Senate Finance Committee Issues Testimony From University of Pennsylvania-Wharton School Professor Burns (Part 1 of 2)

WASHINGTON, June 1 -- The Senate Finance Committee issued the following testimony by Lawton Robert Burns, a James Joo-Jin Kim professor of health Care management at the University of Pennsylvania's Wharton School, involving a hearing on March 30, 2023, entitled "Pharmacy Benefit Managers and the Prescription Drug Supply Chain: Impact on Patients and Taxpayers":

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Good morning, Chairman Wyden, Ranking Member Crapo, and Members of the Committee. Thank you for inviting me to address the role of PBMs in the prescription drug supply chain. My name is Robert Burns and I am a management & strategy professor specializing in health care at the University of Pennsylvania's Wharton School. My research and teaching examine how the entire U.S. healthcare ecosystem operates; I have taught an Introductory Course on this material for nearly four decades at three business schools. I have also recently written a textbook on the topic. Another part of my research agenda examines how the institutional and retail supply chains work in the healthcare ecosystem; I have examined these supply chains since the mid-1990s and written two books on them.

To paraphrase Mark Antony in Shakespeare's Julius Caesar, 4 I come here today not to praise PBMs but to bury some concerns about them. My testimony covers three topics. Part I explains the operations of intermediaries (i.e., "middlemen") in healthcare supply chains and demystify their role. Part II explains why pharmacy benefit managers (PBMs) are not the drivers of the rising prices of brand drugs, as many allege. Part III explains the growing trend of vertical integration in the retail pharmaceutical supply chain and explores its possible impacts.

My conclusions and opinions are based on my own research, teaching, and first-hand experience with the healthcare ecosystem since my doctoral training in late 1970s. They do not necessarily represent the views of the Wharton School.

Part I : Dark Territory: Lifting the Veil on PBMs5 "Dark Territory" describes a section of railroad track not controlled by any signals. There are safety concerns due to the absence of train detection. There is a lessened ability to detect misalignment in track switches, broken rails, or runaway rail cars. It is dark and mysterious.

Healthcare's version of dark territory consists of intermediaries that connect buyers and sellers. Often, these intermediaries are widely mistrusted and vilified. They seem out of control, lack transparency and federal regulation, act in ways that reportedly threaten patient safety, make a lot of money without making anything, and are viewed with suspicion. During the 1990s, health maintenance organizations (HMOs) constituted the dark territory. The criticisms of the HMOs back then pale in comparison with the invective leveled over the past two decades at two other intermediaries: group purchasing organizations (GPOs) and pharmacy benefit managers (PBMs). Like the late comedian Rodney Dangerfield, "they get no respect". Worse yet, they serve as the 'whipping boys' of healthcare who take the rap for others.6

Last year, I published a 650-page volume that takes readers through this dark territory.7 Here, I focus my remarks on the PBMs. The allegations against PBMs include: monopoly power, anticompetitive behavior, collusion with manufacturers, exclusive contracts, financial ties with suppliers that mitigate search for the best products at the lowest cost, reduced provider discretion and patient access to needed medicines, conflicts of interest, preoccupation with growing revenues, excessive fees and profits, kickbacks, secret rebates, lack of full disclosure, harms to patient quality, and higher consumer costs. Most of these allegations can usually be found in just a single newspaper story, book chapter, or industry report. Needless to say, the authors of such stories rarely "go deep" into any of these allegations.

I approach these issues through the lens of "critical thinking". I teach my undergraduate courses at Wharton using the Socratic Method: I show students an argument that someone has proposed, and then get them to first ask the question, "Is What I Just Heard Really True?" I then spend the course training students to evaluate such proposed arguments using published research evidence (both pro and con) to thereby answer the question.

