PBMs and Their Role in The Pharma Supply Chain

Speaker 1:
Welcome to TD Cowen Insights, a space that brings leading thinkers together to share insights and ideas shaping the world around us. Join us as we converse with the top minds who are influencing our global sectors.

Charles Rhyee:
Hello. My name is Charles Rhyee, TD Cowen's healthcare technology and distribution analyst. And welcome to the TD Cowen Future Health Podcast. Today's podcast is part of our monthly series that continues TD Cowen's efforts to bring together thought leaders, innovators, and investors to discuss how the convergence of healthcare technology, consumerism, and policy is changing the way we look at health, healthcare, and the healthcare system.
And in this episode, we look at the PBM industry, which has been in spotlight in recent months, and not necessarily in a good way. PBMs have been painted as the unnecessary middleman that is driving up the cost of drugs, but is this really the case? The PBM industry traces its roots back over 50 years with an initial narrow focus on efficient benefits administration, treating systems that tell pharmacies in real time, what each patient's specific insurance plan meant that customers was supposed to pay for a specific prescription.
Over time, PBMs leverage their intermediary role in the pharmaceutical supply chain to take on additional responsibilities, including pharmaceutical costs and clinical control, pharmaceutical dispensing and disease management. Among the various stakeholders in the pharma supply chain, PBMs have the least interface with consumers of the general public, which often leads to confusion about the role PBMs play. And in our discussion today, we hope to clarify some of the various roles of PBMs and how PBMs interact with other stakeholders in the US healthcare system.
To help dive into this topic I'm joined by Ron Fox. Ron is currently a healthcare consultant specializing in the PBM and health plan sector. Previously, Ron spent over 21 years in the PBM industry, most recently serving as president of the health plan division at Express Scripts now part of Cigna's Evernorth division.
Ron, thanks for joining us today.

Ronald Fox:
Great, Charles. Thank you. I'm delighted to be here.

Charles Rhyee:
So maybe Ron, just to start off, what is the role of the PBM industry in the pharma supply chain?

Ronald Fox:
Yeah, that's a simple question, but very complex answer. And just to simplify, I know we're going to get into a lot of these topics for our time here together today, but if you think the PBM is essentially at the crossroads of everything in the retail pharmaceutical space and really not necessarily retail. It gets into some of the non-retail pharmacy components as well. But truly they're at the crossroads of everything.
If you think of a wheel and spokes and a hub, the PBM is the hub. Everything that happens within the pharmaceutical industry. And they are literally a part and parcel to all of those transactions, whether it's financial, distribution, benefit design, consumer support, and so on and so forth. And so they play a very, very critical role and through consolidation in the last 20 years, they certainly have incredible amount of leverage to play an ever-increasing role within the pharmaceutical landscape.

Charles Rhyee:
And I think that role, which obviously is a little bit more under scrutiny these days, but certainly that scale helps them particularly when negotiating with very large pharma companies. And obviously they have this role as you point out in the middle of things. One being interfacing with drug manufacturers. I think a lot of people hear about the word rebates. It's the buzzword that comes up often in these discussions and I think people maybe misunderstand that a little bit. Maybe start here. Can you explain the concept of rebates and maybe the arrangements that PBMs and drug makers come to and what's driving that?

