Pharmacy benefit management

Based on Wikipedia: Pharmacy benefit management

Here is one of the strangest facts about American healthcare: there exists a nearly six-hundred-billion-dollar industry that most Americans have never heard of, yet this industry touches the prescription drugs of 275 million people. These companies sit invisibly between you and your medication, and they have become so powerful that even pharmaceutical giants blame them for high drug prices—while consumer advocates blame them for the exact same thing.

They are called pharmacy benefit managers, or PBMs, and understanding how they work reveals something profound about how opacity and complexity can become profit centers in their own right.

The Middleman Nobody Asked For

Imagine you need a prescription filled. You might think the transaction is simple: your doctor prescribes a drug, your insurance covers part of the cost, and you pay the rest at the pharmacy. But hidden in this exchange is an entire layer of corporate machinery that most patients never see.

A pharmacy benefit manager is a third-party company that health insurers hire to handle everything related to prescription drugs. They negotiate prices with pharmaceutical manufacturers. They decide which drugs your insurance will cover. They process the claims when you pick up your medication. They even run mail-order pharmacies that ship drugs directly to your home.

The original idea made a certain kind of sense. Health insurers wanted to focus on their core business and outsource the complexity of drug pricing to specialists. Employers who provide health coverage to their workers wanted someone to aggregate their buying power and negotiate better deals. The promise was simple: PBMs would use their market clout to drive down drug prices for everyone.

That was the theory. The reality has become something far more complicated.

The Three Giants

Three companies now control roughly eighty percent of the entire pharmacy benefit management market: CVS Caremark, Cigna's Express Scripts, and UnitedHealth Group's Optum Rx. Together, they manage drug benefits for approximately 270 million Americans—more than four out of every five people in the country who have prescription drug coverage.

This concentration would be remarkable in any industry. But what makes it particularly significant is that these three PBMs are not independent companies. They are all owned by larger healthcare conglomerates that also own insurance companies and pharmacies.

CVS Caremark is owned by CVS Health, which also owns Aetna insurance and operates one of the largest pharmacy chains in America. Express Scripts is owned by Cigna, one of the nation's largest health insurers. Optum Rx is owned by UnitedHealth Group, which runs UnitedHealthcare insurance and operates thousands of healthcare facilities.

This vertical integration—where the same corporate parent owns the PBM, the insurer, and the pharmacy—creates a structure where a company can negotiate drug prices with itself, send patients to its own pharmacies, and process claims through its own systems. Critics argue this arrangement creates obvious conflicts of interest. The industry argues it creates efficiencies.

The Business of Opacity

To understand how PBMs make money, you need to understand a peculiar feature of American drug pricing: the difference between what a drug supposedly costs and what anyone actually pays for it.

Every prescription drug in America has something called a list price—think of it as the sticker price on a car that nobody actually pays. Pharmaceutical manufacturers set these list prices high, and then offer various discounts, rebates, and negotiated reductions to different buyers. The actual price paid for any given drug can vary enormously depending on who is buying it and how the deal was structured.

PBMs operate in this gap between list prices and actual prices. When a PBM negotiates with a drug manufacturer, they obtain a confidential net price that is lower than the list price. The manufacturer pays the PBM a rebate—essentially a kickback for including the drug on the PBM's formulary, which is the list of medications that insurance plans will cover.

Here is where it gets interesting. The PBM does not have to tell anyone what that net price is.

They can charge the insurance plan based on the higher list price while pocketing a portion of the rebate. They can pay pharmacies one amount for dispensing a drug and charge the insurance plan a higher amount, keeping the difference. This practice, known as spread pricing, became so profitable that states like Ohio, West Virginia, and Louisiana eventually demanded that PBMs disclose their actual costs when working with Medicaid programs.

The industry's defense of this secrecy is revealing: they call their negotiated prices trade secrets. In other words, the opacity is not a bug but a feature—it is the source of their competitive advantage and, not coincidentally, their profits.

The Formulary Game

One of the most consequential powers a PBM holds is deciding which drugs appear on the formulary—and where they appear on it.

A typical formulary is organized into tiers. Drugs on the lowest tier have the smallest copayment for patients—maybe five or ten dollars. Drugs on higher tiers cost patients more—perhaps fifty dollars, or a percentage of the drug's price. Drugs that do not appear on the formulary at all are not covered by insurance, meaning patients must pay the full list price.

