PBM aka Perfect Business Model - (Part 1)

Rocket Science is easy, this is Pharma Math

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Warning: This series of posts is long, like a CVS receipt.

There is tons of stuff out there on the interweb about Pharmacy Benefit Managers (PBM). A lot is happening in the policy space right now, and it’s worth capturing the state of affairs. Part 1 of this series covers the market players and some industry jargon. Part 2 of the series covers the history of how PBMs became powerful and their interactions with other market players. Part 3 of the series covers the ever-evolving business model, the systemic problems, and emerging developments on the regulatory and strategy front.

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Let’s go

$350 billion are spent on prescription drugs, accounting for over 8% of the $4 trillion spent on healthcare annually in the US. Americans pay more than double the average OECD country per capita (OECD is a forum of 37 high-income, developed countries). If more people knew about this un-legislated “tax” we would have a modern-day Boston Tea Party.

PBMs first emerged to manage basic pharmacy claims. Over time they evolved into complex organizations that offer soup to nuts prescription drug management tools. A key function of a PBM is to negotiate price concessions from Pharmacies and Manufacturers to lower costs to Plan Sponsors. Employers, state governments, and other payers of medical care do not have the expertise to manage complex drug benefits. These entities could hire a PBM to simplify a complicated drug supply chain, design formularies to exclude wasteful drugs, and use their size and leverage to negotiate better discounts. We need to look at seven key stakeholders to understand the market space.

Seven major categories of industry players

1. Patients: We will all be Patients at some point. This group includes employees, dependents, and beneficiaries of employer-sponsored health plans and government-sponsored health care programs such as Medicare and Medicaid. Uninsured or underinsured individuals also fall under this category.

2. Plan Sponsors: Employer-sponsored health plans, private health insurance companies, governmental health benefits programs (such as Medicare, Medicaid, etc.) These entities offer a health benefits plan for their members, beneficiaries, or employees and provide coverage for pharmacy expenses and drug costs (in addition to traditional medical expenses). Plan Sponsors are the true payers and ultimate financial guarantors of healthcare costs.

3. Health Insurers: Sponsors will typically hire a health insurance company to help offset the risks associated with the cost of care and will pay premiums on behalf of their beneficiaries. A self-funded employer, for example, will work with a Health Insurer to access to the Health Insurers’ network of providers and will offload the management of the benefits program to the Health Insurer. The top 6 insurance companies are UnitedHealth Group, Anthem, Centene, Humana, HCSC, and Aetna, which accounted for 51% of the market. The rest, over 600, only accounted for 49% of the market.

4. Manufacturers: Pharma companies producing drugs and biologics - both brand name and generic fall under this category. The companies spend years doing research (a lot of the basic research is aided by government spending through NIH and other grants - but that’s for another time) to formulate, test, develop, and manufacture drugs. Some well-known examples include Johnson & Johnson, Pfizer, and AbbVie. The top 10 Manufacturers account for 42% of the pharma industry revenue.

5. Wholesalers: Companies in this category contract with Manufacturers and Providers to buy and supply large quantities of drugs. Wholesalers are also the entity responsible for physically distributing the drugs from the Manufacturers to the Pharmacies. The 3 leading Wholesalers, which account for about 85% of the market, are AmerisourceBergen, Cardinal Health, and McKesson.

6. Pharmacy: This category includes retail, specialty, and mail-order pharmacies. They receive drugs from Wholesalers and contract with PBMs to set reimbursement rates for the medications dispensed to Patients. Pharmacies are front-line providers who offer direct medical care. They administer immunizations, medical advice, and health and wellness tests. They help manage chronic diseases and medications for Patients. Market leaders include CVS, Walgreens, and Walmart. Specialty pharmacies such as CVS Specialty, Accredo/Freedom Fertility, Alliance Rx, and BriovaRx manage the distribution of expensive, uncommon, or fragile drugs.

7. Pharmacy Benefit Managers (PBM): Entities in this category are third-party administrators of prescription drug programs. They negotiate drug prices with Manufacturers and process claims on behalf of their payer clients. PBMs are third-party administrators of prescription drug programs covered by a Plan Sponsor. PBMs also provide services related to the admin, formulary design, formulary management, pharmacy network design, and negotiation of branded drug rebates. Almost all major PBMs have merged with Health Insurers. PBMs, often own and operate their affiliated retail, mail-order and/or specialty pharmacies and directly compete with independent providers participating in PBM networks, creating a conflict of interest. Three PBMs provide pharmacy benefits for 80% of covered lives in the US.

