Prescription Drug Benefits: Applying Private Sector Management Methods to
Medicare (Testimony, 03/22/2000, GAO/T-HEHS-00-84).

Pursuant to a congressional request, GAO discussed issues related to a
potential Medicare outpatient prescription drug benefit, focusing on:
(1) the factors contributing to the rise in prescription drug spending
and the impact of the rise in spending on Medicare beneficiaries; (2)
the methods private insurers have developed to manage these rising
costs; and (3) whether and how Medicare can adapt these methods to
control spending, should an outpatient prescription drug benefit be
added to Medicare.

GAO noted that: (1) private insurers, managed care plans, and employers
have tried to manage the high and rising costs of prescription drugs by
adopting cost and utilization control techniques; (2) in many cases,
insurers and managed care plans contract with a pharmacy benefit
management company (PBM) to develop and implement these strategies; (3)
if a prescription drug benefit were added to the Medicare program, the
federal government would face similar cost pressures and would need to
employ methods to control spending; (4) the experience gained in the
private sector can provide useful insights into options for managing a
possible Medicare benefit; (5) however, the unique responsibilities and
characteristics of the Medicare program raise a number of issues and
introduce questions about applying private sector tools to the
traditional Medicare fee-for-service program and the appropriate roles
of the Health Care Financing Administration and other entities, such as
PBMs, in managing a drug benefit; and (6) in adapting these cost and
utilization management techniques, it is important to keep in mind that:
(a) strategies involving coverage restrictions impose an obligation to
provide beneficiaries with adequate information about the benefit; (b)
the size of the Medicare program and the need for transparency in its
actions may reduce the effectiveness of some cost-control techniques;
(c) using private sector entities to implement a drug benefit introduces
concerns related to beneficiary equity and concentrating market power;
and (d) private sector management tools require a capacity to process
and scrutinize a large number of claims more quickly than is typical of
the traditional Medicare program.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-HEHS-00-84
     TITLE:  Prescription Drug Benefits: Applying Private Sector
	     Management Methods to Medicare
      DATE:  03/22/2000
   SUBJECT:  Health care programs
	     Health insurance
	     Drugs
	     Health insurance cost control
	     Health services administration
	     Private sector practices
	     Managed health care
	     Health resources utilization
	     Pharmaceutical industry
IDENTIFIER:  Medicare Program
	     Medicare Fee-for-Service Program
	     Medicare Choice Program
	     Medicare Health Maintenance Organizations Program
	     Blue Cross and Blue Shield Insurance Benefit Plan
	     Medigap
	     Medicaid Program

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   * For Release on Delivery
     Expected at 10:00 a.m.

Wednesday, March 22, 2000

GAO/T-HEHS-00-84

PRESCRIPTION DRUG BENEFITS

Applying Private Sector Management Methods to Medicare

        Statement of William J. Scanlon, Director

Health Financing and Public Health Issues

Health, Education, and Human Services Division

Testimony

Before the Committee on Finance, U.S. Senate

United States General Accounting Office

GAO

Prescription Drug Benefits: Applying Private Sector Management Methods to
Medicare

Mr. Chairman and Members of the Committee:

I am pleased to be here as you discuss issues related to a potential
Medicare outpatient prescription drug benefit. In previous hearings before
this and other committees, GAO has addressed considerations for adding a
prescription drug benefit to Medicare, in light of the fiscal imbalance of
the Medicare program and the need to implement major reforms to ensure the
sustainability of the program. Today, you asked us to provide information on
the methods used by private insurers, managed care plans, and employers to
control their prescription drug expenditures, and the applicability of those
approaches to Medicare. My remarks will focus first, on the factors
contributing to the rise in prescription drug spending and the impact of the
rise in spending on Medicare beneficiaries, particularly those without
coverage. Next, I will outline the methods private insurers, including those
offering Medicare+Choice managed care products to Medicare beneficiaries,
have developed to manage these rising costs. Finally, I will discuss whether
and how Medicare can adapt these methods to control spending, should an
outpatient prescription drug benefit be added to Medicare.

