FTC Staff Comment to Hon. Terry Kilgore Concerning Virginia House Bill No. 945 to Regulate the Contractual Relationship Between PBMs, Health Benefit Plans, and Pharmacies

UNITED STATES OF AMERICA
FEDERAL TRADE COMMISSION
WASHINGTON, D.C. 20580
Office of Policy Planning
Bureau of Economics
Bureau of Competition
October 2, 2006
Terry G. Kilgore, Member
Commonwealth of Virginia House of Delegates
General Assembly Building
P.O. Box 406
Richmond, Virginia 23218
Dear Delegate Kilgore:
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 request for
comments on the likely competitive effects of Virginia House Bill No. 945 (“H.B. 945”
or “the Bill”), which would regulate the contractual relationships between pharmacy
benefit managers (“PBMs”) and both health benefit plans (“HBPs” or “plans”) and
pharmacies. In your letter, dated August 11, 2006, you asked the FTC to “examine H.B.
945 to determine whether the proposed legislation is anti-competitive and will likely
result in the increased cost of pharmaceutical care for consumers.”2
H.B. 945 requires that contracts with PBMs contain certain terms, prohibits the
use of certain contractual requirements, requires disclosure of proprietary information,
and burdens therapeutic interchange and, to a lesser extent, generic drug substitution by
PBMs. We believe that such restrictions, if enacted, will limit the ability of PBMs,
HBPs, and pharmacies to enter into efficient, mutually advantageous contracts, and may
increase prices for pharmaceuticals in Virginia. Ultimately, the restrictions may decrease
the number of Virginia consumers with insurance coverage for pharmaceuticals, without
producing offsetting benefits. Empirical evidence suggests that the potential problems
that the Bill attempts to address are not prevalent. To the contrary, the findings in the
Commission’s recent study of the PBM industry suggest that HBPs can protect
themselves from potential conflicts of interest in arms-length contracts with PBMs.3
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 Letter from Virginia Delegate Terry G. Kilgore to Maureen Ohlhausen, Director, Office of
Policy Planning, Federal Trade Commission (Aug. 11, 2006).
3 Federal Trade Commission, P HARMACY BENEFIT MANAGERS: O WNERSHIP OF M AIL -ORDER
P HARMACIES (Aug. 2005) (“PBM S TUDY”), available at
http://www.ftc.gov/reports/pharmbenefit05/050906pharmbenefitrpt.pdf.

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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.4 Pursuant to its 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 FTC and its staff have issued reports and studies regarding
various aspects of the pharmaceuticals industry,6 and the Commission has brought
numerous enforcement actions against entities in that industry.7
The FTC also has extensive recent experience with PBMs. On June 26, 2003, the
Commission and the Department of Justice Antitrust Division held hearings on PBMs, as
part of our Hearings on Health Care and Competition Law and Policy (“Health Care
Hearings”).8 The report jointly issued by the Commission and the Antitrust Division on
July 23, 2004, also addressed the issues raised by PBMs.9 That same year, Commission
staff commented on proposed Rhode Island legislation that would have affected PBMs’
ability to contract with pharmacies10 and on proposed California legislation that would
have required PBMs to disclose information on their financial arrangements with
4 Federal Trade Commission Act, 15 U.S.C. ' 45.
5 See Federal Trade Commission, FTC Antitrust Actions in Health Care Services and Products,
available at http://www.ftc.gov/bc/hcupdate031024.pdf.
6 See Federal Trade Commission, GENERIC DRUG E NTRY P RIOR TO P ATENT E XPIRATION (July
2002); DAVID REIFFEN AND M ICHAEL R. W ARD, GENERIC DRUG I NDUSTRY D YNAMICS, Federal
Trade Commission Bureau of Economics Working Paper No. 248 (Feb. 2002), available at
http://www.ftc.gov/be/econwork.htm; R OY L EVY, T HE P HARMACEUTICAL I NDUSTRY:
COMPETITIVE AND ANTITRUST I SSUES IN AN E NVIRONMENT OF CHANGE , Federal Trade
Commission Bureau of Economics Staff Report (Mar. 1999), available at
http://www.ftc.gov/reports/pharmaceutical/drugrep.pdf.
7 See Federal Trade Commission, FTC Antitrust Actions in Pharmaceutical Services and
Products, available at http://www.ftc.gov/bc/0310rxupdate.pdf.
8 Health Care Hearings, June 26, 2003, available 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.
9 Federal Trade Commission and Department of Justice, IMPROVING HEALTH CARE : A DOSE OF
COMPETITION Chapter 7 (2004), available at
http://www.ftc.gov/reports/healthcare/040723healthcarerpt.pdf.
10 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),
available at http://www.ftc.gov/os/2004/04/ribills.pdf.

