PBM Terminology Explained: What Every Employer Should Know
Written by
SmithRx
Feb 2, 2026
HR teams are the heart of organizations: they grow employee bases, support staff with professional development, and become experts in compliance for businesses. On top of that, they need to knock benefits out of the park to ensure business success, as they’re a crucial component of talent acquisition and retention.
The legacy players in the pharmacy benefits industry don’t make this an easy task either. They’ve created complex, opaque systems—rife with technical terminology—that can make managing benefits feel impossible. Yet, grasping the full scope of legacy pharmacy benefit managers’ (PBMs) misalignment requires you speak their language.
Understanding PBM terminology is critical for determining cost-management success and effectively advocating for member wellbeing. Knowing the right terms empowers businesses to scrutinize contracts, identify hidden costs, and ultimately make informed decisions about pharmacy benefit vendors.
Moving from confusion to clarity is the first step in regaining control over your healthcare spend and experience.
What Is a PBM?
A PBM, or pharmacy benefit manager, manages prescription drug benefits for health insurers, employers, and other payers. PBMs act as intermediaries between pharmaceutical manufacturers, pharmacies, and a health plan.
Their primary purpose is to process prescription claims, manage drug formularies, negotiate discounts with pharmacies, and negotiate rebates with manufacturers. They implement cost-control measures like prior authorization and step therapy to ensure the use of safe, clinically appropriate, and cost-effective drugs.
PBMs interact with:
Insurers/ Employers: Design and administer the specific drug benefit plan.
Pharmacies: Create a Pharmacy Network and determine how much to reimburse pharmacies for dispensed drugs.
Manufacturers: Negotiate Rebates in exchange for placing drugs on their preferred list (Formulary).
Key PBM Terms Employers Should Know
Understanding the terms legacy PBMs use is essential for contract negotiations, making the most of your benefit plan, and effectively communicating how these structures impact your members.
Let’s explore some of the core terms PBMs use:
Term | Definition | What Employers Should Know |
Formulary/ Drug List | A list of prescription drugs reviewed for safety and effectiveness, encouraging the use of cost-effective medications within the plan's overall coverage goals. This list determines which drugs are covered and at what cost tier. | Does your PBM’s formulary include cost-effective alternatives like biosimilars and generics in the preferred tiers? |
Rebates | A post-sale discount paid by a drug manufacturer to a PBM or plan sponsor, usually in exchange for formulary placement or volume guarantees. | Are these rebates passed back to you in full, or does the PBM retain a portion? |
Client Cross-Subsidization | The practice of legacy and certain pass-through PBMs to artificially lower costs for priority clients (often large, public organizations) by passing inflated costs on to other clients. As non-preferred clients switch to modern vendors, the PBMs practicing client cross-subsidization are left to either raise prices for preferred clients or shoulder the financial burden. | Do all of your PBM’s clients get the same pricing? |
Copay | A fixed dollar amount (e.g., $10) a member pays for a covered drug. | Does your PBM source lowest net-cost drugs for their formulary to optimize for low or $0 copays? |
Coinsurance | A fixed percentage (e.g., 20%) the member pays, typically after meeting their deductible. | Is your PBM generally delivering fiscally sustainable pricing for your members? |
Network Pharmacies | A list of pharmacies the PBM has contracted with where members can fill prescriptions. In-network pharmacies offer contracted rates (lower cost), while filling at an out-of-network pharmacy usually results in higher costs or no coverage for the employee. | Considering where your members live, are there convenient options for in-network pharmacies with your PBM? Are members restricted to filling at PBM owned pharmacies? Can they fill at local independent pharmacies? |
Prior Authorization (PA) | A drug management tool that requires a provider to obtain approval from the PBM or health plan before a specific, typically high-cost and/or clinically complex drug, will be covered. | How much effort/member involvement is needed in the prior authorization process? Does your PBM include medications on their formulary that do not require prior authorization? |
Step Therapy | A type of utilization management that requires a patient to try one or more lower-cost or safer medications first—such as generics or preferred alternatives—before coverage is approved for a higher tier drug. | How is step therapy managed/ supported by your PBM’s service team? Does your PBM partner with care organizations? |
