Traditional PBM Pricing Vs Pass-Through…Look Before You Leap!

Daniel C. Opinante

Mar 8, 2010

Traditional PBM Pricing Vs Pass-Through…Look Before You Leap!

Pass-through PBM pricing models have become very popular in the pharmacy benefit business over the last few years.  Many self-insured benefit plan sponsors have jumped with both feet into pass-through Pharmacy Benefits Manager (PBM) contracts.  The lure of this type of pricing model is the perception that if the PBM is not generating any revenue through margin pricing (i.e. paying the pharmacy less than the amount the PBM is billing the client), a pass-through contract will result in lower plan costs.

Unfortunately, this is not always the outcome.  Before jumping to a pass-through PBM contract, plan sponsors must first understand the differences between Traditional (margin) contracts, and “pass- through” PBM contracts.

Before discussing the intricacies of a pass-through PBM contract, let’s define a few terms:

Transparency:  A PBM contract is considered transparent if the PBM is willing to disclose all revenue streams (e.g., margin pricing, rebates, formulary management fees, data sales, etc.).

Pass-Through: A pass-through contract typically offers the PBM just one source of revenue- a flat administrative fee paid either per member, per month (PMPM), per employee, per month (PEPM) or per claim to the PBM.

Traditional: A traditional PBM contract provides the PBM with revenue sources in addition to, or exclusive of, administrative fees.  PBMs may receive revenue from margin pricing (the difference between what the PBM bills the client and what the PBM pays the pharmacy), as well as retaining a portion of the manufacturer rebates generated from the plan sponsors’ members filling drugs that are eligible for rebate payments.

AWP: Average wholesale price of a medication.  AWP pricing is provided through independent pricing sources.  These pricing sources include: First Databank, Medi-Span, and Red Book.  Most PBMs use either First Databank (FDB) or Medi-Span as their source to price each pharmacy claim.

Plan sponsors that are considering a pass-through PBM contract instead of a traditional agreement should consider the following:

Evaluate PBM Cost Base for Traditional and Pass-Through Agreements

With a pass-through PBM contract, the plan sponsor pays the actual contracted discounts and dispensing fees that the PBM has negotiated with the retail pharmacy network.  The network rates negotiated by the PBM with pharmacy network providers are identical to the pricing invoiced to the plan sponsor.

PBM retail network contracts may be very different however.  Lately, many “private label” or “virtual” PBMs have entered the market.  These “virtual” PBMs have aggressively marketed their business model as 100% pass-through. Further, because pass-through model PBMs do not generate revenue through margin pricing, they often assert to provide the plan sponsor greater savings on their pharmacy spend.  The sole value proposition of most “virtual” PBMs is that the plan sponsor will experience additional cost savings since the PBM does not make revenue on margin pricing. What is being lost is a discussion of the PBM’s cost base and rate guarantees.

A more helpful way to look at cost base from a plan sponsor perspective is to consider this: If a traditional model PBM can guarantee a discount of AWP-16%, and create a margin compared to a pass through model PBM that is not generating margin, but can deliver a discount of only AWP-15%, what model is optimal for the plan sponsor?  If one PBM is capable of generating revenue through margin pricing, and to deliver the best discount at the lowest administrative cost, then the plan sponsor would be wise to select the PBM vendor with the lowest overall net cost.

Plan sponsors should focus on the model that will generate optimal savings, instead of solely evaluating how the PBM is going to receive payment for delivering services.

Evaluate Mail Service Pricing Independently

When evaluating PBM mail service pricing under a pass-through model Plan Sponsors need to determine if the  pricing the plan sponsor is receiving really pass-through?  Is the PBM providing cost plus methodology for mail service claims?  Many “pass-through” PBM contracts provide a pass-through methodology for claims that are dispensed through the retail pharmacy network, but fail to provide “pass-through” pricing at mail service.  The rational for this disparity is that many PBMs treat their mail service pharmacies no differently than other pharmacies in the network.

Much like a retail pharmacy, mail service pharmacy revenue is the difference between the pharmacy’s acquisition cost of the medication and the amount the mail pharmacy receives in payment from the PBM that is adjudicating the claim.

For a simple method of determining whether your PBM contract is providing cost plus pricing, review the dispensing fees or administrative fees.  If you are paying $0 administrative fees, and $0 dispensing fees for your mail service claims the PBM is billing based on margin pricing.  With a true pass-through the typical cost base per claim at mail service is between $6 and $10(a combination of fixed and variable costs).