In summary, private insurers, managed care plans, and employers have tried
to manage the high and rising costs of prescription drugs by adopting cost
and utilization control techniques. In many cases, insurers and managed care
plans contract with a pharmacy benefit management company (PBM) to develop
and implement these strategies. If a prescription drug benefit were added to
the Medicare program, the federal government would face similar cost
pressures and would need to employ methods to control spending. The
experience gained in the private sector can provide useful insights into
options for managing a possible Medicare benefit. However, the unique
responsibilities and characteristics of the Medicare program raise a number
of issues and introduce questions about applying private sector tools to the
traditional Medicare fee-for-service program and the appropriate roles of
the Health Care Financing Administration (HCFA) and other entities, such as
PBMs, in managing a drug benefit. In adapting these cost and utilization
management techniques, it is important to keep in mind that: (1) strategies
involving coverage restrictions impose an obligation to provide
beneficiaries with adequate information about the benefit; (2) the size of
the Medicare program and the need for transparency in its actions may reduce
the effectiveness of some cost-control techniques; (3) using private sector
entities to implement a drug benefit introduces concerns related to
beneficiary equity and concentrating market power; and (4) private sector
management tools require a capacity to process and scrutinize a large number
of claims more quickly than is typical of the traditional Medicare program.

Rising Drug Spending Elevates Beneficiary Access Concerns and The Importance
of Cost Controls

Rise in Prescription Drug Spending Caused by Many Factors

Several factors have contributed to rising expenditures-more third-party
coverage of drugs, the introduction of new drug therapies, and more
aggressive marketing by manufacturers through direct-to-consumer
advertising. The increase in prescription drug coverage provided by private
insurance is a likely contributor to the rise in utilization because insured
consumers are shielded from the direct costs of prescription drugs. In 1988,
private health insurers paid almost a third of all prescription drug
expenditures. By 1998, that share had risen to more than a half. The
development of new, more expensive drug therapies-including new drugs that
replace old drugs and new drugs that treat disease more effectively-also
contributed to the drug spending growth by driving up the volume of drugs
used as well as the average price of medications. Advertising pitched to
consumers is also a likely contributor to the increased utilization of
prescription drugs. Between March 1998 and March 1999, the pharmaceutical
industry's spending on advertising grew 16 percent, to $1.5 billion. A 1999
study found that the 10 drugs most heavily advertised to consumers in 1998
accounted for about 22 percent of the total increase in drug spending
between 1993 and 1998.

Medicare Beneficiary Drug Coverage and Utilization

Although the Medicare benefit package, largely designed in 1965, provides
virtually no outpatient drug coverage, more than two-thirds of Medicare
beneficiaries had at least some prescription drug coverage in 1996. Almost
one-third of beneficiaries had employer-sponsored health coverage, as
retirees, that included drug benefits. About 17 percent of Medicare
beneficiaries had coverage because they chose to enroll in a Medicare+Choice
plan or purchase a Medigap policy with such coverage. About 10 percent of
beneficiaries received coverage through Medicaid.

The rising cost of prescription drug benefits has driven employers,
insurers, and managed care plans to adopt new approaches that limit total
drug coverage or increase enrollees' out-of-pocket costs. Although
employer-sponsored health plans provide drug coverage to the largest segment
of the Medicare population with coverage, there are signs that this could be
eroding. Fewer employers are offering health benefits to retirees eligible
for Medicare and those that continue to offer coverage are asking retirees
to pay a larger share of costs. In addition, the drug benefits offered by
Medicare+Choice plans have become less generous. Many plans restructured
their benefits in 2000, increasing enrollees' out-of-pocket costs and
limiting their total drug coverage.

Private-Sector Techniques for Controlling Drug Expenditures

PBMs originated as claims processors and mail-order or managed care
pharmacies. Today, they provide a wide range of services-such as claims
processing, formulary management, and pharmacy network development-to HMOs,
insurance carriers, Blue Cross Blue Shield plans, plans that cover federal
and state employees, and union members. According to the Pharmacy Care
Management Association, the PBM industry's trade association, PBMs manage
about 1.8 billion prescriptions annually, or about 70 percent of all
prescriptions dispensed to ambulatory care patients. According to a recent
estimate, PBMs are responsible for managing the drug benefits for about 71
percent of the 194 million people with third party pharmacy coverage. There
are more than 140 PBMs, which range in size, scope, and services provided.
Some administer prescription drug benefits nationwide; others focus on
serving clients in particular regions of the country.

PBMs and insurers negotiate rebates from drug manufacturers and thus lower
the net prices they pay for drugs. According to a 1996 study, manufacturers'
rebates averaged 5 to 6 percent of total drug costs. This average masks what
may be considerable variation across products. The negotiated rebate is
typically dependent on the purchasing power of the PBM or insurer, the
availability of several brand-named drugs in a therapeutic class, and
assurances of a particular level of utilization of the product.

