How Prescription Drug Coverage Works: Formulary Tiers, PBM, Rebates, Spread-Pricing Explained

This video provides an in-depth exploration of how prescription drug coverage functions within the U.S. healthcare system, focusing on formularies, formulary tiers, and the intricate financial mechanisms of Pharmacy Benefit Managers (PBMs). The presenter, Dr. Bricker, begins by establishing the significant impact of prescriptions, noting they constitute approximately 20% of all healthcare spending, thus necessitating a clear understanding of their coverage. The discussion progresses from the foundational concept of a formulary—a list of covered medications—to the nuances of non-formulary drugs and the tiered structure that dictates patient co-pays.

The core of the video delves into the role and operations of Pharmacy Benefit Managers (PBMs), which are presented as critical intermediaries, often divisions of major health insurance companies. PBMs are responsible for negotiating drug prices with pharmaceutical manufacturers, determining which drugs are included in formularies, and assigning them to specific tiers. The video identifies the four major PBMs—Express Scripts (now Evernorth/Cigna), Caremark (CVS Health/Aetna), OptumRx (UnitedHealth Group), and Prime Therapeutics (Blue Cross plans)—highlighting their dominant market share and their integration within larger healthcare conglomerates.

A significant portion of the analysis is dedicated to demystifying how PBMs generate revenue, explaining two primary methods: rebates and spread pricing. Rebates, applied to brand-name medications, are depicted as commissions paid by pharmaceutical manufacturers to PBMs, a substantial portion of which PBMs retain, passing only a fraction to employers as a "rebate." This system, the speaker argues, creates an incentive for PBMs to favor higher-cost drugs and increased prescription volume. Spread pricing, conversely, applies to generic medications, where PBMs purchase drugs at a low cost but charge employers a significantly higher, marked-up price, often based on a fictitious "Average Wholesale Price" (AWP), creating a substantial profit margin for the PBM.

Key Takeaways:

• Prescription Drug Spending: Prescriptions account for a substantial 20% of total healthcare spending, underscoring the importance of understanding their coverage and cost structures.
• Formulary and Non-Formulary Medications: A formulary is a list of medications covered by insurance, while non-formulary drugs (e.g., most over-the-counter, cosmetic, and some reproductive medications) are typically not covered, requiring patients to pay cash.
• Tiered Formulary Structure: Health plans typically categorize covered medications into four tiers—Generics (Tier 1, lowest co-pay), Preferred Brand (Tier 2), Non-Preferred Brand (Tier 3, higher co-pay), and Specialty Medications (Tier 4, highest cost, often 20% coinsurance). These tiers directly influence patient out-of-pocket costs.
• High Cost of Specialty Medications: Specialty drugs are exceptionally expensive, often costing thousands of dollars per month, and are typically used for complex conditions like rheumatoid arthritis, HIV, or hepatitis C. Their high cost, combined with coinsurance, can lead to significant annual patient expenses.
• Role of Pharmacy Benefit Managers (PBMs): PBMs are crucial intermediaries that negotiate drug prices with pharmaceutical manufacturers, establish formularies and tiers, and process pharmacy claims. They are predominantly owned by major health insurance companies, creating integrated healthcare ecosystems.
• PBM Revenue through Rebates: For brand-name drugs, PBMs receive "rebates" (effectively commissions) from pharmaceutical manufacturers. PBMs often retain a large portion of these rebates, passing only a smaller percentage to employer clients, which incentivizes PBMs to favor higher-cost medications and increased prescription volume.
• PBM Revenue through Spread Pricing: For generic medications, PBMs profit from "spread pricing," where they charge employer clients a significantly higher price than what they reimburse pharmacies for the drug. This spread can be substantial, often based on an inflated "Average Wholesale Price" (AWP) that is not reflective of actual acquisition costs.
• Fictitious Pricing Benchmarks: The "Average Wholesale Price" (AWP) used in generic drug pricing is often a made-up figure, leading to a lack of transparency and enabling PBMs to negotiate discounts off an artificially high starting point, further obscuring the true cost and profit margins.
• Self-Funded Plan Flexibility: Employers with self-funded health plans have the option to "carve out" their PBM services, allowing them to choose an independent PBM or one from a competing health insurance carrier, potentially offering more flexibility and cost control.
• Patient Cost-Saving Strategies: Patients should be aware that the cash price of some generic medications can be lower than their insurance co-pay. Tools like GoodRx can help patients compare prices and potentially save money by paying cash instead of using insurance.
• Clinical Efficacy vs. Cost: For certain conditions, highly effective and significantly cheaper generic first-line therapies (e.g., methotrexate for rheumatoid arthritis) exist, yet patients are often prescribed expensive specialty drugs (e.g., Humira) without first trying the generic option, leading to higher costs for both patients and health plans.

Key Concepts:

• Formulary: A list of prescription drugs covered by a health insurance plan.
• Non-Formulary: Medications not covered by a health insurance plan.
• Formulary Tiers: Categories of drugs within a formulary, each with a different co-payment or coinsurance level.
• Co-pay: A fixed amount a patient pays for a covered healthcare service, including prescriptions, after their deductible has been met.
• Coinsurance: A percentage of the cost of a covered healthcare service that a patient pays after their deductible has been met.
• Pharmacy Benefit Manager (PBM): A third-party administrator of prescription drug programs for health insurance companies, Medicare Part D plans, and large employers.
• Rebates: Payments from pharmaceutical manufacturers to PBMs, often tied to formulary placement or market share, which PBMs may partially pass on to clients.
• Spread Pricing: The practice where a PBM charges a health plan or employer more for a drug than it reimburses the pharmacy for dispensing it, keeping the difference.
• Average Wholesale Price (AWP): A benchmark price for prescription drugs, often considered an inflated list price that is not reflective of actual transaction prices.
• Maximum Allowable Cost (MAC): The maximum amount a PBM will reimburse a pharmacy for a generic drug.
• National Average Drug Acquisition Cost (NADAC): A survey-based measure of the actual cost pharmacies pay to acquire prescription drugs.
• Self-Funded Plan: An employer-sponsored health plan where the employer directly pays for employees' healthcare costs rather than paying premiums to an insurance carrier.
• Carve Out PBM: The practice by self-funded employers of contracting directly with a PBM separate from their medical insurance carrier.

Tools/Resources Mentioned:

• GoodRx: A platform mentioned as a resource for patients to check cash prices for medications, potentially finding lower costs than their insurance co-pay.

Examples/Case Studies:

• Non-Formulary Medications: Tylenol (OTC), cosmetic creams for wrinkles, Viagra (lifestyle medication), and certain infertility treatments are cited as examples of drugs typically not covered by insurance.
• Formulary Tiers: The cholesterol medications Simvastatin (generic), Zocor (preferred brand), and Crestor (non-preferred brand) are used to illustrate how different tiers lead to varying co-pays ($10, $30, $60 respectively).
• Specialty Medications: Humira (for rheumatoid arthritis and Crohn's disease), certain HIV pill medications, oral chemotherapies, and Hepatitis C treatments (e.g., a $40,000 one-month supply) are highlighted as examples of extremely expensive specialty drugs.
• Cost-Saving Alternative: Methotrexate, a generic medication, is presented as an effective and significantly cheaper first-line therapy for rheumatoid arthritis compared to Humira, emphasizing the potential for substantial cost savings if patients are started on appropriate generic alternatives.
• Cash Price vs. Co-pay: A personal anecdote about a diaper rash cream costing $1.80 cash versus a $10 co-pay demonstrates how paying cash can sometimes be more economical than using insurance for low-cost generics.