CVS’s 2019 Formulary Removals – Negligent Handling Diabetes Test Strip Change


Around the first week in August for the past four years, CVS has made an official announcement of its next year’s formulary changes. It posts these changes on its own websites.

But that changed in 2018. During an August 8th 3Q2018 Earning Conference Call,  CVS said that 2019 formulary details would be available around October 1, 2018.  

But, CVS waited until November 16, 2018 to post details on its own website. We believe that there has been a willful intent by CVS to minimize attention to upcoming formulary changes fearing bad publicity would delay government approval of their merger with the insurance company Aetna. The review included the Department of Justice, state Attorney Generals and Judge Richard Leon of the U.S. District Court of the District of Columbia.    

In particular, CVS has been negligent in giving ample warning to diabetes patients of an upcoming switch in blood glucose test strips from LifeScan’s OneTouch brand to Roche’s Accu-Chek brand.   We estimate that this change is going to affect up to 7.2% of CVS’s 94 Million covered lives,  or 6.8 Million people who have Type I or Type II diabetes, as they require daily blood glucose monitoring via a glucometer and test strips.

We conclude with a look at the impact of this event on state “frozen formulary” laws.


What is a formulary?

One of the most effective cost-controls employed by pharmacy benefit managers (PBMs) are their national formularies. Formularies are lookup tables embedded in software at the retail and mail order point of sale that alerts pharmacists as to which drugs are covered by a customer’s drug benefit plan.   

Via formularies,  PBMs’ have the power to affect the demand for patented, but therapeutically equivalent drugs.  This power enables them to negotiate rebates with pharmaceutical manufacturers (Pharma) in return for formulary placement.  Placement entails more that just inclusion vs exclusion, but also entails a whole array of other conditions including prior authorization, step therapy, and quantity limits.

The more a PBM shelters a given drug from competition via its array of formulary controls, the higher Pharma is willing to pay formulary rebates to avoid those controls.


PBM formulary switches and exclusions are growing

It has only been since 2012 that PBMs began to make significant formulary exclusions of FDA-approved prescriptions drugs. Before that, they would include non-preferred drugs in Tier III of a formulary which carried the highest copayments.

In our 2005 paper The Effect of Corporate Structure on Formulary Design, we looked at key therapeutic classes with small molecule brands having close therapeutic equivalents — proton pump inhibitors (PPI), COX-2 inhibitors, and 2nd generation antihistamines.  We found that  PBMs practiced what we called the “the Soprano approach” to negotiation — threaten harm to all, but negotiate payoffs from all to abstain from harm.

We called this negotiating strategy a “sin of omission” as there was no evidence of harm like formulary exclusion.  It was a sin of omission in that PBMs should have excluded high cost brands in cases where there were generics that were close therapeutic equivalents.  For example, in the mid-2000s, PBMs should have excluded the high cost brand PPI Nexium in favor of other near equivalent PPIs that had gone generic like omeprazole (Prilosec).

Below is a spreadsheet from a 2005 paper The Effect of Corporate Structure on Formulary Design  indicating a tendency in the mid-2000s for PBMs not to exclude brands that had close therapeutic equivalents.

Formulary design has changed significantly since the mid-2000s.  Now, there is a decided tendency among the Big 3 PBMs to grant exclusivity to drugs in formulary therapeutic classes where there are a number of therapeutic equivalents.  

In our 2017 paper Three Phases of the PBM Business Model, we argued that the trend of formulary exclusions stemmed from fundamental shift in the PBM business model after 2010.  PBMs shifted from a reliance on gross profits from mail order generics to a renewed reliance on retained rebates, this time from high list priced specialty drugs.

In addition to outright increases in net exclusions (see graph below), PBMs have become more aggressive in making one-for-one switches between two therapeutic equivalents resulting in no net change in the total number of exclusions.


CVS’s upcoming formulary switch of branded diabetes test strips

This paper focuses on CVS’s handling of one upcoming formulary switch effective January 1, 2019. It involves the replacement of LifeScan’s OneTouch branded diabetes glucometer and test strips with Roche’s Accu-Chek branded glucometer and test strips.  It is by no means the only upcoming switch as “leaked” (more on this later) by a PBM contract consultant and on websites of various plan sponsors using CVS as their PBM.

By far,  it is this test strip switch that will affect the most people.   We estimate that this change will affect up to 7.2% of CVS’s 94 Million covered lives,  or 6.8 Million people who have Type I or Type II diabetes, as they require daily blood sugar monitoring.

The switch in coverage for a medical diagnostic device requires patients to invest a lot more time and energy than a switch between therapeutic equivalent pills.  First, users will have to order the new glucometer and have it arrive before being able to use the new test strips. There is not telling how long that will take.

Then users will have to spend time learning how to calibrate and read their new glucometer.  Finally, if users have installed OneTouch software on their PCs with histories of readings, they will have to transfer that data to Accu-Chek software which will be no easy feat.


Why did CVS decide to switch coverage for test strips?

Our search of past formularies confirmed that CVS gave LifeScan’s OneTouch exclusive formulary placement between 2015-2018.  OneTouch likely enjoyed exclusive coverage going back even longer. Our cursory view of the formularies of the other two big PBMs — Express Scripts and OptumRx — indicated that for the past few years the other two PBMs also included OneTouch on their formularies, although not always exclusively. Finally only CVS decided to make a switch in 2019.

Obviously, gross rebates and related net costs to CVS were important factors in making this impactful switch.  Although we are a leading critic of the PBM practice of making formulary choices on the basis of gross rebates rather than net costs after rebates, we give CVS the benefit of the doubt here.  

Give the inconvenience that this switch will cause to users,  we just cannot fathom CVS making this switch based on small differences in net costs. CVS made the switch because Roche’s likely decided that 2019 was the year to go “all in” with rebates.  Note that it looks like Roche’s substantial rebate commitment to win CVS over in 2019 likely left Roche in no position to offer substantial rebates to the other two Big PBMs as they both continue their exclusive coverage for OneTouch in 2019.    

But, quality may have been another significant factor involved in CVS’s decision to switch.  While LifeScan was the pioneer in electrochemical glucometers and test strips, it has lost its lead to the likes of Accu-Chek, Contour, a division of Panasonic Health Products, and FreeStyle Lite, a division of Abbott.   

Evidence to support this comes from results of a Blood Glucose Monitor System Surveillance Program conducted by the respected Diabetes Technology Society. (see below). They found that only 6 out of 18 meters tested passed their 95% accuracy threshold.   Contour and Accu-Chek were at the top. Both LifeScan OneTouch brands failed the accuracy threshold test.

Another factor in CVS’s decision to switch might have been a change in ownership of LifeScan in 2018.  According to Wikipedia entries, after first being put up for sale in 2017,  LifeScan, a division of Johnson & Johnson, was bought finally by the private equity firm Platinum Equity in June 2018.  

The reason why this sale might have been a factor is that large Pharma companies have a developed a strategy of bundling rebates to lock in exclusive formulary placements for an array of their drugs.  The new private equity firm who bought LifeScan in 2018 was in no position to compete with Roche on basis of  bundled rebates.

We wish to reiterate that our problem with CVS is not its choice to replace OneTouch with Accu-Chek.  The switch looks good both from a net cost and well as from a quality standpoint. The problem we have is CVS’s handling of the switch.  


CVS delayed for three months an official announcement of its 2019 formulary removals

Around the first week in August for the past four years, CVS has made an official announcement of its next year’s formulary changes. It posts details of these changes on its own websites.  Plan sponsors using CVS as their PBM follow suit soon thereafter. This practice is similar to that of the other two big PBMs — Express Scripts and OptumRx

But that changed in 2018.

During a 3Q2018 Earning Conference Call on August 8, 2018,  CVS said that formulary change details would be available around October 1, 2018.

However, on October 1, 2018, there was no official announcement.  Instead, CVS posted a .pdf refresh of its 2018 formulary exclusions accessed via the following URL.

Then, on or after November 16, 2018, CVS deceptively posted the long delayed 2019 formulary change details using THE SAME URL previously used to access its October refresh of the 2018 formulary.  In other words, it deceptively replaced a 2018 formulary .pdf with a 2019 formulary .pdf  leaving no trail indicating there was a sequence of postings.

The document number at the bottom of 2019 .pdf was 106-25923A and the date used was 010119 v2. It also had a document date of November 16, 2018


Fortunately we downloaded the 2018 refresh which now can be accessed  from our website

The document number at the bottom of the 2018 refresh pdf was 106-25923A (same as 2019), but the date used was 100118.  

Here is a the timeline indicating that an official October 1st announcement would have come toward the end of CVS’s efforts to gain government approval for earlier announced merger with the insurance company Aetna.  

October 26, 2017     WSJ first reports merger talks between CVS and Aetna

December 3, 2017   Negotiations complete, submit to DOJ for approval

October 1, 2018   CVS scheduled to announce 2019 removals. Instead posts refresh of 2018 removals using the following URL     

October 10, 2018     DOJ approves merger

October 18, 2018     Multi-state coalition of Attorney Generals approves merger

November 16, 2018   CVS posts actual 2019 Formulary Exclusion List using same URL as the 2018 formulary refresh 

November 28, 2018  CVS announces close of merger agreement with Aetna

November 29, 2018  Federal Judge raises prospect of not approving merger

Any bad publicity from an October announcement of the 2019 formulary changes might have derailed the conclusion of the government approval process.  As it turned out, the merger was approved. The absence of an October 1st announcement might have helped.  

In our opinion, CVS’s failure to announce this major change is a case of negligence.   There has been a willful intent on CVS’s part to downplay this switch in order to minimize potential bad publicity during a period where CVS’s merger with the insurance company Aetna was being reviewed.


