Home The Role of the State Antitrust and Competition Can the FTC’s PBM Complaint Create a Competitive Pharmaceutical Marketplace?

Can the FTC’s PBM Complaint Create a Competitive Pharmaceutical Marketplace?

0
Stephanie Kim/ProMarket

Fiona Scott Morton reviews the merits of the Federal Trade Commission’s complaint against the three largest pharmacy benefit managers (PBMs) for suppressing competition in pharmaceutical markets. Although the complaint’s alleged harms are narrow, it is a welcome start that promises to shed light on the PBM’s expansive anticompetitive practices and ultimately lower drug prices for Americans.


The Federal Trade Commission’s complaint against the big three pharmacy benefit managers (PBMs)—CVS Caremark, Cigna’s Express Scripts, and UnitedHealth Group’s Optum Rx—is a welcome enforcement advance, particularly if it heralds a more holistic agency approach to enforcement in pharmaceutical markets. The design of the FTC’s argument is creative and well-founded, though it touches on only one of the competition problems in pharma. The United States prescription drug pricing system is not procompetitive. Indeed, the best word to describe it may be dysfunctional. All major actors—employers, PBMs, and manufacturers—share blame for the situation.

The drug distribution channel suppresses competition

The prescription drug industry suffers from a trifecta of problems: manufacturers of many drugs and the three largest PBMs have substantial market power; employers (the buyers of health insurance) either suffer from significant principal-agent problems or are purposefully loading the cost of healthcare onto their sick workers; meanwhile, manufacturer pricing is almost totally opaque. To make things worse, these problems are complementary. If employers were good agents for their employees and shareholders, they would choose contracts that both benefited their workers and created incentives for the PBM to reduce costs. If PBMs had to be transparent about prices and rebates and they risked losing employers because employers would switch to lower their costs, PBMs would experience more intense competition with each other and also would create more intense competition among manufacturers. If prices and incentives were transparent, employees and policy makers could force employers to be better agents and policy makers could design regulation that was procompetitive.   

The consequences of this broken system are both pervasive (everyone pays higher prices) and acute (sick patients pay above-market prices for healthcare). The relief the FTC demands would lessen the opacity of the market. This is a limited fix—I offer some other ideas below—but it is a step forward, both because of the direct benefits of transparency on competition and consumers, and because sunlight can provide the information and political will for progress on some other fronts. Interestingly, the complaint takes advantage of the “unfairness” element of Section 5 of the FTC Act.  Creating and sustaining price opacity is an unfair method of competition in pharmaceutical sales because it protects rents for all three parties while harming competition and consumers.

The opacity begins with a drug’s list price, a number that is almost completely arbitrary. A manufacturer of a branded drug faces no regulations constraining the list price it chooses for its product.  And because the list price need not be the actual selling price of the product, a very high list price can be paired with a discount so that the real net price is much lower and customers are not driven away. That high list price is then used as a benchmark while the drug passes through the distribution channel. Wholesalers buy from manufacturers at, for example, 95% of the list price and then sell to pharmacies at, for example, 96% of list price, so that the pharmacy can retail the drug at 100% of list price, which is generally paid by the PBM on behalf of the employer of the customer. Notice that intermediaries earn more as list prices rise, while the cost of trucking and storing a box of a certain size and weight does not change with its list price.

A pharmacy would like to serve a wide range of insurance plans and therefore wants to carry as many drugs as possible. Insurers want a wide pharmacy network to create convenience for their enrollees. But ex ante, no one knows which consumers served by which PBMs will want to buy which drug at which stores. By distributing drugs at a set list price, consumers can access them at many pharmacies and the PBM and manufacturer have a starting point for their negotiation. When the PBM’s patient buys a prescription drug, the PBM pays the pharmacy the full list price (less any copayment by the patient plus a dispensing fee) and then turns around and demands a rebate from the manufacturer to bring its cost down to the negotiated price. Since every PBM may have negotiated a different price for the same drug, the list price system allows them all to use the same distribution channel of neighborhood pharmacies and “true up” with the manufacturer after purchases are made.

