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:
labrams9@gmail.com
831-254-7325

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Insulin Drug Price Inflation: Racketeering or Perverse Competition?

Summary

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.


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

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

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

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

Mayo Clinic: 1

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

Consumer Reports:2

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

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

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

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

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

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

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

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

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

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

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

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

 

The Purchasing Information Branch  

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

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

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

 

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

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

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

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

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

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

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

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

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

 

The Current State of Online Pharmacies

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

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

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

 

List of URLs of Online Pharmacy Survey:

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

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

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

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

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

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

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

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

 

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

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

 

The Display of Generic Substitutes

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

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

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

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

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

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

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

 

The Hypothetical Display of Therapeutic Interchange

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

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

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

 

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

 

Therapeutic Interchange Involving OTC Drugs

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

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

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

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

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

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

 

Therapeutic Interchange Involving Herbal Alternatives

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

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

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

 

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

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

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

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

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

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

 

Cost-Saving From Drug Price Transparency

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

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

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

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

 

Cost Saving From Therapeutic Interchange

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

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

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

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

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

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

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

The Vanguard of Consumer-Directed Pharmacy Benefits

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

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

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

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

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

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

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

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

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

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

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

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

 

The Role of New Intermediaries in Pharmacy Benefits

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Footnotes:

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

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

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

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

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

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

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

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

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

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

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

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

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

(12) Price Disclaimers

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

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

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

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

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

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

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

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

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

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

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

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

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

Savings, “ October 25, 2005. Available at

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

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

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

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

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

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

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

© Lawrence W. Abrams 2007                           


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

Summary

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.  

Introduction

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).

 

Conclusion

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.


AbbVie’s Mavyret Drug Pricing: Disruptive to the Pharmacy Benefit Manager Business Model

Summary:

AbbVie’s pricing for its new Hepatitis C Virus (HVC) drug Mavyret is disruptive to the current PBM business model because it forces the Big 3 PBMs to consider a drug for inclusion in their national formularies that is aligned with their clients interests — more cost-effective than Harvoni — but not aligned with their own interest of squeezing out all the rebates they can from specialty drug manufacturers.

Will PBMs open up the HCV therapeutic class and include Mavyret?

Or, will they expose themselves to claims of misalignment by excluding AbbVie’s Mavyret?

Stay tuned.

The PBM Business Model Today

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 States in 2015.

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

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

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

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

But there are several constraints today on this phase of the PBM business model.

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

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

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

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

Using data supplied by the drug company Merck, we reconstructed a step-by-step sequence of how PBMs and drug companies might negotiate the parameters of a rebate deal under the triple constraints of (1) Pharma’s net prices must grow; (2)  PBMs retained rebate gross profit DOLLARS must grow; and (3) PBM rebate retention rate must be fixed at 10%.  

We found that to do this required PBMs to “coax” drug companies into increasing list prices for brand drugs at double-digit rates yearly while demanding that nearly all of it be rebated back to the PBMs. The result of this scheme is an occurrence now known as the “gross-to-net price bubble.”  Below is a graph of the phenomenon using data supplied by Merck:

PBMs and Formulary Choice

As we said in the prior section, the PBM business model relies heavily today on rebates received from drug companies in return for placement on a list of drugs covered by a Rx benefit plan.  That list of covered drugs is called a formulary.  

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

In 2005, we were the first to conceptualize formularies and their 50-80 therapeutic classes as a group of markets.  On the sell-side are brand drug companies with close, but not perfect substitutes, called therapeutic equivalents.  On the buy-side are the Big 3 PBMs representing plan sponsors and their members.

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

Rebates are essentially tariffs paid by drug companies to gatekeepers (PBMs) for access to markets with limited competition. We have presented that case that the most “rebatable” brand drugs fall in oligopolistic therapeutic classes featuring a small number of patented drugs that are therapeutic equivalents.  

Over time, “me too” drugs enter and older drugs lose patent protection opening the door to generics or biosimilars.  The therapeutic class becomes competitive and no manufacturer has any wiggle room left to negotiate price reductions with PBMs.

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 approved drugs — to being closed — a single approved drug.  We are just beginning to figure out the causes of this change.  

But our basic view of what drives PBMs to choose  open versus closed therapeutic classes is this:

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

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

The Hepatitis C Virus Drug Therapeutic Class

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

In 2016, Gilead’s Harvoni stood at #2 on the list of top selling Rx drugs at $10.0 Billion a year, after AbbVie’s top selling biotech drug Humira at $12.9 Billion used to treat a variety of autoimmune diseases.

