PBMs: They Make More When You Spend More: Inside the PBM Business Model (VHV fundamentals episode)

One of America's largest pharmacy benefit managers (PBMs) just announced they'll stop taking rebates from drug manufacturers. The Senate's response? "Not impressed."

Why? Because rebates are just one of five profit driving "tricks" PBMs use to quietly inflate your drug costs.

In this episode, Dr. Anthony Paravati breaks down the real money flow behind prescription drug pricing, how a system designed to reduce costs does the exact opposite

You'll learn:

• The 7-player money map that explains where every healthcare dollar really goes

• The 5 PBM "tricks" that turn generics into goldmines

• How "spread pricing" means employers (and ultimately you) pay huge markups on actual drug cost

• Why regulatory capture keeps this system legal

• And why this reform moment in Washington matters right now

If you're an employer, benefits consultant, or policymaker, this episode will change how you see pharmacy costs forever.

If you're a patient, you'll finally understand why your prescriptions keep getting more expensive.

Because every dollar diverted to middlemen is a dollar not going to care, wages, or innovation.

🎧 Listen now to understand the role PBMs have played to drive annual healthcare spend in the US to a ridiculous $4 trillion.

What is Value Health Voices?

We discuss the most impactful health policy and healthcare finances developments shaping the US Healthcare system now and in the future. We also discuss personal development for physician executives. Co-hosts Dr Anthony Paravati and Dr Amar Rewari.

Something fairly remarkable just happened in healthcare.

One of America's largest pharmacy middlemen known as PBMs just announced that they're
going to stop accepting rebates from drug manufacturers.

This is news.

However, in the legislative branch, many members and senators are interested in reforming
PBMs and their response to this move was a collective yawn.

In this video, I'm going to explain why I'm going to explain the ways that PBMs make
money.

what they do and how they function as one of the many reasons why drug costs are so high
in the United States.

I'm Dr.

Anthony Paravati and together with my co-host of the Value Health Voices podcast, Dr.

Amar Rewari we have a collective 25 years of experience in health policy and we created
the Value Health Voices podcast specifically to educate healthcare operators about the

vast $4 trillion healthcare system It's 18 % of GDP and if it were a country, it would be
the fourth biggest economy on earth.

And so today I'm going to show you exactly how the money flows through America's pharmacy
system and why your employer and to some extent you as an individual is paying many times

more, maybe 25 times more for generic medication than they should.

So by the end of this video, you're going to understand PBM funds flow so well that you
could recreate it on the back of an envelope.

But more importantly, you'll see why this moment, this momentum for reform of PBMs is so
important and why we, as a society, we have to get smarter.

We cannot continue to allow healthcare to devolve into rent seeking behavior that diverts
money away from productive uses out of your pocket, out of everyone's pocket, money that

could go to research and development to lower costs in general.

to many other better uses.

So let's follow the money.

And to do that, I'm going to show you a great figure from an article that came out a few
years ago in the Journal of Clinical Oncology.

And to help explain this figure and ultimately the funds flow through the pharmacy and PBM
ecosystem, we have to introduce seven players in the game.

So in this figure, you're gonna see the drug manufacturers at the top.

Think the household names Pfizer, Merck, AstraZeneca, for example.

Now on the right side of the figure, you see the wholesalers and there are three of them,
McKesson, Amerisource Bergen and Cardinal.

Below them you see pharmacies, think CVS, Walgreens, many more.

And then the patient at the bottom right.

On the left side of the figure, you see the plan sponsors, which are employers, the
government, the ultimate source of money in this entire funds flow.

You see

their health plans right above them.

And then you see the main focus of our attention, the top left, PBMs and the pharmacy
benefits managers.

In general, there are three large ones.

There's Express Scripts, CVS Caremark and OptumRx and together they make up 85 % of the
market.

So I'm not just going to explain the funds flow.

I'm going to explain the funds of drugs or the flow of drugs.

I'm going to explain the flow of services and the flow of money in all this.

And so let's start with the flow of drugs.

Drugs are made by the manufacturers and they flow to those wholesalers I mentioned.

Pharmacies acquire the drugs from the wholesalers most of the time and then the patient at
the bottom right of the figure is going to pick up their medication as usual in a

pharmacy.

So the money flow on this figure is represented by the green arrows.

And as I mentioned a moment ago, the money starts with the plan sponsor, which is an
employer or the government.

