Trading Pain for Gain: Addressing Misaligned Interests in Prescription Drug Benefit Administration

Sheva J. Sanders* & Jessica C. Wheeler** August, 2022

Abstract

Over the last two decades, Pharmacy Benefit Managers (PBMs), organizations that act as middlemen between health plans and drug manufacturers, have become increasingly powerful players in the healthcare industry. PBMs promise to leverage their expertise and ability to aggregate buying power to negotiate lower drug prices and administer prescription drug benefit plans. In practice, however, PBMs are widely criticized for benefitting from, and contributing to, inefficiencies in the prescription drug market, particularly by imposing restrictions on beneficiary access to drugs in exchange for rebates paid to PBMs by manufacturers. To the extent that the rebates are retained by PBMs, or otherwise do not result in a benefit to the beneficiaries, this practice amounts to trading the pain of plan beneficiaries for the PBM’s own gain. Despite this criticism, regulatory and enforcement efforts directed against PBMs have been anemic.

Existing structural and legal protections for beneficiaries are largely ineffectual. While this problem is widely acknowledged, regulators have failed to pass new laws that successfully address the challenges posed by the insertion of PBMs as middlemen into the web of prescription drug benefits and reimbursement. Regulators express frustration with the complexity of balancing the interests of beneficiaries with PBMs’ aspirational goal of cost-control, as well as with addressing the inherent conflict of interest in PBMs’ competing goals of profitability for themselves and cost containment for their clients. Lawsuits alleging PBM mistreatment of beneficiaries are sparse, and a consistent vision of what is and is not permissible to PBMs has not emerged from the case law.

But the Federal Anti-Kickback Statute can—and there are indications that it increasingly will—be used to regulate manufacturer-PBM rebate arrangements. The U.S. Department of Justice recently settled a case predicated on an allegation that a pharmaceutical manufacturer, Roche, violated the Federal Anti-Kickback Statute when it paid a health insurance company, Humana, a kickback of lump sum debt forgiveness for formulary placement, conditioned on the exclusion of a competitor. Also, the federal government recently adopted a rule applicable to Medicare Part D plans that radically reconfigures the existing incentives by prohibiting manufacturers from extending rebates other than at the point of sale, and from making the rebates contingent on the plans or PBMs taking various steps with respect to encouragement of use of the drugs. These developments likely presage increased use of the Anti-Kickback Statute to attack rebating arrangements and underscore the need for PBMs to reevaluate their current practices with respect to their relationships with manufacturers to ensure that they are complying with the law.

In this Article, we argue that the Federal Anti-Kickback Statute and its state law analogs, state anti-kickback statutes, can be used to effectively protect beneficiary interests against manufacturer-purchased, PBM-imposed restrictions on access to drugs. We also identify key issues that may be hampering effective enforcement, and suggest an analysis that effectively addresses these issues. We demonstrate that current law is best understood to allow manufacturers to extend discounts and rebates to plans (either directly or through PBMs) but not to PBMs, and that those rebates cannot make those payments contingent on PBMs or plans adopting specific preferences for drugs. By embracing these principles, PBMs can protect beneficiary interests, achieve enforcement certainty, and perhaps ward off the ultimate adoption of more radical restrictions.

Introduction

Over the last two decades, Pharmacy Benefit Managers (PBMs) have become increasingly prominent and powerful players in the healthcare industry.¹ PBMs contract with health benefit plans to administer pharmacy benefits,² interposing themselves as middlemen between their client plans and drug manufacturers. PBMs promise to leverage their expertise and ability to aggregate buying power on behalf of health plans to negotiate lower drug prices, and administer prescription drug benefit plans.³ In practice, however, PBMs are widely criticized for benefitting from, and contributing to, inefficiencies in the prescription drug market by using that purchasing power to obtain payments from manufacturers that they retain for their own account, rather than pass through to plans and the individuals who receive benefits under the plans (beneficiaries). Despite this criticism, regulatory and enforcement efforts directed against PBMs have been anemic. Confounded regulators have attempted and failed to pass new laws that successfully address the challenges posed by the insertion of PBMs into the web of prescription drug benefits and reimbursement, expressing frustration with the complexity of balancing the interests of beneficiaries with PBMs’ aspirational goal of cost-control. Lawsuits alleging PBM mistreatment of beneficiaries are rare, and a consistent vision of what is and is not permissible to PBMs has not emerged from the case law.

There are indications that the enforcement landscape is changing. The U.S. Department of Justice recently settled a case which alleged that pharmaceutical manufacturer Roche violated the Federal Anti-Kickback Statute (AKS) when it paid a health insurance company, Humana, a kickback of lump sum debt forgiveness for formulary placement, conditioned on the exclusion of competitors.⁴ Also, the Department of Health and Human Services (HHS) recently adopted a rule amending the discount safe harbor to the AKS with respect to the safe harbor’s application to drugs covered under Medicare Part D plans (the New Rule). The New Rule radically reconfigures existing incentives by (via the denial of safe-harbor treatment⁵) prohibiting manufacturers from extending rebates except at the point-of-service (to ensure that the rebate results in a discount in the drug price that plans and beneficiaries pay) and from making those rebates contingent on either PBMs or plans taking certain actions to promote the drugs.⁶ These developments suggest the AKS is useful for addressing the harms wrought on beneficiaries by runaway PBM self-interest, and underscore the necessity for PBMs to reevaluate their current practices to ensure that they are in accord with the law.

Since 2014, prescription drug prices in the United States have increased by thirty-three percent, compared to an increase of seventeen percent across prices for all medical items and services.⁷ The meteoric rise of prescription drug costs⁸ has prompted increasingly creative efforts by many, including managed care plans,⁹ to control drug spending.¹⁰ One method managed care plans have used to lower the cost of covered pharmaceuticals is to hire PBMs to negotiate rebate arrangements with manufacturers.¹¹ The manufacturer offers to return a portion of the drug’s purchase price if certain conditions, such as “if the total number of prescriptions dispensed, relative to other medicines in the therapeutic class, exceeds a predetermined threshold”¹² or conferring preferential access to the manufacturer’s drugs, are fulfilled.¹³

The main tool that PBMs use to negotiate and earn rebates is the prescription drug formulary, which is a list of drugs that the plan covers along with the conditions under which coverage is available.¹⁴ By erecting and removing barriers to access to particular drugs—such as copayments, prior authorization, and step-therapy—formularies can be used to prefer or disadvantage particular drugs. Making rebates contingent on the achievement of sales volume targets incentivizes PBMs not only to include the drug on formulary, but also to design the formulary to steer patients toward drugs that are subject to the biggest volume rebate.¹⁵ In some cases, the arrangements are more pointed: instead of conditioning rebates merely on attaining volume targets, pharmaceutical manufacturers may also condition discounts and rebates specifically on PBMs giving their drugs preferential formulary status vis-à-vis non-drug alternatives, or on imposing access restrictions on competitor drugs.¹⁶ Accordingly, whether implicitly incentivized or explicitly required, rebates often come at the cost of utilization controls that restrict beneficiary access to competitor drugs. PBMs justify such restrictions on access as necessary to give them the negotiating leverage that makes them valuable to plans and beneficiaries, maintaining that PBMs make trades and strike agreements with pharmaceutical manufacturers in order to design a formulary that reduces prescription drug costs on the whole.¹⁷

The use of a formulary imposes costs on beneficiaries which might include barriers to access to competitive drugs, inconvenience, limited coverage, poorer clinical outcomes, and higher out-of-pocket prices for drugs, copayments, and premiums. To the extent that these costs are offset by a corresponding reduction in price in the preferred drug that is realized by the beneficiary either as a point-of-sale discount or through a reduction in premium cost, the costs may be seen as a fair trade. But when manufacturers adjust drug prices by offering rebates, rather than simply discounting the list price of the drugs, they create an opportunity for PBMs to siphon off, and retain for their own account, a portion of the negotiated “savings.”¹⁸ More fundamentally, rebates incentivize the PBM to prefer the drug with the highest rebate rather than the lowest price.¹⁹ In many instances, the PBM may not even disclose the rebates to its client-plans, let alone the plans’ beneficiaries.²⁰ For beneficiaries, the net result of this scheme can be restricted access to therapies that they may prefer (either because of convenience, cost, or clinical efficacy), with no offsetting decrease in overall out-of-pocket costs.²¹ Because of this dynamic, it is widely acknowledged that rebate arrangements with PBMs have the potential to harm beneficiaries in a manner that standard, up-front discount arrangements do not.²²

When the financial benefits from trading access restrictions for price concessions accrue only to the PBMs, beneficiary interests are harmed, and more broadly, the primary goal of managed care—providing appropriate medical care in an economically efficient manner²³—is undermined. Accordingly, PBMs’ practice of retaining the financial benefits of their buying power for themselves has spawned many efforts at reform.²⁴ In the main, however, these efforts have been either piecemeal or unsuccessful.²⁵ In this Article, we outline how well-established norms and laws, if better understood and observed, are already adequate to restrain, if not foreclose, the practice of trading access restrictions for rebates that are not passed through to beneficiaries.

