Causes and Cures - California Health Care Foundation76 years. People are enrolled longer, are using more drugs. Demand is increasing. The plans systemati-cally underfund pharmacy for

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Abt Associates

April 2001

CALIFORNIA HEALTHCARE FOUNDATION

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Causes and Cures:Stakeholder Perspectives onRising Prescription Drug Costsin California

A COMPANION REPORT TO: PRESCRIPTION DRUG USE ANDEXPENDITURES IN CALIFORNIA

Causes and Cures:Stakeholder Perspectives onRising Prescription Drug Costsin California

Prepared for:

ADVANCEPCSCALIFORNIA HEALTHCARE FOUNDATION

Prepared by:Abt Associates Inc.

April 2001

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Acknowledgments

Abt Associates Inc. is one of the largest private research-basedconsulting firms in the United States. Founded in 1965, it has offices in Cambridge, Washington, D.C., and Chicago.Abt Associates supports a staff of more than 1,000, whichincludes both industry-specific and discipline-specific expertsskilled in management, research-based consulting, marketingstrategy and research, economics, statistics, psychology, model-ling, computer systems, and analytic techniques.

The California HealthCare Foundation (CHCF), a privatephilanthropy based in Oakland, California, was created in1996 as a result of the conversion of Blue Cross of California, a nonprofit organization, to Wellpoint Health Networks, a for-profit company. The Foundation focuses on critical issuesconfronting a changing health care marketplace by supportinginnovative research, developing model programs, and initiatingmeaningful policy recommendations. For more information on CHCF, visit our Web site at www.chcf.org.

ISBN 1-929008-54-6

Copyright © California HealthCare Foundation 2001

Contents

5 I. Interview Process and Key Findings

7 II. Physicians and Medical Groups

16 III. Hospitals and Health Systems

23 IV. Health Plans and Other Insurers

32 V. Employers and Purchasing Cooperatives

40 VI. Consumers

Causes and Cures: Stakeholder Perspectives on Rising Prescription Drug Costs | 5

WHAT DO THE KEY PLAYERS AFFECTED BY RISINGprescription drug costs see as its causes and cures? How dothey perceive each other and the potential for joint effortstoward solutions? From where they sit, what is working andwhat is not? And where do we go from here?

To answer these and other questions, Abt Associates inter-viewed 30 stakeholders across California who play a major rolein defining the trends and in determining the future directionof prescription drug cost and use:

◆ medical directors and pharmacy managers at 13 large medicalgroups and six managed care organizations

◆ medical directors or human resource managers at five largepurchasers, including employers and purchasing cooperatives

◆ chief financial officers, directors of finance, and directors of pharmacy—at five hospitals or health systems.

To capture the perspective of the government on prescriptiondrug trends, we also interviewed a resource person at the statelegislature.

Each of the interviews lasted for approximately 90 minutes andfollowed a structured interview guide created specifically foreach of the stakeholder groups. Table 1 summarizes the inter-view process.

Key Findings

Despite the often intense acrimony and strain that character-izes relationships among major players involved in today’s pre-scription pharmacy market—each tends to blame the othersfor contributing to current conditions—all agree that theymust find a way to cooperate if workable solutions are to befound and implemented.

I. Interview Process and Key Findings

They also agree on at least some of the majorcauses of the recent unprecedented rise in pre-scription drug costs: (1) the availability of newand expensive drugs along with new uses forexisting drugs; (2) a newly empowered andassertive health care consumer whose increasingdemands often reflect the impact of direct-to-consumer (DTC) advertising and the desire for“lifestyle drugs”; and (3) a burgeoning seniorpopulation whose need for medication is greaterthan that of younger consumers.

Our respondents enumerate a daunting list ofbarriers to finding viable solutions:

◆ A lack of access to complete, timely, and adequate information about the cost/benefits of new drugs, patients’ utilization patterns, and physicians’ prescribing patterns

◆ A shifting risk-sharing picture with physicianswithdrawing from risk and dismantling criticalutilization management infrastructures whilehealth plans reluctantly retake risk with fewerresources to reconstruct pharmacy managementprocesses

◆ A lack of price sensitivity and accurate informa-tion among consumers

◆ A low unemployment environment that makesemployers reluctant to risk alienating valuableemployees by curbing pharmacy benefits

◆ The threat of damaging government inter-ference—politically motivated legislation and regulation based on limited understanding.

Despite all these obstacles—or, as some inter-viewees suggest, because of desperation engen-dered by the current drug cost crisis—innovativesolutions are likely to arise. Stakeholders arecounting on technology to improve informationwithin and among groups, a multitiered benefitsystem to enhance consumer responsibility, arenewed focus on quality to bring the drug cost-benefit ratio into balance, and “outside the box”thinking to create an entirely new system for providing and managing prescription drugs.

6 | CALIFORNIA HEALTHCARE FOUNDATION

Table 1. Interview Process Summary Data

Stakeholder Group

Medical Groups Health Plans Employers Other

Total Interviews 13 6 5 1

Location in California 8 south, 5 north 3 south, 3 north 1 south, 4 north north

In Person or Telephone 9 in person, 4 phone 5 in person, 1 phone 4 in person, 1 phone 1 in person

Physician or Pharmacy 7 physician, 6 pharmacy 3 physician, 3 pharmacy physician


CALIFORNIA MEDICAL GROUP RESPONDENTShave passionate opinions about the changes taking place inmedicine today—about pharmaceutical firms’ TV ad campaigns,health plans that no longer collaborate, patients who bringthem reams of information from an Internet search, and regu-lators who may not have the entire story before they introducelegislation for new mandated benefits. They deliver a candidreview of factors driving the unparalleled increases in pharmacycosts and place their bets on the changes that will occur inCalifornia to gain control over these costs.

We spoke with 13 physicians or pharmacists in medical groupsacross the state. In general, medical groups in California aremore organized, larger, and have more management structurecompared to groups in other parts of the country. The groupswe interviewed have between 100 and 600 physicians, six and15 managed care contracts with health plans and insurers, and10,000 to 350,000 covered members.

Overall, medical groups report that the pharmacy budget is“high on the radar screen” in their organization. They viewprescription drugs as critical to their ability to deliver efficientquality care. Trends in new drug development and unexpectedcosts related to pharmacy use and price have hit physicians infour key ways:

1. Prescription drugs strain budgets and doctor-patient relationships.

2. Physicians are moving rapidly away from financial risk for prescription drugs.

3. Medical groups are systematically withdrawing from investment in pharmacy management.

4. Relations with health plans are deteriorating.

“In the early 1990s, phar-

macy risk represented a

bonus to the groups. By the

mid-1990s, it was a break-

even proposition. By the late

1990s, we were paying out

of our own pocket.”

– Pharmacy director, northern California medical group

II. Physicians and Medical Groups

Prescription Drugs Strain Budgets

and Doctor-Patient Relationships

Across the state, there was universal agreementthat prescription drugs are an increasingly impor-tant element of today’s medical office visit.Prescription drugs are elemental to the careprocess, and they are highly effective. Many newdrugs enable physicians to address disease in farbetter ways than they previously could. Becausemedical groups seek ways to increase patient sat-isfaction yet deliver treatment as efficiently aspossible, prescriptions frequently become thepatient’s tangible result of an abbreviatedencounter. Telephone refills for prescriptions area mechanism for ensuring compliance with treat-ment and loyalty to the medical group.

Although pharmacy topics are of high interest formedical groups across California, the degree ofimportance respondents attached to rising costsof prescription drugs varied, depending upontheir group’s financial risk for these costs.

In medical groups that share risk for prescriptiondrugs, pharmacy is the single fastest growing partof the budget. Information is seen as a key toolfor containing utilization and cost of prescriptiondrugs within the organization. Groups are con-tinually generating or receiving health plan dataon comparative patterns in prescription use andcost. Individual physicians are ranked accordingto their judicious or capricious prescribing ofhigh-cost drugs. All in all, prescription drugs arecoloring the financial picture for practices, influ-encing interactions with payers and employers,and injecting new tension into the doctor-patientrelationship.

Tension in the doctor-patient relationship.Physicians report a rising level of tension withpatients around prescription drugs. In conflictwith their doctors’ focus on shorter, more tightlymanaged encounters, patients are attempting toassume more control of their medical encounters.Patients are increasingly challenging their doc-tors, asking more questions, and demanding specific drugs they have learned about throughadvertisements, the Internet, or friends.

These blunt observations by two northernCalifornia physicians illustrate a new level offrustration or impatience with patients:

“If they can’t have the prescription, they want toknow why. Telling them they don’t have the condition addressed by the drug does not resolve the problem! The nature of the visit has changed.There is more tension, more debate, and less satisfaction.”

“I’m keenly aware of the impact of direct-to-con-sumer-advertising on my practice. My patients comein demanding a specific drug and I’m afraid to say no for fear of losing my patient.”


Physicians Move Rapidly

Away from Financial Risk for

Prescription Drugs

California medical groups universally report that the high level of managed care enrollment in commercial and Medicare health plans has dramatically affected their organizations’ financialexposure. Despite an interest in promotingappropriate use of innovative and effective prescription drugs, medical groups have beenanxious about the costs of drugs for the pastfew years. Until very recently, they were sharingthe risk for patient care, particularly for their senior patients in Medicare plans. In the mostrecent contracting cycles with health plans, many groups have refused to retain a high por-tion of the risk for drugs—a signal that they view this area of cost containment as “beyond their control.”

Medical groups originally had a large incentive toassume risk for pharmacy costs. Their willingnessto bear risk was consonant with their belief thatphysicians should manage all components ofpatient care and reap the benefits of appropriateutilization of newly efficacious pharmaceuticalinterventions. However, with the growth ofincreasingly expensive drugs and DTC advertis-ing, medical groups’ ability to manage the cost increases degraded. Explains a southernCalifornia group’s medical director/CEO: “We were managing pretty well for a while. Phar-macy has been the thing that has really tipped thescale for the worst possible outcome. Even withmodest premium increases, our medical group isback to where we were in 1994.”

Senior plans compound the risk. Medicalgroups and health plans deal with capitation for prescription drugs separately from capitation for primary care/office visit services. They address pharmacy benefits for members in seniorplans—those who are covered by Medicare—instill separate negotiations, which they describe as“very challenging.” This is because the pharmacy budget for seniors represents a substantially higher proportion of the overall premium alloca-tion—as much as three times higher than theamount allowed for a commercial health planmember—compared to pharmacy for commer-cially covered populations.

Medical groups report that the negotiations forchanges in risk arrangements on senior plans are not only separate but more acrimonious. Themedical director of a southern California groupreports: “The average age of senior members is 76 years. People are enrolled longer, are using moredrugs. Demand is increasing. The plans systemati-cally underfund pharmacy for seniors. Some plansdidn’t do their homework, but others just used theirmarket power to get the contract terms. It is impos-sible to meet the pharmacy budget goal for seniors.”

Scrambling to give it back. Among our respon-dents, we found a majority of those holdingpharmacy risk had negotiated new contracts forcommercially covered members. Across theboard, they were taking no greater than a 50 percent share of risk on pharmacy cost, with astop-loss of 10 percent on the upside or down-side. Only one group still held 100 percent risk for any enrolled lives, but this group alsonegotiated a 10 percent upside limit (stop-lossamount) on prescription drugs.

“Until last year,” says the director of pharmacy at a southern California medical group, “we wereseeking full risk for prescription drugs in our man-aged care contracts. Now, we are scrambling to giveit back!”


Medical Groups Systematically

Withdraw from Investment in

Pharmacy Management

When medical groups began taking financial risk for pharmacy in the early 1990s, they hiredpharmacists and developed strategies for trackingtheir physicians’ prescribing behaviors. They put in place processes to better recognize a mem-ber’s health plan and use the correct formulary at the time of prescribing. Of course, they also introduced financial incentives related to brand-name/generic drug prescribing, procedural compliance with health plan rules (such as pre-approval for certain drugs), and so forth. The goal was to “keep it simple” and easy forphysicians to use good clinical and economicjudgment when deciding on a prescription drugregimen. Respondents report that investmentwithin the medical groups ran into millions aslarge practices sought to ensure tighter controlover this high-cost area of medical care delivery.

