FTC Staff Comment to the Hon. Nelie Pou Concerning New Jersey A.B. A-310 to Regulate Contractual Relationships Between Pharmacy Benefit Managers and Health Benefit Plans

UNITED STATES OF AMERICA
FEDERAL TRADE COMMISSION
WASHINGTON, D.C. 20580
Office of Policy Planning
Bureau of Economics
Bureau of Competition
April 17, 2007
Nellie Pou thP	
Assemblywoman, 35P District
Chair, Appropriations Committee
New Jersey General Assembly
100 Hamilton Plaza, Suite 1405
Patterson, NJ 07505
Dear Assemblywoman Pou:
The staffs of the Federal Trade Commission=s Office of Policy Planning, Bureau
of Competition, and Bureau of EconomicsTPF
1 are pleased to respond to your request for	FP T
comments on the likely competitive effects of the Assembly Committee Substitute for
Assembly No. 320 (“A-320” or “the Bill”), which would regulate the contractual
relationships between pharmacy benefit managers (“PBMs”) and health benefit plans
(“HBPs”). You asked the FTC to “examine A-320 to determine whether the proposed
legislation is anti-competitive and will likely result in “increased costs of pharmaceutical
care for employers, unions, and consumers.”TPF
2FP T
We believe that A-320, if enacted, will limit the ability of PBMs, HBPs, and
pharmacies to enter into efficient, mutually advantageous contracts, and may increase
pharmaceuticals prices in New Jersey. Ultimately, the restrictions may decrease the
number of New Jersey consumers with insurance coverage for pharmaceuticals, without
producing offsetting benefits. Although some lawsuits have have challenged particular
types of PBM conduct,TPF
3 empirical evidence suggests that the conflicts of interest that the	FP T
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This letter expresses the views of the Federal Trade Commission’s Office of Policy Planning, Bureau of
Competition, and Bureau of Economics. The letter does not necessarily represent the views of the Federal
Trade Commission (Commission) or of any individual Commissioner. The Commission has, however,
voted to authorize us to submit these comments.
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Letter from New Jersey Assemblywoman Nellie Pou to Maureen Ohlhausen, Director, Office of Policy
Planning, Federal Trade Commission (Aug. 9, 2006).
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See, e.g., United States v. Merck-Medco Managed Care, L.L.C., Case No. 00-CV-737 (E.D. Penn. Dec. 9,
2003); In re Pharmaceutical Industry Wholesale Price Litig., MDL No. 1456, Civ. Act. No. 01-cv-12257-
PBS (D. Mass. 2002); Ohio v. Medco Health Solutions, Inc. (Dec. 22, 2003). Some complaints allege that
failure to disclose or remit rebates either breached a contractual requirement or breached an asserted duty to
disclose or remit rebates under some other existing law. See, e.g., AFSCME v. AdvancePCS, Case No. BC
29227 (Super. Ct. Cal. Mar. 18, 2003); New York v. Express Scripts, Inc. (N.Y. Sup. Ct. Aug. 4, 2002).

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Bill attempts to address are not prevalent. To the contrary, the Commission’s recent
study of the PBM industry suggests that HBPs can, and do, protect themselves from
potential conflicts of interest in arms-length contracts with PBMs.TPF
4FPT
Interest and Experience of the Federal Trade Commission
Congress has charged the Federal Trade Commission (“FTC” or “Commission”)
with preventing unfair methods of competition and unfair or deceptive acts or practices in
or affecting commerce.TPF
5 Pursuant to its statutory mandate, the FTC seeks to identify	FP T
business practices and regulations that impede competition without offering
countervailing benefits to consumers. For several decades, the FTC and its staff have
investigated the competitive effects of restrictions on the business practices of health care
providers.TPF
6 The FTC and its staff have issued reports and studies regarding various	FPT
aspects of the pharmaceuticals industry,TPF
7 and the FTC has brought numerous	FP T
enforcement actions against entities in that industry.TPF
8FP T
In particular, the FTC has extensive recent experience with PBMs. The FTC and
the Department of Justice Antitrust Division (“DOJ”) considered diverse competition and
consumer protection issues raised by health care markets in joint hearings conducted over
the course of twenty-seven days in 2003 (“Health Care Hearings”). Given the concerns
regarding PBM activities reflected in then-pending lawsuits, PBM practices, in particular,
were a focus of those hearings.TPF
9 In 2004, the FTC and DOJ issued a report based on the	FP T
Because these duties to disclose or remit rebates allegedly arise under existing legal obligations, it is
unclear how A-320’s additional legal requirements that, e.g., PBMs disclose sensitive financial information
to various parties, serve as fiduciaries of HBPs, and limit therapeutic interchange and mail-order usage, are
likely to serve as direct or effective means of improving compliance with the existing obligations that have
been subject to legal controversy.
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See generally Federal Trade Commission, PHARMACY BENEFIT MANAGERS : O WNERSHIP OF MAIL-O RDER
P HARMACIES (Aug. 2005) (“PBM S TUDY”), available at
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http://www.ftc.gov/reports/pharmbenefit05/050906pharmbenefitrpt.pdfUTH.
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5 Federal Trade Commission Act, 15 U.S.C. ' 45.
