Key Points:
The Employee Retirement Income Security Act of 1974 (ERISA) preempts any state laws that “relate to” employee benefit plans. ERISA challenges have proven the most effective at striking down laws regulating PBMs.
Courts have issued inconsistent rulings about whether laws governing PBMs “relate to” and are therefore preempted by ERISA.
The First Circuit Court found ERISA did not preempt Maine’s 2003 PBM law, but the DC Circuit Court found that ERISA did preempt the same provisions in a DC law (mandating fiduciary duty for PBMs and disclosures over drug costs and PBM benefits). Further, the Eighth Circuit Court held that ERISA preempted certain MAC pricing regulations.
NASHP Model Law B, which contains some of these provisions, may be saved from ERISA preemption, because the law regulates insurers and implicitly excludes self-insured employee benefit plans.
Due to a limited number of court decisions and courts’ inconsistent application of ERISA, states should not hesitate to pass PBM laws as another court may differ significantly in its legal analysis.
State policymakers face legal obstacles when seeking to regulate pharmacy benefits managers (PBMs), the biggest of which is the doctrine of ERISA preemption. Perhaps most troublesome, is that ERISA preemption is not settled law, and courts have been inconsistent in its application to PBM regulations. Nonetheless, detailed consideration of the five court rulings on ERISA preemption of PBM regulation provides guidance to states seeking to write laws that better withstand legal challenges. Furthermore, since most federal courts of appeals have not yet reached a conclusion on the matter, how courts in these circuits may rule is a matter of educated guesswork. As a result, states seeking to regulate PBMs may use the these rulings as guidelines for crafting new legislation and may find courts in their circuit apply a more measured approach to ERISA preemption. As a result, courts may determine that ERISA does not preempt similar state laws.
A. Review of State Statutes Regulating PBMs1
PBMs are middlemen in the drug supply chain. On one end, PBMs negotiate with drug manufacturers to get rebates and discounts. On the other end, PBMs contract with health plans and pharmacies, determining how much health plans pay for drugs and how much PBMs reimburse pharmacies for dispensing drugs. As a result of their position in the market, PBMs have the opportunity to retain rebates or discounts rather than passing savings on to consumers. Consequently, the financial incentives and business practices of PBMs may inflate drug prices and stifle competition. In response, a significant number of states have increasingly considered and passed legislation to target PBM business practices and to reduce high drug prices. These state laws frequently impose five types of regulations: fair pharmacy auditing practices, prohibition of gag clauses, PBM licensure or registration requirements, anti-clawback regulations, and Maximum Allowable Cost (MAC) list regulations. More recently, states have introduced laws prohibiting spread pricing and requiring the pass through of rebates. As states seek to expand regulatory authority over PBMs, they should be aware that some PBM laws more directly targeting PBM business practices may be vulnerable to legal challenges, particularly ERISA preemption.
B. Primary Legal Challenge: ERISA
Nearly every state regulates PBMs in some way and the vast number of state PBM laws have not been challenged. Many of these laws, however, govern how PBMs interact with pharmacies (e.g. regulating fair pharmacy edits and timely updates of MAC lists) and do little to control the cost of drugs or ensure that PBMs act in the best interest of patients and plan sponsors. Nonetheless, laws that govern how PBMs set prices and act on behalf of insurers remain vulnerable to legal challenges and lobbying efforts, often brought by the Pharmaceutical Care Management Association (PCMA), the trade group for PBMs. To date, PCMA challenged five state laws regulating PBMs, and won three of those challenges.2 While courts in Maine and North Dakota have declined to strike down PBM laws, courts in the District of Columbia, Iowa, and Arkansas have struck down PBM regulations, ranging from disclosure requirements to MAC pricing regulations. In all of these suits, PCMA’s most common and successful challenge to state laws regulating PBMs has been ERISA preemption.
