Your company, like most employers, probably has a prescription drug program that includes a drug formulary. You know how the formulary works with your co-pay design, “incentivizing” members to make cost-effective medication choices. Now, peek behind the curtain and see how the formulary works from the insurer’s side.
Insurers (and employers) use the formulary to manage costs and to improve care. When a drug company introduces a new drug that is similar to other drugs already available to treat the same disorder, they are considered to be “therapeutically equivalent” or, work in the same way to treat the disorder. Given an equal choice, the insurer might offer only the less expensive drug in its formulary, i.e., “equal quality at a better price” or require higher co-pay for the more expensive drug. In the case of Lipitor versus Pravachol, both drugs belong in a therapeutic class called “statins.” They lower cholesterol by slowing down the body’s ability to make cholesterol. Drugs in this class include atorvastatin (brand name Lipitor), fluvastatin (Lescol), lovastatin (Mevacor), pravastatin (Pravachol) and simvastatin (Zocor). Consequently, the insurer may choose to cover only one or two of these drugs, based on their ability to negotiate favorable pricing.
Insurers use a pharmacy & therapeutics (P&T) committee to select formulary drugs. The committee, made up of doctors and pharmacists, reviews the medical research on drugs within therapeutic categories. Within each category, they select the drugs that are “best in class” for inclusion on the formulary. The insurer then works to negotiate the best prices for the selected drugs.
The committee also tracks trends in side effects and outcomes of various drugs and may determine that a drug be eliminated if their ongoing research suggests that the benefits are not as real as the drug maker originally claimed.
In this way, the formulary protects plan members from drugs that are not performing as planned.
Insurers or, more frequently, sub-contracted pharmacy benefit managers (PBMs) negotiate the purchase price of drugs based on three factors: Volume, “class of trade” and “ability to move market.”
Volume. Insurers negotiate better pricing based on the volume of drugs they expect to purchase – the greater the volume, the lower the price. To the extent that a formulary delivers greater volume of one drug over another, the formulary creates a volume advantage that is useful in negotiation.
Class of Trade. Drug manufacturers must follow a “class of trade” system that provides:
- Lowest pricing to the federal government;
- Next lowest pricing to hospitals;
- Next lowest pricing to HMOs and other captive settings;
- Next lowest (or highest) pricing to purchasers for retail trade.
Insurers that qualify as HMOs or represent other captive populations will usually achieve a pricing advantage due to special status pricing.
Ability to Move Market. The formulary is vitally important in delivering market to manufacturers. When an insurer or PBM can tell Pfizer, manufacturer of Lipitor, that all (“all” is always qualified) prescriptions for cholesterol-lowering drugs will be written for Lipitor (versus Zocor or Prevachol), they are “delivering market” and creating a competitive advantage for Lipitor that Pfizer is willing to pay for through lowered pricing.
Formularies can improve care through the careful, ongoing review of drug effectiveness results by the formulary decision makers, leading to best choices based on the latest research and use market forces to deliver lower pricing.