display of wellness information and treatment options that does not rely on elites like the Mayo Clinic or PBMs. This approach is based on the idea of “the wisdom of crowds”.  

It is being championed by several Internet pioneers committed to adapting the latest Web 2.0 tools to helping individuals manage their wellness.  These internet companies are prime candidates for becoming new intermediaries between healthcare providers, health insurance plans, and consumers.

It includes Google, led by Adam Bosworth, one of the inventors of XML technology, and now VP of Google Health. He is leading Google’s effort at creating “a better educated patient” through specialized search and the application of “PageRank” algorithms to treatment options all linked to user generated “scrapbooks” of personal medical history.3

It includes Microsoft, led by Peter Neupert, founder and former CEO of drugstore.com and now VP for health strategy at Microsoft.  Microsoft has recently bought two software companies that have developed innovative ways to integrate and disseminate patient medical data in different formats.4   

This effort may be viewed as “Neupert’s Revenge” – a payback to the Big 3 PBMs for not extending coverage to prescriptions filled by drugstore.com, the company Neupert headed during the heyday of the dot-com era.

While Google’s and Microsoft’s efforts are still largely under wraps, the efforts of Steve Case, founder of AOL, are ready to roll out now.  His latest venture is a company called Revolution Health, which is focused on applying social networking and specialized search based on user-generated ratings of the “trustworthiness” of providers (information and health services).

“Isn’t it crazy that we have ratings to help us pick movies, restaurants and hotels,” Case wrote in an introductory letter quoted by CNN.com, “but no comparable tools to help evaluate doctors, hospitals and treatments?” 5   

Unfortunately, there are signs that Case’s venture will be anything but revolutionary – i.e. challenge the status quo in the healthcare industry.  In an interview, Case has been quoted as saying that “we’ll accept advertising from a number of industries, including Pharma…” 6   

Also, Revolution Health has signed on Medco Health Solutions, one of entrenched Big 3 PBMs, as a strategic partner in developing the pharmacy portion of its website.7

 

The Purchasing Information Branch  

The other branch of the CDHC movement is focused on providing consumers with information so that they can purchase the most cost-effective treatment.  The key pieces of purchasing information are prices, quality, and treatment options. It is not surprising that the vanguard of this movement is also found online.

And it is online pharmacies that are the leaders in healthcare price transparency. No other area of healthcare comes close to the degree of transparency we found in our survey of online pharmacies today. Furthermore, the trend has occurred quietly without government coercion.  This is in stark contract to hospitals and physicians groups who seem only willing to disclose “usual and customary” prices to the public if mandated by law.

While online drug prices today come with a disclaimer about “subject to change without notice”, they are real offer prices as opposed to “usual and customer” list prices.  They are meaningful as they do not require additional information about quality in order to compare prices offered by different providers.   

 

Price Transparency as a Threat to the Big 3 PBMs and Chain Drugstores

Of course, the willingness to display drug prices online is not universal in the drug supply chain. Price transparency is a threat to Big 3 independent PBMs – Medco Health Solutions, Express Scripts, and CVS-Caremark – and to large chain drugstores – Walgreen and CVS-Caremark.   

This is due to the conflicted nature of their business models, summarized in our papers “Pharmacy Benefit Managers as Conflicted Countervailing Powers” and “The CVS-Caremark Merger and the Coming Preferred Provider War” 8

The Big 3 PBMs now generate a substantial portion of their gross profits from mail order generics.  Their business model is full of cross subsidies where high margins on rebates and mail order generics subsidize low to nil margins on claims processing, disease management, and mail order brands.  

We have presented the case elsewhere that the price superiority of the captive mail order operations of the Big 3 PBMs is not due to dispensing and procurement scale economies relative to large chain drugstores. 9   PBMs “hold up” retail pharmacy reimbursements because this allows them to offer lower mail order prices without suffering margin erosion.

In turn, the hold-up of retail prescription reimbursements has enabled chain drugstores like Walgreens to engage in “competition by convenience” characterized by aggressive store growth.  This aggressive store growth has outpaced the growth of front stores sales, depressing the net profitability of the front store.10 Walgreens and CVS can live with this because the lack of front store profitability is covered by the high net profitability of the pharmacy in the back.

Both large chain drugstores and the Big 3 PBMs are now locked into business models that rely on high margin generics subsidizing other businesses.  As long as the bulk of prescriptions are covered by traditional insurance plans managed by the Big 3 PBMs, generic prescriptions filled at retail or mail order are protected from price competition.  Otherwise, the chain drugstores and the Big 3 PBMs might be forced to abandon their reliance on high margins generics and would be forced to raise prices elsewhere.  

While there is universal agreement that consumer-directed healthcare has the potential to lower total costs, the value of that outcome depends on how the cost reductions are achieved.  If it achieved through lower unit prices and more cost-effective treatment mix (utilization), then the outcome is positive.  If it is achieve through a shift in burden from business to the consumer or through reduced usage, then the outcome is problematic.

There is a growing body of work, both theoretical and applied, suggesting that CDHC will fail to outperform traditional managed care in the area of unit prices and cost-effective treatment mix.   However, because of the conflicted nature of the Big 3 PBM business model and the hold up of prices of generic drugs, we believe that the best opportunity for CDHC to outperform traditional manage care is in the area of pharmacy benefits.

 

The Current State of Online Pharmacies

Online pharmacies represent the vanguard of healthcare price transparency. Close followers of healthcare price transparency are oblivious to this development. 11 The majority of sites surveyed allowed access without prior registration.  However, CVS, Long’s and Wal-Mart did not.  The accessible sites gave the consumer a good sense of fill economies by presenting a single page display of prices at various prescription counts (e.g. 30, 60, 90)  

 Most sites only quoted prices for delivery via their in-house mail order operation.  One online pharmacy – Wellpartner, an independent mail order pharmacy based in Portland – also provided consumers with a comparison of their own mail order prices with the typical retail prices paid by 100% cash paying customers. The prices presented below are actual prices taken from five online pharmacies on 3-30-07. It includes the following companies:

  •       Costco – a large mass merchant
  •       RxSolutions – the captive PBM of PacifiCare that is chartered to go after outside business.
  •       Wellpartner – an independent mail order pharmacy
  •       Drugstore.com – an independent mail order pharmacy
  •       Walgreen – a very large retail drugstore chain with mail order capability.

 

List of URLs of Online Pharmacy Survey:

  •         Costco:   http://www.costco.com/
  •         RxSolutions:  http://rxsolutions.com/a/discountrx/discountrx.asp
  •         Wellpartner:  http://www.wellpartner.com/
  •         Drugstore.com:    http://www.drugstore.com/default.asp?aid=9225

        Walgreens:    http://www.walgreens.com/library/finddrug/druginfosearch.jsp?cf=ln

None of the websites represented their prices as firm offer prices as you would find at a typical online store.  The price lookup screens were separate from the order entry systems.  Costco and Walgreens come closest to standing by their quotes. Wellpartner, drugstore.com and RxSolutions clearly stated that actual purchase prices may vary. What follows is a summary of the price disclaimers found in our survey of online pharmacies: 12

Costco: “The prices listed apply to those prescriptions purchased and mailed from Costco.com. Our pharmacies located in Costco Warehouses nationwide offer pricing consistent with those listed here. Occasionally prices may vary due to local differences in generic product selection or the bulk package size stocked.”

Walgreens:  “The prices listed reflect the full cash purchase price (excluding shipping) for prescriptions purchased from Walgreens.com and shipped to you.”

Wellpartner:  “Prices show the difference between our retail price and the price available with WellpartnerPLUS, a prescription savings program open to registered members… Prices are also subject to change without notice.”

Drugstore.com: “These are self-pay prices for drugstore.com mail-order delivery and do not take into account any discounts or insurance coverage that you may have. Actual prices are calculated at the time of your order.”

RxSolutions: “Pricing is only for medications available through the Prescriptions Solutions Mail Service Pharmacy. Due to market conditions, prices are subject to change. You will be responsible for the actual price of the medication when it is shipped.”

 

Judged by sheer purchasing power, one might expect that Walgreens would offer the lowest online market prices.  But, their business model is based on a very profitable pharmacy business subsidizing a front store that has low to nil net profitability.  The other companies, while smaller, do not depend on high margin generics subsidizing other lines.  The results are a dramatic confounding of the adage that consumers are best served by purchasing drugs through large intermediaries.

The results also suggest that large drugstore chains like Walgreens are threatened by the consumer-directed health care movement.  Price transparency, so much a part of this movement, exposes the high prices drugstore chains have to charge for generic prescriptions to make up for deficiencies in their front store. CDHC brings the retail pharmacy business a step closer to real price competition and this has the potential to blow apart the cross-subsidies that have been built into the drugstore business model over the last fifteen years.

 

The Display of Generic Substitutes

There are two types of treatment options that might be displayed online: generic substitution and therapeutic interchange.

Generic substitution is a substitution of a generic drug that is bioequivalent to a brand drug that has lost its patent protection.  It varies only in color, shape, and binding agents.  After a brand loses it patent protection, the original manufacturer will market the brand at a much lower price, but will never lower it to match new generics on the market as there is still value in the “brand name”.  The off-patent brand still is priced at 3 to 4 times the price of bioequivalent generics.

Unless a physician indicates that a prescription be “dispensed as written”, it is legal for pharmacists in many states to substitute automatically a generic of an off-patent brand. Most traditional pharmacy benefit plans reinforce this switch by making it a requirement. Today within weeks after losing patent protection, the generic substitution rate exceeds 95%.

If an online pharmacy displayed any prices at all, it always included displays of cost-savings opportunities through generic substitution.  This is as expected as there is little liability risk in such displays.  Still, there are always disclaimers to “consult with your physician” attached to displays of generic substitution.

It is reasonable to assume that all savings opportunities via generic substitution will be mandated as well in CDHC plans, rather than left up to enrollee discretion.  Thus, online displays of generic substitution are unlikely to contribution to additional cost-savings.

The display below is typical of the cost-savings opportunities now displayed online.  We used actual on-line prices of Costco, a mass-merchant that does not depend on its pharmacy to subsidize other operations.

Source: www.costco.com, 3-30-07

 

The Hypothetical Display of Therapeutic Interchange

Therapeutic interchange involves a switch from a costly on-patent brand drug to another drug that deemed to be a therapeutic equivalent, but not bio-equivalent. The less costly drug could be a prescription generic, and OTC drug, or an herbal drug.   While generic substitution is a “no-brainer” choice, therapeutic interchange should only be undertaken with the approval of a prescribing physician.  Nevertheless, there is a large body of evidence in support of drugs deemed therapeutically equivalent to blockbuster “me-to” drugs like Lipitor, Nexium, Celebrex, and Clarinex.  

We have presented the case the Big 3 PBMs receive rebates from Pharma for abstaining from therapeutic interchange of blockbuster “me-too” brand drugs.13  At the same time, no online pharmacy in our survey has taken upon itself to present consumers with treatment options representing therapeutic interchange.  This “chasm” presents a cost-saving opportunity for CDHC entities.  This could be traditional managed care entities without a conflicted business model—from large integrated insurance companies to small startup PBM with fee-based business models.  It could be new intermediaries.