Insurers or PBMs employ various strategies to channel drug utilization to
products for which they have rebate agreements that are based on market
share. Generally, this is done by using a formulary, a list of prescription
drugs, grouped by therapeutic class, that a health plan or insurer prefers
and may encourage physicians to prescribe and beneficiaries to use. A
particular product may be included on the formulary because of its medical
value or because of a favorable price negotiated with the manufacturer. The
inclusion of a particular drug on a formulary can affect its utilization,
which can increase the level of manufacturer discounts or rebates, and lower
a drug's net cost.

Formularies are structured and implemented to steer drug choice when
therapeutically equivalent options are available. Closed formularies, which
restrict insurance coverage to only selected drugs and require enrollees to
pay the full cost of nonformulary drugs, may be the most effective in
channeling utilization. However, closed formularies have faced resistance
from beneficiaries and providers because they can lead to higher enrollee
costs or restrict access to certain medicines. As a result, more insurers
are moving to incentive-based formularies that offer enrollees lower
copayments for the preferred product or generic drugs. The insurer continues
to cover drugs that are not on the formulary, but the beneficiary faces a
higher copayment. A third type, open formularies, is often referred to as
"voluntary" because physicians and beneficiaries may be informed about
preferred drugs, but beneficiaries pay no more for using nonformulary drugs.
Formularies that provide the strongest financial incentives to beneficiaries
to choose one product over another offer more cost control potential. They
can be used to steer utilization to lower-priced products, including
generics, and concentrate market share to elicit the best prices or largest
rebates on particular products. In doing so, however, they may produce
dissatisfaction among consumers, who have to pay more out-of-pocket for
nonformulary drugs, and physicians, who believe formularies restrict their
prescribing practices.

PBMs and private insurers have also targeted drug distribution costs as an
area for cost savings. Similar to their negotiations with manufacturers,
PBMs negotiate with retail pharmacies to obtain prices that are well below
pharmacies' usual price for customers without drug coverage. PBMs attempt to
enhance their leverage with retail pharmacies by limiting the size of the
pharmacy network. Restricting the number of pharmacies in the network can
benefit participating pharmacies by increasing each one's market share, and
as a result, make them more willing to provide larger discounts on the
prescriptions they fill. Potential savings from this cost-control technique,
however, must be balanced with the inconvenience of a limited pharmacy
network. PBMs may also operate mail-order pharmacies that allow enrollees to
obtain prescriptions by mail. This is a cost-effective way of dispensing
drugs, particularly maintenance drugs for chronic health conditions, such as
high blood pressure or asthma.

The claims processing capabilities of PBMs enable them to engage in other
activities that may help control overall health care expenditures or improve
quality of care. For example, drug utilization review (DUR) programs analyze
patterns of drug use on a real-time basis when a pharmacist is actually
filling a prescription. These programs use databases and computer systems
that include a patient's entire drug utilization history for all network and
mail-order pharmacies. These systems identify instances in which a drug may
be inappropriate for a particular patient given a person's medications or
age. Most PBMs use system edits specifically tailored to particular types of
beneficiaries, such as people who are 65 years of age or older who may have
a difficult time tolerating certain medicines. Such interventions can both
improve quality of care and prevent additional health care costs by reducing
drug interactions or flagging evidence of inappropriate use, such as early
refills. DUR can also be conducted retrospectively, usually on a monthly or
quarterly basis, to profile physician prescribing practices, pharmacy
dispensing practices, or patient utilization. The results of retrospective
DUR programs are used to encourage physicians to prescribe less costly
therapeutic alternatives or generics, encourage pharmacies to substitute
generics or preferred formulary drugs for more expensive nonformulary drugs,
and ensure that some patients are not overutilizing prescription medicines.

Applying Private-Sector Techniques to a Drug Benefit Within Medicare

Private-sector entities have attempted to control the growth of prescription
drug expenditures while preserving or enhancing the value of drug coverage
for beneficiaries. As you consider methods to manage a potential Medicare
benefit, these private sector techniques offer a useful starting point. I
would like to discuss four issues to consider in adapting these methods to
the unique characteristics of Medicare and its beneficiaries.

   * In a competitive model for Medicare-such as exists today with
     Medicare+Choice or the models envisioned in some reform
     proposals-cost-containment strategies involving restrictions on
     coverage through formularies or pharmacy networks impose an obligation
     to adequately inform beneficiaries about plan policies.
   * Adaptation of PBM techniques within the traditional fee-for-service
     Medicare program could be difficult given its size and the need for
     transparency in its actions.
   * Contracting with private-sector entities to administer a drug benefit
     for traditional Medicare using cost and utilization controls would
     raise other challenges.
   * The efforts of PBMs to control expenditures involve a capacity to
     scrutinize claims more effectively and quickly than is typical of
     Medicare today.

