EpiPen has become the latest flashpoint in this opaque system. As more health plans shift to very skinny drug formularies and high deductibles, consumers are bearing more of the cost of their drugs. They are taking notice of the list price on their drugs.
But when drug makers hike the widely reported "list" prices on their drug, only a fraction of the additional money comes to them. Most gets paid as fees and rebates to a long series of drug-system middlemen. Some of these rebates eventually flow to consumers in the form of lower premiums. But not every patient benefits equally. Those without insurance can be forced to pay the full freight of the higher prices.
Here's how it works. Drug makers "sell" their drugs to pharmacies, which acquire them through drug wholesalers. When a pharmacy sells a prescription to a patient, the pharmacy-benefit manager (PBM) reimburses it for those costs. The PBM has a contract with the patient's health plan to cover different portions of the cost for different medicines. The PBMs offer purchasing efficiencies, and their large size let them negotiate lower prices.
Drug makers will then return some of the money they're paid to the PBM, in the form of a rebate. The PBM will, in turn, share some of these rebates with the health plan, reducing its drug costs. A rough estimate is that PBMs return to the health plans about 90 percent of their rebates. The PBMs earn more money by operating specialty pharmacies that distribute a lot of the costliest drugs. On average, this can net them another 1 percent on the drug's list price. For pricey drugs, this adds up.
Drug makers launched their own PBMs in the early 1990s as a way to process drug payments, but got out of the business in the 2000's. But they still liked contracting through the PBMs, because it was a pay-to-play arrangement. Drug makers paid rebates to get favorable placement on formularies, and access for their medicines.
But as the PBM's consolidated and began to exert more leverage, and as the drug market became more competitive (with many more "good enough" generics) the pharmaceutical companies had to start paying bigger rebates. To make headway for bigger rebates, they've been hiking the list prices on their medicines.