Understanding drug costs and the role of PBMs

By Kai Wang, M.D.

History of pharmacy benefit managers (PBMs)

In 1968, the Pharmaceutical Card System (PCS) was created to help health insurance companies process prescription drug claims. Initially, prescription drug claims were adjudicated by paper and then electronically in the 1980s. The passage of the Medicare Modernization Act in 2003 allowed Medicare to pay for prescription drugs via Medicare Part D programs. PBMs were tasked with implementing this new federal program by identifying eligible patients, overseeing drug benefit administration, and establishing drug prices. Three PBMs – CVS Caremark, Express Scripts, and Optimum Rx – now control more than 85 percent of the market.

Why do we need formularies?

A formulary is the list of generic and brand medications that are approved to be prescribed at a specific hospital or health care system or that is covered under a particular health insurance policy. Formularies are usually divided into three tiers. Generic drugs are usually tier 1, frequently requiring the lowest copayment. Tier 2 drugs are a plan’s “preferred brands,” usually still under patent and requiring a higher copayment. Tier 3 drugs are “non-preferred brands” that require the highest copayment. As of 2010, the average out-of-pocket costs were $11 for tier 1 drugs, $28 for tier 2 drugs, and $49 for tier 3 drugs. For drugs that aren’t on a formulary, insurers generally do not offer any reimbursement coverage without prior authorization.

Patients are often unable or unwilling to pay the full cost of non-formulary medications, and they usually accept whatever drug physicians or pharmacists offer as therapeutic alternatives. Therefore, drug manufacturers offer various incentives to PBMs during the negotiation process to have their drugs included on a formulary. For drugs that are on a formulary, insurers often require “step therapy” – which means that a cheaper/standard version of the drug must be used before a more expensive version of the drug will be covered. Today, formularies are used as a tool for health care organizations to achieve optimal cost containment.

The traditional approach of cost containment involves transferring health care costs from the plan sponsor to the plan member with deductibles and coinsurances. Over time, the cost of prescription drugs have increased significantly. In 1990, pharmaceuticals accounted for approximately five percent of total health care spending. But that number grew to over 10 percent by 2016. The inflationary trend of prescription drug costs can exceed the benefits budget, and the drug formulary has been used to help achieve benefit sustainability.

Formulary and rebates

Express Scripts’ formulary development process requires the input of three internal committees, including the National Pharmacy & Therapeutics Committee (P&TC), the Therapeutic Assessment Committee (TAC), and the Value Assessment Committee (VAC). The P&TC consists of independent pharmacists and clinicians who offer a non-biased clinical perspective of a drug’s efficacy based on published research and clinical information. The P&TC offers one of the three recommendations, including 1) adding a drug to the formulary (about 15 percent of the drugs reviewed) or 2) excluding a drug from the formulary (about one percent of the drugs reviewed) or 3) making a drug optional (about 85 percent of the drugs reviewed).

The TAC is Express Scripts’ internal clinical review committee. It consists of multiple clinical pharmacists and physicians, and it offers recommendations to the P&T Committee. The P&TC and TAC review medications from a clinical perspective. They do not consider the financial aspect of the therapy. The VAC, on the other hand, does consider a drug’s value by evaluating the financial aspect of the therapy. The VAC consists of Express Scripts employees, including formulary management, product management, finance, human resources, and clinical account management.

Over time, it has become clear that formularies have become an important mechanism for selecting drugs and controlling costs. Therefore, a preferred spot on the formulary translates into to increased sales volume for drug manufacturers. In order to understand the power of a formulary, it is important to define discounts, rebates, and kickbacks. A discount is a reduction in the amount that a seller charges a buyer, something that it is given at the time of sale. A rebate is also a reduction in price, but it is paid to PBMs after the sale. A kickback is when one party provides payment or is willing or offers to pay to get or increase business with another party. It is important to note that kickbacks are illegal.