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See Federal Trade Commission, FTC Antitrust Actions in Health Care Services and Products (Oct. 2003),
available at H T T T U http://www.ftc.gov/bc/hcupdate031024.pdfUTTHU.U T
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See Federal Trade Commission, G ENERIC D RUG ENTRY P RIOR TO P ATENT EXPIRATION (July 2002);
D AVID R EIFFEN AND MICHAEL R. W ARD, GENERIC D RUG I NDUSTRY D YNAMICS , Federal Trade
Commission Bureau of Economics Working Paper No. 248 (Feb. 2002), available at
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http://www.ftc.gov/be/econwork.htmUTH; ROY L EVY, THE P HARMACEUTICAL I NDUSTRY : COMPETITIVE AND
A NTITRUST I SSUES IN A N ENVIRONMENT OF CHANGE, Federal Trade Commission Bureau of Economics
Staff Report (Mar. 1999), available at H T U http://www.ftc.gov/reports/pharmaceutical/drugrep.pdfU T H .
8
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See Federal Trade Commission, FTC Antitrust Actions in Pharmaceutical Services and Products (Oct.
2005), available at H T T T U http://www.ftc.gov/bc/0310rxupdate.pdfUTTHU. U T
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See Hearings on Health Care and Competition Law and Policy, June 26, 2003, available at
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http://www.ftc.gov/ogc/healthcarehearings/030626ftctrans.pdfUTH. (“Health Care Hearings”) See also
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http://www.ftc.gov/ogc/healthcarehearings/03062526agenda.htmUTH. Subsequent references to the hearings
will identify a panelist, affiliation, and transcript page. Affiliations are as of the date of the hearing.

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hearings, a 2002 the FTC-sponsored workshop, and independent research.TPF
10 Also in	FP T
2004, FTC staff commented on proposed PBM legislation in several states, including
North DakotaT P F
11 and California,TPF
12 and the FTC investigated the competitive implications	FP T FP T
of a proposed merger between two PBMs, Caremark and AdvancePCS.TPF
13 In response to	FPT
a request from Congress in 2003, the FTC undertook a substantial “Conflict of Interest
Study” regarding PBM practices.TPF
14 In the course of that study, the FTC analyzed data on	FP T
PBM pricing, generic substitution, therapeutic interchange, and repackaging practices,
and examined whether PBM ownership of mail-order pharmacies served to maximize
competition and lower prescription drug prices for plan sponsors.TPF
15 In its 2005 report	FPT
based on the study (“PBM Study”), the FTC found, among other things, that competition
affords HBPs substantial tools with which to safeguard their interests.TPF
16 Most recently,	FP T
the FTC staff commented on proposed Virginia legislation that would have restricted
PBM contracts and drug substitution practices, while requiring disclosures to HBPs,
consumers, and physicians.T P F
17FP T
Likely Effects of A-320
Several provisions of A-320 regulate relationships between PBMs and HBPs, in
ways that are likely to have an adverse effect on the prices that HBPs, and ultimately
New Jersey consumers, pay for pharmaceuticals.
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Fiduciary Duties
A-320 would make a PBM a fiduciary of any HBP with which it contracts.TPF
18 In	FP T
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See Federal Trade Commission and Department of Justice, IMPROVING H EALTH C ARE: A D OSE OF
COMPETITION (2004), available at H T U http://www.ftc.gov/reports/healthcare/040723healthcarerpt.pdfU T H (Chapter
7, especially, “Industry Snapshot and Competition Law: Pharmaceuticals”).
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Letter from FTC staff to North Dakota State Senator Richard Brown (Mar. 8, 2005), available at
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http://www.ftc.gov/os/2005/03/050311northdakotacomnts.pdfUTH.
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Letter from FTC staff to Rep. Greg Aghazarian (Sept. 7, 2004), available at
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http://www.ftc.gov/be/V040027.pdfUTH.
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Statement of the Federal Trade Commission, In re Caremark Rx, Inc./AdvancePCS, File No. 0310239
(Feb. 11, 2004), available at H T U http://www.ftc.gov/os/caselist/0310239/040211ftcstatement0310239.pdfU T H . The
Commission closed the investigation because it concluded that the transaction was unlikely to reduce
competition.
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See Medicare Prescription Drug, Improvement, and Modernization Act of 2003, Pub. L. No. 108-173, tit.
I, § 110, 117 Stat. 2066, 2174 (2003) (codified at 42 U.S.C. § 1395w-101 (Historical and Statutory Note)).
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See PBM S TUDY, supra note 3, at i-iii.
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See id., at 55 (noting diverse audit rights and reporting under PBM contracts).
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Letter from FTC staff to Virginia Delegate Terry G. Kilgore (Oct. 2, 2006), available at
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http://www.ftc.gov/be/V060018.pdfUTH.
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See A-320 at § 7. The obligation pertains to all PBMs that are not merely providing services for
themselves or their affiliates. Risks, contract restrictions, and administrative costs that are imposed
differently on insurer-affiliated and independent PBMs may raise competition concerns within the PBM
industry. See text accompanying note 19, infra.

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that regard, the stipulation that a PBM “shall have all responsibility attendant to a
fiduciary as established by law,”T P F
19 may implicate a broad set of common law fiduciary	FP T
obligations beyond those contemplated in contracts for PBM services. In addition, the
imposition of fiduciary duties may conflict with or complicate express contractual or
statutory duties that, otherwise, are relatively straightforward. In doing so, the fiduciary
provision imposes additional litigation risks that may be costly ones, and further limits
the abilities of HBPs and PBMs to design and implement certain cost-saving practices for
distributing pharmaceuticals. Moreover, by imposing liability risks and related fiduciary
costs on independent PBMs that are not imposed on insurer-affiliated PBMs, the Bill
confers a competitive advantage on integrated HBP/PBM organizations. This may distort
present competition in the PBM industry and may, in turn, raise costs by encouraging
vertical integration – new or sustained HBP/PBM affiliations – to an extent that would
not be cost-effective, but for the regulation.TPF
20 This section briefly sketches the general	FP T
obligations of a fiduciary, and identifies some of the potential effects of imposing such
obligations on PBMs.