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pharmaceutical manufacturers to covered entities and consumers.11 Most recently,
Commission staff commented on North Dakota legislation that would have restricted
PBMs’ contracting with pharmacies and PBMs’ ability to effect certain drug
substitutions.12 Also in 2004, the Commission investigated the competitive implications
of a proposed merger between two PBMs, Caremark and AdvancePCS.13
In August 2005, the FTC issued a report analyzing potential conflicts of interest
raised by PBM ownership of mail order pharmacies (“PBM Study”).14 The Commission
obtained data – including agreements between PBMs and plan sponsors, agreements
between PBMs and pharmaceutical manufacturers, and data on generic substitution,
therapeutic interchange, and repackaging practices – from several PBMs and
pharmacies.15 These data allowed the FTC to examine how PBMs price their services
and how pharmaceutical manufacturers compete for preferred treatment on a plan’s
formulary. The PBM Study found strong evidence that PBMs’ ownership of mail order
pharmacies generally did not disadvantage plan sponsors and that competition in the
industry appears to afford HBPs sufficient tools with which to safeguard their interests.
Background on PBMs
PBMs provide plan sponsors with a variety of services for managing pharmacy
benefits. Principally, PBMs act as clearinghouses for HBPs, covered individuals, and
retail pharmacies. When a plan beneficiary purchases a drug at a retail pharmacy, he or
she presents a health plan card identifying the source of insurance coverage, and the
pharmacy transmits the card information to the PBM.16 The PBM then verifies the
beneficiary’s policy, whether the drug is covered by the plan, the direct payment the
PBM owes the pharmacy, and the co-payment, if any, owed by the beneficiary. The
PBM conveys this information back to the pharmacy, logs the payment information, and
sends the billing information to health insurers (who will remit payment to the PBM).
The PBM then pays the retailer.
PBMs also help plan sponsors manage the cost and quality of the benefits they
11 Letter from FTC staff to Rep. Greg Aghazarian (Sept. 7, 2004), available at
http://www.ftc.gov/be/V040027.pdf.
12 Letter from FTC staff to North Dakota State Senator Richard Brown (Mar. 8, 2005), available
at http://www.ftc.gov/os/2005/03/050311northdakotacomnts.pdf.
13 Statement of the Federal Trade Commission, In re Caremark Rx, Inc./AdvancePCS, File No.
0310239 (Feb. 11, 2004), available at
http://www.ftc.gov/os/caselist/0310239/040211ftcstatement0310239.pdf. The Commission
closed the investigation because it concluded that the transaction was unlikely to reduce
competition.
14 See note 3, supra.
15 Id. at iii – iv.
16 For mail-order prescriptions, the beneficiary also identifies him or herself and the source of the
insurance coverage, if not by submitting the card itself.

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provide to their enrollees. To varying degrees PBMs:
• 	negotiate rebates from pharmaceutical manufacturers.
• 	provide access to mail order pharmacies for health plan enrollees on
maintenance medications.
• 	develop drug formularies17 and help plan sponsors determine which drugs
should be on the plan’s formulary and whether and how to provide co-
payment incentives to the plan’s enrollees to use those drugs.
• 	provide drug utilization reviews that include analysis of physician
prescribing patterns to identify physicians prescribing high cost drugs
when lower cost, therapeutically equivalent alternatives are available.
• 	provide disease management services by offering treatment information
to and monitoring of patients with certain chronic diseases.
The drug formulary is an important tool for PBMs. Because a formulary affects
the mix of drugs used by beneficiaries, its design can affect significantly the cost of drugs
to a plan sponsor. PBMs use generic substitution and therapeutic interchange procedures
to attain better compliance with their formularies.18 Because generic drugs typically are
much less expensive than their brand-name counterparts, generic substitution lowers
prescription drug costs. Therapeutic interchange also has the potential to increase usage
of less expensive, but therapeutically effective, brand name drugs or their generic
equivalents. Although therapeutic interchange represents a small percentage of prescriptions
filled under PBM arrangements, it does tend to reduce plan sponsors’ costs where it is employed
and can serve as an important tool in PBM negotiations with manufacturers for higher
17 A formulary is a list of plan sponsor-approved drugs for treating various diseases and
conditions. This list will often be broken down into “tiers,” which correspond to different co-
payment levels for enrollees. For instance, a three-tier formulary may consist of a generic tier, a
preferred brand tier, and a non-preferred brand tier. Whether a brand is preferred may depend on
whether a generic alternative is available and also upon the financial terms available to the PBM
on drugs in the same therapeutic class.
18 In generic substitution, a pharmacy provides a drug that is pharmacologically identical to the
name-brand drug indicated on the prescription. “A generic drug is a copy that is the same as a
brand-name drug in dosage, safety, strength, how it is taken, quality, performance and intended
use.” U.S. Food and Drug Administration, Center for Drug Evaluation and Research, Generic
Drugs: Questions and Answers, available at
http://www.fda.gov/cder/consumerinfo/generics_q&a.htm (last checked Sept. 26, 2006). In
therapeutic interchange, a pharmacy substitutes 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 (i.e., two brand-name drug products, from the same therapeutic class,
that treat the same ailment—such products may or may not have the same active moiety; that is,
identical active compounds). See R. Herdman & D. Blumenthal, eds., DESCRIPTION AND
ANALYSIS OF THE VA NATIONAL F ORMULARY (Institute of Medicine June 2000), available at
www.nap.edu/books/0309069866/html.