Medicare Beneficiaries' Experiences With Drug Benefit Management In Medicare
HMOs

Our previous work has identified a number of factors that make it difficult
for beneficiaries to determine which Medicare+Choice plan best meets their
needs. In some cases, detailed information about plans' benefits and
out-of-pocket fees is provided only after a beneficiary enrolls in a plan.
In other cases, detailed information may be available before enrollment from
plan sales agents and member literature, but beneficiaries may find it
difficult to compare available options because plans present the information
in different formats and use different terms to describe covered benefits.
The lack of comparative information can be particularly problematic when
evaluating plans' drug benefits, because many design characteristics
determine the true value of the drug coverage.

Comparing plans' drug benefits can be difficult because formulary types and
management techniques differ considerably, affecting the benefit. A
beneficiary may not be aware of formulary changes until they are at the
pharmacy counter. Aggressive formulary management may control spending, but
beneficiaries need to be aware of how it may affect their access to a
particular medicine and the prescribing practices of their physicians. Such
issues present even greater challenges in the management of a drug benefit
for the entire Medicare population.

Adding a Drug Benefit to the Traditional Medicare Program Raises Issues
About the Feasibility of Applying PBM Techniques

Having a formulary would enhance Medicare's ability to control costs by
enabling it to negotiate significantly discounted prices with manufacturers
by promising to deliver a larger market share for a manufacturer's product.
Yet, implementing a formulary and other utilization controls could prove
difficult for Medicare. Determining whether a drug should be on the
formulary and which drugs should be preferred, typically involves clinical
evaluations based on a drug's safety and effectiveness, and decisions on
whether several drugs are therapeutically equivalent. A pharmacy and
therapeutics committee within the health plan or a PBM may make these
decisions. Plans and PBMs currently make formulary determinations
privately-something that would not be tolerable for Medicare, which must
have transparent policies that are determined openly. Given the stakes
involved in a drug being selected as preferred on a Medicare formulary, one
can imagine the intensive efforts to offer input to and scrutinize the
selection process. In addition, once the formulary is in place it may be
difficult to steer utilization or withstand pressure to allow access to
non-formulary drugs, especially in the fee-for-service environment, where it
may be hard to influence prescribing practices.

If Medicare covered all drugs in a therapeutic class on the same terms,
beneficiaries may not be influenced toward particular drugs and thus
manufacturers would have no incentive to offer deep discounts. Without a
promised share of the Medicare market, manufacturers may determine they
could reap greater returns from charging higher prices and concentrating
marketing efforts on physicians and consumers to influence prescribing
patterns.

If Medicare cannot effectively operate a formulary, it may have to rely
instead on administratively determined prices. These could be similar to the
manufacturer rebates received by the Medicaid program, which is currently
the largest government payer for outpatient prescription drugs, comprising
about 17 percent of national expenditures on outpatient drugs. Since the
enactment of the Omnibus Budget Reconciliation Act of 1990 (OBRA), drug
manufacturers are required to provide rebates to state Medicaid programs on
outpatient drugs based on the "lowest" or "best" prices they charged other
purchasers. In return for the rebates, state Medicaid programs maintain open
formularies that permit reimbursement for all drugs. Although states have
received billions of dollars in rebates from drug manufacturers since OBRA's
enactment, state Medicaid directors have expressed concerns about the rebate
program. The principal concern involves OBRA's requirement for open
formularies, which limits the utilization controls Medicaid programs can use
at a time when prescription drug expenditures are increasing rapidly.

Contracting with PBMs Presents Other Challenges for Medicare

A single PBM contractor administering a Medicare drug benefit would likely
be subject to the same level of scrutiny as a government entity. Such
scrutiny may compromise the flexibility PBMs typically have used to generate
savings. An alternative would be to grant flexibility to multiple PBMs that
are responsible only for a share of the market. Contracting with multiple
PBMs, though, raises other issues. If each PBM had exclusive responsibility
for a geographic area, beneficiaries who want certain drugs could be
advantaged or disadvantaged merely because they live in a particular area.
This kind of geographic variability may be difficult for Medicare to
sustain. While it is true that such variability exists in the
Medicare+Choice program, individuals enrolled in a Medicare+Choice plan have
chosen to enroll and accept the terms of the benefit. For beneficiaries in
traditional Medicare, their regional PBM may be their only drug coverage
option. To reduce variation, Medicare could, like some private-sector
purchasers, specify core benefit characteristics or maintain clinical
control over formulary decisions instead of delegating those decisions to
the PBMs. However, without the ability to create and manage a formulary,
PBMs would have less flexibility to use techniques that have been integral
to their efforts to maximize price discounts and control overall costs.

