Formularies, Rebates, and the Economics of PBM Bargaining

Abstract

For 181 million Americans not on Medicare or Medicaid but insured through their employer, labor union, or private insurance health plan, the primary restraints on pharmaceutical prices are pharmaceutical benefit managers (PBMs) who administer health plan drug benefits. PBMs use the aggregate demand of their constituent plan sponsor clients — employers, unions, government agencies, health insurers, and others — to negotiate lower prices.

Recently, the use of formularies and PBM-negotiated rebates have come under fire. Critics allege PBMs act to maximize rebates rather than reduce prices, and that rebates lack transparency, contribute to increasing prices, and are not passed on to the benefit of patients. Yet, sophisticated plan sponsors have choices in how to administer their prescription drug benefits and almost all choose to hire PBMs to manage their drug benefit rather than internalize drug procurement, negotiation, clinical evaluations, and benefit administration.

This report examines the role of formularies and rebates in the provision of prescription drugs. We respond to the criticisms of PBMs by discussing the often misunderstood principles of formulary management and rebates and how they are essential parts of the bargaining process between PBMs and pharmaceutical manufacturers. We demonstrate that economic logic and evidence, as well as multiple investigations by independent and government groups, find that PBM bargaining reduces drug prices.

Keywords: drug pricing, pharmacy benefit managers, PBMs, rebates, formulary design, prescription drug market

JEL Classification: C70, D4, I11, I13, I18, L1, L42