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pharmaceutical payments or allowance rates.19
PBMs enter into contracts with plan sponsors, retailers, and drug manufacturers.
First, a PBM’s contract with a plan sponsor covers the amount that the plan sponsor will
pay for each prescription, via retail or mail order, and separate charges for the various
PBM services that the sponsor may use.20 In addition, the contract also specifies the
details of how the client will share in payments obtained from pharmaceutical
manufacturers.21
Second, PBMs negotiate drug prices with pharmacies participating in the PBMs’
networks. A price typically is stated as a discount from a measure of a drug’s wholesale
price, plus a dispensing fee.22 Retailers offer discounts depending on the type and
number of clients covered by the PBM and the exclusivity of the network — the more
exclusive the network, the higher the discount. By forming a preferred or exclusive
network, a PBM is able to guide plan beneficiaries to certain pharmacies. The promise of
increased customer volume creates an incentive for pharmacies to bid aggressively on
drug prices.23 A PBM may have several networks that differ in degree or scope of
exclusivity.
Finally, PBMs negotiate with pharmaceutical manufacturers to determine
payments from the manufacturers to the PBMs, based on the treatment of the
manufacturers' products within the plans that the PBMs administer. Preferential
placement on a formulary or reduced co-payments can give a drug product a higher
19 See notes 42-44, infra (PBM Study results regarding therapeutic interchange).
20 Drug pricing in a typical contract between a PBM and a plan sponsor generally is specified as a
discount off of the “average wholesale price” (“AWP”) for branded drugs as reported in various
public databases. So the price formula would be, for example, “AWP - 10% +$2.00.” 	A
discount off of AWP is sometimes also used for pricing of generic drugs, but it is also common
for PBMs to develop “maximum allowable cost” (“MAC”) lists that give prices for many of the
most prescribed generic drug products.
21 These payments are paid to the plan sponsor, retained by the PBM, or shared between them
depending on the specifics of the contract between these parties. See PBM S TUDY, supra note 3,
at 59-60; John Richardson, Health Strategies Consultancy, Health Care Hearings, supra note 8, 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 8, at 124. Typically,
contracts also specify a plan’s audit rights with respect to formulary and payment sharing. See
PBM S TUDY, supra note 3, at 58.
22 See PBM Study, supra note 3, at 4.
23 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 General Accounting Office, Effects of Using Pharmacy Benefit Managers on
Health Plans, Enrollees, and Pharmacies at 11 (Jan. 2003) (“GAO Report”), available at
http://www.gao.gov/cgi-bin/getrpt?GAO-03-196. An extensive discussion of these issues is
found in the Letter from FTC staff to Patrick C. Lynch, Rhode Island Attorney General and Juan
M. Pichardo, Rhode Island Deputy Senate Majority Leader, supra note 10.

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market share. Pharmaceutical companies compete for such placement by offering rebates
and other financial rewards (collectively “pharmaceutical payments”). Because
pharmaceutical payments reduce a PBM’s costs, they tend to lower prices for health care
consumers.24
Competition Among PBMs
Plan sponsors, sometimes with the help of consultants, typically procure PBM
services through a bidding process, which may go through multiple iterations. PBMs
compete for plan sponsors’ business on a variety of price and non-price dimensions. One
survey of plan sponsors using PBMs found that, although financial terms often were key
determinants in the selection of the winning bid, sponsors also focused on non-price
terms, such as benefit design, extent of the retail network, and quality of mail order
service.25 Further, plan sponsors’ preferences for formulary design and pharmaceutical
payment sharing vary considerably. At the Health Care Hearings, panelists stated that
some sponsors want to maximize generic substitution, while others want to maximize
payments from manufacturers.26 Panelists also noted that some plan sponsors want to
receive all payments from manufacturers, while others seek to negotiate deeper discounts
on list prices by allowing the PBM to retain these payments — and many plan sponsors
fall somewhere in-between.27 An FTC analysis of a sample of contracts between HBPs
and PBMs confirmed this diversity of contract terms.28
There are approximately 40-50 PBMs operating in the United States, with three
large, independent, full-service PBMs of national scope: Medco, Express Scripts, and
Caremark.29 Some large insurers manage pharmacy benefits internally. Large retail
supermarket/pharmacy chains own several PBMs, and several local and regional PBMs
can compete with national PBMs for contracts with smaller employers or health plans
that are geographically limited.30 The three large national PBMs are the major players in
24 See GAO Report, supra note 23, at 11 (noting that rebates passed through to health plans
reduced these plans’ annual spending on prescription drugs by three percent to nine percent).
25 See Health Care Financing Administration, STUDY OF P HARMACEUTICAL BENEFIT
M ANAGEMENT (Jun. 2001), available at http://www.cms.gov/researchers/reports/2001/cms.pdf.
26 Thomas M. Boudreau, Express Scripts, Health Care Hearings, supra note 8, at 65; Anthony
Barrueta, Kaiser Foundation Health Plan, Inc., Health Care Hearings, supra note 8, at 105.
27 John Richardson, The Health Strategies Consultancy, Health Care Hearings, supra note 8, at 18
(“A lot of PBMs don't retain any of the rebates; others retain a portion in addition to whatever
percent of the revenue they will keep as their administrative fees. So again, that's going to differ
in each arrangement that is out there.”); John Dicken, General Accounting Office, Health Care
Hearings, supra note 8, at 40 (“of those contracts -- not all, but some -- would have the PBMs
retaining some portion of those rebates to cover their administrative services.”); Thomas M.
Boudreau, Express Scripts, Health Care Hearings, supra note 8, at 58-59.
28 See PBM S TUDY, supra note 3, at 59-60.
29 See id. at 2-3.
30 See I MPROVING HEALTH CARE : A DOSE OF COMPETITION , supra note 9, at 14-15 (2004),