“Leaks” of CVS’s 2019 Formulary Switches

While CVS delayed posting the official announcement until November 16, 2018, there has been a series of  “leaks” in the form of PBM consultant blog posts and postings of .pdfs on websites of plan sponsors using CVS as their PBM.  Basically, a PBM consultant and plan sponsors “jumped the gun” in these announcements thinking that CVS would made it official by October 1, 2018.

We were first alerted to the test strip switch on September 27, 2018.  Knowing that CVS had promised to announce details by October 1st, our online search that day turned up the following  blog post  by the CEO of the largest pure PBM contract consultant Pharmaceutical Strategy Group (PSG).

“CVS is changing their only covered test strips, One-Touch to Accu-Check where members will need to obtain a new meter and learn any new or different features of the new preferred products.”

Further searches revealed other “leaks” of 2019 details in the form of .pdf files. Below is a listing of some of our findings.  Each file was stamped with CVS’s logos and marked with CVS-generated document numbers and date.


What should have CVS done?

With a few exceptions (see below), the following  footnote at the end of the each .pdf on plan sponsor sites is the only effort to date to inform and guide consumers through this switch.

“An ACCU-CHEK  blood glucose meter may be provided at no charge by the manufacturer for those members currently using a meter other than ACCU-CHEK. For more information on how to obtain a blood glucose meter, call 1-877-418-4746

ACCU-CHEK brand test strips are only preferred options.”

In our search of online websites,  we found only  Carefirst Blue Cross Blue Shield, one of CVS’s largest clients covering 3.2 million in the Mid-Atlantic region and the State Health Benefits Plan (SHBP) of Georgia making a real effort to inform and guide members.

On November 14, 2018 , Caremark published a letter that it would be sending via regular mail to every impacted member. Carefirst even labeled the test strip change as constituting “the majority of the negative disruption”

Below is a screenshot of the full letter Carefirst said it would be sending to each impacted member.

The following is a list of other measures  we have come up with that CVS should have undertaken to smooth the transition.

  • Like Carefirst, urge all client plan sponsors to send a letter via regular mail to all impacted members informing them of switch and instructions for ordering a new meter.
  • Upon request, offer December delivery of new Accu-Chek glucometer and one package of test strips. (done by the SHBP of Georgia)
  • Get retail pharmacies involved early by offering to build up inventory with new Accu-Chek meters and test-strips.
  • Post online videos showing how to use new meters. (done by the SHBP of Georgia)
  • Make sure history of readings stored on members’ PC can be transferred easily between OneTouch software programs to Accu-Chek software programs.


Will CVS handling of this switch hasten the adoption of “frozen formulary” laws?

Currently, there is a smattering of states that have passed legislation limiting how often PBMs can make formulary changes during any plan year and require prior notice before the changes takes effect. Due to the trend toward formulary exclusions, more and more  states are considering adopting their own “frozen formulary” laws.  

These so-called  “frozen formulary” laws generally focus on changes within any given plan year.  We could find no state law dealing with requirements for sufficient notification of  formulary changes for the new plan year. 

For example, the general rule has been for the Big 3 PBMs to announce new plan year formulary changes around the first week in August, a full 5 months before the new plan year.  CVS’s official announcement delay to November 16th occurred only 35 days before the beginning of the new plan year.  

As late as this was, it looks like CVS’s November official notification did not violate any existing state laws.  

Still, if CVS’s switch in diabetes test strip coverage causes as much disruption and negative publicity as we anticipate,  we could envision that this event becoming the spark for a whole slew of “frozen formulary” laws requiring a minimum of 3 months or 90 days prior notification of new plan year formulary changes, including individual letters mailed out to impacted consumers.  

The Problem with CVS’s “Guaranteed Net Cost” PBM Business Model


Consider this meta:  CVS opaquely is substituting one opaque source of gross profits — guaranteed net cost markup — for another opaque source — retained rebates.

The pharmacy benefit manager (PBM) CVS Caremark has offered its self-insured corporate clients an alternative business model called “Guaranteed Net Cost”.  The pricing scheme features 100% pass-through of drug rebates and the end of rebate retention as an opaque source of PBM gross profits.

But, CVS has glossed over the fact that their “guaranteed net cost” price to plans is not the same as the net costs to them.  Until CVS tells us otherwise, the new business model allows for a opaque markup on top of PBM net cost. In graphs below, we demonstrate how a markup of guaranteed net costs serves as an opaque offset to foregone rebate retention.  

It is naive to think that CVS Caremark is about to give back a significant source of its annual gross profits without some sort of offset. In fact, CVS admits as much as their spokesperson is quoted as saying

CVS’ manager of corporate communications, Christina Beckerman, told Fierce Healthcare that the company does not expect CVS Health’s profitability to increase or decrease as a result of the shift to 100 percent pass-through rebates.

It is not even clear that CVS’s new business model lessens the incentives to Pharma to inflate list prices in order to compete on rebates for formulary placement.

The Problem With the Current PBM Business Model

The current PBM reseller business model features five major streams of revenue and gross profits.  Four of the five are opaque.

  1. Opaque rebate retention % on speciality (biotech) drugs in return for preferred or exclusive placement on formularies;
  2. Opaque rebate retention % on small molecule brand drugs in return for preferred or exclusive status on formularies;
  3. Opaque profit margins on 90-day generic Rx filled by captive mail order operations of the PBM;
  4. Opaque “spread margins” added by the PBM on top of reimbursements to retail pharmacies included in their networks;
  5. Transparent claims processing and data fees.

The opacity of drug rebates is magnified by the fact that reimbursements for brand drug Rx and related rebates come at different times.   It is impossible for plans match up these two streams and calculate a single net price its pays per drug.

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 two other transparent business models used by managed care companies:  

  1. a PMPY fee-for-service agency model where 100% of all reimbursements and rebates are passed through to plans.
  2. a risk-based insurance model with capitated premiums paid by plans.

Until the PBM Medco’s merger with Express Scripts in 2012, Medco’s financial 10-Q and 10-K reports to the SEC broke out gross rebates received — a credit to cost of sale — and rebates retained — a credit to sales.  We were able to calculate with certainty Medco’s “rebate retention rate”, a name we coined fifteen year ago in 2003.

We calculated that Medco’s rebate retention rate — the percentage of gross rebates retained — fell from 55% in 1Q03 to 28% in 2Q05.  This rapid decline was due to the sudden awareness by clients of the whole rebate retention scheme. To offset this loss, Medco began to push clients toward its captive mail order and fat margins it began to earn on mail order generic Rx fills.

The share of Medco’s overall gross profits coming from retained rebates reflected  outrageous 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.

In our 2017 paper “Three Phases of the PBM Business Model”, we carried forward our mid-2000s work on disaggregating PBM gross profits by sources.  Below is a summary of that work.

Here is a graph of the above data:

CVS’s Guaranteed Net Cost Business Model

On December 5, 2018,  CVS Caremark introduced a new pharmacy benefit manager (PBM) business model option for self-insured corporate drug benefit plans.   

The core of this new business model is a simplified reimbursement price paid by plans to CVS that the company craftily describes as “Guaranteed Net Cost”.  Craftily, in that this so-called “cost” is really a “price” where the difference between “cost” and “price” is a markup.

The company touts the following distinguishing features of this simplified reimbursement price.

  • Drug cost predictability and simplicity
  • 100% of rebates are passed through to plan sponsors
  • Simpler payments flow — no retrospective rebates or inflation adjustments
  • Simpler way to compare different PBM contract proposals

Note this new pricing model is for brand drugs only dispensed at retail, mail order and specialty pharmacies.  The generic Rx drug reimbursement pricing scheme remains the same. That is to say, it preserves an opaque “spread margins” that PBMs like CVS add on top of CVS reimbursements to retail pharmacies for generic Rx drug fills.

This new CVS’s initiative clearly is in response to the tsunami of criticism by plan sponsors over an opaque PBM business model and the difficulty in matching initial Rx reimbursements at an inflated list prices with retrospective rebates occurring months later.

The Problem with CVS’s Guaranteed Net Cost Business Model

One: Opaque Markups

The problem with CVS’s new business model is that guaranteed net cost to plans is not necessarily the same as the net cost to PBMs. CVS never states unequivocally that its guaranteed net cost to plans = net cost to CVS.  In other words, CVS’s new business model allows for an opaque markup on top of its net cost.

Consider this meta:  CVS opaquely is substituting one opaque source of gross profits — guaranteed net cost markup — for another opaque source — retained rebates.

It is naive to think that CVS is about to give back some of its oligopolistic profits.  In fact, CVS admits as much as their spokesperson is quoted as saying

“ CVS’ manager of corporate communications, Christina Beckerman, told Fierce Healthcare that the company does not expect CVS Health’s profitability to increase or decrease as a result of the shift to 100 percent pass-through rebates”

The following is a numeral example of how the opaque markup can serve as a 1-for-1 substitute for retained rebates:

Here is a graphical depiction of our view that CVS is substituting an opaque markup for an opaque rebate retention:


To CVS’s credit, its new guaranteed net cost eliminates timing complexity. It does this by taking a risk and netting the current period Rx reimbursement with an estimated “expected” rebate rather than wait to credit plans with the actual rebate when it is paid by Pharma months later.  

CVS certainly is justified in including some markup as compensation for taking the risk that their estimated expected rebates turn out to be less than actual rebates.

Instead, CVS decided not mention markup at all,  let alone a justified markup as a compensation for assuming timing risk.

