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By Matthew Coffina, CFA | 04-16-2015 05:00 PM

PBMs: Health Care's Hidden Gems

Pharmacy benefit managers aren't household names, but recent consolidation in the industry is proving out the power of scale for these firms, says Morningstar's Matt Coffina.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Matt Coffina--he is the editor of Morningstar StockInvestor newsletter--to see what impact the UnitedHealth-Catamaran merger will have on the pharmacy-benefit-manager space.

Matt, thanks for joining me.

Matt Coffina: Thanks for having me, Jeremy.

Glaser: So, can you give us a little bit of background on what these PBMs are and why they are so important to the health-care system?

Coffina: Pharmacy benefit managers maybe are not household names, but they're very important within the health-care system and their role is really to manage pharmacy benefits on behalf of employers and managed-care organizations. So, when you go to the drugstore, you present your insurance card and what's happening on the back-end of that is that the pharmacy benefit manager is negotiating rebates with branded drugmakers. They are negotiating for discounts with generic drugmakers through their mail-order pharmacies. They are negotiating prices with the retail pharmacy, and then they are taking the funds from the client and passing them through to the retail pharmacy collecting the rebates from the drugmaker and so on.

So, they're really processing claims behind the scenes, operating mail-order pharmacies for consumers who want to get their drugs directly from the PBM through the mail, and then negotiating the best deals that they can with suppliers, which would include generic and branded drugmakers, distributors, and retail pharmacies.

Glaser: How is landscape going to change with this merger?

Coffina: The PBM space is already fairly consolidated. We've seen a lot of mergers over the years. It's been a very active space over the past five years. For example, we saw CVS (CVS), which is a major retail pharmacy, acquire Caremark, which is a major PBM. We saw Express Scripts (ESRX) acquire Medco. Those were two of the top three PBMs before the merger, and now Express Scripts is the largest PBM. Most recently, as you mentioned, UnitedHealth (UNH) acquiring Catamaran (CTRX)--those were the number-three and number-four players coming together to form an even stronger number-three player.

What we are left with is the top three players controlling about 75% of drug spending in the United States, and I think this really points to the importance of scale within this business. So, the larger you are as a pharmacy benefit manager, the more you are able to direct patients to one drug choice over another or one retail pharmacy over another. That really gives the PBMs bargaining power over their suppliers. So, the larger you are, the more bargaining power you have and the better terms you are able to negotiate with those suppliers. And you're able to pass through most of those cost savings to customers--which, again, are the employers or the insurance companies, the managed-care companies.

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