Health Middlemen Thrive, Employers Try to Tame Them
Some Seek More Transparency, Deal With Doctors Directly;
Fighting for Drug Rebates; Caterpillar Uses Its Leverage
By David Wessel, Bernard Wysocki Jr. and Barbara Martinez
The Wall Street Journal
Friday, December 29, 2006
Chicken producer Perdue Farms Inc. used to hire a big health
insurer to bargain with doctors. Gradually, over a decade
it cut out the middleman, dealing directly with doctors and
hospitals just as Wal-Mart Stores Inc. often buys directly
from manufacturers instead of using wholesalers. That has
helped Perdue keep its health costs below the national
Caterpillar Inc. used to rely on a middleman to provide
prescription-drug benefits to employees, but -- like many
U.S. employers -- it didn't have any way to know how much it
was paying for drugs and how much was going to the
middleman's bottom line. It demanded a different, more
transparent deal, and its drug costs fell.
Perdue and Caterpillar are grappling with a big issue in
U.S. health care: the role of middlemen. Employers are
trying to make sure they get their money's worth from
intermediaries, some of whom are reaping bonanzas as they
stand between patients, doctors and those who pay the bills.
A lot of the money that goes to health-care middlemen is
well spent. It allows employers to combine their purchasing
power for leverage with hospitals and drug makers. It
harvests data to uncover which new procedures are valuable
and which aren't. Middlemen offer health-care expertise to
employers who don't have it and don't want to hire it.
But a lot of the money goes more toward fattening
middlemen's bottom lines than toward improving the quality
or efficiency of American health care. "At the end of the
day, the only reasonable conclusion is that we waste a huge
amount of money on the most nuttily cumbersome
administrative system in the world," says Henry Aaron, a
Brookings Institution economist.
While the middleman business booms, health-care costs keep
rising, the ranks of the uninsured grow, and paperwork
expands as each party in the system tries to enlarge its
slice of the pie. "There's more money to be made by
monitoring cash flow than monitoring patients," says David
Cutler, a prominent Harvard University health economist.
Middlemen aren't unique to health care. Banks serve as
middlemen between saver and lender. In the age of Orbitz
and airline Web sites, some people still find travel
agencies worth the fees. Distributors and wholesalers
remain a vital cog in much of U.S. manufacturing.
But while the Internet, deregulation and relentless
corporate cost-cutting have squeezed middlemen elsewhere,
the health-care middlemen are prospering. The three largest
pharmaceutical benefit managers, for instance, had net
income of $1.9 billion last year, a sum that exceeds the
annual operating budget of New York's Memorial
Sloan-Kettering Cancer Center. In corners of the system
such as Medicaid managed care and nursing-home drugs,
little-known intermediaries rack up tens or hundreds of
millions of dollars in profit.
With health-care spending now at 16.5% of the nation's
economy and climbing, an urgent question is how to squeeze
out the waste connected with middlemen -- without squeezing
the valuable services they can provide. Some say the only
solution is a top-to-bottom overhaul of the American
health-care system. But that's far from a universally held
view and is politically impractical.
In some other countries, a single government entity does the
health-care buying, keeps a lid on prices and limits the
availability of care. That's not the American way, at least
not now. The fear is that rampaging bureaucracy could do
more damage than any middleman. Uwe Reinhardt, a Princeton
health economist, says the conventional wisdom in the U.S.
is: "Because you cannot trust government to do anything
right, you always have these private middlemen, who cost
more money." From its birth, for instance, Medicare has
always used private companies to handle claims and
Decades ago, there was little to stop doctors and hospitals
from piling on visits and procedures to boost their income.
Gradually those paying for care developed ways to counteract
these perverse incentives, encouraging the rise of
middlemen. Today, each player in the health-care business
seems determined to get a bigger share of the money pot and
prevent others from taking unfair advantage.
A unit of health insurance giant UnitedHealth Group Inc.
called Ingenix offers technological weaponry to all sides in
this arms race. It sells software to doctors to "achieve
optimal reimbursement" and "increase cash flow" and to
hospitals to "optimize every aspect of a facility's revenue
cycle." It also sells software to insurers for "effective
cost-control initiatives" and to government agencies to
"significantly reduce claim expenses." Ingenix revenues are
running at a rate of $1 billion a year. Its pretax
operating profit margin was an impressive 23% in the quarter
ended Sept. 30.