In Part I, we examine the harm to beneficiaries caused by a system that allows PBMs to profit from formulary placement decisions that are clinically, financially, or otherwise detrimental to beneficiaries. We observe that PBMs often do not pass through to beneficiaries (either in the form of reduced premiums or reduced cost-sharing payments) the rebates manufacturers pay PBMs in exchange for formulary placement and restrictions on competitor products. The result of this arrangement, we argue, is that the PBM and the pharmaceutical manufacturer benefit at the expense of the beneficiaries whom PBMs are intended to serve.

In Part II, we take a closer look at the formulary design process, arguing that without regulation, would-be protections that are built into the PBM structure have been rendered ineffective by the extreme misalignment of interests between PBMs and beneficiaries. Focusing on the role of Pharmacy and Therapeutic (P&T) committees in protecting the interests of patients, we argue that the current system—in which P&T committee input is largely restricted to an assessment of therapeutic utility without due regard to beneficiary costs, and often motivated by regard for PBM profits—does not permit P&T committees to fully realize their role and obligations. We observe that, so long as formulary placement is ultimately determined by PBMs, and PBMs are motivated to maximize their own profit, the presence of a P&T committee alone will not be sufficient to protect beneficiary interests.

In Part III, we examine the AKS and by analogy, state anti-kickback laws²⁶ to demonstrate that, properly understood, those laws protect against the precise harm posed by pay-for-placement arrangements between pharmaceutical manufacturers and PBMs. We explain that, in the context of government health programs, payments made directly to PBMs for inclusion of a drug on a formulary violate the AKS’s prohibition against paying for preferential treatment of a covered item. In the case of commercial or other non-governmental plans, such arrangements may implicate similar prohibitions contained in state anti-kickback laws. By limiting the ability of pharmaceutical manufacturers to pay for formulary access or to otherwise influence formulary design, the AKS and similar state laws can make it more likely that P&T committee recommendations will be observed and more likely that the price repremductions will either be reflected at the point-of-service or result in premium reductions.

In Part IV, we argue that by embracing what we understand to be extant law—that manufacturers may extend discounts and rebates only to plans, and even then, cannot make those payments contingent on according specific preferences to drugs—PBMs can honor these important public policy goals, achieve enforcement certainty, and perhaps ward off the ultimate adoption of more radical restrictions.

I. The Problem: Formulary Access Restrictions May Not Save Plans or Beneficiaries Money

Drug formularies—lists of covered drugs, from which some drugs are excluded entirely, and which impose conditions restricting access to some drugs—have long been viewed as a tool plans use to reduce drug costs. In theory, the lower costs associated with the formulary reduce beneficiary premiums and copayments. Beneficiaries are asked to tolerate utilization controls imposed by formularies because they will benefit from the reduced cost of healthcare. This bargain can be fulfilled only if the restrictions are traded for price concessions that are passed through to plans and ultimately to beneficiaries. Where the restrictions are instead traded for payments to PBMs, it is a false bargain.

A. Managed Care Plans Use Access Restrictions to Constrain
Utilization and Reduce Costs

Health insurers have long struggled with balancing the competing imperatives of ensuring access to care and controlling the cost of providing that care to beneficiaries. As the cost of care has grown, the concept of managed care—a mechanism through which insurance and other managed care plans, such as health maintenance organizations (HMOs),²⁷ control utilization by imposing restrictions on what providers and therapies can be used and under what circumstances—has emerged as a key tool for controlling the cost of healthcare. A central premise of managed care is that access restrictions, such as prior authorization requirements, step-therapy, and beneficiary cost-sharing, can eliminate unnecessary costs.²⁸ Managed care plans apply these utilization controls to drugs using a list of drugs that the plan covers, known as a “formulary.”²⁹ The development of the formulary is typically contracted out to a PBM as part of the administrative services the PBM provides to the plan.³⁰ Drugs that are excluded from the formulary are not covered by insurance,³¹ meaning that a beneficiary may be responsible for paying the full costs of such drugs.³² Coverage for drugs included on the formulary is variable.³³ Drugs that are included on the formulary are grouped into tiers.³⁴ Each tier is associated with certain access restrictions.³⁵ The restrictions become less stringent as one progresses toward the most preferred tier, thereby incentivizing the use of drugs in the preferred tier.³⁶ For example, a drug on a higher (preferred) tier may be fully covered, with only a minimal co-pay and no access restrictions. A drug on a lower tier may be subject to a larger co-pay, prior-authorization requirements, or step-therapy requirements (i.e., the requirement that other therapies be tried before the beneficiary’s desired therapy is covered). For example, excerpts from United Healthcare’s 2021 Drug List illustrate the tiers it utilizes (Figure 1) and the access restrictions it imposes on various drugs (Figure 2):³⁷

Figure 1. Tier Information

Drug Tier		Includes	Helpful Tips
Tier 1	$	Lower-cost Medications that provide the highest overall value. Mostly generic drugs. Some brand-name drugs may also be included.	Use Tier 1 drugs for the lowest out-of-pocket costs.
Tier 2	$$	Mid-range cost Medications that provide good overall value. Mainly preferred brand-name drugs.	Use Tier 2 drugs, instead of Tier 3, to help reduce your out-of-pocket costs.
Tier 3	$$$	Highest-cost Medications that provide the lowest overall value.	Ask your doctor if a Tier 1 or Tier 2 option could work for you.

Using lower-tier medications can help you pay your lowest out-of-pocket cost. Your plan may have multiple or no tiers. Please note: If you have a high deductible plan, the tier cost levels may apply once you hit your deductible.

In Figure 2, overall value indicates medications’ effectiveness and safety, cost, and the availability of alternative medications to treat the same or similar medical condition(s).

Figure 2. Partial Drug List & Key to Conditions

E	May be excluded from coverage or subject to Prior Authorization in Connecticut, New Jersey and New York. (Referred to as First Start in New Jersey.) – Lower-cost options are available and covered.
H	Health Care Reform Preventative – This medication is part of a health care reform preventative benefit and may be available at no additional cost to you.
H-PA	Health Care Reform Preventative with Prior Authorization – May be part of health care reform preventative and available at no additional cost to you if prior authorization criteria met.
PA	Prior Authorization (sometimes referred to as precertification) – Requires your doctor to provide information about why you are taking a medication to determine how it may be covered by your plan.
QL	Quantity Limits – Specifies the largest quantity of medication covered per copayment or in a defined period of time.
RS	Refill and Save Program – Save money on your copayment when you refill your prescription on time as prescribed. Program eligibility may vary.
SP	Special Medication – Specialty medications treat complex or rare conditions and may require special storage and handling. You may be required to obtain these medications from a specialty pharmacy.
ST	Step Therapy (referred to as First Start in New Jersey) – Requires prior authorization and may require you to try one or more other medications before the medication you are requesting may be covered.

Drug Name	Drug Tier	Requirements & Limits
Analgesics – Drugs for Pain
acetaminophen-codeine	1
apap-caff-dihydrocodeine	1	QL
BELBUCA	3	PA, QL
DILAUDID ORAL	3
DURAGESIC-100	E	PA, ST, QL
fentanyl transdermal patch 72 hour 100 mcg/hr, 12 mcg/hr, 25 mcg/hr, 50 mcg/hr, 75 mcg/hr	1	PA, QL
fentanyl transdermal patch 72 hour 37.5 mcg/hr, 62.5 mcg/hr, 87.5 mcg/hr	E	PA, ST, QL
hydrocodone-acetaminophen oral tablet 10-300 mg, 5-300 mg, 7.5-300 mg	E
hydrocodone-acetaminophen oral tablet 10-325 mg, 5-325 mg, 7.5-325 mg	1
hydromorphone hcl er	1	PA, ST, QL
hydromorphone hcl oral	1
hydromorphone hcl rectal	1
HYSINGLA ER	E	PA, ST, QL

The use of a formulary tiering system gives certain drugs preferential treatment, thereby incentivizing patients to choose cost-saving alternatives. Formularies also create another cost-savings opportunity: the opportunity for price negotiation with pharmaceutical manufacturers.³⁸ Formulary design is PBMs’ primary source of leverage to secure discounts and rebates. The threat of access restrictions on even a single blockbuster product creates significant leverage for a PBM to negotiate price concessions, which may relate to that drug or may span any portion of a pharmaceutical manufacturer’s portfolio of drugs.³⁹ PBMs can use several formulary-related tools to negotiate price concessions. These tools have different impacts on formulary design and different implications for beneficiaries.

