Vertical Integration Has Helped Upend Traditional PBM Model, Form ‘New Profit Drivers’

New entities within the biggest vertically integrated PBMs have allowed the parent companies to restructure their profit sources. And the old approach of dispensing generic drugs by mail has largely been abandoned in favor of new ways to grow profit, such as becoming integral parts of the specialty market. Longtime industry expert Adam J. Fein, Ph.D., president of Drug Channels Institute, an HMP Global Company, explored these and other trends and challenges within the PBM industry during an April 4 webinar.

Vertical integration, he explained, can be beneficial to these companies because “they can do more things; they can take more risk.” He pointed to UnitedHealth Group, which has more than 5 million lives for whom it is fully at risk because the company “can control all aspects of care except for hospitalization” via its infusion clinics, physicians, pharmacies, PBM management and insurance. It can “go completely at risk.”

The downside of this model, though, is the “potential for anti-competitive behavior,” said Fein, who pointed to allegations of “raising the cost of PBM services for external customers” vs. an internal partner and paying internal pharmacies a higher rate than external ones receive.

Over the past several years, these vertically integrated companies within the U.S. drug channel have introduced two new types of intermediaries: group purchasing organizations (GPOs) and private-label manufacturing businesses. These, said Fein, “have become the new profit drivers for PBMs.”

The GPOs “started up a few years ago, and they are essentially aggregators,” he explained. The Cigna Group has Ascent Health Services, which is affiliated with Express Scripts; CVS Health has Zinc Health Services, which is affiliated with CVS Caremark; and UnitedHealth has Emisar, which is affiliated with Optum Rx.

“There have always been rebate aggregators, and the PBMs have always provided rebate aggregation services, but they haven’t formed independent companies and located them outside of the U.S. to do this,” Fein stated. Ascent is headquartered in Switzerland, and Emisar is out of Ireland — although both are domiciled as LLCs registered in Delaware — while Zinc is headquartered in the U.S. “So the rebates essentially have gone from something that is sourced domestically to something that is sourced internationally.”

With more aggregation, these companies have more leverage with manufacturers. “The more interesting thing that’s happening is they have all developed new types of fee-based services for primarily manufacturers,” said Fein. “So manufacturers are now paying these entities fees that are earned in other countries. And those fees are often less visible to plan sponsors.”

So while most PBM reform efforts focus on traditional PBM administration fees, these other new fees are different and separate from those. GPOs are “also a hedge against PBM reform,” Fein declared, “because if you want to make me do something different with rebates? Sure. But we have this whole other business.”

The GPOs also have potential tax advantages, he said, but noted that those may be at risk under the new administration, which has flagged investment in countries outside the U.S., specifically mentioning Ireland.

PBMs’ Traditional Profit Sources Have Changed Completely

When it comes to how the Big Three PBMs actually make money, their traditional sources of profits “have shrunk dramatically,” he said. Those profit sources can be placed in three buckets: (1) pharmacy dispensing, usually through mail; (2) manufacturer payments, usually in the form of rebates; and (3) everything else, including spreads on network prescriptions and discount cards and plan sponsor fees.

Retaining a portion of rebates was historically how PBMs made a lot of their money, Fein explained. He recalled that Medco disclosed in 2003 that it kept 54% of the rebates it negotiated, which dropped to 11% by 2011. Similarly, CVS said in 2012 that it kept 27% of all rebates, but that has fallen to less than 2%. So while the value of rebates was growing — in the commercial market last year, they were about $85 billion to $90 billion — PBMs were keeping less of them because plan sponsors were demanding that they should have that money. “So a lot of the rebates don’t stay at the PBM,” he said. “They get passed through to the payer.”

The other profitable area for PBMs was dispensing generic drugs by mail. “A massive generic wave” of primary care blockbusters occurred from the early 2000s to around 2015. “When a product goes generic, it goes from the brand price down to that generic price at 99% off, roughly, on average,” he explained. “And along the way, there’s a lot of money to be made by both retail and mail pharmacies. So there was a big tailwind for PBM profitability.”

But now that generic dispensing rate has plateaued, “the PBMs are kind of happy to let the retail pharmacies take over dispensing low-cost, deflating generics, and they’ve pretty much gotten out of the business.”

