The Hidden Tax on Your Health Plan

Every year, employers review their health plan renewal and accept the explanation that drug costs are rising. What most do not know is that a meaningful portion of their pharmacy spend is going to intermediaries called pharmacy benefit managers — and the way those intermediaries make money is one of the least understood and most consequential issues in employer-sponsored benefits today.

Every year, employers across California sit across the table from their insurance brokers and review their health plan renewal. Premiums are up — again. The broker explains it is market conditions, claims trends, drug costs. And the employer, lacking access to the underlying data, accepts the explanation and signs the renewal.

What most of those employers do not know is that a meaningful portion of their pharmacy spend is not going to pharmacies, not going to drug manufacturers, and not going to their employees’ health. It is going to a category of intermediaries called pharmacy benefit managers — and the way those intermediaries make money is one of the least understood and most consequential issues in employer-sponsored benefits today.

What a PBM Actually Does

A pharmacy benefit manager, or PBM, sits between a drug manufacturer, a pharmacy, and your health plan. On paper, PBMs perform genuinely useful functions: they negotiate rebates with drug manufacturers, process and adjudicate pharmacy claims, build pharmacy networks, design formularies (the lists of covered drugs), and manage utilization. These are real services that create real value — or should.

The problem is not the function. The problem is the business model that has evolved around it — one characterized by opacity, vertical integration, and a set of revenue practices that are, at minimum, misaligned with the interests of the employers and patients the PBM is supposed to serve.

Three Companies, 79 Percent of the Market

The U.S. pharmacy benefit management market is not competitive in any meaningful sense. According to the Federal Trade Commission, the three largest PBMs — OptumRx (owned by UnitedHealth Group), Express Scripts (owned by Cigna), and CVS Caremark (owned by CVS Health, which also owns Aetna) — manage 79 percent of all prescription drug claims on behalf of approximately 270 million people.

Each of these three companies is vertically integrated with a major health insurer. Each owns mail-order pharmacies and specialty pharmacies. Each negotiates rebates with drug manufacturers, processes claims, and designs formularies — and each has a financial incentive structure that does not always align with what is best for the plan sponsor or the patient.

The Spread Pricing Problem

The most direct mechanism by which PBMs extract value from employer health plans is called spread pricing. The mechanics are straightforward: the PBM negotiates a reimbursement rate with the dispensing pharmacy — say, $40 for a generic medication. The PBM then charges the employer’s health plan $55 for the same prescription. The $15 difference — the “spread” — is retained by the PBM as profit.

The employer never sees this transaction. The pharmacy gets paid. The employee gets their medication. The PBM keeps the spread. And the employer’s health plan pays more than the actual cost of the drug, with no visibility into the difference.

“The data you need to make better workforce decisions almost certainly already exists in your HRIS, your performance management system, and your benefits claims data. The question is whether you have the analytical capability — and the organizational will — to use it.”

— Claudia Lin

In the FTC’s January 2025 second interim staff report, investigators found that the major PBMs had systematically hiked costs on a wide range of lifesaving drugs — not through transparent fee arrangements, but through spread pricing and related practices that inflated what plan sponsors paid while steering patients toward higher-cost medications that generated larger rebates for the PBM.

Rebate Retention: The Other Side of the Problem

Spread pricing is the most visible PBM revenue practice, but it is not the only one. PBMs also negotiate rebates with drug manufacturers in exchange for preferred formulary placement — and in traditional PBM contracts, a portion of those rebates is retained by the PBM rather than passed through to the plan sponsor.

The perverse incentive this creates is well documented. To maximize rebate revenue, PBMs have an incentive to favor higher-priced drugs with larger rebates over lower-cost alternatives with smaller or no rebates. A drug that costs $200 per month with a $60 rebate may generate more PBM revenue than a therapeutically equivalent drug that costs $80 per month with no rebate — even though the plan and the patient would be better served by the cheaper option.

What Regulators Are Doing About It

The regulatory response to PBM practices has been building for several years and accelerated significantly in 2024 and 2025. The FTC’s 2024 report and 2025 interim report brought national attention to spread pricing, rebate retention, and vertical integration concerns. In April 2025, the Trump administration issued an Executive Order directing a reevaluation of pharmaceutical “middlemen” to promote a more competitive, transparent, and efficient pharmaceutical value chain.

