Medco's Clash With Clarity

As customers demand disclosure, big mail-order pharmacies face a challenge from upstart rivals.
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Last year, an upstart pharmacy benefit manager for the first time snagged the kind of huge account that normally goes to industry giants like

Medco Health Solutions

(MHS)

and

Caremark Rx

(CMX)

.

Envision Pharmaceutical Services

won over an international labor union and a big health insurance network, in large part by promising so-called transparency. That is, Envision pledged to disclose and turn over all the incentives it receives from drug manufacturers in exchange for a flat administrative fee.

The Sheet Metal Workers International Association, negotiating on behalf of some 150,000 members and their families, felt that the deal made sense.

"There are so many hidden costs, hidden charges, hidden rebates

in the PBM industry that -- if you don't know exactly what's going on -- your members start to suffer," says Thomas Kelly, the union's general secretary-treasurer. "It's kind of simple this way. Why complicate things?"

Indeed, critics contend that big PBMs like Medco, Caremark and

Express Scripts

(ESRX)

enrich themselves at the expense of their clients, by taking in multiple sources of revenue -- such as manufacturer rebates -- that they never disclose. The PBMs insist that they are simply protecting trade secrets that, if divulged, would hurt them competitively and drive prescription drug prices up.

For its part, SMWIA was simply searching for ways to hold down health care costs so that its members might continue to enjoy affordable medical coverage. The union spotted prescription benefits -- where prices have really rocketed -- as an obvious target.

Kelly says he figured out that big PBMs earn tons of money through transactions that benefit customers less than the PBMs themselves. So the union started searching for alternatives.

Specifically, it looked for a PBM willing to reveal -- and ultimately pass through -- all the manufacturer payments it receives. The union says it chose Envision because the PBM "demonstrated the purest model as it related to transparency, full disclosure, auditability and accountability." Moreover, it says that the big three never even bid on the contract.

"They're not interested in something like this," Kelly says. "But I knew that from the get-go."

For now, at least, the major PBMs remain outstanding stock-market performers. Shares of both Medco and Caremark have jumped more than 30% over the past year, while those of Express Scripts have more than doubled.

Buzzword

To be fair, Medco has attempted to distinguish itself from the pack. Following a big multistate settlement in 2004, the company now discloses more than it once did -- particularly about rebates from drug manufacturers -- and declares itself the most transparent of the giant PBM players.

Medco says, quite simply, that transparency "makes good business sense." And several Wall Street analysts, who portray the company as more transparent than most, seem to agree.

But skeptics feel that many PBMs have simply started using a buzzword that customers like to hear.

"Everyone talks about transparency," says Rick Goebel, vice president of sales and marketing at

Pharmacy BenefitDirect

, another smaller PBM that promises complete transparency to its clients. "But I think it's all just kind of a sham."

On the one hand, Goebel says, many PBMs have in fact started responding to customer demands about rebates on expensive name-brand drugs. But on the other, he says, those same PBMs have shifted their focus to generic drugs where -- because of secret pricing schemes -- they can pocket even bigger profits in the end.

Caremark didn't answer questions for this story, and Express Scripts declined to participate.

But Goebel has co-authored an entire study about how the generic game supposedly works. He says that, over time, brand-name drugs have actually become "loss leaders" for PBMs because of the deep discounts the companies now pass on to their clients. He says the PBMs now focus on pushing generic drugs, where they profit from big pricing spreads.

For prescriptions filled at retail pharmacies, he says, PBMs pay a fixed "maximum allowable cost" and then charge their clients a higher price. And for prescriptions filled at their own mail-order pharmacies, he says, PBMs abandon MAC pricing altogether and pocket even bigger spreads.

Goebel says that retail pharmacies push generic substitution because the PBMs secretly allow the pharmacies to keep co-payments that, at times, exceed the entire cost of the drug. Meanwhile, he says, the PBMs' own mail-order pharmacies lure generic-drug users -- increasingly through mandatory employer-sponsored programs -- by promising big discounts off of high-priced drugs and then filling the prescriptions with lower-priced alternatives. Moreover, he says, the PBMs convince their clients to pick up part of the co-payments for mail-order prescriptions in order to receive a discounted price that, in fact, often exceeds what retail pharmacies charge.

"Health plans drive volume to mail-order -- and effectively agree to absorb additional co-pay expenses -- based on perceived savings," Goebel says in a white paper on the subject. But "in reality, co-pays associated with three-tier benefit designs have increased to the point where health plans are spending more money than they save by incentivizing members to use mail-order."

For example, he says, PBM clients can wind up covering a $20 co-payment in order to secure what turns out to be a smaller discount -- totaling perhaps $10 -- on a generic drug. But for some reason, he says, even major corporations have yet to figure this scheme out. Otherwise, he says, they might soon realize that buying the same drug from a retail pharmacy would make a lot more sense.

For its part, Medco says that it offers "a range of pricing models" -- including government-set MAC -- at the discretion of its clients. Moreover, the company says those clients can perform audits to make sure they receive all of the discounts and rebates promised under their contracts.

But Goebel, for one, sees conflicts in the end.

"These PBMs are not able to play an objective role in cost management because they profit more from mismanagement," he insists. "They serve two masters -- plan clients/payers and shareholders -- and cost-management will always be a secondary goal."

Revolution

Even now, the big PBMs continue to resist major changes.

Certainly, they have never liked others telling them what to do. They made that clear last year when California tried -- for the second time -- to implement a law requiring more disclosure.

All three major PBMs zipped off letters to California leaders arguing against passage of the bill. Essentially, they claimed the proposal would hurt PBMs and their customers alike.

"Envision, along with others -- including CalPERS (California Public Employees' Retirement System) -- supported the bill due to its disclosure model regulations and leveling the playing field for all PBMs who wish to participate in California business under the new requirements," says Envision CEO Kevin Nagle. But "ironically, while the Big Three embraced transparency and full disclosure publicly, their lobbyists and own organizations were fighting it behind the scenes vehemently."

Both California houses passed the measure anyway, but Gov. Arnold Schwarzenegger -- widely considered a friend to pharmaceutical interests -- vetoed it.

Maine has fared better. In a hard-fought legal battle, the state last year won the right to implement a particularly tough PBM law that goes so far as to declare the companies "fiduciaries" that must place their clients' interests ahead of their own. Former Maine Sen. Sharon Treat, who sponsored that law, is now working with more than a dozen other states that hope to pass similar legislation going forward.

In the meantime, she suspects, PBM clients could start making more and more demands of their own.

"There's no reason why they can't set standards within their own contracts -- if they know what to put in there," Treat says. "That seems to be the big problem."

Thus, some people feel, PBM clients could increasingly turn to transparent options instead. Envision, for one, sees more business coming its way.

"We had a terrific year (in 2005)," Nagle says. "And we think that 2006 will be even better. ... We're in the middle of a (PBM) revolution -- whether people want to believe it or not."