A fiduciary is required “to act primarily for the benefit of another in matters
connected with his undertaking.”TPF
21 As its fiduciary, a PBM would owe an HBP duties of	FP T
service, obedience and loyalty.TPF
22 Under the duty of loyalty, a fiduciary “acts on behalf of	FP T
the principal and only for his benefit”;TPF
23 among the duties of service is a duty of care and	FPT
skill, under which a fiduciary must “act with a standard of care and with all the care
which is standard in the locality for the kind of work for which he is employed.”TPF
24 In	FP T
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Id.
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A PBM that is an affiliate of a carrier, and “provides [PBM] services solely to that carrier,” is exempted
from the fiduciary duty requirement. A-320 at § 7. The three largest PBMs are independent. At the time
of the PBM S TUDY, insurer-owned or affiliated PBMs accounted for approximately 40% of covered
persons in the U.S., although not all of these PBMs provided benefits solely to the carrier’s beneficiaries.
See PBM S TUDY at 3.
21
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RESTATEMENT (S ECOND ) OF A GENCY § 13, comment a. See also In re Estate of Vayda, 875 A.2d 925,
929 (N.J. 2004) (discussing relative duties of loyalty and care for attorneys as fiduciaries) (citing H T Packard-
Bamberger & Co. v. Collier, 771 A.2d 1194 (N.J. 2001)TH); President v. Jenkins, 814 A.2d 1173, 1185 (N.J.
Super. App. Div. 2003) aff'd in part, rev'd in part on different grounds, 180 N.J. 550, 853 A.2d 247 (2004)
(discussing fiduciary duty of care owed to insureds).
22
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See RESTATEMENT (S ECOND ) OF A GENCY §§ 377-386 (regarding duties of care and obedience) and §§
387-395 (duties of loyalty); J. Dennis Hynes, Freedom of Contract, Fiduciary Duties, and Partnerships:
The Bargain Principle and the Law of Agency, 54 W ASH . & LEE L. REV. 439, 443 (1997).
23
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RESTATEMENT (S ECOND ) OF A GENCY § 387, comment a; Carluccio v. 607 Hudson St., 57 A.2d 452, 453
(N.J. 1948) (duty of “absolute loyalty” to principal); Melveney v. McCrane, 351 A.2d 385, 387 (N.J. Super.
Ct. App. Div. 1976) (as fiduciary, broker “required to exercise fidelity, good faith, and primary devotion to
the interests of his principal.”). Quoting Justice Cardozo, the New Jersey court has explained that, "[m]any
forms of conduct permissible in a workaday world for those acting at arm's length are forbidden to those
bound by fiduciary ties … Uncompromising rigidity has been the attitude of courts of equity when
petitioned to undermine the rule of undivided loyalty by the 'disintegrating erosion' of particular exceptions.
Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the
crowd.” Carluccio, 57 A.2d at 454 (quoting Meinhard v. Salmon, 249 N.Y. 458, 464 (N.Y. 1928)).
24
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RESTATEMENT (S ECOND ) OF A GENCY §379(1); President, 814 A.2d at 1185 (fiduciary duty of care is
“degree of knowledge and skill requisite to the calling”) (quoting Carter Lincoln-Mercury, Inc. v. EMAR
Group, Inc., 638 A.2d 1288, 1288 (N.J. 1994)).

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particular, a fiduciary may owe its principal a “duty to give information” that is
independent of any express disclosure requirements that may be imposed under contract
or statute,TPF
25 as well as a “duty to account for profits” that may require the pass-through of	FP T
payments to the principal.T P F
26 Moreover, although a fiduciary relationship generally may	FPT
be defined by the terms of a contract between the fiduciary and its principal, “even
specific agreements … must be interpreted in the light of the principles which are
applicable to the relation of principal and agent.”TPF
27FPT
In general, fiduciary duties exist in situations where contracting to address
potential conflicts of interest may be prohibitively expensive, often because one party has
superior information about the true nature of his or her performance.TPF
28 In such cases,	FPT
fiduciary duties can ameliorate potential market failures by providing some protection
against opportunistic behavior. As we found in the PBM Study, however, HBPs tend to
be sophisticated repeat purchasers of PBM services. HBPs – often employing consultants
– negotiate contracts through an iterated competitive bidding process that addresses both
price and non-price dimensions of service.TPF
29 Through that process, HBPs appear able to	FPT
avoid potential conflicts of interest with PBMs.TPF
30 For example, HBPs negotiate the pass-	FPT
through of pharmaceutical payments, audit rights, and protections against cost-increasing
therapeutic interchange.TPF
31 Thus, A-320’s imposition of extra-contractual fiduciary duties	FPT
on PBMs appears unwarranted.
Under a mandatory fiduciary duty, future PBM/HBP contracts might need to
account for several categories of new costs. Among them is an increased risk of legal
liability for PBM services. For example, A-320 would provide an HBP the right to bring
a tort action against a PBM for breach of fiduciary duty, in addition to any liability claims
25
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A-320 expressly imposes certain disclosure requirements independent of any general disclosure
obligations that may be found under agency principles. See text accompanying notes 52-53, infra
(disclosure requirements for substitutions) and text accompanying notes 63-71, infra (disclosures of
financial information).
