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entitled 'Medicaid Drug Rebate Program: Inadequate Oversight Raises 
Concerns about Rebates Paid to States' which was released on March 7, 
2005.

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Report to Congressional Requesters:

United States Government Accountability Office:

GAO:

February 2005:

Medicaid Drug Rebate Program:

Inadequate Oversight Raises Concerns about Rebates Paid to States:

GAO-05-102:

GAO Highlights:

Highlights of GAO-05-102, a report to congressional requesters

Why GAO Did This Study:

To help control Medicaid spending on drugs, states receive rebates from 
pharmaceutical manufacturers through the Medicaid drug rebate program. 
Rebates are based on two prices–best price and average manufacturer 
price (AMP)–reported by manufacturers. Both reflect manufacturers’ 
prices to various entities, accounting for certain financial 
concessions like discounts.

Concerns have been raised about rising Medicaid drug spending. GAO 
studied (1) federal oversight of manufacturer-reported best prices and 
AMPs and the methods used to determine them, (2) how manufacturers’ 
determinations of those prices could have affected rebates, and (3) how 
the rebate program reflects financial concessions in the private market.

What GAO Found:

Current rebate program oversight does not ensure that manufacturer-
reported prices or price determination methods are consistent with 
program criteria specified in the rebate statute, rebate agreement, and 
Centers for Medicare & Medicaid Services (CMS) program memoranda. In 
administering the program, CMS conducts only limited checks for 
reporting errors in manufacturer-reported drug prices. In addition, CMS 
only reviews the price determination methods when manufacturers request 
recalculations of prior rebates. In four reports issued from 1992 to 
2001, the Department of Health and Human Services’ (HHS) Office of 
Inspector General (OIG) identified several factors that limited its 
ability to verify the accuracy of drug prices reported by 
manufacturers, including a lack of clear guidance on how AMP should be 
calculated. In some cases, OIG found problems with manufacturers’ price 
determination methods and reported prices. However, CMS has not 
followed up with manufacturers to make sure that the identified 
problems with prices and methods have been resolved.

There was considerable variation in the methods that manufacturers used 
to determine best price and AMP, and some methods could have reduced 
the rebates state Medicaid programs received. Manufacturers are allowed 
to make assumptions when determining best price and AMP, as long as 
they are consistent with the law and the rebate agreement. The 
assumptions often involve the treatment of discounts and other price 
reductions in best price and AMP. Some manufacturers combined price 
reductions associated with particular sales in their price 
determination methods, while others accounted for the reductions 
separately. Separate treatment of the reductions resulted in rebates to 
states that in some cases were lower than they would have been had the 
reductions been considered together. Some manufacturers made 
assumptions that diverged from the rebate agreement and CMS program 
memoranda that could have raised rebates. States could have to repay 
any excess rebates if manufacturers revise their assumptions and 
request recalculations of prior rebates.

The rebates that manufacturers pay to states are based on prices and 
financial concessions manufacturers make available to entities that 
purchase their drugs but may not reflect certain financial concessions 
they offer to other entities. In particular, the rebate program does 
not clearly address certain manufacturer payments that are negotiated 
by pharmacy benefit managers (PBM) on behalf of third-party payers such 
as employer-sponsored health plans and other health insurers. These 
types of financial arrangements are relatively new to the market. CMS’s 
guidance to manufacturers has not clearly stated how manufacturers 
should treat these payments in their determinations of best price and 
AMP. Within the current structure of the rebate formula, additional 
guidance on how to account for these payments to PBMs could affect the 
rebates paid to states, although whether rebates would increase or 
decrease as a result, and by how much, is uncertain. 

What GAO Recommends:

GAO recommends that CMS issue clear, updated guidance on manufacturer 
price determination methods and price definitions. It also recommends 
that CMS implement systematic oversight of manufacturer methods and a 
plan to ensure the accuracy of reported prices and rebates to states. 

HHS agreed with the importance of guidance to manufacturers but did not 
agree that the program had received inadequate oversight. GAO 
acknowledges HHS oversight actions but does not believe they ensure 
accurate rebates to states.

www.gao.gov/cgi-bin/getrpt?GAO-05-102.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Marjorie Kanof at (202) 
512-7114.

