Inside a Drug Formulary

Posted on Monday, June 03, 2019

Your company, like most employers, probably has a prescription drug program that includes a drug formulary. You may know how the formulary works with your co-pay design by providing incentives for members to make cost-effective medication choices. Now, peek behind the curtain and see how the formulary works from the insurer's side. 

Formulary Defined

A formulary is a list of medications that are the preferred treatments for patient conditions. A health plan's formulary can be used as a guide when a doctor is prescribing drugs for his or her patients.
As a rule, formularies are developed by a committee of physicians and pharmacists who work with a health plan. They ensure that the drugs listed are the most appropriate choices from a clinical standpoint, while also being the most-cost effective medications.  

Usually an insured patient can choose another equivalent drug, but choosing drugs on the formulary plan saves out-of-pocket expense.


The Purpose

Insurers (and employers) use formularies to manage costs and improve care. When a pharmaceutical company introduces a new drug that is similar to other drugs already available to treat the same disorder, it is considered to be "therapeutically equivalent" or, work in the same way to treat the condition. Given an equal choice, the insurer might offer only the less expensive drug in its formulary (for example, "equal quality at a better price") or require a higher co-pay for the more expensive drug. 

In the case of Lipitor versus Pravachol, both drugs belong in a therapeutic class called "statins." They lower cholesterol by slowing down the body's ability to make cholesterol. Drugs in this class include atorvastatin (brand name Lipitor), fluvastatin (Lescol), lovastatin (Mevacor), pravastatin (Pravachol), and simvastatin (Zocor). Consequently, the insurer may choose to cover only one or two of these drugs, based on its ability to negotiate favorable pricing.

Drug Selection

Insurers use a pharmacy and therapeutics committee to select formulary drugs. The committee reviews the medical research on drugs within therapeutic categories. Within each category, they select drugs that are "best in class" for inclusion on the formulary. The insurer then works to negotiate the best prices for the selected drugs.

The committee also tracks trends in side effects and outcomes of various drugs and may conclude that a drug should be eliminated if ongoing research suggests that the benefits are not as real as the manufacturer originally claimed. In this way, the formulary protects plan members from drugs that aren't performing as planned.

Cost Factors

Insurers, or more frequently sub-contracted pharmacy benefit managers, reach a deal on the purchase price of drugs based on three factors:

1. Volume - Insurers negotiate pricing based on the volume of drugs they expect to purchase - the greater the volume, the lower the price. To the extent that a formulary delivers greater volume of one drug over another, the formulary creates a volume advantage that is useful in negotiation.

2. Class of Trade - Drug manufacturers must follow a "class of trade" system that provides:

The lowest pricing to the federal government.
Next lowest pricing to hospitals, followed by HMOs and retail purchasers.  

Insurers that qualify as HMOs or represent other captive populations will usually achieve a pricing advantage due to special status pricing.

3. Ability to Move Market - The formulary is important in delivering market to manufacturers. When an insurer or pharmacy benefit manager can tell Pfizer, the manufacturer of Lipitor, that all (the term "all" is always qualified) prescriptions for cholesterol-lowering drugs will be written for Lipitor (versus Zocor or Pravachol) they are "delivering market" and creating a competitive advantage for Lipitor that Pfizer is willing to pay for through lowered pricing.


Formularies can improve care through the ongoing review of drug effectiveness. This can lead to better choices based on the latest research and cause market forces to deliver lower pricing

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Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.

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