What are PBMs, and how do they affect drug costs?

In the bewildering world of how the heck drug prices get set in the US, perhaps the most confusing players are called pharmacy benefit managers, or PBMs. They’re often called “middlemen” because they operate between insurers and pharmacies. We’re going to try to explain PBMs in the simplest way possible, but be warned: Your brain might be sore at the end of this.

PBMs were created in the 1960s, and they work on behalf of insurers. They negotiate with drug manufacturers to create formularies, which are lists of drugs that insurers cover. Those lists are divided into different tiers. The top tier includes mostly generics, which are cheaper than brand-name drugs because they’re required to have identical chemical makeup and therefore don’t have to repeat the same testing process. Insurers cover a larger portion of drugs in the top tier, so manufacturers want their drugs to be listed there.

(The US health system saves money when generics, which cost less, are prescribed over brand-name drugs. Some states even have generic substitute laws that require a pharmacist to dispense the generic version of a brand drug.)

PBMs negotiate with manufacturers over rebates, or the sum of money the producer pays for each drug to be included in the formularies. The amount is calculated as a percentage of the price of the drug, which is divvied up between the PBM and the insurer. Rebates are used by manufacturers to incentivize PBMs to include their drugs in formularies over their competitors’s, said Ronna Hauser, SVP of policy and pharmacy affairs at the National Community Pharmacists Association.

For example, if a manufacturer wants a PBM to put Drug A, which costs $20, at the top of a formulary, it might give the PBM a rebate of 20% of that price ($4) to incentivize them to do so. It’s important to note that we don’t know how much PBMs charge in rebates—they’re considered trade secrets, according to healthcare consulting group Milliman.

PBMs have faced criticism from multiple sectors of the healthcare industry over the amount of power they hold in the drug supply chain. Congress introduced a bill in 2022 called the Pharmacy Benefit Manager Transparency Act that centers around reimbursements and would ban PBMs from charging insurers a different amount than they pay to reimburse a pharmacy.

The PBMs then create a network of pharmacies to contract with and reimburse them for dispensing drugs on the formularies, Hauser said. The PBM determines how much it will reimburse the pharmacies. Reimbursement varies widely for generic drugs, according to a 2020 study by the consultancy 3 Axis Advisors.

The PBM industry is dominated by three players—Caremark, Express Scripts, and Optum Rx—that control around 80% of the market. Also, they’re all owned by insurers, said Hauser.

You can go take some pain meds for that headache now.