About a month ago, the Wall Street Journal reported that the Federal Trade Commission (FTC) was preparing an antitrust suit against the nation’s three largest pharmaceutical benefit managers (PBMs), the intermediaries who negotiate drug prices on behalf of insurers and who manage benefits for nearly nine in 10 insured Americans.
This development followed a two-year investigation of the top six largest American PBMs, and a recent FTC interim report that suggested PBMs engage in anticompetitive practices that hike prices for patients. Those were alleged to include negotiating and accepting rebates from pharmaceutical companies to favorably place their on-brand drugs on insurer formularies—the lists of drugs that an insurer will cover—while imposing onerous conditions for the coverage of competing substitute drugs.
In this post, I will examine the hurdles the FTC will face in making their case and consider other reasons why American insurers, patients, and (in the case of the Centers for Medicare and Medicaid) taxpayers often pay more for prescription drugs than their counterparts abroad.
The FTC’s Interim Report
The FTC issued an interim report on its PBM investigation, titled “Pharmacy Benefit Managers: The Powerful Middlemen Inflating Drug Costs and Squeezing Main Street Pharmacies,” on July 9 following a 4-1 vote by the commissioners to release it publicly. Commissioner Melissa Holyoak wrote a detailed dissent, arguing that the report should never have been released due to its methodological flaws, lack of pricing analysis, and speculative findings that were based largely on anecdotal evidence.
In compiling the report, FTC staff reviewed 1,200 public comments (many of them anonymous), data and internal documents from PBM respondents (including contracts and business documents pertaining to relationships and transactions between PBMs and their insurer clients, and between PBMs and drugmakers), testimony from stakeholders and experts on the industry, as well as publicly available data.
Beyond describing the PBM industry, the report’s primary findings were that PBMs have obtained significant power to determine prescription-drug costs and access due to increased market concentration and vertical integration among pharmacies, insurers, and/or PBMs; that this concentration and market power increase may have allowed PBMs to hurt rivals, increase drug prices, and reduce competition; and that the rebate agreements negotiated between drugmakers and PBMs may curtail or block less-expensive substitute products like generic drug equivalents of branded medication. It found that the six largest U.S. PBMs comprise 94% of the market, with the remaining 60 or so smaller PBMs often contracting with the big six. The three PBMs reportedly targeted by the FTC in the upcoming lawsuit (OptumRx, Express Scripts, and Caremark) are all vertically integrated with large insurers and entities involved in the private labeling of medications.
Following vertical integrations among PBMs and mail-order pharmacies, nearly 70% of specialty-dispensing revenue in the United States accrues to PBM-affiliated mail-order pharmacies. The FTC argues that PBMs have incentives to steer patients to their own pharmacies even if this means they (or their insurer/health plan) get a worse deal. Citing anecdotal pricing information on two drugs (rather than market-wide pricing analysis), the FTC argues that vertically integrated or PBM-affiliated pharmacies receive higher reimbursement rates from the PBM’s health plan or insurer clients than independent pharmacies.
Specifically, the interim report finds that, for two specialty generic medications (Gleevac, which treats leukemia, and Zytiga, which treats prostate cancer), insurers serviced by PBMs provide 20-40 times higher reimbursement rates for those drugs to PBM-affiliated pharmacies than the national average drug acquisition cost (NADAC). The interim report did not, however, detail how many patients use those specific drugs, how many were captured within the study, or whether the cases are representative of broader trends for specialty drugs, cancer drugs, or prescription drugs more generally.
There are also potential pro-competitive explanations for the increase in vertical integration between PBMs and other entities. Pooling a large volume of insured patients, including clients of multiple insurers, gives PBMs bargaining power to negotiate favorable terms, including (theoretically) lower prices and/or large rebates from drugmakers to include their products on insurance formularies. This expected reduction in costs is why insurers may contract or vertically integrate with a PBM, rather than negotiating drug prices and formulary listings directly with drugmakers.