A PBM can play a valuable role in drug distribution by lowering what would otherwise be almost unconstrained (because patients are insured) manufacturer prices. First, the PBM should move consumers from brands to generic equivalents which are much cheaper. When the generic enters the market, the PBM may remove the equivalent brand from the plan or make it very expensive for the consumer to buy. Second, the PBM can use its size to bargain with manufacturers of all drugs for lower prices. And third, and most important, the PBM can use its ability to shift share between competing products to extract lower prices on drugs that are still protected by a patent. The way this works is that a PBM identifies drugs that are therapeutic substitutes (brands that can treat the same condition) and creates a bidding process to see which will offer the most favorable terms. The competitors know that by offering a lower price and winning in this negotiation they can increase their quantity sold because the PBM will steer its enrollees to their drug. The PBM shifts share by offering its enrollees the winning (lowest price) drug at the lowest out-of-pocket cost, either excluding the more expensive rivals altogether, or assigning them higher out-of-pocket costs to discourage their use. When done correctly, this process creates valuable price competition among drugs that are monopolists (in the sense that each has a patent so it is the sole manufacturer of that molecule).

The mechanics of distribution typically work as follows. The PBM reimburses the pharmacy at list price plus a dispensing fee for each drug its enrollees buy. But to achieve the low price offered by manufacturers, those manufacturers have to rebate the difference between the list price (which the PBM has paid) and the lower negotiated price. These rebates can be as large as 30%, 50%, or more, of the original list price. The number of dollars returning to the PBM through the rebate process is therefore a substantial share of the original payment. The PBM keeps track of its enrollees’ purchases, collects a rebate from the manufacturer—the size of which is confidential—and passes some funds back to the employer. The PBM further may charge the employer a per-claim fee, an “administrative fee,” or a “data fee,” the latter two of which are often calculated as a percentage of the drug’s list price.

The PBM and the employer may agree that the employer gets some share of the rebates. However, the flow of money from manufacturers is hidden entirely or is opaque because the PBM will not usually reveal it to the employer. Further, the PBM can categorize funds as “rebates” or may label some of them “data fees” or similar so that it can keep that money for itself. Further, a PBM may guarantee an employer gets a certain dollar value of rebates each year. But the dollar value of rebates depends on the list price of the drugs being bought, not their real net prices. If everything else is held equal, the PBM and the manufacturer together can raise both list prices and rebates so that net price stays the same. Notice that when an increase in list price is paired with a smaller offsetting rebate, PBMs can meet their rebate guarantee, manufacturers profit, and real prices paid by customers rise. Interestingly, it is typical that the contract between the plan sponsor and the PBM is most often not based on the final net cost of drugs for the members of the plan (e.g. cost per member per month).

Now consider what happens to an enrollee with a plan with a $2,000 deductible who fills the first prescription of the year. The medication has a list price of $500, and let’s assume the consumer’s PBM has negotiated a rebate of 50%. The consumer will pay the full $500 because that is within her $2,000 deductible. Her PBM will receive a rebate of 50%*$500, or $250 from the manufacturer. The manufacturer therefore earns a net price of $500-$250, or $250. The PBM is likely to keep some of the rebate. Suppose the PBM keeps $50 and gives $200 to the employer. In this situation the employer has contributed zero to the cost of the medication while receiving a $200 rebate: the employer makes a $200 profit on its own sick employee’s purchase of medication. The PBM has earned $50. A patient with insurance has paid $500 for a medication whose market price is $250. This insurance plan raises the price of medical treatments for consumers rather than lowering them. Manufacturers, distributors, pharmacies, and PBMs all gain from higher list prices. Not surprisingly, since 2014 “[t]he list price of the average brand rose from $364.92 to $657.08,” and from 2019-2013 “spending at list prices … has increased from $636 [billion] to $917 [billion].”

Uninsured consumers likewise face a sales price of $500 and may purchase drugs at this price. Because the list price is so much higher than the market price, manufacturers, pharmacies, and others often offer coupons to induce uninsured consumers to purchase their drugs. Coupons can make it less expensive to buy a drug with cash than through a patient’s “insurance” plan if it is structured like the example above. However, if an “insured” patient anticipates spending more than $2,000 over the course of the year, there may be no point in using coupons: the patient is going to spend $2,000 regardless so they may as well get it over with quickly and with less effort.

