Formulary management is becoming increasingly important for plan sponsors. As drug prices, especially specialty costs, continue to rise, improving participant access to affordable medications is vital to containing overall medical spend and prioritizing participant health.

On the surface, a drug formulary is simply a list of prescription medications approved to be covered by the plan. Routinely held by the Pharmacy Benefit Manager (PBM), formularies are traditionally created on the recommendation of various committees that consider the clinical and financial impact of covering certain drugs. Most formularies are categorized in one of two ways.

A closed formulary covers most medications. Exclusions allow PBMs and plan sponsors to manage costs. An open formulary covers all medications, allowing broad patient access but higher plan costs.

A tiered model governs drug copays. Most formularies have three or four tiers:

  • Tier 1: Generic medications. Lowest copay.

  • Tier 2: Preferred brand-name medications. Middle copay.

  • Tier 3: Non-preferred brand-name medications. High copay

  • Tier 4: Specialty or high-cost medications. Highest copay.

Formularies can also include utilization management protocols that provide additional control of costs. Step-therapy, prior authorizations, and quantity limits are the three most common utilization management techniques.

It is not surprising that, like almost all elements of healthcare, there is little transparency around why certain drugs are included or excluded from the formulary. While most PBMs do prioritize the clinical value of certain medications, other factors play a significant role in formulary development. Chief among those are rebates.

The high cost of many medications leaves patients unwilling or unable to pay the full cost, so pharmaceutical companies contract with PBMs to provide rebates if their medication is included on the formulary. A more favorable spot on the formulary translates into more rebates. These rebates are funneled back to the plan sponsor, or, in the case of point-of-sale-rebates, the patient, but are paid after the sale and leave plan sponsors dependent on prospective dollars.

Rebates are based on the list price of medications. The significant difference in the list price and manufacturing price of medications allows manufacturers to offer rebates of 30 to 50 percent on average and still profit.

This lack of transparency also makes it difficult for generic versions of medications to gain permanency on the formulary. Thirty days’ worth of a generic drug could cost as little as $20, while the same quantity of a brand-name medication could be over $300. Because the brand-name medication has a rebate attached, the brand-name drug may be given preference over the generic medication.

A convoluted rebate system means the most cost-effective medication may not always be included on the formulary.

Transparency into drug rebates and how they affect formulary management allows plan sponsors to take ownership of their contracts. Confirming rebate guarantees and prioritizing clinical effectiveness over rebate dollars will help contain pharmacy costs at the plan and patient level, ultimately lowering overall medical spending.

Updated: Aug 31, 2021