Pharmacy Benefit Managers: Complete Scam or Genuine Need?

Over recent weeks, a past and future president of the U.S. called out the middleman of big pharma: pharmacy benefit managers. He stated that we have a “middleman, that makes more money than the drug companies, and they don’t do anything… We are going to knock out the middleman” (NACDS). PBMs are “third-party companies that function as intermediaries between insurance providers and pharmaceutical manufacturers,” according to the National Association of Insurance Commissioners. These entities are responsible for “creating formularies, negotiating rebates with manufacturers, processing claims, creating pharmacy networks, and reviewing drug utilization” (NAIC). According to Trump, these middlemen are responsible for “driving up prescription drug costs and denying consumers access to vitally needed medications” (Stat News). In general, the veil of healthcare is being pierced further with time, as its final, and some would say, sole intended beneficiaries of the system become more scrutinous over pricing.

Historically, “big pharma” has behaved in an unscrupulous manner. Gag clauses in agreements between PBMs and pharmacies used to prevent pharmacists from informing customers when the cash cost of a drug was less than their copay (NAIC). PBMs have existed since the 1960s, but the deceptive gag clauses were only banned as recently as 2018, by the Patient Right to Know Drug Prices Act. This was one product of Trump’s initial push against PBMs, which is likely to resume over the next four years. Even if no deceptive practices occurred, PBMs would still increase drug prices for the average American. Trump clearly claims that they are unnecessary and should be cut out altogether. So, I will delve into the details of PBMs nationwide, in an attempt to evaluate with clear rationale whether or not these businesses bring a net positive to the healthcare industry, or any positives at all. Then, I aim to develop a reasonable prediction of the effect PBM regulation and/or dissolution will ultimately have on PBM owners, such as CVS and UHG.

The core provisions of a PBM to the broader industry are as follows: the development of formularies, which dictate whether individual drugs are covered by insurers; utilization of their purchasing power to negotiate rebates from drug manufacturers; and direct contracting with pharmacies to reimburse for drugs dispensed to beneficiaries (Commonwealth Fund). They do take on an important role–but is the middleman necessary to optimally perform these duties? Could they be surgically removed from the industry, allowing for direct business relations between pharmacies, insurers, and drug manufacturers, and lowered costs for consumers?

PBMs, particularly those who hold substantial market share, have a high degree of purchasing power. As they represent vast amounts of employers and insurers, and the buying power of all the health plans said entities manage, they can talk down the price of drugs from wholesalers. However, there is a principal-agent problem. Healthcare recipients naturally want the prices of their drugs to be as low as they possibly can be, so long as the drugs remain equally effective. Yet, PBMs have a contradictory motivation to purchase more expensive drugs–they receive discounts on the manufacturer’s list price, which they of course retain a cut of.

Typically, the higher the drug price, the higher the cash amount of a rebate. This is predictable, as an offered discount percentage can often remain constant across a family of products, all of which are priced differently. The higher the price, the more attractive the rebate received by the PBM. As a result, the “purchasing power” of a PBM leads to the payment of quasi-bribes by manufacturers. Since the PBM creates the formulary, they can make whomever offers the best rebate (by gross cash value, rather than percentage basis) the sole approved provider of a given drug, for a health plan that millions of consumers hold. Again, the attractiveness of a deal to a PBM depends not on the dollar cost of the drug, but the dollar value of the rebate. After all, the PBMs themselves do not buy said drugs, and are therefore not affected by a higher per unit cost. Pharmacies and insurers pay that cost–therefore, end consumers pay, because product cost is funnelled straight to them through copays and insurance premiums. PBMs simply negotiate discounts and process claims in return for kickbacks, formulary management, and other perks.

The size of this cut has been debated. A government accountability office report asserted that the retained share is as low as 1%, with the remainder being passed on to health insurers. However, one former PBM employee claimed that the pocketed share is closer to 20%. The accurate number remains largely unknown. PBMs already charge a fee to insurers for their services–a withheld percentage of rebates only adds to the negative impact on drug costs. Naturally, any increase in costs is immediately passed through the insurer, as well as the pharmacy, to the insured, resulting in higher insurance costs in general. For the most part, no company willingly eats an increase in their cost of operations. They pass it on. So, if a pharmacy benefit manager stands between rebates and the ultimate intended recipients of said rebates, taking a cut for themselves, it of course causes problems for the end consumer.

The question is whether the industry could achieve equal or better rebates without these PBMs. Would the standard rebate size diminish in a manner harmful to consumers without the negotiation tools and leverage employed by PBMs? Or could pharmacies and insurers band together on their own to pool their purchasing power and get the same deals? Sure, there stands the risk that even if they could, they’d simply keep end prices the same and pocket the extra rebate for themselves. However, the public eye has been on the healthcare industry for some time. So, if that were to happen, the target of scrutiny would simply shift from PBMs directly to pharmacies and insurers.

In the end, the so-called leverage of the PBMs is based not on the quantity of drugs they are able to buy, but upon the fact that they write formularies and can guarantee a higher-priced drug a degree of market share, if the manufacturer is willing to offer a competitive kickback. If PBMs were done away with, certainly, individual insurers or pharmacies would have less negotiating power on the individual level. However, in the event of PBM dissolution, the reintroduction of the competitiveness of generic drugs in the industry, which cost far less, could easily result in as much or more of a price decrease at the top line. Without PBM control over formularies, the generic drugs would be more competitive once more.