The cost-saving potential of therapeutic interchange is concentrated in a few therapeutic classes as evidenced by recent Express Scripts report.  The number of displays needed to make a big difference is quite limited.  The percentage saved per prescription exceed 90% as exemplified in the hypothetical display presented below using prices taken from Costco’s online pharmacy.

 

Source: www.costco.com, 3-30-07

 

Therapeutic Interchange Involving OTC Drugs

Most statistics of drug usage takes into account only prescription drugs. If a technique like raising copayments or moving to a CDHC plan causes usage to decline, the result is deemed problematic by researchers.

But, recently there have been two prominent instances of drugs in top 10 selling therapeutic classes that have become available over-the-counter (OTC) after losing patent protection.  One instance occurred in the anti-ulcer therapeutic class where Prilosec become available as Prilosec OTC and various OTC versions of omeprazole, the generic version of Prilosec.  The other instance was in the 2nd generation antihistamine class where Claritin became available as OTC Claritin and various OTC versions of loratadine, the generic version of Claritin.  

There is one additional therapeutic class that should be mentioned.  That is anti-arthritis COX II inhibitor class dominated by brand Celebrex.  While there are no other COX II inhibitors that have lost patent protection, there are OTC generics that are generally accepted therapeutic equivalents – ibuprofen and naproxen.

A broader measure of usage is needed in studies where switches to OTC drugs might be significant. We believe this is the case in any study of a consumer-directed pharmacy benefits. 14

The following table is a hypothetical display of cost saving potential of therapeutic interchange involving non-prescription OTC drugs.  It is doubtful that anything like this is made available to enrollees in consumer-directed plans managed by traditional PBMs. But, to give consumer-directed plans a fair chance to succeed, such a display should be offered.

 Source: www.walgreens.com/library/finddrug/druginfosearch.jsp?cf=ln, 5-3-07

 

Therapeutic Interchange Involving Herbal Alternatives

Enrollees in consumer-directed plans are highly motivated to seek out alternatives to costly prescription brand drugs. Managers of such plans should consider presenting enrollees with price comparisons involving herbal alternatives to brand drugs.  While this might understandably not be something that an existing PBM might consider, nevertheless well-respected health experts like the Mayo Clinic and Harvard Medical School to discuss herbal alternatives to traditional drugs on their websites.

We expect that if treatment options are ranked by Web 2.0 social networks, the “wisdom of crowds” will almost assuredly rank herbal drugs as a viable treatment options.  Below is a hypothetical display of savings opportunities available through therapeutic interchange involving herbal drugs.  As in the case of OTC drugs, a decline in usage by CDHP enrollees might not be so problematic if it involves switches displayed below.

     Source: www.walgreens.com/library/finddrug/druginfosearch.jsp?cf=ln, 5-3-07

 

Estimating the Cost-Saving Potential of Consumer-Directed Pharmacy Benefits

Health care costs can be viewed as the product of “U*U*U” – unit prices * utilization * usage — where utilization is treatment option utilized, and usage is the frequency, or persistence, of treatment.  There is concern that CDHC works mostly to reduce the 3rd U – persistence of treatment, which is a dubious benefit.  

If persistence of treatment is set aside, there is a growing believe that CDHC could actual result in higher unit prices and less cost-effective treatments to be chosen. The concern comes from a more sophisticated view of price transparency and skepticism about the potential to guide the consumer through the labyrinth of options involved in treating any given condition.  

Since the initial outburst of enthusiasm for CDHC, there has arisen a more careful consideration of what might be lost by replacing managed care with consumerism.  One valid area of concern is the loss of managed care’s ability to use it purchasing power to countervail providers and negotiate lower unit prices.  Another valid area of concern is the potential of online price transparency to facilitate tacit collusion among sellers resulting in higher, not lower market prices.15

While these concerns are valid, we have presented that case that they are minimized when it comes to outpatient drug prescriptions. Drug price transparency has to potential to break-up tacit collusion in the drug supply chain, not facilitate it.  While there is always a debate among scientists about therapeutic interchange, there are a number of generally accepted options for substituting less expensive generics drugs for brand drugs.

 Estimates of the effect CDHC on persistence of use, and any shift in employer contribution, are beyond the scope of this paper.  Most agree that the benefits derived from reduce usage and increased share are dubious, although one must be open to usage statistics that include switches to over-the-counter drugs and, even herbal drugs like valerian and Estroven.

 

Cost-Saving From Drug Price Transparency

In our paper “Pharmacy Benefit Managers as Conflicted Countervailing Power”, we summarized our case for a PBM holdup of generic drug prices.  The market for generic drugs is characterized by high list prices coupled by steep charge-back credits posted to large drugstore chains accounts at distributors  Generic drug manufacturers negotiate volume discount deals with drugstores, as opposed to PBMs ,because only dispensing pharmacies have the power to choose from an array of suppliers of perfect substitutes.

It hard for insurance companies to know what are the true market prices for generics because the steep discounts off list prices are proprietary information. This gives PBMs some discretion in negotiating reimbursements with retail pharmacies allowing shift in their business model from a dependency on retained rebates to a dependency on mail order gross profits.  Now, the Big 3 PBMs find it in their own self interest to holdup retail prices for generics so that they can price their mail order operations competitively without margin erosion.

Online price transparency has the potential to breakup the PBM stranglehold on generic drug pricing.  

The table below presents our estimate of cost saving potential of drug price transparency, one component of CDHC.  We assume that it will reduce generic drug prices by 25% and have no impact on brand drug prices. We also believe that drug price transparency will cause the mail order channel to gain a 20% market share for outpatient drug fulfillment.

 

Cost Saving From Therapeutic Interchange

Consumer-directed healthcare will have an impact on the unit prices of brand drugs, but it won’t be through price transparency, but therapeutic interchange.  Brand drugs for retailers are a derived demand.  They have no discretionary in affecting demand for a particular brand drug.  On the other hand, PBMs can influence the demand for brand drugs that face competition via therapeutic interchange.  As a result, Pharma only negotiates brand rebates with PBMs, and not retail pharmacies.

The Big 3 PBMs receive rebates from Pharma for abstaining from therapeutic interchange of generics that are therapeutically equivalent to more expensive blockbuster “me too” drugs like Lipitor and Nexium. The power to switch prescriptions by PBMs is greatly reduced in consumer-directed plans.  They can no longer threaten Pharma with adverse switches unless paid rebates to abstain.

We have stated that case before that we expect that CDHC to generate no additional cost saving through generic substitution.   On the other hand, it is reasonable to expect that consumer-direct pharmacy benefits to generate a 10 percentage point increase in the generic dispensing rate strictly through therapeutic interchange.  Based on an Express Scripts study cited in the table below, this translates into a 10% reduction in overall drug spend.16

There is another Express Scripts study in support of the cost-saving potential of therapeutic interchange.  Total brand drug spending today runs about $200 Billion.  Express Scripts recently completed a study of the potential savings that could be obtained if all potential brand-to-generic therapeutic interchange were realized. 17  The table presented earlier summarized Express Scripts’ estimate of the potential for cost-saving switches to generics.

 The $20 Billion estimate comes in at 10% of total drug spend.

Of course, the cost-savings generated by unbiased display of therapeutic interchange will be partially offset by lower rebates received from Pharma.   Based on Medco disclosures, we have estimated that its gross rebates received in 3Q2005 totaled 10.1% of its total brand spend.18  It is reasonable to expect any unbiased CDHC plan to incur a 50% reduction in brand rebates received resulting in an overall 3.5% increase in drug costs.

In sum, we estimate the cost saving potential of consumer-directed pharmacy benefits to be around 15.6% — 9.1% from price transparency, an additional 10% from therapeutic interchange, with a 3.5% offset from lower brand drug rebates.  This does not include any additional saving from reduced usage, including switches to OTC and herbal drugs.  The table below presents the full derivation of our estimate.

The Vanguard of Consumer-Directed Pharmacy Benefits

The vanguard of consumer-directed pharmacy benefits will be those companies whose business models are not threatened by the display of therapeutic interchange and the display of free market prices for prescription drugs.  The list includes large, integrated insurance companies with captive mail order operations.  At the other end, the list includes small startup PBMs whose business model is fee-based, rather than margin-based and a host of specialized pharmacy service providers.  Finally, the list includes new healthcare intermediaries with expertise in specialized search and the use of social networks to rank options.

The vanguard does not include the Big 3 PBMs – Medco, Express Scripts, and CVS-Caremark — or the large chain drugstores – Walgreens, CVS-Caremark, Rite-Aid.

It should be noted that current stance of the chain drugstores toward CDHC is “bipolar”, an appropriate pharmaceutical metaphor.  Drugstores represent the vanguard of the retail health clinic movement and seem very open to price transparency in that area.  At the same, the drugstore chains seem resistant to drug price transparency, especially generics, because they know that this will expose their dependency on high margin generics.  

Right now, the only difference between chain drugstores and “dime store dinosaurs” are those little 200 square foot holes-in-the-wall in that back that generate 70% of sales and virtually 100% of the net profits.

Even among chain drugstore executives, there is a sense that the cross subsidies in the chain drugstore business model cannot continue forever. We have viewed CVS’s acquisition of Caremark as an attempt to transition the chain from an era of “competition by convenience” to an era of “competition by price”.    

But, what happens to the front store when a price competitive pharmacy is not longer able to cover the profitability deficiency in the front store?  The business model of coupling a front store of sundry items with a pharmacy –conceived of 84 years ago by Charles Walgreen when he asked his wife Myrtle to make soup and sandwiches to sell to pharmacy customers during lunch hours — is vulnerable.

There is a way out. We see the “chain drugstore of the future” as the marriage of a price competitive pharmacy in the back with retail clinics on the sides and a Whole Foods style “wellness” midsection replete with knowledgeable associates roaming the isles. Stores are smaller, fewer, but better merchandised.  The convenience business that drugstore chains drop is picked up by supermarket chains, mass merchants, and 7-11 type stores.

Theoretically, the vanguard of consumer-directed pharmacy benefits should include major mass merchants and grocery chains because their pharmacies are not dependent on high margins on generics subsidizing other businesses.  However, we have included only Costco on our list as Costco has been the only entity from this group that currently offers online price transparency.  We are puzzled why Wal-Mart and Target have yet to offer full online price transparency even though they have generated a lot of publicity about their $4/ generic prescription program.  

We are also miffed why none of the pharmacies of the major supermarket chains like Kroger, SuperValu, and Safeway has yet to implement price transparency online.  However, a Consumer Reports survey of “cash only” prices for a bundle of popular generic drug prescriptions indicated that supermarket pharmacies are not price competitive.19   For some reason other than the need to subsidize other businesses, supermarket chains choose not to price generics competitively.  The Consumer Reports survey also confirms the lack of price competitiveness of chain drugstores.  

