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General Counsel and In House Counsel Health Care Law Litigation

Are Pharmacy Benefit Managers' Cost-Containment Claims a Shell Game?

In today's political climate, one of the hottest topics is the rising cost of healthcare and drugs. Following the last election, all industries should anticipate change, especially in healthcare. While much of the focus is currently on whether the Affordable Care Act will be repealed, one of the areas the government continues to scrutinize is costs.


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In today’s political climate, one of the hottest topics is the rising cost of healthcare and drugs. Following the last election, all industries should anticipate change, especially in healthcare. While much of the focus is currently on whether the Affordable Care Act will be repealed, one of the areas the government continues to scrutinize is costs.

As highlighted by political candidates and news agencies, prescription medications are driving up the cost of healthcare. Pharmacy benefits managers, or “PBMs,” as they are known in the industry, administer the prescription drug benefits for almost all health insurance plans. And while they do not control drug prices established by drug manufacturers, they do have significant influence on the prices charged by such manufacturers.

PBMs play a critical role beyond simple drug claims administration in the healthcare plan process, but few people are familiar with the term “PBM,” and even fewer understand how PBMs operate and, most importantly, how they generate profits. While PBMs claim that they are effective in controlling or minimizing rising drug costs for their clients, it is arguable that their methods actually raise medication costs, in their quest to increase their own profits.

What Is a PBM?

PBMs were formed in the 1960s. At that time, health insurance companies needed assistance and expertise in negotiating with pharmaceutical manufacturers and processing the increasing volume of claims for prescription drugs. Enter the PBMs. Acting as third-party administrators of prescription drug programs, PBMs contract with pharmacies, serving as gatekeepers to insurance networks, and determining which pharmacies may participate as part of a network. Additionally, PBMs develop formularies, a list of approved drugs that health insurance plans will cover, steering healthcare providers and patients to these medications. In turn, pharmacies purchase prescription medications that are in demand, and are often those on PBM formularies, from pharmaceutical manufacturers.

At the outset, the PBM concept was simple. PBMs would use their expertise to simplify the administration of prescription drug benefits for health plan members, and health insurance companies would gain cost-management benefits. The PBMs would: 1) maximize market share with health insurance plans to administer the plans’ drug benefits programs; and 2) create a network of pharmacies that would agree to dispense medications to plan members in return for an agreed-upon negotiated fee schedule. However, PBMs have grown into such a huge industry that they literally determine where patients obtain their prescriptions, what medications patients will receive, and how much pharmacies will be reimbursed for such medications.

As the PBM role has evolved, questions emerge over whether they provide consumers with cost benefits or actually contribute to the rise in prescription drug costs. For example, PBMs routinely require pharmacies to switch patients to generic prescriptions unless the physician expressly requires the patient to take a more expensive brand medication. In theory, this would seem to be a cost-saving benefit to health insurance plans and employers. However, PBMs reimburse pharmacies and charge health insurers and employers based on the maximum allowable cost (MAC) for the generic drug. The PBMs unilaterally set the MAC and use differing MACs to charge health plans and employers more for the generic drugs than the MAC used to pay the pharmacy for the generic medication. The result is that PBMs charge health insurance companies and employers more for the generic drug than what the PBM actually paid for the medications.

Similarly, formularies initially helped curb healthcare costs by encouraging the use of low-cost generics. However, today, certain incentives such as manufacturer rebates have increased the number of name-brand drugs on formularies, even when lower-cost generics are available. PBMs leverage their position with pharmaceutical manufacturers, who desire to be on the formularies, to obtain lower drug prices from the manufacturers through the use of rebates. In theory, these rebates should be passed on to the health insurance plans, thereby lowering drug costs for employers and health insurance plan members. The reality, however, is that PBMs are keeping the rebates for themselves, unbeknownst to the health insurance plans or the consumers.

