So rare is bipartisan regulatory legislation in Congress, especially in health care, that when it occurs one must presume it is in response to prohibitive costs to society or a threat to patient welfare. Pharmacy benefit managers (PBMs) seem to be considered both, as no fewer than eight separate bills to change PBM practices have recently been introduced or advanced out of committee, all of them involving both Democratic and Republican co-sponsors. This remarkable collaboration, following on the heels of the historic, and decidedly partisan, decision to allow the Centers for Medicare and Medicaid Services (CMS) to negotiate medication prices, deserves careful policy analysis.
Pharmacy Benefit Management Tools And Strategies
PBMs are a relatively new addition to the health policy scene. Historically, they have not drawn much attention from legislators or regulators. In the late 1970s, as employers began to provide coverage for medications (in 1988, 70 percent of medications were paid out of pocket), entrepreneurial companies began to design automated payment solutions, such as the so-called pharmacy card. Others developed mail order pharmacies to compete with retail pharmacies, using scale to lower prices. Some of these merged and offered their services to self-insured employers, promising to control costs in the way that these companies’ health insurer contractors helped control physician and hospital costs.
Over time, most PBMs employed six techniques to lower the costs of medications. First, they offered a mail order alternative to the retail pharmacies, with lower costs related to greater scale and automation. Second, they used the same contracting techniques with retail pharmacies that insurers did with hospitals, putting together participating networks and threatening to exclude the retail pharmacy if it did not offer lower prices for its services (primarily, filling prescriptions to get a dispensing fee). Third, again like health insurers, PBMs developed in-house medical expertise and undertook utilization management to ensure that medications were being given for the proper indications. Fourth, PBMs used the collective power of their clients to purchase generic medications more cheaply, taking advantage of the many different producers of generics, many overseas.
The other two techniques used by PBMs derived from their control of the formulary. For many medical conditions, there are similar pharmaceutical therapies competing with one another for the doctor’s prescription. Formularies can be designed that offer comprehensive therapy yet exclude some drugs. PBMs developed these formularies, guided by expertise from pharmacy and therapeutics committees that are intended to be objective and independent, to serve two functions. First, they would develop tiers of medications, with the least expensive generic medications on lower tiers. Prescriptions filled on lower tiers would have zero or little copayment, while those on higher tiers would have higher copayment. This was designed to encourage generic use, an area (one of the few) where the US system excels (today, nearly 90 percent of the medications taken in the United States are generic).
The second use of the formulary was to get discounts on branded medications. Newly approved drugs are and remain under patent, a legally granted monopoly. In the US, the manufacturer can name the price of these medications. However, in some circumstances, two branded medications might have the same effect on a disease state or even share much the same mechanism of action. In this situation, a PBM need have only one on the formulary. The PBM can then develop a reverse bidding war with manufacturers to get a discounted price. This discount is delivered as a rebate to the PBM from the manufacturer, causing a gross to net difference in pricing for the pharmaceutical manufacturer.
All these techniques were designed to lower costs of medications for clients, mainly employers and health insurers. PBMs competed largely based on the estimated costs for clients over a typically three-year contract period. So PBMs had the blunt incentive to lower costs to gain business, and their clients were sophisticated employer benefit managers, complemented by benefit consultants. The PBM business techniques have been scrutinized and found satisfactory, specifically the safe harbor for rebate approach that immunized PBMs and pharmaceutical manufacturer from liability under federal anti-kickback laws.
Over the first decade of the 21st century, the industry consolidated, with three firms eventually cornering more than 80 percent of the market and more than 50 other PBMs sharing the remainder. In 2003, PBMs picked up a new market as Medicare finally gained a drug benefit in the form of Part D plans and medication coverage in Medicare Advantage plans. The logic of the Medicare Prescription Drug, Improvement, and Modernization Act was decidedly market-based, with the Part D plans (typically developed by PBMs) submitting bids for coverage of their population—essentially going at-risk for the medication costs, thereby creating strong incentives for lower costs. Moreover, the bids were carefully regulated by CMS, reviewed on a preliminary and final basis annually by CMS officials. The structure of Part D proved effective, with much lower costs for the program than originally predicted.
PBMs also play a large role in the Medicaid program. Nearly three-quarters of Medicaid beneficiaries are in managed care plans operated by private insurers as of 2020. Nearly all these plans use PBMs to manage the drug costs for their clients.