For example, in exchange for price concessions, PBMs may simply offer the manufacturer access to the formulary, which will result in coverage of the drug once the formulary is adopted by the PBM’s client-plan. The PBM may go further and agree to specific formulary placement—that is, to place a given drug on a higher tier than competitor products, such that competitor drugs will be subject to more onerous access restrictions. In either case, price concessions are often made dependent on the achievement of purchase-volume targets for specific drugs.

B. By Creating Coverage Barriers, Formularies Place Burdens on Beneficiaries

The primary goals of medicine are to alleviate morbidity and mortality by providing patients with medically necessary care. Managed care introduces another goal—cost containment, which it pursues primarily through the use of utilization controls, such as copayments, prior authorization requirements, and drug formularies that make some drugs less accessible than others.⁴⁰ As with other utilization control measures, formulary-imposed access restrictions on prescription drugs are undeniably in tension with the provision of good care because they inject financial considerations into what would otherwise be a decision informed only by the best approach to treatment.⁴¹

To contain costs, most, if not all, formularies exclude some drugs, such as “lifestyle drugs” (e.g., those for weight loss or sexual enhancement) entirely,⁴² making the excluded drugs available only if the beneficiary pays for them out-of-pocket or has supplemental coverage. Aside from simple coverage or non-coverage of drugs, formularies also establish tiers, as described above, of preferred and non-preferred covered drugs, each with a different set of access restrictions.⁴³ The less preferred the tier, the more intense the access restrictions and, hence, the potential for the greatest beneficiary burden. These burdens can range from inconvenience (e.g., having to wait for a drug to be mailed from a specialty pharmacy rather than picking it up at the local drug store or having to wait a few days for prior-authorization to clear) to significant detriment (e.g., raising out-of-pocket costs to the point that a medically necessary drug is effectively out of reach).

By way of example, we will consider three major burdens commonly imposed as part of formulary design: (1) increased cost-sharing obligations; (2) step therapy requirements; and (3) restrictions on access to alternative therapies. All of these burdens must be recognized as carrying the potential for real harm to beneficiaries in any analysis that seeks to ensure that beneficiaries’ interests are protected.

In connection with this discussion, we make several public policy-based distinctions that are essential to understanding the extant law. We call price concessions that are offered merely to incentivize coverage, “payments for access.” On the other hand, “payments for placement” are price concessions contingent on (a) the placement of the drug in a particular tier, (b) the exclusion or restriction of competitor drugs, or (c) other elements of formulary design. Payments for access create an impetus for formulary inclusion and perhaps even preferential treatment over competitors, but still allow discretion in formulary design. Payments for placement, on the other hand, require that a given drug be given preferential treatment vis-à-vis competitor products. As such, payments for placement usurp discretion by dictating formulary design and, as we discuss, have the potential to result in higher costs for beneficiaries by making competitor products harder to access.

We also distinguish between pre-sale discounts and post-sale rebates. Because pre-sale discounts, by their very nature, reduce the list price of the drug, the financial benefits of discounts are capable of being, and often are, passed through to beneficiaries in the form of reduced out-of-pocket costs (via reduced copayments or, if the beneficiary is in the deductible phase of their policy, via reduced costs) at the point of sale and, potentially, through reduced premiums from plans who spend less money on drugs.⁴⁴ By contrast, post-sale rebates do not reduce the list price of the drug, so financial benefits may not be realized by the PBM until months after the point of sale, and may never be realized at all by plans. As a result, it is not necessarily true that the value of rebates will be passed through to beneficiaries. Our analysis focuses, therefore, on these rebate arrangements.

1. Increased Cost-Sharing Obligations

Lower-tier drugs may be subject to substantially higher cost-sharing obligations than preferred drugs. It is not uncommon for cost-sharing obligations to be so high that the drugs are effectively non-covered, especially with respect to expensive specialty medications⁴⁵ of which plans want to discourage use. As a result, the high cost of the drugs puts them out of reach of some beneficiaries.⁴⁶ Indeed, if the intended effect of higher cost-sharing obligations is to create an economic incentive that steers patients away from formulary-non-preferred therapies, to be successful such obligations would have to be substantial enough to materially affect patient decision-making. High cost-sharing obligations may, therefore, result not only in a choice to use a formulary-non-preferred drug, but also in a decision to forgo therapy.⁴⁷

2. Step Therapy Requirements

Step therapy requires that beneficiaries try formulary-preferred medications before a non-preferred medication will be covered.⁴⁸ Step therapy regimes may require a prolonged period (e.g., two years) of alternative therapy before a non-preferred therapy is covered.⁴⁹ The cost of step therapy for beneficiaries is more than nuisance or delay. In addition to the costs associated with more doctor’s appointments,⁵⁰ step therapy may increase out-of-pocket costs for beneficiaries by requiring that beneficiaries pay for months (or even years) of additional, less effective therapies before they can access a therapy that works. Moreover, step therapy may delay access to effective therapy until it is too late, allowing health conditions to worsen, sometimes irreversibly, during the course of the less effective alternative therapies.⁵¹ Because many people switch insurance plans from year to year, step therapy may also effectively keep patients from ever accessing effective therapies. A patient who is subject to two years of step therapy may, for example, switch insurance plans one-and-a-half years into step therapy. The patient may have to start step therapy from scratch with the new insurer, or face the substantial administrative burden of collecting paperwork and proving to the new plan that step therapy has been underway.⁵² Even where beneficiaries stay on the same insurance plan, the requirement that the beneficiary fail treatment on a preferred drug to gain coverage for a nonpreferred drug may be triggered not only at the onset of therapy, but every year, as drugs cycle on and off the formulary. For example, a patient may be successfully using one asthma inhalant, but if that inhalant is moved to a non-preferred tier, the patient may be required to fail a trial of the preferred drug before again becoming eligible for coverage of the original inhalant.

3. Restrictions on Access to Therapeutic Alternatives

Where two or more drugs are therapeutically equivalent, it is not uncommon for one drug to be on-formulary or preferred, while alternatives are not covered⁵³ or are placed on lower tiers. In its most straightforward form, this occurs when a generic drug is cheaper than a branded drug. The PBM may include the generic drug on-formulary, while excluding or placing at a lower tier the branded drug, therefore incentivizing patients to choose the generic drug. This dynamic gets distorted, however, when the PBM can profit from preferring the higher-cost brand drug. For example, manufacturers may offer the PBM a lucrative rebate or other payment for placement to induce inclusion of the more expensive drug in a higher tier; or, the PBM may also profit when negotiations between the PBM and manufacturer occur across a manufacturer’s entire portfolio of products.⁵⁴ In such a scenario, the PBM may agree to place access restrictions on (or not even cover) lower cost alternatives to a competitor drug in order to secure discounts, rebates, or other concessions on the expensive drug or on other drugs in the manufacturer’s portfolio.

Unequal treatment of therapeutically-equivalent drugs on formularies has several implications for beneficiaries. Where a pharmacy only stocks one alternative, for example, a beneficiary may find that her local pharmacy does not stock the drug covered. Normally, a pharmacy would simply work with the beneficiary’s healthcare provider to substitute the equivalent medication that is in stock. But if the stocked medication is off-formulary or subject to access restrictions, the formulary may prevent the pharmacy from doing so without significant cost to the beneficiary. Such a scenario may cause the patient inconvenience and delay in obtaining therapy at a time when the patient is under considerable illness-induced stress.

The exclusion of drugs from a formulary when there is no therapeutically-equivalent drug is more clearly problematic as it has the potential to stop patients from receiving a therapeutically beneficial drug. For example, formularies may exclude an expensive drug such as sofosbuvir for hepatitis C because it sells for about $1,000 per tablet.⁵⁵ Patients will be harmed by this exclusion if there is no drug with similar efficacy included in the formulary; or if, as compared to excluded drugs, included drugs have more profound side effects; or if the regime is longer or the drug more difficult to administer.⁵⁶

Tiering can be designed to encourage utilization of lower-priced alternatives (e.g., generics vs. brands), as well as to discourage the use of higher priced drugs even where there is no alternative available.⁵⁷ Where tiering is deployed, access restrictions such as onerous prior-authorization requirements, step-therapy, and high copayments may put the most effective therapy out of reach for many beneficiaries, leaving beneficiaries with only second-best therapeutic options.

