Rx Corner

About 15 years ago my manager told me “I think this transparent PBM thing is gonna be a big deal”.  What’s insane to think now is: He was absolutely right but I don’t think either of us really had any clue what we were talking about or why it would become a big deal.

Consultant knowledge of the pharmacy world has come a long way since the mid-aughts.  It has grown leaps and bounds in the last 5-6 years.  6 years ago there were a handful of brokerage firms that had designated pharmacy consultants.  Today, roughly half of firms have a designated pharmacy specialist in-house.  But one persistent area of debate is on spread pricing vs. pass-through pricing models –which has evolved into near religious zealotry. 

In this piece – I address how plan sponsors get billed, how pharmacies get reimbursed, spread pricing, pass-through pricing, and ultimately some best practices for deciphering which model is better for your clients.

What Determines How a Plan Sponsor is Billed For TheiSpreadr Drugs?

Ultimately, whether on a pass-through or spread contract, the main determinant for how a plan sponsor is going to be charged for their prescription drugs is their contract guarantees.  Almost all pharmacy contracts are based on Average Wholesale Price, with an aggregate discount guaranteed on a basket of drugs such as “Retail 30”, “Retail 90”, “Mail Order” and “Specialty”.  Average Wholesale Price is based on Medi-span, RedBook, or First Data Bank – three independent publishers who do have some variation in their reported prices.  You may have over 1,000 different combinations of manufacturers and drugs representing 350+ unique drugs, with a wide variance in prices, filled under a single mid-size employer benefit plan.  The PBM is going to give you a guarantee as a percentage off of those varying drugs AWP, for example, if the total AWP for all 150 generic drugs filled for a 30-day supply at a retail pharmacy is $1,000,000 – the contract may guarantee 85% off that $1MM for a total cost of $150,000 to the plan.  The discount guarantee is always what is stipulated because the utilization can vary wildly from year to year based on enrollment changes and changes in people’s health conditions.

What Determines How a Pharmacy is Reimbursed for Dispensing A Drug?

A retail pharmacy negotiates a pharmacy network contract similar to that of an employer in order to be considered an “in-network” provider for a PBM.  Many smaller retail pharmacies lack negotiating power and join “Pharmacy Services Administration Organizations” or PSAOs, to aggregate purchasing power and negotiate better reimbursements.  It is critical to understand that pharmacies do not contract for a specific price for a specific drug – but use aggregate pricing similar to that of an employer. In the plan sponsor AWP example – the pharmacy may have a reimbursement of AWP – 90% or 91% for the same $1 MM in AWP – or $100k in reimbursements.

What is Spread Pricing?

The #1 way that a pharmacy benefit manager makes money is by buying low and selling high on prescription drugs.  A PBM’s revenue is how much they charge a plan sponsor for prescription drugs as determined by their contract guarantees.  The PBM’s costs of goods sold are how much they reimburse the pharmacy for a prescription.  This is determined by their retail pharmacy network contracts.  Their profit is the spread between the two numbers.  In the example provided before – the revenue is $150k billed to the plan -the cost of goods sold is $100k paid to the pharmacy  = $50k gross profit.  The biggest benefit of pass-through pricing for the entire pharmacy value chain is that PBMs are highly motivated to drive down the profitability of retail pharmacies and lower their cost of goods sold  – forcing them to be more efficient and lower prices.  (Sidebar:  I will say that this “benefit” has been taken to the extreme to the point where pharmacy revenues have eroded enough that communities are threatened with the loss of access to pharmacists – not unlike Wal-Mart driving local retailers out of business).

Up until the last 5 years – most consultants didn’t understand how PBM’s made money and never negotiated the price of the drugs for their plan sponsors.  Those that did understand it:  Some Health plans, TPA’s, and independent pharmacy consultants – captured the profit as resellers of the PBM’s service.  This left plan sponsors paying costs that were sometimes 2x the market rate while the PBM, Consultant, or Health Plan (or a combination thereof) raked in massive profits or used it to subsidize lower administration fees to win business.

