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Eliminating Anticompetitive PBM Practices Are Free Market Reforms

The current drug pricing market is malfunctioning, an obvious conclusion to anyone who is paying attention. But why? Like much of the healthcare sector, the current government driven, third party payer system misaligns the interests of patients and the companies that manage patients’ drug benefits (called pharmacy benefit managers, or PBMs). These misaligned interests inflate patients’ out-of-pocket costs and often encourages the use of expensive drugs when more affordable alternatives exist. Fixing these problems is an essential precursor for creating a patient-centered healthcare system. Several current Congressional proposals, including the Delinking Revenue from Unfair Gouging Act and the Modernizing and Ensuring PBM Accountability Act, address these adverse consequences. The reforms are not panaceas; but they address several core deficiencies of the current system. Despite the clear pro-market benefits of these reforms, some conservative groups mistakenly claim that reforming PBM practices would push the healthcare system “one step closer” to a complete socialized system. Nothing could be further from the truth. Markets are corrupted when regulations misalign the incentives of market participants or when prices are opaque. Market efficiency is also compromised when consumers (in this case patients) have limited ability to seek out competitors who can meet their needs more effectively and efficiently, an issue because three PBMs control 80% of the pharmacy benefit market and are all subsidiaries of major health insurers – CVS Health/Caremark, Express Scripts (part of Cigna), and OptumRx (part of UnitedHealth).

The misalignment of interests arises because PBMs control the list of approved medicines (i.e., the formularies) that determine which treatments patients can access. Due to this control doctors cannot base their prescriptions solely on the patients’ medical needs, they must account for the drug formulary when making treatment decisions. From an efficient market perspective, PBMs’ control over the formulary has caused the pricing system to malfunction. Like any market, the total amount of spending on a drug depends on the actual transaction price. This transaction price (often referred to as the net price) is the manufacturer’s announced list price minus all the undisclosed discounts that the PBMs negotiate on behalf of insurers.

The incentive of drug manufacturers is to ensure that their medicines receive the best possible placement on the PBM formularies – otherwise, patients won’t be able to access the manufacturers’ drugs. This means that manufacturers must satisfy the needs of PBMs in order to meet the needs of patients. PBMs, and their affiliated insurers, earn more revenue when medicines have high list prices because high list prices enable PBMs to negotiate larger discounts. Since PBM compensation is based on the size of the discount, the larger the discounts, the more revenues they earn. Consequently, PBMs prefer drugs with artificially high list prices.

The current fees PBMs charge to pharmacies, employers, and manufacturers, now an even larger revenue source, are also linked to drugs’ list prices. This link between PBM fees and drugs’ list prices creates another bias toward higher list prices.

The observed drug pricing outcomes have been consistent with these incentives for many years.

The list prices for medicines have been high and growing, but the unknown discounts – negotiated discounts are bizarrely considered proprietary information – have grown even faster. Consequently, net prices, which are the relevant prices from a healthcare system perspective, are growing much slower and have, in fact, declined over the last six years.

Another adverse outcome from these misaligned incentives also arises because higher cost versions of drugs will often generate more discounts and higher PBM revenues compared to lower cost competitors. Consequently, there can be a strong discouragement against using lower cost competitive drugs that are just as efficacious.

Tragically, patients aren’t benefiting from the low net prices because their out-of-pocket costs are based on the inflated gross prices. Put differently, the current PBM controlled pricing system extracts excessive revenues from the patients who require expensive medicines, which are then used to either subsidize other patients through lower premiums or are used to inflate the profits of PBMs or insurers. Either outcome is the exact opposite of how an efficient pharmaceutical market should work. And it is why PBM reforms are necessary.

In response to these well documented costs, Congress is considering reforms that would ensure “full and complete disclosure” of prescription drugs’ costs, prices, and discounts. Further, all fees, charges, and markups that PBMs charge health plans and pharmacies would need to be disclosed. To address the high list price bias created by PBM linked fees, the reforms would break the link between PBM compensation (fees and rebates/discounts) and list prices.

Ensuring that prices, fees, costs, and discounts are disclosed meaningfully addresses the price opacity problem that is a large enabler of the current misalignment of interests. When combined with the reforms that delink PBM fees from the list prices, the out-of-pocket costs would more accurately reflect the actual net prices of the medicines and create significant savings for patients.

Another important reform addresses the PBM anticompetitive practice referred to as “spread pricing”, which occurs when PBMs charge health plans and insurers more for a prescription drug than what they pay to the pharmacy. The difference – the spread – is currently pocketed by the PBM. This practice, which is particularly harmful to smaller family-owned pharmacies who often lose money on the sale of a drug as a result – is only possible because the current system has over-empowered the middlemen. The reforms would prohibit this type of market exploitation.

The PBM legislations under consideration are not silver bullets, but such expectations are unrealistic. The proposed reforms will improve the efficiency of the U.S. pharmaceutical market and help improve drug affordability for patients, all the while bringing down health care costs. More broadly, effective PBM reforms will showcase the broader potential benefits that could be gained by replacing our current third-party payer system with a system that empowers patients and their doctors to manage their healthcare decisions.

Author: Wayne Winegarden, Forbes Contributor

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