A Position Auction Demonstration Project to Lower Reference + Biosimilar Drug Prices In Medicare Part B


We outline below a proposal for a Center for Medicare and Medicaid Services (CMS)  demonstration project involving a position auction overlay to the existing reimbursement system for Medicare Part B.

What is being auctioned off is a yearly “fail first” position in Medicare Part B. 

The auction is limited in scope to therapeutic classes where at least one biosimilar has entered the market to compete with the off-patent reference drug.  While limited in scope, we present data below indicating that the addressable market for this auction covers 22% of total Part B drug benefit costs in 2017.

We fully expect a minimum of a 50% reduction from current Part B average sales price (ASP) reimbursement formula.   It will be a winner-take-all position auction for arguably the largest single physician-administered biologic market in the world.

 The  Blended Ideology of this Proposal

The ideological roots of this proposal come from the writings of economists David Ricardo in the early 1800s and Henry George in the late 1900s.  Unlike labor or capital, they argued that land did not earn its return, which Ricardo called rent.

Rather, land rent was derived fortuitously from its location or position to reap the external benefits of government social welfare projects such as roads or water resource projects or economic growth in general.   George argued that funding government through a tax on land rent would be both efficient and equitable.

George’s ideas were picked up late in life by the economist, and Nobel Prize winner, William Vickery who championed  auctions and congestion pricing as a blending of the command economy ideology of the 1930s with innovative rent-capturing market designs.

The application here of Vickery – Georgist ideas is not an isolated event.  Our awareness that Vickery was a Georgist comes from reading the 2018 book by Eric Posner and Glen Weyl called Radical Markets, who outline a number of innovative market designs aimed at solving some of today’s toughest problems.

Our contribution to this thread is two-fold.

One has been our 2005 conceptualization of a prescription (Rx) drug benefit formulary as a set of therapeutic class markets with varying degrees of substitutability and hence, competitive choice: monopolistic, oligopolistic, and competitive.

What this does is expand the opportunities for Vickery – Georgist rent-capturing market designs beyond traditional industrial or post-industrial oligopolies.  Rx drug sales in 2018 was $344 Billion of which about  $100 Billion came from Medicare Part D and another $30 Billion came from Medicare Part B.

Our other contribution has been an awareness of economist George Stigler’s 1954 criticism of economist John Kenneth Galbraith’s romantic belief that intermediate market countervailing powers would pass-on all rent captured from sell-side oligopolies to downstream consumers.  

Stigler was right, based on our sixteen year analysis of the conflicted business model of pharmacy benefit managers (PBMs).  There has been a complete failure by plans and insurance companies that hire PBMs to see through their deception. Galbraith in the 1950s had no clue how creative private sector healthcare intermediaries like PBMs and insurance companies could be at devising opaque business models.

Today PBMs have such a bad reputation that the authors of a MedPac proposal for a private-sector solution to lowering drug prices in Part B vaguely refer to their proposed entities  as “vendors”. There is little support in Congress for any PBM-like solution to Part B problems.  

As bad as PBMs are, doing away with them without a replacement market design is worse.  It is naive to presume that Pharma would voluntarily lower list prices to net prices after rebates in the absence of some countervailing power.

But, that is exactly what Health and Human Services Secretary Alex Azar,  along with patient advocate groups and popular bloggers,  assumed when Azar advocated  ending the safe harbor for drug rebates in Part D.  Thankfully, the Congressional Budget Office’s (CBO) score for this proposal was an estimated $177 Million over a 10 year period.  The “world without rebates” initiative was killed shortly thereafter.

How to Reduce Rx Drug Prices in Medicare Part B

Medicare Part B covers outpatient healthcare costs including most Rx drugs administered in physicians’ offices and outpatient facilities. Currently, the only government controls on drug prices in Part B has been the imposition of a mild reference price calculated as the average sales price (ASP) in the private sector.

This is in dramatic contrast to Medicare Part D which covers drugs taken or injected by seniors at home.  Here, seniors can choose from a variety of private plans managed by “middlemen” called pharmacy benefit managers (PBMs) who try to hold down costs with the primary tool being rebates paid by Pharma for inclusion in a formulary — a list of covered drugs grouped into 60-80 therapeutic classes and subclasses.

Medicare Part D was hailed initially as a shining example of a private-sector, market-based approach to controlling Rx drug costs. However,  since 2015 PBMs have come under increasing scrutiny as the driver of rising drug list prices due to their conflicted reseller business model dependent on retained rebates.

On May 11, 2018 President Trump announced publicly that “one of my greatest priorities is to reduce the price of prescription drugs.”

This has sparked a thoughtful debate about how the Federal government can best lower drug prices, beginning with Medicare Part B.  The debate and related proposals for Part B can be divided into two groups with readable blog posts conveniently aggregated by Health Affairs:

Proposals for direct government intervention which we label statist:

  1. Bach et al, Part 1 Part 2, and a followup build the case for abandoning biosimilars as a competitive force and regulating the biologics drugs after patent expiration as “natural monopolies”;
  2. Conti and Kleutghen analyze pending legislation for direct government negotiations;
  3. Sachs analyzes a CMS demonstration project involving imposition of an international reference pricing index.

Proposals advocating private-sector market-based initiatives which we label neoliberal:

  1. Brill and Ipolitto’s present a rebuttal and a followup to Bach’s claims of lack price competition within biologic therapeutic classes upon entry of biosimilars;
  2.  Ginsberg et. al and Antos et. al  advocate going forward with a CMS demonstration project involving intermediaries sounding a lot like PBMs.

Within that debate, there is growing recognition that there is no “one-size fits all” solution.

This is due to the fact that the market designs or negotiation strategies available to countervailing powers depend critically on drug “substitutability”  — the number of drugs which are close substitutes — called therapeutic equivalents or biosimilars — and the number of drugs which are perfect molecule-for-molecule substitutes called generics.

In theory,  PBMs or government run auctions can be an effective rent-capturing countervailing power in therapeutic class oligopolies.  But, in cases where there are no substitutes — the monopolistic therapeutic classes — bilateral bargaining under conditions of information asymmetry regarding other party’s willingness to pay,  theoretically is indeterminate per the Myerson – Satterthwaite Impossibility Theorem.

There needs to be some additional rule to the bilateral bargaining game to produce an efficient outcome.  This includes something like a Nash bargaining solution , which assumes knowledge about other party’s willingness to pay, (one party cuts the pie, the other has first choice of piece) or a Rubenstein  game play clock where some draconian penalty like “march-in” rights kicks in if Pharma doesn’t accept the government’s offer in a timely manner.

In cases of monopolistic therapeutic classes, auctions can’t be used.  An alternative could be a Georgist rent tax, but even that seems statist compared to our position auction proposal.


A Position Auction Demonstration Project

We outline below a CMS demonstration project involving a position auction overlay to the existing reimbursement system for Medicare Part B.

What is being auctioned off is a yearly “fail first” position in Medicare Part B.

The auction would be a first price sealed bid, reverse auction with the winning low bid calculated as current ASP minus unit bid.  We expect that the bidding to be competitive and comfortable with having no reserve — i.e. winning bid could be ASP minus 0.

The specific winning bid amount should never be revealed, but the government should be allowed to make qualitative assessments. And like Medicare Part D rebates,  the bid data should never be used in calculating ASPs or Medicaid “best prices”.

The auction is limited in scope to therapeutic classes where at least one biosimilar has entered the market to compete with the off-patent reference drug.  While limited in scope, we present data below indicating that the addressable market for this auction covers 22% of total Part B drug benefit costs in 2017.

Obviously, this constriction of health care options, even between a reference drug and its biosimilars, is open to legal challenges as a possible violation of a Part B rule that insures coverage for all “ reasonable and necessary” treatments.

But, unlike other CMS demonstration project proposals, we believe this auction will work without any legislative changes.  Specifically, we have designed the auction with the idea of making no changes to the existing ASP reimbursement formula.

Position auctions are a subclass of auctions studied by economists.  The most famous is the Google ad position auction designed by Google chief economist Hal Varian and Google co-founder Larry Page.

Access to markets with reduced competition is a position that has value and can be sold by intermediaries.  If members of an oligopoly want access, the intermediary improves consumer welfare by transferring oligopolistic rent to the intermediary which is more or less passed on to downstream consumers with “more or less” the heart of  the Galbraith – Stigler debate of the 1950s on intermediate market countervailing power.

What to name the money transfer in this auction will be debated.  For now, we use the neutral term “proceeds”. It is not a “price” which is usually associated with competitive markets.  We do not think it should be called a “discount” or a “rebate” as, unlike PBMs, the government is not purchasing or taking title to anything.

Actually,  it would be entirely appropriate economics, and astute in pitching this to the current administration, to call the auction proceeds a “tariff.”

This auction become an overlay to the existing ASP-based reimbursement formulas.

There will be three accounting flows with the new auction flow virtually independent of the other two:

  1. The auction proceeds would flow directly to the Federal government reducing overall government plan costs.  We strongly recommend that the copayment of auctioned drugs be changed to a percentage of net costs. This might even spur bidding.
  2. No changes are required to ASP-based reimbursement formulas. With a position auction overlay,  government ASP reimbursements becomes a temporary accounting outlay later netted significantly by auction proceeds a quarter later due to the lengthy time to settle claims.
  3. Provider and distributor margins should remain the same. This demonstration project is focused on extracting oligopoly excess profits or economic rent and not on the relatively minor issue of provider profits.
  4. We do admit to a potential indirect effect as the very success in this government auction could lead to reduced rebate offers in the commercial sector leading to higher ASPs and higher Medicaid “best prices.”

A note on Average Selling Price (ASP) Used in Medicare Part B Reimbursement

Medicare Part B reimburses providers of infused and injected drugs administered in hospitals, outpatient clinics, and physicians offices on a “buy and bill” basis.  Before the Affordable Care Act (ACA) of 2003, the basis was a manufacturers’ list price called average wholesale price (AWP).

However, AWP considerably overstated provider invoice prices due to traditional supply chain discounts for volume and prompt payments. The ACA included a clause which replaced AWP with a lower average selling price (ASP) that better reflected actual provider costs.  

In the case of multi-source generics where distributors have the power to choose from among 3-10 sources, manufacturers pay 80-90% volume discounts, which are reflected on invoices to distributors, or paid retrospectively as quarterly rebates. In turn, competition among distributors would cause these supply chain discounts and rebates to be reflected in invoice prices to downstream providers.

In the case of single source brand drugs where distributors have no negotiation power, volume discounts or retrospective rebates paid by manufacturers to distributors are virtually non-existent.  The difference between AWP and ASP for single source brand drugs are usually less than 10% prompt payment discounts. 

