No. 749

ISSUE BRIEFThe ABCs of PBMsWednesday, October 27, 1999Washington, DC

A discussion featuring

Peter D. Fox, Ph.D.PresidentPDF Incorporated

Terry S. LatanichSenior Vice PresidentMerck-Medco Managed Care

Chris O’Flinn, J.D., LLMManager of Global BenefitsMobil Corporation

Phonzie BrownVice PresidentMIM Health PlansNashville, Tennessee

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ISSUE BRIEF/No. 749

Analyst/Writer: Robin J. Strongin

National Health Policy Forum2021 K Street, NW, Suite 800Washington, DC 20052202/872-1390202/862-9837 (fax)nhpf@gwu.edu (e-mail)www.nhpf.org (Web site)

Judith Miller Jones, DirectorKaren Matherlee, Co-DirectorMichele Black, Publications Director

NHPF is a nonpartisan education and informationexchange for federal health policymakers.

The ABCs of PBMs

As Congress continues to consider adding an outpa-tient prescription drug benefit for Medicare beneficia-ries in this presidential election year, the number ofadministrative and legislative proposals goes on climb-ing. While the nature and scope of these proposals varywidely, they all contain a common element, the use ofPBMs—pharmacy benefit managers.

By acting as intermediaries between pharmaceuticalmanufacturers and third-party payers (that is, employ-ers, managed care organizations, labor unions, andstate-funded pharmaceutical assistance programs for theelderly), PBMs administer prescription drug benefits. Amajor policy and, indeed, practical consideration, willbe the degree of latitude provided a PBM in managinga Medicare outpatient drug benefit.

As new tools to control drug costs have emerged,PBMs have enjoyed dramatic market success. Alongwith the tremendous growth enjoyed by the PBMindustry in the past decade, however, has come in-creased public policy attention.

The FTC is scrutinizing PBMs for possible antitrustviolations, the FDA is concerned about their drugswitching and information disclosure policies, and theGAO is examining how PBMs affect access to drugbenefits in the Federal Employees Health BenefitPlan. To date, however, the degree of actual govern-ment intervention has been modest. This may changein the future.1

In addition to providing background information onthe history and structure of PBMs, this Forum session willfocus on the following public policy questions raised bythe potential use of PBMs in a Medicare milieu:

� What challenges would the government face actingas a purchaser contracting with a PBM?

� What role would PBMs play?

� What tools would PBMs use?

� What implementation obstacles would PBMs haveto overcome?

� How would various stakeholders be affected?

� What impact on quality of care can be expected? Oncost?

� What unintended consequences might result fromthe use of PBMs?

� What competitive issues (within the PBM marketand within the broader health care marketplace) willneed to be addressed?

� What additional research on PBMs is needed?

It is interesting to note that several of these and relatedissues (for example, questions surrounding the potentialconflicts of interest, given the financial arrangements andownership of some PBMs, and consumer protection andconfidentiality of medical data) will remain on the currenthealth care policy radar screen, regardless of the outcomeof a Medicare outpatient drug benefit. In fact, many of thecost management issues that would arise under a Medi-care outpatient prescription drug benefit currently applyto Medigap plans.

EVOLUTION OF THE PBM INDUSTRY

In existence since the late 1960s, the PBM industryhas its roots in claims administration. As prescriptiondrug coverage increased in the private sector, insur-ance companies were faced with the daunting chal-lenge of managing efficiently and economically a highvolume of relatively small dollar claims. It was in thisarena and in the related information systems field thatPBMs were born. Having mastered the art of datastandardization, PBMs became leaders in the field ofelectronic claims processing.

Ushering in a decade of rapid growth for PBMs, thedevelopment of the plastic drug benefit identificationcard in the 1970s changed the way many prescriptionswere bought and paid for. Since that time, an eligible

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InterventionsConsumer behaviormodificationEnhanced patientinterventionsPhysician connectivityClinical consultingDisease managementDUR, includingretrospectiveMailRetail interventionDrug interaction

ManufacturerCompetitive rebatecontracts

Base ServicesPatient informationsystemMember level dataPhysician level dataEfficient transactionprocessingPharmacy networkMail service fulfillment

InterventionsMSA DURMailRetail interventionDrug interaction

ManufacturerCompetitive rebatecontracts

Base ServicesEfficient transactionprocessingPharmacy networkMail service fulfillment

InterventionsPhysician connectivityClinical consultingRetrospective DURDisease managementDUR, includingretrospectiveRetail interventionDrug interaction

ManufacturerCompetitive rebatecontracts

Base ServicesMember level dataPhysician level dataEfficient transactionprocessingPharmacy networkMail service fulfillment

InterventionDrug interaction

Base ServicesEfficient transactionprocessingPharmacy networkMail service fulfillment

1980sEfficient BenefitAdministration

Early 1990sCost and

Clinical Control

Mid 1990sImproved Outcomesthrough Information

2001Patient Health

Focus

Source: PCS Health Systems, June 1999..

