Rebate Economics

Drug manufacturer rebates are the most consequential and least transparent financial flow in pharmacy benefits. They influence which drugs are covered, how much plans actually pay, and whether patients end up on the most cost-effective therapy.

The Mechanics

A manufacturer offers a PBM a rebate, typically expressed as a percentage of the drug's WAC or AWP, in exchange for the PBM placing that drug on a preferred formulary tier. The rebate is paid retrospectively, usually quarterly, based on actual claims volume. The more prescriptions filled for that drug, the more rebate revenue flows to the PBM.

Rebate percentages vary dramatically by therapeutic class. In highly competitive categories like diabetes, where multiple branded options exist, rebates can exceed 60% of list price. In categories with limited competition, rebates may be minimal or nonexistent.

Net Cost vs. Gross Cost

Rebates create a gap between the gross cost of a drug (what appears on the claim) and the net cost (gross cost minus the rebate). A drug with a $1,000 gross cost and a 50% rebate has a $500 net cost. This arithmetic is straightforward, but the implications are significant.

If a therapeutically equivalent drug has a $400 gross cost and no rebate, it appears more expensive on the claim but is actually $100 cheaper on a net basis. PBMs may prefer the higher-cost drug because it generates more rebate revenue, even if the alternative saves the plan money. Whether this preference actually occurs depends on contract structure, pass-through rates, and formulary committee governance.

The Rebate Wall

The existence of large rebates creates a barrier to lower-list-price competition. A manufacturer considering launching a drug at a lower price faces the challenge that PBMs may prefer a higher-priced competitor that generates rebates. This dynamic is frequently cited as a structural driver of rising list prices in the pharmaceutical industry.