There's fully insured employers.

There's self-insured employers.

These are the entry point of the money in the funds flow.

And as a golden rule, right?

And he who has the gold makes the rules.

But in this PBM ecosystem, that's not

fully the case.

And so then following the money, the money originates from the employer plan sponsor, the
government plans, and it goes to the health plan and the health plan pays a PBM to

administer the pharmacy benefit.

This wasn't always the case.

This really took off starting in the 1980s and has now become standard.

The PBM pays the pharmacy for dispensing the medication to the patient.

That's why you see the arrow connecting the PBM.

and the pharmacy.

And as I mentioned in the introducing the players on the field, the pharmacy pays the
wholesaler to purchase the drugs, to acquire the drugs that they have in their inventory

that you go and pick up.

And the wholesaler pays the manufacturer, of course, because the drugs originate in the
manufacturer, go to them, pharmacy gets from the wholesaler and then to the patient.

And the patient, there are some funds originating from the patient as well, because the
patient pays a copay.

uh to the pharmacy and they pay premiums to their plan through payroll deductions, which
might be 20 % of total costs.

So all of this makes sense.

There's nothing to earth shattering here, but where it gets interesting is that the
pharmaceutical manufacturers also pay the PBMs.

So now you can see that the PBM has two customers.

The PBM has the plan sponsor as one customer.

and they have the manufacturers as another.

And the main way, it's not the only way, but the main way that the manufacturers pay the
PBM is through rebates.

And traditionally it works something like this.

If there's a $400 medication, the manufacturer might give, and this is just an example,
might give a rebate to the PBM of a hundred dollars.

And this seems great.

Look at that.

The PBM is acting to save

the plan sponsor money by getting a rebate by negotiating a good deal on the drugs.

But it turns out that the rebates, most of the rebates are retained by the PBM.

On that $100 rebate, the PBM might retain $75 of it.

Nobody knows, there's not transparency and just return 25, the other 25 to the plan
sponsor.

And so what's happening here is the manufacturer knows they're going to

have this rebate to pay.

And so they factor that into the pricing of the drug.

They increase the drug price to account for the fact that this rebate is just the rules of
the road.

And so they're not really saving the system any money.

Now the idea behind this rebates is that the manufacturer, the drug maker is getting
something for it, like favorable placement on the formulary, for example.

But the rebates are not the only thing that they're actually paying.

The manufacturer pays also formulary placement fees.

So that's accounting for the placement on the formulary, perhaps an advantage position on
the formulary.

Market share payments.

This is basically a commission, very clearly a commission for pushing more of drug A

and less of drug B.

They also, the PBMs collect administrative fees and even performance bonuses.

And so once again, the PBM has two customers, the health plan who hired them and the drug
manufacturer who pays them commissions.

That's really what these are.

The whole idea of rebates is nothing more than a euphemism.

And this is very important because this is the fundamental conflict of interest.

The PBM is supposed to act to negotiate lower drug prices

for the employer, again, the plan sponsor.

But they make more money, the PBM makes more money on higher priced drugs because the
commissions are based on a percentage of the drug cost.

And so it's very much in the PBM's interest for more prescriptions to be written and for
higher price prescriptions to be written.

That drives their commission based or rebate based revenue.

The plan sponsor who's there's other customer, they don't want any of this.

They want lower healthcare costs.

And that's the rub.

The last aspect of funds flow on here has to do with the arrow from the manufacturers to
the patient.

And these are copay assistance programs.

You think very expensive monthly costs for high cost specialty drugs, $10,000 a month,
maybe $50,000 a month.

And so the manufacturer subsidizes the patient's copay in a way to keep them on expensive
medications.

Think, um, Enbrel versus methotrexate for arthritis.

the patient on the Enbrel versus the methotrexate that does more for the PBMs objectives.

And of course, there's more sales of the expensive drug on the part of the pharmaceutical
company.

So these co-pay assistance programs have created an incentive to stay on high cost
medications, even when there is a low cost alternative.

Now that you've seen the money flow, let me show you the five specific methods, one might
even call them tricks, that PBMs use to make all of their money.

And these are ways, again, that flow through the system to ultimately make drugs more
expensive.

And this gets at why, even though, again, one of those three large PBMs came out and said,
we're not going to take rebates anymore, this shows why those in the legislative branch,

and the Senate in particular,

who are leading the PBM reform effort were particularly unimpressed with this
announcement.

