The cost of misaligned incentives in the pharmaceutical supply chain

Recent concerns over rising drug prices have focused on the role of pharmacy benefit managers or PBMs. While multiple players make up the pharmaceutical supply chain, PBMs are the conductors who effectively decide which drugs are covered and at what cost. Most PBM contracts tie their compensation to a percentage of a drug's list price, creating a financial incentive to favor high-cost, high-rebate drugs on plan formularies at the expense of lower-cost generics and biosimilars. Furthermore, the PBM industry is highly concentrated and vertically integrated with the country's largest health insurers, making it even harder to assess PBM performance and profitability. A simple analysis of annual drug spending at different reporting levels provides important insight into where the money goes and where savings could be achieved. We find that simply delinking compensation to the list price of a drug throughout the supply chain could reduce annual drug spending by more than $95b or nearly 15% of net spending without adversely affecting manufacturers' incentive to innovate.