Understanding the debate over PBMs 

As policymakers seek to stem rising drug costs, they have focused closely on the role of Pharmacy Benefit Managers. PBMs contend they help to make prescription drugs more accessible and affordable. However, the industry has evolved in ways that make it difficult to evaluate their actual impact on cost. Critics point to vertical integration, pharmacy steerage, and lack of pricing transparency, and recent media stories have fueled this debate by highlighting cases where a participant can purchase a specific drug for less if they don’t use their prescription drug benefits.

Employers are concerned both about prescription drug costs, which are rising faster than other medical plan costs, and about their fiduciary responsibility to members. The complexity of prescription drug pricing arrangements can feed these concerns. We asked MercerRx members Alysha Fluno, PharmD, and Jon Lewis, FSA, to explain the issues and talk about where the market is going. Specifically:

• How the role of the PBM has changed over time
• How drug pricing arrangements vary – and also how they don’t
• Why cross-subsidization of revenue across drug categories is such a big issue
• The new players – their connections to the larger system and the value they may bring

Let’s start with the role PBMs play in employer-sponsored health programs.

At one time, the prescription drug industry was pretty simple: Pharmaceutical manufacturers made drugs and wholesalers stored them and got them to pharmacies where patients purchased them. It wasn’t until the 1980s that PBMs entered the market to process electronic prescription drug claims. Their role has expanded over the past 40 years and today the biggest PBMs typically:

• Manage networks of pharmacies where members can obtain their medications
• Have established mail order facilities for delivery of maintenance medications to members' homes
• Have created specialty pharmacies to handle the fulfillment and distribution of specialty medications, gene and cellular therapies, and biosimilar drugs

PBMs have also taken on the responsibility of administering various programs chosen by plan sponsors. This includes:

• Managing the formulary (the list of drugs available through the plan)
• Handling the verification process (prior authorization) to ensure medication appropriateness for members
• Implementing rules that require members to try lower-cost medications before high-cost alternatives

It's important to note that PBMs provide a range of services beyond what is mentioned here, such as member services and navigating the ever-changing legislative environment. While some may question the necessity of PBMs or their impact on drug costs, it’s important to recognize that, if all PBMs were to disappear, some other entity would have to perform these services.

In recent years, there has been a new entrant to the industry – Group Purchasing Organizations. We’ve seen responsibility for negotiating with pharmaceutical manufacturers for drug rebates shift from the PBM to GPOs. The GPOs use the aggregate purchasing volume of all the GPO participants to negotiate greater savings, primarily in the form of rebates from pharmaceutical manufacturers through preferred formulary placement. In the employer market, rebates negotiated by the GPO are passed to the PBM for distribution to the plan sponsor, and, if elected as a plan design, to members. While GPOs have more leverage than any individual PBM, they add another link in the prescription drug supply chain – which means plan sponsors are further removed from obtaining the full value of what pharmaceutical manufacturers will pay for preferred formulary placement.

Policymakers are very focused on PBM profitability, and proposed legislation commonly includes provisions to ban “spread pricing.” What is spread pricing and is it the only way PBMs make money?

The ways in which PBMs make revenue have evolved over the years and greater transparency is more essential now than ever. Most plan sponsors want to know the revenue generated by PBMs in relation to their plans, particularly as a plan fiduciary. While revenue models and practices vary among different PBMs, let’s look at the more common sources, starting with spread pricing.

In “traditional” contracts, PBMs employ retail spread pricing, where they pay the dispensing pharmacy a certain rate and bill the plan sponsor at a higher rate, retaining the difference as revenue. Alternatively, in “pass-through” contracts, PBMs do not make any spread on retail claims but charge the plan an administrative fee instead.

For mail order and specialty drugs, most PBMs utilize spread pricing, where they obtain the medication at a lower cost than what they sell it for to the plan and its members. However, there are a growing number of PBMs that are starting to provide “pass-through” pricing at mail order and specialty. In these instances, they will charge a dispensing fee, an administrative fee and sometimes shipping charges, all of which helps to offset the revenue lost by moving away from spread pricing.

It is worth noting that larger PBMs often own mail order and specialty facilities, while smaller PBMs may rent these services from larger ones. In such cases, larger PBMs generate revenue by subcontracting services to other PBMs

Rebates are another source of revenue for PBMs. While many contracts today have 100% pass-through of rebates (at the PBM level, not the rebate at the GPO level), some contracts allow PBMs to retain a certain percentage of the rebate value as revenue. The PBM may also charge pharmaceutical manufacturers a fee for administering rebates – distributing rebate payment to each plan sponsor based on factors such as formulary and utilization management programs.

Lastly, PBMs may also generate revenue through various fees, such as charges for administering consumer-driven health plans or clinical programs, and through the sale of data. What all this points to is that, as the broader industry has focused on PBM spread and rebate revenue retention, larger PBMs have shifted their focus toward other areas of revenue.

The plan sponsor’s primary point of entry into the prescription drug supply chain is through the PBM. How is the PBM market evolving?

The three biggest PBMs – representing about 80% of the market share – have all diversified their businesses, establishing their own mail-order and specialty pharmacies. They have divested their rebate negotiations by establishing GPOs. And they have expanded their footprint in the supply chain by entering into the manufacturing of drugs, especially biosimilars. They’ve all vertically integrated with major health carriers, and one has its own retail pharmacy network and brick and mortar stores throughout the US. This diversification has made it even harder to identify and follow the revenue streams and has the potential to result in misalignment of incentives.

