PBM rebates explained

Pharmacy benefits manager (PBM) rebates are one of the most consequential—and least understood—elements of pharmacy benefit management. In this guide, you’ll find PBM rebates explained clearly, including how they work, where incentives become misaligned and what employers and plan sponsors can do to ensure full rebate pass-through.

If you're evaluating your current pharmacy benefit arrangement or looking for a new one, this is the practical reference you need.

Key highlights:

PBM rebates are payments drug manufacturers make to pharmacy benefit managers in exchange for favorable placement on a plan's drug formulary.
Employers who don't require 100% pass-through in writing often receive only a fraction of the rebates generated on their behalf.
Spread pricing, aggregated reporting and opaque specialty arrangements are the primary mechanisms through which rebate value leaks out of employer plans.
Rightway operates on a full pass-through model—every rebate dollar generated flows directly to the plan, with claims-level reporting to verify it.

What are PBM rebates?

Rebates are payments drug manufacturers make to PBMs in exchange for favorable placement on a plan's formulary. The more prescriptions filled for a manufacturer's drug, the larger the rebate payment. Manufacturers compete for preferred tier placement by offering larger rebate deals to the pharmacy benefits manager.

The result is a gap between list price and net price that most employers never see clearly. A drug might carry a $400 list price, but after manufacturer rebates, the net cost could be $180. Whether that $220 difference flows back to the employer—or stays with the PBM—depends entirely on the contract. That distinction is what makes rebate transparency so important.

PBMs earn more than $315 billion annually, according to PSSNY, with rebates representing a meaningful share of that revenue.

Achieving 100% rebate pass-through: 5 key steps.

Most employers don't realize they're losing money on pharmacy benefits until they look closely at the contract. Full rebate pass-through doesn't happen by default, and most PBM agreements don't require it unless you explicitly demand it. The steps below give employers and plan sponsors a practical framework for closing that gap, covering the contract language, reporting requirements and audit rights needed to ensure every rebate dollar comes back to the plan.

Here are the key steps employers should take:

Step 1: Conduct a full rebate contract.

Start by reviewing every rebate-related provision in your current contract. Many employers don't realize that their agreements allow the PBM to retain a portion of drug rebates—or that rebate definitions are written narrowly enough to exclude certain payment types entirely.

A thorough audit should examine:

How "rebates" are defined and what payments fall outside that definition
Whether health plans receive itemized rebate reporting or only aggregated summaries
What percentage of drug rebates is contractually guaranteed to pass through to the plan
Whether administrative fees are bundled with rebate retention in ways that obscure true costs

Step 2: Define 100% pass-through requirements in writing.

If your PBM agreement doesn't explicitly require 100% pass-through of all rebates, discounts and manufacturer payments, you have no enforceable right to them. This step is about closing that gap before the next contract cycle.

When you negotiate rebates and drug pricing terms, the contract language should:

Specify the timeline for rebate reconciliation and payment to the plan
Require that rebate guarantees be calculated on a per-claim or per-member basis, not as a lump sum
Prohibit the pharmacy benefits manager from retaining any portion of manufacturer payments not explicitly disclosed

Step 3: Eliminate spread pricing across all channels.

Spread pricing is a separate but related problem. It occurs when a benefits manager charges the plan more for a prescription than it pays the pharmacy and keeps the difference. The big 3 PBMs generated an estimated $1.4 billion of income from spread pricing from 2017 to 2021, according to the FTC.

Eliminating spread pricing requires explicit contract language requiring pass-through pricing on all prescription drug costs.

Step 4: Require claims-level rebate reporting.

Aggregated rebate reports tell you very little. A single quarterly number doesn't show which drugs generated rebates, how much each manufacturer paid or whether the amounts reconcile with your actual utilization. Claims-level reporting does.

For transparency, your PBM should provide:

Rebate amounts broken down by drug, manufacturer and claim
Reconciliation between estimated and actual rebate payments
Disclosure of any manufacturer payments not classified as rebates
Reporting timelines that allow for independent verification

Step 5: Include independent audit rights in the contract.

Even with strong contract language and detailed reporting, you need the right to verify. Independent audit rights give plan sponsors the ability to confirm that rebate pass-through is happening as contractually required, not just as reported.

Your audit rights provision should include:

Access to manufacturer rebate agreements relevant to your plan
A defined audit window
Clear remedies if the audit reveals underpayment or misclassification

How the PBM rebate process works.

Understanding the rebate lifecycle helps employers identify where transparency breaks down. From the moment a drug is placed on formulary to the moment a rebate check arrives, there are multiple handoffs—and multiple points where value can be redirected. Here's how the process typically works:

Here’s how the rebate process typically works:

Drug manufacturer sets rebate agreements: Manufacturers negotiate rebate contracts with PBMs, offering payments tied to formulary tier placement and market share targets. These agreements are typically confidential and not shared with plan sponsors.
PBM negotiates formulary placement: Based on rebate offers and clinical criteria, the benefits manager assigns drugs to formulary tiers. Higher rebate offers often correlate with more favorable placement, which influences utilization patterns across the plan.
Prescription claim is adjudicated: When a member fills a prescription, claim processing occurs in real time. The PBM applies the formulary tier, calculates cost-sharing and pays the pharmacy. The rebate associated with that claim is tracked but not yet paid.
Utilization data is reconciled: The pharmacy benefits manager aggregates utilization data and reconciles it against manufacturer rebate contracts. The rebate amount owed is calculated based on the volume of qualifying prescriptions filled during the period.
Rebates are paid to the PBM: Manufacturers remit rebate payments to the benefits manager. In a pass-through model, those payments flow directly to the plan. In a retention model, the PBM keeps all or part of them.

