BW 50: Can Caremark's Health Hold Up?

Its drug-benefit business is soaring, but it faces a growing set of legal challenges

Shortly after Edwin M. "Mac" Crawford joined Caremark Rx Inc. (CMX ) as CEO in 1998, the self-proclaimed "chronic worrier" wondered about the mess he had gotten himself into. The Nashville company, then called MedPartners Inc., was hemorrhaging $1 billion a year as it tried in vain to consolidate physician practices and manage them better than the physicians could. The model never caught on, and the company failed to complete a merger, sending its shares plummeting and touching off a rash of investor lawsuits. "The company basically was worthless," says Crawford, a turnaround specialist who was recruited by the board. So he sloughed off the practice-management business and began fostering a tiny unit of the company that sold pharmacy benefit-management plans to employers.

Today, Caremark is the phoenix of a flourishing industry. Pharmacy benefit managers (PBMs) have emerged as key allies for corporate human resources managers, health plans, and government employers that provide drug coverage for employees. PBMs design prescription plans and process pharmacy claims for their customers. In recent years, PBMs have boosted their appeal by offering such services as mail-order pharmacies, which refill drugs at cut-rate prices. Today PBMs manage about 75% of the $235 billion spent on prescription drugs every year, with the bulk of the business going to Caremark and its two biggest competitors, Medco Health Solutions Inc. (MHS ) and Express Scripts Inc. (ESRX )

Caremark has racked up an enviable track record, which has propelled it to the No. 22 spot on the 2005 BusinessWeek 50 list of top corporate performers. And with a March acquisition of rival AdvancePCS Inc., it now processes 684 million drug claims per year. Including AdvancePCS, Caremark's profits soared 38% in 2004, to $650.7 million, on sales of $30.4 billion, up 8% from the previous year. Much of the bottom-line boost is coming from Caremark's mail-order pharmacy, which grew 73% thanks to AdvancePCS. Crawford says mail-order scrips are doubly profitable. Skipping the retail middleman helps. Caremark should earn $2.23 per drug claim this year -- 14% more than Medco and nearly twice Express Scripts's haul, estimates SG Cowen & Co.

All is not rosy, however: A mounting set of legal challenges looms. First, allegations of improper Medicaid billing have prompted state investigations. Caremark is cooperating and says it welcomes guidance on proper practices. The Justice Dept. is looking into the disputes, and Texas' attorney general hopes to unseal a whistleblower suit against the company. At the same time, several federal and state legislators are pushing for new laws to reign in PBMs. "There are many questions about whether [they] are operating in consumers' best interests," says Representative Anthony D. Weiner (D-N.Y.), who introduced a bill on Apr. 14 that would put the brakes on many common PBM business practices, such as switching patients from one drug to another without their consent.

Nonetheless, demand for PBM services continues to skyrocket, and a postmerger Caremark is particularly poised to take advantage of it. Analysts expect a new Medicare drug benefit to add as much as $15 billion to the nation's annual drug spending. Many participants could enroll through Medicare Advantage plans offered by health insurers. Thanks to the merger, Caremark has access to 1.2 million Medicare Advantage patients, says SG Cowen analyst Kemp Dolliver. That's far more than the 400,000 apiece available to Express Scripts and Medco.


Still, every time a contract comes up for renewal, Caremark has to fight tooth and nail against its two major rivals to hold onto the business. That's because customers are prone to play the field. And no wonder: According to a survey by human resources consulting firm Hewitt Associates Inc. (HEW ), 47% of employers suspect their PBM isn't helping them save on their overall prescription costs -- or worse, that it's hiking their outlays. More customers are demanding details from their PBM, such as what incentives the company is paid by pharmaceutical makers to sell certain drugs.

Inevitably, Caremark doesn't always win the bargaining tug-of-war. In February, the state of Illinois ditched Caremark and signed on with Medco, in part because Caremark opposed the state's wish to release the details of its PBM contract to the public. "We're winning business on our elevated level of transparency," says Medco Chief Executive David B. Snow Jr.

Several proposed bills, including Representative Weiner's, seek to make such transparency mandatory. So far no such initiative has gained much traction. And the loss of the Illinois contract hasn't affected Caremark's earnings expectations. Crawford says he was concerned that if Caremark eventually is forced to release financial details about its contracts -- either by law or by competitive forces -- it might result in higher prices for his customers. It could also potentially hurt the company's bottom line, according to some analysts and industry experts. For example, it would be more difficult to negotiate, say, low drug prices from manufacturers, who might balk at giving Caremark a better deal than another drugmaker provides for a similar product. Caremark disputes that, saying the company can provide transparency for customers that require it.


The Medicaid investigation could be an even bigger threat. According to a 2001 report by the Office of the Inspector General, 32 states failed to recover $360 million worth of pharmacy claims for patients covered by both Medicaid and third-party payers. The states allege that Medicaid should not have had to pay the bills. And several federal lawmakers have been grousing about the need for a broad industry crackdown. On Mar. 29, a U.S. district court in Tennessee, one of the states involved in a Medicaid dispute with Caremark, warned that the feds could intervene at any time. "I don't think there's any way you're going to keep the United States out," said U.S. magistrate judge Joe B. Brown.

Analysts expect Caremark to try to settle the case expeditiously. At worst, the company may have to change its billing practices. It's unclear how that would affect Caremark's bottom line. That uncertainty may explain why the company's stock has dropped 1.3% this year, while those of its two major competitors have soared. Crawford explains that Caremark itself filed the complaint in Tennessee, hoping to end a six-year dispute over how Medicaid should be reimbursed. "We're glad to do it, but we'd like some clarification," says Crawford.

The CEO remains upbeat about the future. Caremark's $1 billion cash pile could be used to grow through more acquisitions. As for the legal challenges, "regulation is a part of health care," he says. "I'm always concerned."

At least one worry is off his shoulders, though: The mess of a company he walked into seven years ago is now much more than just a survivor.

Editor's Note: In "Can Caremark's Health Hold Up" (May 9, 2005), BusinessWeek's original story said that CEO Edwin M. Crawford feared that if Caremark eventually is forced to release financial details about its contracts -- either by law or by competitive forces -- it could hurt the company's bottom line. In fact, he said that he was concerned that it could result in higher prices for his customers. The online version has been corrected to reflect this.

By Arlene Weintraub in New York, with Amy Barrett in Willingboro, N.J.

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