Ascendancy of the Transparency Model for PBMs

Many traditional PBMs have revenue streams that are not disclosed or shared with plan sponsors. These revenue streams include pharmaceutical manufacturer rebates, pharmacy network discounts and spread, and data sales. Such arrangements can result in a misalignment of incentives, making it difficult for plan sponsors to achieve the lowest costs possible. Partially transparent or “translucent” PBMs may disclose some but not all rebate revenues. Fully transparent PBMs identify and share all revenue streams with their plan sponsors. (Drug Benefit Trends. 2008;20:98-100)

The Department of Health and Human Services projects that prescription drug spending in the United States will increase from $200.7 billion in 2005 to $497.5 billion in 2016-or 148% in just 11 years. With pharmacy costs expected to jump from 9.3% of all health care expenditures in 2000 to 15.5% by 2013, management of drug costs is essential.

The primary purpose of PBMs is to apply managed care precepts and practices to pharmacy benefits to control costs and enhance quality. PBMs control costs by managing the unit price of drugs and drug utilization through claims processing, network support and development, formulary design and maintenance, rebate programs, clinical services, report generation, and other services.

Not all PBMs conduct business in the same manner. Some PBMs generate revenue through side contracts with retail pharmacies and pharmaceutical manufacturers. Under these agreements, PBMs have revenue streams that are not disclosed to clients. These companies are referred to as “traditional model” PBMs. An alternative PBM business style has gained attention and momentum in recent years based on “transparency.” PBMs that conduct business in this manner are referred to as “transparent model” PBMs.

Transparency: What Is It?

Fully transparent PBMs identify and share all revenue streams with their plan sponsors. Any gains in pricing negotiated with pharmacy networks or pharmaceutical manufacturers are passed on directly to clients, both at the onset and throughout the course of the contract. Transparent model PBMs operate under the assumption that plan sponsors should be informed about all aspects of the PBM business.

No hidden revenue streams. With a transparent business model, the PBM's only revenue sources are an administrative fee (typically calculated on a per-member per-month [PMPM] basis) and any agreed-upon rewards for positive results obtained through clinical programs. These represent the only revenues collected by a transparent PBM from plan sponsors. No hidden revenue streams exist. In this one-fee, transparent business arrangement, plan sponsors know and understand exactly what they are paying for. Any discounts, rebates, and pharmaceutical company rebate management fees are passed directly to plan sponsors.

Operational transparency. Another feature of the fully transparent PBM is operational transparency. Operational transparency enables a plan sponsor to understand all aspects of the pharmacy benefit management process-from the drug manufacturer’s relationship with the PBM to the entire process of managing drug benefits. The plan sponsor is informed about industry practices and how the negotiations are conducted. Some fully transparent PBMs even allow plan sponsors to audit and understand formulary management and the operation of the Pharmacy & Therapeutics Committee, clinical programs such as drug utilization review (DUR), and the process of contract negotiation with network pharmacies and pharmaceutical manufacturers.

Some transparent PBMs manage their DUR programs using pay-for-performance methodology. DUR programs include focused products that help counteract trend, reduce overall drug spend, and improve the quality of care delivered. With pay-for-performance DUR programs, the PBM receives additional revenues only when it saves money for the plan sponsor.

Aligned incentives. Finally, and most important, the business goals of a completely transparent model PBM are fully aligned with its plan sponsor’s motivations and the PBM does not have any incentive to increase prescription drug utilization.

In sum, transparency ensures that the PBM is driven toward the lowest-net-cost model for the plan sponsor and to act as a steward of the sponsor's best interests. Because the transparent model PBM does not retain rebates, it is motivated to maximize generic savings opportunities, select lowest-net-cost brands for its formulary, and implement other cost-containment techniques, allowing for complete alignment of the PBM and the plan sponsor’s objectives.

Traditional PBMs

Traditional PBMs provide the same services as transparent PBMs, including plan design, formulary design and management, rebate management, management of retail pharmacy, mail and specialty networks, and clinical programs.

However, traditional PBMs follow a different business model, typically offering a low administrative fee compared with the transparent PBMs. Some PBMs charge no administrative fee at all, or offer a “negative administrative fee,” seemingly paying plan sponsors to allow the PBM to administer their accounts.

These low or negative administrative fees are misleading because, of course, it does cost money for the traditional PBM to administer accounts. But how does the traditional PBM make enough money to remain financially viable? As mentioned earlier, traditional PBMs generate most of their revenue from a basket of hidden revenue streams: pharmaceutical manufacturer rebates, pharmacy network discounts and pricing “spread,” and pharmacy data sales.

Pharmaceutical manufacturer rebates. Rebates are discounts paid to PBMs by pharmaceutical manufacturers, typically in exchange for preferred placement of their prescription drug products on the PBM’s formulary. By gaining preferred access to the formulary, the manufacturer’s profit from the increased sales offsets the rebate dollars paid to the PBM. The traditional PBM typically keeps a portion of these rebates before passing dollars back to the plan sponsor.

Pharmacy network discounts and spread. Another hidden revenue stream is provided through pharmacy networks. After agreeing on a pharmacy network dispensing fee with the plan sponsor, traditional PBMs may negotiate a lower dispensing fee with the pharmacy. The difference between the 2 rates is called “spread.” Often traditional PBMs set up attractive guaranteed pricing at the outset of a pharmacy contract and then later negotiate even better prices, pocketing the difference. Spread is an even more significant factor in generic drug pricing, especially drugs dispensed by mail.

Data sales. Profit from data sales is another hidden revenue stream tapped by traditional PBMs. While the sponsor may have access to portions of the data, traditional PBMs tend to view this data as their own, using it to generate revenue.

