The Role of PBMs and Government Programs

Medicare

PBM executives, analysts, and employers agree that the Medicare Act of 2003 has dramatically increased the nature and intensity of the relationship between PBMs and government-sponsored pharmacy benefit programs. Medicare Part D, the prescription drug component of the Medicare act, which was approved in December 2003 and becomes effective January 1, 2006, creates significant issues for employers to examine as well. The current legislation is expressly written to encourage employers to continue to offer drug benefits to retirees.

In addition to tax savings, the Centers for Medicare and Medicaid Services (CMS) estimates that an average subsidy for employers who offer drug coverage to their retirees will be around $611 per retiree in 2006 costs. Medicare premiums are about $35/month and will be paid by either the employer or the beneficiary. According to Aon Consulting, employers have three primary options when it comes to Medicare Part D:

1. Do nothing and take the government subsidy.
2. "Wrap-around" Medicare which is how most post-65 medical plans currently coordinate Medicare "Part A" and "Part B".
3. Eliminate the Rx benefit and pay the Medicare "Part D" premium for the retiree.

Employers that opt to offer a drug plan will need to do much more than simply provide the benefit. There are a number of regulations and guidelines employers will have to meet. For example, employers must adhere to formulary guidelines developed by Medicare, offer access to certain drugs, ensure access to generics, and provide detailed reports on their programs to CMS. Employers that self-fund their retiree benefits are at risk not only for costs, but also for costs associated with overseeing the entire pharmacymanagement process and for potential challenges that may arise. Retirees can be a demanding group and when there are changes made to their benefit, they will voice their concerns and may fight those changes that affect their pocketbook or their coverage. To meet the demands and challenges of this population, employers will need to ensure utilization and costs are closely managed. They will also need to be more creative in their approaches to program development and benefit design.

Employers that work with PBMs experienced in formulary development, disease management, and member education will be much better able to implement creative programs that adhere to guidelines and minimize risk. For example, a good PBM or pharmacy benefit consultant will be able to sit down with an employer and target areas of weakness and need, such as where drugs are being used inappropriately or areas where there are significant outliers or disease states that affect a large population of retirees. The PBM can then develop targeted programs specifically for that population. This approach is critical for at-risk employees. It is especially important where there are large populations ofemployees with high cost, high impact diseases, such as diabetes, heart disease or cancer. Left unmanaged, such diseases will only escalate in severity and further increasethe cost of the pharmacy and medical benefits to plans and their members.

While the government seems to have high hopes for PBMs and the private sector to control costs, there are areas of concern. A few larger PBMs have come under investigation over the past few years for some of their business practices.

Recognizing that knowledge is power, employers and consultants have begun to more thoroughly study PBM business practices so that they can better ensure they are securing value for their benefit dollars. As consultants and employers become more knowledgeable and sophisticated regarding PBMs, there has been a clear market correction. They are requiring PBMs to more fully disclose information as part of the RFP process. They are asking questions about revenue sources, how income is reported, administration fees, and other pricing policies. As a result, employers have a much better idea of exactly how and where their PBM secures revenue. As a result of this knowledge, those PBMs that have consistently shown a commitment to openness with their customers and that have not been subjected to lawsuits are securing business; those who are less transparent are finding it increasingly more challenging to secure new business.

The market correction the industry has spearheaded on its own accord has led the government to have further confidence in the ability of PBMs and private industry to help control costs. In a recent report from the Federal Trade Commission and Department of Justice, the government stated that when PBMs are allowed to operate in a competitive marketplace, and to use principles such as closed networks and mail service, they could play a significant role in helping plan sponsors manage costs.

Drug Reimportation

One of the most hotly contested topics over the past few years has been the issue of reimportation of drugs from countries where they are less expensive. Several states, including Massachusetts, Illinois, Minnesota, Rhode Island, and Wisconsin have begun to import drugs from other countries, most notably Canada, in addition to Australia and Europe.

Congress has clearly noted the demand for lower cost drugs and therefore several bills have been introduced to allow reimportation. Political analysts believe that strong public sentiment may force Congress to allow some level of drug reimportation. Not surprisingly, pharmaceutical manufacturers are fighting any efforts to allow reimportation, pointing out that current pricing allows companies to invest in research to create new drugs.