My book evaluates the claims advanced by GPO critics against several bodies of evidence. These include (1) the historical PBM chronicle, (2) the agency role that PBMs play on behalf of insurers, (3) the documented tradeoffs that PBMs make regarding access, cost, and quality while serving their insurer clients, (4) the growing concentration in US healthcare, and (5) the existential threat of supplier consolidation. I conclude that PBMs are nowhere near the villains their critics have painted them to be. They perhaps deserve a bit more thanks for the roles they perform. One should remember that the Kaiser Permanente health plans of today that policymakers laud as solutions to population health and the triple aim were the whipping boys in earlier decades.8

Some History Lessons PBM critics rarely bother to examine their history. The narrative has (until now) never been pulled together from archival and eyewitness sources, which requires a lot of homework. As former President Harry Truman said, "the only thing new in the world is the history you don't know." My recent book devotes two chapters and 115 pages to this chronicle. The lessons from this narrative do not support the allegations and conclusions of the critics.

Like GPOs, PBMs Have Historically Served the Interests of Local Providers and Health Plans

The early PBMs began as local cooperatives providing medical and pharmaceutical services to community members through prepaid groups on a capitated basis. They were less healthcare insurance and more healthcare assurance providers. They were typically organized around HMOs that provided both medical and pharmacy benefits to cover the total health care needs 4 of their enrollees under an affordable budget. The early PBMs were thus tied to health insurers, just like they are today.

Today, following the decline of HMOs, PBMs serve insurers and providers of health services but neither supply these services nor charge for them. They are at least one or more degrees of separation from where healthcare costs and quality are rendered. Efforts by critics to lay the responsibility for rising healthcare costs or harms to patient quality at the feet of the PBMs are misguided.

PBM Leverage Over Product Suppliers

PBMs sought to amass purchasing volume to negotiate lower prices from product manufacturers. HMO-PBMs combined the prescription orders of scores (and then hundreds) of physicians on their medical staffs. Both routed these orders through a centralized negotiating hub to contract as "one" with manufacturers. The game has always been one of "leverage" over suppliers to exchange higher buyer volume for lower unit price. This game became more important for survival and customer service with intensification of input cost pressures and/or reimbursement pressures. When squeezed downstream, PBMs sought to squeeze drug manufacturers upstream.

PBMs Subject to Considerable Federal Oversight

Both GPO and PBM intermediaries have been subjected to considerable scrutiny by the U.S. Congress (House and Senate hearings), the Congressional Budget Office, and various Federal Agencies such as the Federal Trade Commission (FTC) and the Office of The Inspector General (OIG). Such scrutiny led to the development of 'codes of conduct' for both intermediaries during 2004 to 2005. None of this scrutiny has since resulted in any subsequent change in legislation or regulatory oversight of either intermediary. This latter point suggests that the codes of conduct may have served their purpose, as some research suggests.

PBMs Have Utilized Many of the Same Contracting Tools for Decades Certain PBM (and GPO) practices have irritated their critics in the new millennium. For PBMs, they include drug formularies, contract administration fees (CAFs) paid by manufacturers, discounts and rebates from manufacturers, narrow pharmacy networks, and spread pricing.

What critics fail to realize is that most of these contracting tools have long been in place without causing an uproar. That is likely because these tools served the economic interests of their sponsoring organizations downstream (health plans), who developed them to deal with competitive and reimbursement pressures. Just like many contracts between buyers and sellers 5 in the private sector, PBM contracts are never publicly disclosed in order to encourage price discounting by manufacturers (and inhibit any collusion among them).

PBM Business Models Have Changed Over Time

Finally, the historical narrative demonstrates that the business models and revenue sources of these intermediaries have changed over time. PBMs are now heavily focused on the dispensing of specialty drugs, as are other players in the healthcare ecosystem. Yet, PBM critics continue to attack them regarding strategies heavily pursued in the past, particularly manufacturer rebates and pharmacy network management. Although still a sizeable portion of their revenues, such strategies and revenue sources are on the wane.

PBMs' Agency Role in Serving Health Plans

PBMs seek to exert leverage over suppliers, not over their health plan sponsors. Their actions are thus consistent with being 'agents'. Surveys of health plans confirm this agency role via high satisfaction levels and a concordance in their goals and interests. As further evidence of this agency role:

* suppliers have been historically skeptical of intermediaries like PBMs

* suppliers have sought to render them ineffective

* suppliers do not contract with PBMs when they do not have to (due to lack of competition)

* the relationships between suppliers and these intermediaries are characterized as "adversarial", and

* suppliers raise prices unilaterally 'because they can', which the PBM intermediaries seek to counteract.