The only reservation we have for the integrated insurance companies is their willingness to expose their captive mail order operations to an open market for prescriptions. There may be a tendency to protect their investment by limiting choice of mail order fulfillment to their captive operations.  

Finally, we have a concern about the dependency of the vanguard of consumer-directed pharmacy benefits on SXC Health Solutions to provide claims processing, the real “heavy-lifting” of pharmacy benefits management.  SXC Health Solutions already is the key enabler to startup PBMs like Envision and Innoviant.  It is the key enabler of a trend by self-insured private and public plans to drop one of the Big 3 PBMs and to “disintegrate” PBMs functions by carving-in benefit management while contracting out for the capital intensive functions of claims processing and mail order fulfillment.20  If SXC Health Solutions’ were to be acquired by a traditional health care claims processor like Emdeon or Allscripts, its freedom to support up-start entities  might be compromised.

The follow is a list of who we think is vanguard of consumer-directed pharmacy benefits.

 

The Role of New Intermediaries in Pharmacy Benefits

 

There is a sense among high level management consulting firms that consumer-directed healthcare presents an opportunity for new intermediaries to emerge.  Consider the following quote from an insightful paper by consultants at Booz Allen Hamilton on “Healthcare’s Retail Solution”:19

The players that have traditionally held intermediary roles — employers, government, and health plans — do not inspire trust in consumers, nor do they answer all the consumers’ needs. The new intermediaries will identify consumer needs and steer the supply side to answer them. Further, they will catalyze change as suppliers’ inadequacies become more obvious.

In this section, we will present the case that consumer-directed pharmacy benefits represent a good entry point for new healthcare intermediaries and outline how they might function.

Healthcare intermediaries come between healthcare providers — hospitals, physician groups, and pharmacies – and employees covered by healthcare plans.  Traditionally, consumers have been covered by defined benefits plans whose management requires expertise in insurance.  Consumer-directed healthcare is headed toward defined contribution plans with a catastrophic insurance overlay.  

Thus, traditional insurance companies lose much of their competitive advantage when it comes to managing consumer-directed plans.  Also, healthcare intermediaries were once thought to need sufficient scale in order to negotiate lower prices with providers.  But, consumers have bulked at restrictive preferred provider networks and so size is not longer viewed as a competitive advantage for healthcare intermediaries.

Consumer-directed healthcare puts a premium on the display of information necessary to make good healthcare choices.  Information gathering, dissemination and the ranking of options is exactly what the giants of the Internet – Google, Microsoft, Yahoo, and Amazon –do best. These are prime candidates for new healthcare intermediaries.

There are several reasons why pharmacy benefits present the best entry point for new healthcare intermediaries:  

  1. Quality is not an issue. No need for controversial evaluations.
  2. Size is not an issue.  No need for scale to outperform the “conflicted” countervailing power of the Big 3 PBMs.  Just open up a space for the free market to work.
  3. Price transparency is not an issue. Just link up with “outsider” pharmacies that are ready and willing to compete on price.
  4. .Drug treatment options are relatively simple compared to medical treatment options.

The mission would be to merge information about treatment options with prices offered by online pharmacies.  Currently, the only treatment option offered by online pharmacies is generic substitution.  This presents a tremendous opportunity for new intermediaries “to cross the chasm” and offer consumers information about therapeutic interchange – treatment options involving the substitution of generic drugs, OTC drugs, and herbal drugs deemed therapeutically equivalent to costly brand drugs.

There is a good reason why this “chasm” currently exists. New healthcare intermediaries should carefully consider the consequences of presenting consumers with displays of drugs which are deemed therapeutic equivalents to patent-protected brand drugs. All kinds of safeguards should be built into the website.  Disclaimers about consulting with your physician should be posted prominently.  All postings should be delayed until reviewed by responsible parties.

We actually believe that it would be prudent to have a dual system of ranking of treatment options. The purchasing section should link pharmacy order entry systems to treatment options chosen by an elite PBM-like P&T Committee.  

It should concentrate on displays of generic prescription and OTC drugs that therapeutic equivalents to “me-too” brand drugs in a few selected therapeutic classes: Statins, Proton Pump Inhibitors, Cox II inhibitors, and 2nd generation antihistamines.  

A separate section not directly linked to order entry systems should concentrate on wellness and treatment options not normally treated with prescription drugs like colds, minor aches and pains, weight-loss, mild insomnia, menopause, and premenstrual cramps.  This is where active participation of individuals in social networks might actually produce better results than passive reception of advice from some elite group.  

The dual ranking system plus specialized internet search could all be tied together by a user-create “scrapbook” of health data, a module reportedly under development by Google.20  The diagram below summarized our view on the links between modules of a new intermediary website.

 At one time we believed that to outperform the Big 3 PBMs, new healthcare intermediaries has to take an active role in negotiating prices with pharmacies and rebates with Pharma.  Knowing that the Internet companies might become new healthcare intermediaries, we envisioned that such companies would automate negotiations using reverse auctions.  

We now think that simply creating a space for those who want to compete on price will generate enough savings to be noticeable. But, breaking up the Big 3 PBM stranglehold on generic drug pricing creates a one shot, short term gain.  Eventually, new intermediaries will have to become countervailing powers to the drug supply chain and use devices like reverse auctions or preferred provider networks to make a long lasting impact on the trend in prescription drug costs.

Footnotes:

(1)  The Mayo Clinic recommendation for proton pump inhibitors is available at

http://www.mayoclinic.com/health/gerd/DS00967/DSECTION=8

(2) The Consumer Reports recommendation for proton pump inhibitors is available at http://www.consumerreportsbestbuydrugs.org/drugreport_DR_Prop.shtml

(3) “Healthcare Information Matters,” November 30, 2006 posted by Adam Bosworth, VP Google  Available at http://googleblog.blogspot.com/2006/11/health-care-information-matters.html

(4) “Microsoft to Buy Health Information Search Engine,” New York Times, February 27, 2007

http://www.nytimes.com/2007/02/27/technology/27soft.html?ex=1330232400&en=58bf4631d54e82a7&ei=5089&partner=rssyahoo&emc=rss

(5)  “Healthcare 2.0 ?” January 23, 2007 Available at http://www.innosight.com/blog/index.php?/archives/81-Healthcare-2.0.

(6) Quote by Steven Case in CDHC Magazine.  Available at http://www.cdhcsolutionsmag.com/archives/2007/07-MayJun/CDHC_MayJun07-RevolHealth.pdf

(7)  Medco Press Release, May 23, 2007, Available at http://phx.corporate-ir.net/phoenix.zhtml?c=131268&p=irol-newsArticle&ID=1005952&highlight=

(8) LW Abrams, “Pharmacy Benefit Managers as Conflicted Countervailing Powers,” January 2007;  LW Abrams, “The CVS-Caremark Merger and the Coming Preferred Provider War,” December 2006, Available at http://www.nu-retail.com

(9)   LW Abrams, “Exclusionary Practices in the Mail Order Pharmacy Market,” September 2005, Available at http://www.nu-retail.com

(10)  LW Abrams, “The CVS-Caremark Merger and the Coming Preferred Provider War,” December 2006. LW Abrams, “Walgreen’s Transparency Issue,” November 2003.

(11) Health 2.0 Wiki, Websites Displaying Healthcare Price Transparency, Available at http://health20.org/wiki/Transparency

(12) Price Disclaimers

http://www.walgreens.com/library/finddrug/druginfosearch.jsp;jsessionid=EKYFZR33JTBGECSJY2ZHNDQKJHDTE3MK

http://www.rxsolutions.com/a/discountrx/discountrx.asp

http://www.wellpartner.com/main/PriceCheck.jsp

https://www.myrxhealth.com/MyRxHealth/DrugCostEstimateAction.do?ACTOR=VISITOR&SSOSESSION=null&id=4513&name=Lipitor&gpi=

http://www.costco.com/Pharmacy/frameset.asp?trg=HCFrame.asp&hcban=Banner.asp&hctar=finddrugs.asp&catid=678&fromscript=1&Article=pricing%20information&log=

http://www.drugstore.com/pharmacy/prices/drugprice.asp?ndc=00093715256&trx=1Z5006

(13) LW Abrams, “The Effect of Corporate Structure on Formulary Design: The Case of Large Insurance Companies, “Poster Presentation Paper, ISPOR 10th Annual International Meeting, May 2005.  Available at http://www.nu-retail.com

(14) LW Abrams, “Show Me the Display! A Review of an ESI Study of Consumer-Directed Pharmacy Benefits,” July 2007. Available at http://www.nu-retail.com

(15) Paul Ginsberg, “Shopping for Price in Medical Care, “Health Affairs 26, no. 1  (2007) w 208-w216

http://content.healthaffairs.org/cgi/reprint/26/2/w208?ijkey=wkln/qLZb4plc&keytype=ref&siteid=healthaff

Hal Varian, “When Commerce Moves Online, Competition Can Work in Strange Ways, New York Times. August 24, 2000 Available at http://www.ischool.berkeley.edu/~hal/people/hal/NYTimes/2000-08-24.html

(16) Express Scripts, “Geographic Variation in Generic Fill Rate, Available at http://www.expressscripts.com/ourcompany/news/outcomesresearch/onlinepublications/study/regionalgenericvariation.pdf

(17) Express Scripts, “Press Release: Study Reveals $20 Billion in Untapped Generic Drug

Savings, “ October 25, 2005. Available at

http://biz.yahoo.com/prnews/051025/cgtu012a.html?.v=1

(18) LW Abrams, “Quantifying Medco’s Business Model,”  September 2005  Available at http://www.nu-retail.com

(19) The Consumer Reports survey is available at http://www.consumerreportsbestbuydrugs.org/

(20) LW Abrams, “Systems Xcellence Should Continue to Benefit from PBM Disintegration”, May 24, 2007. SeekingAlpha Available at “http://healthcare.seekingalpha.com/article/36413

(21) David Knott, Gary Ahlquist, and Rick Edmunds, “Healthcare’s Retail Solution, strategy + business, May 15, 2007 Available at ”http://www.strategy-business.com/resiliencereport/resilience/rr00046

(22) VC Ratings, “Google Preparing Health Portal” July 7, 2007. Available at

http://vcratings.thedealblogs.com/2006/07/google_preparing_health_portal.php

© Lawrence W. Abrams 2007                           

Was CVS’s Formulary Exclusion of Mavyret a Violation of Antitrust Laws?

Lawrence W. Abrams No Comments

Summary

In October 2017, CVS Caremark (CVS) finally decided to exclude from its 2018 drug formulary the new-to-market Hepatitis C Virus (HCV) drug Mavyret despite it being list priced aggressively by its manufacturer AbbVie at an estimated 72% below the list price of Gilead Sciences’ incumbent HCV drug Harvoni.

We estimate that Gilead Sciences had to offer CVS a minimum of a 83% rebate percentage in order for Harvoni to have a net price below Mavyret’s list price.  The 83% figure would represent an outlier in reported gross rebate percentages today that generally fall in the 40% to 60% range.

If it turns out that the rebate percentage was less, it sets up an anti-competitive and antitrust case that Mavyret was excluded because of lack of pharmacy benefit manager (PBM) rebate retention despite being the lowest cost drug in the HCV therapeutic class.