Ronald Fox:
Yeah, sure. Happy to, Charles. The PBM's relationship with the drug manufacturer is twofold. First, they do acquire drugs directly from generic manufacturers that don't provide a rebate. They buy those directly from the manufacturers. They also though have relationships with the drug wholesalers where they're acquiring drug for their own inventory. And recently they've expanded their relationship where they're actually co-branding some drugs. So they have a relationship on the distribution side. It's important to know that.
But specific to your question, they also have a relationship on the drug rebate side. So first, it's important to understand that drug rebates are paid only on branded products, not generics. And remember, from a volume perspective, generics are 90% of the retail volume, whereas brands are 10%. But from a spend perspective, brands are about 86% of the spend, whereas generics are only about 14% of the spend. So it is an oversized allocation to branded products.
Manufacturers pay rebates when they have to. They don't pay rebates because they're just interested in making sure their discounts are readily available to the payers. They pay them when they're forced to because there's competition within their drug. So if a new drug comes to market, a rebate is not offered.
So Humira, for example, until it lost its patent, never paid a rebate and still got about $7,000 a month. But once it becomes competition, either through generics or in a competitive product category, the manufacturer will provide a rebate to the payer, to the PBM, and it's paid only when certain conditions are met. So that is a negotiated item and the PBM will negotiate directly with the drug manufacturers, plural, for placement on the formulary, and the manufacturers will pay more for less restrictions and pay less rebate when there's more restrictions.
So at a high level, that's how the rebate process works. I think it's also important to note that's a retrospective payment so the claim must adjudicate first, and then the PBM bills the manufacturer for the rebate, the rebate gets paid to the PBM, and then the PBM in turn pays its plan sponsors per its contract. And there's a lot to do with that simple concept and why there's a lot of controversy around rebates, and I think we can dive more into that, Charles, if there's interest.

Charles Rhyee:
Thanks, that's really helpful and I think that makes a lot of sense. Maybe you can explain though I think sometimes people will see instances where a single drug can have potentially hundreds of different price points, or maybe not hundreds, but many different price points in rebates within a single PBM and across multiple formularies. Maybe you can dive into a little bit of that and who really drives that decision.

Ronald Fox:
Yeah, sure. That is one of the biggest controversies that certainly members, people to retail counter have, which complain to their plan sponsor employers or to congressional leaders, is this huge variability of pricing at the retail counter. Rebates can play a part of that. Typically, a rebate is negotiated as part of a formulary, and once a formulary is determined that rebate percentage, it's a percentage off of the AWP, the average wholesale price.
But once that's set at a formulary level, that is set and typically a plan sponsor chooses one formulary. Now, PBMs have multiple formularies and they may have tighter controls on one which generates more rebate or less controls on another that generates less rebates. So there can be some variability for pricing based on formulary design. Certainly there is, but from an individual member or a plan sponsor perspective, once they've chosen a formulary that portion's locked. You're going to see a lot more price variability by choice of other components such as the individual retail pharmacy that's selected because the PBM also negotiates with the retail pharmacy and their contract with a CVS is going to be different than its contract with a Walgreens, that's going to differ than its contract with Costco, which is going to differ from its contract with a small independent pharmacy. And that's where you can tend to get a lot more variability in pricing, certainly on a day in and day out basis.

Charles Rhyee:
How much does also the employer then ... We talk about the plan sponsor, but oftentimes there's an employer for their employees make certain decisions. How much of the formulary and a lot of what members or the consumer sees at the counter really depends on decisions by their employer?

Ronald Fox:
Yeah, it's huge. And I think that in all fairness to the PBMs, they get the brunt of that criticism when in reality they simply make recommendations to their plan sponsor clients, whether it's a health plan or an employer, large or small, or a Taft-Hartley Union fund or a municipality, whatever, what have you. Remember, those are the ERISA fiduciaries, not the PBM. And they have the obligation to put together the best plan for their population. The PBM simply makes recommendations.
So at the end of the day, from a pure contractual perspective, that plan sponsor is 100% responsible for that plan design and they have lots of tools and levers they can pull. They can have a restricted formulary versus an open form and they can have a very open retail network or a very restricted network. They can use a lot of care and case management or they can have no care and case management.
So theoretically, and the PBMs do a pretty good amount of study on this, Charles. They can create benefit designs for their plan sponsor clients that drive negative trend year over year. There's no question there's enough tools out there to do that. Now, they may not have a very happy membership and certainly in bargained organizations that are tightly controlled by unions, they oftentimes can't do that. But it really comes to the philosophy of the plan sponsor in terms of how they want to develop, design and implement that overall benefit. And it's the PBM's responsibility to provide them modeling analysis and recommendations in order to achieve those objectives.

