How to Evaluate a PBM Contract: What Employers Should Be Looking For

Rebates are payments that drug manufacturers make to PBMs in exchange for favorable formulary placement. They are one of the largest revenue streams in the pharmacy supply chain, and the terms governing how they are shared with the plan are among the most important in the contract.

A pass-through [rebate model](/blog/pharmacy-benefit-reform) means the plan receives 100 percent of the rebates the PBM negotiates on the plan's behalf. A retained rebate model means the PBM keeps a portion — sometimes a large portion — of the rebates and passes through only what the contract specifies.

Employers should look for contracts that guarantee pass-through of all rebates, including administrative fees paid by manufacturers, and that define rebates broadly enough to capture all forms of manufacturer compensation. Contracts that define rebates narrowly — excluding "administrative fees," "data fees," or "market share payments" — may be passing through less than the employer assumes.

The contract should also specify how rebates are calculated, when they are paid, and what audit rights the plan has to verify the rebate amounts.

Spread pricing is the practice of charging the plan more for a drug than the PBM pays the pharmacy, and keeping the difference. It is a significant and often invisible revenue source for PBMs, particularly on generic medications where the spread can be substantial relative to the drug's actual cost.

A pass-through pricing model eliminates spread by requiring the PBM to charge the plan exactly what it pays the pharmacy, plus a transparent dispensing fee. This model makes the PBM's compensation explicit and eliminates the incentive to steer toward higher-spread medications.

Employers should ask their PBM directly whether the contract uses spread pricing or pass-through pricing, and for which drug categories. If the answer is unclear or the PBM is reluctant to answer, that is informative.

The formulary — the list of covered medications and their tier placement — is managed by the PBM, but it should serve the plan's interests, not the PBM's. Formulary decisions that favor higher-rebate medications over lower-cost alternatives may increase rebate revenue while increasing the plan's net drug spend.

Employers should understand how the PBM makes formulary decisions, whether the plan has the ability to customize the formulary, and how step therapy requirements are applied. Step therapy — requiring patients to try a lower-cost medication before a higher-cost one is covered — can be a legitimate cost-management tool, but it can also create barriers to appropriate care if applied too broadly.

The contract should specify the plan's rights to request formulary exceptions and the process for doing so.

The audit rights provision determines whether the plan can verify that the PBM is performing its contractual obligations. A strong audit rights clause gives the plan the right to audit the PBM's claims data, rebate calculations, and pricing at any time, using an independent auditor of the plan's choosing.

Weak audit rights — limited to a narrow window, restricted to certain data, or requiring the PBM's approval of the auditor — provide little practical protection. If the plan cannot verify the PBM's performance, the contract terms are only as good as the PBM's voluntary compliance.

Employers should insist on broad, unrestricted audit rights and should exercise them periodically. PBM audits regularly uncover discrepancies between contracted terms and actual performance.

Many PBM contracts include performance guarantees — commitments to achieve certain outcomes, such as a minimum generic dispensing rate, a minimum rebate per claim, or a maximum administrative cost. These guarantees are only valuable if they are meaningful, measurable, and enforceable.

Employers should evaluate whether the guaranteed metrics are the right ones to measure. A high generic dispensing rate guarantee is less valuable if the PBM is steering toward higher-cost branded drugs in categories where the guarantee does not apply. A rebate guarantee is less meaningful if the plan is paying more in spread than it is receiving in rebates.

Performance guarantees should be evaluated in the context of the overall contract economics, not in isolation.

Most employers do not have the internal expertise to evaluate a PBM contract on their own. Working with an independent pharmacy consultant — one who is not compensated by the PBM and has no financial interest in the outcome — is one of the most valuable investments a self-funded employer can make.

An independent consultant can benchmark the contract terms against the market, identify provisions that are below standard, and negotiate improvements. They can also help the employer understand the total cost of the PBM relationship — not just the contracted rates, but the full economics including spread, retained rebates, and administrative fees.

The PBM contract renewal is not the time to rely on the broker who placed the business. It is the time to bring in someone whose only job is to make sure the plan is getting what it is paying for.