A pharmacy benefit manager, or PBM, runs the prescription drug side of a health plan. It decides which drugs are covered, builds the pharmacy network, processes every prescription claim and negotiates rebates with drug manufacturers. For most employers the PBM influences a large share of total plan cost, yet it is the least understood contract in the benefits program.
Key takeaways
- PBMs sit in the middle of health plans, drug manufacturers and pharmacies, and earn money from all three.
- The market is concentrated. The Federal Trade Commission found the three largest PBMs processed nearly 80% of about 6.6 billion U.S. prescriptions in 2023, and the six largest nearly 95%.
- How you are paid matters more than the discount. Spread pricing, retained rebates and specialty pharmacy markups can outweigh a headline discount.
- Control depends on funding. A fully insured plan takes the carrier’s PBM as is. A self-funded plan can choose its PBM, negotiate the contract and audit it.
What a PBM does
- Formulary: the list of covered drugs and which tier each sits in, which sets the copay.
- Pharmacy network: which retail, mail-order and specialty pharmacies members can use, and what each is paid.
- Claims processing: checking eligibility and plan rules at the pharmacy counter in real time.
- Utilization management: prior authorization, step therapy and quantity limits.
- Manufacturer rebates: negotiating payments from drug makers in exchange for preferred formulary placement.
- Specialty pharmacy: dispensing high-cost drugs, often through a pharmacy the PBM itself owns.
How PBMs make money
| Revenue source | How it works | What to ask |
|---|---|---|
| Spread pricing | The PBM charges the plan more for a prescription than it pays the pharmacy and keeps the difference. | Is pricing pass-through, with the pharmacy’s reimbursement billed to the plan at cost? |
| Rebate retention | Manufacturer rebates are paid to the PBM, which keeps part before passing the rest to the plan. | Does the contract define rebates to include all manufacturer revenue, including administrative and data fees? |
| Administrative fees | A per-claim or per-member fee for processing. | Are fees disclosed in one place, or spread across services? |
| Affiliated pharmacies | The PBM steers prescriptions, especially specialty drugs, to pharmacies it owns. | What does the plan pay for specialty drugs compared with other pharmacies? |
| Pharmacy fees | Fees charged back to pharmacies after the claim is paid. | Are those amounts credited to the plan? |
The FTC’s interim staff report in 2024 found that pharmacies affiliated with the three largest PBMs accounted for nearly 70% of all specialty drug revenue, and that they retained an estimated $1.6 billion in excess revenue on just two cancer drugs in under three years. None of this is visible on a standard renewal.
Traditional vs pass-through PBM contracts
| Traditional (spread) | Pass-through (transparent) | |
|---|---|---|
| Drug pricing | Plan price differs from pharmacy payment | Plan pays what the pharmacy is paid |
| Rebates | Shared under a guarantee or percentage | 100% passed to the plan |
| PBM earns from | Spread, rebates, fees | A disclosed administrative fee |
| Audit rights | Often limited | Full claim-level audit |
| Headline discounts | Often look larger | Often look smaller, net cost frequently lower |
Neither model is automatically cheaper. What matters is the net cost per prescription after every source of PBM revenue is accounted for, which is why contract definitions matter more than the quoted discount.
What employers can control
Fully insured plans
The carrier chooses the PBM and the formulary, and the drug cost is built into the premium. You can still choose between plan designs and formulary options, and you can see prescription cost trends in renewal reports.
Self-funded plans
You can carve the pharmacy benefit out of your medical administrator and hire a PBM directly, put the contract out to bid, demand pass-through pricing and audit the results. Because the plan pays the claims, every dollar saved stays in the plan. Our ASO health plan explainer covers how self-funded plans are set up.
Contract terms worth negotiating:
- Clear definitions of brand, generic and specialty drugs that the PBM cannot change mid-contract.
- A broad rebate definition covering all manufacturer payments, with 100% passed through.
- Pricing guarantees measured by drug category, with shortfalls paid back.
- Full audit rights, including an auditor of your choosing, at least once a year.
- The right to receive claim-level data and to terminate without penalty if terms are not met.
Our PBM contract and rebate audits page and our Michigan PBM audit guide go deeper on each term.
Why this is now a fiduciary question
Under ERISA, employers that sponsor health plans are fiduciaries and must pay only reasonable fees for plan services. The Consolidated Appropriations Act of 2021 increased the pressure: it bans gag clauses that keep plans from accessing their own cost and claims data, and it requires annual prescription drug data reporting to federal agencies. An employer that never reviews its PBM contract has a harder time showing it acted prudently. See our gag clause attestation and fiduciary process review pages.
GLP-1s and specialty drugs raise the stakes
Specialty drugs and GLP-1 medications are the fastest-growing part of most pharmacy budgets. Whether they are covered, what prior authorization requires and which pharmacy dispenses them are all PBM decisions. Our employer guide to GLP-1 and specialty drug cost management covers the options, and our pharmacy benefit consulting page explains how we help.
More plain-English benefits explainers
- What Is an HSA?: health savings accounts, limits and employer rules
- What Is an HMO?: how HMO plans work and who they fit
- What Does EE Mean?: EE, ES, EC and family coverage tiers
- What Is Form 1094-C?: the employer transmittal and the 95% offer test
- What Is Form 1095-C?: the employee statement, its codes and deadlines
- What Is an ASO Health Plan?: how administrative services only, self-funded plans work
- How Much Does COBRA Insurance Cost?: averages, deadlines and cheaper options
- What Is EBSA?: the Department of Labor agency that enforces ERISA
- What Is a Broker of Record Letter?: how to change brokers without changing your plan
- Offering Group Health Insurance With No Employer Contribution: a guide for businesses with 2-50 employees
- What Is Stop-Loss Insurance?: specific and aggregate coverage for self-funded plans
- What Is Commercial Health Insurance?: private coverage versus government programs
Frequently asked questions
What does a pharmacy benefit manager do?
A PBM manages the prescription drug benefit for a health plan: it sets the formulary, builds the pharmacy network, processes prescription claims, applies prior authorization and other controls, and negotiates rebates with drug manufacturers.
How do PBMs make money?
Through spread pricing (charging the plan more than it pays the pharmacy), keeping part of manufacturer rebates, administrative fees, fees charged to pharmacies, and dispensing drugs through pharmacies they own.
How big are the largest PBMs?
According to the FTC’s 2024 interim staff report, the three largest PBMs processed nearly 80% of the approximately 6.6 billion prescriptions filled in the U.S. in 2023, and the six largest nearly 95%.
What is a pass-through PBM?
A pass-through PBM charges the plan exactly what it pays the pharmacy, passes 100% of manufacturer rebates to the plan, and earns a disclosed administrative fee instead of profiting from spreads and retained rebates.
Can a small employer choose its PBM?
Generally not on a fully insured plan, where the carrier chooses the PBM. Employers with self-funded or level-funded plans often can choose, or at least negotiate, their PBM arrangement.
Get a second opinion on your pharmacy benefit
CFH Insurance Consultants is an independent employee benefits firm. We are licensed insurance brokers, and for proper coverage of an account we work in teams of five. Send us your PBM contract or your latest renewal and we will show you where the money goes, what the terms actually guarantee, and what a competitive bid could change. Start here, call 248.370.8853, or book a 30-minute call.
This article is general information, not legal advice. Market figures are from the Federal Trade Commission’s July 2024 interim staff report on pharmacy benefit managers.