1. The Doctrine of ERISA Preemption
ERISA expressly preempts any and all state laws that “relate to” any employee benefit plan.3 Congress intended for ERISA to promote nationwide uniformity in employee benefit plan administration. To ensure the “broad scope Congress intended while avoiding the clause’s susceptibility to limitless application,” the US Supreme Court created a test to determine whether ERISA preempts state law.4 Nonetheless, despite more than 20 Supreme Court cases applying the test, the vagueness of the “relate to” provision has not been resolved, sparking a copious amount of litigation resulting in “countless questions about the scope of” ERISA preemption and “seemingly arbitrary and inconsistent answers.”5
The “relate to” question, however, does not apply to insurance laws because ERISA specifically saves from preemption any state laws regulating insurance. For a state law to regulate insurance, “the state law must be specifically directed toward entities engaged in insurance . . . and the state law must substantially affect the risk pooling arrangement between the insurer and the insured.”6 The Supreme Court considered “laws regulating the terms of insurance contracts,” as laws regulating insurance.7 As a result, ERISA will not preempt the application of state insurance laws to fully-insured employee benefit plans.8 However, ERISA does not deem self-insured employer plans to be insurance, therefore ERISA will preempt the application of state insurance laws to self-insured employee benefit plans.9 States seeking to regulate PBMs, therefore, must navigate the inconsistency and broadness of ERISA preemption, but may find lessons in prior court decisions that apply ERISA’s preemption test to PBM laws.
2. Application of ERISA Preemption to State Laws Regulating PBMs
While ERISA preemption has been the strongest challenge to state PBM laws, PCMA also alleged that state PBM laws violated the Dormant Commerce Clause, the Takings Clause, and others (Table 1). Federal district courts, however, have rejected nearly all types of claims except for ERISA preemption (Table 1). On appeal, the federal appellate courts struck down three of four state PBM laws solely or mainly on ERISA preemption (Table 2), making ERISA preemption the most common and most successful legal challenge against state PBM regulations.
Table 1: US District Courts’ Response to State PBM Law Challenges
Maine DC Iowa Arkansas North Dakota
ERISA Preemption X X ✓ X ✓
Contract Clause (Art. I, Sec. 10)
✓
Dormant Commerce Clause ✓
✓ ✓
Medicare Part D Preemption
✓ ✓*
Takings (5th Amendment) X
✓
Void for Vagueness
✓ ✓
✓ = State Law Withstood the Challenge
✓* = State Law Withstood the Challenge Except in One Instance
X = State Law Preempted or Struck Down
Table 2: US Court of Appeals’ Acceptance of Challenges to State PBM Law
Maine DC Iowa Arkansas
ERISA Preemption ✓ X* X X
Dormant Commerce Clause ✓
NR
Due Process ✓
FEHBA Preemption ✓
First Amendment ✓
Medicare Part D Preemption ✓
X
Takings (5th Amendment) ✓
✓ = State Law Withstood the Challenge
X = State Law Preempted or Struck Down
X* = State Law Preempted or Struck Down, in part
NR = Not Reached by the Court
In all five cases, PCMA challenged the prior to or soon after implementation. In the first two cases, Pharmaceutical Care Management Association v. Rowe10 and Pharmaceutical Care Management Association v. District of Columbia,11 PCMA challenged nearly identical statutes12 in Maine and DC with different outcomes (Table 3). Here, both the Maine and DC laws required that PBMs: 1) owe a fiduciary duty to the covered entity; 2) pass all payment or benefit received from manufacturers or based on volume of sales to the covered entity; and 3) disclose conflicts of interest, financial terms and arrangements between a PBM and drug manufacturer, and the costs of both the substituted and prescribed drug, if the substitute drug costs more. Yet, despite the laws’ similarities, the courts differed in its preemption analysis (Table 3).
