Don’t Be Fooled by CVS’s New “Guaranteed Net Cost” PBM Business Model


The pharmacy benefit manager (PBM) CVS Caremark has offered its self-insured corporate clients an alternative business model called “Guaranteed Net Cost”.  The pricing scheme features 100% pass-through of drug rebates and the end of rebate retention as an opaque source of PBM gross profits.

But, CVS has glossed over the fact that their “guaranteed net cost” price to plans is not the same as the net costs to them.  Until CVS tells us otherwise, the new business model allows for a opaque markup on top of PBM net cost. In graphs below, we demonstrate how a markup of guaranteed net costs serves as an opaque offset to foregone rebate retention.  

It is naive to think that CVS Caremark is about to give back a significant source of its annual gross profits without some sort of offset. In fact, CVS admits as much as their spokesperson is quoted as saying

CVS’ manager of corporate communications, Christina Beckerman, told Fierce Healthcare that the company does not expect CVS Health’s profitability to increase or decrease as a result of the shift to 100 percent pass-through rebates.

It is not even clear that CVS’s new business model lessens the incentives to Pharma to inflate list prices in order to compete on rebates for formulary placement.

The Problem With the Current PBM Business Model

The current PBM reseller business model features five major streams of revenue and gross profits.  Four of the five are opaque.

  1. Opaque rebate retention % on speciality (biotech) drugs in return for preferred or exclusive placement on formularies;
  2. Opaque rebate retention % on small molecule brand drugs in return for preferred or exclusive status on formularies;
  3. Opaque profit margins on 90-day generic Rx filled by captive mail order operations of the PBM;
  4. Opaque “spread margins” added by the PBM on top of reimbursements to retail pharmacies included in their networks;
  5. Transparent claims processing and data fees.

The opacity of drug rebates is magnified by the fact that reimbursements for brand drug Rx and related rebates come at different times.   It is impossible for plans match up these two streams and calculate a single net price its pays per drug.

Since the early 2000s, PBMs have continually come under attack for not acting in the best interest of their clients.  We have written a number of papers since 2004 pinpointing an opaque reseller business model as the source of this misalignment.

The PBM reseller business model is in stark contrast to two other transparent business models used by managed care companies:  

  1. a PMPY fee-for-service agency model where 100% of all reimbursements and rebates are passed through to plans.
  2. a risk-based insurance model with capitated premiums paid by plans.

Until the PBM Medco’s merger with Express Scripts in 2012, Medco’s financial 10-Q and 10-K reports to the SEC broke out gross rebates received — a credit to cost of sale — and rebates retained — a credit to sales.  We were able to calculate with certainty Medco’s “rebate retention rate”, a name we coined fifteen year ago in 2003.

We calculated that Medco’s rebate retention rate — the percentage of gross rebates retained — fell from 55% in 1Q03 to 28% in 2Q05.  This rapid decline was due to the sudden awareness by clients of the whole rebate retention scheme. To offset this loss, Medco began to push clients toward its captive mail order and fat margins it began to earn on mail order generic Rx fills.

The share of Medco’s overall gross profits coming from retained rebates reflected  outrageous rebate retention rates.  For 3Q04, we derived with certainty from Medco’s 10-Q that 71% of its gross profits came from retained rebates from small molecule brand drugs.  By 2Q05, we estimated with certainty that Medco’s retained rebate share of gross profits had dropped to 48% with the difference going to their newly found focus on mail order generics.

In our 2017 paper “Three Phases of the PBM Business Model”, we carried forward our mid-2000s work on disaggregating PBM gross profits by sources.  Below is a summary of that work.

Here is a graph of the above data:

CVS’s Guaranteed Net Cost Business Model

On December 5, 2018,  CVS Caremark introduced a new pharmacy benefit manager (PBM) business model option for self-insured corporate drug benefit plans.   

The core of this new business model is a simplified reimbursement price paid by plans to CVS that the company craftily describes as “Guaranteed Net Cost”.  Craftily, in that this so-called “cost” is really a “price” where the difference between “cost” and “price” is a markup.

The company touts the following distinguishing features of this simplified reimbursement price.

