Pharmacy risk-sharing promotes savings - includes related article - Pharmacy Benefits Management: The Next Generation supplement

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When the Ford Motor Co. sought bids on its $174 million pharmacy benefit, management knew it had the clout to ask for--and receive--a capitated rate from pharmacy benefit managers (PBMs). Chrysler recognized its clout, as well, and in the past two years, both auto makers have signed similar capitated PBM contracts. With the stroke of a pen, these self-insured employers set a precedent that other employers and employer groups may follow.

The benefits offered by auto makers often serve "as a bellwether for other unions," says Beach Hall, a health care consultant in Detroit and former director of health plans at General Motors. Two aspects of the contracts stand out, he says. The first is that they introduced a managed pharmacy benefit in lieu of an indemnity drug program. The second is risk-sharing.

Capitation and sharing risk have been used in medical care to ensure that managed-care organizations control costs. Employers prefer these arrangements because they can budget accurately for health care. Health plans that can meet fixed targets also prefer risk-sharing and capitation, because they stand to earn more if they exceed expectations.

But when it comes to drug plans, risk-sharing is relatively new, partly because many plan sponsors have not focused on the costs of pharmacy benefits. FAS No. 106 changed that. That rule, issued by the Financial Accounting Standards Board in Norwalk, Conn., required all employers, beginning in 1993, to record a liability on their financial statements for their future obligation to provide medical benefits to retirees. For retirees over 65, most of these costs arise from pharmacy benefits, because Medicare does not pay for prescription drugs.

When companies with numerous retirees, such as the automotive industry, reviewed their benefit liability for future retirees, they underwent their own version of sticker shock. They wanted to slow the increases in pharmacy benefits, and they wanted to predict the cost. "Capitation seems like a 'quick fix' when retiree costs are an issue with an employer," notes Elizabeth Dichter, who is executive vice president of strategic marketing for PCS Health Systems Inc. in Scottsdale, Ariz.

Soon other employers were eyeing their prescription drug costs. They saw that, even as medical plan inflation began to be reined in, their drug cost trend still seemed out of control.


Curiously, plan sponsors that had carved out drugs as a separate benefit plan discovered their costs rose sharply. PBMs call it the "shoebox" effect. Employees who might place their prescription receipts in a shoebox until they file the claims under a traditional indemnity plan might never empty the shoebox. But when a pharmacy benefit is available at the point of purchase without any managed-care aspects, as in some card systems, that claim is submitted and the employer pays--and pays.

"Utilization increased when the benefit was put in without control," explains Barry Smith, chairman of ValueRx Pharmacy Programs, Bloomfield Hills, Mich., a subsidiary of Value Health Inc., Avon, Conn. "The payors felt they were sold a bill of goods. They felt they needed to put some teeth into these agreements."

As PBMs have become more adept at managing drug benefits in addition to processing claims, they've been able to reduce drug costs substantially. Maureen Quinn, senior benefits consultant for Chemical Bank in New York, implemented a drug plan in January 1994 and found that her initial savings were much more than the 10% to 15% a year she had budgeted for. This sharply reversed an upward trend that included a 2% increase in 1993. Confident they can produce those types of results, PBMs have begun to accept the notion of risk-sharing.


Risk-sharing arrangements vary by contract, but in essence they set an annual target of cost per member for ingredient cost, the cost of the medicines themselves. If the cost per member comes in lower than the target, then the PBM and the employer usually share the savings equally. If costs exceed the target, the employer pays only 50% of the extra cost--the PBM swallows the rest. If a contract calls for capitation, then the employer spends the fully capitated amount per member, whether the cost is incurred or not. Only the PBM bears the risk.

Aside from the auto makers, whose union contracts leave little leeway to change plan design, many employers believe they have more to gain from risk-sharing than from capitation. Risk-sharing rewards employers that can influence employees to choose the least expensive drugs, usually through financial incentives, says Dave Teckman, senior vice president of sales, National Accounts and Carriers Division at PCS. "Employers have to have some financial participation by the employee in the overall cost. Co-insurance works well if it is a percentage, not just a set amount. Otherwise, the true cost of the medication is hidden."

If an employer can motivate employees to hold down ingredient costs, risk-sharing may cost less than capitation. That's because PBMs will set capitation rates higher than target rates for risk-sharing to cover their liability. "We always seem to set a higher capitation cap than risk-sharing target," says Kris Gibney, vice president, prescription services, Caremark International in Northbrook, Ill. "When you don't have all the historical data, you figure what a fiat cap rate would be, and then add some in. Corporations are saying, 'I don't want to have to cover that.'"

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