A formulary is a prescription drug list that controls drug usage in three main ways. First, it lists out what drugs are covered by the health plan. Drugs that are excluded from the formulary will need to be paid for completely out-of-pocket by the beneficiary. In contrast, costs for drugs included in the formulary, or covered drugs, are typically shared between the beneficiary (through co-pays/coinsurance) and the insurer or covered entirely by the insurer depending on the plan. Therefore, as the second utilization tool, a formulary also determines how much of the financial burden is going to fall onto the beneficiary or, in other words, how much the patient is going to pay out of pocket for that drug. In the example above, drugs listed under “Tier 1” are typically generic drugs (note the drugs listed in all lower-case letters) and requires the lowest co-pays and coinsurances. “Tier 2” drugs are preferred branded drugs (drugs listed in all-caps) that require higher out-of-pocket costs than Tier 1 drugs but lower out-of-pocket costs than “Tier 3” drugs, which are non-preferred branded drugs.
Finally, a formulary also determines how easy it is for the patient to obtain a drug. Labels like “(PA)”, “(ST)”, or “(QL)” refer to additional steps a prescriber would need to go through to have the drug covered by the plan. For example, under a “(PA)” requirement, doctors would need to request and receive approval for a certain drug to be covered under a health plan. Under a “(QL)” requirement, the plan will only cover a certain amount of the drug for a certain length of time. For larger amounts, the doctor would need to again request and receive approval from an insurer.
PBM incentives and formulary choices
Given these controls, a branded manufacturer can offer higher rebates for lower barriers to access their drug coverage, lower patient cost-sharing, and lower provider requirements. Theoretically, this is a good thing for consumers and payers.
In maximizing profits, PBMs should be incentivized to lower consumer drug spending. When treatment requires the use of higher cost drugs that have no generics but are, to an extent, substitutable, PBMs can negotiate higher rebates that pass down to payers and decrease out-of-pocket costs or premiums. If generic drugs are an option, treatment should default to that. Insurers (or payers) prefer to have generics dispensed to beneficiaries over branded drugs because lower reimbursements allow them to offer lower premiums and cost-sharing plans to beneficiaries. To align PBM interests with their own, insurers often pay higher spreads (i.e., PBMs get to keep a higher profit margin), for generic drugs than branded drugs.
In 2018, an Ohio Managed Medicaid Audit report showed that PBMs contracting with the Managed Medicaid program received higher spreads with generics (31.4% of the amount paid by plan) than with branded drugs (0.8%). The story is consistent even after taking rebates into account. A 2017 study analyzing the flow of funds in public manufacturer and distribution intermediary companies- wholesalers, PBMs, insurers, pharmacies- found higher gross margins under generic drugs (8%) than under branded drugs (2%) for PBMs. For PBMs, gross margins would be payments from insurers and manufacturer rebates minus reimbursements to pharmacies.
In practice, however, PBMs don’t always favor generics over branded drugs. The FTC’s 6(b) order also indicated that generic formulary placement and substitution are areas of active investigation. There’s some evidence that non-favorable generic formulary placement exists, at least for Medicare Part D plans. Note that Part D plans are voluntary prescription drug benefits provided by private plans that contract with federal government. For example, a 2019 study found that 72% of 57 unique formularies offered across 750 Medicare Part D standalone drug plans placed “at least 1 branded product in a lower cost-sharing tier than its generic product.” A 2021 Association for Accessible Medicines (AAM) report also suggested that Medicare Part D plans were slower to put generics into lower cost-sharing tiers than commercial plans. However, it was suggested that the delay in generic coverage could be due to the design of the current Medicare Part D program creating skewed incentives for PBMs. The authors specifically reference the Coverage Gap Discount Program (CGDP), which allows a health plan to pay less with branded drugs than generics for patients who require higher-cost drugs. However, in paying less, the plans merely shift liability to the federal government.
In commercial plans, there is some evidence showing formularies including higher list-price (i.e., published WAC) brand drugs and excluding lower list-price equivalents. Theoretically, favorable placement of high list-price drugs should indicate higher rebates for that drug and therefore a lower “net” price. That is to say, the actual dollars coming out of beneficiary premiums and OOP payments paying off the cost of the drug should be lower. However, to what extent net spending is lower because of these substitutions is unclear due to the obscure nature of rebate agreements. In fact, contrary to intuition, one study found that manufacturers were receiving less (i.e., decreasing net revenue) between 2014 and 2018 for insulin drugs but consumer and payer spending remained flat over the same period. This suggested that while PBMs may be able to pressure manufacturers for higher rebates, these savings might be retained as profits instead of passed down to consumers.
Conclusion
Although questions about generic dispensing and substitution but-for PBM conduct are not new, the scope of these questions has substantially expanded. For example, in the early 2000s, the government was concerned that since many PBMs owned (and continue to own to this day) mail-order pharmacies, they would be incentivized to increase drug spending instead of lower it to generate additional profits. The FTC therefore collected data between 2002 and 2003 and investigated similar questions within a narrower scope: whether mail pharmacies owned by PBMs dispensed fewer generic drugs compared to branded drugs, switched patients from lower-priced to higher-priced drugs more frequently, and imposed higher costs onto consumers and payers than non-PBM owned mail pharmacies. Instead of comparing these effects in different types of pharmacies, the recent FTC inquiry looks at the PBM level: would consumers and payers be spending less on prescription drugs (e.g., filling prescriptions for more lower cost drugs) if not for the way PBMs are doing things now? In fact, panelists during a recent ABA webinar on PBMs anticipated that the 6(b) study may also be investigating what a world without PBMs could look like, particularly if private industry disrupters like Mark Cuban’s Cost Plus Drug Company are successful.