Charles Rhyee:
And maybe sticking with the employer's plan sponsor side of things. And it goes back to this idea of rebates. So the PBM is negotiating rebates with the pharma manufacturer, and I think a lot of people look at that when you see graphs shown, they look at the rebate and assume that that's what the PBM is earning, and that's what the model is intended to drive rebates.
But then when you speak with PBMs, they'll counter by saying, "Hey, we pass nearly all product rebates back to customers. "I think the top three PBMs say to varying degrees, something like 95% plus of rebates are passed back.
I guess two things. First, why do you think as such, this continues to be such a hot button issue? And then secondly, if that's the case and all the rebates are passed back, you are getting to this kind of lower net cost at the plan sponsor level, why hasn't there been more traction for more of a net cost model?

Ronald Fox:
Yeah, great questions, Charles. So first, why still the controversy? I think it's twofold. Number one, while the PBMs love to point to this 95 to really 98% of all rebates passing back to their clients, which is true, I don't doubt that. That is not 95% of the pharmaceutical manufacturer revenue, total revenue dollars. Each of the PBMs has created a rebate GPO, group purchasing organization. And those GPOs charge, in my opinion, very high fees for the services they provide of aggregating and negotiating and administering rebates. They charge somewhere between five and 7% of the pharmaceutical manufacturer revenue for those services.
So if you have a 100 rebate manufacturer dollars coming into a plan sponsor, the first thing, six of those dollars goes to the rebate GPO for admin fee and margin, and then another 5% comes off for the PBM retention per their contracts. So right, there's 11% coming off of the rebate, the total manufacturer revenue.
Importantly, to get some perspective, rebates in 2022 were over $223 billion with a B. This is a humongous number when during the same year the retail drug spend was only $406 billion. So over 55% of the total drug spend is rebated back to the plan sponsors in the form of rebate and admin fee. So it is a very big dollars. It's controversial really because when the PBMs talk about the dollars passed back, it's not the whole pie.
The second part, in my opinion, the controversy is that ... And the plan sponsors share their responsibility here. The PBMs collect the dollars and pay them to the plan sponsors. The plan sponsors very rarely pass those dollars down to the members at the point of sale or in other ways. They like the dollars coming in so they can use them as fiduciaries as they see best fit for the benefit of all their membership.
So in many cases, the plan sponsors will say, "Well, I've reduced the premiums to the membership by keeping the rebate." Or maybe I improve a behavioral health benefit on the medical side because of the rebate. Or maybe I chose not to put in the more restrictive formulary because of the value of the rebate. So the member is the one who pays the price unfortunately of a rebate model, whereas rebates didn't exist. Or if rebates pass through to the member at point of sale, the highly utilizing, high out-of-pocket spending membership would directly benefit from high rebates. Whereas in today's model, they simply don't.

Charles Rhyee:
And I guess then it's really the decision by plan sponsors and employers to ... Who I guess they're advantaging, right? I guess if we saw more point of sale rebates, is it fair to say we would see overall higher costs to everyone else in the plan?

Ronald Fox:
Theoretically, yes. We really don't have good line of sight because we don't know what the plan sponsors do with those dollars. But some of the larger consulting firms who've done some study on this would tend to support that, yeah, you would have lower dollars for high utilizers and higher cost for low utilizers. Yes.

Charles Rhyee:
I think another issue that tends to come around as it relates to rebates, particularly I guess employers' decision to stick with rebate models, I think tends to sit around this minimum rebate guarantees that PBMs often offer. And I think some people point to that as an incentive for PBMs to really prefer higher cost drugs on the formulary. I think some people have looked at Humira as an example of that more recently. Can you talk about how the minimum rebate guarantee model works and does that create perverse incentives in the system?

