Pharmaceutical Benefit Manager Contracting - ABA YLD 101 Practice Series

By Teresa Kelton, Pharm. D., M.P.H.

Legal review and analysis regarding pharmaceutical contracting - whether in the context of an investigation, litigation or compliance - is highly sophisticated for both the initiated and uninitiated alike. In the context of Medicare Part D Managed Care Contracting, this is especially true, because the question at issue often involves a morass of cross-referenced sub-parts; an interrelated patchwork of laws governing pricing and reimbursement of the federal prescription benefit; and a pharmaceutical industry that consists of a complex group of distinct entities that a) manufacture drugs, b) deliver drugs from manufacturer to consumer, c) Medicare Part D benefit sponsors, and d) reimburse consumers and their health plans, as well as various combinations thereof. For purposes of this article, in regard to pharmaceutical industry contracting, we will address entities focused on reimbursement and management of health plans called pharmaceutical benefit managers (PBMs).

Because PBMs provide services and interact with so many entities, PBM transactions can lack the transparency of those in other markets and industries. PBM contracting directly affects pharmaceutical pricing and, as such, is a bipartisan issue of great interest and of fundamental importance to Medicare Part D (as well as other federal and state health plans). Couple this complex business environment with multiple constituents, each with its own distinct issues related to confusing pricing information based on federally mandated metrics such as average wholesale price (AWP), maximum allowable costs (MAC), and federal upper limit (FUL) or prior-authorization fees and rebates, and you have a business model that is not clearly understood.

Two laws - the Medicare Prescription Drug Improvement and Modernization Act of 2003 (MMA) and the Deficit Reduction Act of 2005 1 (DRA) - and the First DataBank case will arguably create yet-unforeseen changes in pharmaceutical pricing and reimbursement methodologies and effectively end continued use of AWP as a pricing benchmark in coming years. Each law highlights the striking imbalance of verifiable prescription-drug pricing information and the process by which prescription drugs are marketed and sold, including the alignments between drug manufacturers and PBMs.

Calls for Transparency
As important as pharmaceutical pricing information is, ensuring the accuracy and truthfulness of the information flow is vital. The interest in complete and accurate information about PBM programs and practices, however, transcends any isolated enforcement initiative. In fact, certain states require transparency ( e.g., South Dakota). Additionally, the Pharmaceutical Purchasing Coalition (PPC) now has 13 PBMs agreeing to certification criteria designed to promote pricing transparency. The PPC certification 2 process, Transparency in Pharmaceutical Purchasing Solutions (TIPPS), requires PBMs, among other things, to disclose to their clients the actual acquisition costs for drugs and more stringent client audit rights.

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, although simply providing information on revenue will not give plan sponsors the full picture. For some health plans, entities beyond the PBM ( e.g., claims administrators or certain providers of the transaction process) also take some profit from prescription claim transactions. Therefore, it will be difficult for certain transparency regulations to work if these downstream entities are not also a part of the disclosure. Another key issue involves the entity (either the PBM or, in the case of large managed care organizations (MCOs), the MCO itself) that negotiates the rebates with the manufacturers. If the MCO negotiates, is it responsible for providing disclosure information? Based on current mandates, it is argued that a MCO may not have to make such disclosures.

These themes are likely to influence the allegations prosecutors investigate and the litigation they prosecute, as well as the public policy and legislative initiatives at the state and federal levels that politicians undertake to address prescription drug costs.

Specialty Pharmaceuticals
The subset of drugs and biologics dubbed "specialty pharmaceuticals" represents life-changing discoveries, and their value is undeniable. Often referred to as large molecule drugs, these agents are complex sugars or proteins; not chemicals, like most traditional drugs. The specialty pharmacy market has historically addressed high-maintenance biologics and other high-cost medications.

The small number of patients using specialty pharmaceuticals (less than 0.5 percent) has kept them below most payors' radar. However, specialty pharmacy currently represents a $40-billion market, with estimates approaching $75 billion by 2008. This rapid market growth of about 20 percent annually makes specialty pharmaceuticals attractive to PBMs and will have payors paying closer attention to the high per-member per-year costs of such agents. Moreover, 150 new specialty pharmaceuticals are in the FDA approval channels. This increase in specialty pharmaceuticals, and their attendant increased costs, virtually assures increasing PBM involvement in this market segment, because consistent guidelines for managing these products must be established.