On the other hand, manufacturers of brand drugs do pay retrospective rebates to health insurance companies and pharmacy benefit manager (PBM) intermediaries. This is because they have some discretion over demand for brand drugs. This is achieved via coverage formularies in cases of brand drugs with therapeutic equivalents  — e.g. off-patent biologic innovator drugs and their branded biosimilars.  

ASP is designed to be a fair reimbursement to providers. If ASP included formulary rebates, which flow to payers not supply chain distributors or their provider customers, ASP would be much lower than what providers pay.

So, when you read about ASP reflecting “rebates” , it is not rebates paid by brand manufacturers for formulary placement, but volume rebates paid retrospectively by generic drug manufacturers to distributors for being chosen as the supplier from among 3-6 perfect substitutes.

Addressable Market

We target five reference drugs (see chart below) each with one to two biosimilars for this demonstration project.

Based on publicly available data downloadable from the CMS Medicare Part B Drug Spending Dashboard,  these biologics drugs comprise only about 2% of drug J-codes covered under Part B, but their 2017 total spend, including patient copayments, represents 22% of total spend.

The 5 reference drugs are just beginning to face biosimilar competition and represent 5 of the 10 highest ranking drugs by total Part B spending.

According to a chart kept by consultant Stanton Mehr, there are 5 other biosimilars not listed below that have been approved by the FDA, but not yet marketed.  So, by next year, with the exception of Avastin, there could be at least three bidders in each auction.

We left out Neupogen and its two biosimilars as the combination of declining quantities and ASPs have progressed to the point that these drugs barely made it into the top 100 ranking drugs.

With the exception of startup Coherus with its Udencya biosimilar to Neulasta,   these five auctions shape up be match-ups among the titans of the pharmaceutical industry.   There is no need to water-down winner-take-all auctions for these titans.

Three of the five auctions feature bitter rivals in the patent and antitrust courtrooms, but will that translate into spirited competition in the bid room?

Both Amgen and Pfizer potentially will be bidding in 3 of the 5 auctions.   Indications from Amgen and Pfizer that they are open to competing in this arena could be key in making this demonstration project happen.


We fully expect a minimum of a 50% reduction from current ASP-based reimbursements for  a winner-take-all position auction for arguably the largest single physician- administered biologic market in the world.

Winning the Medicare Part B position auction would be would be bigger than winning the exclusivity on the formularies of the largest medical drug benefit payers in the commercial space.  It would represent more business that winning any European tender (procurement). With a few more bidders, say four, the winning bid could even be best the Medicaid “best price”

We see two major deterrents to meeting our expectations. One, of course, is lack of bidders.  The difference between two and four seems huge to us. The second is that, unlike large generic drug manufacturers,  brand-oriented drug companies aren’t used to competing on price. They might not like the fact that the biosimilars market, like the generics market,  becomes a high gross profit dollars, but low margin percentage business because that dilutes their consolidated P&Ls.


If successful, position auctions could be expanded:

  1. Position auctions could be expanded to 340(b) and Medicaid with the stipulation that the auction reserve is set to the Medicaid “best price”.
  2. Home injectable biologics are covered by Medicare Part D.  By 2023 (hopefully), the patent thicket for top selling injectable biologics Humira and Enbrel will be cleared and position auctions for these reference drugs and their biosimilars could begin.  That is, of course, this assumes that the Part D protected class clause is modified to allow for a few winner-take-all position auctions.

Lawrence W. Abrams, an independent Ph.D. economist,  has been analyzing the pharmacy benefit manager (PBM) business model since 2003.  Papers can be found on his website https://nu-retail.com.  He has received no remuneration for any papers written.  He has a Ph.D. in economics from Washington University in St. Louis and a B.A. from Amherst College.

Off-Target: The Pelosi Proposal to Lower Medicare Part D Drug Prices  


The purpose of paper is to show that the binding arbitration proposal championed by Speaker of the House Nancy Pelosi to lower Medicare Part D drug prices is off-target.

We believe that there three broad categories of drugs where binding arbitration based on some neutral party’s estimate of value is more appropriate than mano-e-mano direct government negotiations with heavy-handed bargaining chips sometimes used to reach agreements.

  1. High PMPY  large molecule biologic drugs where patented therapeutic equivalents would be rare.
  2. High PMPY cell therapy cancer drugs where outcomes are uncertain.
  3. High PMPY orphan drugs due to costs having to be amortized over patient population in the hundreds.

The problem is we estimate that only 19% of total 2017 Medicare Part D list price drug spend is suitable for Pelosi’s binding arbitration scheme.



Now that the Democrats are in control of the U.S. House of Representatives, they have taken the lead in Congressional efforts to lower prescription drug (Rx) prices with two proposals to modify Medicare Part D.  In addition to uncertainty as to whether either will be effective,  support for the two proposals within the Democratic Party is divided sharply on ideological grounds.

One proposal is a binding arbitration scheme using a neutral third-party arbitrator to evaluate a pharmaceutical manufacturer’s (Pharma)  price offer in comparison with some independent body’s estimates of the drug’s “value”.

The champion of this proposal is Speaker of the House Nancy Pelosi. She is backed by the centrist New Democratic Coalition house caucus.  The details of this scheme are being worked out behind closed doors headed by Pelosi’s aid on healthcare Wendell Primus.

STAT has reported that Primus is being advised by Harvard economist Richard Frank who co-authored a 2008 article proposing binding arbitration to lower Medicare Part D drug prices.

There are also reports that Pelosi’s drug price advisory group has met with Trump administration officials, including John O’Brien, the special adviser to HHS Secretary Alex Azar on Medicare drug pricing.

The other House proposal is championed by Representative Lloyd Doggett of Texas. Doggett has already introduced legislation — H.R.1046 Medicare Negotiation and Competitive Licensing Act  — that has been co-sponsored by 122 members of the Congressional Progressive Caucus.

The Doggett bill would allow the Department of Health and Homeland Security (HHS) to negotiate directly with drug manufacturers. Specifically, the Doggett bill copies the Medicaid formula specifying that Pharma give government its “best price” globally in return for coverage.  

In addition, the Doggett bill includes a new wrinkle to government negotiating schemes — a heavy-handed bargaining chip:

“…if drug companies refuse to negotiate in good faith, it would enable the Secretary to issue a competitive license to another company to produce the medication as a generic”

However, this bargaining chip has been interpreted as falling under  the “March-In Rights”  clause of the 1980 Bayh-Dole legislation specifying when government can or cannot suspend a drug maker’s exclusive patent.  As a result, the use of this bargaining chip is in doubt.

If the goal of modifying Medicare Part D is to lower senior co-pays, we believe that there is a simpler way to achieve this goal than the Doggett “best price” scheme.  We have tweeted about alternative and will provide details in a later paper.

The Origins of the Pelosi Binding Arbitration Proposal

As of April 2019, the Pelosi binding arbitration scheme is still in the talking stage. There are no white papers let alone a legislative bill.  What is known is that the idea for the scheme came from a 2008 article published in Health Affairs by Harvard economists Richard Frank and Joseph Newhouse.

The original Medicare Modernization Act of 2003 launching Medicare Part D specified that Rx drug benefits or seniors would be managed by private sector entities called pharmacy benefits managers (PBMs).  Frank and Newhouse’s 2008 Health Affairs article presented the case that Medicare Part D needed direct government involvement to augment, not replace, price negotiations managed by PBMs.

Unlike Medicaid, the Medicare Part D legislation specifically prohibited direct government negotiations with drug companies. A likely reason for going full “neoliberal” on Medicare Part D was that private sector PBMs had a successful track record of negotiating rebates from Pharma in return for coverage.  

Furthermore, there were plenty of studies showing problems with hard-wired formulas used by government to negotiate prices with Pharma  — the “best price” formula used in Medicaid, and the “buy and bill” formula of average selling price (ASP)  + 6% used in Medicare Part B.

PBMs had developed a wide-range of bargaining chips in addition to the binary “include / exclude” coverage choice that government-run plans settled on.

The problem that Frank and Newhouse saw was that power of PBMs to negotiate rebates for coverage worked only when PBMs could play one drug manufacturer against another.  

PBMs discovered in the late 1990s that they had negotiating power when a number of “me-too” brand drugs came on the market ( e.g. in the statin class – Pravachol, Zocor, Lipitor or in the ACE inhibitor class — Prinivil, Zestril, Accupril, etc).  

For instance, in therapeutic classes like statins or ACE inhibitors, PBMs discovered they could negotiate substantial rebates in neighborhood of 50% off brand list prices in return for coverage.  

 While PBMs were great at negotiating down list prices in what we have labeled “oligopolistic therapeutic classes”, Frank and Newhouse argued that PBMs were powerless to negotiate rebates in cases where there no therapeutic equivalents — what we have labeled “monopolistic therapeutic classes.”  

In a 2018 paper for the Brookings Institute, Frank and Kennedy School economist Richard Zeckhauser present another argument for government intervention based on design flaws in Medicare Part D that reduce PBMs incentives to bargain hard on price.

The first is the coverage gap — the so-called donut hole — where PBMs cost risk is only 5% in the case of brands.  The other is the so-called catastrophic coverage limit of $8,140 for 2019 after which senior co-pays are held to 5. At the same time PBM cost risk to limited to15% while the federal government picks up rest risk cost at 80% of total drug costs.  Below is a nice depiction by the Kaiser Family Foundation of the current distribution of cost risk in Medicare Part D.


Defining the Target of the Pelosi Proposal

To repeat, Politico’s sources say that Pelosi’s aid Wendell Primus is looking only at binding arbitration for “select group of high-cost drugs”.  

Frank and Newhouse offered two binding arbitration  variants:

“The first is a final-offer arbitration system in which both parties cases are heard and then offer their best and final prices. The arbitrator then evaluates the case and sets the drug price at one of the two final prices.”

“Another potential model would be tri-offer arbitration in which a third-party expert or “fact finder” offers a third price for arbitrator consideration. The tri-offer model may be desirable because neither the Center for Medicare and Medicaid Services nor drug manufacturers alone hold the final say in a drug’s price. The system encourages informed negotiations, and an arbitrator only steps in if the two parties cannot reach an agreement.”

By all accounts, the choice of independent  assessor of price based on value would go to ICER, the leading think tank on such matters.

Frank and Newhouse’s case for augmenting PBMs negotiating efforts is solid in cases where there are not Pharma with therapeutic equivalents to play against each other.  

The question is where exactly do those opportunities exist today and how much is the associated drug spend?

Frank and Newhouse were explicit in saying that in 2008 there were few therapeutic classes where there was both lack of negotiating leverage and, this is key, where the total spend was material, say in the $130 Million Medicare Part D drug spend. Their assessment was similar to a 2007 assessment by the Congressional Budget Office.

