California SB 41: Pharmacy Benefit Managers Now Held To Fiduciary And Transparency Standards

California establishes fiduciary duties and transparency mandates for PBMs, reshaping the PBM contracting landscape with health plans beginning in 2026

California recently enacted California Senate Bill 41 ("SB 41"), a landmark law that fundamentally overhauls the regulation of pharmacy benefit managers ("PBMs") in the state and has big implications for ERISA plan sponsors. Governor Newsom signed SB 41 into law on October 11, 2025, and its provisions go into effect as early as January 1, 2026. SB 41 goes beyond federal pricing transparency reforms by imposing an explicit fiduciary duty on PBMs to act in the best interests of their payer clients, which include both self-insured and fully insured ERISA health plans. The law also prohibits spread pricing, mandates pass-through rebates, requires state licensure, and introduces comprehensive disclosure obligations. Collectively, these provisions mark a fundamental shift in PBM accountability and create new compliance priorities for health plan sponsors, insurers, and other payers in California.

SB 41 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. A PBM does not have to be physically located or headquartered in California to be subject to SB 41.

Enactment of this California legislation comes on the heels of the Department of Labor's ("DOL") release of its regulatory agenda which reflects its upcoming rulemaking priorities. One significant priority is improving transparency into PBM fee disclosure. Specifically, the DOL intends to issue regulations, pursuant to a Presidential executive order, on enhancing visibility of direct and indirect compensation PBMs receive from health plans.

Relationship Between PBMs and Health Plans

PBMs are third-party entities that administer the prescription drug portion of a health plan or on behalf of the plan sponsor or insurer. PBMs are not insurers, but rather, they act as intermediaries between plan sponsors (employers or insurers), pharmacies, and pharmaceutical manufacturers. PBMs negotiate drug prices and rebates with manufacturers, create and manage formularies, process pharmacy claims, operate mail-order or specialty pharmacies, and develop pharmacy networks and utilization management programs.

In a self-insured plan, the employer (plan sponsor) contracts directly with the PBM or its third-party administrator. The employer and participants bear the cost of claims, so a PBM's pricing and rebate arrangements have a direct impact on plan costs.

In a fully insured plan, the PBM contracts with the insurer, not the employer. Employer and plan participants are indirectly impacted by PBM pricing through their contracts with the insurer.

Though PBMs often produce cost savings for plan sponsors and participants, through scale and negotiation power, their role has become controversial due to often opaque pricing models, "spread" practices, and retention of manufacturer rebates.

Key provisions of SB 41 for plan sponsors:

Fiduciary Duty Imposed on PBMs

SB 41 establishes a new state-law fiduciary duty for PBMs toward the payers they serve. A PBM must: act in the best interests of its payer client; be fair and truthful in all dealings; avoid conflicts of interest, including indirect conflicts involving affiliates or manufacturers; and exercise care, skill, prudence, and diligence in performing its duties. PBMs must also disclose in writing any actual or potential conflicts of interest with a payer's interests.

The PBM fiduciary duty runs to the payer client. For self-insured plans, this means the duty is owed to the plan or plan sponsor. For fully insured plans, the duty is owed to the insurer or HMO; however, the fully insured employer plan benefits indirectly, as carriers must ensure PBM compliance.

For plan sponsors, SB 41 creates a stronger legal basis to demand transparency and alignment of incentives, and a right to hold PBMs accountable for self-dealing or opaque pricing practices. It also opens opportunities to renegotiate PBM contracts to include fiduciary representations and remedies.

Licensing Requirement

PBMs must obtain a license from the California Department of Insurance ("CDI") by January 1, 2027. Licensing requires disclosure of ownership, management, affiliates, and financial condition, and authorizes CDI oversight and audits.

