March 5, 2025. By Anne Tyler Hall and Tim Kennedy*-Hall Benefits Law
A plan sponsor’s fiduciary duty to be transparent in Pharmacy Benefit Manager contracts safeguards plan participants’ interests and mitigates the risk of litigation, regulatory penalties, and reputational harm, say Hall Benefits Law practitioners.
Pharmacy Benefit Managers (PBMs), particularly the Big 3 PBMs (CVS Caremark, Express Scripts, and OptumRx), have leveraged their market share and bargaining power to become key players in the administration of prescription drug benefits, serving as intermediaries between group health plans (GHPs), pharmaceutical
companies, and pharmacies. However, despite their critical role, PBM operations often lack transparency, raising serious concerns about inflated drug prices, undisclosed rebates, spread compensation and other cost inefficiencies. For plan sponsors (Plan Sponsors) , this lack of visibility creates significant fiduciary risks, particularly in light of evolving legislative and regulatory requirements. Under the Employee Retirement Income Security Act of 1974, as amended (ERISA), fiduciary risks, include personal liability for any individual failing to comply with ERISA’s fiduciary duties (ERISA, §409). This article explores the legal risks associated with PBM opacity and provides strategies for mitigating these risks.
The No Surprises Act, enacted as part of the Consolidated Appropriations Act, 2021 (“CAA”), underscores the importance of cost transparency to protect health and welfare benefit plan participants (Pub. L. No. 116-260, Div. BB (enacted Dec. 27, 2020); 26 U.S.C. §9816). Coupled with the fiduciary standards imposed by ERISA, Plan Sponsors are legally obligated to ensure that all plan expenses are reasonable and that service providers, including PBMs, act in the best interest of participants. Failure to meet these obligations can result in costly litigation, heavy regulatory penalties, and long-lasting reputational harm. Importantly, ERISA can also hold individual fiduciaries personally liable for any breach of ERISA’s fiduciary responsibilities.
Fiduciary Duties Under ERISA and the CAA
ERISA imposes stringent fiduciary duties on Plan Sponsors, requiring them to act prudently and exclusively in the interest of plan participants and beneficiaries. At the heart of these duties is the obligation to ensure that all plan expenses are necessary, reasonable, and transparent. This extends to the selection and ongoing monitoring of service providers, such as PBMs, which play a pivotal role in administering prescription drug benefits. Fiduciaries must take proactive steps to investigate whether PBM arrangements meet these criteria, ensuring that costs are justified and that participants’ interests are prioritized.
Additionally, fiduciaries are required to make a fully informed determination that GHP fees are reasonable, to avoid having the GHP engage in a “prohibited
transaction” under ERISA and become subject to a significant excise tax. Such a determination can only be made where service providers are transparent regarding their fees. It is difficult to make the required reasonableness determination where not all fees are
disclosed.
The CAA (including the No Surprises Act), as well as the Transparency in Coverage Rules and the price transparency and participant disclosure rules in the ACA (the “Transparency Rules”) build upon ERISA’s fiduciary principles by mandating enhanced transparency in healthcare plans, including PBM fees. Plan Sponsors are now required to obtain detailed disclosures regarding pricing mechanisms, administrative fees, and rebate structures. This level of visibility is intended to protect participants from inflated costs and ensure compliance with fiduciary responsibilities. Failure by the Plan Sponsor, whether by negligence or intentional disregard, to proactively engage and negotiate the contours of the PBM relationship, exposes Plan Sponsors to significant corporate and personal liability under ERISA. Legal consequences include not only regulatory penalties and excise taxes but also participant-initiated lawsuits alleging breach of fiduciary duty. Ultimately, individual fiduciaries are personally liable for any losses resulting from a failure to adhere to ERISA’s fiduciary obligations.
Furthermore, the CAA emphasizes the need for continuous oversight. Simply signing a negotiated PBM contract is not enough; Plan Sponsors must regularly monitor PBM performance and enforce contract terms to maintain compliance. This dual obligation—contractual and fiduciary—creates an added layer of complexity for Plan Sponsors, requiring robust legal and administrative strategies.
