Preferred Pharmacy Networks and Drug Costs

Selective contracting is an increasingly popular tool for reducing health care costs, but these savings must be weighed against consumer surplus losses from restricted access. In both public and private prescription drug insurance plans, issuers utilize preferred pharmacy networks to reduce drug prices. We show that, in the Medicare Part D program, drug plans with more restrictive preferred pharmacy networks, and plans with fewer enrollees who are insensitive to preferred pharmacy discounts on copays, pay lower retail drug prices. We then use estimates of plan and pharmacy demand to estimate the first-order costs and benefits of selective contracting in the presence of enrollees with heterogeneous sensitivity to preferred supplier incentives.