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What are pharmacy benefit managers? A health economist explains how lack of competition drives up drug prices for everyone

The Conversation

James RebitzerbyJames Rebitzer
December 19, 2024
in Health, Biopharma, & Health-Tech, Media Mention
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What are pharmacy benefit managers? A health economist explains how lack of competition drives up drug prices for everyone
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Wegovy and Ozempic are weight loss drugs that promise to transform the treatment of obesity, heart disease and other chronic conditions that afflict millions of Americans. But while everyone agrees these drugs have the potential to transform lives, no one can agree on how best to pay for them.

Wegovy sells for a list price – or price before discounts – of $1,349 per month in the U.S. The same drug lists for $265 in Canada and less than half of that in the U.K. These dramatic differences illustrate a larger issue: The list price of patented drugs in the U.S. are far higher than in other rich countries.

U.S. Sen. Bernie Sanders spoke for many Americans when he said the high cost of drugs in America was “not just an issue of economics” but rather “a profound moral issue.”

Moral outrage leads to a search for villains. Joe Kernan, host of CNBC’s business show “Squawk Box,” cut to the chase when he asked: “Who is screwing us here? The PBMs? The drugmakers?”

As a health economist who writes about innovations in the health sector, I have spent a good portion of the past five years thinking about these questions. What I’ve learned is that high list prices for drugs don’t tell us much about who is screwing whom. To truly understand the problem of drug pricing in the U.S., you need to start with the tricky economics of the PBMs, or pharmacy benefit managers.

What are pharmacy benefit managers?

Pharmacy benefit managers started popping up in the late 1960s as providers of claims processing and administrative services for health insurers. Over time, they became essential middlemen between drugmakers and the many insurers, employers and government entities who purchase drugs on behalf of their members, constituents and beneficiaries.

Mergers between PBMs have led to a market dominated by a small number of very large players. In 2023, the three biggest ones – OptumRx, Express Scripts and CVS Caremark – managed 79% of U.S. prescription claims and served roughly 270 million customers.

The primary role of these companies is to negotiate price, affordability and access to prescription drugs. They do this by operating and designing formularies, which are lists of drugs that insurers cover.

Customer at counter of pharmacy, a stack of bills and drug packages flanking
A drug’s listing on a formulary determines its price. Joe Buglewicz/The Washington Post via Getty Images

Formularies also assign drugs to different tiers that determine what patients must pay out of pocket to access the drug. Generic drugs are typically placed in the tier with the lowest out-of-pocket costs. Patented drugs that insurers prefer are placed in a tier with higher costs, and nonpreferred drugs are in a tier that requires patients to pay even more. Some drugs can even be excluded from the formulary altogether, meaning insurance won’t cover them.

Tier placement determines how affordable a medication is to consumers and the effective drug price that insurers pay. Drugmakers compete with each other for placement on desired formulary tiers by offering PBMs significant discounts off their list price. The price at which the PBM obtains the drug for its clients is the net price – the list price minus the drugmaker’s discount.

If a drugmaker increases its rebate, the net price falls, even if the publicly posted list prices remain high. This is why focusing on list prices to determine the cost of a drug can be misleading.

The price is right?

List prices for drugs are public knowledge, but drugmakers’ discounts to PBMs are closely held secrets. As a result, it’s hard to know exactly how much insurers pay for most prescription drugs.

This secrecy raises challenging questions. Do PBMs use their size and negotiating power to win lower net prices from drugmakers? Or do PBMs use their dominant market position and opaque business practices to enrich themselves at the expense of their customers and the rest of society?

The answer to both these questions is, surprisingly, yes. If the contest for formulary placement works as it should, competition compels drugmakers to offer substantial discounts off the published list price. As a result, insurers and consumers benefit from a reduced net price for drugs. However, formulary competition can be undermined in various ways.

