Pharmacy spend has become one of the fastest-growing and least-examined cost categories in employer-sponsored health plans. According to the Business Group on Health, pharmacy expenses now account for roughly 24% of total employer healthcare spend, with projections pointing higher in the years ahead as specialty medications, GLP-1 drugs, and high-cost biologics continue to drive utilization.
Despite representing nearly a quarter of total plan cost, the pharmacy benefit is the area where most employers have the least visibility and the least control. They know what their medical premiums cost. They know their deductible structure. But when it comes to their Pharmacy Benefit Manager, commonly called a PBM, many employers cannot answer basic questions: Who is our PBM? How are they compensated? Are we getting the drug pricing we were promised? How much of what we are paying actually goes to drug costs versus PBM margin?
That lack of visibility is not accidental. The PBM industry has historically operated with significant opacity, structuring compensation in ways that are difficult for employers to audit and contracts that are challenging to evaluate without specialized expertise. But that is changing. Legislative pressure, increased transparency requirements, and a growing market for independent PBM consulting have created meaningful opportunities for employers who are willing to look closely at this part of their plan.
This post explains how PBMs work, where the cost savings opportunities live, and which types of employer groups are best positioned to capitalize on them.
What a PBM Actually Does
A Pharmacy Benefit Manager is a third-party company that administers the prescription drug component of a health plan. PBMs negotiate drug prices with pharmaceutical manufacturers and pharmacy chains, process prescription claims, manage pharmacy networks, develop and maintain drug formularies, and administer clinical programs like prior authorization, step therapy, and medication management.
On paper this sounds straightforward. In practice the relationship is considerably more complicated, because PBMs are compensated through a combination of mechanisms that can create financial incentives that are not always aligned with the employer’s interest in lower drug costs.
The three largest PBMs in the United States, CVS Caremark, Express Scripts, and OptumRx, collectively manage the pharmacy benefits for the vast majority of employer-sponsored health plans in the country. These three companies are each owned by or affiliated with a major health insurer or pharmacy chain, which creates vertical integration dynamics that have drawn significant Congressional scrutiny in recent years. For employers on fully insured plans, the PBM is typically selected and managed by the carrier, giving the employer little to no direct visibility or negotiating leverage. For self-funded employers, there is often far more opportunity to engage directly with the pharmacy benefit than most employers realize.
How PBMs Make Money and Why It Matters
Understanding where PBM compensation comes from is essential for understanding where the savings opportunities live. PBMs are compensated through several mechanisms, some of which are transparent and some of which are not.
Spread Pricing
Spread pricing is one of the most significant and most criticized PBM compensation mechanisms. Under a spread pricing model, the PBM charges the plan a higher price for a drug than it actually pays the pharmacy, and keeps the difference as margin. The spread is invisible to the employer unless the contract specifically requires pass-through pricing or the employer has the right to audit actual pharmacy reimbursement rates.
In a transparent or pass-through model, the PBM passes the actual cost of the drug to the plan and charges an administrative fee separately. The employer can see exactly what the drug cost and what the PBM is charging for its services. In a spread pricing model, the employer sees only the total amount charged for each drug, with no visibility into what portion represents the actual drug cost and what portion represents PBM margin.
Studies of state Medicaid programs and employer plans that have audited their PBM relationships have found spread pricing margins ranging from a few percentage points to over 20% on some drug categories. For an employer spending $500,000 per year on pharmacy, a 15% spread represents $75,000 in annual PBM margin that is invisible to the employer and provides no value to anyone on the plan.
Rebates
Pharmaceutical manufacturers pay rebates to PBMs in exchange for favorable formulary placement, meaning the PBM agrees to position the manufacturer’s drug as preferred on the formulary, which drives higher utilization and generates more rebate revenue. These rebates can be substantial, particularly for brand-name drugs in competitive therapeutic categories.
The critical question for employers is how much of those rebates are passed through to the plan versus retained by the PBM. In a rebate pass-through model, the employer receives the full rebate, which offsets drug costs. In a rebate retention model, the PBM keeps some or all of the rebate as additional compensation. The difference can be significant. In some cases the PBM’s retained rebate revenue exceeds its disclosed administrative fee by a substantial margin.
