This last week, I spoke with someone who works at an insurer. When I asked if it’s relatively easy for them to identify the pharmacy benefit manager (PBM) that’s offering the best deal, they said that it is, with caveats.
Quick sidenote: I’m finding kind people to answer my probing questions about PBMs, but I’ve also faced a fair amount of hesitancy in general. I think it’s because they worry what is going to happen with the information they are giving. I’m committed to being as transparent and unbiased as possible about the information I receive, and I’m equally committed to not disclosing any of my sources. So I guess that means I cannot prove the reliability of the information I’m sharing, but it’s worth it as long as I maintain access to good sources to help me understand this stuff!
Remember that for a market to be competitive it needs (1) multiple competitors, (2) the customers need to be able to identify the value (price and quality) of each competitor, and (3) the customers need incentives to choose the highest-value option.
The PBM market fulfills all these criteria pretty well. There are plenty of competitors (three big ones, several midsize ones, and lots of smaller ones). So, when an insurer submits a request for proposal (RFP), they will get multiple offers. Identifying the value of the proposals received is doable, if a bit tricky, as discussed below. And the insurer has incentives to choose the highest-value option–getting a great comprehensive formulary with the desirable meds makes for happy members, and lowering the costs goes to their bottom line (assuming there are no annoying medical loss requirement issues).
Let’s talk about the challenges that come into play when they try to identify the highest-value option. It’s actually pretty straightforward–these are incredibly complex contracts, to the point that regular healthcare consultants are not deeply specialized enough. And PBMs leverage that by trying to define things in ways that save them money. To the extent that, if an insurer wants to identify the best PBM proposal, they will probably need a consultant that specializes in helping insurers contract with PBMs. They need the help of someone who knows all the PBMs’ tricks.
I won’t even get into all the complexities of those contracts, partly because I don’t know many of them and partly because those details don’t change the big-picture incentives I’m talking about.
But the good news is that, with the right knowledge/assistance, insurers are able to make value-sensitive decisions in the PBM market! In fact, apparently many insurers submit an RFP every few years to make sure what they’re getting from their current PBM is still competitive, otherwise they’re probably leaving money on the table.
When analyzing healthcare from a “value versus volume” perspective, realizing exactly what we mean by that is an important starting point.
Consider what we mean when we say that healthcare providers are “rewarded for volume.” This is usually interpreted to mean healthcare providers are paid in a fee-for-service way–they deliver a service, they get paid. Which means they make more money when they deliver more services, so the incentive is to deliver as many services as possible.
And when we say that providers are “rewarded for value,” this is usually referring to some form of capitation, which means they get paid per head (that’s where the capit part of capitation comes from). In other words, providers would, for example, get paid a monthly fee for every patient whose care they are responsible for. Which means they make more money when they deliver fewer services (which, theoretically, happens when they are doing the right things to prevent their patients from getting sick).
These two methods of reimbursement are seen as “good” and “bad.” Capitation and its variations have good incentives (to prevent illness) and fee for service has bad incentives.
But they’re not opposites, like two sides of a coin or something. They are actually two different ends of a single spectrum. That spectrum is the “breadth of products/services sold as a single unit” spectrum. (I should come up with a better name for it.)
At one end of the spectrum, you have people buying very narrowly defined things. Like if a hospital really did send you a bill for every single nursing task and bandage and bag of saline and tablet of acetaminophen you received while you were there. This is the essence of fee for service–buying narrowly defined things. A doctor visit here, a procedure there.
The other end of the spectrum is buying very broadly defined things. Like paying a healthcare organization an annual fee for covering every single healthcare need that you could possibly have during that year, all inclusive. Every surgery and cancer treatment and emergency department visit etc. would be included.
I’ve written about all this before (way back in 2013!), but the way to figure out where on the spectrum the service should sit (i.e., how broadly defined the product/service should be) is to think about it from the patient’s perspective to see what “job” they want done that it’s fulfilling for them.