With retail and traditional mail service pharmacies unable or unwilling to handle these agents because of challenges with inventory, product knowledge, and administration tools, PBMs need new cost-management paradigms. Often, these drugs were administered in a physician's office or by a home-health company, and the claims payment has almost always been covered as a medical benefit. However, coverage is moving to the pharmacy benefit, to take advantage of PBM costs and utilization-management tools.


  1. Industry Snapshot
    By way of background, there are several types of PBMs currently operating in the United States. There are independent, full-service PBMs with national scope ( e.g., Medco Health Solutions, Inc. and Express Scripts, Inc.). Other PBMs include entities owned by significant retail supermarket/pharmacy chains ( e.g., CVS's Caremark and Walgreens Health Initiatives) or large insurers that offer in-house PBM functions ( e.g., Aetna Pharmacy Management and Cigna Pharmacy Management). In addition, there are many smaller, privately held PBMs.
    The relative size and ranking of these companies varies according to the measure used, such as annual prescription expenditures, prescriptions per year, or covered lives, and each measure has its own shortcomings. With the successful implementation of Medicare Part D, independent, full-service national PBMs manage the prescription drug benefits of about 210 million people in the U.S. or about 70 percent of the population.
  2. PBMs Defined
    In general, since their creation in the early 1990s, PBMs have acted as middlemen between pharmaceutical manufacturers and health plans or employers. Traditionally, PBMs worked to apply private-sector best-practice techniques to manage drug costs and access. As such, PBMs functioned to negotiate best prices with manufacturers based on volume, develop a formulary or preferred drug list to encourage patients to use only certain drugs, manage drug benefits on behalf of purchasers, and contract with pharmacies to create a network for patients to use. However, the role of PBM has further evolved to include benefit-plan design, mail-order fulfillment, disease management, drug-utilization review, and cost-cutting, thereby combining cost-efficient prescriptions with clinical effectiveness.

    A sizable customer base enables the largest PBMs with the most covered lives to drive the market share of any one pharmaceutical drug product and, therefore, obtain the lowest prices from pharmaceutical manufacturers. PBMs use mail-order pharmacies or contract with retail pharmacies to establish networks of local pharmacies through which enrollees can have their prescriptions filled. Most PBMs contract with 90 percent of the retail pharmacies in the region they serve. National PBMs have established networks that include nearly all retail chain pharmacies.
  3. The PBM Formulary
    The main tool that PBMs use to manage pharmacy benefits is the formulary, which is a compilation of PBM-approved drugs for treating various diseases and conditions. Through a formulary, the PBM controls the price that health plans and enrollees pay, and may influence the use of various drugs and the mix of drugs dispensed. Although PBMs design formularies, plan sponsors often demand customized formularies that address various needs of their enrollees (e.g., cost containment, access to certain medicines, high generic substitution, etc.).

    In deciding which drugs to include in the formulary (and their placement within various tiers on the formulary), two practices come into play: (i) generic substitution and (ii) therapeutic interchange. Generic substitution is the dispensing of a bio-equivalent generic drug product that contains the same active ingredient(s) as the brand-name drug and is, among other things, chemically identical to the substituted brand-name product in strength, concentration, dosage form, and route of administration. Generic substitution generally occurs when a consumer presents a prescription for a brand-name drug and the pharmacist fills the prescription, with patient consent if needed, for a generic version of the drug product, without the need for prior physician authorization. Because generic drugs are substantially less expensive than their brand-name counterparts, generic substitution lowers prescription drug costs.

    Therapeutic interchange involves a pharmacist substituting a therapeutically equivalent, but distinct, drug product for the drug product referred to on the consumer's prescription ( e.g., two drug products that treat the same condition). Prior physician authorization is required before a pharmacist may interchange one drug for another.