Decades have gone by with patients and employees suffering under this system while no agent with any power has wanted and been able to improve it. As the FTC’s complaint describes, manufacturers have responded by launching versions of branded insulins that have a list price very close to their transaction prices. The complaint explains that PBMs have generally excluded those medications from their formularies because manufacturers do not offer rebates on those products and PBMs are generally compensated based on rebates. In this way PBMs have impeded competition from lower-priced products.

As described by John Asker and Heski BarIsaac, an intermediary with market power (the biggest PBMs collectively have close to an 80% share) has little incentive to intensify competition between its suppliers who also have market power. Rather, it is better off softening competition between manufacturers in return for receiving a share of the resulting profits. This model may explain the unwillingness of PBMs to operate on the basis of net price rather than rebate dollars.

Suppressed competition results in harm to consumers

The complaint identifies key elements of PBM behavior that create and preserve market power. Denying information to employers prevents price competition between PBMs and reduces the incentive to switch. Basing contracts on a drug’s list price incentivizes the manufacturer to cooperate with the PBM to raise its list price and harm consumers. But importantly, these behaviors are ensconced inside a system that is perverse. The conduct is a good fit with the FTC Act’s wording to enforce against “unfair methods of competition” because it is the method by which these brands compete—list prices with large rebates—that causes the problem for both the end consumers and for competition.

In addition, the harmed consumer is an appealing plaintiff that is easily understandable by journalists, citizens, and a generalist judge. These are sick Americans who have a hard time affording their medications because of the combined actions of the manufacturer, the PBM, and their employer. When bringing a case based on an argument that is infrequently used and will attract scrutiny from the courts, it can help the court if the topic is easy to understand and clearly causes harm to both competition and consumers. All Americans feel the effects of high drug prices in their own budgets or those of their relatives and friends.

The complaint is strategic in its omission of the reason that PBMs moved to exclude certain medications from their formularies. Before 2012, PBMs used financial incentives to steer enrollees to preferred (cheaper) brands. Suppose a PBM bargains with two brands that each have a $500 list price. The winner agrees to charge only $200 and the loser becomes not preferred and sells at list. The PBM may set a copay of $20 for the preferred brand and $100 for the competitor (once the consumer is past her deductible). This difference of $80 causes patients or pharmacies to ask their doctors to prescribe the cheaper drug and it gains market share at the expense of the more expensive drug. Consumers pay $20 for the cheaper drug and the PBM pays $180 ($200-$20). But the losing brand responds with a clever strategy. It sends coupon cards to patients where the value loaded onto the card is the patient’s out-of-pocket cost difference between the preferred brand and the non-preferred brand: $80 in our example. With a coupon card paying $80 plus her own out of pocket cost of $20, the consumer can buy the nonpreferred brand at the same cost as the preferred brand. The coupon has made the patient indifferent between the two brands, and the PBM’s carefully chosen price difference no longer steers business to the lower-priced drug. Moreover, if the loser engages in marketing that causes more consumers to use the coupon and buy the nonpreferred brand, the PBM pays a net cost of $400 ($500-$100). This is much more than the $180 net price the PBM pays for the preferred brand and therefore raises its costs. Worst of all, in the long run the PBM cannot offer manufacturers a higher market share in return for a lower price because it has lost the ability to steer patients. That lost ability undercuts the PBMs whole business model and purpose.

The PBMs hit back on this coupon strategy with full exclusion of non-preferred drugs. If the patient bears the full cost of the drug ($500), then any coupon would have to bring that drug’s price all the way down to the $20 copay of the preferred drug ($480). In other words the rival brand would have to sell its drug for a net price of $20, something it obviously does not want to do. PBM exclusions were thus a completely rational strategy in response to brand couponing.

However, the FTC is politically astute to cast manufacturers as the “good guys” offering a low list-price insulin product. The pharmaceutical industry is so powerful in the U.S. that it is difficult to defeat in any policy battle. But high drug prices remain a political problem, so the pharmaceutical industry benefits when it can identify some other actor to blame for those high prices. PBMs are a convenient scapegoat, being partly to blame, concentrated, and opaque. For these reasons, it is possible that big pharma will be supportive of this lawsuit. Neither does the FTC blame employers who are accepting (or requesting) insurance designs with out of pocket payments that are list prices within high deductibles. Many employers are agreeing to contracts and permitting a system based on list price that is both harmful to themselves by raising the cost of insurance, and harmful to their sick employees who must buy medicines at artificially high prices.

