More than $200 billion is spent on pharmaceuticals each year in the United States, but less is known about how these billions of dollars are distributed as prescriptions move through the buying process.

Many plan sponsors feel intimidated by the operational and financial complexities that surround prescription benefit programs. The way price is determined for prescription medications can be boiled down into four common influencers:

1. Market demand for the drug and competition in the marketplace.
2. The price the pharmacy benefit manager negotiates to pay the manufacturer for the drug.
3. The price paid to pharmacies for dispensing the drug.
4. The price the plan sponsor agrees to pay the PBM for administering their prescription benefit.

Manufacturers set the price (also known as average wholesale price or AWP) for their drugs. Price influencers include the exclusivity of the product, research and development costs, market demand, competitive climate and the desire to rapidly capture market share.

As new or alternative drugs hit the pipeline, trademark protection of a medication expires, and/or generics become prevalent, the price that a particular medication can command will change. In 2008, nine drug patents expired, allowing for free market production of generic equivalents and dramatically lowering the price that the manufacturer could obtain for the original or branded product.

Once the AWP of a particular medication is established, the manufacturer examines a number of other contributing factors that may encourage it to make pricing concessions in the form of discounts and other manufacturer incentives, such as rebates and/or bonuses based on market share gains.

These incentives vary greatly, depending on how aggressive the manufacturer wishes to be. A PBM with high utilization volume for a particular medication may receive bigger discounts than other PBMs with a lower utilization volume. Successful PBMs are effective in leveraging their aggregated volumes and patient programs to achieve even deeper discounts.

Generic medications typically are priced by a unique formula known as maximum allowable cost, which ensures a cap on the price a PBM is willing to pay pharmacies for a medication.

Next, the PBM must negotiate aggressive pricing structures with local, chain and national pharmacy retailers and/or mail service providers. These dispensing channels are paid for their services via predetermined reimbursements and fees. PBMs, as part of their overall management of the pharmacy benefit, may mark up these fees, creating spread pricing.The fee structures vary between retail and mail-order pharmacies.

The PBM or payer typically contracts with local pharmacies and chain pharmacies to create a network of providers that agree to dispense medications to enrolled members. For that service, the retailer earns a profit on the drug as well as a dispensing fee.

The PBM may mark up that price by charging its client a higher fee for the ingredient costs and/or the dispensing fee than the fee the PBMis obligated to pay the pharmacy. The spread price depends on the contractual agreement between the PBM and the plan sponsor, and this can be a point of negotiation.

Many employers allow or require workers to receive their medications via a mail-order service.

Many PBMs own their own mail-order services, while others outsource this feature. Either way, the end goal is tobypass the retailer in the financial chain and effectively become the dispenser of the medication. Therefore, the revenue stream passes through the PBM's mail service operation, rather than through a retailer, thus generating added revenue for the PBM.

Because the medications are generally dispensed in 90-day increments, the plan sponsor can see some cost savings in the form of bulk buying and dispensing efficiency. In many cases the employer is asked to subsidize copays for employees to help offset costs.

If mail service remains an option for maintenance medications, the employer is likely to have fewer issues with employee satisfaction. However, if it is mandatory for maintenance drugs, plan sponsors need to carefully consider the level of employee pushback they are willing to endure for the cost savings.

A PBM should be incentivized to act on the plan sponsor's behalf and should have enough flexibility to meet the unique needs of the population.

Tips for employers

Employers can take several actions to influence the cost of medications:

» Work closely with their PBM to establish an effective benefit design. Collaborate with a PBM that can help devise effective plan designs that encourage cost-effective behavior and create overall cost efficiencies. Employee education is an essential part of any pharmacy plan. A PBM can provide the tools and training to help workers make better-informed decisions. A localized approach allows you to leverage the economies and goodwill of doing business locally.

» Seek ways to minimize health care costs through plan designs that are evidenced-based and evaluated at regular intervals. A plan design that is evidenced-based puts the appropriate drugs on the right tiers at the right cost.

Regular evaluation of the benefit should occur, including the pharmacy network and formulary, so that adjustments can be made to keep costs in line with business goals. Understand how mail-order pharmacies may or may not right fit corporate goals.

» Get educated about the flow of monies and how pharmacy costs will be determined. Expect a PBM to explain the variables in the cost of the plan, how to maximize costs and increase member responsibility and health.

» Consider incentives that will help change employee behaviors. For example, participation in a wellness program that improves or stabilizes a chronic condition could result in lower copays for participants. Employers could assign significantly lower copays or no copays to generic and over-the-counter drugs. It is a good idea to have disincentives for employees who choose more costly therapies. The goal is to encourage behaviors that lead to greater medication adherence and healthier lifestyles, which can lower the plan sponsor's health care costs.

Positive trends in drug spending

Drug costs may be going up, but not as much as before.

Annual growth in prescription drug spending averaged 9.9% from 1997 to 2007, but it has slowed since 2003, falling to 1.6% in 2007, representing the slowest growth since 1974, according to a study published in the journal Health Affairs in December 2008.

More patent expirations, increased generic use and fewer new product innovations contributed to this trend, the authors report.

You'll be happy to know that employers' efforts, such as establishing tiers in the pharmaceutical benefit to encourage workers to use low-cost generic drugs, have paid off.

"The increased extent and speed of generic penetration has resulted in substantial cost savings for purchasers," the authors state.

Specifically, "the daily cost of drug therapy across all products in that class fell 32% for lipid regulators in the year after generic entry, 32% for bisphosphonates [to treat osteoporosis], 42% for selective serotonin reuptake inhibitors [to treat depression and anxiety], and 20% for calcium-channel blockers [to treat hypertension]."

In recent years, there's been a notable shift away from drugs prescribed principally by primary care physicians and toward those prescribed mostly by specialist doctors.

In 2007, the five leading primary-care-driven therapeutic classes (by dollars) were the lipid regulators, acid pump inhibitors, respiratory agents, antidepressants and oral antidiabetics.

The leading specialist drug therapeutic classes included cancer drugs, antipsychotics, anti-epileptics and autoimmune agents.

In addition, "vaccines, once a neglected sector, have recently become much more important," the authors note.

The study concludes on a positive note: "For payers and consumers, the health spending prospects are more optimistic than many fear. Costs of prescription pharmaceuticals - an important segment of health care - are rising very slowly or even falling. Unless the situation changes unexpectedly in the near future, this trend will continue," the authors predict.