Drug Formularies Decoded: How They Shape Prescription Costs

Drug Formularies Decoded: How They Shape Prescription Costs

One area that often confounds self-funded employers is the management of prescription drug costs. As these expenses continue to rise, it’s essential to understand the mechanisms that influence prescription costs. One of the key players in this equation is the drug formulary. 

A drug formulary is a list of prescription drugs approved for coverage by a health plan. It’s a carefully curated inventory of medications that insurance providers and pharmacy benefit managers (PBMs) have deemed safe, effective, and cost-efficient for specific medical conditions. These formularies serve as a roadmap to guide healthcare professionals in making treatment choices for their patients.

We’re here to decode the mysteries of drug formularies, explore the differences between open and closed formularies, and discuss the impact of preferred versus non-preferred drugs on both members and healthcare plans. 

How Formularies Classify Drugs 

To optimize cost savings and treatment efficacy, formularies classify drugs into various tiers:

Tier 1: Generics

Generic drugs are usually the first tier in a formulary. These are medications that have lost their patent protection, allowing other manufacturers to produce and market equivalent versions of the brand-name drug. Generic drugs are typically much more affordable than their brand-name counterparts, making them a cost-effective choice for both patients and healthcare systems. They must meet the same rigorous standards for safety, efficacy, and quality as brand-name drugs, as established by regulatory agencies like the FDA in the United States. Here’s a more detailed explanation of generics:

  • Cost Savings and Cost-Effectiveness: Generic drugs are the cornerstone of cost-saving strategies for self-funded employers. When a brand-name drug loses its patent protection, it opens the door for other pharmaceutical manufacturers to produce generic equivalents. These generic versions are generally much more affordable than their brand-name counterparts. Employers should prioritize generic drugs in Tier 1 because they can significantly reduce overall drug expenditures for insurance plans and patients. The cost savings are essential for controlling healthcare costs and making prescription medications more accessible to a wider population.
  • Interchangeability and Bioequivalence: One of the key principles behind the inclusion of generic drugs in Tier 1 is bioequivalence. Generic drugs must demonstrate that they are equivalent to the brand-name drug in terms of pharmacokinetics (absorption, distribution, metabolism, and excretion) and therapeutic effects. PBMs rely on scientific evidence and FDA approval to confirm that generic drugs are interchangeable with brand-name counterparts. This interchangeability ensures that patients can safely switch from a brand-name drug to a generic version without sacrificing therapeutic benefits..

Tier 2: Preferred drugs

Preferred drugs are the backbone of a well-structured drug formulary. They are typically selected based on various criteria, such as safety, efficacy, and cost-effectiveness. Here’s why they are considered a cost-effective choice:

  • Cost-Effectiveness: Preferred drugs are chosen because they offer a favorable balance between cost and efficacy. This means that they provide good results in treating specific medical conditions while offering lower costs to members and plans. When healthcare plans utilize preferred drugs, they are more likely to reduce their overall prescription drug expenses.
  • Lower Out-of-Pocket Costs for Members: One of the critical benefits of preferred drugs for members is the reduced out-of-pocket costs. This typically comes in the form of lower copayments or coinsurance rates. When members can access medications at a more affordable price, it encourages them to adhere to their prescribed treatments, improving their overall health outcomes.
  • Encourages Evidence-Based Medicine: By promoting preferred drugs, formularies are indirectly endorsing evidence-based medicine. These medications have been thoroughly researched and proven effective in treating specific medical conditions. Encouraging their use not only saves costs but also ensures that members receive the most appropriate and effective treatments.
  • Quality Assurance: The selection of preferred drugs is typically guided by a committee of healthcare experts who assess their quality and efficacy. This rigorous evaluation process ensures that the medications included in the preferred category meet high standards of safety and effectiveness.

Tier 3: Non-preferred drugs

Non-preferred drugs are medications that do not make the cut to be considered as first-line options in a drug formulary. They are typically classified as non-preferred for several reasons, including higher costs, comparable efficacy to preferred alternatives, or a combination of both. Here’s a closer look at non-preferred drugs:

  • Comparable Efficacy: Non-preferred drugs may offer similar therapeutic effects to preferred medications for specific medical conditions. However, the key difference is that they often come at a higher price. This similarity in effectiveness can make them a viable alternative in some cases, especially when a member has a contraindication or intolerance to preferred options.
  • Higher Costs: One of the defining characteristics of non-preferred drugs is their increased cost. They tend to be more expensive, both in terms of the medication’s price and the cost-sharing that members must bear, such as higher copayments or coinsurance rates.
  • Higher Member Out-of-Pocket Costs:  Non-preferred drugs come with higher out-of-pocket costs for members to encourage them to use the preferred medication. In the event that the member can’t utilize the preferred medication, plans can make an exception to allow the member to take the non-preferred medication.