However,  they could see back in 2008 a pipeline of unique drugs with large drug spend that would justify augmenting PBMs with government-run binding arbitration. Quoting from their paper

We believe that it is premature to conclude that there are enough unique drugs to create a meaningful budget problem. Nonetheless, the likelihood of drug products better tailored to specific genetic defects raises the possibility of many more unique drugs in the future”

We see three broad categories of drugs where binding arbitration is more appropriate than mano-e-mano direct government negotiations with heavy-handed bargaining chips sometimes used to reach agreements.

1. High PMPY large molecule biologic drugs where patented therapeutic equivalents would be rare.

 In the case of large molecule biologics, it is impossible to produce molecule-for-molecule generics so that PBMs have no bargaining leverage.  The only possibility for negotiating leverage would come after the approval of therapeutically equivalent “biosimilars”.   Plus, we believe value become a factor in all cases where where PMPY costs exceeding $50,000.

Here is a table of the top high PMPY drug treatments covered by Medicare Part D in 2017 that we believe would be best suited for binding arbitration  based on an independent assessment of “value”:

Data comes from Medicare Part D Drug Spending Dashboard & Data.  It is based on list price, not net price after rebates.

2. High PMPY cell therapy cancer drugs where outcomes are uncertain.

Much of call for value-based pricing comes for cases in which the degree of success is more in question that the value of the of the outcome itself .  Neutral assessment of probabilities of success are appropriate in these cases.  Prime examples of such drugs are new drugs to treat melanoma  Keytruda and Opdivo whose costs exceed $150,000 a year and with remission rates only somewhat better than just chemotherapy. 

The problem here is that most of these new cell therapy treatments are covered under Medicare Part B, not Part D, as they are infused treatments occurring in physicians’ offices, out-patient clinics, and hospitals.

3. High PMPY orphan drugs due to having to be amortized over patient population in the hundreds.

The justification for binding arbitration as an augment to PBM negotiations is solid for so-called “orphan drugs.” 

The market for orphan drugs is less than several hundred patients so that amortized R&D and manufacturing costs alone exceed $100,000 per person. The cumulative total number of orphan drugs approved by the FDA has accelerated since 2012.



Here, it seems appropriate to treat orphan drugs as a “natural monopoly” with government rather than private PBMs setting the price on a cost-plus or value basis.  Here is a list of the top orphan drugs by PMPY drug spend:

While the number of orphan drugs is on the rise, the total drug spend is relatively low due to the small number of patients treated.  Subjecting orphan drugs to binding arbitration would have a minor impact on overall Medicare Part D drug spend.


An Estimate of the Impact of Pelosi’s Proposal

In terms of % of total Medicare Part D drug spend,  the question is how large is opportunity to lower drug spend using a binding arbitration scheme? 

To answer that question, we use data from the Medicare Part D Drug Spending Dashboard & Data.  It is based on list price, not net price after rebates:

“Drug spending metrics for Part D drugs are based on the gross drug cost, which represents total spending for the prescription claim, including Medicare, plan, and beneficiary payments. The Part D spending metrics do not reflect any manufacturers’ rebates or other price concessions as CMS is prohibited from publicly disclosing such information.”

For purposes of targeting opportunities, this list price data is better than net price data.

We first filter out drugs with multiple sources.  This are mostly generics where dispensing pharmacies have great success in negotiating purchase volume discount off wholesale acquisition costs.

Next, we filtered out drugs with PMPY drug spend > $50,000. We think this filter captures most of the drugs in the three categories better handled by binding arbitration  — unique biologics,  drugs with uncertain outcomes, and orphan drugs.

But, the filter is not perfect. In particular, there are two therapeutic classes  — Insulin and Hepatitis C Virus (HCV) — representing 11% of total drug spend that are arguably more amenable to direct negotiation than binding arbitration.  We chose to place the two therapeutic classes in the direct negotiation subset.

In the case the insulin, while biologics, they have been proved to be therapeutically similar.  Furthermore, the drugs have been around for decades, the outcomes are relatively certain and costs are less than $50,000 PMPY.

In the HCV drugs, while costs are greater than $50,000 PMPY, cure rates exceed 90%, and they have proved to be therapeutically similar by genotype.

In fact, because there are therapeutic equivalents in these two classes, PBMs have had recent success in negotiating rebates in these two classes.

The following is a listing of drugs in these two therapeutic classes we chose to place in the direct negotiation subset and rather than Pelosi binding arbitration subset.



After that, we filtered out drugs with total drug spend > $130 Million to represent the core opportunity for Doggett’s direct government negotiation bill.  Here are the top 36 candidates for direct negotiations in addition to the insulin and HCV therapeutic classes

The remaining drugs was single source drugs representing 61% of drug numbers — 1,786 –but only a paltry 9% of total drug spend.

The following table summarizes the division of drug spend by size of the opportunity targeted by the Pelosi proposal vs the Doggett bill.

We estimate that only 19% of total 2017 Medicare Part D list price drug spending is suitable for Pelosi’s binding arbitration scheme.



Another way to depict the relative targets of opportunity for the two proposals is to graph total revenue by rank.  A comparison of the graphs indicates a much more severe revenue rank power function for drugs best suited for binding arbitration than drugs best suited for direct government negotiations.





Quantifying a Pharmacy Benefit Manager (PBM) Fee-For-Service Business Model


Using CVS’s 2017 10-K reports to the SEC and its 2017 drug trend report, we convert its PBM segment (a.k.a. Caremark) reseller gross profits business model to a single transparent fee-for-service expressed in terms of dollars per member per year (PMPY).  

The following table summarized our results:

Our estimated FFS equivalent of $64 PMPY is a relatively small 6% of CVS’s  $1,067 PMPY drug spend delivered. But, it must be remembered that Rx drugs are a relatively homogenous healthcare benefit compared to hospital procedures or even office visits.

The relatively ease of managing a drug benefit versus a medical benefit is reflected in CVS’s SG&A expense ratio of 1.0% of sales.  In contrast, the SG&A expense ratio in 2017 for healthcare insurance companies Aetna and Cigna was 24.5% and 19.5%, respectively.  

If PBM business models shift to FFS, we expect plans to shift their attention to PMPY trend delivered via significant increases in formulary exclusions.  It would be ironic if  “a world without rebates” becomes a greater threat to Pharma profitability than a world with rebates.   



PBMs have come under attack since the early 2000s for not acting in the best interest of their clients.  We have written a number of papers since 2004 pinpointing an opaque reseller business model as the source of this misalignment.

Over the course of the last 15 years, we have observed dramatic shifts in the distribution of PBM gross profits. These radical shifts in source of gross profits in such a short period of time is unprecedented among Fortune 50 companies.  It is indicative of the opaqueness of the PBM business model to their downstream customers — health care plan sponsors.

It is also indicative of PBMs’ relative power to negotiate rapid changes in payment streams from upstream suppliers — the Big 3 retail pharmacies and pharmaceutical drug companies.   These upstream suppliers and the Big 3 PBMs make up two sides of intermediate market bilateral oligopolies.

Our paper Three Phases of the Pharmacy Benefit Manager Business Model  is an attempt to deduce motives for these shifts.  

We believe that motive is key to determining whether it is Pharma or PBMs who should be blamed for the gross-to-net drug price bubble since 2010. Based on our analysis of the shifting sources of gross profits presented in our paper cited above, we place the blame on PBMs.

In February, 2019,  Health and Human Services Secretary Alex Azar called on Congress to eliminate anti-kickback safe harbors for rebates as a mechanism for making formulary (insurance coverage) choices by private sector PBMs who manage Medicare Part D drug plans. This has been followed up by a bill introduced by Senator Mike Braun (R-Ind) to extend the elimination of rebates to commercial plans in the private sector.

In order to have any meaningful reduction in drug list price,  we strongly believe that two interrelated changes need to be embedded in government or private sector initiatives:

  1. PBMs need to convert to a transparent fee-for-service business model
  2. PBMs need to find an alternative the high list – high rebate market design for formulary placement

Despite our fifteen year critique of PBMs and their misaligned business model, we are not supportive of rebate-ending initiatives if they fail to include alternative PBM business models and alternative formulary market designs.  

Studies by consultants of the impact of eliminating PBM rebates on Medicare Part D varies greatly depending on assumptions about Pharma list price reductions.  To us, this variability in outcomes suggest that it would be dangerous to implement such changes without more specifics about what alternative business model and market design PBMs are likely to adopt.  

The purpose of this paper to take the first steps forward in “a world without rebates” by presenting an estimate a single transparent FFS to replace reseller gross profits using data from the largest PBM — CVS’s pharmacy segment ( a.k.a. Caremark).

The financial data comes from their 2017 annual 10-K report to the SEC: Source: CVS 10-K 2018, Page 14. The PMPY drug trend expenditures comes their 2017 annual drug trend reports: Source: CVS Trend Report – 2017. The number of covered lives comes from another annual reports: Source: CVS Facts and Figures – 2017


The Current PBM Reseller Business Model

PBMs provide a bundle of managed care services designed to provide a cost-effective prescription (Rx) drug benefit to plan sponsors and their members.  The current PBM business model is a reseller business model where the PBM earns margins on prescription drug fills at retail and mail order and retains a percentage of rebates paid by brand drug manufacturers in return for preferred formulary placement.

Specifically, the current PBM business model features five major streams of revenue and gross profits flowing through their financials:

  1. “spread margins” on top of retailers’ own margins and lately, direct and indirect reimbursement (DIR) fees, that are collected from retail pharmacies in return for being included in their networks;
  2. claims processing and data fees;
  3. rebates given by Pharma on small molecule brand drugs in return for preferred status on formularies;
  4. rebates give by Pharma on speciality (biotech) drugs in return for preferred status on formularies;
  5. profit margins on 90-day generic Rx filled by captive mail order operations.

The PBM reseller business model is in stark contrast to the two other transparent business models used by managed care companies:  

  1. a self-insurance agency model with 100% pass through of claims expenses to plans accompanied by per-member-per-month (PMPM) management fees;
  2. a risk-based insurance model with capitated premiums paid by plans.


Converting CVS’s Business Model to a Single Fee-for-Service

Currently, PBMs such as CVS actually buy prescriptions, mark them up (i.e. “spread margin”), and then resell them to plan sponsors that contract with them for drug benefit management.  This spread margin is on top of a dispensing pharmacy fill margin. Separately, PBMs negotiate with brand name drug manufacturers for the payment of rebates, of which they retain a percent, in return for preferred formulary placement.  

As principals in these transactions, these flows are accounted for on  PBMs’ income statement. An interesting accounting question would be raised If PBMs converted customers to a single FFS business model with 100% pass-through of pharmacy claims and Pharma rebates.  Here PBMs become agents, and generally accepted accounting practices (GAAP) might dictate that these flows by-pass the PBM income statements to be posted first on their balance sheets as client receivables and payables.  The account balances would be relieved as they are paid to / by clients.

Today, we estimate that a majority of Big 3 PBMs profits comes from retained rebates.  We still have retail spread margins at 7% of gross profits, which is surprisingly low given the attention to this source of PBM profit at the state level driven by independent pharmacists.


