This article was written before the rebate rule was withdrawn. That's why the PBMs Reborn scenario described below remains relevant.
It’s a tough time to be a PBM. Compensation models are shifting, due to increased scrutiny by payers, regulators, and politicians. Plan sponsors are more sophisticated and seek greater pass-through of rebates, admin fees, and other manufacturer-provided revenues. Network spreads are under pressure, while specialty pharmacy dispensing accounts for a growing share of profits. Plus, the entire drug channel system could move toward a world without rebates.
Below, I update Drug Channels Institute’s look at PBM market share and reflect on four crucial areas in which PBMs’ compensation will be evolving. No PBM discloses detailed information about the sources and composition of its profits, so consider my observations as general guidelines for evaluating the upcoming investor day commentary from management.
STUFF TO READ (SHORTLY)
Presentations and other material will be available on the investor relations section of each company’s website over the next week:
If you are interested in these companies, I encourage you to listen to the webcasts and review the presentation materials. They are usually filled with useful market insights and competitive intelligence.
THE PBM MARKET
For 2018, about three-quarters of all equivalent prescription claims were processed by three companies: CVS Health (including Caremark and Aetna), Express Scripts, and the OptumRx business of UnitedHealth. (See the chart below.) The top 6 PBMs handle more than 95% of total U.S. equivalent prescription claims. This concentration helps plan sponsors and payers, who can maximize their negotiating leverage by combining their prescription volumes within a small number of PBMs.
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These data, along with our review of the largest PBMs’ overall business strategies and structures, appear in Section 5.2. of our 2019 Economic Report on U.S. Pharmacies and Pharmacy Benefit Managers.
FOUR WAYS THAT PBM PROFITS WILL CHANGE
Here are the four most crucial changes to how PBMs make money.
1) Bundled pricing of pharmacy and medical benefits will pressure margins.
Five of the largest PBMs are combined into companies that offer health insurance and operate specialty pharmacies. The chart below provides an updated illustration of the major vertical business relationships for five of the largest PBMs. MedImpact (not pictured) is the only remaining large independent PBM.
This vertical integration is motivated partly by the ongoing growth in specialty drugs. These drugs treat a small minority of patients, but they account for a high and growing share of payers’ drug spending. Specialty drug spending, however, is split between the pharmacy benefit and the medical benefit. What’s more, patients who take expensive specialty drugs tend to have high medical expenses. Managing drug spend across these two categories is crucial for health plans and payers.
The need for integration of pharmacy and medical benefits is triggering changes in how PBMs view benefit design. As I told the New York Times last year: “When you have a hammer, everything looks like a nail. If everything you are thinking about is pharmacy costs, everything looks like a drug pricing problem.”
Integration will encourage insurers and PBMs to compete more aggressively on their bundled services. Today, a majority of larger employers have a carve-out (separate) contract directly with a PBM. (See Section 5.1.2. in our 2019 pharmacy/PBM report.) I expect this share to decline, because vertically integrated insurers will discount their in-house PBM’s services to win the combined business. Any stand-alone PBM contracts will need to lower prices to remain competitive.
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This vertical integration is motivated partly by the ongoing growth in specialty drugs. These drugs treat a small minority of patients, but they account for a high and growing share of payers’ drug spending. Specialty drug spending, however, is split between the pharmacy benefit and the medical benefit. What’s more, patients who take expensive specialty drugs tend to have high medical expenses. Managing drug spend across these two categories is crucial for health plans and payers.
The need for integration of pharmacy and medical benefits is triggering changes in how PBMs view benefit design. As I told the New York Times last year: “When you have a hammer, everything looks like a nail. If everything you are thinking about is pharmacy costs, everything looks like a drug pricing problem.”
Integration will encourage insurers and PBMs to compete more aggressively on their bundled services. Today, a majority of larger employers have a carve-out (separate) contract directly with a PBM. (See Section 5.1.2. in our 2019 pharmacy/PBM report.) I expect this share to decline, because vertically integrated insurers will discount their in-house PBM’s services to win the combined business. Any stand-alone PBM contracts will need to lower prices to remain competitive.
