How Pharmacy Benefit Managers (PBMs) Work

A brief synopsis for curious stakeholders

Pharmacy Benefit Managers (PBMs) came into existence over fifty years ago to solve a simple problem — administer insurance coverage for medications. PBMs became “middle men” between the health plan and pharmacies. Today, medical and pharmacy benefits are still administered as separate operations for most Americans. The same model that started back in the 1960s still exists today. In this series, we’ll break down the history, function, and influence of PBMs in the United States healthcare system.

What PBMs Do

PBMs work with pharmaceutical manufacturers to negotiate prices for brand medications and work with health plans to design formularies, determining which medications will be covered by the plan. From a patient’s point of view, the PBM determines if the patient’s medication costs $10 or $50 at the pharmacy in the form of a copayment or “co-pay.” The PBM bills the remainder of the medication cost back to the health plan. See Figure 1 below for an illustration of the interaction between a PBM and its customers.

Figure 1. How PBMs Work in the Healthcare Ecosystem

All PBMs provide multiple services to their numerous clients around the country. Many of those services are focused around clinical functions, formulary design/management to lower cost, and clinical systems to promote safety and better outcomes. All of these services are necessary for optimal and successful administration of pharmaceutical benefits and provide value to both patients and employers.

Clinical functions focus on safety and efficacy of drug therapies and typically including the following activities:

• Clinical checks for drug-drug interactions and duplicate therapies
• Drug utilization reviews to notify pharmacist that the prescribed therapy may not be safe
• Prior authorizations to help ensure the appropriate use of medications and to serve as a guide to use lower cost medications first, before going to more expensive branded medications
• Medication adherence programs to increase compliance
• Controlled substance monitoring for narcotics
• Specialized clinical support from nurses, dietitians, and pharmacists
• Close clinical monitoring for expensive and/or high-risk specialty therapies (i.e. “specialty pharmacy” — PBMs can own or contract with specialty pharmacies to provide this service)

Clinical functions are closely tied to formulary design in order to guide prescribers and patients toward safe, efficacious, and cost-optimal therapies. The PBM works on behalf of the employer or health plan to design a list of covered drugs and their level of coverage. An example of this would be if a generic and branded medication are clinically equal, then the generic medication would be covered and the brand would be restricted. At times, PBMs work with manufacturers to get better rebates on products to lower the cost to the plan. For example, PBM negotiates a rebate of 60% per unit for “Test Strip A” and a rebate of 75% per unit for Test Strip “B.” Assuming each unit cost $1.00, the PBM would pick Test Strip “B” because they would receive a larger rebate back on the product.

Many service functions are administered through the PBMs software such as claims processing, clinical monitoring, and patient-facing apps to check copays or coverage. In order to offset the cost for the multiple services and software that PBMs offer, multiple revenue streams are needed. Each PBM may employ unique techniques for rate and cost setting. One of the most common methods is to charge a set dollar amount “per member per month” (pmpm) or, similarly, a per claim per month to a self-funded employer.

Who PBMs Are

In 1968, to meet the growing demand of prescription billing and claims processing, McKesson started Pharmaceutical Care System, Inc. (PCS), in Scottsdale, Arizona. Soon, other PBMs like Medco and Diversified Pharmaceutical Services (DPS) began to pop up across the nation. Fast forward to the 1990s when billion dollar mergers and acquisitions in the pharmacy industry become commonplace. In 1993, Merck and Medco merged, followed by SmithKline Beecham (later to become GlaxoSmithKline) and Diversified Pharmaceutical Services, forming UnitedHealthcare for $2.3 billion in May 1994. In July 1994, Eli Lilly acquired PCS for $4 billion. At the time, stakeholders claimed the new vertically integrated models would lower drug costs. Even though the Federal Trade Commission (FTC) initially approved the mergers, there were concerns, leading the FTC to state the Merck-Medco acquisition showed favorable treatment to Merck products. ,

In 2018, Americans filled over 3.7 billion prescriptions. Approximately 95% of all claims were from commercial plans (e.g. private plans offered by an employer), Medicare Part D, or Medicaid. In that same year the top three PBMs — CVS Caremark, Optum, and Express Scripts — controlled 76% of the market share. Each of the Big Three PBMs own their own mail order pharmacy, retail pharmacy, and/or specialty pharmacy.

Below are timelines of how the “Big Three” came to be.

CVS Caremark

Parent company of Aetna.

1963: Customer Value Stores (CVS) began as beauty aid stores and shortly after pharmacies were added to the stores

1993: MedPartners, Inc. was created as a Physician Practice Management Company (PPM). PPMs performs all back end non-clinical office functions, strategic planning, and even capital for future growth,

1994: CVS launched its first PBM, PharmaCare

1996: Medpartners acquires Caremark International PPM and a PBM business owned by Baxter

2000: Medpartners exits PPM business, changes its name to Caremark Rx and becomes solely focused on the PBM business

2003: Caremark Rx purchased Advanced PCS for $5.6 billion

2007: CVS (owners of the pharmacies) purchases Caremark Rx for $21 billion to form CVS Caremark, later branded as CVS Health

2018: CVS Health acquired Aetna

Optum

Owned by UnitedHealthcare (UHC), a Fortune 5 company.

1993: Sold PBM, DPS, to SmithKline for $2.3 billion

2005: Acquired Prescription Solutions as a result of PacifiCare Health Systems purchase

2011: PBM business was rebranded to what we know today, OptumRx

Express Scripts

Owned by Cigna.

1986: Founded in St. Louis, Missouri

1989: Purchased by New York Life Insurance Company

1999: Purchased DPS from SmithKline for $700 Million (DPS was sold by Optum to SmithKline for $2.3 billion in 1993)

2001: Partnered with Merck-Medco and Advance PCS

2012: Purchased Medco for $29.1 billion

2018: Cigna acquires Express Scripts for $67 Billion

The healthcare market continues to see vertical integration of the areas of healthcare delivery and healthcare management.

As we continue throughout our series we will explore the details of the business activities and its effects on employers, patients, and the PBMs themselves.

Nick Wimpey, Pharm.D. is Principal Consultant at Healium, a modern healthcare consultancy.

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About Healium
Healium is a modern healthcare consultancy. We partner with companies we truly believe in and help our clients implement solutions that improve health outcomes and reduce total cost of care. We do our best work on projects related to pharmacy benefit design, specialty pharmacy, 340B program administration, and population health management.

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