A Primer on Pharmacy Benefit Managers

President Trump signed an executive order last month to lower prescription drug costs, partly taking aim at the considerable influence of pharmacy benefit managers (PBMs). Few Americans know what PBMs are.

In short, PBMs have great influence over the logistics and cashflow of the prescription drug industry, setting prices for patients and controlling their access to medicines. But what exactly do they do?

Federal law first mandated prescriptions for certain medicines in the 1950s. In response, health insurance companies added prescription drug benefits to their policies. PBMs arose to help insurers implement these new benefits.

Today, PBMs manage all components of health plans’ (payers’) prescription drug benefit. The “Big Three” – CVS Caremark, OptumRx, and Express Scripts – control 60 percent of the US market, managing about 80 percent of all prescriptions and serving nearly 300 million Americans.

To understand how PBMs operate, we can trace the flow of both prescription drugs and funds in the supply chain.

The flow of the drug is relatively straightforward: Wholesalers purchase drugs from manufacturers, who in turn sell them to pharmacies, who in turn distribute them to patients.

The flow of funds is much more convoluted. While manufacturers are selling their drugs to wholesalers, they are also negotiating with PBMs to include those drugs in health plans’ pharmacy benefits. PBMs secure rebates or discounts from drug makers in exchange for preferred placement on a health plan’s formulary, its list of preferred drugs. The more preferred the placement on the formulary (e.g., with lower cost sharing), the more likely the drug will be chosen for or by patients over other options, leading to greater use and greater profit. In exchange for managing this process, health plans pay PBMs.

Lastly, PBMs reimburse pharmacies for dispensing drugs to patients, and PBMs then bill health plans for the cost of the prescription.

There are two concerns in this process though: vertical integration and spread pricing.

Vertical integration occurs when a PBM’s parent company owns multiple parts of the drug supply chain, such as the insurer, the PBM itself, the pharmacy, etc. Some even manufacture drugs overseas.

Take CVS Health, for example. CVS Health owns Aetna (health insurer), Caremark (PBM), and CVS pharmacy (as well as specialty and mail-order pharmacies). CVS Health has, therefore, vertically integrated its entire operation.

This vertical integration contributes to the “Big Three” PBMs having less competition and more power to steer patients to their own pharmacies and insurers, leading to more profits.

In fact, the Federal Trade Commission (FTC) found that the “Big Three” reimbursed unaffiliated pharmacies at lower rates than their own pharmacies. They also marked up drugs at their own pharmacies by hundreds and thousands of percent, resulting in over $7 billion in revenue from 2017 to 2022.

Spread pricing is another challenge.

Spread pricing is a practice by which PBMs charge the health plan a certain amount for a drug but then turn around and pay the pharmacy less for the same drug. The difference is the spread, often retained (in part or in full) by the PBM as profit.

Spread pricing means that PBMs reimburse independent pharmacies less than what those pharmacies paid for the drugs from the wholesaler, resulting in a loss. Over 25,000 independent pharmacies in the US closed between 2010 and 2020 because of these losses. According to a 2024 FTC report, the top three PBMs generated about $1.5 billion in profits from spread pricing from just 51 specialty drugs from 2017 to 2022.

Ultimately, for patients, vertical integration and spread pricing mean less pharmacy access and choice for patients, alongside higher out-of-pocket costs and premiums.

In response to these concerns, both state and federal governments are increasing their regulatory authority over PBMs.

All 50 states have passed legislation to regulate PBMs. Some laws focus on protecting small pharmacies by ensuring unaffiliated pharmacies are reimbursed at the same rates as PBM-affiliated ones. Others limit patient cost-sharing or require PBMs to be licensed to operate. Additionally, 27 states require PBMs to comply with reporting and transparency requirements.

One state has gone even further: Arkansas now prohibits PBMs from operating their own retail pharmacies in the state, disrupting vertical integration.

Federally, seven PBM-focused, bipartisan, bicameral bills have been introduced this congressional cycle. They focus largely on prohibiting spread pricing, increasing transparency and reporting requirements, and changing how drug manufacturers and PBMs negotiate. Some bills also define penalties for PBMs that don’t play by the rules and give the federal government more enforcement power.

The influence of PBMs in the prescription drug supply chain has grown in recent decades, as have their profits. In response, states and the federal government have proposed or enacted laws to regulate PBMs and lower prescription drug costs for patients. What legislative approaches will regulate PBMs in a way that actually lowers costs for patients, though, is yet to be determined.

Research for this article was supported by Arnold Ventures.