By Ralf Boscheck, Lundin Family Professor of Economics & Business Policy, IMD Business School
The first part of this article introduced pharmacy benefit managers (PBMs) and their business model and explored the monopolization concerns in this market. The focus now turns to state and federal actions regarding PBMs.
In 2011, Mississippi introduced several legislative changes that shifted the regulatory control of PBMs from the Insurance Department to the state’s Board of Pharmacy; two years later, PBMs were given a new fiduciary status.1 Since then, 37 states have adopted similar statutes.2 The core of these requires PBMs to disclose the methods for arriving at the maximum allowable costs (MACs) they use, the actual amounts that are paid and charged in various situations, and the process for appeals and adjusting payments including retroactive compensation. In some cases, PBMs are obliged to reimburse actual acquisition costs even if cheaper alternatives are available. No doubt, these changes affect the ability of PBMs to deliver value.
For one, retroactive compensation and reimbursement of actual costs eliminate efficiency incentives and equate to procuring at-cost if not cost-plus. Making contracts transparent reduces uncertainty about the terms of agreement and limits competition among pharmacists and drug suppliers — and hence the power of PBMs in extracting discounts from them. Transparency also lessens the level of rivalry amongst PBMs when engaging with health plans. Contracting parties, in general, will be less likely to strike any deal once they know their other business partners would want to contract under the same condition. By the same token, as transparency created in one state provides a reference to others, competition may in fact be negatively rather than positively affected, and this could cause prices for prescription drugs to increase nationwide.
Furthermore, obliging PBMs to accept a “fiduciary duty” means requiring them to “operate in the best interest of the patient or citizen.”3 Fiduciary duties are general obligations to deter opportunistic behavior once explicit contracting proves unable or uneconomical to resolve potential conflicts of interest. They effectively delegate regulatory control to companies themselves that, as a result of facing an increased risk of litigation, will drive for less-aggressive bargains, more closely monitor and document behavior, and, in general, pursue more cautionary strategies. But imposing a fiduciary duty on PBMs will not only cut savings potential and administrative efficiencies; it will put an end to its very business model if earning a profit is interpreted as profiting at the expense of clients. With all of the above, what, then, is driving these anti-competitive, anti-efficiency regulatory changes? The short answer is: doubt in federal antitrust enforcement.
Federal Enforcement Action and Local Regulatory Capture
In its Presidential Transition Report 2016, the American Antitrust Institute (AAI) presented a rather chilling review of recent U.S. antitrust policy and called for a return to more aggressive enforcement and a more competition-focused mindset.4 In particular, it pointed out that under the administration of President George W. Bush, the Antitrust Division did not bring a single monopolization case, the number of Section 2 (monopolization) investigations declined considerably, and settlements were accepted that were largely ineffectual. Under President Obama, who as senator campaigned on a platform of reviving antitrust enforcement, the FTC brought more Section 2 cases than the Department of Justice and more than the FTC had under President George W. Bush. Still, in the eyes of the AAI, more needs to be done to restore monopoly and exclusion as core competition concerns, above all, as relates to refusals to deal, unfair methods of competition, and the leveraging of market power by dominant firms.5
With regard to healthcare, the report charges lax enforcement with having enabled high concentration or cartelization in pharmaceuticals, hospitals, and health insurance, driving up costs and cutting access to care. Neither the Bush nor the Obama administration initiated federal enforcement actions against intermediaries, such as PBMs and group purchasing organizations (GPOs). In fact, the AAI criticized that the two recent substantial PBM mergers — Caremark’s acquisition of AdvancePCS and CVS’s acquisition of Caremark — were “approved without a significant investigation, despite leading to a significant increase in concentration” which is rather concerning as “dominant PBMs have been linked with opaque business practices and widespread allegations of fraud.”6 Others add that the FTC, “contrary to its mission,” in fact routinely intervened on behalf of these dominant players (for example, when states allowed independent pharmacists to form their own network, which the commission thought would “impair the ability of prescription drug plans to negotiate the best prices with pharmacies”).7
Obviously, value-based healthcare demands integration — via ownership or contracts — to increase scale and gain operational control. In assessing implications related to horizontal overlaps or vertical restraints, regulatory authorities must address welfare trade-offs and may need to consider the competition between models of healthcare delivery rather than direct competition between providers. The FTC made this point again and again. But that point was clearly pushed aside when states applied the state action doctrine8 to override federal laws ostensibly to protect small, independent pharmacies — typically pillars of the local community — against the depredations of large out-of-state PBMs. As a result, consumer protection turned into provider protection.9
But this is not the usual case of regulatory capture. For one, 34 of the 38 states exclude Medicaid programs and state employees, both part of the state budget, from their new PBM regulation. Evidently, “state legislators made it clear that they thought that the supposed consumer protections were worth doing — right up until the moment the state would bear the costs of doing so.”10 Next, shifting supervisory control over PBMs from the insurance commission to the state’s board of pharmacy, which is made up of pharmacists with no fiduciary duty, places regulatory powers and competitor data into the hands of direct adversaries with clear incentives to shift business prospects and raise their rivals’ costs. PBMs will be weakened and consumers and health plan sponsors will be harmed. The FTC’s efforts to limit the antitrust immunity afforded by the state action doctrine have been recognized in recent Supreme Court decisions, but some vital questions still need to be addressed.
As originally elucidated in Parker v. Brown, 317 U.S. 341 (1943),11 state and municipal authorities are protected against federal antitrust prosecution for executing state policies that clearly have anticompetitive effects. In the 1980s, the Supreme Court extended the doctrine to apply to non-state actors, provided their conduct was undertaken pursuant to an established state policy and they would be actively supervised by the state. Subsequent Supreme Court and lower court decisions effectively waived the need to show such active supervision.12
Against this backdrop, the FTC in 2010 brought a case against the North Carolina State Board of Dental Examiners for systematically barring lower-priced, non-dentists from also offering teeth whitening services. In its 6-3 opinion,13 published on February 25, 2015, the Supreme Court clarified that active market participants must be actively supervised by the state to qualify for antitrust immunity. Such supervision should be “flexible and context dependent” and the supervising state actor cannot itself be an active market participant. The dissenting opinion criticized the majority view for complicating the issue and avoiding to address a straightforward question: Is the board a state agency? Applied to the current PBM discussion, one can only speculate how the Supreme Court would decide when looking at a board of market participants who have no fiduciary obligations regulating others who do.
Almost 50 years after the publication of George Stigler’s “The Theory of Economic Regulation,”14 the current discussion about whether and how to best curtail presumably abusive PBM behavior replays the debate on regulatory capture, albeit with a twist. Regulators/legislators pressured by special interests opt for protective regulation to ensure provider benefits rather than to protect consumers. Different from Stigler’s argument, the PBM case shows local constituencies driving state regulation at the expense of consumers and out-of-state big business. Different also from the original notion of capture, the FTC is attempting to limit the protectionist impact by reining in the state action doctrine. Going forward, decisions by the U.S. Supreme Court could, in effect, either endorse Stigler’s original position or confirm efficiency and consumer benefit as core competition concerns.
About The Author:
Ralf Boscheck is the Lundin Family Professor of Economics and Business Policy at IMD business school, where he is program director of IMD’s MBA program. With more than 20 years of teaching in a number of executive programs, Professor Boscheck believes in using intensive and direct interaction to develop technical competencies, self-awareness and moral judgment. You can reach him at email@example.com.