It’s also been theorized that: “PBMs’ specialized knowledge of drug markets may allow them to perform [functions like negotiating prices, creating provider and pharmacy networks and processing claims] more effectively [than insurers].” Vertically integrating with a PBM provides additional benefits to the insurer, such as better aligning the PBMs’ incentives with their own, reducing the long-term cost of repeatedly contracting for services, and eliminating double marginalization.
The FTC’s Case
The FTC’s interim report asserts that PBM-negotiated rebate agreements can reduce and foreclose competition by steering patients away from cheaper alternatives, such as biosimilar drugs and generics. As a result, patients are left with higher prices and insurance premiums, including higher out-of-pocket costs that force some to forego drugs or restrict their intake, thereby endangering their health. The report also claims that, by steering patients away from generic and biosimilar drugs, new players are deterred from entering the market, as they are unable to reach the economies of scale, contingent on purchase volumes, necessary to compete effectively. Moreover, pharmacies themselves may avoid stocking these drugs entirely. This is because insured patients covered under rebate arrangements and subject to their insurer’s formularies make up most of their customers and are steered away from purchasing competitor drugs, even when these are cheaper.
According to 2021 figures from the U.S. Food and Drug Administration (FDA), 90% of prescription refills are for generic drugs, suggesting a limited PBM rebate-steering effect, or one confined to specific drugs. On average, U.S. generic drugs cost 43% less than the same drugs cost overseas, and the United States has a far higher generic-drug utilization rate than other OECD countries. The Pharmaceutical Care Management Association (PCMA), the trade association for PBMs, suggests that PBMs even play a role in this by “incentiviz[ing] and encourag[ing] the use of lower-cost generic and therapeutically equivalent branded drugs, leading to lower net costs in Medicaid programs.”
Regardless, the agency’s recent allegations do provide a plausible theory of anticompetitive behavior and consumer harm that could hold true in specific cases. Despite facing cheaper generic-drug costs on average, Americans also often pay more for the same nongeneric (branded) drugs than patients and insurers in other countries, even after adjusting for rebates. Indeed, branded drugs cost 4.22 times as much here on average as they do in comparable economies. With the exception of a two-year period around 2015, real-dollar spending on prescription drugs as a share of overall U.S. health-care spending has dropped annually every year from 2005 to 2022. This, however, provides little comfort to the 79% of Americans surveyed in 2019 who complained that prescription-drug prices are unreasonable, or the three in 10 Americans recently surveyed by the FTC who are reportedly skipping doses or rationing their prescriptions to cope with costs.
The Biden administration has promised to address this, and PBM rebate agreements, pricing strategies, and formulary negotiations are typically unavailable to the public. If it is to mount a successful case, however, the FTC will need to provide concrete economic evidence, including pricing analysis across the market. That evidence was conspicuously absent from the interim staff report. Since the Supreme Court has long held that consumer welfare is the paramount goal of antitrust law, the agency will need to do more than assert that PBMs operate in an increasingly concentrated market, as it does in its interim report.
The Legal Burden
While the FTC has not yet filed its complaint, the interim report did outline potential antitrust violations, as did the commission’s June 2022 policy statement on “rebates and fees for excluding lower cost drug products.” Specifically, “[e]xclusionary rebates that foreclose competition from less expensive alternatives may constitute unreasonable agreements in restraint of trade under Section 1 of the Sherman Act; unlawful monopolization under Section 2 of the Sherman Act; or exclusive dealing under Section 3 of the Clayton Act,” as well as violations of Section 2(c) of the Robinson-Patman Act and Section 5 of the FTC Act. Let’s deal with each of these in turn.
The Supreme Court applies the Sherman Act Section 1 prohibition on restraints of trade to unreasonable restraints of commerce involving concerted action between two or more parties. Vertical restraints are judged under the rule of reason, which means that the FTC will need to show evidence of competitive harm that outweighs any countervailing benefits to competition and consumers. Anticompetitive harms could be established through direct or indirect evidence (such as observable market factors) that the arrangement is likely to lead to increased prices, decreased output, or less innovation.
