PBM: Pharmaceutical Bullshit Machines

An Impartial Look at Pharmacy Benefit Managers

“$100 billion of the $500 billion spent on pharmaceuticals in the U.S. is ‘wasted’ on the middleman.”

This quote comes from Faisal Mushtaq, CEO of Truveris, a company that helps employers choose Pharmacy Benefit Managers. The middleman to which he’s referring: Pharmacy Benefit Managers. 

PBMs are the specters of the pharmaceutical supply chain. They have a quiet existence at the center of the transaction, leeching value and hoping you don’t notice exactly what they’re doing. And they do a good job of staying ghostly. Just like most people in horror movies don’t realize there’s a ghost in the house until it’s too late, most Americans don’t realize there’s a 3 in 4 chance they’re actually an indirect customer of a PBM. 

Today we’ll explore the origins of PBMs, how they make money, and what effect their lingering presence has on what is most-certainly a haunted healthcare system. 

The Origin of The PBM

As a history buff, I believe that often the best way to understand a modern institution is by examining its roots. We’re going to go back nearly a century, to the very beginnings of our modern American healthcare system. 

Health insurance, in the early days, was a fairly basic offering. The first group plan was offered in 1929 by Baylor University Hospital in Texas at a rate of $6 per year (roughly $87 in 2018 money). It covered up to 21 days of hospital care in a given year, which was a fairly comprehensive offering at the time as generic hospital care was about all that medicine had to offer. This plan inspired others like it, and became the basis for the health insurance business. 

As medical technology advanced to include more specialized healthcare services and prescription drugs as part of regular ongoing care, health insurance had to follow suit. Drugs delivered in the hospital were simply included as a part of hospital coverage, but drugs prescribed by a physician, purchased from a pharmacy, and taken at home proved to be an administrative can of worms for insurers. If they were to cover the cost of these drugs they would need to develop relationships with the pharmacies in order to reimburse them.

Enter the pharmacy benefit manager. These companies took on the administrative burden of creating a relationship with the pharmacy. They would confirm to the pharmacist that the patient had prescription coverage, dispense payment to the pharmacist for the drug, and then collect payment from the insurer. The insurer was happy to pay them a small fee for managing this complex transaction, as it saved them from the administrative burden, and from having to expend the effort to cultivate a network of participating pharmacies. 

At a time when the retail pharmacy industry was far more fragmented than today, and when business was done entirely on paper, PBMs created real value. But as technology progressed and all of these processes were computerized, the PBM space became more competitive. Competition meant lower administrative fees charged to insurers, and thus slimmer margins for the PBM. These companies now had to look beyond their core administrative business to discover new avenues for revenue and sustainable profitability. 

These new services drifted towards the clinical. An early feature was monitoring for conflicts between prescribed drugs in a specific patient and issuing drug-drug-interaction warnings to pharmacists. As health plans began to get choosier about which specific drugs they would pay for, PBMs began helping to decide on an optimal mix of medications (called a formulary).

PBMs even began to negotiate with pharmacies and drug manufacturers on the prices that the health plan would pay for a given drug. This would redefine the PBM industry.

How PBMs Make Money

Health insurers are effectively patient demand aggregators. They can direct the flow of patients to providers, and thus use that leverage to extract lower fees from providers. By lowering what they pay in fees, they keep a larger portion of the premiums they collect from patients. (As I wrote a few weeks ago, this basic drive to lower fees has been somewhat corrupted by the MLR regulations of PPACA). 

PBMs effectively aggregate the same patient demand, but with prescription drugs. 

A modern PBM is contracted by a health plan (or an employer that is self-insured) and paid administrative fees to manage the pharmacy benefits of the population. This is the age-old activity of a PBM and nothing sexier than ensuring patients are able to easily collect their prescriptions at a pharmacy, and handling all of the subsequent (digital) paperwork. 

But PBMs have been given agency to negotiate on behalf of health plans. This puts them in an especially advantageous position in the prescription drug value chain. By controlling and concentrating patient demand, they can determine the fate of a given drug, and of a given pharmacy. 

PBMs and Pharmacies

Pharmacies must be in a PBM’s network if they want to distribute medications to that PBM’s patient population. As 250 million Americans, or about 3 out of every 4 of us, have our benefits managed by a PBM, pharmacies are essentially at the mercy of the PBM. PBMs use their immense leverage to drive down what they’re willing to pay pharmacies for the drugs they’re dispensing. 

