Rick Kelly, FSA
Division Leader and National Pharmacy Practice Leader
The cost of prescription drugs is a topic that affects nearly everyone, from employees who rely on life-saving medications to employers who foot a growing share of the bill. But how much do we really understand about the journey a drug takes before it appears on an employer’s formulary? This journey—from FDA approval to your benefits plan—is far from straightforward. Along the way, various stakeholders, from drug manufacturers to pharmacy benefit managers (PBMs), play significant roles in determining which drugs are covered, how they are priced, and who ultimately profits.
For employers, this lack of transparency can lead to frustration and ballooning costs. PBMs, in particular, operate with practices that are often opaque, creating challenges for employers trying to understand where their pharmacy dollars are going. Concepts like spread pricing, rebates, and tiered formularies may seem complicated, but breaking them down is essential for anyone looking to regain control over pharmacy spending.
In this article, we’ll take you through the "pharm-to-table" process, uncovering what happens at each stage of the pharmacy pipeline. By following the money and understanding how pricing decisions are made, you’ll be better equipped to make informed decisions that can save costs while ensuring your employees have access to the medications they need.
1. FDA approval: the starting point
The journey of a drug begins long before it reaches your employees’ hands. After years of research, clinical trials, and regulatory hurdles, a new medication earns FDA approval. This rigorous process ensures drugs are safe and effective, but it also comes at a cost—literally. Drug manufacturers often spend billions on R&D and trials, and they factor those costs into the final price of their products.
However, FDA approval is just the beginning. What happens next—how drugs are priced, negotiated, and added to formularies—is where the real complexities and hidden costs emerge.
2. Manufacturer pricing and rebates
Once a drug is FDA-approved, the manufacturer sets its initial price based on factors like development costs, market demand, and competition. For groundbreaking therapies or drugs without alternatives, this price can skyrocket. But this is only the first layer of the cost structure.
Pharmacy benefit managers (PBMs) enter the scene as middlemen, negotiating with manufacturers to determine how and where the drug will appear on a health plan’s formulary. Rebates are central to these negotiations. Manufacturers offer rebates—essentially payments—to PBMs as an incentive to prioritize their drugs. On the surface, this seems like a cost-saving measure for employers, but the reality is more complicated.
PBMs often keep a significant portion of these rebates rather than passing the full savings on to employers or employees. This could incentivize PBMs to prioritize drugs with higher list prices and larger rebates rather than lower-cost alternatives, ultimately driving up overall pharmacy spending. For employers, the result is inflated costs masked by the promise of rebates that don’t fully deliver.
Are pass-through PBM contracts the answer? Unfortunately, generally no. The rebates paid by pharma to the PBM are called many different things, and as such, only those clearly identified as a true rebate are passed through. In addition, most pass-through pharmacies contract with Group Purchasing Organizations (GPOs). These GPOs are the entities negotiating with the pharma companies for rebate dollars, receive the actual payments, and then take money from these payments before they pay the PBM.
Employers should ask: Are the drugs on your formulary truly cost-effective, or are they there because of rebate agreements that benefit the PBM more than the plan sponsor?
Let’s explore the role of the PBM further.
3. The PBM's role in the process
PBMs were originally created to help employers and health plans adjudicate pharmacy claims. Over time, in theory, PBMs negotiated better prices with drug manufacturers, designed formularies that prioritized cost-effective treatments, and processed pharmacy claims efficiently. Over the past few decades, prescription drug costs have skyrocketed, rising from $30 billion in 1980 to over $335 billion in 2018. While PBMs were originally created to help manage these costs, their evolving business model—particularly the use of manufacturer rebates and opaque pricing structures—has contributed to price inflation. Research from the House Oversight Committee has shown that PBMs often prioritize higher-priced drugs in exchange for rebates, making it harder for lower-cost alternatives to gain traction. As a result, drug spending continues to climb, with retail prescription costs increasing by 91% between 2000 and 2020 and expected to rise another 5% annually through 2030.
One of the biggest ways PBMs influence drug costs is through formulary design. Formularies are the lists of drugs covered by a health plan, categorized into different tiers that determine how much an employee pays out of pocket. You might assume that formularies are built solely around clinical effectiveness and cost savings, but in many cases, PBMs prioritize drugs that yield the highest rebates and other revenue rather than the lowest overall cost.
Beyond formulary design, PBMs profit through several additional mechanisms, including:
- Spread pricing: PBMs charge employers more for a drug than they reimburse the pharmacy, keeping the difference as profit. The Federal Trade Commission (FTC) reported that the three largest PBMs profited $1.4 billion from spread pricing between 2017 and 2022.