The fragmented nature of the U.S. health-care system also
increases demand for middlemen. Only a minority of
Americans get health care from entities that integrate all
facets of medical care, such as Group Health Cooperative
Health System, a Seattle health-maintenance organization
with 523,000 members. Group Health doesn't hire
pharmacy-benefit managers. It employs its own pharmacists
to devise a formulary and monitor usage. It also preaches
the virtues of generics to doctors and patients. Group
Health buys drugs directly from manufacturers, increasing
its bargaining clout by teaming up with the nation's largest
HMO, Kaiser Permanente, which has 8.4 million members.
Here are some of the other efforts to change the way
middlemen are used:
Most big companies in the U.S. are "self-insured," meaning
they pay employees' medical bills out of their own coffers.
These companies typically hire a health insurer such as
UnitedHealth or WellPoint Inc. to administer the health
benefit -- negotiating rates with doctors and hospitals and
deciding what care is covered.
Perdue Farms, the Salisbury, Md., poultry empire, contracts
with doctors and hospitals directly. The company has 15
poultry plants and 22,000 employees scattered across rural
communities in the eastern U.S., mostly in tiny towns such
as Perry, Ga., where it is a dominant employer. That gives
Roger Merrill, an internist who has been Perdue's chief
medical officer since the early 1990s, a lot of bargaining
clout with local doctors and hospitals. In exchange for
favorable prices, he promises to pay bills within eight
days, much quicker than the 60- to 70-day norm in health
care. (Dr. Merrill relies on an outside contractor to
handle billing paperwork.)
Perdue also avoids second-guessing hospitals or doctors over
individual procedures. Dr. Merrill says patients usually
get what they want and it isn't worth it trying to stop
them. It's better, he says, to bump wasteful doctors out of
Perdue's network. Like Medicare, Perdue pays hospitals
fixed prices for patient stays, to discourage unnecessarily
long hospitalizations. With help from a Houston consultant,
Howard Lester, Perdue has struck deals with about 60
hospitals and 12,000 doctors, most in groups affiliated with
Dr. Merrill says he likes dealing directly with the
suppliers. "I want to buy a product -- health -- rather
than a process," he says.
Kenneth Sperling, senior vice president at Cigna Corp. --
the big health insurer Perdue used to use for claims
processing -- says direct contracting "is an exception, not
a rule." Most employers don't have the volume to make it
work, he says, and "the more volume you have, the more
leverage. It's true in health care, in paper clips or
The approach requires more staff and expertise than most
employers have. Southern California Edison used direct
contracting in the early 1990s. It shaved 20% from its
health-care bill after accounting for the extra staff it
needed, says Jacques Sokolov, a physician who ran the effort
and is now an independent consultant. "By every metric we
had improved. And providers were satisfied. And every
insurance company and HMO was unhappy that any corporation
could manage their business," he says.
But handling all the negotiations and paperwork with doctors
required a 300-person department. In 1995, new management
switched to a conventional offering of coverage through
insurers, says Dr. Sokolov. "The vast majority of large
corporations don't really want to be in the business of
managing health-care costs," he adds. A spokesman for
Southern California Edison, part of Edison International,
declined to comment.
Perdue's health-care tab is rising more slowly than other
employers and runs less than half of the national average of
roughly $7,000 per capita per year, according to Dr.
Merrill. Direct contracting is only part of the company's
strategy. It also has opened in-house clinics at most
Perdue plants that screen employees for high blood pressure,
diabetes and other chronic diseases that can be costly if
not treated properly. The company does use conventional
insurance in such cases as covering employees when they're
Fire the PBM
The University of Michigan once relied on Caremark Rx Inc.,
one of the big three U.S. pharmacy-benefit managers, to
administer its prescription-drug benefit. But Keith
Bruhnsen, the university's assistant director of benefits,
chafed at the common practice among PBMs of receiving
rebates from drug makers. The rebates are usually in
exchange for the PBM promoting the use of certain preferred
drugs. PBMs may share their rebates with employers, but
they don't always do so.
Mr. Bruhnsen thought Caremark was sometimes steering
Michigan employees toward drugs for which it got rebates
instead of the ones that would save the university the most
money. "The drugs that they had negotiated rebates on were
not best-value drugs," he says.
