Will Amazon’s Online Pharmacy Display Therapeutic Equivalents?

Postscript (12/2/2017)  

Amazon is now the best hope for a consumer-directed pharmacy benefits website that “crosses the chasm” by suggesting lower cost therapeutic equivalents.

It has been ten years since we wrote a paper on The Future of Consumer-Directed Pharmacy Benefits .  The possibility of consumer-directed health care got a new life in the mid-2000s with Web 2.0.  We thought that the likes of Google, Microsoft, or a Steve Case funded startup might soon launch a consumer-directed pharmacy benefit website that might “cross the chasm” by presenting therapeutic interchange informed by “wisdom of the crowd.”

Since then, websites like GoodRx and Blink Health have advanced the cause of drug price transparency, but have failed to “cross the chasm”.  In fact, these so-called disruptive startups have sold out to PBMs by receiving PBM-negotiated brand drug rebates in return for unstated “sins of omission” of not suggesting lower cost therapeutic equivalents when consumers are viewing information about PBM-favored brands.

For us, the surest sign that an online pharmacy is not aligned with the best interests of consumers is the appearance of ads for expensive new brands showing up alongside search results for another drug.

Consider this example of an ad for the very expensive autoimmune drug Imbruvica that showed up while we were searching on GoodRx for pricing of a generic diabetes drug called Acarbose.

Note to ad platform used by GoodRx:  if you are going to allow this kind of c**p, at least you should be serving an ad for a drug that may be of interest to a diabetic, not an ad for some drug based on cookies indicating prior visits to websites with information about autoimmune drugs.

Summary of Original Paper (8/10/07)

Pharmacy benefits present the best opportunity for consumer-directed healthcare (CDHC) to outperform traditional managed care.

This is due to the fact that drugs are commodity purchases with little quality issues. Also, drug price transparency does not require any government intervention because there is a group of “outsider” pharmacies like Costco showing a willingness to compete on price.  

Pharmacy benefits also presents the best entry point for new healthcare intermediaries. The role of new intermediaries will be to link user-created “scrapbooks” of health data to rankings of treatment options based on the “wisdom of crowds” and, in turn,  to price competitive pharmacies.

The following diagram summarizes our view of the future of consumer-directed pharmacy benefits.


The Wellness Information Branch

Consumer-directed healthcare (CDHC) is about presenting consumers with information about price and treatment options so that they can pursue cost-saving opportunities.  It is not surprising then that the vanguard this movement is found online.  There are actually two basic branches of the CDHC movement. One branch is what we call the wellness information branch while the other is what we call the purchasing information branch.  

The wellness information branch traces its roots back to the early 1970s and is marked, in our minds, by the publication of Our Body Ourselves in 1973.  There are plenty of websites today with information about wellness and treatment options, but few are directly linked up to prices displayed on provider websites.  

The wellness information branch can evolve in several fundamentally different directions.  One fundamental split will be over the evaluation of treatment options.  One branch will feature options ranked by experts.  This branch is the domain of traditional healthcare intermediaries – insurance companies with captive pharmacy benefit managers (PBMs) and independent PBMs.   The other branch will feature options ranked by au courant social networks. This branch will be the domain of new intermediaries.

The other fundamental split will be over the business model chosen by these new intermediaries.  

The two major options are a fee-based business model, with fees paid by customers or their insurance plan, and an advertising-based business model.  There are early signs that an advertising-based business model will dominate. This is not unexpected as the dominant business model for search and information websites today is advertising-based.

 Furthermore, there are signs that banner ads will dominate. The drugs now featured on television – brand name drugs in blockbuster therapeutic classes facing competition from other brand and generic therapeutic equivalents – will be the very same ones that will dominate online advertising.  This includes such drugs as Lipitor, Crestor, Vytorin, Nexium, Lunesta, and Clarinex.

The website developed by the Mayo Clinic, www.mayoclinic.com, is an outstanding example of the treatment options representing the “wisdom of an elite”. The website is free, but the business model is heavily dependent on advertising of brand name “me too” drugs in oligopolistic therapeutic classes.   

Search for information on insomnia and up pops up advertisement for Lunesta. Search for information how to reduce cholesterol and up pop up ad for Vytorin. These ads are not some minimalist Google-style hyperlink, but full color Flash ads that dominate the right third of the page.  While the Mayo Clinic makes it clear that their editorial staff is isolated from marketing pressures, one always must be wary of content supported by advertising.  

It is interesting to compare the drug treatment recommendations on the Mayo Clinic website with those presented in a Consumer Reports based on recommendations of the Drug Effectiveness Review Project – a 15 state initiative to help guide Medicaid drug coverage.   

The Consumer Reports repeatedly recommends generics and OTC drugs as substitutes for more costly “me too” brands, whereas the Mayo Clinic is non-committal about therapeutic interchange.  Compare the recommendations of each site for the proton pump inhibitor therapeutic class:

Mayo Clinic: 1

Prescription-strength proton pump inhibitors. These are long-acting and are the most effective medications for suppressing acid production. They’re safe and have few side effects for long-term treatment. To prevent possible side effects, such as diarrhea or headaches, your doctor will likely prescribe the lowest effective dose. Prescription-strength proton pump inhibitors include esomeprazole (Nexium), lansoprazole (Prevacid), omeprazole (Prilosec), pantoprazole (Protonix) and rabeprazole (Aciphex).

Consumer Reports:2

The five available PPI medicines are roughly equal in effectiveness and safety, but differ in cost. One – omeprazole (Prilosec OTC) – is available as a prescription and nonprescription generic drug.

Taking the evidence for effectiveness, safety, cost, and other factors into account, Prilosec OTC is our choice as a Consumer Reports Best Buy Drug if you need a PPI. You could save $100 to $200 a month by choosing this medicine over more expensive prescription PPIs

Could the differences in recommendations be due to differences in business models?

There is another approach to the display of wellness information and treatment options that does not rely on elites like the Mayo Clinic or PBMs. This approach is based on the idea of “the wisdom of crowds”.  

It is being championed by several Internet pioneers committed to adapting the latest Web 2.0 tools to helping individuals manage their wellness.  These internet companies are prime candidates for becoming new intermediaries between healthcare providers, health insurance plans, and consumers.

It includes Google, led by Adam Bosworth, one of the inventors of XML technology, and now VP of Google Health. He is leading Google’s effort at creating “a better educated patient” through specialized search and the application of “PageRank” algorithms to treatment options all linked to user generated “scrapbooks” of personal medical history.3

It includes Microsoft, led by Peter Neupert, founder and former CEO of drugstore.com and now VP for health strategy at Microsoft.  Microsoft has recently bought two software companies that have developed innovative ways to integrate and disseminate patient medical data in different formats.4   

This effort may be viewed as “Neupert’s Revenge” – a payback to the Big 3 PBMs for not extending coverage to prescriptions filled by drugstore.com, the company Neupert headed during the heyday of the dot-com era.