2) PBMs will continue to reduce their reliance on profits from rebates.
The share of commercial rebates and other manufacturer payments that plan sponsors receive has increased, because PBMs pass through the majority of these funds. (See Employers Are Absorbing Even More Manufacturer Rebates from Their PBMs.) Consequently, investment analysts at Nephron Research estimates that the share of PBMs’ profits earned from retained rebates has declined, from 25% in 2013 to 10% in 2018.
That’s why the largest PBMs have announced new approaches that would adapt their compensation to a system that features lower or no rebates:
That’s why the largest PBMs have announced new approaches that would adapt their compensation to a system that features lower or no rebates:
- Express Scripts has announced a novel pharmacy benefit contracting model for members of the National Drug Purchasing Coalition (NDPC). See PBM Pricing Overhaul: Express Scripts Prepares for a World Without Rebates—But Employers May Not Change.
- Express Scripts has also announced a new National Preferred Flex Formulary, an option that favors drugs with lower list prices over the high-list/high-rebate versions of these products. See Express Scripts Launches a New Formulary for a World Without Rebates. Will Plan Sponsors and Drug Makers Play Along?.
An unintended consequence: Express Scripts has excluded lower list price products from its primary formulary. Adoption of the Flex formulary appears to be trivial.
- CVS Health has announced its Guaranteed Net Cost approach, which seeks to guarantee the average net spend per prescription, after discounts and rebates, for each distribution channel. Read the press release.
3) PBMs will depend more on profits from dispensing specialty drugs.
In The Top 15 U.S. Pharmacies of 2018: M&A Reshapes the Market, we show that many of the largest pharmacies are now central-fill mail and specialty pharmacies operated by PBMs and insurers. And as we show in The Top 15 Specialty Pharmacies of 2018: PBMs Keep Winning, PBMs and insurers also dominate specialty drug dispensing channels. See chart below.
Like any other pharmacy, a PBM’s mail and specialty pharmacies earn gross profits from the difference between (1) the reimbursement to the pharmacy minus (2) the pharmacy’s net acquisition cost for purchasing the product. This dispensing spread covers the expenses of operating a pharmacy, including pharmacist salaries, inventory holding costs, licensing, and other costs of dispensing. Mail pharmacies typically do not receive dispensing fees, but a PBM’s specialty pharmacy could earn service and data fees from a manufacturer.
The concentration of specialty and mail dispensing revenues results largely from strategies used by payers and manufacturers to narrow specialty drug channels. In most cases, health plans and plan sponsors require patients to use the mail and specialty pharmacies that the PBM owns and operates.
Consequently, PBMs now earn more than 50% of their profits from dispensing activities. To maintain and grow this profitability, PBMs increasingly demand that manufacturers pay higher service fees and provide deeper off-invoice discounts.
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Like any other pharmacy, a PBM’s mail and specialty pharmacies earn gross profits from the difference between (1) the reimbursement to the pharmacy minus (2) the pharmacy’s net acquisition cost for purchasing the product. This dispensing spread covers the expenses of operating a pharmacy, including pharmacist salaries, inventory holding costs, licensing, and other costs of dispensing. Mail pharmacies typically do not receive dispensing fees, but a PBM’s specialty pharmacy could earn service and data fees from a manufacturer.
The concentration of specialty and mail dispensing revenues results largely from strategies used by payers and manufacturers to narrow specialty drug channels. In most cases, health plans and plan sponsors require patients to use the mail and specialty pharmacies that the PBM owns and operates.
Consequently, PBMs now earn more than 50% of their profits from dispensing activities. To maintain and grow this profitability, PBMs increasingly demand that manufacturers pay higher service fees and provide deeper off-invoice discounts.
4) Payer and government pressure will shrink PBMs’ ability to capture network spreads.