Details of our disaggregation of PBM gross profits by source over the past 15 years can be found at Three Phases of the Pharmacy Benefit Manager Business Model .  Here is  summary graph from that paper:


We propose an alternative business model featuring a single fee-for-service equivalent to PBM gross profits.  It would entail 100% pass through of all Rx claims without any spread margin and 100% pass through of all rebates and drug inflation guarantees. It would also entail elimination of all miscellaneous claims processing and data fees.

Instead of gross profits, the transparent FFS would be used to cover corporate indirect sales, general, and administrative (SG&A) costs. What is left over, “falls to the bottom line” as operating profits and taxes.  As we said before, all other flows would be 100% pass-throughs and no longer have any impact on gross profits.

Whether 100% pass-through would flow through the income statement or by-pass it and flow directly to the balance sheet depends on whether PBM auditors decide to keep PBMs current classification as principals with legal liability in these transactions or re-classify them as agents.

Below is our calculation of a single FFS equivalent for CVS pharmacy segment (Caremark) for 2017.

Discussion of Results:

Our estimated FFS equivalent of $64 PMPY is a small 6% of the average $1,067 PMPY trend management. But, it must be remembered that Rx drugs are a relatively homogenous healthcare benefit compared to a hospital and outpatient procedures,  or even physicians’ office visits.

Plus, most of claims managed come from only 3 drug store chains including CVS’s own whereas healthcare benefit managers need to manage thousands of hospital, outpatient, and physicians accounts.

The relatively ease of managing a drug benefit versus a medical benefit is reflected in CVS’s SG&A expense ratio of 1.0% of sales.  In contrast, the SG&A expense ratio in 2017 for healthcare insurance companies Aetna and Cigna was 24.5% and 19.5%, respectively.  

The relative size of a plan’s drug benefit management cost — $64 PMPY — versus its cost of the drug benefit itself — $1,067 PMPY — suggests plans pay more attention to trend delivered.  So what, if a smaller PBM charges 20% higher FFS — increasing management costs by $13 PMPY –if it can deliver a 10% reduction in trend — saving $107 PMPY.

The movement toward demanding more PBM transparency culminating in significant switches to a FFS business model just might be the beginning of a movement toward more attention being paid by plan sponsors to trend delivered.

Concluding Remarks

FFS is just the beginning in defining an alternative PBM business model.

  1. Our estimated $64 PMPY FFS is too high to serve as a starting point as it represents profits earned by an oligopolist using an opaque business model;
  2. It lacks incentives to bargain hard with Pharma.

The key to discovering what FFS number would emerge in a competitive market is to get small PBMs to start with our estimated $64 PMPY and go from there.

For example, the University of Michigan has been at the forefront at playing an active role in the design of their drug benefit plan at the highest level (formulary and copay design) while contracting out to a small PBM — MedImpact — for claims and rebate management.  Based on data presented in their 2017 annual report, we calculated that their management costs at $17 PMPY — 27% of CVS’s average $64 PMPY.

On the other hand, their trend delivered — $1,246 PMPY — was $179 PMPY or 17% higher.   The question is this higher trend the result of relatively weak rebates bargaining power of MedImpact or a more expansive formulary?


To be sure, smaller PBMs currently do compete with the Big 3 PBMs on the basis of business model, primarily touting 100% pass-through of rebates.  But, their business models are still a mish-mash of fees and even opaque spread margins on retail Rx.

The second problem is that the incentives to bargain down the now inflated drug list prices is lessened when a simple FFS replaces retained rebates.  Incentives for meeting or exceeding drug spend as measured on a PMPY basis needs to be added to a FFS. Also, incentives for meeting patient adherence and other outcome measures need to be included.

Express Scripts and CVS Caremark do disclose average drug spend (“trend”) in their annual Trend Reports.  They are proud of their delivered trend reductions and the importance of formularies in managing trend. But, they do not compete outwardly on that basis.  

Source: CVS Trend Report, 2017


Source: Express Scripts Trend Report, 2017

PBM Startup Papers


Quantifying a Pharmacy Benefit Manager (PBM) Fee-For-Service Business Model (03/19)

IFC Health : An Independent Formulary Company (01 /18)

Will Amazon’s Online Pharmacy Display Therapeutic Interchange (12/17)

Three Phases of the Pharmacy Benefit Manager Business Model (09/17)

The Future of Consumer-Directed Pharmacy Benefits (08/07)

Walgreen’s Transparency Issue (11/03)





CVS’s 2019 Formulary Removals – Negligent Handling Diabetes Test Strip Change


Around the first week in August for the past four years, CVS has made an official announcement of its next year’s formulary changes. It posts these changes on its own websites.

But that changed in 2018. During an August 8th 3Q2018 Earning Conference Call,  CVS said that 2019 formulary details would be available around October 1, 2018.  

But, CVS waited until November 16, 2018 to post details on its own website. We believe that there has been a willful intent by CVS to minimize attention to upcoming formulary changes fearing bad publicity would delay government approval of their merger with the insurance company Aetna. The review included the Department of Justice, state Attorney Generals and Judge Richard Leon of the U.S. District Court of the District of Columbia.    

In particular, CVS has been negligent in giving ample warning to diabetes patients of an upcoming switch in blood glucose test strips from LifeScan’s OneTouch brand to Roche’s Accu-Chek brand.   We estimate that this change is going to affect up to 7.2% of CVS’s 94 Million covered lives,  or 6.8 Million people who have Type I or Type II diabetes, as they require daily blood glucose monitoring via a glucometer and test strips.

We conclude with a look at the impact of this event on state “frozen formulary” laws.


What is a formulary?

One of the most effective cost-controls employed by pharmacy benefit managers (PBMs) are their national formularies. Formularies are lookup tables embedded in software at the retail and mail order point of sale that alerts pharmacists as to which drugs are covered by a customer’s drug benefit plan.   

Via formularies,  PBMs’ have the power to affect the demand for patented, but therapeutically equivalent drugs.  This power enables them to negotiate rebates with pharmaceutical manufacturers (Pharma) in return for formulary placement.  Placement entails more that just inclusion vs exclusion, but also entails a whole array of other conditions including prior authorization, step therapy, and quantity limits.

The more a PBM shelters a given drug from competition via its array of formulary controls, the higher Pharma is willing to pay formulary rebates to avoid those controls.


PBM formulary switches and exclusions are growing

It has only been since 2012 that PBMs began to make significant formulary exclusions of FDA-approved prescriptions drugs. Before that, they would include non-preferred drugs in Tier III of a formulary which carried the highest copayments.

In our 2005 paper The Effect of Corporate Structure on Formulary Design, we looked at key therapeutic classes with small molecule brands having close therapeutic equivalents — proton pump inhibitors (PPI), COX-2 inhibitors, and 2nd generation antihistamines.  We found that  PBMs practiced what we called the “the Soprano approach” to negotiation — threaten harm to all, but negotiate payoffs from all to abstain from harm.

We called this negotiating strategy a “sin of omission” as there was no evidence of harm like formulary exclusion.  It was a sin of omission in that PBMs should have excluded high cost brands in cases where there were generics that were close therapeutic equivalents.  For example, in the mid-2000s, PBMs should have excluded the high cost brand PPI Nexium in favor of other near equivalent PPIs that had gone generic like omeprazole (Prilosec).

Below is a spreadsheet from a 2005 paper The Effect of Corporate Structure on Formulary Design  indicating a tendency in the mid-2000s for PBMs not to exclude brands that had close therapeutic equivalents.

Formulary design has changed significantly since the mid-2000s.  Now, there is a decided tendency among the Big 3 PBMs to grant exclusivity to drugs in formulary therapeutic classes where there are a number of therapeutic equivalents.  

In our 2017 paper Three Phases of the PBM Business Model, we argued that the trend of formulary exclusions stemmed from fundamental shift in the PBM business model after 2010.  PBMs shifted from a reliance on gross profits from mail order generics to a renewed reliance on retained rebates, this time from high list priced specialty drugs.

In addition to outright increases in net exclusions (see graph below), PBMs have become more aggressive in making one-for-one switches between two therapeutic equivalents resulting in no net change in the total number of exclusions.


CVS’s upcoming formulary switch of branded diabetes test strips

This paper focuses on CVS’s handling of one upcoming formulary switch effective January 1, 2019. It involves the replacement of LifeScan’s OneTouch branded diabetes glucometer and test strips with Roche’s Accu-Chek branded glucometer and test strips.  It is by no means the only upcoming switch as “leaked” (more on this later) by a PBM contract consultant and on websites of various plan sponsors using CVS as their PBM.

By far,  it is this test strip switch that will affect the most people.   We estimate that this change will affect up to 7.2% of CVS’s 94 Million covered lives,  or 6.8 Million people who have Type I or Type II diabetes, as they require daily blood sugar monitoring.

The switch in coverage for a medical diagnostic device requires patients to invest a lot more time and energy than a switch between therapeutic equivalent pills.  First, users will have to order the new glucometer and have it arrive before being able to use the new test strips. There is not telling how long that will take.

Then users will have to spend time learning how to calibrate and read their new glucometer.  Finally, if users have installed OneTouch software on their PCs with histories of readings, they will have to transfer that data to Accu-Chek software which will be no easy feat.


Why did CVS decide to switch coverage for test strips?

Our search of past formularies confirmed that CVS gave LifeScan’s OneTouch exclusive formulary placement between 2015-2018.  OneTouch likely enjoyed exclusive coverage going back even longer. Our cursory view of the formularies of the other two big PBMs — Express Scripts and OptumRx — indicated that for the past few years the other two PBMs also included OneTouch on their formularies, although not always exclusively. Finally only CVS decided to make a switch in 2019.

Obviously, gross rebates and related net costs to CVS were important factors in making this impactful switch.  Although we are a leading critic of the PBM practice of making formulary choices on the basis of gross rebates rather than net costs after rebates, we give CVS the benefit of the doubt here.  

Give the inconvenience that this switch will cause to users,  we just cannot fathom CVS making this switch based on small differences in net costs. CVS made the switch because Roche’s likely decided that 2019 was the year to go “all in” with rebates.  Note that it looks like Roche’s substantial rebate commitment to win CVS over in 2019 likely left Roche in no position to offer substantial rebates to the other two Big PBMs as they both continue their exclusive coverage for OneTouch in 2019.    

But, quality may have been another significant factor involved in CVS’s decision to switch.  While LifeScan was the pioneer in electrochemical glucometers and test strips, it has lost its lead to the likes of Accu-Chek, Contour, a division of Panasonic Health Products, and FreeStyle Lite, a division of Abbott.   

Evidence to support this comes from results of a Blood Glucose Monitor System Surveillance Program conducted by the respected Diabetes Technology Society. (see below). They found that only 6 out of 18 meters tested passed their 95% accuracy threshold.   Contour and Accu-Chek were at the top. Both LifeScan OneTouch brands failed the accuracy threshold test.

