PBM contract guarantees 101: network discounts and manufacturer rebates

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November 4, 2021

We are approaching the last quarter of the year which means renewal season for many self-funded employers. It is a great time to take a step back and think about your pharmacy benefits contract. The standard pharmacy benefits contract utilizes two main components to hold PBMs accountable to their performance:

  1. Pharmacy network discount guarantees
  2. Manufacturer rebate payment guarantees

It has become industry standard for PBMs to be evaluated by these metrics, and for understandable reasons since the traditional PBM “black box” does not provide many options for evaluation. However, have you ever wondered why your PBM promises you savings with each new contract negotiation and yet your drug spend continues to rise? Let’s dive into these two guarantee components to get a better understanding of the dynamics taking place that lead to this phenomenon.

(1) Pharmacy Network Discount Guarantees

While discount guarantees seem logical in theory, in practice they can be of dubious value as they are built on two concepts which are vague and manipulatable: Average Wholesale Price (AWP) and drug categories.

The majority of pharmacy benefits contracts utilize the pricing construct of AWP to benchmark the pharmacy network discount guarantees. The best way to think of AWP is the sticker price of the drug. Similar to the sticker price of a car, it is an inflated number that does not accurately reflect the average price at which the product sells. In fact, it can vary so wildly by manufacturer (particularly with generic drugs) that it can seem arbitrary. 

Pharmacy claims can come from different types of pharmacies (known as channels) like retail pharmacies, mail order pharmacies, and specialty pharmacies. They can also come in different drug types (brand vs. generic) and days supply (i.e. 30 day, 90 day). Typically, pharmacy network discount guarantees are bucketed into different categories which combine the pharmacy, drug type, and days supply segmentation (i.e. retail generic 30 day, mail brand 90 day) and then claims are sorted into those categories for the purpose of reconciling against those guarantees.

On the surface this seems fairly straightforward but problems can arise when simple questions are asked, such as: 

  • What if the drug is a 34 day supply?
  • If a member gets a specialty medication at a retail pharmacy does the claim go in the retail bucket?
  • Is the drug a brand or a generic?

How a PBM chooses to questions like these (and many, many more) can mean the difference between achieving the promised guarantees or missing them. A seemingly aggressive set of pharmacy network discount guarantees may not always yield the expected savings outcome due to how a PBM might rearrange definitions and categories. 

In summary, pharmacy network discount guarantees are an average percentage discount off an arbitrarily set price (AWP) across a PBM-determined bucket of claims. These guarantees can offer the illusion of accountability for employer groups, but lack the precision and specificity to be truly effective.

(2) Manufacturer Rebate Payment Guarantees

The most common structure for manufacturer rebate guarantees is one based on a per brand guarantee that is segmented by category (i.e. 30 day, 90 day, mail, specialty). To make sense of this concept it is important to get a foundational understanding of how rebates work. 

Manufacturer rebates are a common mechanism in many industries (i.e. auto dealerships), not just pharmacy benefits. The structure and determination of such rebates may vary by industry, but the concept of a manufacturer conceding a greater discount based on an increase in market share or volume holds true. In the world of pharmacy benefits there are two very important principles to understand: 

  1. Not every drug receives a rebate - rebates are received as a result of the PBM setting drug coverage in a way that drives market share to a particular product. This occurs in competitive categories that have multiple drugs that are similar in nature. Manufacturers do not have an incentive to provide a rebate in a category that is not competitive.  
  2. The actual rebate values vary by drug, and even by claim - highly competitive categories, more aggressive management strategies (i.e. exclusions), and medications soon to be losing patent protection will offer higher rebate discounts to maintain or increase their market share.

If not every drug has a rebate and rebate values vary by drug and claim then how can a contract include a flat guarantee per claim? The answer is that a lot of assumptions need to be made to reach a flat guarantee per claim, and those assumptions are ultimately manipulatable by the PBM.

During the evaluation process you may calculate the expected rebate value by multiplying the guaranteed per brand rebate by the number of branded claims and get an output. However, the actual yield six months later might be lower than expected. This is a result of overlooked contract definitions that will lower the denominator (number of claims) without impacting the numerator (rebate dollars) resulting in overstated per-claim rebate value. Just like for pharmacy network discount guarantees, the ambiguity of manufacturer rebate payment guarantees makes accountability very difficult.

PBM guarantees in context

To help understand the two guarantee types discussed above, and to illustrate how strange they are relative to other industries, imagine this car-buying experience:

You visit a car dealership to shop for cars, but instead of being told how much the various cars cost you are told not to worry about the total price, since the seller has negotiated great discounts on various categories of car parts. You as the buyer have no control over which parts are going to be used, how they are classified, and whether the benchmark prices of the parts are inflated to create the sense of a greater “discount”.  

The likely outcome of this shopping experience is that you would overpay for the car, even while receiving great “discounts” on all of the parts that went into it.  This reflects the current state of the pharmacy benefits industry: increasing “discounts” and yet somehow, at the same time, ever increasing drug costs.

What can be done?

When evaluating pharmacy benefits costs, there are better ways than these manipulable guarantees for employers and brokers to drive PBM accountability.  Some of these strategies include:

  • Work only with pass-through PBMs that don’t take margin on drug costs and rebates, as these margins incentivize PBMs to push pricier drugs to your health plan if it means higher margins for them.
  • Work with a transparent PBM that is willing and able to share claims-level cost details with you. If your PBM is not willing to share data, it is likely because they are manipulating pricing in some way that would render guarantees of dubious value anyway.
  • Be careful of working with PBMs who offer both “traditional” (hidden margins) and pass-through services to their books of business. Those PBMs will be incentivized to pass-through their higher cost claims to their pass-through clients, and apply their lower-cost claims to their “traditional” clients (where they keep the margin).
  • Evaluate your PBM performance on the basis of PMPM (or plan cost), which reflects the real costs of your pharmacy benefits. An effective PBM partner should be able to drive your drug costs down or at least keep them flat.

At SmithRx we are building a PBM that prioritizes the approaches above and puts clients first. We evaluate our success based on actual pharmacy cost reductions delivered to plans, rather than manipulable guarantee values. We can take this approach because we have nothing to hide: our only revenue is a flat per-claim fee and all of our costs and rebates are passed through 100% to our clients. If this approach sounds refreshing, we welcome the chance to work with you.

Written by

A new type of pharmacy benefits manager, SmithRx is working to reduce pharmacy costs by reimagining the traditional PBM as a Drug Acquisition Platform built on transparent modern technology that aligns with the needs of our customers.

Written by

A new type of pharmacy benefits manager, SmithRx is working to reduce pharmacy costs by reimagining the traditional PBM as a Drug Acquisition Platform built on transparent modern technology that aligns with the needs of our customers.

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