We call on CVS Caremark to issue a public statement confirming that its choice to exclude Mavyret was in the best interest of clients because Harvoni was the lower cost drug after rebates.

 

Pharmacy Benefit Managers and Formulary Choice

The pharmacy benefit manager (PBM) business model relies heavily today on rebates received from drug companies in return for placement on a formulary –a list of drugs covered by a prescription benefit plan.

We have observed a change in PBMs’ approach to formulary design over the past 15 years.  Basically, “rebatable” therapeutic classes have gone from being open — a few preferred drugs — to being closed — a single preferred drug.  We are just beginning to figure out the causes of this change, but the basic idea is this:

The more a PBM limits competition in a therapeutic class, the more potential entrants will pay for access.  Small molecule therapeutic classes tend to be open, hence less valuable to entrants.  Specialty and biotech therapeutic classes tend to be closed, hence more valuable to the single favored entrant.  

Today, PBMs need to squeeze everything they can from granting access to specialty therapeutic classes.  This is the reason for the trend toward closed therapeutic classes in formularies and correspondingly more drugs on excluded lists.

Adam Fein of the Drug Channel blog has done a great job at tracking this trend. Below is his latest graph:

 

Antitrust Issues In Exclusive Formulary Contracts

Following the generally accepted theories of the late legal scholar and Supreme Court nominee Robert Bork, vertical restraints such as exclusive dealing in formulary contracts are presumptively welfare-enhancing and procompetitive because it would not be rational for a buyer to exclude the lowest cost supplier.  

Exclusionary formulary contracts between Pharma and PBMs present an interesting variant to Bork’s antitrust theories as the PBM business model is not “rational” in the traditional economics sense of maximizing revenue minus costs.  

While PBMs are resellers of brand drugs, their gross profits on brand Rx are derived only from a retained rebate percentages.  CVS has stated publically  that it retains on average 10% of gross rebates negotiated and received in return for formulary placement.

In contrast to generic Rx fills by retail drugstores, PBMs do NOT markup, or earn a “spread margin” on, brand Rx ingredient costs however measured where ever filled.  A 2005 study conducted by the FTC into possible PBM conflicts of interest confirmed this business model.

The PBM business model setups up a possible misalignment of interests between plan sponsor preferences for the lowest net cost drug in a therapeutic class and PBM preferences for the drug with the highest rebate retention DOLLARS.  

With PBMs, you have to take out Bork’s “presumptive” qualifier to his dictum that vertical constraints are presumptively procompetitive because the PBM business model is not rational in the traditional economics sense.  

With antitrust cases involving PBM exclusive dealing in formulary contracts, you can’t presume anything and the rule of reason apply.  

There have been two recent lawsuits claiming that exclusive dealing in formulary contracts are anti-competitive and violate antitrust laws starting with Section 3 of Clayton Act covering exclusive dealing:

Following Bork, we believe that both of these lawsuits are weak as it is likely that the plaintiffs (the excluded) are NOT the low cost suppliers.  This likelihood is due to the fact  the plaintiffs listed their new-to-market drugs at, or slightly below, the list price of the incumbent drugs.

 Had they started out with a list prices at least 70%-80% lower than the list price of the incumbent, they might have been in a position to show that they were the lowest cost supplier of a therapeutic class and merited inclusion in the formulary. Furthermore, they would have been in a position to expose PBMs’ misaligned business model.

Unlike the two cases mentioned above,  AbbVie’s aggressive list pricing of its new-to-market HCV drug Mavyret creates a real possibility of an anti-competitive and antitrust (Section 3 Clayton Act) case of exclusive dealing due to a lack of rebate retention despite Mavyret being the lowest cost drug available in the HCV therapeutic class.

 

The Hepatitis C Virus Drug Therapeutic Class

In 2013,  the biotech company Gilead Sciences got FDA approval for its innovative Hepatitis C Virus (HCV) drug combo called Sovaldi.  Eight month later, an improved version of Sovaldi,  called Harvoni, came on the market.  These drugs produce fewer side effects than first generation combo drugs requiring painful stomach injections of interferon.  Also, Sovaldi / Harvoni only requires pill regimens lasting 12 weeks, instead of 24 to 28 weeks with prior combo drugs.  

In 2016, Gilead’s Harvoni stood at #2 on the list of top selling prescription drugs at $10 Billion a year, after AbbVie’s top selling biotech drug Humira at $13 Billion a year used to treat a variety of autoimmune diseases.

In the three years since Harvoni came on the market, there have been five additional HCV drugs approved by the FDA, but only AbbVie’s Viekira Pak has garnered any significant sales.  

The two largest PBMs CVS Caremark and Express Scripts (ESRX) have a history of making the HCV therapeutic class a “winner-take-all” proposition, persuading competing companies to choose a high list price to be in a position to offer a “deep discount” rebate to gain exclusivity in the HCV therapeutic class.  

Below is a summary of the 2017 formulary choices of CVS and ESRX for the HCV therapeutic class:  

 

AbbVie’s Mavyret Drug Pricing Is Disruptive to the PBM Business Model

On August 3, 2017, the FDA approved a new HCV drug called Mavyret from AbbVie. According the Speciality Pharmacy Times, this new drug had the potential to challenge the dominant position of Gilead’s Harvoni on two fronts: (1) a regimen requiring only 8 weeks versus 12 weeks for Harvoni; and (2) a disruptive ultra-low regimen list price of $26,400  that left little to no room for PBM rebates while still coming in at 15% below the NET price of Harvoni implying a 78% as the gross rebate percentage.

We have argued in another paper that AbbVie’s pricing for Mavyret is disruptive to the PBM business model.  It forces CVS and Express Scripts to consider a drug for inclusion in their national formularies that is aligned with their clients interests — lower net costs than Harvoni — but not aligned with their own interest of squeezing out all the rebates they can from specialty drugs.

 

Express Scripts’ Choice for the HCV Therapeutic Class

On September 15, 2017 Express Scripts announced its 2018 choices for the HCV therapeutic class.  It chose to add Mavyret as a preferred drug.  But, surprisingly, it also chose to open up completely the HCV class by adding Gilead’s existing HCV drugs.   The new Gilead combo drug Vosevi was also added with a step-therapy proviso.

Below is a comparison of Express Scripts’ closed formulary for 2017 versus its open formulary for 2018.

 

CVS Caremark’s Choice for the HCV Therapeutic Class

In August 2017, CVS Health released a white paper reiterating the criteria it uses for formulary choices and exclusion lists.

“We remove drugs only when clinically-appropriate, lower-cost (often generic) alternatives are available.

CVS stated that it expected to remove 17 products from its 2018 Standard Control Formulary, but noted that  

“We are in the process of finalizing changes for autoimmune and hepatitis C categories, which will be communicated mid-September.”

On September 28, 2018, we noted in a blog post that CVS was two weeks late in making its decision on Mavyret. We also tweeted about it to CVS.

On October 1, 2017 CVS released its drug exclusion list for 2018 with no mention of its decision on Mavyret.  Replicating its 2017 choices, CVS preferred the Gilead drugs and excluded the rest.  

Sometime after October 1, 2017 and before October 10 201,7 CVS released an “undated” Advanced Control Formulary for 2018 that indicated that it finally did decide to exclude Mayvet:

It is interesting to consider the question of why CVS chose to keep the the HCV class closed while ESRX choose to open it up.  Obviously, CVS received more from Gilead for exclusive placement of Harvoni than ESRX received in return for opening the theapeutic class and subjecting Harvoni to competition.  

A less obvious reason is that, because of CVS’s sagging “front store” drugstore convenience business, CVS has to rely on retained rebates from specialty drugs more than the pure play PBM ESRX.  This forces CVS to squeeze all the rebates it can from specialty drug companies by offering exclusivity on its formulary.  

On the other hand, ESRX’s gross profits from rebate retention do not have to subsidize low to negative gross profits from the “front stores” of vertically integrated retail drugstore chain.  ESRX can afford to be more “open” about formulary design than CVS. 

 

Was CVS’s Exclusion of Mavyret Anti-Competitive?

Based on list prices reported by Speciality Pharmacy Times and CVS’ own reported average rebate retention rate of 10%, we estimate that Gilead would have to had to offer CVS Caremark an 83% rebate off list in order for Harvoni to come in at a lower net price than Mavyret’s list price.  

If our estimate of 83% was what actually transpired, then both Gilead and CVS would have a solid case that this exclusive dealing rebate contract was procompetitive and in the best interest of plan sponsors and consumers.

 

On the other hand, our 83% estimate seems to an outlier for rebates negotiations today.

Merck has published data on average gross rebate percentages given to PBMs and others.  For 2016, Merck’s average gross rebate percent stood at 40.9%, far below our estimate of 83% that Gilead would have had to pay CVS to undercut AbbVie’s list pricing for Mavyret.   The Merck data cast doubt on the likelihood that Gilead would given anywhere near 83% rebate.

If the gross rebate was slightly less, say 75%, then Mavyret would be the low cost drug.

In this case, the Bork presumption of the pro-competitiveness of vertical restraints breaks down. Here a “rational” PBM buyer would exclude the low cost supplier because of a misaligned business model based on retained rebates. A buyer with a normal reseller business model would NOT have excluded Mavyret.

We call on CVS Caremark to issue a public statement confirming that its choice to exclude Mavyret was in the best interest of clients because Harvoni was the lower cost drug after rebates.

While there is no prize for second place here, we all benefit from AbbVie’s competitive effort.  It’s aggressive pricing has forced PBMs to consider a low cost specialty drug that offers no rebate potential.  If Gilead’s Harvoni was in fact the low cost drug, then AbbVie forced Gilead to pay an outlier gross rebate percentage of around 83% to gain exclusivity and plan sponsors using CVS as their PBM all benefited.

In addition, AbbVie’s aggressive pricing was likely a factor in Merck and Johnson & Johnson  deciding to halt wasteful R&D spending on “me-to” HCV drugs.  Merck said that it would be writing off a full $2.9 Billion in HVC R&D “due to competition.”   

Finally, while AbbVie’s aggressive list pricing might not have been enough to undercut Gilead’s outsized rebate offer, we believe AbbVie might have planted the seed in other specialty drug companies, especially ones with biosimilars in development,  that you cannot beat out incumbents by matching their high list prices and out rebating them for formulary placement.  

 

Hepatitis C Formulary Choices for 2018: Will CVS Risk Looking Bad?

Lawrence W. Abrams No Comments

Summary:

AbbVie’s aggressive list pricing for its new Hepatitis C Virus (HCV) drug Mavyret is disruptive to the current PBM business model.  It essentially asks PBMs to align with client interests by adding a cost-effective drug to their national formularies despite little to no possibility for retained rebates.

On September 15, 2017 Express Scripts (ESRX) chose to align with client interests by opening up the HCV therapeutic class to include Mavyret as well as other HCV drugs previously excluded.  

CVS Caremark has yet to announce its final choices for the HVC class despite promising that it would do so by mid-September 2017.