While Google’s and Microsoft’s efforts are still largely under wraps, the efforts of Steve Case, founder of AOL, are ready to roll out now.  His latest venture is a company called Revolution Health, which is focused on applying social networking and specialized search based on user-generated ratings of the “trustworthiness” of providers (information and health services).

“Isn’t it crazy that we have ratings to help us pick movies, restaurants and hotels,” Case wrote in an introductory letter quoted by CNN.com, “but no comparable tools to help evaluate doctors, hospitals and treatments?” 5   

Unfortunately, there are signs that Case’s venture will be anything but revolutionary – i.e. challenge the status quo in the healthcare industry.  In an interview, Case has been quoted as saying that “we’ll accept advertising from a number of industries, including Pharma…” 6   

Also, Revolution Health has signed on Medco Health Solutions, one of entrenched Big 3 PBMs, as a strategic partner in developing the pharmacy portion of its website.7


The Purchasing Information Branch  

The other branch of the CDHC movement is focused on providing consumers with information so that they can purchase the most cost-effective treatment.  The key pieces of purchasing information are prices, quality, and treatment options. It is not surprising that the vanguard of this movement is also found online.

And it is online pharmacies that are the leaders in healthcare price transparency. No other area of healthcare comes close to the degree of transparency we found in our survey of online pharmacies today. Furthermore, the trend has occurred quietly without government coercion.  This is in stark contract to hospitals and physicians groups who seem only willing to disclose “usual and customary” prices to the public if mandated by law.

While online drug prices today come with a disclaimer about “subject to change without notice”, they are real offer prices as opposed to “usual and customer” list prices.  They are meaningful as they do not require additional information about quality in order to compare prices offered by different providers.   


Price Transparency as a Threat to the Big 3 PBMs and Chain Drugstores

Of course, the willingness to display drug prices online is not universal in the drug supply chain. Price transparency is a threat to Big 3 independent PBMs – Medco Health Solutions, Express Scripts, and CVS-Caremark – and to large chain drugstores – Walgreen and CVS-Caremark.   

This is due to the conflicted nature of their business models, summarized in our papers “Pharmacy Benefit Managers as Conflicted Countervailing Powers” and “The CVS-Caremark Merger and the Coming Preferred Provider War” 8

The Big 3 PBMs now generate a substantial portion of their gross profits from mail order generics.  Their business model is full of cross subsidies where high margins on rebates and mail order generics subsidize low to nil margins on claims processing, disease management, and mail order brands.  

We have presented the case elsewhere that the price superiority of the captive mail order operations of the Big 3 PBMs is not due to dispensing and procurement scale economies relative to large chain drugstores. 9   PBMs “hold up” retail pharmacy reimbursements because this allows them to offer lower mail order prices without suffering margin erosion.

In turn, the hold-up of retail prescription reimbursements has enabled chain drugstores like Walgreens to engage in “competition by convenience” characterized by aggressive store growth.  This aggressive store growth has outpaced the growth of front stores sales, depressing the net profitability of the front store.10 Walgreens and CVS can live with this because the lack of front store profitability is covered by the high net profitability of the pharmacy in the back.

Both large chain drugstores and the Big 3 PBMs are now locked into business models that rely on high margin generics subsidizing other businesses.  As long as the bulk of prescriptions are covered by traditional insurance plans managed by the Big 3 PBMs, generic prescriptions filled at retail or mail order are protected from price competition.  Otherwise, the chain drugstores and the Big 3 PBMs might be forced to abandon their reliance on high margins generics and would be forced to raise prices elsewhere.  

While there is universal agreement that consumer-directed healthcare has the potential to lower total costs, the value of that outcome depends on how the cost reductions are achieved.  If it achieved through lower unit prices and more cost-effective treatment mix (utilization), then the outcome is positive.  If it is achieve through a shift in burden from business to the consumer or through reduced usage, then the outcome is problematic.

There is a growing body of work, both theoretical and applied, suggesting that CDHC will fail to outperform traditional managed care in the area of unit prices and cost-effective treatment mix.   However, because of the conflicted nature of the Big 3 PBM business model and the hold up of prices of generic drugs, we believe that the best opportunity for CDHC to outperform traditional manage care is in the area of pharmacy benefits.


The Current State of Online Pharmacies

Online pharmacies represent the vanguard of healthcare price transparency. Close followers of healthcare price transparency are oblivious to this development. 11 The majority of sites surveyed allowed access without prior registration.  However, CVS, Long’s and Wal-Mart did not.  The accessible sites gave the consumer a good sense of fill economies by presenting a single page display of prices at various prescription counts (e.g. 30, 60, 90)  

 Most sites only quoted prices for delivery via their in-house mail order operation.  One online pharmacy – Wellpartner, an independent mail order pharmacy based in Portland – also provided consumers with a comparison of their own mail order prices with the typical retail prices paid by 100% cash paying customers. The prices presented below are actual prices taken from five online pharmacies on 3-30-07. It includes the following companies:

  •       Costco – a large mass merchant
  •       RxSolutions – the captive PBM of PacifiCare that is chartered to go after outside business.
  •       Wellpartner – an independent mail order pharmacy
  •       Drugstore.com – an independent mail order pharmacy
  •       Walgreen – a very large retail drugstore chain with mail order capability.


List of URLs of Online Pharmacy Survey:

  •         Costco:   http://www.costco.com/
  •         RxSolutions:  http://rxsolutions.com/a/discountrx/discountrx.asp
  •         Wellpartner:  http://www.wellpartner.com/
  •         Drugstore.com:    http://www.drugstore.com/default.asp?aid=9225

        Walgreens:    http://www.walgreens.com/library/finddrug/druginfosearch.jsp?cf=ln

None of the websites represented their prices as firm offer prices as you would find at a typical online store.  The price lookup screens were separate from the order entry systems.  Costco and Walgreens come closest to standing by their quotes. Wellpartner, drugstore.com and RxSolutions clearly stated that actual purchase prices may vary. What follows is a summary of the price disclaimers found in our survey of online pharmacies: 12

Costco: “The prices listed apply to those prescriptions purchased and mailed from Costco.com. Our pharmacies located in Costco Warehouses nationwide offer pricing consistent with those listed here. Occasionally prices may vary due to local differences in generic product selection or the bulk package size stocked.”

Walgreens:  “The prices listed reflect the full cash purchase price (excluding shipping) for prescriptions purchased from Walgreens.com and shipped to you.”

