Pharmacy Benefits Management Glossary of Terms

Administrative Fees – Per claim fees paid by clients to PBMs for services like claims processing. Also used to denote the fees paid by manufacturers to PBMs for administering formulary rebate contracts.

Average Wholesale Price (AWP) – A published suggested wholesale price for a drug, based on the average cost of the drug to the pharmacy. AWP is often used by pharmacies to price prescription drugs.

Benefit Administration – The administration of drug benefit designs. It includes setting up and maintaining the drug coverage and exclusions, setting limits on drug coverages, and defining member cost sharing requirements.

Capitated Contract – A very rare contract among PBMs. It is used when a PBM agrees to assume financial risk for a client’s drug spending. Capitation is a set dollar amount, established by analysis of pharmacy claims data, used to cover the prescription costs for a member, usually set at a per member per month rate (PMPM).

Claims Adjudication – The online processing of a prescription drug claim. Most claims are submitted electronically at the point of service (the retail or mail pharmacy).

Client – A MCO, employer, or insurer that contracts with a PBM to administer their drug benefits and cost control programs.

Co-pay – A fixed dollar amount paid for every prescription.

Co-insurance – The fixed percentage members pay of the cost of each prescription.

Deductible – A specific annual dollar amount that a member must pay out-of-pocket for prescription drugs before the drug benefit program begins.

Disease Management Programs – Programs developed by PBMs to identify and categorize patients (especially those with chronic conditions) and to direct these patients towards a specific treatment protocol.

Fee-for-Services Contract – The most common pricing arrangement PBMs have with their clients. Under the contract, PBMs are paid for the administrative services they provide, and they do not assume the risk for the cost of the drugs dispensed.

Formulary – An approved list of branded (and generic) drugs developed by the PBM, or the client.

  • Open Formulary – A list of recommended drugs. Under this structure all drugs are reimbursed irrespective of formulary status. However, a client’s plan design may exclude certain drugs (OTC, cosmetic, and lifestyle drugs).
  • Incented Formulary – An incented formulary applies differential co-pays or other financial incentives to influence patients to use, pharmacists to dispense, and physicians to write formulary products.
  • Closed Formulary – A closed formulary limits reimbursement to those drugs listed on the formulary. Non-formulary drugs are reimbursed if the drugs are determined to be medically necessary, and the member has received prior authorization.

Health Care Financing Administration (HCFA) – the federal agency that administers Medicare, Medicaid, and the State Children’s Health Insurance Program (SCHIP).

Ingredient Cost – The cost to the pharmacy for dispensed drugs (AWP – discount %).

Click here to register for: “How To Slash the Cost of Your PBM Service, up to 50%, Without Changing Providers or Employee Benefit Levels.”

Mail Pharmacy – Mail pharmacies dispense a 90-day supply of drugs through the mail; typically used for chronic conditions. Most pharmacy benefit plans offer a mail pharmacy service as a way to promote cost savings and improve access.

Managed Care Organization (MCOs) – A broad term encompassing a variety of healthcare delivery systems utilizing group practice and providing an alternative to fee-for-service health plans. The primary goal of a MCO is to create incentives to use a prepaid and organized healthcare system that serves a defined population.

Manufacturer – A company that manufacturers branded and/or generic pharmaceuticals.

Maximum Allowable Cost (MAC) – The price basis for generic drugs which is typically 50–60% below AWP. PBMs can either set the MAC prices themselves, or use the MAC prices set by HCFA for Medicaid beneficiaries.

Member – A covered individual within a health plan.

PEPM – Per employee per month.

PMPM – Per member per month; in an employer plan includes employees and their covered dependents.

Pharmacy Benefit Manager/Management (PBM) – A company providing administrative and clinical services through a complex system that includes retail pharmacies, manufacturers, clients, physicians, and members. These companies administer drug benefits and drug cost control programs for their clients, and secure substantial discounts from retail pharmacies and drug manufacturers. PBMs establish and maintain large pharmacy networks with chain and independent pharmacies. Also, PBMs contract with manufacturers of branded products to receive rebates and administrative fees.

Pharmacy Network – Specifies which pharmacies are approved for members, and includes retail, mail, and in some cases specialty pharmacies.

Prior Authorization – A prior approval process that allows prescription drugs to be dispensed to members only when specific conditions have been met.

Shared Savings Contract – A contract between a PBM and a client that provides incentives for both sides to collaborate and run the pharmacy benefit effectively and to share in the overall cost savings.

