States Use Their Purchasing Power As Leverage to Limit Drug Prices

By Michael Waldholz

The Wall Street Journal, July 21, 2002

In West Virginia, an agency that provides health benefits to the state's employees has just put into place a novel prescription-drug buying plan that is expected to slash the cost of its drug bill in the next fiscal year by $7 million and provide $25 million in savings over the next three years.

That means that after years of 20% annual price increases, drug costs should only jump 12% next year for the West Virginia Public Employee Insurance Agency.

West Virginia's plan doesn't use states' typical tool of choice -- attempts at price controls through regulation. But the hope is that it will prove far more effective. And if so, it may soon have followers in other governments and private employers as well.

Many state employee and Medicaid programs, which provide coverage for the poor, as well as large and small employers alike are experiencing sharply rising yearly increases, in some cases 15% to 20% and more, in the cost of medicines provided to folks they insure. Often mandated by their legislatures to stay within tight budgets, state programs have no choice but to find ways to trim the bills. A fast-growing number are for the first time using the clout of their large volume-buying -- in some cases joining forces to increase their strength -- to pit one drug maker against another to extract significant price breaks.

"We are using private sector techniques -- the power of the marketplace -- to reduce costs," says Tom Susman, who directs West Virginia's PEIA, the state employee health-insurance provider. When Bob Wise was elected governor in 2000, one of his first acts was to take aim at the state's exploding drug costs. Mr. Susman, a former health-industry consultant hired on by the governor, acted quickly. He forged an unprecedented alliance called RXIS with six other states -- New Mexico, South Carolina, Maryland, Louisiana, Missouri and Mississippi -- to dicker with the drug makers through one of the nation's several large pharmacy benefit managers, the companies that administer drug coverage for most U.S. workers.

The benefit managers, such as Merck-Medco, have been using their volume-buying clout for years to get price discounts -- often called rebates -- from drug makers. Using a variety of techniques, the benefit managers encourage doctors to prescribe the drug within a class of similar-acting medicines that has the better price.

This ploy has become especially effective in recent years with the rise in the number of similar-acting medicines and generic competition. Doctors and patients are less inclined than in the past to balk at having an initial drug choice tweaked. But under most arrangements with employers, the benefit managers have been able to pocket the bulk of the rebated savings, producing huge profits for the so-called PBMs.

Understanding this, Mr. Susman says, was the key to the RXIS strategy. West Virginia and the other states last year said they wanted to get the rebate themselves. After the states put their drug business out to bid, Express Scripts, a St. Louis-based benefit manager, agreed to the new setup. The company is now taking a straight administrative fee for running the plan and is passing on 100% of the rebates back to the states.

"As our costs kept rising by 20% each year, the benefit manager was able to get a 20% a year increase in rebates," Mr. Susman says. "We didn't feel that was right."

Express Scripts executives say they were willing to take the contract because the combined seven-state business was lucrative. Moreover, armed with the large drug-buying client, Express Script believes it can negotiate even better deals with drug makers. Under its contract with the states, Express Scripts can also make more money by helping the states achieve additional cost savings through a variety of other tactics.

"Under this new arrangement the states' interests and ours in getting the best deal we can are now fully aligned," says Barry Rosenthal of Express Scripts.

Other states' approaches are more adversarial, but potentially as effective. In one especially bold move that is gaining fast favor, several state Medicaid programs, most notably the one run by Michigan, have begun aggressively limiting access to certain medicines. In this set up, a pharmaceutical company that refuses to reduce prices has its drug kicked off a special list of "preferred" drugs. Doctors need to jump through extra hoops to prescribe the non-preferred drugs. The approach appears to be working -- drugs off the list swiftly lose market share to competitors, sometimes within weeks.

The drug industry is taking notice. Two drug makers, Merck and AstraZeneca, whose products were left off the Michigan preferred drug list (PDL) after they stood firm on pricing, agreed to lower their prices to get on the list. (See related article) In an even more angry retort, the drug industry has sued Michigan as well as the federal government, which allowed the state to institute the new restrictions, contending the PDL system breaches Medicaid law. Michigan received a strong vote of support late last week when the Senate passed an amendment to a prescription drug bill that would allow Michigan and other states use the PDLs to barter for better prices. (See related article)

Whatever the outcome, states are increasingly bent on finding ways outside of straight regulation to keep costs down. In West Virginia, state employees earlier this year who used generic versions of antibiotics received a waiver of the co-pay they usually must shell out when filling prescriptions. The state is also expected to begin an advertising campaign to encourage use of generics, and to hire pharmacists to encourage doctors to do the same.

But it is the new effort to use volume buying that is becoming most attractive to states that are seeing their Medicaid budgets rise sharply. Indeed, even Congress is expected to take notice. Drug companies say that any Medicare prescription drug plan for the country's elderly should provide the benefit through private insurers such as Express Scripts rather than as a benefit that might employ dictated price controls. Such a private insurance plan was passed by the House late last month and is being considered by the Senate.