EVOLUTION OF PBM BUSINESS

employee armed with an identification card and usinga network pharmacy pays only a small copayment. Thepharmacist receives the balance from the PBM. Thepatient is no longer required to file paper claims and thepharmacist is paid quickly.

In addition to the card system, PBMs created phar-macy networks and pioneered mail service benefits thatenable patients to receive medication through the mailat discounted prices. All of these advances have trans-lated into administrative simplification and reducedadministrative costs.

Another milestone came in 1987, with the introduc-tion of online, real-time electronic drug claims process-ing. As information technology advanced, PBMs weresuccessful in establishing links with pharmacies toenable two-way communication of not only claims databut also clinical information. The entire claims adjudi-cation process became paperless. This advance yieldedan extremely valuable tool for PBMs—a massivecomputer database of prescription records.

The 1990s have witnessed a move by PBMs towardsa greater patient health focus. In addition to fulfilling

their traditional claims processing function, PBMs haveevolved into much more complex organizations, offer-ing a variety of products and services (Figure 1).

THE PBM MARKET

According to the most recent data collected by thePharmaceutical Care Management Association(PCMA), the organization representing “managed carepharmacy, pharmacy benefits management companies,and their healthcare partners in pharmaceutical care,”

� PBMs manage about 1.8 billion prescriptions annu-ally, 70 percent of all prescription orders dispensedfor ambulatory care patients.

� PBMs employ more than 9,000 pharmacists.

� Over two-thirds of prescriptions are covered bypharmacy benefits.

In a recent article, “Pharmacy Benefit ManagementCompanies: Dimensions of Performance,” Helene L.Lipton and colleagues2 noted that, while estimates of thetotal number of PBMs vary slightly due to differences in

Figure 1

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the definition of PBMs, the top ten listed in Table 1(particularly the top four) account for the bulk ofcovered beneficiaries.

Table 1Lives Covered by

Leading Pharmacy Benefit ManagementCompanies, as of December 31, 1997

(in millions)

PCS Health Systems 56.0

Merck-Medco Managed Care, L.L.C. 51.0

Express Scripts/Value Rx 22.7

Diversified Pharmaceutical Services 21.0

WellPoint Pharmaceutical Services 15.5

Integrated Pharmaceutical Services 14.0

Advance Paradigm 13.0

Medimpact Healthcare Systems 12.0

Caremark, Inc. 10.0

Eckerd Health Services 9.0

Source: Helene L. Lipton, David H. Kreling, Ted Collins,and Karen C. Hertz, “Pharmacy Benefit ManagementCompanies: Dimensions of Performance,” Annual Reviewof Public Health, 1999, 20:361-401; data from SMGMarketing Group, Inc. © 1998.

PBM MERGERS AND ALLIANCES

During the 1990s, there was a great deal of jockey-ing within the PBM market, a highly penetrated marketcompared to just a decade ago. In order to remaincompetitive, PBMs have, over the years, merged andformed strategic alliances. Most recently, in 1998 and1999, four major mergers occurred: Rite-Aid’s purchaseof PCS, Express Scripts’ purchase of Value Rx andDiversified, and Advance Paradigm’s purchase ofIntegrated Prescription Solutions.3

While most of the PBM mergers and businessalliances have not come under scrutiny, there have beenseveral instances where critics have questioned thepossibility of conflict. In a book published in 1998,Sheila R. Shulman and Louis Lasagna noted that4

Among other things, questions have arisen about theability of PBMs to conduct their business independ-ently, particularly with respect to the selection ofdrugs for formulary inclusion and with respect tocommunications between PBMs and their managedcare or corporate clients. . . . All of these new organi-zational structures (between PBMs and drug compa-

nies, pharmacy chains, and institutional providers)have generated questions about the roles and interestsof the various parties. . . . Still another set of concernsrelates to the increasing centralization of the drugselection process. The pharmacy and therapeuticscommittees of large PBMs select the drugs for formu-lary inclusion. In so doing, they are effectively deter-mining the drugs to be taken by tens of millions ofpatients in the U.S. What appears to be the distancingof the physician from the final drug selection processraises questions about the impact of PBMs on thenature and quality of direct patient care.

PBM CONTRACTS: EXPECTATIONSAND PAYMENT ARRANGEMENTS

As the PBM industry continues to evolve, themanagement of prescription drugs has become increas-ingly sophisticated. Every customer, whether a man-aged care organization, manufacturer, or employer,enters into an agreement with a PBM with a variety ofexpectations, as illustrated in Figure 2.

