Politicians and the media often highlight the list prices of individual medicines. They would probably be surprised to learn that two-fifths of that price goes to non-manufacturer middlemen, and not to the companies that research, develop, and manufacture those prescription drugs..
It’s a ferociously complicated system that cries out for more efficiency and transparency. A study by the Berkeley Research Group earlier this year summed it up:
Within the U.S. healthcare system, the flow of dollars in the pharmaceutical marketplace is a complex process involving a variety of stakeholders and myriad rebates, discounts, and fees—some of which are paid after a prescription drug is dispensed to the patient. Commonly reported figures for pharmaceutical spending fail to capture these retrospective rebates and discounts, which lower final net spending for payers and the healthcare system. Pharmaceutical spending estimates that omit rebates and discounts do not fully reflect the underlying competitive dynamics of the pharmaceutical sector and provide a misleading impression of drug spending.
The study concluded that brand drug manufacturers – that is, the companies that pour billions into research to create new medicines -- realize only 39% of “initial gross drug expenditures” – which are typically the “list” prices you hear about in the media.
“Of the remainder,” says the study, 42%is realized by non-manufacturer entities, including amounts realized by participants in the supply chain (22%) and transferred by manufacturers to other stakeholders through retrospective rebates, discounts, and fees (20%).” The rest goes to generic manufacturers.
How the Supply Chain Works
To understand who gets the 42% share – and why – you must understand how the drug supply chain works.
Patients and insurers, of course, are the end purchasers of drugs, but they don’t buy straight from the manufacturer. Instead, wholesalers purchase drugs from manufacturers and in turn sell them to pharmacies or other health-care providers, which dispense them to patients.
But the key players in the chain are pharmaceutical benefit managers (PBMs), which work for health insurers and employer groups. PBMs never take physical possession of the drugs. Instead, as the Berkeley study says, “they aggregate the buying power” of their clients “by negotiating discounted purchase prices with retail pharmacies, purchasing drugs at discounted prices for delivery by mail, and separately securing rebates on brand pharmaceuticals from manufacturers.”
We pointed out in our last newsletter that, in the Medicare system, for instance, these PBMs have more market power than the federal government could ever have.
What about these rebates, though? Adding complexity to the system, PBMs negotiate payments from manufacturers as a reward for choosing those manufacturers’ drugs for their formularies – or set of drugs available to patients in specific health plans. Given PBMs’ negotiating power, sometimes more expensive drugs can offer the PBM greater rebate potential.
Gottlieb: A ‘Byzantine’ Model for Selling Drugs
The role of PBMs was highlighted last year during the controversy over the rising price of EpiPen, the lifesaving drug administered by injection. Heather Bresch, CEO of the manufacturer, Mylan, pointed the finger at “middlemen from wholesalers to insurance to PBMs [who] are all playing a part” in driving up drug prices.
In an article in Forbes last September, Scott Gottlieb, a physician and scholar at the American Enterprise Institute who was confirmed Tuesday as FDA Commissioner, wrote:
To fund these rebates, drug makers push up the list price of their pills, only to furtively pay much of the money back to pharmacy benefit managers later. This byzantine model for selling drugs aids both parties–the drug makers who use the rebates to buy access on restrictive drug formularies, and the pharmacy benefit managers that take a cut from these rebates to improve their profit margins.
The model does not, however, benefit consumers, policy makers, or anyone else who seeks efficiency and transparency. Gottlieb points out that the rebate system is the result of a 21-year-old court decision involving 15 drug companies. Gottlieb’s article explains exactly how the decision created the system, so we won’t go into it here. But it’s almost certain that Congress would have to make the fix.
Unit Price Increases of Only 2.5% in 2016
PBMs can perform an important service in negotiating prices. For example, last year, Express Scripts, the largest of the PBMs with 83 million members, used its market clout to hold overall drug spending increases to 3.8% and unit-price increases to only 2.5%. Other PBMs registered similarly small increases. For CVS Caremark, unit prices rose, on average, just 1.2%. For Prime Therapeutics, another large PBM, they rose only 0.6%. In fact, at Express Scripts, unit costs for traditional drugs declined.
In addition, the latest report from the Center for Sustainable Health Spendingfound that in February 2017, prescription drug spending increased, over the same period a year earlier, at a rate slower than that of any other major health-care category, including hospitals, physicians and clinical services, home health, and nursing care. The rise in drug spending was just one-tenth of a point greater than the rise in GDP over the 12 months.
In their zeal to lower prices, however, PBMs, working with health insurers, have been behind many of the attacks on drug companies.
An Inaccurate TV Commercial
A recent example is a television commercial being aired by a coalition called the Campaign for Sustainable Rx Pricing (CSRxP). The coalition includes the Pharmaceutical Care Management Association, the PBM trade group; CVS Health, the second-largest PBM; Prime Therapeutics, a PBM owned by the Blue Cross system; as well as insurers, hospital associations, and other health-care groups.
The TV ad turns on one statistic, which is reported inaccurately. With so many experts involved, the ad’s misleading nature could easily have been detected before it was aired.
The ad is a mock commercial for a new medicine. It claims that “drug companies raise prices to pay for commercials like this one.” It also says, “Nine out of the ten biggest pharma companies spend more on advertising than research and development.”
In tiny type on the bottom of the screen is a reference to a Washington Post article of Feb. 11, 2015. That article shows a graphic that is based on GlobalData research. But the graphic refers, not to “advertising,” but to “sales & marketing,” a category that includes, among other activities, clinical trials, face-to-face sales, educational meetings, and free medications for physicians.
