FTC Staff Comment to the Honorable Richard Brown Concerning North Dakota H.B. 1332 to Regulate the Contractual Relationship Between Pharmacy Benefit Managers and Covered Entities

U NITED STATES OF A MERICA
FEDERAL TRADE COMMISSION
Washington, DC 20580
Office of Policy Planning
Bureau of Economics
Bureau of Competition
March 8, 2005
Senator Richard L. Brown
North Dakota Senate
State Capitol
600 East Boulevard
Bismark, ND 58505-0360
Dear Senator Brown:
The staffs of the Federal Trade Commission=s Office of Policy Planning, Bureau of
Competition, and Bureau of Economics1 are pleased to respond to your requests for comments
on the likely competitive effects of North Dakota House Bill 1332 (“HB 1332” or the “Bill”) that
would regulate the contractual relationships between pharmacy benefit managers (“PBMs”) and
“covered entities” – such as health plans and health insurers – and pharmacies. 2
1 	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.
2 	HB 1332 defines a covered entity as a “nonprofit hospital or a medical service corporation; a health insurer;
a health benefit plan; a health maintenance organization; a health program administered by the state in a capacity of
provider of health coverage; or an employer, a labor union, or other entity organized in the state which provides
health coverage to covered individuals who are employed or reside in the state.” HB 1332 § 26.1-27.1-01 (1).
Covered entities do not include self-funded plans exempt from state regulation pursuant to ERISA, health plans
“issued for federal employees,” or health plans that provide “coverage only for accidental injury, specified disease,
hospital indemnity, medicare supplement, disability income, long-term care, or other limited-benefit health insurance
polic[ies] or contrac[s].” Id.

Senator Richard L. Brown
March 11, 2005
Page 2 of 8
In your letter dated January 19, 2005, you asked us to analyze the competitive
implications of HB 1332 and discuss whether it “will likely result in the increased cost of
pharmaceutical care for consumers.” We believe that HB 1332, if enacted, may have the
unintended consequence of increasing the price of pharmaceuticals and ultimately to decrease
the number of North Dakotans with insurance coverage for pharmaceuticals. Specifically, we
believe that HB 1332 may limit a PBM’s ability to guide consumers to lower-cost pharmacies
and would prohibit switching consumers to certain lower-priced drugs.3
Interest and Experience of the Federal Trade Commission
The Federal Trade Commission (Commission) is charged by statute with preventing
unfair methods of competition and unfair or deceptive acts or practices in or affecting
commerce.4 Pursuant to this statutory mandate, the Commission seeks to identify business
practices and regulations that impede competition without offering countervailing benefits to
consumers. For several decades, the Commission and its staff have investigated the competitive
effects of restrictions on the business practices of health care providers.5 The Commission has
brought numerous enforcement actions against entities involved in the pharmaceutical industry,6
and the Commission and its staff have issued reports and studies regarding various aspects of the
pharmaceutical industry.7
The Commission also has extensive recent experience with PBMs. In 2004, Commission
staff commented on proposed Rhode Island legislation that would have affected a PBM’s ability
to contract with pharmacies8 and on proposed California legislation that would have required
3 	Although our comment is addressed only to these provisions, the Bill also regulates PBMs in other ways.
See note 14, infra. We note that HB 1332 has been amended once by eliminating a requirement that PBMs act as
fiduciaries to covered entities with which they contract and reducing the scope of a PBM’s mandatory disclosure of
financial information. These amendments eliminated other provisions that likely would have produced adverse
competitive effects.
4 	Federal Trade Commission Act, 15 U.S.C. ' 45.
5 	See Federal Trade Commission, FTC Antitrust Actions in Health Care Services and Products, at
http://www.ftc.gov/bc/hcupdate031024.pdf.
6 	See Federal Trade Commission, FTC Antitrust Actions in Pharmaceutical Services and Products, at
http://www.ftc.gov/bc/0310rxupdate.pdf.
7 	See Federal Trade Commission, GENERIC D RUG ENTRY PRIOR TO PATENT EXPIRATION (July 2002); David
Reiffen and Michael R. Ward, GENERIC D RUG INDUSTRY D YNAMICS , Federal Trade Commission Bureau of
Economics Working Paper No. 248 (Feb. 2002), at http://www.ftc.gov/be/econwork.htm; Roy Levy, THE
PHARMACEUTICAL INDUSTRY : C OMPETITIVE AND A NTITRUST ISSUES IN A N ENVIRONMENT OF C HANGE, Federal
Trade Commission Bureau of Economics Staff Report (Mar. 1999), at
http://www.ftc.gov/reports/pharmaceutical/drugrep.pdf.
8 	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

