brand logo

With drug costs likely to increase significantly in the next decade, it's more important than ever to know when to say ‘no’ to risk contracts.

Fam Pract Manag. 1999;6(6):17-21

After several years of near-zero growth, U.S. health care costs can be expected to increase dramatically over the next decade, from 13.6 percent of the gross domestic product to 16.6 percent by 2007. This forecast comes from economists in the Department of Health and Human Services (DHHS) writing recently in Health Affairs.1 In fact, we can already see evidence of their forecast's validity: Several major managed care organizations (MCOs) increased their premiums for 1999 by close to 10 percent.

Sharp increases in health care spending may not exactly sound like breaking news. After all, the last five years or so have been the exception to the rule of the previous 30, when federal entitlement programs (particularly Medicare) coupled with the inflationary pressures of costly new technologies made cost increases seem unstoppable. The recent period of cost control in health care has resulted from service consolidation and competition in the managed care industry. Indeed, in the last three years, most MCOs have competed for membership almost exclusively on price, cutting premiums so aggressively that almost all the major MCOs have suffered losses. These losses have forced several health care plans to downsize, and some have had to declare bankruptcy or close completely. That the insurers would eventually increase their premiums again isn't exactly a surprise.

But the report from the DHHS Health Expenditures Projection Team suggests that the primary causes of this next round of health care cost increases will be substantially different from what we've seen over the past 35 years. Understanding these differences will be critical for medical groups and IPAs assuming risk in areas beyond their own services.


  • Drug costs are said to be likely to increase by 6 percent or more annually for the next decade.

  • Capitation contracts that include pharmacy risk may be too risky for medical groups and IPAs now.

  • Several medical management tips can help those groups that do take on risk for drug costs.

  • The opportunity to profit from sharing risk for other medical services may also be at an end.

Watch drug costs

The big contributor to this round of cost increases, says the DHHS team, will be drug costs. In fact, increases in drug expenses of 6 percent or more per year should be considered the baseline for the coming decade. Therefore, expect that small errors in pharmacy utilization management (UM) will produce large unanticipated losses. The question medical groups and IPAs should be asking in the next 10 years is whether they can wisely enter into or continue capitation arrangements that include pharmacy risk.

The DHHS analysts say three factors will underlie the increases in pharmacy costs:

  • Continued reductions in patients' out-of-pocket payments for prescriptions,

  • Increasing use of prescriptions and greater “intensity” of prescribing (i.e., more prescriptions per patient per visit),

  • An increase in the introduction of new drugs.

These influences are clearly related: Declining out-of-pocket expenses will fuel demand for prescriptions. The introduction of new drugs always means an increase in unit cost, and it can also cause the number of prescriptions per patient to rise as agents used to prevent chronic diseases (e.g., the “statin” HMG-CoA reductase inhibitors for hypercho-lesterolemia) become standard for increasingly younger populations.

In my experience, even health care plans with the best information systems, robust pharmacy databases and rigorous physician education programs have seen a steady rise in the number of prescriptions per member during the last 10 years. The DHHS economists' report suggests that we can expect this pattern to worsen in the next decade and become a “hardened” trend in practice that neither individual physicians nor systematic programs are likely to influence much.

Another trend promising to increase the demand for prescriptions is direct-to-consumer marketing. The past five years have witnessed awesome growth in the power of the pharmaceutical industry to create demand for new medications through “direct detailing” on TV and the Internet. Even the most reasonable patients in my practice ask whether they're “missing out on something really great” by not taking a new lifestyle miracle drug that promises thinness, more hair or better sex. Clearly, the power of pharmaceutical marketing dwarfs the influence of the most informed and diplomatic physician trying to advocate for medically sound drug utilization within the constraints of the limited appointment times available for HMO members. The “good doctor” has become a cipher in patients' evaluation of whether a particular drug is right for them.

Contract with increases in mind

Despite having state-of-the-art information technology and the most aggressive drug UM programs, medical groups can expect their efforts to have less effect on prescription costs in the coming 10 years than they might have had in the past decade. All groups that assume risk for pharmacy expenses would be well-advised to include the estimated 6 percent cost increase as a baseline in risk-sharing contracts with insurers. The size of the account may well determine whether a medical group wants to contract for pharmacy risk at all. (For some questions to consider before assuming pharmacy risk, see “Should our group take risk for pharmacy costs?”)

Should our group take risk for pharmacy costs?

Is assuming pharmacy risk worth the risk? Here are some questions to consider:

  • Can your medical group prescribe medications more cost-effectively than everyone else in the community — but still similarly? Even as you try to manage drug costs, your prescription practices will need to parallel community practices. Variation from community norms will prompt patient questions and the need for increased patient education (either in the exam room or as a separate program, with some expense). On the brighter side, varying from community prescribing practices may actually improve patient outcomes. Capture this information as best you can and report it (advertise it!) to insurers and patients alike.

