PBMs: More on the enigma of how PBMs make money

California Healthline had an article about PBMs role in Medicare Part D. (Hat tip Joe Paduda). Not entirely un-coincidentally, the report that I wrote with Jane Sarasohn Kahn on The Prescribing Infrastructure: Are we ready for eRx, which CHCF published last week also had a little section on PBMs.  However, for space reasons much of the research that I did for that piece didn’t make the cut. So as promised last week, here’s a longer version of what I wrote about what’s going on behind the veil of the PBM.

Pharmacy benefit management companies have become the hidden giants behind the current prescribing infrastructure. After several mergers, three dominant companies have emerged; Medco, Caremark and Express Scripts. How these companies make money has been a major source of controversy, leading to the slow emergence of the “transparent PBM movement.”  PBMs sell their services based on their ability to lower drug costs for their clients. Typically a PBM is not a risk bearing entity, but officially gets paid for providing three services to their clients, who are usually health plans or self-insured employers, and managing the pharmacy use of the “member” (the employee or insured).

The three main ways PBMs make money are via:

  • Transaction processing,including managing the eligibility files, benefit information and payment transactions connected with an Rx.
  • Network and formulary management, such as negotiating with both pharmaceutical companies and pharmacies over pricing, and ensuring that the most cost-effective drugs and most appropriate therapies are available to the member. This includes techniques such as generic substitution, pre-approval, step therapy and compliance programs–all of which tend to add administrative complexity to the current prescribing infrastructure.
  • Mail-order pharmacies, which typically supply lower-cost 90 day supplies of chronic medications to the member

Controversy in PBMland — Channel-switching, the Spread & Rebates 

There has been considerable controversy as to how effective PBMs actually are at lowering drug costs, and how they actually make their money. Some of these issues have been raised by their competitors: retail pharmacies are losing business to mail order PBMs, and are also being forced de facto to spend a lot of unpaid time on the phone with physicians’ offices sorting out formulary issues. Many protests are also being raised by their customers -– both employers and end-user consumers/enrollees.

One frequently heard complaint is that PBMs are restricting consumer choice by forcing members to receive their drugs only from their own mail order pharmacies. In fact, the creation of SureScripts by the largest pharmacy chains was in direct reaction to the initial creation of RxHub by the PBMs, which the pharmacies thought was an attempt to turbo-charge this channel switching by controlling access to online pharmacy channels. These fears were somewhat overblown, and the two networks are working in cooperation together. The truth is that this channel restriction is done with the approval of the benefit plan sponsor (usually the employer), and may actually be a rational method of controlling costs and increasing efficiency. Mail order drug operations are highly automated and require substantially fewer pharmacists per Rx than traditional retail pharmacy.

But the major accusations are that PBMs are withholding information from their clients about the “spread” and their “rebates.”

The spread is the difference between the price the PBM tells its client that it is paying for the drug (or in effect the price its client is charged) and what it actually is paying the pharmacy. Critics accuse PBMs of paying much lower actual prices to pharmacies than they reveal to their clients, and also of giving clients only a small fraction of the extra profit they make when they dispense a drug via mail order. For more on this see Robert Garis, et al Shining The Light On Non-Transparent PBM Cash Flows in America’s Pharmacist, November 2004

The rebate is a payment from a pharmaceutical company to a PBM for driving more volume to its branded product by putting it higher on formulary. There are two separate controversies about the rebates.

    • First, while the revenue from the rebates are officially passed back to the end client, the accounting behind that process is extremely opaque and has been very difficult for customers to audit. PBMs have been commonly accused of either short-changing their clients, or colluding with health plans to keep rebates back from their customers. For instance, Medco paid Oxford Health Plans $87m allegedly for data, but this was widely presumed to be connected to hiding the rebates from its customers, including the government. (As reported in Barbara Martinez U.S. Maintains Medco Offered Insurer a Kickback Wall Street Journal December 3, 2004) –in effect keeping drug prices higher than they need to be. Michael J. Rudolph, Pharm.D., of the University of Southern California School of Pharmacy, noted that one of the three largest PBMs (Medco) admitted in its annual report that of about $3 billion in rebates garnered in 2004, it passed only $1.7 billion to health plan providers. "This is the story that is not being told, and I venture to say most of the plan sponsors do not understand this," he said’. (source is Frank Celia Chains ponder responses to mandatory mail order Drug Topics Apr 18, 2005)

    • The second controversy is that the rebate agreements have been “bribes” that have resulted in the PBMs creating formulary incentives, or campaigns that in fact favor branded products over cheaper generic equivalents. For example, the Detroit Free Press reported that the University Michigan concluded that PBMs working with the university often steered customers towards more expensive brand name drugs and accepted payments from drug companies to promote their products. As a result, the University has moved to a single PBM and is tightly monitoring drug spending. The school has saved $8.6 million as a result. I found this info in Katie Merx U-M’s changes cut drug expense: Pharmacy benefit managers who drove up costs are replaced Detroit Free Press May 18, 2005 (Article is no longer online, although I have a copy if anyone is really interested)

When Sen. Maria Cantwell (D-Washington) suggested that, in order to participate in Medicare Part D, PBMs should be forced to reveal information about these contracting arrangements, their opposition was very vocal, and it was supported by a GAO report. While the PBMs said that this disclosure would prevent their ability to contract on behalf of their clients, cynics drew a different conclusion.

Some studies are now starting to support some of these accusations, and it may be that the tide is slowly turning against PBMs. One survey showed that over 47% of their customers thought that PBMs did not get them the best drug costs Hewitt Associates “Health Care Expectations: Future Strategy and Direction 2005” Executive Summary of Hewitt Teleconference November 17, 2004) but several interviewees we spoke to in the course of this report suggested that PBMs’ customers had in general been slow to try to do anything about these practices. There is though an ongoing legal suit in Illinois (Melissa David "Loyalty Strained at Caremark" The Street.com 2/1/2005), and the slow emergence of the “transparent” PBM movement, such as the breakaway group of employers lead by Hewitt Associates, (Melissa David "Medco and Its Peers Brace for a Flank Attack" The Street.com 8/16/2004).

Overall the trend towards transparency will will probably push PBMs away from looking to rebates and other games with pharma clients. Instead they will try to drive more revenue by switching fulfillment to their mail order businesses, and by more aggressively moving to generic substitution. But it’s still a business that requires more aggressive customers overseeing what’s going on behind the curtain.

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skookumNarayanachar Murali Recent comment authors
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I just had my prescription ‘switched’ by one of these PBMs. I thought I had a CHOICE in my PPO copay structure of BRAND and generic and was willing to pay extra.
The PBM sent me a letter with the doctor’s signature that he had taken away the PRESCRIBE AS FILLED on an 8 month old rx that had been in force. This was done without a consultation with my physician for a drug I used for 10 years.
I want this kind of tactic/behavior explained in the Main Stream Media.

Narayanachar Murali
Narayanachar Murali

PBMS are an insult to both doctors and patients.They are partly to blame for the rising cost of medications. They are heavily favoured by the drug industry, and you know the drug industry has no philanthrophists running their gigantic corporations. If the government is serious about reform in the area of medication and medical device prices, they need to go back to basics. Ask each subspecialty of medicine to make a list of the most necessary drugs. Classify them into “life saving drugs”, “essential drugs” “Biological agents”. Make the life saving drugs ( antihypertensives, heart failure medications, cholesterol lowering drugs,… Read more »