PBM Rebates Explained

Manufacturer rebates are payments from pharmaceutical companies to PBMs in exchange for favorable formulary positioning. They represent one of the most consequential and least understood aspects of pharmacy benefits economics.

How Rebates Work

When a PBM places a drug on a preferred formulary tier, more patients use that drug because it has a lower copay. The manufacturer benefits from increased market share and compensates the PBM through rebate payments, typically calculated as a percentage of the drug's list price (WAC or AWP). Rebates are negotiated confidentially and paid retrospectively, usually quarterly, based on actual utilization.

Rebate rates vary widely by therapeutic class. Competitive categories with multiple branded options, such as insulin, diabetes medications, and inflammatory conditions, generate the highest rebates because manufacturers compete aggressively for preferred status. Rebates of 50-70% of list price are common in highly competitive categories. Classes with limited competition may generate rebates of 10-20% or less.

The Pass-Through Question

The central tension in rebate economics is how much of the rebate revenue reaches the plan sponsor. A contract that specifies 100% rebate pass-through sounds comprehensive, but the actual value depends on how rebates are defined. Exclusions for administrative fees, rebate aggregator costs, clinical program rebates, and manufacturer fees can significantly reduce the effective pass-through percentage.

The Perverse Incentive Problem

Because rebates are calculated as a percentage of list price, the system creates an incentive to prefer higher-list-price drugs that generate larger rebate dollars, even when a lower-list-price alternative would result in lower net cost to the plan. A drug with a $500 list price and a 60% rebate generates $300 in rebate revenue. A therapeutically equivalent drug with a $200 list price and no rebate would cost the plan less, but generates no rebate revenue for the PBM.

This dynamic is widely cited by PBM critics as evidence that the rebate system inflates drug prices. PBMs counter that rebates reduce net costs and that their formulary decisions are clinically driven. The reality varies by PBM, by contract, and by therapeutic category.