Common Agent or Double Agent? Pharmacy Benefit Managers in the Prescription Drug Market

Pharmacy benefit managers (PBMs) play a central role in the U.S. market for prescription drugs. However, the operations of PBMs, like other business intermediaries, are generally opaque and have become controversial as they have grown in size relative to other market participants. We present a model in which PBMs are market intermediaries who operate a “formulary”—a list of prescription drug options—on behalf of payers (consumers and third-party payers). The producers in this market—prescription drug makers—pay rebates to PBMs as bids in a contest for favored formulary positions. We find that formularies improve efficiency even when the PBM is a monopoly. Competition among PBMs has distributional but not efficiency consequences. When PBMs are highly concentrated, the gains from formularies accrue to PBMs rather than consumers or producers. The model also identifies threats to formulary efficiency and offers a framework for understanding both current market organization and proposed market reforms in the health care market. The results also have implications for the operation of intermediaries in non-healthcare markets.