Patients and consumers bear the costs of an inefficient pharmaceutical distribution system through higher costs at the pharmacy counter and reduced access to critical therapies. As policymakers consider reforms to the drug supply chain, they should keep five principles in mind to ensure better outcomes for patients.
While high and rising prescription drug spending has been a policy issue for decades, there has been an increasing shift in attention toward pharmacy benefit managers (PBMs) and their role in the drug pricing ecosystem in recent years. At least a dozen bills were introduced in the House and Senate that aimed to reform the role and power of PBMs in 2023. Even amid partisan positioning leading up to the November election, PBM reform efforts have continued in Congress in 2024, with proposals to ban spread pricing and delink PBM fees from the price of the prescription. Committees of jurisdiction have more hearings scheduled. The Department of Justice (DOJ) and Federal Trade Commission (FTC) are also actively investigating their business practices.
At the USC Schaeffer Center, we and our colleagues have been studying the pharmaceutical distribution system for nearly a decade. In this blog post, we outline five principles that should be the foundation for comprehensive and sustainable PBM reform:
- The PBM industry is highly concentrated, and often this market power works against patient interests.
- Congress must anticipate how businesses will react to new regulation.
- Price transparency is Congress’ best avenue for making markets work better.
- Patients need to see savings.
- PBMs should have a fiduciary responsibility to their clients.
Principle 1: The PBM industry is highly concentrated, and often this market power works against patient interests.
Over the last three decades, PBMs have dramatically increased their size and leverage within the pharmaceutical distribution system. Today, three PBMs handle about 80% of scripts written in the U.S., and all three are vertically integrated with large insurers as well as specialty and mail-order pharmacies. While their scale helps PBMs negotiate more effectively with manufacturers, left unchecked, it also enables them to capture surplus rather than passing savings on to patients and plans.
For example, a study conducted by USC Schaeffer experts combined data from more than a dozen sources to evaluate the flow of funds in the distribution of insulin from manufacturers to consumers. Between 2014 and 2018, the share going to manufacturers decreased by 33% while the share going to PBMs increased by 155%. An additional Schaeffer analysis shows that PBMs and other intermediaries earn significantly higher excess returns than the S&P 500. And over the last decade, PBMs have imposed increasingly tighter limits on the drugs that Medicare patients can access through insurance. This illustrates the duality of principle number one: PBM market power has the potential to both help and harm patients in the pharmaceutical distribution ecosystem. The challenge for policymakers is to create a system where even large PBMs face enough competitive pressure to ensure that they use their leverage to benefit patients and plans, not just their executives and shareholders.
A more competitive environment would limit the degree to which PBMs could engage in business practices that contribute to rising drug costs and ultimately limit patients’ access to needed medications. Such potentially anticompetitive practices as steering patients to affiliated pharmacies, reimbursing affiliated pharmacies more generously, and using opaque pricing and fee structures would be much less common if there were more transparency and competition in the PBM market.
As policymakers consider reforms, they need to find a way to harness the negotiating strength of large PBMs and ensure that it works for the benefit of patients and plans – not just PBM shareholders.
Principle 2: Congress must anticipate how businesses will react to new regulation.
As attention on PBMs has intensified, we’ve seen them shift strategy to maintain their bottom line. Recent reporting reveals how large PBMs have created new offshore entities whose primary purpose is to negotiate manufacturer rebates on their behalf. This has made it harder to scrutinize their activities. As Congress questions PBMs’ rebate retention practices, these new entities – which are not technically PBMs – can pocket rebate and fee revenue before it reaches the PBM, thereby avoiding scrutiny while adding significant complexity and opacity to an already overly complex and opaque system.
PBMs have also changed their business model in recent years to pivot away from rebates as a primary form of revenue, instead focusing on revenue collected from fees assessed on manufacturers, payers and pharmacies as well as building specialty and mail-order pharmacy business enterprises. This type of behavior should be expected in reaction to any legislative reform or new scrutiny, especially if it relies on narrow, incomplete or otherwise easily manipulated definitions for terms like “rebates” or “essential” pharmacies.
First and foremost, policymakers should focus legislation on intermediaries in the supply chain that are performing a broad set of functions to divert excessive profits, regardless of what they are called, so that PBMs cannot dodge legislation simply by outsourcing key functions to other entities with a new label. Second, Congress should consider how companies might more generally game the regulations. For example, banning rebates might lead to higher administrative fees with no change in costs to consumers. Third, Congress should consider whether regulation might inadvertently harm consumers by favoring larger PBMs. For example, banning spread pricing could advantage those PBMs integrated with pharmacies relative to those who are not, because they can recognize profits in other parts of their vertically integrated organization.
More importantly, though, it might be difficult for Congress to predict how business structures and practices will change in response to new legislation. Therefore, Congress should limit its intervention to those actions that the government is uniquely positioned to do well, with an eye toward supporting greater competition. We need to ensure that new regulations are not encouraging businesses to simply shape-shift to avoid scrutiny, but that they are guiding the ecosystem to a more competitive one that improves efficiency in prescription drug markets.
Principle 3: Price transparency is Congress’ best avenue for making markets work better.