If CVS chooses not to add Mavyret, it will be a sign that CVS is so desperate for rebate income that it is willing incur a very public case of misaligned interests.

 

The Pharmacy Benefit Manager Business Model

The management of the prescription (Rx) drug benefit portion of health care plans has become the domain of contracted specialists called pharmacy benefit managers (PBMs).

The three largest, independent PBMs — Express Scripts, CVS Caremark,  and OptumRx,  (known as “The Big 3”) control 73% of the total Rx claims processed the United States in 2015.

Since the early 2000s, PBMs have continually come under attack for not acting in the best interest of their clients.  We have written a number of papers since 2004 pinpointing an opaque reseller business model as the source of this misalignment.

In a 2017 paper, we presented the case that there have been 3 distinct phases of the PBM business model over the past 15 years demarcated by radical shifts in the primary source of gross profits: (graph below)

  1. up to 2005 — reliance on retained rebates from small molecule brand drugs;  
  2. 2005 – 2010 — reliance on mail order generics Rx margins;
  3. 2010 – today — reliance on retained rebates from specialty drugs.

To compensate for declining mail order generic Rx margins after 2010, PBMs saw the rising trend of specialty and biotech drugs as a promising basis for a renewed reliance on retained rebates.

But there are several constraints today that make it difficult to rely on retained rebates from specialty drugs.

The first constraint in that the specialty drug Rx volume “basis” for collecting rebates today is a lot less than it was ten years ago when small molecule drugs were the basis for rebates.

The second constraint is a newfound awareness by clients that retained rebate dollars can be substantial yet an opaque source of PBM gross profits.   As a defensive move, CVS  finally declared publicly on their website that,

“CVS Caremark was able to reduce trend for clients through… negotiations of rebates, of which more than 90 percent are passed back to clients.”

The problem facing PBMs today is how to derive a majority of gross profits from specialty Rx while maintaining a transparent rebate retention rate of 10% on average.

We found that to do this required PBMs to “coax” drug companies into increasing list prices for brand drugs at double-digit rates yearly while demanding that nearly all of it be rebated back to the PBMs. The result of this scheme has been an occurrence now known as the “gross-to-net price bubble.”

Formulary Choice and Drugs Rebates

An important managed care function of PBMs is to develop a list of drugs that are covered by insurance.  That list of covered drugs is called a formulary.  

The formulary is a lookup table that PBMs add to their claims processing systems that checks a Rx request against a list of therapeutic equivalents preferred by the plan.  The formulary is designed to limit Rx to the most cost-effective drug(s) in each of 50-80 different therapeutic classes.  

In 2005, we were the first to conceptualize formularies and their therapeutic classes as a group of markets.  On the sell-side are brand drug companies with close, but not perfect substitutes, called therapeutic equivalents.  On the buy-side are the Big 3 PBMs representing plan sponsors and their members.

Economists call such markets bilateral oligopolies.  We have written a number of papers  about the Pharma – PBM bilateral oligopoly. We have also written a number of papers conceptualizing rebates as tariffs paid by Pharma to gatekeepers (PBMs) for access to markets with limited competition.  

We have observed a change in PBMs’ approach to formulary choice over the past 15 years.  Basically, “rebatable” therapeutic classes have gone from being open — a number of covered drugs — to being closed —  1-2 covered drugs. The corollary of this trend is a growing list of excluded drugs.

Adam Fein of the Drug Channels blog has done a great job at tracking this trend. Below is his latest graph:

 

We are just beginning to think about the causes of this trend.  But our basic view of what drives PBMs to choose open versus closed therapeutic classes is this:

The more a PBMs limits competition in a therapeutic class, the more potential entrants will pay for access.  Small molecule therapeutic classes tend to be open, hence less valuable to entrants.  Specialty and biotech therapeutic classes tend to be closed, hence more valuable to the single favored entrant.  

Today, PBMs need to squeeze everything they can from granting access to specialty therapeutic classes.  This is the reason for the trend toward closed formularies and correspondingly more drugs on excluded lists.   

 

The Hepatitis C Virus Drug Therapeutic Class

In 2013,  the biotech company Gilead Sciences got FDA approval for its “innovative” Hepatitis C Virus (HCV) drug combo called Sovaldi.  Eight month later, an improved version of Sovaldi,  called Harvoni, came on the market.  These drugs produced fewer side effects than first generation combo drugs requiring interferon.  Also, Sovaldi / Harvoni only required regimens lasting 12 weeks, instead of 24 to 28 weeks with prior combo drugs.  

In 2016, Gilead’s Harvoni stood at #2 on the list of top selling Rx drugs at $10.0 Billion a year.  In the three years since Harvoni came on there market, there have been 9 additional HCV drugs approved by the FDA, but only AbbVie’s Viekira Pak has garnered any significant sales to date.  

The main reason is that the two largest PBMs — CVS Caremark and Express Scripts  — chose to close the HCV therapeutic class to all but two drugs that cover all six HCV genotypes.  (see table for 2017 below)

Source: CVS Caremark Formulary 2017

Source: CVS Caremark Formulary Exclusion List 2017

Source: Express Scripts Formulary and Exclusion List 2017

 

Factors Underlying Formulary Choice

The question is what were the determining factors underlying the formulary choices above.  Also, given the opaqueness of the PBM business model and history of misalignment with client interests,  were the above choices aligned or misaligned with client interests?

PBMs all state on their websites that the fundamental criteria governing formulary choice is drug cost-effectiveness.  In the case above, a few of the nine HCV drugs may be less effective than the leader Harvoni,  but effectiveness cannot account for breadth of formulary exclusion above.  

The most important variable affecting HCV formulary choice above is on the cost side.  Specifically it is NET costs — Pharma’s list price less gross rebates negotiated between Pharma and PBMs — that is the determining factor.

A conflict of interest can arise if there are several therapeutic equivalents that are all cost-effective, but there is one drug with a list price so low that it affords PBMs little to no retained rebates.  

Consider this hypothetical choice below:

Until AbbVie’s aggressive list pricing of Mavyret appeared in August 2017 (see below), the regimen list price of all of HCV drugs was about the same.  Unlike the example above, formulary choice for the HCV class did not present a potential conflict of interest prior to AbbVie’s pricing of Mavyret.  

The choices made by ESRX and CVS in 2017 highlighted above are aligned with interests of clients.   The only question for us is why did the two PBMs choose to close the therapeutic class?

We think the reason comes down to the specific rebate formulas used in rebate contracts —  a top secret element in a generally opaque PBM business model.

We speculate that the formula for placement as a preferred drug could take several general forms:

  1. $ discount / unit;
  2. % price discount / unit;
  3. single lump sum in $ tens of millions as a function of market share delivered.

We think that behind closed therapeutic classes are contracts with large lump sum payouts as a function of market share.  We think that behind open therapeutic classes are dollar or % discount formula with no incentives / penalties for market share delivered.

One of the reasons why PBMs want to keep rebate formulas a secret is that such formulas have been a key element in antitrust lawsuits alleging that market share rebates foreclose competition.

 

AbbVie’s Mavyret Drug Pricing Is Disruptive to the PBM Business Model

On August 3, 2017, the FDA approved a new HCV drug call Mavyret from AbbVie. According the Speciality Pharmacy Times, this new drug has the potential to challenge the dominant position of Gilead’s Harvoni on two fronts: (1) a regimen requiring only 8 weeks versus 12 weeks for Harvoni; and (2) a disruptive ultra-low regimen list price that leaves little to no room for PBM rebates.  

Below is our spreadsheet comparison of the NET REGIMEN for Mavyret versus Harvoni:

AbbVie’s pricing for Mavyret is disruptive to the current PBM business model because it forces the Big 3 PBMs to consider a drug for inclusion in their national formularies that is aligned with client interests — as cost-effective than Harvoni — but not aligned with their own interest of squeezing out all the rebates they can from specialty drugs.

On July 31, 2017,Express Scripts released its 2018 National Formulary, but noted:

“Please note that product placement for Hepatitis C and treatment for Inflammatory Conditions are under consideration and changes may occur based upon changes in market dynamics and new product launches. The full list of excluded products will be available on or before September 15, 2017.”

As promised, on September 15th Express Scripts released its choices for HCV class.  It chose to add AbbVie’s Mavyret even though the pricing afforded them little to no rebates potential.  

This choice represents a clear statement by Express Scripts that it is aligned with client interests.

Surprising to us was that Express Scripts also chose to open up the HCV class to 3 other drugs as indicated in the table below.

Source: Express Scripts Formulary and Exclusion List 2017

Source: Express Scripts Formulary and Exclusion List 2018

We believe that underlying the decision to an open therapeutic class is the replacement of a large lump sum rebate predicated on market share to a simple linear rebate as a function of volume.

CVS Health has yet to announce its final choices for the HVC class despite promising that it would do so by mid-September 2017.

If CVS chooses not to add Mavyret, it will be a sign that CVS is so desperate for rebate income that it is willing incur a very public case of misaligned interests.

Postscript added October 17, 2017

Summary

In October 2017, CVS Caremark (CVS) finally decided to  exclude from its 2018 drug formulary the new-to-market Hepatitis C Virus (HCV) drug Mavyret despite it being list priced aggressively by its manufacturer AbbVie at an estimated 72% below the list price of Gilead Sciences’ incumbent HCV drug Harvoni.

We estimate that Gilead Sciences had to offer CVS a minimum of a 83% rebate percentage in order for Harvoni to have a net price below Mavyret’s list price.  The 83% figure would represent an outlier in reported gross rebate percentages today that generally fall in the 40% to 60% range.

If it turns out that the rebate percentage was less, it sets up an anti-competitive and antitrust case that Mavyret was excluded because of lack of pharmacy benefit manager (PBM) rebate retention despite being the lowest cost drug in the HCV therapeutic class.

We call on CVS Caremark to issue a public statement confirming that its choice to exclude Mavyret was in the best interest of clients because Harvoni was the lower cost drug after rebates.

Blame Pharmacy Benefit Managers (Not Pharma) For Driving Drug Price Inflation

Lawrence W. Abrams No Comments

Summary:

We start with a review of the history of the opaque pharmacy benefit manager (PBM) reseller business model. We present our prior estimates of the distribution of PBM gross profits over the past decade showing that they have become dependent today on retained rebates from specialty drugs.

Next, we present numbers showing how PBMs today have painted themselves into a corner with a relatively small basis for drug rebates coupled with promises to hold their overall average rebate retention rate, a term we coined in 2003, to a “reasonable” 10%.

We conclude the paper with a deconstruction of the growing divergence between brand drug list prices (gross) and the prices Pharma actually receive after PBM rebates (net) — the so-called “gross-to-net price bubble”.  We use data supplied by the drug company Merck to go through a step-by-step sequence of how PBMs and drug companies might negotiate the parameters of a rebate deal today under the constraint that PBMs have to grow gross profit DOLLARS over time while fixing the rebate retention rate at 10%.  

We show that the outcome of such constrained negotiations produces a gross-to-net price bubble.