I’m happy to say that the advent of broker-owned consultants, high-integrity independent consultants, helped alleviate this pricing disparity and bring pricing more in line with the market.  But another large contributing factor was the growth of an alternative form of PBM contract:

What is Pass-Through Pricing?

Pass-through pricing is a cost-plus form of PBM contract.  The PBM charges the client the exact amount that the pharmacy is reimbursed and then charges an administration fee for processing.  This fee can be anywhere from $2.50 up to $12.00 per claim or higher.  The benefit, theoretically, is the client is getting the same acquisition cost for the drug as the PBM and so the cost of the drug should be much lower than the marked-up spread pricing cost of the drug. 

What are the Benefits of Pass-Through Pricing?

Pass-through pricing is very effective at constraining pricing abuses by a PBM.  When a plan has very good utilization (lots of low-cost generic drugs), a PBM with a spread contract benefits from that utilization.  The plan sponsor could have a drug mix that is costing the PBM AWP – 95% ($50,000 in the previous example) – and this creates the opportunity for the PBM to continue billing the client the $150k and increase profitability dramatically.  In order to accomplish this, the PBM may target pockets of drugs and dramatically increase the billing amount to the plan sponsor to maximize profitability.  The client has limited to no “upside” in a spread contract whereas the client wins if its drug mix is favorable on a good pass-through contract.

Pass-through pricing was and is, a very well-intentioned response to a market with unbridled greed and abuses that takes place.  But then it got hi-jacked: 

Down the Rabbit Hole, We Go

If you follow the basic math of spread pricing it’s A + S = C.  Acquisition cost + Spread = Client Cost.  If you follow the basic math of pass-through pricing it’s A + F = C.  Acquisition Cost + Fee = Client Cost.  I want to emphasize something here.  The number a consultant cares about is C.  That’s it.  Everything else is superfluous.  But what the focus started to become was on the spread – “S”.  “S” is NEVER a known variable.  And that is incredibly frustrating – you will never know how much a PBM really makes on a spread contract.  “F” is always known.  It is an immutable number – not a variable.  And the assumption became – “If I know “F” and I don’t know “S” – then my “C” will be better because I know “F”. 

But let’s turn our attention to acquisition cost.  There is an assumption in this calculation that acquisition cost is the same across PBMs.  And it absolutely is not.  It varies wildly.  And if you parallel this to a grocery store – you know Wal-Mart’s purchasing power gives them a better acquisition cost than your local grocery store.  But you also know that doesn’t necessarily mean that Wal-Mart is going to offer you a better price on some items than your local grocery store.  Yes, the bigger the PBM, it’s likely the better the acquisition cost.  But that doesn’t mean you are getting the best price because of that darn variable “S”. 

Unfortunately, as the focus became more so on “Spread” vs. “Fee” the focus on “C”, Client Cost, was lost.  Some PBMs started to figure out that they could say they offer a “Pass-Through” contract as an effective sales pitch, or misdirection, to try to incite plan sponsors’ anger at their PBM.  But more importantly – by focusing the conversation on the Fee and not the acquisition cost or client cost – the PBM figured out it could make MORE money on its spread contracts (exacerbating the abuse) by convincing some clients to go on pass-through contracts.  This is where the math gets very complicated and there is something extremely important to remind you about how PBM’s reimburse pharmacies:

A PBM can change what it pays a pharmacy for a prescription ALL THE TIME.  Their contracts with pharmacy chains are in aggregate, just like their contract with employers. 

For simple math:  This means that if a PBM is obligated to pay a pharmacy $4.00 for a lisinopril claim on average – it could reimburse the pharmacy $2.00 one day and reimburse the pharmacy $6.00 the next day.  The average reimbursement of $4.00 is achieved.

