Drug rebates: As if drug pricing isn’t confusing enough

In recent months, direct-to-consumer (DTC) drug programs like TrumpRx have drawn attention for offering medications at prices that sometimes look lower than what patients pay through their insurance. For many people, that experience raises an uncomfortable question: how can the same medication cost less without insurance than with it?

The answer often lies in a part of the drug pricing system that most patients never see. Many discounts in the prescription drug market happen after the sale through rebates negotiated between manufacturers, pharmacy benefit managers (PBMs) and insurers. In 2023 alone, an Economic Report on U.S. Pharmacies and PBMs showed manufacturer rebates paid to wholesalers, PBMs and others reached $334 billion for all brand-name drugs. Those rebates can lower costs for the health system overall, but they do not always reduce the price a patient pays at the pharmacy counter.

DTC programs are not solving the rebate problem, but they are making it easier to see how the system works. In this issue of PolicyRx, we take a closer look at prescription drug rebates, how they influence drug prices and access, and why they remain one of the most debated features of the U.S. drug pricing system.

How do drug rebates work?

While rebates have long been used as a mechanism for driving sales and creating brand loyalty, the process can increase the risk for monopoly-like scenarios and pressure buyers to meet certain sales benchmarks to receive their money back. Additionally, the potential exists for product mark-up by buyers at the point of sale as they leverage the fiscal benefits of rebates from manufacturers.

Rebates in the drug pricing space are especially fraught in that the affected product pricing involves life-saving medications, and the end-users are patients in need of these medications to protect, improve or maintain health. Drug rebates function like typical product rebates; in the prescription drug market, they are provided by manufacturers to incentivize the purchase of specific drug products by wholesalers and influence preferential patient use through PBMs, predominately on brand name drugs.

Drug rebates are dollars paid retrospectively, under negotiated contracts. These contracts typically set tiered structures of payment based on criteria such as volume, rates of sales or usage growth, or the overall use of preferred drugs. One way the amount of a rebate may be calculated is based on the difference in the ‘list price’—or Wholesale Acquisition Cost (WAC), which is what the manufacturer sets the price at—and the Average Wholesale Price (AWP). AWP has its own controversies, as this figure should be the average price wholesalers sell drugs to pharmacies; however, many have challenged whether AWP aligns with the actual cost of drug acquisition by pharmacies from wholesalers. In this rebate model, as the WAC increases, rebates likely increase as well.

One may infer that higher rebates increase the likelihood of manufacturers’ products being purchased, distributed by wholesalers, and placed on PBM formularies. However, rebate payment information is proprietary and not publicly available.

When incentives pull in different directions

One reason drug pricing can feel confusing is that different parts of the system are rewarded for different outcomes. Each entity is responding to incentives that make sense for their role, but those incentives do not always align with patients’ adequate access to necessary medication.

Manufacturers

Manufacturers often compete for placement of their preferred, brand name drugs on insurance formularies. One way to secure that placement is by offering rebates tied to a drug’s list price or market share. In some cases, a higher list price can support a larger rebate, which may make the product more attractive to insurers or PBMs. This does not mean manufacturers are trying to increase costs for patients. It means the system rewards strategies that strengthen formulary position and market share.

PBMs and insurers

PBMs and insurers negotiate rebates to help control overall drug spending and keep insurance premiums low. Larger rebates can reduce the total cost of providing coverage across a population. At the same time, patients often pay deductibles or coinsurance based on the drug’s list price, not the rebated price. That means the financial benefit of the rebate may be spread across the insurance pool rather than applied directly to the patient using the medication.

None of these incentives themselves are inherently wrong. Each reflects a rational response to the rules of the system. But when incentives pull in different directions, they can result in pricing that feels inconsistent or difficult to understand. When standard business incentive structures are applied to medications, their impact on healthcare must be considered, which is why prescription drug pricing does not always behave like pricing in other markets.

How are patients and pharmacies impacted by rebates?

