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PBM Issues

By Natalya Mill

Health Watch, September 2024

A pharmacy benefit manager (PBM) is a third-party administrator of prescription drug programs for commercial health plans, self-insured employer plans, Medicare Part D plans, the Federal Employees Health Benefits Program and state government employer plans. PBMs operate in the middle of the distribution chain for prescription drugs. They work as intermediaries between drug manufacturers, health plans and pharmacies. Prescription drug rebates are payments from drug manufacturers to PBMs in relation to prescription drugs dispensed to plan members. Pharmacy benefit managers negotiate the rebates with drug manufacturers. The amount passed back to health plans is also negotiated but separately and independently. Self-funded health plans may sign their contract not fully understanding what portion of the rebates they have agreed to receive.

There is a lot of debate over whether PBMs should be able to keep the rebates they receive from drug manufacturers. Generally these amounts are not publicly disclosed as there is no legal framework at the federal level to require such disclosure. The only remedy currently available to self-insured health plans is to establish a fiduciary violation under the Employee Retirement Income Security Act of 1974 (ERISA) section 3(21)(A). The recently adopted service provider disclosure requirements under ERISA section 408(b)(2)(B) may be applicable in some circumstances. Congress has raised the issue of prescription drug transparency and rebate retention several times in recent years, but no federal laws have been passed yet.[1]

Some states are trying to solve the issue of rebate retention at the state level. For example, the State of West Virginia passed House Bill 4112, “Regulation of Pharmacy Benefit Managers,” paragraph 33-51-9 (k), which requires cost-share price reduction by the amount of the rebate at the point of sale to covered individuals.[2]

How PBMs Operate

Today, PBMs use large-volume purchasing power to negotiate lower prices from product manufacturers. PBMs act as third-party administrators of prescription drug programs covered by a plan sponsor and are primarily responsible for processing and paying prescription drug claims submitted by participating providers on behalf of covered patients. They also provide bundled services related to the administration of pharmaceutical benefits, including formulary design, formulary management, negotiation of branded drug rebates and control of participating pharmacies’ access to the network.[3] Although plan sponsors may occasionally engage PBMs directly, in many cases, health insurance companies procure PBM services on behalf of plan sponsors.

Employers are not aware of the rebate amount PBMs receive from manufacturers. PBMs may retain a portion of the rebates they receive; the rest is passed back to the employer health plan. Drug rebates are passed back as cash or as offset to the PBM fees (or a combination of the two). The amount and method of payment of the rebates are defined in the service contract between the employer health plan and the PBM. The volume of the rebates depends on the volume of filled prescriptions and is specified in the contract between the drug manufacturer and the PBM. Usually, rebates are paid on brand and specialty drugs only per filled prescription, and this is described in the service contracts between the manufacturer and the PBM and separately between the employer health plan and the PBM.

Although each contractual arrangement between a PBM and its drug plan client is unique, PBMs generally earn money in four different ways:

  • First, the drug plans typically pay various administrative fees to PBMs for processing the prescription drug claims of their members. 
  • Second, PBMs that operate their own mail-order or specialty pharmacies are reimbursed for dispensing drugs in the same way that retail pharmacies are reimbursed.
  • Third, PBMs charge the drug plan more for dispensed drugs than the amount they reimburse the pharmacy; the difference is called the “spread.”
  • Fourth, PBMs receive rebates or fees from drug manufacturers in exchange for inclusion in the drug formulary.[4]

PBMs often pass along a portion of the rebates they receive to their health plan clients, but research shows that they also keep a sizable share for themselves. There is a lot of debate over whether PBMs should be able to keep these undisclosed rebates.

The Pricing Issue

Unlike anyone else in the prescription drug supply chain, PBMs engage in pricing negotiations with almost every other entity: manufacturers, drug plans and pharmacies. This central role—and the fact that the details of the pricing negotiations are typically kept secret—creates significant conflicts of interest as PBMs attempt to maximize their profits in every negotiation.

The most significant conflict of interest arises from rebates paid to PBMs. PBMs negotiate rebates from drug manufacturers in exchange for giving the manufacturers’ drugs preferred formulary status.[5] Favorable placement on the formulary, in turn, channels more customers to the drugs and increases manufacturers’ overall profits thanks to higher sales volume. PBMs may pass along some of the higher rebates to their drug plan clients that can then use the money to reduce plan costs or lower copays for all members. However, the share of rebates retained by PBMs is rarely negotiated or disclosed, even to their drug plan clients, so it is difficult to measure the share that PBMs are retaining. The sharing agreements vary dramatically between PBMs and their clients, with some clients receiving 100% of rebates and others receiving nothing.

Critics argue that PBMs design formularies based on which manufacturers offer the highest rebates, rather than on which drugs are the least expensive for drug plans and their members.[6] In fact, because the rebates paid to PBMs are typically a percentage of a drug’s list price, PBMs have an incentive to select more expensive drugs for formulary status. Moreover, because rebates are generally calculated as a percentage of list prices, PBMs have are incentivized to encourage list price increases (or at least to discourage decreases) in order to increase their profits.[7] Actually, raising list prices is a way drug manufacturers can compete for formulary placement without reducing their profit. The PBMs benefit from higher rebates, and this may encourage manufacturers to hike their list prices, which leads to a win-win situation: the PBM earns more rebates, and the higher rebates earn the manufacturer a more favorable position on the formulary where it can achieve higher sales volume. The consequence of this pricing spiral is high prices to the consumers of prescription drugs. Indeed, US prices are the highest in the world for the same drugs manufactured in Europe or other parts of the world.