* PBMs believe that supplier competition is always in their interest

Tradeoffs: The Name of The Game

Economics and the entire healthcare ecosystem are all about tradeoffs.9 For example, when one examines the different health plans that employers offer workers, those plans that offer a wider choice of providers (more open-network models such as preferred provider organizations, or PPOs) come with higher premiums - that is, PPOs trade off wider access for higher cost.

The same tradeoffs factor into the strategies employed by PBMs. PBMs (in partnership with health plans) have developed formulary tiers that allow plan participants to access the drug(s) they prefer at the cost they can afford. PBMs do not dictate the choice to their plan enrollees.

Product quality is, nevertheless, evident in the decisions made by health plan pharmacy and therapeutics committees. Such committees are heavily comprised of clinicians (physicians, nurses, pharmacists) who focus primarily on product quality, not on product cost. In other words, these committee mechanisms represent local-level decisions by clinicians on the types of products they want. PBMs are not in the business of telling doctors what they can or cannot order or prescribe. To the extent the product choice set is limited, it usually reflects committee (peer) assessments of what are comparable, therapeutically-equivalent products with no evidence-base to differentiate them.

Another area where strategic tradeoffs are evident is national versus local. The GPOs began as local cooperatives and developed contracts for local membership. The proximity and small membership size made it fairly easy to decide upon products and manufacturers to contract with. As they grew, however, the regional and (then) national GPOs faced increasing difficulty in developing contracts that all of their members wanted. The GPOs therefore embarked on several strategies that allowed members to customize contracts to suit local needs and clinician preferences, including regional GPO affiliates, assistance with custom contracting, contracting tiers, etc. The goal was to balance the economic leverage of centralized buying with access to desired products at the local level. PBMs have engaged in similar tradeoffs. They, along with their health plan sponsors, have developed national drug formularies than can be tailored or disregarded by health plans at the local level.

Consolidation

PBMs have come under fire for being concentrated sectors in which a small number of intermediaries manage the vast bulk of sales. This observation is correct. But then critics extrapolate to conclude that these huge oligopolies raise costs, harm their own members, and engage in anti-competitive practices that harm the public's welfare.

The evidence base refutes all of these charges. First, PBMs help their health plan clients by negotiating lower input prices and serve as their agents. Second, there has been no federal antitrust enforcement activity brought against these parties since the early 2000s. There has also been a vastly reduced number of lawsuits filed against them since they adopted codes of conduct in the mid-2000s. Third, the entire healthcare ecosystem and nearly all the intermediaries in the supply chain have grown more concentrated. For some reason, however, critics do not usually complain about the oligopolies among pharmacies, pharmaceutical wholesalers, and specialty distributors. If one really wants to start pointing fingers at the biggest culprits in consolidation and rising cost, one does not have to look very far: large hospital systems ("Big Med").10 11

Existential Threat of Supplier Consolidation, Concentration, And Pricing

The greatest existential threat to intermediaries such as PBMs is consolidation and/or concentration among the manufacturers upstream with whom they contract. The immediate impact is (1) a reduction in the number of suppliers available for customers to contract with, and (2) the reduction in the competitive rivalry among these suppliers.

Research suggests that pharmaceutical mergers and acquisitions (M&A) are sometimes motivated by the desire to limit competition. Researchers have found that a company is 5-7% less likely to complete the drug development project in its acquisition's pipeline if those drugs would compete with the acquirer's existing product line (i.e., "killer acquisition").12 Other research shows that M&A can result in reduced R&D spending and patenting for several years; 13 conversely, higher competition spurs R&D spending by firms.14 15

The threat of supplier concentration particularly resides in the availability of specialty pharmaceuticals, many of which are off patent. There are higher entry barriers in the biologics space due to (among other reasons) the complexity of the science, uncertainty regarding the regulatory process for biosimilars, and the guidelines for 'interchangeability'. The result is fewer competitors and little generic threat to these newer biological products. Biologics as a percentage of drug spending doubled between 2006 and 2016, from 13% to 27%. The wholesale acquisition cost of biologics is a multiple of the cost of small molecules. The approval of biologic license applications (BLAs) for new biological products has recently overtaken the approval of new molecular entities (NMEs) for traditional drugs. The threat facing payers is containing the cost of these drugs. At the same time, the distribution of specialty pharmaceuticals has become a major revenue driver for the PBMs and others.