TWO: Doubtful Elimination of Incentive to Play the High List – High Rebate Game

Under the current retained rebate business model,  PBMs are incentivized to favor drugs with the highest gross rebates to the exclusion of therapeutically equivalent drugs with the lowest net cost.  To be in a position to win this rebate game, Pharma is driven by the PBM-created rebate game to inflate list prices for its brand drugs.  See our paper: Blame PBMs (Not Pharma) for Drive Drug Price Inflation.

The list price – net price bubble began around 2010 and reached its peak in 2017. It was in 2017 that AbbVie first broke the PBM rebate game  winning formulary placement by Express Scripts despite pricing its late entrant Hepatitis C Virus (HCV) drug Mavyret with an ultra low list price with no rebate potential.  However, this was an exception and the norm remains that the basis for formulary placement is gross rebates over net price (list price – gross rebates).

Below is a graphical depiction of how AbbVie broke the rebate game with its ultra low list = no rebate drug HCV drug Mavyret.

It is possible that the rebate game of high list – high gross rebate may be lessened under CVS’s new guaranteed net cost new business model. This is because the basis for PBM profits — markups — could be any number as opposed to being tethered to something like % of gross rebates or % of net cost.

Below is a depiction of CVS’s flexibility in choosing a markup that is independent of the list price or gross rebate. 

On the other hand, we can see the possibility that the new business model preserves the status quo. Here is our line of reasoning for this:

it is likely that brand drug list prices, which are publically available,  will serve as an upward bound for guaranteed net cost as it would look bad for CVS to set a guaranteed net cost that exceeded a drug’s list price.

To look good, CVS will want to show that guaranteed net costs is consistently 40% to 70% below the brand list prices.  

To achieve these percentages while still having room for oligopolistic markups, CVS will signal to Pharma that, while formulary placement is no longer based on gross rebates, high list – high rebate drugs afford CVS latitude in setting guaranteed net cost markups.

Below is a graphical depiction of why, under the new business model, CVS still would be incentivized to favor the high list – high rebate drug.


Will PBMs Behave Differently? CVS – Aetna Merger, Express Scripts – Cigna Merger

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 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

The Formulary Game (07/03)

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


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:


Insulin Drug Price Inflation: Racketeering or Perverse Competition?




We contend that recent insulin drug price inflation is a case of perverse competition rather than a case of illegal racketeering in violation of the RICO Act.  

We will present the case that a now consolidated racketeering RICO lawsuit initiated by the law firm Hagens Berman has inverted the hierarchy of the Pharma – PBM enterprise.  The lawsuit claims that the bidders — Pharma — “spearheaded” rebate negotiations and that pharmacy benefit managers (PBMs) as rebate-collecting gatekeepers are the followers.  This makes no sense and is grounds for a dismissal of the lawsuit.

We concede that there was coordinated list pricing, but these were opening moves in a two-step bidding process driven by a perverse PBM business model rather than initiated by Pharma. We will present charts of formulary choices made by PBMs that are so varied that they could not be the result of collusion.  

Rather the varied formulary choices in this case had to be the result of vigorous competition among insulin drug companies vying to be the highest gross rebate bidder that culminated in rational economic decisions by PBMs to award formulary exclusivity to the lowest net price bidder.  In other words, there are no antitrust issues in this case.


Racketeers as Gatekeepers to Markets With Reduced Competition

Racketeering is organized crime.  It involves hierarchical groups of individuals working cooperatively under the direction of leaders. The organization can run the gamut from a traditional  business like a trade show logistics company to a tight knit “association-in-fact” enterprise like a mafia crew.

The Racketeer Influenced and Corrupt Organizations Act  (RICO) was passed by Congress in the 1970 to deal with organized crime.  For example, the Sopranos of HBO fame operated an ongoing “association-in-fact” enterprise involving rigged bids for suburban New Jersey garbage collection contracts.  The RICO Act is ideally suited to deal with the Sopranos bid-rigging enterprise.

The Soprano scheme can be viewed as being in a class of rackets involving collecting “tariffs” in return either for opening up markets blocked by government or for providing entrance to legitimate markets with the understanding that further competition would be limited.

Prohibition era bootlegging is the classic racket involving opening up markets blocked by government regulations.  Garbage collection bid rigging is the classic racket of illegally limiting entrance to normally competitive markets.

Money laundering, loan sharking, convention center service contracts, building permits issued without inspections, drug smuggling, sports betting, arms dealing, and human trafficking are other examples of rackets involving payment for access to markets with reduced competition.

Potential entrants are willing to make substantial payments in these cases because they are cuts from super-competitive profits that normally would flow to consumers in the form of lower prices.

Potential bidders in racketeering schemes face a “prisoner’s dilemma”. On the one hand,  it is in the best interest of all potential entrants to wait their turn and cooperate.  On the other hand,  the best strategy for any individual bidder is go it alone, defect and enter the market secretly without paying any tariff.  

The ‘prisoner’s dilemma” is the reason why successful rackets often require threat of harm  — horizontal restraints in antitrust parlance —  to insure cooperation. For example, Tony Soprano regularly would dispatch his nephew Christopher Moltisanti to coach sanitation companies on upcoming municipal garbage collection contracts up for bid, and remind them of what would happen to their kneecaps if they failed to cooperate.

RICO enterprises that do not use physical force to insure cooperation look to other mechanisms to foster cooperation among bidders.  In cases of price-fixing, short-term retaliation via sharp undercutting of a defector’s price is used to remind the defector of the costs of competition.  

Also, bidders are more likely to cooperate long term if the racketeering gatekeeper exhibits a sense of “fairness” by distributing the rigged bid opportunities evenly across bidders.


Racketeering Lawsuits

On November 3, 2016, Senators Bernie Sanders (I-Vt)  and Elijah Cummins (D-Md), asked the Department of Justice and the Federal Trade Commission to investigate insulin drug manufacturers for possible anti-competitive practices in setting list prices, noting that “the potential coordination by these drug makers may not simply be a case of ‘shadow pricing,’ but may indicate possible collusion.”

Over the course of 2017, there have been a number of class action lawsuits and state Attorney General Civil Investigative Demand (CID) letters filed against three makers of insulin — Sanofi, Eli Lilly, and Novo Nordisk — on behalf of patients incurring high out-of-pocket costs for needed insulin drugs. The lawsuits alleged a pattern of racketeering — repeated, organized criminal acts involving secret agreements to inflate drug prices to the benefit of drug companies.

These lawsuits all alleged that the three drug companies “spearheaded” the insulin list price inflation and that insulin list price inflation was the “proximate cause” of damages suffered by patients who could not afford to continue treating their diabetes with insulin made by these companies.

The original racketeering lawsuit was filed by the law firms of Hagens, Berman, Sobol, & Shapiro (hereafter Hagens Berman)  and Carella, Byrne, Cecchi, Olstein, Brody & Agnello, P.C. on January 30, 2017, amended on March 17, 2017 and again on December 27, 2017.  Hagens Berman has been consistent in naming the three insulin drug companies — Sanofi, Eli Lilly, and Novo Nordisk — as “spearheading” the racket and as co-defendants.

Hagens Berman characterized pharmacy benefit manager (PBMs)  as “knowing and willing participants” in the racketeering enterprise who helped “perpetuate” the fraud (¶ 300) and “reaped profits” ( ¶ 300) from the racket,  But Hagens Berman has stopped short of naming PBMs as co-defendants. In a June 2017 interview with Bloomberg, Partner Steve W. Berman offered this lame explanation of why his law firms decided to name only drug companies as defendants:

In September, 2017,  U.S. District Judge Brian R. Martinotti of the U.S. District Court for the District of New Jersey consolidated all RICO lawsuits and named Steve W. Berman of Hagens Berman and James E. Cecchi of Carella Byrne as interim lead counsel.

There are two other RICO lawsuits by Weitz & Lutzenberg and by Keller Rohrback LLP  consolidated into the Hagen Berman lawsuit by the U.S. District Judge Martinotti.  These other lawsuits have named the three largest PBMs — Express Scripts, CVS Health, and OptumRx — as co-defendants. But, even these lawsuits characterize the drug companies as the masterminds of the collusion.

In consolidating these lawsuits, the New Jersey District Court has said that

“ the issue of joinder and/or severance of the three pharmacy benefit managers, will be addressed at a later date.”


Formulary Rebate Negotiations Between Pharma and PBMs

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 Health,  and Optum Rx, (known as “The Big 3”) control 73% of the total Rx claims processed the United State in 2015.

We have estimated that a majority of PBM gross profits today come from retained rebates from specialty and injectable biologic drugs — infused autoimmune drugs like Humira and Enbrel and self-injectable insulin drugs like Lantus discussed below.  

These rebates are paid by drug companies in return for placement in a formulary — a table of preferred drugs covered by insurance.   The formulary is a lookup table that PBMs inserted into their retail drug store point of sale 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 PBMs as “gatekeepers” to markets with reduced competition, rebates as “tariffs” willingly paid by Pharma in return for formulary access, and formularies a set of markets with a varying degree of competitiveness (competitive, monopolistic, oligopolistic) among drugs that are “therapeutic equivalents”.

On the sell-side are brand drug companies with therapeutic equivalent drugs vying for placement in therapeutic class “markets”.  On the buy-side are the Big 3 PBMs deciding which drugs among therapeutic equivalents should be listed in the formulary and covered by insurance.

Economists call such markets bilateral oligopolies.  We have written a number of papers about the Pharma – PBM bilateral oligopoly available for download free on our website.

In sum, rebates are tariffs paid by drug companies to PBMs for limiting access to oligopolistic therapeutic classes in formularies.  That broad description — tariffs paid for access to markets with reduced competition — is the same as the Soprano bid-rigging scheme and the same as a whole class of illegal rackets.  RICO lawsuits in this case have to prove an ongoing pattern of overt collusion and conspiracy involving secret plans with the intent to do something unlawful or harmful.