The easy example is if someone needs a hip replacement, let’s say they’ve tried all the conservative measures and now their job is simply to get their hip replaced and then recover/rehab from that. So why would they pay separately for the surgeon’s time, the OR time, the anesthesiologist’s time, the medications administered, the hardware used, the physical therapy appointments, the pre-op and post-op appointments, etc., when they could just pay a single lump sum to get their job fulfilled?
When we buy a plane ticket, we don’t pay a separate bill for the airplane depreciation, the fuel, the pilot’s time, the flight attendant’s time, the snack, etc., right? No, we just pay for the single plane ticket that includes all the products and services that go into getting us from point A to point B.
Using that principle of identifying the job to be done and then defining the service as broadly as is necessary to allow the patient to pay a single price for getting that job fulfilled will allow anyone to determine where on the “breadth of products/services sold as a single unit” spectrum anything in the world should sit.
So what about the drug market?
Much of the time, we know pretty well how long we’ll be on a medication. If it’s an asthma med, such as an inhaled corticosteroid, usually the patient will be on it for years or decades, so just knowing how much it costs per month is probably the right breadth of services.
Or, if it’s not a chronic medication, such as a cure for hepatitis C, figuring out the total cost of your direct-acting antiviral regimen is pretty easy if you at least know how much each pill will cost you and how many days (weeks) your treatment course will last.
My point is that the drug market, even though you’re typically buying either a short course of pills or a monthly allotment of them, is already “value based” because the breadth of products is attuned to the job you have for the medication (“keep my asthma at bay for 1 month,” or, “cure my hepatitis C”).
How do PBMs fit into all this?
Well, they’re middlemen. As far as I can tell, even though they’re the ones making the formularies, they aren’t really doing anything to actively shift the breadth of products sold one way or another, which is good because it already seems to be sitting on the spectrum in a good place.
Is there a role for including medications in capitated arrangements so that patients’ diabetes and hypertension and heart failure meds are all included in their annual or monthly fee? I guess that’s possible–it would encourage providers to choose cheaper meds, and it would decrease financially motivated medication nonadherence. So maybe PBMs would be involved in coordinating those efforts.
Ultimately, the big improvements that will change the drug market aren’t so much going to come from optimizations in the volume versus value space, but rather they will come from increasing competition and value-sensitive decisions. And maybe from limiting the degree to which PBMs distort the market? But I’m still figuring that one out.
In the “I’m still Confused by PBMs” article, I went through the step by step process of PBMs coming into existence, which they did by filling a need in the market for companies to help consumers pay the correct copay right up front when they buy a medicine.
This time, I want to think more about how they went from that simple software solution (integrating an insurer’s formulary into the pharmacy’s software system so that it can spit out the right out-of-pocket price on the cash register when a patient buys a medicine) to being seen by many as the “shady middlemen.”
The starting point is the position they found themselves in the market. They were responsible for creating formularies for several different insurers. Their goal, assuming the PBM industry is competitive, is to help insurers have the most generous formulary for the cheapest.
I bet at some point, some young upstart working for a PBM had an idea . . .
Young upstart: “If we want to offer a cheaper formulary than our competitor, why don’t we try to negotiate directly with drug manufacturers to lower the costs of the drugs?”
Old manager, feeling superior: “But how are we going to do that? You don’t understand that drug manufacturers only negotiate with pharmacy wholesalers. The wholesalers are the only party to which manufacturers sell their drugs. Nobody else buys directly from the manufacturers, so no one else can negotiate with manufacturers.” And then, with a taunting eyebrow raise, “Unless you are suggesting something radical, like that we start backward integrating to act as drug wholesalers as well?”
Young upstart, undaunted: “Not at all. How about this. Why don’t we pay a visit to a drug manufacturer that is selling a medication that has several competitors in the same drug category and make them an offer they can’t refuse. We could tell them we’ll put their medication in the lowest copay tier and all the other medications in that same category will still be in the middle copay tier. They will sell way more of their medicine and make a lot more money. But, in return, they have to pay us a “rebate” for every transaction of their medication that we process. They still make more money because they’re selling so much more of their medication, and we get some of it.”
Old manager, interest piqued: “And how is this going to allow us to offer a cheaper formulary than our competitors?”