Moreover, specialty drugs are more buffered from the effects of drug formularies and tiers. Formulary position is driven by competition within the therapeutic area. Such competition is greater in some areas (e.g., metabolic, cardiovascular, central nervous system, gastrointestinal) than in others (oncology, infectious disease, immunology, and respiratory). In the former areas, there is less clinical differentiation among drug classes and more variation in tiering; in the latter areas, there is more clinical differentiation among drug classes and much less dispersion of formulary drugs across price tiers. This reflects the considerable unmet clinical need and variation in patient response to specialty (e.g., oncologic) drugs, making it harder to restrict and/or channel physician choice among products. Finally, drugs that treat widely prevalent conditions (e.g., diabetes) and thus incur high aggregate spending are more likely to be targeted by formulary tiers than are specialty drugs that incur lower aggregate spending which are more likely to attract payer strategies such as step therapy.

Summary

GPOs and PBMs occupy parallel roles in the institutional and retail channels of the health care value chain. There are multiple similarities in their historical origin, product selection bodies, role in the value chain, role as agents for downstream buyers, business model, operating guidelines, transparency, rebates earned, cost management efforts, tradeoffs managed, and directional influence in the supply chain. These similarities are counter-balanced by their differences in channel served (institutional vs. retail), products contracted for, customer served (hospital vs. health plan), founding period, owner/sponsor, number of firms, and industry financials.

Finally, they are both intermediaries. They do not buy, sell, or price products conveyed through the supply chain. They are also not providers of health care services. Their impact on the cost and quality of care rendered to patients is thus removed from the parties who play the major roles here. The remarkable finding here is that these intermediaries may nevertheless serve the public's welfare by controlling the rise in healthcare costs.

Part II : The Brouhaha over Rebates and the Gross-to-Net Price Disparity16 Over the past few years, observers have noted not only the rise in drug list prices but also the growing disparity between gross and net prices for pharmaceutical products. As a percent of drug price growth, rebates accounted for only 6-9% during 2011-2012 but then accounted for 57-77% during 2013-2015.17 The disparity has continued. More recent data published by IQVIA show that between 2015-2018 branded drug invoice price grew between 5.5% and 11.2%, while branded drug net price grew between 0.3% and 2.9%; between 2018-2021, branded drug invoice price grew between 4.3% and 6.6%, while net price either fell or grew only modestly (2.9% to +1.7%).18 The latter data indicate that net brand prices are growing less than the annual average growth in the consumer price index, and that manufacturer rebates are partly responsible. Some health economists argue that rebates roughly constitute the difference between list price and net price.19

Indeed, a recent report by a small, provider-owned PBM (Navitus Health Solutions) shows that per-member-per-month (PMPM) drug spending for its plan sponsor clients grew only 1.5% during 2021. This (low) growth rate was driven by higher utilization (9.1% for specialty drugs, 1.3% for nonspecialty drugs) and not by unit cost (-4.8% for specialty drugs, -2.2% for nonspecialty drugs).20 Another recent report by Milliman estimates that manufacturer rebates reduced total per-capita healthcare costs by 6% ($397) in 2022.21

Some observers allege that the rise in list prices is partly caused by the higher rebates (and other payments made by manufacturers to PBMs), which are represented by the gap between 9 gross and net price. In their view, the facts that (1) higher rebates and other fees account for a higher percentage of the drug's list price increase and (2) the rebate size increases with list price are evidence of causation. The theory behind this presumed causality is that the PBMs benefit from higher rebates, and that this may encourage manufacturers to hike their list prices which leads to a win-win situation: the PBM earns more rebates, and the higher rebates earn the manufacturer a more favorable position on the formulary where they can achieve higher sales volume. These observers nevertheless admit that the lack of granular data on PBM rebates and drug prices (due to confidentialty clauses) renders this causal assertion uncertain. As the great 'philosopher' Yogi Berra once said, "In theory, theory and practice are the same. In practice, they are not."