Table 3: On Substantially Similar Laws, Courts Differ in its ERISA Preemption Analysis
Maine DC
Fiduciary Duty to Covered Entity ✓ X
Disclose Conflict of Interest ✓ X
Disclose Costs of Both Drugs and Direct and Indirect Benefits Accrued by PBM ✓ X
Transfer Benefits or Payment Received to Covered Entity Related to Drug Substitution ✓ X
Disclose to Covered Entity All Financial and Utilization Information Requested by Covered Entity ✓ ✓
Transfer Benefits or Payment Received to Covered Entity Based on Volume of Sales ✓ ✓
Disclose All Financial Terms/Arrangements Between Manufacturer/Labeler ✓ ✓
✓ = Provision Upheld
X = Provision Struck Down
NC = Not Challenged by PCMA
In Rowe, the First Circuit held that ERISA did not preempt Maine’s PBM regulations, because PBMs did not exercise discretionary authority or control in the management and administration of the plan. The court found that PBMs performed purely ministerial duties and therefore were not ERISA fiduciaries and not among the “principal players in the ERISA scenario.”13 Additionally, the court further reasoned that Maine’s PBM regulations did not restrict employee benefit plans from administrating their plans. Because the court interpreted ERISA to only preempt “state laws relating to acts performed by ERISA fiduciaries,” the court did not find Maine’s law preempted by ERISA.14 In DC, the DC Circuit held the exact opposite by concluding that laws regulating third party administrators of an ERISA plan “function[ed] as a regulation of an ERISA plan itself.”15 There, the court held that the DC law regulated “a PBM’s administration of benefits on behalf of an employee benefit plan.”16 In addition, the court found the administration of employee benefits an area of core ERISA concerns. These two findings were enough for the court to decide that ERISA preempted the DC law. To seal the preemption case, the court observed that the PBM law would force employers to decide whether they would administer pharmaceutical benefits on their own or contract with a PBM to administer those benefits. The court further noted that because ERISA preempts any law that bound a plan administrator to a particular choice, much of the DC law was also preempted. However, the court found that ERISA did not preempt voluntary provisions, because these provisions either (a) allowed the PBM and the covered entity to waive that provision by contract, or (b) permitted disclosure only upon request of the covered entity.17 The court held that opting out of a state law or negotiating a waiver did not affect plan administration and imposed no meaningful burden, allowing those voluntary provisions to stand.18
Many years later, PCMA challenged MAC pricing regulation in Iowa (in Pharmaceutical Care Management Association v. Gerhart)19 and Arkansas (in Pharmaceutical Care Management Association v. Rutledge).20 Specifically, Iowa’s §510B.8 required PBMs to: 1) submit to the insurance commissioner their pricing methodology for their MAC lists; 2) limit MAC lists to certain drugs; 3) disclose to pharmacies the source of the pricing data for MAC pricing; and 4) have an appeals process for pharmacists that will include retroactive payments if a MAC pricing has been applied incorrectly. Similarly, but distinctly, Arkansas’s Act 900, as challenged in Rutledge, mandated that PBMs: 1) reimburse pharmacies for generic drugs at a price equal to or higher than the pharmacies’ cost for the drug; 2) update their MAC lists at least seven days after a certain increase in acquisition costs; 3) allow pharmacies to reverse and re-bill each claim when a pharmacist cannot procure a drug at a cost that is equal to or less than the MAC price; and 4) allow pharmacies to decline to dispense if they will lose money on a transaction. Unlike Rowe and DC, where similar laws were decided differently by different courts, in Gerhart and Rutledge similar laws were decided by the same court in the same way.
