Pharmacy Benefits 101

Pharmacy Benefits 101: What is a Formulary?

May 9, 2023

Justin Venneri

At a high level, the formulary* is a list of prescription drugs covered or preferred by a prescription drug plan or another insurance plan offering prescription drug benefits1.

So why is the list of brand and generic drugs covered through your health plan’s prescription drug coverage worth a write-up by a pharmacy benefit manager (PBM)? Because what’s going on below the surface is much more complex and can be confusing if you’re new to or unfamiliar with the PBM industry.  

To help clarify many of the key aspects of formularies, I asked Capital Rx’s Director of Formulary Operations, Nisha Bhide, PharmD, several of the most common questions we field around this core administrative function performed by PBMs. Here are her answers and insights (lightly edited):

What is the purpose of a formulary?

The primary purpose of a formulary is to promote the safe and effective use of medications while delivering value to the plan (our clients) and their members. Since the formulary is the list of covered drugs – and plans may have more than one formulary – it’s important because it dictates what drugs members have access to during the plan year and what the potential cost of the drug is for the member (i.e., the copay).  

Okay, and what is a formulary typically based on?

Formularies are generally prepared to ensure that plan members have access to a robust offering that balances needs and overall prescription drug costs. The typical formulary is based on the recommendations of a committee – usually called a P&T Committee - of highly skilled physicians and pharmacists with diverse backgrounds that review all commercially available drugs regulated by the United States Food and Drug Administration (FDA).  

Clinical efficacy and safety are considered when developing a formulary, as are market trends and the cost of the drugs available to treat and prevent diseases. It's worth noting that the factors/variables considered to set a formulary can change throughout the year, so a formulary will generally be subject to change throughout the year as well.

Are all FDA-approved/regulated drugs going to be included on a formulary?

No, not necessarily. And this is where things start to get more complicated. Drugs that do not appear on the list are generally excluded under the formulary. Drugs may be excluded for several reasons, but it’s often simply because they are a high-cost drug that is just a combinate of two older products and could be what a PBM considers a “patent extender” (there are some “wasteful drugs” in the market). Or perhaps the plan chooses not to cover “cosmetic” drugs.  

If a prescribed medication is not covered, the next logical question is, “What should a member do?” Members can usually contact their prescriber or PBM to see if a covered alternative is available. All formulary exclusions have alternatives on the formulary, but if a prescriber determines that a member needs a drug that is not covered on the formulary, a drug exception request with clinical documentation may be submitted.  

Additional restrictions may apply and will be indicated next to the drug on the formulary list. Some drugs may only be covered for members within a certain age range due to recommendations based on FDA-approved labeling and/or clinical practice guidelines. Other drugs may be subject to prior authorization, step therapy requirements, or quantity limits.

Medications flagged as Specialty Drugs are usually used to treat more complex medical conditions (e.g., hepatitis, multiple sclerosis, or hemophilia) and require special handling, administration, and member care management. Depending on the pharmacy benefit design and formulary, specialty drugs may be part of a benefit with specific coverage and copay requirements. If there is not a defined specialty benefit, a member’s copay may be based on what “tier” the drug is in.

What does it mean if a formulary is open or closed?

Open and closed formularies balance access and savings differently. Clients – plan sponsors – elect the degree of how “open” or how “closed” a formulary is, but a closed formulary will usually provide a health plan with greater savings compared to an open formulary, and an open formulary will provide relatively broader access to drugs than a closed formulary. It’s an oversimplification, but that’s the basic tradeoff.  

Ok, and what is a Formulary Tier?

Formularies are organized into categories called tiers. Each prescription drug is placed in a tier depending on the type of drug. Formularies are commonly divided into three tiers. Some plans may have more or less than three tiers, but how the tiers are managed is usually the same. The lower-tier drugs often cost less than those in higher-tier categories.

For example, generic drugs are usually, but not always, tier 1 drugs. And drugs newly approved by the FDA may not be covered until they have been fully evaluated.

What is a prior authorization (PA)?

The short answer is that PA is a process whereby approval based on clinical criteria may be required before your pharmacy benefit plan will cover certain drugs. This process ensures you receive a safe and cost-effective prescription, but we’ll have to save the details for a separate discussion.

What is a quantity limit (QL)?

With QLs, there’s a limit on the maximum dosage or quantity for certain medications that are covered per prescription or within a specific time frame. For example, there’s often a QL for opioids – the narcotic pain medications that can be addictive and are unfortunately often abused.

What is step therapy (ST)?

If a member is prescribed a drug and there’s an ST program/requirement, they may be required to try one medication before they “step through” to another medication. Members will usually start with a generic medication before starting a brand medication.

What else do plan sponsors/administrators and consumers need to know about formularies?

Depending on the level of coverage a health plan wants to provide its members and how involved the benefits/administration team wants to be in managing the plan (for example, some providers or health plans have the clinical resources to leverage JUDI®, our enterprise pharmacy platform, directly), another thing plan sponsors may want to consider is flexibility.  

A good question to ask a PBM partner is: “Once you select a formulary, can we control what drugs are included in the various tiers or make changes?” I think this is important because, as I mentioned earlier, there are wasteful drugs in the market that could be covered on a formulary, which might lead to higher costs for a health plan. And having the flexibility to influence that could be helpful.

*If you'd like to dive into the details of a formulary, check out Capital Rx's Freedom (Open) Formulary Lookup or Capital Rx’s Liberty (Closed) Formulary.

Contact us if you’d like to learn more about Capital Rx’s full-service PBM or pharmacy benefit administration (PBA) solutions.  

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