Pharmacy benefit managers (PBMs) are essential for prescription drug claims and cost management. In theory, PBMs negotiate between drug manufacturers and pharmaceutical companies to ensure fair drug costs and availability for insurers and patients. In recent years however PBM practices have come under scrutiny due to widespread concerns about price, rebate, and fee manipulation and their cumulative effects on increasing drug costs. Companies contracting with PBMs need to understand their function and workflow to guarantee fair and transparent prices for their clients. This blog describes a few areas for improvement in the traditional PBM model. No single solution exists, but working with a PBM that minimizes conflicts of interest, uses reportable evidence to set drug prices, and provides transparency into its business model ensures a fair result for all parties.
Pharmacy benefit managers started in the 1960s as a mechanism for managing and processing outpatient prescription drug claims on behalf of private insurance entities. The Medicare Act of 1965 covered the costs of inpatient hospitalization; however, outpatient prescription drugs were not included in government-sponsored plans until 2003, after the enactment of the Medicare Modernization Act. Public health plans' exclusion of outpatient prescription drug costs lingered due to concerns regarding drug costs and drug spending. During this time, pharmacy benefit managers acted as administrative controls — essentially managing drug claims and evolving into health insurance companies' intermediaries by negotiating drug costs with pharmacies and drug manufacturers.
PBMs primarily negotiate fees for claims between pharmaceutical companies and payers (i.e., health insurance companies). PBMs are third-party intermediaries that directly deal with drug costs with Pharmacy Services Administration Organizations (PSAOs) acting on behalf of pharmaceutical companies. PBMs are ubiquitous throughout the healthcare system — utilized by Medicare Part D plans, commercial health plans, self-insured employer plans, state government employee plans, and other public and private health plans.
PBMs have an array of functions beyond drug cost negotiation. PBMs may partner with or own retail pharmacy chains. For example, CVS Health owns CVS Caremark, the largest PBM in America. Many PBMs also provide special pharmacy services, such as mailing services for prescription drug delivery.
Separate from negotiating claims, PBMs influence drug costs, and prescription drug benefits by setting the "maximum allowable cost" (MAC) for drugs, which can have downstream effects on drug formularies and availability. MAC is formed by a PBM and refers to the highest amount a plan will pay for generic drugs or the generic alternative of a brand-name drug. MAC can differ between PBMs; there is no standard process for determining these prices or which drugs are on a MAC list.
Three companies dominate the PBM industry: CVS Caremark, Express Scripts, and OptumRx control almost 90% of drug claims and negotiations between health insurance providers and drug manufacturers for all Americans. Each "Big 3" PBM processes over one billion drug claims annually related to over one hundred thousand unique drugs.
Caremark Rx started in 1979 as a home healthcare company, shifting to a physician practice management company in the 1990s before rapidly growing as a PBM by the early 2000s. Caremark became CVS Caremark in 2008 after its purchase by CVS Health. CVS Caremark remains the largest PBM, owning 34% of the market share of prescription claims managed in 2020.
Express Scripts was founded in 1986 out of a partnership with a St. Louis-based retail pharmacy chain Medicare-Glaser. Express Scripts was one of the first companies to provide prescription drugs by mail for customers in nearby cities without retail locations for physical pick-up. Cigna bought Express Scripts in 2018 for $54 billion and is now the second largest PBM, controlling 24% of drug claims.
OptumRx is a subsidiary of the United Health Group (UHG) but contributes significantly to UHGs yearly earnings. OptumRx is the third largest PBM, managing 21% of prescription drug claims in 2020.
The PBM business model depends on administrative charges for claims processing services, spread pricing, rebate sharing and price negotiations, partnerships or ownership of pharmaceutical companies, and other revenue sources such as direct and indirect remuneration (DIR) fees. Large PBM companies generally utilize a combination of these revenue streams. Smaller PBMs, such as Capital Rx, have altered their business model to eliminate conflicts of interest and increase drug price and fee transparency.
Administrative fees are service fees collected for each claim electronically processed. Some PBMs may choose not to incorporate administrative fees into their business model, whereas others may charge a nominal fee for each claim. The two primary models PBMs use are traditional or transparent ("pass-through") contracts. Standard contracts allow PBMs to generate revenue from the sources outlined below, whereas transparent agreements limit PBM revenue to a single (usually much higher) flat administrative fee. Newer PBMs have more tailored business models which address current problems in mainstream revenue schemes. For example, Capital Rx’s “Clearinghouse Model” extends transparency to include drug costs and methods for setting drug prices.
Spread pricing is perhaps the most controversial of PBM business practices. PBMs may charge their employers (e.g., health insurers) more than they reimburse drug companies. PBMs can use their MAC lists to generate significant revenue through spread pricing by reimbursing pharmaceutical companies based on the lowest MAC price for a drug. The PBM reimburses pharmacies or drug manufacturers the lowest amount yet charges the insurance company more for the claim. The difference between the charge to the health insurer and payment to the pharmaceutical company is known as the "spread" and is retained as a profit by most PBMs.
