Pharmacy benefit managers or PBMs, the mysterious middlemen of US health care, explained

Democrats, Republicans, and pharmaceutical companies don’t always agree on everything about high prescription drug prices. But over the past few years, they’ve increasingly found common ground on one thing: pharmacy benefit managers are part of the problem.

Pharmacy benefit managers are companies that, behind the scenes, determine what patients have to pay for medications. They manage insurance benefits for prescription drugs, dictating which drugs are covered by insurers and what costs patients will face when they fill their prescriptions.

To do that, they negotiate discounts, or rebates, with drug manufacturers and afford privileged status to the companies that give them the best deals.

And over the past few decades, as the prescription drug market has evolved and become more lucrative, so have PBMs. They run their own mail-order and specialty pharmacies. More recently, they have begun merging with health insurers, creating behemoth companies with the power to determine where and how billions of dollars are spent within the US health system.

Pharmacy benefit managers have become known as the mysterious middlemen of the pharma trade — and as a useful scapegoat for drug companies seeking to deflect blame from their own pricing practices.

Now the Senate, as part of forthcoming prescription drug legislation, appears poised to impose new rules on them. The committee overseeing health care debated last week a slew of measures requiring PBMs to be more transparent about their business and cracking down on some of their moneymaking practices. Several PBM CEOs will testify before the committee on Wednesday.

“While the pharmaceutical industry blames the PBMs for high drug prices, the PBMs blame the pharmaceutical industry for high drug prices,” Sen. Bernie Sanders (I-VT) said to open last week’s hearing. “The reality is both of them are right.”

Experts generally agree that these companies play a role in driving up drug costs for some US patients, even as they negotiate discounts with drugmakers that benefit others, and that the amount of secrecy about their financial arrangements warrants scrutiny.

But reforms to the PBM industry aren’t a cure-all for making drugs more affordable: Sanders said the PBM measures being considered in the Senate would not meaningfully lower the cost of medicine for most people, even if they would bring more accountability and transparency to the sector.

So reforming PBMs can’t be the end of the country’s debate over drug prices. But it’s an important step.

How PBMs evolved to play a critical role in US health care

If you’ve ever had a prescription filled, you’ve likely dealt with a pharmacy benefit manager — whether you realized it or not. Most people have their benefits managed by one of three companies: Express Scripts, CVS Caremark, and OptumRx, which together control about 80 percent of the market.

The primary function of pharmacy benefit managers is exactly what it sounds like: managing coverage for prescription drugs on behalf of health insurers.

In the 1960s, when the precursors to modern-day PBMs first emerged, most people paid for their medications out of pocket. This was in part because there were comparatively few drugs to take — certainly not the highly specialized treatments for hypertension, high cholesterol, and other chronic conditions that are commonplace today; while data from 60 years ago is scarce, the number of drugs being prescribed per American has grown by almost 50 percent since just the mid-1990s.

When Medicare was first created in 1965, it was “common” for private health plans to exclude coverage for prescription drugs. (Medicare did not begin covering outpatient prescription drugs until the mid-2000s.) But the US pharmaceutical industry soon began to develop more advanced, costlier drugs, and employers and their health insurers realized they would need to pick up some of the cost for those new treatments.

As they added that coverage in the 1970s and ’80s, the first PBMs formed within health insurers, according to Taylor Christensen, a physician who has researched their history and business practices. They were made up of early coders who connected the health insurer’s formulary, the information on the drugs the plan would cover and at what cost to the patient, to pharmacies across the country. This meant that, instead of filing a claim with their insurer, the patient could pay the out-of-pocket price at the pharmacy.

Soon, the employees specializing in pharmacy benefits saw a business opportunity. Through their work, they had a clearer look at how the costs of prescription drugs affect people’s behavior. They saw that lowering a drug’s copay, for example, led to more people taking that medicine versus a more expensive option, which saves the insurance company money. And rather than conduct that work for one company in-house, they realized they could spin their business off and become independent.

In the 1980s and ’90s, the modern standalone PBMs were founded with a simple pitch to health insurers: We can save you money if you delegate your prescription drug benefits to us. “They figured out they could do it better than each in-house insurance group,” Christensen said.