In fact, direct-to-consumer advertising, of the type to which the commercial and website clearly refer, last year totaled only $5.6 billion, according to Nielsen data readily available to CSRxP or anyone else who cares to look. Overall, according to many sources, drug companies spent $59 billion on research and development in 2015, the latest year for statistics. In other words, these companies spent more than 10 times as much on R&D as they did on advertising.
Several individual drug companies – by themselves – spent more on R&D than the entire drug industry spent on advertising.
In fact, according to the National Science Foundation, pharmaceutical companies have a higher R&D intensity (that is proportion of total revenues devoted to R&D) than any other manufacturing industry – far higher, for example, than industries such as computers/electronics and aerospace products/parts.
Again, according to the NSF, the drug industry has 122,000 employees in the U.S. working on R&D; that is the third-highest figure in the nation, behind only computer/electronics and software publishers.
The animosity toward PBMs is increasing, and it comes from both left and right. Here, for instance, is an article by David Dayen in the spring issue of The American Prospect, a liberal publicatiion:
Over the past 30 years, PBMs have evolved from paper-pushers to significant controllers of the drug pricing system, a black box understood by almost no one. Lack of transparency, unjustifiable fees, and massive market consolidations have made PBMs the most profitable corporations you’ve never heard about.
It would be a mistake, however, for regulators and legislators to try to remove or severely hobble PBMs. The likely replacement – government – would be worse. As Gottlieb has written, “PBMs add a lot of efficiency to the way drugs are sold.” But they subtract a lot of efficiency as well. PBMs must act more responsibly within the drug payment system and help reduce the opacity and perverse incentives.
In a Forbes piece, Wayne Weingarden of the Pacific Research Institute (PRI), a center-right think tank, writes, “PBMs are incentivizing higher list prices for medicines that enable them to create large rebates and discounts.” In other words, PBMs make more money when list prices are higher (since they get a percentage of the list price), creating what Weingarden calls “higher patient co-pays than necessary because co-pays typically depend on list prices, not the final transaction prices.”
PRI on Monday released a report by Weingarden titled, “The Economic Costs of Pharmaceutical Benefit Managers: A Review of the Literature.” One of the conclusions is: “Through control of the drug formularies, [PBMs] impose undue influence on the medicines patients can access.” Daven makes this point as well: “There are indications that PBMs place drugs on their formularies based on how high a rebate they obtain, rather than the lowest cost or what is most effective for the patient.”
Do we really want a PBM, rather than a doctor, dictating the right drug for a patient?
Sometimes Drugs Cost More With Insurance
Consider this story that appeared on the local CBS affiliate in Boston. Amy Frostland, a waitress in Rockland, Mass., is insured by a health plan through her husband’s employer. She discovered that she has to pay more for certain drugs if she uses her insurance than if she pays on her own out-of-pocket.
“If I run my insurance,” she said in an interview on a TV news program, it’s going to cost me $90 for a three-month supply. If I do it without insurance, it is $10 for a three-month supply.”
The report quotes Todd Brown of the Massachusetts Association of Independent Pharmacists: “It’s a huge problem.” According to the report: “Brown says much of the blame lies with pharmacy benefit managers, or PMBs. They act as middlemen between insurance companies and pharmacists to process your prescriptions.”
But why can’t the pharmacist simply tell the patient at the cash register that she will be overpaying if she uses her insurance? Because contract language between pharmacies and PBMs often outlaws that disclosure.
Brown is quoted in the report as saying, “Pharmacies are prohibited from talking to patients about how much a patient would pay if they just pay cash and didn’t go through their insurance.” The report continued:
The I-Team reached out to an industry group, a spokesperson for the Pharmaceutical Care Management Association. They say, ‘Patients should not have to pay more than a network drugstore’s submitted charges to the health plan.’ But when we asked them to clarify, the spokesperson never responded.
Lawsuits against PBMs are now shining a light on such practices. The CBS report used an example from one of the suits: “An insurance plan requires a $20 co-payment on all prescription drugs. But the price owed to the pharmacy for the medicine is only $1.75. The suit alleges the PBM pockets the change of $18.25, which is called a ‘clawback.’”
These clawbacks generally involve relatively inexpensive, rather than specialty, medicines. Examples are the antibiotic Azithromycin, the blood pressure medication Lisinopril and cholesterol drugs like Atrovastatin.
There’s a simple remedy: State governments should prohibit gag rules in PBM contracts. Pharmacists should be free to exercise their First Amendment rights and tell patients that it would be cheaper to buy the medicines.
Less Coverage for Medicines than for Hospitals
But the deeper question is this: Why do Americans have to pay so much for drugs when they are covered by insurance plans? This is not merely a tactical consumer issue but a strategic policy issue.
According to CDC data, patients pay only 3% of the cost of a hospital stay out of their own pockets, but they pay 15% of the cost of medicines out-of-pocket. This design creates the wrong incentives for a strong health-care system. Taking medicines keeps patients out of the hospital, where they incur extremely high costs. The average cost of a three-day hospital stay, according to the U.S. Government, is $30,000.
As co-pays and deductibles have risen, Americans end up digging deeper and deeper into their own pockets for the most common antidote to illness: medicines. No wonder, politicians, the media, and average families see drugs as expensive.
The truth is that prescription drugs represent only one-eighth of total U.S. health-care spending while hospitals represent one-third and physicians and other medical personnel represent one-fifth.
It’s time to rationalize our health care system and bring down costs. But reform requires understanding its complex, confusing nature. And a good place to begin is PBMs.
Online newsletter dedicated to helping you understand the costs and benefits that sometimes lie obscured in our complicated health care system