Often, the list price for a drug is substantially higher than the cost of manufacturing it. Drug manufacturers are often willing to offer substantial discounts or rebates (30 percent to 50 percent on average) in exchange for higher sales volume (i.e., a more favorable formulary placement).

Recently, Mylan was put under the spotlight for increasing its Epipen price from about $100 for a two-pack to more than $600 per two-pack. In a hearing before the U.S. House Committee on Oversight and Government Reform, Mylan CEO Heather Bresch was asked how much her company paid in rebates to PBMs, but she declined to comment – asserting the contracts are confidential.

The Pharmaceutical Care Management Association (PCMA) is an organization that represents PBMs. PCMA argues that non-transparency is the key for PBMs to be able to negotiate lower prices with drug manufacturers. And so far, just a few states have passed laws requiring PBMs to disclose drug costs.

The National Community Pharmacists Association (NCPA) has expressed its concerns regarding the non-transparent nature of PBMs and their contribution to higher drug prices. One example is Nexium, a commonly-used heartburn medication. A month’s worth of a generic version of this drug could cost as little as $20, while the same quantity of brand-name version can cost as much as $700. As Business Insider noted in 2015, the maker of Nexium, AstraZeneca, had to pay a fine of $7.9 million for allegedly paying kickbacks to Medco Health (currently Express Scripts) to ensure that Medco kept Nexium on its formulary. Court documents showed that AstraZeneca agreed to give Modeco about $40 million, largely in the form of discounts on other drugs, in exchange for Medco’s agreement to maintain Nexium’s “sole and exclusive” status on its list of approved drugs.

According to Express Scripts, one of the main factors it considers to determine whether to include a medication on its formulary is the “clinical appropriateness of the drug – not the cost.” A drug’s clinical appropriateness certainly plays a role in determining whether a drug will be included on a formulary, but frequently so does cost. It is also worth noting that pharmaceuticals is a “sellers” versus a “buyers” market. Over the years, it has become clear that the cheapest and most cost-effective medication does not always end up on the formulary. In fact, sometimes medication may be excluded for that reason. “Rebate pumping” is the term that is used to describe when PBMs favor a higher-cost drug because higher cost medications tend to be associated with higher manufacture rebates. By including medications with high manufacturers’ rebates, PBMs can generate more profits.

For example, Express Scripts updated its 2019 formulary list and made changes to its Hepatitis C category. The 2019 formulary excluded Mavyret, which is manufactured by Abbvie. Mavyret was approved in 2017 by the FDA for the treatment of Hepatitis C. A treatment course of Mavyret costs approximately $26,400. Although this is still expensive, Mavyret is significantly cheaper than its competitors – as Epclusa, Sovaldi and Harvoni are priced at $76,760, $84,000 and $94,500, respectively. According to the clinical trial, Mavyret is just as effective as Harvoni, with a cure rate of more than 97 percent.

Manufacturers’ rebates are more synonymous with brand drugs, but brand name drugs are only about 10 percent of total prescription volume in the U.S. Approximately 90 percent of all prescription dispensed in the U.S. are generic drugs. Generic drugs are cheaper to manufacture, but they are not always cheaper for patients. PBMs often use a practice called “spread pricing” to artificially inflate generic drug prices. PBMs practice “spread pricing” when they charge their clients more for a prescription drug than they are actually paying.

Bloomberg examined the prices of the 90 best-selling generic drugs that were used by Medicaid in 2017. It found that PBMs obtained a $1.3 billion profit on the $4.2 billion Medicaid insurers spent on those 90 types of generic drugs by using “spread pricing.” In 2017, West Virginia decided to cut PBMs (Express Scripts and CVS Caremark) out of its Medicaid program. Under West Virginia’s new health care model, the state is using the West Virginia University School of Pharmacy to recommend drugs for patients. This change saved the state $30 million in one year.