From a patient welfare point of view, two issues regarding PBMs are salient. First, many worry that utilization management can delay necessary care for patients; it certainly represents a hassle factor for physician-prescribers. Second, the effort to steer patients to lower-cost drugs depends on out-of-pocket payments that some patients cannot afford, decreasing adherence to medication regimens. Fortunately, both utilization management and out-of-pocket reforms are underway independent of the PBM-centered proposed bills.
PBM Reform Proposals
Approximately five years ago, voices began to rise, asserting that PBMs were making inordinate profits and raising the costs of medication. Some of these concerns were led by pharmaceutical manufacturers that argued the price of branded medications had to increase in light of the rebating driven by the PBMs. Another source of criticism was from the retail pharmacies, especially independent pharmacies that were being forced by PBM network managers to accept very low prices.
Some state Medicaid authorities sued PBMs, alleging that PBMs had hidden fees and were contributing to exorbitant drug prices. Over time, the portrayal of PBMs as somewhat shady middlemen began to stick. The bipartisan conclusion today is that new regulation is needed.
It is worth noting that these new conclusions come following a period of massive increase in pharmaceutical launch prices, with increases of 20 percent annually from 2008 to 2021. For existing drugs under patent, CMS found that prices increased on average more than 10 percent per year for the period 2016–22. With more inflationary pressure, PBMs are appropriately under more pressure to constrain costs. The PBM industry association has maintained that only 4 percent of the drug dollar are costs related to PBM administration, and 2 percent to PBM profit. But as more dollars flow into drug costs, clearly that means more profit for PBMs. Analyses have suggested that PBM profit margins are between 4 percent and 7 percent, but some question if PBM pass-through revenues should be included in this calculation. PBMs counter that pharmaceutical manufacturers’ average margins are nearly 14 percent. Meanwhile, independent analysts, such as the Congressional Budget Office (CBO), have documented that since the mid-2000s, spending on drugs has fallen as percentage of all health care services, even in the face of massive increases in brand medication prices.
Legislative Action On PBMs
As this debate swirls, Congress is taking action. Among the seven bills, five main themes emerge:
Transparency. PBM efforts to reduce costs have always been cloaked in a dizzying array of different pricing formulations and secrecy about contracts with manufacturers. This is especially true regarding rebate contracts, and the percentage of rebates that PBMs retain as opposed to passing along to their clients. The majority of the proposed federal bills require comprehensive reporting on costs and rebate amounts to clients, as well as summary data transmitted to the General Accounting Office, so that the government can track industry practices. In some ways, this follows on the trend of increased transparency in health care pricing that has already been required for insurers and hospitals, and so it can hardly be objectionable. The only odd feature is that information is not really intended for the public, but rather for clients (employers and insurers), who should already have access to this kind of information as part of standard contracts. As well, CMS is fully informed about pricing in any Part D plan.
The transparency requirements do raise a question about agency issues. It might be that PBMs are abusing their clients, and hence the public, by hiding information and obfuscating financial details. But as mentioned above, these clients—including large employers and even larger insurers, the federal government, and many state governments—are sophisticated purchasers. Moreover, employers have not been in the vanguard of calling for regulation of PBMs.
Spread Pricing. The second major theme is that about half of the proposed bills ban spread pricing, which generally applies to the commercial relationships with the retail pharmacy network. A PBM using spread pricing guarantees a client a certain cost for prescription fulfillment; if the PBM gets discounts from pharmacies that exceed that guarantee, it can keep the difference. On the other hand, failure to get sufficient discounts leads to losses for the PBM. It is a risk-based contract.
For years, clients have been offered the alternative of straight pass-through of retail pharmacy costs or spread pricing. These clients include Medicaid managed care organizations contracting for PBM services. But this area has been the scene of greatest concern for many state legislators, who believe that Medicaid spread pricing, or any spread pricing, should be eliminated. Federal legislation mandating pass-through pricing would accelerate an existing market trend. Notably, spread pricing in Medicare Part D is de minimis, due to CMS reporting requirements.