For example, your pharmacy dispenses to you a supply of antibiotics prescribed by your doctor to deal with a lingering sinus infection. You give your insurance information at the counter and pay nothing. The pharmacy software requests $9 from your PBM to pay for this. The pharmacy has purchased these medications from a drug wholesaler for $8, meaning they now make $1 in gross profit on that transaction. 

With this market dynamic it’s apparent why both pharmacies and PBMs have seen massive industrial conglomeration. The larger a PBM gets, the more aggregated patient demand it controls, and the more it can drive down pharmacy reimbursements. As pharmacy chains grow larger they can extract better volume pricing from drug wholesalers, and put up more of a fight when PBMs drive down reimbursements. And if pharmacy chains get big enough, they can just buy the PBM entirely like CVS did when it acquired Caremark. 

Most PBMs also operate their own specialty and mail order pharmacies. These account for a sizable share of PBM revenue as their prices per drug can be set to be near the average selling price, but the PBM gets to earn both their regular margin and the margin usually given away to the pharmacy.

PBMs and Drug Manufacturers

PBMs can control where patients get their prescriptions, but they can also control which drugs they’re actually allowed to have covered by insurance. PBMs help the health plan design the formulary of medications they’ll offer to patients. This gives them a huge amount of power over drug manufacturers. 

A drug company can develop a wonder drug - the kind that saves lives - but if none of the PBMs will pay for it, very few people will actually get it. 

The more typical interaction between a drug company and a PBM occurs when there is more than one drug available to treat a certain condition. For example, if you’re diagnosed with high blood pressure, your physician will prescribe a statin. Pfizer, who manufactures Lipitor, may strike a deal with the PBM to ensure that Lipitor gets preferential placement on the formulary, meaning that if there is a situation where the PBM can steer patients towards a specific statin, it’ll be Lipitor. This could mean a PBM automatically switches the medication to Lipitor when it hasn’t been specified by brand name by the physician, or that using another brand’s statin carries a higher co-pay from the patient than if they got Lipitor.

As you may have ascertained by this point, PBMs aren’t the giving type. So they don’t grant preferential placement on the formulary out of the goodness of their hearts. 

When a PBM places a specific drug higher on the formulary, they do so with the expectation that if they help grow the market share of that drug by a certain margin, they are entitled to receive rebates from the manufacturer. These rebates are, jargon aside, sizable cash bonuses in return for pushing specific drugs.

Rebates aren’t such a bad thing, especially if they’re used to lower the overall effective cost of the drug, and if those savings ultimately make their way back to the health plan and the end consumer. But you guessed it: much of the money paid by drug companies to PBMs stays with the PBM. They achieve this through a variety of methods, the first of which is ensuring that manufacturers won’t publicly declare how much they’ve paid in rebates, and PBMs won’t declare how much they’ve received. They’ll also categorize these rebates as fees paid by manufacturers for services rendered, meaning that even if they are passing rebates back to employers and insurers, they’re entitled to retain all of their fee based income as it wasn’t directly related to the drugs sold. If you’re interested in all of the ways PBMs obscure fees for their own gain, Linda Cahn will take you through it.

PBMs and their Customers

PBMs earn revenue from their customers - health plans and employers - two ways. The first is through regular-course fees for the service of managing pharmacy benefits for the population. And the second major source is essentially bonuses for achieving performance milestones such as cost containment. 

But PBMs, unsurprisingly, have found ways to magnify their profitability from these regular-course activities. Axios, earlier this month, obtained a standard contract template used by Express Scripts and it details many of the ways PBMs set themselves up for increased profits including:

  • Vague definitions of branded vs generic drugs. PBMs charge different rates for branded drugs than they do for generics, so by tweaking their definitions they can charge health plans different amounts for the drugs they’ve already purchased. The retrospective ability to tweak how much they charge a client, as Axios quotes an unnamed source, means that they never miss their earnings expectations. 

  • Vague definitions of payment schedules. PBMs can, through obfuscating actual pricing, pay pharmacies less for drugs than what the health plan is paying them. This transforms drug reimbursement from being a pass through to being an activity where the PBM can skim money off the top of the transaction. 

  • As mentioned above, language allowing PBMs to collect and retain fees from drug manufacturers without sharing with the health plan. 

Most tellingly this contract contains language to the effect of establishing that Express Scripts negotiates with drug manufacturers primarily for their own benefit and not for the benefit of anyone else. 