Tensions between drug company reps andpharmacists. One side effect of pharmacy management within the medical group has beentension between the medical group pharmacistand drug company representatives, who have historically played an important educational andeconomic role for physicians. Respondents reportnew levels of control over the sample closet inphysician offices, with medical groups oftenpolicing the samples being brought in or deliv-ered by pharmaceutical companies. They recountnew protocols, rules and guidelines, even debateover whether the drug company rep can buypizza for the office staff on Fridays!

According to the director of pharmacy at asouthern California medical group, “We keepcareful tabs on the sample closet, and have circu-lated a written policy for manufacturer reps regarding their access to our groups and to our sample closet. If it isn’t on the formulary, it isn’t inthe sample closet. But we still see a lot of unautho-rized samples being doled out to patients!”

Physicians in the group may see these activities as restricting their ability to learn about new drug developments or provide optimal care. Forinstance, in the past they have used the samplecloset to test a patient on a new regimen beforeprescribing the drug, or to subsidize low-incomepatients. Respondents are challenged to showthat all of these changes are worth the animosityand ill will being created.

Says a director of pharmacy for a northernCalifornia medical group: “Even though we haveour disputes with the reps, the elimination of ‘academic detailing’—that is, the educational infor-mation on research related to drugs—is a loss to our physicians. It creates a void.”

Returning to the status quo. Since a majority of California medical groups have now effectivelyshifted the pharmacy financial risk back to thehealth plans and the sponsors or employers, willthe efforts to understand and manage prescrip-tion drug use be abandoned? We asked how thisshift in risk affects medical group and physicianattention to formulary decisions or cost trade-offswith high-volume prescriptions. We heard thatgenuine management of pharmacy requires consistent interaction between physicians and agroup’s pharmacist. Patients also need informa-tion and access to data on new drugs. But suchefforts draw resources away from other activitiesin the medical group. When there is little or nofinancial risk for pharmacy, groups estimate that they are spending less time and energy onmanaging this aspect of premium dollar.


We heard about a systematic and ongoing withdrawal of investment in pharmacy-relatedmanagement efforts. What has taken a decade toconstruct—the information infrastructure, the disease management protocols, and the peer-review processes—is being dismantled at abreathtaking pace. While medical group phar-macy departments continue to argue for usinginformation and education to influence physicianand consumer behavior, there is general agree-ment that draconian practices related to financialincentives and constant surveillance of physicianprescribing are no longer needed within the medical groups themselves. Remaining controlinfrastructures focus on compliance with man-aged care plan formularies and protocols ratherthan drug management.

A director of pharmacy explains how a northernCalifornia group is divesting itself of pharmacymanagement along with risk: “Drug manage-ment has been really important to our group! We hired two pharmacists for 100,000 enrolledlives. As we start losing risk, pharmacy managementprobably won’t be as big a focus. We will lay off at least one of our pharmacists, since we have to control overall administrative cost—after all, weno longer have control or responsibility when itcomes to pharmacy.”

Will behavior changes in prescribing be lost as soon as risk is given back to the plans? It isn’tclear that anyone cares. To a large extent, res-pondents view the return on their investment asunsatisfactory. While medical groups were developing tools to change behavior, deliveringdata to physicians, and lobbying health plans for better information, pharmacy costs rose an average of 15 percent to 20 percent in a year.

The impact is clear, reports a southern Californiamedical group pharmacy services specialist: “Our physicians are saying, ‘Stay out of my face; I don’t want to hear anymore. Let me do my job.’”

Relations with Health Plans

Are Deteriorating

Relations between medical groups and healthplans in California are strained. While our resultsconfirm the stresses in these relationships, thepurpose of this study did not include an analysisof the causes of this tension. However, the inter-viewers did ask about the impact of pharmacymanagement issues on contract negotiations andcollaboration with plans.

Respondents note three causes for deteriorationin relations with plans: (1) Managed care contracts create an “us vs. them” atmosphere; (2) rebates and multiple formularies create animosity; and (3) health plans have a disjointedinformation strategy.

An “us vs. them” atmosphere. While medicalgroups acknowledge that “partnership” withhealth plans was the idealized goal in the 1990s,many cite the tension created by new bureau-cratic red tape in today’s interactions. Healthplans are actively trying to influence prescriptionwriting from afar. When health plans have therisk for prescription drug costs, and the physi-cians write the prescriptions, there is “more andmore tension.” The HMOs focus on better management of formulary compliance, and theirefforts to control prescription volume and costcreate a new set of procedures to be followed.

One chief medical officer in northern Californiadescribes a typical interaction: “There is a hugehassle factor with everything we do. If you try toprescribe the drug you think is best for the patient,but is not the preferred drug of the HMO, you canexpect to have several calls from a pharmacy techni-cian or a retail clerk with no clinical experience—asking a set of predefined questions before they areable to authorize the prescription.”


The interviews also revealed an underlying feeling that the health plans have ulterior motivesfor every change in formulary, drug managementprocess, or contracting. For example, while it is probable that plans underpredicted pharmacycosts for the most recent period, medical groupsare likely to suspect that plans knew somethingwas coming and purposefully kept it under wraps.

Says the medical director of a southern Californiamanagement services organization: “The healthplans bought market share with our money. Theydid this by shifting the risk to groups, and then sell-ing out those who took the risk. They sold short thevalue of medicine, at $70 per member per month!”

Some medical group leaders are more philoso-phical about the roles of the plan and group, and describe their differences as a natural set ofchecks and balances needed in the health caresystem: “I see more and more tension between theplans and groups in the future. This is good. There needs to be more tension, since it is a natural tendency for people to use way too many prescrip-tion drugs. The health plans that fight back thehardest are the ones I like the best,” says a southernCalifornia management services organizationmedical director.

For the most part, however, medical groups see relations with health plans at a low point inCalifornia. They are on opposite sides in a frantic economic skirmish. Last year, for example,groups experienced a large cost overrun in manymanaged care contracts after an unexpected surgein pharmacy costs due to the launch of high-priced, new injectable medications in the middleof the contract year.

Injectables:

Health Plans Needle Medical Groups

Recently introduced high-technology injectablecompounds are extremely expensive—averag-ing more than $5,000 for a single treatment. A crisis in medical groups’ injectable budgets—and in relations between medical groups andhealth plans—arose last year, when these newinjectable drugs came out but were not coveredin the prescription drug plan.

Since the vast majority of traditional office injec-tions, such as immunizations or flu shots, arerelatively inexpensive, groups have historicallyborne this cost in their primary care budgetwithout much debate. When health plans givemedical groups capitation payments for primarycare services, it is customary to include officeinjections as a covered expense.

While some health plans had alerted the groups to the potential implications of the newdrugs, there was no budget for what turnedinto a large cost overrun in many managed care contracts.

This latest experience is typical of the type ofthing that throws a monkey wrench in relationsbetween the health plans and medical groups.For the medical groups, injectable medications,posed a sudden and significant unreimbursedbudget item. The new drugs—much more effec-tive than any treatment previously developed—are also exponentially more expensive, yetwere not included in the pharmacy budget.Therefore physicians were caught scrambling tocover the shortfall until the new contract cyclelet them reopen discussions with the plans.

“Do you administer this expensive, but highlyeffective, drug to a patient—and hope that youhave a cushion in your budget to cover theoffice-based expense? Or do you postpone thetreatment until the argument over coverage isresolved in the next contract year? Of course,you could ask the patient to pay—but patientswith prescription drug coverage and primarycare coverage believe they are entitled to suchtreatment, at no extra cost.”

– Medical director of a southern California medical group


Medical group respondents saw the health plansas unwilling to offer financial relief. They depictedthe budget crisis over injectables as a typical“gotcha” with health plans. “They simply threwup their hands and said it wasn’t their problem,”reports one medical director in San Diego.

One health plan executive described the dilemmafrom the payers’ vantage point:

“We had been briefed by the pharmaceuticalreps that new injectables were on the launchpad, but employers were not interested in pre-funding an expense that was yet to occur.Our suspicions about the impact on medicalgroup operating budgets were borne out. Therewas an outcry across the physician community.However, our hands were tied. The contractsstipulated that these expenses were included inthe primary care capitation payment.

“When medical groups propose that we coverthese unanticipated drug expenditures for thefirst year or so, it is unreasonable. We all getpaid through the employers and other sponsors.If they are not willing to pay more, where wouldwe come up with the extra money?”

In many cases, managed care contract nego-tiations have made allowances for the shortfallmedical groups experienced last year. For others, there was no recourse. The lesson weheard about was one of discouragement andincreased tension between the key players inthe delivery of health care. ♦

Rebates and multiple formularies create animosity. Medical groups believe health plansare compromising clinical value for financial reasons when they put rebates above good clinical decision making. Pharmaceutical companyrebates lead to a preferred drug list that is notclinically superior and constantly changes as newdeals are made with manufacturers.

Discussions of health plan formularies quicklymove to concerns about rebate arrangementsbetween pharmaceutical manufacturers and health plans. Since plans receive discounts or incentive payments (rebates) for achieving volume thresholds on prescriptions for preferreddrugs, medical groups see the rebates as drivingdecisions that should be strictly clinical. As a newdeal is made, one formulary drug is removed and another takes its place. Or a new blockbusterdrug is added to the formulary, but so are twoother less effective but costly drugs from thesame manufacturer (as when drugs are “bundled”for rebate arrangements). Medical groups see the health plans making self-interested deals thathurt relations with their physicians, or under-mine patient trust in physician decision making.

According to a pharmacy services specialist with a southern California medical group: “Healthplans tout ‘partnerships.’ We should be able to work things out. But rebates and the bundlingof medications create more hostility.”

One source of constant friction is the health plan preferred drug list or formulary—and thefrequency of changes in drugs on the formularylist. Their frustration is exacerbated by multiple-tiered benefit plans that further complicate formularies as drugs move from one tier toanother. If a typical medical group has six toeight contracts with plans, there are an equalnumber of formularies. It is safe to summarizetheir reaction by saying that medical groups hate multiple formularies and that health plans varyin their ability to keep groups current with formulary changes.


When a patient receives a prescription for a nonpreferred drug or a nonformulary drug, thatpatient faces a higher copayment and a possibledelay at the pharmacy. Of course, the patient ismore likely to be dissatisfied with the physician.When the patient calls the health plan to com-plain, respondents say, the plan representativemay state that it was the physician’s choice to order the drug.

“My biggest problem with the health plans? That’s my biggest problem, the fact that their for-mularies are always changing!” says a southernCalifornia group pharmacy services specialist.

Through the mid-1990s, before cost minimi-zation became the dominant concern with phar-macy benefits, medical groups had representativeson the health plan’s pharmacy and therapeutics(P&T) committee that jointly evaluated the efficacy of new drugs. These committees assessedthe effectiveness of new drugs, considered thevalue to patients and the community at large, andset policies for use for the health plans’ members.

With the precipitous increase in prescriptiondrug expenditures, physicians saw a new emphasis on the economics of a particular drug.Medical group respondents report that the rebatethe HMO receives from a manufacturer is thesingle largest factor in decisions about whichdrug is “preferred” for a given therapeutic class.

“Plans chase the rebates!” exclaims one director of pharmacy for a large medical group in northern California.

Another medical director in northern Californianotes that the increased tension between healthplans and medical groups has affected the jointP&T committees, and “many have stopped involv-ing representatives from medical groups altogether.”

The medical director of a southern Californiagroup sums it up like this: “Health plan partner-ing? No, not really. It’s more of a ‘good guy/bad guy’thing. A patient will complain to the plan about amedication we feel forced to administer (by theirformulary)—we will try to work with the plan, but I am struck by how they will persistently let ustake the hit for the patient’s unhappiness.”

Health plans’ disjointed information strategy.Information on prescription drug use and cost isessential to a successful pharmacy managementapproach. Plans typically administer the paymentfor prescriptions, so they have the current dataon physician prescribing, patient compliance,changes in volume of particular medications, costtrends, and so forth. These data are essential to amedical group’s understanding of its own pat-terns and of the longer-term disease managementpotential of particular protocols. Respondentsreport that the information they receive is betterthan ever, but that it is still received in ways thatmake it difficult to merge across all health plansand that it comes to groups at varying timesthroughout the year.