Specialty Drugs | High-cost, high-complexity medications used to treat rare, chronic, or complex conditions. They often require special handling and administration, leading to dramatically increased costs for employers and requiring specialized attention in benefit design. | Does your PBM offer low-cost biosimilars and generics on their preferred tiers for “specialty” medications? |
Modern PBM | A class of innovative pharmacy benefits managers committed to fiduciary alignment and radical transparency. Unlike legacy players, it eliminates hidden markups to act solely in the client's interest, using a unified model to simplify the member experience and turn data into measurable drug savings. | Is your PBM net-cost focused or more reliant on ‘discounts’ to prove savings? |
Maximum Allowable Cost (MAC) | A list that sets the upper reimbursement amount to the pharmacy for generic drugs and brand-name drugs that have a generic product available, helping control costs for plan sponsors. A MAC list encourages pharmacies to purchase the lower-priced drugs to prevent health plans and patients from overpaying. | What does my PBM’s MAC list look like? Is it frequently updated to include new, low-cost alternatives to curb plan spend? How many MAC lists does my PBM have per pharmacy? |
Average Wholesale Price (AWP) | A benchmark or "sticker price" that represents the average price at which wholesalers sell prescription drugs to pharmacies and other providers, often used in contracts between plan sponsors and pharmacy benefit managers (PBMs) for drug reimbursement. | Is my PBM using true benchmark AWPs for our pricing, or are they inflating costs? |
Wholesale Acquisition Cost (WAC) | The price paid by wholesalers and direct purchasers, such as distributors and pharmacies, when they purchase drugs from manufacturers. This does not include any discounts or rebates. | Alternatively, is my PBM using true benchmark WASs for our pricing, or are they inflating costs? |
For more detailed definitions and to continue building your expertise, refer to the full glossary here.
Why PBM Education Matters for Employers
A strong grasp of PBM language directly translates into improved plan performance and member satisfaction:
Informed Decision-Making: You can more easily spot PBMs who have cost-based, clinically-informed formularies and use appropriate tools (like step therapies and prior authorizations) that balance cost control with members’ access, aligning the plan with your organization's goals.
Support Contract Negotiations: When you understand industry terms like Rebates, MAC, AWP, and more, you can demand clearer contract language, hold the PBM accountable for savings promises, and ensure you retain all manufacturer rebates and discounts.
Reduced Confusion and Frustration: A well-designed plan that is clearly structured, using the terminology you now understand, leads to fewer surprises at the pharmacy counter, improving employee trust and experience.
Making Informed Pharmacy Benefit Decisions
To effectively manage your pharmacy benefits to best serve your business needs and members, it’s best to take an active role in examining, and scrutinizing, your PBM’s practices. Along with being educated on PBM lingo, terminology, and common practices, it’s also important to build a team of strategic advisors who are also experts in legacy and modern PBMs. They’ll help you:
Push for Transparent Reporting and Dashboards: Demand comprehensive reporting that breaks down drug spend by category, network vs. non-network utilization, and where your rebates are flowing. Look for reports showing ingredient cost, dispensing fee, and administrative fee for full cost visibility.
Conduct Thorough Contract Review: Your team of experts can help you ask the tough questions. Will you pass through 100% of all manufacturer rebates and administrative fees back to our plan? How often is your MAC List updated? How often do you update your formulary? How many fees are listed in the contract? Is there a per claim administration fee? Prior authorization fee? Clinical program fee?
Spot Red Flags and Misaligned Incentives: Look for signs of "spread pricing" (the PBM reimburses the pharmacy less than they charge you) and other poor practices. If your rebate reports are complicated or seem vague, or if your plan's gross spend increases dramatically while rebates also increase, it may signal misaligned incentives.
The language of pharmacy benefits doesn't have to be a barrier. By dedicating the time to understand key terms and concepts, you can achieve sustainable cost management and ensure your employees receive the best care.
At SmithRx, we’re proud to lend our expertise to businesses looking to get the most out of their pharmacy benefits. Check out our complimentary PBM Evaluation Guide and schedule a time to chat with our team to discover how we can help you balance drug savings with exceptional member experiences.
Written by
SmithRx
SmithRx is the #1 Modern PBM, relentlessly focused on eliminating the conflicts and complexity of legacy pharmacy benefits. Built on radical transparency and fiduciary alignment, we empower employers to take control of their pharmacy spend and experience with our 100% pass-through model.