Senator Richard L. Brown
March 11, 2005
Page 3 of 8
PBMs to disclose certain information to covered entities and consumers related to a PBM’s
financial arrangements with pharmaceutical companies.9 Also in 2004, the Commission
investigated the competitive implications of a proposed merger between Caremark and
AdvancePCS.10 On June 26, 2003, the Commission and Department of Justice Antitrust
Division (Division) held a half-day of hearings on PBMs, as part of their Hearings on Health
Care and Competition Law and Policy (Health Care Hearings).11 The report jointly issued by the
Commission and the Division on July 23, 2004 addressed the issues raised by PBMs as well.12
Finally, Congress has required the Commission to analyze the prices that plan sponsors and
participants pay for pharmaceuticals dispensed through different distribution channels.13
Description of HB 1332’s Provisions Related to Contracting with Retail Pharmacies
and Restrictions on Certain Drug Substitutions
Although HB 1332 would regulate PBMs in several ways, this comment is directed only
to certain provisions of the Bill that would restrict PBMs’ contracting with pharmacies and that
would prohibit certain drug substitutions.14 Specifically, HB 1332 would prohibit a PBM from
discriminating “on the basis copayments or days of supply” when contracting with pharmacies.15
Further, it requires that “a contract must apply the same coinsurance, copayment, and deductible
to covered drug prescriptions” to all pharmacies or pharmacists in a network. 16
http://www.ftc.gov/os/2004/04/ribills.pdf.
9 	See Letter from FTC staff to Rep. Greg Aghazarian (Sept. 7, 2004), at
http://www.ftc.gov/be/V040027.pdf.
10 	Statement of the Federal Trade Commission, In re Caremark Rx, Inc./AdvancePCS, File No. 0310239 (Feb.
11, 2004), at http://www.ftc.gov/os/caselist/0310239/040211ftcstatement0310239.pdf.
11 	Health Care Hearings, June 26, 2003, at http://www.ftc.gov/ogc/healthcarehearings/030626ftctrans.pdf.
See also http://www.ftc.gov/ogc/healthcarehearings/03062526agenda.htm. All subsequent references to the hearings
will identify a panelist, affiliation, and transcript page. Affiliations are as of the date of the hearing.
12 	Federal Trade Commission and Department of Justice, IMPROVING H EALTH C ARE: A D OSE OF
C OMPETITION Chapter 7 (2004), at http://www.ftc.gov/reports/healthcare/040723healthcarerpt.pdf.
13 	Federal Trade Commission, Pharmacy Benefit Manager Conflict of Interest Study Public Notice (Mar. 26,
2004), at http://www.ftc.gov/os/2004/03/040326pnpbm.pdf.
14 	For example, HB 1332 would prohibit a PBM from excluding a pharmacy or pharmacist from one network
“solely because the pharmacist or pharmacy declined to participate in another plan or network managed by the
[PBM].” HB 1332 § 26.1-27.1.04(2). It also would require a PBM to offer covered entities contracting options that
allow the covered entity to keep some, all, or none of the rebates collected by the PBM. Id. at § 26.1-27.1-05 (1).
Further, any contract between a PBM and a covered entity must allow the covered entity to audit the PBM to
“confirm that the benefit of rebates and other retrospective utilization discounts are being shared as required by the
contract.” Id. at § 26.1-27.1-05(2). This letter does not address any of these provisions.
15 	HB 1332 § 26.1-27.1.04(3).
16 	Id.

Senator Richard L. Brown
March 11, 2005
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HB 1332 would allow the PBM to request the substitution of a “lower-priced generic or
therapeutically equivalent drug” for a prescribed drug.17 It is unclear in the Bill whether the term
“therapeutically equivalent” drug refers to those drugs that are pharmaceutically equivalent or
those that are pharmaceutically distinct, but are within the same therapeutic class.18 To the
extent that the Bill adopts the former narrower definition, HB 1332 would prohibit a PBM from
requesting that the drug referred to in a patient’s prescription be substituted for another drug that
is designed to have similar therapeutic effects – but that is pharmaceutically distinct – unless the
substitution is “for medical reasons that benefit the covered individual” and the prescribing
physician approves the substitution.19
Background on PBMs
PBMs manage the pharmacy benefits of covered entities. At the Health Care Hearings,
one panelist estimated that ninety-five percent of patients with prescription drug insurance
coverage receive their benefits through a PBM.20 There are approximately 60 PBMs operating
in the United States today. There are three large, independent, full-service PBMs with national
scope: Medco, Express Scripts, and Caremark. Some large insurers manage pharmacy benefits
internally. A few PBMs are owned by large retail supermarket/pharmacy chains. In addition,
there are many smaller, privately-held PBMs. The relative size and ranking of these companies
varies according to the measure used. The three large national PBMs are the major players in
many markets, but anywhere from one-third to one-half of the market is made up of the other
types of PBMs listed above. In our most recent antitrust investigation in the PBM industry, the
FTC found competition among PBMs for contracts with plan sponsors to be “vigorous.”21
One important tool used by PBMs to manage pharmacy benefits is a formulary, which is
a list of PBM-approved drugs for treating various diseases and conditions. Because a formulary
affects the mix of drugs used by enrollees in a plan, its design significantly can affect the cost to
the covered entity. Two procedures that PBMs use to attain better compliance with their
formularies are generic substitution and therapeutic interchange.22 Because generic drugs are
17 	HB 1332 § 26.1-27.1.04(1)(a).
18 	For example, the FDA defines therapeutically equivalent drugs to be those that are pharmaceutically
equivalent and have the same therapeutic equivalence codes. See
http://www.fda.gov/cder/drugsatfda/glossary.htm#T.
19 	HB 1332 § 26.1-27.1.04(1)(b).
20 	John Richardson, The Health Strategies Consultancy, Health Care Hearings, supra note 11, at 8.
21 	Commission Statement, supra note 10.
22 	Therapeutic interchange is the substitution of the drug product referred to on the consumer=s prescription
with a drug that is designed to have similar therapeutic effects, but is pharmaceutically different (i.e., two brand-
name drug products that treat the same ailment). See R. Herdman & D. Blumenthal, eds., DESCRIPTION AND
A NALYSIS OF THE VA N ATIONAL FORMULARY (Institute of Medicine June 2000), at
www.nap.edu/books/0309069866/html.

