What are PBMs?

Most health plan sponsors – employers, HMOs, insurance carriers and others – provide a prescription benefit as part of overall health insurance coverage. Because of the increasing size and complexity of pharmacy benefits, many plan sponsors contract with companies known as Pharmacy Benefit Managers (PBMs) to administer the process for them.

PBMs are third-party administrators of prescription drug benefits. They handle such administrative tasks as collecting funds from health plan sponsors and using those funds to pay providers, processing claims; answering questions posed by pharmacists, doctors and health plan participants; and negotiating with drug companies. They operate mail-order pharmacies which they force an increasing number of plan participants to use. PBMs have become a dominant, rapidly growing force in the pharmacy industry.

Three PBMs control over half of America’s prescription drug transactions: Medco Health, Express Scripts and Caremark. They have become a lightning rod for controversy because of business practices described below.

Moreover, while PBMs represent themselves as prudent managers of drug benefits, prescription drug benefit costs to health plans are doubling every five years. At the same time, the major PBMs enjoy robust profits.

How PBMs began

Pharmacy Benefit Managers were formed in the 1960s when prescription drug benefits became available to employees, retirees and their dependents. The first significant medication benefit began in 1970 under a collective bargaining agreement between the United Auto Workers and vehicle manufacturers. At the outset, PBMs were simply pharmacy third-party administrators, manually processing paper claims for a per-claim fee.

How the industry has evolved

PBMs have evolved into a potent industry that has changed the face of pharmacy and made the large PBMs extremely profitable. For example:

• PBMs now manage about 75 percent of all private-pay prescription claims.

• Claims processing is fully automated. Pharmacies submit claims directly from in-store computers and they are processed online by the PBMs, typically in less than five seconds.

In most cases, the pharmacy receives payment from the PBM about a month after the prescription is filled.

• While there are more than 100 PBMs, three dominate the industry and manage more than half of all retail prescriptions.

• The growth of PBMs has had a profound effect on the economics of retail pharmacy. PBMs have used their marketplace dominance to ratchet down reimbursements – at the expense of drug retailers.

• All of the large PBMs are huge, publicly traded firms. Their performance has delighted investors and the financial community. There has been considerable consolidation.

How PBM services have evolved

While PBMs continue to function as fiduciaries and claims processors for some plan sponsors, they perform a wide array of expanded services. These include:

Clinical services, such as Drug Utilization Review
Clinical services involve controls on adverse drug reactions, fraud and abuse controls, limits on the amount of drug that can be dispensed at one time. Critics say these services encroach on the practice of pharmacy, and a number of states have considered regulating PBMs through their Boards of Pharmacy.

Formulary and rebate management
Simply put, a formulary is a list of drugs that are covered under the benefit provided by the plan sponsor. PBMs negotiate with drug manufacturers to include or exclude their products from such a list. Manufacturers pay rebates to the PBM for the privilege of including their drugs. Typically, rebates are based on helping a drug company reach a particular share of the market for a given therapeutic class, or for an above-average usage rate by patients whose benefits are administered by the PBM. PBMs share some – but not all – of these rebates with plan sponsors, who generally are not aware of the full incentive amounts.

Mail order pharmacy
PBMs learned that by operating mail order pharmacies, they could become both managers and providers. This lets them skew benefit design and pricing in ways that maximize their own profits.

All large PBMs own and run mail-order pharmacies, which have become vital profit centers that account for about 17 percent of all retail prescription sales in the United States. PBMs have convinced their customers that mail order pharmacies can achieve significant savings through automation and bulk purchasing. In fact, community pharmacies are just as automated, and the major chains buy far more than the PBM-owned mail-order facilities do.

The growth of the PBM mail-order business is remarkable considering they can fill only prescriptions for what are called “maintenance” drugs taken for chronic conditions. Because there is typically a two-week turnaround between order submission and receipt of shipment, prescriptions for antibiotics and other acute care drugs can be filled only by community pharmacies.

By being both manager and provider, PBMs find ways to promote themselves and maximize profits. Typically, they design the payment system so that plan sponsors often pay higher unit drug costs by mail than from the community pharmacies.