Wellpartner:  “Prices show the difference between our retail price and the price available with WellpartnerPLUS, a prescription savings program open to registered members… Prices are also subject to change without notice.”

Drugstore.com: “These are self-pay prices for drugstore.com mail-order delivery and do not take into account any discounts or insurance coverage that you may have. Actual prices are calculated at the time of your order.”

RxSolutions: “Pricing is only for medications available through the Prescriptions Solutions Mail Service Pharmacy. Due to market conditions, prices are subject to change. You will be responsible for the actual price of the medication when it is shipped.”


Judged by sheer purchasing power, one might expect that Walgreens would offer the lowest online market prices.  But, their business model is based on a very profitable pharmacy business subsidizing a front store that has low to nil net profitability.  The other companies, while smaller, do not depend on high margin generics subsidizing other lines.  The results are a dramatic confounding of the adage that consumers are best served by purchasing drugs through large intermediaries.

The results also suggest that large drugstore chains like Walgreens are threatened by the consumer-directed health care movement.  Price transparency, so much a part of this movement, exposes the high prices drugstore chains have to charge for generic prescriptions to make up for deficiencies in their front store. CDHC brings the retail pharmacy business a step closer to real price competition and this has the potential to blow apart the cross-subsidies that have been built into the drugstore business model over the last fifteen years.


The Display of Generic Substitutes

There are two types of treatment options that might be displayed online: generic substitution and therapeutic interchange.

Generic substitution is a substitution of a generic drug that is bioequivalent to a brand drug that has lost its patent protection.  It varies only in color, shape, and binding agents.  After a brand loses it patent protection, the original manufacturer will market the brand at a much lower price, but will never lower it to match new generics on the market as there is still value in the “brand name”.  The off-patent brand still is priced at 3 to 4 times the price of bioequivalent generics.

Unless a physician indicates that a prescription be “dispensed as written”, it is legal for pharmacists in many states to substitute automatically a generic of an off-patent brand. Most traditional pharmacy benefit plans reinforce this switch by making it a requirement. Today within weeks after losing patent protection, the generic substitution rate exceeds 95%.

If an online pharmacy displayed any prices at all, it always included displays of cost-savings opportunities through generic substitution.  This is as expected as there is little liability risk in such displays.  Still, there are always disclaimers to “consult with your physician” attached to displays of generic substitution.

It is reasonable to assume that all savings opportunities via generic substitution will be mandated as well in CDHC plans, rather than left up to enrollee discretion.  Thus, online displays of generic substitution are unlikely to contribution to additional cost-savings.

The display below is typical of the cost-savings opportunities now displayed online.  We used actual on-line prices of Costco, a mass-merchant that does not depend on its pharmacy to subsidize other operations.

Source: www.costco.com, 3-30-07


The Hypothetical Display of Therapeutic Interchange

Therapeutic interchange involves a switch from a costly on-patent brand drug to another drug that deemed to be a therapeutic equivalent, but not bio-equivalent. The less costly drug could be a prescription generic, and OTC drug, or an herbal drug.   While generic substitution is a “no-brainer” choice, therapeutic interchange should only be undertaken with the approval of a prescribing physician.  Nevertheless, there is a large body of evidence in support of drugs deemed therapeutically equivalent to blockbuster “me-to” drugs like Lipitor, Nexium, Celebrex, and Clarinex.  

We have presented the case the Big 3 PBMs receive rebates from Pharma for abstaining from therapeutic interchange of blockbuster “me-too” brand drugs.13  At the same time, no online pharmacy in our survey has taken upon itself to present consumers with treatment options representing therapeutic interchange.  This “chasm” presents a cost-saving opportunity for CDHC entities.  This could be traditional managed care entities without a conflicted business model—from large integrated insurance companies to small startup PBM with fee-based business models.  It could be new intermediaries.

The cost-saving potential of therapeutic interchange is concentrated in a few therapeutic classes as evidenced by recent Express Scripts report.  The number of displays needed to make a big difference is quite limited.  The percentage saved per prescription exceed 90% as exemplified in the hypothetical display presented below using prices taken from Costco’s online pharmacy.


Source: www.costco.com, 3-30-07


Therapeutic Interchange Involving OTC Drugs

Most statistics of drug usage takes into account only prescription drugs. If a technique like raising copayments or moving to a CDHC plan causes usage to decline, the result is deemed problematic by researchers.

But, recently there have been two prominent instances of drugs in top 10 selling therapeutic classes that have become available over-the-counter (OTC) after losing patent protection.  One instance occurred in the anti-ulcer therapeutic class where Prilosec become available as Prilosec OTC and various OTC versions of omeprazole, the generic version of Prilosec.  The other instance was in the 2nd generation antihistamine class where Claritin became available as OTC Claritin and various OTC versions of loratadine, the generic version of Claritin.  

There is one additional therapeutic class that should be mentioned.  That is anti-arthritis COX II inhibitor class dominated by brand Celebrex.  While there are no other COX II inhibitors that have lost patent protection, there are OTC generics that are generally accepted therapeutic equivalents – ibuprofen and naproxen.

A broader measure of usage is needed in studies where switches to OTC drugs might be significant. We believe this is the case in any study of a consumer-directed pharmacy benefits. 14

The following table is a hypothetical display of cost saving potential of therapeutic interchange involving non-prescription OTC drugs.  It is doubtful that anything like this is made available to enrollees in consumer-directed plans managed by traditional PBMs. But, to give consumer-directed plans a fair chance to succeed, such a display should be offered.

 Source: www.walgreens.com/library/finddrug/druginfosearch.jsp?cf=ln, 5-3-07


Therapeutic Interchange Involving Herbal Alternatives

Enrollees in consumer-directed plans are highly motivated to seek out alternatives to costly prescription brand drugs. Managers of such plans should consider presenting enrollees with price comparisons involving herbal alternatives to brand drugs.  While this might understandably not be something that an existing PBM might consider, nevertheless well-respected health experts like the Mayo Clinic and Harvard Medical School to discuss herbal alternatives to traditional drugs on their websites.

We expect that if treatment options are ranked by Web 2.0 social networks, the “wisdom of crowds” will almost assuredly rank herbal drugs as a viable treatment options.  Below is a hypothetical display of savings opportunities available through therapeutic interchange involving herbal drugs.  As in the case of OTC drugs, a decline in usage by CDHP enrollees might not be so problematic if it involves switches displayed below.

     Source: www.walgreens.com/library/finddrug/druginfosearch.jsp?cf=ln, 5-3-07


Estimating the Cost-Saving Potential of Consumer-Directed Pharmacy Benefits

Health care costs can be viewed as the product of “U*U*U” – unit prices * utilization * usage — where utilization is treatment option utilized, and usage is the frequency, or persistence, of treatment.  There is concern that CDHC works mostly to reduce the 3rd U – persistence of treatment, which is a dubious benefit.  

