What are PBMs and Why do They Get a Bad Rap?

Pharmacy Benefit Managers (PBMs) have become a common scapegoat for high drug prices and the target of state and federal legislation.

PBMs play a central role in the pharmaceutical supply chain.

But what exactly do PBMs do? How do they make money? And are they really the culprit behind high drug costs?

What are PBMs exactly?

PBMs serve three main roles, all of which are related.

First, PBMs serve as an intermediary between drug manufacturers and health plan sponsors such as insurers and businesses.

Health plan sponsors hire PBMs to negotiate lower costs from drug manufacturers on their behalf.

One PBM will often represent multiple health plans. By representing multiple consumers from different employers and insurers, they have greater negotiating power with drug manufacturers. PBMs control a high-level of demand and can therefore drive lower costs.

Second, PBMs work with health plans to develop utilization criteria and formularies.

A formulary is just a fancy word for a list of drugs that your insurance plan covers. Drugs are “tiered.” These tiers determine your costs. Tier 1 drugs are typically generic medications, which will have low out-of-pocket costs. Out-of-pocket costs go higher as tiers go up.

Tiers help lower costs because drug manufacturers will compete to get their medications onto lower tiers by offering discounts.

For example, let’s say three different manufacturers produce three different brands of Drug X, all of which do the same thing. A PBM can go to each of the manufacturers and ask for their lowest cost in exchange for a better tier placement. The manufacturer will want to provide the lowest cost, because they will get the best access to those consumers who are represented by the PBM. The manufacturer who provides the largest discount gets the best spot on the formulary.

Third, PBMs reimburse pharmacies on behalf of consumers.

When you go into a pharmacy, you pay an out-of-pocket cost. What you pay, however, is not the full price of the drug. PBMs collect money from your insurer to reimburse the pharmacy the balance of your prescription cost.

How Do PBMs make money?

PBMs make money in two main ways.

First, PBMs make money through negotiating rebates, or discounts, with manufacturers.

Let’s say a manufacturer sets the cost of a drug at $1,000. But in exchange for favorable placement on the plan’s formulary, a manufacturer may offer a PBM a $300 rebate, bringing the net cost of the drug down to $700.

The rebate in this instance works more like a fee paid from the manufacturer to the PBM. In exchange for covering the drug at a preferred tier, the manufacturer pays the PBM $300 every time one of its consumers purchases the drug.

Then, one of two things then happens to that $300 based on what the PBM’s client prefers.

The client can opt for a “100 percent pass through” where the $300 goes directly back to the client. The PBM makes no money on the negotiated rebate but is instead paid an administrative fee from the insurer for negotiating the rebates and setting up the formulary.  

Or, the PBM can keep a portion of the rebate, say $30, and pass the remaining $270 back to the client.

The second way PBMs earn money is through spread pricing.

Again, spread pricing is a contractual arrangement between a PBM and its client. In spread pricing, the PBM and the client will agree to a set price for a drug. Every time that drug is purchased by someone on the health plan, the plan pays the PBM a fixed amount.

Let’s return to the $1,000 drug example. The PBM and the client agree to guaranteed rate of $700 on the drug. If the PBM can negotiate a reimbursement rate of $650 with a pharmacy, it makes $50. If the PBM can only negotiate a $750 reimbursement with a pharmacy, it loses $50.  

Or a health plan may choose to pay the PBM whatever the pharmacy charges, and an administrative fee for the PBM’s services.

Criticisms of PBMs

Criticisms of PBMs typically focus on how PBMs make money.

Some critics argue that a PBM’s use of spread pricing drives up drug costs because they pay the pharmacy less than what the health plan gives them for the drug.

Criticism of spread pricing, however, ignores the important fact that it is a choice, not a requirement.

No one is forced into a spread pricing contract. PBMs and health plans must agree to a spread pricing model together. Many businesses and health plans choose spread pricing because it offers cost predictability.

Critics also argue that PBMs do not pass back rebates to consumers, and instead pocket the money as profit.

Again, how much of a rebate a PBM retains is a contractual matter. Plans may choose to allow the PBM to retain some rebate in exchange for lower administrative fees. Others maybe choose to have 100 percent of the rebate passed back.

Rebates are passed back in full a vast majority of the time.

99.6% of prescription drug rebates negotiated by PBMs with drug manufacturers in Medicare Part D are passed through to drug plan sponsors.

And two of the largest PBMs, CVS Caremark and Express Scripts, return up to 98% and 95% of rebates, respectively, to those they serve in the commercial market.

Experts also agree that removing the incentive for PBMs to negotiate with manufacturers and pharmacies for the lowest price will likely result in higher costs for patients and taxpayers, and more revenues for drug manufacturers.

“Incentives matter for PBMs just as they do for other market participants. A financial reward for greater rebates and discounts results in greater rebates and discounts,” said University of Chicago Professor Casey Mulligan. “Absent the financial incentives, plans would pay more to manufacturers and to pharmacies because plans would receive less manufacturer rebates and pharmacy discounts.”

So, are PBMs really the cause of high drug costs?

PBMs are middlemen. And middlemen make a good scapegoat.

But the truth is, PBMs do far more to lower drug costs than increase them.

Research suggests that PBMs will help save health plans sponsors and consumers more than $1 trillion between 2020-2029.

PBMs help generate savings of nearly $1,000 per person per year and reduce costs by $6 for every $1 spent on their services.

So, if it’s not the PBMs, who’s to blame?

To find the answer, follow the money all the way back to the very beginning of the supply chain where drug manufactures set the price.

Let’s return to our $1,000 drug. The $1,000 price tag is set by the drug manufacturer.

Wholesalers buy the drug from the manufacturer for $1,000. Wholesalers then mark it up and sell it to a pharmacy. Let’s assume the pharmacy buys the drug for $1,100.

Now, the pharmacy, in its negotiation with a PBM for drug reimbursement, will want a larger reimbursement than what it paid for the drug because the pharmacy wants to make money too. The drug now costs $1,150.

The PBM, representing the consumer, goes to the manufacturer and says ‘$1,150 is too much for the drug, we need a rebate.’ The drug manufacturer offers a $300 rebate.

So now your drug costs $850. Still a great return for the manufacturer. But what happens when they want more money next year?

They raise the price.

Now the list price is $1,250. By the time it’s marked up by the wholesalers and pharmacists, it costs $1,400. The PBM goes back to the manufacturer and asks for a bigger rebate since they raised the price. The manufacturer says “sure, we’ll up the rebate to $350.”

The manufacturer will claim they are giving even bigger rebates – which they are – but the $50 rebate increase isn’t close to offsetting the $250 list price increase. In the end, the drug manufacturer increases their return from $850 to $1,150.

This is what happens across the pharmaceutical industry. Research has found that prices have far outpaced rebates, with prices after rebates more than doubling between 2010 and 2020.

Middlemen make easy targets. But in this case, they are not an accurate one.

If you are looking for someone to blame for high drug costs, look at drug manufacturing giants at the top of the food chain.

They set the prices.