Association for Public Policy Analysis & Management

This paper explores the potential for the use of non-price competition as a way to obtain favorable formulary treatment in Medicare Part D. Rather than setting prices, the Medicare Prescription Drug Benefit (or “Part D”) relies on private third-party insurers to negotiate with drug manufacturers over price. Typically, manufacturers will exchange discounts off the price of drugs (i.e., rebates) for more advantageous treatment on an insurer’s formulary. Drugs covered on a formulary and placed on a lower tier will require a lower out-of-pocket price from beneficiaries, resulting in a greater quantity demanded. Rebates, which are estimated to total 10% of gross Part D drug costs, are critical for controlling Part D spending for both the federal government and beneficiaries.

Price concessions may not be the only way for manufacturers to succeed in being placed on a low cost-sharing tier, however. Drug advertising, including physician-directed detailing and direct-to-consumer advertising, may be an effective strategy for manufacturers to increase demand for their products and apply pressure on insurers to cover their drugs on a lower tier without offering large discounts. Insurers, which must compete for enrollment based on the cost-sharing requirements of their formularies, will be subject to such pressure if Medicare beneficiaries respond to advertising by favoring plans that treat the advertised drugs more generously.

This study seeks to measure the effect of both detailing and direct-to-consumer (DTC) advertising on the formulary tier decisions of insurers. We use the 2006-2011 Prescription Drug Plan Formulary Files from the Centers for Medicare and Medicaid Services to observe how 147 brand-name drugs in 11 therapeutic classes (e.g., statins, proton pump inhibitors, inhaled corticosteroids) are treated in formularies. Using instrumental variables to control for the endogeneity of drug advertising, we estimate the effect of national detailing and DTC on the probability of a drug being placed on an insurer’s lowest brand-name tier using a two-stage residual inclusion model. The results of this study will add to the literature of effects of drug advertising, but through an as-yet unexplored mechanism, the composition of drug formularies. The findings will also shed light on the financial ramifications of drug advertising for Medicare Part D spending and the ability of private plans to constrain prices.