The FTC’s complaint is narrow, however, and omits a number of PBM and manufacturer tactics that raise the cost of drugs. A manufacturer may offer a PBM a large rebate to induce it to place its brand on the formulary instead of therapeutic substitutes available in generic form. Because generic manufacturers don’t pay rebates on their very cheap drugs, the expensive brand raises the PBMs rebate total and the brand’s sales—but it also raises costs for patients and employers. A contract form that is common in pharma and has attracted antitrust scrutiny in several other contexts is the loyalty rebate. This contract between the brand and the PBM penalizes the PBM if it includes rival drugs in the plan alongside the brand. The brand manufacturer is able to create a financial penalty for disloyal PBMs by raising the price of its own drug if the PBM offers the choice of a cheaper rival to its customers. Some customers will stay with the original brand, raising the PBMs costs. Nonetheless,  the PBM may prefer this contract if the manufacturer shares the resulting profits with the PBM. Other anticompetitive tactics abound, such as kickbacks to patients that consume expensive drugs and charitable foundations funded by  manufacturers that subsidize manufacturers’ own drugs, limit competition and raise prices. Careful study of the industry reveals that both drug manufacturers and PBMs have contributed to the present dysfunction and lack of competition in the industry and that employers have notably failed to protect their employees from the consequences.

The case seems to be a good example of the unfair methods of competition (UMC) of Section 5 of the FTC Act as explained in the FTC’s Policy Statement from 2022. This document says that the unfair conduct must be a method of competition that goes beyond competition on the merits and tends to negatively affect competitive conditions. Establishing an artificially high list price and basing fees and rebates on that list price is a creation of market actors, not an inherent aspect of selling prescription drugs. The resulting distorted system and its opacity is exploitative of end consumers and perhaps of employers. The system weakens competition on the merits, particularly price competition, and leads to higher prices paid by enrollees as well as higher healthcare costs.

If the matter gets to trial, the sunshine will do as much good as any remedy the agency achieves. Rather like the Microsoft monopolization case, where having businesses and consumers fully understand the conduct helped them resist it, the information on how drug pricing and distribution works may be impactful.

• Workers can understand how their employers are choosing a plan that taxes the sick and subsidizes the healthy and demand a different benefit plan.

• Regulators can decide if a benefit design that charges an enrollee a price above the market price when they need healthcare is actually “insurance” under any normal understanding of the word, and whether it should qualify for pre-tax treatment under the Employee Retirement Income Security Act.

• Employers can demand a contract that rewards the PBM for lowering the net per member per month cost of drugs, rather than increasing an artificially constructed rebate number.

• Manufacturers can try to improve their reputations by launching drugs at list prices close to transaction prices.

• Large PBMs can use the moment of scrutiny to settle by changing the system entirely. This would require ending contracts with employers that guarantee a flow of rebate dollars and replacing them with contracts that do not rely on list price.

• Politicians can grapple with prescription drug prices that are unrelated to (and often well above) patient benefit and the method by which the government procures them.

This list describes many actors and many improvements. Purists may say that an antitrust complaint should be designed to identify a narrow problem and seek narrow redress in court. This complaint formally does that. But it has the possibility to do much more, particularly if it were paired with other FTC enforcement protecting competition in these markets. When a market dysfunction is complicated and hidden, politicians, policymakers, and voters have a difficult time seeing it and therefore no progress toward solving it may occur. An action by the FTC to try to change conduct in one part of the industry may galvanize broader change. An antitrust case can provide the evidence and attention that helps all parties understand how a market is failing. Any relevant law can then be applied by appropriate authorities anywhere in the system, including of course the law of the agency that has brought the case. But if actions beyond the narrow legal process at hand take place because of improved understanding by all parties, that is an excellent outcome for democracy.

Author Disclosure: In the past three years, Fiona Scott Morton has consulted on several healthcare and pharmaceutical cases on behalf of private plaintiffs and defendants as well as for governments. More recent corporate clients include Bard, Cigna, Pfizer, Regeneron, and Sanofi. You can read our disclosure policy here.

Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.

Exit mobile version