Understanding Pharmacy Benefit Managers, Spread Pricing, and Rebates

Pharmacy Benefit Managers (PBMs), spread pricing, and the rebate system—these terms are often cloaked in industry jargon, creating confusion. For HR professionals managing benefits, understanding these mechanisms is key to balancing employee needs with cost control. Let’s demystify these components to see how PBMs work and their influence on drug pricing.

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Decoding Formulary Tiers: Not All Medications Are Created Equal

PBMs manage drug costs through formularies—tiered lists of medications that categorize drugs based on cost, therapeutic value, and coverage options. These tiers determine both the availability of specific drugs and the out-of-pocket costs for patients, significantly impacting an employee’s choices and expenses when seeking medication. Each tier has distinct characteristics and cost implications:

Tier 1: Generic Medications

This tier includes generic versions of brand-name drugs, typically the most affordable options for patients. PBMs encourage the use of Tier 1 drugs due to their cost-effectiveness, as generics offer similar therapeutic effects as brand-name drugs but at a fraction of the cost. Employees may face minimal co-pays, promoting accessibility for essential medications.

Tier 2: Preferred Brand-Name Medications

These drugs are brand-name medications that PBMs have negotiated for discounts with manufacturers, making them more affordable than non-preferred options. By negotiating reduced rates, PBMs aim to keep these drugs accessible while slightly higher than Tier 1 generics. Preferred brands are strategically included to provide cost-effective alternatives without sacrificing treatment quality.

Tier 3: Non-Preferred Brand-Name Medications

This category comprises brand-name drugs that lack significant PBM-negotiated discounts, often due to limited competition or high manufacturer pricing. These medications generally have higher co-pays, encouraging patients to consider Tier 1 or Tier 2 alternatives. Employers and patients may experience increased costs if they choose medications from this tier, as PBMs apply additional charges.

Tier 4: Specialty Drugs

Specialty medications, often used to treat complex or chronic conditions like cancer or autoimmune disorders, reside in Tier 4. These drugs typically require special handling, administration, or monitoring, which contributes to their high cost. Co-pays and out-of-pocket expenses are the highest for this tier, reflecting the elevated cost of producing and distributing specialty medications. Patients may face significant financial burdens, even with coverage, due to the lack of affordable alternatives.

While these formulary tiers offer a structured approach to drug coverage, they don’t always result in lower costs for employees. Rebates, spread pricing, and PBM negotiations further complicate how drugs are placed within these tiers, often making it difficult for patients and plan sponsors to identify the most cost-effective options.

Navigating the Complexities of Rebates

PBMs often negotiate rebates from pharmaceutical manufacturers in exchange for favorable placement on formularies. While rebates theoretically aim to lower costs, PBMs frequently retain a large portion as profit, resulting in higher out-of-pocket patient expenses. This practice can obscure true drug costs, making it difficult for employers and patients to gauge actual spending.

The lack of transparency surrounding rebates allows PBMs to benefit financially while plan sponsors and employees bear the brunt of inflated prices. Spread pricing further compounds this issue, highlighting the need for increased oversight in PBM practices.

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Spread Pricing: Widening the Gap Between Cost and Reimbursement

Spread pricing occurs when PBMs charge employers more than what they reimburse pharmacies, pocketing the difference as profit. PBMs use an average wholesale price to negotiate a discount with employers, then reimburse pharmacies at a lower rate. This practice results in a hidden margin, increasing costs for employers and employees.



When spread pricing is prevalent, neither employers nor patients have a clear view of the actual cost of prescriptions. Without transparency and regulatory oversight, PBMs can continue this practice with minimal accountability, impacting overall healthcare spending.

Legislative Efforts and Calls for Reform

As awareness grows, so does the call for transparency in PBM practices. Several states and federal legislators are pushing for reforms that aim to curtail self-serving PBM practices and introduce transparency in drug pricing.

●     Pharmacy Benefit Manager Reform Act

A Senate bill aiming to ensure PBMs act in the best interest of clients, advocating for open contracts and accountability.

●     Protecting Patients Against PBM Abuses Act

A bipartisan House bill designed to eliminate spread pricing, making PBM profits more service-based and transparent.

●     The DRUG Act

A federal bill aimed at setting benchmarks for Medicare drug pricing, increasing transparency, and driving savings for Medicaid programs.

●     Transparency in Coverage Final Rule

This rule promotes clarity in drug pricing to empower consumers and employers, allowing them to make informed decisions regarding prescription coverage.

These legislative efforts reflect a growing recognition of the need for a system that serves employers and employees, not just corporate interests.

FAQs About Pharmacy Benefit Managers, Spread Pricing, and the Rebate System

How does PBM spread pricing work?

PBMs negotiate discounts on medications with employers and insurance providers, then reimburse pharmacies at a lower rate than the negotiated price. The difference between what the employer pays and what the pharmacy receives—known as the "spread"—serves as profit for the PBM. This practice raises costs for plan members and employers.

How do PBM rebates work?

What is the pass-through pricing model?

What is the difference between spread and pass-through pricing?

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