The Risks of PBM Opacity
Spread Compensation
PBM opacity remains a critical issue, posing substantial risks to Plan Sponsors. Key practices such as spread pricing, rebate retention, and the use of proprietary formularies often operate under a veil of secrecy, leaving Plan Sponsors in the dark about the true cost of administering prescription drug benefits. Spread pricing, for instance, allows PBMs to charge health plans significantly more than the amount paid to pharmacies, and to pocket the difference as profit. This practice inflates costs for Plan Sponsors and participants while generating significant revenue for PBMs, often without the Plan Sponsor’s knowledge.
Rebates
Rebate retention is another common issue. While PBMs negotiate rebates with drug manufacturers, and promise to pass all rebates on to the GHP, they frequently retain a portion of these rebates by recharacterizing payments from drug manufacturers as something other than rebates. Often this practice is supported by the agreements which are carefully drafted by the PBMs. The lack of transparency around these transactions makes it difficult for sponsors to assess whether their plans are benefiting appropriately from negotiated savings. In many cases, these opaque arrangements drive up overall plan costs, eroding the value provided to participants.
MAC List
A “MAC List” specifies the maximum allowable cost that a PBM will reimburse a pharmacy for each drug on a GHP’s formulary. It purports to maximize savings by incentivizing pharmacies to purchase the lowest-priced generic drugs. Often, however, there are many different MAC Lists at a PBM’s disposal, which can be used selectively by the PBM to instead maximize a PBM’s revenues over the interest of the GHP to keep costs down.
Formulary Lists
One of the services PBMs perform is to create the GHP’s formulary. The formulary is simply the list of drugs covered by the GHP. The formulary should be comprehensive and offer a good mix of specialty, brand, and generic drugs. The overall design should also aim to keep GHP drug spend down. However, PBMs are often incentivized by the drug manufactures (through rebates and other mechanisms) to promote brand drugs or other expensive drugs over lower cost generics that are equally effective. This results in formulary that serves the interest of the PBM over the interests of the GHP participants.
Gag Clauses
Certain contractual provisions exacerbate these risks. Gag clauses, for example, prevent pharmacies from informing patients about lower-cost alternatives, undermining efforts to reduce out-of-pocket expenses. Gag clauses are no longer permissible under the CAA, and Plan Sponsors are obligated to ensure none of the GHP’s service provider agreements contain any gag clauses. Non-disclosure agreements (NDAs) further limit transparency by prohibiting sponsors from sharing contract details with third-party auditors or advisors. These provisions not only obscure the financial relationships between PBMs and other stakeholders but also hinder sponsors’ ability to exercise effective oversight.
The legal and fiduciary implications of failing to address these issues are significant. Failure by the Plan Sponsor to investigate or mitigate PBM opacity is a breach of fiduciary duties under ERISA that puts the GHP and the fiduciaries at risk of penalties and a lawsuit. Courts have consistently held that fiduciaries must act with the care, skill, and diligence that a prudent person would exercise under similar circumstances (Donovan v. Bierwirth, 680 F.2d 263 (2d Cir. 1982), (under ERISA, fiduciaries are required to act “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use”); Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014) (ESOP fiduciaries are subject to the same duty of prudence that applies to all ERISA fiduciaries, mandating actions with the care, skill, prudence, and diligence of a prudent person under similar circumstances); Tibble v. Edison Int’l, 575 U.S. 523 (2015) (fiduciaries have a continuing duty to monitor investments and remove imprudent ones, underscoring the obligation to act with the care, skill, prudence, and diligence of a prudent person in similar situations). Ignoring PBM practices that drive up costs or conceal critical information exposes sponsors to legal action, agency scrutiny, and reputational damage.