Access restrictions often result in the exclusion of competitors who could offer a cheaper price to patients, and these restrictions may also lead to increased beneficiary costs.⁵⁸ A common example of this phenomenon occurs when preferential treatment is given to brand-name drugs. In such cases, patients may not have access to a cheaper generic or biosimilar drug because only the brand drug is covered. Where patients have cost-sharing obligations such as copayments and deductibles, restricted access to generic and biosimilar drugs may substantially increase beneficiary out-of-pocket costs—for preferential treatment of a drug that is therapeutically indistinguishable from its generic competitors. As one commentator notes, discussing insulin:

Studies have revealed that pharmaceutical companies give pharmacy benefits managers (PBMs) volume-based rebases [sic] in exchange for keeping competing generic/biosimilar competitors off the formulary. A study found that only 17 percent of Medicare plans for seniors covered Basaglar, a biosimilar drug, although nearly all plans covered Sanofi’s more expensive biologic drug Lantus (Basaglar’s originator).⁵⁹

Another study found that only nineteen percent of generic drugs covered by Medicare Part D were in formulary tiers that imposed the lowest out-of-pocket costs on beneficiaries.⁶⁰

Formulary restrictions on access to lower priced drugs is costly in another way: it may push Medicare Part D beneficiaries into a coverage “doughnut hole” between the maximum amount of standard drug coverage that a plan offers and the point at which catastrophic coverage kicks in. For Medicare Part D beneficiaries, drug benefits change once the plan has spent approximately $4,000 on a beneficiary in a given year.⁶¹ At that point, a new scheme begins, and the beneficiary is responsible for a higher proportion of the beneficiary’s prescription drug costs.⁶² This new coverage scheme, which is substantially more costly to the beneficiary, continues until the beneficiary has spent approximately $6,000 of their own money out-of-pocket.⁶³ At that point, catastrophic coverage kicks in.⁶⁴ Centers for Medicare and Medicaid Services (CMS) explained the impact of higher cost drugs on beneficiary out-of-pocket costs vis-à-vis the doughnut hole:

[T]he list prices also play an important role in a beneficiary’s progression through the different phases of the Part D benefit; higher list prices mean quicker progression through the benefit and higher overall costs in the catastrophic phase once the beneficiary reaches it. Rebates and other price concessions received after the point-of-sale do not mitigate these impacts.⁶⁵

Access restrictions that drive beneficiaries toward higher-priced drugs may increase costs for beneficiaries in a number of ways. Beneficiary copayments may increase, especially where copayment obligations are calculated as a percentage of a drug’s list price. Beneficiaries who have not yet met their deductible, moreover, may be responsible for the entire list price of the drug. A higher list price may also push beneficiaries into coverage doughnut holes where they have hit their standard coverage cap, but have not yet met the out-of-pocket amount necessary for catastrophic coverage to kick in.

In sum, as a part of negotiations with manufacturers, PBMs may agree to restrict access to more or equally effective therapies to secure price concessions that benefit the PBM and sometimes the plans they work for, but often not the beneficiaries who purchase the drugs. Access restrictions may operate to the clinical and financial detriment of patients who have been prescribed restricted drugs. There are, of course, at least some circumstances in which restricting access to competitive drugs may result in price reductions that are passed through to beneficiaries. As the next Section discusses, however, under certain circumstances, and especially in the context of rebates, payment-for-placement arrangements may operate exclusively to the detriment of beneficiaries.

C. Access Restrictions May Not Benefit Plan Members

Even though beneficiaries clearly bear the cost of access restrictions, they do not always benefit from them.⁶⁶ By aggregating the buying power of their client plans and using formulary design to concentrate purchasing volume, PBMs can extract deeper price concessions than can their clients acting independently.⁶⁷ As a district court recently explained:

[M]anufacturers contract with PBMs to pay “rebates”. . . directly attributable to the plan’s use of “preferred” formulary pharmaceuticals. . . . [R]ebates are owed, and directly paid, to the PBMs.

Oftentimes, PBMs develop proprietary formularies, irrespective of the plans with which they deal; in other cases, plans participate in selecting certain criteria or identifying specific drugs for inclusion (and/or exclusion). . . . Where the plan participates in a formulary program, PBMs are often paid an additional amount, e.g., a portion of market share rebates, for their performance of services related to encouraging pharmacies, physicians, and members to participate in and/or facilitate the same.⁶⁸

Because PBMs often retain a portion of rebates as payment for their services, PBMs have an incentive to maximize rebates.

A rebate is a partial refund of a purchase price, made after the sale of the subject item. As such, the rebates secured by PBMs are not reflected in a drug’s list price, but rather are paid retrospectively after the time of sale.⁶⁹ Therefore, rebates may not flow through to beneficiaries in the form of lower cost-sharing obligations. Indeed, CMS has observed that, while manufacturer payments to PBMs as a proportion of drug cost trended dramatically upwards during a recent five-year period, these payments have not resulted in a proportionate reduction in the price assessed at the point-of-service.⁷⁰ As beneficiary cost-sharing obligations are often assessed as a percentage of the point-of-service price, any reduction in drug cost that is not reflected at the point-of-service will not result in a reduction of the beneficiary’s cost-sharing obligation.⁷¹ Everson v. Blue Cross and Blue Shield of Ohio includes a discussion of how a discount or rebate may benefit a payor but not result in a reduction in copayments.⁷² The Everson plaintiff-beneficiaries alleged the defendant-group health plan had caused them

to make copayments in excess of the fixed percentage set forth in the group plan. Plaintiffs claim that the excess payments are the result of the allegedly undisclosed practice of defendant negotiating discounts with health care providers and failing to pass a proportionate share of such discounts on to its insureds. As a result, plaintiffs allege that defendant actually pays a percentage of the health care providers’ charges which is less than that specified by the terms of the plan. The insureds’ portion, on the other hand, is not discounted, but is still based on the total charges. Thus, the copayment paid by the insured is greater than that specified by the terms of the plan.⁷³

Even if rebates do not reduce drug prices at the point-of-service, one might expect that rebates would benefit plans and, ultimately, beneficiaries, in the form of lower premium costs. However, this is not always the case. PBMs do not usually pass rebates through in their entirety—or even at all—to plans, and plans do not always pass through any cost savings they do realize to beneficiaries.⁷⁴ All of this means that the PBM’s opportunity to profit from formulary design decisions, including attendant access restrictions, often does not correlate with benefits to beneficiaries in the form of reduced costs or improved access to care.

The incentives that rebate arrangements create for PBMs can be at odds with the incentives plans have to minimize plan costs, particularly when the rebate is a payment for placement. Rebate arrangements can result in higher costs, which in turn result in higher premiums and, even when they do not, can result in higher copayments⁷⁵ or other cost-sharing obligations for beneficiaries.⁷⁶

Rebates may also cause clinical or other benefits of competing drugs to be eclipsed in the formulary design process.⁷⁷ As a result, the PBM’s guiding light is not a careful consideration of healthcare and cost outcomes for beneficiaries, but rather the ultimate profitability to the PBM of the placement decision, which may be entirely divorced from (if not adverse to) beneficiary interests. The opportunity of a PBM to profit from limiting drug access is fundamentally at odds with patient clinical and economic wellbeing. When PBMs accept and retain rebates in lieu of pre-sale discounts or other price concessions that are passed through to beneficiaries, and when PBMs agree to lift utilization controls from one drug but then apply them to others in exchange for a payment for placement, the interests of PBMs, patients, and plans diverge. In this system, rather than acting in the interest of cost-containment through benefit administration, PBMs become rent-seeking, third-party intermediaries whose involvement is primarily one of economic friction—driving up costs for beneficiaries (in terms of dollars, time, or clinical outcome) so as to collect a reward merely for their presence in the pharmaceutical distribution and payment system.

II. Pharmacy & Therapeutic Committees Play a Limited Role in Protecting Beneficiary Interests

In theory, where the interests of PBMs and beneficiaries diverge, the interests of beneficiaries should be accounted for in the formulary design process through the use of P&T committees.⁷⁸ P&T committees are comprised of clinical professionals (such as physicians and pharmacists) and other persons with expertise in healthcare, public health, and benefits design.⁷⁹ These committees are tasked with assessing available therapeutic options and advising on formulary design.⁸⁰ Because P&T committees are intended to serve as a check on self-interested decision-making by PBMs, they function with some amount of independence from the PBMs they advise.⁸¹ Indeed, in many contexts, P&T committees are required to have a certain number of members that are free of any conflict of interest that may cause them to prioritize PBM or plan preference over the interests of beneficiaries in receiving safe and effective therapy.⁸² P&T committee members who are clinical professionals, moreover, must act in a manner that is consistent with their status as licensed medical professionals, under rules that are dictated by state laws, state professional licensing boards, and non-government professional associations. These rules—which apply not only when such professionals are treating individual patients, but also any time such professionals act in their capacity as licensed clinical professionals⁸³—include standards that broadly require that physicians and pharmacists act only in the best interests of patients, making decisions free from conflict of interest or undue influence.⁸⁴