Rebates. The third major theme is required rebate pass-through, with no retention of rebates by PBMs. Since Part D started, there has been no rebate retention by the PBMs for the federal program. Many private clients have sought the same, insisting in contract language that all rebates be transmitted directly to clients. But some clients choose a risk-based approach, preferring to have a high guaranteed amount of rebates and putting the PBM at risk to gain them. Some of the bills prohibit this going forward, although none outlaw the rebate mechanism itself. Congress already knows the value of rebates; when the Trump administration proposed eliminating the safe harbor for rebates, the CBO estimated that would cost the government $177 billion from 2020 to 2029.
Out-Of-Pocket Costs. Fourth, some of the bills seek to relieve individual beneficiaries from out-of-pocket costs, pursuing two mechanisms. The first involves the price the beneficiary experiences at the point of sale. This can be the non-rebated “list” price, or the rebated price. If the latter, then any co-insurance paid by the beneficiary would be discounted by the amount of the rebate, but the amount of the rebate going to the plan sponsor—that is, an insurer or employer—would be reduced accordingly. PBMs have long had the ability to offer either approach at the point of sale, but many plan sponsors prefer to maximize their rebate totals, and so insist on unrebated prices at point of sale. Plan sponsors make the decisions about the architecture of out-of-pocket payments and distribution of rebates. Some of the proposed bills require point-of-sale application of rebates, reducing plan sponsor control.
The second tactic to reduce out-of-pocket costs is to prohibit copay accumulator programs. Over the past decade, pharmaceutical manufacturers have done the calculation that it is more profitable to pay out-of-pocket costs (copayments or co-insurance) for patients, so patients can access the expensive medications that the PBMs and their clients are trying to block by using economic incentives to drive patients to lower-cost alternatives. For example, consider a drug that in 2010 cost $40,000 and today costs $80,000. The cost of manufacturing it has changed very little over that time. Covering the $4,000–$8,000 out-of-pocket costs for the patient, thereby assuring that the patient is not moved to a lower-cost drug, makes good sense for the manufacturer.
These payments by manufacturers to patients (copay assistance programs) are generally not allowed by Medicare. The federal government has long been convinced that such payment by pharmaceutical manufacturers unnecessarily increases health care costs by steering patients past PBM and health insurer plan designs that encourage use of less expensive generic medications. But pharmaceutical company payments for out-of-pocket costs are not prohibited in commercial contracts. As a result, use of expensive, branded medications grows, increasing costs for employers and insurers.
PBMs have answered back by setting up so-called copay accumulators that discount the pharmaceutical manufacturer payments and maintain liability for patients. Many states now prohibit copay accumulators, but the states do not regulate self-insured employers. Some of the new proposed laws would add a federal ban for copay accumulators, allowing the pharmaceutical industry to purse a financial strategy that is prohibited under federal payment. A federal ban would affect the 83 percent of commercial health plan enrollees who are in plans that use an accumulator program. This would likely lead PBMs and their clients to accelerate the use of so-called maximizer programs as an alternative to accumulators. Maximizers are plan strategies that facilitate beneficiary participation in manufactures’ financial assistance programs, effectively getting the manufacturers themselves to pay for their expensive, branded medications. Maximizers do not depend on out-of-pocket payments by beneficiaries to drive beneficiaries to generics.
Part D. Finally, at least two of the bills would change the nature of the Part D architecture. They want to remove what they see as the PBM appetite for expensive drugs by limiting PBMs’ compensation to a flat fee. Exactly how this mechanism would work is not entirely clear from existing proposed bills, although the focus appears to be on the fear that PBMs are getting hidden fees to place more expensive medications on the formulary. This prohibition may have some impact, although the CBO has recently estimated it at only $70 million per year.
This likely pales in comparison to the substantial changes the Inflation Reduction Act has recently made in the risk architecture of Part D, re-instating the Part D plan’s risk in the catastrophic phase of the benefit. Part D plans, and their PBMs, had strong incentives to include high-price medications when the government had 80 percent of the risk. These brilliant and little-discussed IRA changes reiterate the incentives for Part D plans (and their PBMs) to push beneficiaries to lower-cost medications.
Other Changes. The PBM bills are littered with other small technical changes, some of which could be useful. For example, one bill requires participation by retail pharmacies in the National Average Drug Acquisition Cost survey. This will help provide comprehensive data on an alternative, but uniform, system of pricing generic drugs. Another bill requires that PBM Pharmacy and Therapeutics Committee determinations cannot be overridden by other PBM committees or decision makers, a best practice that should be enforced.
