Restricting Pharmacy Benefit Managers Could Decrease Competition and Increase Drug Costs

PBMs are a pro-competitive creation of the free market for prescription drugs that improve consumer welfare.

C ongress is considering multiple bills that aim to restrict the ability of pharmacy benefit managers (PBMs) to negotiate discounts and rebates and to require the PBMs to disclose confidential contracting information. Several hearings are upcoming. In a new Competitive Enterprise Institute paper, I explain why these PBM measures will be counterproductive, resulting in reduced competition, higher costs, worsened health, and an end to market evolution that benefits actors in the drug-distribution system.

Most Americans have prescription-drug coverage either through private or government insurance. Nearly all of those drug-insurance-plan sponsors have found value in pharmacy-benefit management services that are administered by PBMs. The reason is simple: PBMs are a free-market solution that enhances competition through group purchasing and negotiated discounts that provide substantial economic and health benefits for consumers and taxpayers. 

PBMs, acting on behalf of drug-insurance plans, negotiate with drug manufacturers on the one hand and with pharmacies on the other. They design drug-benefit plans, selecting drugs to include on the plan’s formulary list of covered drugs and allocating those drugs to different copay tiers in an attempt to incentivize patients to use the least costly drug (such as generics) appropriate for their condition. Drug manufacturers trade lower prices, in the form of rebates and discounts, in exchange for access to those plans and increased sales volume.

PBMs also select which pharmacies to include in their plan networks and focus on obtaining better terms for plan sponsors and their beneficiaries. They obtain pharmacy discounts and higher quality retailing in exchange for favorable pharmacy placement in drug-plan-pharmacy networks, which drives traffic to cooperating pharmacies. Patients can use more beneficial drugs at lower costs, which translates into lower insurance premiums and improved health. 

PBMs function like buyers’ clubs such as Costco, pooling the market power of their many members to obtain lower prices and facilitating increased use of health-enhancing medications. University of Chicago economist Casey Mulligan has estimated that PBM services generate at least $145 billion in annual value to society beyond the PBM resource costs. This includes consumer savings resulting from manufacturer and pharmacy rebates and discounts, the value of encouraging better drug utilization in preventing more serious illness and expensive health-care use, an increased pace of drug development, and government savings from decreased premium subsidies and premium expenditures.

Some critics disparage PBMs as “middlemen” who prey on actors in the drug distribution system. Yet middlemen — intermediaries such as dealers, brokers, or specialists who facilitate transactions between buyers and sellers — are ubiquitous in our economy. Few goods are purchased by consumers directly from the manufacturers who produced them. No one forces market actors to use middlemen; they are voluntarily utilized because they provide important services and value to buyers, sellers, and the public generally.

In fact, PBMs do not earn outsized profits. A study of profits across the drug-distribution system shows that PBMs’ net margins were 2 percent — less than other participants in the system such as manufacturers (26 percent), pharmacies (4 percent), and insurers (3 percent). And PBM’s net margins were lower than margins in similar industries.

The legislation being debated would limit or eliminate rebates and discounts that pass through PBMs, and require PBMs to disclose pricing and other confidential contract terms. These provisions could decrease competition and result in higher costs, thereby sacrificing much of the value PBMs provide. The proposals will limit the ability of smaller PBMs to compete and could lead to anti-competitive collusion.

There is nothing unique or nefarious in the use of rebates by PBMs for drug sales. Rebates — price discounts based on sales volume — are used by a wide range of manufacturers in different industries to drive demand for their products. PBMs already pass nearly all of the rebates and discounts they obtain back to plan sponsors and the private-plan subscribers and taxpayers who fund the premiums.

When the Congressional Budget Office evaluated an earlier regulatory proposal restricting manufacturers’ rebates to PBMs, it estimated it would end up lowering overall discounts currently offered as rebates, resulting in $176 billion in extra Medicare Part D spending over ten years. Another study of restrictions on discounts paid by pharmacies estimates that every dollar of benefit to pharmacies will cost plans and patients nearly $3.

Nothing keeps the market from transitioning to a different, no rebates, no discounts system. New market entrants and smaller PBMs already compete by offering set fees for administration of pharmacy benefits. Plan sponsors will be able to determine if these alternative payment models offer better value without government instruction. The proposed legislation will foreclose sponsors from making this determination and could mandate a less efficient, more costly arrangement.

The transparency and reporting requirements in the legislation could be counterproductive. Disclosure of currently confidential information would enable some PBMs to learn what terms their competitors are offering, which could facilitate tacit collusion and reduce price competition in the concentrated PBM industry. Information about competitors’ prices can enable sellers, particularly the larger PBMs that are integrated with health insurers and pharmacies, to maintain above market, oligopoly prices. Smaller, independent PBMs will face competitive disadvantages since they will have fewer ways adjust their remuneration.

The CBO has noted, “under current law, smaller PBMs compete with larger PBMs by offering more transparent contracts. Removing that point of leverage may reduce the competitiveness of those smaller PBMs, which could reduce competition if large PBMs garner greater market share as a result.”

Likewise, the FTC has repeatedly stated that disclosure requirements could suppress competition among manufacturers, pharmacies, and PBMs. The amount of transparency in plan design is a differentiating factor that PBMs use to compete, often trading more transparency for lower rebates or worse formulary placement. According to the FTC, required disclosure of proprietary, competitively sensitive information, “may chill competition by facilitating or increasing the likelihood of unlawful collusion, and may also undermine the effectiveness of selective contracting by health plans, which serve to reduce health care costs and improve overall value.”

Disclosure requirements will likely reduce discounts offered by manufacturers and pharmacies. Once drug manufacturers and pharmacies know what competitors are offering, they will reduce their rebates and discounts to the lowest levels in the market.

Ultimately, PBMs’ customers — health plans and employers — compare competing PBMs performance and can negotiate and contract on a variety of terms that are important to them. There is little evidence that this system does not work, nor is there proof that transparency and disclosure requirements would improve matters.

PBMs are a pro-competitive creation of the free market for prescription drugs that improve consumer welfare. The advent and proliferation of PBMs suggest they provide value to all actors in the drug-distribution system. New market entrants and approaches will change the current market and further improve consumer welfare.

Congress should reject these new proposals which are more likely to make the market worse than better. The market for prescription drugs should be allowed to continue to evolve and become more efficient through negotiations among the market actors.