Despite the generally-accepted role of P&T committees, there is no standard approach to assuring that P&T committees engage in a robust cost-benefit analysis from a beneficiary’s perspective, meaning that the role of P&T committees has been mostly limited to advising on the comparative safety and therapeutic value of available drugs without consideration for the broader, pharmacoeconomic implications of formulary design.⁸⁵ In many cases, P&T committees are explicitly limited by their mandates to consider only the relative safety and efficacy of drugs.⁸⁶ Where P&T committee mandates instruct the P&T committee to conduct a more holistic, pharmacoeconomic analysis that accounts for costs to beneficiaries, the resulting analysis may be limited to simple comparisons of list price between therapeutic equivalents or may explicitly be made subordinate to considerations of cost to the plan.⁸⁷ More fundamentally, even if P&T committees function entirely independently of plan and PBM interests, fully accounting for beneficiary interests in their analysis, PBMs and plans are not bound by the recommendations of P&T committees; this means that PBMs and plans can and do simply disregard P&T committee recommendations that may increase PBM costs or decrease PBM revenues.⁸⁸

As an illustration of both how beneficiary costs may be overlooked and how PBM consideration of profitability infects formulary design, we take a brief look at the formulary design of Express Scripts, a PBM that services about a quarter of the market.⁸⁹ Express Scripts explains that it uses “a four-step process involving the work of three distinct committees.”⁹⁰

The first step is taken by the Therapeutic Assessment Committee, which is made up of PBM-employed clinical pharmacists and physicians, whose task is to evaluate new drugs and make a formulary placement recommendation to the P&T committee.⁹¹ It is unclear whether this committee considers the profitability of the drug for the PBM in making its recommendations, but it seems likely that it does, given the specific disclaimer of such considerations with respect to the National Pharmacy & Therapeutics Committee.

The second step is taken by the National Pharmacy & Therapeutics Committee (referred to by Express Scripts as the P&T Committee), which is made up of independent physicians and pharmacists.⁹² According to Express Scripts, at this stage:

The P&T Committee is tasked to review medications from a purely clinical perspective. The Committee does not have access to, nor does it consider, any information regarding Express Scripts’ rebates/negotiated discounts, or the net cost of the drug after application of all discounts. The Committee does not use price, in any way, to make formulary placement decisions. . . . The P&T Committee can establish one of the following four placement designations: include, access, optional, or exclude from a formulary.⁹³

The third step is taken by the Value Assessment Committee (VAC), which is made up of PBM-employees who consider the

net cost, market share, and drug utilization trends of clinically similar medications [to make formulary recommendations]. . . . [E]conomic considerations are superseded by the clinical requirements of the P&T Committee. Once complete, formulary and tier placement recommendations are then forwarded to the P&T Committee for final approval.⁹⁴

The VAC committee clearly injects economic considerations of the plan and PBM into the mix, with the caveat that they are to be “superseded by clinical requirements.”⁹⁵

The fourth and final step is taken by the National Pharmacy & Therapeutics Committee. At this juncture, this committee seems to perform a broad oversight function rather than engage in any significant independent analysis. The National Pharmacy & Therapeutics Committee’s mandate with respect to this last step is to annually “review the final formulary recommendations, by drug class, for the upcoming plan year. The Committee uses this opportunity to ensure adherence to previously established formulary placement recommendations, and to validate continued alignment with best medical practices.”⁹⁶

Notably, despite what would appear to be a robust, multi-layer review structure, none of the considerations mentioned at any stage are beneficiary costs or benefits, other than clinical safety and efficacy. To the extent that beneficiary interests supersede the PBM’s own financial considerations, it is only with respect to the P&T committee’s assessment of the clinical safety and efficacy of a drug. It would appear, therefore, that in practice the two-step consideration of clinical, then economic, effects, means that so long as the drug is clinically appropriate, the determining factor as to where it will be placed is economic and largely informed by the benefit (measured in terms of short-term profit) of the placement to the PBM, (and, perhaps to the plan), with little, if any, regard to the cost to patients or to the public.

When the Express Scripts formulary development process is taken as a whole, the minor effort to manage conflicts—segregation of cost considerations from clinical considerations—perversely renders the P&T committee unable to ensure that PBM cost data and recommendations are not infected by a conflict of interest or to ensure that beneficiary interests are appropriately taken into account. The result is a formulary design system in which the only limit on the PBM’s ability to trade beneficiary interests for profit is a requirement that the PBM not go so far as to wholly ignore the clinical assessments of the P&T committee. This limitation does little to protect against the strong incentives for PBMs to act in contravention of beneficiary interests in order to obtain payments for placement from pharmaceutical manufacturers.⁹⁷

Adding to this problem is that incentives that may have biased PBM decision-making are not transparent. As noted above, the P&T committee itself may be entirely unaware of how profit-related considerations have biased the data which it is provided. Beneficiaries and plans are also in the dark, because rebate contracts are secret.⁹⁸ Accordingly, nobody knows the full extent of the practice nor how much it costs the health system in unrealized savings. In this regard, Professor Robin Feldman, of the University of California, Hastings College of the Law explained:

The deals between the drug companies and the PBM middle players are guarded as fiercely as Fort Knox. . . . No one gets to see them. But new research is turning up plenty of evidence of rebates distorting the market, such as numerous instances of effective, less expensive generics missing from formularies or patients burdened with higher out-of-pocket costs for generic drugs.⁹⁹

P&T committees are perhaps the only structural aspect of the formulary design process that, at least theoretically, may protect beneficiary interests. However, because P&T committees are so closely affiliated with and largely dependent on PBMs, they are unable to robustly protect beneficiary interests. Under a system that allows manufacturers to pay PBMs for formulary placement, PBMs have every incentive to, and do, limit P&T committees to a therapeutic advisory role. This dynamic renders P&T committees ineffective at, if not entirely unconcerned with, preventing the imposition of barriers to access to care. Simply put, there is no one assuring that beneficiaries are fairly rewarded for the restrictions imposed upon them, as cost-savings that result from the formulary structure are often diverted to PBMs and plans, rather than reflected in lower costs to beneficiaries.

III. Anti-Kickback Statutes Could Mitigate Manufacturer Influence on PBMs

While the risk of harm posed to beneficiaries by payment to PBMs for placement seems clear, whether and how to address this risk has been a source of great consternation for legislators and regulators.¹⁰⁰ In this Part, we demonstrate that the federal,¹⁰¹ and by analogy, the state anti kickback laws,¹⁰² can be used to stop manufacturers from paying PBMs to influence purchasing decisions through formulary placement.¹⁰³ The anti-kickback laws create a comprehensive framework of powerful beneficiary protections that has proven effective with respect to other arrangements for the delivery of healthcare items and services. Making it clear that PBMs must follow the path established by this framework should go a long way toward protecting beneficiary interests. Despite much handwringing by lawmakers and regulators as to whether and how to refine these laws so as to better address PBM incentives, these laws can be employed, in their current form, to address misalignment in economic incentives that causes PBMs to enter into arrangements that harm beneficiaries. In other words, the problem is not that the law permits the abuse of beneficiaries, but that understanding and enforcement of the law has been sub-par, rendering it essentially meaningless in this context.

In this Part, we argue for a clearly expressed, coherent, and predictable approach to anti-kickback enforcement. This enforcement must focus on manufacturer payments to PBMs for placement, which we argue are legally impermissible, as distinct from payments to plans for access or inclusion, which we argue are legally permissible. Whether payments for placement are styled as rebates or otherwise, they are designed to induce the PBM-recipient to improperly drive purchase volume toward the manufacturer’s product. Clearly, these payments are not permissible price concessions offered to plans (or to PBMs as agents for the plans), but are, rather, payments offered to PBMs for their own account.¹⁰⁴ This is problematic because there is at least the prospect that payments made to plans may be passed through to beneficiaries in the form of lower drug prices or lower premiums, whereas payments to PBMs will not benefit plans, let alone beneficiaries. Also, these payments for placement differ from permissible price concessions, and would be problematic regardless of the intended recipient. Permissible price concessions come without any strings attached (i.e., with only the hope or expectation that favorable treatment may result), while payments for placement are contingent on placement; that is, they are made in exchange for taking specific action to prefer a drug over its competitors.¹⁰⁵ Price concessions offered without conditions serve the interests of price competition without requiring the imposition of burdens on beneficiaries. On the other hand, price concessions with conditions require that burdens be imposed on beneficiaries, and essentially supplant the P&T committee’s role in the formulary design process. The distinction between payments for placement and payments for inclusion is well-supported by existing law, with the former being permitted if structured properly (and made to a plan), and the latter being prohibited. However, this distinction is often ignored in analyzing when a payment from a manufacturer to, or through, a PBM is proper.

