Pfizer CEO Ian Read recently told investors that he believes pharmaceuticals will soon be sold without rebates. While this change, if it comes to pass, is undoubtedly positive for patients, a question naturally arises: why? After all, rebates and discounts are a normal part of most competitive markets.
The problem is that a healthy competitive process does not currently exist in the pharmaceutical market because the current market structure does not effectively account for the interests of patients, who are the ultimate consumers. Without the constraint created by an effective demand-side of the market, the current price rebates and discounts end up harming patients.
To understand why this nonsensical result emerges, it is essential to understand that PBMs have gained an unwarranted amount of market power through their control of the drug formularies. Drug formularies are the list of prescription drugs (both generic and brand name drugs) that a committee of doctors, nurses, and pharmacists (working for the PBM) decree are safe and effective. The formularies determine whether or not patients’ insurance companies will pay for the medications that their doctors have prescribed. If a drug does not have the right place on the formulary, then, effectively, a patient cannot access the medicine.
Through their control over the formularies – which is strengthened by the market concentration of the PBM industry, where the top 3 PBMs (Express Scripts, CVS Caremark, and OptumRx) control nearly 75 percent of the market – PBMs are supposedly representing the demand side of the pharmaceutical market.
The problem is that the incentives of the PBMs are not aligned with the incentives of patients. PBMs are reimbursed based on the savings they enable – PBMs earn a percentage of the gap between a medicine’s list price and its transaction price. The larger the gap between the list and transaction prices, the more revenues that the PBMs earn.
Since PBMs control the formularies, they are also able to reward the manufacturers who generate the largest gap between list prices and the transaction price. Manufacturers oblige in order to receive the right formulary placement, and because those manufacturers who don’t oblige are, effectively, shut out from their ultimate customers.
While this process sounds like it should lead to lower prices, it is leading to the exact opposite. In practice, it is easier for all industry participants to earn more money by inflating the list prices of drugs thereby enabling larger price discounts and rebates. These are rebates in name only, however, because the rebates have only been enabled by the large increases in the list prices.
By playing this game, large profit opportunities have been created that have mostly benefited the PBMs due to their control over the formulary.
The biggest losers in this system are patients. Patients co-insurance and deductibles are based on the inflated list prices meaning patients are spending more for their drugs than the medicine’s actual transaction price warrants.
Since rebates have become a means for PBMs and other middlemen to increase their revenues at the expense of patients, eliminating the current rebate practices, which has also been advocated by Health and Human Services Secretary Alex Azar, is a positive first step that will help address the problems that plague the pharmaceutical market.
Instead of paying rebates, manufacturers should lower the list price to reflect the actual transaction price of medicines. Patients’ costs would subsequently decrease because their co-insurance and deductibles would now be based on a lower list price.
However, the benefits from eliminating rebates can be reversed. For example, beyond their payment on the spread between the list and transaction prices, PBMs charge pharmaceutical companies and pharmacies all types of fees. If the lost rebates are shifted to higher fees on pharmaceutical companies and/or higher claw back provisions on pharmacies, then these higher costs will deny patients the potential savings that eliminating rebates can create.
These shenanigans exist because the rebate problem is a manifestation of the misaligned incentives that distort the current pharmaceutical market. Therefore, ensuring that the spirit of the reform is achieved also requires two fundamental changes.
First, the renumeration of the middlemen should be flat, transparent, and connected to the value-added services they provide. Second, patients and doctors must be empowered so that the consumers role is reasserted into the pharmaceutical market.
Such reforms can ensure that the rebate reform achieves its ultimate goal: provide patients with the best medicines at the lowest prices.