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many regional markets, but typically one-third to one-half of each market is serviced by
other, smaller PBMs. The FTC found, in its most recent antitrust investigation of the
PBM industry, that competition among PBMs for contracts with plan sponsors is
“vigorous.”31
Description of H.B. 945’s Provisions
Several provisions of H.B. 945 significantly restrict the provision of PBM
services in ways that are likely to harm Virginia consumers. It may be useful to partition
the Bill’s provisions into three general categories: (1) contract restrictions; (2) mandatory
disclosures of financial information; and (3) drug interchange and substitution burdens.
Contract Restrictions
H.B. 945’s “non-discrimination” provisions (a) allow beneficiaries to obtain
benefits from any pharmacy within a PBM’s network, and (b) prohibit a PBM from
requiring any beneficiary to obtain any pharmacy service from a mail order pharmacy
rather than a retail pharmacy;32 the Bill’s “freedom of choice” provisions prohibit
insurers and PBMs from barring access to the pharmacy of the beneficiary’s choice,
whether or not the pharmacy of choice is a preferred provider.33 Furthermore, the Bill
prohibits PBMs and HBPs from encouraging the use of either preferred provider or mail-
order pharmacies via differential copayments or other financial incentives.34
available at http://www.ftc.gov/reports/healthcare/040723healthcarerpt.pdf; Kaiser Family
Foundation, F OLLOW THE P ILL : UNDERSTANDING THE U.S. COMMERCIAL P HARMACEUTICAL
S UPPLY CHAIN, at 16 (Mar. 2005), at
http://www.healthstrategies.net/research/docs/Follow_the_Pill.pdf.
31 Commission Statement, supra note 13.
32 See id. at § 38.2-1384.
33 Insurers and PBMs cannot “prohibit any person receiving pharmacy benefits … from selecting,
without limitation, the pharmacy of his choice to furnish such benefits. This right of selection
extends to … nonpreferred providers … that have previously notified the insurer … of their
agreement to accept reimbursement for their services at rates applicable to pharmacies that are
preferred providers.” § 38.2-4209.1 (emphases added); see also id. at § 38.2-4312.1. 	Disclosure
provisions in the Bill (both as they address HBPs and as they address pharmacies) may further
undermine a PBM’s ability to form efficient network contracts. See text accompanying notes 37-
40, and 71-72, infra, (regarding relevant disclosure provisions).
34 Under the Bill’s “freedom of choice” provisions, no “insurer or pharmacy benefits manager
shall impose … 1. Any copayment, fee or condition that is not equally imposed upon all
individuals … whether or not such benefits are furnished by pharmacies who are nonpreferred
[sic] providers; 2. Any monetary penalty that would affect or influence any such person’s choice
of pharmacy; 3. Any reduction in allowable reimbursement for … nonpreferred [sic] providers; or
4. A different copyament, fee, or condition for persons wishing to have prescriptions filled at a
participating pharmacy other than a mail order pharmacy, regardless of the number of months
for which the prescription is written.” H.B. 945 § 38.2-3407.7(B). Under the Bill’s non-
discrimination provisions, a PBM cannot “[u]se any financial or other disincentives, penalties, or
other means to influence, coerce, or steer beneficiaries away from a retail or institutional

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H.B. 945 also mandates a number of contract terms for contracts between PBMs
and HBPs and for contracts between PBMs and pharmacies.35 These terms include
disclosure and payment timetable requirements, as well as a requirement that a PBM
must act as a fiduciary of a pharmacy, on behalf of which the PBM receives payment.36
Disclosures
H.B. 945 mandates that PBMs disclose certain proprietary business information to
pharmacies, prescribing physicians, beneficiaries, and health benefit plans. For example,
PBMs must disclose formulary information to preferred and “nonpreferred [sic] or
nonparticipating pharmacists” alike.37 Contract terms regarding the reimbursement of
network pharmacies must be disclosed to any out-of-network pharmacy wishing to take
advantage of the Bill’s “freedom of choice” provisions.38 For drug substitutions
proposed under principles of therapeutic interchange, the Bill requires PBMs to disclose
financial information, as well as potentially relevant medical information, to prescribing
physicians.39 Although the Bill would provide that, purchasers of PBM services (chiefly,
HBPs) would be subject to private confidentiality conditions, those provisions apply only
to purchasers, and then only for information that would be disclosed under certain of the
Bill’s disclosure provisions.40
pharmacy that can meet the same terms and conditions as a mail order pharmacy; or … [l]imit the
quantity of drugs that a beneficiary may obtain at any one time from any type of pharmacy
provider ….” Id. at § 38.2-1384(C).
35 For example, under new § 38.2-1379 are mandatory contract terms for all contracts executed by
PBMs for the provision of PBM services. Certain general provisions regarding PBM contracts
are found at § 38.2-1378 (Contracts; agreements must be approved; prohibited provisions); and
provisions required of PBM/PP contracts are at § 38.2-1382.
36 Id. at 38.2-1378(E).
37 See id. at § 38.2-3407.9: 01
38 See id. at § 38.2-4209.1, 4312.1.
39 See id. at § 38.2-1381 (requiring disclosure not just of medical rationale for the substitution but,
e.g., “cost savings for the purchaser [the HBP], if any,” and the “existence of additional payments
received by the pharmacy benefits manager that are not reflected in the cost savings to the
purchaser”).
40 That is, HBPs would be subject to private contractual assurances for at least some of the
information that would be disclosed directly to them. See id. at § 38.2-1375 (regarding
“[p]rerequisites to disclosure[s]” under 1377-1378). We suppose that an apparent anomaly
among these prerequisites is merely a formatting error soon to be (if not already) corrected. In
this draft, the Bill provides for mandatory disclosure to a prospective purchaser under § 38.2-
1376 and for mandatory disclosure to a purchaser under § 38.2-1377. However, the relevant
confidentiality assurance for a PBM disclosing copious proprietary information is found at §
38.2-1375. That assurance provision—regarding “prerequisites to disclosure”—states that, “a
pharmacy benefits manager need not make the disclosures required under §§ 38.2-1377 and 38.2-
1378 unless and until the prospective purchaser or the purchaser agrees in writing to maintain as
confidential any proprietary information disclosed by the pharmacy benefits manager.” Id. at