According to a northern California group’s chiefmedical officer: “I think the whole pharmacy benefit management thing will go the way of [otherobsolete ideas of the past]—we’ll see that they arenot cost effective! In the meantime, we have twofull-time pharmacists trying to facilitate appropriateutilization, while our physicians are being hassledby clerks from the plans. I can’t remember anythingthat’s been turned down for anything other thancapriciousness. What a waste of time and money.”

Medical groups crave information that will helpthem perform in a cost-effective manner but also help them improve the quality of care they provide to their patients. Interviewees report alack of information from health plans not onlyabout individual physician performance but alsoabout the effectiveness of a new drug versus thealternative drugs in a class already available.


What’s Ahead?

Our respondents offer a view of the future ofprescription drug costs in California that is colored by relief that they no longer hold drugrisk—since they see little slowdown in the escalation of costs related to new drugs andincreasing use of existing drugs. Discouragementabout the doctor-patient relationship and what it will look like in the next few years also colors their viewpoint.

No slowdown in sight. When it comes to es-calating prescription costs, physician groups saythat DTC advertising is the main culprit. Untilmanufacturers are required to communicateobjectively and consumers have access to com-plete clinical information, medical groups do notharbor hopes for a slowdown in expenditures.

They report that patients are increasingly educated about their drug choices through infor-mation available on the Internet and ads. Sincethese patients are buffered from the full cost of their drug choices, they continue to makedemands during office visits. These demands aremore frequently for lifestyle drugs—in somecases, they are drugs that are not on the preferreddrug list or are not covered under their plan.

The proliferation of lifestyle and DTC-promoteddrugs has heightened the tension in the doctor-patient relationship, laments a medical groupPCP in Los Angeles: “We have created a false senseof knowledge with the information that is floatingaround out there. People confuse ads with clinicaldata, and come in here ready for a fight. We arefighting with patients all the time.”

As to future changes, physicians predict twomajor trends:

Escalating tiers. Among the major changes medical groups expect to see are three-tier—evenfour-tier —benefit designs that should encouragethe gradual emergence of more rational con-sumer behavior. Says a southern California groupmedical director: “Three-tier benefit plans take usout of the middle. Our patients come in and saythat they want us to prescribe a drug that is tier oneor tier two—they make the trade-off themselves!”

Automation. Groups expect electronic recordkeeping and data transmission to become the standard. They hope that the return on their investments in automation will finally be realized. Their continued interest in prescriptiondrug data reflects their view that disease management successes will require continuousinformation on patient status, prescription patterns, and drug research results.

“We’re betting everything on an electronic medicalrecord,” declares the director of pharmacy at anorthern California medical group. “We’ve beenworking on it for the past four years. We will haveautomated prescribing, automatic entries into themedical record, and real-time data updates. It willdramatically improve our control over our group’sprescription drug trends.”



SENIOR MANAGEMENT AT CALIFORNIA HOSPITALShave a great deal to contend with right now. Responses to the instability of managed care plans, payer contracts, govern-ment reimbursement rates, legislative requirements (for such items as seismic rebuilding), clinical quality, informationrequirements, and skyrocketing costs compete for strategicemphasis. Among those strategic priorities, hospitals haverecently begun to focus on prescription drugs.

We interviewed senior executives at five hospitals or health systems located in southern and northern California inDecember 2000 and January 2001. Respondents were chieffinancial officers, directors of finance, and directors of phar-macy. Each of the hospitals has at least 350 staffed beds andoffers a significant number of outpatient services. Of the fivehospitals, one was part of a larger health system; one was a free-standing, not-for-profit institution; one was an inner-city,publicly owned institution; and two were multi-hospital academic medical centers.

Hospital executives’ chief focus is on the quality of care issuesthat most closely affect their patients and could adverselyimpact public perception of the institution, such as medicationerrors. However, more hospitals recently have begun addressingthe cost implications of prescription drugs.

In their new focus on inpatient pharmacy, hospital executivesacross California report four areas of concern:

1. Escalating pharmacy costs overwhelm hospital budgets.

2. Hospitals are searching for effective cost control measures.

3. Relationships with health plans and payers are impaired.

4. Patient safety is a big investment.

“The hospital and physician

are at risk for costs on

HMO products. One seven-

year-old hemophiliac cost

us $5 million last year—

and 90 percent of that was

for blood and blood products.

We reached our max on

reinsurance, but the hospital

kept paying out of its own

pocket.”

– CFO, Orange County health system

III. Hospitals and HealthSystems

Escalating Pharmacy Costs

Overwhelm Hospital Budgets

Acute care hospitals have always been responsiblefor prescription drugs dispensed to patients dur-ing an inpatient stay. Until recently, the cost ofpharmacy was a relatively small supply item easilyincluded in a per diem or other negotiated rate.In general, supply costs had a comparatively marginal impact on the cost of hospital care.However, steady growth in supply costs, drivenby huge increases in prescription drug costs, hasshifted hospitals’ focus squarely onto this issue.

“We’re seeing pharmacy costs increasing three to five times faster than any other supply cost,” reportsthe vice president and director of finance at anorthern California medical center.

An Orange County health system CFO echoesthe alarm: “Right now supplies represent 20 percent of our inpatient costs and nearly all of that is pharmacy!”

Such significant growth in cost is a mountingsource of pain to the hospital respondentsbecause payer reimbursement is not keepingpace. “We’re predicting a 20 percent increase indrug costs next year and only 10 percent of that will be covered—the rest is dollar-for-dollarours,” laments the CFO of a northern Californiapublic hospital.

Adds a Los Angeles area hospital executive vicepresident/CFO, “Drugs are purely added cost.There is no revenue for drugs, they are nothing butoverhead.”

What’s causing the increases? Hospital adminis-trators state strongly that most rising drug costshave been driven by inflation and the develop-ment of new, highly effective drugs. Respondents,like the following CFOs, cite technology as thelargest contributor to soaring pharmacy costs:

“Drivers aren’t hospital over-bedding and physiciansalaries, but new technologies. Technological innovations in the last five years have driven trendsway up. The technology is amazing and it will get even more expensive with genetics coming downthe pike.”

– CFO, Orange County health system

“Right now the trend is towards more and morecostly drugs. It is so hard to measure the benefit versus the cost. A new one comes and we say ‘that’s a wow,’ and they keep coming up with those.”

– Executive vice president/CFO, Los Angeles area hospital

Respondents also criticize the pharmaceuticalmanufacturers for purposely driving up drugcosts to increase profits. Along with other stake-holder groups, hospital executives observe thatthe pharmaceutical industry is benefiting fromprice and volume trends that are multiplying at an unprecedented rate. Respondents point toDTC advertising that raises patient expectations,consolidation in the pharmaceutical industry that limits competition, and supply strategies thatdrive up costs for high-demand products.

“In 20 years drug costs have increased, but neverlike this. I think it is really fishy that drug costs haveskyrocketed since competition decreased through con-solidation in the pharmaceutical industry,” suggeststhe vice president and director of finance at anorthern California medical center.


The director of pharmacy at a Los Angeles healthsystem is equally suspicious: “We’re seeing drugshortages that drive up costs and then miraculouslyreappear. Like this year’s flu vaccine. There was a reported shortage that was highly publicized, thenall of a sudden there was plenty to go around but it cost twice as much.”

Respondents cite recently launched drugs forcancer and AIDS and psychotropic medicationsthat are extremely expensive and did not existwhen reimbursement rates were negotiated with health plans. They also point out that newinjectables and blood products that hospitals dispense under per diem contracts quickly over-whelm hospital budgets. Often costing morethan $500,000 per month, these new productsexceed even hospital reinsurance or stop-loss levels.

Cost increases are not limited to these new classes of drugs. Hospitals are seeing growth inthe cost of oral drugs as well. “Orals” constitutethe highest volume of drugs in inpatient and outpatient settings, so the impact of this trend isfelt widely across the institution. “We never hadto deal with these kinds of costs on an oral tabletfive years ago,” remarks a Los Angeles health system director of pharmacy. Oral medicationsare an area of focus for hospitals that see oppor-tunities in group purchasing to contain costs forthe most commonly used products.

Hospitals Search for Effective

Cost Control Measures

The increases in pharmacy costs felt across allstakeholders in California are only now hittinghospitals, and cost control measures are justbeing implemented. Our respondent hospitalsare starting to adopt some of the cost controlstrategies for pharmacy that medical groups or managed care plans have already demonstratedto be effective. While senior management hastensto point out that their first efforts focus squarelyon pricing, they are also looking at controllingdrug utilization.

Formulary control and clinical guidelines.One of the most powerful tools for containingpharmacy costs for managed care plans has beenthe tight administration of a restrictive drug formulary. Hospitals, because they have neitherbeen able to make their formularies restrictivenor assure strict physician compliance, have beenless successful in using this strategy.

Each of the hospitals we interviewed has devel-oped a specific formulary of preferred drugs that are stocked in the inpatient pharmacy.Developing and maintaining the formulary is theresponsibility of the hospital’s P&T committee.All committee decisions are clinically based andmembers are staff physicians. Still, most P&Tcommittees have financial data available andsome have significant finance department input.“We are really fortunate that the pharmacy areaand the VP are tuned in financially,” says the CFOof an Orange County health system. “They willput in for the lowest cost drug and if all clinicalissues are resolved, the doctors go along.”


Some of the respondents are implementing clinical guidelines, particularly for injectables andother really expensive drugs. Others have path-ways that include drug recommendations. Oneof the hospitals reports implementing pre-printedorder forms to facilitate compliance with the recommendations in the protocols.

Despite these measures, the enforcement de-scribed by all of the hospital managers is largelyvoluntary. There are no “teeth” for physicianswho are not compliant with the formulary or clinical pathways. “Our P&T committee tries to contain costs,” explains the CFO at a northernCalifornia public hospital, “but they seldom say‘no.’ The state formulary is liberal, but ours is evenmore liberal. If a drug is not on the state formularybut it is on ours, the doctors push us to provide itand we usually do.”

In the most aggressive hospitals, physician volunteers review orders for nonformulary or off-pathway drugs and call the ordering physicianto see if that is indeed the right drug for thepatient. In many cases, the prescribing physicianwill modify the orders; otherwise the drug is usually approved. Other hospitals may require aco-signature by another physician for approval.

“Our physicians are all independent practitioners,”explains the executive vice president/CFO of a Los Angeles area hospital. “They order what theywant. The formulary is easy to override. If a physician orders something off-formulary, the phar-macy director or someone on the P&T committeemight talk to them, but if they still want it, we getit for them.”

Almost across the board, the approach of thehospitals to controlling utilization and adheringto the formulary is educational. The P&T com-mittees gather information about therapeuticvalue and outcomes from the literature to try andshape physician preferences. If there is a robustinformation system, a hospital may also usereporting tools, such as utilization or prescribingpatterns, to modify behavior.

“We monitor utilization and cost using our decision-support system,” reports an OrangeCounty health system CFO, “but it is not tiedinto the patient record. Our information system isgood at financial reporting but it’s missing the clinical-financial marriage that would allow us toprofile physician utilization.”

Some hospitals are hiring pharmacist educatorsto inform formulary development as well as educate doctors. That too, has run into barriers:

“We’re hiring specialized pharmacists to control costsand help the physicians understand how to use thedrugs. But we can’t find the pharmacists!” declares anorthern California public hospital CFO.

Purchasing power. Some hospitals are currentlypart of purchasing groups for pharmacy that offer price relief through the clout of large pur-chaser discounts—a tool previously established tocontrol other supply costs. They have achieved

savings for the most commonly prescribed drugsbut not for the very expensive blood products or injectables.

Respondents report that although they have hadsome success in containing costs through thepurchasing consortia, they anticipate bigger savings through utilization changes that theyhope will occur over the longer term. “Last yearwe undertook a huge project to get drugs off of the formulary. The physician group was charged withgetting savings. They ended up benchmarking costs through the university consortium and thenjoining the purchasing consortium to get someclout,” explains the vice president and director offinance at a northern California medical center.