Many employers, unions, and health plans have explored reimbursement for foreign prescriptions as a component of cost reduction. While reimbursing health plan members for prescriptions filled while traveling is commonplace, extending payment to foreign source drugs ordered by the member has significant risk. The plan may assume significant liability if their member is harmed by a drug from an illegal distribution system which the plan has endorsed.

While some states view reimportation as a solution to higher drug costs, there are concerns that must be closely examined. For example, current payer reimbursement strategies are based on the average wholesale prices (AWP) of distributed prescription drugs and their corresponding National Drug Code (NDC) numbers. Imported drugs may not have an NDC code, or the NDC code may not be recognized by the established U.S. data companies. If an NDC is not recognized by the adjudication system, that prescription drug claim will be rejected by most of the U.S.-based reimbursement systems.

Reimportation may also pose some challenges for the Medicare system. The government will have to decide whether to credit drugs reim-ported from other nations as part of theout-of-pocket amount for purposes of calculating the beneficiary drug coverage. Lastly, the primary concern related to drug reimportation is safety. The FDA has reported numerous instances of tainted and even counterfeit drugs, primarily those purchased from unlicensed Web-sites located outside of the United States. However, there clearly remain safe sources of medications and unless American consumers and state and city governments experience significant and potentially life-threatening events due to reimportation, they will continue to view it as a viable alternative. Until legislation is passed, employers or states considering reimportation would be well served to work within existing legal channels.

Mandated Benefits

State governments, often using Federal guidelines and rulings, and supported by the courts, have become increasingly involved in mandating benefit coverages. Mandatedbenefits take the decision-making process out of the hands of the PBM and payer and place it into the hands of elected officials who may or may not have a strong grasp of theimplications of their actions.

One of the more common mandated benefits involves contraceptives. Plan sponsors and employers that offer drug therapies for male sexual dysfunction may be challenged with legislative mandates that require parity by providing contraceptives to female members. Special interest groups are also influencing coverage for other therapeutic categories including AIDS and antipsychotics. For example, groups representing the mentally ill have successfully lobbied in many states to ensure coverage of drugs for depression. Still other states are requiring that plans that cover diabetes medications, must also cover supplies. California has mandated that all drugs for chronic or debilitating illnesses (which in theory could include virtually any disease or illness) be covered. The result is a patchwork of laws that make it difficult for multistate employers to develop effective and compliant pharmacy benefit programs.

Desiring greater autonomy over how their money is spent, some employers have chosen to carve-out their pharmacy benefit. In effect, this creates a self-funded benefit. Thepharmacy benefit is then regulated by the Employee Retirement Income Security Act (ERISA), which provides greater freedom and flexibility by allowing employers to cover medications they deem necessary and appropriate for their employees and beneficiaries.

While there are benefits to self-funding the pharmacy benefit, there are some issues to examine—most of which can be readily addressed through an experienced PBM. For example, it may be difficult to integrate pharmacy programs with the medical benefit if they are administered by separate companies and if the PBM does not have experience in working with health plans and with data collection and analysis. If the employer group does not have ready access to the medical data, that too can present challenges. A number of PBMs have experience in working with employers and their medical plans to obtain and integrate data, however. Therefore if an employer wants to pursue that option, it should proceed.

Mail Service

Over the past decade, states and the federal government have been asked by retail pharmacy organizations to examine PBMs use of mail service. One of the arguments made by retail pharmacy is that when PBMs are allowed to provide a 90-day supply of drugs for 30-day copay, it gives the PBM an unfair pricing advantage.

The Pharmaceutical Care Management Association (PCMA) estimates that mail service discounts are 11 percent deeper than discounts on retail drugs and that currently mail service spending represents 16 percent of total prescription drug spending. That figure is expected to increase to 20 percent in 2014, representing millions of dollars in potential savings for plan sponsors. Conversely, PCMA estimates that provisions to increase regulations and limit mail service practices would increase costs by $97 billion between 2005 and 2014. This increase in costs would likely lead to hundreds of thousands of individuals losing prescription drug coverage.

Recent efforts to limit mail service appear to be failing in many areas. For example, in Michigan in 2004, the once widely touted Michigan's Consumer Prescription Protection Act failed after analysis from employers indicated that the law would increase costs to consumers significantly.

