SB41: Shaking up the Rx Landscape in California

SB41 is a landmark law aiming to reduce prescription drug costs for Californians. The law materially reshapes the regulation of Pharmacy Benefit Managers (PBMs) which have become powerful intermediaries in the healthcare ecosystem.SB41 imposes a fiduciary responsibility on PBMs to act in the best interests of their clients, which includes both fully insured and self-funded employer sponsored health plans.  

This legislation takes direct aim at the opaque business practices of PBMs which have widely been considered to have driven up prescription drug prices and created excessive profits for PBMs.  Specifically, the law prohibits spread pricing, mandates pass-through of manufacturer rebates, and introduces comprehensive disclosure obligations. Collectively, these provisions create a fundamental shift in PBM transparency and accountability.  

Effective Date

Most of the provisions will be phased in, becoming effective for contracts executed or renewed on or after January 1, 2026. This means that if a PBM is currently in the middle of a multiple year contract, the new provisions of the law won’t apply until after the renewal. While technically the law is effective on January 1, 2026, the lack of immediate marketplace panic is a result of the actual effective date being delayed until the renewal of contracts.

What Are Pharmacy Benefit Managers (PBMs)?

PBMs play a pivotal role in the pharmaceutical supply chain, acting as intermediaries between pharmacies, drug manufacturers, and payers (health plans and self-funded employers). They are the third-party entity that administers the prescription drug portion of a health plan. PBMs are responsible for managing formularies (lists of covered medications), negotiating drug pricing and rebates with manufacturers, operating mail order and specialty pharmacies, and processing prescription claims. 

Key Provisions for Employee Benefit Plans

This section summarizes the provisions of the law that have an impact on employee benefit plans.

• Fiduciary Duty.  SB41 establishes a new fiduciary duty for PBMs under state law. PBMs must act in the best interests of their payer client, be fair and truthful in all dealings, avoid conflicts of interest, and perform their duties with care, skill, prudence, and diligence. This provision is foundational in creating a new level of accountability for PBMs and in closing down prior practices of self-dealing and opaque pricing practices.
  
  
• Ban on Spread Pricing. Under spread pricing arrangements, PBMs charge health plans a higher price for prescription drugs and pay pharmacies a lower price for dispensing the same drug. The difference or “spread” is retained by the PBM as profit. These hidden markups have long been a controversial practice because they hide both the true cost of the drugs and the PBM margin. The new prohibition will be phased in, with PBMs no longer being able to include spread pricing terms in their contracts or renewals effective January 1, 2026.  For existing contracts, any legacy spread pricing terms become void after January 1, 2029.   
  
  
• Copay No More than Cost of Drug. Health plans and insurers cannot calculate an employee’s cost sharing for a prescription based on inflated list prices that exceeds the actual rate paid by the plan for the prescription.  This addresses the issue when, as an example, the drug cost is $12, but the participant is charged a standard plan copay of $20.  
  
  
• Transparency in Drug Pricing and Rebates. One of the centerpiece provisions of SB41 is the requirement for PBMs to disclose information about drug pricing, rebate structures, negotiations with manufacturers, and other financial arrangements. PBMs must report annually on the rebates and fees they receive from drug manufacturers. The law specifies that such funds be passed on to health plans and ultimately to consumers in the form of reduced premiums, deductibles, copays, and other participant cost sharing.  
  
  
• 100% Rebate Passthrough. For fully insured plans, SB41 requires the PBM to redirect 100% of all manufacturer rebates to the health insurance carrier. These rebates are to be used for the sole purpose of offsetting cost sharing, deductibles, and coinsurance and for reducing premiums for plan participants.
  
  
• Passthrough Pricing Required. PBMs must use a passthrough pricing model. This means that all discounts, rebates, fees, and concessions must be passed directly through to health plans or patients rather than be retained by the PBM. Passthrough pricing stipulates that health plans pay exactly what the pharmacy pays for a drug, plus a fixed administrative or dispensing fee. 
   

Other Provisions Impacting PBMs

• New licensing, regulation, and oversight requirements for PBMs.
• Business environment protections for retail pharmacies.
• Data reporting and state auditing to monitor PBMs for potential abuses or violations.
• Requirements for fair reimbursement practices by PBMs to pharmacies.
• Restrictions on PBMs ability to steer business to affiliated pharmacies and away from non-affiliated pharmacies (those not owned or controlled by the PBM).
• Prohibition of gag clauses in contracts that prevent pharmacists from informing patients about cheaper drug alternatives or cash payment options.
• Restriction on exclusive contracting rights with a manufacturer unless the PBM can show the exclusivity results in the lowest cost for the plan and plan participants.  
• State licensing is required for PBMs to do PBM business in California.  
• Consumer protection measures to safeguard patient interests, facilitate complaints and appeals regarding PBM practices, and enable the DMHC to enforce penalties.
   
  

Legislative Reach

The law applies to PBMs that "operate in California" by providing pharmacy benefit management services to any payer, plan sponsor, insurer, or health plan that covers California residents. Practically speaking, for employers, it would apply on a contract basis (to all employees covered under a group health contract); it would not apply to individual employees based on where an employee lives. Additionally, PBMs do not have to be physically headquartered or located in California to be subject to SB41. 

ERISA Preemption Challenge Expected

It is highly likely that PBMs will challenge many of the provisions of SB41 as preempted by ERISA.  ERISA broadly preempts any state law that “relates to” any employee benefit plan. Vigorous debate can be expected as to whether the provisions of SB41 “relate to” employee benefit plans or whether they merely regulate the business conduct of PBMs without imposing design or benefit mandates on ERISA plans.
 

Looking Ahead: What's Next for PBM Oversight?

SB41 represents a major step forward in regulating PBMs at the state level, however, it’s just the beginning. As implementation unfolds, California will likely continue to refine its approach, responding to market feedback as well as the new requirements under the newly passed Consolidated Appropriations Act of 2026 and newly released proposed regulations from the DOL. In addition, other states are watching closely, and SB41 could become a blueprint for similar reforms nationwide, obviously depending on the results of ERISA challenges and the impact on the industry pursuant to recent federal laws and regulations.  

 
Conclusion