Transparency Requirements and Legal Implications
The CAA establishes a robust framework for transparency that imposes specific obligations on Plan Sponsors (26 U.S.C. §9824). Central to these requirements is the need to obtain comprehensive disclosures from PBMs regarding pricing, fees, and rebate arrangements. These disclosures enable Plan Sponsors to assess the financial impact of PBM practices and determine whether plan expenditures are reasonable and aligned with fiduciary obligations.
Monitoring PBM practices is another critical requirement. The CAA calls for Plan Sponsors to implement mechanisms for ongoing oversight, such as regular audits and performance reviews. These measures help ensure that PBMs adhere to contractual terms and do not engage in practices that inflate costs or undermine plan efficiency. Without these safeguards, Plan Sponsors may inadvertently allow excessive costs to persist, violating their fiduciary duty to act in participants’ best interests.
The legal implications of failing to meet these transparency requirements are far-reaching. Regulatory agencies, including the Department of Labor (DOL), have the authority to investigate and penalize non-compliant Plan Sponsors. Penalties may include substantial fines, mandatory corrective actions, and increased scrutiny of future practices. Additionally, participants who believe their benefits have been adversely affected by opaque PBM practices may file lawsuits alleging breach of
fiduciary duty. These lawsuits can result in costly settlements, reputational harm, and long-term financial consequences for sponsors.
In this regulatory environment, Plan Sponsors must prioritize compliance not only to avoid penalties but also to build trust with participants. Transparency is no longer a mere best practice; it is a legal obligation that underscores the sponsor’s commitment to ethical and effective plan management.
Examples of Challenging PBM Contract Clauses
Rebates
PBM contracts often include clauses that create significant compliance challenges for Plan Sponsors. These provisions are designed to maximize PBM profits while limiting sponsors’ ability to enforce transparency and accountability. One such clause is the rebate retention provision, which allows PBMs to keep a portion of manufacturer rebates without disclosing the full amount to the Plan Sponsor. This lack of transparency makes it nearly impossible for sponsors to determine whether their plans are receiving fair value from rebate arrangements.
Spread Pricing
Spread pricing agreements present another common challenge. Under these arrangements, PBMs are able to charge the plan a higher price for a drug than what they pay the pharmacy, and to retain the difference as profit. While this practice generates revenue for PBMs, it increases plan costs and reduces the value provided to participants. Sponsors who fail to identify and address spread pricing risk breaching their fiduciary duty to ensure reasonable plan expenses.
Gag clauses and NDAs further complicate compliance efforts. Gag clauses restrict pharmacies from informing patients about lower-cost drug options, undermining efforts to reduce out-of-pocket expenses. NDAs, meanwhile, prevent sponsors from sharing contract details with auditors or consultants, limiting their ability to conduct effective oversight. These provisions not only hinder transparency but also expose sponsors to regulatory penalties and litigation.
Plan Sponsors must proactively identify and negotiate the removal of these clauses to align contracts with legal and fiduciary obligations. This requires a thorough review of contract terms, supported by expert legal counsel, to ensure that all provisions meet the transparency standards outlined in the No Surprises Act and ERISA.
Consequences of Failure to Require Transparency
The consequences of ignoring the lack of transparency in PBM contracts are both legal and practical, with significant implications for Plan Sponsors. On the legal front, non-compliance with transparency requirements exposes sponsors to ERISA litigation and regulatory penalties. Participants who perceive that their benefits have been compromised by opaque PBM practices may sue for breach of fiduciary duty and seek financial restitution and corrective actions. Regulatory agencies, including the DOL, may also impose fines and mandate corrective measures, adding to the financial and administrative burden on sponsors.
Beyond these legal risks, the reputational consequences of non-compliance are profound. Public exposure of opaque PBM practices can damage an employer’s reputation, eroding trust among employees and beneficiaries. In today’s competitive job market, organizations that fail to prioritize transparency and ethical plan management may struggle to attract and retain talent. Participants increasingly value employers who demonstrate accountability and a commitment to protecting their interests.
