International Journal of the Economics of Business
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`~ Routledge
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`ISSN: 1357-1516 (Print) 1466-1829 (Online) Journal homepage: http:llwww.tandfonline.comlloilcijb20
`
`Pharmacy Benefit Management: Are Reporting
`Requirements Pro- or Anticompetitive?
`
`Patricia M. Danzon
`
`To cite this article: Patricia M. Danzon (2015) Pharmacy Benefit Management: Are Reporting
`Requirements Pro- or Anticompetitive?, International Journal of the Economics of Business, 22:2,
`245-261, DOI: 10.1080/13571516.2015.1045741
`
`To link to this article: https:lldoi.orgll 0.1080/13571516.2015.1045741
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`Published online: 26Jun 2015.
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`Page 1 of 18
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`Int. J. of the Economics of Business, 2015
`Vol. 22, No. 2, 245-261, http://dx.doi.org/10.1080/13571516.2015.1045741 I~ Routledge
`l~4or&Fr~.dsC~up
`
`Pharmacy Benefit Management: Are Reporting
`Requirements Pro- or Anticompetitive?
`
`PATRICIA M. DANZON
`
`ABSTRACT The market-based US healthcare system relies on pharmacy benefit
`managers (PBMs) to control pharmaceutical costs, in contrast to most other countries
`that regulate drug prices and access. Optimal structuring and regulation of PBM
`contracts pose significant agency challenges for private and public payers. However,
`recent reporting requirements for PBMs may be counterproductive and reflect the
`interests of competitors rather than customers.
`
`Key Words: Pharmaceuticals; Pharmacy Benefit Management; Insurance;
`Transparency; Regulation.
`
`JEL classifications: D4; I13; I18; L8.
`
`1. Introduction
`
`Insurance coverage for drugs provides consumer protection but also reduces
`consumer demand elasticity. This creates both consumer moral hazard (use of
`low benefit care) and producer moral hazard (producers charge higher prices).
`US insurers/payers manage pharmacy benefits to restrain these effects, using
`formularies of covered drugs and patient cost-sharing, negotiating prices
`charged by drug manufacturers and pharmacies, and processing claims. Self-
`insured employers and many smaller health plans contract out these functions
`to specialized pharmacy benefit managers (PBMs), while some large health
`plans have developed in-house PBMs.
`In response to concerns of whether payers have the information necessary
`to contract efficiently for these services, recent legislation has increased data
`reporting requirements for PBMs. Reporting of cost data to the government
`was required for prescription drug plans (PDPs) that perform PBM functions
`for Medicare Part D, and the Affordable Care Act requires data reporting by
`PBMs serving health plans in insurance exchanges. Similar requirements have
`been proposed for data reporting to self-insured employers.
`Previous literature on PBM data reporting requirements has questioned the
`need for data reporting and recognized that in the context of oligopoly,
`
`Patricia M. Danzon, The Wharton School, University of Pennsylvania, 3641 Locust Walk, Philadelphia, PA
`19104, USA; e-mail: danzon@wharton.upenn.edu.
`
`© 2015 International Journal of the Economics of Business
`
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`246 P.M. Danzon
`
`transparency of competitor prices may facilitate collusion.1 This article
`contributes to this literature by reviewing empirical evidence on concentration
`in this industry, with the two largest PBMs accounting for 59% of industry
`revenues in 2013, and the limited extent of competitive entry over the last
`decade. It also reviews recent survey evidence of employer contracting with
`PBMs. Competitive dynamics in this industry are complex, because the
`independent PBMs are both suppliers to large health plans and sometimes
`competitors with their in-house PBMs. Similarly, because large PBMs operate
`mail-order pharmacies, they are both customers of retail pharmacies and
`competitors. Any mandates for data reporting should evaluate the demand
`from employer customers and also consider potential anticompetitive effects in
`the market for PBM services and pharmacy services.
`In this article, Section 2 outlines the basic business model of PBMs,
`including their roles as suppliers to health plans and competitors, and as both
`purchasers from retail pharmacies and competitors, through PBMs’ operation
`of mail-order pharmacies. Section 3 describes the industry structure and
`evidence on competitive entry. Section 4 discusses survey evidence from PBM
`customers. Section 5 evaluates proposals for data reporting and concludes.