Paying the PBM

The different contract arrangements—fee-for-service, risk sharing, and capitation—each offer advan-tages and disadvantages (Table 2). Currently, PBMsgenerally do not go at risk. Rather, the majority of theirpayment comes from fee-for-service arrangements forclaims processing and selected services, such as reportsor disease management programs. In addition, PBMsare compensated by retaining a fraction of the rebatethey negotiate with the manufacturer.

PBM SERVICES

In addition to offering their core services—claimsprocessing, record keeping, and reporting programs—PBMs offer their customers a wide range of services,including drug utilization review, disease management,consultative services, and most recently, Internet prescrip-tion fulfillment. (Issues regarding online pharmacies willbe the focus of a future Forum session.)

PBMs also assist clients with establishing theirbenefit structure. Options for plan design includedeveloping and maintaining a network of pharmacyproviders, providing a mail service component, anddeveloping and maintaining a drug formulary.

Retail Pharmacy Networks

Beneficiaries can receive their medication throughretail pharmacies, mail service, or a combination of

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HMO-Managed Care

Control of product selectionComplex data analysis andreportingControl of member andphysician relationshipComplex benefit designwith rapid changesClinical services

Manufacturers Employers

Mail retail interventionsData accessSegmentation of PBMcustomersFormulary access/controlAccess to customerpayers

Simple benefitsFew customerdisruptions andinterventionsLarge pharmacy networkPredictable costConsulting services

������

����

PBMs

MarketingBusiness strategyIS development andresourcesIntervention and formularypolicies

Source: Health Strategies Group, Inc., 1999.

PBM CUSTOMER EXPECTATIONS

Figure 2

Table 2Advantages and Disadvantages of PBM Contract Types

Advantages Disadvantages

Fee-for-service � Potential for lower cost because the PBM isnot exposed to insurance risk.

� Employer does not know in advance what thecost of the pharmaceutical benefit will be.

Risk sharing � Employers have an incentive to help controlcosts. To the extent that the employers caninfluence employee utilization patterns (that is,through coinsurance), they can achieve costsavings.

� PBM has a financial incentive to control thecost of the benefit.

� Few companies have the data necessary toaccurately price the drug benefit.

� Potential for higher cost due to partialinsurance risk.

Capitated � Employers know the annual price of thepharmaceutical benefit in advance and canplan accordingly.

� If the PMPM* rate is set too low, employersbenefit at the PBM’s expense.

� Few companies have the data necessary toaccurately price the drug benefit.

� Potential for higher overall costs due to fullinsurance risk.

� If the PMPM rate is set too high, the PBMbenefits at the employer’s expense.

*Per member per month.Source: Robert J. Rubin, Anne Hawk, and Elisa Cascade, “PBMs: A Purchaser’s Perspective,” in PBMs: Reshaping thePharmaceutical Distribution Network, ed. Sheila R. Shulman, Elaine M. Healy, and Louis Lasagna (Binghamton, N.Y.: ThePharmaceutical Products Press, 1998), 35.

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both. Retail pharmacy networks can be either open (veryinclusive) or preferred (very restrictive). In an opennetwork, beneficiaries enjoy greater access, but typicallyat a higher cost per prescription. Preferred pharmacynetworks, while restricting access, are able to offer greaterdiscounts in exchange for increased service volume.

If PBM contracts can be restricted to limited numbersof pharmacy providers, additional discounted pricesmay be obtained from those participating providers, inreturn for the potential for increased customer volume.However, in 31 states there are legislative barriers inthe form of “any-willing-provider” laws that canconstrain PBMs from excluding pharmacies from thenetwork.5

Independent pharmacies contracting with PBMs haveraised a number of concerns, one of which involveswhat the pharmacies consider to be “frighteningly lowpayment rates . . . offered on a take it or leave it basis. Infact, several hundred community pharmacies have goneout of business in the last three years. A primary causeof this is continued low reimbursement rates paid byPBMs.”6 (Under a typical arrangement, a pharmacyreceives the list average wholesale price for a drug,minus a percentage, usually around 12 to 15 percent. Inaddition, the pharmacist receives a dispensing fee,typically $2.00 to $2.50 per prescription.) Others pointout, however, that while payment rates may havecontributed to the demise of many of the communitypharmacies, other factors, such as the proliferation ofthe chain drug stores, were also involved.

Advocates of PBMs point out that one of the majoradvantages of PBMs, given the breadth of their data-bases, is their ability to pick up potentially dangerousdrug interactions. In addition, given the PBMs’ abilityto amass a patient’s drug history in one place, they canmore easily spot inadequate prescribing and refilling ofdrugs used to treat chronic conditions.