Exclusive dealing contracts under Section 3 of the Clayton Act are also judged under the rule of reason. In their rule-of-reason analysis, courts will consider the degree and duration of foreclosure, and the degree to which this deters entry. When the rebate contracts result in less-favorable formulary placement and increased formulary conditions for the competitor drugs to be substituted, rather than excluding them completely (partial foreclosure), the FTC would have greater difficulty winning than in the case of full foreclosure. A partial foreclosure would increase consumption of a particular drug while reducing consumption of another, potentially creating ambiguous net effects on competition and raising potential difficulties for the FTC in defining the relevant market in which the injury occurred. Partial or even full foreclosure could also create an incentive for drugmakers to compete vigorously to secure their desired formulary placement and “win” the market.
For an unlawful monopolization claim to succeed, the FTC will have to show that these rebates didn’t represent “competition on the merits,” and inefficiently excluded biosimilar and generic substitute drugs, making no business sense other than for maintaining the drugmakers’ monopoly.
Similar to the Sherman and Clayton acts, the prohibition on unfair methods of competition (UMC) in Section 5 of the FTC Act also upholds the competitive process, rather than protecting the interests of competitors. Though the Biden administration FTC eschewed this characterization of the law in its 2022 policy statement on UMC, it is one that courts have upheld for decades, and one that the judiciary is unlikely to abandon.
Leaving aside per se illegal practices like bid rigging, price fixing, and market-allocation agreements, the rule of reason is applied to economic evidence and market facts and circumstances to decide if a particular practice is a UMC. Judicial dicta and prior FTC statements suggest that Section 5 proscribes conduct that violates the spirit, letter, or public policy of the Sherman or Clayton acts, or that would likely “ripen” into a Sherman Act violation if allowed.
But apart from limited cases—such as invitations to collude—there is relatively little agreement on the extent to which, or regards in which, the scope of Section 5 exceeds that of the Sherman and Clayton acts. There must be at least a “reasonable probability” that it will develop into a Clayton Act violation, or a “dangerous probability” that it will develop into a Sherman Act violation. Since the Sherman and Clayton acts support competition on the merits, practices that enhance efficiency on net are unlikely to be proscribed as “unfair” even if they “foreclose” or take market share from a competitor.
Countervailing Benefits
The PBMs can be expected to argue for a range of countervailing benefits that formulary-rebate contracts provide. For instance, they may argue that these rebates allow for lower drug costs, lower insurance premiums for patients and employers, and that competition to secure favorable formulary listings provides incentives for the research and development of new cures.
Notably, the recent FTC interim report on PBMs and “rebate walls” charted just two anecdotal examples of drugs whose prices may have risen as a result of formulary-listing rebates, but failed to examine industrywide empirical pricing data, or empirical economic data on the contractual relationships among all the parties in the medicine-procurement chain. These criticisms were noted in Commissioner Holyoak’s dissent to the report, which argued that the report’s failure to provide transparent and consistent methodology, its use of loaded language, and it lack of empirical industrywide data compromise not only its utility, but also the quality standards to be expected from the agency’s research products. She also noted that the FTC’s last investigation of PBMs and their impact on competition and drug prices in 2005 found that PBM negotiations lower drug prices and insurance premiums—at least, on average. Both of these findings could constitute evidence of procompetitive efficiencies. Holyoak also criticized the current FTC for having dismissed its 2005 report for being inconsistent with current market realities, without providing evidence of why or how, and without establishing empirically that the 2005 findings no longer hold.