`
`2. The PBM Business Model
`
`PBMs use a range of strategies to manage and administer pharmacy benefits
`on behalf of payers/sponsors.2 These strategies include management of drug
`utilization and negotiation of rebates on drug prices, by means of formularies
`with tiered patient cost-sharing and access controls; negotiation with retail
`pharmacies for discounts on drug prices and dispensing fees, in return for
`participation in the preferred pharmacy network; claims processing and
`reimbursement of retail pharmacy claims; and operation of mail-order
`pharmacy. The basic principle is that PBMs can drive discounts on drug prices
`and pharmacy fees by restricting patients’ choice of drugs or pharmacies,
`thereby increasing volume for preferred suppliers that accept the discounted
`prices. Thus, more restrictive drug formularies or pharmacy networks
`generally obtain larger discounts.
`
`2.1. Strategies
`
`2.1.1 Formulary Structure
`
`PBMs (sometimes in conjunction with a health plan’s Pharmacy and
`Therapeutics Committee) structure a formulary of covered drugs and
`associated patient cost-sharing. Most formularies now have three or four tiers.
`The lowest tier covers generics, with average co-pay of $11; the second tier
`includes preferred brands, with average co-pay of $30; the third tier includes
`nonpreferred and off-patent brands, with average co-pay of $56 (PBMI 2013).
`Many plans also have a fourth tier for expensive specialty drugs, often with a
`co-insurance of 20-30% of drug price. Utilization of nonpreferred and specialty
`drugs may be further managed through requirements that physicians obtain
`prior authorization and/or that patients first try less cosily alternatives ("step
`edits"). Large self-insured employers may structure their own formulary, but
`smaller self-insured employers usually choose one of several standard
`formularies offered by their PBM or health plan.
`
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`Pharmacy Benefit Management 247
`
`2.1.2 Negotiating Drug Rebates with Pharmaceutical Manufacturers
`
`Restrictive formulary structures enable PBMs to "shift market share" to
`preferred drugs with relatively low patient cost-sharing and possibly other
`access controls. PBMs may enhance share shifting by encouraging pharmacies
`to call the patient’s doctor to authorize switching to preferred drugs.3 PBMs’
`ability to shift share enables them to negotiate discounts/rebates off list prices
`from branded drug manufacturers, in return for preferred placement and
`increased market share for their drugs. PBMs’ ability to shift share and thereby
`negotiate rebates is greatest in therapeutic classes with several drugs of very
`similar efficacy, such that physicians and patients accept restrictions on their
`choice and are sensitive to modest cost-sharing differentials. Drug price rebates
`are typically paid by electronic transfer from the drug manufacturer to the
`PBM, on evidence of preferred formulary status and/or increased drug
`utilization. The pass-through of the drug rebates by PBMs to plan sponsors has
`been a contentious issue, but recent evidence suggests that most sponsors
`capture most of the rebates (see below).
`
`2.1.3 Contracting for Discounted Pharmacy Costs
`
`When pharmacies dispense drugs to patients, they add a mark-up to the ex-
`wholesaler price at which they purchased the drugs, to cover their inventory
`and other costs, and a dispensing fee for their time. An important source of
`PBMs’ cost savings for payers is the negotiation of discounts on pharmacy
`mark-ups and dispensing fees. Under pressure from retail pharmacy
`associations, many states have enacted Any Willing Provider laws that require
`PBMs to contract with any pharmacy willing to accept their fees.4 Theory and
`evidence suggest that such laws lead to higher costs to consumers, by limiting
`PBMs’ ability to contract selectively in return for discounted fees (Frc 2014).
`
`2.1.4 Processing Pharmacy Claims
`
`PBMs provide convenience for pharmacies and patients by providing IT
`services that enable pharmacies to verify at point-of-sale whether a drug is
`covered by the patient’s plan and their co-payment. The pharmacy then
`collects the co-pay from the patient and bills the PBM for the remaining drug
`cost and dispensing fee, at agreed rates.
`
`2.1.5 Mail-Order Pharmacy Dispensing
`
`All major PBMs operate their own mail-order pharmacies that dispense
`medications through the mail. PBMs offer patients lower cost-sharing on drugs
`dispensed through the mail, to encourage acceptance of mail dispensing.
`
`2.1.6 Other Functions
`
`In addition to these basic services, large PBMs offer a range of other services,
`including drug utilization review, compliance and therapy management, and
`specialty pharmacy services such as home infusion.