These practices have gotten PBMs into major trouble. Express Scripts very publicly broke up with longtime customer Anthem after Anthem sued them alleging they’d held back on $3 billion in drug savings. Express Scripts also settled out of court after numerous state attorneys general sued them for withholding rebate savings.

It would seem that pressure is mounting for PBMs as both Aetna (soon to be a part of CVS-Caremark) and Optum (the captive PBM owned by health insurance giant UnitedHealth Group) have announced they’ll start ensuring that rebates make it back to the consumer in one form or another. And while this is certainly a step in the right direction, as we’ve seen above, PBMs are very good at obscuring what’s actually going on in the drug transaction. In effect: don’t expect much. 

Do PBMs Actually Lower Drug Costs?

If you ask a PBM what value they create, they’ll tell you they help lower drug prices. There are two ways to evaluate that claim. 

The first is to look at the industry in aggregate. We established above that roughly 75% of Americans get their drugs via some sort of PBM relationship. If these PBMs were, in fact, achieving drug savings for their clients, then drug prices across the board should be declining. 

And yet, here’s the summary of a report from Senator Claire McCaskill released this week:  

The prices of some of the most popular brand-name drugs have increased by 12% on average each year from 2012 to 2017, based on Medicare Part D data, according to a report released by Sen. Claire McCaskill, D-Mo. That's 10 times greater than the rate of inflation during that same period. 

Though the number of these prescriptions decreased by 48 million in that window, profits increased by $8.5 billion. Twelve of the 20 medications included in McCaskill's report saw prices increase by 50% between 2012 and 2017. For six drugs, prices increased by more than 100% during that period.

Drug price increases continue unabated, which means that all the patient demand concentrated in a small number of PBMs is likely not being effectively utilized to put pressure on drug prices. 

Secondarily, we can examine the business model of the PBM. How do they make the most money for themselves? 

PBMs make money when they contain the drug costs for their health plan clients. But they get to help set the goals for cost containment. They likely sit down at their contract negotiation meeting with the client, pull out the report I just quoted above, and say “drug prices are growing like crazy, so we think we can ensure that your overall costs don’t rise more than 5% per year, which is 7 points lower than the market average.” This justifies the expense of the plan to the client and the contract is signed. 

The problem is that PBMs also make money by negotiating with drug manufacturers. Drug manufacturers get to keep increasing the prices for their drugs and PBMs won’t put up too much of a fuss if the drug manufacturers pay them rebates. Those rebates are then used to help ensure PBMs achieve their overall cost containment goals for their clients, with the leftover rebates staying in the PBM’s coffers. 

PBMs will point fingers at the drug companies claiming they’re responsible for these dramatic increases in drug prices, but the PBMs represent the collective market will of a majority of Americans and thus have the ability to put a stop to it. The tricky part is that PBMs actually make more money as drug prices rise. 

Looking at the supply chain from the perspective of the drug manufacturer, it’s easy to see why they like PBMs. If they’re making a drug and their cost to manufacture and distribute the drug is $2 per dose, they’ll set a price of $100 per dose. This gives them plenty of margin to give away to PBMs to ensure they’ll include this expensive drug on their formulary. Effectively, PBMs serve as a mechanism for drug manufacturers to pay for market share. 

The Future of PBMs

It’s hard to imagine PBMs maintaining the status quo for much longer. Much of the healthcare discussion has lately focused on the core healthcare issue of exploding drug prices. The Kaiser Family Foundation’s health tracking poll recently showed that 80% of Americans believe drug prices are unreasonable, and when asked what the major legislative focus of the government should be, more than half of respondents say government should work on lowering the price of prescription drugs. This level of focus, and agreement, on a single issue is something you don’t see much of in the political sphere these days. 

If the government does act on drug pricing, it will most likely negatively effect PBMs and their ability to continue business as usual.

Even short of government intervention, standalone PBMs are quickly becoming rare. If the CVS-Aetna and Cigna-Express Scripts acquisitions are approved by the government, two of the largest PBMs will be operating as part of health plans, while Optum, the other major PBM, already does. 

Will this conglomeration help the American healthcare consumer? It remains to be seen. 

In the case of CVS-Aetna, the combined company will occupy all of the consumer-adjacent spaces in the value chain, acting as pharmacy, PBM, and health plan. There’s no question that a company with that much concerted market presence could have a downward effect on drug pricing, but will they have the incentive? If these companies start to see it as more profitable in the long-run to reduce the cost of drugs, it will happen.