- The pricing process for prescription drugs is complex and contributes to high drug prices for customers.
- The supply chain for prescription drugs involves pharmaceutical companies, wholesalers, pharmacies, insurance companies, and pharmacy benefit managers (PBMs).
- PBMs negotiate rebates with pharmaceutical companies, which can affect the placement of drugs on insurance formularies.
- The higher the rebate, the better the placement on the formulary, leading to lower copays for patients and potentially higher sales for pharmaceutical companies.
- Pharmaceutical companies claim that the need to raise list prices is due to demands for higher rebates.
- PBMs argue that rebates reduce the cost of drugs by lowering the price insurance companies pay and ultimately reducing patient premiums.
- Patients often pay based on the list price, not the price after rebates, and those without insurance or high deductibles may pay the entire list price.
- The details of rebates are not transparent, resulting in different prices for the same drugs among different people and insurance companies.

Drug pricing is complicated and secretive. WSJ explains how the flow of money, drugs and rebates behind the scenes may drive up the price of prescription medicine for consumers. Illustration: Mallory Brangan

Don’t miss a WSJ video, subscribe here: http://bit.ly/14Q81Xy

More from the Wall Street Journal: 
Visit WSJ.com: http://www.wsj.com
Visit the WSJ Video Center: https://wsj.com/video

On Facebook: https://www.facebook.com/pg/wsj/videos/
On Twitter: https://twitter.com/WSJ
On Snapchat: https://on.wsj.com/2ratjSM 

#WSJ

You might think the process that determines how much you pay for something is pretty straightforward.

For example, here's the supply chain for a beverage you might buy at the drugstore.

PepsiCo manufactures the soda and sends it to a retailer who sells it to a customer.

The customer pays the retailer and the retailer pays PepsiCo.

Well, that is not the case for the products behind the pharmacy counter.

Here's a typical supply chain for prescription drugs.

That's because the way that drugs are priced is not at all a straightforward process.

Experts and politicians argue that the very complexity of this chain is part of why drug prices have grown so high for customers.

Everyone involved in the broken system, the drug makers, insurance companies, distributors, pharmacy benefit managers, and many others contribute to the problem.

To understand this debate, first you should understand the flow of drugs and money within this chain.

Let's start here, with the pharmaceutical companies.

They're the ones who develop a drug and set a price, known as the list price.

This isn't as straightforward as it might look, which we'll explain in a moment.

Next you have the wholesalers who transport the drugs and sell them to the pharmacies.

The patient pays the copay, and the pharmacy sends out a bill that gets paid by the insurance company.

That's simple enough, but we're missing a link.

The link that manages this transaction and adds a lot of complexity to the chain.

Meet the pharmacy benefit managers, or PBMs.

They're who the drug companies and some politicians are talking about when they refer to middlemen.

They work for insurance companies, big employers, and government agencies.

And A big part of their job is to bring down the cost of drugs for their employers.

They do this by negotiating with pharmaceutical companies for rebates.

Yep, for many of the drugs a pharmaceutical company sells, it pays a rebate to the PBM.

The PBM sometimes pockets a portion of the rebate and passes another portion on to the insurance company or employer.

Why the pharmaceutical company pays these rebates is the source of a lot of controversy.

What happens is the drug company gets moved up on something called a formulary.

It's the list of drugs that the insurance company covers, and it's grouped in tiers.

Each tier represents what portion of the list price the patient pays and what portion of the list price the insurance company pays.

The highest tier in the formulary is the lowest copay for the patient And the lowest tier is the highest copay for the patient.

When the pharmaceutical company pays a higher rebate, the PBM will move the drug up on the formulary.

Pharmaceutical companies want high placement on the formulary.

That's because patients are more likely to take the drug that's most affordable, and that usually means higher sales for the pharmaceutical company.

If a patient wants to take a drug that's lower down on the formulary or not on it at all, they have to pay higher co-pays or even the full list price of the drug.

If this seems confusing, that's because it is.

Let's take another walk through that transaction, this time with an example.

A PBM negotiates a $50 rebate, $10 of which they pocket, and $40 of which they pass on to the insurance company or employer.

In return for that rebate, the PBM moves the drug to a better spot on the formulary, making it cheaper for the patient to buy the drug.

This transaction is important because the pharmaceutical companies say it's a big reason they keep raising the price of drugs.

You've probably seen a chart like this before.

It's the rise in the price of a drug in the U.S., in this case, Humalog, according to its maker, Eli Lilly.

The pharmaceutical companies say they have to raise list prices to protect their sales and profits from the demands of these higher rebates.

Here's the CEO of the pharmaceutical company Merck at a hearing on drug prices.

If you bring a product to the market with a low list price in this system, you get punished financially and you get no uptake because everyone in the supply chain makes money as a result of a higher list price.

And here's that Humalog chart again, this time with the net price, or the average revenue that Eli Lilly says they take in under this system.

For their part, the PBM say the drug companies don't have to raise prices to boost their bottom lines and that rebates reduce the cost of drugs, not inflates them.

They say rebates reduce the real cost of prescription drugs because they lower the price that insurance companies pay.

That helps the insurers lower the premiums that the patients have to pay for their plans.

Here's Derricka Rice, an executive vice president at CVS Caremark, 1 of the pharmacy benefit managers.

Our job is to work with the employers, unions and government programs we serve to ensure that when their members get to the pharmacy counter, they get the medicines that they need at the lowest possible cost.

