Imagine if you never had to directly pay for your morning cup of coffee again. Instead, a coffee insurer guaranteed that, for a small co-pay, you could enjoy a cup of coffee every morning.
The catch, and there is always a catch, is the caveat “directly pay.” In this bizarre world, you would still be paying for your cup of coffee every morning, but instead of paying your favorite barista, you would now pay your local coffee insurer.
But, bureaucracy loves complexity. Instead of the coffee insurer directly paying the coffee shop, a middleman enters, promising that he can increase efficiency and reduce costs.
With the entry of the middleman, now, to receive a cup of coffee every morning, you must pay a small co-pay at the coffee shop and your coffee insurance premium. Your coffee insurer uses those premiums to pay the middleman, who then, after a negotiation with the coffee shop, pays the coffee vendor, kicking back a portion of any savings to the insurer.
This scheme, which sounds ridiculous and ripe for abuse, is actually how prescription medications are purchased for most Americans. Three of these middlemen, known as Pharmacy Benefit Managers (PBMs), now control prescription drug benefits for more than 260 million Americans.
After years of quietly gaining power, PBMs are coming under heightened public and congressional scrutiny. And, for good reasons.
One reason, there is mounting evidence that PBMs price drugs arbitrarily. An analysis by Avalere Health found wide variation under Medicare Part D in generic drug prices sold on the same day, depending upon the payer (e.g. PBM). Such arbitrary pricing imposes costs on pharmacies, and the unpredictability makes it more difficult for these pharmacies to serve their customers.
Another reason is the adverse impact PBMs have on drug costs. PBMs earn revenues, in part, by charging various fees to pharmacies. Some of these fees effectively require pharmacies to pay PBMs for the right to be compensated by the PBMs. If that sounds complicated, it’s because it is.
PBMs also earn revenues based on the difference between the manufacturer rebates and discounts and the list prices of medicines. This compensation system creates potential conflicts between a PBM’s financial interests (to push the medicines with the biggest discounts and rebates) and each beneficiary receiving the best medication clinically. Since there is no PBM transparency however, there is no ability to evaluate these potential conflicts.
Relative to the total gross drug expenditures, these rebates and discounts have become quite sizable. According to a Berkeley Research Group (BRG) study, retrospective rebates and discounts accounted for 31 percent of gross expenditures on branded pharmaceuticals, or $106.4 billion, in 2015.
The total amount of revenues branded manufacturers received in 2015 was $218.6 billion, or 62.6 percent of gross expenditures on branded pharmaceuticals. The difference was earned by wholesalers and retailers.
Importantly, during a period of rising concern regarding drug costs, the manufacturer’s share of total revenues has been in decline. According to the BRG study, the total branded manufacturer’s share of gross branded drug expenditures fell 4.4 percentage points between 2013 and 2015.
During this same period, PBMs share of the gross branded drug expenditures grew 5.2 percentage points, more than offsetting the decline in the manufacturers’ share. Put differently, PBMs’ share of revenues rose at the expense of the manufacturers’ who actually produce the drugs for consumers, and the pharmacies’ who actually dispense the drugs to consumers. The middlemen are getting bigger and richer, while contributing nothing substantive to patient care.
These concerns were substantiated in a January, 2017 report from the Centers for Medicare & Medicaid Services (CMS). The CMS report found that the rebates that drug companies and pharmacies pay are growing, but it is the PBMs that are benefiting. The rebates are not lowering costs for patients or government health care programs.
PBM pricing vagueness also reduce the efficiency of the overall pharmaceutical market by rendering a drug’s actual list price almost meaningless. As a consequence, neither the patient nor the doctor knows how much is being spent when prescribing medications.
Broader reforms to the status quo that focus on creating a simpler, more transparent pricing structure for pharmaceuticals are necessary. However, PBMs oppose change because their current profitability is enhanced by the negotiated rebates and discounts, and from the accompanying opacity.
The good news? Congress is paying close attention.
In response to these trends, Congress is considering legislation that would improve the transparency of the fees, rebates, and costs of the PBMs. Broader health care reforms are also necessary to improve the current payment system that only Rube Goldberg could love, but greater transparency can play an important role in the meantime. The ultimate beneficiaries? Consumers and taxpayers.
Wayne Winegarden, Ph.D. is a Sr. Fellow in Business Economics at the Pacific Research Institute and Managing Editor for EconoSTATS.