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See RESTATEMENT (S ECOND ) OF A GENCY §§ 381 (duty to give information) and 388 (duty to account for
profits arising out of employment, subject to contract, general duty to convey profits to principal). With
regard to disclosure, “contracts or transactions which in their essential nature are ‘intrinsically fiduciary’
and ‘necessarily call [] for perfect good faith and full disclosure without regard to any particular intention
of the parties.” United Jersey Bank v. Kensey, 704 A.2d 38, 44 (N.J. Super. Ct. App. Div. 1997) (quoting
Berman v. Gurwicz, 458 A.2d 1311 (N.J. Ch. Div. 1981) aff’d).
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RESTATEMENT (S ECOND ) OF A GENCY at Chapter 13, introductory note; President, 814 A.2d at 1184 (“Of
course, we enforce ambiguous insurance contracts in accordance with the reasonable expectations of the
insured”; that is, with the principal, as against the fiduciary.)
28
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For example, fiduciary duties often arise in situations involving professional services. See, e.g.,
Carluccio, 57 A.2d at 452, 453 (real estate agents); H T Packard-Bamberger & Co, 771 A.2d at 1203TH
(attorneys); Fasolo v. Bd. of Trustees of Div. of Pensions, 464 A.2d 1180, 1187 (trustees).
29
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See PBM S TUDY, supra note 3, at 8.
30
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See id., at 9-10 (diversity of PBM/HBP contracts).
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See, e.g., id. at 57-59 (diverse pass-through, payment sharing, and audit arrangements) and 90-94
(potential benefits of interchange and plans contract for diverse protections against costly interchanges).

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that might arise under their contract.TPF
32 This increased legal liability is likely to entail	FPT
legal and administrative costs, and some of these costs may be passed on to clients in the
form of higher fees.
Also, liability concerns may make a PBM less willing to engage in cost-reducing
practices, such as employing incentives to guide beneficiaries to its own mail-order
pharmacy or contracting with plan sponsors that want to provide limited networks of
retail pharmacies or place few preferred drugs in each therapeutic class on their
formularies. For example, because a fiduciary cannot profit at the expense of its
principal, a PBM might be concerned that ownership or management of a mail-order
pharmacy could create at least the appearance of self-dealing and that co-payment plans
or other incentives for beneficiaries to use such pharmacies could trigger claims that the
PBM breached duties of loyalty owed to the beneficiaries themselves; at the same time, if
network discounts, manufacturer rebates, or formulary design appear to depart from best
industry practices, PBMs may be exposed to claims for breach of duties of care and
skill.TPF
33 The PBM Study found that mail-order pharmacies typically are less expensive	FP T
than retail pharmacies, even after controlling for prescription size and drug selection.TPF
34FP T
In addition, the PBM Study found that average total prices at mail-order pharmacies
owned by large PBMs “typically were lower than at mail-order pharmacies not owned by
PBMs.”T P F
35 Further, many pharmacies trade higher customer volume for lower prices, by	FPT
offering deeper discounts to PBMs with more exclusive networks,TP
36 and pharmaceutical	F FPT
manufacturers tend to offer higher payments in return for more prominent formulary
presence. In response to litigation risk, PBMs may adopt defensive business practices
that would curtail such cost-saving measures.
32
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For example, in Pickett v. Lloyd’s, the New Jersey Supreme Court recognized a private cause of action in
a regulated insurance matter because, “[a]lthough the regulatory framework does not create a private cause
of action, it does declare state policy and we do not think that finding a cause of action for the breach of the
[fiduciary] duty of good faith and fair dealing would conflict with that policy.” 621 A.2d 445, 468 (N.J.
1993).
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Such concerns are not unrelated to those that gave rise to the PBM Study in the first place. See text
accompanying notes 19-24, supra. Alleged breaches of fiduciary duty could occur, e.g., if a plan sponsor
feels that a PBM negotiated pharmaceutical payments that are “too low,” or pharmacy reimbursement rates
that are “too high,” relative to terms negotiated by the PBM in contracts with other plan sponsors or to the
terms negotiated by other PBMs.
34
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See PBM S TUDY, supra note 3, at 25; see also General Accounting Office, Effects of Using Pharmacy
Benefit Managers on Health Plans, Enrollees, and Pharmacies at 11 (Jan. 2003) (“GAO Report”),
available at H T T T U http://www.gao.gov/cgi-bin/getrpt?GAO-03-196UTTHT (reporting that PBMs negotiate substantial
discounts with retail pharmacies, but achieve greater savings using mail-order pharmacies, with an average
mail-order price “about 27 percent and 53 percent below the average cash price customers would pay at a
retail pharmacy for the selected brand name and generic drugs, respectively.” GAO Report at 8.
35
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PBM S TUDY, supra note 3, at vi.
36
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Further, a credible threat to exclude a pharmacy from a network and channel customers elsewhere creates
a strong incentive for pharmacies to bid aggressively. Letter from FTC staff to Patrick C. Lynch, Attorney
General, and Juan M. Pichardo, Deputy Senate Majority Leader, State of Rhode Island and Providence
Plantations (Apr. 8, 2004), at 4 n.11, available at H T U http://www.ftc.gov/os/2004/04/ribills.pdfUTH. See also
Michael G. Vita, Regulatory Restrictions on Selective Contracting: an Empirical Analysis of “Any Willing
Provider” Regulations, 20 J. H EALTH ECON. 955 (2001) (finding that “any willing provider” laws lead to
higher drug prices).