Senator Richard L. Brown
March 11, 2005
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typically substantially less expensive than their brand-name counterparts, generic substitution
lowers prescription drug costs. Therapeutic interchange also has the potential of increasing the
utilization of less expensive brand name drugs.
Preferential placement on a formulary, accompanied with reduced co-payments, can give
a drug product a higher market share within a drug plan. Pharmaceutical companies compete by
offering rebates and other financial rewards based on some combination of a percentage of a
reference price, achieving certain specified sales or market share targets, and preferred
placement of certain drug products on a PBM’s formulary. These rebates are either paid to the
covered entity, retained by the PBM, or shared between them depending on the specifics of the
contract between these parties.23 Rebates can lead to lower health care costs.24
PBMs also enter into contracts with retail pharmacies to create a retail network. The
contract generally specifies the amount the PBM will reimburse the pharmacy for dispensing a
prescribed pharmaceutical, expressed as a discount from a reference price plus a dispensing fee.
By forming an exclusive network, a PBM is able to guide a covered entity’s participants to
certain pharmacies. The promise of increased customer volume creates an incentive for
pharmacies to bid aggressively with lower drug prices in exchange for membership in a
network. 25 Pharmacies will be willing to compete more vigorously for inclusion in a network as
the exclusivity of the network and the number of pharmacies in the relevant market increases.
Likely Effects of HB 1332
HB 1332 limits PBMs’ freedom in contracting with retail pharmacies and prohibits
certain drug substitutions. These provisions are likely to lead to higher prices for
pharmaceuticals and health insurance, which in turn is likely to increase the number of North
Dakotans who go without pharmaceuticals and/or health insurance. As a recent article in Health
Affairs noted, “when costs are 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
23 	John Richardson, Health Strategies Consultancy, Health Care Hearings, supra note 11, at 23-24 (PBMs
“can be paid through administrative fees, share of rebates, or some combination.”); Thomas M. Boudreau, Express
Scripts, Health Care Hearings, supra note 11, at 124.
24 	See General Accounting Office, Effects of Using Pharmacy Benefit Managers on Health Plans, Enrollees,
and Pharmacies at 11 (Jan. 2003) (“GAO Report”) (noting that rebates passed through to health plans reduced these
plans’ annual spending on prescription drugs by three percent to nine percent), at http://www.gao.gov/cgi-
bin/getrpt?GAO-03-196.
25 	For example, the GAO Report noted that when Blue Cross Blue Shield introduced a plan with a smaller
network of retail pharmacies, it included deeper discounts in its retail pharmacy payments. See GAO Report at 11.
An extensive discussion of these issues is found in the 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, supra note
8.

