The Hidden System of Legal Kickbacks Shaping the U.S. Prescription Drug Market

In the United States, as in most other countries, it is illegal for pharmaceutical companies to bribe doctors or hospitals to prescribe their products. Those who get caught engaging in this sort of corruption can suffer severe penalties. For example, in 2020, the pharmaceutical giant Novartis agreed to pay the U.S. government almost $700 million to settle a case involving allegations that the company had violated the federal Anti-Kickback statute by offering “cash payments, recreational outings, lavish meals, and expensive alcohol” to doctors to induce them to prescribe Novartis drugs. Yet when pharmaceutical companies offer financial inducements worth billions of dollars to Pharmacy Benefit Managers (PBMs)—not the meager thousands spent on doctors—to promote use of their drugs, the conduct is entirely legal.

What, you may ask, are PBMs? Good question. Most laypeople outside the health care field are unfamiliar with PBMs, and may not even know they exist. But PBM’s play a crucial, if underappreciated and extremely complex role in determining prescription drug prices and insurance coverage decisions. Simplifying somewhat, PBMs’ primary function is to manage insurance companies’ prescription drug plans, a role that includes, among other things, negotiating with drug companies to determine which drugs insurance will cover, and which will be favored. Given that just three PBMs control over 80% of the prescription drug market, PBMs can have an enormous effect on pharmaceutical sales, as drugs that lack insurance coverage are significantly less attractive to consumers than those with coverage. Additionally, PBMs also reimburse pharmacies on behalf of insurance providers for the costs of filling beneficiaries’ prescriptions.

In short, PBMs, which stand in between many of the transactions in the pharmaceutical supply chain, play a major role determining the prices paid by insurers, pharmacies, and patients for prescription drugs. And although kickbacks to doctors, hospitals, insurance companies, and other actors in the system are strictly prohibited, drug companies can and do take advantage PBMs’ complex payment structures to discreetly offer financial inducements in order to gain PBMs’ favor during insurance coverage determinations. There are two main ways in which this de facto bribery occurs:

First, drug companies offer “rebates” to the PBMs who reimburse the pharmacies that dispense the prescription drugs. Understanding how this works is a bit challenging—which is perhaps why this scheme for offering kickbacks has escaped public scrutiny—but roughly speaking, it works like this: Pharmaceutical companies sell drugs (through wholesaler intermediaries) to pharmacies, who then sell them to patients. For drugs that are covered by insurance, an insurance company will contract with a PBM to reimburse the pharmacies (up to a certain amount) for the cost of the drugs the pharmacies dispense, and the insurance company will in turn reimburse the PBM. After the point of sale, drug companies can offer the PBM what is described as a “rebate”—but what is essentially a payment made directly to the PBM—if the PBM includes the drug on the insurance company’s list of covered products. In principle, the idea of such rebates is to reduce the price of the drugs, thus lowering insurance premiums or out-of-pocket drug costs.

  • To illustrate with a simplified hypothetical example, imagine that a pharmaceutical company sells a pill to a pharmacy for $90, and the pharmacy charges the patient $100 for that pill. The insurance company covers 80% of the drug price, so the patient ends up paying $20, and the PBM, acting on behalf of the insurance company, reimburses the pharmacy the $80 difference; the insurance company then reimburses the PBM that $80. (The PBM is also compensated by the insurance company for its work in managing the complex payment and coverage system, but put that to one side for now—with respect to insurance reimbursement of pharmacies, the PBM essentially functions as a pass-through.)
  • Now imagine that the pharmaceutical company wants to make sure that the PBM doesn’t drop its product from the insurance company’s list of covered treatments in favor of some cheaper or more effective alternative. The pharmaceutical company offers the PBM a $20 “rebate” on each of the pills for which the PBM reimburses the pharmacy. In principle, the PBM could pass these savings onto the consumers: The PBM only needs $60 from the insurance company to reimburse it for the $80 the PBM transferred to the pharmacy. If the PBM passed the entire $20 rebate on to the insurance company, the insurance company could cover or reduce the patient’s $20 copay (the patient pays the pharmacy $0, the PBM pays the pharmacy the $100 list price, the insurance company pays the PBM $80, and the drug company pays the PBM the remaining $20), or the insurance could lower its customer’s annual premiums to reflect the fact that it now only has to reimburse the PBM $60 per pill rather than $80 per pill. And indeed the majority of rebates are, in fact, translated into cost-saving measures in this way.