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Therapeutic Interchange and Generic Drug Substitutions
H.B. 945’s disclosure provisions also burden a PBM’s ability to implement its
clients’ programs that promote the therapeutic interchange of one branded drug product
for another. The Bill potentially burdens certain substitutions of generic drugs for brand
name drugs as well. As noted above, very extensive disclosure obligations are required
for therapeutic interchange under the Bill.41 Although therapeutic interchange is not
widely practiced by PBMs,42 it tends to reduce health plan sponsors’ costs where it is
employed,43 may play a useful role in the negotiation of discounts with drug
manufacturers,44 and may, in certain instances, serve therapeutic ends.45 Even more
importantly, the Bill imposes high threshold conditions for therapeutic interchange, such
as requiring there be medical or financial benefits to purchasers.46
Likely Effects of H.B. 945
H.B. 945 likely would restrict the ability of HBPs to enter into the types of
contractual relationships that best suit their needs. The Bill would undercut a PBM’s
38.2-1375 (emphasis added). On its face, the draft Bill neglects to provide “prerequisites” for
disclosures to prospective purchasers required under its own § 38.2-1376. In any case, we note
that the prerequisites expressly pertain only to disclosures made under two of the Bill’s
subsections.
41 See text accompanying note 39, supra.
42 Two large PBMs submitting data for the PBM Study 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.” PBM Study, supra note 3, at 84. Although these
figures do not include refills or renewals of interchanged prescriptions, and may not be
representative of practices across the industry, they do suggest that therapeutic interchange
represents a small share of filled prescriptions, if not a trivial number of prescriptions in absolute
terms.
43 See id. at 81.
44 The PBM Study 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.” Id. at 84.
45 The PBM Study notes that adequate information was not available to determine when
therapeutic interchange may be employed for drug safety reasons, e.g., to avoid adverse drug
interactions. See id. at 82, n. 4.
46 H.B. 945 § 38.2-1380 generally prohibits substitutions (generic substitution and therapeutic
interchange), absent “medical reasons that benefit the beneficiary; or … financial savings and
benefits to the purchaser.” Id. Because, e.g., a plan’s net cost for a drug with a higher Average
Wholesale Price may be lower than its cost for the prescribed drug, once pharmaceutical
payments or market share payments are taken into account, demonstrating compliance with this
provision on a substitution-by-substitution basis may be at least complex and uncertain. See
PBM S TUDY, supra note 3, at 7 (regarding market share payments).

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ability to negotiate provider networks for HBPs, require a PBM fully to disclose diverse
proprietary information, and burden the ability of a PBM to employ therapeutic
interchange and, potentially, to effect certain drug substitutions.. Additional disclosure
and contract responsibilities, including the imposition of a fiduciary duty on a PBM in
certain of its dealings with pharmacies, are likely to increase administrative costs and
legal liability for performing the PBM’s core functions. All of these legislative
requirements are likely to cause the prices that PBMs charge for their services – and
concomitantly, the price of pharmaceutical coverage – to rise.
Contract Restrictions
Several provisions of H.B. 945 significantly restrict PBM contracting in ways that
are likely to be counter-productive for Virginia consumers.47 In particular, the Bill’s
“freedom of choice” and “non-discrimination” provisions restrict the ability of a PBM to
form service networks.48 Service network contracts are central to PBM negotiations with
pharmacies on price.49 Network participation offers an incentive to pharmacies to
bargain on price, because participation promises increased sales volume. The Bill,
however, places very strong limitations on a plan’s ability to steer beneficiaries to one
pharmacy rather than another,50 together with restrictions on a PBM’s ability to enter into
efficient contracts with pharmacies.51 Thus, the Bill undercuts the likelihood or
magnitude of sales that a PBM/Pharmacy contract may reasonably contemplate.52
47 Absent such restrictions, PBM business models and contracts tend to be diverse, as “PBMs
compete on price and non-price dimensions to serve … varying client needs.” PBM S TUDY,
supra note 3, at 8; see also PBM S TUDY at ix, xiv, 8-10, 37-39, 48-60, 90-92 (contract terms
between PBMs and manufacturers, and between PBMs and HBPs, show variation in payment
terms, substitution incentives, reporting and disclosure requirements).
48 See text accompanying notes 32-34, supra.
49 See text accompanying notes 22-23, supra.
50 See text accompanying notes 32-34, supra (regarding H.B. 945’s “non-discrimination” and
“freedom of choice” provisions generally); see also note 34, supra (regarding stipulations that
plans cannot use differential financial incentives to encourage use of certain pharmacies).
51 See notes 32-36, supra (regarding contract restrictions).
52 Pharmacy choice provisions may have economic effects similar to those of “price matching”
policies (whereby a seller guarantees that it will match the lowest available price) or “any-
willing-provider” regulations (where the same sort of price matching guarantee is imposed on
sellers by regulation). On their face, such policies may appear to be pro-competitive. In effect,
however, they may tend to result in higher prices, because they reduce sellers’ willingness to bid
aggressively on price to begin with. See, e.g., Aaron S. Edlin and Eric R. Emch, The Welfare
Losses from Price-Matching Policies, 47 J. I ND. E CON. 145 (1999). Empirical work on the
effects of any-willing-provider regulations on managed care generally, bear this out. See Michael
G. Vita, Regulatory Restrictions on Selective Contracting: An Empirical Analysis of “Any-
Willing-Provider” Regulations, 20 J. HEALTH E CON. 955, 965 (2001) (panel data show
expenditures rise when any-willing-provider laws are enacted, and tend to rise more with stronger
laws).