He was worried, for example, when he saw doctors receive
information from Caremark plugging Concerta, a Johnson &
Johnson drug for attention-deficit hyperactivity disorder.
Concerta is an extended-release form of a medicine whose
active ingredient is available more cheaply in generic form
. (Caremark has noted in literature for medical
professionals that generic ADHD drugs "should be considered
the first line of prescribing.")
Big PBMs make their money from a variety of sources which
aren't necessarily disclosed: drug-maker rebates, margins
on drugs sold via the pharmacy counter or the PBMs' own
mail-order operations, and other payments.
Mr. Bruhnsen replaced Caremark with SXC Health Solutions
Inc. of Milton, Ontario, which has a different model. The
university pays SXC the cost of the drug plus an
administrative fee on each of its 900,000 claims per year.
Mr. Bruhnsen won't disclose the fee but says it is less than
$1 per prescription. If SXC gets any rebates, they go to
Mr. Bruhnsen expects drug costs for the university's 80,000
covered workers and family members to rise about 6.2% this
year to about $72 million this year. Last year, when
Michigan was using Caremark, costs rose nearly 12%.
Caremark declined to comment. Mark Merritt, president of
the PBM trade association, the Pharmaceutical Care
Management Association, says, "Fee-based plans haven't had a
lot of uptake in the marketplace." He says fee-based
middlemen have little incentive to bargain hard with drug
makers for discounts and rebates. He also says big PBMs
strive harder to push employees to low-cost generics, making
them the best choice for employers.
When Sidney Banwart became Caterpillar Inc.'s vice president
for human services in 2004, he discovered a difference
between suppliers of health-care services and suppliers of
steel and tires. In health care, he says, "we were doing
business in the manner in which the suppliers had
established even though we were paying the bills."
The construction-equipment maker's PBM was Restat of West
Bend, Wis., a unit of privately held F. Dohmen Co. Mr.
Banwart found it hard to tell how much Caterpillar was
paying for drugs and how much for Restat's services.
Mr. Banwart says he told Restat, "You've got to be
transparent. We need to know what the costs of the drugs
are." He insisted on a new method under which Caterpillar
would get all the drug-company rebates and pay Restat
specified fees for the services it provided.
Caterpillar started the new approach in 2005. Caterpillar's
drug spending fell to $157 million that year from $166
million in 2004. This year, Mr. Banwart expects spending to
be flat or slightly down. In the new year, using some of
the savings, Caterpillar will eliminate co-payments on some
drugs for chronic conditions, such as high cholesterol, to
encourage employees to take them.
Restat Chief Executive Michael Clark, eager to hold onto a
big customer that it had served since 1992, says he's happy
with the outcome. "Caterpillar understands the PBM wants to
make money, too, and we came to terms on what a fair
reimbursement was," he says. About a third of Restat's
customers have opted for fully transparent, fee-only deals
similar to Caterpillar's, while many others prefer the old
way, he says.
Now Mr. Banwart is at the forefront of a business campaign
to press PBMs for more transparency. He is chairman of a
coalition of 56 big companies sponsored by the HR Policy
Association. Ten PBMs, including big ones such as Medco
Health Solutions Inc., have agreed to comply with the
coalition's transparency standards. Certified PBMs agree to
hand drug-company rebates over to employers or employees.
The standards also say that when a PBM pays a pharmacy for
drugs dispensed, the PBM can pass on only that amount to the
employer -- not tack on a margin. Participating employers
say they've reduced drug spending 3.5% to 6.2% at a time
when other employers are seeing drug costs rise.
The combined leverage of the employers was key, Mr. Banwart
says. "A strong coalition of brand-name companies said we
were serious about transparency," he says. "It's hard to
argue about transparency. It's like motherhood and apple
Some in the business question how far PBMs will open their
books and whether employers can understand the numbers. In
a recent report, Mercer Human Resource Consulting, part of
Marsh & McLennan Cos., says "very few PBMs [are] willing to
provide true (100 percent) transparent arrangement."
Mr. Merritt, the PBM trade association president, says
transparency is a vague term and more of it may not save
employers money. He warns against "micromanaging or
creating something so ham-handed that there's no way for
different players to find ways to save money in ways that
are proprietary or innovative."
-- Heather Won Tesoriero
contributed to this article.
Write to David
firstname.lastname@example.org, Bernard Wysocki Jr. at
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