Prescription Drug Coverage: How it Works & What You Should Know

Tons of money is being spent on prescription drugs in America each year — on average, more than $1,000 per person, up from less than $100 per person in 1980.

That number bounces around over time — spiking, dropping, leveling off, spiking again. But interestingly, the out-of-pocket spending (how much you pay at the pharmacy), while trending upward, has remained relatively steady.

Thank you, prescription drug coverage.

But what about the money that makes up the difference between overall spending and what we pay the pharmacy?

That goes to a variety of players in the pharmaceutical supply chain, which is one reason why prescription drug pricing can seem so opaque and mysterious.

Until the system changes, one way to get the most out of it is to understand how your prescription drug coverage works—as well as its limitations.

Getting coverage

Prescription benefits are almost always included with an employer’s medical plan. The Affordable Care Act (aka Obamacare) requires prescription coverage to be included in all small-group and individual plans health plans you can purchase on your own.

You pay premiums (your share of the cost of coverage) monthly, or through paycheck deductions as part of your employer’s medical plan premiums.

Which drugs are included?

Insurance companies typically hire a pharmacy benefit manager (PBM) to manage prescription claims and to determine which drugs will be covered by a particular plan.

The PBM reviews the effectiveness, safety, and cost of existing and new drugs, and chooses which ones to include on the plan’s list of approved drugs, called a formulary. Formularies can differ from plan to plan, even from the same insurance company.

Each drug on a formulary is classified by coverage level, or “tier,” which determines how it’s covered by that plan. Three tiers are typical, but some plans have as many as 7.

Some plans label tiers with numbers (Tier 1, Tier 2, etc.) and others use descriptors (generic, preferred brand, non-preferred brand, etc.) Tier 1 drugs are generally generic medications and the least expensive, with each higher tier costing more.

Every formulary is unique, so a given drug could be on different tiers under different plans. And since formularies often change, avoid surprises by checking at least once a year to be sure how your medication is covered. (See your plan information for how to access the formulary.)

How drugs are covered

The specifics of prescription drug coverage vary from plan to plan, but virtually all insurance plans require you to pay either coinsurance (a percentage of the retail price), a fixed copay amount, or a combination of the two.

For example, with a coinsurance plan, after you meet your deductible, you might pay 10% of the retail cost of Tier 1 drugs, 25% for Tier 2, and 45% for Tier 3. Often, coinsurance plans have minimum and maximum dollar limits for each tier.

A copay plan might require you to pay $10 for Tier 1 drugs, $20 for Tier 2 and $30 for Tier 3.

While plans with copays have more predictable costs, they often have much higher premiums than plans with a deductible and coinsurance. So, if you don’t fill a lot of prescriptions, the extra you pay in premiums for a copay plan goes for coverage you don’t use.

Remember that any coinsurance you pay is a percentage of the price you pay at the pharmacy, so the lower the price, the less you’ll pay in coinsurance.

That’s why if your insurance features preferred or “network” pharmacies, you should use them — otherwise, your copay or coinsurance may be higher or may not apply at all.

So, what IS that price?

This is where things can get murky in a hurry, because the dollar amount you pay at the pharmacy usually bears little resemblance to the price the manufacturer originally charged.

That’s because in addition to managing formularies and paying claims, PBMs also negotiate with manufacturers and wholesalers for discounts and rebates to help lower costs.

On top of that, pharmacies can set whatever retail price they want on prescriptions.

When you add in available discounts, the actual price for any given drug can vary from a few dollars to hundreds of dollars from pharmacy to pharmacy.

The result of all this? Depending on the drug, you may be able to get your prescription for less than you would normally pay through your insurance—even in plans with low copays.

That’s why it’s so important to check the pricing on your medication before you fill a prescription, with or without insurance.