An interesting and important set of interactions in the healthcare system revolves around negotiating prices and payments between insurers and drug manufacturers for prescription drugs and managing the prescription drug portion of insurance plans. These interactions also introduce an important additional new entity into the mix that we should talk about. Let's take a look. Insurance companies have to do a couple different things with respect to their prescription drug benefits. One is work out the prices to be paid for prescription drugs with the manufacturers. In the US, once a drug is approved as safe and effective by the FDA, then it can be marketed. We allow manufacturers to set their prices. And the various intermediaries work with the manufacturers and negotiate with them as much as they can over prices. Note that this process can go quite differently in the US than in other countries where there's more often a large public intermediary or other regulatory apparatus with significant negotiating power, different from the US with its many smaller intermediaries. A second thing insurance companies have to do is set up the structure of their insurance benefits for prescription drugs, the formulary, the cost sharing, and so on. In principle, insurers could do all this themselves, but it turns out that most commonly they contract with a third party called a pharmacy benefit manager or a PBM to handle these things. PBMs are private companies that have set themselves up to do these tasks, and they generally operate as for profit businesses. We'll note three important classes of things PBMs can do. First PBMs can manage the benefit design of prescription drug coverage. This includes things like organizing a network of pharmacies, developing formularies, making the decisions about which exact drugs should be on or off the formulary or making the formulary tiers putting some drugs in higher and lower tiers. Working out what the cost sharing should be, possibly differently for different tiers, and setting up other structures like utilization review or step therapy requirements. PBMs are also involved in payments. They'll receive claims from the pharmacy when the pharmacy sells a drug to a patient. The patient will pay some cost sharing perhaps directly to the pharmacy at the point of purchase, but that won't cover all the costs. So the pharmacy has to send a bill for the rest and they'll commonly send that to the PBM. The PBM will then handle getting the money from the insurer and pay the pharmacy. Third, PBMs are involved in negotiating prices. This is a slightly complicated but important thing worth taking a minute to look at. We can break down a couple key pieces here. First, the PBM will negotiate the amount the pharmacy will be paid for each drug. For each drug, the PBM can go to the pharmacy or pharmacies and negotiate a price that they'll pay the pharmacy whenever they sell the patient a drug and they can try to go get a good deal. In the second part, the PBM may also negotiate rebates that a drug manufacturer will pay the PBM when patients buy the manufacturer's drugs. Rebates are most often associated with branded drugs which have higher prices than generics. And a common story is that the manufacturers may agree to pay a rebate, if that helps get their drug placed in a more preferred formulary tier. So if there's a rebate, then when patients from the PBM buy some drug, drug A for example, the manufacturer of drug A might pay the PBM some money. The key idea is that these two things affect the amount the PBM has to charge the insurer. Remember, the insurer is the one ultimately on the hook for paying the prescription drug costs here. And ultimately then how much the insurer has to charge the customers and premiums. If they hire a PBM and the PBM is a good negotiator on their behalf and they can get good rates to pay the pharmacies and good rebates from the manufacturers, then this can lower the cost to the insurer. If you look into it, you'll find some debate about how well this works out in practice, but that's the idea. Now this leaves out some of the finer points about PBMs and what they do, but we can get some important takeaways. One is just that PBMs are an important player in this world. If you're going to understand drug benefits and drug pricing and payments, you need to keep track of them. And if you're trying to understand the prices that insurers pay for prescription drugs, you always have to keep in mind the rebates. If you see for example the retail prices paid by PBMs to pharmacies, this may or may not be a reflection of the actual amount an insurer paid at the end of the day, net of the rebates. Similarly, if you see wholesale prices the pharmacy paid to the manufacturer or to some middleman company to stock the drugs, this may not be an accurate representation of what the manufacturer actually earned, since they may have paid out rebates to the PBM, which would offset some of that. While we're talking about the interesting world of prescription drug benefits and the entities involved in them, there's one more interesting entity to note here. A company commonly called a pharmacy switch. Here's where switches come in. Suppose a patient comes to a retail pharmacy with a prescription. The pharmacy wants to sell them the drug, how much should they be charged right there at the cash register? The patient may have a copay or a deductible. They may have to pay that for example, or maybe not, or maybe there's other rules. How is the pharmacy to know what to do? Here is what happens. The patient gives some information about their insurance to the pharmacy and the pharmacy puts it into a computer system which transmits it to a company informally called the switch. The switch in turn has connections to different PBMs so they can take the insurance information, figure out which PBM is handling the coverage for the patient, electronically get the information about cost sharing or other rules from the PBM, and then turn around and send it back to the pharmacy. So the pharmacy will get some instruction like collect $20 from the patient or something like that. And this happens in a short time generally, so the patient or the customer doesn't have to wait too long. Another interesting entity to keep track of in this space then, a pharmacy switch. So there you have a bit about a couple of the interesting entities and structures that come up when we talk about pharmaceutical pricing and payments.