If persistence of treatment is set aside, there is a growing believe that CDHC could actual result in higher unit prices and less cost-effective treatments to be chosen. The concern comes from a more sophisticated view of price transparency and skepticism about the potential to guide the consumer through the labyrinth of options involved in treating any given condition.  

Since the initial outburst of enthusiasm for CDHC, there has arisen a more careful consideration of what might be lost by replacing managed care with consumerism.  One valid area of concern is the loss of managed care’s ability to use it purchasing power to countervail providers and negotiate lower unit prices.  Another valid area of concern is the potential of online price transparency to facilitate tacit collusion among sellers resulting in higher, not lower market prices.15

While these concerns are valid, we have presented that case that they are minimized when it comes to outpatient drug prescriptions. Drug price transparency has to potential to break-up tacit collusion in the drug supply chain, not facilitate it.  While there is always a debate among scientists about therapeutic interchange, there are a number of generally accepted options for substituting less expensive generics drugs for brand drugs.

 Estimates of the effect CDHC on persistence of use, and any shift in employer contribution, are beyond the scope of this paper.  Most agree that the benefits derived from reduce usage and increased share are dubious, although one must be open to usage statistics that include switches to over-the-counter drugs and, even herbal drugs like valerian and Estroven.


Cost-Saving From Drug Price Transparency

In our paper “Pharmacy Benefit Managers as Conflicted Countervailing Power”, we summarized our case for a PBM holdup of generic drug prices.  The market for generic drugs is characterized by high list prices coupled by steep charge-back credits posted to large drugstore chains accounts at distributors  Generic drug manufacturers negotiate volume discount deals with drugstores, as opposed to PBMs ,because only dispensing pharmacies have the power to choose from an array of suppliers of perfect substitutes.

It hard for insurance companies to know what are the true market prices for generics because the steep discounts off list prices are proprietary information. This gives PBMs some discretion in negotiating reimbursements with retail pharmacies allowing shift in their business model from a dependency on retained rebates to a dependency on mail order gross profits.  Now, the Big 3 PBMs find it in their own self interest to holdup retail prices for generics so that they can price their mail order operations competitively without margin erosion.

Online price transparency has the potential to breakup the PBM stranglehold on generic drug pricing.  

The table below presents our estimate of cost saving potential of drug price transparency, one component of CDHC.  We assume that it will reduce generic drug prices by 25% and have no impact on brand drug prices. We also believe that drug price transparency will cause the mail order channel to gain a 20% market share for outpatient drug fulfillment.


Cost Saving From Therapeutic Interchange

Consumer-directed healthcare will have an impact on the unit prices of brand drugs, but it won’t be through price transparency, but therapeutic interchange.  Brand drugs for retailers are a derived demand.  They have no discretionary in affecting demand for a particular brand drug.  On the other hand, PBMs can influence the demand for brand drugs that face competition via therapeutic interchange.  As a result, Pharma only negotiates brand rebates with PBMs, and not retail pharmacies.

The Big 3 PBMs receive rebates from Pharma for abstaining from therapeutic interchange of generics that are therapeutically equivalent to more expensive blockbuster “me too” drugs like Lipitor and Nexium. The power to switch prescriptions by PBMs is greatly reduced in consumer-directed plans.  They can no longer threaten Pharma with adverse switches unless paid rebates to abstain.

We have stated that case before that we expect that CDHC to generate no additional cost saving through generic substitution.   On the other hand, it is reasonable to expect that consumer-direct pharmacy benefits to generate a 10 percentage point increase in the generic dispensing rate strictly through therapeutic interchange.  Based on an Express Scripts study cited in the table below, this translates into a 10% reduction in overall drug spend.16

There is another Express Scripts study in support of the cost-saving potential of therapeutic interchange.  Total brand drug spending today runs about $200 Billion.  Express Scripts recently completed a study of the potential savings that could be obtained if all potential brand-to-generic therapeutic interchange were realized. 17  The table presented earlier summarized Express Scripts’ estimate of the potential for cost-saving switches to generics.

 The $20 Billion estimate comes in at 10% of total drug spend.

Of course, the cost-savings generated by unbiased display of therapeutic interchange will be partially offset by lower rebates received from Pharma.   Based on Medco disclosures, we have estimated that its gross rebates received in 3Q2005 totaled 10.1% of its total brand spend.18  It is reasonable to expect any unbiased CDHC plan to incur a 50% reduction in brand rebates received resulting in an overall 3.5% increase in drug costs.

In sum, we estimate the cost saving potential of consumer-directed pharmacy benefits to be around 15.6% — 9.1% from price transparency, an additional 10% from therapeutic interchange, with a 3.5% offset from lower brand drug rebates.  This does not include any additional saving from reduced usage, including switches to OTC and herbal drugs.  The table below presents the full derivation of our estimate.

The Vanguard of Consumer-Directed Pharmacy Benefits

The vanguard of consumer-directed pharmacy benefits will be those companies whose business models are not threatened by the display of therapeutic interchange and the display of free market prices for prescription drugs.  The list includes large, integrated insurance companies with captive mail order operations.  At the other end, the list includes small startup PBMs whose business model is fee-based, rather than margin-based and a host of specialized pharmacy service providers.  Finally, the list includes new healthcare intermediaries with expertise in specialized search and the use of social networks to rank options.

The vanguard does not include the Big 3 PBMs – Medco, Express Scripts, and CVS-Caremark — or the large chain drugstores – Walgreens, CVS-Caremark, Rite-Aid.

It should be noted that current stance of the chain drugstores toward CDHC is “bipolar”, an appropriate pharmaceutical metaphor.  Drugstores represent the vanguard of the retail health clinic movement and seem very open to price transparency in that area.  At the same, the drugstore chains seem resistant to drug price transparency, especially generics, because they know that this will expose their dependency on high margin generics.  

Right now, the only difference between chain drugstores and “dime store dinosaurs” are those little 200 square foot holes-in-the-wall in that back that generate 70% of sales and virtually 100% of the net profits.

Even among chain drugstore executives, there is a sense that the cross subsidies in the chain drugstore business model cannot continue forever. We have viewed CVS’s acquisition of Caremark as an attempt to transition the chain from an era of “competition by convenience” to an era of “competition by price”.    

But, what happens to the front store when a price competitive pharmacy is not longer able to cover the profitability deficiency in the front store?  The business model of coupling a front store of sundry items with a pharmacy –conceived of 84 years ago by Charles Walgreen when he asked his wife Myrtle to make soup and sandwiches to sell to pharmacy customers during lunch hours — is vulnerable.