Pass-through vs traditional models: Understanding the difference.

The difference between pass-through and traditional models comes down to how the PBM makes money and whether that model creates incentives that increase or reduce your total drug spend. Traditional pharmacy benefit managers generate revenue through mechanisms like spread pricing, retained rebates and undisclosed fees, which can reward higher costs.

A pass-through model removes those revenue streams and replaces them with a clearly defined administrative fee, so plan sponsors can see exactly where dollars are going and how decisions are made.

Reasons why traditional rebate models create misaligned incentives.

Rebate structures don’t just affect pharmacy costs. They influence clinical and formulary decisions in ways that often don’t serve the plan or its members. When a PBM’s revenue depends on rebate volume, every decision—from drug selection to formulary design and specialty management—introduces a built-in financial conflict.

These dynamics are often obscured by what can only be described as legacy PBM lies, making it harder for plan sponsors to see where incentives are misaligned. Understanding where those conflicts exist is the first step toward addressing them.

Rebate volume is prioritized over the lowest net cost.

When a PBM retains a share of rebates, maximizing rebate volume becomes a revenue strategy. That means a drug with a $300 list price and a $120 rebate may be preferred over a $150 drug with no rebate, even though the net cost to the plan is higher in the first scenario.

This dynamic directly shapes how formularies are built and managed.

Higher-cost branded drugs may receive preferred tier placement over lower-cost generics
Rebate-eligible drugs may be protected from step therapy or prior authorization requirements
Formulary exceptions for lower-cost alternatives may be harder to obtain

High list prices increase rebate pools.

Manufacturer rebates are typically calculated as a percentage of the list price. That means higher list prices generate larger rebate payments, which benefits the PBM if it retains any portion of those rebates. This creates a structural incentive to tolerate, or even encourage, list price inflation.

This drives up pharmacy costs for plan sponsors and members, as:

PBMs may resist negotiating lower list prices if doing so reduces rebate volume
Price protection provisions, which require manufacturers to pay additional rebates when list prices rise above a threshold, may be negotiated weakly or not at all
Members pay cost-sharing based on list price, not net price, so high list prices increase out-of-pocket costs

Formulary decisions can favor rebate yield.

Formulary design is supposed to reflect clinical evidence and cost-effectiveness. In practice, rebate economics can influence which drugs appear on which tiers and which alternatives are excluded from insurance plans entirely. When drug formulary decisions are made with rebate yield in mind, the plan's clinical and financial interests may not be fully represented.

The conflicts show up in several ways:

Drugs with strong clinical profiles but low rebate potential may be placed on non-preferred tiers
Biosimilars and generics, which typically carry no rebates, may not receive the formulary positioning needed to drive adoption
Therapeutic alternatives that would reduce plan costs may be excluded to protect rebate-generating drugs

Performance guarantees depend on rebate maximization.

A performance guarantee is supposed to hold your benefits manager accountable for delivering real value. But when the guarantee is built around rebate yield, hitting the rebate target doesn't necessarily mean your costs were lower. A PBM can meet a rebate guarantee while still driving higher net spend, because larger rebates often come attached to higher list prices.

The issue isn’t whether the guarantee is met; it’s which behavior guarantees rewards. Watch for these patterns:

Guarantees are measured on gross rebate dollars without accounting for the true net cost of the drug after all discounts and fees
Formulary decisions are influenced more by rebate potential than by the lowest-cost clinically appropriate options
Performance metrics that can be achieved while the overall pharmacy spend continues to rise

The financial, contractual and reporting challenges employers face with rebates.

Rebates represent real money, often millions of dollars annually for mid-size and large employers. But the structural complexity of contracts makes it difficult for most plan sponsors to verify what they're owed, when they'll receive it or whether the amounts are accurate. The fiduciary exposure is significant, and the information asymmetry between PBMs and plan sponsors is by design.

Here are the most common challenges employers encounter:

Transparent reporting: Most PBMs provide rebate summaries at the plan or quarter level, not the claim level. Without claim-level detail, employers cannot verify that rebates were calculated correctly, identify which drugs generated the most rebate value or detect discrepancies between reported and actual payments.
Contract complexity: Rebate provisions are often buried in exhibits, side letters and addenda that are difficult to parse without legal and actuarial expertise. Definitions of "rebates" may be written narrowly to exclude certain manufacturer payments—such as administrative fees or data fees—that function economically as rebates.
Specialty opacity: Specialty drugs generate the largest rebates, but specialty rebate reporting is often the least transparent. When the PBM owns the specialty pharmacy, the line between dispensing margin and rebate revenue becomes blurred—and employers may not see the full picture of what's being captured.
Guarantee structures: Rebate guarantees are only as strong as the definitions and audit rights that support them. A guarantee that promises "$X per member per month in rebates" may be met on paper while still leaving significant value on the table if the definition of "rebates" excludes certain payment types.