Therapeutic Substitution Programs – Typically operated in mail pharmacies to encourage physicians and patients to switch from the drug prescribed to lower cost, comparable drugs. Substitution requires physician and typically member permission.

Rebates – Paid by manufacturers to PBMs for the sale of branded drugs to PBM members.

Usual and Customary (U&C) – The price pharmacies charge to cash paying customers for prescription drugs.

Utilization Management Programs – Programs designed to lower drug costs and utilization and to encourage the use of generics or preferred products. These programs include services such as prior authorization, drug utilization review (concurrent and retrospective), academic detailing programs, and patient education.

Click here to register for: “How To Slash the Cost of Your PBM Service, up to 50%, Without Changing Providers or Employee Benefit Levels.”

10 Questions to Ask your Pharmacy Benefit Manager

Pharmacy Benefit Managers are often known simply as “PBMs.” While they are largely unrecognized by most employees — and even by many benefit managers — they have a tremendous impact on US health care decision-making because they influence more than 80 percent of prescription drug coverage. The sector is dominated by a handful of very large national players, but there are smaller and regional PBMs as well.

PBMs commonly operate on behalf of employers, insurance companies, and unions; they are also sometimes referred to as “third-party payors.” The original purpose of PBMs was straightforward: issue drug cards for easy ID and account tracking and offer their customer groups cost-effective services as well as reliable claims information.

Over time, however, PBMs have evolved into much more complex organizations. PBMs now take advantage of various strategies associated with rapid growth, including large-scale “block purchases” of drugs and medical products that dramatically lower their wholesale costs — even as PBM fees have consistently increased for customers. Some PBM practices are, in fact, the subject of lawsuits or federal and state regulatory investigations.

So how can you, as a benefit manager, make the best pharmacy decision for your employees?  How can you have confidence that your company is receiving optimum PBM value and service?  What key questions should you ask your current or potential PBM—or your health insurer contracting with a PBM?  The following 10 questions are designed to help you and other Benefit Managers select the best PBM for your organizations.

1) Do you use the same average wholesale price (AWP) and maximum allowable cost (MAC) in calculating price to clients and payments to pharmacies?

Some PBMs realize hidden profits by employing a practice known as “differential or spread pricing.” Differential pricing is when a PBM establishes a discount off the average wholesale price (AWP) for the individual employee filling a prescription, but establishes a different AWP discount for retailers.

Here’s an example of differential pricing in action:

Your employee or group member pays AWP minus 15%
PBM pays retailer AWP minus 18%
PBM pockets the 3% differential

Although PBM revenues derived from differential pricing can run between $5 and $8 depending on the type of program served, typical PBM disclosed fees hover at $1 per prescription. While differential pricing is a common business practice, PBMs should disclose the differential to you or your health insurer.

If you have a plan governed by ERISA, you should keep in mind that the U.S. Department of Labor requires full disclosure of all compensation, fees, and income from a PBM that acts in a fiduciary capacity as an administrator and/or claims payor for an employer with a benefits plan.

Recommendation: Ask to see your PBM’s contract with network pharmacies (including large chains) and compare to the PBM’s contract with your organization. The reimbursement rates should be the same on both contracts for both AWP and MAC.

2) Do you participate in rebates from drug manufacturers?

PBMs often receive rebates from drug manufacturers in return for placing products on formularies and for working to increase sales volume for these drugs (rebates can range from $.50 to $2.50 per claim). Some employers permit PBMs to keep 100 percent of rebates in exchange for lower administrative fees. Alternatively, some employers have agreed to a sharing arrangement, typically 50/50.

Recommendation: Require your PBM to disclose the total amount of rebate dollars collected as a result of the business you represent to the PBM—and ask for supporting documentation that explains how rebate revenue is calculated.  Some PBMs reclassify rebates using categories such as education grants, research, advertising, promotion, access fees, formulary management fees, and data collection fees.  You are entitled to 100% of all rebates, regardless of reclassification, so be sure to get every penny and to spell this out in your contract.

3) Does your PBM offer full transparency and 100% pass-through?

Many PBMs offer “transparency” and they will even tell you how they make money by collecting network spread, mail order operations, or in rebates, but unless you are very experienced in the industry; it is difficult to ascertain the real amounts of money involved.

“Transparency and PASS THROUGH” means a PBM will collect an administrative fee for processing and managing the pharmacy benefit, but that is the only source of revenue.  Rebates are passed back 100 percent to the payor and there is no network spread. (These can be audited and validated very easily.)