`
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`248 P.M. Danzon
`
`Figure 1 shows the flow of money and goods in pharmacy benefit
`management. Pharmaceutical manufacturers typically sell their drugs to
`wholesalers that distribute the drugs to pharmacies, including PBMs’ mail
`pharmacies. PBMs contract with and collect rebates from drug manufacturers,
`contract with and reimburse retail pharmacies, and dispense drugs through
`their mail pharmacies.
`
`2.2. How PBMs Make Money
`
`Although the survival and growth of PBMs suggests that on balance they offer
`net savings to plan sponsors on essential claims processing, management of
`drug utilization and prices and management of pharmacy dispensing costs,
`nevertheless concerns have been raised over how far PBMs pass through the
`savings realized and whether sponsors have the information needed for
`informed contracting. In particular, the following components of PBM
`revenues are at issue:
`
`2.2.1. Spreads on Retail Pharmacy-Dispensed Drugs. PBMs capture the spread
`between the prices at which they are reimbursed by sponsors and the prices
`they pay to pharmacies for dispensed drugs. These contractually agreed prices
`are typically expressed as a percentage of a widely available list price
`benchmark, most commonly average wholesale price (AWP). For example, the
`PBM may reimburse pharmacies for drugs at AWP minus 18% plus a $1
`dispensing fee. The PBM contracts for reimbursement from the sponsor at a
`somewhat smaller discount off AWP, say AWP minus 16% plus a $2
`administration fee per script. The difference between the sponsor’s payment to
`the PBM and the PBM’s payment to the pharmacy (the "retail spread") is a
`significant source of PBMs’ net revenue.
`These payment rates from PBMs to pharmacies and from pharmacies to
`wholesalers are complex and not generally known to plan sponsors.
`
`Figure 1. The flow of money and goods in pharmacy benefit management.
`
`Page 5 of 18
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`

`Pharmacy Benefit Management 249
`
`Manufacturers of on-patent brand drugs typically sell their drugs to
`wholesalers at the manufacturer’s list price or wholesale acquisition cost
`(WAC), net of any discounts for prompt payment and so on. Manufacturers
`also supply their list price(s) to third party database companies such as Medi-
`Span that calculate and publish the AWP. AWP is generally based on the
`standard formula (WAC + 20%), but if manufacturers also list a suggested
`wholesale price (SWP), Medi-Span sets AWP at the manufacturer’s SWP.s
`Thus, for on-patent brand drugs AWP is a list price that is usually higher than
`and roughly but not strictly proportional to the price the wholesaler actually
`paid. Wholesalers distribute drugs to pharmacies, adding their own margin,
`and retail pharmacies add their own mark-up to the drug price plus a
`dispensing fee. In a cash transaction to a self-pay patient, this marked-up retail
`price would be charged in full to the patient. PBMs reduce costs for sponsors
`by negotiating discounts on the pharmacies’ customary drug mark-ups and
`dispensing fees.
`
`2.2.2. Generics. Managing generics has been a major source of PBM savings for
`payers. Under most state substitution laws, pharmacies are authorized to
`substitute any bio-equivalent generic for the brand, even if the physician
`prescribes the brand, unless the physician explicitly notes "brand required."
`PBMs incentivize patients to accept generic substitution, by offering much
`lower cost-sharing on generics. PBMs also incentivize pharmacies to substitute
`low priced generics by reimbursing pharmacies for generics using a maximum
`allowable cost (MAC). The MAC is the same for all generic versions of a drug,
`and is based on the PBM’s estimate of generic acquisition cost to pharmacies.
`MAC reimbursement incentivizes pharmacies to use the lowest cost generic
`available as the pharmacy captures the spread between the MAC and its
`acquisition cost. MAC reimbursement thus also incentivizes generic suppliers
`to offer price discounts to pharmacies. Over time, PBMs revise down their
`MAC, based on actual pharmacy acquisition cost for generics, thereby
`capturing (some of) the savings from competitive discounting by generic
`manufacturers to pharmacies. Unlike AWP, which is a list price schedule set
`by third party database companies, each PBM sets its own MAC
`reimbursement prices for pharmacies (Eberle and Van Amber 2008). The
`majority of PBM contracts with plan sponsors (75%) bill for generics based on
`MAC pricing, and the remainder bill for generics using discounted AWP
`(PBMI 2013). PBMs earn a spread on generics dispensed through retail
`pharmacies, as they do on brand drugs. However, retail pharmacies retain
`significant discounts on generics.6
`
`2.2.3. Mail-Order Pharmacy Business. Mail dispensing substitutes the PBM’s
`own dispensing costs for those of retail pharmacies. Mail dispensing may also
`enhance a PBM’s ability to ensure patient adherence and formulary
`compliance, because the PBM can ensure that their in-house pharmacist calls
`physicians to switch patients to preferred drugs and contacts patients with
`reminders for prescription renewal. PBMs’ enhanced ability to influence
`
`Page 6 of 18
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`

`

`250 P.M. Danzon
`
`utilization through mail dispensing may enable them to capture larger rebates
`on branded drugs.
