Healthcare benefits and PBM contracts are filled with complex terminology that can make it difficult for employers and HR leaders to fully understand how their plans work—and where costs are actually coming from.

This glossary is designed specifically for plan sponsors who want clear, plain-language definitions of common healthcare benefits and PBM terms. Bookmark this page as a reference when reviewing PBM contracts, RFPs, or renewal proposals, or when you want to better understand how pharmacy benefit managers actually operate.

A

Administrative fee

An administrative fee is the amount a plan sponsor pays a PBM for services such as claims processing, reporting, and customer support. In transparent pricing models, this fee is clearly stated and separate from drug costs. In other models, administrative costs may be embedded in pricing, making them harder to identify.

Administrative services only (ASO)

Administrative services only (ASO) is a funding arrangement where the employer pays prescription drug claims directly while the PBM provides administrative services such as claims processing and reporting. The employer retains the financial risk for claims. ASO arrangements are common among self-funded employers seeking greater transparency and control.

Average wholesale price (AWP)

Average wholesale price (AWP) is a published benchmark price used as a reference in many PBM contracts. It does not reflect the actual price pharmacies pay to acquire drugs. Because AWP is often inflated, discounts off AWP can be misleading and should not be confused with true net cost.

B

Balance billing

Balance billing occurs when a provider or pharmacy bills a member for the difference between its charge and the amount paid by the plan. This practice is generally restricted in-network but may occur out-of-network. Balance billing can result in unexpected costs for members.

Benefit design

Benefit design refers to the overall structure of the pharmacy benefit, including formularies, cost-sharing levels, coverage rules, and utilization management programs. It is one of the most important levers employers have to influence cost, utilization, and member experience.

Biologic

A biologic is a medication derived from living organisms or their components, such as proteins or cells. Biologics are commonly used to treat complex or chronic conditions. These drugs are typically high cost and frequently classified as specialty medications.

Biosimilar

A biosimilar is a medication that is highly similar to an approved biologic and has no clinically meaningful differences in safety or effectiveness. Biosimilars offer savings opportunities in high-cost biologic categories. Adoption depends on formulary placement and provider acceptance.

Brand name drug

A brand name drug is marketed under a proprietary trade name and is typically protected by patents or exclusivity periods. Brand drugs are usually higher cost than generics. They are often associated with manufacturer rebate arrangements.

C

Capitated contract

A capitated contract is an arrangement in which the PBM is paid a fixed per-member amount to cover a defined set of pharmacy services or claims. This model shifts more financial risk to the PBM. Capitated contracts can simplify budgeting but require careful oversight.

Carve-in

A carve-in is an arrangement where pharmacy benefits are integrated with the medical plan under a single carrier. This structure can simplify administration. However, it often reduces transparency into pharmacy pricing and performance.

Carve-out

A carve-out is an arrangement where pharmacy benefits are contracted separately from the medical plan with a standalone PBM. Employers often choose carve-outs to increase transparency and gain more control over pharmacy costs.

Claim adjudication

Claim adjudication is the real-time process used by a PBM to evaluate a prescription claim at the pharmacy counter. It determines whether the claim is approved, what the plan pays, and what the member pays based on eligibility, formulary rules, pricing, and utilization management criteria.

Claims data

Claims data consists of detailed records of prescription drug transactions, including drug identifiers, pricing, utilization, and member cost sharing. Employers use claims data to analyze trends, monitor performance, and identify savings opportunities.

Clinical edits

Clinical edits are automated rules applied during claim adjudication to enforce coverage criteria or safety checks. They support appropriate prescribing and help prevent unsafe or unnecessary medication use. Clinical edits also help ensure compliance with plan design.

Coinsurance

Coinsurance is a cost-sharing arrangement where the member pays a percentage of a drug’s cost rather than a fixed dollar amount. This structure exposes members to price differences between medications. Coinsurance is commonly used for specialty drugs.

Copay accumulator program

A copay accumulator program prevents manufacturer copay assistance from counting toward a member’s deductible or out-of-pocket maximum. This preserves the employer’s intended cost-sharing structure. Accumulators can reduce overall plan spending.

