Until recently, prescription drugs have not materially altered the trajectory of the Milliman Medical Index (MMI). With drug costs being roughly 15.9% of the annual healthcare expense of our typical family of four, drug trends must be very different from other categories of care to materially influence overall healthcare cost trends. Nevertheless, they are doing just that. As discussed below, a combination of forces is creating the perfect pharmaceutical storm. Employers and families alike feel the financial consequences more than ever when a prescription is filled.

Specialty drugs
Specialty drug expenditures have grown over the past 25 years to the point where they now account for one of every three dollars spent on prescription drugs. While various definitions of specialty drugs are used in the industry, they nearly all have a common denominator: They are expensive. Medicare defines specialty drugs as those costing more than $600 per prescription. But the costs can be much higher than that. The category includes the well-publicized treatments for hepatitis C, some of which cost more than $1,000 per dose. Many subclasses of specialty drugs have huge potential to improve health outcomes, but also come at a significant cost. Experts project that the pipeline for specialty drugs is substantial and likely will not subside in the near future as manufacturers focus their efforts on targeted genetic profiles and rare disease states.

Compounded drugs
Compounded drugs have become one of the most costly components of pharmacy spending over the past several years. In fact, several recent national news stories have focused on this phenomenon. The U.S. Food and Drug Administration (FDA) defines compounding as "a practice in which a licensed pharmacist, a licensed physician, or, in the case of an outsourcing facility, a person under the supervision of a licensed pharmacist, combines, mixes, or alters ingredients of a drug to create a medication tailored to the needs of an individual patient." Many of these drugs (often custom creams and ointments) have questionable clinical value, and compounding pharmacies are receiving much higher prices for compounds than the individual ingredients they comprise. As a result, drug trends have accelerated for compounded drugs, which is due in part to more limited regulation for them than for other drugs, along with increases in the average wholesale price (AWP) of these drugs. Pharmacy benefit managers (PBMs) have responded with specialized programs targeting the inappropriate use of this emerging drug class.

"Patent cliff" aftermath
Over the past few years, many brand-name drugs have lost patent protection, including some of the highest-grossing drugs in history such as Lipitor, Plavix, and Nexium. This "patent cliff" benefited consumers because generic versions became available at much lower costs. Now that many of the heavily utilized brand-name drugs have lost patent protection, the year-over-year price reductions produced by generic shifts have slowed as well. In addition, there is also evidence that generic price trends are on the rise, where in past years they have been flat or even negative. Manufacturer consolidation and reduced competition, particularly among generic manufacturers, may be a contributor to the increase in cost.

AWP increases
By some accounts, the cost of brand-name drugs is accelerating at a rate of over 10% annually, with generics increasing at a slower rate, but still higher than in the recent past. In large part, this has to do with the AWP increases themselves and with the fact that many payers' contracts are tied to a discount off the AWP. Because most employer prescription drug contracts are based on discounts from the AWP, consumer prices are at the mercy of the manufacturer's price increases.

Pharmacy rebates--another ingredient in drug costs
When we discuss prescription drug "costs," we are talking about the costs incurred at point of sale. However, pharmacy costs are often reduced by manufacturer rebates. After a prescription is filled, the drug manufacturer may give a significant rebate to the PBM or health plan. The rebate amount typically varies by drug and by purchasing volume. To encourage use of their blockbuster drugs, manufacturers may give very high rebates, as much as 60% for a given drug. Patients, unfortunately, do not benefit from these rebates at point of sale. For example, if their out-of-pocket costs are 20% of the prescription price, then they pay 20% of the negotiated retail price and do not benefit directly from the rebates. Depending on the contractual arrangements in place, rebates reduce healthcare premiums indirectly, if they make their way all the way back to the insurance company (or self-funded employer), and are deployed to reduce premiums. The magnitudes of the rebate payments can materially affect a health plan's net benefit expenses.

What is being done to limit growth in prescription drug costs?
Employers and employees alike are addressing the rising cost of prescription drugs in the following ways.

Encouraging consumerism
Employers continue to combat drug price increases with changes in their plan designs. One example is adding separate higher cost-sharing tiers for specialty drugs. It is also increasingly common to create two cost-sharing tiers for generics--one for lower-cost generics and another for higher-cost generics. Sometimes families are able to limit their out-of-pocket costs by being wise consumers--doing things such as asking their doctors or pharmacists for generic alternatives when more expensive brand-name drugs are prescribed, or even pursuing over-the-counter alternatives.

Narrow formularies
A formulary is a health plan's list of the drugs they will cover. It may also assign each drug to a tier, which defines how much a patient has to pay out-of-pocket for that drug. Some employers and PBMs create closed formularies that limit the number of drugs on their formularies to improve manufacturer rebates and target products with the best clinical effectiveness, often coupled with lower copays or coinsurance. While choosing this type of plan may require families to change their prescriptions, the intent is to reduce costs for both families and employers without sacrificing health outcomes by excluding clinically substitutable medications, higher-priced medications, or medications without significant manufacturer rebates.

Re-contracting
Employers often sign multiyear contracts with PBMs to lock in drug price guarantees, administrative expenses, and methods to share manufacturer rebates. Given the material shifts in the prescription drug landscape (PBMs and manufacturers), employers are finding that significant savings can often be achieved by re-contracting these financial terms. Employers can then leverage those savings by reducing their plan spending, improving their plan designs, reducing employee contributions, or some combination thereof.

There are many signs that drug costs will continue to see upward pressure, given the dynamics at play in the market. Employers and families both need to make changes if they hope to mitigate the financial impact.

This content first appeared in the 2015 Milliman Medical Index.