To compensate, PBMs have grown their profits in other ways. The first way is through administrative fees from manufacturers of about 3% to 5%; while most get passed through to plan sponsors, PBMs still retain some. And fees from GPOs affiliated with PBMs “has been a significant driver of profits.”

PBMs Are ‘Significant Players’ in Specialty

Another path to profit has been “becoming significant players in the specialty business.” However, “nothing in the PBM industry is as straightforward as you think it should be,” Fein said. “Specialty dispensing spreads are nothing new, right? A pharmacy buys at one price usually, and that’s their gross profit. But inside that model, especially below that cost-of-goods line, are a number of possible things that are happening.”

There has been an increase in nonbiologic specialty drugs going generic, which “has been a big tailwind for PBMs.” The growth of copay maximizers, private-label biosimilars and 340B contract pharmacies are also big sources of profitability, as are the fees PBMs receive from performing specialty pharmacy services.

“So the PBM essentially has shifted their business model to getting paid in ways that may not be apparent to the plan sponsor and which the plan sponsor may not mind,” Fein remarked.

The Federal Trade Commission (FTC) in January published a report on generic specialty drugs and how they produced profits for vertically integrated PBMs. Researchers looked at nonbiologic specialty drugs, including oncology agents such as Gleevec (imatinib mesylate) and Zytiga (abiraterone acetate) and nononcology drugs such as Tecfidera (dimethyl fumarate). Those agents’ prices dropped by 99% once they went generic.

The FTC found that in 2017, the pharmacy dispensing spread above the national average drug acquisition cost for specialty generic drugs at PBM-affiliated pharmacies was $1.1 billion, an 88% markup over NADAC. But by 2021, the pharmacy dispensing spread above NADAC was $2.6 billion, a 427% markup.

“The margin, the gross profit dollars earned by the PBMs from this activity out of their own specialty pharmacies, grew dramatically, and the markups were very, very high,” observed Fein.

Next he shared data from Nephron Research that will be included in an upcoming report from the health care equity research provider. The value of the fees that the three PBMs are earning from their GPOs can be broken down into two buckets: data and portal fees and contracting entity vendor fees.

“There were minimal fees in 2018, essentially almost immaterial,” noted Fein. But by 2024, they had increased to $3.4 billion from manufacturers. “My interpretation is plan sponsors are not always fully aware of these fees, and therefore the PBMs can retain a greater share of them than they can retain of admin fees. So this is an important element of their profitability that is novel.

“It’s not that they’re keeping rebates,” he continued. “It’s not even that they’re adding a lot in network spreads. That’s like yesterday’s news, and they are moving away quickly from those business models into business models like this.”

PBM-Associated Pharmacies Lead Specialty Dispensing

PBM-affiliated pharmacies dominate in specialty drug dispensing with CVS, UnitedHealth and Cigna securing about 70% of that market, which has “well over $200 billion in prescription dispensing revenues.” There are two reasons why this has happened, according to Fein. PBMs incentivized plans to use their specialty pharmacies by offering lower reimbursement rates than an external pharmacy by leveraging other profit sources such as 340B, specialty generics and private-label biosimilars. PBMs also will bundle pharmacy and PBM services, and “they will link what you’ll get as your rebate guarantee to what’s happening at the specialty pharmacy, the use of the specialty pharmacy.”

He pointed to research by Pharmaceutical Strategies Group (PSG), an EPIC company, that asked plan sponsors to what extent their formulary rebate guarantees were affected by whether they used a PBM’s specialty pharmacy. In 2018, about 43% of plan sponsors said that was the case, but that percentage rose to 68% in 2023.

The other driver of PBM domination within the specialty space is manufacturers, most of whom make their specialty drugs available via a limited network, usually consisting of four or five pharmacies, including almost always the three large PBM specialty pharmacies. “Manufacturers have a lot of reasons for having these limited networks: service and data and other characteristics,” said Fein.

Challenges, however, exist when a manufacturer decides upon an exclusive network that excludes the bigger specialty pharmacies. And hospitals, which “have become the fastest growing participants in the specialty pharmacy business,” are pulling some share as well.

Ultimately, said Fein, “I think if you sell to PBMs, if you work for PBMs, if
you work for a PBM, if you contract with a PBM, you’re going to see some of the
same dynamics playing out over the next few years.”