Relationships with Health Plans

and Payers Are Impaired

In our interviews with medical groups, respon-dents reported serious breaches in their relation-ships with health plans. Many of these rifts weredriven by a feeling that they were left “holdingthe bag” when health plans should be sharing inthe financial responsibility for increasing drugcosts. The same situation is shaping up betweenhospitals and health plans.

Most of the hospitals have per diem, case rate, or other fixed-price contracts with their payers.These amount to risk-bearing contracts as they relate to drugs because pharmacy costs areincluded with other supply costs under the nego-tiated rate. Therefore, hospital respondents citeconcerns that are very much like those of otherrisk-bearing stakeholders (such as medical groupsand health plans). They worry about curbing theupward trend in drug cost and utilization, andsee pharmacy as a major problem in their ongo-ing relationships with other stakeholders.

“We do not get another dime from payers to accountfor high pharmacy costs,” points out the vice president and director of finance at a northernCalifornia medical center. “If we try to carve specific drugs out, the managed care plans decreasethe per diem [to make up the difference].”

Perverse incentives. Hospitals also cite specificexamples where health plans’ reimbursementpolicies actually drive up pharmacy costs for in-patient care. One problem is with chronic medications that require clinical monitoring,such as infusions where nurses need to watch theprocedure. Because of low reimbursement tophysicians by payers, patients are being admittedfor the treatment. These infusion drugs areextremely expensive and the hospital is respon-sible for the whole cost.

In another example, HCFA is pushing back onwhat it will pay physicians to administer oncolo-gy drugs. Hospitals report that oncology admis-sions are increasing as physicians admit patientsrather than accept declining reimbursement. Sothe trend that was originally sought by managedcare—a shift to lower levels of care where appro-priate—is being reversed to avoid high drugcharges in outpatient settings.

Poor coordination. Additional serious concernsfocus on clinical issues in the continuity ofcare for patients because hospital formularies arenot integrated with managed care company formularies. Each of the hospitals has its own for-mulary that reflects the needs and preferences of its physicians. In creating the formulary, thephysicians do not consider the formularies of the managed care companies or other payers(Medi-Cal has its own formulary as well). A different group of pharmaceutical company salesstaff (“drug reps”) focus exclusively on institu-tional providers.

The result is a lack of coordination that, at worst,can seriously compromise patient health and, atbest, confuse and annoy the patient. The mostcommon scenario occurs when the patient isstarted on one drug in the hospital and then goeshome to discover the drug is not on their man-aged care organization’s formulary. They eitherhave to change drugs in mid-treatment or seek aplan override.

The same situation can occur in reverse at thetime of admission, as described by this director of pharmacy at a Los Angeles health system:“This is our number one dilemma. Patients areadmitted for surgery who are on a whole host of chronic meds. Then you find out two of the sixdrugs aren’t on our formulary so we don’t have themin stock. The patient won’t change drugs because of their insurance, so you send a family memberhome to get the patient’s supply. The hospital looksfoolish, patient satisfaction is affected, and thepotential for drug errors increases.”


Patient Safety Is a Big Investment

Each of the respondent hospitals is in the processof undertaking a strategic effort to assure thesafety of patients in the distribution and dosingof prescription drugs. Hospitals are making significant investments to eliminate medicationerrors through better prescribing tools and delivery systems.

While these institutions report that they have not experienced a catastrophic medication error,they are reacting to the possibility of a potentialerror—particularly in light of the high level ofpublic scrutiny that has followed the Institute ofMedicine’s widely publicized 1999 report onmedical errors.

Interventions to reduce medication errors rangefrom low-tech, such as mandating that physiciansprint instead of write all orders, to high-tech bedside devices and automated dispensing to beimplemented over the next several years.

“This is an area of investment for us. We are imple-menting an automated distribution system. We have paper systems now, but we are bringing up aphysician order entry system that will enable ourdoctors to order drugs online,” says the vice presi-dent and director of finance of a northernCalifornia medical center.

“On the outpatient side, our physicians are usinghand-held devices,” reports a Los Angeles healthsystem director of pharmacy. “We will be imple-menting a physician order entry system with clinicaldecision rules and resource management interven-tions in our inpatient units next fall and winter.”

There is no doubt that quality of care hasimproved as a result of the interventions atCalifornia hospitals to reduce or eliminate drugdosing and dispensing errors. At the same time,reducing these errors has required significantinvestments that have driven up drug-relatedhospital costs.

Finding money to fund these new systems isproblematic for most of the hospitals weinterviewed. One medical center that is focusingon improving operations and compliance byupgrading to the seismic building requirementscurrently has no hand-held or bedside devices for prescribing. It is looking to the HMOs for funding.

Other institutions expect to break even in thenear future. Says the executive vice president/CFO of a Los Angeles area hospital: “We’re look-ing at robotics now for dispensing, but it will take afew months to implement. It is pretty close to beingcost justified. We anticipate it will give us a lot moreinformation and a lot more control.”

What’s Coming?

Hospital respondents are pessimistic about solu-tions to the problems associated with prescriptiondrugs. They predict that pharmacy costs will continue to increase as new drugs are developedthat are both highly effective and extremelyexpensive. The majority of respondents see devel-opments in two areas: technology and govern-ment involvement.

Drug and information technology. Technology,a major contributor to cost increases at hospitalsover the recent past, will continue to drive updrug-related costs in the future, respondents predict. For these hospital administrators, technology includes the development of new generations of pharmaceutical agents as well asnew distribution and information systems thatcontinue to evolve.


Developments in next-generation drugs, such as those that have recently been introduced, are sure to continue. In addition, advances in genetics will result in even more expensive clinical agents. More and more of these newagents require a higher level of medical monitor-ing than can be achieved outside the hospital.Therefore, respondents anticipate an increase inboth inpatient and outpatient utilization of newpharmacological products.

Hospital management predicts that investmentsin information technology will continue to stress budgets for the foreseeable future. For pre-scription drugs, investments will center aroundsystems to control medication errors and improvecoordination of care for patients, such as inte-grated/electronic medical records, hand-held orbedside ordering tools, and robotic dispensing.While these solutions have been discussed in thepast, the growing financial role of prescriptionsin the overall clinical picture may accelerate theiradoption by hospitals.

Hospitals are also investing in information systems to help them understand the utilizationtrends that contribute to cost increases. Lack ofinformation is a major problem for many of theinstitutions, who currently have no integratedmedical record and little ability to gather infor-mation on outcomes to give back to doctors.

Respondents see integrated patient utilizationand cost information as a key component of drugutilization control. These data will be applied todevelopment of more sophisticated formulariesand allow for more aggressive adherence to protocols and pathways. Decision-support andreporting systems are improving and will soonreplace existing manual or paper systems.External data about drug effectiveness and clini-cal outcomes will be necessary, and will be inte-gral to P&T committee activities. Respondentspredict that contemporary data will be moreaccessible to decision makers as electronic medical records and other real-time informationsources become more commonplace.

More government involvement. Hospital exe-cutives see no clear solution to the problem of escalating prescription drug costs. Quite pes-simistic about the potential for market forces tocurb increases in cost or to provide relief to their institutions, these executives exemplify acommon outlook: They reluctantly predict thatgovernment intervention is unavoidable and, atthe same time, unlikely to result in any signifi-cant assistance to hospitals.

“I don’t see relief on the hospital side, but I see thegovernment getting involved. There will be a government plan for prescription drug coverage forMedicare. They want to control it because of thesize of the program.”

– Executive vice president/CFO, Los Angeles area hospital

“The state program cost a lot of money. They aregoing to have to sacrifice programs to offset inflationso they will become more strict with their formulary out of necessity.”

– CFO, northern California public hospital

“If something doesn’t happen, there is going to berationing. All we can do is keep actively lobbyingand pointing out the problem.”

– Vice president and director of finance, northern California medical center



HEALTH PLAN RESPONDENTS APPROACHED OURinterview topics, including the rise in prescription drug costs,with caution. Looking back at the past few years, they say theyhave been battered by price wars. There is universal concernthat an active legislature and aggressive regulators are challeng-ing their industry’s reputation. They argue that they werecaught in a cycle of change marked by unrealistically low pre-miums and heavy consolidation of plans and medical groups.The health plan premium is only now beginning to rise againin California, after years of highly competitive pricing.

Plans speak about the need to re-establish a partnership withmedical groups to regain control over drug benefits. Theydescribe the need for financial arrangements with pharmaceu-tical companies to subsidize pharmacy benefit administration.They also predict that the next wave of health care purchasingwill be driven by “quality of care”—with disease managementand prescription drug coverage a centerpiece of all new efforts.

We met with representatives—four physicians and two clinicalpharmacists—from six health plans and traditional insurers.Much has been written about the evolution of health plans inCalifornia, and the amount of consolidation that has takenplace in the past five years. Our sample reflects these changes.Two health plans are national organizations, two plans coverthe entire state of California, and two plans are available onlyin a region of the state (one northern California, one southernCalifornia). At the time of the interviews, plans offered bothcommercial and Medicare risk products.

We heard about four areas of concern in the discussions withphysicians and pharmacists in health plans across California:

1. Rising drug costs have created a crisis for health plans.

2. Health plans are taking back financial risk for prescription drugs.

3. Plans face significant obstacles to pharmacy management.

4. Relationships with medical groups and employers are worrisome.

“Pharmacy costs make me

nervous. We need some

speed bumps on this phar-

macy benefit highway.”

– Clinical pharmacist, northern California health plan

IV. Health Plans and Other Insurers

Rising Drug Costs

Create a Crisis for Health Plans

Health plan respondents report that prescriptiondrugs are critical to their organizational strategy.Pharmacy, its impact and cost, is an issue of very high visibility. All of the stakeholders—employers, members, physicians, and pharma-ceutical firms—clamor for favorable treatment in the pharmacy area.

To create differentiation in the highly competi-tive California health care market, health plansand insurers have mounted a campaign forimproved quality of medical care that centerspartly on disease management. For the vastmajority of conditions being treated in ambu-latory care settings, disease management is drivenby pharmaceutical intervention. When pharmacycosts spike unexpectedly, the underlying diseasemanagement strategy is threatened. On this issue,health plans align with employers and members:Prescription drugs must be accessible and affordable for health care delivery to functionefficiently in California’s managed care system.

Cost pressures. Like other stakeholders, healthplans see rising prescription drug costs as a crisisfor their business. As the following statementsattest, plans are concerned about curbing theupward trend in cost and utilization:

“Pharmacy is very high on our radar screen. We lost the most in this area last year—the highestpercentage over budget. We’re projecting a 20 per-cent trend in this part of our premium, unless wecan gain better control over it.”

– Chief medical officer, northern California health plan

“We are in ‘survival mode.’ Everybody’s losingmoney [on drugs]. We know the market will win inthe end, and we are supporting good economicbehavior. It is just a question of who will survivelong enough to get there.”

– Medical director, southern California health plan

The senior risk. Until this year, almost everyplan in California offered a senior “risk” product.Because of the penetration of Medicare riskplans, our respondents spoke at length about the importance of Medicare enrollees’ pharmacyexperience. Compared to commercial plan members, the pharmacy premium is often three times higher for Medicare enrollees. So the senior population’s use of prescription drugs is of great concern.

“With Medicare risk, members need much moreeducation,” explains a southern California healthplan medical director. “Our job has been to deliveraccess to members, and to help with education. The physicians needed to convince the member tofollow their advice, but there isn’t the same bondbetween the member and doctor. No. So the processdidn’t control cost, it didn’t work! Now everybody isgoing to pay the price for ‘candyland’!”

Health Plans Take Back Financial

Risk for Prescription Drugs

For a period in the 1990s, California health plans relinquished some or all financial risk forpharmacy to the medical groups. Medical groupseventually found themselves in the red for phar-macy costs, and began negotiating to return thepharmacy risk to the health plans. This transfor-mation has taken two or three years to complete,but health plans are once more in the position of holding the lion’s share of the financial risk forprescription drugs.


