Case preview: Court’s newest ERISA dispute will clarify states’ authority to regulate prescription-drug middlemen

Next Tuesday morning, on the second day of the 2020-21 term, the justices will turn once again to the tangled topic of preemption under the Employee Retirement Income Security Act of 1974. The case, Rutledge v Pharmaceutical Care Management Association, presents a challenge to the validity of state laws that regulate the reimbursements that pharmacies receive when they sell prescription drugs.

To portray what is at stake requires considerable background. We start with the reality that most prescription drugs in this country are sold by retail pharmacies to customers who purchase them under employee health plans. The great majority of those health plans do not contract directly with pharmacies; instead they contract with a pharmacy benefit manager, or “PBM,” such as OptumRx or Express Scripts. At the time of sale, the PBM confirms the purchaser’s insurance status and advises the pharmacy of the co-pay (if any) that the purchaser must tender under their insurance plan. Later, the PBM reimburses the pharmacy for the difference between the maximum allowable cost, or “MAC,” that the PBM has set for the medication in question and the amount of the co-pay. So, for example, if the MAC for a medication is $100 and the co-pay is $10, the PBM reimburses the pharmacy for $90. Separately, the insurance plan reimburses the PBM for all of the payments it has made to pharmacies, with some additional spread or fee to compensate the PBM for its efforts.

The dispute in Rutledge arises from the reality that the MAC on occasion is less than the price that the pharmacy paid to acquire the medication; when that happens, the pharmacy loses money on that particular prescription sale. The parties bitterly dispute how often that happens, but suffice it to say that all agree that it happens on occasion, and that the downward price pressure on pharmacies is related to the failure in recent decades of a large number of independent pharmacies, especially in rural locations.

Arkansas (like most states) has responded to this situation by adopting a statute, known as Act 900, designed to protect pharmacies from unreasonably low reimbursements related to the MAC decisions of PBMs. The statute includes a number of procedural requirements, such as a specified process for a pharmacy to appeal a particular MAC and a requirement that PBMs update their MAC lists within seven days whenever Arkansas drug wholesalers increase their prices. But the most important provision probably is one that obligates the PBM to reimburse the pharmacy for the invoice price stated by the pharmacy’s wholesaler, without regard to the MAC that the PBM has set; apparently this is true even if rebates and other considerations mean that the invoice price (which the PBM must pay to the pharmacy) is higher than the actual net price that the pharmacy paid to its wholesaler. To enforce those rules, Act 900 states that a pharmacy can simply refuse to sell any drug if it finds the MAC too low.

The legal question in the case is whether ERISA preempts that statute (and the dozens of similar statutes adopted by other states). ERISA has a notoriously broad preemption provision that prohibits states from enacting laws that “relate to any employee benefit plan” covered by ERISA. That provision generally reserves the regulation of such plans to Congress, but its scope is often unclear. The Supreme Court has a voluminous jurisprudence on ERISA preemption, and few observers would say that the court’s decisions applying it are entirely consistent. The most commonly cited formulation of the standard from recent cases condemns a state statute for an impermissible “connection” with an ERISA plan if the statute “governs a central matter of plan administration” or “interferes with nationally uniform plan administration.”

The Pharmaceutical Care Management Association (the national trade association for PBMs) argues that Act 900 violates both prongs of that standard. On the first point (plan administration), PCMA portrays Act 900 as directly regulating how plans pay for benefits. Instead of paying standardized MAC-based reimbursement amounts – which give pharmacies a powerful incentive to seek out the lowest-priced supplier – the statute obligates PBMs to reimburse the pharmacy’s invoice cost without regard to the availability of lower-priced suppliers. Similarly, PCMA argues that Act 900 interferes with plan administration by obligating plans to adopt a particular appeal process when they deal with Arkansas pharmacies and by barring plans from requiring (as they universally do) that participating pharmacies fill all covered prescriptions that customers present to them. On the second point (uniform administration), PCMA points to the differential reimbursement and procedural rules that the various states have adopted in their efforts to protect pharmacies from PBMs. The trade group contends that those state-to-state disparities create a “crazy-quilt regime.”

For her part, Arkansas Attorney General Leslie Rutledge argues that Act 900 falls within a general rule that ERISA does not preempt rate regulation. She discerns a “sharp line” between laws that regulate the relationship between plans and their beneficiaries and those that regulate the conduct of plans toward third parties. Pointing to a case that permitted New York’s pervasive regulation of hospital billing, Rutledge argues that ERISA’s preemption provision is not at all concerned with laws affecting the costs that plans bear. Recognizing that Act 900 goes far beyond price-setting, Rutledge argues that the various enforcement mechanisms in the act (such as the mandated appeal process and right not to dispense) are permissible because they are mere “incidents” to Arkansas’s wholly lawful regulation of rates.

PCMA responds that Act 900 has nothing to do with rate regulation, because it does not establish the price of pharmaceuticals “in the marketplace.” Pharmacies remain free after the adoption of Act 900 to charge consumers whatever they like and are equally free to agree, or not agree, to the contractual rates that PBMs choose to offer. Rather, PCMA emphasizes, Act 900’s only effect on price is on the way that a plan uses a MAC list to control costs. In any event, PCMA notes, the dizzying array of procedural rules that the various state statutes adopt are far more than “incidental,” as they impose a substantial and undeniably procedural disuniformity on plan administration.

Although the justices will hear this case while rising prescription-drug prices are a contentious political issue, the dispute here is considerably removed from the concerns about insurance coverage and consumer prices that dominate much of the discourse on the topic. Because the Arkansas law and similar state laws do not regulate the prices that consumers pay for prescriptions, the decision in the case is unlikely to be front-page news, and the justices will know that. Rather, the case primarily is about shifting the share of profits in the pharmaceutical supply chain. These statutes increase the profit share that pharmacies get and depress the share that flows to PBMs and insurers.

That said, both sides argue that a ruling in their favor would help consumers at the pharmacy counter. Invalidating the statutes, PBMs say, would preserve an important cost-containment mechanism that PBMs use to encourage pharmacies to buy drugs from low-cost wholesalers and, indirectly at least, reduce consumers’ drug prices down. On the other hand, states, pharmacies and other industry stakeholders accuse PBMs of abusive practices that restrict consumers’ access to less-profitable drugs, drive independent pharmacies out of business, and ultimately lead to higher drug prices. They say that laws like Act 900 are necessary to curtail those practices and protect consumers.

I wouldn’t be at all surprised to see a split decision – allowing the purely rate-regulation aspects of Act 900 but preempting the procedural aspects – but we should know a lot more about how the justices view the case after we hear them react at the argument on Tuesday.