Ronald Fox:
Yeah, you bet. It's difficult for a plan sponsor through its consultant or its broker to evaluate PBMs on rebates in the absence of a guarantee. So again, the rebates are set up as a percentage of AWP or more precisely WAC, but we won't get in the details there. So it's a percentage. And for contractual purposes, the PBM will set up a rebate guarantee usually on a per rebated drug basis. So they want to know that, hey, I'm going to get at least, let's just call it $50, per rebated drug in my contract. And the PBM in order to be competitive, in order to simplify for their consultant and plan sponsor clients who are in an active RFP request for proposal process will give them that guarantee.
If you think of a timeframe, typically there's a three-year contract. The PBM is usually working anywhere from 18 months to sometimes 24 months before the beginning of that contract. So they have to forecast three, four, and five years in the future of what their rebates are going to be, and they're at 100% risk for that. So yes, they take the risk, the better rebate guarantee they get, the better they model in a competitive bid process and they win or lose the business. So they are incented then to have higher rebate products to meet those minimum guarantees as time evolves because they're making these big bets well into the future.
So in my opinion, it is a bit of a perverse incentive. It does cause them to always have an eye toward the overall rebate pool. Now, they do have some contractual flexibility that says that if a plan sponsor makes contractual changes that decrease the value of the rebates, the PBM can go back and reset the rebate guarantees. Those frankly become very difficult to administer. And a lot of times, unless it's a significant change in the industry, it doesn't happen and the PBM can find itself behind the curve in that scenario.
So that's how it works, Charles, to try to put a pin on it here. But I think the criticism from the industry is on point that because of the way that rebate guarantees are structured, there is an incentive for PBMs to want to see more rebate dollars, particularly when you couple that with the rebate GPO and that GPO fees I mentioned a moment ago. You put those two incentives together and you've got an industry that's pretty wired to overall drug rebates.

Charles Rhyee:
And I think that has been the concern for a lot of folks. But if we of tie some of those things together, how successful then have PBMs been in driving down costs for plan sponsors? Because it would look like, given some of the incentive structures that innate in the model, perhaps PBMs aren't really helping their end customers as much as people think.

Ronald Fox:
Yeah, that's a great question and I've wrestled with that as I think the industry at large has wrestled with that. Here's the way I would answer that. First of all, the question is do PBMs make an outsized profit? And I think if you look at the industry players at the net profit margins, we know retail pharmacies are in the three to 4% range. Wholesalers are in about a half a percent range. Health plans, four to 5%. PBMs in four to 5% net margins and drug manufacturers in 24 to 26% margins still.
So you take a look at it from that perspective. They're right there. And realize that's about half of what the S&P 500 generates in that margins, which is about 10 to 11%. So you would say as an industry participant, as a company, they're not making outsized margins. They should get paid for their services and the risks that they bear.
Now, that being said, do they play a key role and have they taken advantage of that? The first part of that question is I would say absolutely they play a key role. If it weren't for the PBMs consistently beating up the drug manufacturers to try to get that 26% margin down, it may be 30, 35 or 40. In the US, we allow direct to consumer advertising. We allow detailing physicians. We do things here that the UK never would imagine doing that would promulgate more branded drugs, more expensive utilization in the system. And I think that PBMs do a good job of that.
If you look at the retail side, the PBMs do a very good job. Some would say too good of a job if you look at the challenges in the retail pharmacy industry right now of really curtailing their spend and their margins and they enjoy somewhere at a 25 to 26% reduction in what a retail pharmacy would otherwise charge its customers.
So I think if you take just the financial component, they add value. They also do a critical job in the adjudication. They do a sub-second adjudication, and they do a lot of benefit design work as well as safety, efficacy, member communication that otherwise in absence of the PBM wouldn't happen.
So I think those are all important points to why the PBM is a critical part of the industry. Now, I think the criticism is pretty well-found, is have they gotten too big? Are they operating as a monopolistic industry? Do they take advantage of their leverage and their size? Do they have too much inside information that is to their advantage? I think those are all fair criticisms to certain degrees, and therefore I think that's why you see a lot of controversy, criticism, suspicion from certainly the membership, their plan sponsor clients, and of course state and federal government. Both regulators and lawmakers all got the PBMs certainly in their sights and it's, I think, for all of those reasons.

Charles Rhyee:
Yeah. And certainly one group that you just mentioned that at the end, retail pharmacies has been a struggling industry now for a number of years when you look at the bankruptcy of Rite Aid, some of the challenges that Walgreens is going through, for example. And I think part of that derives the way PBMs have built pharmacy networks to make available for members to go to. Maybe if we focus on pharmacies for a little bit, can you describe the concept of a pharmacy network and why PBMs include only certain pharmacies versus others?

