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How Pharma Reference Pricing Can Contain Healthcare Costs


Reference pricing models are emerging as increasingly popular approaches for lowering drug costs.



Shifting federal regulations are causing chaos within the healthcare industry, and everyone is trying to adapt to the changing landscape while keeping costs somewhat manageable for employers and consumers. Prescription drugs, which represent the third-largest and fastest-growing cost center in healthcare, are a main driver of these ever-climbing healthcare costs. As a result, the pharmacy benefit manager (PBM) model is under growing scrutiny as industry insiders and outsiders alike are calling this model what it is: an opaque, necessary evil in need of a major overhaul.

Amid this intense period of change, a technique known as therapeutic reference pricing is emerging as a powerful and increasingly popular program for lowering drug costs. Because many brand-name and even generic drugs today have lower-cost equivalents that are equally clinically effective, reference pricing programs can dramatically reduce costs by establishing therapeutic equivalent benchmarks to encourage members to select least expensive alternatives. 

While reference pricing has long been used in the federal systems common in European countries with great success, it is only recently gaining traction in the U.S. due to new technological advancements, as well as new research proving the program’s efficacy being featured in journals, such as New England Journal of Medicine. To maintain a competitive edge in the new era of healthcare, forward-thinking employers, benefit administrators, and plan sponsors are looking at implementing reference pricing to achieve optimal savings for their organizations across an array of industries.

How reference pricing works

Historically, there have only been so many levers for plan sponsors to pull in order to affect costs-and most of these levers have been variations on benefit reduction or cost-shifting. Reference pricing is a real cost-reduction lever that results in immediate and ongoing savings of 15% to 20% per year, without reducing benefits or increasing member out-of-pocket costs. A reference pricing model leverages complex algorithms to correlate lower-cost, therapeutically equivalent drugs with the utilization patterns of the specific member population, and then combines customized member communications with changes to sponsor contribution levels to encourage members to switch to the least-expensive medications.

While this may sound like a simple solution-it’s not. Because of the dynamic nature of drug pricing, the frequency of new medications hitting the shelves, and the wide-ranging clinical conditions in any given benefit population, it takes a carefully constructed program combined with finely-tuned algorithms, continuous recalibration, and deep knowledge of behavioral economics to successfully lower costs.

What makes reference pricing unique

By design, reference pricing achieves savings that surpass those from other drug pricing models. For example, step therapy and therapeutic substitution models have experienced some success but are limited by their primary focus on switching from brand-name to generic drugs. For several years now, generic drug prices have been in a state of flux, thanks to loose federal regulations. This has resulted in a market with a wide range of cost differentials between clinically equivalent generic drugs-and between generics and brand-name equivalents-including cases where a generic is more expensive than the brand. Because of these market dynamics, the financial impact of generic-oriented cost reduction programs has become muted at best.

Taking a more holistic approach to medication switches, reference pricing incorporates real-time drug pricing data and a proprietary algorithm that identifies the best equivalents at the lowest cost for each drug, and for every member. It then leverages principles of behavioral economics and other best practices for member communications to minimize member abrasion through the transition to the new copay design.

Compared to traditional programs, reference pricing delivers a dramatic increase in savings on pharma spend. An average reference pricing program will see 41% of therapeutic switches from high- to low-cost generics, frequent swaps from high-cost generic to low-cost brand-name options, and a nominal 7% increase in the generic dispensing ratio (GDR).

The Lipitor case

The brand-name cholesterol medication, Lipitor, has long been one of the most popular and best-selling brands in the U.S., ranking seventh on a Business Insider list of the 10 most popular drugs of 2017. With an average cost to the plan of approximately $184 per script, Lipitor is not just popular but costly. So it was a big deal when a generic version of Lipitor (atorvastatin) came on the market two years ago, with a cost of only $36 per fill. That represents a savings of $148 per fill, especially significant for employers and plans with thousands of members on Lipitor. As a result, in the last year most plan sponsors have applied incentives to shift members from Lipitor to atorvastatin.

However, the story doesn’t end there. Just because a drug is a generic doesn’t mean it is the lowest cost alternative. In this case, there is another therapeutic equivalent in this category that lowers LDL cholesterol just as effectively as Lipitor and atorvastatin, called simvastatin. Simvastatin is based on a different active ingredient, but yields the same clinical impact on the underlying disease, and costs only $7 per fill-an additional $29 in savings per script and per employee.

The Lipitor/atorvastatin/simvastatin case is an excellent example of the impact that more sophisticated reference pricing programs can have over simple mandatory generic programs.

Implementing a reference pricing model

As the Lipitor example illustrates, the potential savings associated with switching members to therapeutic equivalent drugs can be very significant. However, the available alternatives and their pricing can change frequently, and one of the biggest challenges for reference pricing advocates is keeping up-to-date on drug pricing and availability to ensure that they maintain the appropriate right switching logic to streamline savings.

Fortunately, there are experts and organizations devoted solely to the science of medication switching, and they are valuable partners in any reference pricing initiative. This type of partner can provide access to sophisticated algorithms to identify appropriate drugs to target, the clinical equivalent options, and the appropriate switching logic-while also tailoring the program to reflect the specific medications the members are prescribed. Reference pricing experts can also help plan sponsors routinely check prices of existing and new-to-market drugs to best identify all cost-saving opportunities. A partner can also support and streamline member communications by providing the tools they need to be more involved in their own healthcare, as well as to talk to their doctor about the pros and cons of switching to a lower-cost medication.

The bottom line

Given the large and growing cost of pharmacy as a percentage of overall health benefit costs, it is imperative for plan sponsors to investigate and implement new types of cost-savings programs. Reference pricing presents an opportunity for plan sponsors to achieve an average savings of 15% to 28% on plan spend, as well as save its members an average of 10% to 15% per prescription. Reference pricing will continue its growth as an attractive and effective strategy, and progressive purchasers are already focusing on getting these programs designed and implemented in order to be successful in the coming year.


David Henka is CEO at ActiveRADAR, a company specializing in pharmacy cost-reduction programs based in Sacramento, California.

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