Pharmacy Rebates: How They Work and Who Really Benefits

What Are Pharmacy Rebates?

Pharmaceutical manufacturers pay rebates to PBMs in exchange for preferred placement on the PBM's formulary — the list of covered drugs. A drug on the preferred tier has lower cost-sharing for members, which drives higher utilization. Higher utilization means more revenue for the manufacturer. The rebate is the manufacturer's payment for that market access.

Rebates are negotiated confidentially between manufacturers and PBMs. The amounts are not publicly disclosed. For common brand-name drugs, rebates typically range from 20 to 50% of the list price. For specialty drugs, rebates can exceed 50% of list price. In aggregate, manufacturer rebates to PBMs exceeded $200 billion in 2022 — making them one of the largest financial flows in the US healthcare system.

How Rebates Flow Through the System

Understanding the rebate flow helps employers identify where value is being captured — and where it is being lost.

1. 1Manufacturer sets a list price (WAC — Wholesale Acquisition Cost) for a drug.
2. 2PBM negotiates a rebate with the manufacturer in exchange for preferred formulary placement.
3. 3Member fills the prescription; the plan pays based on the list price minus the contracted discount.
4. 4Manufacturer pays the rebate to the PBM — typically quarterly, based on utilization data.
5. 5PBM retains a share of the rebate as revenue and passes the remainder to the plan.
6. 6The plan's net cost is the amount paid at the pharmacy minus the rebate received — but most employers never see this calculation.

The Rebate Retention Problem

Traditional PBMs retain a portion of manufacturer rebates as undisclosed revenue. The retained amount varies by PBM and contract, but industry estimates suggest that traditional PBMs retain 10 to 30% of total rebates — representing hundreds of millions of dollars annually across their book of business.

• Retained rebates are not disclosed in standard PBM reporting. Employers typically see only the rebates passed through — not the total rebates generated.
• The only way to know the total rebate generated is through an audit with access to manufacturer invoices — which traditional PBM contracts often restrict.
• Retained rebates create a conflict of interest: the PBM has a financial incentive to prefer drugs that generate large rebates, even when lower-cost alternatives exist.
• Some PBMs charge administrative fees as a percentage of rebates before passing the remainder — a second layer of retention on top of the base retention.

The Formulary Incentive Problem

Rebates create a structural incentive for PBMs to design formularies that maximize rebate revenue rather than minimize plan cost. A drug with a high list price and a large rebate may be preferred over a lower-cost drug with no rebate — even when the net cost of the lower-cost drug is lower.

This dynamic is most visible in the specialty drug market, where list prices are highest and rebates are largest. A biologic drug with a $50,000 annual list price and a 40% rebate generates $20,000 in rebates — of which the PBM may retain $4,000 to $6,000. A biosimilar alternative with a $30,000 list price and no rebate generates no PBM revenue — even though it costs the plan $20,000 less after rebates.

Maximizing Rebate Value

Employers who want to maximize the value of manufacturer rebates have several options:

• Pass-through contract: Require 100% rebate pass-through in your PBM contract. Transparent PBMs offer this as their standard model.
• Rebate audit: Conduct an independent audit of rebates generated versus rebates passed through. This requires access to manufacturer invoices — negotiate this audit right explicitly.
• Formulary optimization: Work with your PBM or a pharmacy consultant to design a formulary that minimizes net cost — not just maximizes rebates. These are not always the same thing.
• Rebate aggregators: Some independent consultants aggregate rebate contracts across multiple employer plans to negotiate better rebate terms than any single employer could achieve alone.
• Point-of-sale rebates: Some PBMs now offer point-of-sale rebate programs that apply rebates directly to the member's cost-sharing at the pharmacy — reducing out-of-pocket costs and improving adherence.