How the right PBM model mitigates rebate risk.

Transparent models reduce structural conflicts by removing the financial incentives that drive them. When a PBM earns a flat administrative fee rather than a share of rebates or a spread on drug costs, its revenue is no longer tied to drug selection, formulary design or specialty routing.

That changes the nature of the relationship from one in which the PBM profits from complexity to one in which the pharmacy benefit manager's success depends on the plan's success. A fiduciary-aligned PBM is built around that principle.

Full rebate pass-through eliminates retention incentives.

When manufacturer rebates flow directly to the plan, the PBM has no financial reason to favor high-rebate drugs over lower-cost alternatives. Formulary decisions can be made on clinical and net-cost grounds without a competing revenue motive.

That structural change has real downstream effects. Without a rebate retention incentive, there's no reason to protect high-list-price drugs from step therapy, prior authorization or generic substitution.

In a 100% pass-through model, you should expect to see:

Formulary placement decisions are documented and defensible on clinical and cost grounds
Rebate amounts are reported at the claim level, not aggregated
Manufacturers cannot “purchase” preferred placement through rebate offers alone

Flat administrative fee structures reduce revenue conflicts.

A flat per-member-per-month or per-claim fee means the PBM earns the same amount regardless of which drugs are dispensed, which pharmacy is used or how large the rebate pool is. There's no financial upside to routing prescriptions through affiliated pharmacies or protecting high-cost branded drugs.

When revenue is fixed and fully disclosed, the plan sponsor can evaluate costs clearly and hold the PBM accountable without having to reverse-engineer a complex fee structure. A well-structured flat-fee arrangement should include:

All PBM revenue is disclosed and fixed in the contract
No hidden fees tied to drug selection, formulary tier or specialty routing
Administrative costs are predictable and auditable

Claims-level transparency strengthens oversight.

Claim-level reporting gives plan sponsors the data they need to verify rebate calculations, identify cost drivers and hold the PBM accountable. It's the foundation of meaningful oversight, and it's only possible when there is no reason to obscure what's happening at the transaction level.

Without claim-level data, employers are essentially taking the PBM's word for it. With it, rebate reconciliation becomes something you can verify independently. At a minimum, claims-level reporting should cover:

Rebate reporting tied to individual claims, not quarterly summaries
Reconciliation between estimated and actual rebate payments
Full disclosure of all manufacturer payments, regardless of how they're classified

Independent audit rights protect plan sponsors.

Audit rights are only valuable if they're broad enough to cover the full scope of manufacturer payments and if the plan sponsor can choose its own auditor. A well-structured audit provision gives employers the ability to verify pass-through compliance independently.

Without meaningful audit rights, even the strongest contract language is difficult to enforce. The right to verify is what gives every other provision its teeth. A complete audit rights provision should include:

Access to manufacturer rebate agreements or summaries relevant to the plan
The right to engage a third-party auditor without PBM approval
Clear remedies for underpayment, including repayment with interest

Net-cost-aware incentives improve alignment.

When PBM performance is measured on net plan cost rather than gross rebate dollars, the incentive structure shifts. A pharmacy benefits manager that earns recognition for reducing total drug spend, increasing generic adoption and improving formulary efficiency is aligned with the plan's actual goals.

The key is making sure performance frameworks measure outcomes that matter to the plan, not metrics that can be padded through rebate volume. A well-designed incentive structure should track:

Net cost per member per month as the primary performance measure, not gross rebate yield
Generic dispensing rate guarantees that aren’t tied to actual net cost savings
Specialty cost management outcomes are tracked independently of rebate volume
Any performance-based compensation tied to plan cost reduction, not rebate maximization

Keep your incentives aligned with a neutral PBM solution from Rightway.

Rightway is built as a neutral PBM solution—no spread pricing, no rebate retention and no affiliated or owned pharmacies. Every rebate dollar generated on your plan flows back to the plan sponsor, with claims-level reporting to verify it. That's not a feature we added. It's how we were built.

Here's what employers get with Rightway:

Employers receive 100% of manufacturer rebates, with no retention, dilution, or hidden offsets.
Formularies are designed around net cost, ensuring decisions are made to lower total spend—not to maximize rebate volume.
Employers pay the true cost of drugs with no spread pricing or hidden revenue streams, supported by a single, transparent administrative fee.
Clinical pharmacists actively guide members to lower-cost, clinically appropriate alternatives, even when those options do not generate rebates.
Employers have full visibility into rebate activity through claim-level reporting, making it clear how rebates impact overall plan costs.

Book a demo today to explore how Rightway supports 100% rebate pass-through and long-term financial alignment.