In many cases, these newer model PBMs are not as big as the major players in the industry, but because of the type of model they operate, they can actually save the client money compared to a traditional model PBM due to the increased transparency and reduced alternate revenue sources other PBMs maintain.  Even the fact that they are smaller and have less perceived buying power is offset by the model design

Recommendation: Hire a consultant to help manage the PBM jungle, make sure that consultant is also transparent. That is, ask them if they have any ties to any particular PBM and ask them their philosophy regarding transparency in PBM operations.

4) Are your mail-order and retail MAC lists identical?

PBM operations have a lot of moving parts, and many processes that can be manipulated either intentionally or not.  For example, a PBM may agree to use a MAC (Maximum Allowable Cost) program for generic drugs, but neglect to tell the payer that they have multiple MACs that allow for additional margin to the PBM that may not be in the best interest of the payer.  The PBM may also use the MAC for their retail network, but not for their mail order operations.

Recommendation: Ask for a copy of the PBMs price lists (pharmacy and sponsor) and get regular updates.  Conduct periodic comparisons of actual claims cost to the PBMs price list.  If there is a difference in price then spreads or other hidden costs are likely the issues. It is red flag when a PBM does not offer full audit rights or access to all price lists.

5) Does your formulary limit drugs that will be covered?

A formulary is a list of “preferred drugs that pharmaceutical manufacturers discount to employers and other groups in exchange for volume usage.” The most effective formularies optimize and balance quality, effectiveness, and costs.

Check to see if your health plan has to pre-approve a medication before plan members can get their prescription filled. Many plans require physicians to get prior authorization of medications before the plan will cover the drug. That means physicians or pharmacists must call the health plan or PBM for permission to write or fill certain prescriptions.  Some plans also require members to try a less expensive medicine first, before they will cover the one recommended by the member’s physician.

Recommendation: Make sure that any switching of drugs is constructed to save you money and
not the PBM. Check with your plan to understand its authorization process so members are not
surprised when they arrive at the pharmacy. And, be sure to learn how to appeal requirements
and decisions when your members have complaints.

6) How often do you change your formulary?

In most states, even though medications may be covered when the health plan is selected, a PBM may change its list (both prices and availability) of approved medicines at any time throughout the year. If a medication is removed from the formulary without prior notice, the individual patient must either pay out-of-pocket or accept a medication that the PBM prefers.

Recommendation: Check with your PBM for policies related to formulary changes. Will you receive notice of formulary changes in writing?  If not, ask for notification.

7) How are co-payments set?

Most health plans require a co-payment for each prescription. Some plans have a single co-payment — for example, $10 for any prescription. Other plans have different levels of copayments for different medications, a system known as “tiered co-pay.” A PBM can shift medications from tier to tier at any time, leading to potentially unpleasant surprises for employees presenting prescriptions at pharmacies.

Recommendation: Ask about how you and plan members will be notified when the PBM makes a tiered co-pay change for a medication.

8) Do you offer performance guarantees?

Performance measurement is a key function for clients as they assess their ongoing relationship with their PBM. Traditionally, performance measurement is divided into the following two categories: Cost and utilization; and PBM service performance.

Cost and utilization performance measurement includes such metrics as the number of prescriptions dispensed per member, average ingredient cost per prescription and per member, generic use rates, and rebates. Cost and utilization results may vary significantly by client based on the client’s demographics and the client’s overall benefit plan design.

Conversely, PBM service performance measurements are more uniform. Clients have established a series of benchmarks and service guarantees to measure the overall service performance of a PBM. Many of the service guarantees were derived from the guarantees used by medical claims administrators. Service guarantees deal primarily with the administrative aspects of a PBM’s performance, as this is the main service provided by the PBM.

Since PBMs do not manufacturer, prescribe and dispense drugs (with the exception of mail order), the service performance measurements are the main “quality” measurement for a PBM.

Recommendation: One of the best means of tracking overall PBM performance is by conducting annual customer satisfaction surveys. In almost all cases, the monitoring of performance measures is performed and paid for by the PBM.  Another feature that all clients should demand is a market check at specified intervals during a typical three year contract – say, every year or at the 18 month mark – such that there is an opportunity to review and renegotiate some of the terms if market conditions change.

9) Can you provide a detailed explanation of your fee schedule and specifically the cost of clinical programs?

Be sure to compare “apples to apples” when evaluating a financial proposal from a PBM.  Inexpensive claims processing fees may be less attractive if you are “nickel and dimed” on everything else. Clinical programs are an area where fees vary widely.