Another factor in CVS’s decision to switch might have been a change in ownership of LifeScan in 2018.  According to Wikipedia entries, after first being put up for sale in 2017,  LifeScan, a division of Johnson & Johnson, was bought finally by the private equity firm Platinum Equity in June 2018.  

The reason why this sale might have been a factor is that large Pharma companies have a developed a strategy of bundling rebates to lock in exclusive formulary placements for an array of their drugs.  The new private equity firm who bought LifeScan in 2018 was in no position to compete with Roche on basis of  bundled rebates.

We wish to reiterate that our problem with CVS is not its choice to replace OneTouch with Accu-Chek.  The switch looks good both from a net cost and well as from a quality standpoint. The problem we have is CVS’s handling of the switch.  


CVS delayed for three months an official announcement of its 2019 formulary removals

Around the first week in August for the past four years, CVS has made an official announcement of its next year’s formulary changes. It posts details of these changes on its own websites.  Plan sponsors using CVS as their PBM follow suit soon thereafter. This practice is similar to that of the other two big PBMs — Express Scripts and OptumRx

But that changed in 2018.

During a 3Q2018 Earning Conference Call on August 8, 2018,  CVS said that formulary change details would be available around October 1, 2018.

However, on October 1, 2018, there was no official announcement.  Instead, CVS posted a .pdf refresh of its 2018 formulary exclusions accessed via the following URL.   


Then, on or after November 16, 2018, CVS deceptively posted the long delayed 2019 formulary change details using THE SAME URL previously used to access its October refresh of the 2018 formulary.  In other words, it deceptively replaced a 2018 formulary .pdf with a 2019 formulary .pdf  leaving no trail indicating there was a sequence of postings.

The document number at the bottom of 2019 .pdf was 106-25923A and the date used was 010119 v2. It also had a document date of November 16, 2018


Fortunately we downloaded the 2018 refresh which now can be accessed  from our website https://nu-retail.com/CVS_100118_refresh.pdf

The document number at the bottom of the 2018 refresh pdf was 106-25923A (same as 2019), but the date used was 100118.  

Here is a the timeline indicating that an official October 1st announcement would have come toward the end of CVS’s efforts to gain government approval for earlier announced merger with the insurance company Aetna.  

October 26, 2017     WSJ first reports merger talks between CVS and Aetna

December 3, 2017   Negotiations complete, submit to DOJ for approval

October 1, 2018   CVS scheduled to announce 2019 removals. Instead posts refresh of 2018 removals using the following URL               https://www.caremark.com/portal/asset/Formulary_Exclusion_Drug_List.pdf

October 10, 2018     DOJ approves merger

October 18, 2018     Multi-state coalition of Attorney Generals approves merger

November 16, 2018   CVS posts actual 2019 Formulary Exclusion List using same URL as the 2018 formulary refresh 

November 28, 2018  CVS announces close of merger agreement with Aetna

November 29, 2018  Federal Judge raises prospect of not approving merger

Any bad publicity from an October announcement of the 2019 formulary changes might have derailed the conclusion of the government approval process.  As it turned out, the merger was approved. The absence of an October 1st announcement might have helped.  

In our opinion, CVS’s failure to announce this major change is a case of negligence.   There has been a willful intent on CVS’s part to downplay this switch in order to minimize potential bad publicity during a period where CVS’s merger with the insurance company Aetna was being reviewed.


“Leaks” of CVS’s 2019 Formulary Switches

While CVS delayed posting the official announcement until November 16, 2018, there has been a series of  “leaks” in the form of PBM consultant blog posts and postings of .pdfs on websites of plan sponsors using CVS as their PBM.  Basically, a PBM consultant and plan sponsors “jumped the gun” in these announcements thinking that CVS would made it official by October 1, 2018.

We were first alerted to the test strip switch on September 27, 2018.  Knowing that CVS had promised to announce details by October 1st, our online search that day turned up the following  blog post  by the CEO of the largest pure PBM contract consultant Pharmaceutical Strategy Group (PSG).

“CVS is changing their only covered test strips, One-Touch to Accu-Check where members will need to obtain a new meter and learn any new or different features of the new preferred products.”

Further searches revealed other “leaks” of 2019 details in the form of .pdf files. Below is a listing of some of our findings.  Each file was stamped with CVS’s logos and marked with CVS-generated document numbers and date.


What should have CVS done?

With a few exceptions (see below), the following  footnote at the end of the each .pdf on plan sponsor sites is the only effort to date to inform and guide consumers through this switch.

“An ACCU-CHEK  blood glucose meter may be provided at no charge by the manufacturer for those members currently using a meter other than ACCU-CHEK. For more information on how to obtain a blood glucose meter, call 1-877-418-4746

ACCU-CHEK brand test strips are only preferred options.”

In our search of online websites,  we found only  Carefirst Blue Cross Blue Shield, one of CVS’s largest clients covering 3.2 million in the Mid-Atlantic region and the State Health Benefits Plan (SHBP) of Georgia making a real effort to inform and guide members.

On November 14, 2018 , Caremark published a letter that it would be sending via regular mail to every impacted member. Carefirst even labeled the test strip change as constituting “the majority of the negative disruption”

Below is a screenshot of the full letter Carefirst said it would be sending to each impacted member.

The following is a list of other measures  we have come up with that CVS should have undertaken to smooth the transition.

  • Like Carefirst, urge all client plan sponsors to send a letter via regular mail to all impacted members informing them of switch and instructions for ordering a new meter.
  • Upon request, offer December delivery of new Accu-Chek glucometer and one package of test strips. (done by the SHBP of Georgia)
  • Get retail pharmacies involved early by offering to build up inventory with new Accu-Chek meters and test-strips.
  • Post online videos showing how to use new meters. (done by the SHBP of Georgia)
  • Make sure history of readings stored on members’ PC can be transferred easily between OneTouch software programs to Accu-Chek software programs.


Will CVS handling of this switch hasten the adoption of “frozen formulary” laws?

Currently, there is a smattering of states that have passed legislation limiting how often PBMs can make formulary changes during any plan year and require prior notice before the changes takes effect. Due to the trend toward formulary exclusions, more and more  states are considering adopting their own “frozen formulary” laws.  

These so-called  “frozen formulary” laws generally focus on changes within any given plan year.  We could find no state law dealing with requirements for sufficient notification of  formulary changes for the new plan year. 

For example, the general rule has been for the Big 3 PBMs to announce new plan year formulary changes around the first week in August, a full 5 months before the new plan year.  CVS’s official announcement delay to November 16th occurred only 35 days before the beginning of the new plan year.  

As late as this was, it looks like CVS’s November official notification did not violate any existing state laws.  

Still, if CVS’s switch in diabetes test strip coverage causes as much disruption and negative publicity as we anticipate,  we could envision that this event becoming the spark for a whole slew of “frozen formulary” laws requiring a minimum of 3 months or 90 days prior notification of new plan year formulary changes, including individual letters mailed out to impacted consumers.  

The Problem with CVS’s “Guaranteed Net Cost” PBM Business Model


Consider this meta:  CVS opaquely is substituting one opaque source of gross profits — guaranteed net cost markup — for another opaque source — retained rebates.

The pharmacy benefit manager (PBM) CVS Caremark has offered its self-insured corporate clients an alternative business model called “Guaranteed Net Cost”.  The pricing scheme features 100% pass-through of drug rebates and the end of rebate retention as an opaque source of PBM gross profits.

But, CVS has glossed over the fact that their “guaranteed net cost” price to plans is not the same as the net costs to them.  Until CVS tells us otherwise, the new business model allows for a opaque markup on top of PBM net cost. In graphs below, we demonstrate how a markup of guaranteed net costs serves as an opaque offset to foregone rebate retention.  

It is naive to think that CVS Caremark is about to give back a significant source of its annual gross profits without some sort of offset. In fact, CVS admits as much as their spokesperson is quoted as saying

CVS’ manager of corporate communications, Christina Beckerman, told Fierce Healthcare that the company does not expect CVS Health’s profitability to increase or decrease as a result of the shift to 100 percent pass-through rebates.

It is not even clear that CVS’s new business model lessens the incentives to Pharma to inflate list prices in order to compete on rebates for formulary placement.

The Problem With the Current PBM Business Model

The current PBM reseller business model features five major streams of revenue and gross profits.  Four of the five are opaque.

  1. Opaque rebate retention % on speciality (biotech) drugs in return for preferred or exclusive placement on formularies;
  2. Opaque rebate retention % on small molecule brand drugs in return for preferred or exclusive status on formularies;
  3. Opaque profit margins on 90-day generic Rx filled by captive mail order operations of the PBM;
  4. Opaque “spread margins” added by the PBM on top of reimbursements to retail pharmacies included in their networks;
  5. Transparent claims processing and data fees.

The opacity of drug rebates is magnified by the fact that reimbursements for brand drug Rx and related rebates come at different times.   It is impossible for plans match up these two streams and calculate a single net price its pays per drug.

Since the early 2000s, PBMs have continually come under attack for not acting in the best interest of their clients.  We have written a number of papers since 2004 pinpointing an opaque reseller business model as the source of this misalignment.

The PBM reseller business model is in stark contrast to two other transparent business models used by managed care companies:  

  1. a PMPY fee-for-service agency model where 100% of all reimbursements and rebates are passed through to plans.
  2. a risk-based insurance model with capitated premiums paid by plans.

Until the PBM Medco’s merger with Express Scripts in 2012, Medco’s financial 10-Q and 10-K reports to the SEC broke out gross rebates received — a credit to cost of sale — and rebates retained — a credit to sales.  We were able to calculate with certainty Medco’s “rebate retention rate”, a name we coined fifteen year ago in 2003.

We calculated that Medco’s rebate retention rate — the percentage of gross rebates retained — fell from 55% in 1Q03 to 28% in 2Q05.  This rapid decline was due to the sudden awareness by clients of the whole rebate retention scheme. To offset this loss, Medco began to push clients toward its captive mail order and fat margins it began to earn on mail order generic Rx fills.

The share of Medco’s overall gross profits coming from retained rebates reflected  outrageous rebate retention rates.  For 3Q04, we derived with certainty from Medco’s 10-Q that 71% of its gross profits came from retained rebates from small molecule brand drugs.  By 2Q05, we estimated with certainty that Medco’s retained rebate share of gross profits had dropped to 48% with the difference going to their newly found focus on mail order generics.

In our 2017 paper “Three Phases of the PBM Business Model”, we carried forward our mid-2000s work on disaggregating PBM gross profits by sources.  Below is a summary of that work.

Here is a graph of the above data:

CVS’s Guaranteed Net Cost Business Model

On December 5, 2018,  CVS Caremark introduced a new pharmacy benefit manager (PBM) business model option for self-insured corporate drug benefit plans.   

