Anyone who's been paying attention knows that the pharmaceutical industry deserves a generous share of blame for the drug prices that are squeezing consumers, taxpayers and employers. But between the pharma company's factory door and the consumer, there is a large network known as the drug distribution system. Because health care in the U.S. is primarily a means of pursuing profit rather than the public's health, this drug distribution system is filled with companies that are also trying to line their pockets from the misery of sick people.

Here are some of the ways the drug distribution channel also forces the U.S. to pay at least two or three times what other advanced countries pay for the same medications.

First there are the pharmacy benefits managers (PBMs). These are the agencies hired by payers such as insurers and employers to negotiate prices with manufacturers, manage payer formularies and process claims. The U.S. is one of very few countries where PBMs exist. The rationale for having them here consists of the claim that they can use the purchasing power they obtain from managing the drug coverage for numerous payer clients to obtain lower drug prices from manufacturers.

In fact the process works this way. The arrangements in the private market involving insurers and/or employers take their lead from the legislated laxity (i.e., pharma payoffs to Congress) known as the 340B-pricing program. A pharma company with a new product goes to the Centers for Medicare & Medicaid Services (CMS) and offers a minimum 23.7 percent discount off a published price known as Wholesale Acquisition Cost (WAC). This 340B program, ostensibly designed for hospitals and other entities that treat lower income individuals, is the entitlement available to any government program. CMS is prohibited by law from using its purchasing power, as the country's largest payer, to negotiate a more favorable price for Medicare, although Medicaid and the Veterans Administration do get somewhat lower prices. With Medicare and Medicaid agreeing to cover the product, the private payers are then constrained to follow suit.

The PBMs then negotiate a price with the drug companies in the range of 10-15 percent off a published benchmark price that is usually stated as "average selling price" (ASP) or "average wholesale price (ASP). In return for stocking and selling the drug for people covered by that particular client, pharmacy chains and wholesalers negotiate with the PBM to receive 17-21 percent off the ASP/AWP price. The difference is known as the "spread" and PBMS put it in their own pockets.

The higher the price published by the manufacturer, the larger the spread that goes to the PBM. That makes for the ironic situation in which PBMs, putatively established to reduce drug prices, actually receive larger profit margins, i.e., spreads, as a result of higher drug prices.

But that's not the only place in this drug distribution channel where PBMs dip their beaks.  PBMs also squeeze the pharmas for additional rebates and fees. They will share a generous portion (and sometimes all) of the rebates with their payer clients, but they won't pass on rebates from specialty drugs and, similarly, they retain all fees they receive for PBM services.

The payer clients remain in the dark about the precise amounts their PBMs are extorting from pharmas and paying to pharmacies, but these clients are often mollified when they receive the 30-50 percent rebates. That means PBMs gain yet again when pharmas make more of their price concessions in the form of PBM fees instead of rebates.

Another member of the drug distribution channel also does its share of contributing to higher drug prices. These are the limited distribution, specialty pharmacy networks.

Once again, the rationale for creating specialty pharmacies made sense, but the methods for operating the system contribute to higher drug prices.

Specialty pharmacies were created for those drugs distributed through a buy-and-bill system that involves selling drugs to specialist physicians who buy them at deal prices negotiated with the pharma companies. The physicians in specialties such as oncology and rheumatology then make hefty profits on the drugs they administer by virtue of getting higher reimbursements from the payers at ASP/AWP-minus-discount levels that are larger than the deal prices.

The problem lies in the fact that physicians are not set up to function as merchandising middlemen, particularly when the medications run into five or six figures for a patient's course of treatment. Operating that way would require the medical practices to tie up millions of dollars in drug purchases, store the acquired drugs somewhere, wait for months before receiving reimbursement, and employ a claims staff to haggle payment with the payers.

Specialty pharmacies arose to relieve physicians from that purchasing, storing, hassling and waiting obligation.

The problem involves the rise of so-called limited distribution specialty pharmacy networks. These networks amount to specialty pharmacies that function as dedicated confederates and sales agents for particular pharma companies.

Some of the veil was recently torn off this racket when a short-seller in California and two media outlets uncovered how Valeant was using Philidor as its limited distribution network. The larger truth is that while Big Pharma's lobby and some of the industry's CEOs loudly try to dissociate themselves from Valeant, Turing and similar "hedgefund" pharmas, the AbbVie's, Novartis's and other Big Caps operate with their own limited distribution pharmacy networks.

First, the networks work out deals with specialist physicians, promising them faster turnaround for reimbursement, a relief of the need to hassle with payers and a lower copayment for the doctor's patients.  In return for these incentives, the physicians steer their patients to the particular network.

Then if there are competing brands in the class prescribed by the physician, the specialty pharmacy tries to steer the prescription to the brand from the pharma company with which it is in league. Few will go as far as Philidor was alleged, by actually changing prescriptions to the confederate pharma's brand, but the pharmacy will emphasize to physicians and patients the advantages of going with one product over another.

In this way and others, the limited distribution, specialty pharmacy networks operate as sales forces and as managed care departments for those drug companies with which they cut their deals. The networks thereby contribute to rising drug prices because they remove some of the need for pharmas to compete on price as a means of obtaining formulary positions.

In abbreviated form, this is how the U.S.'s for-profit health care system works. Layers of middlemen furiously compete to extract profit at the expense of others up and down the line, especially consumers and taxpayers.

That's not a cheery thought for this time of year, but merry Christmas and happy holidays anyway.


Read more from the Check Up blog »