Mail Service

In addition to retail pharmacy, the use of mail servicehas been growing. The 1998 edition of PharmacyBenefit Report: Trends and Forecasts, published byNovartis, reported the following:

� 91.3 percent of HMOs surveyed estimated they willoffer mail service by 1999, favoring an externallycontracted service to manage this option.

� Mail service is predicted to constitute nearly 10percent of total prescriptions and over 22 percent oftotal budget dollars by 1999, with the dispensingratio of brand to generic remaining fairly constant infavor of brand.

� PBMs report that mail service is mandatory forabout 16 percent of the retiree benefits they manage.

The 1998 edition of the Novartis Pharmacy BenefitReport: Facts & Figures concluded that

mail service continued to be a source of savings formembers who share their pharmacy benefit coststhrough copays. Usually covering a 90-day supply(actual days’ supply reported averaged 88 days), mail-service copays ranged to $45 for brands and $20 forgenerics from lows of less than $2 in some staff-modelplans. The mail-service brand copay averaged $13.88.Compared to the patient who pays an average of $8.65for a 30-day supply of a brand prescription obtainedthrough a retail pharmacy, mail service represents avalue.

Mail service pharmacy must be used judiciously inorder to retain its value. Robert J. Rubin and colleagueshave noted, for instance, that

the use of mail service is increasing because of itspotential to be a low-cost and convenient means ofproviding maintenance medications for chronic condi-tions. However, faulty benefit design might decreaseexpected savings if employee cost-sharing is set artifi-cially low or if mail service is used to distribute medi-cations for acute (i.e., nonchronic) medical conditions.7

Drug Formularies

The formulary—which specifies which drugs will becovered and therefore paid for—is the centerpiece ofthe pharmaceutical benefit. A powerful lever fortransforming the drug purchasing market, formulariesfall into three broad categories: open, or voluntary;managed, or preferred; and closed, or restricted. Liptonhas offered the following distinctions based on the workof David H. Kreling8 and K. A. Schulman9:

Open formularies are the least restrictive type offormulary, listing all drugs and drug products buttypically providing rankings of which products arepreferred relative to one another; full reimbursementis provided for nonformulary drugs.

Managed formularies are similar to open formular-ies in their breadth of covered products but use incen-tives and interventions to encourage the use of “pre-ferred” products by physicians (e.g., drug withholds,academic detailing, and prior authorization), pharma-cists (e.g., higher dispensing fees to pharmacies forformulary compliance), and patients (e.g., highercopayments if nonpreferred drug products are used).

Closed formularies are the most restrictive, relyingon a limited list of drugs approved for use or coveredunder the health plan; in the past, closed formulariesallowed patients access to nonformulary drugs only afterthey paid a financial penalty (e.g., a higher copaymentor the price difference between a formulary product and

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its related nonformulary product); increasingly, closedformularies are growing more restrictive by requiringpatients to pay for nonformulary drugs in their entirety(unless an exception is granted via a prior authorizationprocess.)

How drugs make their way onto a particular formu-lary is a complex process. Members of a pharmacy andtherapeutics (P&T) committee usually assist in thedecision. Criteria for formulary inclusion include thesafety and efficacy of a drug product. Another criterion,the cost of the product, has become an increasinglyimportant consideration.

Many of the new breakthrough drug and biotech-nology products on the market, while clinically valu-able, are expensive. The decision to include or excludethese products from a formulary has the potential toprofoundly affect patient health outcomes. Many criticsare concerned that, while even restrictive formulariesmake available nonformulary products, the price is toohigh, especially for lower-income patients. The abilityto successfully appeal for coverage of a nonformularyproduct is a growing health policy concern, particularlyas the use of open formularies decreases.

Rebates

In an effort to save plan sponsors money, PBMsnegotiate with pharmaceutical manufacturers for rebateson products selected for the formulary. According to aMay 1997 American Druggist article, “Tug-of-Warover Rebates,” by Robert DiChiara, Patricia Pesanello,and Ellen Cappelino, rebates flow from the manufac-turer through the PBM and are split with the benefitplan of the HMO or employer (Figure 3).

Rebate arrangements have caught the attention ofmany, especially in Washington, D.C. Critics argue thatthe potential is there for products to be included on the listof preferred formulary drugs on the basis of the rebatenegotiated rather than the drug’s clinical efficacy. Often,the terms of individual rebate agreements are confidentialand not made public, even to the plan sponsor.

In his July 13,1999, New York Times article “Track-ing Just What the Doctor Ordered,” Robert Pear pointedout that, should Medicare become a PBM customer,

Congress and the public would probably insist onknowing the details of any discounts negotiated onbehalf of Medicare patients. The Comptroller Generalof the United States would want to audit Medicare’sdrug spending. Medicare officials would be temptedto regulate the activities of pharmacy benefit manag-ers to protect Medicare patients and to save taxpayers’money. And pharmacists would demand an explana-

tion if they were excluded from the list of drugstoresserving Medicare beneficiaries in a particular region.

