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In 2022, an executive at a health insurance company expressed concern at the games his company was playing with drug prices. He pointed at the drug Gleevec, which when it was approved in 2001, was a miracle treatment for blood cancer. “For a lot of people, Gleevec was simply too good to be true. But these once-dying patients were getting out of bed, dancing, going hiking, doing yoga. The drug was amazing,” said the researcher who discovered the chemical compound behind the drug, Brian Druker.
Gleevec was also expensive, at $26,000/year when it launched. By 2015, when the patent ran out, it was priced at $132,000/year, bringing in $4.7 billion for Novartis that year alone. But like all drugs, its patent expired, and soon it faced generic competition. As more companies entered the market, the cost of this drug, according to a pricing metric used by pharmacies called the National Average Drug Acquisition Cost (NADAC), fell by 99%.
This kind of pricing change is a tremendous policy success, it’s the idea behind American patent policy, and how that was implemented in pharmaceuticals through the Hatch-Waxman Act of 1984, which allowed for a period of tremendous profit for the creator of a drug, and then fostered a path for generics to bring the price down after the patent ran out.
But then, something odd happened. Though the acquisition cost of Gleevec collapsed, in some places, the cost to the payer did not. Here, for instance, is what happened in Ohio.
Most patients didn’t front the full cost, paying co-payments, but Medicaid systems and companies using certain insurers had to cover it on the back end. Such costs are one reason that health care costs keep going up far above the rate of inflation.
Why was there such a big spread between the cost of buying the drug and the price being paid by payers? It wasn’t what most people expected, that the pharmaceutical company Novartis, had found a way to maintain its patents. The answer, according to a new Federal Trade Commission report, is that a small group of middlemen were inflating the price.
These middlemen are called pharmacy benefit managers, and what they are supposed to do is clerical work. When a pharmacy dispenses medicine, it sends the claim to a PBM, which bills the insurer and patient and remits the pharmacist money. But because of a legal change I’ll explain, just three PBMs are now in control of pricing of pharmaceuticals, and are redirecting vast amounts of money to themselves. And they are why the price of generic Gleevec didn’t drop as it should have.
In fact, the concerned executive worked at the parent company of one of these PBMs. He was not worried about the price, but that such a price would look bad, and possibly violate the law. “We’ve created plan designs to aggressively steer customers to home delivery where the drug cost is ~200 times higher,” he wrote. If you went to Costco, he went on to say, the cost was $97, so the plan didn’t recommend patients go there. If a patient went to Walgreens, which the plan did recommend, it was $9000. And if a patient chose home delivery via the PBMs own mail order pharmacy, it was $19,200. “The optics are not good and must be addressed,” he added. He didn’t need to say that the added revenue for PBMs, just for that one drug, was $902.1 million over a few years. Another drug studied by the FTC, one for prostate cancer called Zytiga, was similarly inflated by an extra $685 million. That’s $1.6 billion for the two of them. Think about all the drugs used in our healthcare system, and that will give you a sense of why healthcare costs keep going up. (Yes, each inflated drug cost is an economic termite.)
Most people think of high pharmaceutical prices, and blame the companies you’d expect in Big Pharma. These firms, with storied names like Merck, Pfizer, Novartis, Genentech, etc, are powerful, and they are in the business of developing and selling drugs. But this other group, corporations you haven’t heard of, composed entirely of middlemen, price and handle payment for pharmaceuticals between doctors, pharmacies, and patients, are perhaps equally important, if not more so. And unlike pharmaceutical companies, who actually employ doctors and scientists, PBMs don’t do anything difficult. They keep lists.
PBMs are a topic I’ve covered, mostly as a cause of the disappearance of rural independent pharmacies, but last week, the FTC sparked a big political fight by releasing this report on the PBM business model. Chair Lina Khan did so with support from one Republican commissioner, Andrew Ferguson, but opposition from another, Melissa Holyoak. The FTC also indicated in the report’s final pages, and the Wall Street Journal noted, that it was likely to sue PBMs over the high prices they foster for insulin, which could potentially change the entire drug claims system, and bring down prices dramatically.
To understand the world of pharma pricing, we have to start at the beginning. In the 1950s and 1960s, pharmaceutical development exploded, as did the health insurance industry. Insurers needed a way to help their patients to easily buy them the new cornucopia of drugs at pharmacies. Enter pharmacy benefit managers, who were claims processors that issued a plastic card to insurance customers, got pharmacies to accept those cards, and tracked the money flows, including reimbursements. PBMs were very similar to Visa and Mastercard, with the very first PBM actually called “Pharmaceutical Card System.”