In a policy brief that I co-authored last year with my Mercatus Center colleague and former FTC General Counsel Alden Abbott, I canvassed some of the government and external research on PBMs and their impact on drug prices and insurance premiums:
[R]esearch finds that forcing insurers to undertake PBM services in-house would increase management costs that are likely to be passed on to consumers through higher drug prices or premiums, forgoing 40 percent of the net value of PBM services. The annual benefit to the wider economy of these services is approximately $50 billion. TheCongressional Budget Office separately concluded that forcing drugmaker rebates to PBMs to be passed on through drug-price subsidies to end consumers at the point of sale would increase premiums and deliver smaller discounts on drugs, thereby increasing costs to the Medicare public health system by $170 billion over 10 years and to Medicaid by $7 billion.
It may be that the FTC has access to either pricing information or economic data that support its theory of competitive injury and undermine the narrative of countervailing consumer benefits in the case of the specific rebate contracts that it challenges in litigation. It will, however, need to bring evidence to bear that it has not yet released (and may not have) if it is to win in court. Alternatively, it may have one last fallback option: the Robinson-Patman Act.
Robinson-Patman Act
The FTC’s best chance to overcome the burden of having to demonstrate injury to the competitive process might be a Robinson-Patman Act (RPA) charge, as this statute was enacted to protect competitors from injury, rather than necessarily upholding competition itself. The RPA disallows certain discriminatory discounts on price offered by sellers to particular buyers, and prohibits reimbursement for certain promotional services.
Section 2(c) of the RPA bans payments from sellers of goods to intermediaries representing a buyer’s interest, specifically prohibiting any party to the transaction from obtaining or providing “commission, brokerage, or other compensation, or any allowance or discount in lieu thereof, except for services rendered.” Thus, the rebates offered by drugmakers to PBMs for favorable formulary listings could constitute a brokerage, commission, or discount intended to induce a favorable outcome for the drugmaker over their competitors by enriching the PBM intermediary, rather than simply a payment to compensate the PBM “for services rendered.” Notably, courts have ruled that a Section 2(c) violation can arise regardless of whether the intermediary passed the discount on to the buyer it represents.
Conversely, however, the last Supreme Court decision on Section 2(c) is more than 60 years old, and courts subsequently have interpreted the “for services rendered” exception broadly, so long as the services were not against the interest of the buyer whom the intermediary represents. For instance, this exception has applied to payments from the buyer in exchange for the intermediary guaranteeing payment from the seller, and to payments to compensate for “promotional services” for the seller’s product provided by the buyer or PBM.
The PBMs might therefore argue that accepting rebates from drugmakers supplements a range of services that they or their insurer clients provide. These could include promotion of the drug through favorable formulary listings, promotion of the drug to health-care providers and patients through education and advisory campaigns and engagement efforts, and payment for administering PBM-affiliated or integrated pharmacy chains and pharmacy claim-processing services. Importantly, since the RPA and Section 2(c) aren’t contingent on the consumer welfare standard, several of the countervailing benefits to consumers and competition noted in the preceding section would not stand as defenses justifying rebates.
Judges have noted the RPA’s perverse results as an antitrust statute that punishes economic actors, even when there has been no demonstrated injury to competition or consumers in the wider market for a product. Government agencies and bodies, including the U.S. Justice Department (1977) and the 2007 Antitrust Modernization Commission, have charged that the statute is premised on discredited economic assumptions and at odds with consumer welfare. They have thus recommended that it be repealed.
But the RPA does remain on the books. And while successive courts have broadened the scope of defenses available against RPA claims, thereby making them harder to prosecute, the Biden administration FTC has made clear its interest in using the statute as part of its arsenal. This position flies in the face of the FTC’s purported objective of protecting consumers from unjustifiably high drug prices.
Who’s to Blame for High Drug Prices?
The Pharmaceutical Research and Manufacturers of America (PhRMA), the pharmaceutical industry’s trade association, posits that:
PBMs make money through fees that are predominantly tied to the list price of a medicine. That means the higher the price of a medicine, the more money the PBM can make. As a result, PBMs may deny or limit coverage for lower-priced versions of medicines because of their misaligned incentives.