The flaw in this causal logic is shown by several pieces of evidence. Drug manufacturers raise prices several times a year, whereas PBMs negotiate contracts and rebates every two to three years, with the rebates remaining constant during the duration of each contract. Moreover, drug manufacturers raise prices in anticipation of losing patent protection (and thus market share), in the event of filing patent lawsuits against competitors (potentially gaining share), in anticipation of a generic product entering the market (losing market share), in anticipation of new competitors entering the market (and thus losing market share), or in the event that an existing competitor pulls their product from the market (gaining market share). In general, drug manufacturers raise prices because they can - - e.g., when they enjoy more of a monopoly position in their therapeutic category, when they have superior marketing, when their product is a physician preference item (PPI), and when their product has brand preference among patients. Most health economists acknowledge that drug manufacturers control list price.

Multiple factors have contributed to the growing spread between gross and net drug prices (known as the gross-to-net disparity). First is the growing consolidation of the PBM sector. PBM consolidation was legitimated by the Federal Trade Commission's (FTC) sign-off on Express Scripts' (ESI) acquisition of WellPoint's Next Rx in-house PBM in 2009, and the market valuation placed on Next Rx's business.22 This consolidation accelerated in the 2012-2015 period, led by ESI's acquisition of Medco (2012), Catamaran's acquisition of ReStat and TPG's acquisition of EnvisionRx (both in 2013), and then Optum's acquisition of Catamaran (2015).23 By 2017, the top three PBMs commanded 71% of the market (measured in scrips): CVS (25%) ESI (24%), and Optum (22%). The top 7 PBMs controlled 95% of the market. This market concentration of buyers allows PBMs and health insurers to extract large discounts in price from manufacturers in exchange for a drug's position on the formulary. This is a major driver of drug rebates (discounts on list price) paid to the PBMs.

Second, complementing the growing concentration on the buyer side (PBM market), there can be growing competition on the supplier side in the form of competing pharmaceutical products. This is also referred to as "crowded therapeutic categories." Such product competition gives PBMs and health insurers leverage over manufacturers by virtue of playing one manufacturer off another and threatening to move market share to the manufacturer who offers better terms (including higher rebates).

Third, beginning around 2012, but picking up around 2014, PBMs began to utilize the strategy of "formulary exclusion" whereby manufacturers are threatened with product removal from the PBM's national formulary.24 CVS/Caremark removed 34 brand-name drugs from its standard national formulary in January 2012, and added another 17 drugs to the exclusion list in 2013; ESI followed CVS' example in 2014. Both PBMs have added more drugs to the list over time. Optum, Prime Therapeutics, Aetna, and Cigna embraced drug exclusions by 2016.

Such a strategy works in the presence of therapeutically comparable brand-name drugs. In 2016, more than 50% of the commercial market was covered by plans with formulary exclusions. Note that exclusions block access to specific products on a PBM's recommended national formulary; they are, thus, suggestions rather than mandates. ERISA Plan Sponsors and health insurers can ignore the PBM's national formulary, but then face reduced rebates and/or higher plan costs. They, thus, tradeoff higher access to drugs for higher costs incurred - - much in the way that formularies financially reward patients for selecting generic and lower-tier drugs with lower costs, while allowing access to additional drugs on higher tiers but requiring patients to face higher costs via higher copays or coinsurance. Nevertheless, the prospect of exclusion leads manufacturers to offer larger rebates. A precipitating event here was the introduction of AbbVie's Hepatitis-C drug Viekira Pak to compete with Gilead's Sovaldi and Harvoni. The number of products on the formulary exclusion lists for two PBMs (CVS and ESI) has grown steadily since 2012.25