Even if a less drastic step were to occur, for example, if PBMs were to lose the ability to receive kickbacks on rebates, things would be far better–because PBM interests would become more aligned with end-consumer interests. They’d simply be motivated to find the lowest cost, yet still effective drugs, to satisfy their customers. Without rebates, they would solely generate revenue through consistent fees on each deal, limiting their revenue prospects to the number of customers they can attract. It seems to be clear that the leverage PBMs possess, in terms of purchasing power as well as formulary development, in conjunction with their commanding of rebates, does not guarantee better outcomes than might occur in the absence of these managers. In fact, by sheer common sense, these realities nearly guarantee a worse outcome.

Now, let us examine the other role of PBMs. On top of their dealmaking role with big pharmaceutical manufacturers, they craft agreements with pharmacies regarding their received rebate percentage, and transfer reimbursements from insurers to pharmacies. This region of the conversation will take far less time to cover, as it ties in quite nicely with the prior section. Put simply, pharmacies buy their drugs from wholesalers, who in turn purchase from a manufacturer. They make their purchases at the manufacturer’s list price. However, contracts between all parties with PBMs guarantee a given percentage rebate to be received, often at a later date.

Say a PBM secures a deal for a 16% rebate with a manufacturer. PBMs may, through a contract with a pharmacy, then offer to reimburse them 14% on drug costs incurred with that producer. In return for the reimbursement, pharmacies agree to solely fill prescriptions with the drugs on the formulary. To reiterate from earlier–I provide this illustration to simplify the workings behind the scenes, but the rebate granted directly from the manufacturer to the PBM is usually not divulged to the pharmacy, leaving the profit spread unknown. The pharmacy would be informed that a 14% rebate had been successfully negotiated, but the rest of the information would remain enshrouded.

It seems that the industry could certainly do without this middleman. At the very least, substantial modifications to the workings of PBMs seem perfectly reasonable. Proposed reforms, assuming the continued existence of PBMs, include a mandate that 100% of rebates be passed through, that they may bring maximum benefit to the end consumer. Additionally, they suggest that PBMs be prohibited from utilizing a pricing spread to profit at the patient’s expense (AJMC). They tend, currently, to charge health plans slightly more than they reimburse pharmacies for filled prescriptions, pocketing the difference.

Now, assuming these reforms are implemented, how might they impact CVS Caremark, UnitedHealth Group’s OptumRx, and other PBMs? Well, the measures within the bill, even if it is passed, will not be brought into effect until two and a half years pass (Managed Healthcare). Still, the PBM industry is worth billions of dollars, so it will naturally take time for them to shift into compliance. Changes may begin occurring not long after the bill’s passage. If PBMs are required to quit taking cuts off the discounts, it would hurt their parent companies significantly. A cursory look over CVS Health’s annual report displays that the Health Services division was responsible for just shy of $190 billion in revenue (Annual Report). CVS Caremark, the PBM subsidiary, makes up the majority of this. That is more than half of CVS’ total revenue in 2023. As one would expect, even a small decline of those revenues will eat substantially into CVS’ income statement.

CVS does have a high dividend at the moment, however, and their market cap is sitting at one seventh of its revenue, at a P/E ratio of 11. So, it seems unclear for now as to whether the PBM reform will be a catalyst to drive the stock even lower, or instead the stock has already found its lowest point. All in all, these reforms are bound to impact those companies with large PBM divisions. It will be for the consumer’s best interest. However, it is hard to evaluate exactly the degree to which the corporations will be harmed. Due to the historical lack of transparency on kickbacks and fees, even the lone requirement of 100% rebate passthrough may make far more difference than we expect.

Even still, the market does tend to price in expected boons or pitfalls to a company long in advance. As it seems near guaranteed that PBM reform, at the least, will happen, the argument could be made that these events are already reflected in the stock price. However, as always, any investor must perform their due diligence in order to determine the veracity of a stock thesis.

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Works Cited

Grossi, Giuliana. “Year-End Spending Bill to Feature Reforms for Pharmacy Benefit Managers and Telehealth Access.” AJMC, 18 Dec. 2024, www.ajmc.com/view/year-end-spending-bill-to-feature-reforms-for-pharmacy-benefit-managers-and-telehealth-access. Accessed 3 Jan. 2025.

“Insurance Topics | Pharmacy Benefit Managers | NAIC.” Content.naic.org, 1 June 2023, content.naic.org/insurance-topics/pharmacy-benefit-managers.

Myshko, Denise. “PBM Reform Is Part of Congress’ End of Year Bill.” Managed Healthcare Executive, 17 Dec. 2024, www.managedhealthcareexecutive.com/view/pbm-reform-is-part-of-congress-end-of-year-bill. Accessed 3 Jan. 2025.

Tesfaye, Nebiyou. “In Case You Missed It: President-Elect Trump Affirms Commitment to PBM Reform in Two National Media Events in One Week | NACDS.” NACDS, 17 Dec. 2024, www.nacds.org/news/in-case-you-missed-it-president-elect-trump-affirms-commitment-to-pbm-reform-in-two-national-media-events-in-one-week/. Accessed 3 Jan. 2025.

The Commonwealth Fund. “Pharmacy Benefit Managers and Their Role in Drug Spending | Commonwealth Fund.” Commonwealthfund.org, 22 Apr. 2019, www.commonwealthfund.org/publications/explainer/2019/apr/pharmacy-benefit-managers-and-their-role-drug-spending, https://doi.org/10.26099/njmh-en20.

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