Ronald Fox:
Yeah, sure. Great question. And this was the focal point of those who looked at the interim report from the FTC. The Federal Trade Commission released an interim report last month that predominantly focused on this exact issue as the retail pharmacies. And the retail pharmacies have very strong lobbies and they've been lobbying very hard with Congress around what they believe is unfair practices caused by the PBMs.
The crux to the issue is that there is significant oversupply of retail pharmacies. There are roughly 65,000 retail pharmacies nationwide. We know that we only need between 35 and 40,000 of those store locations when we look at CMS's access standards. So within the regulated markets, PBMs have to meet access standards. There's a rural and urban and a suburban standard. And in the vast majority of the locations in the United States, you can meet access standards with about 40,000 stores. So that's 25,000 store oversupply on 65,000, which really, if you think about CVS announcing closing 900 stores and Rite Aid now has closed about a 1,000 stores. Walgreens originally said they were going to close somewhere between 150 and 200. Now they've restated that it's going to be closed for like 2,500 stores.
Even with those known closures, they're so significantly oversupplied. And the problem with oversupply in Economics 101, we all know when you have way too much supply and way too little demand, all of the leverage goes to the demand side and the demand is concentrated within the PBMs. So that's the retail pharmacy's biggest issue. There are many others that contribute here, but the core issue retail pharmacies experience today is continue to oversupply of retail pharmacy stores, complete loss of leverage to the PBMs and the PBMs take advantage of that leverage by creating narrow networks.
And so they essentially go to each retail pharmacy and say, "If you want to be in my network, I need more discount. I need other terms and conditions as well, payment terms, audit terms, and some other things." But predominantly it's financial. "And if you don't want to play, that's fine. I'll just exclude you from the network." And the PBMs have been very successful in working with their plan sponsor clients to successfully recommend and get approval and then after that execute on a narrow design because they have 100% visibility to the membership, they have 100% ability to communicate to and manage the membership. And they have shown over many years they can successfully narrow a network and keep a membership very happy with a narrow network.
So that's the crux to the issue for the retail pharmacies and the advantage squarely on the side of the PBMs.

Charles Rhyee:
That begs the question, obviously you look at the interim report and they're zeroing in on this idea that pharmacies are at a disadvantage here and maybe on some of the practices of PBMs as it relates to independent pharmacies or non-affiliated pharmacies, let's say. But at the same time, the bigger picture though is the government's own regulations requiring that you only need 40,000 to meet a network. I guess if they had written the rules to say you needed 65,000, would that change the dynamics? I guess is it two sides or two different voices from the government saying two different things?

Ronald Fox:
Well, just to be clear, the way the regulation is written, it's not number of stores. It's distance from the member zip code. So the member zip code, the geo-axis analysis, and they're just saying in an urban setting, you need to have 95% of the membership within two miles of a pharmacy. Within a suburban, it's five miles. Within rural it's 10 miles. And so if they're all concentrated in the same location, yeah, that's just the way the regulation is written. It's on geo-basis, not on a store count basis.

Charles Rhyee:
Got it. Maybe moving on here. Want to touch on some of how PBMs really interface with the public, or rather the limited ways they interact with the public. If you read the news, all you hear about is the rising cost of out-of-pocket costs for patients. If you listen to one of the big PBMs, Cigna's Express Scripts, I think they recently noted that 80% of patients spend less than $250 out-of-pocket on all the prescriptions. How successful do you think PBMs have been in reining in out-of-pocket costs? And I guess more importantly, it seems like they've lost the messaging battle here.