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Absent a well developed body of case law regarding the duties of PBM fiduciaries
in particular, the limits of future tort liability are unclear. Also unclear is the extent to
which PBMs will go to minimize their exposure to such tort claims, as the case law
develops. Still, at the outset, the risk of liability based on general principles of agency
law may be substantial. Removing the fiduciary obligation would reduce the cost of
uncertainty in HBP/PBM contract formation, and would permit HBPs and PBMs greater
latitude to explore business arrangements that may be more efficient generally, or may
better suit the needs of individual HBPs. In addition, when all PBMs are able to tailor
their prices – and pricing mechanisms – based on each HBP’s preferences, PBMs may be
forced to compete more vigorously for each contract.TPF
37FP T
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Restrictions on Requiring Mail-Order Pharmacy Usage
The Bill also may limit HBPs’ abilities to require or encourage, through financial
incentives, beneficiary use of mail-order pharmacies for certain prescriptions. Because
the potential cost-savings from the mail-order provision of maintenance drugs is
substantial, such limitations may raise the cost of providing pharmaceutical benefits to
New Jersey consumers.T P F
38 For example, A-320 states that a PBM must disclose to	FPT
purchasers “the availability of a voluntary mail-order service provided by the [PBM] for
prescription drugs or specialty drugs, which shall be available to a covered person who
chooses to use the service through an express written request submitted to the [PBM].”TPF
39FPT
The Bill also would permit a PBM, pursuant to a written contract with a purchaser, to
provide mail-order pharmacy services to a covered person, “provided that the covered
person chooses to use the mail-order service through an express written request submitted
to the [PBM]. T P F
40FPT
Typically, as noted above, mail-order pharmacies are less expensive than retail
pharmacies.TPF
41 Consequently, HBPs and PBMs have adopted diverse incentives to	FP T
encourage the use of mail-order pharmacies, especially for beneficiaries taking
maintenance medications.TPF
42 Such incentives include, among others, lower co-payments	FPT
for mail-order drugs, deductibles for retail purchases, and limitations on the number of
37
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See James C. Cooper et al., Does Price Discrimination Intensify Competition? Implications for Antitrust,
72 A NTITRUST L.J. 327, 332-42 (2005).
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See text accompanying note 34, supra, and note 42, infra (cost savings from mail-order) and note 47,
infra (cost of statutory impediments to mail-order).
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A-320 at § 9.a.(8).
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Id. at §8.a.(2).
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See text accompanying note 28, supra (savings remain after adjusting for Rx size and selection).
42
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See PBM S TUDY, supra note 3, at 17-19. Maintenance medications are “prescription drugs that treat
chronic illnesses and conditions.” Id. at 17. It should be noted that, while mail-order usage tends to lower
costs, and while “[m]ail-order distribution of prescription drugs has grown dramatically,” not all plans
administered by PBMs have implemented incentives for beneficiaries to use mail-order. See id. at 17-18.

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times a prescription may be filled, or refilled, at a retail pharmacy.TPF
43 Certain health plans	FP T
employ relatively strong incentives, such as “mandatory mail-order” programs that
reimburse beneficiaries for maintenance medications only if the beneficiaries fill those
prescriptions by mail.TPF
44FPT
On its face, A-320 appears to prohibit HBPs from adopting mandatory programs,
and could be read to prohibit incentive-based programs that impose strong financial
penalties on certain retail purchases. Although the findings and declarations section of
the Bill prohibits “mandating the use of mail-order services,” the Bill does not define
“mandating” or “mandatory mail-order,” which leaves unclear whether certain types of
incentive-based programs would be prohibited. To the extent that A-320 impedes HBPs
from creating incentives for beneficiaries to use mail-order pharmacies, the Bill is likely
to increase drug prices for both HBPs and New Jersey consumers.TPF
45 As a Maryland	FPT
study has shown, statutory impediments to mail-order provision of, e.g., maintenance
drugs, can be very costly for a State and its citizens.TPF
46FP T
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Substitution Requirements
Although A-320 appears to allow PBMs and HBPs to engage in generic
substitutionTPF
47 without triggering the Bill’s limitations on drug substitutions generally, it	FPT
places several conditions on therapeutic interchange.TPF
48 Because therapeutic interchange	FP T
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See id. at 18-19.
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See id. at 19.
45
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See text accompanying notes 28-30, supra. As noted above, the Bill is unclear about the extent to which
the “voluntary,” expressly chosen nature of mail-order use, in itself, or bundled with fiduciary duties, may
require that beneficiaries have access to local pharmacies under covered rates.
46
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According to the Maryland report, greater use of mail-order maintenance drugs, as would be enabled by
liberalizing Maryland insurance law, would save Maryland consumers 2-6% on retail drug purchases
overall, and third-party carriers 5-10%. See Md. Health Care Comm. and Md. Ins. Admin., Mail-Order
Purchase of Maintenance Drugs: Impact on Consumers, Payers, and Retail Pharmacies, 2-3 (Dec. 23,
2005).
47
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Although the Bill does not define the terms “generic drug” or “generic substitution,” generic substitution
is generally understood to be the provision of a drug that is pharmacologically identical to the name-brand
drug indicated on the prescription. FDA, Office of Generic Drugs, What are Generic Drugs?, available at
http://www.fda.gov/cder/ogd/index.htm#Introduction (last checked Nov. 20, 2006).
48
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See generally A-320 at § 12 (permitted and prohibited drug substitutions). Therapeutic interchange is the
substitution of a drug that is designed to have similar therapeutic effects, and is approved by FDA for
treatment of the same indication, but is in some regard pharmaceutically different. See R. Herdman & D.