This creates enormous leverage over pharmaceutical manufacturers. If a PBM threatens to move your drug to a higher tier—or exclude it entirely—patients will face higher costs and many will switch to a competitor's product. Manufacturers therefore compete vigorously to get favorable formulary placement, and the primary way they compete is by offering larger rebates to the PBM.

Notice the incentive structure this creates. A PBM does not necessarily benefit from lower drug prices. It benefits from larger rebates. And rebates are calculated as a percentage of the list price. This means a PBM might actually prefer a drug with a higher list price and a larger rebate over a drug with a lower list price and smaller rebate—even if the lower-priced drug would be better for patients and the healthcare system as a whole.

As former Health and Human Services Secretary Alex Azar put it: "Everybody wins when list prices rise, except for the patient. It's rather a startling and perverse system that has evolved over time."

The Clawback and the Gag Order

Perhaps nothing illustrates the baroque complexity of PBM economics better than a practice called the clawback.

When you fill a prescription and your insurance covers part of the cost, you pay a copayment. That copayment is typically calculated based on the list price of the drug. But sometimes—roughly a quarter of the time, according to studies—your copayment is actually higher than what the drug would cost if you simply paid cash and did not use your insurance at all.

Read that again. You might pay thirty dollars as your insurance copay for a drug that costs twenty dollars in cash. The extra ten dollars does not go to the pharmacy or the drug manufacturer. It goes to the PBM.

This would be merely absurd if pharmacists could simply tell you about it. But for years, they could not. PBM contracts with pharmacies included provisions called gag clauses that prohibited pharmacists from volunteering information about cheaper cash prices. The pharmacist standing across the counter from you, who knew perfectly well that you could save money by not using your insurance, was contractually forbidden from telling you so unless you specifically asked.

The backlash against gag clauses was one of the few areas of bipartisan agreement in healthcare policy. Starting in 2017, individual states began banning these clauses, and Congress followed with federal legislation in 2018 that prohibited gag clauses for private insurance, extended to Medicare in 2020.

The gag clause episode reveals something important about how PBMs operate. Their business model depends not just on complexity but on information asymmetry—on patients and pharmacies knowing less than the PBM knows about the actual economics of each transaction.

Vertical Integration and the Independent Pharmacy

If you live in a small town or rural area, you may have noticed something in recent years: independent pharmacies closing their doors. The economics have become increasingly difficult, and PBMs are a significant part of the story.

When a PBM owns its own pharmacies—as all three major PBMs do through their corporate parents—it controls both the reimbursement rates for pharmacies and which pharmacies patients are steered toward. Studies and lawsuits have alleged that PBMs sometimes reimburse their own affiliated pharmacies at higher rates than independent pharmacies, or actively direct patients away from independents.

For an independent pharmacy, this creates an impossible situation. The PBM sets the price you get paid for dispensing a drug. The PBM can change that price with little notice. The PBM can steer your customers to its own mail-order pharmacy or its own retail locations. You have essentially no negotiating power because the PBM controls so much of the market.

Between 2015 and 2019, health insurance premiums increased by nearly seventeen percent nationwide. States that had enacted regulations on PBM practices saw slightly lower increases; states without such regulations saw slightly higher ones. The differences were small but measurable—evidence that regulatory scrutiny might at least moderate some of the industry's practices.

A History of Consolidation

The PBM industry began innocuously enough. In 1968, a company called Pharmaceutical Card System invented the plastic benefit card—the little card you show at the pharmacy to prove you have insurance coverage. Through the 1970s and 1980s, PBMs served primarily as claims processors, handling the paperwork of prescription drug transactions.

Everything changed in the 1990s as healthcare costs began their relentless climb. Employers and insurers desperate to control spending turned to PBMs as specialists who could negotiate better deals. The industry began consolidating rapidly.

In 2007, CVS acquired Caremark, transforming from a drugstore chain into an integrated healthcare company. In 2012, Express Scripts acquired rival Medco Health Solutions for over twenty-nine billion dollars, creating a dominant player. In 2015, UnitedHealth Group acquired Catamaran for nearly thirteen billion dollars. Each wave of consolidation reduced competition and increased the leverage of the remaining giants.