Ronald Fox:
Yeah, good point, Charles. And there's a bit to unpack there. So the first thing is, let's talk about out-of-pocket costs. As I mentioned earlier, the plan sponsor has 100% of the responsibility of plan design. They file the summary plan document under ERISA and so forth. The PBM makes the recommendations, but the plan sponsor is ultimately responsible. The plan sponsor can create a zero out-of-pocket plan if they want to. Some bargaining groups at one time had zero out-of-pocket. Some today still have very, very little out-of-pocket, but that's really up to the plan sponsor. The PBM though, does all the analysis makes the recommendation to plan sponsor and the plan sponsor's got so much of a budget, it's got to figure out how best to deploy that.
The interesting thing is that the way the utilization works, it is rather unique in the industry. You mentioned 80% at 250 out of pocket. Realize about 50% of a typical plan sponsors membership never utilizes the pharmacy benefit in a year, whereas 2% of their population on average has over 55% of the spend that is within the specialty class. And that's pretty consistent. We've seen that from a number of the leading consultants out there.
So it is a situation where the very sick drive the vast majority of the expenses and those who are healthy pay the price for the sick. Not dissimilar to what happens on the medical side, I don't think. But I think today, particularly with some of the drugs like the GLP-1s and some of the cell therapies and others, that situation is only going to get worse, not better.
I think that the PBMs do a pretty good job of helping the plan sponsors look at ways to manage overall costs. At the end of the day though, it's the plan sponsors decision on what's going to happen at the point of sale at the pharmacy counter. How much of it it's going to utilize, what type of pharmacies and other distribution points, how much care and case management is utilized.
So the problem is all the brunt falls to the plan sponsors members who understand all this and all they know is when they go to a retail counter and a drug that used to cost them $20 now cost them $60 or a $200 drug or a $500 drug if they're in specialty. So that's the problem. It's complex. It's not retail. This is business to business and therefore the individual member is left guessing as to why this is happening to them.

Charles Rhyee:
And the fact that PBM seems to have lost the narrative here and the message. What do you think they can do to reverse that?

Ronald Fox:
Well, let's talk about why we think that is. First of all, as a business to business play, they don't advertise. Most consumers don't know they exist until the plan sponsor chooses the health plan who chooses the PBM. And then they get something in the mail and they get an ID card. Until that time they don't know. And they still don't most cases fully understand that.
So there is no retail component to it from a retail consumer perspective. But what does happen is there's a retail pharmacy in every member's backyard. There are congressional leaders who have retail pharmacies in their districts. They have lots of members in their districts, and they're trying to keep all of those people happy while they only have one PBM that's probably not in their district. And if they were to start pointing fingers, placing blame, they can go after the big monopolistic industry dog that's not in their district and appease district participants.
So I think that's why there's so much anti-PBM rhetoric out there right now. One, they're an easy target. Two, you got to blame somebody out there. The drug manufacturers blame the PBMs, the PBMs blame the manufacturers. The plan sponsors are ultimately responsible for all this, but they're the ones that are throwing the spears in many cases. So I think that's, Charles, where the challenge is, is monopolistic tendencies with various stakeholders and constituents being supported at the congressional level and the PBMs are simply the scapegoat because the congressional leaders can support and satisfy a lot of stakeholders while taking on very few.

Charles Rhyee:
I know you've used the word monopolistic tendencies a couple of times, but I think maybe to be clear here, we're talking about still a fairly competitive market, wouldn't you say? You recently saw big contracts moving. I think Centene for example, a very large contract, changed hands recently. When you see that kind of movement, and then we talked earlier about from a financial perspective, the margin characteristics of the various service industries, does that suggest to you that there's still a pretty competitive environment?

Ronald Fox:
It is, and I appreciate you clarifying that. I do not mean to indicate there are monopolies. That's not my role. That's why I say tendencies. You do have 70% of the industry controlled by four players, 80% by three. When you go to rebates, it's 95% of rebates are controlled by three players. And so that gets pretty close to that and that's a lot of the criticism, is it's too much power and too few hands certainly underscored by the FTC and their interim report. But the PBMs will be the first to point out lots of competition, first among themselves, and then certainly among a number of industry players out there as well. There are multiple independent PBMs that operate in various ways. Some of them are pure transparent, which means that they don't charge a spread for anything that they do. There are others that do charge a spread but aren't owned by anybody in the health plan space, anybody in the retail space, any of the drug manufacturers. They're truly independent.
So there certainly are options out there. And to your point, we've seen some very large plan sponsor clients, both health plans as well as employers, who've moved to some of these new, I'll call them startup innovator, disruptor PBMs. So that model is out there for plan sponsors to choose if they see fit. There are also other industry participants that aren't PBMs but are giving PBMs a challenge and those would be organizations that do direct mail order services like an Amazon or a Mark Cuban Cost Plus and others. So to answer your question, there's a competition in this industry, but when you boil it all down, there is still a lot of concentration in the hands of very few.