Employers should recognize that mail service should be more than a cost-saving strategy or prescription delivery mechanism. Through education programs such as refill reminders, information on the importance of persistency and compliance programs, as well as newsletters and brochures with articles regarding commonly asked questions about popular drugs, mail service has the potential to insure both the plan sponsor and plan member will secure maximum value from the pharmacy benefit.

Medicaid

While mail service has been an active area for government involvement for several years, clearly the area where government and PBMs have the most interaction is with Medicaid and Medicare. It is estimated that Medicaid programs will see the most significant increase in prescription drug expenditures over the next decade. CMS projects that, by 2011, Medicaid will be paying for almost 20 percent of all U.S. prescriptions. To help manage these costs, many states are turning to PBMs.

There are considerable implications for employers as Medicaid coverage grows. Employers can learn valuable lessons from the research conducted and programs implemented by state Medicaid programs. According to a 2004 study by Atlantic Information Services, a leading publisher of healthcare data, managed care PBMs could save some states up to 50 percent in Medicaid costs through strategies such as pharmacy networks, closed formularies and prior authorization.

Before implementation, Medicaid programs are subject to intense scrutiny. In particular, states are spending considerable resources to ensure that formularies, prior authorization and disease management programs provide adequate and fair coverage. Employers seeking new ways to manage costs might consider some of the tactics approved by state Medicaid programs as applicable to their own pharmacy benefit.

GOVERNMENT REGULATION OF QUALIFIED PLANS

Qualified retirement plan receives special federal tax benefits in return for being designed in accordance with rules imposed by the federal government.We will discuss how the federal government imposes these rules. The federal rules are the most important because federal law generally preempts state and local laws in the qualified plan area.

Benefit planners need a basic understanding of the federal regulatory scheme. Planners must often interpret the significance of various official rules and interact with government organizations. These government rules and organizations must be understood in order to be effective in plan design and management.

Government regulation is expressed through the following, in the order of their importance: (1) statutory law, (2) the law as expressed in court cases, (3) regulations of government agencies, and (4) rulings and other information issued by government agencies.

Statutory Law

Theoretically, the highest level of regulatory law is the U.S. Constitution because all regulation must meet constitutional requirements, such as due process of law and equal protection for persons under the law. However, relatively few issues of federal regulation are actually resolved under constitutional law. For practical purposes, the "law" as expressed by statutes passed by the U.S. Congress is the highest level of authority and is the basis of all regulation; court cases, rulings, and regulations are simply interpretations of statutes passed by Congress. If the statute was detailed enough to cover every possible case, there theoretically wouldn't be any need for anything else. But despite the best efforts of Congressional drafting staffs, the statutes can't cover every situation.

Benefit planners should become as familiar as possible with statutory law because it is the basis for all other rules, regulations, and court cases. One of the main causes for confusion among nonexperts is a lack of understanding of the relative status of sources of information. That is, while a rule found in the Internal Revenue Code is fundamental, a statement in an IRS ruling or instructions to IRS forms may be merely a matter of interpretation that is relatively easy to "plan around."

In the benefits area, the sources of statutory law are:

• Internal Revenue Code (the Code). The tax laws governing the deductibility and taxation of pension and employee benefit programs are fundamental. These are found primarily in Sections 401–425, with important provisions also in Sections 72, 83, and other sections.

• ERISA (Employee Retirement Income Security Act of 1974), as amended, and other labor law provisions. Labor law provisions such as ERISA govern the nontax aspects of federal regulation. These involve plan participation requirements, notice to participants, reporting to the federal government, and a variety of rules designed to safeguard any funds that are set aside to pay benefits in the future. There is some overlap between ERISA and the Code in the area of plan participation, vesting, and prohibited transactions.

• Pension Benefit Guaranty Corporation (PBGC). The PBGC is a government corporation set up under ERISA in 1974 to provide termination insurance for participants in qualified defined-benefit plans up to certain limits. In carrying out this responsibility, the PBGC regulates plan terminations and imposes certain reporting requirements on covered plans that are in financial difficulty or in a state of contraction.

• Securities laws. The federal securities laws are designed to protect investors. Benefit plans may involve an element of investing the employees' money. While qualified plans are generally exempt from the full impact of the securities laws, if the plan holds employer stock, a federal registration statement may be required and certain securities regulations may apply.