PBMs soon started to create what are called drug formularies, which are lists of drugs payers will cover, specifying the kind of drugs included and the cost-sharing arrangements. They also put together networks of pharmacies, and began helping design strategies to encourage patients to take the correct medicine for the lowest price, known as utilization management. It was a business to business service. If you’re an employer, a union, a state or Federal government program, and you need drug benefits for a group, you hire a PBM and they set you up with a range of formularies and pharmacy networks. Today, commercial health plans, Medicare drug plans, Medicaid managed care, and affiliated health insurers use PBMs.
But then, several changes shifted the business model. The first was consolidation. From the 1980s to the 2000s, PBMs consolidated both horizontally and vertically, so each big PBM is now owned by a major healthcare conglomerate. CVS owns Caremark, Cigna has Express Scripts and UnitedHealth Group (UHG) runs Optum Rx. (For a case study, see my 2020 piece called “How CVS Became a Health Care Tyrant.”) There were big acquisitions, like Express Scripts buying Medco in 2012 and CVS buying Aetna in 2018, but smaller ones as well. “According to PitchBook,” the FTC report noted, “these four entities and their subsidiaries (which include the largest PBMs) collectively engaged in more than 190 transactions over the 2016 to 2023 period (UHG, 88; CVS, 53; Humana, 39; and Cigna, 14).”
UHG, for instance, is one of the top PBMs, but it also employs 10% of the doctors in America, is America’s biggest health insurer, runs Optum Bank through which bailout funds during Covid flowed to hospitals, and even owns Change Health, the large payment network for hospitals and pharmacies. More importantly, the big PBMs, while they contract with independent pharmacies, also own their own retail and mail-order pharmacies, thus setting the reimbursement rates for themselves and their competitors. (UHG is a frequent target of medical comedian Dr Glaucomflecken.)
The other change was the legalization of price discrimination, which fostered an era of secretive pricing.
PBMs had been clerical agents, paid by insurers to negotiate with drug makers, or on a per transaction basis to handle transactions. But in 1987, Congress passed an exemption to a Medicare Anti-Kickback statute, which created a safe harbor for group buying entities to accept payment from drug manufacturers in the form of rebates, with certain guardrails in place. Enabling kickbacks created a clear conflict of interest, since a PBM is supposed to be negotiating for the buyer, but could now be paid by the seller. The second change was an antitrust suit in 1994, where pharmacies sued to get the same discounts for drugs offered to health insurance plans and hospitals. In the settlement of that case, the parties and the judge said that if a buyer was big enough that it could prove it could shift market shares, it was entitled to a secret rebate. And the third was in 1999 when the government used its authority to explicitly say that rebates were permissible legal discounts. Today’s system, where PBMs get large secret rebates in return for allocating market shares, was born.
Today, it’s virtually impossible to get any clear pricing on most drugs, because there is no one price. There are different benchmarks, for instance the one I used above to describe what manufacturers get for selling Gleevec. But there are other benchmarks depending on who you are, such as average wholesale price (AWP), wholesale acquisition cost (WAC), Average Sales Price (ASP), Average Manufacturer Price (AMP), Maximum Allowable Cost (MAC), Usual and Customary (U&C), etc, each of which means something different, and many of which are arbitrary mark-ups designed to make it looks like there are discounts when there aren’t, or to extract extra money from pharmacists or patients.
Many drug pricing contracts use several of these benchmarks, along with rebates, reimbursements, and fees that are sometimes assessed six months after a point of sale transaction goes through. The endless number of such adjustments make it impossible to know what anything costs. Just one PBM, for instance, has over ten thousand different price lists for drug reimbursement rates, sometimes updated daily, which means the price of a particular drug depends on who you are, when you bought it, other drugs you might have purchased, or what the PBM executive had for lunch.
Pharmacists are often not allowed to look at the price they would be given for reimbursement prior to submitting a claim because, as one PBM manual notes, “price lists are the PBMs confidential and proprietary information.” There are often multiple prices for the same transaction. A drug might seem like it costs $100 at the point of sale for a drug that cost the pharmacist $50, where the patient would pay a $60 copay and the insurer paid $40. But then six months later the PBM will claw back $75 from the pharmacist in what’s called a DIR fee. In that case, because of the copay, the insurer/PBM is actually extracting money from both the patient whose medical costs it should be covering, and the pharmacy it should be reimbursing. The whole system is insane .
Price discrimination and consolidation weren’t separate phenomena, but drove each other. In fact, if a PBM had to charge the same price for its service to all comers, then it would not matter if a PBM were big; a drug manufacturer negotiating with a PBM would have to give the same price, regardless of size. It also wouldn’t make sense to own its own pharmacy, nor could it charge different amounts for cancer drugs and keep the difference. But the legalization of price discrimination changed the market. And today, there’s really no way to convey how weird this world of pricing is, except that it feels Soviet and arbitrary to everyone in it.