Young upstart, gaining momentum: “We’ll simply charge less for insurers to use our formulary. Sure, they’ll have to pay a slightly larger share of the total cost of that specific medicine, but the lower price we offer them will more than make up for that. And the best part is, everyone wins! The drug manufacturer wins by increasing profit, the patient wins by paying a lower copay, the insurer wins by getting a cheaper overall formulary, and we win because we keep some of the rebate!”
Old manager, ever skeptical: “If everyone wins, then where is the money coming from?”
Young upstart: “The money comes from the other drug manufacturers, whose market share goes down. That profit that they’re losing is being divvied up among (1) us, (2) the drug manufacturer we’re contracting with, and (3) the insurers using our cheaper formularies, some of which will be passed on to patients.”
Old manager: “Ok, that makes sense, but this sounds too good to be true. You haven’t mentioned pharmacies yet–how would this impact them?”
Young upstart: “I was hoping you’d ask. This won’t impact pharmacies at all. They won’t even know about this transaction between us and the drug manufacturer. As far as they’re concerned, all they see is that they’re still getting paid the negotiated price for the medication, it’s just that patients are paying less and the insurer is paying more.”
Old manager, nodding: “So the patient pays less but the insurer pays more. Yet the insurer is saving money overall because our formulary is cheaper enough to more than compensate for that.”
Young upstart: “Exactly.”
And that is what I imagine to be the start of PBMs negotiating “kickbacks” with drug manufacturers. It was all in the name of PBMs being able to offer lower-priced formularies to insurers by orchestrating a way to help some drug manufacturers sell more drugs and get rebates/kickbacks/volume discounts in return.
This surely boosted the profitability of the PBMs that started doing it, which, when others heard about it, started doing the same thing.
Eventually, every drug manufacturer started paying some kind of rebate to PBMs, which means it became a zero sum endeavor overall for manufacturers because the net effect of having a higher market share through a specific PBM but a lower market through the others that made deals with their competitors means that they end up with essentially the same market share, the only difference being that now they are paying money to PBMs to avoid losing that market share.
Shady middlemen indeed. But I can’t blame them for doing it–this is what capitalism and competition is all about. It’s just a market failure that this specific strategy turns out to be a cost-increaser in the market.
Let’s see if I can make sense of pharmacy benefit managers (PBMs), the companies that seem to have a reputation as shady price-increasing middlemen in prescription drugs. This is part of my effort to better understand prescription drug prices and what’s wrong with that market.
First, consider the flow of a medicine from start to end.
The obvious start is that drug manufacturers make the medicine. And then that medicine has to get to pharmacies. Pharmacies do not want to contract with every single drug manufacturer directly, so instead they use wholesalers, who do that contracting for them and buy the drugs from the manufacturers and store them, and then those wholesalers are able to quickly supply all the drugs a pharmacy could want for a small markup. I don’t know the details on whether pharmacies can shop around for the best deal on a drug from different wholesalers or if they just contract with a single one, but, regardless, now the pharmacy has its drugs, and this part of the supply chain seems to work properly.
Next, the patient. They buy the drugs from the pharmacy. If they’re going through insurance, the pharmacy inputs into their computer the medication details and the patient’s insurance information and then out of the black box comes an out-of-pocket price for the patient to pay to obtain the medication and a price for the insurer to pay (and that bill gets sent directly to the insurer). That’s the end of the line for the medicine.
But the tricky part is that final transaction, how the prices are determined in that black box. This is where the mystery and intrigue and confusion come in.
Let’s talk about PBMs.
Originally, the precursors of today’s PBMs were simply companies that helped insurers process medication claims after patients would buy them. I’m not sure exactly how they morphed into today’s version of a PBM, but based on what I’ve been reading, my guess is that it went something like this . . .
Insurers (especially smaller self-insured employers) wanted someone with expertise in all things medications to create a formulary for them–surely a very complicated process–and since these precursor PBMs were already processing all the drug claims anyway, they were an obvious choice to ask to take on the new role of creating and managing formularies.