`The PBM’s mail-order pharmacy also captures the discounts from generic
`manufacturers that would normally accrue to the retail pharmacy. Discounts
`on generics have become an increasingly important source of revenue for both
`PBMs and retail pharmacies, as the generic share of prescriptions has grown to
`>80% in the USA (Zirkelbach 2014). PBMs typically incentivize enrollees to use
`mail dispensing by offering a 90-day mail co-pay that is only roughly two
`times rather than three times the 30-day retail co-pay (PBMI 2013).
`Unsurprisingly, mail dispensing has been strongly opposed by retail
`pharmacies, leading to pressure for restrictive legislation in some states.
`
`2.2.4. Manufacturer Rebates. Sponsor-PBM contracts usually specify the
`percentage of brand manufacturer rebates to be passed through to the sponsor.
`Although competition among PBMs should in theory assure rebate pass-
`through to plan sponsors, in practice this is a contentious issue because the
`magnitude of rebates is confidential, which is arguably necessary to encourage
`discounting by manufacturers and effort by PBMs. The amounts involved are
`unobservable because rebates are transmitted electronically to PBMs, which
`book their share as a reduction to the cost of revenues.7
`The available evidence suggests that rebates have declined absolutely and
`as a share of PBMs’ profits. In 2003, Medco retained $1.59 billion in rebates
`(>50% of total rebates) on $1.52 billion of gross profit, whereas in 2011, Medco
`retained only $757 million in rebates (12.1% of total rebates) on $4.62 billion of
`gross profit? This decline in retained rebates reflects several factors. First, the
`opportunity to capture brand rebates has declined following the patent
`expiries and generic erosion of many blockbuster brand drugs. In 2004,
`generics accounted for 57% of prescriptions in the USA; by 2013, the generic
`share of prescriptions was 86% (IMS Health 2014). Second, an increasing share
`of drug expenditures is for specialty drugs, which are typically differentiated.
`Strong doctor/patient preferences between differentiated drugs undermine
`PBMs’ ability to shift share and negotiate rebates for specialty drugs. Third, in
`2006, the establishment of Medicare Part D coverage of outpatient drugs for
`seniors included requirements for transparency and pass-through of
`manufacturer rebates.~ A 2011 study found that on average, PBMs
`administering Part D plans retained <1% of negotiated rebates (Department of
`Health and Human Services, Office of Inspector General 2011). These practices
`on Part D programs may have spilled over to private plans. Fourth, the threat
`of litigation may have reduced PBMs’ capture of rebates)°
`Recent survey evidence (PBMI 2013) shows that contracts with plan
`sponsors include a variety of different mechanisms for rebate pass-through,
`which complicates comparison across plans. In 2013, only 6% of large
`employers reported capturing no rebates, compared to 25% of small
`employers. However, conclusions from such evidence are tentative because
`contracts with greater PBM rebate retention may have offsetting decreases in
`other types of PBM compensation. That retained rebates are less important to
`overall PBM profitability is underscored in Medco’s FY2004 SEC 10-K filing,
`which states, "the impact on profitability from the increase in generic
`utilization, particularly in mail order, more than offsets the impact from lower
`
`Page 7 of 18
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`

`Pharmacy Benefit Management 251
`
`rebate retention on brand name prescriptions." Similarly, Express Scripts’
`investor presentations state that while rebates drove earnings growth in the
`1990s, increases in generic utilization accounted for the majority of earnings
`growth in the 2000s (Express Scripts 2014).
`
`3. PBM Market Structure and Competition
`
`Employer plan sponsors have three options for managing pharmacy benefits.