In Gerhart, the Eighth Circuit perplexingly found that the law’s explicit exclusion of self-insured employee benefit plans, which was written to avoid ERISA preemption, nonetheless created an impermissible “reference to” ERISA. As a result, the court held that ERISA preempted the law in question.21 Additionally, the court found that Iowa’s law had an implicit “reference to” ERISA by regulating PBMs who administered benefits for a “covered entity,” which included health benefit plans, employers, and labor unions.22 Because the court believed such entities were subject to ERISA, the court inexplicably concluded that the Iowa law “applies to only PBMs who administer prescription drug benefits for plans subject to ERISA regulation.”23,24
Furthermore, the court in Gerhart found the regulation of PBMs affected ERISA benefits and thus ERISA plan administration. Specifically, the court found Iowa’s law interfered with nationally uniform plan administration. For example, the court viewed the provision that allowed pharmacies to appeal MAC reimbursement rates as restricting an administrator’s ability to control an ERISA plan’s drug benefits.25 As a result, the Eighth Circuit held ERISA preempted the Iowa law.
In Rutledge, the Eighth Circuit, relying heavily on its decision on Gerhart, held that Arkansas’s and Iowa’s laws were “similar in purpose and effect,” and thus, ERISA preempted Arkansas’s law by the same reasoning in Gerhart.26 As seen above, while both Arkansas and Iowa’s law regulated MAC pricing and MAC appeals processes for pharmacies, Arkansas’s law proved more extensive than Iowa’s law. Arkansas has since appealed the Eighth Circuit’s preemption decision to the Supreme Court. Thirty-two states and the District of Columbia have submitted a brief to the Supreme Court arguing that states should be able to regulate PBM conduct without the threat of ERISA preemption. As of Aug. 4, 2019, the Supreme Court has not decided on whether to take up that appeal.
Seemingly emboldened with its successes in the Eighth Circuit, PCMA then sued North Dakota, also in the Eighth Circuit, over two bills regulating PBMs in Pharmaceutical Care Management Association v. Tufte.27 Unlike Gerhart and Rutledge, the North Dakota bills would have regulated PBM conduct like PBM fee collection in relation to pharmacy performance, clawbacks, gag clauses, disclosures by pharmacies to plan sponsors, conflict of interest prohibitions, and disclosure of spread pricing to the payer. In Tufte, the U.S. District Court for the District of North Dakota rejected all but one of PCMA’s claims. The court observed that neither bill contained any provisions regarding ERISA matters such as “claimant eligibility determinations, the monitoring of funds for benefit payments, or the keeping of appropriate records for reporting requirements.”28 Furthermore, similarly to Rowe, the court did not see how the bills would impose any requirements on ERISA plans or change the administration of ERISA plans. However, the district court found that Medicare Part D preempted the provision requiring disclosure of spread pricing practices, since federal standards already covered this area.29
Nonetheless, the ruling did not preempt the entire law; it just prohibited its application to PBMs serving Medicare Part D plans, while still requiring other plans to disclose these spread pricing practices. While the district court rejected the ERISA preemption argument, PCMA appealed the district court ruling. Because of the Eighth Circuit’s prior decisions in Gerhart and Rutledge, it is probable that the Eighth Circuit will find that ERISA preempts the North Dakota bills.
C. Recommendations for State Laws Regulating PBMs
While PCMA has brought forth several challenges to PBM legislation, states should be most concerned with ERISA preemption. Only the First Circuit, DC Circuit, and the Eighth Circuit have ruled on challenges to PBM regulation and those decisions have been inconsistent. Pending the Rutledge appeal by the US Supreme Court, ERISA preemption remains an unpredictable and uncertain area of law. Due to the limited number of cases and inconsistent application of ERISA preemption by the courts, states should not be intimidated by the Eighth Circuit decisions as another circuit court may differ in its view of ERISA preemption of PBM laws. If other states do not pass legislation, the rulings in the Eighth Circuit may remain the only, overly broad, interpretation of ERISA preemption of laws governing PBM practices.