A 2021 report from the minority staff of the U.S. House Oversight Committee accused drugmakers of raising drugs’ list prices to offset the rebates and discounts negotiated by PBMs, and claimed that PBMs encouraged this practice. The report cited a 2020 USC Schaeffer study that found a $1 increase in rebates correlated with a $1.17 increase in drug list price, although it did not confirm a causal link. It could make economic sense for drugmakers to pay higher rebates to secure prime formulary-listing status for drugs that are more expensive to research and develop, since this would make it all the more crucial that the company can tap into the large base of insured customers in order to recover its investment.
In any case, other factors significantly contribute to the higher prices that U.S. insurers and patients pay for branded (non-generic) drugs—prices that are significantly higher than what payers in other countries pay for the same drugs. One of these is the high cost and delay involved in the FDA approval process, even for generic drugs that replicate an already-approved medication. A 2016 report found that these take a median of 47 months to garner approval, and noted a backlog of more than 4,000 applications pending approval.
Also significant are regulations governing what the U.S. Centers for Medicare & Medicaid Services (CMS) pays for drugs, which contribute to price hikes for both public (taxpayer-funded) and privately insured patients. Specifically, CMS is not allowed to negotiate drug prices with drugmakers the way that private insurers or public insurers in single-payer healthcare countries are. Instead, Medicaid is legally required to pay drugmakers the lowest price paid by private-market drug purchasers (typically, private health insurers) for every drug they purchase, and Medicare Part B (which covers certain prescription drugs) must pay the average private-market sales price.
Drugmakers can make the most of this system by raising prices on the private market above the market rate and selling fewer drugs than they otherwise would. This wouldn’t normally be a profit-maximizing strategy, as it reduces sales volumes, due to fewer private-market purchases. But doing so means that the higher price is obtained for every drug purchased by CMS, which purchases extremely large volumes as the public health insurer. Thus, deliberate policy settings make raising drug prices above market rates a profit-maximizing strategy for drugmakers.
Regulatory changes that alter or abolish this pricing model—such as allowing CMS to negotiate drug prices as any private party does, or pegging the drug prices paid by CMS to prices paid by public insurers in other countries that negotiate prices—would lead to lower drug prices for private patients and insurers and would significantly trim the federal drug budget. Estimated savings for taxpayers amount to more than $100 billion a year.
Some libertarian groups and the pharmaceutical industry have wrongly described these reforms as “price controls.” Price controls, by definition, are government interventions into private contracts and price negotiations. If U.S. government policy were to tell private insurers what they’re allowed to pay pharmaceutical firms for drugs, then that would be a price control. Governments, on the other hand, should exercise stewardship of taxpayer resources by negotiating purchases as a private party would.
Conversely, however, switching to a negotiation model for CMS or pegging CMS prices offered to drugmakers to those offered by public insurers overseas would also likely drive a significant decline in funding to research, discover, and develop new drugs, and to bring them to market. This was the idea behind the original decision to implement the current policy settings, and it has no doubt helped to make the United States a world leader in pharmaceutical development and innovation, delivering cures that benefit patients worldwide. Americans are typically the first to benefit from these innovations.
Some studies find that most of the social benefits generated by pharmaceutical research are not internalized by profits from drug sales, even under the status quo. This would be even less so if CMS were allowed to negotiate drug prices, something that the Biden administration’s recent Inflation Reduction Act would permit for some drugs, and a purchasing model already followed by the Department of Veterans Affairs.
Policy decisions have tradeoffs, and we should keep these in mind, regardless of what ends we prioritize. The same holds true for decisions to pass laws or regulate against private business practices that could have both pro- and anticompetitive implications. Applying the rule of reason allows us to weigh these to see if competitive harms are offset by benefits to consumers and competition. Accurate decisions can only be made when based on hard economic evidence and an examination of how specific arrangements work within the relevant market. Judges, competition enforcers like the FTC, regulators, and legislators alike can best uphold healthy economic competition and serve Americans by keeping these principles in mind.