Figure 3

TOOLS OF THE TRADE

In order to achieve their double-pronged goal ofobtaining cost savings and increasing patient health carequality, PBMs have developed a broad spectrum oftools. For example, PBMs rely on utilization controlmeasures such as prior authorization to minimize netdrug costs for at least a comparable level of quality.

Another crucial group of tools relied upon by PBMsare those geared toward encouraging formulary compli-ance by patients, physicians, and pharmacists. Aformulary is only as good as its implementation. Manyof these tools have their origins in the managed careworld and have been adapted specifically to the phar-maceutical sector.

Patient Cost-Sharing

Copayments are the most common type of cost-sharing. For example, in response to rising drug costs,insurers have begun a three-tiered copay arrangement.Typical of this arrangement are copays in the followingamounts: $5 for generics, $10 for preferred brand-namedrugs, and $20 to $25 for nonpreferred brand-name drugs.

Most recently, health plans such as Highmark BlueCross and Blue Shield of Pittsburgh are considering

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calculating copayments as a proportion of drug costs,perhaps as much as one-third. This approach is essentiallya form of coinsurance. The objective with both copaysand coinsurance is to motivate beneficiaries to use themost economical drug, whether purchasing prescriptionsin a retail pharmacy or through a mail service.

Based on data from the 1998 Managed Care Phar-macy Director CUE Program, the Novartis 1998Pharmacy Benefit Report: Facts and Figures indicatedthat “the differential between brand and generic copay-ments for formulary drugs tightened at $8.65 to $6.02,respectively. The copayment for nonformulary brandsjumped to an overall average of $12.28, with highsranging to $25 in some IPA models.”

Physician Prescribing Practices

Getting to the physician early on is critical forformulary compliance. In addition to the more tradi-tional methods, such as communication about preferreddrug products between doctors and PBM pharmacistsand informational materials sent directly to patients, arecent approach involves the assumption of risk on thepart of physician organizations—a potent incentive forformulary compliance. Not surprisingly, most physi-cians are less than enthusiastic about this arrangement,particularly as drug prices continue to climb and direct-to-consumer advertizing continues to increase.

Physician connectivity—enabling the physician inhis or her office to prescribe online—is one of thenewest tools making its way into medical practice.Going from a POS (point of sale) system in the phar-macy to a POP (point of prescribing) system in thephysician’s office enables the PBM to intervene morerapidly. A problem message (such as “potential druginteraction” or “nonformulary drug”) could immediatelyflash on the physician’s computer screen, allowing aphysician to change the prescription instantly, thuseliminating the need for the pharmacist to call. Whilethis technology exists, it is not yet widespread. It isthought that within five to ten years this tool willbecome commonplace.

Formularies and PharmacistsTo encourage formulary compliance by pharmacists,several PBMs have instituted financial incentives,such as “floating” dispensing fees based on formularyor generic dispensing levels attained within specificpharmacy networks. Kreling et al. found that pharma-cists’ willingness to respond to such incentives maybe mitigated by other requirements and incentivescreated by PBMs, such as high-volume dispensing andtime-intensive documentation of drug interchanges.10

Drug Interchange Programs

The use of various drug interchange programs byPBMs, such as generic substitution and therapeuticsubstitution, has sparked a good deal of controversy. Atissue is the question of whether these programs compro-mise patients’ access to necessary therapies, therebycontributing to negative health outcomes. On the otherhand, proponents are of the opinion that these programshold great promise in slowing the growth rate of drugexpenditures by promoting clinically appropriate andcost-effective products.

PBMs are geared towards keeping costs down fortherapeutically similar drugs. The challenge will be infiguring out how to moderate spending for new, im-proved, more expensive products.

THE FORUM SESSION

Should an outpatient prescription drug benefit beimplemented under Medicare and should PBMs becomea cornerstone of that benefit, Medicare will most likelyfind itself in a precarious situation. While it will enjoyits clout as a (very) large purchaser, it will no doubt besubjected to the vagaries of special interests and thescrutiny of Congress—challenges private companies donot have to overcome. Additionally, the administrationof such a benefit and the infrastructure necessary totransform policy into practice raise numerous questions.

The purpose of this Forum meeting is to shed lighton the structure of PBMs while raising implementationissues and public policy concerns regarding their role ina Medicare outpatient prescription drug benefit. It isnot, however, designed to address whether Medicareshould cover outpatient prescription drugs and what thatbenefit should be.