Back to the future. The health plans havemoved, in some cases reluctantly, to negotiatearrangements of shared risk for pharmacy. In ourinterviews, the most commonly described riskarrangement for pharmacy, negotiated separatelyfrom all other medical care risk, is 50 percentshared risk with very limited downside risk (typically, a maximum of 10 percent exposurewhen the medical group exceeds expected costs).These contracts also have a variety of incentivesfor upside risk (such as equal sharing in the pharmacy budget surplus at the end of thecontract year).

Some health plan respondents view the takingback of risk as a precursor to a return to the traditional full-insurance model. Pharmacy cover-age for an insurance plan or health plan wouldbe offered as a separate rider and would be fullyinsured. Says a medical director at a southernCalifornia health plan: “The model cannot last, itis going to change. We believed in the delegatedmodel, thought that it would lead to tighter controlson pharmacy cost. Instead, we got ‘fee-for-service’models. We will end up going all the way back tolarge pool, indemnity-type coverage for pharmacy.”

Plans Face Significant Obstacles

to Pharmacy Management

When it comes to pharmacy benefit manage-ment, health plans say that they will continue todrive behavior change through active investmentin educational and data-related activities directedat medical groups and consumers. Since mostplans believe that quality will become the nextdifferentiator among the health plans, they willsupport good prescription drug access and costmanagement through data, physician education,relationships with pharmaceutical manufacturers,research, and ongoing development of diseasestate management standards.

The majority of our respondents also have a third-party pharmacy benefits management(PBM) partner involved in the day-to-day administration of utilization management and pre-authorization programs. The PBM firm alsopays claims and reports on the prescription drugpurchasing programs for rebate managementwith pharmaceutical firms.

Regulation and legislation. A major stumblingblock, say health plan respondents, is the esca-lating interest of California regulators in phar-macy coverage and consumer satisfaction. Health plans see regulators—the Department of Corporations, and its newest incarnation, theDepartment of Managed Health Care—as “mis-guided” and adding to the administrative burdenthey face. “Regulators in California have goodintentions,” remarks a northern California healthplan clinical pharmacist. “But the results are diffi-cult for the MCO to implement.”

Legislative involvement is even more of a con-cern, since respondents, like these two medicaldirectors, view legislators as having inadequateinformation and basing decisions on political,not clinical, judgments:

“Managed care is the legislators’ number one issue.There is continued legislative furor around drugbenefits, strictly for political reasons. Unfortunately,the headlines detract from the real message—thatthe cost of drug coverage is making prescriptionsunavailable to many people.”

– CMO, northern California health plan

“Decisions about pharmacy coverage are being madeon the legislative floor—bills are being introducedthat are built off of a single case! It’s pitiful.”



Working with pharmaceutical firms. Arrange-ments with pharmaceutical firms for volume discounts (rebates) have become integral to costmanagement for health plans. There appears tobe no waning of commitment to this economiclever for health plans: “Contracting with the manufacturers is essential to avoid huge premiumincreases,” explains a clinical pharmacy director ata northern California health plan. “We contractfor volume discounts with the lowest AWP [averagewholesale price] products in a class. And this is oneway of lowering manufacturer costs.”

Adds a medical director of a southern Californiahealth plan: “The whole system is driven by politics and marketing! Physicians resent that theirautonomy is being taken away—but rebatearrangements are part of the way we can support an affordable pharmacy benefit.”

Health plans view contractual formularies (influenced by clinical choices and economicdeals with pharmaceutical firms) as essential tofinancial survival. The tools they use includeclosed formularies and tiered benefits. They com-bine these with pre-authorizations for manyhigh-priced, nonpreferred drugs.

On the other hand, health plans are not thrilledwith manufacturer behavior on two other fronts.First, they detest direct-to-consumer advertisingas heartily as do the physicians. Health plans gobeyond that, though, and object to the phar-maceutical firms’ marketing to the providers.They see the pharmaceutical sales reps as “buyingthe doctor with cups and trips,” reports onemedical director in southern California.

“Pharmaceutical firms have far more power, control, than they should have,” contends a senior executive medical director at a northernCalifornia health plan. “The pharmaceuticalindustry is going to regret their heavy-handedapproach when the federal government gets involved(over Medicare drug benefits).”

On balance, respondents in health plans view the pharmaceutical industry as critical to thedevelopment of breakthrough therapeutics andargue that some of the new drugs being launchedare real clinical stars. They want to center the discussion of pharmacy costs on the question of“Who pays?” as opposed to blaming the developersand marketers of drugs for the cost crisis.

Returning to the status quo. When they origi-nally delegated drug risk to medical groups, mosthealth plans had turned their administrativeresources to other priorities. While they activelymaintained pharmacy consultation services andcontinued to make formulary management decisions through the P&T committee structure,any duplicative administrative oversight activitieswere dismantled. Now health plans are facedwith the need to reconstruct basic processes forpharmacy management—a range of activitiesthat have been performed by the medical groupsfor several years. Plans have far smaller budgetsthis time around—so they may have trouble taking on this task, and many will use third-partyPBMs to maintain pharmacy benefits manage-ment. Respondents express little confidence thatthis return to the status quo will bring relief:

“We’ll lose some of the progress we’ve made. I seeproviders opting for the easy way out. The easiestway is to reach into the sample closet.”


“Now that we are retaining drug risk, we are having a problem finding upside incentives thatwork for physicians. Without these, the providerswill have no skin in the game. They won’t noticepharmacy costs.”


“We’re giving the groups data. If they’re not at risk,will they use it? Remember, the M.D. controls whatis prescribed. He has the influence.”

– Director of pharmacy services, northern California health plan


Relations with Medical Groups and

Employers Are Worrisome

Physicians as partners—“us vs. them”? Whenit comes to pharmacy benefits management,medical group respondents are suspicious abouthealth plan motives. Plan respondents, in con-trast, are somewhat more reluctant to criticizemedical groups or physicians.

Tensions are running high, and pharmacy is right at the top of the list of sources of dissen-sion. Plan respondents report that pharmacybudget overruns have made contract discussionshighly contentious this year. The overruns are afunction of price and volume increases, com-pounded by the medical group experience with“injectables” and their unanticipated impact onmedical premium.

The result is a major rift between health plansand medical groups across the state. “Physicianswant out of this end-game,” says a northernCalifornia health plan director of pharmacy.“There is a groundswell out there—maybe you can’tsee or hear it, but if you talk to the doctors youknow it is happening. There is more professionalantagonism between the health plans and physiciansthan ever before.”

Health plans, forced to retain pharmacy risk in the most recent contract cycles, now findthemselves liable for the expense of pharmacy,while medical groups and individual prescribingphysicians influence the behavior of members.The situation does not lend itself to harmoniouspartnerships:

“In our market, everyone is in conflict—physicians,payers, hospitals, ancillary providers, and retailpharmacies—each plays a role in pharmacy andeach wants ultimate control. The only good thing isthat everyone is aware of the problem and talkingabout it. Still, there is no trust relationship.”


“Working together is a problem. Unfortunately, this is not going to be easy to solve. That’s becausethe MCOs are cutting cost at the expense of the providers—which is like shooting ourselves in the foot, because the provider is our key link to consumers.”


Expectations for physician compliance with phar-macy management are mixed. Plans echo theconcern of medical groups that these two stake-holder groups have conflicting goals. Intervieweesdescribe their difficulty finding a commonground for moving forward. Now that they havedrug risk again, they worry that they are justreplacing yet another layer of bureaucracy, butwill have little impact on physician day-to-daybehavior when it comes to pharmacy benefits:

“Providers are so busy with everyday stuff, it’s hardfor them to see beyond 5:00 P.M.—much less col-laborate with us on a drug management program.”

– Medical director, northern California health plan

“Physicians in California are just like doctors every-where. They have the same dreams and weaknessesof providers any other place. They are just doctors insunny locations. The only difference for them is thatthe premiums here are higher, and the reimburse-ment far lower, compared to anywhere else.”

– Medical director, health plan, southern California

“It’s hard to fault prescribers (I used to be one!)—but, doctors just aren’t as honorable...”

– Medical director, health plan, southern California

Relations with employers strained. Pharmacy isthe single largest driver of premium increaseswith employers in California. It worries employersand is driving a wedge between plans and theircustomers.


Part of the issue is increased use of existing drugs;part is the proliferation of new, high-priceddrugs. Some of these are lifestyle drugs, which aresources of frustration for both plans and employers.According to a northern California health plandirector of pharmacy services, “Three-tier benefitdesigns help with ‘lifestyle drugs,’ but in the longrun the only way we’re going to deal with these is asan industry. We need to decide what ‘lifestyle’ is andcreate coverage that is consistent across plans.”

Without reservation, our respondents seeemployers as having realized the benefits ofCalifornia’s highly competitive managed care market in the 1990s. When it comes to rising costs of pharmacy coverage, they report that employers want to contain rising employeeexpectations without any loss of employee satisfaction or goodwill.

Health plans see drug benefits management as a no-win scenario, since rising prescriptiondrug costs require tighter adherence to formulary,benefits, and utilization management compli-ance. Tightening up controls will inevitably leadto more employee prescription denials and moreconversations with physicians about prescriptions.

Rather than added policing of formularies, health plans promote benefit designs that shiftresponsibility to employees/members. With theexception of Kaiser Permanente, health plansreport more friction with employers over how tobest stem rising drug costs. Our respondents areintent upon moving employers to three-tier bene-fit plans, more general use of NDC (NationalDrug Code) blocks at the retail pharmacy, andmore coverage exclusions for lifestyle drugs.

Reacting to disappointment over pharmacy pre-miums, employers and their consultants appearto be moving toward third-party carve-outs andgreater reliance on group purchasing solutionsoutside of the health plan arrangement.

Clearly plans and employers are not writing fromthe same page. “Our large employers want more,not less!” says the medical director of a northernCalifornia health plan. “Today, they are excitedabout electronic linkages to the medical groups, andare demanding more of health plans in this area.”

The medical director of a southern Californiahealth plan characterizes the relationship like this: “How have things changed? Look at the response of employers or members to us. When you ask employers or members to speak onbehalf of the health plan—their health plan—theanswer is ‘No!’”


Kaiser Permanente: A More

Seamless Approach to Prescription

Drug Cost Increases

Kaiser Permanente is not plagued by some of the same cost and quality trade-offs facing health plans and groups that have contracted to worktogether. So say interviewees from both KaiserPermanente and the employers who contract withthem. An organization that combines health plan,medical group, and hospital in one entity, KaiserPermanente is one of the oldest staff-model HMOsin the country (although in recent years it hasextended its delivery model to include contractedphysicians and institutions).

What makes the difference? For one thing, sincephysicians work directly for Kaiser PermanenteMedical Group (KPMG), it has more than 95 percentcompliance with its prescription drug policies: “The physicians set the policies, evaluate all newdrugs, and determine what our preferences will be in delivering the highest quality drug therapies,”reports a senior physician on Kaiser’s P&TCommittee.

Kaiser’s unique health care delivery model alsoappears to help spark the impetus to action on quality-of-care measurement. One employerrespondent argues that only Kaiser delivers the kindof information needed to fully assess the value ofadopting new drugs as they become available: “No one wants to delay adoption of new drugsbecause they are expensive, not if they will makedramatic difference in the healthy recovery of apatient. But without data and the ability to weighthe trade-offs, too often the decisions are based onthe cost of the old drug compared to the new one.”

Employers claim that Kaiser is consistent and appliesa standard protocol for evaluating and adoptingnewly available drugs—even when they are pricierthan their older predecessors.

Kaiser also collaborates on outcomes studies withkey customers. A benefits manager in northernCalifornia notes that “Kaiser does what’s good forthem, and good for us. We have a ‘best practices’project going on. Physician pharmacy ordering isreviewed against Kaiser benchmarks for best prac-tice. Everybody wins. We get improved prescriptiondrug ordering; Kaiser brings their docs up to speedon drug practice using technology to give immediatefeedback on quality and to keep it all very current.”