There is a way out. We see the “chain drugstore of the future” as the marriage of a price competitive pharmacy in the back with retail clinics on the sides and a Whole Foods style “wellness” midsection replete with knowledgeable associates roaming the isles. Stores are smaller, fewer, but better merchandised.  The convenience business that drugstore chains drop is picked up by supermarket chains, mass merchants, and 7-11 type stores.

Theoretically, the vanguard of consumer-directed pharmacy benefits should include major mass merchants and grocery chains because their pharmacies are not dependent on high margins on generics subsidizing other businesses.  However, we have included only Costco on our list as Costco has been the only entity from this group that currently offers online price transparency.  We are puzzled why Wal-Mart and Target have yet to offer full online price transparency even though they have generated a lot of publicity about their $4/ generic prescription program.  

We are also miffed why none of the pharmacies of the major supermarket chains like Kroger, SuperValu, and Safeway has yet to implement price transparency online.  However, a Consumer Reports survey of “cash only” prices for a bundle of popular generic drug prescriptions indicated that supermarket pharmacies are not price competitive.19   For some reason other than the need to subsidize other businesses, supermarket chains choose not to price generics competitively.  The Consumer Reports survey also confirms the lack of price competitiveness of chain drugstores.  

The only reservation we have for the integrated insurance companies is their willingness to expose their captive mail order operations to an open market for prescriptions. There may be a tendency to protect their investment by limiting choice of mail order fulfillment to their captive operations.  

Finally, we have a concern about the dependency of the vanguard of consumer-directed pharmacy benefits on SXC Health Solutions to provide claims processing, the real “heavy-lifting” of pharmacy benefits management.  SXC Health Solutions already is the key enabler to startup PBMs like Envision and Innoviant.  It is the key enabler of a trend by self-insured private and public plans to drop one of the Big 3 PBMs and to “disintegrate” PBMs functions by carving-in benefit management while contracting out for the capital intensive functions of claims processing and mail order fulfillment.20  If SXC Health Solutions’ were to be acquired by a traditional health care claims processor like Emdeon or Allscripts, its freedom to support up-start entities  might be compromised.

The follow is a list of who we think is vanguard of consumer-directed pharmacy benefits.


The Role of New Intermediaries in Pharmacy Benefits


There is a sense among high level management consulting firms that consumer-directed healthcare presents an opportunity for new intermediaries to emerge.  Consider the following quote from an insightful paper by consultants at Booz Allen Hamilton on “Healthcare’s Retail Solution”:19

The players that have traditionally held intermediary roles — employers, government, and health plans — do not inspire trust in consumers, nor do they answer all the consumers’ needs. The new intermediaries will identify consumer needs and steer the supply side to answer them. Further, they will catalyze change as suppliers’ inadequacies become more obvious.

In this section, we will present the case that consumer-directed pharmacy benefits represent a good entry point for new healthcare intermediaries and outline how they might function.

Healthcare intermediaries come between healthcare providers — hospitals, physician groups, and pharmacies – and employees covered by healthcare plans.  Traditionally, consumers have been covered by defined benefits plans whose management requires expertise in insurance.  Consumer-directed healthcare is headed toward defined contribution plans with a catastrophic insurance overlay.  

Thus, traditional insurance companies lose much of their competitive advantage when it comes to managing consumer-directed plans.  Also, healthcare intermediaries were once thought to need sufficient scale in order to negotiate lower prices with providers.  But, consumers have bulked at restrictive preferred provider networks and so size is not longer viewed as a competitive advantage for healthcare intermediaries.

Consumer-directed healthcare puts a premium on the display of information necessary to make good healthcare choices.  Information gathering, dissemination and the ranking of options is exactly what the giants of the Internet – Google, Microsoft, Yahoo, and Amazon –do best. These are prime candidates for new healthcare intermediaries.

There are several reasons why pharmacy benefits present the best entry point for new healthcare intermediaries:  

  1. Quality is not an issue. No need for controversial evaluations.
  2. Size is not an issue.  No need for scale to outperform the “conflicted” countervailing power of the Big 3 PBMs.  Just open up a space for the free market to work.
  3. Price transparency is not an issue. Just link up with “outsider” pharmacies that are ready and willing to compete on price.
  4. .Drug treatment options are relatively simple compared to medical treatment options.

The mission would be to merge information about treatment options with prices offered by online pharmacies.  Currently, the only treatment option offered by online pharmacies is generic substitution.  This presents a tremendous opportunity for new intermediaries “to cross the chasm” and offer consumers information about therapeutic interchange – treatment options involving the substitution of generic drugs, OTC drugs, and herbal drugs deemed therapeutically equivalent to costly brand drugs.

There is a good reason why this “chasm” currently exists. New healthcare intermediaries should carefully consider the consequences of presenting consumers with displays of drugs which are deemed therapeutic equivalents to patent-protected brand drugs. All kinds of safeguards should be built into the website.  Disclaimers about consulting with your physician should be posted prominently.  All postings should be delayed until reviewed by responsible parties.

We actually believe that it would be prudent to have a dual system of ranking of treatment options. The purchasing section should link pharmacy order entry systems to treatment options chosen by an elite PBM-like P&T Committee.  

It should concentrate on displays of generic prescription and OTC drugs that therapeutic equivalents to “me-too” brand drugs in a few selected therapeutic classes: Statins, Proton Pump Inhibitors, Cox II inhibitors, and 2nd generation antihistamines.  

A separate section not directly linked to order entry systems should concentrate on wellness and treatment options not normally treated with prescription drugs like colds, minor aches and pains, weight-loss, mild insomnia, menopause, and premenstrual cramps.  This is where active participation of individuals in social networks might actually produce better results than passive reception of advice from some elite group.  

The dual ranking system plus specialized internet search could all be tied together by a user-create “scrapbook” of health data, a module reportedly under development by Google.20  The diagram below summarized our view on the links between modules of a new intermediary website.

 At one time we believed that to outperform the Big 3 PBMs, new healthcare intermediaries has to take an active role in negotiating prices with pharmacies and rebates with Pharma.  Knowing that the Internet companies might become new healthcare intermediaries, we envisioned that such companies would automate negotiations using reverse auctions.  

We now think that simply creating a space for those who want to compete on price will generate enough savings to be noticeable. But, breaking up the Big 3 PBM stranglehold on generic drug pricing creates a one shot, short term gain.  Eventually, new intermediaries will have to become countervailing powers to the drug supply chain and use devices like reverse auctions or preferred provider networks to make a long lasting impact on the trend in prescription drug costs.