For example, a prior authorization (PA) program establishes protocols for prior approvals of expensive, nonformulary drugs. A PA program is one tool, among many, that keep costs under control. However, PA program fees vary widely, ranging from $2 to $40 per PA.

Recommendation: Ask for detailed disclosure and explanation of a PBM’s fee schedule. If policies related to prior authorization systems are not clearly explained — ask.

10) What is your policy on selling pharmacy data?

In the business of health care, information equals revenue.  Every drug manufacturer would like to know about your plan members’ demographics and utilization patterns.  You have the right to demand that your company’s proprietary information not be sold by your PBM to the highest bidder.  And, that all PBM practices are in compliance with the privacy regulations established under the Health Care Portability and Accountability Act (HIPAA).

Recommendation: Ask the PBM to include a paragraph covering the sale of data in your contract. If you have no objection to aggregate data being sold, you should still require disclosure of the sales. Also consider the value of your company’s data and whether or not to ask for some form of compensation from the PBM.

All of the above questions are important points to keep in mind the next time you have the opportunity to comparison shop for a PBM. Just remember that it is only after the layers of each offering are peeled back will the PBM representing the best fit be determined.

What is a spread? Certainly not a Topping for Toast.

Plan sponsors, while getting smarter about managing prescription drug benefits, continue to be plagued by drug spreads.  A drug spread is the difference between the amount paid to a PBM and the amount that should’ve been paid, by the plan sponsor, for the prescription drug ingredient portion of a transaction in the pharmacy benefit manager’s retail pharmacy network.  This definition is very simplistic, but the strategies a PBM employs to maintain these spreads are often complicated and inconspicuous.

The larger spreads generally take place with generic medications.  This is due in part to much smaller COG (cost of goods) and larger profit margins attained from generic compared to brand medications. Think about it for a second.  A generic medication may have fifteen different manufacturers (multi-source) all competing for the same purchaser while a brand product will have in most instances only one manufacturer (single-source).  This, ultimately, leads to lower costs for generic medications and much higher costs for brand medications.

Supply-side economics tell you that much more money is too be had from the sell of generic medications vs. brand medications.  Don’t be upset with your local pharmacist due to the high price of brand medications.  He or she has very little control, to the downside, on the price of these products.

Small to medium-sized businesses are most often the victims of spreads.  Larger companies often maintain a staff (which may include a seasoned pharmacist or two) dedicated to thwarting the efforts of any PBM attempting to hide cash flows.  Make no mistake about it; spreads are an opportunity cost and hidden cash flow.  I urge you to read the pilot study conducted by American Pharmacists Association.  Here is the abstract from this study.

Objective: To document the difference between what pharmacy benefits management companies (PBMs) charge employers and what they pay dispensing pharmacies for the drug ingredient portion of prescription transactions (the “spread”).

Design: Descriptive, cross-sectional study.

Participants: Two large employer groups, each of which used a different PBM, and six independent community pharmacies participating in these plans during 2002.

Interventions: Two sets of financial records issued by each of two PBMs were reviewed retrospectively, including 129 line-item prescription transactions billed to the employer and the line-item transaction information that accompanies the PBM payment to the dispensing pharmacy.

Main Outcome Measure: Spread between drug ingredient cost billed to the employer by the PBM and drug ingredient cost paid to the dispensing pharmacy by the PBM for brand name versus generic drug products.

Results: For both PBMs, the mean (± SD) spread was $12.29 ± 27.93 per prescription, with a range of –$1.67 to $201.65. Considering all 129 transactions, the mean spreads for brand name and generic medications were significantly different from one another, with mean (± SD) spreads of $4.65 ± 10.47 and $23.45 ± 39.47 per prescription, respectively. The two PBMs differed significantly in their spreads for brand name drugs ($3.20 ± 2.85 and $5.93 ± 14.12), but the spreads for generic products did not achieve statistical significance in absolute dollars ($10.83 ± 13.58 and $31.74 ± 48.11) because of their greater variation (as reflected in the larger standard deviations). However, the percentages difference for generic products differed significantly.

Conclusion: This pilot study indicates the possibility of substantial and widely varying differences in the spread and spread percentage between PBMs for brand name and generic medications. A more transparent business model for the PBM industry could produce better relations with PBM clients and business partners, including community pharmacies.

I know what you’re thinking, “there is no way this is happening to my organization.”  Guess what yes it is unless your PBM has agreed, contractually, to a fiducuary role.  And if you’re a fully-insured company with more than 300 employees forget about it!  You may as well send your insurer or TPA a blank check and ask them [nicely] to fill it in with any amount they believe suitable for the drug portion of your health benefit.