It’s not surprising that the multi-billion dollar pharmaceutical industry attracts a great deal of government scrutiny. As prescription drug prices and uninsured rates continue to climb, states and the federal government are constantly watching the activities of major players in the industry, seeking to root out wrongdoing and wastefulness that raise consumer prices.

To achieve that, Maine took a hard look at the practices of pharmacy benefit managers (PBMs)–the powerful middlemen between drugmakers and large purchasers, such as insurers, Medicaid and health plans. PBMs pool the purchasing power of these entities to negotiate volume discounts and rebates with manufacturers, a practice that–at least in theory–lowers purchasers’ costs.

However, when Maine legislators looked at the PBMs’ practices, they saw something else–secretive operations that lined the PBMs’ pockets and helped certain manufacturers gain market-share, but did little to help consumers.

In response Maine passed the Unfair Prescription Drug Practices Act (UPDPA) in 2005 with an eye to putting health benefit providers in a better position to determine whether PBMs were really giving them the best deals for their money. The law requires PBMs to disclose conflicts of interest and their financial arrangements with third parties to any “covered entities” they deal with, including Maine’s Medicaid program, employer health plans and insurance companies.

The Pharmaceutical Care Management Association (PCMA)–the trade association that represents the largest PBMs–was furious and sued in federal court, challenging the law on several grounds. While laws that sought to regulate the practices of PBMs in other states have usually been struck down when challenged in court, a unanimous panel of the 1st Circuit Court of Appeals upheld the law Nov. 8, 2005.

The controversial ruling could have a nationwide impact on the practices of PBMs going forward, and on the way insurers, employer health plans and government agencies buy prescription drugs.

“This decision will certainly change the business relationships PBMs have,” says Bruce Armon, a partner in the life sciences practice at Saul Ewing in Philadelphia. “It will give the people they contract with far greater leverage to search for a better deal.”

Whose Savings?

Maine’s UPDPA is not the first attempt by a state to regulate the practices of PBMs, nor the first time their activities have come under scrutiny.

In April 2004 the nation’s largest PBM, Medco Health Solutions, paid more than $20 million to settle a suit brought by 20 states and the federal government that alleged the PBM violated consumer protection and mail fraud laws. Massachusetts squeezed an additional $5.5 million from Medco for alleged activity in which the PBM negotiated discounts with drug manufacturers, but failed to pass along any of the savings to health benefit providers. New York Attorney General Eliot Spitzer also got into the act in August 2004, suing PBM Express Scripts for allegedly inflating the prices of generic drugs and defrauding New York State of $100 million.

Despite this litigation activity, state attempts to regulate the practices and policies of PBMs have largely been unsuccessful. Fourteen states considered legislation in 2004 to require greater transparency in the activities of PBMs, but all of them except those in Washington, D.C., and Maine were either quashed in the legislature or struck down in court.

This is likely due to concerns that regulating PBMs will harm competition and ultimately lead to higher prices for consumers. Others argue the regulations are illegal.

“No other industry has to tell customers and government entities about the rebates it gets,” says Stephanie Kanwit, special counsel for PCMA. “Wal-Mart doesn’t have to disclose when it negotiates a rebate on buying Christmas ornaments from a certain manufacturer. The idea is unprecedented and the logic behind it doesn’t work.”

The FTC agrees. When California Assembly member Greg Aghazarian asked the commission for guidance on whether a similar law being proposed in California in 2004 would be beneficial to consumers, the FTC replied with a resounding, “No.”

“We believe that AB 1960, if enacted, may have the unintended consequences of limiting competition, thus increasing the cost of pharmaceuticals and ultimately decreasing the number of Americans with insurance coverage for pharmaceuticals,” wrote Susan Creighton, director of the FTC Bureau of Competition.

But Maine–and the 1st Circuit–saw good reasons for the law. If the PBMs do not have to disclose any of their arrangements with drugmakers to the benefit providers with which they contract, they can engage in self-dealing without any consequences.

“The health benefit provider often has no idea that a PBM may not be working in its interest,” Judge Juan Torruella wrote in his Nov. 8, 2005, decision. “This lack of awareness is the result of the fact that there is little transparency in a PBM’s dealings.”

PCMA dismisses the argument that PBMs have all the power in their contractual relationships. “PBMs deal with very sophisticated entities such as brokers and large health plans–not with 90-year-old Ms. Jones,” Kanwit says.

The Upshot

Although PCMA has asked for an en banc rehearing and, failing that, plans to appeal to the Supreme Court, the decision will still have a lasting effect on the pharmaceutical industry.

First, the success of the Maine law in court will encourage other states to reconsider implementing laws that regulate PBM disclosures. In their 2005 legislative sessions, six states–California, Colorado, Hawaii, Illinois, Iowa and Kentucky–considered legislation to regulate PBMs, and those efforts may get new life due to the 1st Circuit decision.

“State AGs talk to each other,” Armon says. “If there’s a perception that this is a legitimate way to ensure the integrity of how state budgets are spent, this will become more attractive to states.”

That in turn will increase the burdens on PBMs–which could potentially have to comply with 51 different regulatory schemes. In addition, employer health plans and insurers will be able to leverage the disclosures PBMs are required to make in Maine to negotiate in other states.

“If Maine shows that it’s realizing cost savings, that might spur a federal initiative,” Armon says. “In the meantime, PBMs will be very cognizant of their activities, and their government affairs folks are going to be lobbying state governments.”