If a PBM has a pass-through contract with “Employer A” and a spread contract with “Employer B” – they can increase their profit margin on Employer B by driving up the cost of Employer A.  See the example below:

But if “Employer A” has negotiated its contract and focused on “C” – their cost would still be potentially higher in this example than “Employer B”, but the PBM won’t have the opportunity to increase its profits.

This brings us to one final consideration:  MAC lists.  A MAC (Maximum Allowable Charge) list is a schedule of charges for each drug class.  With up to a dozen different manufacturers of a particular drug, a PBM will set a list of charges to the plan regardless of which manufacturer made the drug.  A PBM can have multiple Mac lists, each representing a different profitability depending on a client’s utilization.  They also have the ability to “factor” these lists up or down in price.  Some PBMs have dozens of MAC lists.  Others have a single MAC list – or, if their pricing is based on NADAC (National Average Drug Acquisition Cost) that is equivalent to having a single MAC list.  To get the “upside” of drug utilization your PBM has to have a single MAC list or use NADAC.  Otherwise, the PBM can still manipulate the plan sponsor’s pricing. 

Here are the key takeaways I hope you take from this:

1.       If A PBM Offers both Spread and Pass-Through – lean towards the Spread:  It is a paradox that while the PBM is going to make more money on your contract because of the spread – they will be doing so at the expense of their pass-through clients. 
2.       If A PBM Offers Pass–Through, You Need to Know Your MAC List:  If the PBM has multiple MAC lists – there is a limitation to the amount of upside you may see on your contract.  If a PBM will share their MAC list with you – you’re in.  I lean towards the concept that NADAC is the most effective cost basis and I believe we may see a shift towards it in the industry for Pass-Through PBM – the PBM has essentially relinquished its control of its MAC lists in this situation (at least for drugs that have a NADAC price).
3.       All Things Being Equal – Pass-Through is Better:  The profit still came from the spread contract – not the pass-through contract.  If your sole focus is on controlling PBM profitability, pass-through accomplishes this.  You also get the upside on a pass-through contract of improvements in acquisition cost.  You are unlikely to get much if any upside on a spread contract.  But you need to address with the PBM the other contracts that they offer in the market and their use of MAC lists in order to identify if you’re on a “high quality” pass-through contract.  Also – “All Things Being Equal” is the critical caveat.  Don’t ever lose sight of Client Cost in the contract – a pass-through contract still needs to have strong contract language that is competitive with other offers.
4.       If Your Client Owns the Pharmacy – You HAVE to be on Pass-Through:  Grocery store chains, pharmacies, hospitals, or physician practices with in-house pharmacies or tribal entities with tribal-owned pharmacies should all have Pass-Through contracts.  This is because the spread mechanism acts like a sieve draining money out of the organization by charging the health plan a high amount and reimbursing the pharmacy a low amount.  In this situation, the only thing we care about is limiting the PBM’s profitability – which as mentioned is best done by a Pass-Through contract.

Conclusion

In conclusion, the debate between spread pricing and pass-through pricing models in pharmacy benefit management (PBM) contracts has evolved into a complex discussion with significant implications for plan sponsors and pharmacies alike. While spread pricing historically allowed PBMs to generate substantial profits by leveraging pricing differentials between plan sponsors and pharmacies, pass-through pricing emerged as a response to promote transparency and constrain potential abuses. However, the narrative surrounding these models has become increasingly nuanced, with PBMs sometimes leveraging the focus on fees in pass-through contracts to maximize profits on spread contracts. Understanding the dynamics of acquisition costs, maximum allowable charge (MAC) lists and contract guarantees is essential for consultants and plan sponsors to navigate this landscape effectively. Ultimately, the key takeaway is to prioritize client cost (C) and ensure that contract structures align with the best interests of the plan sponsor, whether it be through well-negotiated spread contracts or high-quality pass-through arrangements. Each scenario demands careful consideration and a strategic approach tailored to the specific needs and goals of the client.