Is a margin revenue model for mail service claims disadvantageous?  Not as long as your plan is getting the best discount that can be achieved based on current market conditions.  Is cost plus mail service pricing superior to margin pricing? Once again the answer depends on the actual discounts realized by the plan sponsor combined with the mail service cost base.  For readers preferring cost plus at mail service, you should consider the following:  How will you determine whether or not you are actually receiving cost plus pricing?

Evaluate Your “Network Risk”:

The big difference between pass-through contracts and traditional PBM contracts involves who is responsible for the network risk.  The challenge with pass-through contracts is that if your members purchase their prescriptions from pharmacies where the PBM does not have strong discount rates, your plan will pay a higher cost.  For example, if your member buys their prescriptions at a local pharmacy where the PBM only receives AWP-14% discount for brands, this will also be the discount the plan receives.  If your members purchase at a large chain pharmacy where the PBM has a great discount (e.g., AWP-17%), your plan savings will subsequently be much higher.  Network risk is a major factor for plan sponsors in rural areas when considering a pass through model.

Under a traditional model PBM contract, the PBM assumes the network risk.  In the example above, if your members visit a pharmacy where the PBM reimburses at AWP-14%, and your PBM contract calls for AWP-15%, the PBM will lose revenue in the transaction, and the member’s purchasing decision will not have a negative effect on your plan cost.

Transparency:

Transparency in the PBM industry should be used to determine which PBM pricing model is in the plan sponsor’s best interest.  At the end of the day, a plan sponsor should select a PBM based on how that PBM will control costs and provide the best service.

Transparency should also be used to ensure that, after a contract is awarded, the PBM is in compliance with the contract.  Contrary to perceptions in the marketplace, a PBM can offer transparency with either the pass-through model or the traditional model.  The fundamental problem with the big push in the marketplace to pass-through contracts is plan sponsors focus so much on determining how much revenue a PBM is generating, that the sponsor agrees to terms that are impossible to evaluate for compliance.  For example, often, pass-through model PBM representatives convince plan sponsors to forgo discount guarantees (in their contracts with the rationale that since the model is pass-through the guarantees are unnecessary.  This is a catastrophic mistake on the part of the plan sponsors.

The popularity of pass-through PBM contracts have resulted from what many plan sponsors and industry consultants view as “smoke and mirrors,” practices with regard to PBM pricing .  While much of this criticism is justified, unfortunately, many of the pass-through marketing campaigns are guilty of equal or greater “smoke and mirrors” tactics than the traditional PBM campaigns.  Much of the pass-through PBM marketing is attempting to divert the plan sponsors’ attention away from guaranteed discounts, and focus on PBM revenue.

PBM Revenue: A Look from the PBM’s Side

The purpose of this article is not to imply that traditional PBM pricing is better than pass-through pricing. Rather, the objective is to make the reader aware that the only difference between traditional PBM pricing and pass-through pricing involves how the PBM is paid to deliver their services. The manner in which a PBM is compensated should not be the primary focus in PBM vendor evaluation.   Plan sponsors should dedicate their efforts to comparing vendors based on how, and how much the PBM will save the plan sponsor, as well as evaluating the quality of the vendor’s services.

When a Pass-Through Contract is Better for the PBM

Keep in mind that a pass-through contract guarantees the PBM a profit.  If a PBM’s revenue is solely based on administrative fees and does not provide any discount performance guarantees, the PBM has no risk.  The network risk under a pass-through contract is entirely that of the plan sponsor, rather than the PBM.  If the PBM can secure very low/no guarantees in the client contract, a pass-through model is a prompt way to ensure profit.

Pass-through contracts are more beneficial for those PBMs that do not have the critical mass to negotiate deep discounts with their network, or competitive rebate contracts with manufacturers.  The PBM revenue sources and pricing methodologies are not well known to plan sponsors; thus, it is easier to deflect a competitive traditional price by casting doubt on whether the discount is “too good to be true.”  This marketing practice of “casting doubt” on traditional PBM pricing contracts has done significant damage to the PBM industry.

When a Traditional Contract is Better for the PBM

Traditional pricing provides the PBM with a great deal of flexibility to provide competitive pricing. If the PBM analyzes a plan sponsor’s utilization without the restriction of pass-through model, the PBM can offset losses in one area, simultaneously applying the revenue to another area to cover the loss.  A good example of this includes plan sponsors that have high mail service.  If the PBM owns their mail facility, the PBM can estimate the revenue at mail and be willing to take a loss on retail claims.