  • Do you know what pharmaceutical costs you can really influence? The key is to identify them and focus on them. Find the three drugs that account for the highest costs and the three practice sites with the highest drug expenditures, and then make it a priority to manage these cost areas. You should also play to your group's strengths by focusing on savings in areas of practice where your collective expertise can help you avoid delays in diagnosis and therapy — thereby saving money by getting people better faster. Finally, seek to manage the use of treatments, such as chemotherapy, that have extraordinarily high costs. These treatments can't be avoided, but your review team can seek to control them. “Internal detailing” and patient education are critical to support changes in prescribing patterns, as are ongoing monitoring and explaining of the results to group members.

  • Do you know how much it costs per member per month to perform pharmacy utilization management? Ensure that this expense is less than what you have put at risk.

Bear in mind that effective, systematic medical management costs money, and the law of diminishing returns applies when the size of the group is small. Preparing a thumbnail estimate of these costs can help your group or IPA determine the likelihood that you will profit from a given contract. (For an analysis of one hypothetical group's experience, see “The costs of pharmacy risk contracting.”)

The costs of pharmacy risk contracting

Hometown Medical Associates, a large multispecialty group contracting with Mega Health Plan for full-risk capitation, receives $5 per member per month (PMPM) for pharmacy costs. Hometown's managers believe they can keep drug expenses at $3.75 PMPM. A total of 30,000 patients sign up with Hometown through Mega. Hometown's pharmacy utilization management (UM) effort costs approximately $30,000 monthly in physician, support staff and overhead costs ($1 PMPM).

Several new drugs are introduced during the contract's first year, and two bone marrow transplants during the fourth quarter result in extraordinary medication expenses that are expected to continue into the contract's second year. The UM team locates a discount vendor for some of the chemothera-peutic agents, and it directs the patients to outpatient chemotherapy services. First-year pharmacy costs (not including the UM expenses) run to $4.32 PMPM.

Hometown saved 68 cents PMPM of its pharmacy capitation, but it spent more than this on its drug UM efforts ($1 PMPM) — thereby losing 32 cents (or $9,600) PMPM. More worrisome for Hometown's managers is the knowledge that the contract with Mega calls for a lower capitation for year 2 of the contract, as well as the projection from economists at the Department of Health and Human Services that drug costs are likely to increase 6 percent (or 30 cents PMPM) that year.

If your group is considering a pharmacy risk contract, you would be well advised to work through this sort of calculation with some hypothetical scenarios in mind before you sign the contract rather than after it has run for a year.

10 tips for managing risk

On the other hand, for relatively large, well-organized and skillful groups, pharmacy risk-sharing arrangements still represent a source of opportunity to improve the bottom line and provide excellent care to patients. But to benefit from these arrangements financially, medical groups will need to use every tool in their medical management toolboxes. Here are some specific tips:

  1. Monitor pharmacy utilization through detailed weekly and monthly reporting for both individual physicians and practice sites. The group's leadership and managers must review these reports and act on them if they want to manage pharmacy risk. Medical groups that can't generate these reports shouldn't even consider assuming pharmacy risk.

  2. Maintain a constant focus on the pharmacy budget and try to anticipate areas of expense growth. It's particularly important to keep an eye on the largest expense categories. One useful approach is for the management team to concentrate each month on one category of chronic-disease medications plus one or two “acute outliers” for that month (i.e., agents whose utilization is unexpectedly high). This will help you stay on top of your utilization patterns so that blips don't become trends.

  3. Provide regular feedback to physicians — both individual data and data for each practice site. The feedback should document prescription utilization (highlighting medications you've identified as priorities for aggressive management), and it should offer tips and guidelines for medical management using equally effective but less-expensive drugs.

  4. Provide large-group CME sessions on appropriate broad-interest topics in pharmacy management. The sessions should be based on nationally recognized guidelines and criteria (e.g., the recent CDC guidelines for antibiotic use in children2). Consider mandating or providing incentives for attendance at these sessions.

  5. Provide small-group CME based on the needs of particular practice sites. For example, you might want to review the appropriate use of selective serotonin reuptake inhibitors in a practice with a large proportion of patients who have depression.

  6. Take a page from the drug reps' playbook and practice “counter-detailing”: Develop specific, brief bulletins about new drugs or season-specific medications and circulate them on group stationery to physicians.

  7. Practice counter-detailing in the waiting room and exam rooms by providing handouts explaining formulary restrictions for each insurance plan and by educating patients about new drugs and season-specific medications.

