PBM aka. Perfect Business Model - (Part 3)
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.
The Perfect Businesses Model “PBM”
PBMs make money in a variety of ways. In fact, they make money from nearly every participant in the value chain.
Rebates for preferred status on Formulary from Manufacturers ~ 46% of revenue
Spread margins on retail Pharmacy from Plan Sponsor ~ 22% of revenue
Profit margins on generics filled by own mail-order Pharmacy ~ 22% of revenue
DIR fees for inclusion in PBM networks from Pharmacy ~ 10% of revenue
Copays - You could even argue that PBMs profit off of copays from Patients
The pharmacy value chain is incredibly complex. The graphic above is a “simplified” version. It all starts at the List Price. The Manufacturers discuss pricing strategy and its effect on formulary placement with the PBMs. Manufacturers will offer healthy rebates to get good formulary placement, which ultimately drives drug sales. The cost of issuing the rebate is, of course, reflected in the List Price. Next, the drug’s price is marked up at each stage, from wholesaler to pharmacy. The patient pays a copay or co-insurance, and the PBM pays the remaining amount of the Maximum Allowable Cost set by the PBM to reimburse the pharmacy. The PBM then charges a higher price to the Health Insurer or the Plan Sponsor (Spread) and returns a portion of the Manufacturer Rebate. The amount spent and profited by each participant may vary depending on the copay, deductible, co-insurance, plan, and formulary design, as well as many other rules. Prices are abstract because of rebates, fees, and the principal- agent problem. A plan sponsor may technically pay less than the List Price, because it is artificially inflated to account for rebates. For example, for a $100 List Price drug, the PBM and Rebate Aggregator can take a $35 cut together!
Here’s another example of an insulin drug that has been in the news recently for its unaffordability to Patients on high deductible health plans.
Rebate Aggregators aka Group Purchasing Organizations, a new player?
As I mentioned in my post on Maryland’s healthcare model, healthcare is a game of whack-a-mole. Disincentives create new misaligned incentives. The push for regulatory oversight and transparency on payments, rebates, discounts, fees, and other price concessions from industry players pushes the industry further underground. Rebate Aggregators, which we will cover next, are just one example. The definition of rebates can be fluid and contracts may create new nomenclature that reclassifies rebates as ambiguous fees.
CVS, Optum, and Express-Scripts (ESI) dominate the PBM market. The hundreds of other smaller PBMs, don’t really matter in terms of real market competition. In fact, a little-known entity pulls the strings behind the curtain - the Rebate Aggregators or Group Purchasing Organizations (GPOs). The Rebate Aggregator aggregates the “aggregated demand” from Plan Sponsors. The three big PBMs own the three big Rebate Aggregators - CVS owns Zinc, ESI owns Ascent, and Optum owns Emisar. Even if you are not one of the big 3 PBMs, you will still have to work with these Rebate Aggregators to drive down the drug’s net price. In fact, in some cases, even the big 3 PBMs might use each other’s Rebate Aggregators. While PBMs are technically contractually bound to return the large majority of the Manufacturer’s rebate to Plan Sponsors, aggregators make it challenging to know what the Manufacturer’s rebate actually was. Often, Plan Sponsors have no visibility into the actual rebate negotiated by the Rebate Aggregator and the amount that is passed through to the PBM itself.
The Rebate Aggregator can collect 100% of the Manufacturer rebate but only pass on 40% of the rebate to the PBM. Even if the PBM says they will pass on 90% of the rebate to the Plan Sponsor, the sponsor doesn’t know that the Rebate Aggregator and the PBM together extracted over 60% of the rebate. The Rebate Aggregators / GPOs are set up as overseas entities by design to avoid regulatory and compliance oversight.
PBMs have been under tremendous regulatory pressure. The HHS and OIC recently removed the safe harbor from AKS for PBMs. HOWEVER, Rebate Aggregators or GPOs still enjoy the safe harbor. This has prompted a shift towards the marketing of a “pass-through” model. The portion kept by GPOs is still just as opaque as it always.
Transparent PBMs, an oxymoron?
A new model is emerging in the world of PBMs. Rather than profiting off spread pricing, rebates, and clawbacks, Transparent PBMs operate based on actual costs and charge an administrative fee while passing along all the savings to the Plan Sponsor. This fee is often set on a per-prescription basis rather than as a percentage of the drug cost. However, transparent PBMs are probably also using third party Rebate Aggregators. The portion kept by Rebate Aggregators is ironically not transparent.
Plan Sponsors generally issue Request For Proposals (RFP) to manage their pharmacy benefits. They hire brokers to handle this process. PBMs are savvy. They have built networks and provide financial incentives to brokers so the selection can be tilted in their favor. Real transparency can fundamentally unbundle this pharmacy marketplace. Smaller transparent PBMs can compete, but they’d need to build some sharp elbows and set aside cash to fight. Plan Sponsors, especially government-funded plans, have competitive bidding standards. If transparent PBMs lose out on an RFP award, they can and should dispute by pursuing legal action to challenge the award. Of course, none of this is easy. But the status quo is just too darn costly.
Federal Trade Commission (FTC) is singing a new song
After decades of turning a blind eye to mergers, consolidation and anti-competitive behavior, the Federal Trade Commission (FTC), under Lina Khan, just kicked off a formal study. The study sanctioned in June 2022 will investigate the business practices of the six largest PBMs that control 95% of the market. Excerpt from FTC’s statement
The largest PBMs are now vertically integrated with the largest health insurance companies and wholly owned mail order and specialty pharmacies. Those who own competing pharmacies have complained that PBMs impose unfair fees and clawbacks, impose byzantine contracts that often reimburse pharmacies less than their costs of acquisition, and steer patients to PBM-owned pharmacies. PBMs have also been accused of harming patients by extracting rebates and fees in exchange for refusing to cover generic and biosimilar drug products, ultimately raising the price that consumers pay for medicines. Doctors have also complained that PBMs impose unnecessary and burdensome prior authorization and other administrative requirements.
Congress is not far behind. U.S. Senators Maria Cantwell (D-WA) and Chuck Grassley (R-IA) introduced the Pharmacy Benefit Manager Transparency Act of 2022 in May, 2022. The bill prohibits PBMs from arbitrary, unfair, or deceptive financial practices. It requires PBMs to report the money they make from sources, differences in fees and reimbursement, and when and why a drug’s tier in the formulary was shifted.
The momentum is building. The only question is if it will actually change anything.
That’s it! 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!