`First, the sponsor may "carve in" these functions to the health plan that
`administers the sponsor’s medical benefit, which would typically either
`operate its own in-house PBMs or contract with an independent PBM. Second,
`the sponsor may "carve out" the pharmacy management directly to an
`independent PBM. Third, very large employers may conduct some of the core
`formulary-related PBM services in-house, outsourcing to a PBM only the
`claims processing that requires specialized IT (Bisping 2010). In practice, 66%
`of small employers contract for their PBM through a health plan administrator,
`and only 30% contract with a PBM directly, whereas 30% of large employers
`contract through a health plan, and 65% contract directly with a PBM (PBMI
`2013). The efficient performance of the PBM industry for plan sponsors relies
`on competition. As one indicator of competition, this section provides evidence
`on industry structure and entry.
`
`3.1. PBM Market Shares
`
`Defining PBM market shares is problematic because some PBMs outsource
`claims processing to other PBMs, which leads to significant duplication in
`shares measured as covered lives or total claims processed. Market shares
`based on 2013 PBM total revenue are shown in Table 1 (Lofberg 2012).
`Market shares based on claims processed are shown in Table 2 (Atlantic
`Information Services (AIS); Casey 2013). This measure shows a larger role of
`companies such as Argus Health Systems that process claims for other PBMs
`and plan sponsors, but capture a small share of total revenue.11
`The large PBMs also play a major role as PDPs that administer the
`Medicare Part D program. Table 3 shows the top eight PDP sponsors by total
`PDP lives.12
`
`Table 1. PBM market shares, by 2013 revenue
`
`PBM
`
`Express Scripts
`CVS Caremark
`OptumRx (United)
`Prime Therapeutics (BC)
`Catamaran
`Humana
`MedImpact
`Cigna
`
`Market share by 2013 PBM revenue
`
`34%
`26%
`12%
`5%
`5%
`5%
`3%
`3%
`
`Note: Shares do not sum to 100 due to All Other residual.
`Source: http://media.corpomte-ir.net/mediafileslirol/99199533/dec2012/CVS_Caremark 2012 Analyst
`Day-Per Lofberg Ih’esentation.t:,df
`
`Page 8 of 18
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`

`

`252 P.M. Danzon
`
`Table 2.
`
`PBM market shares, by claims processed
`
`PBM
`
`Express Scripts
`CVS Caremark
`OptumRx (United)
`Argus Health Systems
`Catamaran
`
`Expected market share by 2014 claims processed
`
`27%
`19%
`12%
`11%
`10%
`
`Source: Atlantic Information Systems (AIS); Casey (2013).
`
`Table 3.
`
`PDP market shares, by PDP lives
`
`Part D plan parent
`
`UnitedHealth Group
`Humana
`CVS Caremark
`Express Scripts
`Aetna
`CIGNA
`WellCare Health Plans
`WellPoint
`
`Market share
`
`21.8%
`16.4%
`11.4%
`7.3%
`6.3%
`4.6%
`4.4%
`2.9%
`
`Source: htt~s://kaiserfamflyf~undati~n.files.w~rdpress~c~m/2~14/~8/8621-exhibit-1-6.~ng~ based
`on Georgetown/NORC analysis of C_MS Enrollment files, 2006-2014. Includes PDP and MA-PD
`plans.
`
`Based on annual revenue shares (Table 1), the two and four largest
`independent PBMs account for almost 60% and 76% of the market,
`respectively. Concentration has increased over the last decade through mergers
`and acquisitions. Express Scripts acquired Wellpoint’s wholly owned NextRx
`PBM in 2009 (Wellpoint 2009) and then merged with Medco in 2012 (Express
`Scripts 2012). CVS and its PBM, PharmaCare, merged with Caremark Rx in
`2006 (CVS Caremark 2007) to become CVS Caremark and later acquired Longs
`Drug Stores’ PBM, RxAmerica, in 2008 (CVS Caremark 2008). Catamaran was
`created by SXC Health Solution’s 2012 acquisition of Catalyst (Catalyst Health
`Solutions 2012), which had previously purchased Walgreens Health Initiatives
`in 2011 (Catalyst Health Solutions 2011). Catamaran was acquired by United in
`May 2015.
`Several large health plans have attempted to develop their own PBMs to
`compete with the large independent PBMs. OptumRx is wholly owned by
`United Healthcare and primarily provides PBM services to United’s clients.