The Cause of The Recent  Drug List Price Inflation

We have written a number of papers presenting the case that it has been PBMs, not Pharma, that has driven the recent drug list price inflation.

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.

To compensate for declining mail order generic margins after 2010, 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 and biologic drug rebates.  The first is that basis for gross rebate percentages — specialty and biologic drug — represents only 20% of the Rx volume of the “rebatable” small molecule drugs available to PBMs a decade earlier.  

The second constraint that there is an awareness by plans and the public today that opaque retained rebate are a dominant source of gross profits.    Today,  articles critical of PBMs in general, and retained rebates specifically,  seem to be at least ten times 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 and biologic Rx while maintaining a transparent “reasonable” rebate retention rate at 10% on average?  

How have the Big 3 PBMs accomplished this?  Pharma knows that PBMs are desperate to make formulary choices in oligopolistic therapeutic classes on the basis of gross rebates received first and net prices second.

 Pharma knows that it will disqualify itself from a chance to be winning bidder for placement in a formulary if their first move in rebate negotiations is a low list price without any room for further rebate offers.

In sum,  it is the perverse PBM business model that drives tacit cooperation among Pharma to increase list prices in lock-step. Since 2010, PBMs required ever increasing retained rebates to offset continuing losses in mail order generic margins.  The timing of the need to offset one source of gross profits with another fits the acceleration in drug list price inflation between 2010 and 2014 with a tailing off since then (see chart below).

Source: Motley Fool , April 2017


Lock-Step Insulin Drug List Pricing

There is little question that there has been some sort of coordination among the insulin drug companies in setting list prices — formally known as wholesale acquisition costs (WAC) over the last decade.

We think the coordination is not overt, but a “follow-the-leader” understanding developed independently over the years. Pharma understands that a move to list price significantly below a competitor only reduces their ability to compete on gross rebates in the second round of this two-step bargaining process.   Here is a quote from Novo Nordisk’s CEO admitting that they follow closely any list price change of their competitors.

Below are charts of lock-step increases in insulin drug prices presented by the law firm Hagens Berman in their RICO lawsuit.   These charts are clearly the most damaging evidence of in support of the allegations of collusion.


Source: Business Insider, September 2016

But, we believe that the insulin list price inflation is NOT an offensive move to increase gross profits, but defensive opening moves in a competitive two-step rebate negotiating game “spearheaded” by PBMs.

Negotiable prices are a hallmark of bargaining situations involving a few sellers and a few buyers.  Baseball player salary arbitration starts with each party offering prices far apart from what both parties ultimately agree to.

The real estate website Zillow presents extensive historical data showing that the norm in residential home sales is a high opening list price followed by periodic price reductions until a sale is made.

In healthcare, it is a standard practice for providers vying for preferred provider status to start negotiations with high list prices and then offer varying degrees of discounts in return for the higher volume that comes with being named a preferred provider.   

What is going on between insulin drug manufacturers and PBMs is no different.  High list prices are just the standard opening round in a negotiation process among companies vying for preferred status on formularies for their “therapeutic equivalent” drugs.  

The practice of lock-step drug list price inflation is not unique to insulin drug makers.  Below is a chart of lock-step list prices between two manufacturers of top selling autoimmune drugs — AbbVie’s Humira and Amgen’s Enbrel.  Both drugs require regular infusions at clinics and hospitals.  These drugs are covered by a medical benefit managed by insurance companies  rather than a drug benefit plan managed by PBMs.  

It is interesting to note that the lock-step drug price inflation pattern  exists even though the “gatekeepers” in this case are insurance companies.   Unlike PBMs, insurance companies have rational business models — 100% pass through or capitated insurance premiums — where the only consideration is net price regardless of gross rebates received.

The lock-step list pricing for autoimmune drug managed by insurance companies is another piece of evidence that cast doubt on the claim that insulin drug price inflation is a case of organized crime rather than a standard open move in all negotiations for preferred provider status between healthcare providers and healthcare benefit managers.

Source: Washington Post, November 2016


The Motivation for Insulin List Price Drug Inflation

The Hagens Berman RICO lawsuit argued that insulin drug inflation was driven by drug companies motivated to increase profits.  But, there is plenty of evidence that insulin drug companies received relatively small cumulative increases in net prices after a decade of substantial list price inflation.  

Here are two charts provided by Novo Nordisk to show that their net price after rebates for their Novolog insulin vial has increased only a cumulative 36% over the last decade even though their list price have risen a cumulative 363%.

Here are two other charts of gross to net price increases from a June 2016 Bloomberg article based on data assembled by SSR Health, an investment research company.  The first is Eli Lilly’s Humalog indicating cumulative list price inflation of 138% over a six year period from 4Q09 to 4Q15, but only a cumulative net price inflation of 6%

Here is another chart of Sanofi’s Lantus showing a cumulative list price inflation of 189%, but a net price inflation of only 42% over a 5 year period.

Finally, here are a couple of quotes from an October 2016 Biopharma Dive article on fierce price competition among insulin manufacturers:

“Long-acting insulins have become a commodity,” said David Kliff, who publishes the industry newsletter Diabetic Investor, in an interview with BioPharma Dive. “In today’s environment, payers have the upper hand when it comes to making deals.”

That advantage is translating into pressure on insulin pricing, which all three drugmakers have begun to feel.

Novo has said average net prices for its diabetes drugs, particularly in the basal segment, are expected to be low- to mid-single digit percentages lower next year compared to 2016”.

Eli Lilly, which recently committed to averaging 5% revenue growth through 2020, has also baked in intensified pricing pressures in the U.S. to its forecasts. Lilly CFO Derica Rice, speaking on recent earnings call, pointed to increased rebating and discounting for diabetes products as a byproduct of stepped-up competition.

And Sanofi gave guidance last October forecasting its global diabetes sales will decline by an average annualized rate of between 4% and 8% through 2018.”

These quotes run counter to the RICO lawsuit claim that insulin list price inflation has been driven by Pharma and has resulted in substantial increases in profits.  Rather, we have argued earlier that the high list price / high gross rebate scheme has been driven by PBMs with a business model under stress needing more and more retained rebates to offset continuing losses in mail order generic margins since 2010.


Charges of Violation of Antitrust Laws

Besides allegation of  violations of the RICO Act, two RICO lawsuits by Weitz & Lutzenberg (Count ONE and TWO, pages 54-57) and by Keller Rohrback LLP ( Count 7, page 175), but not the final consolidated lawsuit of Hagen Berman,  include counts of violation Sections 1 and 3 of Sherman Antitrust Act.

We believe these antitrust allegations are frivolous and should be summarily dismissed.

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.  

However, in the case of PBMs you have to take out Bork’s “presumptive” qualifier because the PBM business model is not rational in the traditional economics sense.  

While PBMs are resellers of brand drugs, their gross profits on brand Rx are derived only from a retained rebate percentages. 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.  

But, because insulin drug list prices are in lock-step, the insulin drugs with the greatest gross rebate offer are also the drugs with the lowest net price.  This means that PBM formulary choices with regard the insulin drugs are aligned with client’s interests. There is not an antitrust issue associated with recent insulin drug price inflation.

Below is a spreadsheet of the 2016 list prices (WAC)  of long-lasting insulin drugs at the time of the introduction of the Lilly’s Basaglar, a follow-on biologic to Sanofi’s best selling drug Lantus.  Lilly chose to “play to game”, not challenge the PBM business model, and takes its chances competing on the basis of gross rebates.


The result was that Lilly and Basaglar was excluded by Express Scripts and OptumRx, but included by CVS Health.   Per Chicago School theory, all of these choices are pro-competitive as  it would be irrational for any PBM to exclude the lowest cost supplier.

Had Lilly started out with a list price for Basaglar at least 70%-80% lower than the list price of the incumbent Lantus, they might have been in a position to show that they were the lowest cost supplier in the long-acting insulin therapeutic class and merit inclusion in all 3 PBM formularies. Furthermore, they would have been in a position to expose any of the PBMs’ misaligned business models should one of them exclude Basaglar.

We have written a paper recently which compares AbbVie’s aggressive list pricing of its new-to-market Hepatitis C Virus (HCV) drug Mavyret versus the incumbent biologic drug Harvoni.

Mavyret’s exclusion by CVS Health created a real possibility of an anti-competitive and antitrust case of exclusive dealing  despite Mavyret being the lowest cost drug available in the HCV therapeutic class.  We discussed this case in more detail in another recent paper titled Was CVS’s Formulary Exclusion of Mavyret a Violation of Antitrust Laws?


Inversion of the Pharma – PBM Enterprise

The  consolidated RICO lawsuit filed by Hagens Berman has inverted the hierarchy of the Pharma – PBM rebate negotiations relationship.  This lawsuit claimed that the bidders — Pharma — “spearheaded” the rebate negotiations and that the rebate-collecting gatekeepers — PBMs — are the followers.

Here are quotes from he consolidated RICO lawsuit on how it views the hierarchy in the Pharma – PBM Enterprise:


The Levemir / Novolog Pricing Enterprise





The Humalog Pricing Enterprise


The Lantus / Apidra Pricing Enterprise

This makes no sense.  Hagens Berman’s steadfast insistence that Novo Nordisk, Eli Lilly, and Sanofi “spearheaded” the racket is inexplicable. Generally, in cases of bidders vying for access to markets with reduced competition, it is the tariff-collecting gatekeepers that “spearhead” the scheme and the bidders are the followers.