• Civil rights laws. Benefit plans are part of an employer's compensation policies; these plans are subject to the Civil Rights Act of 1964, which prohibits employment discrimination on the basis of race, religion, sex, or national origin.

• Age discrimination. The Age Discrimination Act of 1978, as amended, has specific provisions aimed at benefit plans.

• State legislation. ERISA contains a broad "preemption" provision under which any state law in conflict with ERISA is preempted—has no effect. If ERISA does not deal with a particular issue, however, there may be room for state legislation. For example, there is considerable state legislation and regulation governing the types of group term life insurance contracts that can be offered as part of an employer plan. There are also certain areas where states continue to assert authority even though ERISA also has an impact, as in the area of creditors' rights to pension fund assets.

Court Cases

The courts enter the picture when a taxpayer decides to appeal a tax assessment made by the IRS. The courts don't act on their own to resolve tax or other legal issues. Consequently, the law as expressed in court cases is a crazy-quilt affair that offers some answers but often raises more questions than it answers. However, after statutes, court cases are the most authoritative source of law. Courts can and do overturn regulations and rulings of the IRS and other regulatory agencies.

A taxpayer wishing to contest a tax assessment has three choices: (1) the Federal District Court in the taxpayer's district, (2) the United States Tax Court, or (3) the United States Claims Court. Tax law can be found in the decisions of any of these three courts.

All three courts are equally authoritative. Most tax cases, however, are resolved by the U.S. Tax Court, because it offers a powerful advantage: The taxpayer can bring the case before the Tax Court without paying the disputed tax. All the other courts require payment of the tax followed by a suit for refund.

Decisions of these three courts can be appealed to the Federal Court of Appeals for the applicable federal "judicial circuit"—the U.S. is divided into 11 judicial circuits. The circuit courts sometimes differ on certain points of tax law; as a result, tax and benefit planning may depend on what judicial circuit the taxpayer is located in. Where these differences exist, one or more taxpayers will eventually appeal a decision by the Court of Appeals to the United States Supreme Court to resolve differences of interpretation among various judicial circuits, but this process takes many years and the Supreme Court may ultimately choose not to hear the case. Congress also sometimes amends the Code or other statute to resolve these interpretive differences.

Regulations

Regulations are interpretations of statutory law that are published by a government agency; in the benefits area, the most significant regulations are published by the Treasury Department (the parent of the IRS), the Labor Department, and the PBGC.

Regulations are structured as abstract rules, like the statutory law itself. They are not related to a particular factual situation, although they often contain useful examples that illustrate the application of the rules. Currently, Treasury regulations are often issued in question-and-answer form.

The numbering system for regulations is supposed to make them more accessible by including an internal reference to the underlying statutory provision. For example, Treasury Regulation Section 1.401(k)-2 is a regulation relating to Section 401(k) of the Internal Revenue Code. Labor Regulation Section 2550.408b-3 relates to Section 408b of ERISA.

Issuance of regulations follows a prescribed procedure involving an initial issuance of proposed regulations followed by hearings and public comment, then final regulations. The process often takes years. Where taxpayers have an urgent need to know answers, the agency may issue temporary regulations instead of proposed regulations. Technically, temporary regulations are binding, while proposed regulations are not. However, if a taxpayer takes a position contrary to a proposed regulation, the taxpayer is taking the risk that the regulation will ultimately be finalized and be enforced against him.

Rulings and Other Information

IRS Rulings

IRS rulings are responses by the IRS to requests by taxpayers to interpret the law in light of their particular fact situations. A General Counsel Memorandum (GCM) is similar to a ruling, except that the request for clarification and guidance is initiated from an IRS agent in the field during a taxpayer audit, rather than directly from the taxpayer.

There are two types of IRS rulings—Revenue Rulings, which are published by the IRS as general guidance to all taxpayers, and Private Letter Rulings (PLRs), which are addressed only to the specific taxpayers who requested the rulings. The IRS publishes its Revenue Rulings in IRS Bulletins (collected in Cumulative Bulletins [CB] each year). Revenue rulings are binding on IRS personnel on the issues covered in them, but often IRS agents will try to make a distinction between a taxpayer's factual situation and a similar one covered in a ruling if the ruling appears to favor the taxpayer.