Another northern California employer points out that Kaiser is willing to be tested against a quality standard: “Kaiser is working with large employers tostandardize a quality rating that would be used topay ‘extra credit’ for performance at the end of a contract year.”

Distinguishing characteristics in

drug management

In the course of the study, the distinctions in theKaiser Permanente Medical Group’s pharmacy management model crystallized. There was clearevidence that organizational structure enabled executive policy makers to strongly influence pre-scribing behavior across medical sites. Through theformulary review process, with active participationby local and regional physician leaders, medical policies related to drug utilization and quality controlwere effectively adopted and broadly followed.Physicians are employed by Kaiser PermanenteMedical Group, and while they are free to use theirbest medical judgment, their continued exposure tocompany guidelines and best practice explain theextent of uniformity in prescribing and compliancewith P&T Committee policies. We found manyexamples of this during our interviews:

♦ Physician leaders conduct on-site medication educational forums.

♦ KPMG physicians in specialty areas are regularlyshown evidence-based data on the effectivenessof specific drugs.

♦ Physicians at all sites are restricted in their abilityto receive special treatment from pharmaceuticalsales representatives.

♦ KPMG distributes physician and site-specificreports on prescribing patterns and compliancewith Kaiser P&T standards.


Bringing it together to benefit members

These efforts at impacting physician orderingbehavior are coupled with the fact that KaiserPermanente benefit coverage requires membersto fill their prescriptions at Kaiser pharmacies(located at most large medical group sites). Theimmediate economic effect of Kaiser’s rigorouslymanaged pharmacy program is that Kaiser’snegotiations with pharmaceutical firms—for volume-based discounts or “rebates”—arestrengthened by its ability to deliver on commit-ments to use preferred drugs. Kaiser’s formularydoes not contain every possible medication in a therapeutic class. On the contrary, the P&TCommittee works arduously to identify and support the use of the drug that is most effica-cious, that is clinically as effective as others, but also economical. When volume discounts are calculated, this means that some high-priceddrugs demonstrated to be clinically superiorbecome affordable when negotiations assumepreferred use across all of Kaiser’s enrolledmembers.

The unmatched levels of prescribing complianceat KPMG are created by the organizational integration of the health plan, the medical group,and Kaiser’s network of provider facilities.Kaiser’s is the exemplar of the staff-model HMO,in which each of the individual parts works tooptimize the economics and clinical effective-ness of the others. In the case of pharmacymanagement, Kaiser’s commitment to superiorclinical outcomes, at the lowest appropriatecost, gives it a unique position amongCalifornia’s health care delivery system. ♦

What Does the Future Hold?

There are no universal predictions among healthplan respondents about the trends or tools forprescription drug management in the future.Health plans recognize the need for partnershipsto craft responses, although they doubt suchpartnerships could be easily formed or would bestable enough to create change. Many health planpredictions center around technology, consumers,and government intervention.

Information and technology essential to healthplan success. In the future, respondents say, clinical information will be used to build datareporting consistency across plans. Real-timeinformation will drive disease managementstrategies with incentives based on the use of current prescription drug data. Health planswill collaborate on raising the standard for quality and completeness of pharmacy data.These respondents voice their hopes and con-cerns about future technology and collaboration:

“We [providers and health plans] need to worktogether to plan for costs, risk, or incentive structuresthat ensure appropriate utilization. We need to getto electronic prescribing.”

– Clinical pharmacy director, northern California health plan

“We see efforts like CALINX—California Links forQuality—as the next big change in informationquality and availability. The major stakeholders allparticipate and it is a joint effort mounted to createconsistency and standardization. In pharmaceuti-cals, we are working on standardizing claims datatransmissions from the plans to the medical groups(so they see their experience across all plans andmembers).”

– Director of pharmacy services, northern California health plan


“We need to partner with employers in order to get information into the hands of members, at thework site.”

– CMO, health plan, northern California

“In the future, we believe that quality will drivepurchase decisions for buyers of health plan prod-ucts. Our concern is the availability of data on benefits, service, and outcomes. Who will monitorin the future? That’s one of the big questions.”

– Senior executive medical director, northern California health plan

Greater consumer choice with accountability.Managed care accomplished revolutionarychanges in California health care. Unfortunately,it also raised consumer expectations about the“right” to prescription drugs. Since consumers areshielded, to a large extent, from the retail pricefor their drugs, they may not be prudent users of their drug benefit. In the future, health planrespondents foresee the continued expansion of tiered-benefit designs for pharmacy that willencourage members to recognize and feel the cost of drug choices.

As one northern California health plan CMOsuggests: “The three-tier benefit is helping a lot,even if it isn’t solving the whole problem. It doescontrol cost, and it makes constituencies better con-sumers! Using this model, if members want more,they will need to pay more, to bear more of the costfor their personal preference. It is sort of ‘the Lexusvs. the Toyota’ idea.”

More government involvement. In California,health plans have a fairly dark view of the immediate future for pharmacy benefits. Part of the pessimism stems from concern aboutlegislative intervention. They believe that govern-ment tinkering with drug benefits will compli-cate the cost picture and add to the tensionsbetween physicians and health plans. Unfundeddrug benefit mandates are a concern, particularlygiven the low level of collaboration among stakeholders today.

“Unfunded mandates for coverage are going to challenge us all. It is worrisome, when you look atthe notion that legislators can continue to definewhat is ‘medical care’ and what belongs in aninsurance pool.”

– Senior executive medical director, northern California health plan

“Pharmacy cost increases will slow down, becausenew drugs will be redundant—more and more ‘me too drugs’—and government will intervenewith everything from price controls to mandatedbenefit designs.”

– Clinical pharmacist, health plan, northern California



EMPLOYERS IN CALIFORNIA HAVE BEEN HITwith double-digit cost increases in providing coverage for pre-scription drugs for their employees. Employers report that prescription drug costs are being discussed at the highest levelof management at their companies. They are unwilling to con-tinue to absorb the increased costs and are looking at a varietyof incremental changes to contain the costs to their organiza-tions without decreasing the levels of coverage provided totheir employees and covered dependents. They are also consid-ering more dramatic changes over the next several years thatchallenge the status quo, address the needs they foresee in thefuture, and capitalize on the technological developments thatwill enable innovation.

To understand the impact of rising prescription drug costs onCalifornia employers, we spoke with individuals representingfive major plan sponsors or purchasing cooperatives across the state. These employers represent a full spectrum of philoso-phies and approaches to providing benefits in a full-employ-ment environment where they balance the need to attract andretain employees with skyrocketing prescription drug costs.

Four themes emerged from the discussions with employers,plan sponsors, and purchasing groups across California:

1. Employers are ready for major change.

2. Prescription drug benefits are critical to attracting andretaining employees.

3. Relations with other stakeholders are adversarial.

4. Employers are enacting incremental changes in benefit coverage.

“There are big, big changes

in benefit design coming.”

– Benefits manager, northern California employer

V. Employers and PurchasingCooperatives

Employers Are Ready for

Major Change

With prescription drugs representing more than15 percent of benefit expense and increasing at 12 percent to 15 percent per year, this benefit is an immediate focus of benefit managers and senior management at employers in California.

In the past, employers have taken a hands-offapproach to prescription benefits management.For the most part, they paid the premium andexpected the health plans or prescription benefitsmanagers to contain utilization and costs. As utilization increased, employers increased pres-sure on health plans and PBMs to “take care ofthe problem.”

Unfortunately, carve-outs not only did not con-tain costs as anticipated but actually contributedto increasing utilization because they double-buffered employees from costs. Consumers werecompletely unaware of the impact of their pur-chasing decisions on the true cost of prescriptiondrug insurance.

Further, PBM incentives were not necessarilyaligned with purchaser incentives. For example,new drugs, though expensive for the PBM, may contribute to an earlier return to work—a benefit to the employer but not to the PBM.

The most profound effect of the rise in prescrip-tion drug benefit costs is a new willingnessamong purchasers to assume an active role in cost control. In contrast to medical groups andhealth plans, employers see themselves as thelikeliest drivers of change in the future. Theyreport that they cannot keep absorbing costincreases at the current levels and envision a crisisin funding for prescription drugs that will pre-cipitate major changes in the way prescriptiondrug benefits are administered and financed.Over the near term, purchasers will continue tomake incremental changes but, as one northernCalifornia employer puts it, “We’re getting to thepoint where there’s not much more we can do.”

“This upward trend in pharmacy costs represents anunbearable increase to our company,” lamentsanother northern California manager. “We can’tlet it go on indefinitely. For one thing, I don’t thinkwe have the stomach to cut employee choices—but we will look at it. For another, pharmacy adds to a growing liability in our retiree health plan.Our balance sheet can’t take it!”

Purchasers are not sure what major changes arecoming, but they are preparing for governmentintervention and/or benefits restructuring.“Restrictions are coming. The pressure is building.In three plus years it’s going to blow! I see it heatingup,” exclaims a medical benefits manager for anorthern California employer.

Although forward-thinking purchasers welcome atransformation, they believe the current situation,with incremental changes and Band-Aid solu-tions, will only delay the necessary revolution. “A few years ago, medical costs were spiraling out of control,” reflects the director of insurance serv-ices at a northern California purchasing group. “The specter of the Clinton health plan slowedthings down for three to five years, but now theeffect has worn off and the scare is gone so the speedis picking up. I just wonder if that’s going to have to happen with drugs to get the dramatic kinds of change that needs to happen.”


Prescription Drug Benefits

Are Critical to Attracting and

Retaining Employees

Unemployment, at record lows nationally, is par-ticularly low in California with its thriving econ-omy in both old and new economy industries.Competition for employees is fierce, especially inthe hot Silicon Valley area. Salaries are high andfringe benefits have become key differentiators inthe attraction and retention of qualified staff. As companies re-evaluate and reconstitute theirbenefit programs, they find it unthinkable to takedrugs out of benefit, regardless of the cost:

“Our position is that we are going to continue to offer the most liberal plan possible for as long as possible.”

– Benefits manager, northern California employer

To enable plans to continue at current levels,many companies are subsidizing programs heavily. Others are looking at cost redistribution. For example, some employers are redirecting the focus of their benefits back to their activeemployees by reducing retiree coverage for prescription drugs.

At the same time, employers are promoting theirprograms by providing information to employeesabout the cost to the corporation of the prescrip-tion drug benefit. They have asked suppliers toprovide reports, either at the point of sale or insummary, detailing the actual price of the drug,the cost to the employee, and the cost to the plansponsor. Employers are hoping this informationwill have two outcomes: (1) to remind employeesabout the richness of the benefit plan, and (2) to increase employees’ understanding of the costof the drugs so they become better consumersand decision makers.

Continuous review of health benefit programs tosee how they compare to competitor businesses is the norm. In the tight labor market, manyemployers are reluctant to upset workers withbad news about medical benefits. Instead, pur-chasers target cost management efforts at troublespots, which may include prescription drugs.Savvy employers survey employees and familiesfor trade-offs among benefit provisions.

Relations with Other Stakeholders

Are Adversarial

The purchasers we interviewed expressed frus-tration with all of the stakeholders for their contributions to high drug costs. Perhaps the mostblame is focused on pharmaceutical companies.Employers blame direct-to-consumer advertisingfor driving up demand and decreasing employeesatisfaction. As consumer preferences, influencedby advertising, conflict directly with the cost con-trols implemented by employers, human resourceand benefits managers are seeing an increasingnumber of complaints and requests for overrides.Moreover, they are disgusted with the amount of money they perceive as going for advertisinginstead of reducing the cost of drugs.

Purchasers are also out of patience with healthplans. Employers look to the plans to either control prescription drugs costs or demonstratemedical offset achieved through increased use ofnew drugs. Purchasers expect increased premiumsto buy them increased quality of care.

This medical benefits manager for a northernCalifornia employer doesn’t mince words: “Whereis the value in our health plans? What value are wegetting for our purchasing dollar? Health care hasn’timproved quality at all (even minutely) in the lastfive years. Now rates are going back up. We are notgetting our money’s worth at all.”