Below is our diagrams of the Hagen Berman inverted view versus the correct view of the Pharma – PBM enterprise.  To highlight the nonsense of the Hagens Berman view, we compare it with two views of the Sopranos bid-rigging racket enabled by use of force to insure cooperation among bidders.



Formulary Choices as Evidence of Competition

In all likelihood,  there was a preliminary competitive round in the Soprano bid-rigging racket where Tony Soprano solicited bids from the suburban municipal garbage collection companies for the rights to be the rigged “winning” bid on any given garbage collection contract.

In order to make the actual bidding process seem legitimate, Tony probably told other companies to participate in the actual bidding, but make their bids higher than the favored company.  Obviously, the Soprano bid-rigging racket took lots of cooperation to pull it off even with threats of physical violence for defection.

Bid-rigging without threats of violence for defectors is problematic.  The RICO lawsuits essentially claim that insulin drug pricing was a bid-rigging racket. Not only did the bids have to be coordinated,  but according to the lawsuit, the bid-rigging was coordinated by the bidders and not the PBM gatekeepers.  A racket with this inverted hierarchy of command would be extremely hard to pull off.

We acknowledge that the lock-step list-price inflation was the result of a common understanding among insulin manufacturer that the perverted PBM business model favored  bidders with the highest gross rebates over bidders with the lowest net price after rebates.

But, what kind of mechanism did Pharma and PBMs use to rig the rebate offers? Unless RICO lawyers can present evidence of some sort of mechanism to enforce cooperation among insulin drug companies, the resulting pattern of formulary choices is more than likely the result of a competitive bidding process.

Below is a series of spreadsheets which show no favoritism among insulin drug companies.  This evidence tends to refute the claim that there is collusion between any given PBM and the three insulin drug companies vying for preferred formulary placement.

The following formulary choices below shows Novo Nordisk winning the the rights from Express Scripts for exclusivity for one of its drugs Levemir but losing the rights from Express Scripts for exclusivity for its other drugs Novolog.  

Was this achieved via just horizontal collusion among drug companies without any knowledge of the horizontal collusion by Express Scripts?   Or, more likely was this a case of an all-around horizontal and vertical collusion among both bidders and PBMs?  

If so, the highly varied outcome depicted above would have required a ton of coordination with potential for a lot of bickering among bidders as to its fairness.    And the outcome depicted above is just one of three bidding outcomes between drug company bidders and PBM gatekeepers.  

 The charts presented above and below depict formulary choices made by PBMs that are so varied that they could not have been the results of collusion.  

Rather the varied formulary choices in this case had to be the result of vigorous competition among insulin drug companies vying to be the highest gross rebate bidder and ending in a rational decisions by PBMs to award formulary exclusivity to the lowest net price bidder.



Below is an alternative spreadsheet of PBM formulary choice that in our opinion indicates no overriding  cooperation between drug companies and PBMs.  It is indicative of a pro-competitive rebate negotiation process in which the low net cost supplier wins exclusivity on the PBM formulary of drugs covered by insurance.

IFC Health ™ – “An Independent Formulary Company”


Misaligned Big 3 PBM (Express Scripts, CVS Caremark, OptumRx) business model dependent on retained rebates resulting in PBM national formularies that are far from cost-effective. (see founder’s 15-year analysis of PBM misalignment at )  

Value Proposition:

Misaligned national formularies of the Big 3 PBMs which are uncritically adopted by plan sponsors

Deliver 10%-plus incremental drug trend dollar reduction via changes to client’s PBM-generated formulary in four targeted therapeutic classes and via exclusion of scores of individual high-priced orphan drugs and off-patent brand drugs.

Total PMPY Rx Spend — $1,100 (source Express Scripts Trend Report 2016)

Our Target 20% trend reduction – $220 PMPY (per member per year)

How to Achieve Target: work with clients to increase formulary exclusions of misaligned Big 3 PBMs national formularies from 154 to 254 without loss in efficacy.


Initial Product-Market Fit:

Product Fit: Redesign four therapeutic classes having a combination of high cost and high misalignment plus other special situations

  • Diabetes
  • Oncology
  • Autoimmune
  • Multiple Sclerosis
  • Hard look at included orphan drugs, moving scores from included to excluded with override procedures
  • Hard look at whole cost-effectiveness of indications-based formularies
  • Exclude remaining small molecule off-patent brands with generic substitutes


CVS Chart — 2018  Without Formulary Exclusion – $1,300 PMPY  — With Exclusion – $1,067

CVS achieved 19%  PMPY drug benefit costs with basic formulary exclusion

IFC Value Proposition — achieve another 20% PMPY reduction by excluding an addition 100 drugs. 






Market Fit: Drug benefit plans of large self-insured entities — Fortune 1000 companies — 20,000 employees

  • Big payers “mad as hell”  with current PBMs but understand “you can’t throw out the baby with the bathwater”
  • looking to carve-out “brains” of benefits management while retaining the incumbents to manage the “plumbing” (what likely drives BezosCare)



Source: Venrock 2018 Survey of Healthcare CEOs



A Virtual P&T Committee of World Class MDs and PhDs:

  • In essence, company is an independent consulting company that is allowed legally in PBM contracts to make modifications to PBM national formularies designed initially for efficacy by PBM P&T (Pharmacy and Therapeutics) Committee but later misaligned by a “Value Assessment Committee” driven by rebate considerations
  • Link to Express Scripts White Paper acknowledging right of client to customize:
    • “Express Scripts’ plan sponsors often adopt Express Scripts-developed formularies as their own or use them as the foundation for their own custom formularies”. (p.4)
  • World class MDs and PhDs with signed affidavits as to no conflicts of interests
  • Company connected with collaborative tools including licenced AI for search and decision-making
  • Outcomes based pay — fractional ownership points for all MDs and PhDs on P&T Committee


Investment and Valuation Considerations:

  • Positive — need only one angel or seed round, profitable in Year 2, with possible exit in Year 3 at 10x ROI to investors
  • Negative — subject to “efficient market hypothesis” — exploiting an inefficient market leads to elimination of inefficiency  
  • Negative — Copyable IP
  • Positive —  early success with Fortune 500 companies at trend management through formulary modification can lead to other opportunities to spearhead innovation  — outcomes-based pricing, patient adherence micropayments, etc.



Established PBM Consultants — opaque business models with brokerage fees paid by Big 3 PBMs

  • Pharmaceutical Strategies Group (PSG)
  • Milliman
  • Burchfield Group

Established Employee Benefits Consultants — too big –no real Rx formulary focus which is “sweet spot” for cost reduction

  • Willis Towers Watson
  • Aon Hewitt
  • PwC
  • Mercer

New Generation of VC funded Startups —No real Rx formulary focus which is “sweet spot” for cost reduction

  • SmithRx — $9 Million total with Series A lead Founders Fund
  • Truvesis — $64 Million total with Series D lead by McKesson Ventures
  • RxAdvance  — funding by John Scully and Centene 


Company Business Model:

Value Proposition in Numbers:

  • Total PMPY Rx Spend — $1,100 (source Express Scripts Trend Report 2016)
  • Our Target 20% trend reduction – $220
  • How to Achieve Target: work with clients to increase formulary exclusion list of misaligned Big 3 PBMs from 154 to 254 without loss in efficacy.

Business Model Revenue:

$20 PMPY

Revenue Projection:

Total revenue per company with 10,000 members = $ 200,000

Total revenue for company with 100,000 members = $2,000,000

  • FYE First Year           1 client — $200,000
  • FYE Second year      3 clients —  $600,000  
  • FYE Third year         8 clients — $3,400,000 including 1 big co.

Valuation Projections:

Valuation — low end of SaaS –  4 times ARR

  • Year 1  —     $800,000
  • Year 2 —    $2,400,000
  • Year 3 —   $13,400,000 –cash flow positive




I have a B.A. in Economics from Amherst College and a Ph.D. in Economics from Washington University in St. Louis.  I was born and raised in St. Louis, Missouri.  I now live in North Monterey County, California.

My writings are at the intersection of economics, accounting,  financial analysis, and high tech.  I like to write about companies and industries that few follow.  This includes 15 years writing about the PBM business model, explaining drug price inflation using economic theory, antitrust of exclusive dealing formulary contracts, and the $10 Billion unicorn Machine Zone (MZ).

At the bottom of each piece I write, I will disclose any position in stock mentioned.  I will also disclose any remuneration from companies mentioned.


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The Winner of Biosimilars vs Incumbents in 2017: Competition


While 2017 has been bad for biosimilar entrants, it has been good for competition as prices for incumbent drugs such as Remicade have dropped significantly for the first time.  Rather than argue for more legal and legislative protection for biosimilars, we argue for a rethinking of competitive strategy on the part of the entrants.

One of the most profound quotes in antitrust law can be found in a 1962  Supreme Court opinion by Chief Justice Earl Warren regarding Brown Shoe Co. v. United States, 370 U. S. 320.  He argued that the U.S. Congress enacted antitrust laws “for the protection of competition, not competitors.”

This idea will being tested to the maximum in the coming years as new biosimilar entrants will have a tough time gaining insurance coverage because of exclusive dealing formulary contracts between incumbents and pharmacy benefit managers (PBMs) and insurance companies.

If manufacturers of biosimilars choose to litigate, we believe that the courts will dismiss antitrust lawsuits summarily based on the now widely accepted Chicago School theories that vertical restraints such exclusive dealing formulary contracts are presumptively pro-competitive. 

This is because it would not be rational for a buyer to exclude the lowest cost supplier.   See our recent paper Biosimilars and Exclusive Dealing Antitrust Law: The Case of Pfizer, Inc v Johnson & Johnson et. al.