Senator Richard L. Brown
March 11, 2005
Page 6 of 8
cost of pharmaceuticals, the more people skip doses or do not fill their prescriptions.”26 We
provide details on our concerns below.
A. 	Restrictions on Contracting with Pharmacies
HB 1332 would prohibit PBMs from charging different copayments, coinsurance, or
deductibles at various pharmacies within a plan’s pharmacy network.27 An important element of
the design of pharmacy benefit plans administered by PBMs, however, is the determination of
how the price for drugs will be split between the covered entity and its participants. This price
sharing is achieved through the copayments, coinsurance, or deductibles that the participant pays
to the pharmacy at the time the drug is dispensed.
Both a GAO study and an academic article reported that the prices charged to covered
entities can vary substantially across different types of pharmacies. 28 This Bill, however, would
prevent covered entities from designing benefit plans to encourage participants to use network
pharmacies that provide drugs to the plan at a lower cost than other network pharmacies.
Participants ultimately make the decision about where the drugs will be dispensed, but the
covered entity bears most of the cost of the purchase. To encourage the participant to make
efficient decisions, covered entities must be free to design plans that align its and the
participants’ interests.
The uniform copayments required by HB 1332, however, will prevent that alignment of
interests and will likely generate inefficient decisions and higher drug costs. Under the Bill,
participants would be less likely to use low-cost pharmacies than if they had been allowed to
share in the cost savings via a lower copayment. Both the participants and the covered entity
will miss out on the savings they could have shared from using the low-cost pharmacies. Only
the high-cost pharmacies will benefit. A potential secondary effect of this uniform copayment
structure is that low-cost pharmacies may lose the incentive to offer lower prices to covered
entities. Pharmacies would not want to offer lower prices because doing so would generate no
more sales than offering a high price under the legislation, since the final decision makers – the
26 	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, HEALTH C ARE AND THE PUBLIC SECTOR , NBER Working Paper W8802, Table 5 (Feb. 2002), at
http://papers.nber.org/papers/W8802.
27 	HB 1332 § 26.1-27.1-04(3).
28 	The study found that the lowest average prices for 30-day supplies were obtained when the drug was
purchased through the PBM=s mail order pharmacy, and that cash-paying customers at retail pharmacies paid the
highest prices. See GAO Report. Similar cost savings for PBM clients have been reported in another study. See
Cindy Parks Thomas et al., Impact of Health Plan Design And Management On Retirees
= Prescription Drug Use
And Spending, 2001, Health Affairs Web Exclusive W2-408 (Dec. 4, 2002), at
http://content.healthaffairs.org/cgi/reprint/hlthaff.w2.408v1.

Senator Richard L. Brown
March 11, 2005
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participants – are shielded from the price differences.
B. 	Prohibitions on Certain Drug Substitutions
HB 1332 may limit a PBM’s ability to effect certain drug substitutions. It is unclear in
the Bill whether “therapeutically equivalent” drugs are those that are pharmaceutically
equivalent or those that are pharmaceutically distinct, but are within the same therapeutic class.
To the extent that the Bill adopts the former narrower definition, HB1332 substantially would
impair a PBM’s ability to engage in price-reducing therapeutic interchange. Although North
Dakota already requires physician approval before one branded drug may be switched for
another, 29 HB 1332 further would limit substitutions to those that are “for medical reasons that
benefit the covered individual.” Consequently, the Bill would prevent a PBM from switching a
prescription for one brand-name drug with a less expensive brand-name drug that is designed to
have similar therapeutic effects, but that is pharmaceutically distinct, unless the switch was for
medical reasons. To the extent HB 1332 makes safe and cost-reducing drug substitutions less
common, it is likely to increase the cost of pharmaceuticals, which in turn is likely to increase
health insurance premiums and reduce the availability of insurance coverage for
pharmaceuticals.30
At the same time, it is unclear how the additional requirements in HB 1332 are likely to
provide consumers with any additional countervailing benefits, because, as noted above, North
Dakota requires prior prescriber authorization before a pharmacist is allowed to substitute one
brand-name drug for another. Thus, existing safeguards appear sufficient to protect consumers
from inappropriate therapeutic interchange.
Conclusion
29 	See N.D. C ENT. C ODE § 19-02.1-02(14) (prohibiting “Dispensing or causing to be dispensed a different
drug or brand of drug in place of the drug or brand of drug ordered or prescribed without the express permission in
each case of the person ordering or prescribing”).
30 	Additionally, HB 1332 may reduce the value to a pharmaceutical company of securing a preferred spot on a
PBM’s formulary. When PBMs can use the formulary to guide consumers from one branded drug to another they
can promote competition between pharmaceutical manufacturers, which is likely to result in reduced drug prices
and/or insurance premiums. To the extent that HB 1332 reduces a PBM’s ability to use therapeutic interchange,
pharmaceutical companies may compete less vigorously for inclusion on the formulary, which could lead to higher
drug prices.

Senator Richard L. Brown
March 11, 2005
Page 8 of 8
HB 1332 is likely to limit a PBM’s ability to reduce the cost of prescription drugs
without providing consumers any additional protections. Any such cost increases are likely to
undermine the ability of some consumers to obtain the pharmaceuticals and health insurance they
need at a price they can afford. Accordingly, we would urge the North Dakota legislature not to
adopt HB 1332.
Respectfully submitted,
Maureen K. Ohlhausen, Acting Director
Office of Policy Planning
Luke M. Froeb, Director
Bureau of Economics
Susan A. Creighton, Director
Bureau of Competition