The legislation of price discrimination happened in areas beyond PBMs and health care, it is perhaps the biggest victory of the law and economic school, and certainly one of the most important legal shifts in our society in the last fifty years, far more impactful than most of the economic fights we hear about.
Before the 1980s, it had been a fundamental axiom of America that everyone gets access to the same publicly posted price for the same class of service or good. Grangers fought for this principle in the 1870s, populists in the 1880s, business and labor leaders at the 1899 conference on trusts agreed on it even though they disagreed on everything else, it was understood as part of the Sherman Act in 1890, explicitly embedded into the Clayton Act in 1914, written into the Robinson-Patman Act of 1936, and across dozens of statutes across state and Federal government, from railroad to shipping to electric utility rules.
I mean, even the conservative Heritage Foundation advising the Reagan administration in 1981 decried secret rebates and discounting to select customers. “These kinds of discounts seem contrary,” it said, “to basic American precepts of justice, as they would “effectively end the value of publicly posted prices” and “favor the large organized interests with competitive alternatives at the expense of the unorganized, uneducated, or captive.” That’s the main policy recommendation to the most conservative Republican President since Herbert Hoover.
But starting in the 1970s, economists decided that price discrimination, far from problematic, was actually efficient. Indeed, if you could charge a high price to the rich, and a low price to the poor, then price discrimination could also be progressive. What could be wrong with selective discounting, after all? It turns out, plenty, and if you want to understand why, just look at PBMs.
Today, as a result of these changes, PBMs are big. Really big. The parent insurance companies of the biggest PBMs top nearly $1 trillion in revenue annually, roughly 4% of the GDP of America. Just the top four equal 22% of national healthcare expenditures, up from 14% in 2016. And no other country has anything like the PBM industry. The revenue of American PBMs is larger than what France spends on its entire healthcare system.
The top three PBMs have immense market power. While it looks like an oligopoly, PBMs have monopolies in certain areas. OptumRx, for instance, runs 83% of the South Carolina retail pharmacy network management services, while a different PBM has 85% of the market in Alabama. If you are a company or union that needs to buy prescription drugs or if you are a pharmacist that dispenses prescriptions, you have to run on their rails.
And they use their size and bulk to thwart rivals. They use information from their insurance arms to conduct marketing campaigns targeting patients of rival pharmacists. They make it easier to buy drugs if you buy them from their mail order pharmacy, a practice known as steering, they impose endless fees on pharmacies, and they also take kickbacks from pharmaceutical manufacturers to steer their patients to more expensive medication and cut off access to cheaper generics. They also go after rival PBMs, with the FTC noting that “Some health insurers reportedly do not permit their clients to comparison shop for PBM services; rather, the client must use the PBM affiliated with the health insurer.” (The giant PBMs also have exclusive contracts with certain pharmaceutical makers, which means that if you don’t use those PBMs you just can’t get critical medicines.)
The net effect is higher prices. Here, for instance, is a rebate contract for Sanofi’s Lantus, a popular branded insulin. The list price might be high, but that’s not all going to Sanofi. In fact, 63% of that was going to the PBM in the form of a rebate, as long as Lantus is the only insulin offered to the patient. In other words, there’s competition, but not to lower prices to the consumer, but to pay higher rebates to the PBM.
It’s not just insulin, of course. Take the most expensive drug historically in America by aggregate revenue, Humira, which made over $22 billion for AbbVie in 2022. It recently lost its patent protection, and there are several generics, known as ‘biosimilars,’ coming into the market. Several drug manufacturers (Coherus, Sandoz, Boehringer Ingelheim, etc.) invested in developing biosimilars to launch when the Humira patent expired. These drugs brought the sticker price of the drug down 10x from $80,000 per year to as low as $8,000 per year.
But none of these are able to get onto the shelf. Instead, what happened is that CVS started a drug manufacturing company called Cordavis to sell Humira biosimilars to its specialty pharmacy (CVS Specialty). They charge $1,300 per month, compared to some that are less than half that. Since CVS owns a PBM they controlled the formularies – and therefore the drug access – of between a fourth and third of Americans. They directed their PBM to preference their own drug through Cordavis and ignore the other biosimilars available on the market from smaller pharma companies, adding what I’m told is $50-100 million to CVS’s bottom line.
The negative impacts are twofold. First, consumers have to pay much more for the drug. Second, the pharma companies who invested to make biosimilars suffered financial losses. Here’s the share price of Coherus, which makes a Humira biosimilar.