Patients and Plan Sponsors jointly contribute to health insurance premiums in exchange for healthcare benefits - medical, dental, vision etc. Prescription drug coverage (Rx Drug coverage) is usually covered as a part of our benefits. It may also be separate, as in the case of Medicare Part D. The Health Insurer contracts with a Pharmacy Benefit Manager (PBM) to negotiate drug prices and manage pharmacy network and claims. The Health Insurer makes payments on a per prescription basis. The PBM negotiates the drug price and its placement on formulary tiers. In exchange, the Manufacturer provides rebates or discounts to the PBM designed to flow down to the Plan Sponsor. The Manufacturer distributes the drugs via a Wholesaler. The Pharmacy buys the drugs from the Wholesaler and dispenses the drug to the Patient. The Pharmacy is required to collect a copay on behalf of the PBM. Sometimes these copays can be higher than the price of the drug! - explaining the popularity of coupon vendors such as GoodRx that offers visibility into cash pay rates. Sometimes, Manufacturers themselves will provide copay assistance to cultivate demand.

Urban Dictionary of PBMese

1. Formulary: The list of drugs that a Health Insurer will cover is divided into 4 tiers. Tier 1 is limited to generic drugs, will result in automatic approval, and cost Patients the lowest copay. Tier 2 comprises preferred brand name drugs or expensive generics and may require prior authorization. Tier 3 consists of expensive, non-preferred brand name drugs and will require Patients to pay a higher copay and typically require prior authorization. Tier 4 or specialty drugs are newly approved drugs that are very expensive and require a large copay or percentage of the cost. The PBM will discourage its use and will almost always require prior authorization.

2. Specialty Pharmacy: It is worth independently calling out specialty pharmacies that dispense newly approved expensive drugs. Even though only 2% of Patients use drugs from specialty pharmacies, they account for 52% of prescription drug spending in the US. The top 3 specialty pharmacies are owned by the top 3 PBMs and account for 62% of the total prescription revenue.

3. Rebate: These are Manufacturer discounts provided to PBMs for preferred Tier placement on the formulary. The rebates are paid retroactively after the point of sale transaction (i.e., after the Patient has bought a drug from the Pharmacy). About 25% of the $350 billion in prescription spending are Manufacturer rebates. These rebates are meant to be shared with Health Insurers and Plan Sponsors. The rebates are mainly used for high-cost brand-name drugs rather than generics.

4. Spread: PBMs pay pharmacies less than they would charge the Health Insurer or the Plan Sponsor. These create misaligned incentives where PBM will look to maximize the difference between what they pay vs. what they get paid. Buy low, sell high, make money.

5. Gross-to-Net: This term refers to the difference between the list price of brand-name drugs and the net prices after rebates, discounts, and other reductions. The gap between these two prices has been growing. The overall dollar value of the difference across the industry is called the Gross-to-Net bubble. The gap exceeded $200 billion in 2021, while the net prices remained relatively steady. The people most impacted by this are uninsured poor people who pay list price. A perverse form of reverse insurance.

6. Pass Through: Health Insurers and Plan Sponsors can contract with PBMs based on Spread Pricing or Pass Through Pricing. The Pass-Through model permits PBMs to only retain a small reasonable administrative fee. Many states have passed laws requiring contracting to be done on a Pass-Through basis.

7. DIR Fees: This acronym stands for Direct and Indirect Remuneration fees. PBMs charge pharmacies price concessions, known as DIR fees. These are post-point-of-sale adjustments to the negotiated price of a drug. These fees are specifically charged under Medicare Part D. PBMs have linked pharmacy performance on adherence metrics for chronic diseases to DIR Fees.

8. Clawbacks: There are times when the Patient’s prescription drug costs are less than the copay. Instead of returning the difference to Patients, many PBMs will collect and keep the difference from the Pharmacy as a “clawback.” As a result, Patients end up overpaying for their prescriptions 23% of the time.

9. Prior Authorization: Practicing medicine without a license, exhibit A. Depending on the drug’s tier, a PBM may require prior authorization for dispensing expensive drugs. The rebate on offer by Manufacturers often influences the tier of the drug. Even if the Patient’s doctor says that a particular medication would be the optimal course of action, PBM will essentially have veto rights on whether the Patient can access a prescribed medication through their pharmacy benefits.

10. Fail First: Practicing medicine without a license, exhibit B. “Fail first” step therapy requires a Patient to fail once or twice on a medication specified by the PBM before being allowed to “step up” to the treatment prescribed by the physician. As you might have guessed, the medication dictated by the PBM is not the least expensive but the most profitable drug for the PBM because of rebates.

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Let’s take a break here! Pharmacy is way, way, way more complex and we obviously haven’t covered many important aspects of this complex industry. Do you work in the pharma space? Do you know this stuff really well? Reach out or comment below and share where I got things right and where I got them wrong. Always open to feedback!

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