The financial implications are equally significant. Opaque PBM practices often result in inflated plan costs, reducing the resources available for other employee benefits or initiatives. Over time, these inefficiencies can undermine the sustainability of the plan, leading to increased contributions from both employers and participants. Addressing transparency issues proactively is therefore essential not only for legal compliance but also for long-term plan sustainability.
Steps to Enhance Transparency in PBM Contracts
Require Full Disclosure
To address transparency challenges and mitigate fiduciary risks, Plan Sponsors should take a proactive approach to PBM contract management. First and foremost, sponsors must demand full disclosure of all pricing structures, fees, and rebate arrangements. Comprehensive transparency is essential for assessing the financial impact of PBM practices and ensuring compliance with fiduciary obligations.
Clarify Opaque Provisions
Eliminating opaque provisions is another critical step. Plan sponsors should negotiate the removal of gag clauses, rebate retention provisions, and NDAs that hinder transparency and oversight. By aligning contract terms with the transparency standards outlined in the No Surprises Act, sponsors can reduce the risk of regulatory penalties and litigation.
Audit PBM Regularly
Regular audits are essential for ensuring ongoing compliance. Sponsors should establish mechanisms for independent audits of PBM practices, focusing on pricing accuracy, rebate pass-through, and adherence to contractual terms. These audits provide valuable insights into plan performance and help identify areas for improvement.
Compare Pricing to “Pass-Through” PBMs
Partnering with transparent PBMs is another effective strategy. Sponsors should seek out PBMs that operate on a fully transparent model, offering clear pricing structures and comprehensive disclosures. These arrangements not only simplify compliance but also enhance trust and accountability.
Engage ERISA Counsel
Finally, engaging specialized legal counsel is crucial. ERISA attorneys who specialize in these regulations can provide invaluable guidance on drafting and reviewing PBM contracts, ensuring that all provisions align with legal and fiduciary requirements. By leveraging legal expertise, sponsors can navigate the complexities of PBM arrangements and protect their participants’ interests. Moreover, ERISA counsel will document the review and negotiation process, which is critical to show compliance with ERISA’s fiduciary obligations and to protect the GHP and the fiduciaries from penalties and/or lawsuits.
Best Practices for Mitigating Legal and Fiduciary Risks
In addition to addressing transparency in PBM contracts, Plan Sponsors should adopt broader best practices to mitigate legal and fiduciary risks. Educating decisionmakers about their responsibilities under ERISA and the applicable legislative requirements is a critical first step. Plan Sponsors should provide training and resources to ensure that all fiduciaries understand the importance of transparency and their role in upholding these standards.
Developing robust monitoring protocols is equally important. Plan Sponsors should establish procedures for ongoing oversight of PBM practices, including regular contract reviews and performance evaluations. These protocols help ensure that PBMs adhere to transparency requirements and provide value to the plan.
Regularly reviewing and updating contracts is another key best practice. As regulatory requirements and market conditions evolve, sponsors must revisit their PBM agreements to address new challenges and opportunities. This proactive approach ensures that contracts remain compliant and aligned with participants’ needs.
Engaging third-party advisors can provide additional support. Benefits attorneys, consultants, and auditors offer valuable expertise in identifying potential risks and opportunities for cost savings. By fostering collaboration with these experts, sponsors can enhance their oversight capabilities and strengthen their commitment to transparency and accountability.
Conclusion
Transparency in PBM contracts is not just a legal obligation but a fiduciary responsibility that safeguards the interests of plan participants and mitigates risks for Plan Sponsors. By aligning PBM agreements with the requirements of the No Surprises Act and ERISA, Plan Sponsors are avoiding costly litigation, regulatory penalties, and reputational harm. Proactively addressing transparency and implementing these best practices ensures that plan costs remain reasonable and participants’ interests are prioritized. In an era of increasing scrutiny on PBMs, these steps are essential for achieving compliance, shielding fiduciaries from personal liability for fiduciary breaches, and fostering trust among stakeholders.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Hall Benefits Law, LLC
