PBMs Explained - What Are They and How Do They Relate to Soaring Pharma Costs?

As prescription drug prices continue to rise, the power of these once-obscure entities is coming under increasing scrutiny.

A Pharmacy Benefit Manager (PBM) is a third-party administrator of prescription drug benefits. PBMs were created to be the healthcare system’s pharmaceutical middlemen, helping patients with employer-sponsored health insurance to access affordable and effective medications and treatments. PBMs create formularies, negotiate rebates with manufacturers, process claims, create pharmacy networks, review drug utilization, and can even manage mail-order specialty pharmacies.

When PBMs first came into existence in the 1960s, they played a benign role in the American healthcare system. In these early days, PBMs served only as fiscal intermediaries, processing paper Rx claims on behalf of their clients. In the 1980s, PBMs began to expand their purview, issuing benefit cards, setting copays and coinsurance amounts, and contracting directly with pharmacies and drugmakers. A huge milestone in the late 80s was the introduction of online, real-time drug claims processing. It was hoped that this and other new technologies would reduce costs by increasing competition, improving the member experience, and advancing clinical outcomes.

However, in the 1990s, the business model of PBMs began to change. There was a quiet shift away from recommending inexpensive generic medications in favor of marketing expensive brand-name drugs that brought in greater amounts of revenue. As part of this shift, PBMs began developing lists called formularies, which created new pharmaceutical hierarchies and granted preferred status to certain medications and manufacturers.

Throughout the 2000s, the PBM sector was defined by fierce competition that should have worked to keep drug costs low. Nevertheless, pharma costs ballooned during this period, causing immense financial hardship for patients and plan sponsors alike.

Recent years have seen extreme consolidation in the PBM sector, with the top three PBMs - CVS Caremark, Express Scripts, and Optum RX - controlling approximately 89% of the market and covering a mind-boggling 270 million Americans. In an industry valued at $482 billion in 2022, this consolidation has created a challenging environment for many employers. Organizations with fully-insured plans are typically “locked in” to one of these big three PBMs, unable to advocate for their interests, audit their pharmaceutical expenses, or enact simple cost-containment measures.

Since 1980, nationwide spending on prescription drugs has risen dramatically. During this period, pharma spending has increased by an average of over 1,000 percent nationwide (this figure takes inflation into account – in actual dollars, the increase is far greater). As time has gone on, many industry experts have begun to question whether the very entities that were created to help patients access affordable healthcare are actually doing just the opposite.

Though PBMs continue to face growing scrutiny about their role in rising prescription drug costs, the status quo appears unlikely to change anytime soon. In the remainder of this series, we will continue to highlight the issues that are driving up pharmaceutical costs and discuss ways that employers can break free and regain control of their spending.

If you didn't catch the previous entry in this series, make sure to check it out here: America’s Growing Healthcare Crisis.