The “Gross-To-Net Price Bubble”

Before 2017, there had been two well-publicized exposes of massive increases in the list price of off-patented brand drugs that were rubber-stamped by pharmacy benefit managers (PBMs).  This included Mylan’s EpiPen and Martin Shkreli and his Turning Pharmaceutical’s HIV drug Daraprim.

There are now numerous reports providing quantitative evidence of outrageous increases in specialty brand drugs list prices over the past 5 year.  For example, consider this table of list price inflation between 2012-7 of Multiple Sclerosis drugs taken from Congressman Michael Vounatsos’ request to manufacturers for more information:

In April 2017, Adam Fein first reported on his blog Drug Channels that the health information company QuintilesIMS had just published  aggregate trend data for brand name drug prices before (gross) and AFTER rebates (net) had been paid to pharmacy benefit managers (PBMs).

The data showed  two trends beginning in 2011: (1) gross prices were growing faster than net prices; (2) the divergence itself was growing.

Dr. Fein coined the term “gross-to-net rebate bubble” to describe (2) above, which has become the standard lexicon for the phenomena. Below is graph summarizing QuintilesIMS latest findings taken from an April 2017 blog post by Dr. Fein:

The PBM Business Model:  2005 – 2010

In an earlier 2017 paper, we presented the case that there has been three distinct phases of the pharmacy benefit manager (PBM) business model over the past 15 years. Each has been demarcated by radical shifts in their primary source of gross profits:

  1. up to 2005 — reliance on retained rebates from small molecule brand drugs;  
  2. 2005 – 2010 — reliance on mail order generic Rx margins;
  3. 2010 – today — reliance on retained rebates from specialty drugs.

Below is graph of our estimates of the distribution of PBM gross profits over the past 15 years.

The majority of PBMs gross profits between 2005 – 2010 came a mail order generic Rx.   The Big 3 PBMs devised a strategy of tacitly colluding with their counterpart Big 3 retail pharmacies — Walgreen, CVS, and Rite-Aid — to hold up margins on generic Rx fills.  

Essentially the Big 3 PBMs have the power to set their competitors’ prices, an anti-competitive weapon if there ever was one.   PBMs gave retailers fat margins for 30-day generics in return for promises not to compete on 90-day Rx.  Then, PBMs set the prices of generic Rx filled by captive mail order operations slightly less than retail to give the appearance of alignment with client interests.  But, the supply chain hold up still allowed for fat mail order generic Rx margins.

The first blow to this scheme came in late 2006 when Walmart saw the fat retail margins and began a disruptive  $4 / generic Rx campaign. They could do this as an “outsider” retailer because their business model wasn’t dependent on fat pharmacy margins subsidizing the rest of the store.

The final blow to this “hold-up” scheme came around 2008 several years after the vertical merger of the pharmacy retailer CVS and the PBM Caremark.   Consistent with the business model of the merged company, CVS-Caremark began offering preferred provider pharmacy networks featuring lower  unit prices at retail in return for Rx volume.  

While this managed care technique is used successfully in reducing hospital and physician costs, it has never really been instituted by PBMs prior to the CVS-Caremark merger.  This absence had been an obvious sign to us at the time of tacit collusion between the Big 3 retail pharmacies and the Big 3 PBMs.

The PBM Business Model: 2010 – today

To compensate for declining mail order generic margins after 2010, PBMs saw the rising trend of specialty and biotech drugs as a promising basis for a renewed reliance on retained rebates.

But there were several problems with the goal of deriving a majority of gross profits from specialty drug rebates.    Reconstructing how PBMs solved these problems is the key to understand why PBMs, not Pharma, drive the gross-to-net drug price bubble today.

First, assume that since 2010, the Big 3 PBMs needed additional gross profits each year from specialty drug retained rebates to replace incremental losses in margins from mail order generics Rx.

This creates a problem in that the specialty drug Rx volume “basis” for collecting rebates today is a lot less than it was ten years ago when small molecule drugs were the basis for rebates.  How much less?  The Pew Charitable Trust Foundation sponsored a study which found that in 2015 special Rx comprised only 1% of total Rx.  

A decade ago, we estimated that about 20% of total Rx filled were “rebatable” brand drugs, i.e. in therapeutic classes with a few other brand drugs that were therapeutic equivalents.  So instead of 1:100 specialty Rx to total Rx basis differential, we arrive at a 1:20 “rebatable” specialty drug Rx to “rebatable” small molecule brand drug Rx basis differential.

In other words,  ten years ago PBMs has 20 times the volume of Rx available to them to use as a basis for generating retained rebates as they do today.

The second constraint that PBMs have today is an awareness by their clients that retained rebate dollars can be a substantial yet opaque source of PBM gross profits.    

Today,  there seems to be an order of magnitude more articles critical of PBMs in general, and retained rebates specifically,  As a defensive move, CVS Health finally declared publicly on its website that,

“CVS Caremark was able to reduce trend for clients through… negotiation of rebates, of which more than 90 percent are passed back to clients.”

The problem facing PBMs today is how to derive a majority of gross profits from specialty Rx while maintaining a transparent rebate retention rate at 10% on average.

The business model of the drug companies is simple and stable by comparison.  Sure, drug companies want to maximize profits just like the PBMs.  But drug companies are not constrained as much as the Big 3 PBMs and don’t need a convoluted gross-to-net price scheme to achieve their targets.

It is important to remember that it takes two parties to negotiate drug rebate deals. Drug companies have some power in determining how these deals are structured, especially if there are only one or two other brands drugs that are therapeutic equivalents.

The Big 3 PBMs today have a lot of power in rebate negotiations.  Drug companies have a lot to lose if negotiations fall through.  Exclusion of a single drug from one of Big 3 PBMs’ national lists of drugs covered by an insurance plan  — called formularies — can cost a widely-used or expensive drug $3+ Billion dollars in lost revenue.

It is the Big 3 PBMs who drive schemes involving high-list-price / high-rebate specialty drug deals.  For now, drug companies are accomplices along for the ride. They are culpable, but much less so than PBMs.  

A Deconstruction of Merck’s Gross-to-Net Drug Price Bubble

We conclude the paper with a deconstruction of the growing divergence between brand drug list prices (gross) and the prices Pharma actually receive after PBM rebates (net) — the so-called “gross-to-net price bubble”.  We use data supplied by the drug company Merck to go through a step-by-step sequence of how PBMs and drug companies might negotiate the parameters of a rebate deal today under the constraint that PBMs have to grow gross profit DOLLARS over time while fixing the rebate retention rate at 10%.

We show that the outcome of such constrained negotiations reproduces produces a gross-to-net price bubble.

Below is a screenshot from a Merck memo laying out for all to see their “gross-to-net drug price bubble”.  Other drug companies are publishing similar data as a way of defending themselves against charges of “double-digit” price-gouging tactics.

This is a graphic depiction of Merck’s gross-to-net price bubble:

Below we build a spreadsheet which “deconstructs” Merck’s bubble for a hypothetical specialty drug.  It  shows how PBMs can grow retained rebates dollars via a combination of growing rebate percentages while maintaining a retention rate fixed at 10%.

A larger view of the spreadsheet above:

 

Note that despite being constrained to a 10% rebate retention rate, this deal scheme give PBMs yearly retained rebate DOLLARS that are 176% greater that what they received 6 years earlier.

Some have predicted that the divergence between gross and net prices will level off after 2017.

We tend to agree with that prediction as the current bubble was fueled by PBMs’ need to REPLACE a declining trend in gross profits from mail order generic Rx.  With that loss fully offset, PBMs could grow gross profits in the future by maintain a steady divergence between list prices and net prices.

Three Phases of the Pharmacy Benefit Manager Business Model

Lawrence W. Abrams No Comments

We present the case that there has been three distinct phases of the pharmacy benefit manager (PBM) business model over the past 15 years. Each phase has been demarcated by a major shift in the dominant source of gross profits.

These radical shifts in the primary source of gross profits in such a short period of time is unprecedented among Fortune 50 companies.  This is indicative of the opaqueness of the PBM business model to their downstream customers — health care plan sponsors.  

It is also indicative of PBMs’ relative power to negotiate rapid changes in payment streams from upstream suppliers — the Big 3 retail pharmacies and drug companies.   These upstream suppliers and the Big 3 PBMs make up two sides of intermediate market bilateral oligopolies.

It is instructive to understand why PBMs had to recalibrate their business model twice now in the last 15 years.  In today’s terminology,  what “disrupted” this powerful cartel? Our examination of recent history suggests that  government regulations and lawsuits have had little impact on PBM decisions to change their business model.  

Rather, our view is that the disruptors have been “rent-seekers” whose business models were not in alignment with the rest of the cartel.  This included the emergence of a vertically integrated PBM in the form of CVS-Caremark and the powerful outsider Walmart with a business model that allowed for the retail pharmacy to be a “loss-leader”.

Below is a spreadsheet which summarizes the data sources for our estimation of distribution of PBM gross profits over the past 15 years.

Below is a graph of our estimates of PBM gross profits share by source over the past 15 years indicating that there have been 3 distinct periods where a different source dominated.

In support of our contention of the replacement of lost margins on mail order generics with retained rebates after 2010, we present data assembled by Adam Fein  estimating total rebates to PBMs and discounts to drug distributors between 2007 – 2016.   Note that the total increases was 126% between 2010 and 2016.

 

The Pharmacy Benefit Management Business

PBMs provide a bundle of managed care services designed to provide a cost-effective prescription (Rx) drug benefit to plan sponsors and their members.  The PBM bundle includes the following list of services:  

  1. create a retail preferred provider pharmacy network and negotiate brand and generic Rx reimbursements;
  2. provide 90-day Rx exclusively from captive mail order pharmacies;  
  3. provide specialty (high priced and biotech) drugs Rx from captive specialty pharmacies;
  4. create a formulary — a look up table that restricts fills to preferred drugs — and negotiate rebates with Pharma in return for placement;
  5. provide other Rx cost-saving measures such as prior authorization, step-therapy, quantity limits, and co-pays.   

Concentration in the PBM Business

The three largest PBMs today — Express Scripts, CVS Health,  and Optum Rx, (known as “The Big 3”) control 73% of the total Rx claims processed the United State in 2015.  

Prior to 2013, the Big 3 PBMs were Express Scripts, Medco, and Caremark with a combined concentration similar to today.  The concentration in the PBM industry today has been the result of a series of horizontal mergers mistakenly approved by the Federal Trade Commission (FTC).

In 2004, there was a horizontal merger between #3 PBM Caremark and #4 PBM AdvancePCS.

In 2007, there was, in our opinion, a disruptive pro-competitive, vertical merger between #2 retail pharmacy CVS and #2 PBM Caremark. At the time, #1 PBM Express Scripts make a hostile bid for Caremark, but withdrew over concerns over the length of antitrust investigations by the FTC.