The core of this new business model is a simplified reimbursement price paid by plans to CVS that the company craftily describes as “Guaranteed Net Cost”.  Craftily, in that this so-called “cost” is really a “price” where the difference between “cost” and “price” is a markup.

The company touts the following distinguishing features of this simplified reimbursement price.

  • Drug cost predictability and simplicity
  • 100% of rebates are passed through to plan sponsors
  • Simpler payments flow — no retrospective rebates or inflation adjustments
  • Simpler way to compare different PBM contract proposals

Note this new pricing model is for brand drugs only dispensed at retail, mail order and specialty pharmacies.  The generic Rx drug reimbursement pricing scheme remains the same. That is to say, it preserves an opaque “spread margins” that PBMs like CVS add on top of CVS reimbursements to retail pharmacies for generic Rx drug fills.

This new CVS’s initiative clearly is in response to the tsunami of criticism by plan sponsors over an opaque PBM business model and the difficulty in matching initial Rx reimbursements at an inflated list prices with retrospective rebates occurring months later.

The Problem with CVS’s Guaranteed Net Cost Business Model

One: Opaque Markups

The problem with CVS’s new business model is that guaranteed net cost to plans is not necessarily the same as the net cost to PBMs. CVS never states unequivocally that its guaranteed net cost to plans = net cost to CVS.  In other words, CVS’s new business model allows for an opaque markup on top of its net cost.

Consider this meta:  CVS opaquely is substituting one opaque source of gross profits — guaranteed net cost markup — for another opaque source — retained rebates.

It is naive to think that CVS is about to give back some of its oligopolistic profits.  In fact, CVS admits as much as their spokesperson is quoted as saying

“ CVS’ manager of corporate communications, Christina Beckerman, told Fierce Healthcare that the company does not expect CVS Health’s profitability to increase or decrease as a result of the shift to 100 percent pass-through rebates”

The following is a numeral example of how the opaque markup can serve as a 1-for-1 substitute for retained rebates:

Here is a graphical depiction of our view that CVS is substituting an opaque markup for an opaque rebate retention:


To CVS’s credit, its new guaranteed net cost eliminates timing complexity. It does this by taking a risk and netting the current period Rx reimbursement with an estimated “expected” rebate rather than wait to credit plans with the actual rebate when it is paid by Pharma months later.  

CVS certainly is justified in including some markup as compensation for taking the risk that their estimated expected rebates turn out to be less than actual rebates.

Instead, CVS decided not mention markup at all,  let alone a justified markup as a compensation for assuming timing risk.

TWO: Doubtful Elimination of Incentive to Play the High List – High Rebate Game

Under the current retained rebate business model,  PBMs are incentivized to favor drugs with the highest gross rebates to the exclusion of therapeutically equivalent drugs with the lowest net cost.  To be in a position to win this rebate game, Pharma is driven by the PBM-created rebate game to inflate list prices for its brand drugs.  See our paper: Blame PBMs (Not Pharma) for Drive Drug Price Inflation.

The list price – net price bubble began around 2010 and reached its peak in 2017. It was in 2017 that AbbVie first broke the PBM rebate game  winning formulary placement by Express Scripts despite pricing its late entrant Hepatitis C Virus (HCV) drug Mavyret with an ultra low list price with no rebate potential.  However, this was an exception and the norm remains that the basis for formulary placement is gross rebates over net price (list price – gross rebates).

Below is a graphical depiction of how AbbVie broke the rebate game with its ultra low list = no rebate drug HCV drug Mavyret.

It is possible that the rebate game of high list – high gross rebate may be lessened under CVS’s new guaranteed net cost new business model. This is because the basis for PBM profits — markups — could be any number as opposed to being tethered to something like % of gross rebates or % of net cost.

Below is a depiction of CVS’s flexibility in choosing a markup that is independent of the list price or gross rebate. 

On the other hand, we can see the possibility that the new business model preserves the status quo. Here is our line of reasoning for this:

it is likely that brand drug list prices, which are publically available,  will serve as an upward bound for guaranteed net cost as it would look bad for CVS to set a guaranteed net cost that exceeded a drug’s list price.

To look good, CVS will want to show that guaranteed net costs is consistently 40% to 70% below the brand list prices.  

To achieve these percentages while still having room for oligopolistic markups, CVS will signal to Pharma that, while formulary placement is no longer based on gross rebates, high list – high rebate drugs afford CVS latitude in setting guaranteed net cost markups.

Below is a graphical depiction of why, under the new business model, CVS still would be incentivized to favor the high list – high rebate drug.


Will PBMs Behave Differently? CVS – Aetna Merger, Express Scripts – Cigna Merger

The Effect of Corporate Structure on Formulary Design: The Case of Large Insurance Companies
Poster Presentation, ISPOR 10th Annual Meeting, Washington DC, May 2005

The Role of Pharmacy Benefit Managers in Formulary Design: Service Providers or Fiduciaries?
Journal of Managed Care Pharmacy Vol. 10 No. 4 July/August 2004 pp 359-60

The Formulary Game (07/03)

Hepatitis C Virus Formulary Choices for 2018: Will CVS Caremark Risk Looking Bad? (09/17)


ABout the author:


I have a B.A. in Economics from Amherst College. I have a Ph.D. in Economics from Washington University in St. Louis.

My writings are at the intersection of economics, accounting,  financial analysis, and high tech.

I have received no remuneration for these articles. I have no financial relation with any company written about in these articles.

Lawrence W. Abrams

To Contact:


Insulin Drug Price Inflation: Racketeering or Perverse Competition?




We contend that recent insulin drug price inflation is a case of perverse competition rather than a case of illegal racketeering in violation of the RICO Act.  

We will present the case that a now consolidated racketeering RICO lawsuit initiated by the law firm Hagens Berman has inverted the hierarchy of the Pharma – PBM enterprise.  The lawsuit claims that the bidders — Pharma — “spearheaded” rebate negotiations and that pharmacy benefit managers (PBMs) as rebate-collecting gatekeepers are the followers.  This makes no sense and is grounds for a dismissal of the lawsuit.

We concede that there was coordinated list pricing, but these were opening moves in a two-step bidding process driven by a perverse PBM business model rather than initiated by Pharma. We will present charts of formulary choices made by PBMs that are so varied that they could not be the result of collusion.  

Rather the varied formulary choices in this case had to be the result of vigorous competition among insulin drug companies vying to be the highest gross rebate bidder that culminated in rational economic decisions by PBMs to award formulary exclusivity to the lowest net price bidder.  In other words, there are no antitrust issues in this case.


Racketeers as Gatekeepers to Markets With Reduced Competition

Racketeering is organized crime.  It involves hierarchical groups of individuals working cooperatively under the direction of leaders. The organization can run the gamut from a traditional  business like a trade show logistics company to a tight knit “association-in-fact” enterprise like a mafia crew.

The Racketeer Influenced and Corrupt Organizations Act  (RICO) was passed by Congress in the 1970 to deal with organized crime.  For example, the Sopranos of HBO fame operated an ongoing “association-in-fact” enterprise involving rigged bids for suburban New Jersey garbage collection contracts.  The RICO Act is ideally suited to deal with the Sopranos bid-rigging enterprise.

The Soprano scheme can be viewed as being in a class of rackets involving collecting “tariffs” in return either for opening up markets blocked by government or for providing entrance to legitimate markets with the understanding that further competition would be limited.

Prohibition era bootlegging is the classic racket involving opening up markets blocked by government regulations.  Garbage collection bid rigging is the classic racket of illegally limiting entrance to normally competitive markets.

Money laundering, loan sharking, convention center service contracts, building permits issued without inspections, drug smuggling, sports betting, arms dealing, and human trafficking are other examples of rackets involving payment for access to markets with reduced competition.

Potential entrants are willing to make substantial payments in these cases because they are cuts from super-competitive profits that normally would flow to consumers in the form of lower prices.

Potential bidders in racketeering schemes face a “prisoner’s dilemma”. On the one hand,  it is in the best interest of all potential entrants to wait their turn and cooperate.  On the other hand,  the best strategy for any individual bidder is go it alone, defect and enter the market secretly without paying any tariff.  

The ‘prisoner’s dilemma” is the reason why successful rackets often require threat of harm  — horizontal restraints in antitrust parlance —  to insure cooperation. For example, Tony Soprano regularly would dispatch his nephew Christopher Moltisanti to coach sanitation companies on upcoming municipal garbage collection contracts up for bid, and remind them of what would happen to their kneecaps if they failed to cooperate.

RICO enterprises that do not use physical force to insure cooperation look to other mechanisms to foster cooperation among bidders.  In cases of price-fixing, short-term retaliation via sharp undercutting of a defector’s price is used to remind the defector of the costs of competition.  

Also, bidders are more likely to cooperate long term if the racketeering gatekeeper exhibits a sense of “fairness” by distributing the rigged bid opportunities evenly across bidders.


Racketeering Lawsuits

On November 3, 2016, Senators Bernie Sanders (I-Vt)  and Elijah Cummins (D-Md), asked the Department of Justice and the Federal Trade Commission to investigate insulin drug manufacturers for possible anti-competitive practices in setting list prices, noting that “the potential coordination by these drug makers may not simply be a case of ‘shadow pricing,’ but may indicate possible collusion.”

Over the course of 2017, there have been a number of class action lawsuits and state Attorney General Civil Investigative Demand (CID) letters filed against three makers of insulin — Sanofi, Eli Lilly, and Novo Nordisk — on behalf of patients incurring high out-of-pocket costs for needed insulin drugs. The lawsuits alleged a pattern of racketeering — repeated, organized criminal acts involving secret agreements to inflate drug prices to the benefit of drug companies.

These lawsuits all alleged that the three drug companies “spearheaded” the insulin list price inflation and that insulin list price inflation was the “proximate cause” of damages suffered by patients who could not afford to continue treating their diabetes with insulin made by these companies.

The original racketeering lawsuit was filed by the law firms of Hagens, Berman, Sobol, & Shapiro (hereafter Hagens Berman)  and Carella, Byrne, Cecchi, Olstein, Brody & Agnello, P.C. on January 30, 2017, amended on March 17, 2017 and again on December 27, 2017.  Hagens Berman has been consistent in naming the three insulin drug companies — Sanofi, Eli Lilly, and Novo Nordisk — as “spearheading” the racket and as co-defendants.

Hagens Berman characterized pharmacy benefit manager (PBMs)  as “knowing and willing participants” in the racketeering enterprise who helped “perpetuate” the fraud (¶ 300) and “reaped profits” ( ¶ 300) from the racket,  But Hagens Berman has stopped short of naming PBMs as co-defendants. In a June 2017 interview with Bloomberg, Partner Steve W. Berman offered this lame explanation of why his law firms decided to name only drug companies as defendants:

In September, 2017,  U.S. District Judge Brian R. Martinotti of the U.S. District Court for the District of New Jersey consolidated all RICO lawsuits and named Steve W. Berman of Hagens Berman and James E. Cecchi of Carella Byrne as interim lead counsel.

