Some ‘inconvenient’ truths about pharmacy benefit managers

Pharmacy benefit managers have been in the crosshairs of late, as the focus of media scrutiny, government investigations and reports, and proposed federal legislation. A few recent examples make the point: A New York Times story in June 2024 bore the headline, “Pharmacy benefit managers are driving up drug costs for millions of people, employers and the government.” The title of the Federal Trade Commission’s interim staff report released on July 9, 2024 called PBMs “The Powerful Middlemen Inflating Drug Costs and Squeezing Main Street Pharmacies.” A report from the House Committee on Oversight and Accountability issued on July 23, 2024, was almost as scathing, finding that PBMs “inflate prescription drug costs and interfere with patient care for their own financial benefit.”

As these examples reflect, PBMs are widely viewed as middlemen that contribute nothing to society except for driving up prescription drug prices. That view is wrong.

We write to provide some context on PBMs as authors of an academic study on the subject recently published in JAMA Health Forum, which was cited in the New York Times story and extensively referred to by both the FTC report and House Committee on Oversight report. It is important to clarify three critical facts about the role PBMs play in prescription drug prices and the consequences of various regulatory approaches.

Fact #1: PBMs exist because insurers and self-insured employers use them

PBMs were first established by pharmacists in 1958. Since then, they have been owned by all types of players in the prescription drug supply chain: wholesalers, drug manufacturers, insurance companies, and pharmacies. As the prescription drug market evolved, PBM functions also evolved in response to the needs of insurers and self-insured employers seeking help in developing, managing, and delivering prescription benefits to their enrollees.

Employers’ human resources departments typically seek proposals from different PBMs through a competitive and transparent process. HR executives are responsible for selecting a PBM and working with it to design the company’s pharmacy benefits plan, such as specifying the deductible, premium, out-of-pocket costs, and formulary tiers that suit the needs of their workers. These companies must believe that PBMs generate value, which is why they hire them in the first place.

Some employers are savvy purchasers of drug benefits, but many lack this expertise or interest, so they rely on benefits brokers and consultants. The resulting incentives might not be perfectly aligned with the best interests of an employer and its workers. This means that employers may be unable to effectively address potential contractual problems in the PBM proposal evaluation and selection process. This dynamic creates opportunities for PBMs to generate profits at the expense of employers and/or workers.

Fact #2: Congress created a safe harbor and enacted patent laws

PBMs often retain a portion of rebates and other post-sale price concessions and pass through the remainder to insurers and employers. Although this practice helps contain premiums, it incentivizes drug manufacturers to adopt a high-list price, high-rebate strategy, and it encourages PBMs to prefer such drugs on their formularies. Because patients’ cost-sharing is usually based on pre-rebate list prices, a larger “spread” between gross (list) and net (post-rebate) prices means greater cost-sharing for patients. The opaque nature of these arrangements raises concerns for employers about PBMs’ lack of transparency. Such practices would not be legal if it were not for the protections granted by Congress.

For decades, the anti-kickback statute (Section 1128b of the Social Security Act) has prohibited kickbacks and rebates for federal health care programs. In Section 14 of the Medicare and Medicaid Patient and Program Protection Act of 1987, Congress established safe harbor provisions that were used to exempt various arrangements from the anti-kickback statute, including rebates on prescription drugs and other post-sale price concessions. These safe harbor provisions were narrowed in 2020, but PBMs can still qualify for the safe harbor as long as their arrangements meet certain requirements.

High prices for branded and specialty drugs are the result of a different policy, also authored by Congress. Patents allow a drug developer to charge high prices because it can exclude competitors for a specified period of time. After generics or biosimilars enter the market, prices drop. This sequence reflects the government-induced tradeoff of granting temporary exclusive rights to innovative drug companies as an incentive for developing new and improved drugs.

Removing PBMs from the equation will not change U.S. patent law. Indeed, PBM formularies are one of the few available strategies that can encourage drug companies to cut their prices.

Fact #3: Every player in the prescription drug supply chain wants to make money

Just like PBMs, every other player in the drug supply chain wants to make money. In this complex ecosystem, horizontal competition with a player’s peers and vertical competition against its upstream suppliers and downstream purchasers places downward pressure on prices. For example, drug manufacturers, wholesalers, and pharmacies all compete with PBMs to capture margins off the sale of prescription drugs. What potential changes would take place in the delivery of pharmacy services in lieu of PBMs? Who would step in to provide such services? Would patients necessarily benefit as a result?

PBMs have significant control over the revenues received by drug manufacturers and pharmacies, and they affect the prescription drug spending of insurers and employers. Financial conflicts between all of these players are to be expected. In fact, a PBM that makes employers happy will make manufacturers and pharmacies unhappy — and vice versa.

Before regulatory actions are taken, concrete evidence is needed to illustrate whether a counterfactual, in which PBMs are substantially weakened or eliminated by regulation, would actually benefit the people regulators are trying to help.

Policy solutions

Policymakers should focus on removing roadblocks that restrict employers and patients from accessing prescription drugs without PBMs. Large PBMs can use their size advantages to erect barriers that prevent competing business models such as Mark Cuban’s Cost Plus Drug Company from entering the market. For example, they may request manufacturers to limit rebate offerings to competitors. Such anticompetitive PBM behavior, which clearly compromises consumer welfare, should be eliminated.

Generic drugs constitute 90% of filled prescriptions. Thanks to the 1984 Hatch-Waxman Act, the U.S. is home to some of the most affordable generic drugs in the world. Due to the administrative complexity of insurance and the potential for agency costs, it is more efficient to pay for generic drugs with cash rather than with insurance. Policymakers should relax insurance regulations to allow for more flexible benefit design and greater use of health savings accounts for this purpose. Patients and employers would benefit from lower premiums and lower drug prices as a result.

These reforms would also encourage direct contracting between pharmacies and employers, as well as direct transactions between drug manufacturers and people who need medicines. LillyDirect, which provides for home delivery of Lilly medications directly from the manufacturer, is an example of this approach. More extensive competition will motivate PBMs and all other players to constantly strive and innovate to offer better pharmaceutical products and services at cheaper prices, creating value for patients, employers, and taxpayers.

T. Joseph Mattingly II is an associate professor of pharmacotherapy at the University of Utah College of Pharmacy. David A. Hyman is the Scott K. Ginsburg Professor of Health Law & Policy at Georgetown Law School. Ge Bai is a professor of accounting at the Johns Hopkins University Carey Business School and a professor of health policy and management at the Johns Hopkins Bloomberg School of Public Health.