Despite the big three PBMs’ market dominance, new PBMs are jumping into the market and employers are expressing a lot of interest in exploring these new options – in fact a good third of the RFPs that MercerRx manages on behalf of clients these days include at least one PBM that is not part of the big three. However, it’s important to keep in mind that many of these smaller PBMs end up renting services behind the scenes from one of the big three. While it varies from one vendor to the next, these services may include claims processing, pharmacy network management, mail order and specialty pharmacy, utilization management, formulary management and rebate administration. In some instances, plan sponsors contracting with a PBM that rents services may find themselves one or two steps farther removed from these revenue streams, and the fees to rent those services may increase overall plan costs.

Some policy proposals call for changing the pricing benchmark for prescription drugs. What are the pricing benchmarks in the market?

The most widely used drug pricing benchmark is Average Wholesale Pricing. It is the undiscounted list price – similar to a “billed charge” on the medical benefit. But these days an AWP is neither an average nor an indication of the wholesale price, so it's a misnomer. Other common benchmarks used include:

• Wholesale Acquisition Cost – Most comprehensive and usually the highest cost. If a plan sponsor were to always pay the WAC, their current cost would likely go up.
• National Average Drug Acquisition Cost – Publicly available data and an indication of acquisition cost for some pharmacies, but not an available metric for every drug in the market
• Predictive Acquisition Cost – More comprehensive and slightly lower cost than NADAC, but is proprietary and not publicly available
• Actual Acquisition Cost – Based on actual invoices and estimated to be the lowest cost, but unfortunately this metric is not published or consistently accessible.

Typical pricing models guarantee an AWP less a percent discount, which varies based on the dispensing pharmacy and whether the drug is brand, generic, or specialty. Some of the new PBM contracts use undiscounted WAC, NADAC and PAC. For brands, this may result in pricing that is similar to or, in some cases, worse than AWP discounted pricing. For generics, where competing manufacturers produce the same drug, it’s more varied.

What’s behind the cases where patients have found they can purchase a drug for less outside of their health plan?

PBM contracts historically have been based on AWP discount guarantees and per script rebate guarantees. Going back to the first PBM contracts 30-40 years ago, generic dispensing rates were fairly low (in the 20 – 40% range), specialty drugs as a category were either not established or not yet material, and the concept of a specialty generic or biosimilar was not on the radar. Because of that, the primary metric PBMs competed on was brand drug discounts.

Now, however, generic dispensing rates have risen to the 80% - 90% range; specialty drugs as a percentage of drug cost are at or over 50%; and specialty generic drugs are now mature in a variety of therapeutic categories. Many historical contract metrics have struggled to keep pace with these market changes, particularly since plan sponsors contract with a PBM in aggregate, for all drugs bundled together. One key issue is that spread pricing revenue is not consistent across all drugs. As brand discounts have continued to rise, generics became a bigger source of spread revenue; today, for both the PBM and the pharmacy, the margin on brand drugs is generally small (or even negative in some cases).

At the same time, because generic drugs are not under patent protection, they represent an easier entrance for entities to both manufacture and sell at a competitive cost, especially if there exists a large pricing spread due to other market dynamics. Technology and apps have made it easier for entities to take full advantage of this arbitrage opportunity by messaging direct to consumers. This is the origin of many of the examples of overpriced drugs that have been discussed in news articles and reports – they are typically cases of specialty generic drugs with extraordinary PBM spread revenue versus either the NADAC price or another publicly available cash price option.

This type of market competition is positive in that it has helped patients save money and has exposed this cross-subsidization of spread revenue. Another positive change is that while the ability to purchase these drugs at the lowest cost was initially only available outside of the plan benefit – which meant the cost wouldn’t apply to the member’s deductible or out-of-pocket maximum, and the data for that prescription was unlikely to flow through to the health insurer or provider for continuity and quality of care – this is starting to resolve as more PBMs partner with entities like GoodRx and Mark Cuban Cost Plus Drug company.

To address the concern of cross-subsidization (especially in the specialty space), the Mercer SelectRx offering provides a technological solution for specialty drug prescriptions to be placed on a dynamic marketplace platform allowing pharmacies to bid down the cost of the drug in real time. This active bidding on each new specialty fill combats the cross subsidization in the market while still achieving competitive (and current) prices.

Can you describe some of the innovative pricing strategies that are emerging as a result of increased PBM scrutiny?

As we’ve discussed, under traditional pricing arrangements PBMs make a portion of their revenue through spread pricing – charging plan sponsors more for a drug than the amount they reimburse network pharmacies. Some plan sponsors now have transitioned to a pass-through “hybrid” model. Spread pricing is still used for mail order and specialty drugs, but for retail claims the plan pays the same drug cost and dispensing fee that the PBM pays to the pharmacy. The PBM collects an administrative fee for services provided.

The “transparent” model differs by PBM but generally eliminates spread pricing across the retail, mail and specialty channels. The PBM collects an administrative fee and very high dispensing fees. In addition, these PBMs may rent services from another PBM that may add cost for the plan sponsor.

The most novel pricing model is the “cost plus” model where an acquisition pricing metric is used instead of AWP. The PBM collects an administrative and/or dispensing fee that serves as the main source of revenue in this contract structure that may be higher than what plan sponsors are used to seeing. While the PBM revenue stream is shifted, the pricing is not inherently better under some of these acquisition-based contracts than what’s seen through an AWP less discount model.

Where else do you see potential for progress?

The challenges in the current PBM market are giving rise to new entrants, disrupters and innovation, pointing the way toward a more dynamic marketplace in the future. Plan sponsors will need comprehensive – and equally dynamic – strategies to keep up with the pace of change and find new opportunities to drive value to their members and their organizations.

We hosted a webinar to discuss the key drivers behind the changing PBM landscape and how you can adapt to these shifts with the bottom line in mind. You can view the replay here: Prescription for Savings.