Key Takeaways
- A pharmacy benefit manager (PBM) administers prescription drug benefits on behalf of health plans — processing claims, managing formularies, and contracting with pharmacies.
- The three largest PBMs — CVS Caremark, Express Scripts, and OptumRx — control roughly 80% of the US market and are vertically integrated with insurers and pharmacy chains.
- PBMs generate revenue through spread pricing, rebate retention, and administrative fees — creating conflicts of interest that cost employers billions annually.
- Transparent, independent PBMs pass 100% of rebates to the plan and charge a flat per-claim fee — eliminating the hidden revenue streams of traditional PBMs.
- Understanding how your PBM makes money is the first step to controlling your pharmacy spend.
What a PBM Does
A pharmacy benefit manager is the intermediary between your health plan and the pharmacy system. When an employee fills a prescription, the PBM processes the claim, verifies eligibility, applies the formulary, adjudicates cost-sharing, and pays the pharmacy. The PBM also negotiates drug prices with manufacturers, manages the network of pharmacies, and administers clinical programs like prior authorization and step therapy.
On paper, the PBM is a service provider working on your behalf. In practice, the PBM is a profit-maximizing intermediary with multiple revenue streams — many of which are not visible to the employer and are not aligned with the employer's interest in lower drug costs.
The three largest PBMs — CVS Caremark, Express Scripts (Cigna), and OptumRx (UnitedHealth) — are owned by or affiliated with the largest health insurers and pharmacy chains in the country. This vertical integration creates structural conflicts of interest that are baked into the traditional PBM model.
How PBMs Make Money
Traditional PBMs have multiple revenue streams, most of which are opaque to employers. Understanding these revenue streams is essential to evaluating your PBM contract and identifying where you are being overcharged.
| Revenue Stream | Description | Employer Impact |
|---|---|---|
| Spread pricing | PBM charges plan more than it pays the pharmacy; keeps the difference | Direct cost to employer; often hidden in generic claims |
| Rebate retention | PBM negotiates manufacturer rebates but keeps a share before passing remainder to plan | Employer receives less than 100% of rebates earned |
| Administrative fees | Per-claim fees, setup fees, reporting fees | Visible but often negotiable |
| DIR fees | Pharmacy "direct and indirect remuneration" fees clawed back from pharmacies after dispensing | Reduces pharmacy reimbursement; may affect network access |
| Formulary placement fees | Manufacturers pay for preferred formulary placement | May result in higher-cost drugs being preferred over lower-cost alternatives |
| Mail order margin | PBM-owned mail order pharmacy captures margin on dispensing | Employer steered to PBM-owned pharmacy regardless of cost |
Spread pricing alone costs self-funded employers an estimated $2 to $4 billion annually. A 2019 Ohio Medicaid audit found that PBMs charged the state $224 million more than they paid pharmacies for generic drugs in a single year. The same dynamic exists in commercial employer plans.
The Traditional vs. Transparent PBM Model
The PBM market has bifurcated into two models: traditional (opaque) PBMs and transparent (pass-through) PBMs. Understanding the difference is the foundation of any pharmacy cost-containment strategy.
| Dimension | Traditional PBM | Transparent PBM |
|---|---|---|
| Pricing model | Spread pricing on generics and brands | Pass-through: plan pays actual ingredient cost + flat fee |
| Rebates | Retain a share; pass remainder to plan | Pass 100% of rebates to plan |
| Mail order | Steers to PBM-owned pharmacy | Agnostic; best-price dispensing |
| Reporting | Limited; aggregate data only | Full claim-level transparency |
| Conflicts of interest | High — vertically integrated | Low — independent, no ownership of pharmacies |
| Administrative fee | Bundled and opaque | Explicit per-claim fee |
Transparent PBMs include vendors like Navitus, Capital Rx, SmithRx, and RxBenefits. They charge a flat per-claim administrative fee (typically $2 to $5 per claim) and pass 100% of rebates and ingredient cost savings to the plan. For most employers, the switch from a traditional to a transparent PBM saves 15 to 30% on total pharmacy spend.
The PBM Procurement Process
Selecting or re-evaluating a PBM requires a structured procurement process. The key steps are:
- 1Claims data extraction: Obtain 24 months of claim-level pharmacy data from your current PBM. This is your baseline for evaluating alternatives.
- 2RFP development: Issue a request for proposal to at least 3 PBMs — including at least one transparent PBM. Require a shadow claim analysis on your historical data.
- 3Shadow claim analysis: Each PBM reprices your historical claims under their contract terms. This is the most reliable way to compare total cost.
- 4Contract review: Engage a pharmacy benefits consultant or attorney to review the contract for spread pricing provisions, rebate guarantees, audit rights, and termination clauses.
- 5Implementation planning: A PBM transition requires employee communication, formulary mapping, and pharmacy network verification. Plan for 90 to 120 days.
Key Contract Terms to Negotiate
Whether you stay with your current PBM or switch, these contract terms are non-negotiable for a well-protected employer.
- Pass-through pricing: The plan pays actual ingredient cost (AWP minus a guaranteed discount) plus a flat dispensing fee. No spread.
- 100% rebate pass-through: All manufacturer rebates are passed to the plan within 30 days of receipt. No retention.
- Audit rights: The employer has the right to audit PBM claims data, rebate calculations, and pharmacy payments at any time.
- Most Favored Nation (MFN): The employer receives pricing no worse than the PBM's best commercial contract terms.
- Termination for convenience: The employer can terminate the contract with 90 days notice without cause.
- Data ownership: The employer owns all claims data and can extract it in a standard format at any time.
Your Action Steps
- 1Request 24 months of claim-level pharmacy data from your current PBM — ingredient cost, plan paid, and rebates received.
- 2Calculate the spread on your generic claims: compare what your plan paid versus the pharmacy's acquisition cost (available from NADAC data).
- 3Identify what percentage of manufacturer rebates your PBM passes through versus retains.
- 4Issue an RFP to at least one transparent PBM and request a shadow claim analysis on your historical data.
- 5Review your current PBM contract for audit rights, rebate pass-through language, and termination provisions.
- 6Engage a pharmacy benefits consultant to evaluate your PBM contract and RFP responses — the fee is typically recovered in the first month of savings.
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