It is also worth understanding that rebate-driven formulary design does not always optimize for the lowest net drug cost. A PBM may place a higher-list-price drug in a preferred formulary position because it generates a larger rebate, even when a lower-cost therapeutic alternative or biosimilar would produce a better net cost for the plan. Employers who want their formulary optimized for total cost rather than gross rebate generation need contract language that requires exactly that.
Network Fees and Administrative Charges
PBMs also charge employers administrative fees, network access fees, and various other service charges that vary widely in transparency and justification. Some of these fees are legitimate costs for services the employer genuinely needs. Others are padding that experienced advisors can identify and negotiate down or eliminate.
Where the Savings Opportunities Live
Given this landscape, the pharmacy benefit represents a meaningful cost savings opportunity for employers who are willing to examine it carefully. Here are the most significant levers available.
Auditing the Current PBM Relationship
For self-funded employers who have been on the same PBM arrangement for several years without a formal review, an audit is typically the starting point for understanding the actual cost of the pharmacy benefit. A PBM audit compares the amounts the employer was charged against the contract terms, actual pharmacy reimbursement rates, and rebate pass-through provisions. Audits of employer PBM contracts frequently surface discrepancies that result in retroactive recoveries and contract corrections.
The right to audit is a contract provision that not all PBM agreements include by default. Employers negotiating or renewing PBM contracts should ensure that the right to conduct an independent audit is explicitly included.
Moving to a Pass-Through or Transparent Pricing Model
For employers who are currently on a spread pricing arrangement, moving to a transparent or pass-through model is often the single most impactful change available. Under a pass-through model, the employer pays the actual ingredient cost of each drug plus a fixed dispensing fee, and the PBM charges a separate transparent administrative fee for its services. The employer can see exactly what each drug costs and exactly what the PBM is being paid.
Employers who move from opaque spread pricing to transparent pass-through arrangements frequently find that their effective drug costs are lower than they appeared under the spread model, because the spread that was previously invisible is now eliminated and replaced by a disclosed administrative fee that is often smaller.
Improving Rebate Pass-Through
Negotiating for 100% rebate pass-through is a straightforward contract improvement that can produce meaningful savings for employers with significant brand-name drug utilization. Some PBMs will resist full pass-through in favor of guaranteed rebate arrangements, where they promise a minimum rebate per claim regardless of actual manufacturer payments. Employers should be cautious about guaranteed rebate arrangements because they can obscure the true rebate economics and give the PBM room to retain excess rebates above the guarantee.
Formulary Optimization for Net Cost
Working with a PBM or independent pharmacy consultant to review the formulary with a focus on net cost rather than gross rebate generation can surface opportunities to substitute lower-cost therapeutically equivalent alternatives, including generics and biosimilars, for higher-cost brand drugs that are on the formulary primarily because of their rebate value. In some therapeutic categories, the net cost of a brand drug after rebates is actually higher than the list price of a generic or biosimilar alternative that generates no rebate.
Specialty Drug Management
Specialty medications represent a growing share of pharmacy costs for most employer plans and are one of the highest-leverage areas for targeted management. Specialty drugs used to treat conditions like rheumatoid arthritis, multiple sclerosis, cancer, and increasingly obesity through GLP-1 medications can cost tens of thousands of dollars per patient per year. PBM contracts that include robust specialty drug management provisions, including site of care optimization, copay assistance programs, and biosimilar substitution policies, can produce substantial savings in this category.
Site of care management is particularly valuable for specialty drugs that can be administered in lower-cost settings such as at home or in an outpatient infusion center rather than in a hospital outpatient department. The same drug administered in a hospital outpatient setting can cost two to four times what it costs in a lower-cost setting, and hospital systems have strong financial incentives to administer specialty drugs in their facilities. A PBM or plan design that steers specialty drug administration to lower-cost appropriate settings can generate significant savings without any reduction in clinical quality.
