Four tier formularies/generics driving costs down


More health plans/payers are looing beyond three-tier incentive-based formularies to four tier.

While still in a distinct minority, more health plans and payers are looking beyond three-tier incentive-based formularies to four tiers. And not just for lifestyle drugs. Some plans—including some so-called consumer-directed plans—are combining four-tier designs with other incentives to encourage the use of generic drugs. And some plans are moving away from branded-versus-generic groupings to tiers based almost entirely on established medical effectiveness.

What all incentive-based formularies have in common is an attempt to control utilization through consumer cost, either through copayment or co-insurance. Ten years ago, most insured persons paid a standard co-pay of $5 or less for a prescription, regardless of the type of medication they purchased. Today, incentive-based formularies are the norm, said Cindy Parks Thomas, Ph.D., a senior scientist at the Schneider Institute for Health Policy at Brandeis University in Waltham, Mass.

"The goal of incentive-based formularies is to encourage people to choose lower-cost prescription drugs, thereby creating cost savings for the health plan, which can, in theory, then be passed on to the consumers," said Thomas in an article in the Dec. 4, 2003, issue of the New England Journal of Medicine titled "Incentive-Based Formularies."

"This approach was born of necessity," said Thomas, because "prescription drug expenditures are the fastest-growing component of personal health care, increasing by 15% to 18% per year" and accounting for one-fourth of the increase in employers' health insurance premiums in 2002. "Almost half the increase in drug expenditures is due to higher rates of use of prescription drugs, with the remaining half divided between inflation in the prices of existing drugs and the use of newer, more expensive drugs," she said.

In incentive-based formularies, the lowest co-pays ($10 or less) usually are for generic drugs, higher copayments ($15 or more) are for preferred brand-name drugs, and the highest co-pays ($25 or more) are for nonpreferred brand-name drugs. Preferred drugs are often less expensive brands for which there is no generic substitute.

Fourth tiers (with much higher co-pays) are usually for what are called lifestyle drugs, such as those treating impotence and baldness. Drugs used to treat obesity are often, at least currently, also considered lifestyle drugs.

On the rise

No current figures are available on exactly how many health plans and employers are using four tiers to help control spiraling drug costs, although a two-year-old study by Verispan Scott-Levin put the figure at less than 13% of 83 surveyed plans. But experts are seeing growth in plans using three-tier systems: going from covering 27% to 63% of all workers between 2000 and 2003, according to research by the Henry J. Kaiser Family Foundation in Menlo Park, Calif. This implies that we may be seeing an increasing number of four-tier formularies in the next year or two, said Bradford J. Holmes, a researcher with Forrester Research Inc. in Cambridge, Mass.

A Forrester study published in September 2002, titled "Employers Step Up the Battle on Drug Costs," showed that 48% of employers planned to increase co-pays and 31% planned to implement a three-tier or four-tier formulary in 2003 or 2004. "Plans and employers are employing increasingly aggressive tactics to encourage the use of generics," said Holmes, "And four tiers do make some sense. To the extent consumers can choose among multisource drugs, higher co-pays can affect costs."

Pharmacy benefit managers responsible for helping employers lower drug costs say four-tier formularies are increasingly popular. "We're seeing more and more people willing to move to four-tier formularies from three-tier," said Medco Health Solutions CEO David Snow. In fact, employers are even quicker to embrace four-tier formularies to lower drug spending than are health plans, said Snow.

AdvancePCS' CEO David Halbert agreed, adding that employers are continuing to widen the difference between co-pays for second- and third-tier formulary medications and increasing the number of drugs subject to step-therapy requirements, in which a patient must first try a generic or lower-cost drug before a brand-name or higher-cost medication is covered. "We're seeing customers be more aggressive with multitier co-pays," he said. (AdvancePCS, in Irving, Texas, agreed to merge with Caremark in September 2003. The companies are currently awaiting final approval from their shareholders.)