Blumenthal, eds., DESCRIPTION AND A NALYSIS OF THE VA N ATIONAL F ORMULARY (Institute of Medicine
June 2000), available at H T U www.nap.edu/books/0309069866/htmlUTH. The Bill states that its provisions “shall
not apply” when “the drug prescribed is being substituted with a generic drug or chemical equivalent, in
accordance with the purchaser’s contract or in compliance with State law, unless the prescriber objects to
the drug substitution on medically necessary reasons and the covered person is willing to pay any increase
in co-payments or other out-of-pocket expenses for the originally prescribed drug.” Id. at §12.a.(3).
Because the Bill does not define the term “generic drug,” there is some uncertainty about the meaning of
both the statutory carve-out for generic drugs or chemical equivalents, under Section 12.a.(3), and the
procedural prerequisites to non-exempt substitutions, under Section 12.b.(1)(e). That uncertainty could be
resolved by appropriate statutory definition of terms.

Page 9 of 14
programs have the potential to increase usage of less expensive, but therapeutically
effective, branded drugs or their generic equivalents, such restrictions may raise the cost
of drug benefits. Several of the Bill’s restrictions on drug substitution practices appear to
duplicate existing provisions under New Jersey law,T P F
49 but other provisions may make	FP T
therapeutic interchange more difficult.TPF
50 The Bill requires PBMs to disclose substantial	FPT
financial information, and imposes a default obligation on a PBM to obtain HBP
authorization, for any substitution not otherwise prohibited under the Bill’s paragraph
12.b.(1).TPF
51 Under the plain language of A-320, it appears that HBPs and PBMs may	FPT
contract to waive the authorization requirement, but it is unclear whether parties may
waive the disclosure requirements as well.TPF
52 The Bill also imposes a two-year waiting	FPT
period, per patient per drug, on a second request for interchange authorization.TPF
53FP T
To the extent that A-320 reduces the incidence of cost-saving substitution, it is
likely to increase pharmaceutical costs for HBPs. Therapeutic interchange programsT P F
54FPT
have the potential to increase usage of less expensive, but therapeutically effective,
branded drugs or their generic equivalents (which are much less expensive than their
brand-name counterparts).TPF
55 The PBM Study noted that interchange programs are costly	FP T
to implement and that, in practice, interchanges have been relatively rare.TPF
56 Nonetheless,	FP T
the Study data confirm that, if implemented, interchange programs should tend to reduce
49
T
P
P
T
See, e.g., N. J. Stat. Ann. § 24:6E-7 (regarding, e.g., mechanisms whereby a prescribing physician can
prevent a substitution or interchange and a beneficiary’s ability to opt-out of a proposed drug substitution
independent of coverage implications). Cf PBM S TUDY, supra note 3, at 81-82 (noting that interchange
programs, while representing a very limited share of prescriptions, tend to be more prevalent in mail-order
programs than retail ones, because the reduced time pressure facilitates physician authorization).
50
T
P
P
T
Under the Bill’s paragraph 12.b.(1), certain conditions are imposed among limitations, some partial and
some absolute, on all drug substitutions. Under paragraph 12.b.(2)-(3), certain conditions are imposed on
all drug substitutions not otherwise prohibited by 12.b.(1) or contract.
51
T
P
P
T
See id. at §§12.b.(2)-(4). Disclosures required “at the time of substitution,” under Section 12(b)(4) are
enumerated, and discussed more fully, together with the Bill’s more general disclosure requirements, at
notes 63-67, infra,
52
T
P
P
T
See text accompanying notes 24, 32-35, supra. Paragraph 12.b.(2)(1) provides that a PBM must have an
HBP’s authorization for each drug substitution not otherwise prohibited by the Act, “unless otherwise
provided for in a contract for [PBM] services ….” The same paragraph subsequently states, in a separate
sentence, that such otherwise non-prohibited substitutions require that substantial disclosures be made to
the HBP, making no mention of the possibility of waiver. Further, waiver provisions that might be
relatively straightforward, under contract law, for sophisticated corporate parties such as HBPs and PBMs,
may be confounded by the imposition of unsettled fiduciary obligations.
53
T
P
P
T
That is, if a prescribing physician has rejected a proposed interchange once, that interchange cannot be
proposed again for two years. See A-320 § 12.b.(1)(f).
54
T
P
P
T
See note 49, supra, for a definition of therapeutic interchange.
55
T
P
P
T
See, e.g., PBM S TUDY, supra note 3, at 28, Fig. II-2, and 61.
56
T
P
P
T
Two large PBMs submitting data for the PBM S TUDY under special orders employed therapeutic
interchange in filling “less than one-half of one percent (0.5%) of prescriptions dispensed at retail and at
PBMs’ owned mail-order pharmacies.” Id., at 84. The data represent the practices of two large PBMs in
2002 and 2003 and may not represent the frequency of therapeutic interchange across the industry. See id.

Page 10 of 14
costs for health plan sponsors that use them.TPF
57 Furthermore, interchange programs can	FP T
play a useful role in the negotiation of discounts with manufacturers.TPF
58 At the same time,	FP T
it is unclear how these restrictions on HBP/PBM contracting are likely to provide
countervailing benefits. As the PBM Study found, HBPs appear able to protect
themselves from cost-raising substitutions.TPF
59FP T
Further, although New Jersey may wish to further a policy goal of insulating
physicians against repetitive therapeutic interchange authorization requests, the Bill’s
required two-year waiting period on a second authorization request for a given drug
nonetheless appears artificially restrictive.TPF
60 First, because therapeutic interchange is not	FP T
frequently undertaken by PBMs,TPF
61 the potential benefits of a restriction on the frequency	FPT
of authorization requests may be slight. Second, it appears that the restriction is over-
broad as a limitation on repetitive authorization requests, because the two-year
moratorium appears to apply independent of questions whether the drug is being
prescribed for the same indication or significant new data on drug choice has emerged;
the restriction appears to apply without regard to whether the drug is being prescribed by
a different physician.