Price Competition Between Biosimilars and Incumbents

The potential of biosimilars to compete on price has been greatly enhanced by Federal legislation passed as part of the Affordable Care Act of 2010.  This legislation greatly abbreviated the FDA approval process for biosimilars by allowing entrants to use test results supplied to the FDA by incumbents.

 The accelerated approval process has reduced biosimilar R&D costs by more than 90% from an estimated $2.6 Billion for a new drug to an estimated $100 – $200 Million to develop a biosimilar.

Prior to 2017, most of the attention has focused on the competitive potential of biosimilars. Not much attention had been paid to the potential of incumbents to respond with aggressive price cutting of their own.    Also,  until this year, not much attention had been paid to the potential of insurance companies and pharmacy benefit managers (PBMs) to drive price competition through exclusive dealing formulary contracts.   

This is surprising because there there has been considerable evidence  that PBMs have been driving price competition among small molecule brand drugs via exclusive dealing formulary rebate contracts since 2012.  


Biosimilars Inflectra® and Renflexis® vs the Incumbent Remicade®

Johnson & Johnson’s (J&J) incumbent biologic drug Remicade was approved by the FDA for use in August 1998.  It was the first autoimmune drug to be approved in three different therapeutic classes and is used to treat patients with autoimmune diseases including rheumatoid arthritis, psoriatic arthritis, Crohn’s disease, plaque psoriasis, and ulcerative colitis.

In 2016, Remicade was the 5th highest selling drug in the United States with estimated sales of $5.3 Billion.  Remicade was J&J’s top selling drug, representing 20% of its total global drug sales.     

In November 2016,  Pfizer introduced Inflectra as the first biosimilar to Remicade. It was followed by the introduction of a second biosimilar called Renflexis in June 2017  by Merck and Samsung Bioepis.

At the time of its introduction,  Pfizer list priced Inflectra only 15% below the incumbent, but increased the discount to 35% seven months later to match the list price of the second biosimilar entrant Renflexis.

On September 20, 2017, Pfizer filed a lawsuit Pfizer Inc, v Johnson & Johnson et al (link to the full court filing)  claiming that Johnson & Johnson (J&J) violated Section 2 of the Sherman Antitrust Act by monopolizing the market for its incumbent biologic drug Remicade.   This was achieved via rebate contracts with the largest insurance companies in the USA that had the effect of excluding from coverage Pfizer’s biosimilar drug Inflectra.

Pfizer argued that its rebate offers would have make Inflectra the lower cost drug on a “unit-for-unit” basis.  But, in our paper dealing with this lawsuit,  we presented a spreadsheet (see below)  comparing Pfizer’s unit rebate offer with an estimate of J&J lump-sum rebate offer estimated at 28% off Remicade’s list price contingent on exclusive coverage.  

We concluded that Remicade was still the low cost choice on a total dollar basis and that exclusive dealing contracts between J&J and insurance companies were pro-competitive and not in violation of antitrust laws.  

In September 2017, J&J’s CFO Dominic Caruso told Wall Street analysts  that Remicade sales had dropped only 5% year-over-year.   He attributed J&J’s success to doing a  “pretty good job of contracting for Remicade well in advance of the biosimilar entry from Pfizer.” He also attributed J&J’s success to natural barriers to biosimilar adoption in general.

With the 5% figure doesn’t seem like much, it is masking a larger YoY drop in the net price of Remicade due to the biosimilar entry.  Below is a chart of quarterly US sales for Remicade for a full two years from 3Q15 through 3Q17.   Note the drop in sales dollars beginning in 4Q16 when the biosimilar was first introduced.  A simple projection of sales from 2015 before the biosimilar entry results in a “what-if?” no entry estimated 3Q17 US sales for Remicade of around $1,700 Million.  While YoY sales from 3Q16 to 3Q17 only dropped 5%, we believe that a more accurate estimate of the effect of biosimilar entry is a 20% decline in sales dollars  = (1,700 – 1,362 ) / 1,362.  Again this 20% decline in Remicade sales dollars has to be broken down into quantity changes vs unit price changes.

 According to Pfizer in a 2Q17 conference call with investors,  the results to date with its biosimilar entry had been “disappointing” and “slower than expected”  taking only a 2.3% of the Remicade’s market.

The competition between Remicade and Inflectra represents the first “clean” case study of biosimilar price competition in the United States.   We see several takeaways that future biosimilar entrants might want to keep in mind:

  • Incumbents will have in place insurance coverage contracts with $100+M lump sum rebates contingent upon exclusivity.
  • Entrants should consider adopting a “land and expand” strategy going after coverage for new patients first. 
  • Understand the differences between how PBMs versus how insurance companies negotiate rebates.  With PBMs, it is gross rebates that matter. With insurance companies, it is net price that matters.  In either case, gross rebates in the area of 40% won’t dislodge the incumbent.  It look like it will take gross rebates in the order of 60% to 70% off list price to gain any coverage.


The Follow-On Biologic Basaglar® vs the Incumbent Lantus®

Sanofi’s Lantus was the first long-acting insulin drug approved by the FDA in April 2000.  Since then, there has been a number of other long-acting insulin drugs approved that are in the same therapeutic class:  Sanofi’s Toujeo (glargine) and Novo Nordisk’s Levemir (detemir) and Tresiba (degludec). Because these drugs are self-injectable, they are usually covered by a drug benefit plan managed by PBMs as opposed to a medical benefit plan managed by insurance companies.

While Lantus faces competition from therapeutic equivalents, it has remained the dominant drug in the long-acting insulin class.   In 2016, Lantus was the #9 best selling drug in the US with estimated sales around $3.3 Billion dollars.  

On December 15, 2015, Eli Lilly introduced a rapid-acting insulin drug called Basaglar.  It is formally classified as a follow-on biologic, not a biosimilar,  because it was approved under a different approval process.   Notwithstanding the label, this case has relevance to biosimilar competition.

According to Business Insider, Lilly list priced Basaglar only 15% below Lantus at the time of its introduction.  The table below summarizes the 2016 list prices of all rapid acting insulin drugs relative to the incumbent and top seller Lantus.  

According to BioFarmDive, Lantus sales have fallen nearly 17% YoY from 2Q15 to 2Q16.  Some of that has been attributed to price competition from therapeutic equivalents.  Some has been due to quantity reductions as patient have moved to new drugs including Sanofi’s own drug Toujeo.

It appears that Lilly’s tepid list pricing of its biosimilar Basaglar has added nothing to the the price competition (via rebates for formulary placement) that already existed in the rapid-acting insulin therapeutic class.

The fact that the incumbent here was facing significant competition before the entry of a biosimilar is probably unique to the insulin class due to a relative lack of patents protecting biologic production processes for insulin.

As a result, the Basaglar entry is not a “clean” case study of biosimilar competition.  But, what it demonstrates is that once again list pricing a biosimilar not more than 15% below the list price of the incumbent and playing the rebate game is insufficient to gain much insurance coverage.

This lack of impact is reflected in the recently announced 2018 national formularies of the four largest PBMs.  Only CVS Health has decided to include Basaglar and exclude Lantus.


Other Biosimilars Approved Since August 2017

We have identified five other biosimilars approved by the FDA in the last half of 2017.  Four have been delayed because of patent disputes, with one  — Humira, the #1 selling drug in the US — being a controversial “pay for delay.”

On December 13, 2017  Pfizer announced that a second biosimilar to the J&J’s incumbent Remicade was approved by the FDA.  Given the failure of Pfizer’s first biosimilar, it did not surprise us to see Pfizer announce that it had no immediate plans to commercialize this second biosimilar.  

We have presented in more detail the price competition between Remicade and Inflectra in our recent paper Biosimilars and Exclusive Dealing Antitrust Law: The Case of Pfizer, Inc v Johnson & Johnson et al.  We believe this experience will impact future biosimilar entry strategies pertaining to list pricing, rebate offers, and target markets.  

In addition, it may increase “no go” decisions regarding biosimilars in the R&D pipeline and “pay for delay” agreements between biosimilars and incumbents.

While 2017 has been bad for biosimilar competitors, it has been good for competition as prices for incumbent drugs Remicade and Lantus have dropped significantly.  Rather than argue for added legal and legislative protection for biosimilars, we argue for a rethinking of competitive strategy on the part of the entrants.

Will Amazon’s Online Pharmacy Display Therapeutic Equivalents?

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,, 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 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, 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, “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
  • – an independent mail order pharmacy
  •       Walgreen – a very large retail drugstore chain with mail order capability.


List of URLs of Online Pharmacy Survey:

  •         Costco:
  •         RxSolutions:
  •         Wellpartner:


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, 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 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 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.” “These are self-pay prices for 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:, 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:, 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:, 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:, 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.


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

(2) The Consumer Reports recommendation for proton pump inhibitors is available at

(3) “Healthcare Information Matters,” November 30, 2006 posted by Adam Bosworth, VP Google  Available at

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

(5)  “Healthcare 2.0 ?” January 23, 2007 Available at

(6) Quote by Steven Case in CDHC Magazine.  Available at

(7)  Medco Press Release, May 23, 2007, Available at

(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

(9)   LW Abrams, “Exclusionary Practices in the Mail Order Pharmacy Market,” September 2005, Available at

(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

(12) Price Disclaimers;jsessionid=EKYFZR33JTBGECSJY2ZHNDQKJHDTE3MK

(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

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

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

Hal Varian, “When Commerce Moves Online, Competition Can Work in Strange Ways, New York Times. August 24, 2000 Available at

(16) Express Scripts, “Geographic Variation in Generic Fill Rate, Available at

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

Savings, “ October 25, 2005. Available at

(18) LW Abrams, “Quantifying Medco’s Business Model,”  September 2005  Available at

(19) The Consumer Reports survey is available at

(20) LW Abrams, “Systems Xcellence Should Continue to Benefit from PBM Disintegration”, May 24, 2007. SeekingAlpha Available at “

(21) David Knott, Gary Ahlquist, and Rick Edmunds, “Healthcare’s Retail Solution, strategy + business, May 15, 2007 Available at ”

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

© Lawrence W. Abrams 2007                           

Biosimilars & Exclusive Dealing Antitrust Law: Pfizer (Inflectra) v J&J (Remicade)


Following the generally accepted theories of the legal scholar Robert Bork and his Chicago School colleagues, vertical restraints such as exclusive dealing contracts are presumptively procompetitive and welfare-enhancing because it would be irrational for a buyer to exclude the lowest cost supplier.  