PLRs are not published by the IRS, but are available to the public with taxpayer identification deleted. These "anonymous" PLRs are published for tax professionals by various private publishers. They are not binding interpretations of tax law except for the taxpayer who requested the ruling, and even then they apply only to the exact situation described in the ruling request and do not apply to even a slightly different fact pattern involving the same taxpayer. Nevertheless. PLRs are very important in research because they are often the only source of information about the IRS position on various issues.

Other Rulings

The Department of Labor and the PBGC issue some rulings in areas of employee benefit regulation under their jurisdiction. DOL rulings include the Prohibited Transaction Exemption (PTEs) which rule on types of transactions that can avoid the prohibited transaction penalties—for example, sale of life insurance contracts to qualified plans.

Other Information

Because of frequent changes in the tax law, the IRS has been unable to promulgate regulations and rulings on a timely basis, and has increasingly used less formal approaches to inform taxpayers of its position. These include various types of published Notices and even speeches by IRS personnel. Finally, many important IRS positions are found only in IRS Publications (pamphlets available free to taxpayers) and instructions for filling out IRS forms. The IRS also maintains telephone question-answering services, but the value of these for information on complicated issues is minimal.

THE GOVERNMENT'S ROLE—PENSION POLICY ISSUES

Management objectives are one major factor in pension design; the other is the government regulatory structure. This section discusses the development of the government's role in this area.

Most employees covered under an employer-sponsored retirement plan are covered under what is known as a qualified retirement plan. A qualified plan is one that receives certain valuable federal tax benefits, but its design, funding, and administration must meet an extraordinarily complex set of federal statutory and regulatory requirements. Most federal regulation in this area specifically preempts state and local regulation. The tax benefits from such plans to both employer and employee are generally (though not always) adequate to justify the inconvenience of this severe regulatory regime. A nonqualified plan is any other retirement or deferred compensation plan. Nonqualified plans are subject to much simpler federal regulation, along with less favorable tax treatment. Nonqualified plans are used primarily for executive compensation arrangements that replace or supplement qualified plan coverage for a selected group of highly compensated executives.

The government's role in the retirement income area has been dictated primarily by historical factors. Beginning in the late 19th century, the economy of the United States changed fairly rapidly from predominantly agricultural to predominantly industrial and service oriented. Coinciding with this change—and probably in response to it—the large, supportive extended family of the agricultural economy was largely replaced by smaller, more fragmented family units. The shift away from agriculture reduced the amount of economically useful work available to older people, and family structural changes reduced the amount of family support for the aged.

Because of these economic and social trends, people generally must make specific plans for their retirement. This is a difficult matter for most individual employees to do alone and, consequently, employer-sponsored pension plans have become increasingly important.

In the 20th century, federal government involvement in retirement plans for the aged also greatly expanded. The federal government's involvement is twofold. For most people, the most obvious federal government program in this area is the Social Security system adopted in the 1930s to provide direct benefit payments to the aged. But even before the Social Security system was adopted, the federal government became involved in a more traditional way by measures designed to encourage the private pension system.

Governments tend to be reluctant to adopt direct payment arrangements for dependent individuals, particularly in the United States—a reflection of the generally conservative social values of the American public. Historically, governments have tended to look first at private organizations to act in this area. This is one reason why charitable institutions, such as orphanages and hospitals, have for centuries been granted various forms of tax exemption.

In the tradition of encouraging private initiatives, in the 1920s the federal government began encouraging private, employer-sponsored retirement plans by providing two kinds of tax benefits. First, pension funds were made tax exempt under the Revenue Acts of 1921 and 1926. Then, in the Revenue Act of 1928, employer contributions to plan funds were made currently deductible by the employer, even though benefits were not paid to employees until later years. These basic provisions still apply and form the basis for today's vast federal regulatory scheme for qualified plans.

The embryonic private pension system of the 1920s declined significantly during the depression of the 1930s. This was one reason for the adoption of the Social Security system. However, since the 1940s, private pension plans have revived to an enormous degree. Assets in private pension plans now amount to more than three trillion dollars, which constitutes a very substantial portion of the nation's entire capital.