- Rebate aggregation: PBMs bundle rebates across multiple clients, making it difficult for individual employers to track whether they’re getting their fair share of negotiated savings.
For employers, the lack of transparency in these practices makes it nearly impossible to know whether they’re getting a fair deal. Without clear contract terms and full visibility into how PBMs make money, many companies end up overpaying for pharmacy benefits without realizing it.
So, what can employers do? The first step is recognizing that PBMs don’t always have their best interests in mind. The second step is demanding greater transparency—whether through contract negotiations, alternative PBM models, or independent audits of pharmacy spending.
4. Employers and their formulary: Who really decides?
For many employers, pharmacy benefits feel like a black box—complex, expensive, and difficult to influence. Most rely on their PBM to design and manage their formulary, assuming it’s built with cost-effectiveness and employee health in mind. But the process is heavily shaped by PBM priorities, often at the expense of plan sponsors and their employees.
When a PBM designs a formulary, several factors come into play:
- Rebate maximization: PBMs often prefer high-cost drugs with bigger rebates over lower-cost alternatives, even when clinical outcomes are similar.
- Exclusive contracts: Some PBMs strike deals with manufacturers to favor certain drugs, limiting competition and keeping prices high.
- Required use of PBM’s fulfillment: Many PBM contracts require mail-order and specialty drugs to be filled by pharmacies the PBM itself owns.
- Tier placement games: A PBM may place a high-cost brand-name drug on a lower tier than a cheaper alternative because it yields a bigger rebate, leading to higher overall plan spending.
For employers, the impact of these decisions is twofold. First, plan costs rise because formularies are not always optimized for actual cost savings. Second, employees often pay more out of pocket due to the way cost-sharing structures are built around these inflated prices.
A formulary should be designed to balance cost, clinical effectiveness, and employee well-being—not to maximize PBM profits. Employers who take control of the process can rein in costs while still providing high-quality pharmacy benefits.
5. Follow the money: exposing the hidden costs
To truly understand why pharmacy costs are skyrocketing, employers need to follow the money. Every step in the “pharm to table” process—FDA approval, manufacturer pricing, PBM negotiations, and formulary placement—adds layers of complexity, and with each layer comes another opportunity for hidden fees and profit-taking.
Here’s how money flows through the system and where the biggest cost drivers hide:
- From manufacturers to PBMs: Drug manufacturers set high list prices, knowing that PBMs will demand large rebates in exchange for favorable formulary placement. This system creates an incentive to keep list prices high rather than lowering drug costs outright.
- From PBMs to employers: PBMs negotiate discounts, but those savings don’t always make it back to employers. Many PBMs pocket a portion of the rebates and use opaque pricing strategies like spread pricing to increase their revenue.
- From employers to employees: Employers pass on pharmacy costs through premiums and out-of-pocket expenses. When high-cost drugs are prioritized over lower-cost alternatives, employees end up paying more—whether through higher deductibles, copays, or coinsurance.
What employers can do
By following the money, employers can uncover the drivers of pharmacy overspending—and start making informed decisions to take control of their pharmacy benefits.
Employers can take a more active role in formulary management by:
- Pushing for transparency: PBMs should disclose how drugs are placed on the formulary and how rebates are handled.
- Scrutinizing PBM contracts for hidden fees, spread pricing, and vague rebate arrangements.
- Conducting regular audits: Employers should evaluate whether their formulary is driving unnecessary costs and consider third-party audits to uncover hidden spending.
- Exploring alternative PBMs: Pass-through PBMs, unfortunately, do not solve all of these issues as their name would imply. However, some newer PBMs in this (and other types) of arrangement are providing more transparency for employers.
The Rx Solutions team at Marsh McLennan Agency (MMA) brings clarity to an unnecessarily convoluted environment. With over 200 years of combined pharmacy experience in roles within PBMs and pharmacy organizations, each member uses their industry knowledge to help clients better understand the system and save money. Rx Solutions operates independently, with no proprietary coalition or PBM product, ensuring that our only priority is helping employers find the best solution for their needs.
If it’s been a year or more since you last reviewed your PBM contract, you may be missing out on opportunities to save considerably on your pharmacy costs. Get in touch with an MMA consultant to schedule a complimentary pharmacy consultation.
Our goal is to help employers save money and navigate the complex pharmacy system. We work together with employers to craft the best pharmacy plans for their organizations while taking care of their employees.
