What Is a Pharmacy Benefit Manager (PBM)?

The pharmacy industry has changed dramatically over the years, with new drug alternatives, technology, and processes constantly being introduced to an already complex system. One of the roles that emerged with this evolution is the pharmacy benefit manager (PBM), which helps determine prescription drug lists and prices. 

However, all these changes have only served to make the pharmacy industry more labyrinthian, resulting in employers and consumers shouldering more of the costs with little idea of what goes on behind the scenes. 

That’s why it’s crucial to understand what a PBM is — they play an outsized (and not always positive) role in prescription drug plans today. In this post, we’ll explore what pharmacy benefit managers do, how they operate, and why the larger, legacy PBMs pose an issue for the industry. 

Pharmacy Benefit Managers Defined 

A pharmacy benefit manager, or PBM, is a third-party entity that acts as a middleman between drug manufacturers, insurance providers, employers, and more. Some of the services that PBMs provide include creating and maintaining formularies, negotiating drug prices and rebates, creating pharmacy networks, and processing claims.

Their services were born out of legitimate need. Back in the 60s, pharmacies struggled to work with health plans to determine the correct amount to charge for prescription medications– they simply weren’t set up for this type and volume of collaboration. The original PBM was supposed to be an answer to this problem: a middleman designed to save the day by doing all the administrative work needed behind the scenes in order to help pharmacists charge appropriately.

And now? PBMs have been making the news for all the wrong reasons. Rather than maintaining their straightforward administrative role, legacy PBMs began expanding their control through vertical integration, leading to today’s 80% ownership of the market. With so much influence, they’ve been able to obscure the details of their negotiations, making it difficult for employers, insurers, and pharmacies to understand how much of a drug’s rebates the PBM pockets for themselves and how much (if any) gets passed through to members. 

Let’s explore the largest PBMs in more detail.

Who Are the 3 Big PBMs?

Today, the three largest pharmacy benefit managers are CVS Caremark, Express Scripts (owned by Cigna), and Optum Rx (owned by UnitedHealth). So how did they get so large? 

Traditionally, PBMs operate with a discount-based price evaluation model. However, this model meant that whoever could drive the biggest discounts would naturally get more customers. As a result, drug prices started to increase because all that mattered was who could negotiate the largest rebates, not what the drug price itself was. 

That’s where the vertical integration comes in. Caremark, Express Scripts, and Optum Rx (among others) consolidated with huge drug and healthcare companies to be able to swing negotiations in their favor. With PBMs, insurers, specialty pharmacies, and provider services all under the same umbrella, the big three can better prioritize formulary drugs that provide bigger rebates — and profits. 

How Do PBMs Make Money?

While legacy PBMs claim to optimize pharmacy benefits, their main revenue streams can create complex incentives. To understand how PBMs impact drug costs and access, it's crucial to examine a two primary profit sources:

Rebates and Discounts 

Rebates and discounts are financial incentives that PBMs negotiate with different parties in the pharmaceutical supply chain:

• Manufacturer Rebates: Drug manufacturers pay rebates to PBMs for including their drugs on formularies (preferred drug lists). These rebates are usually based on volume - the more prescriptions filled, the higher the rebate. They typically apply to brand-name drugs.
• Pharmacy Discounts: PBMs negotiate discounts with pharmacies in their network, reducing the price they pay for dispensed drugs.

Both rebates and discounts can lower the net cost of drugs. However, legacy PBMs may not always pass the full value of these savings to plan sponsors or patients. The amount retained by the PBM becomes a source of profit.

Key Considerations

• Generated by manufacturers and pharmacies
• These arrangements can incentivize PBMs to prefer higher-priced drugs that offer larger rebates over less expensive alternatives.
• Often lack transparency; actual amounts may not be fully disclosed

Spread Pricing

PBMs charge health plans more for a prescription drug than they reimburse the pharmacy, keeping the difference (the "spread") as profit. This practice can lead to higher costs for health plans and patients.

For example, let’s say a PBM pays a pharmacy $50 for a prescription. The PBM then bills the plan sponsor $60 for the same prescription, pocketing the extra $10, or spread. 

Key Considerations

• Generated by the PBM itself
• Occurs at the point of transaction
• Based on the difference between what the PBM pays and charges
• Even less transparent; plan sponsors often unaware of the actual cost paid to pharmacies

The Relationship Between Insurers and PBMs

To summarize, PBMs are chosen to act on behalf of insurers in negotiating agreements with drug manufacturers. PBMs determine which drugs make it on a health plan’s drug lists, then get paid in rebates by the drug manufacturers (some of which they’ll keep as profits). 

Then, the PBMs will reimburse pharmacies a certain amount while charging the insurer for the drug (and with spread pricing, these may not always be the same).

As you can see, it’s a complex system with many touch points along the way where PBMs can extract big profits. 

What Is the Problem With PBMs?

All of these profits are great for PBMs…but not for everyone else. Practices such as spread pricing only serve to increase drug prices, making it harder for consumers to afford the medication they need. And, because the largest PBMs are driven by their bottom line, they also aren’t incentivized to change their practices or try to lower drug prices. 

Additionally, PBMs have been criticized for lacking transparency. This problem is compounded by the vertical consolidation among the largest PBMs, where they can make contracts more convoluted and hide all the fees they pocket. A major contributor to this is the use of discount-based pricing — PBMs can manipulate the numbers to make it seem like the large discount they provide is a deal when in reality they’re keeping a larger percentage. 

Finding a New Path Forward With PBMs

It’s clear something needs to change with PBMs, but what can be done? You’ll want to look for PBMs that operate on transparency. In particular, PBMs that use cost-based evaluation will always look for the lowest price (instead of the best “deal”). Ideally, PBMs will use streamlined pricing — like a per member, per month (PMPM) model — to make it easier to understand the value you’re getting in the healthcare process. 

With a simple fee structure, PBMs can also pass through more (if not all) of the rebates they get from drug manufacturers, ensuring employers can reduce the overall costs for their business and for their members.

If you’re ready to stop paying more for drugs, learn how SmithRx is bringing transparency to the pharmacy industry.