A formulary is a continually updated list of covered prescription medications used by insurance companies or Pharmacy Benefit Managers (PBMs) to manage a prescription drug plan. This list is a blueprint for prescription drug benefits, balancing clinical effectiveness and safety with financial considerations. A closed formulary represents the most restrictive type of drug list, limiting coverage to only the medications specifically included on that list.
Defining the Closed Formulary
A closed formulary defines a precise and limited selection of drugs that a health plan will cover. If a drug is not explicitly listed, the patient is responsible for the full cost of the medication. This structure contrasts with an open formulary, which covers a much wider range of medications, often with fewer restrictions, though typically at a higher overall cost to the plan.
The selection process begins with the Pharmacy and Therapeutics (P&T) Committee, composed of physicians, pharmacists, and other healthcare professionals. This committee evaluates medications based on clinical evidence, safety, and therapeutic value. While the P&T Committee makes recommendations, the final decision on which drugs to include or exclude is driven by the insurer or PBM, often emphasizing cost-effectiveness and negotiated rebates.
Structure and Categorization of Covered Medications
The medications included on a closed formulary are organized into a tiered structure that determines the patient’s out-of-pocket costs. Plans use this structure to encourage the use of the most cost-effective drugs, typically employing three to five tiers, each with a different associated copayment or coinsurance requirement.
Tier 1 usually consists of generic medications, offering the lowest copayment for the patient. These drugs are therapeutically equivalent to their brand-name counterparts but are less expensive. Tier 2 often includes preferred brand-name drugs with a moderate copayment, while Tier 3 contains non-preferred brand-name drugs, carrying a substantially higher cost-sharing obligation. Higher tiers may also exist for specialty drugs, which are high-cost medications used to treat complex or rare conditions.
Navigating Exclusions and Exceptions
If a patient is prescribed a medication that is not on the closed formulary or one that is on a non-preferred tier, specific administrative steps are required to obtain coverage. These mechanisms ensure the patient still has access to medically necessary treatments while maintaining cost control for the plan. Prescribers can request a formulary exception for a non-covered drug if they demonstrate that the patient cannot take the preferred, covered alternatives.
Two common management strategies used to control access to certain drugs are Prior Authorization (PA) and Step Therapy.
Prior Authorization (PA)
Prior Authorization requires the prescriber to submit documentation proving the medical necessity of a drug before the insurer agrees to cover it. This process is often applied to high-cost specialty drugs or medications with a high potential for misuse, ensuring they are used appropriately.
Step Therapy
Step Therapy, also known as “fail first,” requires the patient to try and fail a lower-cost, preferred medication for a specific condition before the plan will cover a more expensive, non-preferred drug. If the initial, cheaper drug is ineffective or causes adverse effects, the provider can then request an exception to move to the prescribed, higher-tier medication. If an exception request is denied, patients maintain the right to appeal the decision with their health plan.
The Role of Cost Containment
The primary rationale for employing a closed formulary is to control the overall cost of prescription drug benefits for the insurer and the plan sponsor. By restricting the number of covered drugs, the PBM gains substantial leverage in negotiations with pharmaceutical manufacturers. This system creates a competitive environment where manufacturers offer deeper discounts and rebates to ensure their products are included on the preferred list.
The restrictive nature of a closed formulary allows the PBM to aggregate purchasing power, directing a large volume of prescriptions toward specific drugs that have the most favorable financial agreement. Drugs are prioritized for inclusion based on a combination of clinical efficacy and financial deal, which helps keep overall plan premium costs lower for the employer or insurer. This focus on cost-effective alternatives ultimately influences the prescribing habits of physicians and the purchasing decisions of patients toward lower-cost options.