Fourth, statutory rebates are another large driver of gross-to-net discounts. The Patient Protection and Affordable Care Act (PPACA 2010) increased the mandatory rebates that pharmaceutical manufacturers must pay under the Medicaid program. For single-source (nongeneric) drugs, the Unit Rebate Amount (URA) increased from 15.1% of a product's average manufacturer price (AMP) to 23.1% of AMP. It also required manufacturers to provide rebates in the Medicare Part D coverage gap. The Bipartisan Budget Act, signed into law in February 2018, increased these discounts. Rebates and other channel discounts to PBMs and pharmacies constitute "Direct and Indirect Remuneration" (DIR) payments made to Part D Plan Sponsors. These payments were stable from 2010-2012 but began to accelerate beginning in 2013. DIRs help to create a gap between list and net prices.

Fifth, the pharmaceutical industry experienced steep patent cliffs in 2012 and 2015, and much higher level of patent expiries in the period 2013-2019 compared to earlier levels (e.g., 2010).26 Attending these patent expiries was a wave of new generic drugs entering the market. The advent of biosimilars in the biotechnology market constituted a parallel development, but on a smaller scale. Research documents that drug prices decrease markedly after patent expiration.27 In 2017, the generic dispensing rate - - the percentage of drug prescriptions dispensed with a generic drug instead of a branded drug - - was 90%. The rise in generics and generic dispensing rates occasioned a slowdown in the price growth of branded drugs.

Sixth, the same increase in rebates has been observed in Medicare Part D. Between 2006 and 2020, Part D drug rebates as a percentage of total drug costs rose from 8.6% to 27.0%.28 This is relevant since PBMs, which administer the drug benefit, retain less than 1% of these rebates and thus do not benefit. Instead, analysts point out that the growing Part D rebates are tied to competition among manufacturers within a given drug class to get on the formulary.29 Research by Milliman shows that, among drugs with rebates covered under Part D, rebates as a percentage of gross drug costs reached 39% in the presence of direct brand competition.

Rebates reached 34% when there were 3+ competitors including a direct generic substitute, 27% when there were 1-2 competitors with a direct generic substitute, and only 23% in the absence of direct brand competition or a generic substitute.30 Seventh, the growth in the gross-to-net difference observed over time has been driven not by commercial rebates but instead by Medicare Part D rebates and 340B discounts.31 According to Adam Fein, the gross-to-net difference in the price of branded drugs reflects a declining share in commercial rebates (22% of difference in 2021, down from 27% in 2017), a rising share in Part D rebates (23% of difference in 2021, up from 19% in 2017), and a sharply rising share in 340B discounts (20% in 2021, up from 10% in 2019).

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Eighth, there is correlational evidence of an association between rebates and list prices, and an association between increases in rebates and increases in list prices. However, the evidence here is not consistent, and can oftentimes suggest no relationship at all.36 Moreover, the researchers who report these findings are somewhat circumspect in their conclusions, arguing that to the degree that PBMs retain rebates (rather then pass them along to health plans) "a higher list price might generate more revenue for PBMs" [italics added].37 Some of my researcher friends similarly hedge their bets, stating that rebates are "probably at least partially responsible for the faster increase in list prices than in the amounts received by drug manufacturers (net prices)" [italics added]. They are also quite clear in stating that rebates have moderated the growth in drug prices.39

Ninth, and finally, there is growing research evidence that a main driver in the list prices of brand drugs is not PBM rebates but rather federal reimbursement policies. Economists suggest that Medicare Part D dynamics encourage growth in list prices and thus in rebates. These dynamics include Part D benefit design and beneficiary cost-sharing. The Federal Government is at greatest financial risk for high drug spending in Part D by virtue of shouldering 80% of costs in the catastrophic coverage phase, thereby encouraging higher list prices. Via this mechanism, Part D cost-sharing and beneficiary out-of-pocket costs are tied to list price.40 13