The real advantage for a PBM under a traditional pricing model occurs when the plan sponsor is complacent and does not continually compare its PBM agreement to the current market to ensure that its PBM terms keep pace with prevailing market rates.  If a plan sponsor is complacent, the PBM can realize increasing revenue solely based on the trend of the plan sponsor’s health plan.  Consider this example:  If a PBM provides a plan sponsor with a revenue margin of 1%, and maintains this margin for more than five years, the PBM’s revenue per claim will increase.  One percent of a $100 claim is $1.  As the cost of the medications increase, the value of the 1% margin increases.  One percent of a $110 claim is now $1.10 in revenue. One percent of a $120 claim is now $1.20 revenue per claim.

For plan sponsors electing a traditional margin PBM contract, the most important course of action is to ensure that the Plan Sponsor test the market competitiveness of their PBM agreement at least every 2 years.

When a Pass-Through Contract is Better for the Plan Sponsor

Pass-through contracts work best for plan sponsors that understand the PBM industry, and are willing to dedicate resources and time for the evaluation of the plan sponsor’s PBM vendor.  Typically, this also means a plan sponsor that has the wherewithal to take advantage of what a pass-through contract can offer.  If the plan sponsor is willing to implement innovative plan designs such as OTC step-therapy, generic substitution of brands with generics in their therapeutic class, and others, then the pass-through contract may offer substantial savings.

Plan sponsors that have very low mail service utilization, and high generic utilization can also take advantage of a pass-through contract.  Child Health Plus, Family Health Plus, and Medicaid plans can take advantage of a pass-through contract.

When a Traditional Contract is Better for the Plan Sponsor:

If a plan sponsor does not have the time or desire to get involved with all of the moving parts in the PBM and they are looking to get measurable guarantees, a traditional contract may be the correct choice.

Conclusion:

Plan sponsors should decided if a pass-through PBM contract is better than traditional arrangement based on the sponsor’s unique and specific needs.  Sponsors should carefully review both pricing models before deciding and avoid pressure to select a pass-though contract simply because many other sponsors are selecting this type of contract.  Pharmacy benefit expenditures are increasing each year.  Choose the right contract based on carefully reviewed guarantees and evaluations – not because of the latest fashion.  Whatever PBM agreement you decide on, don’t become complacent; sponsors should review the PBM market competitiveness of their contract every two years.

If a plan sponsor has doubt about how the PBM’s contract will affect his or her plan cost, he or she should take the steps to gain knowledge by hiring a respectable consulting or auditing firm for assistance. 

About the Author:

During his eight years working within the Pharmacy Benefit Management (PBM) industry, Mr. Opinante has had many notable accomplishments.  His primary responsibility during his tenure in the PBM industry was Business Development for the eastern United States.  His efforts contributed to his employer being named as the #1 fastest growing businesses in CRAINS, and the #4 fastest growing business in America. In addition to his business development responsibilities, Mr. Opinante was responsible for the conception and implementation of a PBM revenue forecasting model that is still in use today.  It is this exceptional level of technical knowledge of the Pharmacy benefit industry that makes Mr. Opinante uniquely qualified as an auditor and consultant.

Mr. Opinante has been very active in educational initiatives designed to help unveil the complexity of the pharmacy benefit industry.  As the featured speaker of the national PBM educational series “Taming the Tiger”, Mr. Opinante has had the opportunity to present his “PBM 101: Pricing and Revenue Models” throughout the Country.  Mr. Opinante has had the privilege of supporting education and awareness of PBM business models at many industry venues.  As a speaker at the Health and Welfare Conference for Mid- Sized Employers, Made In America Taft Hartley Benefits Summit, the National Association of Police Officers (NAPO), and Health Care Administrator Association (HCAA), Mr. Opinante is dedicated to offering his experience to provide industry colleagues with a unique understanding of the pharmacy benefit industry.  Most importantly, Mr. Opinante provides valuable insight into how pharmacy benefits interface with the healthcare delivery system as a whole.

Prior to working within the PBM industry, Mr. Opinante had a successful management career working for a New York based Blue Cross Blue Shield plan, and as a Large Group Representative for US Healthcare.  This background in health plan operations provides Mr. Opinante with a very highly attuned awareness of all aspects of the healthcare delivery system.