Last month, I spoke before a committee of the Ohio Senate on the proposed child tax credit, a topic we have done a bit of work on in the past.
The state Child Tax Credit was originally proposed in the Governor’s executive budget, but has not been included in the House or Senate versions of the bill. Nonetheless, if there is a place for the Child Tax Credit to come back, it will be in the budget bill.
Because of this, people testifying on the child tax credit sat in these hearings alongside people testifying on a range of different issues, from local control of cannabis to the tax rate for sports betting. One topic in particular that took up a lot of time while I was waiting was debate about regulation of pharmacy benefit managers.
I will admit, I was not very familiar with pharmacy benefit managers (who were often referred to as “PBMs,” a phrase I will not use) when I attended this meeting. While I may have heard of them in passing before, I certainly could not have told you what the acronym stands for if I was asked. But I have come to learn the importance of these players in drug markets and why state lawmakers are paying more and more attention to them.
Pharmacy benefit managers are “middle men” who manage prescription drug benefits on behalf of insurers, employers, and government programs. Pharmacy benefit managers originated in the late 1960s, beginning with the creation of the first plastic benefits card by Pharmaceutical Card System Inc., which routed paper prescription claims. These organizations got a boost from the 1974 Employee Retirement Income Security Act, which allowed large employers to develop and deploy cost-containment strategies for their covered population including hiring pharmacy benefit managers to manage their prescription drug benefits. By the 1980s, pharmacy benefit managers had emerged as major intermediaries in health care, adjudicating claims and negotiating drug benefits on behalf of insurers and employers.
Pharmacy benefit managers have a range of key roles. They negotiate drug prices and rebates with manufacturers on behalf of insurers, employers, and government programs. They create and manage lists of drugs covered by plans. They also manage networks of pharmacies covered by health insurance plans. On the ground, they cover processing and reimbursing claims.
Pharmacy benefit managers can drive up drug pricing through a range of strategies. While many pharmacy benefit managers “pass through” the costs of their drugs and charge a fee, others have a “spread pricing” scheme where they charge health plans more than they reimburse the pharmacy and pocket the difference. Pharmacy benefits managers also often negotiate for rebates from manufacturers that do not get passed on to patients or health plans and have contracts that reward them for choosing more expensive brand-name drugs over equally-effective generic drugs. Many of these negotiations happen confidentially as well, keeping the status of savings obscured from patients, pharmacies, health plans, and manufacturers and creating a further incentive for pharmacy benefit managers to drive up the price of drugs.
Another tool of pharmacy benefit managers to capture rents is vertical integration. When a pharmacy benefit manager is owned by the same company as a pharmacy, that can allow them to exercise more market power on other independent pharmacies and drive up prices to capture rents for themselves. This drives up prices without making the market more efficient.
This matters a lot to state and local governments because of how entwined the public sector is with the health care system. Public employee health plans often contract with pharmacy benefit managers. Medicaid programs often use them, especially when they utilize managed care models where they are contracting management to private companies. When costs are hidden, they can lead to higher costs for the public that are not driven by efficiencies, but instead by exploiting information asymmetries between pharmacy benefit managers and public sector health plans. This can lead to higher costs for governments, which can strain their budgets, causing them to allocate funds away from other programs or resort to raising more revenue through taxes.
This has led to some actions by state governments. In 2018, the state of Ohio terminated a number of contracts with pharmacy benefit managers due to spread pricing schemes. Arkansas has banned spread pricing, a policy that has been upheld by the U.S. Supreme Court, and is now in legal battles with pharmacy benefit managers over its ban on vertical integration of pharmacy benefit managers and pharmacies. West Virginia moved pharmacy benefit management for Medicaid in-house in 2017, ensuring its state Medicaid program would not be left in the dark on how benefit management impacts drug prices.
Policymakers interested in ensuring efficient drug markets have some options at their disposal. Almost every state (Ohio one of the six exceptions) has made it illegal for pharmacy benefit managers to contractually obligate pharmacists to push more expensive drugs on clients. 35 states (Ohio also not included) have limits on the amount patients are required to pay for medications. 33 states (nope, not Ohio) require pharmacy benefit managers to be licensed or registered with the state.
About half the states prohibit discrimination against non-affiliated pharmacies, eroding the power of pharmacy benefit managers to drive up prices through vertical integration. About half also require pharmacy benefit managers to report rebate information to the state. Sixteen states have made it harder to or banned the practice of spread pricing.
Pharmacy benefit managers provide an important service by negotiating prices for drugs between health plans, pharmacies, and patients. Without proper oversight, though, pharmacy benefit managers can and do reduce system efficiency and capture rents. Like any market, if one participant in the market has significantly more information than another participant, they have incentive to abuse the market, capture rents, and create inefficiencies that drive up costs without delivering value to society. State policymakers have the ability to regulate pharmacy benefit managers to ensure that drug markets operate efficiently and that prices aren’t unnecessarily high for consumers and the public.