That means we won’t see any more biosimilar R&D anymore, because everyone knows that PBMs will block them from the market.
For decades, PBMs operated in the shadows. But the passage of Obamacare changed the dynamic of health care, because it capped the profits of health insurance companies. To get out from under this cap, insurers began vertically integrating into different areas, and in the 2010s, every major PBM turned into an arm of a conglomerate. (See “How Obamacare Created Big Medicine”.) Today, there’s an acronym that describes who controls health care. It’s BUCAH, meaning Blue Cross Blue Shield, UHG, Cigna, Aetna and Humana.
And employers started getting angry at high prices. Mark Cuban, for instance, started a pharmacy called Cost Plus Drugs, and is running a high-profile campaign against PBMs.
More importantly, a group in Ohio, a random Wall Street quant named Eric Pachman, a pharmacy lobbyist named Antonio Ciaccia, and a pharmacist named Ben Link began playing around with public pricing data, and realized that government Medicaid programs were getting ripped off by hundreds of billions of dollars a year by PBMs for no reason. They started an organization called 46 Brooklyn, and their research has led to changes in dozens of states.
In 2021, for instance, Kentucky got rid of its use of big PBMs in Medicaid, and saved $285 million out of $1.2 billion its program spent on prescription drugs. It even led to an attempt by the Trump administration to get rid of the ability of PBMs to engage in certain forms of secret rebating. Academics are now focused on the problem of vertical integration, and so is Congress. And there have been dozens of PBM-related hearings – the next one is on July 23 with the CEOs of the ExpressScript, OptumRX, and Caremark – and Congress is closer to passing PBM legislation than it has ever been.
For decades, the FTC, far from helping, was on the wrong side of the argument. Its economists had promoted the idea that price discrimination and rebates were good, that vertical integration made sense, that PBM consolidation would help consumers, and that a PBM owning a mail order pharmacy was not a conflict of interest, but was efficient. But in 2021, then-FTC Commissioner Rohit Chopra shocked the commission by attacking his own agency, saying “There is a growing consensus that the Federal Trade Commission’s approach… is not working.” In 2022, the FTC put out a policy statement saying that the use of rebates by dominant middlemen in the insulin market were a potential legal violation. It also launched the investigation that led to this report.
What’s interesting is that the report is not final, because PBMs would not submit the information the FTC subpoena’d. In fact, some of the PBMs said they would send certain documentation until 2025. It’s a clear run out the clock strategy. The FTC could sue the PBMs to get this information, but it’s not clear that would be faster, and it would eat up litigation resources. And there’s good original information in the report, including the cancer drug analysis overpayment story, which is based on raw claims data. Normally, the commission waits until it has completed its analysis to publish a report, but in this case, the FTC sought to release the interim analysis and publicly name the PBMs as operating as bad faith actors for withholding information.
The politics then flipped. The vote to release the report was 4-1, with the three Democrats seeking to put it out, along with Republican FTC Commissioner Andrew Ferguson. Ferguson not only voted to release the report, but said that the FTC should have sued, arguing they weren’t being aggressive enough. His colleague Melissa Holyoak, however, dissented, and said the report needed economic analysis to show that consumer prices were affected. It was a standard U.S. Chamber of Commerce process-troll, and Holyoak likely thought she would get plaudits for opposing Lina Khan. Instead, at a Congressional hearing, multiple Republican members were annoyed with her, including Rep. Buddy Carter, who is an actual pharmacist that needed to deal with PBMs and understood the problem up close.
A lot of government reports sit on the shelf and gather dust. This one won’t. It’ll lead to litigation by the FTC, and it’ll change litigation and state-level lawmaking happening all over the country around PBMs. It will also affect private markets, as CEOs begin asking why they are paying so much for their pharmaceuticals. Here’s Mark Cuban:
It could even prompt Congress to pass PBM reforms, though too many are still listening to economists, and not yet sold on the need to get rid of price discrimination and rebating. These are weird days in politics and policy, but under the surface of our wild news cycle, the tectonic plates keep moving. No one likes monopolies. And the days of PBM as the organizer of our pharmaceutical markets are numbered.
Thanks for reading! Your tips make this newsletter what it is, so please send me tips on weird monopolies, stories I’ve missed, or other thoughts. And if you liked this issue of BIG, you can sign up here for more issues, a newsletter on how to restore fair commerce, innovation, and democracy. Consider becoming a paying subscriber to support this work, or if you are a paying subscriber, giving a gift subscription to a friend, colleague, or family member. If you really liked it, read my book, Goliath: The 100-Year War Between Monopoly Power and Democracy.
cheers,
Matt Stoller
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