    The co-pays that enrollees must pay are determined with all of the foregoing variables in mind because they significantly influence drug utilization. Most group health-plan sponsors negotiate a three-tiered co-pay arrangement with the PBM, with the lowest co-pay for generic drugs, the middle tier for brand-name drugs with no generic equivalent, and the highest co-pay for brand-name drugs with a generic equivalent. Some plan sponsors negotiate a fourth tier for drugs not included on the PBM formulary and so-called lifestyle drugs, e.g., drugs to combat hair loss. The ascending rates of the co-pays are designed to create an incentive for the enrollee to prefer the lowest-cost, yet still clinically effective, alternative.

    Lastly, plan sponsors may negotiate with PBMs to give enrollees incentives to use the PBM network pharmacies, so the PBM has greater control of reimbursement and adherence to formulary drugs. Those incentives range from differential co-pays to denial of coverage for out-of-network purchases. Plan sponsors and PBMs also negotiate over incentives for enrollees to use mail-order distribution 3 for maintenance medications.

    As such, greater formulary compliance allows the PBMs to negotiate with the pharmaceutical manufacturer for better prices, because formulary compliance is an indicator of the ability of the PBM to manage drug utilization. Thus, in practical terms, formulary compliance allows a PBM to negotiate what it can deliver for a manufacturer in terms of growth of their market share or avoidance of lost market share.
  4. Flow of Payments for Drug Benefits and PBM Services
    In broad terms, PBMs pay health plans a percentage of manufacturer rebates; pharmacies for the wholesale cost of the prescription drug (minus the patient co-payment); and manufacturers for drugs that PBMs dispense through their own pharmacy divisions. Generally, PBMs collect money - in rebates and fees from health plans for managing member benefits; from manufacturers as rebates for placing drugs on the PBM's formulary; and in pharmacy network adjudication fees.

    As discussed above, to perform its services, a PBM enters contracts with health-care plans, retail pharmacies, and drug manufacturers. Among other things, when a PBM establishes retail networks, it contracts with retail pharmacies on reimbursement amounts for drugs dispensed by the pharmacy. Specifically, for a given drug, the price that the PBM will reimburse a retail pharmacy is stated as a discount from a measure of wholesale price plus a dispensing fee for the pharmacy. For brand-name drugs, the AWP, as stated by the manufacturer, is used as a basis for the discount, so the price formula would be, for example, "AWP - 10% + $4.00." For generic drugs, the average price used is the MAC as specified by the PBM, so the formula might be "MAC - 10% + $4.00." Retail pharmacies are willing to offer discounts from the reference prices (AWP or MAC), depending on the type of plan sponsors covered by the PBM and the exclusivity of the retail pharmacy network. The more exclusive the network, the larger the discount retail pharmacies will offer, believing that greater exclusivity is likely to bring them more customers.

    The PBM's contract with a plan sponsor covers, but is not limited to, the amount that the plan sponsor will pay the retail pharmacy per prescription of each drug, as well as separate charges for the variety of PBM services that the plan sponsor may use. The PBM's charge to the plan sponsor per script is similar in form to the retail pharmacy contract. For brand-name drugs, it is a discount off AWP plus an administration charge per script, e.g., "AWP - 5% + $.90." For generic drugs, the charge has the same form except the discount will be from MAC, as specified by the PBM.

    Finally, the contract negotiated with the pharmaceutical manufacturer may provide a rebate off the fees owed by the PBM, based on achieving certain specified sales or market share and administration fees; providing promotional services; drug utilization reviews, which analyze physician prescribing patterns to identify physicians who prescribe high-cost drugs when lower-cost alternatives are available; disease management services, which offer treatment information to, and monitoring of, patients with certain chronic diseases; drug interaction reviews, to determine what other drugs patients may be taking so the pharmacist can ensure against adverse reactions; and specialty pharmacy services.

Contracting Process
It is critical, in such a complex industry, to understand a) the contracting process between and among the biopharmaceutical manufacturer, the PBM, and the PDP and/or MA-PDP plan; and b) at least the three ways PBMs make money, which include, in large part, charging administrative fees, collecting a percentage of the cost of each drug dispensed, and taking advantage of manufacturer rebates. As a general matter, review of a PBM contract, whether from the payor or provider perspective, requires consideration of evidence and facts around various key themes.

