Health care cost control through a
pharmacy benefits "carve out":
is it the right prescription for your company?

Thilman Filippini guidelines for employers by TF benefit-plan specialists

By Brian Uhlig, Vice President
Thilman Filippini Employee Benefits Division

Spending for prescription drugs has more than quadrupled in the last 15 years. It's now the fastest-growing cost-component of a $1.6 trillion health industry, representing roughly 10% of all expenditures. And experts say this trend will only gain velocity in the years ahead. Prescription drug costs are expected to jump from $190 billion in 2003 to as much as $446 billion in 2012.

Many factors have converged to create this phenomenon: an aging, increasingly drug-dependent population; innovative therapies from research labs and prodigious marketing by pharmaceutical manufacturers; the advent of genetic medicine.

Conventional wisdom used to hold that it was more expensive to put people in the hospital than to give them prescription drugs. Health care economists say that's no longer true. Pharmaceutical costs are fast approaching and may soon surpass the average costs of inpatient services.

Inevitably, many smaller and medium-size fully-insured employers contemplate a so-called "carve-out" of their prescription benefit plan. Let's look at this option more closely.

To define terms, a "carve-out" means that you separate a segment of your health plan — say, the prescription drug benefit — to have it administered by a specialist third party vendor, say, ABC Pharmaceutical Management. The concept is well-known. Dental plans frequently are carve-outs. Vision programs too.

A decade ago, pharmacy benefit carve-outs were expected to dramatically cut costs — on the assumption that Pharmacy Benefit Managers (PBMs) could leverage their buying power and administrative expertise. But results have been mixed.

Generally speaking, carved-out programs have been more effective in larger, self-insured companies. The smaller a company, the more problematic the administrative challenge. If a company is large enough to spend $4 million on annual health coverage, for example, and can save 10% through a carve-out, that $400,000 certainly justifies the extra paperwork.

On the other hand, a company with 500 employees may find that it can't generate enough savings to justify the administrative headaches and claims-tracking involved.

A recent consulting study found that:

• Only 19 percent of employers with fewer than 1,000 employees used carve-outs in their health benefit plans.
• 60% of employers with 10,000 or more employees use carve-outs.

Nonetheless, under the right circumstances a self-funded, carved-out program can make sense even for a smaller or medium-size firm. We recommend consulting with a broker who brings to the table in-depth knowledge of the PBM industry.

For example, you'll need a careful analysis of carrier premium credits, stop-loss premiums, and expected claims. Although stop-loss coverage is readily available, you're not immune from risk. Aggregate stop-loss will provide a limit to the maximum risk for any one employer. But the combination of stop-loss premiums, claims and the risk-corridor created by attachment points (typically around 125%) can lead to loss situations.

Another consideration: carving out drug benefits may result in reduced drug costs but at the same time create disincentives for some drug therapies that would reduce other types of medical expense (i.e., hospitalization or surgery). Dealt with in isolation, a carved-out drug plan may or may not help effect overall health-plan cost efficiency.

Benefits that have relatively little interrelationship with other health benefits - such as vision - can be carved out easily and are simpler to design and monitor. Mental health or prescription drugs, by comparison, are more integrated into healthcare delivery.

By and large, many carved-out pharmacy benefit programs do produce a first-year savings. Only in subsequent years will your plan design, administration and monitoring of claims prove the sustained value of this option.

Here, in brief, is the plus side of a self-funded carve-out:

• Pharmacy benefit managers maintain discount contracts with a network of pharmacies. They adjudicate claims in real-time, provide customer service support, employ their own clinical staff, report plan results directly to you.
• You can take advantage of the more innovative cost management programs such as mail-only prescriptions or step therapy.
• Generally, you will see financial benefits, such as a reduction in state premium taxes, elimination of surcharges for reinsurance, earned interest on reserves and better cash flow (since claims are paid as they occur).
• You'll have plan-design flexibility and access to better data.

But there are potential drawbacks to consider:

• The reduction in premium from the fully insured prescription drug benefit may result in your carrier returning an unsatisfactory renewal or lower than anticipated premium credit.
• Data that was once integrated for disease management programs must now be fed back into your carrier's system.
• If your self-funding experience is adverse, some carriers may decline to offer a fully-insured benefit for two years.
• Although stop loss coverage is available, you accept full financial risk for a benefit that can fluctuate from month to month.