Next, since these precursor PBMs were now making formularies for several different insurers, they inadvertently had amassed significant power over many patients’ out-of-pocket prescription prices (and, therefore, patients’ prescription choices). So when drug prices started to climb higher, these precursor PBMs wanted to stay competitive and offer formularies with all the best medicines for the cheapest, so they got into the game of negotiating directly with drug manufacturers. And that is probably the point where they became modern-day PBMs. The three PBMs with the largest market share today are Express Scripts, CVS CareMark, and UnitedHealth’s OptumRx
But if the drug manufacturer is selling their drugs to pharmacies via wholesalers, what are PBMs and drug manufacturer negotiating over?
Kickbacks for PBMs to get more patients to buy their medications. That’s really what it boils down to. Although the payments from drug manufacturers to PBMs can take various forms, the simplest one is that the drug manufacturer pays a PBM a nice sum for the PBM to include their drugs on the PBM’s formulary. The PBM then passes some of this money on to the patients by lowering their copay for those drugs.
There are a lot of hidden details in these PBM-drug manufacturer negotiations. It’s an area rife with hidden numbers. The main question is, How much do PBMs actually get paid (including all the different forms of kickbacks) from the drug manufacturers? Nobody knows. There have been government attempts to force them to disclose this, but the laws only require them to report on certain kickbacks, and it’s probably not too difficult for them to look really good by shifting the majority of their kickbacks to different categories that are not reported.
My other question is, How do insurers choose a PBM? This should be a fairly answerable question with the right contacts. Is this a fairly transparent market, where insurers can go to each PBM and ask how much the total cost will be of the drugs their patients will get, plus the fees paid to the PBM? Based on the sheer complexity and number of variables involved, I doubt the PBM selection is easy and transparent. This means PBMs can get away with not only hiding how much they are getting paid by drug manufacturers, but also not passing much of that money on to the patients and insurers. And nobody will ever know truly how much these middlemen are adding to our skyrocketing drug prices.
Last week, I wrote about pharmacy benefit managers (PBMs), which are the companies that insurers contract with to help them create and manage their drug formularies. These PBMs also have significant power in the market as the ones who, to a fair extent, influence which prescriptions patients get because they control the patient’s copay for each medicine, so they take advantage of that by getting kickbacks from manufacturers to make those manufacturers’ drugs cheaper for patients.
First, what is GoodRx? It’s a company that offers a free prescription card that patients can use to get discounts on their medications, and you can check what the discounted price will be at pharmacies in your area. (They’ve since branched out now into subscription programs and telehealth, but I’ll focus on their original line of business here.) GoodRx prescription discount cards don’t work in addition to insurance; rather, you either buy the medication through your insurance plan or you pay without insurance and use a GoodRx card to get a better price.
I have no financial interest in GoodRx, but it seems like a no-brainer for anyone who is about to buy a medication through insurance to ask how much their copay will be and then pull up the GoodRx app right then and there to see if any local pharmacies can offer the med cheaper through GoodRx (and, according to a couple journalists who tried that, they got a cheaper price through GoodRx about 40% of the time for the most commonly prescribed medications). Just remember though that the money spent on medications when using GoodRx does not count toward your deductible.
It makes sense that there would be a website/app that lists the prices of medications at multiple pharmacies so patients can price shop, but what’s with these discount card prices being lower than the cash prices?
Pharmacies, in their contracts with PBMs, will not get paid more than their list price. So, to avoid missing out on money that PBMs would be perfectly willing to pay them, they make sure to set their list price (i.e., cash price) higher than what any contracted price with a PBM will be. So you should expect cash prices to always be higher than the price you’ll get by going through your insurer, although I’m sure this rule is broken sometimes. Because it’s American healthcare.
On the GoodRx website/app, the prices shown are not cash prices though. They’re the actual prices that pharmacies have contracted with PBMs. These prices vary significantly from pharmacy-PBM contract to pharmacy-PBM contract, mostly because of the complexity and sheer number of different medications that they are negotiating over, which means they cannot possibly negotiate over every individual medication, so instead they negotiate over groups of medications. This means some medications in that group will end up being cheaper than they would otherwise be, and others in that group will end up being more expensive.