Copay assistance

Copay assistance refers to manufacturer-funded programs that help members cover out-of-pocket costs for certain medications. These programs can improve adherence. However, they may also steer utilization toward higher-cost brand drugs.

Copay coupon

A copay coupon is a form of manufacturer copay assistance that offsets part or all of a member’s copayment at the pharmacy. Coupons can bypass formulary incentives. This may undermine generic or preferred brand strategies.

Copay maximizer program

A copay maximizer program spreads the value of manufacturer copay assistance across the plan year while limiting the plan’s payment. These programs are often used for high-cost specialty drugs. They can reduce employer liability but require careful member communication.

Copayment (copay)

A copayment is a fixed dollar amount a member pays for a prescription at the point of sale. Copays are predictable and easy to understand. However, they can mask true price differences between drugs.

D

Deductible

A deductible is the amount a member must pay out of pocket for covered services before the plan begins to pay. Deductibles are common in high-deductible health plans. Pharmacy deductibles may be separate or integrated with medical deductibles.

Dispense as written (DAW)

Dispense as written (DAW) codes indicate whether a prescription must be filled exactly as written or whether generic substitution is allowed. DAW codes can significantly influence drug costs. They are a key driver of brand versus generic utilization.

Dispensing fee

A dispensing fee is the amount paid to a pharmacy for the professional service of dispensing a prescription. This fee is separate from the drug’s ingredient cost. Dispensing fees contribute to total claim cost and are negotiated in PBM contracts.

Drug utilization review (DUR)

Drug utilization review (DUR) is the process of evaluating prescription drug use for safety, appropriateness, and adherence. DUR may be conducted prospectively, concurrently, or retrospectively. It helps reduce risk and inappropriate utilization.

F

Fiduciary alignment

Fiduciary alignment refers to the degree to which a PBM’s financial incentives and decision-making responsibilities are aligned with the best interests of the plan sponsor. In an aligned model, the PBM’s revenue is not tied to drug prices, rebates retained, or hidden margins. Fiduciary alignment is important for employers seeking transparency, predictable costs, and assurance that benefit decisions prioritize plan value over vendor profit.

Formulary

A formulary is the list of prescription drugs covered by a health plan. Drugs are typically organized into tiers based on cost and clinical value. Formularies are a primary tool for managing utilization and spend.

Formulary alternative

A formulary alternative is a clinically appropriate drug on the formulary that can be used instead of a non-preferred or excluded medication. Employers and PBMs promote alternatives to improve value. This helps manage costs without compromising care.

Formulary placement

Formulary placement refers to where a drug is positioned within a plan’s formulary and tier structure. Placement influences member cost sharing and utilization. Decisions are typically based on clinical value, net cost, and rebate arrangements.

G

Generic drug

A generic drug is bioequivalent to a brand-name drug and marketed after patent expiration. Generics provide the same clinical effect at a lower cost. Increasing generic utilization is one of the most effective ways to reduce pharmacy spend.

Group purchasing organization (GPO)

A group purchasing organization (GPO) aggregates purchasing volume across multiple plan sponsors to negotiate better pricing or PBM terms. GPOs can improve leverage for small and mid-sized employers. Transparency varies by structure.

H

High-risk medication

A high-risk medication is associated with a higher likelihood of serious side effects or harm, particularly in vulnerable populations such as older adults. These medications are often monitored through safety programs. They may trigger utilization or clinical review.

I

Ingredient cost

Ingredient cost represents the portion of a prescription claim attributable to the drug itself, excluding dispensing fees. It is a core component of total drug cost calculations. Ingredient cost is influenced by pricing benchmarks and MAC lists.

International drug sourcing

International drug sourcing refers to the practice of obtaining prescription medications from pharmacies or suppliers outside the United States, typically in countries where drug prices are lower. These programs are sometimes used for high-cost brand or specialty drugs. While international sourcing can reduce costs, it requires careful oversight to address regulatory compliance, drug safety, and continuity of care.

L

Lifestyle drug

A lifestyle drug is considered non-essential or cosmetic in nature, such as medications for hair growth or erectile dysfunction. These drugs are often excluded from coverage or subject to higher cost sharing. Employers may limit coverage to manage costs.