As rebates have increased and broadened in scope over recent decades, the pricing structure for insurance has come to rely upon these rebates to keep premiums down. Wholesalers rely upon rebates to keep prices feasible for purchasers (e.g., pharmacies) and balance profit margins. Ultimately, rebates impact patients and pharmacists in a few different ways.

PBMs can ‘pass through’ all or a portion of the rebate funds to the employers they contract to manage their drug benefits. Some estimates have shown that between 91% to 95% of commercial market rebates are passed through to employers. Insurers or employers may use these funds to reduce overall insurance premiums for patients, but, as stated, the drug rebate incentive funds do not fully pass through to those who use the rebated medications.

Similarly, rebates to wholesalers influence the prices paid by pharmacies to acquire these drugs. This cost determines cash prices paid by patients. As the price for a drug increases for the pharmacy, the cost to the patient can be inflated beyond what is reasonable or feasible to pay, thus limiting patients’ access to the prescribed medication.

For the pharmacy, the reimbursement from the PBM for dispensing the medication is not based on the actual cost the pharmacy paid to acquire the drug from the wholesaler; thus, this discrepancy contributes to the unpredictable business model facing pharmacies in this current landscape. This challenge relates back to reimbursement being tied to AWP, which doesn’t accurately represent the actual acquisition cost.

Consider this example:

• Manufacturer list price: $1,000
  • They negotiate rebates of 20% with PBMs and wholesalers based on preference and volume.
• Wholesaler purchase price: $1,000
  • When they meet negotiated volume levels, they receive the 20% ($200) rebate.
• PBM administrative fee: $50
  • PBMs receive the $200 rebate, keep a $50 administrative fee and pass the rest onto the insurer ($150).
• Insurer rebate: $150
• Pharmacy purchase price: ~$1,000
  • After they dispense the drug to the patient, they are reimbursed by PBMs based upon negotiated dispensing rates tied to AWP, which may or may not align with the $1,000.
  • Patients pay the price set at the pharmacy, which is based upon the price the pharmacy paid the wholesaler for the medication.
  • As the rebate savings does not pass down to the pharmacy, the pharmacy is unable to pass this savings to the patient.

If that list price increases to $1,500, the rebate increases to $300. For the same drug, the financial implications become more complicated, predominately for pharmacies and patients

Policy considerations

Because rebates shape incentives across the system, policymakers have proposed several approaches to improve transparency, align incentives and reduce unintended consequences.

1. Require reporting by manufacturers of rebates paid to PBMs and wholesalers.

Pros

• Transparency in which manufacturers are paying rebates, how much is being paid and to whom they are paid for specific drugs

Cons

• This does not address transparency in how the rebate funds are ‘passed through’ to insurers, employers, pharmacies or patients

2. Require a set amount/percentage of ‘pass through’ to insurers and pharmacies

Pros

• Clarity and potentially increased equity in rebate funds disbursement to PBMs, insurers/employers and pharmacies

Cons

• The amount of money paid by manufacturers in rebates still influences formulary preference by PBMs for insurance coverage and access via wholesaler purchasing options

3. Delink rebates from list prices

Policymakers could restrict manufacturers from basing rebates for prescription drugs on their list prices, a practice that incentivizes higher drug list prices. Instead, PBMs and wholesalers could receive a “service fee” from manufacturers that reflects the fair market value for the services provided.

4. Prohibit rebates

Pros

• The costs of drugs may be decreased as rebate dollars are reallocated back to the manufacturer
• Formulary placement for insurance coverage preference can be based solely upon evidence vs. influenced by rebates paid to PBMs
• Drug pricing in the market will have one less variable confusing the actual cost of drugs

Cons

• Major adjustments in drug pricing would be needed and/or drug costs may be insurmountable, decreasing access for patients

Looking ahead

Drug rebates are often described as discounts, but they function as a set of financial incentives that shape how medications are priced, covered and used across the healthcare system. Those incentives can lower overall costs for insurers and employers while still leaving patients and pharmacies facing higher prices at the point of sale.

As policymakers continue to debate reforms, understanding how rebates influence behavior across the system will be essential to designing solutions that improve access, affordability and sustainability.