Health insurers decided that was a good deal. Then PBMs saw another business opportunity. Already in business with insurance companies, they turned around and made a pitch to drug companies, too: Through our formularies — which can give priority to certain medications with those lower copays — we can direct more customers to your medications.

But PBMs wanted a deal in exchange, and drug rebates were born.

Unlike more conventional commercial rebates, prescription drug rebates are invisible to the patient. When a patient fills their prescription, the drug company pays a pre-negotiated rebate to the PBM, providing a discount off the list price. The PBM then passes all or most of that rebate to the health plan; in the latter case, it keeps a cut for itself.

And so the modern pharmaceutical market took shape. Drug manufacturers develop (or acquire) medications. After FDA approval, they produce these drugs. They sell those medicines to wholesalers, who distribute them to individual pharmacies. Health insurers contract with PBMs to determine copays, and the PBMs negotiate rebates with drug companies.

All this determines what a patient pays in the pharmacy when it’s time to pick up their meds.

Over time, the importance of PBMs grew. Breakthrough treatments for all kinds of serious conditions that plague Americans came onto the market, with ever-increasing price tags. The launch of Medicare Part D in 2006 provided prescription drug coverage to the people who use prescription drugs the most: seniors.

According to the Congressional Budget Office, patients paid almost 60 percent of the cost of their medications out of pocket in 1990. That share had fallen to 15 percent by 2018. Insurers, in turn, picked up more and more of the tab, with their share of drug costs doubling from 26 percent in 1990 to nearly 50 percent in recent years.

PBMs expanded their operations to grab a bigger share of the pie. They started operating mail-in pharmacies, cutting out the brick-and-mortar stores, and specialty pharmacies that handle certain high-cost medications. They also merged with one another — so much so that Express Scripts, CVS Caremark, and OptumRx now dominate the PBM market.

And in recent years, PBMs, their pharmacy businesses in tow, have begun reintegrating with the health insurers from which they were spawned. Today, CVS owns the health insurer Aetna, in addition to its own PBM business and its own specialty pharmacy business. Cigna and United Healthcare have purchased Express Scripts and OptumRX, respectively, and their parent companies have their own specialty pharmacies. Those deals gave the insurers a better window into the mysterious finances of the PBMs and let them keep all of the rebates being negotiated with drugmakers.

These business arrangements have created a lot of anxiety among policy experts and lawmakers — and with good reason.

Why PBMs are under scrutiny from lawmakers

The trouble starts here: Nobody outside of the PBMs and drug manufacturers really knows the size of the rebates being negotiated.

PBMs argue that is a necessary condition of their job. If everybody knew the size of the rebates they are securing, they would start to lose their leverage and thus their ability to get a better deal for their customers. But this impenetrability has helped create the image of PBMs as a mysterious conduit in the pipeline between pharma and patients.

“Over time, questions have been raised whether PBMs are overcompensated for their services,” said Stacie Dusetzina, a health policy professor at Vanderbilt University. “The lack of transparency makes it impossible to judge and makes everyone suspicious. There is a dramatic lack of clarity on how their business model typically works.”

PBMs generally make money in one of two ways: Either they earn a percentage of the rebates they negotiate with drug companies on health plans’ behalf or on a per-prescription fee basis paid by the insurer. But because their books are locked in a proverbial black box — even for a publicly traded company like Express Scripts, their contracts with drugmakers are generally considered to be trade secrets — it can be difficult to tell from the outside how a company makes its money.

There is some evidence of clever accounting on the part of PBMs: A 2019 Government Accountability Office report concluded that PBMs kept just 1 percent of rebates, but Christensen interviewed a former PBM employee who said the real share is closer to 20 percent. From the outside, it’s impossible to know which is true.

“No one has clear information about how they’re getting paid, so it’s hard to say if they’re getting paid too much,” Dusetzina said.

The rebate structure also can create perverse economic incentives that could result in patients paying more money for medications. Drugmakers now know that they will have to negotiate rebates with PBMs, which can motivate them to set higher list prices — prices that are eventually borne by some consumers or, in the case of Medicare patients, by the government.