Charles Rhyee:
And necessarily that creates a lot of the controversies. And we've talked a lot about it today. When we think about, though, the value that's being created, it's fair to say there's still value being created by the PBM model today? And if so, what are the key ones that if we were going to envision what this model looks like in the future, should be capped, I guess to start? And then maybe one of the aspects you would say should be probably re-envisioned or remodeled.

Ronald Fox:
Yeah, you bet. I guess the best way I could answer that, Charles, would be to say if this model didn't work, absent all the criticism and concern with the model, plan sponsors are still contract with PBMs. If they had an alternative, they would certainly choose it. And we just talked about some alternatives they have and they've chosen those but at a relatively small percentage. If the PBM industry should go away tomorrow, something would have to likely fill that void because I think a typical PBM when they complete all their analysis, that if a plan sponsor didn't have a discount on its retail pharmacy, add 20 to 25% to the cost of the drugs.
If the branded drugs weren't getting rebated, add 25 to 50%. I just told you $223 billion industry, 55% of all costs would go up. If the PBM industry didn't exist and you didn't have electronic adjudication, you'd have safety, drug-drug interaction, other potential negative side effects and so forth that wouldn't exist that do under the PBM model.
Absent the PBM, you wouldn't have reporting and data analytics to be able to look at high utilizers, no utilizers and how you would best create a plan for the benefit of the membership. So I do think they play a critical role. I do think that in pure absence of the PBMs, if something else didn't fill the void, the manufacturers would increase their prices, the retail pharmacies would increase their prices, and therefore I think the plan sponsor would experience even at higher costs. I think that answers your question that just because the plan sponsors, at the end of the day, they'll complain, but they do vote with their feet. And heretofore, we've seen them always contract with a PBM in one way, shape or form, whether it's a major three or a disruptor or innovator. But they do see value and they don't see really another alternative.

Charles Rhyee:
I think a lot of the concerns come from really high-cost drugs, like specialty in particular, which is the bulk, a large percentage of drug spent today, but an even smaller percent of prescriptions. Is there a way to break apart drug spend into more separate categories and contract separately models for folks? Is that one way when you contract with PBMs? I'm just thinking as we look to the future, how does this industry adapt or what changes can be made? So maybe something along that line. Or do you think maybe we need a faster progress on biosimilar interchangeability to drive down costs? Because certainly when we look at the growth in specialty particularly, it does not look like we're looking at a world where overall spend is going to moderate, at least not in the near to medium term.

Ronald Fox:
Yeah, well, I think that's the crux of all the congressional action right now. There are three senate bills or two house bills. There was a recent congressional hearing from an oversight committee, there's FTC action as we know, there are state AG action. So everybody is concerned with this model, and they all try to get the same things. It's steering patients to their affiliated pharmacies. It's spread pricing, it's too much rebate keep. It's all of these things we've been talking about today.
And I think that all these stakeholders want to see change there, and they'd like to see it happen to be more transparent, to be more fair to, they believe, bring down costs. And they believe to have better transparency for the plan sponsors and the individual member. At the end of the day, certainly most of these organizations are concerned about the individual member, and it's absolutely clear that the member is confused and, for all the reasons we talked about today, is the one who usually ends up holding the bag here.
So I would say that, yeah, there's plenty of criticism and blame to go around in a model that, as I said earlier, there's value created for sure. It's how fair is it and who ends up paying for that value? Where is it created and how is it dispersed? I would say that the future state, if these organizations, congressional, state, agency and so forth, are successful in what they're trying to get to, I would envision a future state maybe looks more like the health plan industry.
Health plans, if you think about it, they don't inventory direct services usually and to disperse them on their own though. There's been acquisition of doctor practices. At the end of the day, the health plan industry is not making spread on their business. They pass their discount a 100% back to their plan sponsors. They charge a PMPM or a PEPM, per member, per month, per employee, per month fee, and they do all their services for that fee. And it's completely transparent and there's good reporting, good analytics, and the system works. It's been around much, much longer than pharmacy has.
So if I had a crystal ball and had to forecast the future state, if regulation should happen on a federal level anywhere to what's contemplated today or FTC or other action should become a reality, I would think we'd start getting closer to what we see in the health plan industry, which is still a very healthy industry. It's concentrated not nearly as much as PBMs, but I mentioned earlier they're all enjoying a four to 5% margin, which is right in line with PBMs. They're successful in the regulated space just like PBMs. Maybe not so much recently given some of the changes in the MA and the Medicaid's reimbursements, but still that would be maybe the model I would look to, to perhaps come to fruition in the event that there is substantial regulatory change in one way, shape, or form, that affects the way that PBM's business model operates prospectively.

