Drug costs are both high and baffling. Here are the basics you need to know.

The list price is the price of a drug that the manufacturer initially sets. However, very few people pay list price. The list price is only the starting point for complex negotiations and discounts.

The net price is the amount of money received by a drug company and is usually lower than the list price. The drug manufacturer offers rebates and other discounts to federal, state and private payers and offers direct financial assistance to help patients cover out of pocket costs of a drug that are not covered by insurance. These discounts and rebates can be as high as 50%.

The drug manufacturer then sells his products to wholesalers. There are 3 major drug wholesalers that account for 90% of the market, so they have a lot of clout in negotiating discounts. The wholesalers then mark up the drug and sell it to pharmacies. The larger pharmacy chains can negotiate better prices. The actual price that a consumer pays for a drug is then determined by their insurance coverage.

The insurance companies, employers, Medicare Part D, self-insured employer plans hire pharmacy benefit managers (PBMs) to administer their drug plans and negotiate drug purchases. The PBMs contract with big pharmaceutical companies to try to get better drug prices. They are intermediaries between insurers and other members of the health care industry. They are hired by insurers and employers, operate mail orders, manage distribution among a network of pharmacies, negotiate rebates, process claims from patients and pharmacies and manage formularies for individual health plans. The five largest PBMs control more than 50% of the market. They are for profit companies and include familiar names such as Express Scripts, CVS Caremark, and Optum Health Rx. Health insurance companies work with their PBMs to set formularies, set copays and determine how much patients have to pay for drugs. The PBMs make money by keeping a small percentage of the discounts they negotiate.

Each formulary has different tiers. Drugs in the lowest tier (often generic brands) have the lowest or no copay. Drugs in the highest tier have the highest copay. Each insurer establishes its own formulary and tier system, so there is no uniformity. In the past 10 years, insurance companies started passing 25-80% of the cost of drugs along to patients through copays and deductibles. That is why when a patient is looking for prescription drug insurance through Medicare, it is wise to go to medicare.gov with a list of the drugs that you are taking and find the part D plan with the lowest copay and out of pocket costs for the medications you use. In addition, most part D plans offer several options with different deductibles. There are different complicated rules for Medicaid which is guaranteed a minimum discount of 23.1% off of the average manufacturer’s price (i.e. the average net price the manufacturer bills to wholesalers or pharmacies).