(1)  The Mayo Clinic recommendation for proton pump inhibitors is available at


(2) The Consumer Reports recommendation for proton pump inhibitors is available at http://www.consumerreportsbestbuydrugs.org/drugreport_DR_Prop.shtml

(3) “Healthcare Information Matters,” November 30, 2006 posted by Adam Bosworth, VP Google  Available at http://googleblog.blogspot.com/2006/11/health-care-information-matters.html

(4) “Microsoft to Buy Health Information Search Engine,” New York Times, February 27, 2007


(5)  “Healthcare 2.0 ?” January 23, 2007 Available at http://www.innosight.com/blog/index.php?/archives/81-Healthcare-2.0.

(6) Quote by Steven Case in CDHC Magazine.  Available at http://www.cdhcsolutionsmag.com/archives/2007/07-MayJun/CDHC_MayJun07-RevolHealth.pdf

(7)  Medco Press Release, May 23, 2007, Available at http://phx.corporate-ir.net/phoenix.zhtml?c=131268&p=irol-newsArticle&ID=1005952&highlight=

(8) LW Abrams, “Pharmacy Benefit Managers as Conflicted Countervailing Powers,” January 2007;  LW Abrams, “The CVS-Caremark Merger and the Coming Preferred Provider War,” December 2006, Available at http://www.nu-retail.com

(9)   LW Abrams, “Exclusionary Practices in the Mail Order Pharmacy Market,” September 2005, Available at http://www.nu-retail.com

(10)  LW Abrams, “The CVS-Caremark Merger and the Coming Preferred Provider War,” December 2006. LW Abrams, “Walgreen’s Transparency Issue,” November 2003.

(11) Health 2.0 Wiki, Websites Displaying Healthcare Price Transparency, Available at http://health20.org/wiki/Transparency

(12) Price Disclaimers







(13) LW Abrams, “The Effect of Corporate Structure on Formulary Design: The Case of Large Insurance Companies, “Poster Presentation Paper, ISPOR 10th Annual International Meeting, May 2005.  Available at http://www.nu-retail.com

(14) LW Abrams, “Show Me the Display! A Review of an ESI Study of Consumer-Directed Pharmacy Benefits,” July 2007. Available at http://www.nu-retail.com

(15) Paul Ginsberg, “Shopping for Price in Medical Care, “Health Affairs 26, no. 1  (2007) w 208-w216


Hal Varian, “When Commerce Moves Online, Competition Can Work in Strange Ways, New York Times. August 24, 2000 Available at http://www.ischool.berkeley.edu/~hal/people/hal/NYTimes/2000-08-24.html

(16) Express Scripts, “Geographic Variation in Generic Fill Rate, Available at http://www.expressscripts.com/ourcompany/news/outcomesresearch/onlinepublications/study/regionalgenericvariation.pdf

(17) Express Scripts, “Press Release: Study Reveals $20 Billion in Untapped Generic Drug

Savings, “ October 25, 2005. Available at


(18) LW Abrams, “Quantifying Medco’s Business Model,”  September 2005  Available at http://www.nu-retail.com

(19) The Consumer Reports survey is available at http://www.consumerreportsbestbuydrugs.org/

(20) LW Abrams, “Systems Xcellence Should Continue to Benefit from PBM Disintegration”, May 24, 2007. SeekingAlpha Available at “http://healthcare.seekingalpha.com/article/36413

(21) David Knott, Gary Ahlquist, and Rick Edmunds, “Healthcare’s Retail Solution, strategy + business, May 15, 2007 Available at ”http://www.strategy-business.com/resiliencereport/resilience/rr00046

(22) VC Ratings, “Google Preparing Health Portal” July 7, 2007. Available at


© Lawrence W. Abrams 2007                           

Three Phases of the Pharmacy Benefit Manager Business Model

We present the case that there has been three distinct phases of the pharmacy benefit manager (PBM) business model over the past 15 years. Each phase has been demarcated by a major shift in the dominant source of gross profits.

These radical shifts in the primary source of gross profits in such a short period of time is unprecedented among Fortune 50 companies.  This 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 drug companies.   These upstream suppliers and the Big 3 PBMs make up two sides of intermediate market bilateral oligopolies.

It is instructive to understand why PBMs had to recalibrate their business model twice now in the last 15 years.  In today’s terminology,  what “disrupted” this powerful cartel? Our examination of recent history suggests that  government regulations and lawsuits have had little impact on PBM decisions to change their business model.  

Rather, our view is that the disruptors have been “rent-seekers” whose business models were not in alignment with the rest of the cartel.  This included the emergence of a vertically integrated PBM in the form of CVS-Caremark and the powerful outsider Walmart with a business model that allowed for the retail pharmacy to be a “loss-leader”.

Below is a spreadsheet which summarizes the data sources for our estimation of distribution of PBM gross profits over the past 15 years.


Below is a graph of our estimates of PBM gross profits share by source over the past 15 years indicating that there have been 3 distinct periods where a different source dominated.


In support of our contention of the replacement of lost margins on mail order generics with retained rebates after 2010, we present data assembled by Adam Fein  estimating total rebates to PBMs and discounts to drug distributors between 2007 – 2016.   Note that the total increases was 126% between 2010 and 2016.


The Pharmacy Benefit Management Business

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 PBM bundle includes the following list of services:  

  1. create a retail preferred provider pharmacy network and negotiate brand and generic Rx reimbursements;
  2. provide 90-day Rx exclusively from captive mail order pharmacies;  
  3. provide specialty (high priced and biotech) drugs Rx from captive specialty pharmacies;
  4. create a formulary — a look up table that restricts fills to preferred drugs — and negotiate rebates with Pharma in return for placement;
  5. provide other Rx cost-saving measures such as prior authorization, step-therapy, quantity limits, and co-pays.   

Concentration in the PBM Business

The three largest PBMs today — 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.  

Prior to 2013, the Big 3 PBMs were Express Scripts, Medco, and Caremark with a combined concentration similar to today.  The concentration in the PBM industry today has been the result of a series of horizontal mergers mistakenly approved by the Federal Trade Commission (FTC).

In 2004, there was a horizontal merger between #3 PBM Caremark and #4 PBM AdvancePCS.

In 2007, there was, in our opinion, a disruptive pro-competitive, vertical merger between #2 retail pharmacy CVS and #2 PBM Caremark. At the time, #1 PBM Express Scripts make a hostile bid for Caremark, but withdrew over concerns over the length of antitrust investigations by the FTC.

In 2012, there was a horizontal merger between the #1 PBM Express Scripts and #3 PBM Medco.  In our opinion, this anti-competitive merger was mistakenly approved by the FTC with a one vote majority.  The deciding vote was made by a President Obama appointee, and Harvard Law School classmate, Edith Ramirez.

 In our opinion, Edith Ramirez has cost the American public $75+ Billion in excessive Rx costs over the past 5 years —   5 times an estimated inflated 5% of $300 Billion in yearly Rx drug expenses.