Traditional vs Transparent

Pharmacy benefit management can be a complicated, confusing business with its rebate negotiations, administrative fees, and jargon, including terms such as “spread” and “MAC pricing.” Further confusion comes with trying to evaluate traditional and transparent PBMs and their business practices.

Traditional model confusion. With all of the jargon and cryptic fees employed by traditional PBMs, plan sponsors can become confused and may opt for a traditional plan because it seems less expensive. But as noted earlier, it costs money to manage pharmacy benefits, and plan sponsors may not understand the complexity and the financial dynamics of how their PBMs operate. And if the plan sponsor does not understand these nuances, it is easier for the PBM to not completely disclose everything. For example, the plan sponsor often is not able to see what its PBM makes in incentives and rebates for putting particular drugs on a formulary. Also, the PBM might not freely disclose its contracts with third parties that contribute to the PBM’s revenue. Plan sponsors might not be aware of the contracts-and even if they are, they might not know how to audit these contracts.

Complicated techniques may be used to hide revenue streams. Often, it has several maximum allowable cost (MAC) drug lists. The PBM shows the plan sponsor one MAC list and then negotiates a different MAC list with the pharmacy network, if doing so will generate a little more income for the PBM. The difference between these lists results in greater spread in the pricing of generics.

Transparency model confusion. Despite the apparent simplicity of the transparent business style, plan sponsors sometimes have a hard time comparing fully transparent PBMs with traditional PBMs. Aspects of the transparent model may seem confusing. Specifically, it can be difficult for plan sponsors to understand what they are currently paying traditional PBMs, so they have no basis to compare when they examine transparent PBMs.

The administrative fee charged by a transparent PBM may appear inflated to the plan sponsor accustomed to a traditional model. If administrative fees of transparent and traditional PBMs are examined on the same level, the transparent PBM seems to be charging much more. But when the entire fee structure is explained and evaluated and the benefits of transparency are understood, the reasons for a higher administrative fee become clear. Even with the higher administrative fee charged by the transparent PBM, the actual cost may be lower than that paid to a traditional model PBM when revenues from preferred formulary placement, spread, and data sales are included.

The transparent model can also be confusing because many traditional or translucent model PBMs claim to be transparent. As discussed, any PBM that does not disclose everything-contracts, MAC lists, discounts, rebates, data sales, rebate management fees, and so on-cannot be considered truly transparent. But often plan sponsors do not know what questions to ask.

Translucent Model PBMs

An offshoot of the traditional PBM is the partially transparent or “translucent” PBM. The translucent PBM generates revenue through pharmaceutical manufacturer rebates and pharmacy network discounts-but then discloses and passes back only some of this revenue to its clients.

A translucent PBM might disclose how much it keeps in rebates. For example, the PBM could arrange to give the plan sponsor 80% of rebates collected-and keep 20%. But this does not align the interests of both parties. In this example, one of the PBM's objectives will be to maximize rebates because it will receive 20% of such revenues.

A good test of a PBM’s transparency is to ask to audit its contracts. If the PBM will not allow a plan sponsor to audit its contracts, the PBM may be keeping additional revenue it does not want to disclose. Some PBMs promote themselves as transparent-but that does not mean they are 100% pass-through. These PBMs may provide “transparent pricing” but do not disclose entire contracts.

Achieving Plan Objectives

Plan sponsors need to make a choice: become informed and know exactly what they are paying for in their pharmacy benefits-or remain unaware of how some PBMs operate.

Some traditional PBMs make it difficult to figure out how much is kept in spreads, data sales, and other revenue streams. Contracts are written to support hidden revenues and are often unavailable or difficult to audit. But the plan sponsor has a vested interest in understanding what is going on. The traditional PBM creates a situation in which there is predisposed decision making about which drugs are available for plan members. Drugs with high rebates and incentives from pharmaceutical manufacturers may make it onto the plan's formulary, while other medications may not.

In contrast, the fully transparent, 100% pass-through PBM ensures its interests are entirely aligned with the plan sponsor’s interests, not with its own bottom line. Interests are aligned from a clinical program perspective because the PBM is only paid for its performance. They are aligned from a rebate perspective because rebate negotiations have no hidden revenues. In addition, they offer operational transparency with plan sponsor contracts and claims.

By utilizing the PMPM pay arrangement, the transparent PBM can focus on achieving its sponsor’s plan objectives to lower net cost while improving member health-rather than chasing discounts and rebates.

The Future of Transparency

The PBM business was founded on the traditional model PBM. And as the industry grew, this PBM found more and more ways to build revenue.

But those streams of hidden revenue add up. And through analysis of the plan sponsor’s claims data, the transparent PBM can illustrate the plan’s unrealized savings that the traditional model siphons by taking a spread out of every claim and selling data to the highest bidder.

Many PBMs will continue to work under the traditional model. It is lucrative, and many plan sponsors do not have the time or wherewithal to put the effort into understanding the often complicated and confusing pharmacy benefit management business. Not only do plan sponsors need to comprehend the PBM industry, they must also monitor their PBMs and ensure their contracts offer reasonable compensation.

And transparent PBMs can seem more expensive at the outset than traditional PBMs. When a PBM does not obtain the fees, rebates, and incentives of hidden revenue streams, it must charge a higher administrative fee. If plans only look at their bottom lines at one particular moment and not the whole sweep of issues in front of them, they may overlook the benefits of transparency.

Some government agencies, labor organizations, and other plan sponsors are focusing on drug costs and looking for cost savings. In many cases, they are looking for transparency. The industry is moving toward full disclosure and transparent pass-through and toward providing a more complete understanding of drug management to plan sponsors.

Plan sponsors who seek pharmacy benefit management services need a business model that works as an advocate on their behalf. Transparency PBMs can serve that need by providing more information. This is not just about pricing-it is about giving plan sponsors the ability to openly assess their choices.