All right, so let's go with method one,

is called spread pricing and spread pricing has to do exclusively with generic drugs.

Let me show you an example of an employer that would be paying 20 times more than they
should for the generic version of one of the best selling meds in history.

So it's a torvastatin.

You might know it as Lipitor cholesterol medication at its peak Lipitor generating $13
billion a year in sales for Pfizer and now it's generic.

And so let's introduce the three key pricing terms.

to understand all of this.

The first is average wholesale price.

And in this case, it's $3.15 per pill.

Seems like a lot per pill for a generic drug, because it kind of is.

And the average wholesale price is what the pharmaceutical benefits manager charges the
health plan for the drug.

but it doesn't charge them this average wholesale price exactly.

It charges them, it goes to the plan and says, I'm gonna negotiate you an aggressive
discount on this average wholesale price.

Let's say 85 % of it.

And so 85 % off of $3.15 would be something like 47 cents.

The important thing to know though, is that this average wholesale price is totally
arbitrary and set by two companies.

It's so arbitrary that in the industry it's known by

the alternative name ain't what's paid.

So this 47 cents, this huge discount off of 3.15 is what the plan gets charged.

Well, the next thing we need to know is something called the MAC or the maximum allowable
cost.

So in order to get this drug to the patient, the pharmacy benefits manager has to pay an
amount to the pharmacy per pill.

And in this particular case, it's 32 cents.

In general, these numbers, the MAC, are secret and proprietary.

Different PBMs have a different negotiated MAC with the pharmacy.

But then how does the pharmacy get the drug?

That's where the third cost comes in, and that's called NADAC.

This is the National Average Drug Acquisition Cost, and it's four cents, four cents per
pill.

So the PBMs in the middle of this charging the plan,

47 cents per pill, some grand discount off of 3.15, which is the ain't what's paid or
average wholesale price.

But in reality, the actual cost for the pharmacy to obtain that drug from the wholesaler,
the NADAC, was only four cents per pill.

And so in all of this on a per pill basis, the PBM pockets 15 cents for what?

If we take it on an annual basis with a daily dose, that's 365 days a year, the employer
is going to end up paying $171 a year, but the actual pharmacy cost is only $15 a year.

And so that equates to a hidden markup of $156 per patient per year for generic
medication.

A case study on all this is that Ohio Medicaid discovered that spread pricing was costing
that state $208 million a year on generic drugs.

So not brand names, no specialty drugs.

This is just generic cost froth in the market that they're paying more or less for no
reason.

another feature that's important to know is that in certain states, it's actually allowed
for the physicians themselves to dispense medications.

And when that happens,

They basically sell the entire year of a Torvastatin for 10 to 15 bucks at cost.

And this is the same as what an insurance company, what your insurance company might be
paying for just one month.

And so PBM method number two or trick number two, let's get back to rebates and rebates
are opaque.

Nobody knows exactly what they are.

Let's use that example again of $400 medication with a hundred dollar rebate.

So of that hundred dollar rebate, the manufacturer is giving to that PBM and the PBM says,
look, I got you a rebate to the plan.

Well, the PBM in many cases is keeping the lion's share of that rebate.

Let's say $75, $80, something in that range.

and then passing only $25 onto the plan as the savings.

And the employer, the plan sponsor thinks, wow, we got $25 back.

That's outstanding or $20 back as the case may be, but they don't know the full size of
the rebate.

And as I mentioned earlier, rebates are just one of the many fee types that the PBMs are
charging to their other customer, the drug manufacturer that again, makes up a huge amount

of

their revenue, the PBM's revenue, and it is a significant upward driver in drug costs.

Let's call method number three, the whole business of the misaligned incentives that the
PBMs have.

And it flows from having those two different customers who have diametrically opposed
objectives.

And if you listen to the large companies, the CVS, the United, the Cigna that operate,
that own and operate the biggest PBMs in the country, they make up 85 % of the market.

It's very clear.

what this conflict of interest is.

The Wall Street analysts who call in and have these conversations with these companies,
they're interested in script count.

They want to know how many prescriptions the PBM is processing, because that allows the
analysts on Wall Street to understand or to triangulate how much revenue these guys are

likely to make.

So everything about the PBM is more scripts and more higher cost scripts.

That's their objective.

That's what they do by interacting with the manufacturing side of their customer base.