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Because any pharmacy may “free-ride” on a competitor’s successful network proposal,
pharmacies may be less willing to invest in the development of innovative, competitive
proposals to begin with. While pharmacy choice provisions may seem superficially
attractive, a likely effect of such provisions is the suppression of efficient service
networks, not the expansion of real consumer choice. The higher retail prices that are
likely to follow ultimately would be passed on to Virginia consumers.53
Similarly, H.B. 945 restricts the ability of a PBM to negotiate for discounted mail
order provision of chronic use drugs, as plans may neither require the use of mail order
pharmacies nor implement financial incentives to encourage it.54 On the one hand, a
beneficiary is only guaranteed access to a pharmacy willing to “meet the same terms and
conditions as a mail order pharmacy.”55 On the other hand, the Bill makes it likely that
those terms and conditions will be easier to meet.56 Retail prices tend to exceed mail
order prices on prescription drugs.57 Moreover, data indicate that retail prices exceed
mail order prices even after adjusting for prescription size.58 Plan sponsors, on balance,
can negotiate larger discounts in contracting with mail order pharmacies for any given
reference drug.59 The Bill’s restrictions on the preferred use of mail order, however,
undermine sponsors’ abilities to promise larger volumes of purchasing in exchange for
price reductions. As such, the restrictions are likely to diminish the prospect or
magnitude of negotiated discounts.60
53 Data on any-willing-provider regulation of managed care show that both hospital and physician
expenditures rise with strong any-willing-provider laws. See Michael G. Vita, supra note 53, at
962, 965 (states with the laws spent roughly 2% more on healthcare than states without).
Although choice generally is beneficial to consumers, not all health care consumers prefer
additional choices if they are costly ones. Many employers, for example, offer a choice between
higher-cost/higher-benefit plans and lower-cost/lower-benefit plans, and many employees choose
the latter. See, e.g., Dennis P. Scanlon, et al., Impact of Health Plan Report Cards on Managed
Care Enrollment, 21 J. HEALTH E CON. 19, 36-37 (2002); Nancy Dean Beaulieu, Quality of
Information and Consumer Health Plan Choices, 21 J. HEALTH E CON. 43, 44, 55-57(2002)
(employees respond to information on price and quality in choosing health plans).
54 Id. at 38.2-1384(C).
55 Id.
56 As with retail pharmacy choice, the mail order provisions effectively operate as any-willing-
provider regulations, which tend to raise, rather than lower, health care expenditures. See text
accompanying notes 34, 47-51, and n. 53, supra.
57 This appears to be partly, although not entirely, due to economies of scale in filling larger
prescriptions. See PBM S TUDY, supra note 3, at 23, 26-7 (mail order prescriptions less expensive
and three times larger, economies of scale in filling larger prescriptions).
58 Id. at 25.
59 Id.
60 H.B. 945 prohibits a PBM from requiring that a beneficiary obtain pharmacy services from a
mail order pharmacy; it also prohibits the PBM from implementing “any financial or other
disincentives, penalties, or other means to influence, coerce, or steer beneficiaries away from a
retail or institutional pharmacy….” Id. The Bill also limits a PBM’s ability to limit “the quantity
of drugs that a beneficiary may obtain at any one time….” Id. Pharmacy choice provisions may

