The Truth About Transparency

September 2004
John D. Jones, R.Ph., J.D.,
Vice President, Regulatory Affairs and Health Policy
Prescription Solutions

Over the past few years, the term transparency has become one of the most widely used in the pharmacy benefit management (PBM) industry. Use of the term began after plan sponsors realized that some PBMs were playing “games” with rebate accounting and pricing practices. It was a simple strategy. In fact, it was one used by other industries. The PBM would promise artificially low or free administration fees, but would recoup those fees by exploiting other revenue streams related to the clients’ business, with, or without, their knowledge. Recognizing that these games were costing money – potentially lots of it – government and other plan sponsors acted.

Several high profile lawsuits put some of the industry’s largest PBMs under the looking glass – and people didn’t like what they saw. Practices many viewed as misleading resulted in higher costs to plan sponsors and significant profits for some PBMs, while payers struggled to manage costs and plan members coped with rising out-of-pocket expenses.

Part of the backlash related to these PBM practices has led to a concerted effort to more tightly regulate PBMs. Many of the industry’s biggest opponents have pointed to the lack of transparency as a reason for greater state regulation and oversight. At least one state government, South Dakota, now demands transparency from PBMs under its laws. Most significant of the recent programs to address transparency is the landmark Medicare Modernization Act of 2003, which includes specific language mandating transparency for any provider of pharmacy benefit services in the program.

While some believe that regulation will promote transparency, others question that theory. In July, a Department of Justice (DOJ) and Federal Trade Commission (FTC) report concluded that competition, rather than regulation, will drive transparency and related cost savings to plan sponsors. Indeed, it asserted that state laws and regulations mandating transparency may result in increased benefit costs and that a competitive environment with private parties agreeing contractually upon the level of transparency is more likely to preserve discounts and rebates. This has led some analysts to note that transparency may soon become one of the most important strategies PBMs will use to differentiate themselves in the marketplace. 

So is that it? Will all PBMs become transparent? Perhaps not; despite the recent coverage and heightened scrutiny, many plan sponsors may not fully understand what transparency is, or more importantly, what it should be. There is no standard definition of transparency – either from an industry or legal standpoint – and one PBM’s definition may differ completely from another.

Most within the industry define transparency as the full disclosure of rebate revenue and other profits made by the PBM through a specific client's business. But just providing information on revenue won’t give plan sponsors the full picture. For some health plans, there are entities beyond the PBM (e.g., the claims administrator or the provider of the transaction process) that also take some profit in the prescription claim transactions. Therefore, it will be difficult for some transparency regulations to work if these entities are not also a part of the disclosure. Another key issue involves the entity that negotiates the rebates with the manufacturers – in some cases the PBM or in the case of large MCOs; the MCO itself. If the MCO negotiates, is it responsible for providing disclosure information? Under current interpretations for transparency, the MCO may not have to make such disclosures.

Disclosure and Pass-Through Pricing

So how can plan sponsors ensure they are getting all relevant information about their PBM’s business practices? Because of the likelihood that the true intent of transparency may be weakened to become just a marketing buzzword, plan sponsors, with the help of their consultant, will need to drill down to get the complete picture as to pricing policies and strategies. Two key areas to examine are disclosure of revenues and pass-through pricing. While closely related to transparency, full disclosure ensures that PBMs provide all the information necessary for a plan sponsor to fully understand the true cost of their PBM program and the profit margin of their PBM. For example, under a standard transparency agreement, PBMs might not disclose the spread between Maximum Allowable Cost (MAC) pricing obtained at retail pharmacies versus MAC discounted costs billed to clients. Plans sponsors should require that the PBM charges them the same discounted ingredient cost that the PBM pays to the network retail pharmacies or at least understand the cost impact of the mark-up.

Pass-through pricing is another key component of a truly open approach to transparency. Under pass-through pricing, the PBM should guarantee that direct discounts, future drug purchase credits and performance-based credits will be “passed- through” to the plan sponsor. Pass-through pricing should also be audited annually to validate rebate payments and submissions.