But that's again, directly oppositional to the objectives of their other customer, the
plan sponsor that's trying to save money, trying to perhaps foster value based care.

Well, how are we going to have value based care if this massive, powerful, highly
consolidated middleman wants to drive costs up, wants to crank the wheel, if you like.

of fee for service in the form of a high script count.

All right, PBM method number four has to do with all of these commissions, including the
rebates, because as I said, the rebates are just an example of a commission.

Well, it turns out that...

Entities in the US healthcare system are governed by an anti-kickback statute because it
is not legal.

It makes good sense that entities cannot organize themselves in such a way to drive up
federal healthcare spending.

That's the purpose of the anti-kickback statute.

Well, the PBMs were aware that there's a type of entity in the US healthcare system that
has a safe harbor against

this law that gives them protection exemption from having to abide by the anti kickback
statute and it's called a GPO or a group purchasing organization They were originally

created so that hospitals could negotiate could buy all the things they need through these
entities think bandages or syringes in bulk or certain medical devices Again, these

entities these GPOs they have safe harbor from the anti kickback laws

And so what the PBMs did is that they created or acquired their own GPOs to protect
themselves from exposure to the anti-kickback statute.

The other thing that's interesting in all of this though, is that currently the PBMs don't
even need a GPO to be able to be exempt from the anti-kickback statute because they have

an exemption that was granted to them by the Biden administration.

It turns out,

that the Trump administration 1.0 wanted to put an end to this and they did it through
executive action.

Well, then President Biden actually undid that.

And furthermore, they passed a law that had nothing to do with PBMs.

I don't even remember the name of it.

Had something to do with safe communities and gun laws.

Well, tucked in that was protection until the year 2027 for the PBMs themselves, exemption
from the anti-kickback statute.

So they have the once 2027 arrives, the option of being protected again, by using the
GPOs.

And to not make the video go too long, this final conversation about the anti-kickback
statute and the PBMs being exempt from it is really the exemplification of method number

five, and that is regulatory capture.

And when we say regulatory capture, we mean regulations being written by the entities or
the industry that they're supposed to regulate.

That's how we got here.

And that's how we have a lot of the problems that we have in this vast $4 trillion US
healthcare system.

So the point of this video today is that we're at a very interesting moment where momentum
is building among many stakeholders and most importantly, the government itself to do

something about all this because they understand that many stakeholders, but patients in
particular or beneficiaries, members are being fleeced by all of this.

And so that's why this moment matters.

That's why I'm making this video particularly today.

And you now have the knowledge to participate in reform of this industry.

So that's why to bring it full circle, when one PBM announces that they're stopping to
take rebates from the drug manufacturers, the Senate knows that they're still spread

pricing, they're still GPOs, they're still on disclosed fees, market share payments, all
of that.

And so ending one method of making money by stating we're not taking rebates anymore, it's
really just an olive branch or marketing, if you like.

The reform effort is going to continue to march forward.

So my bet is that once the government reopens, is that there's going to be bipartisan
Senate support for doing this.

We've got state Medicaid programs also suing states rallying around reform and employers
finally waking up and becoming more sophisticated themselves.

They understand that they face liability and I didn't even get into that.

What is the statutory nature of the employer's liability to not allow their employees,
their members

to be fleeced by anybody in the US healthcare system, not least the PBMs.

And so we have a choice as a society.

Healthcare, as I've said many times in my content, $4 trillion industry, 18 % of GDP, when
that money gets diverted into this rent seeking behavior, into middlemen extracting value

without creating any value, that's money that's not going to workers' wages, business
investment, research and innovation, and actual patient care.

And so we cannot continue to allow healthcare to be

opaque commission schemes that benefit a handful of players while harming everybody else.

you did it, you made it to the end.

You now understand PBM money flows so well that you can draw it on an envelope.

And you know the five methods that they use to make money and protect their position in
the healthcare marketplace.

Use this knowledge, ask your employer questions, support alternatives, support reform
efforts.

I'd say this is how change gets created and momentum is with a lot of these changes.

Again, I'm Dr.

Anthony Paravati.

For more healthcare policy education and healthcare finance education, check out the
podcast I make with my colleague, Dr.

Amar Rewari, Value Health Voices.

We put out podcasts twice a month.

If you found this valuable, share it with somebody who needs to understand how their
healthcare dollars flow.