Based on discussions above, I provide factors and considerations an attorney attempts to weigh and evaluate when reviewing activities or operations, or other contractual provisions, relative to such contracts. Any discussion of other equally important technical but relatively esoteric issues - such as audit rights; compliance with Fraud Waste & Abuse (FWA), Chapter 9; audit rights; any willing provider and sub-contractor versus delegation issues and requirements - are not addressed here in detail. Please find in further detail below an outline and possible analytical approach:

  1. 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 a PBM program and the profit margin of a PBM. 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 at least annually to validate rebate payments and submissions.
  1. Benefit design strategies, alignment of interests, and value-added evaluations. When possible, this process should begin with the bidding process (e.g., RFPs). With so many approaches to PBM contracts, payors are challenged to obtain an apple-to-apple comparison of bids, but a full understanding of the PBMs revenue stream can help analyze and compare alignment of objectives in the business relationship.

Historically, the federal government set statutorily defined metrics or benchmarks for reimbursement for federal health-care programs and the various Parts of Medicare that cover prescription drugs. For instance, under Medicare Part B, which covers a limited number of prescription drugs and biologics, 4 the estimated "average sales price" (ASP) is the benchmark for drug reimbursement. For Medicaid outpatient drug reimbursement, there are various benchmarks for drug reimbursement payments, including EAC, which - depending on state - references AWP or WAC, FUL or MAC. For the Medicaid Drug Rebate Program, manufacturers are required to report their Average Manufacturer Price (AMP) quarterly and Best Price (BP) monthly for each covered outpatient drug. 5 Unlike these federal health programs, under Medicare Part D, there is no statutorily prescribed benchmark. Rather, the government relies on regional prescription drug plans (PDPs) and Medicare Advantage (MA) as the entities that provide the drug benefit.

The rules governing Part D place significant reporting and compliance burdens on plans, including requiring the creation of a program to ensure accurate reporting of incurred costs and a signed certification by the top management of validity of the report. Those rules give prosecutors an easy point of entry into investigations of Part D plans. As such, the review and consideration of value-added services and benefits warrant additional consideration and re-evaluation with respect to influence on "other business lines" or access.

  1. Generation of dollars. PBMs have moved to a model in which revenues are generated from various sources, including manufacturer rebates, network spreads, and mail-order and specialty pharmacy services. Other complicating factors include multiple sources of MAC pricing lists for generics and confusion over AWP, which can change depending on whether products are in bulk form or repackaged in smaller units. This may complicate the analysis regarding how much a purchaser is actually paying a PBM for a basket of services.
  1. Formulary development. Many national PBMs include 87 percent of all brand drugs in their formularies. If the formulary is evidence-based, the number of brand drugs in a formulary should be approximately 60 percent or less. In fact, many pharmacy and therapeutics committees argue that fewer than 20 percent (and possibly fewer than 10 percent) of new products introduced onto the market in the last four years add any value in terms of effectiveness or safety.
  1. Performance standards. Contracts between the new PBM model and its clients are increasingly based upon per-member/per-month (PMPM) administrative fees and mutually developed performance standards. The new PBM will de-emphasize the focus on pharmacy spread, manufacturer rebates, and per-claim administrative fees, and will shift that focus toward driving the most cost-effective, evidence-based care possible in partnership with its clients.
  1. Fees. All PBM revenue streams, such as drug-level rebates, funding of clinical programs, administrative fees, service fees, management fees, research/educational grants, etc., are fully disclosed to the payor. The full value of retail and mail-order pharmacy discounts is passed on to the client; data is shared with the client in a clear, concise format; and the client is given significant decision-making control over its drug benefit design and formulary management.
  1. Enforcement. Part D plans are under unprecedented scrutiny, and Part D sponsors must understand that federal regulations implementing the Part D program have effectively codified the False Claims Act 6 certification theory of liability. Regulations for the Medicare Part D Program require, as a condition of payment, full compliance with all federal and state laws, including specifically the federal anti-kickback 7 laws. The long-settled standard to establish liability includes actual knowledge, deliberate ignorance, and reckless disregard. DRA, when implemented, will make reckless disregard a virtual non-issue.