Peter D. Fox, Ph.D., president of PDF Incorpo-rated, is a consultant who specializes in managed carefor both private- and public-sector clients. He hasassisted clients in selecting PBMs and is currentlypreparing a report for the American Association ofRetired Persons’ Public Policy Institute on the costmanagement issues that could arise if a Medicareoutpatient prescription drug benefit materializes. Foxwill lead off with an overview of PBMs, focusing onthe complex relationships between stakeholders andPBMs. He will also illustrate the various techniquesutilized by PBMs to decrease drug spending. In addi-tion, he will address administrative issues related to theHealth Care Financing Administration should a Part DMedicare drug benefit materialize.

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Terry S. Latanich, senior vice president for govern-ment affairs with Merck-Medco Managed Care, willprovide the “inside story” of PBMs, focusing hisremarks on the potential role of PBMs in a broad-basedMedicare outpatient prescription drug benefit. ChrisO’Flinn, J.D., LLM, manager of global benefits forMobil Corporation, will describe the private-sectorexperience with PBMs, both in specific terms regardingMobil’s retirees and more generally regarding Mobil’spart in the three-year-old National Prescription DrugCoalition, a prescription drug group purchasing entity.

Wrapping up the session will be Phonzie Brown, vicepresident of MIM Health Plans. Brown will discuss theadvantages and disadvantages of PBMs in the Medicaidprogram (specifically in the TennCare program) and willshare Tennessee’s experiences with outpatient prescrip-tion drugs, PBMs, and that segment of its populationdually eligible for Medicare and Medicaid. This group,although small, accounts for a significant amount of drugspending. The lessons learned from the states will beimportant as policymakers analyze the potential Medicareoutpatient drug benefit.

GLOSSARY11

Academic detailing: An educational outreach programin which pharmacists provide one-to-one, objective, andunbiased consultations to physicians, designed topromote cost-effective drug prescribing.

Average Wholesale Price (AWP): the published sug-gested wholesale price of a drug obtained from the drugmanufacturer/labeler or from a price survey of wholesal-ers; often used by pharmacists to price prescriptions;drug manufacturers suggest a list price that wholesalerscharge pharmacies; the average of the list prices, col-lected for many wholesalers, is called a drug's AWP.

Capitation: A method of reimbursement in which pay-ments are made in advance on a per-member-per-month(PMPM) basis to a health care provider for providingspecified services during a specified period of time toenrolled members of a managed care organization.

Carve-out: Agreement between a managed care organi-zation or other insurer and a separate firm or organiza-tion that specializes in providing specific plan benefits(for example, mental health services or pharmacybenefits) on a stand-alone basis.

Chargeback: An amount of money returned by a pharma-ceutical manufacturer directly or through a wholesaler to

an HMO after the HMO's purchase of pharmaceuticals. Achargeback is essentially a "discount" for the purchase ofthe pharmaceuticals. It is usually the difference betweenthe average wholesale price of a drug and the price bid bythe pharmaceutical manufacturer.

Closed formulary: A limited list of drugs approved foruse; nonformulary drugs are not covered by the healthplan and require prior authorization and higher copay-ments or full payment by patients (see formulary,managed formulary, and open formulary).

Copayment: A fixed fee paid by the patient each timehe or she uses certain medical services.

Detailing: Provision of information about drug prod-ucts by sales representatives of the pharmaceuticalindustry to physicians to influence the physicians'prescribing behavior.

Disease management: A philosophy toward the treat-ment of the patient with an illness (usually chronic innature) that seeks to prevent recurrence of symptoms,maintain high quality of life, and prevent future need foracute and more costly medical interventions by using anintegrated, comprehensive approach to health care;pharmaceutical care, continuous quality improvement,practice guidelines, and case management all play keyroles in this effort, which (in theory) will result in de-creased health care costs and improved patient outcomes.

Drug claims processing: An automated assessment ofdrug claims at the point of service, meant to detectpotential problems that should be addressed beforedrugs are dispensed to patients (for example, checkingpatients' eligibility for drug coverage or checkingwhether the prescription has been filled at anotherpharmacy in the last prescription cycle).

Drug risk-sharing arrangements: Health care organi-zations may be at partial, full, or no risk for drug costs.

Groups at partial risk for drug costs share in aproportion of savings and/or cost overruns; thegroup can share in savings if it prescribes less thanthe budgeted amount ("upside risk"), and it may alsoshare in any over-expenditures (downside risk).

Groups at full risk for drug costs realize all of thesavings or absorb all of the losses.

Groups at no risk for drug costs absorb none of thelosses and profits (typically, risks are absorbed bythe HMO or other managed care organization).

Drug utilization review/evaluation: An authorized,structured and continuing program that reviews, analyzes,

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and interprets drug-prescribing patterns against predeter-mined standards (see prospective and retrospective drugutilization review).