Mail-order pharmacies are regulated by almost all states. While they cannot legally be based in Michigan, interstate commerce laws leave the state powerless to stop mail-order pharmacies located elsewhere from shipping drugs into the state.

Why PBM business practices increasingly are being scrutinized

As publicly owned firms, PBMs focus on increasing shareholder value. This has encouraged them to develop a number of tactics that, while legal, serve to increase their profits at the expense of health plan sponsors, recipients and providers. In times of skyrocketing healthcare costs, such practices are viewed with increasing suspicion. These practices include:

• Paying pharmacy providers at a lower price than the PBM charges health plans. When this happens, the PBM pockets the difference.

• Selling detailed claims data on prescribing and dispensing history. Drug companies often use these data to target sales efforts to prescribers.

• Soft-money or rebate arrangements under which drug makers provide economic rewards that PBMs do not share with plan sponsors as part of the rebate split. A January 2004 report in the American Journal of Health-System Pharmacy says some health plan sponsors have received just 4 percent in the form of a manufacturer rebate through their PBM, although the drug firm actually paid 15 percent to 20 percent in rebates.

• Formulary and rebate arrangements that are skewed by the PBM to favor more expensive products, simply to provide higher rebates to the PBM. The most glaring example is an arrangement under which Medco is contractually obligated to favor Merck products. Merck owned the PBM for many years and this commitment became public during a spin-off of Medco, now a separate firm.

• Gaining a federal drug-repacker license, which lets a PBM buy bulk packages from manufacturers at a discount. The PBM repacks medicine into smaller containers for its mail-order affiliate at artificially elevated “wholesale” prices, according to a January 2004 report in the American Journal of Health-System Pharmacy by four professors at Creighton University Medical Center in Omaha, Neb. A repacker’s license brings “extra revenue for the PBM of which the payer is unaware,” wrote the scholars, citing a 2002 article in Business Insurance magazine.

• Profiting from a “spread” between what a PBM pays a participating pharmacy network to fill short-term prescriptions and what the PBM bills an employer, HMO or government agency that is its client. The following example of that type of price gap comes from a 2003 report by the California Health Care Foundation, based in Oakland, Calif.

“There is potential for conflicts of interest,” according to Dr. Robert I. Garis of Creighton and his journal paper co-authors. “For instance, such a conflict arises when a PBM faces the decision of either maximizing its rebate from the drug manufacturer (thus maximizing cash flow to itself) or selecting the best formulary value for its client.”

Some PBM practices not only are ethically questionable, but may be illegal. As a result, they have been subject to class-action and whistle-blower lawsuits. Medco, the giant of PBMs, is the target of a massive suit by the U.S. Justice Department.

There is a push to require PBMs to become more transparent in their business practices. Purchasing coalitions have been formed for this purpose and several states now mandate more open business practices. Eight southern states have organized a coalition that may form its own PBM.

The Nebraska professors conclude their journal report with a recommendation that employers and other benefit plan sponsors “insist on full disclosure of cash flows to and through the PBM that is administering their drug benefit. Without this level of scrutiny, the plan sponsor cannot be sure if its PBM is providing a good service for a fair price or is acting primarily in its own interest.”


Pharmacy benefit costs continue to escalate in spite of PBM control efforts. At the same time, PBM profits continue to rise. It is time to require PBMs to deal openly and honestly with their constituencies.

Critics say rebate contracts are responsible for 10 percent of the $122 billion Americans spend on prescription drugs annually, according to a 2002 U.S. News and World Report article headlined “When Is a Rebate a Kickback?”

Failure to mandate open disclosure of side deals by PBMs will perpetuate prescription cost inflation and may make medicines unavailable to fixed-income or low-income patients who need them most. Moreover, pressures to force recipients to use PBMs’ mail order pharmacies are sure to reduce the availability of local pharmacy service.

The Coalition for Quality Healthcare is a not-for-profit 501(c)6 organization that seeks to protect the right of patients to fill prescriptions wherever they wish. It strongly supports efforts to reduce healthcare costs for employers and patients.


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