From Benefit Cards to Billions in Profits: The Evolution of the Modern PBM

Over the course of the past decade, pharmacy benefit managers (PBMs) have garnered a less than positive reputation as the middlemen at the center of the prescription drug value chain, shouldering much of the blame for the rising costs of medications. As prescription drug prices continue to outpace every other healthcare expenditure, it is easy to understand the criticisms launched by employers and patients, whose medication costs have continued to increase at pace while PBM profits have soared, growing exponentially over the course of their 5-decade existence. Most recently, we’ve watched as major mergers have further solidified PBMs as some of the most profitable organizations within the healthcare industry. Optum Rx has established itself as Optum’s most profitable business unit, and multiple PBM conglomerates now rank in the top 10 on the Fortune 500 list.

As profitable as today’s PBMs are, it might be hard to imagine that there was ever a time when they weren’t controlling the lion’s share of the prescription drug market. In reality, PBMs had much humbler beginnings. The first of these companies, which emerged to handle the paper-based claims adjudication process for their large health plan clients, have little in common with today’s “Big Three,” who now control 70-80% of the market. With such an innocuous origin story, how did we find ourselves where we are today, in a world where PBMs are responsible for controlling their clients’ fastest growing budget item, yet inspire so little confidence in those same clients, nearly 80% of whom report a lack of trust in their PBM*?

Where did PBMs lose their way?

It started innocently enough, when PBMs began layering additional services on top of their original core operation. In addition to adjudicating claims, PBMs began issuing benefit cards, setting copayment and coinsurance prices, and contracting directly with pharmacies and drug manufacturers on behalf of the plan sponsors they served.

In theory, these services would reduce their clients’ (plan sponsors) costs, improve the member experience, and ultimately advance clinical outcomes. In practice, the adoption of this expanded business model would ultimately ensure a misalignment of incentives between themselves and their clients. This deterioration was not instantaneous. However, this period of expansion gave rise to some of the practices PBMs are still best known (and most criticized) for today: spread pricing & rebates.

Building pharmacy networks & the advent of spread pricing

With aims to increase convenience for members and reduce drug costs for plan sponsors, PBMs began to assemble pharmacy networks on behalf of their clients.

While the opportunity to negotiate lower costs for members sounds attractive from an employer’s or plan sponsor’s perspective, the actual results of this practice have been less than ideal. In entrusting PBMs with the task of contracting directly with pharmacies without any oversight from their clients, the advent of spread pricing was made possible, and this practice has been further exploited by PBMs’ focus on mail order pharmacies.

• Contracting directly with retail pharmacies

In contracting with retail pharmacies, PBMs leverage their clientele’s combined purchasing power to negotiate the reimbursement rates the pharmacy receives in exchange for dispensing drugs to patients. Pharmacies that are willing to accept lower reimbursement rates in exchange for higher foot traffic in their stores are more likely to earn “preferred” pharmacy status within a plan’s network.

In this process, PBMs may charge members and plan sponsors more for a drug than the price they’ve negotiated with the pharmacy. When the PBM distributes the agreed-upon reimbursement to the pharmacy, they can pocket the difference (the “spread”). And with no mechanisms in place to hold PBMs accountable to delivering the cost savings they’ve promised their clients, PBMs can instead use spread pricing to grow their own profits.

• Taking advantage of mail order pharmacies.

Further enabling the practice of spread pricing are PBM-owned mail order pharmacies. Initially devised as a way to offer members a more convenient and affordable way to obtain their medications, these pharmacies have also turned PBMs into major drug distributors, directly managing a meaningful percentage of their members’ medications. This, in turn, has further bolstered PBMs’ buying power with wholesalers, and increased their ability to profit from spread pricing.

While this shift toward mail order has helped lower costs for plan sponsors, it has also led to some significant waste. Many PBM-owned mail order pharmacies will encourage patients to switch from 30-day supplies to 90-day supplies. While a larger supply can be optimal for some patients or therapies, this isn’t always the case. In this common situation, employers end up losing money when a patient, who has been dispensed 90-days worth of a medication rather than the standard 30-day supply, abandons the medication before finishing out the full course.

Rebates: They don't always lower costs

With an initial goal of consolidating purchasing power on the most effective drugs within a class, PBMs began negotiating directly with drug manufacturers. The goal to secure volume discounts, what we now know as rebates, in exchange for priority positioning on PBM-controlled formularies.

Despite their goal of generating savings for their clients, PBMs’ opaque contracting processes prevent plan sponsors from validating these supposed savings. This lack of transparency and oversight has, in turn, enabled PBMs to manipulate the rebate system to prioritize their own bottom lines. Many critics have posed the question: what is stopping PBMs from auctioning formulary space off to the highest bidder, regardless of whether the corresponding drug is the best from a comparative effectiveness standpoint (when taking cost, efficacy, and quality of life into account)?

It’s a fair question, and such scenarios have been in the news more than you’d hope. In 2017, plan sponsors found themselves paying more than $2,000 a month for each patient who had been prescribed a combination pill called Duexis, whose clinical effect could be replicated for less than $20. While it seems inconceivable that such a drug could make it onto a formulary, when you consider the potential profits a PBM could generate on Duexis via rebates, it becomes a little easier to understand how this medication secured placement on formularies across the nation.

Slowly shifting focus to the member

PBMs have slowly started to take a more active role in promoting patient health via higher-touch clinical services. PBMs now oversee utilization management strategies for their clients’ health plans; monitor prescription drug safety and outline standards for safe use; provide education on new drugs; partner with specialty pharmacies to aid in the administration of complex therapies; and deploy interventions for high-risk claims.

On the surface, these solutions appear promising in their potential to reduce medication errors, increase adherence, and deliver an improved member experience. In execution, however, they feel more like an afterthought. This isn’t entirely surprising. From a profit perspective, PBMs don’t have much to gain from delivering against any of these markers of success. While PBMs may aspire to be trailblazers in improving the member experience, this is not what they have become known for. Indeed, it is in the field of contracting innovation that they’ve exerted their greatest influence.

Can't we do better?

Concerns about the PBM industry have only been amplified by recent high profile mergers, like those between CVS and Aetna and Cigna and Express Scripts Inc. While vertical integration within the healthcare industry does present some obvious benefits, it also poses some extreme challenges to other stakeholders. This consolidation of power is particularly threatening to employers, who face increasingly limited choice. As competitors are pushed out of the market, the Big Three can continue operating with very limited transparency or accountability, driving up their profits while employers and patients continue to shoulder the brunt of rising drug costs.

PBMs manage the prescription benefits of more than 253 million Americans, and the population directly impacted by these entities continues to grow every day. Employers and patients are eager for solutions that place their needs at the center. Yet, how can we hope for a different future unless we change the underlying business model? The traditional PBM model has allowed them to profit from rising drug costs and growing utilization for far too long. We believe a better future is possible, but in order to realize it, this underlying model must undergo a fundamental shift that truly aligns PBM and employer incentives. We believe this alignment can be achieved with a full pass through model, where the PBM is paid a single administrative fee, with substantial fees at risk based on achieving the employer’s key objectives: lower costs, better outcomes, and an Net Promoter Score (NPS) we can all be proud of.

* According to the NBGH 2019 Large Employers Healthcare Strategy and Plan Design Survey