In addition, purchasers have seen health planscost-shift to provider groups rather than assumeresponsibility for controlling costs of prescriptiondrugs. One plan sponsor in southern Californiasaid that HMOs were “not managed care, justmanaged dollars.” Purchasers are angry becausehealth plans are not acting like businesses—theyare shifting costs rather than reducing costs.

Purchasers also feel that some level of responsibil-ity for runaway costs belongs to medical groups.They had high expectations that medical groupswould improve quality of care. Instead, they sawphysicians reacting to risk-bearing contracts bycompromising the quality of the interaction withtheir employees as the cost of prescription drugscontinued to soar. According to the medicaldirector for a large purchasing group, purchasershave “no empathy for doctors” because “they arenot good business people.”

One benefits manager in northern Californiasays, “Doctors are a problem—plans pushed risk toproviders, but they’re going broke so they are blam-ing the health plans in the newspapers.”

Purchasers are concerned about the best way tomanage doctors in going back to a fee-for-servicesystem. They are already beginning to see physi-cians attempting to circumvent cost controls andseek plan limit overrides by telling the patient to“see if you can get this” from the human resourcedepartment.

The plan sponsors recognize that adversarial relationships among stakeholders are a seriousbarrier to the kinds of changes that need to happen. One benefits manager for a large north-ern California firm describes the situation as dire:“We’re at a stage now where stakeholders have never been more at odds—more ready to cut theirown arm off to get the other guy, not just their ownnose! Worst I’ve seen in 20 years of California health care.”

Employers Enact Incremental

Changes in Benefit Coverage

Purchasers faced with exponentially rising prescription drug benefit costs can implement avariety of cost-savings techniques. Proven effec-tive interventions include benefit design changes,tiered copayments, restrictive formularies, retailpharmacy interventions/education, outsourcingrisk to PBMs, Internet education, mail order, and disease management. In addition, employerscan require health plans to implement coveragerestrictions or other cost control mechanisms,such as shared financial incentives with medicalgroups. However, the issues of attraction andretention significantly hamstring employersattempting to introduce restrictive benefit designschemes or provisions.

As employers experiment, we see specific inter-ventions introduced at some companies at thesame time they are being discarded at other companies. The incremental changes discussedbelow are in place or under consideration at largeemployers in California.

Cost sharing. Employees are being asked toassume more of the cost of their prescriptiondrug benefit. Many benefit designs incorporatelarge percentage increases in out-of-pocket costs for prescription drugs. In other cost sharingmechanisms, employers are rethinking themethodology they use for calculating the premiumcost sharing for employees. Some employers areswitching to a “defined contribution” financingmethodology in which they contribute a set dollar amount (usually pegged at a percentage ofthe lowest cost plan offered) and ask employeesto pay the difference to get the plan they want.


Benefit limits. Employers are building in finan-cial incentives to use generics or plan formularythrough a multi-tier copayment. Most often dis-cussed was a three-tier copayment strategy inwhich the patient pays a low copayment (such as$5) for a generic drug, a slightly higher copay-ment (such as $10) for a nongeneric formularydrug, and much higher copayment (such as $25or $50) for nonformulary prescriptions.Employers have also incorporated limits orexcluded coverage for certain new prescriptiondrugs or lifestyle drugs. One employer recentlyincorporated a plan with mandated mail-orderrefills required after the second refill (otherwisethe enrollee has to pay cash), no physician over-ride for generics, prior authorization for “dis-pense as written,” and a requirement that theenrollee pay the difference for brand-name drugsif generics are available.

Employee consumerism. Employers are trying toeducate their employees about the costs of pre-scription drugs. One human resources managernoted that her role has changed; it is now herresponsibility to educate consumers. Employerssponsor health Web sites specifically targeted atemployees. Employees and their families are ableto access these Web sites through intranet sys-tems at work or at home. Most employers try tosend clear messages with incentives aligned totheir benefit provisions. “Our goal in transitioningto a three-tier benefit in 2000 is to try to changebehavior, not cost-shift. We want to make theemployee a better purchaser,” maintains a healthand welfare plans manager for a northernCalifornia employer.

Carve-out programs. Prescription benefits man-agers have been an important piece of the pre-scription drug puzzle for a long time. They typi-cally perform an administrative function as wellas a drug management function through drugutilization review, formulary management, andrebate management. Many employers do notcontract directly with a PBM; instead they relyon the PBM used by the managed care plansthey offer. As drug costs continue to rise, however,employers are re-evaluating these relationships.Some employers are taking the benefit away fromthe health plans and carving out prescriptiondrug coverage to their own PBM.

They see two benefits to this strategy. First, itevens out the coverage when plans are putting indifferent limits and different formularies.

Second, it enables them to work closely with thePBM to achieve higher levels of performancethan have previously been demonstrated. Oneway PBMs are being asked to improve perform-ance is through use of technology. Informationsystems and hand-held devices increase efficiencyand cut costs. As one purchaser put it: “Peoplewho pay money put a premium on economy andprocess improvement.” PBMs are also being askedto provide physician feedback on utilization andcost, and to perform a “counter-detailing” func-tion for medical groups and patients to combatthe effects of direct-to-consumer advertising.

Feeling less confident that the traditional cost-cutting measures will continue to provide thelevel of relief they need, purchasers are looking toother stakeholders to come up with new inter-ventions that will keep the situation in check, butthey are also meeting together to develop solu-tions and learn from one another.

“Hopefully, we can keep pulling rabbits out ofhats,” muses the insurance services director of anorthern California purchasing group.


The Key to the Future

Lies in Innovation

As traditional interventions fail or achieve lessthan satisfactory results, purchasers are expectingmajor changes to the way prescription drugs are covered and financed. The desperation theyfeel is driving some real innovative thinking. Themedical director of a purchasing cooperative toldus, “Good things are possible through destruction.”

Purchasers predict new solutions will take ad-vantage of technology and consumerism and willfeature quality as a keystone. They may grow out of existing models or be developed de novo,driven by the threat of government interventionor by truly “outside the box” thinking in responseto market conditions.

Big, big changes in benefit design. Purchasersanticipate major changes in the design of pre-scription drug benefits that take advantage of therise in consumerism as well as the growth oftechnology. Says a benefits manager for a north-ern California employer: “There are big, bigchanges in benefit design coming. [Current designsdon’t] take into account any of the impact of theInternet—information, ordering, distribution, marketing, education.”

Purchasers have focused on educating theiremployees about the costs of prescription drugs,increasing their sensitivity to price by enforcingtiered copayments. At the same time, more andbetter information is becoming available aboutthe relative value of different drugs or treatments.At some point not far away, consumers will beable to evaluate their willingness to pay againstthe effectiveness of a particular drug, opening thedoor to new benefit designs. As the informationon the relative value of different therapies in aclass become quantified, we could start seeingcontinuously variable copayments, rather than anartificially contrived three-tier limit. Alternatively,a “consumer value plan” could emerge wherewhichever drug is most cost-effective gets coveredfor a given condition.

Cancel the middleman. Purchasers are increas-ingly frustrated with their health plans, beyondthe costs of prescription drugs. One option thatis surfacing for consideration is direct contractingwith providers by employers, essentially cuttingout the health plan. How this would work is yet to be defined. It could reintroduce drug riskfor physician groups or be combined with one of the information-based benefit options andadministered by a PBM. Another option wouldbe the introduction of an insurance rider forpharmacy coverage. With this approach, employ-ees would decide whether to buy pharmacy coverage separately.

Governmental action. Under current U.S. law,American companies are banned from importingpharmaceuticals. However, given the fact that the price for a drug in the United States is oftentwice as high as the price for the same drug inanother country, foreign purchasing has emergedas a means for achieving some savings on pre-scription drugs. Foreign purchasing could includeinternational mail order or managed prescriptiontourism. Some employers we interviewed areanticipating legislative reforms that will permitimporting of drugs for distribution to Americanemployees.

Other legislation being discussed would cancelsome of the dramatic inconsistencies in drugpricing between the United States and othercountries. For example, the government couldmandate price controls based on drug prices inother countries.

Purchasers also see the potential for federal orstate government intervention to control pre-scription pricing trends. They believe legislationshould focus on the pharmaceutical industry,which, between rebates, direct-to-consumeradvertising, giving samples to providers, andgreed, they see as a root cause of cost increases.Legislation could come in the form of price controls or in elimination of rebates.


This medical benefits manager at a northernCalifornia employer doesn’t beat around thebush: “We need to throw the gauntlet down at thepharmaceutical industry or else—direct price con-trols. They could do price controls on a shorter timeframe. The biggest dip in drug trend in the last 20years was due to the Clinton health care proposal.The reason is they have all the money in the worldto solve the public policy problem. They can’t just goon killing the geese that lay those golden eggs.”

The legislature could also intervene by breakingcompanies up, separating marketing and researchand development functions, then prohibitingthem from merging back, thereby forcing compe-tition. One interviewee suggests a sunrise law—if industry hasn’t solved the problem within threeyears, the government will.

The return to quality. Throughout our discus-sion, purchasers bemoaned the loss of quality as a goal for stakeholders in the prescription drugarena. Employers believe that it is essential tobring quality into the cost-benefit equation if costs are to be controlled. “Doctors should be saying ‘we need to improve quality and outcomes.’Instead they want to go back to the way it was. If we operated on the principle of quality, that’swhere the savings could come to doctors and plansponsors,” insists a health and welfare plans manager for a northern California employer.

Purchasers call for the coming together of all parties—employers, physicians, and healthplans—so that outcomes studies, including “best practices” and physician review against bench-marks, can be shared.

“What will it take to get quality back on thetable?” asks a northern California benefits man-ager. “First, partnerships. All successful marriagesare based on true partnerships—and having successof the marriage be first and foremost. Partners must have a common interest, both give and get,and recognize that it is in everyone’s interest to come together.”

Purchasers see quality as an issue for health plansthat needs immediate attention. They suggestthat if plans competed on quality, everyonewould benefit. A northern California benefitsmanager explains: “What is the value of the pur-chasing dollar? Quality is not going up, but the pre-mium is soaring. Employers are focusing anger onthe plans. Plans aren’t acting like businesses, they areshifting the risk rather than reducing costs.”

Purchasers also suggest that they would pay forperformance if they could be confident that themoney would actually go to improving quality.According to one employer, if physicians “needseed money, employers could pony up if that’s whereit’s going to go. [But there’s] no reason to believe thatif we raised the premium, the providers or planswould invest it wisely.”

Technology. Technology will play a key role inexpediting and facilitating benefit changes andquality improvement. Respondents use the termtechnology to include a wide range of concepts,including information systems, decision support,new devices, and the Internet.

Purchasers expect technology to generate the data that will enable them to manage quality andoutcomes. They envision technology’s ability tocollect data about the effectiveness of particulardrugs, automate prescribing, and provide sophis-ticated decision support vehicles. They hope that technology will be used to measure quality.Purchasers mentioned the potential of hand-held,“McDonald’s cash register” type of instrumentsthat enable immediate and accurate data capture.They are already beginning to experience thebenefits of improved consumer decision support,particularly in provider profiling to supportdirect contracting.


One benefits manager in northern Californiabelieves “the Internet is going to play an importantrole. Technology can facilitate direct contacting withmedical groups—an option we are considering.”

Technology will also have a role in getting qualityand outcomes data to consumers. Employers arealready instituting communications mechanismsthrough corporate intranet, for example, to support benefits decision making and retrievehealth information. Once outcomes data becomeavailable, there are many tools that can be usedfor dissemination.

The technology purchasers cite most frequentlyas a significant driver of change, and as havingthe greatest potential influence in the future, is the Internet. The Internet featured in manyinterviews as a long-awaited tool to revolutionizecommunication, education, and supply-chainmanagement as well as applications that have notyet been developed.

Starting from scratch. One employer predictsthe need for an entirely new system of coveringprescription drugs: “Take out a new piece of clothwhole and design a new system so each componenttakes a new accountability: purchasers, health plans,consumers, and society.”

Ideally, that would be a market-side solution thatwould need to rationalize the system, not shiftingcost, but really redesigning around four corner-stones: access, choice, quality, sustainable cost.

