Executive Summary: Pharmacy Benefit Design: PBM Relationships, Formulary Strategy, and the Small Group Disadvantage
LFP-11.07 — Benefits Architecture#
Small group level funded plans face a structural pharmacy disadvantage. CVS Caremark, Express Scripts, and OptumRx control approximately 80 percent of pharmacy benefit administration. A 25-person group accesses one of these PBMs through the TPA’s existing contract and receives standard terms reflecting its lack of negotiating leverage: spread pricing, minimal rebate pass-through, and formulary decisions optimized for PBM revenue rather than plan cost.
Spread pricing allows the PBM to pay the pharmacy one amount and charge the plan a higher amount, keeping the difference. The spread is opaque in most traditional contracts. The plan cannot see what the pharmacy was actually paid. Rebate pass-through is minimal or absent for small groups: drug manufacturers pay PBMs for preferred formulary placement, and in small-group contracts the PBM retains most or all of that revenue. The rebate arrangement also distorts formulary design because a brand-name drug with a higher rebate may be preferred over a lower-cost generic or biosimilar regardless of the plan’s clinical or economic interest. Specialty drug management compounds the problem: the PBM’s specialty pharmacy is often a captive subsidiary charging the plan higher prices than independent specialty pharmacies would. Employer pharmacy costs rose 7.7 percent in 2024 following an 8.4 percent increase in 2023. Pharmacy is the fastest-growing health benefit cost component, and small groups absorb those increases without the leverage to resist them.
Alternative models exist and are accessible. Transparent PBMs including Capital Rx, SmithRx, and Rightway use pass-through pricing with no spread, 100 percent rebate pass-through, and flat administrative fees. SmithRx reports reducing pharmacy benefit costs by an average of 30 percent and saving clients an average of $25 per member per month. Capital Rx uses National Average Drug Acquisition Cost as a public pricing benchmark, providing visibility into actual drug costs. Both serve employers across size ranges, including smaller groups. Pharmacy benefit coalitions aggregate multiple small groups into a purchasing arrangement that produces terms no individual 25-person group could negotiate. A TPA with 50,000 covered lives across 500 small employers has leverage that its individual employer clients do not.
The regulatory environment is shifting toward transparency. The Consolidated Appropriations Act of 2026 limits PBM compensation to flat bona fide service fees in Medicare Part D effective 2028 and mandates 100 percent rebate pass-through. These requirements will restructure PBM revenue models across the market.
Pharmacy benefit design is the highest-return benefits architecture decision a small employer can make and the one most commonly left to the default. The employer who accepts the TPA’s default PBM arrangement is practicing accretion. The employer who evaluates transparent alternatives, understands formulary incentive structures, and manages specialty drug exposure is practicing design. For specialty drugs specifically, the difference between traditional and transparent management can exceed the savings on all other pharmacy spend combined.