November 19, 2019
3 min read

Formulary Construction in America: ‘Perfectly Legal’ and ‘Perfectly Wrong’

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How can a system that a) incentivizes higher drug prices; b) steers patients to drugs that make the most money for the middleman; c) creates god-knows how many different step therapy regimens subject to change at any time, and; d) actually fosters monopolies of certain drugs that are very expensive, be perfectly legal?

Let’s recap the kickback system leading to this unfortunate situation.

Madelaine A. Feldman, MD, FACR
Madelaine A.

Pharmacy benefit managers (PBMs) create the formularies that determine what drugs will be paid for, when they can be taken, where they can be purchased and how much they will cost the patient. Obviously, this becomes very important for our expensive rheumatologic medications because, if an expensive medicine is not on the formulary, it is completely unaffordable for patients.

To get the coveted “preferred” status on the formulary, manufacturers send in secret kickback package bids to the PBMs. The highest kickback package amount wins the prize of “preferred” status, meaning patients must step through the winner’s drug before taking the less preferred drugs. This gives automatic market share to the winning kickback package bidder. The greater the market share and the number of indications a drug has, the more leverage that manufacturer has to control the formulary. This leads to a “rebate wall” which is a discussion for another time.


These secret kickback packages promise not only formulary rebates but administrative, service and other “bona fide” fees based on the list price of the drug. It is easy to see that the higher the price of your drug, the better your kickback package looks to the PBM. Remember that competition in this system raises prices, just like at an art auction when everyone is bidding on that same coveted work of art.

In addition, part of the secret kickback package includes price protection rebates that bring in additional money for the PBM if the drug maker raises the price of their drug during the contract year — yes, PBMs make even more money if the price of the drug goes up!

Initially, PBMs were pharmacy claims adjudicators and then came the spread pricing business, mail order pharmacies and specialty pharmacies. When the very expensive specialty drugs came onto the scene, it became clear that control of the specialty formulary and putting in place step therapy rules — to the advantage of certain manufacturers — meant lots of money could be made. The more manufacturers bidding for the coveted spots with secret kickback packages, the higher those package bids went. Competition succeeded in raising the price of the drugs!

How is this legal, you might ask? If kickbacks are supposed to be illegal, why are they not illegal for PBMs? In the early 90s, PBMs and other health care companies were granted “safe harbor” from the anti-kickback statute — and voila! The beginning of the money-making machines we know today.


Utilization management tools developed by the PBMs, such as prior authorizations, step therapy and nonmedical switching, create delays in patients getting the proper treatment and keep them on the most profitable medications. PBMs are allowed to stop paying for treatments in the middle of the health plan’s contract year even for stable patients, usually to move them to a more profitable medicine. This can result in stable patients being “whipsawed” from one medicine to another as often as every 6 months or any time they change jobs.

Unfortunately, our patients pay the price of this system, both literally and in terms of delayed effective therapies. For expensive medications, patients pay their coinsurance on the list price of the drug, not the ultimate low price paid by the PBM after all of the secret kickbacks.

PBMs howl and scream if legislation is proposed to remove their “safe harbor,” regulate their utilization management tools or create transparency of the secret kickback packages. They claim that transparency will soften competition and raise prices, in spite of the fact that it is quite obvious that competition to get preferred status on formulary raises prices.

If we are forced to keep this present system in a world of massive political and financial agendas — a “perfect” system is a discussion for another time — I have a few limited suggestions.

Formularies should be constructed on efficacy, safety and lowest list price, which removes kickbacks from the picture and creates a race to the bottom of pricing as opposed to our present system which fosters a race to the top.

If this is impossible at this time, at the very least, we could implement a system in which:

  • All middlemen would be paid a fixed fee based on market value of their services.
  • Patients would pay coinsurance on the post-kickback cost of the drug.
  • Stable patients’ medications would continue to be covered regardless of changes in health plan formularies.

Perhaps, in some small way, if any of these suggestions come to fruition, the “perfectly legal” system we have today will transform into something that is not so “perfectly wrong” and into something “imperfectly right.”

Disclosure: Feldman reports no relevant financial disclosures.