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Disclosure Requirements
H.B. 945 mandates that PBMs disclose considerable proprietary business
information to pharmacies, prescribing physicians, beneficiaries, and HBPs. Although
PBM/HBP contracts would, under the Bill, bar HBPs from disclosing some of this
proprietary information, there are no analogous protections for information disclosed to
pharmacies, prescribing physicians, or plan beneficiaries. For example, therapeutic
interchange would require that prescribing physicians receive information regarding
manufacturer payments to PBMs.61 In addition, provisions regarding pharmacy choice
require at least certain PBM disclosures, and could be read as requiring broad,
unprotected disclosures of proprietary information. As mentioned above, a beneficiary
may elect to receive pharmacy benefits via a local pharmacy (instead of a mail order
pharmacy) or a non-preferred provider (instead of a preferred provider).62 Such
pharmacy choice is unrestricted, provided that, (a) the non-preferred provider notifies the
PBM of its willingness to confer benefits on the same terms as those offered to preferred
providers,63 and (b) a pharmacy shall, if requested to do so by the PBM in writing,
execute “the direct service agreement or preferred provider agreement which the
corporation or pharmacy benefits manager requires all of its preferred providers to
execute.”64 A PBM is obligated to verify, promptly, “the terms of the reimbursement.”65
Unclear is the extent to which full contract terms with network pharmacies must be
disclosed to non-preferred, or non-participating, pharmacies under these provisions.
What does appear clear is that the Bill’s contemplated protections for proprietary
information apply only to two of the sections expressly requiring certain disclosures.
Consumers need accurate information on price and quality to make efficient
purchasing decisions. For this reason, the FTC has challenged collusive attempts to
obfuscate price information for consumers66 and has opposed government regulation that
have economic effects similar to those of “price matching” policies (whereby a seller guarantees
that it will match the lowest available price). 	On their face, such policies may appear to be pro-
competitive. In effect however, they may tend to result in higher prices, because they reduce
sellers’ willingness to bid aggressively on price to begin with. See, e.g., Aaron S. Edlin and Eric
R. Emch, The Welfare Losses from Price-Matching Policies, 47 J. Ind. Econ. 145 (1999).
61 See notes 39-41, supra.
62 See text accompanying notes 32-34, supra.
63 Under the Bill’s “non-discrimination” provisions, § 38.2-3407.7, pharmacies must agree “to
accept reimbursement for their services at rates applicable to pharmacies that are preferred
providers”; under the “freedom of choice provisions, pharmacies may provide services if they are
willing to do so “at rates applicable” to preferred providers. § 38.2-4209.1(A).
64 See § 38.2-4209.1(D). The proposed statutory language is unclear about the choice of contract
obligations in the event that a PBMs preferred provider agreements vary.
65 Id. at § 38.2-3407.7.
66 See 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

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restricts advertising to consumers.67 But there is a difference between protecting
consumer access to the information required for a healthy benefits market and the
mandatory disclosures that would damage it. The disclosure of pharmaceutical payment
information required by H.B. 945 would not necessarily convey needed pricing
information to PBMs' current or prospective clients. Pharmaceutical payments received
by the PBM from manufacturers (along with costs such as amounts paid to network
pharmacies for drugs dispensed, operating expense, etc.) are merely one factor among
many that PBMs consider in determining competitive prices for their services. The
payments can be thought of as discounts on the costs of drug products supplied to
members of plans administered by the PBM. Therefore, the Bill’s disclosure
requirements are analogous to a requirement that a firm reveal aspects of its cost structure
to its customers. Moreover, while consumers need accurate information on price and
quality to make efficient purchasing decisions, there is no reason that consumers require
the seller’s underlying cost information for markets to achieve competitive outcomes.
The Commission found in its analysis of the Caremark/Advance PCS merger that
the market for PBM services is competitive.68 Further, plan sponsors – or the consultants
they hire to assist them in contracting with PBMs – often are highly sophisticated, repeat
purchasers of PBM services who, typically, award contracts based on sealed bidding.69
Thus, there is no indication that the market provides PBM clients insufficient information
to contract for, and purchase, competitively priced services; there are, however,
substantial and clear reasons to worry that the Bill’s mandatory disclosure provisions may
harm, rather than improve, market outcomes.
Public disclosure of proprietary information can foster tacit collusion or otherwise
undercut vigorous competition on drug pricing. If, for example, pharmaceutical
manufacturers learn the particulars of rebates and other payments and incentives offered
by their competitors, then tacit collusion among them may be more feasible. Inclusion in
a PBM formulary offers pharmaceutical manufacturers the prospect of substantially
Internet); Cal. Dental Ass’n v. FTC, 526 U.S. 756 (1999) (vacating appellate decision upholding
FTC decision finding illegal a dental association rule that prohibited advertising on price). 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).
67 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), at http://www.ftc.gov/os/2004/05/040512dtcdrugscomment.pdf; Letter from FTC to
Supreme Court of Alabama (Sept. 30, 2002), at http://www.ftc.gov/be/v020023.pdf; FTC Staff
Comments in the Matter of Direct-to-Consumer Promotion, Public Hearing before the FDA,
Docket No. 95N-0227 (Jan. 11. 1996), at http://www.ftc.gov/be/v960001.htm. See also T HE
E FFECTS OF RESTRICTIONS ON ADVERTISING AND C OMMERCIAL P RACTICE IN THE P ROFESSIONS:
T HE CASE OF OPTOMETRY, FTC Bureau of Economics Report (1980).
68 See Commission Statement, supra note 13.
69 See PBM S TUDY, supra note 3, at 8.

