Health Insurers & Pharmacy Benefits
A Primer.
This is my inaugural post. I hope you enjoy the work I put out going forward, I am sure my writing will get better over time, and I would love to hear your feedback @KarstResearch on X/Twitter. Rather than a lengthy introduction post, I will dive in. I feel confident in saying that I am knowledgeable when it comes to the world of healthcare and insurance (Health, P&C, and Reinsurance). This piece is meant to be a primer for understanding the healthcare/insurance system within the USA.
Note: PBM = Pharmacy Benefit Manager, MCO = Managed Care Organization.
The BUCAs
The large health insurers are known as BUCA – Blue Cross Blue Shield, United Healthcare, Cigna, and Aetna. They are known as Managed Care Organizations or payers.
Some notes regarding the structure of the BUCAs:
Blue Cross Blue Shield: A non-profit organization, however they do own a publicly traded for-profit company known as Elevance (NYSE: ELV), as well as Prime Therapeutics PBM.
United Healthcare: the health insurance arm of United Health Group (NYSE: UNH), United Health Group also owns Optum PBM.
Cigna: Publicly traded company (NYSE: CI), which owns Express Scripts PBM.
Aetna: Purchased by CVS Health (NYSE: CVS) in 2018 and currently utilizes the CVS Caremark PBM.
Health insurers are often referred to as carriers or payers, these terms are used interchangeably. Payers insure individuals via Medicare/Medicaid, ACA, or commercial channels. At its simplest, when an individual is insured by a payer, they receive medical insurance and pharmacy benefits. The insured individual has access to a network of providers and pharmacists. When a payer underwrites a fully-insured (no stop-loss) contract, they use both pharmacy and medical claims to determine how much the insured owes in premium. A good rule of thumb is 70/30 - 70% of the claims come from medical (ie. going to a primary care physician) and 30% of the claims come from pharmacy benefits (ie. filling a prescription at a pharmacy).
Given how large the pharmaceutical/pharmacy industry is, many payers (as mentioned previously), own their own Pharmacy Benefit Manager (PBM) or have the same parent company.
Source: Drug Channels Institute’
Insurance Company Structure
The diagram below is an example of a fully integrated Managed Care Organization focusing just on the wholly owned PBM and insurance subsidiary.
In the above figure, the Managed Care Organization owns an insurance company subsidiary and a PBM subsidiary. The insurance company has a medical network of contracted providers and provides medical insurance through an employer for its employees/members. The PBM creates a network of contracted pharmacies and a master formulary, which can be customized further depending on the plan being offered. The pharmacy benefits are a combination of the network and formulary. The pharmacy benefits are bundled together with a medical network/medical insurance coverage as a single health plan product.
How Insurers View Risk
To understand how an insurance company views medical and pharmacy risk, it’s important to understand a term known as Medical Loss Ratio (MLR) and Combined Ratio. MLR is measured by taking the total amount of claims paid by the total premium received.
Say an employer pays $1,000,000 to insure its employees for a full year and the employees incurred $750,000 of medical claims throughout the health plan year. The insurance company had a 75% MLR meaning it paid 75 cents of every dollar it received in premium, leaving $250,000 after all the claims are paid. There are further administrative costs, often referred to as “Administrative Expense Ratio”, which calculates salaries, network access fees, partnership fees, etc. When you add the Medical Loss Ratio and the Administrative Expense Ratio you have the Insurance Company’s “Combined Ratio”. This is a good metric for understanding the fixed costs of an insurer and their underwriting standards relative to peers. This is key to understanding how insurers view risk, there are a lot of levers to pull, but if the fixed costs are too high, you need to make that up in your underwriting margin (MLR) and directly impacts how payers behave when adjudicating claims and covering new treatments.
There are two primary funding arrangements for health insurance: Fully Insured and Self-Funded.
1) Fully Insured arrangements are what individuals most often think of when they think of health insurance. The insurance company will underwrite your risk applying all the necessary factors and produce a premium that is owed to the insurer. Under this arrangement the group that purchases insurance is *fully insured*, which means that outside of the premium there are no additional costs owed by the group for the duration of the contract until renewal, no matter how excessive the claims may become.