Will The Federal Reforms Have A Substantial Effect On PBMs And Drug Prices?
The next step for many of the proposed bills is CBO evaluation of each of the bills and these proposals. The CBO’s generally even-handed and thoughtful assessments will allow legislators to understand whether the new bills will increase or decrease costs, and that will likely help to determine eventual passage.
But even if all these proposals result in new federal regulations, it is difficult to see how they will substantially change the overall architecture of pharmacy commerce. Considering the five main themes of the many bills outlined above, the first conclusion is that transparency will likely improve policy. Health plans and employers will get new data, but it is worth noting that these are data they should already have access to under their contracts. PBMs (and manufacturers) may complain about pricing data being made public, but hospitals and insurers have made the same complaint to no avail. So long as the patient has responsibility in terms of out-of-pocket costs, he or she should have access to the prices.
Second, PBMs will no longer have access to margins from spread pricing and rebate retention, but they will still retain strong incentives to manage pharmacy networks, and push for higher rebates, as they compete for business on cost. The PBM profit on rebate retention and spread pricing has decreased substantially over the past 15 years as more clients have asked for pass-through pricing. But that has not in any way reduced the PBM effort to increase rebates and reduce pharmacy compensation, as both efforts lead to lower prices for clients, and PBMs compete on price.
Third, to reduce out-of-pocket costs, Congress may prohibit copay accumulators, but it stands to reason this will increase use of expensive medications that have reasonably priced alternatives. Here the CBO analytics will be very important. But if the measures pass, the federal government will find itself in the odd position of mandating that pharmaceutical manufacturers can pay the out-of-pocket costs for those commercially insured, while prohibiting this same strategy for Medicare. Meanwhile, commercial clients (insurers and employers) will likely move from accumulators to the maximizer strategies offered by the PBMs.
The other approach to reducing out-of-pocket costs by requiring rebate adjudication at the point of sale is a rare policy “no-brainer.” This will reduce the rebate check for the employer but have no financial impact on PBMs.
Finally, the Part D reforms enacted as part of the IRA already address the PBMs’ use of government subsidy to favor high-price medications. More importantly, they retain the risk structure in Part D plans that most agree have worked quite well to keep costs of the Medicare drug benefit in line. The proposed reforms to alter fees under Part D plans are unlikely to have substantial impact on pharmacy commerce.
The preliminary CBO analysis of one bill that has many of the features noted above, the Modernizing and Ensuring PBM Accountability Act, reinforces the impression that little change will occur with new legislation. The CBO finds approximately $170 million in savings for the government per year for each of the next 10 years, not a small amount. But given the that the United States PBM market size is estimated at $468 billion in 2021, and that the Medicare Part D program spending in 2023 will be $119 billion, the new savings line up to be something less than 1/10th of 1 percent of the federal outlays.
In summary, there is clearly a felt need to regulate PBMs in Washington today. The current proposals will introduce some transparency on PBM and pharmaceutical pricing, which will be a salutary change for the health care system. It could also potentially help some insurers and employers better understand the contracts they have had with PBMs for years.
Rebate retention and spread pricing bans will decrease profit margin for some PBMs, but that is very unlikely to be significant. Pressure on pharmaceutical manufacturers and pharmacies to lower costs will not slacken as PBMs, including many new entrants, compete for clients. A federal ban on accumulators may join the bans that many states have put in place, but those bans will not affect the closely related maximizer programs, which many clients prefer today. None of this will substantially affect the business of reducing pharmaceutical costs for employers, insurers, and state and federal governments.
Ultimately the best approach to reducing costs for medications is for the government to set prices, just as most other higher-income countries do. Considering the US government grants pharmaceutical products a monopoly through patent protection yet has no tools to influence launch prices, the government has implicitly relied on PBMs to control drug prices for society. The legislation currently being considered provide no new tools to manage prices, and while they may be intuitive and foster transparency, they cannot be expected to meaningfully alter drug prices in the US. The United States has taken the first, incremental steps toward drug price negotiation with the Inflation Reduction Act. But until price-setting becomes comprehensive, the PBM toolbox of strategies is going to be needed. Proposed PBM legislation must be evaluated with that context in mind.
Authors’ Note
Troyen Brennan holds stock and stock options at CVS Health. Will Shrank owns Humana stock. Shrank’s current company invests in health care-related companies.
