HEW Hewitt Associates

The U.S.'s big pharmacy benefit managers continue to offer clients better deals this year as they compete for business, but they don't appear to be sliding into a frenzy of unreasonable pricing.

In the current "selling season," when PBMs look to sign customers for the following year, discounts on new contracts have deepened by one or two percentage points, on average, from a year ago. While PBMs are still lowering their pricing, the pace is slower than a year ago, when PBMs were willing to expand discounts by as much as five percentage points, according to benefit consultants who guide employers on choosing a vendor.

It is unclear how the lower prices will impact margins next year at large PBMs like Medco Health Solutions Inc. (MHS), CVS Caremark Corp. (CVS) and Express Scripts Inc. (ESRX). The increased use of generic drugs, which lowers PBMs' costs, allows them to be more flexible with prices. That accounts for some of the discount.

The big PBMs have reported lower margins this year, citing a variety of reasons. Medco, though, specifically mentioned lower pricing on renewing contracts, among other items.

PBMs "are taking a little bit of a hit to margin, not much, but they are taking one," said Michael Jacobs, national clinical practice leader at Xerox Corp.'s (XRX) Buck Consultants. He said the companies have ways of making up elsewhere for client discounts -- through greater operating efficiency, cost-shifting to members or raising prices on other drugs.

PBMs handle prescription-drug benefits for employers and health plans, negotiating pricing -- including rebates and discounts -- with drug makers and pharmacies. They also run their own profitable mail-order pharmacies. The competitive industry has come under increasing pressure to pass along rebates and discounts and improve transparency.

Currently, the industry is engaged in its selling season for 2011 contracts, with billions of dollars in new and renewing business up for grabs or already won.

"Pricing got more competitive this year," said Kristin Begley, national pharmacy practice leader at benefits consultant Hewitt Associates Inc. (HEW), who didn't see much switching among her large, national clients, many of which contract with CVS Caremark or Medco.

Rebates got better, and there were "overall better deals across the board," Begley said. Also, she said, most Hewitt client bids this year required full transparency on pricing structure, with PBMs earning an administrative fee and making money on mail-order while forgoing a margin on drugs dispensed at retail.

PBMs are offering clients better discounts on generic drugs, said David Dross, partner and managed pharmacy practice leader at the Marsh & McLennan Cos. (MMC) Mercer LLC consulting business. Dross added that he has seen some bigger discounts for brand-name drugs as well, although underlying costs on branded drugs generally are increasing.

PBM managements have indicated pricing trends are rational, even though a Sanford C. Bernstein & Co. employer survey earlier this summer suggested a "notable deterioration of the PBM pricing environment," with more than 40% of respondents noting a decrease in prices.

"Our pricing disciplines have been applied consistently for the past several years as well as going forward to 2011," Medco spokesman Lowell Weiner said. Medco CEO David Snow Jr., who earlier this year noted instances of aggressive pricing, said last month that he was feeling more comfortable with the competitive marketplace.

Meanwhile, Express Scripts CEO George Paz has said that while "pricing has always been extremely aggressive," the company uses clinical tools to help drive out costs.

Per Lofberg, who heads CVS Caremark's PBM operation, recently told analysts that pricing is "intensely competitive like it always ... has been, but it's fundamentally very similar to the past. When plans go out for bid, they are always looking for better economics, and that's a very important part of the negotiations."

John Malley, eastern region pharmacy practice leader at Towers Watson & Co. (TW), said PBM pricing isn't irrational, although it is changing in structure so that players offer better pricing without necessarily losing margin.

"So more simply put, the level of discounts off prescription drugs is not that different between last year and this year, but the overall value of this year's deals, all in, is better than last year" for the clients, Malley said.

Pricing will become less important a competitive factor as more drugs go generic, Mercer's Dross predicted. PBMs already are trying to differentiate their clinical offerings, which aim to close gaps in care, customize prescriptions based on genetics and improve compliance to produce better health outcomes and lower costs.

-By Dinah Wisenberg Brin, Dow Jones Newswires, 215-656-8285; dinah.brin@dowjones.com

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