Emory University in Atlanta, for example, turned to a four-tier plan this year for 15,000 employees and dependents with the express desire to increase the use of generic alternatives managed by the PBM Caremark in Nashville. "Without effective cost-management, today's skyrocketing prescription drug costs are eroding our ability to afford comprehensive healthcare benefits," said Emory's Human Resource manager Alice Miller. "The more we can keep our drug and healthcare costs down, the more we can pass the savings on to our employees." The university's plan places all generic drugs in tier 1, with the lowest co-pay.

Peoria, Ill., did the same thing last year. It developed a four-tier copayment system based on a one-month supply of drugs. For generic drugs and brand-name drugs on the formulary, members pay $7 and $15, respectively. For a nonformulary brand-name drug that does not have a generic equivalent, members pay $30 or the price of the prescription, whichever is less. For a nonformulary brand-name drug with a generic equivalent, members pay $50 or the price of the prescription, whichever is less.

"This is something simple enough that the patients could understand it, and it could significantly affect choices members make while making sure that people got the proper drugs," commented Patrick Parsons, Peoria's human resources director. "If there's a generic available, and you want to take a brand-name drug, you're going to pay for it."


But there can be more to a four-tier formulary design than just encouraging the cost savings associated with generics. It can offer an opportunity for a creative form of cost-control, said Burton Orland, B.S., R.Ph., VP of pharmacy for Oxford Health Plan in Trumball, Conn. Oxford is discussing the possibility of adding a four-tier plan that has a reauthorization requirement, especially for lifestyle drugs, and may also include some injectable drugs.

"We will probably do it at some point," said Orland. "But we want to minimize confusion among our members, especially if we are first in our region, and make certain that we are in compliance with relevant state regulations. In Connecticut, for example, there are regulations governing how high a co-pay can be, and in New Jersey you can't have a closed formulary."

Regulatory hurdles are one issue in implementing tiered formularies, but another issue for some employers and plans is whether tiered formularies actually work. Although short-term savings are well established, the problem is that no one knows whether they really control cost in the long run, said Haiden A. Huskamp, Ph.D., an assistant professor of health economics in the Department of Health Care Policy at Harvard Medical School.

Huskamp and several colleagues recently examined the effect of incentive-based formularies on long-term healthcare costs and concluded that they may adversely affect the quality of care, especially if they are based on cost alone. They published their findings in the Dec. 4, 2003, issue of the New England Journal of Medicine in an article titled "The Effect of Incentive-Based Formularies on Prescription-Drug Utilization and Spending."

"Whether or not incentive-based formularies are successful depends on one's perspective," said the authors. "From the point of view of insurers and employers, there is strong evidence that incentive-based formularies can slow the growth of pharmaceutical expenditures. According to a recent study, increasing incentive copayments in a three-tier drug benefit resulted in approximately 30% savings in overall drug expenditures. These savings were achieved by both decreasing the number of medications purchased per member and increasing the proportion of lower-cost brand-name drugs and generic drugs used."

But their work also showed that some people simply stop taking important drugs, such as ACE inhibitors, when the drug costs more because of tier placement. That is leading some plans to consider tiered plans related to effectiveness as well as cost.

Destiny Health, a consumer-directed plan in Chicago that creates personal medical funds with employer and member contributions to cover health costs, has developed a three-tier plan for drugs that treat about 100 chronic medical conditions, with generic drugs the least expensive tier (a $10 co-pay), but places all drugs—including generics—for nonchronic conditions in the highest, or third tier, with a $45 co-pay. The third tier also includes nonformulary drugs for chronic diseases and the second tier, with a $25 co-pay, is for branded drugs treating chronic conditions. The balance of drug costs for second- and third-tier drugs comes from members' personal medical funds.

But Destiny couples its third tiers with a rewards program, including frequent flyer miles, if members choose third-tier generics. These systems work, said Stuart Slutzky, Destiny's senior director for product development. "We found that when we get new members, 70% fill their prescriptions with brand name," he said. "Within 21 months, 50% of our members are using generics."