`Prime Therapeutics is co-owned by 13 nonprofit Blue Cross Blue Shield
`Licensees and serves primarily these health plans. Large health insurers
`Humana, Cigna, and Aetna all operate their own captive PBMs, but outsource
`some services to third party PBMs. Catamaran has grown quickly since the
`2012 SXC/Catalyst merger. This evidence indicates significant consolidation
`over time in the PBM industry. Competitive entry by full service PBMs has
`been limited and has occurred mainly through large health plans insourcing
`their own pharmacy management. Some of these health plan-owned PBMs
`
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`Pharmacy Benefit Management 253
`
`continue to rely partly on external PBMs for claims processing; for example,
`Wellpoint sold its in-house PBM to Express Scripts and Humana and Cigna
`contract with external claims processors. This evidence suggests that scale
`economies are significant, particularly in claims processing, which may
`preclude entry by new operators other than related health plan businesses
`with existing large-scale operations.
`The limited public evidence on contracting strategies also sheds light on
`competitive dynamics in this industry. Catamaran has grown by offering fixed
`fee per transaction pricing with clarity on rebates and other fees.13 MedImpact
`offers clients full disclosure on rebate administration.14 Large employer
`members of the HR Policy Association have negotiated an exclusive agreement
`with Prime Therapeutics, including dear pass through pricing with no
`undisclosed PBM mark-ups, 100% pass through of pharmaceutical rebates, and
`the option for additional savings through narrowing the pharmacy network.~5
`However, as Morningstar points out, "Express Scripts’ operating income
`accounts for well less than 1% of its clients’ overall health-care costs. If Express
`Scripts can lower its clients’ health-care costs by even a few percentage points
`more than the competition, it will justify the company’s margins and facilitate
`market share gains" (Morningstar 2012). This underscores the agency challenge
`facing sponsors: focusing solely on driving down a PBM’s operating income
`could be counterproductive, if this leads the PBM to skimp on efforts to
`constrain drug costs.
`
`4. Survey Evidence on Employer Contracting with PBMs
`
`Employers seeking to contract for PBM services may request proposals from
`several PBMs, possibly using a third party benefits consultant. A basic PBM
`proposal typically includes, among other terms: any per claim fees, for
`example for claim processing, dispensing, prior authorization, and so on; the
`reimbursement rate to be paid to the PBM for brand and generic drugs, at
`retail and mail order, usually expressed as a % of AWP for brands and % of
`MAC for generics; and the share of drug rebates to be passed through to the
`employer.
`The PBMI (2013) study provides survey evidence on the PBM contracting
`experience of large (>5,000 employees) and small firms (-<5,000 employees).
`This study surveyed a broad sample of employers, including most size classes,
`geographies, and industries. However, it was not a random sample of
`employers, and not all employers responded to all questions, so findings may
`not be generalizable. Nevertheless, this survey provides the best available
`evidence on employer contracting with PBMs.
`Consider first the PBM charges for drugs dispensed through their own mail
`order versus retail pharmacies. The average reimbursement level is AWP
`minus 16% for branded 30-day retail drugs and AWP minus 22% for branded
`mail-order drugs. The median dispensing fee for 30-day retail prescriptions is
`$1.50 and $0 for mail-order prescriptions. These data indicate that PBMs
`typically pass on some savings from mail dispensing, and incentivize sponsors
`and patients to use mail service. MAC pricing for generics is used by 75% of
`employers for 30-day retail prescriptions and 70% of employers for mail-order
`prescriptions. In other cases, the average reimbursement level for generics is
`
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`

`254 P.M. Danzon
`
`AWP minus 65% for 30-day retail and AWP minus 61% for mail order, but
`this differential is not statistically significant. The evidence confirms that the
`majority of employers receive a share of manufacturer drug rebates through
`various mechanisms, including a specified percentage of actual rebates, a
`guaranteed flat minimum level of rebates per prescription or per rebateable
`drug (preferred tier brands). Different ways of calculating rebates complicate
`comparison across contracts. The mean and median employer shares of drug
`rebates were 60% and 80% for retail dispensed drugs, for employers with a
`rebate share arrangement that responded to this question (PBMI 2013).
`The PBMI study also highlights some differences in negotiated pricing
`between large and small employers. Large employers received higher retail
`discounts on branded and generic drugs, paid lower dispensing fees, and were
`more likely to receive manufacturer rebates than were smaller employers. All
`of these differences were found to be statistically significant. There were no
`significant differences by employer size for mail or specialty discounts.