The transformation was not just in size but in function. PBMs evolved from claims processors to active managers of drug benefits, creating formularies, negotiating rebates, and making decisions that directly affected which medications patients could access and afford. As one Wall Street Journal article noted in 2002, PBMs had "quietly moved" from steering doctors toward cheaper generic drugs to marketing expensive brand-name medications—whichever approach generated more revenue.

The Legal and Regulatory Reckoning

By the 2020s, the scrutiny had become intense. The Federal Trade Commission launched a two-year investigation into PBM practices, releasing an interim report in July 2024 that accused the industry of raising drug prices through conflicts of interest and excessive consolidation. Multiple states filed lawsuits—Vermont, California, Kentucky, Ohio, and Hawaii among them.

Senator Ron Wyden of Oregon called PBMs "as clear a middleman rip-off as you are going to find," noting that they profit more when they select higher-priced drugs over lower-priced alternatives. The House Committee on Oversight and Accountability released a report finding that PBMs use various schemes to increase pricing for health plans and employers.

The industry's response has been consistent: they argue they are the only entity in the drug supply chain that puts downward pressure on prices by negotiating rebates and discounts. Without PBMs, they contend, drug prices would be even higher.

This argument received an interesting test in late 2024, when the prices of Ozempic and Wegovy—the popular weight-loss and diabetes medications—became a subject of congressional scrutiny. The Danish pharmaceutical company Novo Nordisk, which manufactures both drugs, sent its CEO to testify before the Senate. He argued that PBMs were preventing Novo Nordisk from lowering prices, claiming they might remove the drugs from their formularies if prices dropped too low.

The Senate committee investigated—and found his claim was false. All three major PBMs had provided written commitments that they would not remove the drugs from coverage if Novo Nordisk reduced prices. The high prices, the committee concluded, were Novo Nordisk's choice, not the PBMs' doing.

The episode illustrated a peculiar feature of the drug pricing debate: both pharmaceutical manufacturers and their critics can point to PBMs as the villain, even when the evidence suggests the story is more complicated than either side admits.

The Deeper Problem

What makes PBMs so difficult to reform is that they are not simply a parasitic middleman that could be removed from the system. They perform real functions—processing claims, negotiating bulk discounts, managing formularies—that someone would need to do if they disappeared.

The problem is not their existence but their incentives. A system where the middleman profits from opacity rather than efficiency, where rebates matter more than actual prices, where the party negotiating drug prices also owns pharmacies and insurance companies—this system was not designed by anyone. It evolved, as Secretary Azar said, "over time."

And like many evolved systems, it has become remarkably resistant to change. PBMs have enormous lobbying power. Their contracts are written to be impenetrable. Their pricing is deliberately obscured. Even sophisticated employers who hire PBMs to manage their drug benefits often cannot determine whether they are getting a good deal.

Some states have responded by requiring PBMs that work with Medicaid to pass through all rebates and accept flat administrative fees—essentially converting them into transparent service providers rather than profit centers. Others have enacted licensing requirements, disclosure rules, or bans on specific practices like spread pricing.

The federal government has moved more slowly, though the gag clause bans showed that bipartisan action is possible when practices become egregious enough.

What This Means for You

If you take prescription medications, the odds are overwhelming that a PBM has shaped your experience in ways you never noticed. The copayment you paid, the pharmacy you used, the specific drug you received rather than an alternative—all of these may have been influenced by decisions made in PBM headquarters, based on calculations about rebates and formulary placement that you will never see.

There are small ways to push back. Ask your pharmacist about cash prices, especially for generic medications—now that gag clauses are banned, they can tell you. Use tools like GoodRx to check if discount programs offer better prices than your insurance. If you have a choice of insurance plans, look at their formularies to see where your medications fall.

But the larger reality is that PBMs represent a systemic feature of American healthcare that individual consumers cannot negotiate their way around. The complexity is the point. The opacity is the product. And until that changes, the question "how much does it cost?" will remain far harder to answer than it should be.

In this way, the American prescription drug market has become the opposite of that old game show. On The Price Is Right, contestants competed to guess the actual price of everyday items. In American healthcare, the actual price is deliberately hidden—and the closest thing to a winner is the entity that can best exploit the confusion.