Humana Inc. embraced a four-tier system three years ago but has recently implemented a new incentive-based formulary that incorporates elements of a co-insurance design. Humana implemented Rx4 in 2001 for all its 6.6 million members (see sidebar). Drugs are grouped based on cost, not generic or branded categories, but the HMO also considered a drug's proven effectiveness in deciding tier placement, said William Fleming, Pharm.D., Humana's VP for pharmacy and emerging technologies.

"Looking at outcomes allows us to more closely link pharmaceuticals with other medical expenses. There are drugs that we know, if used, will save on medical expenses," said Fleming.

In July 2003, Humana unveiled RxAllowance, as an alternative to Rx4, at least for now. It's a four-tier formulary with a co-insurance twist. According to Jonathan Lord, M.D., Humana senior VP and chief clinical strategy and innovation officer, RxAllowance, which Humana made available in-house in July 2003 and plans to roll out nationally during the first half of this year, is a new kind of pharmacy benefit that ties employees' out-of-pocket payments to a drug's ability to prevent illness or help the patient avoid further medical care. "Decisions in most tier systems are artificially based on cost alone, not effectiveness," said Lord.

Under RxAllowance, the HMO assigns each drug to one of four groups, using the latest available scientific evidence (see sidebar). Humana pays participating pharmacies an allowance ranging from $5 to $30 per Rx, based on a drug's grouping. After that, the patient pays any balance out-of-pocket, with a $200-per-prescription cap. This leads, of course, to widely varying out-of-pocket contributions. Someone taking 40 mg of the cholesterol-lowering drug Lipitor (atorvastatin, Pfizer), for example, might shell out more than $70 at the pharmacy after Humana's $20 contribution.

The idea is to offer virtually unlimited choice of medications but constrain selection by making members sensitive to cost. The new option considers the value drugs provide in keeping people out of the hospital, preventing disease-related complications, or reducing patients' pain and suffering, for instance. "It aligns what drugs do with the way drugs are organized in the benefit plan," Lord said, and thereby adds cost savings to those already realized through generic use.

Humana's four-tier, incentive-based formulary

In 2001, Humana rolled out a four-tier incentive-based formulary called Rx4 for its 6.6 million members. It was, and remains, the largest HMO to use a four-tier formulary. The tiers look like this:

• Tier 1 is made up of lower-cost drugs, whether generic or brand. These are medications that are either simply less expensive or those that have a high potential of preventing other healthcare costs.

• Tier 2 is for higher-cost drugs. Again, these could be generic or brand.

• Tier 3 is made up of drugs that have therapeutic equivalents in the first two tiers, brands where generics are available, and some injectables.

• Tier 4 is reserved for most injectables, gene therapies, and biotechnology treatments.

This year, the HMO is rolling out a new product named RxAllowance, in which drugs are grouped according to their ability to help prevent a serious medical episode or the need for further medical care. Humana pays an allowance to a participating pharmacy for each prescription or refill. The member pays the balance, if any, of the amount due to the pharmacy. If the cost of the covered drug is less than the specified allowance, the member pays nothing for the prescription. Here's how it works:

• Group A includes brand and generic drugs that are used to treat conditions such as asthma, bacterial infections, and juvenile diabetes and drugs that prevent pregnancy. Allowance: Up to $30 covered per prescription or refill

• Group B includes brand and generic drugs for the control of chronic conditions such as cancer, heart disease, AIDS, and multiple sclerosis. Allowance: Up to $20 per covered prescription or refill

• Group C includes brand and generic drugs that may reduce symptoms and improve day-to-day functioning for people with conditions such as allergies and arthritis. Allowance: Up to $10 covered per prescription or refill

• Group D includes brand and generic drugs that may improve the well-being of people with conditions such as obesity, impotence, and tobacco addiction. Allowance: $5 per covered prescription or refill

A member's cost will not exceed $200 per covered prescription or refill for drugs in Group A, Group B, or Group C. However, there is no out-of-pocket maximum per prescription for drugs in Group D, and there is no annual out-of-pocket maximum for any of the groups.


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