What is the role of pharmacy benefit managers in employer drug costs?

Pharmacy benefit managers (PBMs) are the often-unseen architects behind your employees’ prescription drug coverage. They sit between employers, health plans, drug manufacturers, and pharmacies, managing the complex web of pricing, formularies, and distribution. Their original purpose was to leverage scale and expertise to control costs and improve access. Today, PBMs administer drug benefits for more than 275 million Americans, and for most self-insured employers, they are the single most influential force on pharmacy spend-which can account for 20% to 30% of total healthcare costs.

How PBMs Influence Drug Costs

PBMs shape employer drug costs through four primary levers:

• Formulary Design and Rebate Negotiation: PBMs decide which drugs are covered (the formulary) and at what tier. They negotiate rebates with manufacturers in exchange for favorable formulary placement. These rebates can be substantial-often 20% to 60% of a drug’s list price-and are a critical lever for offsetting costs. However, the flow of rebate dollars back to the employer varies widely by contract type.
• Pharmacy Network Management: PBMs set reimbursement rates to pharmacies and determine dispensing fees. By steering members to preferred pharmacies and using mail-order facilities, PBMs can reduce ingredient-cost spreads and improve adherence. However, aggressive below-cost reimbursement can destabilize independent pharmacies and lead to access issues.
• Utilization Management: Prior authorization, step therapy, quantity limits, and therapeutic interchange are all PBM-driven tools that influence which prescriptions get filled. When used appropriately, they prevent wasteful spending on high-cost, low-value drugs. When overly restrictive, they can delay care and frustrate employees.
• Specialty Drug Management: Specialty medications now represent over 50% of total drug spend for many employers. PBMs manage these high-cost therapies through limited distribution networks, white-bagging, and site-of-care restrictions, which can dramatically alter the total cost of care.

The Transparency Problem and Hidden Revenue Streams

While PBMs can lower unit costs, their business practices can also inflate employer expenses in less visible ways. Traditional PBM models retain a portion of rebates, engage in spread pricing (where the plan pays a higher amount than the pharmacy is reimbursed, and the PBM keeps the difference), and collect administrative fees from manufacturers and pharmacies. These retained revenues can erode the savings employers think they are getting. A 2023 analysis by the ERISA Industry Committee found that spread pricing alone can add 15% to 30% to the cost of generic drugs compared to a pass-through model.

Further complicating the picture are direct and indirect remuneration (DIR) fees, which PBMs claw back from pharmacies months after a claim is adjudicated. These fees are often not transparent to plan sponsors and can mask the true net cost of the benefit. The net result: an employer may achieve a low “spread” on claims but still overpay when all opaque revenue streams are tallied.

Fiduciary Duty and the Regulatory Shift

The Consolidated Appropriations Act of 2021 (CAA) fundamentally changed the game for employer-sponsored health plans. It requires PBMs and other service providers to disclose direct and indirect compensation, effectively making much of the hidden revenue visible for the first time. Under ERISA, plan sponsors have a fiduciary duty to ensure that the fees they pay are reasonable and that the plan’s assets are used solely for the benefit of participants. That means employers must now actively scrutinize PBM contracts, understand true net cost, and be able to demonstrate that their PBM selection was made in the best interest of plan members.

The CAA also prohibits gag clauses that prevented PBMs from sharing cost or quality data with plan sponsors. Additionally, upcoming prescription drug reporting mandates (RxDC) will require detailed data submissions on pharmacy spend, rebates, and premiums, arming employers with benchmarking data to identify whether their PBM is delivering competitive value.

Strategies for Employers to Align PBM Incentives

Given this landscape, employers can take several concrete steps to ensure their PBM relationship drives down net costs rather than simply moving money off the balance sheet:

1. Adopt a Pass-Through Model: In a pass-through arrangement, all rebates, discounts, and network fees are passed directly to the plan sponsor, and the PBM is paid an administrative fee per claim. This removes the incentive for the PBM to favor higher-priced drugs with larger rebates.
2. Carve Out the PBM from the Medical Plan: Instead of bundling PBM services through a health plan’s integrated TPA, consider a standalone, transparent PBM contract. This allows for a direct fiduciary relationship and often yields better financial guarantees.
3. Conduct Regular Audits: Engage a pharmacy benefit auditor to review claims, rebate guarantees, and MAC (maximum allowable cost) pricing accuracy. Many organizations recover 1% to 3% of total drug spend through audit recoveries and contract enforcement.
4. Leverage Coalition Purchasing and RFPs: Employer-led coalitions like the PBM Accountability Project or groups such as the National Alliance of Healthcare Purchaser Coalitions can aggregate purchasing power and demand transparent contracting. Regularly re-bidding the PBM service every three to five years ensures market-competitive pricing.
5. Focus on Clinical Value: Work with a PBM that offers a robust drug evaluation process not solely based on rebate potential. Value-based formularies that prioritize high-value therapies (e.g., biosimilars, proven generics) can lower net cost per member while maintaining quality.

The Bottom Line

PBMs are indispensable to controlling drug costs, but they are not a set-it-and-forget-it vendor. Their role in employer drug spend is as much about contract architecture and incentives as it is about clinical management. An employer that treats the PBM relationship with the same rigor as a 401(k) investment committee-demanding transparent, reasonable fees, monitoring performance, and documenting fiduciary decisions-will be best positioned to protect both their bottom line and their employees’ health. In today’s environment, the role of a PBM is what you negotiate it to be.