Charles Rhyee:
Isn't what you're mentioning a PEPM or a PMPM model, isn't that effectively what a full pass through model looks like for other PBMs or is that priced differently?

Ronald Fox:
No, it's exactly what that is. It's where they just price it out. What's different for the major PBMs is they do own the rebate GPOs, where the independent transparent PBMs don't. They do own specialty and mail order pharmacies where the independent and transparent PBMs don't. So they do own part of the distribution supply chain. And again, if the regulatory organization should be successful, they would no longer allow steerage to those affiliates. They would no longer allow retention of dollars to those affiliates. And I think over time, you may wonder is an affiliate relationship make sense for the PBM if they can't get what the FTC says is out-sized benefits as a result of those affiliations?

Charles Rhyee:
Yeah, that'll be interesting to see. And so we could see a real reversal in some of the corporate strategies of some of these companies then if that model goes that way. But I say that, but you just mentioned before you look at the big managed care organizations and it would almost seem like they are really moving forward more with acquiring service businesses to deliver services as well.

Ronald Fox:
Yeah, they are. And I don't know if they consider that very successful if you looked at some of the recent earnings reports and some of that, but that all ebbs and flows over time. But you're right, they're the same way. They're trying to say, "How can I grow my margin? How can I grow my share? How can I continue to grow my revenue in a frankly zero-sum game?"
And so that's what they're trying to do. And maybe in that case, they're taking a low page out of the PBM models. But I do think it's really going to come down to the success of the regulators and the plan sponsor clients who are equally critical, but also, as I said earlier, vote with their feet. And I think it's very hard to say what's going to happen. I will say that near term, I think very little happens. It's going to just be over the longer period of time. The midterm and longer term would be the effected change if we see any coming out from any of the controversy and any of the actions to date.

Charles Rhyee:
I think we'll end it there. Ron, really, really helpful in your insights here and helping, I think, people understand the role PBMs play, but all the different factors that go into that and the role of the various stakeholders. Really appreciate you being with us today and to share your thoughts. Thanks everyone for tuning into this episode and look forward to having you join us on future episodes of the TD Cowen Future Health Podcast.

Speaker 1:
Thanks for joining us. Stay tuned for the next episode of TD Cowen Insights.

This podcast should not be copied, distributed, published or reproduced, in whole or in part. The information contained in this recording was obtained from publicly available sources, has not been independently verified by TD Securities, may not be current, and TD Securities has no obligation to provide any updates or changes. All price references and market forecasts are as of the date of recording. The views and opinions expressed in this podcast are not necessarily those of TD Securities and may differ from the views and opinions of other departments or divisions of TD Securities and its affiliates. TD Securities is not providing any financial, economic, legal, accounting, or tax advice or recommendations in this podcast. The information contained in this podcast does not constitute investment advice or an offer to buy or sell securities or any other product and should not be relied upon to evaluate any potential transaction. Neither TD Securities nor any of its affiliates makes any representation or warranty, express or implied, as to the accuracy or completeness of the statements or any information contained in this podcast and any liability therefore (including in respect of direct, indirect or consequential loss or damage) is expressly disclaimed.