Drug manufacturers supply drugs to pharmacies that sell directly to the consumer. The collective sales are submitted as a series of prescription drug claims to the PBMs, who collect rebate money from the drug manufacturers based on drug claim negotiations. The money in the form of rebates is split between the PBM and their employer (i.e., health insurer) based on contractual agreements. Ideally, rebate money passed to the health insurers would be used to offset costs, thereby keeping premium costs down for consumers.
PBMs may own or partner with specialty pharmacies and direct payers toward utilization of PBM-associated pharmacy services either through contractual obligations or cost-saving incentives. PBMs may also generate revenue through specialty services such as mail-order prescriptions.
PBMs can also gain revenue through fees charged outside of administrative fees collected after the point of sale. The fee amount is often unknown to pharmacies at the time of claim processing, and PBMs can retroactively charge pharmacies these fees any time after the initial sale.
PBM business practices and their effects on drug costs are difficult to ascertain, given the complex nature of healthcare spending and the lack of fiduciary responsibility for PBMs. Investigations into PBM business practices on state and federal levels stems from the need to increase transparency within the PBM industry. Potential issues due to lack of transparency are outlined below.
PBMs pocket hundreds of millions of dollars annually through spread pricing practices. Multiple state-wide audits of Medicaid services have shown extraordinary profiteering off of spread pricing by PBMs as payers are charged more and pharmacies receive lower reimbursements for drug claims. Since 2018, many states have adjusted their managed care programs to decrease spread pricing, with most adopting models to eliminate spread pricing.
Rebates account for a quarter of prescription drug benefit costs and can have undue influence on drug list prices and availability. For example, some manufacturers may pay higher rebates for the preferred formulary placement of their drug. To offset the cost of a higher refund, the manufacturer may increase the price of its drug, thereby increasing the list price. The increased costs can be passed to health insurers and patients.
Contractual agreements between PBMs and their employers are generally kept private. Given the large market share of drug claims managed by the "Big 3," payers may have little negotiating power with PBMs leading to "take it or leave it" contracts that unfairly favor PBMs. Moreover, before 2018, many PBMs included "gag clauses" within their contracts, which prevented pharmacies from informing patients of lower out-of-pocket drug costs at the point of sale.
PBM ownership of pharmacies and services such as mail services is a conflict of interest, given PBM's role in claim negotiation and its potential as a competing provider within a pharmacy network. PBMs may influence pharmacy networks - through either contractual requirements of payers or financial incentives - that favor utilization of PBM-owned pharmacies and services. Driving patients towards PBM-owned services is known as "patient steering" and can severely undercut the use of local independently owned drug companies. Some patients living in rural communities may have restricted access to care, notably if their local independent pharmacy is excluded from their preferred network.
Multiple statewide PBM audits have revealed the exorbitant cost of spread pricing to state health plans: for example, Ohio found that PBMs earned $224.8 million over a one-year through spread pricing alone. These audits have led to many state agencies adopting a "pass-through pricing model" in which PBMs may only receive administrative fees as part of the revenue from managing drug claims. An increased understanding of PBM revenue schemes can better guide the regulation of PBM practices. The Creating Transparency to Have Drug Rebates Unlocked ACT (S. 637) and the Prescription Drug Price Transparency ACT (H.R. 1316) were introduced in 2017-2018 but failed to gain traction. Both pieces of legislation would have increased public disclosure of rebates and discounts negotiated by PBMs and limited patient steering practices.
Capital Rx champions business model transparency through their “Clearinghouse Model.” As part of this model, drug costs are determined through publicly available and reported trends in drug costs, which avoids arbitrary price determination and manipulation while minimizing monetary gains through spread pricing.
The Pharmacy Benefit Manager Transparency Act of 2022 (S. 4293) was recently introduced to the Senate. Under this legislation, the Federal Trade Commission would gain increased oversight of PBM practices, and controversial techniques, such as spread pricing, would be eliminated. Increasing support for this and similar legislation will be paramount for creating an equitable environment for PBM reform.
The Patient Right to Know Drug Prices Act (S. 2554) and Know the Lowest Price Act (S. 2553) was passed in 2018, both restricting the ability of a PBM or drug plan from including "gag clauses" in their contract — i.e., hiding potential lower out-of-pocket costs of a prescription drug relative to the drug cost under their health plans. Proponents for PBM reform, such as the NCPA (National Community Pharmacists Association), have advocated for anti-steering legislation which limits the practice of "patient steering" or mandatory use of PBM-owned services by patients.
The Center for Medicare Services (CMS) recently issued a final rule to eliminate retroactive DIR fees. Starting in 2024, the final net cost for a drug will be at the drug's point of sale rather than weeks or months after purchase. Though this helps increase the predictability of drug costs for pharmacies, PBMs may still apply DIR fees and other arbitrary fees upfront at the point of sale. Further fee usage evaluation and application clarification will likely be included in future reformative iterations.
In an ideal model of our current healthcare system, PBMs should function to maximize drug cost savings for their employers, who can pass along savings to the patient. The problems associated with traditional PBM models have outgrown their benefits and new approaches to drug claim negotiations and price determinations are needed. Newer PBMs, such as Capital Rx, are advocating for increased business model transparency, rational and evidence-based determination of drug prices, and minimizing conflicts of interest. Responsible stakeholders need to understand PBM business models and ask the right questions about their PBM to ensure they are offering the best possible health coverage.
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