In a similar vein, the Congressional Budget Office (CBO) recently concluded that Medicaid's statutory rebates provide incentives to manufacturers to negotiate higher prices with commercial insurers as well as employ higher market-wide launch prices. The CBO's causal argument is as follows: more people covered by public insurance (such as Medicaid) leads to more third-party (public) coverage of drug spending which, in turn, means more patients less exposed to high drug prices and more willing to buy high-priced drugs - - all of which alleviates pressure on manufacturers to restrain their price hikes.41 The cause is not PBM rebates, but rather moral hazard resulting from public insurance coverage. This last point suggests that - - to paraphrase the old comic strip Pogo - - we have met the enemy and the enemy is us. Rising prices and out-of-pocket of costs may have been unwittingly induced by Federal payment policy.42

All of these factors contribute to gross-to-net discounts. These discounts accelerated from 2014 through 2019.43 The majority of these gross-to-net discounts were not realized by PBMs and other drug channel participants such as wholesalers and pharmacies, but rather were realized by public and private payers (62%). Researchers estimate that pharmacies capture the bulk (15%) of the remainder, with PBMs (5%) and wholesalers (2%) capturing much less.44 45

This means that ERISA Plan Sponsors and the health insurers they contract with realized large discounts off of drug list prices, which accounts for the majority of the growing gross-to-net disparity. This is reflected in data for both small and large employers that capture the rebates flowing back to the ERISA Plan Sponsors in 2021.46 The data indicate that a growing percentage of both smaller and larger employers are receiving 100% of the rebates negotiated by their PBMs. Among larger employers, the 100% pass-through is by far the most common rebate arrangement; a majority of smaller employers also received 100% pass-throughs, but nearly one-quarter receive a percentage share of rebates.

The question is what did ERISA Plan Sponsors and health insurers do with the rebates (savings)? The rebates can be used in a number of ways, according to insurance executives.47 First, they can be used to offset the healthcare costs generated by employees (or plan members) and thereby reduce their insurance premiums; this approach benefits everyone. Second, they can be used to fund employer wellness programs, which also benefits all members. Third, they can be used to finance patient engagement programs which extend enhanced benefits to those choosing more cost-effective plans or those more compliant with their medications. Alternatively, the rebates can be used to lower patient copays for members using specific drugs or reduce the prices paid at point-of-sale; this benefits specific members.

PBMI survey data suggest that the vast majority of employers (68%) use the rebates to offset the overall plan costs to the employer, especially their own spending on drugs.48 By contrast, a smaller percentage of employers (11%) use the discounts to reduce the premiums of their employees (11%), a strategy that benefits all workers. A small percentage of employers (15%) split the savings with employees, or reduce employee out-of-pocket costs at the point-of-sale (4%). This means that employers use the discounts generated by their employees with more severe illnesses that require expensive drugs (which earn higher rebates) to cover their overall health expenditures rather than benefit the employees who generate the rebates. The irony, according to industry analysts, is that the employees' actual out-of-pocket costs are set by their insurer and ERISA Plan Sponsor. It is not the PBMs, but rather the Plan Sponsors and health insurers who elect not to share the rebates directly with employees.49

Over time, employers' drug benefit designs have shifted out-of-pocket spending from flat copayments to deductibles and coinsurance arrangements. By 2019, more than half of all consumer out-of-pocket spending on prescription drugs was for coinsurance or deductibles, both of which are tied to list price.50 Evidence shows the decline in cost-sharing using copayments, the rise in cost-sharing using coinsurance when employer plans include high deductibles, by drug tier, and the dollar amount of cost-sharing by drug tier for both copayment and coinsurance. Moreover, over time, the percentage of ERISA Sponsor Plans with pharmacy benefit deductibles has risen. These deductibles can be separate from or combined with the medical deductible.51

A recent survey of large employers by the National Business Group on Health suggests some change in employer sentiment here. In 2019, 18% of employers reported having a point-of-sale rebate program in place; 2% said they were implementing a program in 2020, and another 40% were considering such a program for 2012-2022.52 Such programs pass the rebates directly to the employee at point of purchase. Such point-of-sale programs are most appropriate when the employee is filling a prescription during the deductible phase of coverage or when paying a coinsurance. As industry analysts make clear, this decision about point-of-sale programs is at the discretion of ERISA Plan Sponsors and the health insurers they contract with. These two parties choose the overall prescription drug benefit that is offered to plan participants, which can include: which drugs are covered, the different levels of cost-sharing, the number of pharmacies available to participants, and the incentives for using certain network pharmacies.