So what does all of this mean for the patient back at the pharmacy counter?

At the heart of all this is that what the patient pays is often based on the list price, not the price the insurance company is responsible for after the rebates.

And patients who don't have insurance or co-insurance or who have really high deductibles sometimes pay the entire list price.

It's important to know that the details surrounding rebates are shrouded in mystery.

Pharmaceutical companies and PBMs don't release their rebate data, saying it's proprietary.

But it's clear that different people and different insurance companies pay different prices for the same drugs.

As you can see, the way that prices work behind the counter is totally different from how they work in front.


Speaker 0: You might think the process that determines how much you pay for something is pretty straightforward. And it often is. For example, here's the supply chain for a beverage you might buy at the drugstore. Say a Pepsi. PepsiCo manufactures the soda and sends it to a retailer who sells it to a customer.

The customer pays the retailer and the retailer pays PepsiCo. Simple, right? Well, that is not the case for the products behind the pharmacy counter. The drugs. Here's a typical supply chain for prescription drugs.

It looks really different. That's because the way that drugs are priced is not at all a straightforward process. Experts and politicians argue that the very complexity of this chain is part of why drug prices have grown so high for customers.

Speaker 1: Everyone involved in the broken system, the drug makers, insurance companies, distributors, pharmacy benefit managers, and many others contribute to the problem.

Speaker 0: To understand this debate, first you should understand the flow of drugs and money within this chain. Let's start here, with the pharmaceutical companies. They're the ones who develop a drug and set a price, known as the list price. This isn't as straightforward as it might look, which we'll explain in a moment. Next you have the wholesalers who transport the drugs and sell them to the pharmacies.

The patient pays the copay, and the pharmacy sends out a bill that gets paid by the insurance company. That's simple enough, but we're missing a link. The link that manages this transaction and adds a lot of complexity to the chain. Meet the pharmacy benefit managers, or PBMs. They're who the drug companies and some politicians are talking about when they refer to middlemen.

They work for insurance companies, big employers, and government agencies. And A big part of their job is to bring down the cost of drugs for their employers. They do this by negotiating with pharmaceutical companies for rebates. Yep, for many of the drugs a pharmaceutical company sells, it pays a rebate to the PBM. The PBM sometimes pockets a portion of the rebate and passes another portion on to the insurance company or employer.

Why the pharmaceutical company pays these rebates is the source of a lot of controversy. What happens is the drug company gets moved up on something called a formulary. So what's a formulary? It's the list of drugs that the insurance company covers, and it's grouped in tiers. Each tier represents what portion of the list price the patient pays and what portion of the list price the insurance company pays.

The highest tier in the formulary is the lowest copay for the patient And the lowest tier is the highest copay for the patient. When the pharmaceutical company pays a higher rebate, the PBM will move the drug up on the formulary. Pharmaceutical companies want high placement on the formulary. That's because patients are more likely to take the drug that's most affordable, and that usually means higher sales for the pharmaceutical company. If a patient wants to take a drug that's lower down on the formulary or not on it at all, they have to pay higher co-pays or even the full list price of the drug.

If this seems confusing, that's because it is. Let's take another walk through that transaction, this time with an example. Say a hypothetical drug costs $100. A PBM negotiates a $50 rebate, $10 of which they pocket, and $40 of which they pass on to the insurance company or employer. In return for that rebate, the PBM moves the drug to a better spot on the formulary, making it cheaper for the patient to buy the drug.

This transaction is important because the pharmaceutical companies say it's a big reason they keep raising the price of drugs. You've probably seen a chart like this before. It's the rise in the price of a drug in the U.S., in this case, Humalog, according to its maker, Eli Lilly. The pharmaceutical companies say they have to raise list prices to protect their sales and profits from the demands of these higher rebates. Here's the CEO of the pharmaceutical company Merck at a hearing on drug prices.

Speaker 2: If you bring a product to the market with a low list price in this system, you get punished financially and you get no uptake because everyone in the supply chain makes money as a result of a higher list price.

Speaker 0: And here's that Humalog chart again, this time with the net price, or the average revenue that Eli Lilly says they take in under this system. For their part, the PBM say the drug companies don't have to raise prices to boost their bottom lines and that rebates reduce the cost of drugs, not inflates them. They say rebates reduce the real cost of prescription drugs because they lower the price that insurance companies pay. That helps the insurers lower the premiums that the patients have to pay for their plans. Here's Derricka Rice, an executive vice president at CVS Caremark, 1 of the pharmacy benefit managers.

Speaker 3: Our job is to work with the employers, unions and government programs we serve to ensure that when their members get to the pharmacy counter, they get the medicines that they need at the lowest possible cost.

Speaker 0: So what does all of this mean for the patient back at the pharmacy counter? At the heart of all this is that what the patient pays is often based on the list price, not the price the insurance company is responsible for after the rebates. And patients who don't have insurance or co-insurance or who have really high deductibles sometimes pay the entire list price. It's important to know that the details surrounding rebates are shrouded in mystery. Pharmaceutical companies and PBMs don't release their rebate data, saying it's proprietary.

But it's clear that different people and different insurance companies pay different prices for the same drugs. As you can see, the way that prices work behind the counter is totally different from how they work in front.

See all The Wall Street Journal transcripts on Youtube

How Drug Prices Work | WSJ