2) Self-funded arrangements are typically used by larger employers or employers with significant cash flows. In this arrangement the employer purchases stop-loss insurance and covers the initial healthcare costs for its employees up to a certain dollar amount when the stop-loss insurance kicks in. It is typically cheaper than being fully insured in the long run but requires far more work and management. Self-insured groups also have far more control over their healthcare costs.
Self-funded arrangements can be quite complex since you can piece together different products from different companies. A possible structure for a self-funded health plan designed by and for XYZ Employer:
Third Party Administrator (TPA): Meritain, an Aetna Company (owned by CVS Health).
The TPA can provide XYZ Employer with network access as well as claims management.
Pharmacy Benefit Manager: OptumRx, a United Health Group Company.
Stop Loss Insurance Carrier: Symetra.
In the example I pose above, you have a fully functional health plan, but each component is offered by an entirely different company. This is not uncommon.
PBMs, Pharmacy System, and Pharmacy Plan
The PBM is essentially a middleman. They are at the intersection of the pharmacy benefits offered to members and the relationship between drug manufacturers and pharmacies. A few portions of the pharmacy “chain” that are important:
Wholesaler: Companies such as Cardinal (NYSE: CAH), McKesson (NYSE: MCK), Cencora (NYSE: COR) formerly AmerisourceBergen.
These companies will buy pharmaceuticals in bulk and distribute them to pharmacies.
Formulary: Drugs that are available and covered on a health plan.
Formularies are tiered with different cost structures as a function of each tier.
P&T Committees: Pharmaceutical & Therapeutics committees develop the master formulary for Pharmacy Benefit Managers and are in-house at the PBM or other governing bodies (governments may have their own P&T committees).
Rebates: Offered by drug manufacturers to PBMs to offset the cost of prescription drugs with the guarantee the drug will be placed on a formulary or preferred drug list to maximize prescription volumes.
*Note: This is not an exhaustive list, but for the purpose of this piece it is sufficient.
A pharmacy may purchase its drugs directly from a manufacturer, but in most cases, they purchase their drugs from a wholesaler. The wholesaler will have purchased the drugs directly from the manufacturer in bulk at a wholesale price and distribute these drugs as needed to its clients (pharmacies, hospitals, etc.)
A pharmacy plan’s formulary is determined by the PBM’s P&T Committee. The PBM will cover the drugs that are on the formulary and the formulary will contain tiers. As of 2022 according to the Kaiser Family Foundation over 50% of “covered workers” have a 4 (or more) tiered formulary. Commonly, the covered drugs under a pharmacy plan are referred to as PDLs (Prescription Drug Lists).
Tier 1 – Generic Drugs
Least expensive
Tier 2 – Preferred Brand Name Drugs
Moderate cost
Tier 3 – Non-Preferred Brand Name Drugs
Higher cost.
Tier 4 – Specialty Drugs
Most expensive prescription drugs.
Each tier will have a cost structure, often a copay, but there are various arrangements. Each tier’s cost structure will depend on the plan because a drug in Tier 2 of a 4-Tiered Formulary may be considered Tier 1 in a 3-Tiered Formulary, or vice versa. If you are a manufacturer of a drug, your goal is to find comparable drugs (if applicable) and price it accordingly and negotiate rebates with the PBM to drive purchase volumes.
Next Time
In the next post I will continue explaining in detail the cost structure, pricing differences between drug tiers, what influences drug placement in a tier, pre-authorizations, different purchasing organizations, and the importance of rebates/coupons. My goal is to provide clarity regarding how newer drugs will be viewed by the insurance companies and their PBMs and why they may or may not be covered on a formulary.
When I began writing the piece I started to remember how confused I was when I was first learning how the healthcare system in the US works. I felt that I had to write some type of primer. This post will not be paywalled, although I hope you enjoyed it and consider subscribing.