Because of the large sums involved, any tax benefits provided to qualified plans cost the government a great deal in lost tax revenues; the government estimate is well over $75 billion annually. This large "tax expenditure" is often given as a primary justification for the exhaustive scheme of government regulation that now applies to qualified pension plans. Fundamentally, the argument is that the large tax expenditure is designed to help prevent individuals from becoming dependent on the government in retirement. Consequently, the government attempts to make sure that plan benefits go where they are most needed so that this tax expenditure is cost effective. Much pension regulation is aimed at discouraging plans that primarily benefit highly-compensated employees who have other sources of retirement income. Other rules are intended to assure that the large sums set aside for plan benefits are managed in the exclusive interest of plan participants and beneficiaries.

In practice, the government frequently adopts new or modified statutes and regulations relating to pensions without clear or articulated long-range policy objectives. The absence of a coherent federal retirement policy is currently a critical federal policy issue. Current issues in pension regulation include those covered in the following sections.

Tax Revenue Loss

At times, revenue-raising needs outweigh retirement policy issues in Congress. The tax benefits for qualified plans cause a substantial apparent decrease in tax revenues. The criticism is also frequently made that too much of the tax benefit goes to high-income individuals who don't need government help. Whatever the merits of this argument, it is indisputable that "fine tuning" the rules to reduce tax benefits for certain plan participants can increase tax revenues in the short run, without the political pain of visibly "raising taxes." The need to raise revenue has motivated many recent changes in the qualified plan law, and it probably will be a factor in future legislation. Changes of this type are often enormously complex as a result of the need to carefully target the group whose benefits are to be reduced, typically the owner-employees of closely held businesses. Revenue-motivated changes are often criticized as resulting in bad retirement policy.

Discrimination in Favor of Highly Compensated Employees

Although a major thrust of virtually all qualified plan legislation since the 1940s has been to discourage employers from discriminating in their plans in favor of highly compensated employees, a considerable amount of such discrimination is still possible, as discussed throughout this text. Because of this, much qualified plan legislation has been designed to reduce the "tax shelter" aspects of qualified plans, particularly those for smaller businesses whose owner-employees receive substantial benefits. Many of the most complex and awkward provisions of the law, such as the top-heavy rules, were designed in this vein.

Seemingly, it would be easy to eliminate the discrimination problem by simple, appropriate benefit or contribution limits. However there is a counter-vailing policy consideration. Small businesses, collectively, employ a large and increasing segment of the work force. Owners of these businesses may not be interested in maintaining a qualified plan for their employees unless the plan provides substantial, and possibly disproportionate, benefits for the owners themselves. This policy issue, therefore, involves tension between tax-benefit equity and efficiency on the one hand, and the need to encourage small business retirement plans on the other. No simple resolution of this is likely in the near future, and complex legislative compromises on this issue will probably continue to emerge from Congress.

Encouraging Private Saving

Surprisingly, in view of the trillions invested in pension plans, relatively little policy emphasis has been given to the role of the qualified plan rules in encouraging private savings. One problem is that policy makers agree neither on the appropriate level for private savings nor on whether government policy should encourage savings rather than allowing the free market to set the level. Another factor is that economists are divided about the efficacy of the qualified plan provisions in encouraging savings. Some economists argue that these plans merely displace private saving that would take place in any event. Nevertheless, the savings issue is an ongoing factor in the policy debate.

Interest-Group Pressures

As the foregoing discussion indicates, retirement policy poses difficult problems even if viewed from a neutral intellectual viewpoint. The actual political climate, of course, is not neutral. The qualified plan business is large and involves many firms and individuals. Most of these organizations eagerly and frequently convey their views to Congress in great technical detail. This complicates the resolution of issues and makes change more difficult.

Mandatory Retirement Plan Coverage

A presidential commission formed in the late 1970s to study pension policy recommended the establishment of a Minimum Universal Pension System (MUPS) for all workers, to be funded by employers at an initial rate of at least 3 percent of payroll. The MUPS benefit would be completely portable from job to job. In general, the MUPS approach is not popular with employers and benefit plan designers, who prefer the flexibility of current rules; at the present time, Congress is not considering it seriously.

Age and Sex Discrimination

Age and sex discrimination have not been addressed by Congress specifically as retirement plan issues. However, recent federal legislative and regulatory activity related to employment discrimination in general has affected retirement plans