Firewall: FTC requirement that PBMs owned bypharmaceutical manufacturers must prevent the flow ofcertain information between the PBM and its parentcompany and vice versa; for example, the parentcompany is prevented from obtaining information onpricing and bid features submitted by competitors to thePBM.

Formulary: A list of drugs that are approved for use bya hospital, health plan, or other health care organizationand that will be dispensed through participating phar-macies to an insured person (see open formulary,managed formulary, and closed formulary).

Generic drug: A chemically equivalent copy of a brandname drug with an expired patent; typically less expen-sive and sold under a chemical name for the drug, notthe brand name.

Generic substitution: Substitution of generically equiv-alent drugs for their brand-name counterparts as acost-saving device.

Global budget: A comprehensive fixed payment for allhealth care services for a given period of time withinwhich a provider of services must operate; with a globalbudget attempts are made to align financial incentivesacross different provider types (for example, a verticallyintegrated organization such as Kaiser may have aglobal budget that encompasses primary care andspecialty physician services, pharmacy costs, hospital-ization, and other health care services).

Hard edit: A preprogrammed block that cannot beoverridden by the patient, the pharmacist, or the physi-cian without a prior authorization or edit override; oftenimplemented by HMOs to block the use of a nonformu-lary drug product.

Mail service: Program offering pharmaceutical agentsthrough the mail, typically at discounted prices relativeto those of independent or chain pharmacies.

Managed formulary: A list of "preferred" drugs devel-oped by an HMO or other managed care organization,typically a subset of its open formulary; incentives arecreated at the physician, pharmacist, and patient levelsto encourage use of "preferred" drug products (forexample, lower patient copayment for such products)(see formulary, open formulary, and closed formulary).

Market share: The percentage of the total population(nationally, by state, by region, by local market, etc.)

that is participating in a managed care product, such asa specific HMO.

Maximum Allowable Cost (MAC): A maximum pricethat retail pharmacies in 'plans' networks may be paidfor certain generic drugs.

Maximum Allowable Cost (MAC) list: List of prescrip-tion medications established by a health plan and dis-tributed to pharmacies for which reimbursement will beprovided at a generic price level only, regardless ofwhat is dispensed.

"Me too" drug: brand-name drug that falls into thesame therapeutic class as another drug product butconfers no additional therapeutic benefit.

Open formulary: Provides coverage for almost alldrugs; the patient's copayment is not based on a drug'sformulary status (see formulary, managed formulary,and closed formulary).

Payer: Party, organization, or individual paying forhealth care services (for example, patient for out-of-pocket payments, insurer, HMO, or self-insured em-ployer for capitated or fee-for-service payments).

Pharmaceutical care: A strategy that attempts to utilizedrug therapy more efficiently to achieve outcomes thatimprove a patient's quality of life; a set of relationshipsand decisions through which physicians, pharmacists,nurses, and patients work together to design, imple-ment, and monitor a treatment plan that will producetherapeutic outcomes.

Pharmacoeconomics: The description and analysis ofthe costs and consequences of drug therapy to healthsystems and society.

Pharmacy and Therapeutics (P&T) Committee: Acommittee of physicians, pharmacists, and other healthcare professionals in a health care organization thatdetermines drug treatment policies and formularyissues; the P&T Committee manages the formulary andacts as the organizational line of communicationbetween the medical and pharmacy components of thehealth care organization.

Pharmacy network: Pharmacies under contract withHMOs and/or their contractual PBM partners to providedrug services, typically at a negotiated discounted fee.

PMPM: Per-member-per month; specifically applies torevenue or cost for each member enrolled in a healthplan each month.

Practice guidelines: Treatment procedures arrived atand agreed upon by a medical committee or group for

11

1. Henry Grabowski, “Foreword” in PBMs: Reshaping thePharmaceutical Distribution Network., eds. Sheila R.Shulman, Elaine M. Healy, and Louis Lasagna (Binghamton,N.Y.: The Pharmaceutical Products Press, 1998), xii.

2. Helene L. Lipton, David H. Kreling, Ted Collins, andKaren C. Herz, “Pharmacy Benefit Management Companies:Dimensions of Performance,” Annual Review of PublicHealth, 1999, 20:364-5.

3. Health Strategies Group, Inc., “Pharmacy Benefit Man-agement: Competitive and Industry Analysis,” section 1,volume 8 of PBM Industry and Profiles, a private, ongoing,multiclient study, April 1999, I-15.

4. Sheila R. Shulman and Louis Lasagna, “PBMs of the1990s: Why They Deserve a Second Look,” in PBMs:Reshaping the Pharmaceutical Distribution Network., eds.Sheila R. Shulman, Elaine M. Healy, and Louis Lasagna(Binghamton, N.Y.: The Pharmaceutical Products Press,1998), 2-3.

