Across most markets in our economy consumers can easily obtain and process information regarding products for sale. So when, for instance, Ford launches the latest version of the F-150, based on consumer reports and comparative price information, customers can evaluate whether the price is worth it to them. Here, the conditions for an efficiently functioning market are met. There is competition, free flow of information regarding the product’s characteristics, and transparency regarding pricing. Not so with prescription drugs.
Pricing of drugs generally follows a script in which drug manufacturers set a benchmark or list price, then pharmacy benefit managers (PBMs) or other purchasers express a willingness to pay at that price or at some other price. Negotiations ensue, usually resulting in a transaction price lower than the list price. Regarding PBMs, the key operative term with respect to price negotiations is rebating; in exchange for increased market share of their product drug makers give PBMs a percentage off of a drug’s list price. PBMs can achieve an increase in market share by designating certain drugs with a preferred status on the formulary, that is, lower patient co-payments and fewer conditions of reimbursement.
Precisely how much of a rebate drug makers provide and what amount ultimately passed through to the end-user remains a carefully guarded trade secret. From published reports of gross and net sales of drugs (after off-invoice discounts, rebates, and other price concessions) the approximate rebate amount can be inferred. Observers note that rebates have been steadily increasing in recent years, perhaps in response to the use of new formulary management tools, such as exclusion lists and co-payment accumulators.
The mutually agreed upon transaction prices (post rebate) could theoretically be considered "value-based" to the extent that they reflect how much purchasers appear to be willing to pay for a drug. But, willingness to pay is not a good gauge of value in an imperfect market. Several key assumptions underlying an efficiently functioning competitive market do not hold in healthcare, which can cause a deviation between the market price and value of a drug. First, drugs are patented as single-source (branded) monopoly products for a period of time without generic competition. This implies that in therapeutic classes with few or no competitors drug manufacturers can more or less dictate the price in the market. Second, third-party health insurance shields end-users (patients) from the actual cost of prescription drugs. Third, the existence of asymmetries in information between suppliers and purchasers, as well as physicians and patients, leads to distortions in the market. Fourth, there is a high degree of uncertainty in healthcare on the demand (incidence of disease) and supply (effectiveness of treatments) sides.
Furthermore, the basis on which rebates are computed and formulary placement determined is not necessarily clinical or cost-effectiveness (gauges of value). A recently published studyon the use of PBM exclusion lists suggests that PBMs often do not make value-based reimbursement decisions to determine which drugs to cover on the formulary. It’s observed in a number of therapeutic classes that products that are superior from a clinical and cost-effectiveness perspective may be excluded from coverage, while products that are inferior may be included. As such, formulary positioning of products appears in some cases to be more a function of financial deal-making than a clinical and cost-effectiveness assessment.