Benefiting the Middleman At the Health Insurers and Employers’ Expense

Imbalance of Information

PBMs are the ultimate middlemen in their ability to control information. This control enables them to reap profits from all parties involved in the process of the administration of medications as none of the players — health insurance plans, employers, pharmaceutical manufacturers or pharmacies — have complete information relating to the PBMs’ arrangement with any of the other players in the arrangement. For example, a pharmacy is in the dark as to what the health insurance plan has agreed to pay the PBM for the price of a drug. Health insurance plans and employers are equally unaware of what the PBM paid the pharmacy for the drug. Through the use of these types of opaque contracts, PBMs have been able to amass huge revenues, profiting from the difference between the price they charge the health plans and employers for medications and the price they pay pharmacies for the medications. The difference is often referred to as “spread pricing,” which PBMs keep for themselves to drive up revenue instead of passing the savings onto the health plan or employer.


Rebates have supported arguments that PBMs’ decisions are driven by profits over patient care. Initially, rebates were meant to be used as a mechanism to reduce drug costs for health insurance plans and employers. But now, PBMs use rebates to increase their own profits rather than help health plans and employers save money. Pharmaceutical manufacturers’ rebates incentivize PBMs to put certain drugs on their formularies, and exclude other drugs. These rebates, once a cost-saving mechanism, may now be playing a role in the ever-increasing price of drugs. Because rebates are set up as a percentage of the drug’s list price, the higher the price, the higher the rebate for the PBM. In other words, PBMs seeking profit logically are NOT negotiating lower drug prices, because they receive larger rebates on higher-cost medications. Rebates may lead pharmaceutical manufacturers to increase drug prices to account for the payment of rebates back to PBMs. Thus, it may contribute to the skyrocketing drug prices which PBMs were originally designed to control.

PBM profits from rebates appear to be so substantial that some PBMs have reported doubling their profits in the wake of steep drug-price hikes without any corresponding cost-benefit to their health insurance plan or employer clients. Indeed, rebates would appear to create a conflict of interest between PBMs’ stated goals of drug-price cost containment and their desire to drive revenues. In at least one case, a PBM settled a lawsuit with several states for $28 million that alleged PBMs actually shifted patients to higher-cost medications in order to reap the benefits of the manufacturer’s rebates.

‘Maximum’ Allowable Costs

As the health insurance plans and employers became increasingly aware of the rebates that the PBMs were retaining, PBMs then sought to maximize the “spread” on generic medications. Generic prices are generally set by the PBMs through the use of MAC lists. But PBMs use multiple MAC lists for generic medications and routinely use different ones for payments to pharmacies and billing health insurance plans and employers. This allows the PBMs to profit off the “spread” from the difference between the two lists. In addition, PBMs generally retain complete discretion as to which drugs they will include on MAC lists.

Not every generic drug may be included on a MAC list. That is significant because health plans and employers generally pay the PBM the lowest of three prices: 1) the pharmacies’ usual and customary price, which is generally always the highest; 2) the MAC price for the drug; or 3) the average wholesale price (AWP) minus a discounted percentage (e.g., 18%). If the generic drug is not on the MAC list, the price generally defaults to the AWP formula, which is used for branded medications. Since PBMs generally pay a pharmacy along the lines of AWP — 70% for generics, charging health insurers and employers AWP — 18% is a huge windfall for simply opting not to add a particular generic drug to its MAC list. Again, this practice leads to increased drug costs for health insurance and employers, even though lower cost generic drugs are being encouraged by the PBMs.

DIR Fees

In a further effort to dominate the pharmacy marketplace, PBMs have developed their own captive pharmacies, a fact that has spawned efforts by PBMs to eliminate competition from independent pharmacies. For example, PBMs’ use of direct and indirect remuneration (DIR) fees is yet another illustration of how PBMs continue to amass their own profits. DIR fees began as a mechanism for the federal Centers for Medicare and Medicaid Services (CMS) to track rebates received by PBMs to ensure that they were passed on to CMS. Later, PBMs transformed DIR fees into “pay-to-play” fees they charge pharmacies to participate in their network.

