Formulary Additions: The Big Picture

Sep 30, 2005

Product managers at pharma firms know how fiercely new drugs compete for inclusion on health plans' formularies. But health-plan actuaries would be forgiven if they called most companies' efforts half-hearted. An actuary, who is often the plan's CFO, has to keep the financial big picture in focus. When she sees the information supplied by pharma, which filters through the formulary decision makers, she is almost always disappointed.

Actuaries are responsible for the bottom line of a health plan, so when they evaluate the formulary and its new products, they look at the impact on the plan's total budget. Typically, they are asked to figure out what will happen, on a dollar-and-cents level, to the plan's entire system of treatments once doctors begin to write prescriptions for a new drug. Which other prescriptions will be written less? How much will it cost to treat side effects? How many hospital days can be avoided? If the profit-and-loss balance tips against the new drug, actuaries will push back against the formulary decision makers.

Drug companies cannot answer all such big-picture questions. But actuaries want them to at least try to explain how a drug stacks up against competitors that target the same disease. Persuasive evidence that a new drug is superior might propel it straight onto the preferred list of the formulary. But most companies avoid this question.

Not that companies have no data. Quite the contrary: Most submit mountains of clinical-trials data, including a detailed study of the effectiveness of a drug versus a placebo. But such information fails to answer the health plan's questions. Prescribing a placebo is never a treatment option.

Managed Care Runs the Numbers
Sometimes, pharmaceutical companies point out that a product costs less per pill than the competition—a fact that often impresses the pharmacy department of a health plan. But this too is incomplete information for an actuary. As JD Kleinke, a noted medical economist, puts it, high-priced new drugs may be the cheapest weapon against rising overall medical expenses. The trick is convincing the health-plan actuaries.

Talking to Actuaries

Pharma already has the actuaries' attention, not least because the cost of pharmaceuticals is growing faster than the cost of healthcare as a whole. The overall nine-to-10-percent annual growth in the cost of healthcare is outpaced by the 10-to-14-percent growth in pharmacy costs. So pharmacy costs are getting more scrutiny from actuaries. To justify the faster cost growth, pharmaceuticals must save a health plan money elsewhere.

One such source of savings is the cost offset, which actuaries look for all the time. For example, a new drug treating a skin condition might be 12 percent more expensive than a competitor, but it could be cheaper for the plan as a whole if its increased effectiveness offsets other costs. For example, if patients make fewer doctor visits and switch dosages less often, the cost offsets make up for the higher per-treatment cost. Similarly, if an asthma drug is more effective, or even easier to use, it prevents expensive emergency-room visits.

If drug companies cast more of their sales pitches in terms of the overall financial impact of a new treatment, they would find it easier to argue the merits of their products. Drug companies need to understand not only the care-giving and business concerns of health plans, but also their cost models. Health plans break total costs down into several dozen mutually exclusive service categories (see "Managed Care Runs the Numbers"). For each service category, they look at utilization rates and unit costs.