But this means pharmacies are stuck selling medications to tons of people at prices that they accidentally undervalued in a negotiation with a single PBM. Sure, short of adding a gag clause to their contract, they can’t stop the PBM from sharing that price with GoodRx, but why in the world would pharmacies ever agree to let tons of other patients not even covered by that PBM walk out with a medicine for that same undervalued price?
They actually don’t have a choice. PBMs require in their contracts with pharmacies to accept the GoodRx discount card price. GoodRx does try to make pharmacies feel better about it by saying that “once patients are in the pharmacy, they are also more likely to purchase non-prescription items at the store.” Ok great, so the medication turns into a forced loss leader.
There’s one more big piece to this puzzle. Why would PBMs go along with GoodRx in the first place? Think about it from their perspective. They are angering pharmacies by forcing acceptance of GoodRx as part of their contracts, and they are the ones sharing all their contracted prices with GoodRx and then left looking bad after patients find out their PBM didn’t get the best negotiated price on a large minority of medications. In short, what’s in it for the PBMs?
Money. I suspect the PBM is getting a cut of every transaction that uses GoodRx because the PBM is the one adjudicating the claim. They’re also giving a cut of it to GoodRx as a reward for bringing them the extra claim.
PBMs and GoodRx both seem to win, as do patients if they’re finding lower prices. So if GoodRx is actually decreasing prescription spending, where is the money coming from? There’s only one party left. Pharmacies must be the ones taking the loss. I wonder if that loss-leader argument actually makes pharmacies more than they are losing on this whole venture. My suspicion is that it’s hard to prove one way or the other, but I doubt it.
The New York Times has a healthcare blog called The Upshot, and Austin Frakt of The Incidental Economist is a regular contributor. He recently wrote an article about drug prices, which is what got me thinking a little more about drug prices and prompted my post last week.
Sidenote: He has not been blogging very regularly anymore on The Incidental Economist, and it feels like a great hole has opened up in the health policy blogosphere. He has a great way of getting interested in a topic and finding all the useful evidence on the subject and then synthesizing it all, and through that process thousands of followers get carried along that journey of learning about an important health policy topic.
I think the topics Dr. Frakt covers in his most recent Upshot article are important, so I want to highlight some of them.
First, there is a link between higher prices and more innovation. Drug company executives aren’t dumb–if there’s a lot of money to be had in a certain drug market, they will put their R&D investments into those areas.
But the potential to make a lot of money with a drug doesn’t always line up with the potential to make a lot of health with a drug. We try to help those two things line up by manually setting patent lengths longer for drugs that will have a greater impact on health, but American politics is messy, so it doesn’t always work out that way. Another way to try to help those two things line up is by using administrative pricing. For example, New York Medicaid, similar to many countries, establishes prices based on a drug’s “therapeutic value.” If there is a high therapeutic value, the drug will be priced higher, and therefore the drug company will make more money if they focus their R&D on areas that are the most likely to increase health.
There is a whole independent nonprofit group dedicated to helping figure out the therapeutic value of drugs, and it’s called the Institute for Clinical and Economic Review (ICER). Some have proposed Medicare use the recommendations from ICER, but these days the trending proposal (which essentially accomplishes the same thing but is more politically palatable) is to instead look at the prices other countries set for drugs (presumably based on therapeutic value assessments) and then set our prices similarly. This is referred to as international reference pricing.
And while I think these proposals make a lot of sense because I, too, want more medications available to help my patients better, from a market perspective, I still have huge reservations to these sorts of administrative pricing proposals. It’s the same argument I end up at every time an administrative pricing proposal comes up: Taking the pricing power away from the collective knowledge of the market and putting it in the hands of a group of experts will never be accurate enough to allow the most efficient use of resources. And, in impossible-to-predict ways, it may create barriers to innovation.
I will talk more about the specific downsides of administrative pricing next week. And, by the way, my purpose here is not to say that administrative pricing is always wrong; rather, my purpose is to say that there are significant unpredictable costs associated with such a policy, and those short- and long-term costs need to be taken into account when deciding which policy would be best.