Restrict the Middleman? Quantitative Models of PBM Regulations and their Consequences | February 2023


This paper provides the first quantitative economic models of pharmacy benefit management (PBM)
regulation. Indeed, few economic models of the pharmaceutical industry even acknowledge that drug
benefits are managed and that companies specialize in benefit management. The models in this paper
project a rich variety of consequences of rebate rules in Medicare Part D, commercial, and insulin
markets. They also estimate the economic effects of contract transparency rules and restrictions on
pharmacy Direct and Indirect Remuneration (DIR). The consequences specified in the models include
utilization of brands and generics, plan spending, cost sharing, and spillovers to nonpharmacy medical
spending, government budgets, and the pace of drug innovation.

The various regulatory consequences are connected in a logically consistent economic framework that
allows for various market frictions and imperfections including market power, coordination costs, tax
distortions, and incomplete innovation incentives. A rigorous economic interpretation is provided for
what are sometimes called “rebate walls” or “rebate traps.” The model’s ingredients and operation
are explained so that readers may adjust the model to consider alternative PBM regulations or invoke
alternative assumptions.

As others have before, I find that rebate rules would substantially reduce volume discounting by drug
manufacturers. More novel is that rebate rules can increase net brand prices by up to 52 percent and
drug-plan premiums up to 31 percent. Rebate rules may reduce drug utilization (including generics)
up to 8 percent for insulin and about 1 percent for drugs generally. Rebate rules reduce the pace of
drug innovation even while redistributing from patients and plans to manufacturers because of the
differential effects of rebate rules over the course of the drug life cycle. Through these mechanisms,
rebate rules redistribute to incumbent drug manufacturers by imposing costs on patients, plans, and
other third parties (such as taxpayers and future consumers) that are at least double the
manufacturers’ benefit.

Albeit on a smaller scale, pharmacy DIR regulations also increase net drug prices (both for brands
and generics), increase drug-plan premiums, and reduce drug utilization. These are some of the
regulatory costs of pharmacy DIR regulations imposed on patients, plans, and third parties that
together are more than six times the benefit to pharmacies in the form of greater profits.
Section I of this paper begins with rebate rules. The impact of two rebate rules are estimated: the rule
finalized in late 2020 by the Department of Health and Human Services (HHS) and the part of the
proposed INSULIN Act that would prohibit manufacturer rebates paid to plans and PBMs on insulin
products. Subsection I.D. specifically addresses the effect of rebates and their regulation on generics,
which is the issue of “rebate walls” raised by the Federal Trade Commission (FTC) and others. The
effects of regulating Pharmacy DIR are estimated in Section II, particularly for the proposed PBM
Transparency Act (II.D) and the 2022 CMS rule (II.E).

Making it more difficult for PBMs to do business, as rebate rules and pharmacy DIR regulations do,
will not encourage more companies to get into the PBM business. These regulations might discourage
competition among PBMs to the extent that larger incumbent PBMs are better able to adapt to them,
although the primary effect of these regulations would be to discourage competition among drug
manufacturers and among pharmacies.

Section III analyzes possible effects of disclosure or transparency requirements on competition among
manufacturers, pharmacies, PBMs. The FTC has noted in other healthcare contexts that requirements
to disclose detailed information about price and cost, which the PBM Transparency Act would do in
the prescription supply chain, can harm consumers by discouraging competition. The annual net costs
of the potential anticompetitive effects of disclosure rules are likely in the tens of billions of dollars.
Any rigorous and realistic analysis of the consequences of PBM regulation must acknowledge what
benefit management does and how its benefits compare to its costs. Section IV recaps the economic
role of PBMs in pharmaceutical markets and in the regulatory impact models, with additional
technical details provided in Appendices I-V.

To see the full paper click here.


Posted on

February 15, 2023

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