Beware of Games That Some PBMs Play

While many consultants and employers are beginning to more fully understand pass-through pricing and disclosure, there are still games that some PBMs continue to play that make it difficult to get a clear picture of costs. For example, a tactic some PBMs might use is to offer pass-through pricing for prescriptions filled at in-state pharmacies and spread pricing for out-of-state pharmacies. The PBM will then negotiate with the pharmacy to pay certain in-state retail pharmacy chains inflated prices for generic drugs, and then pass through these inflated prices to the plan. In exchange, the pharmacies will agree to accept lower rates for the out-of-state “spread” plans. While providing significant profits to the PBM, this provides little value to the plan sponsor.

Yet another game that consultants should watch for is when a PBM offers a certain percentage as a rebate, yet really gets more than that amount through its agreements with the pharmaceutical manufacturer. For example, a PBM discloses its rebate with a particular manufacturer for a particular drug at 12% – which is shared with or passed through to the plan sponsor according to details disclosed in the contract. But in a separate agreement not apparent to the plan sponsor, the PBM has negotiated with the manufacturer a rebate of 12% along with a 3% administrative fee – totaling 15% of the drug cost.  If the agreement was for rebates alone, 15% would be available to split with the plan sponsor rather than the 12% that was disclosed. A PBM that engages in this type of practice may be touting itself as transparent, but in reality is keeping what could amount to a significant sum from the plan sponsor. Taking this game a step further, the PBM may take the 3% that wasn’t disclosed and use it to offset a more aggressive Average Wholesale Price (AWP) that it offers to the client, and which is actually lower than the AWP it pays to the pharmacy. This is clearly not full disclosure, and gives the appearance of more favorable pricing on a spreadsheet when compared to PBMs who don’t practice these types of shell games.

It’s important for consultants to help their clients become fully aware of these practices so that when comparing PBMs, they select the one that is truly transparent and truly provides the lowest net cost.

Questions to Ensure Real Transparency

The crux of the transparency issue must focus on two key issues: 1) Are we getting the lowest cost and can that be proven? and 2) Are we getting the best overall quality in terms of outcomes and satisfaction for that cost?

Clearly this is a complex matter and one that will continue to be an issue for consultants and their clients. Here are questions that can be asked of PBMs, to ensure that transparency is not just a marketing tactic – but a strategic approach to ensuring quality, fairness and the lowest costs.

How does the PBM define transparency? 

Ensure your PBM discloses ALL revenue sources attributable to your client's business on a negotiated schedule. In a hypothetical situation, a large PBM covers 100,000 lives for a health plan in the Midwest. The PBM is approached by a pharmaceutical manufacturer who offers to pay the PBM a certain amount if the PBM institutes a persistency program including that health plan's members. There are two key issues:  1) The plan sponsor should be aware of that arrangement and agree that their members should be exposed to the program; and 2) They will also want assurances that the drug being promoted improves quality and cost-effectiveness better than other drugs within the category or available generics. There should be reporting back to the client so they are assured that this arrangement is appropriate and provides value.

What are the specific elements that a PBM will disclose?

Again, disclosure must go well beyond rebates – components a PBM should disclose include:

  • The PBM's low net cost strategy for the client.
  • Pass-through pricing (revenues go directly to the plan sponsor).
  • Full disclosure (all revenue related to a book of business is disclosed including pricing and alternative revenues).
  • Any fees from retail pharmacies are agreed upon and disclosed.
  • Any formulary rebate administrative fees from manufacturers are disclosed.

Will the PBM provide specific information on rebate strategies?

Plan sponsors should ask to see a list of the 50 prescription drugs with the highest utilization among plan members and ask the PBM for the price of the drugs with rebates and the overall net costs for the drugs. Comparing the costs will help show just how much savings the PBM is offering and where some charges may be hidden. Ask to see a comparison of rebates and therapeutic value as well as outcomes of medications. With guidance from the PBM's clinical team, the employer can determine if the drugs recommended provide the best overall value. But perhaps the most important point to keep in mind is that as the industry changes, rebates should NOT be the sole focus of the pharmacy benefit program. All programs should be designed to ensure they provide the lowest net cost to plan – and as generics increase and industry practices change – rebates should become much less of focus for plan sponsors.

Is the PBM willing to share all rebate dollars? 

