Pharmacy Benefit Managers (PBMs) play a crucial role in controlling the cost of prescription drugs, making them more affordable for millions of consumers. They use their networks and purchasing power to negotiate lower drug prices with pharmaceutical manufacturers and pharmacies. The discounts and rebates that PBMs secure lower prescription drug costs, which directly benefits both insurers and patients in the form of reduced premiums and out-of-pocket expenses for drugs.
However, critics of PBMs often label them as needless “middlemen” whose sole intent is to pad their profits by raising drug costs and erecting barriers to life-saving treatments. Some version of this narrative serves as the ostensible motivation behind the recently introduced legislation in the U.S. House of Representatives and several additional bills currently being considered aimed at constraining the role that PBMs play in the pharmaceutical market.
However, that perspective is far from the truth, and the confluence of an otherwise impotent Congress, replete with members desperate to signal to constituents that they are “doing something” to reduce drug costs, and pharmaceutical companies wanting to avoid dealing with competitive forces could spell disaster for consumers if these bills become law.
While the pharmaceutical supply chain can be very complex, an analogy to the travel industry can help elucidate how it works and the role PBMs play.
On one end, airlines, hotels, and other travel destinations offer services to consumers, and they earn higher profits when they increase sales, of course. They have an incentive to produce high quality services demanded by consumers at reasonable prices. They are analogous to pharmaceutical companies.
At the other end is the consumer looking for a fun and affordable travel experience.
Travel agents sit in the middle of this network of service providers and negotiate to obtain the highest quality experience at the best prices, and they are analogous to the PBMs. Travel agents compile information on flights, hotels, and vacation packages from various providers, giving consumers a consolidated place to make informed decisions; PBMs aggregate information about various drug options, their prices, and efficacy to offer a range of options to health plans and insurers.
Travel agents leverage their customer base to negotiate deals from airlines, hotel chains, and other service providers, much as PBMs do with drug prices. Travel agents can customize travel packages or itineraries based on individual or group preferences; PBMs customize drug benefit plans to match the needs of the insurance company or employer based on a specific patient population. Like PBMs, there are many travel agents to choose from, so an agent cannot gouge travel service providers—or by extension, consumers. All the entities in the travel supply chain have an incentive to provide high-quality services at reasonable prices, and each of the three must make a profit to stay in business.
The analogy begins to break down when we consider that pharmaceutical companies can exercise monopoly power for the drugs they own that are still under patent. A monopolist has the power to set prices without worrying about a competitor undercutting it, so high prices propagate through the system. Society accepts monopoly prices because we recognize that these outsized profits can incentivize the creation of new and innovative drugs.
Hotels and airlines, on the other hand, face stiff competition every day.
However, even patented drug products frequently have a modicum of competition in the form of other, similar drugs or generics that treat the same underlying health conditions, and it is precisely in these circumstances that PBMs can obtain substantial savings for patients. PBMs negotiate with the pharmaceutical companies by offering access to all the insurers and other health plan sponsors they represent, which can be a sizable population, in exchange for a discount. If they fail to extract a discount they can threaten to recommend a competing drug for their customers’ patients.
One particularly destructive provision among the PBM reform proposals would prohibit linkages between pharmacy benefit companies’ compensation and prescription drug list prices in Medicare Part D. A recent NBER paper authored by University of Chicago Professor Casey Mulligan finds that such a provision would undermine incentives for pharmacy benefit companies to maximize competition in the market and secure savings for patients and health plan sponsors. Mulligan estimates that taxpayers and patients would see drug prices increase by $18 billion and Medicare premiums go up by $10 billion.
Legislators have also taken aim at eliminating the practice of spread pricing, which is simply the difference between the price the PBM contracts with the plan sponsors to pay for drugs and the price at which they reimburse the pharmacies that fill the prescriptions. Spread pricing in general is common throughout the economy: Any place along the value chain, such as wholesale/retail trade, there is a difference between the price paid for something and price at which it is sold.
Spread pricing creates incentives for PBMs to obtain the lowest price possible from the pharmacies. Additionally—and certainly not unique to PBMs—spread pricing subsumes administrative fees or other regulatory costs incurred by the PBM. If the government banned travel agents in our analogy from using spread pricing, they would have no incentive to negotiate lower prices that benefit consumers. Moreover, administrative fees would quickly appear to make up for those being incorporated into the spread.
These provisions reveal that the intent behind the plethora of bills by Congress to constrain the negotiating power of PBMs is nothing less than a coordinated effort to remove and otherwise neutralize the mechanisms PBMs employ to reduce drug prices. The PBMs’ ability to reduce the amount of money that drug companies make has put them squarely in their cross-hairs, and drug companies have ponderously attempted to place the blame on them for high prices.
The truth is, in fact, the exact opposite: drug companies want to preserve high prices and avoid competing on price whenever possible. As a result, these legislative initiatives amount to a Big-Pharma-championed strategy to effectively de-link PBMs from incentives to negotiate lower prices. The proposed legislative measures are ill-considered if the goal of policy is to reduce drug costs.
It certainly isn’t the goal of the pharmaceutical industry.
Tony Lo Sasso, professor of economics at Depaul University, co-authored thi