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On December 11, 2024, lawmakers presented a bipartisan initiative to direct pharmaceutical middlemen to divest from health insurance companies and pharmaceutical companies, stressing concerns over vertical integration. In parallel action, the Federal Trade Commission (FTC) has commenced reviewing monopolistic practices in the industry. This action comes as part of general frustration with the rising price of prescription drugs in the US.

Over the past 50 years, Americans have seen their spending on prescription drugs skyrocket by around 700 percent, faster than inflation (about 540 percent over that same period). Branded drug prices in the U.S. are 322 percent to 422 percent higher than in comparable OECD countries, even after accounting for rebates. This leaves patients frustrated and often forgoing essential treatments. Three in ten US adults have skipped or reduced medication due to cost. Frustration with the system has even led to tragic events, like the recent assassination of a UnitedHealthcare executive, a stark reminder of the desperation some feel navigating a seemingly stacked healthcare ecosystem.

While many blame pharmaceutical companies, the issue is more complex. Subsidies in other OECD countries explain some of the difference. What is more, development costs account for 60 to 70 percent of total drug costs; in some cases, it can cost up to $1 billion and take up to 20 years to reach the market. The success rate for new medications is less than 7 percent. Another factor is R&D; the US maintains the edge as the world’s leading engine for pharmaceutical innovation, accounting for more than 60 percent of new drug approvals globally, and consumers in other countries benefit from this positive externality. While initial investment costs and aggressive innovation contribute to higher prices, they do not explain the constant price hikes Americans face. Instead, we must look to other actors, which use their role as gatekeepers to set high list prices. Pharmacy Benefit Managers (PBMs) act as middlemen between drug manufacturers and insurers. Created in 1965 to streamline pharmacy benefit claims, PBMs have become influential brokers. They decide which medications will be reimbursed by insurance companies and at what rate.

Factors driving drug price increases stem from two primary drivers: innovation and R&D costs and inefficiencies in the supply chain. The presence of intermediaries like PBMs introduces layers of complexity and opacity, leading to misaligned incentives. Rebate-driven models encourage inflated list prices, distorting market dynamics and disproportionately impacting uninsured and underinsured populations. According to the Pharmaceutical Care Management Association, PBMs use three main strategies to generate profits. First, rebate retention contracting allows PBMs to keep a portion of the rebates they negotiate with drug manufacturers, ranging from 0.4 percent in Medicare Part D to 9-22 percent in the commercial market. Second, spread pricing contracting involves PBMs charging a fixed amount for each drug, pocketing the difference between what they charge and what they pay pharmacies. Third, PBMs charge administrative fees for their services when plan sponsors pay the actual cost of prescriptions.

PBMs claim that patients get the most affordable deal. But their practices often involve complex rebate schemes, retroactive fees, and vertical integration that discourage competition. A past practice of gag clauses – forbidding pharmacists from sharing price information with patients, or cheaper alternatives to insurance claims – was ended by law just a few years ago. In an efficient market, bargaining power should be synonymous with consumer savings. Instead, PBMs take advantage of information asymmetries and secretive deals, increasing prices and limiting patient choice. This leaves independent pharmacies and patients struggling. PBMs profit from a percentage of these inflated prices, meaning patients and health plans rarely see the benefits, even with discounts. For example, the 340B program intended to provide affordable medicines is exploited by hospitals and PBMs for gains. Hospitals charge higher prices, and PBMs boost their bottom lines. Today, PBMs have over 85,000 contracts with 340B providers, with more than half of the profits going to just four companies, diverting funds that could lower drug costs for those in need. 

One key aspect is that in the 1970s, hospital spending grew the fastest, but in the 1980s and 1990s, spending on prescriptions and physician/clinic services surged. From 2020 to 2022, retail prescription drugs saw the fastest spending growth at 7.6 percent, up from an average annual growth of 3.3 percent from 2010 to 2020. This sharp increase is partly driven by PBMs practices, which inflate drug prices through tactics like rebate retention and spread pricing. In contrast, spending on hospitals and physicians/clinics grew by 3.4 percent and 4.0 percent during the same period, respectively.

Over the last three decades, the PBM industry has solidified its negotiating power and vertical integration. In 1995, five PBMs controlled 80 percent of the market; by the 2010s, it was three companies: CVS Caremark, Express Scripts, and Optum Rx. Vertical integration exacerbates the problem. Many PBMs own specialty pharmacies and mail-order services, steering patients toward these outlets and making it difficult to track the money.

 A bipartisan group in Congress introduced the Patients Before Middlemen Act (S. 1967) to break up these vertical integrations. With the FTC involved and growing consumer outrage, there is real momentum for change.

PBMs thrive on secrecy, obscuring fees from drug manufacturers and pocketing spreads that should be passed on to health plans. This lack of transparency drives up costs for everyone, from employers to working families, and squanders chances to rein in skyrocketing healthcare expenses. Some saw a solution in see the price controls imposed by the Biden-Harris Inflation Reduction Act as a solution to high drug prices. But price controls do not address any of the core issues. PBMs use tactics like spread pricing and overseas entities to avoid scrutiny. Price controls do not address the fundamental problems of distribution, rebates, and hidden fees that characterize the PBM business model. Just as price controls have unintended consequences and don’t fix the underlying problems, the antitrust approach in the proposed legislation is problematic. Antitrust actions are normally a blunt instrument, used for political favoritism and based on dodgy, speculative claims of knowledge of what the competitive price would look like in the absence of monopolistic practices.

PBMs are clearly part of a bigger problem, one the Austrian school of economics labeled as the dynamics of intervention. Intervention in one market distorts the information function of the price mechanism; this leads to a distortion in another market, and a call for further intervention. That intervention, in turn, distorts another market, leading to more intervention. Intervention begets intervention, and PBMs are just the latest case. The federal government and the states have been intervening in health care markets for more than a century. Regulations, certificate of need laws, licensing requirements, the FDA, the preferential treatment of institutional health insurance premiums, the federal government’s presence as a big player in health insurance – all of these are distorting the market.

But congressional attention does means that there is awareness of the anti-competitive practices of PBMs, within the bigger problem of soaring healthcare prices. The current US medical system needs a major overhaul – a major liberalization from regulation and government spending – to address its inefficiencies and misaligned incentives. The country spends about 17 percent of GDP on healthcare, and in an era of high deficits and government bloat, more than 25 percent of the budget is spent on healthcare. 

Moving from PBMs to a value-based system would be a good start. True value in healthcare comes from improving patient outcomes relative to costs. The current transaction-based reimbursement model rewards quantity over quality, penalizing providers for better performance and innovation. To implement value-based care, healthcare organizations should identify and understand patient segments with shared health needs, design comprehensive solutions, and measure health outcomes and costs. Integrated, multidisciplinary teams can then process this data to make continuous improvements. By organizing care around patient needs and fostering partnerships, we can create a system that rewards excellence and enhances patient value, ultimately dismantling the harmful practices of PBMs.

But lawmakers should tread carefully in their use of regulatory instruments. They should consider the problem of prescription drugs within an holistic overhaul and deregulation of health insurance.