Prohibition on Spread Pricing and Transition to Pass-Through Pricing

The law phases out spread pricing arrangements. Under a spread pricing model, the PBM charges a health plan a higher price for a prescription drug, pays the pharmacy a lower price for dispensing that same drug, and keeps the difference (i.e., the spread). Spread pricing has been a controversial practice because health plans often do not know the cost of the drugs or their hidden markups.

For new or renewed contracts starting in 2026, PBMs must charge payers in a manner that reflects actual pharmacy reimbursement plus a separately stated administrative fee, rather than pocketing undisclosed markups. If not already eliminated, all legacy spread pricing contract terms become void on January 1, 2029.

Rebate Transparency

For contracts entered into or modified on or after January 1, 2026, SB 41 requires that negotiated manufacturer rebates and similar price concessions be directed back to the payer when the PBM is responsible for negotiating those rebates. The law specifies that such funds be applied to reduce premiums, deductibles, or other participant cost-sharing.

Contracting Restrictions with Pharmacies and Manufacturers

In contracts with non-affiliated pharmacies executed, amended, or renewed on or after January 1, 2026, PBMs may not impose exclusivity requirements that restrict the pharmacy's ability to contract with other payers, plans or employers. PBMs also cannot prohibit a non-affiliated pharmacy from offering mail order or delivery services as an ancillary service.

With respect to pharmaceutical manufacturers, a PBM cannot not enter into, amend, enforce or renew a contract with a manufacturer that imposes express or implied exclusivity of that manufacturer's drugs, medical devices or other products, unless the PBM can demonstrate that such exclusivity results in the lowest cost to the payer and the lowest cost-sharing for plan participants.

Preemption Application

It's possible (and even highly likely) that PBMs will challenge many of SB 41 requirements as preempted by the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). Section 514(a) of ERISA broadly preempts any state law which "relates" to any employee benefit plan. The Supreme Court and lower courts have held that state laws that interfere with the uniform regulatory scheme ERISA creates for self-insured employer plans can be preempted. However, where state laws merely regulate business conduct of non-ERISA entities and do not impose design or benefit mandates on ERISA-governed plans, such provisions are more likely to survive ERISA preemption. See Rutledge v. Pharmaceutical Care Management Association, 592 U.S. 80 (2020) (state PBM regulation is not preempted by ERISA when it governs PBM conduct rather than plan design).

SB 41's fiduciary duty requirement represents a novel and potentially contentious extension of state PBM regulation. By requiring PBMs to "act in the best interests of their payer clients" and to avoid conflicts of interest, SB 41 arguably introduces state-imposed fiduciary standards that overlap —and may conflict —with federal ERISA fiduciary duties for self-insured plans. Courts could view this as intruding into plan administration, triggering ERISA preemption.

SB 41's pricing transparency, spread pricing prohibition, rebate pass-through, and licensing provisions are more likely to withstand preemption challenges. Since these elements regulate the economic relationships and business practices of PBMs without dictating plan design or benefit structures, they are less likely to be preempted in accord with Rutledge.

Action Steps for Health Plan Sponsors

Self-Insured Health Plan Sponsors:

• Update PBM contracts
  • Review your current PBM agreement to see if it has language indicating the PBM will not operate in a state that imposes fiduciary obligations on a PBM. Contact your PBM to discuss revising the service agreement.
  • In all negotiations for implementation or renewal, require PBM contracts to expressly acknowledge SB-41 compliance and to define fiduciary breaches as cause for termination.
• Evaluate pricing structures
  • Review whether your PBM agreement contains or proposes spread pricing.
  • Ensure new contracts and renewals remove any spread pricing arrangements and include PBM pricing models that comply with pass-through requirements.
• Conduct vendor diligence
  • Confirm PBM's California licensure.
  • Request disclosure of affiliates and revenue sources.
• Monitor fiduciary compliance
  • Establish audit rights and require conflict-of-interest reporting.

Fully Insured Health Plan Sponsors

• Coordinate with carriers
  • Ensure insurer's PBM contracts meet SB 41 standards.