How Rebates Work
Manufacturers pay rebates to PBMs in exchange for preferred formulary placement — placing the drug on a lower cost-sharing tier (Tier 2 vs. Tier 3) or excluding competing drugs from the formulary. Preferred placement drives higher utilization — which is why manufacturers pay for it. Rebates are calculated as a percentage of the drug's list price — typically 20–60% for brand drugs.
The Perverse Incentive
The rebate system creates a perverse incentive: PBMs benefit from high list prices because rebates are calculated as a percentage of list price. A drug with a $10,000 list price and a 40% rebate generates $4,000 in rebates; the same drug with a $5,000 list price and a 40% rebate generates only $2,000. PBMs have a financial incentive to prefer drugs with high list prices — even if lower-cost alternatives are available.
Pass-Through Contracts
IQ Insight
Pass-through PBM contracts pass 100% of rebates to the employer — eliminating the PBM's financial incentive to prefer high-list-price drugs. Under a pass-through contract, the PBM earns only administrative fees — not rebate retention. Pass-through contracts are more transparent and better aligned with the employer's interest in lower drug costs.