  • Drug cost predictability and simplicity
  • 100% of rebates are passed through to plan sponsors
  • Simpler payments flow — no retrospective rebates or inflation adjustments
  • Simpler way to compare different PBM contract proposals

Note this new pricing model is for brand drugs only dispensed at retail, mail order and specialty pharmacies.  The generic Rx drug reimbursement pricing scheme remains the same. That is to say, it preserves an opaque “spread margins” that PBMs like CVS add on top of CVS reimbursements to retail pharmacies for generic Rx drug fills.

This new CVS’s initiative clearly is in response to the tsunami of criticism by plan sponsors over an opaque PBM business model and the difficulty in matching initial Rx reimbursements at an inflated list prices with retrospective rebates occurring months later.

The Problem with CVS’s Guaranteed Net Cost Business Model

One: Opaque Markups

The problem with CVS’s new business model is that guaranteed net cost to plans is not necessarily the same as the net cost to PBMs. CVS never states unequivocally that its guaranteed net cost to plans = net cost to CVS.  In other words, CVS’s new business model allows for an opaque markup on top of its net cost.

Consider this meta:  CVS opaquely is substituting one opaque source of gross profits — guaranteed net cost markup — for another opaque source — retained rebates.

It is naive to think that CVS is about to give back some of its oligopolistic profits.  In fact, CVS admits as much as their spokesperson is quoted as saying

“ CVS’ manager of corporate communications, Christina Beckerman, told Fierce Healthcare that the company does not expect CVS Health’s profitability to increase or decrease as a result of the shift to 100 percent pass-through rebates”

The following is a numeral example of how the opaque markup can serve as a 1-for-1 substitute for retained rebates:

Here is a graphical depiction of our view that CVS is substituting an opaque markup for an opaque rebate retention:

To CVS’s credit, its new guaranteed net cost eliminates timing complexity. It does this by taking a risk and netting the current period Rx reimbursement with an estimated “expected” rebate rather than wait to credit plans with the actual rebate when it is paid by Pharma months later.  

CVS certainly is justified in including some markup as compensation for taking the risk that their estimated expected rebates turn out to be less than actual rebates.

Instead, CVS decided not mention markup at all,  let alone a justified markup as a compensation for assuming timing risk.

TWO: Doubtful Elimination of Incentive to Play the High List – High Rebate Game

Under the current retained rebate business model,  PBMs are incentivized to favor drugs with the highest gross rebates to the exclusion of therapeutically equivalent drugs with the lowest net cost.  To be in a position to win this rebate game, Pharma is driven by the PBM-created rebate game to inflate list prices for its brand drugs.  See our paper: Blame PBMs (Not Pharma) for Drive Drug Price Inflation.

The list price – net price bubble began around 2010 and reached its peak in 2017. It was in 2017 that AbbVie first broke the PBM rebate game  winning formulary placement by Express Scripts despite pricing its late entrant Hepatitis C Virus (HCV) drug Mavyret with an ultra low list price with no rebate potential.  However, this was an exception and the norm remains that the basis for formulary placement is gross rebates over net price (list price – gross rebates).

Below is a graphical depiction of how AbbVie broke the rebate game with its ultra low list = no rebate drug HCV drug Mavyret.

It is possible that the rebate game of high list – high gross rebate may be lessened under CVS’s new guaranteed net cost new business model. This is because the basis for PBM profits — markups — could be any number as opposed to being tethered to something like % of gross rebates or % of net cost.

Below is a depiction of CVS’s flexibility in choosing a markup that is independent of the list price or gross rebate. 

On the other hand, we can see the possibility that the new business model preserves the status quo. Here is our line of reasoning for this:

it is likely that brand drug list prices, which are publically available,  will serve as an upward bound for guaranteed net cost as it would look bad for CVS to set a guaranteed net cost that exceeded a drug’s list price.

To look good, CVS will want to show that guaranteed net costs is consistently 40% to 70% below the brand list prices.  

To achieve these percentages while still having room for oligopolistic markups, CVS will signal to Pharma that, while formulary placement is no longer based on gross rebates, high list – high rebate drugs afford CVS latitude in setting guaranteed net cost markups.

Below is a graphical depiction of why, under the new business model, CVS still would be incentivized to favor the high list – high rebate drug.