There are two other RICO lawsuits by Weitz & Lutzenberg and by Keller Rohrback LLP  consolidated into the Hagen Berman lawsuit by the U.S. District Judge Martinotti.  These other lawsuits have named the three largest PBMs — Express Scripts, CVS Health, and OptumRx — as co-defendants. But, even these lawsuits characterize the drug companies as the masterminds of the collusion.

In consolidating these lawsuits, the New Jersey District Court has said that

“ the issue of joinder and/or severance of the three pharmacy benefit managers, will be addressed at a later date.”


Formulary Rebate Negotiations Between Pharma and PBMs

The management of the prescription (Rx) drug benefit portion of health care plans has become the domain of contracted specialists called pharmacy benefit managers (PBMs).

The three largest, independent PBMs — Express Scripts, CVS Health,  and Optum Rx, (known as “The Big 3”) control 73% of the total Rx claims processed the United State in 2015.

We have estimated that a majority of PBM gross profits today come from retained rebates from specialty and injectable biologic drugs — infused autoimmune drugs like Humira and Enbrel and self-injectable insulin drugs like Lantus discussed below.  

These rebates are paid by drug companies in return for placement in a formulary — a table of preferred drugs covered by insurance.   The formulary is a lookup table that PBMs inserted into their retail drug store point of sale claims processing systems that checks a Rx request against a list of therapeutic equivalents preferred by the plan.  The formulary is designed to limit Rx to the most cost-effective drug(s) in each of 50-80 different therapeutic classes.  

In 2005, we were the first to conceptualize PBMs as “gatekeepers” to markets with reduced competition, rebates as “tariffs” willingly paid by Pharma in return for formulary access, and formularies a set of markets with a varying degree of competitiveness (competitive, monopolistic, oligopolistic) among drugs that are “therapeutic equivalents”.

On the sell-side are brand drug companies with therapeutic equivalent drugs vying for placement in therapeutic class “markets”.  On the buy-side are the Big 3 PBMs deciding which drugs among therapeutic equivalents should be listed in the formulary and covered by insurance.

Economists call such markets bilateral oligopolies.  We have written a number of papers about the Pharma – PBM bilateral oligopoly available for download free on our website.

In sum, rebates are tariffs paid by drug companies to PBMs for limiting access to oligopolistic therapeutic classes in formularies.  That broad description — tariffs paid for access to markets with reduced competition — is the same as the Soprano bid-rigging scheme and the same as a whole class of illegal rackets.  RICO lawsuits in this case have to prove an ongoing pattern of overt collusion and conspiracy involving secret plans with the intent to do something unlawful or harmful.


The Cause of The Recent  Drug List Price Inflation

We have written a number of papers presenting the case that it has been PBMs, not Pharma, that has driven the recent drug list price inflation.

Since the early 2000s, PBMs have continually come under attack for not acting in the best interest of their clients.  We have written a number of papers since 2004 pinpointing an opaque reseller business model as the source of this misalignment.

To compensate for declining mail order generic margins after 2010, PBMs saw the rising trend of specialty and biotech drugs as a basis for a renewed reliance on retained rebates.

But there are several problems with the goal of deriving a majority of gross profits from specialty and biologic drug rebates.  The first is that basis for gross rebate percentages — specialty and biologic drug — represents only 20% of the Rx volume of the “rebatable” small molecule drugs available to PBMs a decade earlier.  

The second constraint that there is an awareness by plans and the public today that opaque retained rebate are a dominant source of gross profits.    Today,  articles critical of PBMs in general, and retained rebates specifically,  seem to be at least ten times more numerous than a decade ago.  In 2016, CVS Health has even stated publicly on its website that,

“CVS Caremark was able to reduce trend for clients through… negotiation of rebates, of which more than 90 percent are passed back to clients.”

The problem facing PBMs today is how to derive around 50% of gross profits from specialty and biologic Rx while maintaining a transparent “reasonable” rebate retention rate at 10% on average?  

How have the Big 3 PBMs accomplished this?  Pharma knows that PBMs are desperate to make formulary choices in oligopolistic therapeutic classes on the basis of gross rebates received first and net prices second.

 Pharma knows that it will disqualify itself from a chance to be winning bidder for placement in a formulary if their first move in rebate negotiations is a low list price without any room for further rebate offers.

In sum,  it is the perverse PBM business model that drives tacit cooperation among Pharma to increase list prices in lock-step. Since 2010, PBMs required ever increasing retained rebates to offset continuing losses in mail order generic margins.  The timing of the need to offset one source of gross profits with another fits the acceleration in drug list price inflation between 2010 and 2014 with a tailing off since then (see chart below).

Source: Motley Fool , April 2017


Lock-Step Insulin Drug List Pricing

There is little question that there has been some sort of coordination among the insulin drug companies in setting list prices — formally known as wholesale acquisition costs (WAC) over the last decade.

We think the coordination is not overt, but a “follow-the-leader” understanding developed independently over the years. Pharma understands that a move to list price significantly below a competitor only reduces their ability to compete on gross rebates in the second round of this two-step bargaining process.   Here is a quote from Novo Nordisk’s CEO admitting that they follow closely any list price change of their competitors.

Below are charts of lock-step increases in insulin drug prices presented by the law firm Hagens Berman in their RICO lawsuit.   These charts are clearly the most damaging evidence of in support of the allegations of collusion.


Source: Business Insider, September 2016

But, we believe that the insulin list price inflation is NOT an offensive move to increase gross profits, but defensive opening moves in a competitive two-step rebate negotiating game “spearheaded” by PBMs.

Negotiable prices are a hallmark of bargaining situations involving a few sellers and a few buyers.  Baseball player salary arbitration starts with each party offering prices far apart from what both parties ultimately agree to.

The real estate website Zillow presents extensive historical data showing that the norm in residential home sales is a high opening list price followed by periodic price reductions until a sale is made.

In healthcare, it is a standard practice for providers vying for preferred provider status to start negotiations with high list prices and then offer varying degrees of discounts in return for the higher volume that comes with being named a preferred provider.   

What is going on between insulin drug manufacturers and PBMs is no different.  High list prices are just the standard opening round in a negotiation process among companies vying for preferred status on formularies for their “therapeutic equivalent” drugs.  

The practice of lock-step drug list price inflation is not unique to insulin drug makers.  Below is a chart of lock-step list prices between two manufacturers of top selling autoimmune drugs — AbbVie’s Humira and Amgen’s Enbrel.  Both drugs require regular infusions at clinics and hospitals.  These drugs are covered by a medical benefit managed by insurance companies  rather than a drug benefit plan managed by PBMs.  

It is interesting to note that the lock-step drug price inflation pattern  exists even though the “gatekeepers” in this case are insurance companies.   Unlike PBMs, insurance companies have rational business models — 100% pass through or capitated insurance premiums — where the only consideration is net price regardless of gross rebates received.

The lock-step list pricing for autoimmune drug managed by insurance companies is another piece of evidence that cast doubt on the claim that insulin drug price inflation is a case of organized crime rather than a standard open move in all negotiations for preferred provider status between healthcare providers and healthcare benefit managers.

Source: Washington Post, November 2016


The Motivation for Insulin List Price Drug Inflation

The Hagens Berman RICO lawsuit argued that insulin drug inflation was driven by drug companies motivated to increase profits.  But, there is plenty of evidence that insulin drug companies received relatively small cumulative increases in net prices after a decade of substantial list price inflation.  

Here are two charts provided by Novo Nordisk to show that their net price after rebates for their Novolog insulin vial has increased only a cumulative 36% over the last decade even though their list price have risen a cumulative 363%.

Here are two other charts of gross to net price increases from a June 2016 Bloomberg article based on data assembled by SSR Health, an investment research company.  The first is Eli Lilly’s Humalog indicating cumulative list price inflation of 138% over a six year period from 4Q09 to 4Q15, but only a cumulative net price inflation of 6%

Here is another chart of Sanofi’s Lantus showing a cumulative list price inflation of 189%, but a net price inflation of only 42% over a 5 year period.

Finally, here are a couple of quotes from an October 2016 Biopharma Dive article on fierce price competition among insulin manufacturers:

“Long-acting insulins have become a commodity,” said David Kliff, who publishes the industry newsletter Diabetic Investor, in an interview with BioPharma Dive. “In today’s environment, payers have the upper hand when it comes to making deals.”

That advantage is translating into pressure on insulin pricing, which all three drugmakers have begun to feel.

Novo has said average net prices for its diabetes drugs, particularly in the basal segment, are expected to be low- to mid-single digit percentages lower next year compared to 2016”.

Eli Lilly, which recently committed to averaging 5% revenue growth through 2020, has also baked in intensified pricing pressures in the U.S. to its forecasts. Lilly CFO Derica Rice, speaking on recent earnings call, pointed to increased rebating and discounting for diabetes products as a byproduct of stepped-up competition.

And Sanofi gave guidance last October forecasting its global diabetes sales will decline by an average annualized rate of between 4% and 8% through 2018.”

These quotes run counter to the RICO lawsuit claim that insulin list price inflation has been driven by Pharma and has resulted in substantial increases in profits.  Rather, we have argued earlier that the high list price / high gross rebate scheme has been driven by PBMs with a business model under stress needing more and more retained rebates to offset continuing losses in mail order generic margins since 2010.


Charges of Violation of Antitrust Laws

Besides allegation of  violations of the RICO Act, two RICO lawsuits by Weitz & Lutzenberg (Count ONE and TWO, pages 54-57) and by Keller Rohrback LLP ( Count 7, page 175), but not the final consolidated lawsuit of Hagen Berman,  include counts of violation Sections 1 and 3 of Sherman Antitrust Act.

We believe these antitrust allegations are frivolous and should be summarily dismissed.

Following the generally accepted theories of the late legal scholar and Supreme Court nominee Robert Bork, vertical restraints such as exclusive dealing in formulary contracts are presumptively welfare-enhancing and procompetitive because it would not be rational for a buyer to exclude the lowest cost supplier.  

However, in the case of PBMs you have to take out Bork’s “presumptive” qualifier because the PBM business model is not rational in the traditional economics sense.  

While PBMs are resellers of brand drugs, their gross profits on brand Rx are derived only from a retained rebate percentages. The PBM business model setups up a possible misalignment of interests between plan sponsor preferences for the lowest net cost drug in a therapeutic class and PBM preferences for the drug with the highest rebate retention DOLLARS.  

But, because insulin drug list prices are in lock-step, the insulin drugs with the greatest gross rebate offer are also the drugs with the lowest net price.  This means that PBM formulary choices with regard the insulin drugs are aligned with client’s interests. There is not an antitrust issue associated with recent insulin drug price inflation.