Reliable, pertinent information about market prices is a public good and, as such, the government has a legitimate role to play in assembling and publishing price benchmarks in these markets. While regulating specific activities in a shape-shifting market quickly becomes a game of whack-a-mole, benchmark data adds sunshine to the market overall and makes it harder to abuse market power.
The government is also uniquely positioned to inject price transparency and has established systems in place to do so. The publicly available National Average Drug Acquisition Cost database (NADAC) was created to help Medicaid programs ensure they are getting fair prices for prescription drugs. A weekly survey is used to understand what pharmacies are paying to acquire drugs, and these data are used as an input in determining Medicaid reimbursements. A similar process could be used with existing survey infrastructure to generate similar benchmarks of what pharmacies are being paid and what plans are being charged (the difference between the two is called the pricing “spread”), and make them widely available. This reporting should be made mandatory to better ensure that data collected is representative and accurate. Using these benchmarks, plans and employers can see whether the terms they are being offered in their PBM contracts are reasonable, or whether they could do better with a different PBM. By facilitating such price shopping on the part of plans and employers, public benchmarks will intensify competitive pressure on PBM markets.
Once these benchmarks are published, new competitive opportunities should follow: new, lower margin PBMs will enter these markets, employers will have tools to evaluate competing PBM contracts, and independent analysts can help identify opportunities for patient savings and compare rates for PBMs, plans and pharmacies.
Similarly, competitive benchmarks can also improve competition in pharmacy and drug distribution markets. The benchmarks will help establish how much money is being retained by different entities in the supply chain and thus eliminate the finger-pointing that occurs in the current system where each entity blames others in the supply chain for high drug prices. However, the key is that the benchmarks should be based on real transaction prices that include all rebates, discounts and fees. Our research shows that, so far, state laws have failed to achieve real transparency.
Policymakers should aim to bring real price transparency to all the transactions throughout the drug supply chain, by establishing benchmark data that will shine a light on hidden profits and allow plans and employers to find the best deals for their beneficiaries and employees. Moreover, all PBM clients should have unfettered access to their pharmacy claims data in order to verify the value and efficiency of their drug benefit.
Principle 4: Patients need to see savings.
High and rising drug list prices are hurting consumers, forcing them to spend more at the pharmacy counter. Schaeffer research has shown that rebates and list prices of drugs are positively correlated and while manufacturers are taking home a smaller share of net expenditures, the share going to PBMs has more than doubled. According to a 2023 GAO report, drug rebates in Part D were used to lower plan premiums while increasing costs for those beneficiaries who are sick and took highly rebated drugs – the antithesis of how health insurance is supposed to work.
This puts patients in a real bind, struggling to afford needed therapies. Schaeffer Center experts have documented worse adherence and discontinuation of prescription treatments as cost sharing increases. Poor adherence to treatment for chronic conditions leads to poorer health outcomes for patients, which increases costs throughout the healthcare system.
Today, patients are frequently exposed to list prices through deductibles and coinsurance that do not account for the rebates that PBMs negotiate. PBMs argue that the rebates they receive are passed to plans and employers who use them to lower premiums, but they do so in part by using money from the sickest patients to reduce premiums for the healthy. A 2021 Schaeffer study found that greater competition within a drug class, which tends to increase rebates, would have also increased cost-sharing burdens for Part D beneficiaries whose coinsurance was based on list prices. If rebates were passed through, cancer patients and those with chronic conditions would see substantial savings.
Policymakers should prioritize patients by ensuring that any legislation expected to generate system-wide savings should also reduce costs for the patients who need medicines. One way to do this would be to require that patient out-of-pocket amounts are based on the negotiated net price rather than the list price. While premiums might rise modestly, the insurance market will be functioning as it was designed – to protect sick patients from large and otherwise unaffordable health costs – and most seniors will be insulated from these costs.
Principle 5: PBMs should have a fiduciary responsibility to their clients.
The main job of a PBM is to lower healthcare costs for employers and health plans while maintaining access to life-saving drugs. But as their market power has grown, PBMs’ interests have diverged from those of employers and health plans, leading them to make decisions that prioritize their profits over their clients’ (health plans, employers and public programs) interests. For example, PBMs might choose drugs with higher rebates and pocket those rebates even if this increases costs for employers and employees. Lack of transparency and increasing concentration in PBM markets enables these behaviors. Requiring PBMs to act as fiduciaries for their clients – and ultimately, consumers and employees – would encourage behavior we want in the market without creating unnecessary regulation.
Under ERISA, employers already have a fiduciary responsibility to their plan enrollees and must “run the plan solely in the interest of participants and beneficiaries and for the exclusive purpose of providing benefits and paying plan expenses,” according to the U.S. Department of Labor. The Consolidated Appropriations Act (CAA) of 2021 further strengthened this responsibility, requiring employers’ to disclose compensation to brokers and consultants, add protections against surprise bills and meet new mental health parity and pharmacy benefit requirements. Those provisions are currently being tested in court.
Regulators should extend fiduciary responsibilities to PBMs, which would make it easier for employers to fulfill their fiduciary responsibility to their employees and improve the cost and quality of benefits for employees.
A collection of Schaeffer research and resources about the pharmaceutical distribution system is available here.
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