A. Other Bodies of Law Fail to Sufficiently Protect Beneficiaries

To the extent that targeted attempts have been made to address misaligned incentives between PBMs and beneficiaries, they have, at best, been piecemeal and insufficient to meaningfully protect beneficiary interests—and, at worst, entirely failed. For example, plaintiffs in lawsuits against PBMs have asserted that PBMs and plans have violated their ERISA¹⁰⁶-based fiduciary duties by entering into payment-for-placement arrangements with pharmaceutical manufacturers that disadvantage the plan beneficiaries.¹⁰⁷ On the whole, these plaintiffs have not succeeded in their arguments because courts have held that the PBM is not a fiduciary to the plan beneficiaries.¹⁰⁸ States have also passed legislation imposing various duties on PBMs,¹⁰⁹ seeking to protect beneficiaries from being charged more in cost-sharing than would be the case if they were to buy a comparable drug (e.g., a generic) outside of the plan, as well as “anti-claw-back”¹¹⁰ and “anti-gag rule”¹¹¹ legislation. However, the effects of these state laws are sometimes undermined by ERISA preemption.¹¹² In any event, these types of state laws are directed at fixing very limited problems deriving from the current state of PBM-manufacturer relationships, but they do not address the fundamental problem of distorted, hidden incentives, and they have not stopped PBMs from entering into problematic payment-for-placement arrangements with manufacturers.

Some state¹¹³ and federal¹¹⁴ laws attempt to mitigate the risks posed by PBM conflicts of interest by mandating transparency. These laws require disclosure of financial information that could shed some light on the extent to which PBMs may be profiting from arrangements that are costly to beneficiaries.¹¹⁵ These laws depend on “sunshine” having its intended effect, which, in such a complex area, seems unlikely.

Most recently, an attempt to essentially outlaw rebates to PBMs or plans for drugs reimbursed by Medicare Part D plans (via amendment of the AKS’s regulatory discount safe harbor) seems doomed to flounder for both political and procedural reasons.¹¹⁶ As discussed further below, even if this regulation is adopted, it applies only to Part D plans and leaves some important questions unanswered.

Though well intended, these piecemeal efforts at regulating PBMs have proven ineffective. They are largely side-stepped or ignored by PBMs and have been enforced only sporadically. Significantly, rather than provide clarity, the regulatory focus on transparency, when combined with limited enforcement (and the fact that much enforcement ends in settlements rather than opinions providing authoritative guidance) opens the door to confusion and defensiveness, especially in the face of widespread acknowledgment of manufacturer payments to PBMs. For example, a PBM may think or argue that manufacturer rebates to PBMs are permissible so long as they are disclosed (under the rationale that the disclosure requirement connotes the permissibility of the underlying arrangements). Likewise, a PBM may think or argue that there is ambiguity as to what is prohibited by the AKS, or as to the wrongfulness of the conduct (i.e., that the practice is so widespread and well known that if it were impermissible, there would be more enforcement).¹¹⁷ Even though there are clearly counterarguments to these assertions,¹¹⁸ the government should more clearly signal that it supports, and then in fact engage in, enforcement of, a bright-line prohibition on the problematic behavior—that is, payments for placement by manufacturers to PBMs. This will provide clear guidance to PBMs and manufacturers, change the way business is done, and protect beneficiary interests.

B. The AKS’s Potential Remains Untapped

To our knowledge, despite the widespread practice of making payments to PBMs for inclusion and/or placement, and the various governmental statements indicating that the practice implicates the AKS, there has been little AKS enforcement activity in this area. For example, we are not aware of any cases squarely holding that manufacturer rebates to PBMs conditioned on formulary inclusion or placement violate the AKS. The government has acknowledged that the “current system” is problematic, essentially for all the reasons that we have discussed, but seems to assume that some radical regulatory change is required in order to address these problems.¹¹⁹

We speculate that a number of factors contribute to this lack of AKS enforcement against manufacturer payments to PBMs for inclusion or placement. First, the fact that the practice is so widespread creates both practical and political problems. The PBM industry is powerful and large, and its profitability is dependent on the receipt of manufacturer rebates.¹²⁰ There is a strong lobby advocating that PBMs serve important policy goals.¹²¹ Second, volume rebates to plans are clearly permissible and desirable, and it is difficult to identify when a payment is being made for the account of the PBM and when it is being made to the PBM as an agent for the plan. Indeed, the two settlements we have located that deal with the legality of manufacturer payments for placement under the AKS both seem to assume that rebates to PBMs are legally permissible, presumably under the discount safe harbor, so long as the payment is made in the form of a rebate on the drug being accorded the preference, rather than in some other fashion.¹²² Third, it is not easy to articulate a clear analytical distinction between rebates that are protected by the discount safe harbor and those that are not. Making this distinction requires that one identify not only when rebates are extended to PBMs and when they are extended to plans (as the discount safe harbor categorically excludes the former but not the latter), but also when they are extended to plans, when they are made in exchange for actions that implicate the AKS, and when they are extended solely in the service of price competition. Depending on the facts, these distinctions can be fairly subtle and may not be widely appreciated.

These complexities are underscored by the New Rule,¹²³ under which the Office of the Inspector General (OIG) has indicated that payments to plans predicated on the performance of some contingencies (denominated as “services”) are impermissible, but that other contingencies are not considered services and may be permitted.¹²⁴ In this regard, the government explains that developing and managing a formulary is a service that a PBM provides to a plan, and thus, presumably is not something for which a manufacturer could ever pay a plan.¹²⁵ Additionally, developing and managing preferred drug lists and prior authorization programs, performing drug utilization review, and operating disease management programs all qualify as “services” for which payment is not protected, and, thus, essentially prohibited under the Final Rule.¹²⁶ However, “[w]hether other arrangements would be considered a ‘service’ that would not be protected, such as . . . conditioning a reduction in price on a formulary not covering a competing drug . . . , would be subject to a case-by-case analysis.”¹²⁷ Conditioning payment on exclusion of a competitive drug would seem to implicate the statute in the same manner as the services for which that government has indicated it is impermissible to pay (i.e., developing and managing a preferred drug list and paying for competitive placement seem to be the same thing). It is unclear why OIG sees this as an open question, or why it has not seen fit to articulate the rationale on which it might predicate such a distinction. Also unarticulated are the factors that will be used to determine what constitutes a service in any particular case. Accordingly, even in the context of what appears to be an attempt at comprehensive reform, the government has not grappled with exactly what contingences are improper, and has left the door open to imposing significant contingences as a quid pro quo for a rebate (albeit one that is passed to beneficiaries).¹²⁸

While current law can be fairly read to prohibit PBMs and plans from accepting payments for formulary placement, applying that law is a painstaking process that requires an understanding of many factual and legal subtleties. Given this, the PBM industry might do well to consider following the example of other industry actors faced with similar problems by adopting a code of ethics that clarifies what is and is not permissible in terms of day-to-day patterns of operation.¹²⁹

C. A Brief Overview of the Anti-Kickback Statute

The AKS, 42 U.S.C. § 1320a–7b, is a federal anti-corruption law which seeks to prohibit financial incentives from distorting selection decisions of persons in a position to mediate access to healthcare items and services that are paid for by Medicare, Medicaid, or other federal government healthcare programs.¹³⁰ To ensure that the selection of covered products is made on the basis of appropriate considerations, such as price, quality, and service, rather than on the basis of personal benefits to gate-keepers, the AKS prohibits a pharmaceutical manufacturer from paying anything of value to a person who can influence product selection (such as a PBM) to induce that person to purchase a covered product.¹³¹ Specifically, the statute provides that:

(1) Whoever knowingly and willfully solicits or receives any remuneration (including any kickback, bribe, or rebate) directly or indirectly, overtly or covertly, in cash or in kind . . .

(B) in return for purchasing, leasing, ordering, or arranging for or recommending purchasing, leasing, or ordering any good, facility, service, or item for which payment may be made in whole or in part under a Federal health care program, shall be guilty of a felony and upon conviction thereof, shall be fined not more than $25,000 or imprisoned for not more than five years, or both.¹³²

Subsection (2) of the statute contains identical provisions applicable to the offeror of the remuneration.¹³³

A violation of the AKS occurs only when remuneration is given with the improper purpose of inducing the recipient to deliver business.¹³⁴ The AKS does not contain a definition of “inducement” and the term has not been conclusively defined. However, courts have indicated that in order to be considered inducement, the intention must be to actually exert influence through the provision of the remuneration, rather than simply understanding that the situation might normally lead to business. For example, the 2000 Tenth Circuit case United States v. McClatchey^[137]holds that the mere hope or expectation that referrals may result from remuneration designed for entirely different purposes is not a violation of the AKS, and that there must be an actual offer or payment of remuneration with the goal of inducing referrals.¹³⁵

The AKS has been interpreted to cover any arrangement where one purpose of remuneration is to induce or reward such actions, even if the arrangement serves other, legitimate purposes.¹³⁶ Thus, even if there is a proper justification for the payment at issue, that proper purpose is irrelevant if there is evidence of an additional, improper purpose.