    Section 423.308 states that prescription-drug plan sponsors can only be paid for drug costs that are "actually incurred" under the program. In other words, as government contractors, Medicare prescription-drug plans are legally obliged to report their costs accurately, and any fictitious or inaccurate charges are subject to prosecution. It specifies that drug costs "actually incurred" must be calculated "net of any direct or indirect remuneration." That includes "discounts, chargebacks or rebates, cash discounts, free goods contingent on a purchase agreement, up-front payments, coupons, goods-in kind, free or reduced-price services, grants or other price concessions, or similar benefits offered to some or all purchasers." Thus, the "actually incurred" requirement affects not only the drug plan but also the pharmaceutical manufacturer.

    Please note that, under the FCA, there are several theories of liability. However, for purposes of this article and particularly relevant Part D plans, our focus regarding liability centers on false certification of compliance with federal or state plans.
  1. Claims processing and adjudication. PBMs manage the pharmacy benefit of group health-plan sponsors, such as HMO plans, self-insured employers, indemnity plans, labor union plans, and plans covering public employees. When an enrollee in one of these plans purchases a drug at a retail pharmacy, he or she presents a health-plan card identifying the source of insurance coverage. The pharmacy will transmit the insurance coverage information to the PBM, which verifies coverage and determines if the plan covers the prescribed drug, what the plan owes as direct payment to the pharmacy, and what the enrollee's co-payment will be (if any). The PBM transmits this information back to the pharmacy, logs the payment information in its system, and transmits the billing information to health insurers. These insurers then remit payment to the PBM, which forwards payment to the retailer. This process, known as claims adjudication, is handled electronically. Ninety-five percent of patients with prescription-drug insurance coverage receive their benefits through PBMs.

    Part D requires coordination of benefits (COB). Thus, a primary concern with regard to claims adjudication for Part D patients includes, but is not limited to, compliance with COB Chapter 14; State-to-Plan reconciliation; State Pharmaceutical Assistance Programs (SPAP); Plan-to-Plan reconciliation; and wrap/secondary plans.

1 At the time of publication, while the Deficit Reduction Act went into effect Oct. 1, 2007, a judge in the U.S. District Court for the District of Columbia granted a preliminary injunction that prevents CMS from taking further steps to implement the rule (e.g., posting AMP data publicly on its website).
2 The certification fee is $50,000 and re-certification cost is $30,000. A PBM pays the fee only if it meets the PPC certification standard. The 13 PBMs that agreed to meet or exceed HRPA's transparency contracting principles for large employers are: Aetna Pharmacy Management; BlueCross and BlueShield of Alabama; CVS Caremark; Catalyst Rx, a HealthExtras company; CIGNA Pharmacy Management; Express Scripts; Humana Pharmacy; Medco Health Solutions; Prime Therapeutics LLC; RESTAT LLC; SXC Health Solutions; Walgreens Health Initiatives; and WellPoint NexRx.
3 Mail-order distribution typically is handled through the PBM's own internal mail-order pharmacies or through mail-order pharmacies under contract with another PBM.
4 Drugs furnished incident to a physician's services; drugs furnished via durable medical equipment, such as respiratory therapies (albuterol or ipatropium bromide); or statutorily defined categories of drugs, including oral anti-cancer drugs, anti-emetics; and certain drugs billed by end-stage renal disease facilities. 42 U.S.C. § 1396r-8(b)(3)(A).
5 42 U.S.C. § 1396r-8(b)(3)(A).
6 31 U.S.C. § 3729(a)(1), (2),  (7) (2006) (establishing liability for anyone who 1) knowingly presents, or causes to be presented . . . a false or fraudulent claim for payment or approval; 2) knowingly makes, uses, or causes to be made or used, a record or statement to get a false or fraudulent claim paid or approved by the government; . . . or 7) knowingly makes, uses, or causes to be made or used a false record or statement to conceal, avoid, or decrease an obligation to pay or transmit money or property to the government, as well as other types of conduct).
7 42 U.S.C. §§ 1320(a)-7b(b).


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About the Author

Dr. Kelton is an associate with Nixon Peabody LLP in Washington DC. She specializes in FDA regulation, prescription drug policy, including controlled substances and prescription samples, and regulatory issues relating to the marketing and approval of prescription drugs, medical devicies and biologics.

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