Health-care inflation is back, and prescription drug costs are rising at a double-digit rate. Here are some ways to get in front of the problem.

Health-care cost inflation is back with a vengeance, and prescription drugs are leading the way. The U.S. population is aging, new and more expensive drugs are emerging, and pharmaceutical companies are aggressively marketing directly to consumers and doctors. For businesses, managing the rise in prescription drug costs is becoming a fixture on finance and HR agendas.

Even though prescription drugs account for only about 10 percent of the nation's total health-care costs, they have been driving health-care inflation for the past few years, according to a study conducted early this year by the National Institute for Health Care Management Research and Educational Foundation in Washington, D.C. The study found that outpatient prescription-drug spending totaled $154.5 billion in 2001, up from $131.9 billion in 2000. It also found that although 9,482 drugs are available on the retail market, 50 of those accounted for more than 44 percent of prescription drug expenditures last year. It is easy to understand why, as usage of these medications is growing rapidly and their average price is much higher than that of other medications (see Name Brands Lead Skyrocketing Drug Costs below).

How these numbers trickle down to individual companies varies greatly, according to the 2002 Segal Health Plan Cost Trend Survey conducted by The Segal Company, a benefits consulting firm based in New York City. The survey found that the prescription drug costs for some companies rose more than 40 percent last year, while other organizations' bills grew at rates in the single digits. Staying near the low end of this spectrum is particularly important for businesses that self-insure prescription drug coverage, as increased spending directly affects corporate coffers.

Rising drug costs' impact on a given company depends on how proactively the organization manages the issue. Companies can reduce their spending on prescription drugs, but they need to be realistic about what a cost-cutting program can accomplish. Shaving a few percentage points off of increases might be an achievable goal, but keeping spending constant from one year to the next is probably not possible. "The goal should be for each company individually to see where they are on the spectrum," says Sean Brandle, vice president with The Segal Company. "Some companies will have the opportunity to shave four to six percentage points off projected increases."

There is no off-the-shelf solution to battle rising prices. Each business has to develop a strategy that meets its unique needs. "A lot of this depends on demographics," says Tom Billet, a senior consultant with Watson Wyatt Worldwide in Stamford, Conn. "The older the workers, the higher the costs." Yet no matter what their situation, companies can take steps to deal with prescription drug costs.

Look at Plan Design

Plan design is an important tool for keeping costs under control. While companies have long used two-tiered programs that reimburse generic drugs at a higher level than brand-name drugs, many organizations are refining plan design to reflect the changing realities of the prescription drug market.

Some are creating a payment structure in which employees have purchasing freedom but face varying levels of co-payment or coinsurance. "We are seeing more, not less, of this approach," explains Terry Sutherland, a consultant with the pharmaceutical practice group of Towers Perrin in Atlanta. For example, an employee might pay $5 for a generic drug, $15 to $20 for the employer's preferred brand-name equivalent, and $35 to $40 for a nonpreferred brand-name drug. The Wyeth-Ayerst Prescription Drug Benefit Cost and Plan Design Survey found that 39 percent of 446 companies surveyed require employees to pay more for brand-name medications than for generic alternatives.

Companies are also moving away from flat-dollar co-pays in favor of percentage-based coinsurance. Instead of requiring employees to pay a set fee per prescription, some businesses ask them to pay, say, 10 percent of the cost of a generic drug, 20 percent for the organization's preferred brand-name equivalent, and 35 percent for a nonpreferred brand-name drug. Switching from a flat-dollar co-pay to coinsurance helps reduce the company's share of price increases.

The three-tiered approach to plan design and the switch to coinsurance have the added benefit of focusing employees on the total cost of their drugs and creating an economic incentive for workers to choose the most cost-effective option. "Employees can make a difference when it comes to prescription drug costs by looking for substitutions," says Billet. Indeed, prescription drugs are a prime area for cost-conscious employees to make a difference, especially when compared with other areas of health care. "It is easier to educate employees about prescription drug costs and get them to act than it is to get employees to shop around for a cheaper MRI," says Billet.

