Pharmacy Benefit Managers: The Middlemen Driving Drug Costs

Between the doctor who writes a prescription and the patient who picks it up, there's an industry most people have never heard of that controls what you pay, what drugs are available, and how much your pharmacist gets reimbursed. Pharmacy Benefit Managers — PBMs — process over 80% of all prescriptions in the United States. Three companies (Express Scripts, CVS Caremark, and OptumRx) control roughly 80% of the market. And their business model creates perverse incentives that may be driving up the cost of the $275.65B in Medicare Part D drug spending we analyze.

What PBMs Actually Do

PBMs were originally created to simplify prescription drug claims processing. In theory, they negotiate lower drug prices on behalf of health plans and employers. In practice, their business model has evolved into something far more complex — and far more profitable for the PBMs themselves.

The Big Three

How PBMs Profit: The Mechanisms

1. Spread Pricing

Spread pricing is arguably the most controversial PBM practice. Here's how it works: a PBM charges the health plan (in Medicare's case, the Part D plan sponsor) one price for a drug, then reimburses the pharmacy a lower price, and keeps the difference — the "spread."

The Ohio Medicaid program audited its PBMs in 2018 and found spread pricing cost taxpayers $224 million in one year. For generic drugs — which should be cheap — PBMs charged Medicaid an average of 31% more than they paid pharmacies. The practice has since been banned in Ohio Medicaid but remains legal in most Medicare Part D contracts.

2. Rebate Clawbacks

Drug manufacturers pay PBMs rebates for favorable formulary placement — essentially paying to have their drug on the "preferred" list. These rebates can be 30-70% of the drug's list price. Here's the catch: PBMs often don't pass the full rebate through to the plan (and thus to Medicare/patients).

A 2024 FTC report found that the Big Three PBMs retained an average of 23% of all manufacturer rebates. On a $275.65B Medicare Part D program, even a few percentage points of retained rebates translates to billions of dollars.

3. Formulary Manipulation

PBMs decide which drugs are on their formulary and at what "tier" (which determines patient copays). This creates a powerful incentive structure: a PBM might prefer a $500/month brand drug that offers a 60% rebate over a $50/month generic that offers no rebate — because the PBM makes more money on the expensive drug even though it costs Medicare more.

4. Pharmacy DIR (Direct and Indirect Remuneration) Fees

DIR fees are retroactive charges that PBMs impose on pharmacies after prescriptions are filled. A pharmacy might fill a prescription and receive $100, only to have $15-25 clawed back months later as a DIR fee. These fees make it nearly impossible for independent pharmacies to predict their revenue — and many have closed as a result.

The PBM Impact on Medicare Part D Drugs

The drugs that generate the most PBM profit are typically expensive brand-name medications with high rebates. Here are the top 20 drugs in Medicare Part D by total cost — each one passes through the PBM system:

These top 20 drugs account for $41.40B — roughly 15% of all Medicare Part D spending. Each transaction passes through a PBM that extracts value at every step.

The Perverse Incentive Problem

The fundamental issue with PBMs is structural: PBMs make more money when drugs cost more. Their profit comes from percentages — rebates calculated as a percentage of list price, spread pricing margins that increase with higher prices, and administrative fees pegged to drug costs. A PBM that successfully lowered overall drug prices would be reducing its own revenue.

Impact on Independent Pharmacies

The PBM business model has been devastating for independent pharmacies. Over 10,000 independent pharmacies have closed since 2010, with PBM reimbursement practices cited as the leading cause. The pattern is clear:

• PBMs reimburse independent pharmacies at lower rates than their own affiliated pharmacies
• Retroactive DIR fees make revenue unpredictable and often negative on individual prescriptions
• Preferred pharmacy networks steer patients to PBM-owned or PBM-affiliated pharmacies
• Audit clawbacks — where PBMs audit pharmacy records and demand refunds — create an adversarial dynamic

This matters for Medicare patients because independent pharmacies disproportionately serve rural communities and underserved urban neighborhoods. When these pharmacies close, patients lose access — creating prescription deserts that compound existing health disparities.

What's Being Done About It

The FTC Investigation (2024-2025)

The Federal Trade Commission launched a comprehensive investigation into PBM practices in 2022, culminating in a 2024 report that confirmed many long-suspected abuses. Key findings included:

• PBMs steered patients toward PBM-owned pharmacies, even when cheaper alternatives existed
• Rebate structures favored higher-cost drugs over clinically equivalent cheaper alternatives
• Pharmacy reimbursement rates were often below the pharmacy's acquisition cost
• The three largest PBMs had collective market power that stifled competition

Congressional Action

Multiple bills have been introduced targeting PBM practices:

• Pharmacy Benefit Manager Transparency Act — Would require PBMs to disclose rebate amounts, spread pricing margins, and administrative fees
• PBM Reform Act — Would ban spread pricing in Medicare and require 100% rebate passthrough
• Delinking Act — Would decouple PBM compensation from drug prices, requiring flat-fee contracts

CMS Rule Changes

CMS has made incremental changes to Medicare Part D that affect PBMs:

• DIR fee reform (effective 2024) requires price concessions to be reflected at the point of sale
• IRA provisions cap insulin at $35/month and begin Medicare drug price negotiations
• New transparency requirements for Part D plan sponsors regarding PBM contracts

How This Connects to Our Data

When you see a drug in our database costing $171 per claim on average, that figure reflects the price after PBM processing. The actual amounts flowing between manufacturers, PBMs, pharmacies, and plans are far more complex:

The Brand vs. Generic Decision

PBM incentives directly affect the brand-vs-generic prescribing patterns we see in our data. Currently,13.4% of Medicare Part D claims are for brand-name drugs. But brand drugs account for$185.46B of the $275.65B total — a disproportionate share driven partly by PBM formulary decisions that favor rebated brands over cheaper generics.

When a generic drug becomes available, the PBM should switch patients to save money. But if the brand manufacturer offers a large enough rebate, the PBM may keep the brand on the preferred tier. The patient pays more (higher brand copay), Medicare pays more (higher plan liability), but the PBM profits from the rebate.

What Would Real Reform Look Like?

1. Ban spread pricing in Medicare — PBMs should be paid flat administrative fees, not percentage-based margins
2. 100% rebate passthrough — All manufacturer rebates should flow to plans and patients, not PBMs
3. Delink PBM compensation from drug prices — Remove the incentive to prefer expensive drugs
4. Prohibit vertical integration — or at minimum require structural separation between PBM, pharmacy, and insurance functions
5. Real-time pricing transparency — Patients and prescribers should see the actual net cost of drugs at the point of prescribing

Explore Related Analysis

• Brand vs Generic: The Prescribing Gap That Costs Billions
• Why Doctors Still Prescribe Brands When Generics Exist
• Where Does $275.6 Billion Go?
• The Drugs That Cost Medicare Billions
• The Most Expensive Prescribers in Medicare