If lawmakers want to make pharmaceuticals more affordable, they should look past populist policies like price controls that will only make matters worse and set their sights on reforming the Pharmacy Benefit Manager market.
PBMs manage the drug benefits for insurers and negotiate discounts with drug manufacturers. You probably use one every time you go to the pharmacy to get your medications refilled and don’t even realize it. The top three PBMs, which process about 80% of all prescription claims, are health conglomerates that include major insurance companies.
PBMs argue that their negotiations lower drug costs, which logically makes sense but fails to account for an essential question: whose costs? When it comes to the drug market, this distinction is everything.
When PBMs negotiate discounts with manufacturers, they consider the resulting net prices to be proprietary information and keep consumers in the dark. Consequently, the actual prices paid for medicines are not widely known. Since the actual transaction prices are unknown, discounts that would benefit patients in a properly functioning market are actually raising patients’ out-of-pocket spending.
Such a bizarre outcome occurs because patients’ costs are tied to the only visible price – the drugs’ list prices. But these prices exclude the negotiated discounts. As a result, a patient whose health insurance requires a 20% co-insurance payment will spend $20 for a drug with a list price of $100. However, the actual drug cost is not $100. On average, total rebates and discounts for a drug are around 50% of the list price. So, the total cost of the drug is really $50, not $100.
Consequently, patients are paying a 40% co-insurance rate on a drug’s net costs ($50) rather than the expected 20% rate. Insurers benefit by only needing to pay $30. Several adverse outcomes result.
This system inequitably shifts some of the costs that should be covered by insurers to patients that require expensive medicines. As shown above, patients end up paying twice as much as they should.
Even worse, the dollar costs shifted to patients have been growing. Since 2018, list prices for brand-name drugs have grown, but the negotiated discounts have grown even faster.
These trends mean that the costs covered by insurers have been consistently declining. Meanwhile patients’ out-of-pocket costs, which are based on list prices, are growing.
PBMs respond by claiming that they are faithfully serving their role by passing all the negotiated discounts to insurers. While that’s true, it is irrelevant to consumers because the PBM and the insurer are now part of the same conglomerate.
The insurer’s justification – that they use the discounts to lower premiums for everyone – also falls flat. While also true, it means that insurers are subsidizing the costs for all beneficiaries by increasing the costs for patients who require expensive medicines. This is exactly the opposite of how insurance is supposed to work.
These problems alone warrant reforms to how PBMs operate, but PBM operations impose even more troubling outcomes. For instance, PBMs will often receive payments from payers (especially Medicaid and Medicare) that exceed their payments to pharmacies. This practice, known as spread pricing, unnecessarily inflates costs.
Small independent pharmacies are also harmed due to a practice referred to as clawbacks. Clawbacks occur when PBMs reduce the dollar amount that they reimburse a pharmacy long after the medicine has been dispensed. The difference between what was originally promised and what is actually paid is then “clawed back” from the pharmacy. At times, these fees are so high that independent pharmacies lose money from dispensing drugs.
Efficient markets require transparent prices and efficiently aligned incentives. The PBM market lacks both, which is why reforms are necessary. These reforms should mandate price and cost transparency, eliminate the spread pricing practice, and delink PBM compensation from the price of medicines.
While efforts failed last year, Congress is currently considering legislation that could improve the PBM market.
Congress continually struggles to find bipartisan reforms that improve affordability and increase the quality of care; reforming PBMs should be a no-brainer.
Wayne Winegarden is a senior fellow in business and economics and director of the Center for Medical Economics and Innovation at the Pacific Research Institute. You can reach Wayne at: wwinegarden@hotmail.com