Furthermore, careful crafting of PBM legislation should mitigate preemption. Specifically, states should not explicitly exclude ERISA plans, but instead include a provision stating that nothing in the law is intended to or should be construed to be in conflict with existing relevant law. Avoiding use of the word “ERISA” in the law should also avoid any misinterpretation of the “relate to” standard for ERISA preemption. Additionally, states may consider whether to allow employers or plan sponsors to opt out of provisions via contract. In District of Columbia, the court did not preempt certain sections of DC’s PBM regulation, because such provisions were “in essence voluntary” by allowing the covered entity to contract differently with a PBM over the usage back provision or have the PBM disclose only upon the request of the covered entity.30 The court did not believe that negotiating a waiver would be considered an administration of benefits and therefore was not preempted by ERISA.31 Therefore, if a state chose to require that a PBM act or disclose information to a plan sponsor and allowed a plan sponsor to waive that disclosure, the law should survive preemption.
On the other hand, states should feel more comfortable passing provisions to ban clawbacks, mandate licensure, and establish fair pharmacy audit procedures. Despite challenging North Dakota’s gag clauses and anti-clawbacks provisions in Tufte, PCMA praised and supported similar provisions in a 2019 New Jersey bill,32 containing a ban on gag clauses and clawback provisions.33 PCMA’s explicit support for such a bill suggests PCMA is unlikely to litigate these issues in other states. PCMA has never challenged PBM licensure/registration and fair pharmacy audit procedures, so states choosing to regulate these practices are unlikely to face legal challenges.
Finally, to minimize the risk of litigation, states may require insurers to contract with PBMs in specific ways rather than directly regulating the business practices of PBMs. Using this novel approach, the Maine legislature crafted L.D. 1504 to impose regulatory requirements on insurers (“carriers” in L.D. 1504) rather than on PBMs. Specifically, L.D. 1504 requires carriers to monitor and oversee PBMs to ensure the requirements of the act are met. Among many provisions, the carrier must include fiduciary duty, anti-clawback, and adequate network provisions in its contract with PBMs. Additionally, the carrier or the PBM under contract with a carrier must use a single MAC list, and only certain drugs can be on a MAC list as specified.
As discussed above, ERISA saves insurance law from preemption, so Maine’s law is also likely saved from ERISA preemption. The law regulates the business of insurance by imposing requirements on state-regulated insurance carriers, which includes fully insured employee benefit plans but, importantly, excludes self-insured employee benefit plans governed completely by ERISA. Because ERISA’s saving clause allows state insurance laws to regulate fully insured employee benefit plans governed by ERISA and because the regulation of carriers and the contracts of carriers would be considered a state insurance law, Maine’s law provides a novel path for states seeking to pass PBM regulations that likely avoid ERISA preemption.
To further assist states seeking to regulate PBMs, the National Academy for State Health Policy (NASHP) and the National Community Pharmacists Association (NCPA) with the National Conference of Insurance Legislators (NCIL) drafted versions of model PBM legislation. Table 1 in the Appendix provides a comparison of the three model laws. The NCPA/NCIL model law was intentionally written to sidestep any possible ERISA preemption challenges but, as a result, may have only minimal effects on drug prices. The NASHP model laws, in contrast, contain more comprehensive provisions and may be more likely to be challenged. Nonetheless, NASHP Model Law B has a low chance of preemption, because it is based on Maine’s L.D. 1504. Whether ERISA preempts a law is a matter for a court to decide, but NASHP Model Law B minimizes the risk of ERISA preemption by regulating the insurer and its contract with a PBM. States, seeking to further minimize the risk of ERISA preemption, could also pass a modified NASHP Model Law B that includes Maine’s definition of insurer, as described above, which implicitly excludes self-insured employee benefit plans fully governed by ERISA.
In conclusion, because courts have been inconsistent in their applications of ERISA, states should not be chilled from passing laws to more directly regulate the business conduct of PBMs. Nonetheless, states should be cognizant of potential legal challenges, in particular, ERISA preemption. States may craft legislation that avoids explicitly exempting ERISA plans and requires insurers to oversee conduct of any PBM with which they contract. Ultimately, states passing meaningful PBM regulations can use these suggestions but should also be prepared to defend these laws in court.34