Which Employers Are Best Positioned to Capitalize on PBM Savings
Not every employer is equally positioned to take advantage of PBM optimization strategies. The opportunity set is meaningfully larger for some groups than others.
Self-Funded and Level-Funded Employers
This is where the opportunity is largest and most accessible. Self-funded employers have direct contractual relationships with their PBM and full visibility into the terms of that relationship. They can negotiate contract language, require pass-through pricing, demand audit rights, and select independent PBMs that are not owned by or affiliated with a health insurer or retail pharmacy chain. The full range of PBM optimization strategies described above is available to self-funded employers.
Level-funded employers typically access pharmacy benefits through their carrier’s PBM arrangement, but some level-funded products allow employers to carve out the pharmacy benefit and contract with an independent PBM separately. Whether this option is available depends on the specific level-funded product and carrier, but it is worth asking about.
Employers With 100 or More Covered Lives
Group size matters in PBM negotiations because larger groups have more leverage to demand better terms and a larger aggregate pharmacy spend to make independent PBM arrangements financially viable. For employers with fewer than 50 to 75 covered lives, the savings available from PBM optimization may not justify the administrative complexity of an independent arrangement. For employers in the 100 and above range, the math typically becomes increasingly compelling.
That said, the market for transparent PBM arrangements has expanded meaningfully in recent years and there are now independent PBM options that serve smaller employer groups than was historically the case. The threshold at which PBM optimization makes sense is lower today than it was five years ago.
Employers With Significant Brand Drug or Specialty Utilization
The savings opportunity from PBM optimization is directly proportional to the volume and cost of brand-name and specialty drug utilization in the plan. Employers whose covered population uses primarily generic drugs at modest cost have less to gain from sophisticated PBM arrangements than those with significant brand or specialty utilization. A plan where one or two employees are on high-cost specialty medications for chronic conditions, or where GLP-1 drug utilization is growing, has a pharmacy cost structure where the PBM relationship deserves close attention.
Employers Who Have Never Reviewed Their PBM Contract
Perhaps the most actionable group of all is simply employers who have been on the same PBM arrangement for several years without ever having someone with specialized expertise review the contract terms. Regardless of group size or utilization profile, a first-time PBM contract review almost always surfaces opportunities for improvement, whether through contract language corrections, pricing adjustments, rebate improvements, or simply a clearer understanding of what the plan is actually paying for pharmacy services.
The Fully Insured Employer’s Limited but Real Options
For employers on fully insured plans, the PBM relationship is managed by the carrier and the employer has no direct contract with the PBM. This limits the available optimization strategies significantly. The carrier selects the PBM, negotiates the contract terms, and determines how much of the pharmacy cost savings flows through to the employer’s renewal versus is retained by the carrier.
That said, fully insured employers are not entirely without options. Asking the carrier directly about the PBM relationship, the rebate pass-through methodology, and how pharmacy costs are factored into the renewal provides information that can inform the renewal negotiation. And for employers who have been on a fully insured plan and are evaluating whether a self-funded or level-funded arrangement might be a better fit, the PBM opportunity is one of the most compelling arguments for making that transition. Moving off a carrier-controlled PBM arrangement to an independent transparent PBM is one of the clearest financial wins available when an employer transitions to self-funding.
How Cypress Benefit Solutions Approaches This
The PBM conversation is one of the areas where the depth of a benefits advisor’s expertise makes the most meaningful difference. Understanding how PBM contracts are structured, how to evaluate whether an employer’s current arrangement is competitive, and how to negotiate for transparency and better pricing terms requires specialized knowledge that most generalist brokers simply do not have.
At Cypress Benefit Solutions, we treat the pharmacy benefit as a strategic component of the health plan that deserves the same analytical attention as the medical benefit. For employers who have never had a serious PBM conversation or who have been on the same arrangement for years without a review, this is one of the areas where engaging with us can produce the most tangible and immediate financial results.
If your pharmacy costs have been climbing and you are not sure whether your PBM arrangement is working in your favor, that is a conversation worth having. Reach out anytime and we would be glad to take a look.
