Pharmacy Benefit Managers and Vertical Relationships in Drug Supply

The final delivery of many products depends in part on intermediaries who bargain with upstream manufacturers and then sell reduced-price product bundles to retailers downstream. In health care, pharmacy benefit managers (PBMs) fill a crucial role in the supply chain for drugs by creating drug formularies that include drugs in bundle that is sold to insurers downstream. We study the role of vertical integration between pharmacy benefit managers and insurers in driving access to drugs. Vertical integration allows the two integrated parties to share the rents accrued from the PBM’s upstream bargaining effort, eliminating double marginalization and aligning incentives between these suppliers. However, this integration can also have anticompetitive effects, inducing the PBM to be less willing to deal with rival insurers, passing through a lesser portion of the accrued rebates. We study this empirically in the context of Medicare Part D, the public prescription drug insurance program for seniors. We develop a model of the industry, and use it to empirically to study the impacts of vertical integration. We find that consumers place a higher revealed value on premium reductions than cost savings due to drug tiering. Vertical integration does lead to integrated PBMs raising rivals’ costs, but by a small amount because rival insurers can ultimately substitute to backup formularies at cheaper costs.