In 2012, there was a horizontal merger between the #1 PBM Express Scripts and #3 PBM Medco.  In our opinion, this anti-competitive merger was mistakenly approved by the FTC with a one vote majority.  The deciding vote was made by a President Obama appointee, and Harvard Law School classmate, Edith Ramirez.  In our opinion, Edith Ramirez has cost the American public $75+ Billion in excessive Rx costs over the past 5 years —   5 times an estimated inflated 5% of $300 Billion in yearly Rx drug expenses.

In 2013, the largest health insurer in the USA, UnitedHealth Group,  ended its long running PBM contract with Medco, now owned by Express Scripts.  To handle its own PBM needs, UnitedHealth created an internal unit OptumRx. It grew the unit via taking business away from CVS and Express Scripts and via a 2015 purchase of the tech-savvy PBM Catamaran.

The Pharmacy Benefit Manager Business Model

Since the early 2000s, PBMs have continually come under attack for not acting in the best interest of their clients.  We have written a number of papers since 2004 pinpointing an opaque reseller business model as the source of this misalignment.

The PBM reseller business model is in stark contrast to the two other transparent business models used by managed care companies:  

  1. a self-insurance agency model with 100% pass through of claims expenses to plans accompanied by per-member-per-month (PMPM) management fees;
  2. a risk-based insurance model with capitated premiums paid by plans.

The way companies monetize their businesses — a key component of their overall business model — is a choice.  Often companies sell bundles of products and services and make strategic decisions to monetize one component at a higher margin rate than another component.  Disguising gross profit margins by line of business or bundle components is considered a good business practice.

Take, for example, General Motors. It aspires to build great cars, yet a good share of its gross profits comes from car finance. McDonald’s aspires to offer customers a great tasting hamburger, yet the company has a higher markup on beverages that it does on food. Best Buy recoups slim margins on consumer electronics products with fat margins on extended warranties.

So why should the opaque PBM reseller business model be judged differently than, say, Best Buy’s?  Aren’t PBMs subject to ERISA laws mandating fiduciary responsibility — i.e. acting in best interest of clients?  

Actually no, according to court cases.  It is up to clients of PBMs to hold them accountable for claims that they act in clients’ best interests.  It is up to clients of PBMs to pressure them to offer alternative, more transparent business models.

The Evolution of the PBM Business Model

The PBM business model has evolved considerable over the past 15 years both in terms of the array of managed care services offered and the corresponding distribution of gross profits.

In 2001, PriceWaterhouseCoopers  published an excellent business history of PBMs to that date.   PBMs started out in the 1980s as computer networking specialists who automated Rx claims processing by connecting retail pharmacy point of sales terminals to back-office health insurance mainframes.  

Between 1980-1990, PBMs’ prime source of revenue was claims processing fees.  PBMs only focus was minimizing claims processing costs, a goal totally in line with the goals of their clients.

The excellent PriceWaterhouseCoopers PBM history did mention that PBMs tried a totally transparent insurance premium business model in the early 1990s. But, they abandoned it after a few years due to losses caused by unexpected mid-year increases in unit drug costs and uncontrollable, Pharma-initiated direct-to-consumer advertising campaigns that greatly increased utilization.

The current PBM business model features five major streams of revenue and gross profits:

  1. “spread margins” on top of retailers’ own margins and lately, direct and indirect reimbursement (DIR) fees, that are collected from retail pharmacies in return for being included in their networks;
  2. claims processing and data fees;
  3. rebates given by Pharma on small molecule brand drugs in return for preferred status on formularies;
  4. rebates give by Pharma on speciality (biotech) drugs in return for preferred status on formularies;
  5. profit margins on 90-day generic Rx filled by captive mail order operations.

Since we began following PBMs in 2002, the distribution of gross profits has changed dramatically. These radical shifts in such a short period of time is unprecedented among Fortune 50 companies.

These radical changes are indicative of the opaqueness of the PBM business model to their downstream customers — health insurance plan sponsors.  It is also indicative of the power of the Big 3  PBMs to negotiate rapid changes in payment streams with upstream suppliers — retail pharmacies and brand drug companies — who tacitly collude with them in two intermediate market bilateral oligopolies.

We see 3 distinct phases of the PBM business model over the past 15 years demarcated by radical shifts in the primary source of gross profits:

  1. up to 2005 — reliance on retained rebates from small molecule brand drugs;  
  2. 2005 – 2010 — reliance on mail order generic Rx margins;
  3. 2010 – today — reliance on retained rebates from specialty drugs.

Phase 1:  Retained Rebates from Small Molecule Brand Drugs

Phase 1 ended in 2005 after blog posts started appearing which disaggregated the 10-Qs and 10-Ks of Medco’s business model revealing outrageous rebate retention rates.  There was also a 2004 lawsuit initiated by U.S. Philadelphia District Attorney Patrick Meehan (now Congressman) accusing Medco of switching mail order generic Rx to higher priced rebatable brands.  As part of the settlement, Medco agreed to inform plans of gross rebates received and their rebate retention rates.

For 3Q04, we derived with certainty from Medco’s 10-Q that 71% of its gross profits came from retained rebates from small molecule brand drugs.  By 2Q05, we estimated with certainty that Medco’s retained rebate share of gross profits had dropped to 48% with the difference going to their newly found focus on mail order generics.

We have written extensively about the Pharma – PBM bilateral oligopoly that enabled this phase of the PBM business model.  Rather than rehash this, we refer to the following papers downloadable for free from our website:

  1. Pharmacy Benefit Managers as Conflicted Countervailing Powers , January 2007
  2. Who is Best at Negotiating Pharmaceutical Rebates?  December 2005
  3. PBMs as Bargaining Agents Paper presented at the 80th Annual Western Economic Association Meeting, July 6, 2005, San Francisco
  4. PBMs as Bargaining Agents PowerPoint presented at the 80th Annual Western Economic Association, Meeting, July 6, 2005, San Francisco
  5. The Effect of Corporate Structure on Formulary Design: The Case of Large Insurance Companies Poster Presentation, ISPOR 10th Annual Meeting, Washington DC, May 2005
  6. The Role of Pharmacy Benefit Managers in Formulary Design: Service Providers or Fiduciaries? Journal of Managed Care Pharmacy Vol. 10 No. 4 July/August 2004 pp 359-60

Phase 2: Mail Order Generic Rx Margins

The “interregnum” Phase 2 featured a successful replacement of retained rebates with mail order generic margins.   The Big 3 PBMs devised a strategy of tacitly colluding with the Big 3 sell-side retail pharmacies  — Walgreen, CVS, and Rite-Aid — to hold up retail generic prices in order to allow for PBMs’ mail order generics prices to be lower but still with fat margins.  

Essentially, it was a scheme to limit price competition between retailers and mail order by “buying off” retail pharmacies with reimbursements for 30-day generic Rx at fat margins in return for ceding  90-day generics Rx to captive mail order operations at lower prices but equally fat margins.

According to PBMs,  mail order was good for plans because mail order generic Rx were cheaper than at retail.  Nevermind, if this was only because of PBMs’ rare ability to set the price of their competitors.  This hold-up scheme was just a sure-fire version the anti-competitive tactic of raising rivals costs.

Below is a diagram which compares the margins at the height of Phase 2 “hold-up” scheme versus the lower prices and margins existing today.

The “hold-up” scheme worked for a couple of years.  Our 2003 paper which disaggregated Walgreen’s gross profits likely was read by an “outsider” retailer with a different business model that wasn’t dependent on fat Rx margins subsidizing the rest of the store.  That outsider was Walmart.  

Our paper confirmed what they saw — the fat generic Rx margins of Walgreen, etc. dispensed from a “1,000 square foot hole in the back” (our words) making up for slim margins coming the poorly merchandised, 10,000 square foot “front store”.   

In 2006,  Walmart rolled out a  transparent $4 / generic Rx campaign that proved to be the first blow to this hold-up scheme.

The 2007 vertical  merger of the pharmacy retailer CVS and the PBM Caremark marked the beginning of the end of the era of fat generic Rx margins.

A fundamental tool of managed care companies are preferred provider networks.  They succeed in reduce costs by promising increased volume to preferred providers in return for lower unit prices.  In 2006,  we found PBMs’ lack of use of preferred provider networks , along with lack of 90-day Rx at retail, to be obvious signs of the tacit collusion between the Big 3 pharmacy retailers and the Big 3 PBMs.

CVS likely read our 2005 paper confirming their success at beating out competitors in a Medicare Part D precursor program which was agnostic as to whether the Rx was filled at retail or mail order.

At the time of the CVS Caremark merger in 2006, we predicted  a “coming preferred provider war” among PBMs. Ten years later  “narrow networks” are common.  Generic Rx prices and margins are on a downtrend. And, PBMs no longer tout their mail order generics as the key to their profitability.

Phase 3: Retained Rebates From Specialty Drugs

To compensate for declining mail order generic margins, PBMs saw the rising trend of specialty and biotech drugs as a basis for a renewed reliance on retained rebates.

But there are several problems with the goal of deriving a majority of gross profits from specialty drug rebates.   Reconstructing how PBMs solved these problems provides insights in two observable phenomena of the era of specialty drug rebates:

  1. the so-called deep rebate practice and related gross to net drug price bubble;
  2. the trend of growing number of drugs excluded outright from PBM formulary lists.

First, assume that Big 3 PBMs need to derive about the same 50% of gross profits from specialty drug retained rebates as was derived a decade ago from retained rebates from small molecule “rebatable” brands.

This creates a problem in that the Rx volume “basis” for collecting rebates today is a lot less than it was ten years ago.  How much less?  The Pew Charitable Trust Foundation sponsored a study which found that in 2015 special Rx comprised only 1% of total Rx.  

A decade ago, we estimated that about 20% of total Rx filled were “rebatable” brand drugs, i.e. in therapeutic classes with a few other brand drugs that were therapeutic equivalents.  So instead of 1:100 specialty Rx to total Rx basis differential, we arrive a 1:20  “rebatable” specialty drug Rx to “rebatable” small molecule brand drug Rx basis differential.

In other words,  ten years ago PBMs has 20 times the volume of Rx available to them to use as a basis for generating retained rebates as they do today.

The second constraint that PBMs have today that they did not have a decade ago was the awareness by plans and the public that opaque retained rebate could be a dominant source of gross profits.    

Our 2003-8 era papers listed below were rare examples of quantitative articles exposing PBM reliance on retained rebates:

  1. Quantifying Medco’s Business Model: An Update November 2008
  2. Medco As a Business Model Imperialist  July 2008
  3. A Tale of Two PBMs: Express Scripts vs. Medco November 2005
  4. Quantifying Medco’s Business Model April 2005
  5. Estimating the Rebate-Retention Rate of Pharmacy Benefit Managers April 2003

Today,  articles critical of PBMs in general, and retained rebates specifically,  seem to be at least 10 more numerous than a decade ago.  In 2016, CVS Health has even stated publicly on its website that,

“CVS Caremark was able to reduce trend for clients through… negotiation of rebates, of which more than 90 percent are passed back to clients.”

The problem facing PBMs today is how to derive around 50% of gross profits from specialty Rx while maintaining a transparent “reasonable” rebate retention rate at 10% on average?