The drug manufacturers retain profit margins by inflating the drug list price; PBMs retain profit margins by receiving the rebates from the manufacturers and keeping those rebates. As a result, prescription drug plans and consumers experience steep price increases. One of the solutions to the problem is increased price transparency; the other is making each PBM a fiduciary.

Increased price transparency was criticized by the federal antitrust agencies. Absolute transparency removes manufacturers’ incentive to bid aggressively for the formulary placements. The Federal Trade Commission and Department of Justice have concluded that the disclosure of sensitive business information, such as price, can lead to tacit collusion among drug makers.[8]

Other proposals have suggested imposing a fiduciary mandate on PBMs. PBMs do not currently have a fiduciary duty to their clients, despite efforts to impose one. Courts have repeatedly concluded that PBMs are not ERISA fiduciaries and that state laws imposing a fiduciary duty are preempted by ERISA.[9]

In the absence of disclosure requirements and the ability to establish PBM fiduciary status, prescription drug plans are trying to use state consumer protection laws to obligate PBMs to disclose rebate retention. Unfortunately, drug plans and their agents are viewed as “sophisticated entities.” Consumer protection laws protect unsophisticated individuals and are not applicable to prescription drug plans.

On March 27, 2023, the Ohio State attorney general filed a complaint against Ascent Health Services LLC, which is jointly owned by Express Scripts and Prime Therapeutics. The complaint was filed under the Ohio Valentine Act, which protects competition and prohibits price fixing. The attorney general brought this action to obtain equitable and injunctive relief and statutory forfeiture against Ascent. It is too early in the litigation process to know the outcome of the case.[10]

Conclusion

PBMs are positioned in the health care delivery system as the only entities not regulated for profitability. The commercial fully insured health insurance plans are heavily regulated by the state insurance commissioners, who allow only a 2% to 3% profit margin. The self-funded health plans are regulated by ERISA fiduciary responsibility that prohibits excessive compensation. PBMs are classed as service providers and are not regulated by either the insurance commissioners or ERISA. This allows PBMs to implement large, unreasonable markups for profit. Prescription rebates are only part of the bigger issue. In the end, US consumers pick up the tab for expensive medications that may be produced at the same overseas facility and sold to consumers overseas for a fraction of the US price. PBMs are massive commercial entities that states are trying to sue under antitrust laws, but PBMs found a sweet spot in the regulation. Large insurance carriers understood that and either acquired large PBMs or merged with them.

It is likely that a combination of measures will be needed to regulate PBMs. The most direct approach would be for Congress to pass a law establishing PBMs as fiduciaries under ERISA just like “investment advisors” providing advice for a fee. Establishing PBMs as fiduciaries could help courts and other federal agencies ensure that PBMs do not unfairly retain rebates and inflate the prices of prescription drugs sold to employer health plans and the US population in general.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the editors, or the respective authors’ employers.


Natalya Mill, FSA, FIA, MAAA, is employed at the US Department of Labor. Natalya can be reached at fsafiamaaa@outlook.com.

Endnotes

[1] Pharmacy Benefit Managers and the Prescription Drug Supply Chain: Impact on Patients and Taxpayers, Full Committee Hearing, US Senate Committee on Finance, March 30, 2023, https://www.finance.senate.gov/hearings/pharmacy-benefit-managers-and-the-prescription-drug-supply-chain-impact-on-patients-and-taxpayers.

[2] Regulation of Pharmacy Benefit Managers, State of West Virginia House Bill 4112, paragraph 33-51-9 (k), May 11, 2022, http://www.wvlegislature.gov/wvcode/chapterentire.cfm?chap=33&art=51&section=9.

[3] Joanna Shepherd, “Pharmacy Benefit Managers, Rebates, and Drug Prices: Conflicts of Interest in the Market for Prescription Drugs,” Yale Law & Policy Review 38 (2019): 360–96, https://1.next.westlaw.com/Document/I0f73fda115cd11ebbea4f0dc9fb69570/View/FullText.html?originationContext=typeAhead&transitionType=Default&contextData=(sc.Default).

[4] Ibid.

[5] Ibid.

[6] Ibid.

[7] Ibid.

[8] Ibid.

[9] Retirement Plan for Chicago Transit Authority Employees, Plaintiff-Appellant v. Dorval Carter, Dennis Anosike, Joyce Coleman and Lynn Sapyta, Defendants-Appellees. Appellate Court of Illinois, First District, First Division, No. 1-20-0485. Order filed April 12, 2021, 2021 IL App (1st) 200485-U. https://1.next.westlaw.com/Document/I22cb5e709def11eb8abd818e63801f95/View/FullText.html; In re Express Scripts, Inc. Pharmacy Benefits Management Litigation, US District Court, E.D. Missouri, MDL No. 1672. September 13, 2006. https://casetext.com/case/in-re-express-scripts-2.

[10] Ohio v. Ascent Health Services LLC, Common Pleas Court, Delaware County, Ohio. Complaint filed March 27, 2023. https://www.ohioattorneygeneral.gov/Files/Briefing-Room/News-Releases/Yost-v-Ascent.aspx.