Tier 4: Specialty drugs

Specialty drugs are a distinct category of medications that are primarily prescribed for severe, chronic, or rare medical conditions. They are characterized by several key attributes:

  • High Cost: Specialty drugs are among the most expensive medications available. Their price tags can be significantly higher than both preferred and non-preferred drugs. This high cost is primarily due to the complex research, development, and manufacturing processes required to produce these specialized treatments.
  • Complex Administration: Specialty drugs often require specialized modes of administration, such as injection, infusion, or unique delivery devices. The administration process may involve training for healthcare providers or even home-based self-administration under healthcare professional supervision.
  • Severe Conditions: These medications are typically used to treat severe and chronic medical conditions. Examples include cancer, multiple sclerosis, rheumatoid arthritis, and rare genetic disorders. Specialty drugs are often the last line of defense for patients with limited or no alternative treatment options.
  • Prior-Authorization Requirements: Healthcare plans often implement prior-authorization processes for specialty drugs. This means that before a member can access a specialty medication, the prescribing healthcare provider must demonstrate that it is medically necessary and that there are no preferred or non-preferred alternatives that would be as effective.
  • Limited Preferred Alternatives: In many cases, specialty drugs do not have preferred alternatives due to their unique mechanisms of action or the nature of the conditions they treat. When a healthcare provider determines that a patient requires a specialty drug, there may be limited room for choice.
  • Optimal Outcomes: Specialty drugs are designed to deliver optimal treatment outcomes for patients with complex medical conditions. They may slow the progression of the disease, alleviate symptoms, or even provide a cure in some cases. The high cost of these drugs is often justified by their potential to improve the patient’s quality of life and overall prognosis.
  • Ongoing Monitoring: Given the complexity of specialty drug treatments, ongoing monitoring by healthcare providers and collaboration with dispensing pharmacies is crucial. This ensures patients receive the appropriate care and support necessary to manage potential side effects and achieve the best results.

The Complexities of Formularies and their Influence on Prescription Costs

Open Formularies vs. Closed Formularies

Open Formularies

Open formularies, often referred to as inclusive or comprehensive formularies, are designed to be more expansive in their coverage of prescription medications. They generally include a wide range of drugs, offering patients and healthcare providers a greater selection of options. While open formularies may still differentiate between preferred and non-preferred medications, they typically do not exclude any drugs entirely. Instead, they may have varying tiers or copayment levels for different drugs to encourage the use of more cost-effective or preferred options.

Closed Formularies

Closed formularies, on the other hand, are also known as restrictive formularies. The defining characteristic of closed formularies is their exclusivity. These formularies limit the number of drugs available for coverage to a more select list. The key distinction is that closed formularies have exclusions – specific drugs are deliberately left off the formulary and are not covered by the plan. While they still have preferred and non-preferred medications, many of the non-preferred drugs are entirely excluded from coverage.

One of the significant drivers behind the use of closed formularies is the potential for higher rebates from pharmaceutical manufacturers. This practice is motivated by the manufacturers’ desire to ensure that their medications are included on the formulary, even if it means offering more substantial financial incentives to the healthcare plan.

Both open and closed formularies have preferred and non-preferred medications. These distinctions are often based on factors like cost, effectiveness, and safety. However, the key difference is in the extent of exclusions. In a closed formulary, a substantial number of non-preferred drugs are excluded, and the plan does not cover them. In an open formulary, while some drugs may have higher copayments or restrictions, they are typically not completely excluded from coverage, giving patients and providers more flexibility in their treatment choices.

The Impact of Preferred vs. Non-Preferred Drugs

One of the critical aspects of understanding formulary management is recognizing the distinction between preferred and non-preferred drugs and the impact on both members and healthcare plans.

Impact on Members

Preferred drugs typically come with lower out-of-pocket costs for members. These lower costs can significantly ease the financial burden of managing chronic conditions or taking long-term medications. Additionally, preferred drugs are often accompanied by lower copayments or coinsurance, making them more affordable and accessible for members.

Non-preferred drugs, on the other hand, are usually more expensive for members. Higher copayments or coinsurance rates can be a significant deterrent, potentially leading some individuals to forgo necessary treatments or seek alternatives.

Impact on Healthcare Plans

For healthcare plans, the preference for covering preferred drugs is motivated by cost savings. Preferred drugs are typically more cost-effective, allowing plans to manage expenses more efficiently. When members opt for non-preferred drugs, the plan’s overall costs increase, which can result in higher premiums or reduced benefits over time.

In essence, the preference for preferred drugs benefits both members and healthcare plans by lowering out-of-pocket costs for the former and reducing expenses for the latter.

MaxCare’s Approach to Formulary Management

At MaxCare, we believe that the ultimate goal of formulary management should be to achieve the lowest net cost while ensuring members have access to safe and effective medications. While rebates play a role in cost management, we prioritize optimizing formularies to reduce expenses for both healthcare plans and their members. This approach is built on the following principles:

  • Plan and Member-Focused Formularies: We focus on creating formularies that prioritize high-value drugs, ensuring that they are cost-effective and beneficial for members. Our goal is to promote health and well-being while minimizing overall expenses.
  • Transparency: We maintain transparency in our formulary management to help both self-funded employers and their members understand the rationale behind drug selection, and the potential rebate impact and overall cost.
  • Ongoing Evaluation: We continuously evaluate the effectiveness of our formularies, taking into account changes in the healthcare landscape and new drug developments. This ensures that our formularies remain aligned with the latest medical advancements and cost-saving opportunities.

At MaxCare, we advocate for a formulary management approach that places the lowest net cost as the ultimate goal, rather than solely focusing on driving rebates. By doing so, we aim to create a win-win scenario where healthcare plans and their members can enjoy both cost-effective access to medications and improved health outcomes.

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