Disclosure of Financial Information
Explicit statutory provisions and the fiduciary requirement also would require
PBMs to disclose sensitive financial information to HBPs; such disclosures may facilitate
collusion, raise price, and harm the patients the bill is supposed to protect. In addition to
disclosure requirements that would pertain to PBMs generally under the Bill’s Sections 9
and 10,T P F
62 Section 12 requires substantial additional disclosures of financial information	FP T
whenever a PBM implements certain drug substitution programs.TPF
63 Although A-320	FPT
57
T
P
P
T
See id. at 81. Examining data regarding drug pairs for which PBMs had authorized a program to
substitute (interchange) one member of the pair for the other provides some indication of the potential for
therapeutic interchange to lower costs if implemented. “In the 10 therapeutic categories the Commission
examined, study participants’ data showed that the use of TI could reduce plan sponsors’ costs in a majority
of cases.” Id. Therapeutic interchange may also, in certain instances, serve therapeutic ends, although the
PBM S TUDY lacked adequate information to determine the frequency with which therapeutic interchange
may be employed for drug safety reasons, e.g., to avoid adverse drug interactions. See id. at 82, n. 4. Note,
too, that the substitution restrictions imposed under § 12 of the Bill do not apply to substitutions “initiated
for patient safety reasons.” A-320 at § 12.b.(1).
58
T
P
P
T
The PBM S TUDY reports that “[o]ne PBM indicated that it regards the real value of [therapeutic
interchange] programs as a negotiating tool with manufacturers to obtain higher pharmaceutical payments
or allowance rates.” PBM S TUDY, supra note 3, at 84.
59
T
P
P
T
See id. at 82 and n. 2.
60
T
P
P
T
See id. at § 12.b.(1)(f) (imposing the restriction per drug, per patient).
61
T
P
P
T
See note 57, supra.
62
T
P
P
T
Substantial disclosure of information regarding a PBMs operating practices and financial arrangements
with third parties are required for all PBM/HBP contracts under Section 9. Among other things, a PBM
“shall disclose to a purchaser on a quarterly basis…the nature, type, and amount of non-purchaser
remuneration that the [PBM] received during the reporting period ….” A-320 at § 9(b)(3).
63
T
P
P
T
See id. at §§12.b.(2)-(4). For example, a PBM is to disclose to the HBP, “at the time of initiation of the

Page 11 of 14
provides confidentiality protections for information disclosed to purchasers, under
Section 9, and prospective purchasers, under Section 10, it is unclear whether such
protections would extend to disclosures to purchasers, under Section 12.b., or any
additional disclosures that would be required under common law fiduciary duties.TPF
64 In	FP T
addition, there do not appear to be any safeguards for financial information that might be
disclosed to beneficiaries under Section 12.b.(4).TPF
65 To the extent that the Bill mandates	FPT
the disclosure of proprietary business information without effective protection, the Bill
increases the likelihood of proprietary business information becoming public knowledge.
If pharmaceutical manufacturers know the precise details of rebate arrangements offered
by their competitors, then tacit collusion among them may be more feasible.TPF
66 Absent	FPT
such knowledge, manufacturers have powerful incentives to bid aggressively for
formulary position, because preferential formulary treatment offers the prospect of
substantially increased sales. Unprotected disclosures thus may raise the price that New
Jersey consumers pay for pharmaceutical coverage by softening competition among
pharmaceutical companies for preferred formulary treatment.
Consumers need accurate information on price and quality to make efficient
purchasing decisions. For this reason, the FTC has challenged collusive attempts to
suppress price information for consumersTPF
67 and has opposed government regulation that	FP T
restricts advertising to consumers.TPF
68 Pharmaceutical payments PBMs receive from	FP T
substitution … (a) the cost savings as a result of the substitution; (b) any additional costs that will be
incurred by the purchaser as a result of the substitution and the mechanism by which the [PBM] will
reimburse the [HBP] for those costs, or, if applicable, a reiteration of the contract provision stating that the
purchaser agreed to pay for any increase in costs …; (c) any non-purchaser remuneration the [PBM] has
received or will receive as a result of the substitution and how much, pursuant to the contract, the purchaser
will receive; and (d) the date on which the [PBM] received approval from the prescriber to initiate the drug
substitution.” Id. Disclosures to beneficiaries are to include “payments … and any other remuneration or
revenue received by a [PBM] in connection with a purchaser’s prescription drug benefits or drug
utilization, regardless of how that remuneration or revenue is categorized.” Id. at § 12.b.(4).
64
T
P
P
T
A-320 § 9.c. provides, for example, that a PBM “shall make the disclosures pursuant to this section upon
receiving a written agreement from the purchaser that it will keep the information confidential.” (emphasis
added) The plain language of the provision does not appear to condition other disclosures on such an
agreement and leaves ambiguous the question whether such disclosures could be fully protected by
contract. Also potentially unprotected are disclosures to other entities. Moreover, because the disclosures
required under Section 9 are waived for insurer-affiliated PBMs, administrative and other costs they may
entail could create an undue pressure toward excessive vertical integration—that is, in favor of new
PBM/HBP affiliations that would not be efficient were it not for the regulatory cost or savings choice
imposed under the Bill.
65
T
P
P
T
See notes 52, 63, supra (regarding substitution disclosure requirements).
66
T
P
P
T
See, e.g., Svend Albaek et al., Government Assisted Oligopoly Coordination? A Concrete Case, 45 J.