By imposing DIR fees on independent pharmacies, PBMs are squeezing out independent pharmacies that cannot afford to pay a fee on each prescription filled. By eliminating these pharmacies, PBMs are able to redirect patients to their own retail and specialty pharmacies.

Wrongful Terminations of Provider Agreements

PBMs are arguably incentivized to terminate pharmacies that do not dispense prescriptions covered by formularies. PBMs are incentivized to terminate these pharmacies, because the PBM does not receive a rebate on these prescriptions. For this reason, certain pharmacies have argued that they were terminated because their practices deny PBMs substantial rebates from drugs covered by the health insurance plans and employers. By eradicating independent pharmacies from the marketplace, PBMs can increase their own affiliated pharmacies’ market share and leverage with health insurance plans and employers.

Pushing Back on PBMs

Because “PBM” is not a household term and PBMs run complex and often opaque operations, their business practices have gone largely unchecked by health plans, employers and government officials. This is starting to change. With greater frequency, PBMs encounter opposition from employers and health insurers over the use of rebates, MAC lists and spread pricing during contract negotiations and litigation. More specifically, PBMs are facing allegations of impropriety related to their conflicts and interest, which has caused PBMs to be driven predominantly — if not entirely — by their own profits as opposed to cost-containment efforts for the benefit of their clients.

For instance, health insurance company Anthem, Inc. (Anthem) recently allegedly discovered that its PBM was improperly boosting its profits. In its suit, Anthem alleges, among other things, that the PBM violated their contract by failing to negotiate new drug prices in good faith. Anthem, Inc. v. Express Scripts, Inc., 1:16-cv-02048 (S.D.N.Y.). The government has also begun scrutinizing PBMs’ business practices, and recently subpoenaed a number of PBMs requesting information about their rebate arrangements with pharmaceutical manufacturers.

America’s largest employers have also gotten wise to PBMs’ schemes, and have started taking action to curb certain questionable PBM practices. Now, these employers, including Macy’s, Coca-Cola and American Express, have formed the Health Transformation Alliance (HTA). The Alliance aims to increase employers’ leverage to hold PBMs accountable for their actions. In particular, HTA is focused on eliminating the imbalance of information in drug pricing between insurance companies, pharmaceutical manufacturers and pharmacies, which will hopefully eliminate the various avenues that enable PBMs to increase costs and their own profits. The Alliance also proposes that PBMs should receive primarily administration fees; after all, their role began as just that: handling claims administration for overwhelmed insurance companies.

Pharmacies have chosen to challenge the PBMs on their business practices. In particular, cases by independent pharmacies against PBM-giant Express Scripts, Inc. (Express Scripts) have proliferated. The allegations against Express Scripts range from breach of contract to tort claims to violations of antitrust and Any Willing Provider laws. With the growing number of cases against PBMs such as Express Scripts, independent pharmacies have presented to the courts the decision as to whether efforts by PBMs to boost profits run afoul of the law.

In 2017, it is incumbent upon employers, particularly large companies whose employees are affected by PBM profit-driven decision-making and coverage, to hold PBMs accountable by asking some questions. Does the relationship continue to be beneficial? Would the company benefit from joining a similar alliance to Health Transformation Alliance? Or, as some employers have started to do, should the company move to contracting directly with pharmacy networks? Either way, an essential factor to effectuating change in the way PBMs currently operate and decreasing drug and healthcare costs will not occur without pressure from health insurance plans and employers alike to require PBMs to focus less on their own profits and more on providing cost savings to their clients.

***** Jonathan L. Swichar is co-chair of Duane Morris’ Specialty Pharmacy Litigation Group. He regularly represents healthcare providers in the investigation and defense against healthcare-related offenses in regulatory, civil and criminal proceedings. Erin M. Duffy, a partner in the firm’s Philadelphia office, concentrates her practice on corporate healthcare regulatory matters. Robyn Stoter is an associate, also based in the Philadelphia office. For more information, please visit

The views expressed in the article are those of the authors and not necessarily the views of their clients or other attorneys in their firm.

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