How do PBMs Determine Prescription Drug Pricing?

Prescription drug prices are an ongoing concern for employers and employees alike, given their undeniable impact on healthcare costs and accessibility. Businesses being thoughtful about the bottom line have to pair cost-effective healthcare benefits with practical and positive outcomes. But how a company reaches that equilibrium can be highly dependent on how their Pharmacy Benefits Manager (PBM) negotiates and sets drug prices.

What is a PBM?

A PBM manages prescription drug programs and benefits on behalf of the health insurer. They support employers as they determine which prescription drug benefits to offer, and work as intermediaries between drug manufacturers, pharmacies, and insurance companies to negotiate prices and manage drug formularies (e.g., the list of covered medications). 

Beyond negotiating costs, PBMs determine which drugs will be included in their formularies, secure rebates from manufacturers, and establish the terms under which pharmacies are reimbursed for distributing and dispensing medications. While PBMs have an important role in controlling costs, traditional pricing structures can be complex and difficult to understand, leaving employers and consumers unclear about how drug prices are set or why. 

How are Prescription Drugs Priced?

Prescription drug pricing is an expensive, bureaucratic, and multi-layered process involving various players in the healthcare supply chain, from manufacturers to wholesalers and pharmacies. Each milestone includes a markup, which contributes to the final price that consumers or health plans pay. 

On average, it takes anywhere from 10 to 15 years and over $2.6 billion to bring a single drug to market. The process involves extensive research, development, and regulatory approval, all of which pharmaceutical companies factor into the final price of new medications. Drugs that are innovative or lifesaving often come with higher price tags as companies aim to recoup their substantial investments.

Once a drug is developed, it is typically protected by a patent, granting the manufacturer exclusive rights to sell it for a specific period—usually about 20 years from the patent’s filing date. During this exclusivity window, the manufacturer holds the sole right to produce and sell the medication, often leading to higher prices due to the absence of competition. However, once the patent expires, competitors can introduce generic versions or biosimilars, significantly driving down prices.

The journey from the manufacturer to the consumer involves several intermediaries, each contributing to the final price through markups. After a drug is manufactured, it is sold to wholesalers, who add their own margin before distributing the medication to pharmacies. Pharmacies then apply their own markups to cover the costs of dispensing, staffing, and other operational expenses. 

Insurance companies also influence the cost of prescription drugs. They negotiate with PBMs to establish reimbursement rates for medications, which directly impacts the final cost to patients. Depending on their insurance plans, patients may face various out-of-pocket costs, including copayments, coinsurance, or deductibles, all of which influence the total price they ultimately pay for their prescriptions.

These cumulative markups mean that, by the time the drug actually reaches the consumer, its cost could be considerably higher than what the manufacturer initially set.

How Do PBMs Determine Prescription Drug Pricing?

At the root, one of the PBM’s jobs is to work with drug manufacturers to secure lower prices. This often involves rebates, where the manufacturer agrees to give the PBM a refund on the price of the drug in exchange for favorable placement on the PBM’s formulary. If a drug is included in a preferred tier, the rebate will likely be higher—meaning the potential for lower copayments for employees. 

But some (legacy) PBMs have been known to retain a portion (and sometimes all) of that cashback as profit, preventing these upfront savings from making it downstream to consumers—and bringing deep scrutiny to legacy PBMs and their practices in recent years. More than one presidential administration has highlighted the need for PBM reform, and there have been multiple investigations into how PBMs handle rebates, and whether those savings are effectively passed to patients. The Senate Finance Committee and various state legislatures have proposed or passed legislation aimed at increasing transparency and regulating how PBMs operate.

Because PBMs control which drugs are covered under a health plan and which cost tier they belong in, manufacturers will sometimes offer larger rebates to a PBM to ensure their medications are placed on more favorable tiers. This can create competition among manufacturers, which might create lower costs for employers and insurers. 

Finally, through contractual agreements, PBMs get to determine how much they will reimburse pharmacies for dispensing medications. These rates are often lower than the price the pharmacy pays to acquire the drugs in the first place, leading some pharmacies to sell at a loss. Inevitably, this affects the availability of certain medications, especially for smaller or independent pharmacies that struggle to compete with larger chains.

The Future of PBMs and Prescription Drug Pricing

Several trends are shaping the future of PBM involvement in drug pricing, but compliance, patient outcomes, and modern solutions are taking center stage. It’s such a focus, in fact, that the U.S. Congress is demanding that top executives at the biggest legacy PBMs correct “statements that contradict the Committee’s and the Federal Trade Commission’s findings about the PBMs’ self-benefitting practices that jeopardize patient care, undermine local pharmacies, and raise prescription drug prices.” 

With such deep concerns around transparency and rebate retention have come growing calls for increased regulation of PBMs. Several states have already enacted laws requiring PBMs to disclose more information about how rebates are handled and how prices are determined. Down the road, we may see more federal regulations aimed at improving transparency and ensuring that savings are passed down to consumers.

The healthcare industry is gradually moving toward value-based care, where providers and payers are incentivized to focus on patient outcomes rather than the volume of services delivered. In the realm of prescription drugs, this could mean more PBMs adopting value-based pricing models, where the price of a drug is tied to its effectiveness in improving patient health.

How SmithRx is Changing the Benefits Game

At SmithRx, transparency and fairness are only the starting line when it comes to managing prescription drug costs the right way. We're a modern PBM that passes 100% of the savings from rebates and discounts directly to our clients, ensuring that employers and their employees benefit from the best possible pricing available. Our transparent pricing model, combined with advanced data analytics, allows us to provide customized, cost-effective solutions for managing your prescription drug benefits and supporting your organization’s diverse needs.

We also offer real-time pricing data and a streamlined user experience, so employers and employees can easily track drug costs, compare prices across pharmacies, and always find the most cost-effective options. Connect with us today to take control of your prescription drug benefits and confidently provide your employees with affordable, accessible healthcare options.