Formulary Additions: The Big Picture

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.

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.

Managed Care Runs the Numbers

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.

Both unit costs and utilization rates are adjusted to reflect the details of a specific employer's plan, and then combined to calculate the expected monthly claim-cost rate per population. This is known as the per-member-per-month claim cost (PMPM). This number captures the impact of plan-specific details, such as covered benefits, cost sharing, and financial incentives (for example, creating disbursement-fee incentives so pharmacists will fill prescriptions with generics), as well as data on demographics, geographic area, and the employer's industry. (Teachers get more dental care than miners, for example, because they appear in public at work, speaking in front of groups.)

When drug companies talk to health plans, they need to present details about the expected utilization of the treatment and its costs in all areas of healthcare delivery. To do so, manufacturers must refine their understanding of how different elements of the healthcare system interact, and what variables affect them. This is a primary expertise of health-insurance actuaries. Using the in-depth knowledge and expertise of such professionals will enable the development of a solid base model for the manufacturer, which can then be tailored to meet the needs of different health plans. Customized models can be created to include the impact of benefit design, geographic area, healthcare-delivery management level, and other relevant factors.

Models can also be made more valuable by the implementation of dynamic population modeling, typically employed by actuaries. Models generated by pharmaceutical companies are often based on information gathered in clinical trials, or from populations that are derived from canned databases, rather than reflecting the population pertaining to the health plan of interest. A pharmaceutical company would not need to know the demographic characteristics of each health plan. Instead, it could develop a model that allowed utilization and cost estimates based on user-defined demographic data.

A Long Way to Go

In 2000, the Academy of Managed Care Pharmacy (AMCP) developed the Format for Formulary Submissions, an effort to help pharmaceutical companies give health plans more complete information about new products. Designed to speed the decision-making process at health plans, the Format was a guideline for companies to present information in a standardized dossier.

Version 2.1 of the Format, released in April 2005, provides specific requirements regarding the requested cost-effectiveness model, and specifies that a budget-impact model (if any) be done separately. Creating separate cost-effectiveness and budget-impact models is good advice. Proponents say the Format levels the playing field between manufacturers and health plans by going beyond clinical information to create a standard for constructing, presenting, and critiquing cost-effectiveness models. Most manufacturers are now submitting dossiers, although they are often incomplete, especially when it comes to comparisons with competitors.

However, a cost-effectiveness analysis does not use units that help the actuary estimate and budget for future costs, or monitor claims. In too many cases, the manufacturers aggregate the purported health benefits of a drug into a single index, such as saved Quality-Adjusted Life Years (QALYs). By combining factors that actuaries like to weigh separately, the manufacturers obscure the very information their customers value.

Savvy pharmaceutical companies can do better. An actuarially sound, full-budget-impact model may be out of reach. But companies could express data in units that a health plan can integrate into its own internal actuarial analysis. Financial decision makers at a health plan want to know how a new drug or medical device affects the value of expected claims. Clinical efficacy and even cost-effectiveness may impress a pharmacy and therapeutics committee. But the financial decision makers will look at the big picture and the bottom line. Companies that want to maximize their chances of achieving preferred status on the plan's formulary need to provide health plans with their most complete, actuarially sound budget-impact analysis.

Dereliction of Data

A report published by the International Society of Pharmacoeconomic and Outcome Research suggests several reasons why health plans make little use of drug-company data Five of them are listed below. Not surprisingly, they echo comments frequently heard at most health plans when the Pharmacy and Therapeutics Committee holds a meeting.

» Health-plan decision makers are skeptical of information provided by drug makers.

» Decision makers remain skeptical of extensively used assumptions in pharmacoeconomic analyses. Instead of estimates, they prefer empirical data, such as results from randomized control trials. Health-plan decision makers cannot use data that aggregates health benefits into a single index, such as Quality-Adjusted Life Years (QALYs) saved. They prefer to examine independent components, such as utilization rates and claim-cost rates (PMPM) for relevant medical services.

» Pharma rarely provides estimates of a drug's total budget impact. At best, the cost of introducing a new drug is summarized by its affect on the pharmacy budget alone. This approach misses the impact in other areas of healthcare expenditure, such as hospital in-patient days or physician office visits.

» Pharmacoeconomic information presented by pharmaceutical companies often compares a new drug to a placebo or to one other drug. Plans need comparisons with all other important treatment options, including the other drugs or procedures against which the new drug will actually compete.

» Health-plan decision makers need to know how a particular drug is going to affect their own population. This is one of the big reasons why pharmacoeconomic models are not heavily used. Plans worry about transferring the model to their own populations. The cost impact of a drug may be much different when the average age of the covered population is older (see General Motors) rather than younger (Microsoft).

Jill Van Den Bos is a consultant in the Denver health practice of Milliman, Inc. She can be reached at jill.vandenbos@milliman.com