‘Clawbacks’ and ‘gag clauses’

For insured patients, the out-of-pocket cost for a drug is frequently called a copayment – a fixed dollar amount that is paid by the patient per-prescription. Most patients assume that a copayment is less than the cost of the drug since the word copayment suggests that the patient and insurer are sharing the total cost of the drug. However, recent investigations and lawsuits have uncovered that the total cost of a drug is sometimes less than the patient’s copayment, and the insurers or PBMs keep the difference in what is known as “clawback.”

According to a 2018 study that was conducted by the University of Southern California’s Shaeffer Center for Health Policy and Economics, insurance copays are higher than the cost of the drug about 28 percent of the time for generic drugs and six percent of the time for brand name drugs. This study also found that the average overpayment is about $7.69 per claim, and the overpayment for Medicare payments alone was over $135 million in 2013.

Overpayment has huge potential to negatively impact health care outcomes in the U.S. As prescription drug costs increase, many patients struggle to afford their copayment – and cost-related medication non-adherence is increasingly common. In the past, PBMs have forced retail pharmacies to sign a “gag clause,” which prohibit pharmacists from informing their patients when the cash price for a prescription is less than what they would pay using their insurance plan. The good news is that the 2018 ‘Know the Lowest Price Act’ prohibits “gag clauses” for Medicare drug plans.


PBMs are a $238 billion market. The industry has evolved from simple prescription claims processing to home drug delivery, formulary development, specialty pharmacy, and discount/rebate negotiation with drug manufacturers. Over the years – and through the process of acquisition/consolidation – the three aforementioned PBMs have gained control over 85 percent of the market.

Insurance companies have become increasingly-aware of the role of PBMs in increasing prescription drug costs. In 2016, Anthem filed a lawsuit against Express Scripts – accusing it of breaching its benefits management service contract by charging inflated prices and refusing to negotiate in good faith. Anthem believes that it has been overpaying Express Scripts by approximately $3 billion per year.

Transparency is important in the PBMs industry. It enables plan sponsors and payers to confirm that a PBM is, in fact, providing its clients with low drug costs. Without transparency, there is no reliable way for plan sponsors and payers to verify whether PBMs are passing on manufacturer rebates. PCMA argues that there is no evidence that transparency will bring down drug prices, suggesting that the “wrong kind” of transparency may even result in higher drug prices. Given recent public backlash and lawsuits, PCMA launched a Twitter campaign called #OnYourRxSide that is aimed at reorienting public opinion to favor PBMs. The rebate system was initially designed to benefit consumers, but evidence shows that PBMs frequently divert rebates and discounts to pad their bottom line.

It will require multiple policy changes to make the PBMs industry more transparent and accountable. First, legislation should be enacted to define what constitutes a rebate, a discount, a fee, etc. Second, PBMs should be required to disclose the percentage of a drug’s price that is related to a rebate or a discount, the fees associated with its service, and the amount given to the sponsors. Finally, we need to use this information to establish a minimum required rebate PBMs return to the sponsors.

At the request of the Trump administration, the Medicare and Medicaid programs will end manufacturers’ rebates to PBMs on January 1, 2020. As the result, any rebate/discount that PBMs negotiate with drug manufacturers will have to apply directly to the drug’s list price. This new regulation will hopefully decrease out-of-pocket spending and lead to better patient adherence to medications. The end of PBMs rebates could also lead to higher utilization of low-cost generic and biosimilar drugs since PBMs will no longer have incentives to favor more expensive branded drugs based on manufacturer rebates.

In 2016, 20 large employers – including the likes of Coca-Cola and Marriott – formed the Health Transformation Alliance (HTA) to eliminate the use of PBMs. By 2018, the HTA included more than 40 corporations. Small corporations may not have the means to form these kinds of alternative entities, but they may be able to use transparent PBMs that charge a flat fee for each prescription.

Dr. Wang is a MAG member and a transitional year resident at Gwinnett Medical Center. He wrote this report with the assistance of Melanie Feldman, M.D., with the Coalition of State Rheumatology Associations, and Adam Fein, M.D., with Drug Channels.


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