PBMs can earn a portion of their profits from spread pricing by handling the flow of drug payments from plan sponsors to network pharmacies. Plan sponsors compensate the PBM by permitting the PBM to retain differences, or spreads, between (a) the amount that a PBM charges to a plan sponsor and (b) the amount that the PBM pays to the pharmacy that dispenses the drug to a consumer.
It's no secret that spread pricing is one way for a plan sponsor to compensate its PBMs. The fact that PBMs are earning a spread does not necessarily mean that they are earning too much.
However, spread pricing has become highly controversial in Managed Medicaid programs, which are run by PBMs and account for a majority of Medicaid prescriptions and spending. For example, an Ohio state audit revealed that for generic drugs, pharmacies were paid an average of $13.40 per generic prescriptions, while PBMs were paid an additional $6.15 per generic prescription. A consultant hired by the state of Ohio estimated that the PBMs’ fees should have been in the range of $0.95 to $1.90 per prescription. See our August 2018 news roundup or Section 5.4.1. in our 2019 pharmacy/PBM report .
Last week, the Centers for Medicare & Medicaid Services issued guidance targeting spread pricing by PBMs. CMS Administrator Seema Verma was blunt in her official statement:
That said, the state Medicaid program is responsible for managing the program—and taxpayer funds—appropriately. If a plan allows a PBM to be overcompensated, it's hard to blame the PBMs for accepting the extra money. Nonetheless, I expect these network spreads to decline in importance as payers become savvier at negotiating effective contracts with their PBMs.
It's no secret that spread pricing is one way for a plan sponsor to compensate its PBMs. The fact that PBMs are earning a spread does not necessarily mean that they are earning too much.
However, spread pricing has become highly controversial in Managed Medicaid programs, which are run by PBMs and account for a majority of Medicaid prescriptions and spending. For example, an Ohio state audit revealed that for generic drugs, pharmacies were paid an average of $13.40 per generic prescriptions, while PBMs were paid an additional $6.15 per generic prescription. A consultant hired by the state of Ohio estimated that the PBMs’ fees should have been in the range of $0.95 to $1.90 per prescription. See our August 2018 news roundup or Section 5.4.1. in our 2019 pharmacy/PBM report .
Last week, the Centers for Medicare & Medicaid Services issued guidance targeting spread pricing by PBMs. CMS Administrator Seema Verma was blunt in her official statement:
“States are increasingly reporting instances of spread pricing in Medicaid, including cases in Ohio and Texas, and I am concerned that spread pricing is inflating prescription drug costs that are borne by beneficiaries and by taxpayers. Today’s guidance will ensure that health plans monitor spread pricing in Medicaid appropriately. PBMs cannot use spread pricing to upcharge health plans and increase costs for states – spread pricing must be monitored and accounted for, and not used to inflate profits.” (emphasis added)The Lower Health Care Costs Act of 2019 also prohibits spread pricing.
That said, the state Medicaid program is responsible for managing the program—and taxpayer funds—appropriately. If a plan allows a PBM to be overcompensated, it's hard to blame the PBMs for accepting the extra money. Nonetheless, I expect these network spreads to decline in importance as payers become savvier at negotiating effective contracts with their PBMs.
PBMs REBORN?
As I noted in March, PBMs’ services will remain crucial to the functioning of the U.S. drug channel. As long as we have third-party payment for our prescriptions, PBMs will not be removed from drug channel.
In my April webinar Preparing for a World Without Rebates, I outlined a black swan scenario—a world without rebates in commercial and Medicare plans.
It’s still possible, however, that rebates will remain a feature of the U.S. drug channel, despite efforts to reform the system. This would be the PBMs Reborn scenario.
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I expect that if rebates remain, commercial and Medicare benefit designs would shift from the excessive and unfair cost sharing that has characterized the past few years. The gross-to-net bubble would not pop, though patients would be shielded from its excesses. Point-of-sale rebates, which rely on PBM intermediation, would become more common.
The four changes that I outline above will occur to varying degrees whether we enter a Black Swan or PBMs Reborn scenario.
Of course, I could be wrong. Prediction is very difficult, especially if it's about the future. D'oh!
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