In the three years since Harvoni came on there market, there have been 5 additional HCV drugs approved by the FDA, but only AbbVie’s Viekira Pak has garnered any significant sales.  

The reason has been that the Big 3 PBMs have decided the make the HCV therapeutic class a “winner-take-all” proposition, coaxing competing companies to choose a high list price to be in a position to offer PBMs  a “deep discount” rebate reaching 70% to 80% of list price to gain exclusivity in the HCV therapeutic class.  Below is a summary of the formulary choices of Big 3 PBMs and Prime Therapeutics for the HCV therapeutic class for 2017.   

Gilead has secured exclusive preferred status for Harvoni with CVS Health, OptumRx and Prime Therapeutics. AbbVie has secured exclusive status for Viekira Pak with Express Scripts.   

All of these choices are aligned with plan interests of having the most cost-effective drug included in the formulary.  All choices are also aligned with PBMs’ interest of securing the most rebate DOLLARS.

Harvoni and Viekira Pak are both about equally effective so rebates become the determining factor for cost-effectiveness.  For CVS Health, OptumRx and Prime Therapeutics, Gilead’s Harvoni is more cost-effective choice because Gilead’s rebate offer was greater than AbbVie’s.

For Express Scripts, Viekira Pak is the most cost-effect choice because AbbVie’s rebate offer was greater than Gilead’s whose bid might have been constrained due to a depleted budget after all the other wins.   

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

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

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

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

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

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

In August 2017, CVS Health released a white paper outlining the criteria it uses for formulary choices and exclusion lists. It stated that in January 1, 2018,  it expects to remove 17 products from their Standard Control Formulary in 10 drug classes, but noted that  

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

Will the PBMs open up the HCV therapeutic class and add Mavyret?  

Or, will they expose themselves to claims of misalignment by excluding AbbVie’s Mavyret?

Stay tuned.

Postscript added October 17, 2017

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


Merck Data Discredits PBM-Sponsored Study of Brand Drug Price Inflation

Summary

We present data supplied by the drug company Merck that discredits a study sponsored by the pharmacy benefit manager (PBM) trade association showing no correlation between PBM rebate rates and brand drug price inflation.

Introduction

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 States in 2015.

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

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

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

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

But there are several constraints today on this phase of the PBM business model.

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

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

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

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

In order to show how PBMs can overcome these constraints,  we have deconstructed data supplied by the drug company Merck (see below) that depicts a growing a divergence between their list prices for brand drugs (gross) and the prices they receive after deductions of rebates paid to PBMs (net).

This growing divergence has come to be known as   “gross-to-net rebate bubble”   Other drug companies are publishing similar data as a way of defending themselves against charges of double-digit price-gouging tactics.

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

Our deconstruction of the Merck data lays out a step-by-step sequence of how PBMs and drug companies might negotiate the parameters of a rebate deal today under the constraint that PBMs have to grow gross profit DOLLARS over time while fixing the rebate retention rate at 10%.

We can use the same Merck-supplied data to plot annual % increases in list prices (line 1 above) against the annual negotiated rebates and discounts as a % of the list prices (line 3 above).  The result shows a significant positive correlation coefficient ratio of .653

PBMs Under Attack for Causing Drug Price Inflation

In January, 2017 newly elected President Donald Trump attacked drug companies in press conference for “getting away with murder” by raising drug prices at double-digit rates in recent years.

Since the Trump rant,  there have been articles in the New York Time, the Los Angeles Times and other publication where both retail pharmacists and drug companies are quoted as saying it is PBMs that drive drug price inflation.  Here is a quote from the New York Time article,

“Want to reduce prescription drug costs?” the pharmacists argued during their visits. “Pay attention to the middlemen.”

The PBM-Sponsored Study

The PBM trade group association Pharmaceutical Care Management Association (PCMA) commissioned a study by the health care consulting company Visante to provide data relevant to the issue of the causes of recent drug price inflation.  

In April 2017, the PCMA announced in a press release that results of the Visante study were available on-line.  The key result:

“There is no correlation between the prices drug companies set and the rebates they negotiate with PBMs”

The press release also provided a quote by PCMA President and CEO Mark Merritt:

“This study debunks the notion that the prices drugmakers set are contingent on the rebates they negotiate with PBMs…”

Below is a screenshot of the graph depicting the finding of “no correlation”

Reconciling Differences in Results: A Question of Sample Chosen

The Merck data shows a significant positive correlation between annual brand drug list price inflation and annual rebates rates that Merck has negotiated with PBMs.  The PBM-sponsored study shows no correlation.