How have the Big 3 PBMs accomplished this?  They are doing by tacitly colluding with Pharma to increase brand list price at double digit rates which enables PBMs to opaquely offset the list price inflation with growing “deep discount” rebates.  

Below is a screenshot from a Merck memo laying out for all to see its “gross-to-net drug price bubble”: 

In another paper, we “deconstructed” the Merck data by laying out a step-by-step sequence of how PBMs and drug companies might negotiate the parameters of a rebate deal today under the constraint that PBMs have to increase gross profit DOLLARS over time while fixing the rebate retention rate at 10%.   Below is a spreadsheet of that step-by-step process:

It is clear that Pharma is getting fed up as an enabler of a convoluted PBM business model. There are other drug companies besides Merck that are publishing similar data as way of defending themselves against charges of “double-digit” price-gouging tactics.  A testy exchange between executives at Gilead Science and Express Scripts over who is to blame for the high list prices of Gilead’s top selling Hepatitis C virus drugs went public.

We have written about AbbVie’s “disruptive” low list pricing of its new HCV drug Mavyret that dares PBMs to exclude a no-rebate drug that also happens to be the most cost-effective HCV drug now on the market.

 

PBMs as Business Model Imperialists

It is the PBM business model, not the Pharma business model, that is currently stressed.   If PBMs can no longer rely on specialty drug retained rebates,  they will have to seek a new service to build up opaque margins or convert finally to a 100%  pass through fee-for-service business model.

An example of this is Express Scripts’  October 2017 acquisition of the medical benefit management company eviCore Healthcare for $3.6 Billion dollars.

On the one hand, self-injectable biologic drugs are covered under a drug benefit plan administered by a PBM like Express Scripts. On the other hand,  biologic drugs requiring infusion or injection supervised by a physician at a doctor’s office, clinic, or hospita are covered by a medical benefit plan managed by insurance companies and contracted specialists like eviCore.

The business models are different with PBMs using a reseller model while companies like eviCore use a fee-for-service model.

We think that Express Scripts will try to convince insurance companies that contract with eviCore to switch from a fee-for-service model to a reseller model.  Express Scripts will promise eviCore customers a reduction in overall drug benefit costs if they allow a business model switch.

Express Scripts will achieve cost-saving by promising specialty drug companies exclusivity in insurance coverage for any given therapeutic class in return for greater rebates.  The opaque rebate retention Express Scripts earns should exceed what eviCorp had been getting from fees-for-services.

This is not the first time that a PBM has pursued  a new area of managed care with the intent of changing the business model.

In a 2008 article, we called Medco’s move into fee-for-service disease management a case of “business model imperialism.”

Another example of PBM business model imperialism was a 2009 deal between Express Scripts and Anthem (formerly Wellpoint) to managed its PBM business.  It was structured as a “book of business” deal  where Express paid $4.68 Billion upfront in return a 10 year right to the opaque P&L.  An alternative would have been to structure the deal as a normal fee-for-service contract with 100% pass through.

We called the deal a “double-trouble front” and sure enough, it proved very lucrative for Express Scripts.  It was a headache for Anthem because they had not idea how much Express Scripts was profiting from managing their PBM business.  Express Scripts was painted as the bad guy in this deal, but the fault equally lies with Wellpoint’s then CEO Angela Braley for selling out Wellpoint’s customers with little controls over how much Express Scripts could make off of them.

The top priority of both Express Scripts and CVS Caremark today is looking to get into the medical drug benefit business — managing drugs requiring infusion or injection  at physician offices, clinics, or by mobile nurses in the home — and converting the business model from fee-for service or capitated insurance premium to a reseller model with opaque retained rebates.

Pharmacy Benefit Managers

Lawrence W. Abrams No Comments

CURRENT PAPERS ON PBMs

Three Phases of the Pharmacy Benefit  Manager Business Model (9/17)

Will Amazon’s Online Pharmacy Display Therapeutic Interchange (12/17)

Hepatitis C Virus Formulary Choices for 2018: Will CVS Caremark Risk Looking Bad? (09/17)

AbbVie’s Mavyret Drug Pricing is Disruptive to the PBM Business Model (09/17)

Merck Data Discredits PBM-Sponsored Study of Brand Drug Price Inflation (09/17) 

LEGAL ISSUES

Biosimilars & Exclusive Dealing Antitrust Law: The Case of Pfizer Inc v Johnson & Johnson et al. (10/17)

Was CVS’s Formulary Exclusion of Mavyret a Violation of Antitrust Laws? (10/17)

Hepatitis C Virus Formulary Choices for 2018: Will CVS Caremark Risk Looking Bad? (09/17)

Blame Pharmacy Benefit Managers (Not Pharma) For Driving Drug Price Inflation (09/17)

Pharmacy Benefit Managers as Conflicted Countervailing Powers (01/07)

Exclusionary Practices in the Mail Order Pharmacy Market (09/05)

Practical Issues With PBM Full Disclosure Laws
Originally Published in Update Magazine, Issue 4, 2004. Available with permission from FDLI

The Formulary Game (07/03)

 THE PHARMACY BENEFIT MANAGER BUSINESS MODEL

Pharmacy Benefit Manager Valuation and Profitability: Business Models Matter (07/09)

Medco As a Business Model Imperialist (07/08)

Quantifying Medco’s Business Model: An Update (11/08)

A Tale of Two PBMs: Express Scripts vs. Medco (11/05)

Searching for Windfall Profits from a Change in the AWP Markup Ratio (09/09)

Exclusionary Practices in the Mail Order Pharmacy Market (09/05)

Quantifying Medco’s Business Model (04/05)

Estimating the Rebate-Retention Rate of Pharmacy Benefit Managers (04/03)

Walgreen’s Transparency Issue (11/03)

 UNDERSTANDING DRUG REBATES THROUGH BARGAINING THEORY

Pharmacy Benefit Managers as Conflicted Countervailing Powers (01/07)

Who is Best at Negotiating Pharmaceutical Rebates? (12/05)

The Role of Pharmacy Benefit Managers in Formulary Design: Service Providers or Fiduciaries?
Journal of Managed Care Pharmacy Vol. 10 No. 4 July/August 2004 pp 359-60

PBMs as Bargaining Agents
Paper presented at the 80th Annual Western Economic Association Meeting, July 6, 2005, San Francisco

PBMs as Bargaining Agents
PowerPoint presented at the 80th Annual Western Economic Association, Meeting, July 6, 2005, San Francisco

The Effect of Corporate Structure on Formulary Design: The Case of Large Insurance Companies
Poster Presentation, ISPOR 10th Annual Meeting, Washington DC, May 2005

PREFERRED PROVIDER PHARMACY NETWORKS

The CVS-Caremark Merger and the Coming Preferred Provider War (12/06)

Medicare Part D and Preferred Provider Pharmacy (04/05)

The CVS-Caremark Merger: The Creation of an Elasticity of Demand for Retail Rx (11/06)

Contrary to What Wall Street and the FTC Say, The PBM Business Model is Misaligned (11/05)

Sins of Omission’: A Review of the FTC Study of PBM Conflict of Interest (10/05)

THE EXPRESS SCRIPTS – ANTHEM 2009 DEAL

Express Scripts – Anthem 2009 Deal as Double Trouble Front (08/09)

Express Scripts Misses on Guidance of Anthem’s NextRx PBM Business Article Written for Seeking Alpha, November 4, 2010

THE FUTURE OF CONSUMER-DIRECTED PHARMACY BENEFITS

The Future of Consumer-Directed Pharmacy Benefits (08/07)

Show Me the Display: A Review of an ESI Study of Consumer-Directed Pharmacy Benefits (07/07)

About the author:

I have a B.A. in Economics from Amherst College. I have a Ph.D. in Economics from Washington University in St. Louis.

My writings are at the intersection of economics, accounting,  financial analysis, and high tech.

I have received no remuneration for these articles. I have no financial relation with any company written about in these articles.

Lawrence W. Abrams

To Contact:
labrams9@gmail.com
831-254-7325

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PBM Drug Rebates

Lawrence W. Abrams No Comments

All papers downloadable .pdf

 Pharmacy Benefit Managers as Conflicted Countervailing Powers (01/07)

Who is Best at Negotiating Pharmaceutical Rebates? (12/05)

The Role of Pharmacy Benefit Managers in Formulary Design: Service Providers or Fiduciaries?
Journal of Managed Care Pharmacy Vol. 10 No. 4 July/August 2004 pp 359-60

PBMs as Bargaining Agents
Paper presented at the 80th Annual Western Economic Association Meeting, July 6, 2005, San Francisco

PBMs as Bargaining Agents
PowerPoint presented at the 80th Annual Western Economic Association, Meeting, July 6, 2005, San Francisco

The Effect of Corporate Structure on Formulary Design: The Case of Large Insurance Companies
Poster Presentation, ISPOR 10th Annual Meeting, Washington DC, May 2005

 

The Pharmacy Benefit Manager Business Model

Lawrence W. Abrams No Comments

CURRENT PAPERS:

Three Phases of the Pharmacy Benefit Manager Business Model (09/17)

Will Amazon’s Online Pharmacy Display Therapeutic Equivalents (12/17)

Blame Pharmacy Benefit Managers (Not Pharma) For Driving that Driving Drug Price Inflation (09/17)

Merck Data Discredits PBM-Sponsored Study of Brand Drug Price Inflation (09/17) 

Biosimilars and Exclusive Dealing Antitrust Law: The Case of Pfizer Inc vs J&J et al (12/17)

Hepatitis C Virus Formulary Choices for 2018: Will CVS Caremark Risk Looking Bad? (09/17)

AbbVie’s Mavyret Hep C Drug Pricing is Disruptive to the PBM Business Model (09/17)

PAST PAPERS:

Pharmacy Benefit Managers as Conflicted Countervailing Powers (01/07)

Pharmacy Benefit Manager Valuation and Profitability: Business Models Matter (07/09)

Medco As a Business Model Imperialist (07/08)

The Express Scripts – Wellpoint (Anthem) Deal as a “Double-Trouble” Front (08/09)

Quantifying Medco’s Business Model: An Update (11/08)

A Tale of Two PBMs: Express Scripts vs. Medco (11/05)

Searching for Windfall Profits from a Change in the AWP Markup Ratio (09/09)

Exclusionary Practices in the Mail Order Pharmacy Market (09/05)

Quantifying Medco’s Business Model (04/05)

Estimating the Rebate-Retention Rate of Pharmacy Benefit Managers (04/03)

Walgreen’s Transparency Issue (11/03)

 

Preferred Provider Pharmacy Networks

Lawrence W. Abrams No Comments

PREFERRED PROVIDER PHARMACY NETWORKS

The CVS-Caremark Merger and the Coming Preferred Provider War (12/06)

Medicare Part D and Preferred Provider Pharmacy (04/05)

The CVS-Caremark Merger: The Creation of an Elasticity of Demand for Retail Rx (11/06)

Contrary to What Wall Street and the FTC Say, The PBM Business Model is Misaligned (11/05)

Sins of Omission’: A Review of the FTC Study of PBM Conflict of Interest (10/05)