But here’s the rub: There is currently no legal requirement in the U.S. that PBMs pass along these rebates to insurers or individual patients. In the stylized example above, the PBM could simply pocket the $20-per-pill rebate from the drug company and seek the full $80 reimbursement from the insurance company for the $80 that the PBM reimbursed the pharmacy. Indeed, such “retained rebates” have become an important source of PBM revenue. The problem should now be obvious: Drug companies that want to make sure that insurance companies continue to cover their products can offer a powerful financial inducement—for all intents and purposes a kickback disguised as a discount—to the PBMs, which function not only as middlemen in pharmacy reimbursement, but, crucially, decide which prescription drugs insurance companies will cover.

Even worse, the size of the rebate is often calculated as a percentage of the drug’s list price and sales volume, which means that as a drug’s list prices increase, so do the profits earned by PBMs from retained rebates. Perversely, pharmaceutical companies can offer more enticing financial rewards to PBMs simply by increasing the list price of a drug. To illustrate, consider insulin, a lifesaving diabetes treatment. The insulin products offered by various drug companies are largely interchangeable, which gives PBMs’ significant discretion to select particular insulin drugs for coverage based on alternative factors, potentially including the attractiveness of rebates offered. As a consequence, two pharmaceutical companies engaged in competition to increase their insulin prices at greater rates in order to offer more attractive “exclusive rebates” to PBMs, which one pharmaceutical company raised from 3% to 56% of the list price in just five years. This perverse competition has contributed to the notoriously high prices of insulin, which has grown from $21 per vial in 1996 to $378 per vial today.

PBMs have also developed a second method for extracting kickbacks from pharmaceutical companies in exchange for favorable treatment: PBMs charge drug companies a host of “fees” for a variety of vaguely described services, such as drug education programs and administrative services. Like rebates, the fees PBMs charge are also often linked to the list prices and sales volume of prescription drugs and thus similarly have the potential to function as kickbacks. Growing suspicion over whether rebates are actually translated into lower drug costs has recently led PBMs to shift to this more opaque income stream from pharmaceutical companies. For example, in 2019, the share of PBMs’ gross profits derived from manufacturer fees increased a whopping 51% from just two years earlier. 

Between these “rebates” and “fees,” the amount of money flowing from pharmaceutical companies to PBMs has been “nothing short of enormous,” and has likely influenced the selection of drugs available to patients and contributed to pharmaceutical companies’ drug price increases and. Strikingly, $217 billion of the increase in drug prices in 2020 were not actually pocketed by pharmaceutical companies, but rather passed on to various actors in the supply chain, mainly PBMs.

None of this is to deny that PBMs serve an important function in the convoluted U.S. health care market. PBMs connect purchasers, insurers, and manufacturers and make it possible for patients to pick up prescriptions before they are fully paid for by insurance. Reform is clearly needed, but that reform must balance the need to curtail the potential for undue influence with the need to ensure PBMs’ continued viability. Fortunately, there are a number of steps that can and should be taken:

  • First, legislators and regulators should act swiftly to close the legal loopholes and gaps in enforcement that enable pharmaceutical companies’ use of financial inducements to push their products, conduct that would otherwise be criminal under anti-kickback or consumer protection laws. This would include the immediate repeal of the statutory “rebate” exception to the federal Anti-Kickback Statute, which prohibits the offer or acceptance of anything of value to induce the reward of federal healthcare business, such as Medicare or Medicaid. Additionally, regulators should more aggressively enforce commercial anti-bribery laws, which prohibit compensating an intermediary to act against the interests of the party it represents in the transaction. The FTC has already taken steps along this path, launching a probe into the operations of PBMs, and should continue vigorous investigation and enforcement efforts.
  • Second, the law should impose caps on rebate retention and/or mandatory cost-sharing provisions, so that “rebates,” which are intended to reduce the price of drugs for the ultimate purchasers (the insurance companies and the consumers), do not function simply as windfalls to the entities that also decide which drugs will be covered by insurance.
  • Third, because regulation of retained rebates will be ineffective without also cracking down on the abuse of “fees,” legal reforms should target the latter practice as well. However, capping PBM fees would be challenging, as doing so would require regulators to determine the fair market value of the services provided. Instead, regulation of PBM fee structures should rely on sunlight as “the best of disinfectants” and impose certain mandatory reporting obligations, such as more detailed information regarding the fees charged for various services provided to pharmaceutical companies and patients.

Unlike the doctors bribed by Novartis, whose white coats and Hippocratic oaths communicate the public’s clear, entrusted authority over patient care, PBMs’ role in making vital healthcare decisions is not well understood outside a small circle of experts. Yet PBMs play a very powerful role in the drug delivery ecosystem and can exert a significant influence on a patient’s course of treatment and medical outcomes. Accordingly, enhanced oversight of these intermediaries will help to limit a particularly insidious form of corruption in the healthcare market.

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