What happened

Shares of CVS Health (CVS 0.28%), America's largest pharmacy benefits manager (PBM), jumped 8.6% in early-morning trading after the White House dropped a plan to outlaw the way PBMs earn a living. Investors relieved to see a serious threat to a source of industry profits recede have pushed the stock 5.4% higher as of 12:15 p.m. on Thursday.

So what 

Last July, Pfizer (PFE -0.97%) and many of its peers made a promise to delay price increases on branded drugs. At around the same time, the Department of Health and Human Services (HHS) submitted a proposal that would have rescinded special protections specifically allocated to the PBM industry that it can't operate without. 

Colorful assortment of pills in a toy shopping cart on a bed of money.

Image source: Getty Images.

Instead of negotiating directly with drugmakers, thousands of smaller healthcare plan sponsors hire PBMs to negotiate on their behalf. The PBMs wrangle undisclosed discounts and rebates from drugmakers in return for the placement of high-priced drugs on affordable copay tiers. In other words, PBMs indirectly encourage drugmakers to raise list prices because the practice allows them to offer larger rebates to PBMs without losing revenue. Secretive rebates also encourage insurers with copay percentages linked to soaring list prices to transition patients to more expensive brand-name drugs when available generics might be sufficient.

As an insurer, a PBM, and a retail pharmacy chain, CVS Health had a lot to lose if it were no longer allowed to play the rebate game. Today's gains would have been more significant if the proposal's eventual death weren't already a foregone conclusion.

Now what

The White House spokesman who announced the president's decision to withdraw the rebate rule change said the administration was encouraged by bipartisan legislation to control drug costs. While this is great news for CVS Health and its peers, the twisted economic incentives that force drugmakers to make enormous price hikes will probably continue to drive up prices for U.S. consumers.

Luckily for the country's drugmakers, a federal judge recently ruled on the plan to force drugmakers to display theoretical list prices of their drugs on all advertisements. According to the ruling, HHS overstepped its authority with the plan. At least when companies like CVS Health lean on drugmakers to offer bigger rebates, they won't have to frighten consumers with soaring list prices.