I’ve studied the drug supply chain for years. Like many economists, I saw pharmacy-benefit managers (PBMs) as valuable actors in restraining drug prices, particularly when they went to bat for employer-based health plans.
I’ve had a change of heart. While these giant middlemen in the supply chain still drive hard bargains with manufacturers, they are increasingly finding ways to expand their profitability at the expense of employers and patients. Federal regulators need to be empowered to restore order, and soon.
Unbridled powerHere’s an example of how wacky the process has gotten. I recently learned that a generic drug manufacturer surveyed what prices its employee health plan paid for its own drugs after they entered the supply chain. The final price was on average 5.8 times what the manufacturer received. You would expect some kind of multiple as the drug goes from maker to retail, but almost six times?
This drug company is far from alone in facing the unbridled power of PBMs, who sit astride the pharmaceutical pricing apparatus like modern colossuses.
The large PBMs often portray themselves as fighting the “good fight” on behalf of employers and employees. They say they are simply behind-the-scenes, low-margin middlemen negotiating with greedy manufacturers to constrain drug prices.
In reality, they are highly profitable intermediaries that typically do not take possession of the drug, bear little to no risk, and minimally innovate.
As such, PBM profit margins are much higher than other players in the supply chain who bear much of the public’s anger over rising drug prices. Express Scripts for example, one of the largest PBMs, reported gross profits of $8.76 billion in 2017. Outside of their mail-order operation, they don’t take delivery of the drug. Thus most of the gross profit coverts into EBITDA (earnings before interest, taxes, depreciation and amortization), the standard measure of bottom line profitability. By this metric, Express Scripts and the other major PBMs are living large, both in absolute terms and relative to manufacturers, wholesalers, pharmacies, and insurers.
From humble beginnings to success and industry consolidationIt wasn’t always this way.
PBMs had a humble beginning several decades ago. Large employers needed help keeping track of all the drugs their employees were being prescribed, and the resulting flow of benefit payments. The PBMs stepped in to run the back-office claims functions.
Over time, the PBMs realized they could save their clients money by developing formularies, or lists of covered drugs. By playing one manufacturer against another for favorable placement on a formulary, PBMs could negotiate steep discounts off list prices. Initially this created several favorable outcomes. It was a good development for controlling prices in the market overall. Employers benefited by getting a large share of the rebates negotiated by the PBMs. The rebates helped the employers keep premiums in check, which benefited employees.
For the PBMs, success spurred consolidation. Today three PBMs dominate the national market: Express Scripts ESRX, +0.49% CVS Caremark (part of CVS Health CVS, +1.17% ) and OptumRx. While their size means greater negotiating power with drugmakers, it also limits the options of their employer clients, and enabled PBMs to carve out a larger share of drug industry revenues.
Pharmacies needed to be included in the new supply chains, so PBMs began collecting higher fees to join their networks. The PBMs realized that they could impose copayments on insured individuals no matter the actual price of the drug; in some cases these copayments could exceed the price of the drug that a pharmacist would collect from a customer with no insurance at all. And to prevent patients from finding out when cash is cheaper than an insurance copay, PBMs could impose “gag orders” on pharmacists.
Because rebates and profits might be higher with brand drugs, PBMs could require members to use their insurance to buy them instead of cheaper generic versions.
In some cases, copayments can exceed the price of the drug that a pharmacist would collect from a customer with no insurance.The biggest PBM profit center is the “spread,” or the difference between what the PBM pays the pharmacy and what it charges the employer-sponsored health plan. While the spread may be small in absolute terms, it adds up nicely over 4.5 billion prescriptions a year.
For example, a PBM might agree to pay a pharmacy $10 for each 30-day supply of a generic drug it dispenses. Fortunately for the PBM, the plan sponsor doesn’t know how much the pharmacy was reimbursed, and thus the PBM can bill the plan $11 or $12 or more. The only constraint on this practice is that the sponsor might seek out a different PBM if drug spending increases too rapidly. But at the same time, sponsors have fewer PBMs to choose from.
While this is a big issue for corporate insurance plans, similar issues affect Medicare’s drug benefit (Part D). However, Part D requires plans to report all rebates and discounts to the Centers for Medicare and Medicaid Services, so some of the most profitable PBM actions are mitigated in Part D.
The client’s best interestWhat is the remedy? One option is to regulate PBMs under the federal Employee Retirement Income Security Act of 1974. ERISA sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in those plans. In essence, federal regulators would require the PBMs to act in the best interests of their clients. By that definition, “spreads” would become transparent, outsized copayments and gag orders would disappear, and generic drugs would no longer be disadvantaged by artificial favoring of branded drugs.
Overall, giving ERISA regulators oversight of PBMs would change much of what is wrong in the pharmaceutical supply chain. It would return PBMs to their original, and still important role of efficiently and administrating drug benefits.
Geoffrey Joyce is director of Health Policy at the Leonard D. Schaeffer Center for Health Policy & Economics at the University of Southern California.