In Congress, the PBM Reform Act of 2025 proposes banning spread pricing in Medicaid and establishing a transparent reimbursement model to ensure pharmacies are fairly compensated. While the PBM provisions were not included in the final version of the legislation signed into law in July 2025, the legislative momentum is real and bipartisan. The House passed separate legislation in December 2025 requiring PBMs to report detailed prescription drug utilization and spending data to employer plan sponsors — a transparency requirement that would fundamentally change the information asymmetry that currently allows spread pricing to persist.

The Pass-Through Model: What Transparency Actually Looks Like

The alternative to spread pricing is called the pass-through or transparent model. In a pass-through arrangement, the PBM charges the plan sponsor exactly what it pays the pharmacy for each drug — no spread, no markup. The PBM’s compensation comes entirely from a flat, disclosed administrative fee per claim or per member per month. All manufacturer rebates are passed through to the plan sponsor in full.

The financial implications for employers are substantial. When every dollar of rebate flows back to the plan, and when the plan pays actual drug costs rather than inflated spread-pricing rates, the savings are direct and measurable. When combined with a self-funded health plan structure — which gives the employer direct access to claims data and eliminates carrier profit margins — a transparent PBM model can produce compounding savings year over year.

A California Financial Institution: The Case Study

This is not theoretical. In my work with a major California-based financial institution (name withheld) — a 3,000-employee organization that I guided through a transition from a fully insured health plan to a self-funded structure — the implementation of a transparent, 100 percent pass-through PBM model was a central component of the financial strategy.

The transition involved moving from a traditional carrier arrangement, where the employer had no visibility into actual drug costs or PBM margins, to a self-funded structure with a transparent PBM that disclosed all rebates, charged only a flat administrative fee, and passed through 100 percent of manufacturer rebates to the plan.

The results were concrete: a major California-based financial institution (name withheld) achieved 10 percent annual savings in health plan costs without increasing employee contributions, and realized $4 million in total savings over two years. The transparent PBM model was not the only driver of those results — stop-loss architecture, claims management, and wellness program design all contributed — but the elimination of spread pricing and the full pass-through of rebates were foundational to the financial case.

What Employers Should Do Now

The regulatory environment is moving toward transparency, but the timeline is uncertain. Employers who wait for legislation to solve this problem will continue paying PBM margins in the meantime. Here is what I recommend to every mid-market employer I work with.

- Audit your current PBM contract. Request a full disclosure of the PBM’s compensation model, including all sources of revenue: administrative fees, spread pricing, rebate retention, and any other arrangements. If your PBM is unwilling to provide this disclosure, that is itself informative.

- Demand pass-through pricing at renewal. Most major PBMs now offer pass-through contract options alongside their traditional spread-pricing arrangements. The pass-through option is almost always financially superior for the plan sponsor.

- Require full rebate transparency. Your PBM contract should specify that 100 percent of manufacturer rebates are passed through to the plan, with quarterly rebate reports showing drug-level rebate data.

- Use an independent PBM consultant. An independent consultant — compensated solely by the plan sponsor — can conduct an objective analysis of your current contract and manage the RFP process without a stake in the outcome.

- Consider self-funding. The full benefit of a transparent PBM model is realized within a self-funded health plan structure, where the employer has direct access to claims data and captures the financial benefit of a healthy claims year.

A Note on the Fiduciary Dimension

There is a legal dimension to this conversation that is becoming increasingly important. ERISA imposes fiduciary duties on employers who sponsor health plans — a duty to act prudently and in the exclusive interest of plan participants. A growing body of case law is establishing that employers who fail to scrutinize PBM contracts and demand transparency may be exposing themselves to fiduciary breach claims.

The question is no longer just whether your PBM contract is financially optimal. It is whether your failure to investigate and optimize that contract constitutes a breach of your duty to your employees. The employers who are getting this right are not waiting for their brokers to raise the issue. They are asking the questions themselves — and they are finding that the answers are worth asking.