Throughout the plan design process, companies should be mindful of one other issue: Cost shifting must not discourage employees from buying prescription drugs or taking them appropriately. If employees' share of drug costs is too high, companies risk even larger medical bills for illnesses that could have been prevented with medication. "Employers have to look at the big picture," says Glenn Yokoyama, director of clinical services for Prescription Solutions, a pharmacy management company based in Costa Mesa, Calif. "Rising co-pays may deter patients from getting or complying with medication direction, saying instead, 'I can't afford an entire month's prescription, so I'll take half a pill a day.' "

Leverage Volume

As they did during the health-care inflation crisis of the 1980s, many businesses are banding together to pool purchasing power and negotiate better deals. To gain worthwhile concessions, a company or group of companies needs to cover 25,000 to 50,000 people, says Brandle. Organizations that do not cover this many of their own employees can find like-minded companies in their geographic region with which to form a purchasing coalition. DaimlerChrysler's Chrysler Group has formed a coalition with some of its 4,000 direct suppliers to reduce prescription drug costs through volume buying.

Some large companies can gain this type of leverage on their own. For example, Unisys Corp. centralized its prescription drug buying -- rather than allowing each health-plan provider to offer its own prescription drug program -- and concentrated all its claims with one pharmacy benefits manager (PBM). The leverage Unisys gained through this move enabled the company to avoid any increase in prescription drug costs the first year and to keep second-year increases in line with its peer companies, according to Charlene Parsons, vice president of global rewards for the Blue Bell, Pa.-based business.

Choose Vendors Carefully

Many companies rely on pharmacy benefits managers to get them the best possible price on prescription drug benefits. But an arrangement with a PBM is no guarantee of a good deal. When contracting with a pharmacy benefits manager, an employer must specify the levels of discounts, rebates and administrative fees it expects and must be "aggressive in getting the best possible deal based on company size," says Brandle.

Even after the contract is signed, an organization must manage the relationship carefully and review the agreement on a regular basis -- every two years, at least -- to determine whether renegotiating the contract or shopping for a new vendor would be prudent. "PBMs are consolidating rapidly, so what is competitive now may not be competitive in six months," says Sutherland.

Beyond contract negotiations, companies should carefully review usage data every two years to make sure the plan is operating as efficiently and cost-effectively as possible. Claim audits can also provide important information about where money is being spent. With that information, the company can make decisions about issues like whether to cover so-called lifestyle drugs, like Viagra, based on their cost and their impact on the plan. It is also a good idea to make sure supplemental services the company is paying for are being delivered, promised discounts are materializing, and drugs are readily available to fill prescriptions.

Although the Segal trend survey predicts that price increases for mail-order prescription drugs will be only slightly lower than retail costs (19.4 percent for retail vs. 18.8 percent for mail order), many argue that mail-order plans can offer significant savings if they are set up properly. For example, a well-designed mail-order plan should allow an employee to purchase a 90-day supply of a particular drug at a greater discount than a retail pharmacy. However, this approach may not be cost-effective for new prescriptions.

"When new patients are started immediately on long-term medication, there is tremendous opportunity for waste," says Yokoyama. After all, if the person does not use the prescription or if the drug turns out to be inappropriate for that individual, the 90-day supply will be wasted. "A better approach is to begin with a small supply," which is increased over time once the individual is maintained on the medication, says Yokoyama.

Educate Consumers

Pharmaceutical companies are using advertising to convince prescription drug purchasers to ask for a specific brand-name drug, which is usually the higher-cost drug, even when a suitable generic substitute is available. Not surprisingly, the National Institute for Health Care Management Research and Educational Foundation study found that many of the drugs that drove 2001 cost increases were those that manufacturers most heavily advertised to consumers and doctors. To keep prices under control, employers need to move just as aggressively as the drug companies to educate employees about the costs and consequences of their buying decisions.

A good place to start such a program is with communication about the design of the prescription-drug benefit plan and about why the plan covers different drugs at different levels. "This can help spur greater consumerism and bring employees into the decision-making process," says Sutherland. "You have to give them an investment in the economic decision."

But education should also extend to ensuring compliance -- that is, making sure individuals are taking medications properly. By some estimates, about half of all medications are not taken as prescribed, which significantly reduces their effectiveness and wastes a lot of money in the process.

Some organizations also offer employees information about various prescription drugs through a Web site or via e-mail to inform them that choosing a prescription drug is a financial decision as well as a health issue. Sutherland explains, "Employees need help to make the most considered decision possible. Most companies believe that the more educated and informed employees are about costs, the more rational they will be in making those decisions."

Companies today are trying to stretch benefits dollars as far as possible. The nagging question is whether they will be able to continue to fund prescription drug coverage as costs skyrocket. As they work through that question, executives can take steps to manage these costs more effectively and minimize prescription drugs' impact on the bottom line.