While we are naming names responsible for one the most consumer unfriendly antitrust  decisions in recent history, we want to called out Howard Shelanski et al  at the FTC and George Rozanski, partner at Bates White  Economic Consulting as the economists whose analysis of this merger focused mistakenly on PBMs as sellers of benefits management services rather than as buyers of drugs for resale to plans.

In 2013, the largest health insurer in the USA, UnitedHealth Group,  ended its long running PBM contract with Medco, now owned by Express Scripts.  To handle its own PBM needs, UnitedHealth created an internal unit OptumRx. It grew the unit via taking business away from CVS and Express Scripts and via a 2015 purchase of the tech-savvy PBM Catamaran.

The Pharmacy Benefit Manager Business Model

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 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.

The way companies monetize their businesses — a key component of their overall business model — is a choice.  Often companies sell bundles of products and services and make strategic decisions to monetize one component at a higher margin rate than another component.  Disguising gross profit margins by line of business or bundle components is considered a good business practice.

Take, for example, General Motors. It aspires to build great cars, yet a good share of its gross profits comes from car finance. McDonald’s aspires to offer customers a great tasting hamburger, yet the company has a higher markup on beverages that it does on food. Best Buy recoups slim margins on consumer electronics products with fat margins on extended warranties.

So why should the opaque PBM reseller business model be judged differently than, say, Best Buy’s?  Aren’t PBMs subject to ERISA laws mandating fiduciary responsibility — i.e. acting in best interest of clients?  

Actually no, according to court cases.  It is up to clients of PBMs to hold them accountable for claims that they act in clients’ best interests.  It is up to clients of PBMs to pressure them to offer alternative, more transparent business models.

The Evolution of the PBM Business Model

The PBM business model has evolved considerably over the past 15 years both in terms of the array of managed care services offered and the corresponding distribution of gross profits.

In 2001, PriceWaterhouseCoopers  published an excellent business history of PBMs to that date.   PBMs started out in the 1980s as computer networking specialists who automated Rx claims processing by connecting retail pharmacy point of sales terminals to back-office health insurance mainframes.  

Between 1980-1990, PBMs’ prime source of revenue was claims processing fees.  PBMs only focus was minimizing claims processing costs, a goal totally in line with the goals of their clients.

The excellent PriceWaterhouseCoopers PBM history did mention that PBMs tried a totally transparent insurance premium business model in the early 1990s. But, they abandoned it after a few years due to losses caused by unexpected mid-year increases in unit drug costs and uncontrollable, Pharma-initiated direct-to-consumer advertising campaigns that greatly increased utilization.

The current PBM business model features five major streams of revenue and gross profits:

  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.

Since we began following PBMs in 2002, the distribution of gross profits has changed dramatically. These radical shifts in such a short period of time is unprecedented among Fortune 50 companies.

These radical changes are indicative of the opaqueness of the PBM business model to their downstream customers — health insurance plan sponsors.  It is also indicative of the power of the Big 3  PBMs to negotiate rapid changes in payment streams with upstream suppliers — retail pharmacies and brand drug companies — who tacitly collude with them in two intermediate market bilateral oligopolies.

We see 3 distinct phases of the PBM business model over the past 15 years demarcated by radical shifts in the primary source of gross profits:

  1. up to 2005 — reliance on retained rebates from small molecule brand drugs;  
  2. 2005 – 2010 — reliance on mail order generic Rx margins;
  3. 2010 – today — reliance on retained rebates from specialty drugs.

Phase 1:  Retained Rebates from Small Molecule Brand Drugs

Phase 1 ended in 2005 after blog posts started appearing which disaggregated the 10-Qs and 10-Ks of Medco’s business model revealing outrageous rebate retention rates.  There was also a 2004 lawsuit initiated by U.S. Philadelphia District Attorney Patrick Meehan (now Congressman) accusing Medco of switching mail order generic Rx to higher priced rebatable brands.  As part of the settlement, Medco agreed to inform plans of gross rebates received and their 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.

At the same time Medco’s rebate retention rate — rebates retained divided by gross rebates received — dropped from 55% in 1Q03 to 28% in 2Q05

We have written extensively about the Pharma – PBM bilateral oligopoly that enabled this phase of the PBM business model.  Rather than rehash this, we refer to the following papers downloadable for free from our website:

  1. Pharmacy Benefit Managers as Conflicted Countervailing Powers , January 2007
  2. Who is Best at Negotiating Pharmaceutical Rebates?  December 2005
  3. PBMs as Bargaining Agents Paper presented at the 80th Annual Western Economic Association Meeting, July 6, 2005, San Francisco
  4. PBMs as Bargaining Agents PowerPoint presented at the 80th Annual Western Economic Association, Meeting, July 6, 2005, San Francisco
  5. The Effect of Corporate Structure on Formulary Design: The Case of Large Insurance Companies Poster Presentation, ISPOR 10th Annual Meeting, Washington DC, May 2005
  6. 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

Phase 2: Mail Order Generic Rx Margins

The “interregnum” Phase 2 featured a successful replacement of retained rebates with mail order generic margins.   The Big 3 PBMs devised a strategy of tacitly colluding with the Big 3 sell-side retail pharmacies  — Walgreen, CVS, and Rite-Aid — to hold up retail generic prices in order to allow for PBMs’ mail order generics prices to be lower but still with fat margins.  

Essentially, it was a scheme to limit price competition between retailers and mail order by “buying off” retail pharmacies with reimbursements for 30-day generic Rx at fat margins in return for ceding  90-day generics Rx to captive mail order operations at lower prices but equally fat margins.

According to PBMs,  mail order was good for plans because mail order generic Rx were cheaper than at retail.  Nevermind, if this was only because of PBMs’ rare ability to set the price of their competitors.  This hold-up scheme was just a sure-fire version the anti-competitive tactic of raising rivals costs.

Below is a diagram which compares the margins at the height of Phase 2 “hold-up” scheme versus the lower prices and margins existing today.

The “hold-up” scheme worked for a couple of years.  Our 2003 paper which disaggregated Walgreen’s gross profits  was read by an “outsider” retailer with a different business model that wasn’t dependent on fat Rx margins subsidizing the rest of the store.  That outsider was Walmart.  

Our paper confirmed what they saw — the fat generic Rx margins of Walgreen, etc. dispensed from a “1,000 square foot hole in the back” (our words) making up for slim margins coming the poorly merchandised, 10,000 square foot “front store”.   

In 2006,  Walmart rolled out a  transparent $4 / generic Rx campaign that proved to be the first blow to this hold-up scheme.

The 2007 vertical  merger of the pharmacy retailer CVS and the PBM Caremark marked the beginning of the end of the era of fat generic Rx margins.