M

Mail order pricing

Mail order pricing refers to the pricing structure applied to prescriptions dispensed through mail order pharmacies. Mail order can reduce costs for maintenance medications. Savings depend on contract terms and utilization patterns.

Maximum allowable cost (MAC)

Maximum allowable cost (MAC) is the maximum amount a PBM will reimburse a pharmacy for a multi-source generic drug. MAC pricing is a key lever for controlling generic drug spending. Update frequency and appeals processes are critical for fairness.

Medication adherence

Medication adherence measures how consistently a member takes medications as prescribed. Poor adherence is linked to worse outcomes and higher medical costs. Employers often invest in programs to improve adherence for chronic conditions.

Medication therapy management (MTM)

Medication therapy management (MTM) is a structured clinical service where pharmacists or clinicians review a member’s medication regimen. MTM focuses on safety, effectiveness, and adherence. These programs are commonly targeted to high-risk or high-cost members.

Multi-source drug (MSD)

A multi-source drug is available from multiple manufacturers, typically as generics. These drugs are commonly subject to MAC pricing. Competition among manufacturers usually results in lower costs.

N

National drug code (NDC)

The national drug code (NDC) is a unique identifier assigned to each drug product, including manufacturer, product, and package size. NDCs are used for pricing, reimbursement, and formulary management. They enable detailed claims analysis.

Net cost

Net cost represents the true cost of a drug after accounting for discounts, rebates, and fees. Net cost is the most meaningful metric for evaluating PBM performance. Headline discounts alone do not reflect actual spend.

Non-formulary drug

A non-formulary drug is not included on the plan’s formulary and is generally not covered unless an exception is approved. Excluding non-formulary drugs helps avoid spending on lower-value therapies. Exceptions may apply for medical necessity.

O

Out-of-pocket maximum (OOP)

The out-of-pocket maximum is the most a member will pay in covered cost sharing during a plan year. Once reached, the plan pays 100 percent of covered expenses. OOP limits protect members from catastrophic costs.

P

Pass-through pricing

Pass-through pricing is a model where the PBM charges the plan sponsor exactly what it pays the pharmacy, plus a defined administrative fee. This structure eliminates spread on claims. It is considered more transparent than spread pricing.

Performance guarantees

Performance guarantees are contractual commitments related to service levels, accuracy, turnaround times, or financial outcomes. They provide accountability if the PBM underperforms. Guarantees may include financial penalties.

Per member per month (PMPM)

Per member per month (PMPM) is a pricing metric that expresses costs or fees as a fixed amount for each enrolled member per month. For employers, PMPM pricing can improve predictability and budgeting, but it should be evaluated alongside total net cost to understand overall financial impact.

Pharmacy benefit manager (PBM)

A pharmacy benefit manager (PBM) is a third-party administrator that manages prescription drug benefits for employers and health plans. PBMs handle claims processing, formularies, pharmacy networks, and contracting. The PBM model directly affects cost and transparency.

Pharmacy channel

Pharmacy channel refers to the dispensing setting, such as retail, mail order, specialty, or home infusion. Each channel has different pricing and utilization dynamics. Channel management is important for controlling costs.

Pharmacy navigation

Pharmacy navigation is a service that helps members understand their pharmacy benefits and make informed decisions about prescriptions, including where to fill medications, lower-cost alternatives, coverage rules, and prior authorization requirements. Pharmacy navigation focuses on guiding members in real time so they can access appropriate medications at the lowest possible cost. For employers, effective pharmacy navigation can improve adherence, reduce avoidable spend, and minimize member confusion.

Pharmacy network

A pharmacy network is the group of pharmacies contracted to provide prescriptions under a plan. Network design affects member access and pricing. Narrower networks may offer lower costs.

Plan sponsor

The plan sponsor is the employer or entity responsible for funding and overseeing the prescription drug benefit. PBM contracts, guarantees, and pricing ultimately apply to the plan sponsor. Employers bear the financial impact of benefit decisions.

Preferred brand drug

A preferred brand drug is a brand-name medication placed on a lower cost-sharing tier. Preferred status is typically based on net cost and clinical value. These drugs are encouraged over non-preferred brands.