These choices reflect the tradeoffs that ERISA Plan Sponsors and health insurers make between access, quality, and cost. These two parties then contract with PBMs to administer their prescription drug plans and implement the choices made by Plan Sponsors.

Part III : Vertical Integration Along the Retail Pharmaceutical Supply Chain53 Adam Fein at Drug Channels has continued to update researchers and policy-makers on the growing consolidation of diverse players operating in the retail pharmaceutical supply chain.

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We do not know whether the vertical chains in the Figure above are pro- or anti-competitive. There are no data on the costs, prices, or other performance metrics resulting from these combinations. Researchers acknowledge that "it is well known in antitrust economics that assessing policies in industries with important vertical relationships is challenging ... Even in the presence of reliable data, how vertical relationships affect consumer welfare is generally theoretically ambiguous, and under various models of supplier behavior, stronger vertical relationships can greatly improve consumer welfare or greatly harm it."54

Some observers look at this chart and quickly conclude that the emergence of such behemoth, bureaucratic intermediaries may not be good for the public. Even a seasoned analyst such as Adam Fein suggests, "These organizations are poised to exert greater control over patient access, sites of care/dispensing, and pricing."55 At the same time, Fein argues that whether they do or can exercise such control is pure speculation. Other researchers go further, concluding that competing value chains such as those depicted above might serve as the new basis of competition in an ecosystem that is quickly consolidating.56 This sounds like a great topic for critical thinking.

The Key Issue in Vertical Integration: Make versus Buy

The type of combinations depicted in the Figure above are known as "vertical integration". Management researchers often argue that the central decision in corporate strategy concerns "make versus buy": i.e., make it in house or buy it in the marketplace. The choices are also known as "insource versus outsource". There are advantages to each approach such as: use the company's managerial hierarchy versus market forces to coordinate the two parties' behaviors, seek the advantages of collaboration versus the benefits of specialization, diversify versus focus, etc. With regard to pharmaceutical benefits, the two approaches are known as "carve-in" versus "carve-out".57 There is no clearly-defined calculus regarding which option to take in the make-vs-buy decision. One has to calculate the costs and benefits of each option - - and be satisfied with the tradeoffs. In the absence of data on costs and prices, no one that I know of has made these calculations for the vertically integrated firms depicted here.

It is important to note that, historically, the players in the retail pharmaceutical supply chain have taken both approaches. For example, the PBM sector began using a carve-in approach when staff model HMOs served as their own pharmacy benefit managers working under a capitated budget constraint.58 The objective was to provide comprehensive coverage of both inpatient and outpatient services, including prescription drugs, at an affordable cost ("assurance" rather than insurance). Standalone PBMs that originally developed as staff-model HMOs waxed and waned in popularity. Later PBMs evolved a different set of benefits and services that attracted both employers and health plans as clients; while some PBMs could be carved in, many were carved out of the health plan. United's acquisition of Pacificare in 2005 marked the beginning of the current trend to the carved-in approach (a return to the roots).

United's move was motivated by its desire to acquire Pacificare's health plan operations; the PBM came with the deal. By virtue of acquiring Pacificare's 3.3 million enrollees, United increased its enrollment stature (25.7 million lives) relative to its larger competitor Wellpoint (27.7 million lives), diversified geographically into the West (where Pacificare was located), gained traction in the Medicare risk market, and helped it to prepare for the coming Medicare drug benefit. The deal was also part of the M&A frenzy among health plans in the 2005-2006 era.59 Thus, the sector has experimented with both approaches over time, oftentimes based on historical circumstances, opportunities, or rationales specific to that point in time - - but not necessarily to get into the PBM business.

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(Continues with Part 1 of 2)

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Original text here: https://www.finance.senate.gov/imo/media/doc/Lawton%20Robert%20Burns.Senate%20Testimony.March%202023[1].pdf