5. Lipton et al., “Pharmacy Benefit Management Compa-nies,” 374.

certain common medical conditions; a guideline pro-vides the clinician with specific treatment options orsteps when faced with a particular set of clinical symp-toms, signs, or laboratory data.

Prior authorization: The approval a physician mustobtain from an HMO or other payer before hospitaliz-ing a patient, performing certain procedures, or usingcertain medical products or drugs, for the service to becovered by the health plan.

Profiling: An analytical tool that uses epidemiologicmethods to compare practice patterns of providers on thedimensions of cost, service use, and/or quality of care; theprovider's pattern of practice is expressed as a rate,aggregated over time, for a defined population of patients.

Prospective drug utilization review (P-DUR): De-signed to enable pharmacists to detect potential prob-lems with drug therapy before dispensing medications.

Purchaser: Buyer of health care services or insurance;includes patients who purchase individual privateinsurance policies or pay for health care out-of-pocket,as well as self-funded employers, employer coalitions,and government organizations as group buyers.

Quality assurance (QA)/management: A peer reviewprocess that audits the quality of care delivered; may bemeasured with instruments such as member satisfactionquestionnaires, chart audits, member transfer rates, etc.

Rebate: A sum of money given to an organization(typically a health plan) by a drug manufacturer inexchange for inclusion of the manufacturer's drugproduct on the formulary or, more recently, in exchangefor moving market share of a particular ("preferred")drug or combination of drugs ("bundling").

Retrospective drug utilization review (R-DUR): Auto-mated checks of drug claims data after drugs are dis-pensed, to identify potentially inappropriate prescriptionsfor individual patients; if the computer program finds thata physician's prescription for a particular patient hasviolated the criteria for optimal drug use, the case isreviewed by a panel of physicians and pharmacists; if thepanel finds the prescription problematic, it sends anadvisory letter asking the physician to change it.

Risk: Acceptance of the possibility of financial gain orloss for provision of health care benefits at a fixed rate;potential to lose money, earn money, or spend moretime without additional payment.

Risk pools: Sums of money set aside by a managed careorganization for payment of hospital, emergency room,physician services, or specialized services such as

drugs; risk pools constitute a portion of a managed careorganization's direct medical expenses or a percentageof profit, which the managed care organizationcontracts to pay the provider if specific performancegoals are met.

Therapeutic interchange: A therapeutically similardrug of equal efficacy and less expense is interchangedfor a nonpreferred drug; typically this occurs in pharma-cies through the use of an online hard edit that indicateslack of coverage of a prescribed drug and offers cov-ered alternatives; this change can occur only with theconsent of the physician (also referred to as "switch" or"conversion" programs).

Third-party administrator: An entity, usually aninsurance company, that provides health plan adminis-tration services, including claims processing, andassumes no financial risk.

Withhold: An amount (often 10 percent to 20 percentof the monthly capitation payment), held in reserve bythe managed care organization; at the end of each fiscalyear, the money withheld from the risk pool is used tosatisfy outstanding assessments, and any remainder isdistributed to the providers; withholds can be tied to aphysician’s own practice quality, efficiency and referralcosts or to the aggregate performance of a larger groupof physicians.

ENDNOTES

12

6. Calvin J. Anthony, “The Effects of PBMs on the Market-place: A Pharmacy Perspective,” in PBMs: Reshaping thePharmaceutical Distribution Network., eds. Sheila R.Shulman, Elaine M. Healy, and Louis Lasagna (Binghamton,N.Y.: The Pharmaceutical Products Press, 1998), 179.

7. Robert J. Rubin, Anne Hawk, and Elisa Cascade,“PBM’s: A Purchaser’s Perspective,” in PBMs: Reshapingthe Pharmaceutical Distribution Network., eds. Sheila R.Shulman, Elaine M. Healy, and Louis Lasagna (Binghamton,N.Y.: The Pharmaceutical Products Press, 1998), 30.

8. David H. Kreling, Helene L. Lipton, Ted Collins, andKaren C. Herz, Assessment of the Impact of Pharmacy BenefitManagers: Final Report to the Health Care FinancingAdministration, publication number PB97-103683, NationalTechnical Information Service, Springfield, Virginia, 1996.

9. K. A. Schulman et al., “The Effect of PharmaceuticalBenefits Managers: Is It Being Evaluated?” Annals ofInternal Medicine, 124:906-13.

10. Lipton et al., “Pharmacy Benefit Management Compa-nies,” 376.

11. Lipton et al., “Pharmacy Benefit Management Compa-nies,” 393-401; the following source was used to generatesome of the definitions within this glossary: Ciba GenevaPharmaceuticals, “A thru Z Managed Care Terms,” Bronx-ville, N.Y., Medicam International.