In a 2024 report, for example, the U.S. Federal Trade Commission found evidence that the manufacturer of a patented form of insulin offered higher rebates to a PBM if competing insulins were placed on a less favorable tier of a formulary or excluded altogether. This arrangement reduces consumer choice. If a cheaper generic equivalent is excluded, the arrangement would also favor a more expensive drug that raises patient costs. Widespread use of such exclusionary rebates might even discourage new generics and reduce competition.

Introducing biosimilar drugs manufactured specifically for PBMs to substitute for expensive biologics manufactured elsewhere can also undermine formulary competition. When PBMs favor their in-house products in formularies, this reduces the incentive for other drugmakers to introduce competing products. The result is both less competition and higher prices.

Competition within the formulary can also be distorted when drugmakers post very high list prices. This artificially inflates rebates for PBMs without lowering net prices for insurers and other parties. Inflated list prices also increase the cost of drugs for some groups of patients – notably, people who lack health insurance or have high deductible plans.

Market competition

Just as fair competition can break down within the PBM’s formulary, it can also fall apart in the market for PBM services.

The current regulatory environment in the U.S. tolerates overly large PBMs that engage in anticompetitive practices to accumulate excessive profits. Without strong competitors, dominant PBMs are free to charge their customers high fees and keep a larger portion of drugmaker rebates for themselves.

In theory, this problem should be self-correcting. High profits should attract new competitors into the industry. Competition from these entrants should lower fees and reduce the fraction of rebates these companies keep. However, things work out differently in practice because the largest PBMs have merged with the largest health insurers. CVS has merged with Aetna. Express Scripts and OptumRx merged, respectively, with Cigna and UnitedHealthcare. These combinations reduce the number of potential customers for new PBMs and so keep new competitors from entering the market.

Person walking past CVS Pharmacy storefront
CVS Health has its own PBM (CVS Caremark), pharmacy chain (CVS Pharmacy) and health insurer (Aetna). Charles Krupa/AP Photo

Scrappy upstarts that could shake up the status quo also find themselves at a disadvantage due to common contracting practices. Large PBMs, for example, often insist on “most-favored-nation” contracts that require drugmakers to meet or beat the prices they offer to other buyers. These contracts eliminate the competitive advantage a new PBM might gain from obtaining better prices than incumbent companies.

There is growing concern among experts that dominant PBMs also use formularies to steer profitable “specialty prescriptions” to pharmacies with whom they are affiliated. The pharmacies affiliated with the three biggest PBMs expanded their share of the specialty drug market from 55% to 67% between 2016 and 2023. Concerns over such anticompetitive practices have led to bipartisan legislation to force PBMs to sell off their retail or mail-order pharmacies.

Who are the villains?

So, are PBMs screwing us? If we didn’t have PBMs, we would need to invent them – or something like them – to obtain reasonable prices on patented drugs. But the concentration of market power among a few companies threatens to dissipate the value they create.

Increasing competition within the PBM marketplace will likely require a larger number of smaller PBMs, and large insurers may also be required to divest their PBM units.

Contrary to conventional wisdom, smaller PBMs will likely be just as able to negotiate a low net price for Wegovy and other patented drugs as larger PBMs. Beyond a certain minimum scale, it is competition for formulary placement, not PBM size, that matters. A more competitive and transparent market for PBM services will help keep that contest fair and transparent – to the benefit of customers and society.

In that sense, PBMs aren’t the villain. Too much market power in too few hands is the problem, and that’s something more competition, sensible regulation and vocal consumers might fix.

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Source: What are pharmacy benefit managers? A health economist explains how lack of competition drives up drug prices for everyone
Via: The Conversation
Tags: James RebitzerJim RebitzerPharmacy Benefit ManagersThe Conversation
James Rebitzer

James Rebitzer

Jim Rebitzer is the Peter and Deborah Wexler Professor of Management and Professor of Markets, Public Policy, and Law at Boston University’s Questrom School of Business. He focuses on organizational economics and human resource economics with a special emphasis on behavioral issues.

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