On September 20, 2017, the drug manufacturer Pfizer filed a lawsuit Pfizer Inc, v Johnson & Johnson et al (link to the full court filing)  claiming that Johnson & Johnson (J&J) violated Section 2 of the Sherman Antitrust Act by monopolizing the market for its incumbent biologic drug Remicade®.  This was achieved via rebate contracts with the largest insurance companies in the USA that had the effect of excluding from coverage Pfizer’s biosimilar drug Inflectra®.

We will present the case that Pfizer’s antitrust case is weak because it was unlikely that Pfizer was the low cost supplier based on a view of lump sum rebate offers as  efficiency-enhancing “signals” of expected consumer demand for a product.  


Johnson & Johnson’s (J&J) biologic drug infliximab — trade name Remicade® —  was approved by the FDA for use in August 1998.  It was the first autoimmune drug to be approved in three different therapeutic classes and is used to treat patients with autoimmune diseases including rheumatoid arthritis, psoriatic arthritis, Crohn’s disease, plaque psoriasis, and ulcerative colitis.

In 2016, Remicade was the 5th highest selling drug in the United States with estimated sales of $5.3 Billion.  Remicade was J&J’s top selling drug, representing 20% of its total global drug sales.     

Remicade consists of monoclonal antibodies bioengineered from mouse tumors. It is prescribed to patients with autoimmune diseases. Because it is infused at physician’s offices or outpatient clinics, it is almost always covered by a medical benefit plan rather than a drug benefit plan.  Remicade is a live, large molecule protein.  It is impossible for other companies to manufacture perfect substitutes, only “biosimilars”.  

Remicade now faces competition from biosimilars due to the expiration of FDA exclusivity coupled with court judgements invalidating some of J&J’s patents protecting it bio-engineering processes.

In November 2016, the FDA approved Pfizer’s biosimilar drug Inflectra® followed by a June 2017 approval of Merck and Samsung’s biosimilar drug Renflexis®.

Pfizer’s Antitrust Lawsuit 

On September 20, 2017, Pfizer filed a lawsuit Pfizer Inc, v Johnson & Johnson et al (link to the full court filing)  in the U.S. District Court, Pennsylvania Eastern District Court, Philadelphia Office, No 17-04180.

Pfizer claimed that J&J violated Section 2 of the Sherman Act by monopolizing the infliximab market using a

“…web of exclusionary contracts on both health insurers and healthcare providers (e.g., hospitals and clinics) to maintain its stranglehold in respect of an important biologic, brand named Remicade, also known by its generic name, infliximab.”

It is significant to note that the Pfizer chose Section 2 (monopolization) of the Sherman Act rather than Section 1 (restraint of trade) of the Sherman Act or Section 3 (exclusive dealing) of the Clayton Act.

Former FTC Commissioner J. Thomas Rosch had noted in a 2007 article that the one exception to the trend of courts ruling against plaintiffs in vertical restraint cases focused on Section 2 of the Sherman Act.  He found that the 1978 case of Eli Lilly v SmithKline was often cited by plaintiffs who won their cases.

It is interesting to note that the SmithKline case involved bundled drug discounts. It was tried by the Third Circuit Court of Appeals which encompasses the District Court in which the Pfizer case is to be tried.

J&J’s exclusionary contracts were

“… designed to block both insurers from reimbursing, and hospitals and clinics from purchasing, Inflectra or other biosimilars of Remicade despite their lower pricing.”

The suit also claimed that J&J engaged in below cost predatory pricing:

“..when the total amount of discounts and rebates that J&J offers to insurers and providers under the contracts described herein, including multi-product bundle contracts, is attributed to the portion of Remicade sales that is contestable by a biosimilar like Inflectra, J&J is pricing Remicade below its own average variable cost.”


Expectation for Price Competition Between Biologics and Biosimilars

The pattern of price competition in 2017 between Remicade and Inflectra represents the first “clean” case study of price competition in the United States between a newly introduced biosimilar and its original biologic.

A year and a half earlier in March 2015, Sandoz introduced a self-administered, injectable drug called Zarxio that was a biosimilar to Amgen’s biologic Neupogen used to stimulate white blood cell production after chemotherapy.

Zarxio’s ease at gaining exclusivity on drug benefit formularies turned out to be an anomaly. That is because Amgen decided not to compete with Sandoz on price. Instead, Amgen focused its marketing efforts on converting existing Neupogen users to Amgen’s newly introduced, long-lasting version of Neupogen called called Neulasta.   

Before we turn to the lawsuit itself, we want to discuss the expectations that experts had for biosimilar competition in general.  We also want point to signs indicating what Pfizer’s own expectations were.  

The reason for this is to show that no one was expecting aggressive price competition from the incumbent.  When Pfizer realized its strategy was a failure, it decided to sue, claiming it was J&J fault.  

Instead, it should have renewed its efforts by devising a “winnable” strategy involving deeper discounts and rebate percentages on contracts that offered exclusive coverage for a subset of infliximab users.

At the time of its launch, Pfizer list priced Inflectra at $946 a vial, only 15% below $1,113 for a comparable vial of Remicade.  The normal regimen for both drugs consists is an IV infusion every 8 weeks or 6.5 times a year.  This translates to a yearly list price of $6,149 for the biosimilar versus $7,235 for Remicade.

Pfizer stated in its antitrust lawsuit that it

“… introduced Inflectra with a list price 15 percent lower than Remicade, and, in negotiations with insurers and providers, offered substantial additional pricing concessions in the form of discounts and/or rebates that in some instances were more than 40 percent below Inflectra’s list price. The goal and effect was to offer Inflectra for less than J&J was offering Remicade; indeed, for many customers, Pfizer committed to ensure that Inflectra would have a lower net per-unit price than Remicade”

Pfizer failed to mention in its lawsuit that, when Merck launched a second biosimilar called Renflexis in June 2017, Pfizer reduced its list price from 15% to 35% to match Merck.   We view this downward revision as an acknowledgement by Pfizer that its pricing between November 2016 and July 2017 had not been competitive.

In September 2017, J&J’s CFO Dominic Caruso told Wall Street analysts  that Remicade sales had dropped only 5% year-over-year since the introduction of Pfizer’s biosimilar.   He attributed J&J’s success to doing a  “pretty good job of contracting for Remicade well in advance of the biosimilar entry from Pfizer.” He also attributed J&J’s success to natural barriers to biosimilar adoption in general.

The costs above do not include infusion costs, running $3,000+ per visit or $19,500 a year, for administering the infusion at physicians offices or outpatient clinics.   Insurance coverage for the combination of drug and infusion fall under a medical benefit plan rather than a drug benefit plan, which limits coverage to self-administered drugs.  In the case of Medicare, both drugs are covered under Medicare Part B as opposed the drug benefit plan Medicare Part D.   

Pfizer’s choices for discounts off list have been in line with general expectations for new biosimilars.   Experts had thought that biosimilar competition would mirror the modest price competition that had been observed among branded, but therapeutically equivalent, small molecule drugs.  

No one believed that the competition would mirror the vigorous price competition initiated by generic manufacturers once a brand drug lost its patent protection. In these cases, a number of generic manufacturers with offshore operations would enter the market within a year and offer perfect substitutes that pharmacists could switch to automatically.  The vigorous competition caused generic prices to fall  80+% lower than the original brand.

These expectations for modest price competition seemed to be based only on the economics of the biosimilar manufacturer.  The idea was that the willingness of a biosimilar manufacturer to compete on price was a lot less than a generic manufacturer.  This stems from a need to cover amortized R&D expenses estimated at $100 Million to $250 Million for a biosimilar versus $1 Million to $4 million for a generic.

Biologic and Biosimilar manufacturing

It was also felt that biosimilar manufacturers would hold back from aggressive pricing because substantial gross profits would be needed to cover large sales expenses for consumer advertising and “physician detailing.”  This non-price competition followed from the expectation that physicians would be reluctant to switch existing patients to another drug that was not a perfect substitute.

No one in general, and not Pfizer specifically, expected that the manufacturer of the biologic would become the driver of vigorous price competition upon entry of a biosimilar.  After enjoying 16 years of monopoly profits with fully amortized R&D, the incumbent could afford to undercut any biosimilar “burdened” by the yearly amortization of $100 – $250 Million in R&D expenditures.

Also, no one considered  the possibility that payers — insurance companies and plan sponsors  — would be the drivers of biosimilar price competition.  This is surprising because there there has been considerable evidence since 2010  that payers and contracted specialists called pharmacy benefit managers (PBMs),  have been driving price competition among small molecule brand drugs via exclusive formulary rebate contracts.  


The Chicago School on Exclusive Dealing

Following the now generally accepted theories  of the legal scholar Robert Bork and his University of Chicago colleagues,  vertical restraints such as exclusive dealing contracts are presumptive welfare-enhancing and procompetitive because it would not be rational for a buyer to exclude the lowest cost supplier.    

