To Regain Control of Drug Costs, Health Plans Must Understand the Road They've Traveled

Gregory S. Kaupp, JD, MPA, MLT, and Scott B. Lynch, JD

In This Article


We've all heard it: prescription drug costs have been rising rapidly over the last several years, with increases between 14% and 18% annually. Drug costs now account for about 15% of total health care expenses. What can be done about it? Who really is in control of these costs?

Health plans and employer groups must understand the history of the PBM industry to fully understand whether their interests in managing the pharmacy benefit are being met. Today's PBM industry grew out of a business known as pharmacy claims processing, which was founded more than 30 years ago. Established on a unique principle of providing PBM services to health plan members through a drug card, this business initially created a more efficient way for health plans to handle pharmacy claims processing. The early drug card allowed for the operation of some simple benefit management features, such as generic incentive programs and limitations (by age, sex, or otherwise) regarding the exclusion and inclusion of certain pharmaceuticals. Before drug cards, pharmaceutical products were typically reimbursed under major medical expenditures and were lumped in with physician visits, laboratory work, x-rays, and other health care costs.

During those early years, employers turned to health care insurers to provide member-friendly pharmacy benefit services. These health plans often outsourced the pharmacy benefit administration to a claims processing company with an established national network. Over time, health plans began to expect these claims processors to provide additional cost management services. Thus, we began to see the development of discounted average wholesale price networks, generic/brand differential copayments, PPO pharmacy networks, and maximum allowable cost pricing for generic drugs.

The late 1980s brought the establishment of online claims systems, which were developed and rolled out nationally. Clinical products and services also were developed, starting with formularies and drug utilization reviews, both of which became standard operating procedures for the industry. The carving out of pharmacy from the major medical health benefit continued to grow as online systems made these programs more attractive. Health plans also believed that the new electronic system would bring with it more advanced management of the pharmacy benefit. Today's PBM, however, is in the unique position of being both the provider of services and the payer of these services and, thus, is managing both sides of the process. How did this happen?

Elsewhere, changes in the management and delivery of prescription drug benefits began to generate market reactions from the pharmaceutical companies, which started designing programs based on rebates to PBMs for inclusion of their drugs in the formulary. Pharmaceutical sales forces also began aggressively targeting managed care clients. By the early 1990s, several manufacturers went a step deeper into drug benefit management by acquiring the largest PBMs in the industry. At the same time, mail-order delivery of prescription drugs began to rise, while retail pharmacies established their own PBMs.

Until the early 1990s, claims processing was the primary source of revenue for PBMs, and the health plan or employer was the primary customer. Before electronic point of service (POS) claims processing, nearly the entire amount of a PBM's revenue was derived from claims processing. However, electronic claims processing brought increased competition and efficiency to the business, forcing PBMs to find new sources of revenue, some in conflict with the best interests of their health plan clients.

Those PBMs with an ownership connection to mail-order pharmacy or retail-chain revenues began selling claims processing at or below cost. The strategy to use claims as a strategic loss leader was supported through a growth in profits -- either from mail-order drug sales or in getting the patient into the retail store. This created a "price war" among PBMs for large health plan business and resulted in a market-wide perception of POS pharmacy claims processing as a commodity.


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