I NDUS . ECON. 429 (1997).
67
T
P
P
T
See, e.g., Fair Allocation System, Inc., FTC Docket No. C-3832 (1998) (consent order) (challenging
concerted action by auto dealers to restrict a competing dealer’s ability to advertise over the Internet); see
also FTC v. Indiana Fed’n of Dentists, 476 U.S. 447 (1986) (challenging a dental association rule that
prohibited dentists from submitting x-rays to dental insurers in connections with claims forms).
68
T
P
P
T
See, e.g., Massachusetts Bd. of Registration of Optometry, 110 F.T.C. 549 (1988); FTC Staff Comments
in the Matter of Request for Comments on Agency Draft Guidance Documents Regarding Consumer-
Directed Promotion, Before the FDA, Docket No. 2004D-0042 (May 10, 2004), available at

Page 12 of 14
manufacturers, however, are just one factor among many that determine PBM pricing –
in essence, the payments function as manufacturer discounts on the cost of drug products.
Thus, the disclosure requirements are analogous to requirements that firms reveal aspects
of their cost structures to customers. There is no theoretical or empirical reason to
assume that consumers require sellers’ underlying cost information for markets to
achieve competitive outcomes.TPF
69 At the same time, our analysis of PBM/HBP contracts	FPT
shows that HBPs already are able to negotiate contract terms – including diverse
information disclosure and audit rights – that protect them from conflicts of interest.TPF
70FPT
Press reports too suggest that many contracts provide for full disclosure to client HBPs.TPF
71FPT
With no evidence that PBM clients lack accurate information on the price and quality of
the services that they purchase, it is unclear how requiring PBMs to reveal rebate
information would improve on current market outcomes.
Conclusion
Allowing competition among PBMs is more likely to yield efficient levels of
payment sharing, disclosure, and price than contract terms mandated by government
regulation. By forcing HBPs to accept terms they would not bargain for, A-320 will
likely increase the price of pharmaceutical coverage; ultimately this may suppress the
number of New Jersey consumers who have pharmaceutical coverage, and the scope of
coverage for those who have it.TPF
72 As an article in Health Affairs noted, “when costs are	FP T
high, people who cannot afford something find substitutes or do without. The higher the
cost of health insurance, the more people are uninsured. The higher the cost of
pharmaceuticals, the more people skip doses or do not fill their prescriptions.”TPF
73FP T
H
T
U
http://www.ftc.gov/os/2004/05/040512dtcdrugscomment.pdfUHT; Letter from FTC to Supreme Court of
Alabama (Sept. 30, 2002), available at H T U http://www.ftc.gov/be/v020023.pdfUHT; FTC Staff Comments in the
Matter of Direct-to-Consumer Promotion, Public Hearing before the FDA, Docket No. 95N-0227 (Jan. 11.
1996), available at H T U http://www.ftc.gov/be/v960001.htmUTH. See also THE EFFECTS OF R ESTRICTIONS ON
A DVERTISING AND C OMMERCIAL P RACTICE IN THE P ROFESSIONS : THE CASE OF O PTOMETRY, FTC Bureau
of Economics Report (1980).
69
T
P
P
T
The notion that health insurance beneficiaries should know the cost structure of the service that
administers their pharmacy benefits, on behalf of their insurers, is more dubious still.
70
T
P
P
T
See PBM S TUDY, supra note 3, at 58.
71
T
P
P
T
See, e.g., Milt Freudenheim, Employers Unite in an Effort to Curb Prescription Drug Costs, N.Y. Times,
Feb. 3, 2005; Milt Freudenheim, Big Employers Join Forces in Effort to Negotiate Lower Drug Prices,
N.Y. TIMES , June 12, 2004.
72
T
P
P
T
In addition to costs that may be entailed by specific restrictions on established preferred contract terms,
HBPs and PBMs may be concerned that numerous statutory restrictions on their ability to contract freely
will harm their ability to develop and test innovations in this relatively new marketplace. See, e.g., Neil
Model, PBM transparency: More than meets the eye, Employee Benefit News (Nov. 2006), available at
H
T
U
http://www.benefitnews.com/detail.cfm?id=9740U T H (regarding new contract provisions addressing pass-
through pricing and disclosure and possible advantages and disadvantages to different contract options
being explored).
73
T
P
P
T
William Sage, David A. Hyman & Warren Greenburg, Why Competition Law Matters to Health Care
Quality, 22 H EALTH A FFAIRS 31, 35 (March/April 2003). Although estimates of the elasticity of demand
for health insurance coverage vary, the empirical evidence is clear that higher costs result in less coverage.
See David M. Cutler, H EALTH CARE AND THE P UBLIC S ECTOR , NBER Working Paper W8802, Table 5

Page 13 of 14
At the same time, there does not appear to be any compelling reason to restrict
competition to protect HBPs. While some lawsuits have raised concerns about certain
PBM conduct, as we concluded in the PBM Study, HBPs appear able to protect
themselves from potential conflicts of interest for PBMs already through arms-length
contracts.
We urge the New Jersey General Assembly to consider the adverse effects on
competition and consumer welfare that A-320 will likely produce. We appreciate this
opportunity to share our views and welcome any further discussions regarding
competition policies.
(Feb. 2002), available at H T U http://papers.nber.org/papers/W8802UTH.

Page 14 of 14
Respectfully submitted,
Maureen K. Ohlhausen
Director
Office of Policy Planning
Michael A. Salinger
Director
Bureau of Economics
Jeffrey Schmidt
Director
Bureau of Competition