Beginning in the 1980s, Federal courts have ruled that most cases involving various vertical restraints — exclusive dealing, tying arrangements, slotting arrangements, rebate bundling, etc —  are procompetitive and do not violate antitrust laws.

The Chicago School argued persuasively that antitrust cases involving vertical restraints  should be decided on the basis of prices and costs.  The Chicago School has rendered the industrial organization paradigm of structure-performance-conduct and related data, which Pfizer offered as evidence in its lawsuit,  as irrelevant to vertical restraint antitrust cases.

We believe that Pfizer’s antitrust lawsuit is weak.  Following the Chicago School, we believe that the exclusive dealing contracts between J&J and insurance companies are procompetitive as it is highly unlikely that Pfizer’s biosimilar had a lower price after rebates than Remicade.

Pfizer Inc v Johnson & Johnson et al is no different that the 2014 case of Eisai Inc. v. Sanofi-Aventis U.S., LLC, No. 08-4168 (MLC) (D.N.J. Mar. 28, 2014)  tried in The United States District Court for the District of New Jersey. The court ruled that contracts between a drug company and hospital groups offering “loyalty discounts” if buyers met market share targets were procompetitive as long as the net prices exceeded costs.


Predatory Pricing

Pfizer alleged in its lawsuit that “J&J is pricing Remicade below its own average variable cost.”

Predatory pricing is a form of vertical restraint initiated from the sell-side.  The Chicago School argued that predatory pricing is unlikely to occur as it would be irrational for a seller operating under a normal profit-maximizing business model to so.

Pfizer’s claim of predatory pricing is weak. The bioengineering costs to manufacture infliximab have to be about the same for the two companies.  Where the two firms’ cost structures differ is in the area of amortized R&D expenditures.   

J&J has been amortizing Remicade’s R&D costs for the past 18 years. By now J&J’s R&D expenditures on its balance sheet have been fully amortized. No longer is J&J required by GAAP to “burden” its cost of goods sold.  

On the other hand, Pfizer introduced Inflectra a year ago and has to “burden” its cost of goods sold with a yearly amortization of the total R&D for its biosimilar in range of $100 Million to $250 Million.

Unburdened by amortization,  J&J could easily underprice Pfizer without going below its costs of goods sold.  In other words, J&J would not have to engage in predatory pricing to outbid Pfizer for exclusive dealing contracts.  It would be irrational for them to do so.


Business Model Misalignment

One factor that might have bolstered Pfizer’s case would have been a misalignment of the business model of the buyers.  But, we rule that out here.

The buyers in this case are the largest national health insurance companies in the United States and a slew of regional Blue Cross Blue Shield companies. Below is the list of these companies and how they chose to cover Pfizer’s biosimilar.

  • UnitedHealthcare  – only after Remicade failed first
  • Anthem — outright exclusion
  • Aetna — complex indication list before approval
  • Cigna — only after Remicade failed first

In its lawsuit Pfizer estimated that “70% of medical drug benefits of commercially insured patients in US”  are managed by the companies named in its lawsuit.  

EVERY SINGLE ONE of the national health insurance companies either excluded Inflectra outright or required Remicade to “fail first” before covering Inflectra. It is presumed that EVERY SINGLE ONE of these big insurance companies signed these exclusive coverage contracts only after a thorough investigation of competing bids leading to the conclusion that J&J was the low cost supplier.

In the lawsuit, Pfizer did make the persuasive argument that “fail first” coverage for Inflectra amounted to de facto exclusion.  They argued that if one infliximab drug — Remicade — did not work, a physician would then turn to a non-infliximab drug, not to another biosimilar infliximab drug like Inflectra. This is because years of clinical trials submitted to the FDA  proved that there was no meaningful difference in outcome between Remicade and Inflectra.

The question is are there other circumstances under which a large insurance company would intentionally exclude coverage for a biosimilar with lower costs?

We have been the first to raise the possibility that a buyer with a misaligned business model could be an exception to the Chicago School dictum about vertical restraints. This is because their conclusion depends on the assumption that the buyer has a rational business model in the economic sense of maximizing revenue minus costs.

But, we rule the possibility of irrational business model out as the insurance companies in this case operate under normal economic business models.  

One is an insurance model based on revenue from fixed premiums offset by provider reimbursement costs.  The other is a self-insured model where the insurance company operates as a fee-for-service contractor offering medical benefits management with 100% pass through of provider reimbursements to plan sponsors.

While mistakes can occur without affecting profits in the short run,  it is in the best interest of an insurance company to produce a cost-effective medical benefit as plans will compare results at contract renewal time.

Unlike cases involving insurance companies as buyers, we have pointed out that the Chicago School’s assumption of a rational buyer business model is problematic in instances involving exclusionary formulary contracts between drug companies and PBMs as buyers.  

PBMs have a reseller business model where their gross profits on brand Rx are derived only from opaque retained rebate percentages.  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.


Lump Sum Rebates

The question is how do you determine the low cost supplier in cases where the defendant uses market share or lump sum rebates in return for exclusive deals?

Pfizer alleged that its rebates offers would have make Inflectra the lower cost drug on a “unit-for-unit” basis.  While Pfizer’s specific descriptions of the form of J&J rebates is somewhat vague in the lawsuit, it appeared that J&J’s payments to insurance companies were in the form of a contractual commitments of multimillion dollar lump sums contingent upon meeting near 100% market share targets for Remicade.  

Below, we  present a “stylized facts” comparison of rebates offers where our estimate for the total annual lump payment paid by J&J reasonably could have been as much as $2 BILLION, or 28% off Remicade’s list price.  

We show that on “unit for unit” basis, Pfizer is the low cost supplier.  However, on a “dollar for dollar” basis, J&J is the low cost supplier given our estimated 25:1 volume advantage for Remicade coupled with our estimated $2 Billion lump sum rebate.

Who is the low cost supplier here?

J&J is the low cost supplier based on a view of lump sum rebate offers as  efficiency-enhancing “signals” of expected consumer demand for a product.   

Lump sum rebates can be viewed as the product of a unit rebate times a manufacturer’s expected demand for their product.   They provide a “signal” to buyers of which product among a group of therapeutic equivalents might offer buyers the single best opportunity for satisfying downstream consumer demand.

The intermediate market buyer is looking to maximize expected profits.  This can be cast at the product of unit margin (unit resale price – unit cost) times expected downstream demand.  It would be irrational for an intermediate market buyer to enter into exclusive dealing contracts only on the basis of unit costs after rebates without considering expected demand as well.

What buyers are doing by comparing rebates on a lump sum basis and not on a unit basis is similar to the AdWord algorithm Google came up with for “slotting”  search ads based on keyword bids on a unit basis.  

Slotting ads based only on cost per click (CPC) bids most likely would have resulted in the top slots going to bidders advertising products that few viewers were interested in,  resulting in few clickthroughs.  Slotting ads only on the basis of CPC bids would be far from revenue-maximizing as measured by the product of CPC times clickthroughs.

Instead, Google looked at past data on bidders, their ad relevancy to viewers,  and calculated something called an expected clickthrough rate (eCTR), a measure of expected demand.  Google then sold the top slots to bidders with the highest “AdRank”, a rating index that is function of CPC and eCTR.

Consider insurance company in a situation similar Google selling a single slot for insurance coverage of supplying infliximab vials to patents. The insurance companies received two rebate bids — $333 per vial from J&J vs $400 per vial from Pfizer.  Who should they choose for the slot?

Unfortunately, insurance companies did not have a genius like Larry Page to come up with a “AdRank” for the two bids — a measure combining unit bid with expected consumer demand.  But, insurance companies were provided with a “signal”  of expected demand in the form of a J&J’s market share or lump sum rebate offer.

Pfizer could have chosen to outbid J&J’s on a market share or lump sum basis.  But, this would have required Pfizer to have the confidence that it could deliver a 25x increase in patient demand for its biosimilar if given exclusive coverage. But Pfizer did not have such confidence.  


 Bundling or Tying Arrangements

Pfizer’s anticipated the “signaling”  defense of lump sum rebates by arguing that J&J’s rebates covering the entire market for infliximab were exclusionary bundling or tying arrangements.  In its lawsuit, Pfizer viewed the “contestable” market for its biosimilar as consisting only of new patients.  It viewed as “uncontestable” current users of Remicade.

Pfizer argued that J&J’s offer should be viewed as tying a lump sum payment for supplying existing patients with a lump sum payment for supplying new patients.  

Pfizer argued that its rebate offer should be compared with J&J’s lump sum, but only after it had been prorated over the “contestable” market.  In effect, pro-rating amounts to an “unbundling” of J&J lump sum rebate offer turning it into a “unit-for-unit” offer.  As we have shown above, Pfizer would be the low cost supplier on a “unit-for-unit” basis.

Again, the Chicago School argued that it is presumptive to expect that rational buyers would accept bundling or tying arrangements if they involved excluding the low cost supplier.

We recommend that in the future Pfizer asks insurance companies to create two types of contracts: (1) one contract offering exclusive coverage of patients already using Remicade; and (2) another contract offering exclusive coverage for new infliximab patients.  Give this division, Pfizer has a chance to outcompete J&J on price by bidding only on (2).



We believe that Pfizer’s case is weak.  Pfizer did compete, but only moderately so. Pfizer never expected existing users of Remicade to switch to its biosimilar.  Being excluded from that market was not a shock.  

Pfizer really thought it had a chance to win over physicians looking to prescribe an infliximab for new patients.  But, Pfizer was not smart enough to devise a “winnable” contract specifying rebates in return for coverage only in its “contestable” market.

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


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.