If multiple PBMs operate in each area, beneficiaries would choose one to
administer their drug benefit. PBMs would compete for consumers directly,
unlike the private-sector where they normally compete for contracts with
insurers or other purchasers. With multiple PBMs, issues would arise
regarding informing beneficiaries about the differences in each PBM's
policies, monitoring the PBMs' marketing and recruitment strategies, and
accounting for differences in health status of beneficiaries using each PBM.
Having more than one PBM in an area may also dilute the market power of each
PBM, because they would individually control fewer beneficiaries and need to
be concerned about retaining beneficiaries. Having PBMs compete for
beneficiaries may create an incentive for the PBM to have less stringent
formularies, if all beneficiaries are subject to the same cost-sharing
requirements regardless of the PBM they use.

The competitiveness of a bidding process for contracts to administer a
Medicare drug benefit would depend, in part on, the size of the region for
which PBMs compete. One recent study showed that the PBM industry is
competitive, but that it is dominated by a few large companies. If a
contract were awarded for the entire country or a few large regions, these
large companies may have an advantage. Large regional contracts would
concentrate Medicare's market power in these few firms, giving them more
leverage to negotiate with manufacturers. If PBMs competed for smaller
areas, more regional PBMs may bid to provide services in their region.
Awarding more contracts that cover fewer beneficiaries may encourage
participation by a greater number of PBMs, but may also dilute the overall
market power associated with providing a drug benefit to Medicare
beneficiaries. It may also be more burdensome to administer more PBM
contracts.

Drug Benefit Administrative Functions are Unlike Traditional Medicare
Activities

Duplicating the type of controls PBMs have exercised over private-sector
drug benefits will likely involve devoting a larger share of total
expenditures to administration than is currently expended in the traditional
Medicare program. The magnitude of the increase is difficult to estimate.
Much depends on what services PBMs are asked to provide and how much of the
Medicare drug benefit each PBM will administer. Even if the dimensions of
the PBM's or contractor's role are specified, estimating the likely costs
remains problematic. A Medicare drug benefit will be a large-scale endeavor.
The number of prescriptions for Medicare beneficiaries could easily approach
the current number of claims for all other services combined or about 900
million annually. It is unclear how much PBMs or others would have to
increase current capacity or instead use more of the capacity already built
into their information and claims processing systems-a consideration that
could significantly affect the administrative costs that may be incurred.

Concluding Observations

There is growing consensus that Medicare needs to change its benefit
structure to include outpatient prescription drug coverage. Yet such an
undertaking has substantial consequences for the cost of the program. In
fact, one recent study suggests that such an expansion would add between 7.2
and 10 percent annually to Medicare outlays. The structure of such a new
benefit-whom it would cover and the extent of its coverage-is an important
determinant of the added cost. This is why, in previous hearings, the GAO
has emphasized the need to make prescription drugs more affordable to
beneficiaries who lack coverage by expanding access to group rates,
extending discounts associated with group purchasing, and targeting
government subsidies for those most in need. To the extent that this is
accomplished through expanding Medicare's benefit package, cost-control
methods need to be incorporated into the management of the benefit. The
private sector has developed and refined techniques, which have been
implemented in some Medicare+Choice plans and private health plans, to
control prescription drug costs. Applying these techniques to the larger
Medicare population will require adaptations that may diminish their
effectiveness.

The challenge in adding prescription drug coverage to the Medicare program
will be in designing and implementing drug coverage to minimize the
financial implications for Medicare while maximizing the positive effect of
such coverage on Medicare beneficiaries. Most importantly, this benefit
expansion must be consistent with efforts to ensure the long-run
sustainability of Medicare so that the program does not consume an
unreasonable share of our productive resources and does not encroach on
other public programs or private sector activities. Private sector tools for
controlling drug expenditures provide options for controlling drug
expenditures. However, how to apply these tools effectively to a Medicare
drug benefit presents a number of challenges and requires careful
consideration of the nature and magnitude of the Medicare program.

GAO Contacts and Acknowledgments

(201045)

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