A PBM today should be willing to share all rebate dollars if requested by the payer. The plan sponsor should recognize that while rebate dollars will be shared, specific terms and conditions of the manufacturer contracts are confidential. To help confirm the PBM's rebate policy, and assure the client they are securing full disclosure, the PBM should also agree to submit to an outside independent audit to review rebate payments and reconciliation. Some PBMs even have a Rebate Management business unit to further ensure the integrity of all practices. One approach plan sponsors should consider is a PBM that does not charge an upfront rebate administrative fee and one that is willing to share all rebates collected from manufacturers if that is the payer's wish.

What is the PBM's philosophy on drug-specific rebates? 

While some PBMs may agree to drug-specific rebates to secure a client's business, in the long run, such an approach is not advisable as costs may increase and the PBM's ability and willingness to negotiate across the entire book of business may decrease.

Does the PBM up-charge the negotiated retail pharmacy network rates and if so, what is the spread or margin on those rates?

This question is not as simple as it seems.  A number of factors should be evaluated when developing pricing for clients. In some cases, negotiated retail pharmacy network rates may be up-charged and in others, these rates may actually be down-charged.  The key driver in the pricing should be the client-specific utilization and mix of drugs. Whatever strategy is used, the PBM should clearly indicate to the plan sponsor what was done and for what purpose and be able to show that their pricing strategy resulted in lower dispensing fees and discounted AWP.

Does the PBM negotiate for administrative fees, in addition to rebates, from pharmaceutical manufacturers?

If a PBM has negotiated an administrative fee in addition to the rebate, be sure the details of the arrangement are transparent to you and your clients. You will also want to know if the PBM is using the administrative fees to offset what may appear to be a more favorable AWP. To get to this level of transparency, you will need to ask very specific questions and may have to “run the numbers”. But without this degree of transparency and due diligence, it is difficult to get a clear picture of costs and ensure your PBM is really providing the lowest net cost to the plan sponsor.

Am I really getting this for free? 

Plan sponsors must also take responsibility for recognizing that the old proverb "if it seems too good to be true, it probably is," holds true for pricing within the PBM industry as well. A PBM may well offer to provide administration for free, but they will have to make up those monies somewhere – likely on the pricing or rebate side. That's where consultants play such a critical role in helping their clients understand the need to examine ALL elements that comprise the pharmacy benefit. Plan sponsors can't always accurately take a spreadsheet approach and say PBM A charges X for administration and PBM B charges XX. It is wise to examine the total costs and ultimately the impact on net cost to plan. It is better to pay a reasonable fee for program administration and know that you are getting high value for the money paid than to get free administration and not know how much the PBM is receiving from other revenue sources.

Has the PBM been sued for lack of transparency or unfair practices in the past? 

While many in the industry believe that past PBM practices such as hiding revenue sources or not fully disclosing revenue sources were simply the way business was done, some PBMs were and are still committed to transparency long before it became a controversial issue. When reviewing PBM proposals, likely some of those competing for your business will have been sued for disclosure practices; still others will have no legal action and will be able to prove their historical commitment to transparency. These PBMs will have more credibility and experience in implementing a fully "transparent" benefit.

Summarizing the Importance of Transparency and Full Disclosure

For transparency to become more than a marketing buzzword, it must be focused on ensuring that clients have a full understanding of how the business practices of their PBMs affect not only their pricing and rebates, but the overall quality of the program as well. As transparency becomes a key differentiator, PBMs will likely continue to find ways to further quantify their business practices, creating even more value to plan sponsors.  The key to ensuring maximum value is knowledge of what to look for in a strong transparency program and an understanding of the key questions to ask a PBM.

In this era of escalating healthcare costs and intense scrutiny on all facets of PBM pricing and practices, what plan sponsors really need are pharmacy benefit programs that exemplify the principles of knowledge, innovation and commitment. Health plans, employers, union trusts and other plan sponsors have every right to demand a PBM that offers the best pricing and overall programs, without games, without empty promises and without allegiances to outside organizations. To ensure that transparency provides real value to clients, look for PBMs that openly communicate all relevant sources of revenue and pricing policies, as well as the agreements with outside organizations. That means no games; no pricing programs that promise lower costs on one section of the benefit, while using higher pricing elsewhere, and a dedication to the plan sponsor and its people, not just to their own bottom line or to the pharmaceutical industry. The result of an open approach to pricing will be more assurances of fairness, lowest prices and ultimately a more stable and higher quality pharmacy benefit program for your client and their members.


© 2004 Prescription Solutions. All rights reserved


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