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CVS-Caremark Rx Merger Raises Questions for Employers

Companies wonder whether the combination of the retail drugstore chain and the pharmacy benefits manager will lower their prescription drug costs.

November 2, 2006
The CVS merger with Caremark Rx raises many questions but few answers for employers wondering whether the marriage between the nation’s second-largest retail drugstore chain and the second-largest pharmacy benefits manager will lower their prescription drug costs.

Customers of Caremark, which works for employers to manage prescription drug benefits and filled 530 million prescriptions last year, will likely experience some disruption as the merger is completed over the next year, benefit managers and consultants say. The 30 million customers of PharmaCare, the pharmacy benefit manager already owned by CVS, will also face a host of changes as it moves its operations to Nashville, Tennessee, where Caremark is headquartered.

Beyond that assessment, the merger may highlight industry trends whose impact on employers remains unclear, analysts say. In statements issued Wednesday, November 1, both Caremark and CVS said the merger would create an economy of scale and efficiency that would lower costs for customers.

The apparent benefits to CVS are plenty. By acquiring Caremark, the Woonsocket, Rhode Island-based drugstore chain instantly increased its potential customer base and the potential foot traffic into its stores. The $21 billion merger comes--unsurprisingly, analysts say--at a time when Wal-Mart is trying to use discount drugs and in-store clinics to attract shoppers.

Caremark, like other PBMs, has been growing its prescription mail-order business by offering discounts to employers who require employees to get their drugs through the mail. Analysts can only guess at how prices will be affected if the traditional competition between mail-order and retail pharmacies ceases to exist.

"You lose the checks and balances in the system," says Sean Brandle, a consultant with the Segal Co.

The deal could signal a new wave of so-called preferred provider pharmacies that give customers special deals in return for making the pharmacy chain their exclusive provider of prescription drugs, writes industry analyst Lawrence Abrams.

Caremark clients may be given incentives to steer their employees to CVS stores by way of reduced co-pays, discounts on over-the-counter drugs, reduced reimbursement rates that plans pay retailers, and the option of getting 90-day prescriptions--something usually reserved for mail-order drugs.

"The CVS-Caremark merger is supposedly a merger of equals based on the prospects of greater purchasing power," Abrams, a consultant based in Watsonville, California, wrote November 1 in a paper analyzing the merger. "But, really it will be Caremark attempting to save CVS as it transitions its business model from being dependent on a profitable pharmacy operation subsidizing a front store with low to nil net profits."

Abrams believes that to increase foot traffic into its stores, CVS will have to offer greater discounts on drugs, something that could be a boon to employers.

"The merger signals a pure win for consumers/employers," Abrams wrote in an e-mail. "In my opinion consumers/employers should thank Wal-Mart for this development. Once again, Wal-Mart seeks out oligopolies (e.g., grocery unions, brand manufacturers) and smashes their attempt to hold up prices in the supply chain."

Some companies have gone so far as to make CVS their exclusive retail pharmacy in exchange for deep discounts. Employers must decide whether making CVS an exclusive provider will burden employees.

"It’s all about access and how restrictive you want to be," says Keith Bruhnsen, assistant director of the University of Michigan’s benefits office.

CVS, with 6,200 drugstores in 43 states, could use its convenience to drive business to Caremark if it decides to not do business with other PBMs, Bruhnsen says. This could persuade employers to switch to Caremark if the convenience of being able to fill a prescription at CVS is worth the cost of cutting out other pharmacies.

Bruhnsen terminated Michigan’s contract with Caremark because he says the PBM’s business practices were opaque and that its operations were not well-managed. Now he pays a PBM a fee to administer claims. He foresees a number of conflicts of interest that could be problematic for employers and threaten the success of the merger.

Traditionally, PBMs hired by employers have a fiduciary responsibility to negotiate the best price for drugs with manufacturers and the lowest dispensing fees with the retailer. With the merger, Caremark has no incentive to negotiate aggressively.

"If you own the stores, you’re negotiating with yourself," Bruhnsen says.

Public perception may prove to be a challenge for the new company, if past experience is a guide. Rite-Aid bought a PBM in 1998 but sold it two years later for less than what it paid--some say because the appearance of conflicts of interest was hurting its business.

Likewise, Medco--the largest PBM--was split off from parent company Merck in 2003 after it came to light that its was giving Merck drugs special preference even though the preferential treatment did not save money for the employer clients of the PBM.

Some retail drugstores have operated their own PBMs, including Walgreen’s and CVS. The Segal Co.’s Brandle believes these companies have successfully managed to keep the two businesses and their interests separate and that CVS/Caremark will be able to do the same.

Still, judging by the dip in stock prices of both companies after the merger was announced, analysts believe the problems of the past may be present in CVS/Caremark.

--Jeremy Smerd