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PBM offer raises concerns about market control

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While the possible merger of two of the nation's largest pharmacy benefit managers has potential advantages for employers, some express concern that ongoing consolidation of the PBM industry will lead to decreased competition and, ultimately, higher prescription drug benefit costs.

St. Louis-based Express Scripts Inc. has proposed a $26 billion acquisition of its larger rival Caremark Rx Inc. in a deal that would create the largest PBM in lives covered and revenues (see box). The Express Scripts offer, if accepted, would derail Nashville, Tenn.-based Caremark's planned $21 billion merger with Woonsocket, R.I.-based CVS Corp. (BI, Nov. 6).

The PBM industry has already seen significant consolidation in recent years, with Caremark purchasing rival AdvancePCS in 2003 (BI, Sept. 22, 2003) and Express Scripts completing five acquisitions since 1998. The three largest PBMs—Franklin Lakes, N.J.-based Medco Health Solutions Inc., Caremark and Express Scripts—control 70% to 75% of the U.S. PBM market.

While the merger of CVS and Caremark was generally seen as creating significant benefits for employers through more effective cost management and innovative new programs, an Express Scripts/ Caremark merger would have positive and negative implications for plan sponsors, observers say.

A combined entity would be a positive development for employers as it would have greater leverage to negotiate better pricing arrangements for prescription drugs and rebates from drug manufacturers, benefit managers say.

"Those rebates or discounts being passed on to an employer may lower the employer's drug costs," said Jim Crockett, manager of risk and benefits at Denver Water, a municipal utility company.

A combined entity could achieve substantial operational synergies, observers say. The transaction is expected to generate annual cost synergies of about $500 million, according to Express Scripts.

A merger of Express Scripts and Caremark would make the combined PBM more competitive with pharmacy services provided by insurance companies, Mr. Crockett said. This might be a good option for self-insured employers because insurers "have less negotiating leverage for lower priced drugs in comparison to a large, merged PBM" with its far greater number of covered lives, Mr. Crockett said.

Express Scripts, meanwhile, has distinguished itself in moving its members to generic drugs and may be able to implement some tools it uses to promote generic utilization at Caremark, which would effectively lower drug costs for employers, said David Dross, national practice leader for Mercer Health & Benefit's managed pharmacy practice based in Houston. Express Scripts had a generic dispensing rate of 58.3% in the third quarter of 2006 vs. Caremark's retail generic dispensing rate of 57.6% and mail service generic dispensing rate of about 44.1%.

The key employer and consultant concern is whether the combined PBM would have too much market power as it would control about 45% to 50% of the PBM market.

"I personally think there might be some antitrust issues now," Mr. Crockett said. In a less competitive environment, the PBMs would have "the power to control the price of drugs and raise the price of drugs."

"You just have to be careful you don't end up with some lack of competition that will drive prices up," said Scott Clark, risk and benefits officer for Miami-Dade County Public Schools.

While there is significant price competition currently, "With fewer entrants involved, I would be concerned that we would see less and less price competition in the future and that would be a concern for employers," Mr. Dross said.

Factoring in pharmacy services offered by health plans, retailers and independent PBMs, there is "significant competition" in the market that should overcome any regulatory questions related to an Express Scripts/Caremark merger, said George Paz, president, chief executive offer and chairman of Express Scripts. "We feel confident we can pass those hurdles."

Employer concerns

Many employers are concerned about the potential for erosion in service delivery that arises from having a contract with a large PBM, and better pricing from a combined entity will not matter if the PBM fails to do a good job of delivering pharmacy services, Mr. Dross said.

An increasing number of employers may be open to a different business model than the one employed by the major PBMs, observers say.

"It's just safe to say there is some concern that employers feel PBMs may not be operating 100% in their best interests," Mr. Dross said.

Smaller PBMs are more willing to be transparent than the three big PBMs, observers say.

Innoviant Inc., a Wausau, Wis.-based PBM with nearly 1 million lives, provides employers with access to its drug manufacturer and pharmacy network contracts; explains how it makes decisions on which drugs to promote; and discloses savings from rebates, discounts or cost management programs. "Our model makes it easier for them to make those informed decisions," said Mark Campbell, president and CEO of Innoviant. "Transparency to us is a business philosophy, an open access policy."

Whether CVS will counter the Express Scripts offer remains uncertain. In a statement last week, CVS said it had not yet reviewed Express Scripts' proposal, but the organization believed the prospects for completing the merger were excellent.

Also last week, in separate statements by CVS and Caremark, the companies said a primary regulatory hurdle to their potential merger was removed when the initial waiting period required by the Hart-Scott-Rodino Act expired without the U.S. Federal Trade Commission seeking more information. Even so, shareholders still would have to give their approval.

Long-term impact

If Caremark were to accept the Express Scripts offer, the next question will be whether the cost would have any long-term impact on cash flow or return on investment for the merged PBM, Mr. Dross said.

The Caremark board also has to consider which offer has the potential to bring the most value to the marketplace and deliver more innovation or service delivery improvements. A possible disadvantage of an Express Scripts/Caremark union is that it may not feature the same innovation potential as a CVS/Caremark merger because of substantial overlap of products and services that Express Scripts and Caremark offer, benefit consultants say.

"I think the CVS/Caremark merger is a little bit more intriguing in that employers wouldn't really know what to expect because it would be a new type of arrangement, whereas Express Scripts/Caremark would just be more PBM consolidation," said Sean Brandle, a vp at The Segal Co. in New York.

The Caremark board, though, may be pressured to take Express Scripts' offer because the financial value offered is in the best interests of shareholders, Mr. Dross said.

The Express Scripts offer of $58.50 per share in cash and stock is a 15% premium over the all-stock purchase price to be paid to Caremark stockholders if acquired by CVS, Mr. Paz said during a conference call.

PBM rival Medco's reaction to an Express Scripts/Caremark merger is another uncertainty. A Medco spokeswoman declined comment on the possible merger, but said Medco "is confident in its business model."

"If I'm Medco, I'm just sitting tight right now because there's so much confusion," Mr. Brandle said. "Maybe they're in a good position to actively benefitÖfrom all this turmoil happening around their major competitors."