Contracting over Pharmaceutical Formularies and Rebates

We investigate how formularies used by pharmacy benefit managers (PBMs) can affect manufacturer rebates for branded drugs. We first present a theoretical model of multidimensional contracting in which a PBM negotiates with drug manufacturers over menus of formulary-contingent rebate payments and then selects a formulary. We then 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 theoretical model and demand estimates, we predict how rebates are affected by the use of a preferred tier in the formulary or the ability to exclude a drug from coverage. Our predictions align with aggregate rebate data, and we find that allowing a PBM to place branded drugs on preferred and non-preferred tiers can substantially increase negotiated rebate payments.