In such a system, purchasers would not just beconcerned about price, but would try to satisfyemployees and even be prepared to manage the benefit themselves if health plans falter.

Health plans would need to be a true market for freestanding insurance programs for drugs,offering creative insurance products for a broad range of packages, including life insurance and universal life riders. Plans would use P&T committees to create a closed formulary,which may not include new or “me too” drugsfor a couple of years. Plans would offer a tight, well-managed drug rider for a third tier (lifestyle or other off-formulary drugs).

Employees would be recast as consumers. As they assumed more of the costs, the prescriptiondrug benefit would reflect consumer preferences,including alternative medicine and increasedaccessibility.



ONE CONSTANT FACTOR IN DISCUSSIONS OF THEissues contributing to the changes in utilization and cost ofprescription drugs in California was the changing role of theconsumer in health care. Although this study did not gatherinformation from consumers directly, each of the participatingstakeholders identified the consumer as a key driver in boththe rise and potential reduction of prescription drug costs.

Historically, a patient suffering from a medical conditionsought out a physician, who would perform an examinationand prescribe an appropriate treatment. The patient would relyon the judgment of the medical professional, bearing only theresponsibility for compliance. Over the past several years, how-ever, patients have evolved into consumers, making informeddecisions based on their needs, finances, and the best availableinformation. While the rise of consumerism is not unique tohealth care, its development has had significant implicationson the rise in prescription drug costs in California.

Stakeholder groups observe that consumers, particularly thesenior population, are extremely concerned about rising prescription drug costs. Medical groups, employers, and healthplans across California see both positive and negative impli-cations of this interest. Two themes emerged from our discussions about the new role of the consumer in prescriptiondrug utilization:

1. There are serious gaps in today’s health care consumerism.

2. Consumers are assertive about their preferences and entitlements.

“I love it when a patient

comes to me and says,

‘Take me off of that Prilosec,

my co-pay is too high!’

I love that—it makes people

stop complaining.”

– Senior medical advisor, southern California medical group

VI. Consumers

Serious Gaps in Today’s

Health Care Consumerism

In the 1980s and early 1990s, the fastest growinghealth care costs were for inpatient care. Phar-maceutical interventions were encouraged byhealth plans and employers as inexpensive alter-natives to costly inpatient care. Under risk formedical care, physicians recognized drugs as goodpreventive therapy that minimized their exposureand improved patient health. To facilitate accessto drugs and manage utilization, managed care plans incorporated coverage as an integralpart of the benefit.

Since the introduction and widespread adoptionof the prescription drug card more than a decade ago, respondents report that consumershave been “buffered” from the actual cost of theirmedications. From the users’ perspective, the prescription “cost” only $5 or $10 (the amountof the copayment), when in fact the true cost ofdrugs was rising exponentially.

The result? “Both use and cost have been driven by low out-of-pocket costs,” reports the medicaldirector of a northern California medical group.“Utilization increases have been fueled by direct-to-consumer advertising. But with no out-of-pocketcost, demand is high, which raises prices and then costs.”

Cost controls were introduced that focused primarily on medical providers, such as drug utilization review and requirements to write pre-scriptions for generic substitutes. Tiered copay-ments for generic drugs were the first incentivesfor consumers to participate in the cost controlmeasures. Recently, cost controls such as multiple-tiered copayments have focused moredirectly on the consumers, creating concernamong users that they will not be able to affordor have access to the prescription drugs they need.

Our interviews suggest that these efforts have notbeen effective at controlling costs so far. One ofthe reasons is that all of the elements required forconsumerism to be effective are not yet present.For prescription drug users to behave like con-sumers, they need to develop price sensitivity andhave access to good, if not “perfect,” information.

Price sensitivity. With the exception of seniors,who have borne a direct burden for their pre-scription drugs, consumers have been largelyunaware of the cost of prescription drugs. “Ouremployees need to understand what prescriptiondrugs cost so they can make appropriate trade-offs.We need to provide them with a statement thatshows them what they would have paid for the pre-scription without our plan,” advises a northernCalifornia human resources manager.

Respondents cite three-tier copayments as thefirst tool that will force consumers to understandthe cost of their prescription drug decisions.According to the medical director of a northernCalifornia medical group, “New copayment struc-tures only work if there are significant differencesbetween tiers. If there is negligible difference in cost,it makes no difference in behavior. If there is a bigdifference in cost or they hit their limits, you see thepatient say, ‘I need a lower cost drug for this condi-tion.’”

With significant differences in cost between classes of drugs, providers have begun to noticechanges in consumer preferences that reducedemand for the newest, most expensive drugwithout consideration of effectiveness or cost.


“I love it when a patient comes to me and says,“Take me off of that Prilosec, my co-pay is too high!’I love that—it makes people stop complaining,”says the senior medical advisor at a southernCalifornia medical group.

Consumers also respond to price issues underbenefit limit situations—although the responsemay be to change health plans or providersbefore changing their prescription preferences.One medical director reported that, for the firsttime in his memory, patients are willing tochange medical groups to get a specific drug oravoid prescription drug caps.

Good information. There is more and moreinformation available to the consumer throughthe Internet, news media, and advertising thatcould support better economic decisions.However, the quality and source of the infor-mation is often suspect and it is difficult for consumers to have the confidence to act on whatthey learn. The most important new sources ofinformation are direct-to-consumer advertising bypharmaceutical manufacturers and the Internet.

In all of the interviews, respondents spoke inhighly negative terms about their own feelingsabout direct-to-consumer advertising. They also universally report that patients “love” DTCadvertising. The reason most frequently cited is consumer education; patients feel they learn alot, not only about the drug but also about their own health conditions. Providers considermuch of this learning questionable; they reportanecdotes of patients demanding drugs for conditions they don’t have. The provider ends upspending more time with the patient, either disabusing them of information gained on TV oranswering questions generated from the patient’sInternet search.

Providers and health plans bemoan the lack ofinformation available to them and their patientsabout the value of drugs. Is a new drug betterthan what is currently available? Is it worth themoney? Over the next several years, stakeholderssuggest, information about quality and value willbecome more available and will enable betterconsumer decision making.

Employers realize they have a role to play in helping to promote better consumerism. One employer respondent reflects that humanresources personnel are becoming mediators,educating employees in response to direct-to-consumer advertising and increased employeefinancial responsibility.

“In our benefit design and philosophy,” says anorthern California employee benefits manager,“we’re not just in this for the cost shift, we are tryingto change employee behavior—we want to makeemployees better purchasers when there is not muchmore we can do.”

Consumers Are Assertive about

Their Preferences and Entitlements

(“It Isn’t Lifestyle for Me.”)

Consumers not only have stronger preferencesabout prescription drugs than they have had inthe past, but they are more assertive about get-ting their needs met. The development ofstronger preferences is a direct result of theincrease in information available (DTC advertis-ing, medical information as “news,” Internetsources, and the like). The assertiveness comesfrom the financial stake consumers now hold intheir treatment, legislation that has empoweredconsumers, and a distrust of the motives ofhealth plans in setting medical policy.


Because of the improvements in drug therapiesover the past several years, medical groups reportthat consumers expect a prescription to treatevery condition. The patient may present withsymptoms that are self-limiting; nevertheless, sheor he expects a prescription and will feel cheatedwithout some active treatment. The provider isactually pressured to give the patient a prescrip-tion as the required result of a medical visit. “Mypatients are demanding new, expensive treatmentsthey hear about on TV, even though the old treat-ment was perfectly effective. And I end up giving itto them,” says a northern California physician.

Consumers have come to expect an interventionat the time of illness rather than seek preventivecare. The example most commonly cited isinfluenza. Patients demand prescriptions for thetreatment of flu symptoms, which are likely to be ineffective, but avoid taking a flu shot.

Consumers also demand access to the full spec-trum of products available in the market. Theplethora of so-called “lifestyle drugs” hitting themarket are seriously impacting not only the costof prescription drug programs but also members’satisfaction with their plans. In many cases, con-sumers understand in the aggregate that drugs forbaldness, acne, or erectile dysfunction may notbe “medically necessary” for everyone; as patients,however, they do not consider such drugs discretionary but vital to their personal well-being. Therefore, they want these drugs availableto them under their prescription drug benefit.

There is evidence that consumers are willing topay higher out-of-pocket costs for lifestyle drugs to ensure that they are included under theplan benefit, even if they are not under the preferred formulary. Many employers are seriously reducing coverage for lifestyle drugs, but some are using differential copayments (for example, 50 percent) as a tool to maintainemployee satisfaction with the plan while controlling utilization.

What Will the Consumer of the

Future Look Like?

Will today’s aggressive, demanding consumerbecome tomorrow’s informed, prudent con-sumer? The answer, according to our respon-dents, will depend on a host of factors, not justeasy access to adequate and objective informationabout drugs and increased cost awareness, butalso the quality of consumer relationships withproviders and plans, how the burgeoning seniorpopulation responds to rising drug prices, and what the legislature does.

Relationship with providers. Interviews high-lighted the growing adversarial relationshipsbetween consumers and their physicians and health plans. In the provider’s office the consumer seeks more information and asks forspecific treatments. Patients may come to theoffice armed with questions about their con-dition as well as alternative therapies. There theymeet with a physician who is under enormouspressure to keep the visit as brief as possible andoffer treatment plans that are consistent with thepractice’s goals as well as the limits and incentivesin the patient’s health plan.

“We don’t have the luxury of time when it comes todemanding patients,” explains a Los Angelesphysician. “It is easier to write the prescription fora drug that is off-formulary or requires pre-authori-zation than to take precious time to explain why mypreferred drug is as good and less expensive.”

At the same time, physicians are actively involvedin establishing new techniques to maintain solidpatient relationships. Medical groups reportchanging their orientation in an attempt to helpconsumers assume a higher level of responsibilityfor their health status. “I want to be more of acoach, less of a parent with the patient,” says anorthern California medical group respondent.“Rather than being foes, let’s be friends. We reallydon’t have a choice, so let’s try to make it as pleasantas possible.”


Many practices and hospitals are developing disease management programs and Internet-based educational solutions to provide a higherlevel of service to consumers. One very largepractice is starting a Web site on key diseases tohelp consumers sift through the volume of infor-mation on both diseases and treatments. Theirgoal is to work with patients to select the appro-priate treatment by providing information aboutthe benefit of different drug alternatives.

Role of seniors. The “wild card” of the future forthe growth of prescription drug costs is the seniorpopulation. Seniors represent the largest users ofprescription drugs now, and stakeholders believethe utilization will increase astronomically afterpassage of legislation mandating prescriptiondrug coverage for seniors.

One northern California medical director is pessimistic: “The average age of the seniors in ourgroup is 76. People are living longer and using moredrugs, which just increases the demand. Congress’sbenefit for seniors will drive up utilization and cost even more.”

Another northern California physician suggeststhat it might help to stop looking at the seniorpopulation as a single indivisible whole: “Half ofmy seniors use no medications and the others use an enormous amount. We need to establish a differ-ent risk pool—partner with commercial insuranceto set up risk pools for high users.”

In contrast to the lack of price sensitivity prevalent in employed populations, seniors areextremely aware of the price of their drugs. Even seniors who participate in managed careplans are aware of the costs of their medicationsbecause of finite benefits and program limits.

With many health plans abandoning the seniormarket, more seniors are bearing the direct expense for their medications. Many senior con-sumers are dealing assertively with their pre-scription drug expense by looking at alternativepurchasing models (such as sources outside of the country) and aggressively lobbying fordrug coverage.

Consumers are looking to the legislature inCalifornia and at the federal level to grant themfurther rights in dealing with their health plans.Consumer empowerment and patient rights are key elements in legislation evolving at thestate and federal levels. Respondents feel thatultimately consumers will have even moreresponsibility for treatment decisions, and bearmore of the burden for treatment costs. Theyexpress hope that insurance and information systems will evolve to enable consumers to make appropriate decisions.


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CHCF FOCUS ON PHARMACEUTICALS

Documents

Causes and Cures - California Health Care Foundation76 years. People are enrolled longer, are using more drugs. Demand is increasing. The plans systemati-cally underfund pharmacy for