The Pharmacy Rebate System: Traditional vs. Fee-Based Model

By Andrew Royce, September 24, 2018

The pharmacy rebate system is under fire and companies are beginning to make moves toward more transparency

In 2018, Carl Ichan (a large investor in Cigna) stated that Cigna's merger with Express Scripts, a national Pharmacy Benefit Manager (PBM), rivaled 'the worst in corporate history'. Ichan went on to say, “When Cigna entered into this agreement several months ago, I believed a $60 billion purchase price made no sense, but there were at least arguments that could be made by management to try to persuade us into thinking that it was not completely ridiculous”.

In his letter to shareholders, however, he continued, “These arguments now disappear in light of certain material events of the last month, such as Amazon’s almost certain entrance as a competitor to Express Scripts and the government’s direct challenge to the highly flawed rebate system. As a result, Express Scripts’ earnings will almost certainly be seriously diminished, but even more importantly, Express Scripts will be existentially challenged, i.e., their very existence might well come into question over the next few years.”

To be sure, the pharmacy rebate system is under fire and companies are beginning to make moves toward more transparency in light of criticism from employers, lawmakers, and the Trump administration - which is pushing for lower drug prices.

“The current administration is particularly focused on bringing down prescription drug prices for consumers and has specifically targeted PBMs as the part of the supply chain that is overearning relative to the value they produce,” Icahn wrote in his letter. “There is a strongly held belief that the rebate system, which Express Scripts relies on heavily, is a rigged game with conflicting incentives that might actually be pushing up drug prices”, according to Ichan.

"It is our belief that the PBM industry will move to an entirely fee-based model over time, which already exists for some customer groups," Icahn said of the Cigna-Express Scripts deal. "Since rebate customers are among the highest margins for PBMs, this shift is very likely to result in significant margin compression."

How Rx Rebates works with Traditional Insurance Carriers:

To understand how the Rx rebate work, we first must understand the six stakeholders in the supply chain of prescription drugs:

  1. Pharmaceutical manufacturers – (e.g. Pfizer, Roche, AbbVie)
  2. Wholesalers – (e.g. McKesson, Cardinal Health)
  3. Pharmacies – (e.g. CVS, Walgreens, Wal Mart)
  4. Pharmacy benefit managers (e.g. Caremark, Express Scripts, OptumRx)
  5. Health insurers (e.g. UHC, BCBS, Cigna)
  6. Patients

The pharmaceutical manufacturer pays prescription drug rebates to the PBM, who then shares a portion with the health insurer. Rebate contract terms vary widely among brands, pharmaceutical manufacturers, and health insurers, but tend to be highest for brands in therapeutic classes with competing products. The aim is to incentivize PBMs and health insurers to include the pharmaceutical manufacturer’s products on their formularies and to obtain a “preferred tier” placement.

Without further governmental regulation or a disruption in the market (e.g., Amazon Rx), the lack of required transparency between the parties receiving the rebates (manufacturer, PBM, insurer) and the consumer makes cost comparisons of competing brands nearly impossible. This currently sanctioned “black box” of rebates creates a major profit center in the prescription drug distribution chain because consumers do not know the true cost of the drug. Neither the patient nor the employer knows how much the pharmaceutical manufacturers are paying in rebates, or how much the PBMs and the health insurers are withholding. While average rebates are close to 20% of the Rx price, some brands have no rebates, while others offer rebates of over 75%. To add to the complexity, rebate levels change each year as a result of negotiations between health insurers, PBMs, and pharmaceutical manufacturers.

All of this has resulted in a rigged system, and is exactly what Express Scripts - and other PBMs - have relied on to beef up its profits. As more employers demand transparency and explore a fixed fee PBM model, the valuation and success of the Cigna/Express Scripts merger is threatened, as predicted by Mr. Ichan.


Companies with 50 full-time employees or more may consider a fully transparent fee-based PBM model. In a fee-based PBM model the employer pays a flat fee for the PBM services and the employer recovers 100% of the Rx rebates. The fee-based model is transparent and more cost effective than the traditional Rebate system. Further, the employer is equipped with Rx utilization reports and true cost data that allow the employer to properly manage and control healthcare costs. With rebates ranging from 20-75% for Rx, the savings can be substantial. Furthermore, with $64 billion in brand drugs becoming available as generics, self-funded employers have never been in a better position to maximize every dollar they spend. In contrast, specialty pharmacy costs and utilization are on the rise for these specialized, high-cost therapies.

Fee-based PBM options:

Some traditional insurers will not allow their insureds to switch to a fee-based model because of the profitability it produces for the insurer. In these cases, companies are looking at programs such as Employee Benefits Captives to drive down healthcare costs. When compared to traditional insurance, Employee Benefits Captives provide a long-term cost reduction strategy for: Rx, medical claims, wellness, case management, stop loss premium, etc. Instead of each of these components being a profit center for the traditional insurer, they function on a fee-based and transparent model to reduce the employer’s total healthcare spend.


The independent fee-based PBM is just one component of the many costs reduction strategies that an employer can incorporate to reduce healthcare costs. The key for an employer is to partner with independent providers in a transparent model in which the providers work to reduce costs for the employer. The trio of Buffet, Bezos and Dimon are doing exactly that for their employees. As employers demand transparency and explore options for their companies, many will find that its yield could be enhanced thereby partnering with independent providers.

If you would like more information on an Employee Benefits Captive, please contact BlueStone Advisors at 630.504.6400.

Andrew Royce, CIC, CRM, CLCS, CRIS is Co-Founder & President of BlueStone Advisors, LLC, an insurance brokerage and consulting firm specializing in Property & Casualty, Employee Benefits and Captives. He specializes in Captives for P&C and Employee Benefits and has over 15 years of industry experience. Andrew can be reached at

Tags: Pharmacy Benefits Manager, Employee Benefits

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