Below is a spreadsheet of the 2016 list prices (WAC)  of long-lasting insulin drugs at the time of the introduction of the Lilly’s Basaglar, a follow-on biologic to Sanofi’s best selling drug Lantus.  Lilly chose to “play to game”, not challenge the PBM business model, and takes its chances competing on the basis of gross rebates.


The result was that Lilly and Basaglar was excluded by Express Scripts and OptumRx, but included by CVS Health.   Per Chicago School theory, all of these choices are pro-competitive as  it would be irrational for any PBM to exclude the lowest cost supplier.

Had Lilly started out with a list price for Basaglar at least 70%-80% lower than the list price of the incumbent Lantus, they might have been in a position to show that they were the lowest cost supplier in the long-acting insulin therapeutic class and merit inclusion in all 3 PBM formularies. Furthermore, they would have been in a position to expose any of the PBMs’ misaligned business models should one of them exclude Basaglar.

We have written a paper recently which compares AbbVie’s aggressive list pricing of its new-to-market Hepatitis C Virus (HCV) drug Mavyret versus the incumbent biologic drug Harvoni.

Mavyret’s exclusion by CVS Health created a real possibility of an anti-competitive and antitrust case of exclusive dealing  despite Mavyret being the lowest cost drug available in the HCV therapeutic class.  We discussed this case in more detail in another recent paper titled Was CVS’s Formulary Exclusion of Mavyret a Violation of Antitrust Laws?


Inversion of the Pharma – PBM Enterprise

The  consolidated RICO lawsuit filed by Hagens Berman has inverted the hierarchy of the Pharma – PBM rebate negotiations relationship.  This lawsuit claimed that the bidders — Pharma — “spearheaded” the rebate negotiations and that the rebate-collecting gatekeepers — PBMs — are the followers.

Here are quotes from he consolidated RICO lawsuit on how it views the hierarchy in the Pharma – PBM Enterprise:


The Levemir / Novolog Pricing Enterprise





The Humalog Pricing Enterprise


The Lantus / Apidra Pricing Enterprise

This makes no sense.  Hagens Berman’s steadfast insistence that Novo Nordisk, Eli Lilly, and Sanofi “spearheaded” the racket is inexplicable. Generally, in cases of bidders vying for access to markets with reduced competition, it is the tariff-collecting gatekeepers that “spearhead” the scheme and the bidders are the followers.

Below is our diagrams of the Hagen Berman inverted view versus the correct view of the Pharma – PBM enterprise.  To highlight the nonsense of the Hagens Berman view, we compare it with two views of the Sopranos bid-rigging racket enabled by use of force to insure cooperation among bidders.



Formulary Choices as Evidence of Competition

In all likelihood,  there was a preliminary competitive round in the Soprano bid-rigging racket where Tony Soprano solicited bids from the suburban municipal garbage collection companies for the rights to be the rigged “winning” bid on any given garbage collection contract.

In order to make the actual bidding process seem legitimate, Tony probably told other companies to participate in the actual bidding, but make their bids higher than the favored company.  Obviously, the Soprano bid-rigging racket took lots of cooperation to pull it off even with threats of physical violence for defection.

Bid-rigging without threats of violence for defectors is problematic.  The RICO lawsuits essentially claim that insulin drug pricing was a bid-rigging racket. Not only did the bids have to be coordinated,  but according to the lawsuit, the bid-rigging was coordinated by the bidders and not the PBM gatekeepers.  A racket with this inverted hierarchy of command would be extremely hard to pull off.

We acknowledge that the lock-step list-price inflation was the result of a common understanding among insulin manufacturer that the perverted PBM business model favored  bidders with the highest gross rebates over bidders with the lowest net price after rebates.

But, what kind of mechanism did Pharma and PBMs use to rig the rebate offers? Unless RICO lawyers can present evidence of some sort of mechanism to enforce cooperation among insulin drug companies, the resulting pattern of formulary choices is more than likely the result of a competitive bidding process.

Below is a series of spreadsheets which show no favoritism among insulin drug companies.  This evidence tends to refute the claim that there is collusion between any given PBM and the three insulin drug companies vying for preferred formulary placement.

The following formulary choices below shows Novo Nordisk winning the the rights from Express Scripts for exclusivity for one of its drugs Levemir but losing the rights from Express Scripts for exclusivity for its other drugs Novolog.  

Was this achieved via just horizontal collusion among drug companies without any knowledge of the horizontal collusion by Express Scripts?   Or, more likely was this a case of an all-around horizontal and vertical collusion among both bidders and PBMs?  

If so, the highly varied outcome depicted above would have required a ton of coordination with potential for a lot of bickering among bidders as to its fairness.    And the outcome depicted above is just one of three bidding outcomes between drug company bidders and PBM gatekeepers.  

 The charts presented above and below depict formulary choices made by PBMs that are so varied that they could not have been the results of collusion.  

Rather the varied formulary choices in this case had to be the result of vigorous competition among insulin drug companies vying to be the highest gross rebate bidder and ending in a rational decisions by PBMs to award formulary exclusivity to the lowest net price bidder.



Below is an alternative spreadsheet of PBM formulary choice that in our opinion indicates no overriding  cooperation between drug companies and PBMs.  It is indicative of a pro-competitive rebate negotiation process in which the low net cost supplier wins exclusivity on the PBM formulary of drugs covered by insurance.

IFC Health – “An Independent Formulary Company”


Misaligned Big 3 PBM (Express Scripts, CVS Caremark, OptumRx) business model dependent on retained rebates resulting in PBM national formularies that are far from cost-effective. (see founder’s 15-year analysis of PBM misalignment at nu-retail.com )  

Value Proposition:

Misaligned national formularies of the Big 3 PBMs which are uncritically adopted by plan sponsors

Deliver 10%-plus incremental drug trend dollar reduction via changes to client’s PBM-generated formulary in four targeted therapeutic classes and via exclusion of scores of individual high-priced orphan drugs and off-patent brand drugs.

Total PMPY Rx Spend — $1,100 (source Express Scripts Trend Report 2016)

Our Target 20% trend reduction – $220 PMPY (per member per year)

How to Achieve Target: work with clients to increase formulary exclusions of misaligned Big 3 PBMs national formularies from 154 to 254 without loss in efficacy.


Initial Product-Market Fit:

Product Fit: Redesign four therapeutic classes having a combination of high cost and high misalignment plus other special situations

  • Diabetes
  • Oncology
  • Autoimmune
  • Multiple Sclerosis
  • Hard look at included orphan drugs, moving scores from included to excluded with override procedures
  • Hard look at whole cost-effectiveness of indications-based formularies
  • Exclude remaining small molecule off-patent brands with generic substitutes


CVS Chart — 2018  Without Formulary Exclusion – $1,300 PMPY  — With Exclusion – $1,067

CVS achieved 19%  PMPY drug benefit costs with basic formulary exclusion

IFC Value Proposition — achieve another 20% PMPY reduction by excluding an addition 100 drugs. 






Market Fit: Drug benefit plans of large self-insured entities — Fortune 1000 companies — 20,000 employees

  • Big payers “mad as hell”  with current PBMs but understand “you can’t throw out the baby with the bathwater”
  • looking to carve-out “brains” of benefits management while retaining the incumbents to manage the “plumbing” (what likely drives BezosCare)



Source: Venrock 2018 Survey of Healthcare CEOs



A Virtual P&T Committee of World Class MDs and PhDs:

  • In essence, company is an independent consulting company that is allowed legally in PBM contracts to make modifications to PBM national formularies designed initially for efficacy by PBM P&T (Pharmacy and Therapeutics) Committee but later misaligned by a “Value Assessment Committee” driven by rebate considerations
  • Link to Express Scripts White Paper acknowledging right of client to customize:
    • “Express Scripts’ plan sponsors often adopt Express Scripts-developed formularies as their own or use them as the foundation for their own custom formularies”. (p.4)
  • World class MDs and PhDs with signed affidavits as to no conflicts of interests
  • Company connected with collaborative tools including licenced AI for search and decision-making
  • Outcomes based pay — fractional ownership points for all MDs and PhDs on P&T Committee


Investment and Valuation Considerations:

  • Positive — need only one angel or seed round, profitable in Year 2, with possible exit in Year 3 at 10x ROI to investors
  • Negative — subject to “efficient market hypothesis” — exploiting an inefficient market leads to elimination of inefficiency  
  • Negative — Copyable IP
  • Positive —  early success with Fortune 500 companies at trend management through formulary modification can lead to other opportunities to spearhead innovation  — outcomes-based pricing, patient adherence micropayments, etc.



Established PBM Consultants — opaque business models with brokerage fees paid by Big 3 PBMs

  • Pharmaceutical Strategies Group (PSG)
  • Milliman
  • Burchfield Group

Established Employee Benefits Consultants — too big –no real Rx formulary focus which is “sweet spot” for cost reduction

  • Willis Towers Watson
  • Aon Hewitt
  • PwC
  • Mercer

New Generation of VC funded Startups —No real Rx formulary focus which is “sweet spot” for cost reduction

  • SmithRx — $9 Million total with Series A lead Founders Fund
  • Truvesis — $64 Million total with Series D lead by McKesson Ventures
  • RxAdvance  — funding by John Scully and Centene 


Company Business Model:

Value Proposition in Numbers:

  • Total PMPY Rx Spend — $1,100 (source Express Scripts Trend Report 2016)
  • Our Target 20% trend reduction – $220
  • How to Achieve Target: work with clients to increase formulary exclusion list of misaligned Big 3 PBMs from 154 to 254 without loss in efficacy.

Business Model Revenue:

$20 PMPY

Revenue Projection:

Total revenue per company with 10,000 members = $ 200,000

Total revenue for company with 100,000 members = $2,000,000

  • FYE First Year           1 client — $200,000
  • FYE Second year      3 clients —  $600,000  
  • FYE Third year         8 clients — $3,400,000 including 1 big co.

Valuation Projections:

Valuation — low end of SaaS –  4 times ARR

  • Year 1  —     $800,000
  • Year 2 —    $2,400,000
  • Year 3 —   $13,400,000 –cash flow positive




I have a B.A. in Economics from Amherst College and a Ph.D. in Economics from Washington University in St. Louis.  I was born and raised in St. Louis, Missouri.  I now live in North Monterey County, California.

My writings are at the intersection of economics, accounting,  financial analysis, and high tech.  I like to write about companies and industries that few follow.  This includes 15 years writing about the PBM business model, explaining drug price inflation using economic theory, antitrust of exclusive dealing formulary contracts, and the $10 Billion unicorn Machine Zone (MZ).

At the bottom of each piece I write, I will disclose any position in stock mentioned.  I will also disclose any remuneration from companies mentioned.


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