“When the starting price of a drug rises, and the PBM negotiates a rebate, the PBM appears successful,” said Robin Feldman, a law professor at UC Hastings who studies the pharma market. “It’s like a store that raises the price of a coat before putting it on sale.”

PBMs can also now use their contracts to funnel business away from retail pharmacies to the specialty pharmacies they own, creating a potential conflict of interest, and there is some evidence that this practice is becoming more common.

PBMs could also provide a way around federal regulations that require insurers to spend a certain percentage of their revenue on actual medical claims. As the scholars at the Brookings Institution recently wrote, insurer payments to other entities owned by the same parent company — such as PBMs — can still count as medical spending under those rules, even if the money ultimately ends up staying inside the larger business organization.

How a bipartisan Senate deal would affect PBMs

When the drug company Mylan was criticized in 2016 for the EpiPen’s egregious price hikes, Mylan CEO Heather Bresch and other leaders in the drug industry testified before a Senate committee and pointed the finger squarely at PBMs.

“So you get this pressure year after year that tends to escalate the price increases,” Ron Cohen, then the chairman of the Biotechnology Innovation Organization, a biotech trade group, told the committee, explaining how the rebates negotiated by PBMs drove up list prices.

Until that hearing, PBMs had been frequently ignored in the US health care discourse. One person who was working at the Department of Health and Human Services at the time told me the CEO’s comments were what brought PBMs to their attention.

In response, those companies have argued that focusing on their business is a distraction from the egregious pricing practices perpetrated by pharmaceutical companies.

“EpiPens are expensive because Mylan raised the price of EpiPens,” Steve Miller, chief medical officer at Express Scripts, said in a 2016 interview. “To blame it on distributors … is just ridiculous.”

But in the view of many lawmakers and experts, as Sanders articulated at last week’s hearing, both sectors bear part of the blame.

The EpiPen price scandal of 2016 was just one of many controversies (Martin Shkreli, Valeant Pharmaceuticals, the ever-growing cost of insulin, the enormous opening prices of the hepatitis-C cures) that have made drug prices one of Congress’s top priorities in recent years. Last year, lawmakers for the first time authorized Medicare to negotiate prices for a limited number of drugs directly with drugmakers. They also placed a cap on out-of-pocket costs for insulin for people on Medicare.

But Bresch, intentionally or not, also put PBMs on the radar — and seven years later, Congress is on the verge of acting to rein in the industry. Sanders and his Republican counterpart on the health committee, Bill Cassidy of Louisiana, recently announced a deal on legislation that would be the first significant attempt by Congress to address the PBM industry. It is expected to clear the Senate health committee this week.

Experts and lawmakers alike caution that these provisions are a first step. The bill starts chiefly with simply forcing more transparency from PBMs. They would be required to share more information with health plans on prescriptions and discounts; they would also need to disclose information about, for example, any arrangements that could lead to prescriptions being funneled to the mail-order or specialty pharmacies owned by the PBM. They would be required to submit the same information to the federal government too. Another provision would ban the practice of “spread pricing,” in which a PBM charges the health insurer more money for a drug than is paid to the pharmacy to acquire it.

Eventually, the plan is for these measures to be folded into a larger legislative package focused on drug pricing that Senate Majority Leader Chuck Schumer hopes to bring to the Senate floor in the coming weeks.

Still, reforming PBMs doesn’t fundamentally change a US pharmaceutical market that gives companies carte blanche to set whatever list prices they want for new drugs. It doesn’t affect the gamesmanship that can prevent generic drugs from coming to the market and thereby keeping prices elevated long after the initial patents expire. It also doesn’t change the long-running trend of health plans shifting more of the cost of medical care onto patients through high-deductible plans and other benefit designs.

Some of those issues will be addressed in the legislative package the Senate is pulling together. But others will be part of a later debate — one that Sanders, even as he excoriated PBMs for their worst practices, promised would be coming.

“For anyone here who believes this is going to be end of the work we do here on prescription drugs, I have bad news for you,” Sanders said at his committee’s hearing last week. “This isn’t the end, but the beginning.”