Preferred drug list (PDL)

The preferred drug list (PDL) is a subset of the formulary identifying preferred medications. Drugs on the PDL usually have lower member cost sharing. Selection considers clinical guidelines and net cost.

Prior authorization (PA)

Prior authorization requires approval before certain drugs are covered. It is commonly applied to high-cost or high-risk medications. PA helps ensure appropriate and cost-effective use.

Prospective drug utilization review

Prospective drug utilization review occurs before a prescription is dispensed. It identifies potential safety issues such as drug interactions or inappropriate therapy. This review helps prevent harm in real time.

Q

Quantity limits (QL)

Quantity limits restrict the amount of medication dispensed per prescription or time period. These limits help reduce waste and overuse. They are commonly used for safety and cost control.

R

Rebate

A rebate is a payment from a drug manufacturer, typically in exchange for favorable formulary placement. Rebates can reduce net cost when passed through to the plan sponsor. However, rebate structures may incentivize higher-priced drugs.

Rebate aggregator

A rebate aggregator pools rebate volume across multiple clients to negotiate with manufacturers. Aggregation can increase leverage. It may also reduce transparency for individual employers.

Rebate pass-through

Rebate pass-through describes how much of the manufacturer rebate is returned to the plan sponsor. Full pass-through means the employer receives 100 percent of rebates earned. Partial pass-through allows the PBM to retain a portion, which can create misaligned incentives.

Rebate retention

Rebate retention refers to the portion of manufacturer rebates kept by the PBM rather than passed back to the plan sponsor. Retained rebates represent a source of PBM revenue. Understanding rebate retention is critical for evaluating true net cost.

Reconciliation

Reconciliation is the process of comparing estimated pricing, rebates, and guarantees against actual performance over a contract period. This process determines whether the PBM owes the plan sponsor additional funds. Reconciliation timing and methodology can significantly affect transparency.

Retrospective drug utilization review

Retrospective drug utilization review analyzes prescription patterns after claims are processed. It identifies trends such as overuse, underuse, or unsafe combinations. Findings may inform future interventions.

S

Self-funded plan

A self-funded plan is one where the employer assumes the financial risk for paying claims. Self-funded employers often use ASO arrangements. This structure provides flexibility and transparency.

Single index drug pricing

Single index drug pricing is a pricing approach where all prescription drugs are priced using a single benchmark and discount methodology, rather than different pricing formulas for different drug categories or channels. This model is intended to simplify pricing and make costs more predictable. However, depending on how the index is set and maintained, single index pricing may still obscure true net cost if not paired with full transparency and reporting.

Single-source drug (SSD)

A single-source drug is available from only one manufacturer. These drugs typically face limited price competition. As a result, they often have higher costs.

Specialty carve-out

A specialty carve-out is an arrangement where specialty pharmacy services are contracted separately from the broader pharmacy benefit. Employers may use carve-outs to gain more control over specialty drug pricing, clinical programs, or dispensing channels. This approach can increase transparency but requires coordination across vendors.

Specialty drug

A specialty drug is a high-cost medication that may require special handling, monitoring, or administration. Specialty drugs represent a significant share of total pharmacy spend despite low utilization. Managing specialty spend is a top priority for employers.

Specialty pharmacy markup

Specialty pharmacy markup refers to additional margins or fees applied to specialty drug claims. These markups can materially increase total cost. Transparency into specialty pricing is critical.

Spread pricing

Spread pricing is a model where the PBM charges the plan sponsor more than it reimburses the pharmacy and keeps the difference. This spread is often hidden from employers. Spread pricing is a major source of PBM revenue and scrutiny.

Step therapy (ST)

Step therapy requires members to try lower-cost or preferred medications before accessing higher-cost options. This approach promotes cost-effective treatment. Step therapy is commonly used for chronic conditions.

T

Tiered formulary

A tiered formulary organizes drugs into tiers such as generic, preferred brand, non-preferred brand, and specialty. Each tier has different cost sharing. Tiers influence member behavior and utilization.

True out-of-pocket (TrOOP)

True out-of-pocket (TrOOP) represents the total member costs that count toward the catastrophic coverage threshold in Medicare Part D. This concept is primarily relevant for employers involved with Part D coverage. It does not apply to most commercial plans.