`PBM spreads are not transparent to sponsors, because most PBMs do not
`disclose either the price that they pay to retail pharmacies or drug acquisition
`costs for their mail operations. However, given the common use of AWP
`minus x% pricing for reimbursement by the sponsor to the PBM for branded
`drugs, this enables sponsors to compare their costs for branded drugs
`meaningfully across PBM proposals. Although comparison of generic prices
`across proposals is less precise because PBMs’ MAC prices may differ, in
`practice these differences are unlikely to be systematically materially large,
`given that these MAC prices must be sufficient to attract pharmacies to
`participate in the PBM’s network.
`PBMs also sometimes take risk by guaranteeing a certain level of savings
`on drug costs compared to the sponsor’s expenditures in the previous year.
`However, the frequency of such arrangements is unclear.16 It is also unclear
`whether such arrangements would benefit sponsors, if spending less on
`pharmaceuticals increases other medical costs or reduces benefits to
`consumers.
`
`4.1. Allegations of Conflict of Interest
`
`Various sources of conflict of interest have been alleged against PBMs. First,
`allegations related to PBM ownership of mail pharmacies and self-dealing
`prompted the Frc to obtain proprietary data on PBM contracts and claims
`paid from 2002-2003. The Frc concluded, "These data provide strong
`evidence that ... PBMs’ ownership of mail-order pharmacies generally did not
`disadvantage plan sponsors ... these allegations [of self-dealing arrangements]
`are without merit" (Frc 2005). The evidence above suggests that PBMs do
`typically share with plan sponsors the savings realized on mail dispensing.
`Second, retention of rebates by PBMs has led to the allegation that a PBM
`has incentives to encourage members to take a drug with a higher net cost to
`the plan sponsor if the PBM receives a larger rebate than on a drug with lower
`net cost to the plan sponsor. For example, litigation in 2004 accused Medco of
`switching patients from lower cost drugs to similar drugs that cost the sponsor
`more but paid higher rebates. The resulting out-of-court settlements with the
`Department of Justice and state Attorneys General deemed it illegal for a PBM
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`to incentivize a patient to switch to a drug with higher net cost to the plan
`sponsor (Freudenheim 2004). However, the decline in opportunity for brand
`rebates and the growth in generics availability have resulted in better
`alignment between the PBMs’ incentives and those of sponsors, to encourage
`generic substitution whenever possible. The pass-through of generic discounts
`has so far not emerged as a major issue. On a related point, Abrams (2007)
`argues that PBMs keep retail pharmacy reimbursements for generic drugs
`artificially high in order to protect margins in their mail-order business. In
`theory, competition on other contract terms could enforce a competitive pass-
`through of generic discounts while preserving the PBM’s incentives for effort
`in squeezing retail pharmacy margins and obtaining generic discounts for their
`mail-order pharmacy. In practice, the limited evidence provides little support
`for the allegation. Frc (2005) found that employers pay lower prices on mail
`order and, overall, rejected the allegation that PBMs’ ownership of mail-order
`pharmacy harms their customers.
`Third, the fact that the PBM’s retail spread is usually a fixed percentage of
`the drug’s list price in theory implies that PBMs have little incentive to control
`the rate of increase in drug prices or to prefer drugs with lower list prices.
`This potentially perverse incentive may be mitigated if competition is effective
`in forcing PBMs to compete on their ability to control drug spending and its
`growth for sponsors. However, this presupposes that sponsors are able to
`evaluate the effectiveness of PBMs at managing drug expenditures while
`preserving cost-effective levels of access and health outcomes. In fact, PBMs do
`not generally take financial risk for the rate of growth of total drug spending,
`which would eliminate this potential conflict of interest, possibly because such
`risk sharing could also lead to excessive controls on patient access.17 More
`generally, in any PBM carve-out situation, the health plan or sponsor foregoes
`the ability to coordinate pharmacy and other healthcare cost management
`optimally. Obtaining transparency on PBM costs and margins alone would be
`a blunt and ineffective tool to achieve optimal cost-quality coordination across
`pharmacy and other services.
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`5. PBM Reporting Requirements: Pro- or Anticompetitive?
`
`The Affordable Care Act (ACA) requires specific disclosures by PBMs
`participating in qualified health plans in federal or st