A discount clearly is something of value, normally offered with the intent of inducing purchases, and, without more, would consequently implicate the AKS. But the AKS allows certain discounts as long as they are properly disclosed and appropriately reflected in the provider’s claim.¹³⁷ The statute does not specify when a reduction in price is “properly disclosed and appropriately reflected.” The OIG’s regulatory guidance clarifies that what must be reported is the reduced price, net of discount, not a comparison to a list or contract price.¹³⁸ In other words, a discount is properly reported if the applicable report shows the price actually paid by the buyer.

Many states have enacted “mini-AKSs” that mirror the language and purpose of the AKS, but often they are not limited to government-reimbursed healthcare items or services; they also apply to items or services paid for by commercial insurers.¹³⁹ Taken together, state mini-AKSs and the federal AKS create a comprehensive (and overlapping) legal framework that is explicitly designed to prevent financial incentives from improperly influencing the decision-making of those who are in a position to drive healthcare purchases.¹⁴⁰

Regulations that implement the federal AKS contain a number of safe harbors protecting common renumeration arrangements that regulators have deemed non-problematic.¹⁴¹ Arrangements that meet the requirements of a safe harbor are protected from the inference that any remuneration that flows between parties to the arrangement may be grounds for liability under the AKS. For example, an arrangement with a physician in which the physician is paid for bona fide consulting services will be deemed non-problematic if it meets the requirements of the safe harbor for personal services, including the requirement that all payments be fair market value for the consulting services rendered, without additional inquiry into the subjective purpose of the arrangement.¹⁴²

Recognizing the necessity of price competition in a commercial health care market, both the AKS and state mini-AKSs (either implicitly or explicitly) permit purchase incentives that take the form of discounts.¹⁴³ The federal AKS accomplishes this through a regulatory discount safe harbor.¹⁴⁴ It provides that “the term discount means a reduction in the amount a buyer (who buys either directly or through a wholesaler or a group purchasing organization) is charged for an item or service based on an arms-length transaction.”¹⁴⁵ Accordingly, to qualify for safe harbor protection, the discounts must be offered to a buyer, either directly, or through an intermediary, such as a PBM.¹⁴⁶ This means that the discount safe harbor does not protect inducements to middlemen who are not buyers. Thus, as further developed below, the discount safe harbor does not protect payments to PBMs that are not passed through to plans as price reductions.

Also, under the discount safe harbor, the discount must be limited to incentivizing selection based on price.¹⁴⁷ The discount safe harbor does not protect discounts that are given to induce plans or PBMs to take some action that benefits the pharmaceutical manufacturer in a manner otherwise precluded by the AKS beyond simply “purchasing” the drug because it is cheaper.¹⁴⁸ In the context of formulary development, a discount is protected by the safe harbor if offered to a plan with the goal of influencing the plan, acting through its PBM, to put the drug on formulary, because doing so will save the plan money. Discounts are not protected by the safe harbor (and violate the AKS) if made contingent on plans (or PBMs) engaging in specific behaviors that encourage the use of the drug over another, such as placing the drug in a preferred tier or giving a drug specific utilization-related preferences (e.g., conditioning the discount on exempting the drug from prior authorization requirements). Such a payment is not a discount, but rather a payment for the service of arranging for the purchase of the drug, and therefore does not fall under the discount safe harbor—instead, it squarely implicates the statute. Accordingly, as further developed below, the AKS and its state law analogs¹⁴⁹ should be read to preclude any payments to PBMs for either formulary access or formulary placement, as well as payments to plans for formulary placement.

D. Payments by Manufacturers to PBMs Implicate the AKS and Are Not Protected by the Discount Safe Harbor

Payments by manufacturers to health insurers who offer Part D, Medicare Advantage (Part C),¹⁵⁰ or Medicaid managed care plans implicate the AKS because the federal government pays for some or all of the premiums for coverage extended under these plans, and thus can be indirectly seen as a purchaser of the items and services covered by the plan; that is, they are “federal health care programs” (FHPs) within the meaning of the AKS.¹⁵¹ Depending on the terms of the mini-AKS, state and non-governmental funded plans may be regulated under these statutes either because the states pay for the services, or because the statutes are deigned to apply regardless of payor. When a plan that is covered by the AKS or a mini-AKS makes a coverage or utilization review related decision, it is influencing the choice of covered items or services, and thus is arranging for provision of the item or service within the meaning of these laws.¹⁵² Most fundamentally, insurance coverage influences which items or services are ordered (a physician may, for example, choose to write a prescription for a covered drug, rather than a non-covered drug) and whether referrals ultimately result in a purchase (a patient may, for example, choose not to purchase a prescribed drug if it is not covered).¹⁵³ When manufacturers make payments for access and payments for placement, they are paying PBMs to permit and encourage access to their product and, more specifically, to drive purchase volume toward their product.¹⁵⁴ As with remuneration flowing between manufacturers and insurance plans, therefore, payments from manufacturers to PBMs likewise implicate the AKS.

Where an arrangement implicates the AKS, the question becomes whether the arrangement falls within a safe harbor. Whereas discounts from list price, whether extended as up-front discounts or after-the-fact rebates to plans and beneficiaries could be protected by the discount safe harbor, rebate payments to PBMs cannot. The discount safe harbor protects discounts and rebates from the AKS only if such discounts and rebates are made to a buyer.¹⁵⁵ The government has long observed that payments from manufacturers to PBMs are not protected under the discount safe harbor because PBMs are not buyers. CMS has explicitly stated: “Rebates paid by drug manufacturers to or through PBMs to buy formulary position are not reductions in price. In the Secretary’s view, such a payment would not qualify as ‘a discount or other reduction in price.’”¹⁵⁶ OIG has also explained that payments by drug manufacturers to PBMs “that are based on, or otherwise related to, the PBM’s customers’ purchases potentially implicate the anti-kickback statute”¹⁵⁷ and that they can be protected by structuring them “to fit in the [group purchasing organizations] safe harbor at 42 C.F.R. § 1001.952 (j).”¹⁵⁸ That same guidance provides that “[l]ump sum payments for inclusion in a formulary or for exclusive or restricted formulary status are problematic and should be carefully scrutinized.”¹⁵⁹ In late 2020, the government again affirmed this view, stating that payments to PBMs, because they are not buyers, have never been protected by the discount safe harbor.¹⁶⁰

E. Payments by Manufacturers to PBMs Are Generally Not Protected
by the GPO Safe Harbor

In the face of both the law and this guidance, the widespread practice of PBMs retaining a portion of the rebates can be justified only if the retention qualifies as a protected administrative fee under the group purchasing organizations (GPOs) safe harbor, or can be characterized as a payment by the manufacturer to the plan, and then from the plan to the PBM for its services.¹⁶¹ To our knowledge, most rebating arrangements do not fit neatly into either such category.

The GPO safe harbor explicitly allows for the payment of fees by manufacturers to GPOs, in return for their services in acting as broker between manufacturers and purchasers. Since payments for placement are made to PBMs for their services, they would seem much more susceptible to characterization as GPO fees paid to PBMs than discounts paid to plans, and, indeed, the government has specifically recommended the use of the GPO safe harbor for such payments.¹⁶² In our experience, however, rebate arrangements are not typically structured for conformance with the GPO safe harbor,^[166]likely because it requires quite a bit of transparency,¹⁶³ and providing that level of transparency would put the PBMs at a negotiating disadvantage.

It might be argued that the rebates are payments by manufacturers to plans, and that the PBMs are merely serving as conduits for the payments. However, rebates are almost never passed through in full,¹⁶⁴ thereby suggesting that the PBMs are not serving as conduits. It might also be possible to argue that the portion of the rebate retained by the PBM is simply an offset for the PBM’s fee. However, in a situation where the plan knows neither the amount of the rebates or the “offset,” such a characterization seems strained. If this is not enough, in a situation where the rebate payment is negotiated and received by the PBM, in exchange for PBM commitments, it seems clear that the payment is to the PBM and not the plan. In short, under the traditional model, where a secret payment is made by manufacturers to PBMs in exchange for favorable treatment, and only a portion of that payment ever reaches the plans, it strikes us as a stretch to characterize rebates as being made to plans rather than PBMs.¹⁶⁵ Rather, it would seem that any payment for placement not intended as a pass-through can be best characterized as a payment by the manufacturer in exchange for the PBM’s agreement to influence formulary placement. In this regard, the terms of the contract between both the manufacturer and the PBM and the PBM and the plan would be relevant to determining the issue of intent, as well as such considerations as the plan having title to the rebate, knowledge of the amount of the rebate, and the amount charged as PBM fees. However, we are aware of no authorities that give clear guidance as to when a rebate should be considered to be paid to a plan through a PBM and when it should be considered to be paid directly to the plan. This ambiguity perhaps accounts for some of the lack of enforcement activity.

