Contracting over Rebates: Formulary Design and Pharmaceutical Spending

Abstract

We investigate how formularies used by pharmacy benefit managers (PBMs) to steer consumer demand can constrain spending by affecting manufacturer rebates for branded drugs. We present a theoretical model of multidimensional contracting in which a PBM offers multiple drug manufacturers a menu of formulary-contingent rebate payments and then selects a formulary. We estimate how formulary placement affects drug demand for statins using data from Princeton University, a large employer that contracts with a single PBM to offer prescription drug coverage to its employees. Using our model and demand estimates, we predict the magnitude of rebates with one preferred and one non-preferred tier; we also examine the impact of changing the number of drug tiers or allowing for complete exclusion. Our predicted magnitudes align with aggregate rebate data, and we predict that allowing a PBM to flexibly place branded drugs on preferred- and non-preferred tiers can substantially increase rebate payments.