  8. Promote the use of over-the-counter (OTC) medications to both physicians and patients. Using OTC analgesics and cold preparations, for example, not only helps save prescription expenses but also avoids needless costs associated with refills.

  9. Cultivate physician champions who will advocate for medically sound therapy using less expensive medications.

  10. Pursue focused disease management for chronic conditions, choosing the conditions to target based on the expense of the drugs used to treat them. You may find it is cost-effective — and higher quality care — for all patients with certain conditions to be evaluated by the appropriate specialists annually, with an eye toward moving some of them off unnecessary (and expensive) medications that otherwise might be continued as endless monthly refills.

Other risky areas

In the early days of risk sharing, some capitated groups and IPAs achieved great success by assuming risk for many other medical services. Some of these groups even found themselves able to purchase and run hospitals and urgent care facilities. This consolidation of services had advantages related to both economy of scale and ease of medical management. Following the same line of reasoning, many medical groups have recently committed considerable resources to developing hospitalist programs to expedite emergency and inpatient care. These groups are gambling that they will see savings from decreased hospital admissions and lengths of stay, and they have long-term hopes for additional savings from improved outcomes.

But the DHHS report suggests strongly that the opportunity to imitate the wild successes — and profits — of the early capitated groups in consolidating medical services has passed. According to the report (and the sense of the industry generally, according to several consultants), the savings in hospital, nursing home and specialty referral costs that might be achieved through medical management may have already been gained in most medical markets. In other words, the window of opportunity for capturing these savings for your group's bottom line may well have closed in your area. (To help you gauge whether such savings may still be available, see “How competitive is your medical market?”)

This conclusion aligns with predictions by many industry gurus that the service-consolidation (“arbitrage”) phase of HMO-generated savings in national health care spending would be over by the late 1990s. These gurus also predict that the next round of savings — reduced costs through improved quality — will be dearly bought with more comprehensive medical management investments involving sophisticated information systems and expert staff (in other words, through spending a lot of money). Needless to say, these kinds of capital risks pose a barrier for smaller, independent groups hoping to enter the risk-sharing market. After many years of making (and losing) large capital expenditures in the pursuit of quality, the large health care plans are still measuring “quality savings” in fractions of percentages of multimillion-dollar budgets. It's not exactly welcoming territory for a medium-sized group or IPA.

How competitive is your medical market?

Are there still significant savings in hospital, nursing home and specialty referral costs to be gained in your area through improved medical management? The answer depends on the level of competitiveness in your area. The more competitive your medical market, the riskier your risk-sharing arrangements will be. Here are some characteristics you can use to evaluate your market's level of competitiveness.

Managed care penetrationDominant insurance plansCommercial hospital bed days per thousandContracting rates for specialty servicesDominant provider mix
Uncompetitive marketsLow (less than 10 percent of covered lives)PPOs and indemnity insurance plansGreater than 250Often more than 150 percent of MedicareSmall groups, solo practices and individual hospitals
Moderately competitive marketsIncreasing (10 percent to 20 percent of covered lives)PPOs and HMOs; indemnity insurance plans are still activeAbout 200Rarely more than 150 percent of MedicareTransitional medical groups (some very large); many solo doctors retiring, closing or merging practices; small hospitals merging or closing
Highly competitive marketsHigh (20 percent to 40 percent of covered lives), with three or four national corporations dominating the marketPPOs and HMOs; indemnity insurance plans are rareLess than 200Often less than 100 percent of MedicareLarge medical groups, a few medical center hospitals and their affiliates

Risk exposure vs. opportunity

Although savings related to service consolidation have been fairly reliable and predictable thus far, most experts agree that these are onetime savings — and that the “one time” has come and gone in many areas. Thus, the issue for groups and IPAs now is one of risk exposure vs. risk opportunity: Where there is little chance to profit from major steps to improve efficiency, why be exposed to the risk of cost increases, particularly in pharmaceuticals, that could tie up your opportunity capital? Clearly, the message from the DHHS Health Expenditures Projection Team is that most medical groups should limit their exposure to risk for pharmacy costs. To everything there is a season, and the season for pharmacy risk sharing seems to be coming to an end.

Continue Reading

More in FPM

More in PubMed

Copyright © 1999 by the American Academy of Family Physicians.

This content is owned by the AAFP. A person viewing it online may make one printout of the material and may use that printout only for his or her personal, non-commercial reference. This material may not otherwise be downloaded, copied, printed, stored, transmitted or reproduced in any medium, whether now known or later invented, except as authorized in writing by the AAFP.  See permissions for copyright questions and/or permission requests.