F. Payments for Placement by Manufacturers to Plans Implicate the AKS and Are Not Protected by the Discount Safe Harbor

Even when the payment is made to a plan, it cannot be made for services and still be afforded protection under the discount safe harbor.¹⁶⁶ Most fundamentally, the discount safe harbor protects discounts, which are defined as “a reduction in the amount a buyer . . . is charged for an item or service based on an arms-length transaction.”¹⁶⁷ Among other exclusions, the term discount does not include either “[s]ervices provided in accordance with a personal or management services contract; or . . . [o]ther remuneration, in cash or in kind, not explicitly described in paragraph (h)(5) of this section.”¹⁶⁸ In other words, a payment that is made in return for a service is not a discount within the meaning of the discount safe harbor.¹⁶⁹

As the Government explained in its brief in United States ex rel. Herman v. Coloplast Corp.:¹⁷⁰

If [the distributor] CCS and [the manufacturer] Coloplast simply agreed to a pricing structure that offered escalating discounts in return for increased sales . . . then the United States agrees that such an arrangement would qualify as a “discount” and therefore would not violate the AKS. In contrast, if CCS and Coloplast agreed that CCS would undertake patient conversion and referral activities in return for Coloplast granting price concessions, the United States submits that such an agreement would not be a “discount” at all and would violate the AKS. . . .

Relators’ allegations carry a reasonable inference that Coloplast was paying CCS to use its special influence with its customers to switch them to the Coloplast products. As alleged, CCS’s agreement to undertake conversion campaigns in exchange for the price concessions thus transformed the price concessions into illegal kickbacks. Such an arrangement is different in kind from merely offering escalating discounts in return for increased sales volumes in an arms-length transaction. The collusive quality of the arrangement alleged by the relators fundamentally distorts the transparency of price competition in the healthcare market that Congress sought to promote with the discount exception. . . .

In a 1994 Special Fraud Alert, the HHS OIG made clear its view that the AKS prohibits manufacturers from offering financial incentives to those selling their products to effectuate “product conversion” programs where one purpose is to induce the increase [sic] use of such products covered by Federal health care programs. 59 Fed. Reg. 65,371, 65,372, 65,376 (Dec. 19, 1994). One of the examples provided in the Special Fraud Alert was of a “product conversion” program in which a drug manufacturer provided supplier pharmacies with cash awards for changing from a competitor’s product to the drug manufacturer’s product. Id. at 65,376. A price concession is functionally no different than such a cash award, regardless of the label the parties use to describe it.

In sum, a price reduction conditioned on promotional or conversion campaign activities is not a “discount” within the meaning of the discount exception at 42 U.S.C. § 1320a-7b(b)(3). A price reduction that is contingent on the recipient taking affirmative steps to generate additional business for the seller does not foster price competition that inures to the benefits of the federal health care system.¹⁷¹

As discussed at length in Part II, tiering (or placement) decisions are often made for the purpose of promoting one drug over another. When such a payment is made for placement, it is being made not just with the hope or expectation that the PBM (as agent of the plan) might prefer the discounted product, but specifically in exchange for the PBM taking specific action designed to promote a particular drug over its competitors. In other words, the payment is made for the services of the PBM in driving purchasing volume away from competitor products and toward a given manufacturer’s products. More fundamentally, the fact that payments for placement are often articulated in terms of a percentage rebate on products sold by the manufacturer to plan beneficiaries does not make them discounts in the true sense of the word. Rather, they are payments made to plans and PBMs that are contingent on formulary design services achieving the desired outcome—driving sales volume toward the manufacturer’s product. It seems clear, then, that payments for placement are not bona fide discounts off list price that are provided in an arms-length transaction. Rather, payments for placement are payments made by manufactures to secure beneficial formulary design and formulary administration services which redirect purchase volume away from competitor products and toward the manufacturer’s products.

G. Effective AKS Enforcement Would Enable P&T Committees to
Meaningfully Protect Beneficiaries

Restricting manufacturers from paying PBMs rebates for formulary placement should remove PBMs’ incentives to favor drugs that are more profitable for them, and thus, more closely align the interests of PBMs and P&T committees. This makes it more likely that PBMs will give their P&T committees latitude to consider the full range of beneficiary interests, and ultimately more likely that PBMs will adopt P&T committee recommendations. Limiting manufacturers to incentivizing plans for formulary access means that the relative cost of the drug, and not the value of the rebate, is likely to drive purchasing decisions. Thus, beneficiaries would benefit from lower drug prices in the form of either pointof-service reductions (where the manufacturer offers a discount) or premium reductions (where the manufacturer offers a rebate).

Rebates may still encourage plan sponsors to depart from the P&T committee’s recommendation and prefer a drug that is most profitable to the plan, but the plan must do so (1) of its own volition (i.e., without the placement being dictated by pharmaceutical companies), which would presumably weaken the effect of any volume-contingent payment; and (2) in the face of a formal finding by the P&T committee that an alternative formulary structure would have benefitted their beneficiaries to a greater extent. This behavior may leave them open to attack through a number of avenues: for ERISA plans, as breach of fiduciary duty; for Part D plans, as being inconsistent with CMS requirements; and for commercial plans, in a court of law (and in the court of public opinion).

Because these laws prohibit PBMs from siphoning off a portion of the payments for placement for their own account, funds should be readily available for pass-through to beneficiaries who are burdened by the attendant access restrictions. If these laws are properly enforced to prohibit PBMs from conditioning formulary design decisions on receipt of wheel-greasing payments from manufacturers, P&T committee recommendations are more likely to carry the day. So, the P&T committee would have both the latitude and the funds to protect beneficiaries. Any impetus on the part of a plan to deviate from the committee’s recommendations would be mitigated by the fact that such deviation would be an overt, documented departure from the best interests of patients, which might be actionable under state laws imposing fiduciary duties on PBMs¹⁷² and principles of fiduciary duty applicable to ERISA plans (which require that plan sponsors act in the best interests of their beneficiaries and ensure that third parties they employ do the same).¹⁷³ With respect to Medicare Part D plans,¹⁷⁴ the departure would be obvious to CMS, and would seem inconsistent with CMS’s concern that plan sponsors “perform adequate oversight of their PBMs and other delegated entities to verify” that “utilization management requirements applied at point of sale (POS), such as prior authorization (PA), step therapy (ST), and quantity limits (QL) not based upon the FDA’s maximum daily dose limits” not cause “beneficiary harm due to impermissible delayed or denied access to Part D drugs.”¹⁷⁵ We suggest that the P&T committee’s duty may extend to conditioning their services upon their recommendations being respected.

Conclusion

Formularies are a useful tool in managing over-utilization and drug costs. However, they impose burdens on beneficiaries. These burdens are not ethically tolerable if they do not result in a comparable benefit to beneficiaries. At present, the benefits are often siphoned off to PBMs in the form of retained rebates, and there is no real commitment to passing them through to beneficiaries. Ensuring that all rebates are passed through to plans, and that they are not made in exchange for formulary placement, will protect beneficiary interests.

The extant laws, regulations, and guidance detailed in Part III can be used to address this problem and ensure that beneficiary interests are better protected. Enforcing these principles would create an environment where P&T committees are free to engage in a true pharmacoeconomic analysis, and where that analysis—not manufacturers—would dictate formulary placement. Even if the New Rule is not implemented, at least for Part D and Medicaid managed care plans, the AKS can be used to entirely preclude manufacturer-rebates to PBMs and to plans for specific placement conditions. With respect to other plans, state statutes can be used to achieve the same result. By observing existing law and recognizing the distinctions between payments to plans and payments to PBMs, as well as the distinction between payments for coverage and payments for placement, beneficiaries could be protected without further legislation.

* Partner, Stinson, LLP; Adjunct Professor (MSL Program), Northwestern University School of Law.
** Associate, Stinson, LLP; Adjunct Professor, University of Minnesota Law School.

Trading Pain for Gain: Addressing Misaligned Interests in Prescription Drug Benefit Administration

Abstract

Introduction

I. The Problem: Formulary Access Restrictions May Not Save Plans or Beneficiaries Money

A. Managed Care Plans Use Access Restrictions to Constrain Utilization and Reduce Costs

Figure 1. Tier Information

Drug Tier

Includes

Helpful Tips

Tier 1

$

Medications that provide the highest overall value. Mostly generic drugs. Some brand-name drugs may also be included.

Use Tier 1 drugs for the lowest out-of-pocket costs.

Tier 2

$$

Medications that provide good overall value. Mainly preferred brand-name drugs.

Use Tier 2 drugs, instead of Tier 3, to help reduce your out-of-pocket costs.

Tier 3

$$$

Medications that provide the lowest overall value.

Ask your doctor if a Tier 1 or Tier 2 option could work for you.