Obviously, a key reconciling difference revolves around the sample chosen.  

The Merck results are heavily weighted by three brand drugs.  Merck has reported In its 2017 annual 10-K report that about one-third of its drug sales comes from three brand drugs: (1) the diabetes drug Januvia; (2) the cholesterol drug combinations Zetia/Vytorin; and (3) the cervical cancer prevention vaccine Gardasil.  

In terms of rank among the top 200 selling brand drugs, Januvia ranked #19, Zetia #38, and Gardasil #56 according to a 2015 listing.

Each of these drugs are what we call highly “rebatable” — in therapeutic classes where there are a number of other brand that are therapeutically equivalent.  

Merck competes vigorously with other drug companies for preferred status on formularies which list drugs approved by PBMs for coverage.  Competition insures that winning bids are high for placement in these therapeutic classes.  Merck has to “pay to play” and covers higher and higher rebate percentages paid to PBMs with list price inflation.

To achieve such high rankings,  it means that Merck must be winning placement for its top selling drugs with each of the Big 3 PBMs who control collectively 73% of the market.

While Merck’s sample size is small compared to the PBM-sponsored study, Merck’s data represents the essence of what has been going on between Pharma and Big 3 PBMs since 2010.

The sample size of the PBM-sponsored study is much larger. It contained a

“sample of the top 200 self-administered, patent protected, brand-name drugs, 24 drugs were excluded because of incomplete data for the study time period, leaving a remaining sample of 176 drugs for analysis”.

First, the initial sample size of 176 was aggregated in 23 therapeutic classes with the averages used in plots.  No mention is made as to whether the 23 data points represent simple or averages weighted by revenue.  In any case, samples of averages smooth out differences in the raw data.

Second, the larger sample size could contain significant number of drugs that just are not “rebatable” — in “aging” therapeutic classes with a 4+ brand drugs that are therapeutically equivalent (“me-too drugs”) plus a number of off-patent, low cost generic drugs.

In short, we believe that the sample used in the PBM-sponsored study is a smoothed-out representation of the outcomes of negotiations between drug companies with “rebatable” brand drugs and the Big 3 PBMs.

 


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

Summary:

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

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

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

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

The “Gross-To-Net Price Bubble”

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

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

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

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

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

The PBM Business Model:  2005 – 2010

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

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

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

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

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

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

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

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

The PBM Business Model: 2010 – today

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

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

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

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

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

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

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

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

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

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

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

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

The Big 3 PBMs today have a lot of power in rebate negotiations.  Drug companies have a lot to lose if negotiations fall through.  Exclusion of a single drug from one of Big 3 PBMs’ national lists of drugs covered by an insurance plan  — called formularies — can cost a widely-used or expensive drug $1+ Billion dollars in lost revenue.

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

This analysis has relevance to RICO cases in at least three areas:

  • the  “proximate cause” of damages : Pharma, PBMs, and/or plan sponsors?
  • the “association-in-fact” enterprises — horizontal, vertical, or both?
  • the  very question of conspiracy — a cooperative vs non-cooperative game?

For example, assuming this is a racket, we would argue that PBMs are the “capos” and drug companies are the flunkies.  And what about plan sponsors, including the Federal, state and local governments?

Aren’t plan sponsors, not PBMs, directly responsible for setting copayment or coinsurance?     We addressed this question 12 years ago in our 2005 letter published by the Journal of Managed Care Pharmacy called The Role of Pharmacy Benefits Managers in Formulary Design: Service Providers or Fiduciaries? 

So, why don’t RICO lawyers go after the Feds with their donut hole concoction?  Well, RICO lawyers are calculating types and their cost-benefit calculations point to flunkies, not “capos”, and surely not the Feds, are the most likely to “cop a plea” here.

(Note: see a detailed follow-up article written in January, 2018 called Insulin Drug Price Inflation: Racketeering or Perverse Competition? )

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

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

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

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

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

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

A larger view of the spreadsheet above:

 

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

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

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


PBM Drug Rebates

All papers downloadable .pdf

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

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

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

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

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

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

 


The Pharmacy Benefit Manager (PBM) Business Model

CURRENT PAPERS:

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

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

Blame PBMs (Not Pharma) For Driving Drug Price Inflation (09/17)

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

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

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

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

PAST PAPERS:

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

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

Medco As a Business Model Imperialist (07/08)

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

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

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

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

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

Quantifying Medco’s Business Model (04/05)

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

Walgreen’s Transparency Issue (11/03)