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increased sales. Because particular products and their manufacturers can be excluded
from formularies, manufacturers have powerful incentives to bid aggressively for
inclusion. Knowledge of rivals’ prices can dilute incentives to bid aggressively and
facilitate tacit collusion, which increases prices.70 Consequently, the required disclosures
may lead to higher prices for PBM services and pharmaceuticals.
Similarly, disclosure of contract particulars in PBM/Pharmacy contracts may
undercut competition or foster collusion between pharmacies. Pharmacies — including
large pharmacy chains — compete on drug prices for network, or preferred provider,
contracts with PBMs. Again, knowledge of rivals’ prices can dilute incentives to bid
aggressively and foster tacit collusion. The disclosure provisions may thus work in
tandem with the pharmacy choice provisions to undercut the most efficient network
contracts, leading to higher pharmaceuticals prices.71
As we found in the PBM Study, plan sponsors generally appear able to negotiate
contract terms – including terms regarding information disclosure – to protect themselves
from conflicts of interest. Press reports suggest that, as a result of competition to provide
the best mix of price and quality, many PBMs offer contracts that provide both full
disclosure and rebate sharing to their clients.72 Further, it is common for contracts to
provide for audit rights, so that HBPs can verify that pharmaceutical payments are being
shared as per agreement.73 Thus, there is no reason to suppose that competition between
PBMs is less likely than government regulation to produce efficient levels of information
disclosure. In brief, HBPs and pharmacies appear to be able to bargain for the
information they need to participate effectively in the health care market. Regulation that
damages competition by requiring anticompetitive disclosures is likely to harm
consumers.
Burdens on Therapeutic Interchange and Certain Generic Drug Substitutions
H.B. 945 also would limit greatly a PBM’s ability to implement its clients’
therapeutic interchange, and may also stand as an impediment to certain generic drug
substitution policies. The disclosures required for therapeutic interchange, for example,
would likely result in not just the dissemination of proprietary information, but the
70 See, e.g., Svend Albaek et al., Government Assisted Oligopoly Coordination? A Concrete Case,
45 J. I NDUS. E CON. 429 (1997).
71 See text accompanying notes 47-52, and n. 53, supra (regarding pharmacy choice and the
economic effects of price-matching policies).
72 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. T IMES, June 12, 2004. Panelists at the Health Care hearing also
testified that PBMs compete on price and non-price dimensions to win contracts. See IMPROVING
HEALTH CARE : A DOSE OF COMPETITION at 15-17 (2004); see also Health Care Financing
Administration, S TUDY OF P HARMACEUTICAL BENEFIT M ANAGEMENT (Jun. 2001), available at
http://www.cms.gov/researchers/reports/2001/cms.pdf.
73 See PBM S TUDY, supra note3, at 58.

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imposition of significant administrative costs on otherwise efficient pharmacy practices.
Collectively, such requirements may constitute an impediment or bar to interchanges that
would lower health plan costs overall. In addition, certain threshold savings requirements
for therapeutic interchange may be difficult to establish.74 For example, a plan’s net cost
for a drug with a higher Average Wholesale Price may be lower than its cost for the
prescribed drug, once pharmaceutical payments or market share payments are taken into
account.75 Overall, the PBM study indicates that, (a) health plans can benefit from
therapeutic interchange,76 (b) interchange with apparently more costly drugs need not
harm plans or beneficiaries,77 and (c) plans presently contract for diverse protections
against interchanges that are actually costly.78 The Bill’s restrictions on therapeutic
interchange are likely to limit PBMs’ ability to obtain benefits, potentially resulting in
higher costs for consumers. The regulatory protections contemplated by the Bill thus
seem both unnecessary and expensive.
Conclusion
Allowing competition among PBMs is more likely to yield efficient levels of
payment sharing, disclosure, and price than mandating the terms through government
regulation. By forcing health plan sponsors to accept contractual terms they would not
otherwise bargain for, H.B. 945 will probably increase the price of pharmaceutical
coverage; ultimately the number of Virginians who have pharmaceutical coverage, and
the scope of coverage for those who have it, is likely to be suppressed. As an 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 cost of pharmaceuticals, the more people skip doses or do not
fill their prescriptions.”79
At the same time, there does not appear to be any compelling reason to restrict
competition to protect pharmacies or HBPs. As we concluded in the PBM Study, HBPs
74 Although those requirements pertain equally to generic substitutions, savings typically are
likely more transparent when generic products are substituted for branded ones.
75 Market share payments are used by pharmaceutical manufacturers to encourage PBMs to
dispense their drugs, especially in crowded therapeutic classes. See PBM S TUDY, supra note 3, at
7.
76 See id. at 92-94.
77 See id. at 94-95.
78 See id. at 90-92.
79 William Sage, David A. Hyman & Warren Greenburg, Why Competition Law Matters to
Health Care Quality, 22 HEALTH AFFAIRS 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 CARE AND THE P UBLIC
S ECTOR, NBER Working Paper W8802, Table 5 (Feb. 2002), available at
http://papers.nber.org/papers/W8802.

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appear well able to protect themselves from potential conflicts of interest for PBMs. If
the Virginia General Assembly nonetheless is concerned that some plan sponsors may be
unable to protect themselves through arms-length contracts, we would suggest that the
General Assembly consider modifying H.B. 945 to allow plans sponsors to waive its
requirements. This would allow those sponsors who want to employ PBMs on terms
other than those in the Bill to do so.
We urge the Virginia General Assembly to consider the adverse effects on
competition and consumer welfare that H.B. 945 will likely produce. We appreciate this
opportunity to share our views and welcome any further discussions regarding
competition policies.

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