A fundamental tool of managed care companies are preferred provider networks.  They succeed in reducing costs by promising increased volume to preferred providers in return for lower unit prices.  In 2006,  we found PBMs’ lack of use of preferred provider networks , along with lack of 90-day Rx at retail, to be obvious signs of the tacit collusion between the Big 3 pharmacy retailers and the Big 3 PBMs.

CVS read our 2005 paper confirming their success at beating out competitors in a Medicare Part D precursor program which was agnostic as to whether the Rx was filled at retail or mail order.

At the time of the CVS Caremark merger in 2006, we predicted  a “coming preferred provider war” among PBMs. Ten years later  “narrow networks” are common.  Generic Rx prices and margins are on a downtrend. And, PBMs no longer tout their mail order generics as the key to their profitability.

Phase 3: Retained Rebates From Specialty Drugs

To compensate for declining mail order generic margins, 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 drug rebates.   Reconstructing how PBMs solved these problems provides insights in two observable phenomena of the era of specialty drug rebates:

  1. the so-called deep rebate practice and related gross to net drug price bubble;
  2. the trend of growing number of drugs excluded outright from PBM formulary lists.

First, assume that Big 3 PBMs need to derive about the same 50% of gross profits from specialty drug retained rebates as was derived a decade ago from retained rebates from small molecule “rebatable” brands.

This creates a problem in that the Rx volume “basis” for collecting rebates today is a lot less than it was ten years ago.  How much less?  The Pew Charitable Trust Foundation sponsored a study which found that in 2015 special Rx comprised only 1% of total Rx.  

A decade ago, we estimated that about 20% of total Rx filled were “rebatable” brand drugs, i.e. in therapeutic classes with a few other brand drugs that were therapeutic equivalents.  So instead of 1:100 specialty Rx to total Rx basis differential, we arrive a 1:20  “rebatable” specialty drug Rx to “rebatable” small molecule brand drug Rx basis differential.

In other words,  ten years ago PBMs has 20 times the volume of Rx available to them to use as a basis for generating retained rebates as they do today.

The second constraint that PBMs have today that they did not have a decade ago was the awareness by plans and the public that opaque retained rebate could be a dominant source of gross profits.    

Our 2003-8 era papers listed below were rare examples of quantitative articles exposing PBM reliance on retained rebates:

  1. Quantifying Medco’s Business Model: An Update November 2008
  2. Medco As a Business Model Imperialist  July 2008
  3. A Tale of Two PBMs: Express Scripts vs. Medco November 2005
  4. Quantifying Medco’s Business Model April 2005
  5. Estimating the Rebate-Retention Rate of Pharmacy Benefit Managers April 2003

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 Rx while maintaining a transparent “reasonable” rebate retention rate at 10% on average?

How have the Big 3 PBMs accomplished this?  This is achieved by a perverse business model that forces Pharma to play a two-step negotiating game starting with lock-step list price inflation at double digit rates which enables PBMs to opaquely offset the list price inflation with growing “deep discount” rebates.  

Below is a screenshot from a Merck memo laying out for all to see its “gross-to-net drug price bubble”: 

In another paper, we “deconstructed” the Merck data by laying out a step-by-step sequence of how PBMs and drug companies might negotiate the parameters of a rebate deal today under the constraint that PBMs have to increase gross profit DOLLARS over time while fixing the rebate retention rate at 10%.   Below is a spreadsheet of that step-by-step process:

It is clear that Pharma is getting fed up as an enabler of a convoluted PBM business model. There are other drug companies besides Merck that are publishing similar data as way of defending themselves against charges of “double-digit” price-gouging tactics.  A testy exchange between executives at Gilead Science and Express Scripts over who is to blame for the high list prices of Gilead’s top selling Hepatitis C virus drugs went public.

We have written about AbbVie’s “disruptive” low list pricing of its new HCV drug Mavyret that dares PBMs to exclude a no-rebate drug that also happens to be the most cost-effective HCV drug now on the market.


PBMs as Business Model Imperialists

It is the PBM business model, not the Pharma business model, that is currently stressed.   If PBMs can no longer rely on specialty drug retained rebates,  they will have to seek a new service to build up opaque margins or convert finally to a 100%  pass through fee-for-service business model.

An example of this is Express Scripts’  October 2017 acquisition of the medical benefit management company eviCore Healthcare for $3.6 Billion dollars.

On the one hand, self-injectable biologic drugs are covered under a drug benefit plan administered by a PBM like Express Scripts. On the other hand,  biologic drugs requiring infusion or injection supervised by a physician at a doctor’s office, clinic, or hospital are covered by a medical benefit plan managed by insurance companies and contracted specialists like eviCore.

The business models are different with PBMs using a reseller model while companies like eviCore use a fee-for-service model.

We think that Express Scripts will try to convince insurance companies that contract with eviCore to switch from a fee-for-service model to a reseller model.  Express Scripts will promise eviCore customers a reduction in overall drug benefit costs if they allow a business model switch.

Express Scripts will achieve cost-saving by promising specialty drug companies exclusivity in insurance coverage for any given therapeutic class in return for greater rebates.  The opaque rebate retention Express Scripts earns should exceed what eviCorp had been getting from fees-for-services.

This is not the first time that a PBM has pursued  a new area of managed care with the intent of changing the business model.

In a 2008 article, we called Medco’s move into fee-for-service disease management a case of “business model imperialism.”

Another example of PBM business model imperialism was a 2009 deal between Express Scripts and Anthem (formerly Wellpoint) to manage its PBM business.  It was structured as a “book of business” deal  where Express paid $4.68 Billion upfront in return a 10 year right to the opaque P&L.  An alternative would have been to structure the deal as a normal fee-for-service PBM contract with 100% pass through.

We called the deal a “double-trouble front” and sure enough, it proved very lucrative for Express Scripts.  It was a headache for Anthem because they had no idea how much Express Scripts was profiting from managing their PBM business.

Express Scripts was painted as the bad guy in this deal, but the fault lies mostly with Wellpoint’s then CEO Angela Braley for selling out Wellpoint’s customers with little controls over how much Express Scripts could make.

The top priority of both Express Scripts and CVS Caremark today is looking to get into the medical drug benefit business — managing drugs requiring infusion or injection  at physician offices, clinics, or by mobile nurses in the home — and converting the business model from fee-for service or capitated insurance premium to a reseller model with opaque retained rebates.

In January 2018, the new Secretary of Health and Human Services Alex Azar made the recommendation at a Senate Finance Committee that infused drugs coverage Medicare Part B be taken over by private sector PBMs who manage Medicare Part D.

This change might result in a lower costs incurred by the government. But, under the current opaque PBM reseller business model, it would be impossible to tell how much profits PBMs would be making.