[End of section]

Contents:

Letter:

Results in Brief:

Background:

Current Program Oversight Does Not Ensure That Manufacturer-Reported 
Prices or Price Determination Methods Are Consistent with Program 
Criteria:

Manufacturer Price Determination Methods Varied: Some Could Have Led to 
Lower Rebates:

Rebate Program Does Not Clearly Address Certain Financial Concessions 
Negotiated by PBMs:

Conclusions:

Recommendations for Executive Action:

Agency and Industry Comments and Our Response:

Appendix I: Comments from the Department of Health and Human Services:

Appendix II: GAO Contact and Staff Acknowledgments:

GAO Contact:

Acknowledgments:

Figure:

Figure 1: Example of How Prompt Payment Discounts in Chargeback 
Situations Affect the Net Amount Realized by a Manufacturer:

Abbreviations:

AMP: average manufacturer price: 
CMS: Centers for Medicare & Medicaid Services: 
DOJ: Department of Justice:
HHS: Department of Health and Human Services: 
HMO: health maintenance organization: 
OIG: Office of Inspector General: 
PBM: pharmacy benefit manager:

United States Government Accountability Office:

Washington, DC 20548:

February 4, 2005:

The Honorable Henry A. Waxman: 
Ranking Minority Member: 
Committee on Government Reform: 
House of Representatives:

The Honorable Charles E. Grassley: 
Chairman: 
Committee on Finance: 
United States Senate:

Prescription drug spending accounts for a substantial and growing share 
of state Medicaid program outlays.[Footnote 1] The Omnibus Budget 
Reconciliation Act of 1990 established the Medicaid drug rebate 
program[Footnote 2] to help control Medicaid drug spending. Under the 
rebate program, pharmaceutical manufacturers pay rebates to states as a 
condition for the federal contribution to Medicaid spending for the 
manufacturers' outpatient prescription drugs. In fiscal year 2002, 
Medicaid drug expenditures were $29.3 billion out of $258.2 billion in 
total Medicaid spending;[Footnote 3] under the rebate program, 
manufacturers paid rebates to states of about $5.6 billion for covered 
outpatient drugs.[Footnote 4] In recent years, concerns have been 
raised about increasing Medicaid spending on prescription drugs. 
Medicaid drug spending increased at an annual average rate of 19 
percent from fiscal year 2000 to 2002, while Medicaid spending as a 
whole grew 12 percent annually during that period.[Footnote 5]

Medicaid rebates for brand name outpatient drugs are calculated with 
two prices that participating manufacturers must report to the federal 
government for each drug: the "best price" and the "average 
manufacturer price" (AMP). Best price and AMP represent prices that are 
available from manufacturers to entities that purchase their drugs. 
Best price for a drug is the lowest price available from the 
manufacturer to any purchaser, with some exceptions. AMP for a drug is 
the average price paid to a manufacturer by wholesalers for drugs 
distributed to the retail pharmacy class of trade. Both best price and 
AMP must reflect certain financial concessions, such as discounts, that 
are available to drug purchasers. The basic Medicaid rebate for a brand 
name drug equals the number of units of the drug paid for by the state 
Medicaid program multiplied by the basic "unit rebate amount" for the 
drug, which is either the difference between best price and AMP, or 
15.1 percent of AMP, whichever is greater.[Footnote 6] The closer best 
price is to AMP, the more likely the rebate will be based on 15.1 
percent of AMP--the minimum rebate amount.

The Centers for Medicare & Medicaid Services (CMS),[Footnote 7] an 
agency of the Department of Health and Human Services (HHS), 
administers and oversees the rebate program, entering into rebate 
agreements with manufacturers,[Footnote 8] collecting and reviewing 
manufacturer-reported best prices and AMPs, and providing ongoing 
guidance to manufacturers and states on the program. The Secretary of 
Health and Human Services, by law, may verify manufacturer-reported 
prices and has delegated that authority to HHS's Office of Inspector 
General (OIG). OIG regularly conducts audits, evaluations, and 
investigations pertaining to HHS programs.

Recent litigation has highlighted the importance of the accuracy of 
prices manufacturers report to CMS and the rebates they pay to states. 
Since 2002, several manufacturers have agreed to make payments to 
settle allegations that they underpaid rebates to states by reporting 
inaccurate prices.[Footnote 9]

You asked us to study the Medicaid drug rebate program. We are 
reporting on (1) federal oversight of manufacturer-reported best prices 
and AMPs and the methods manufacturers used to determine those prices, 
(2) how manufacturers' methods of determining best price and AMP could 
have affected the rebates they paid to state Medicaid programs, and (3) 
how the rebate program reflects financial concessions available in the 
private market.

To report on the oversight of manufacturer-reported prices and methods, 
we reviewed the rebate statute, the standard rebate agreement, CMS 
program memoranda, and OIG reports on the rebate program. We also 
interviewed officials from CMS and OIG. To assess how manufacturers' 
price determination methods could have affected rebate amounts, we 
reviewed the pricing methodologies for the 13 manufacturers that 
accounted for the highest Medicaid expenditures in the last two 
quarters of 2000. We compared manufacturers' methods of determining 
best price and AMP to the rebate statute, rebate agreement, and 
relevant CMS program memoranda. In addition, we examined sales 
transaction data provided by these manufacturers. We received data for 
the 10 brand name drugs that produced the highest Medicaid expenditures 
for the last two quarters of 2000 for each manufacturer, as well as 
data for 5 additional frequently prescribed brand name drugs--135 drugs 
in total. We examined the sales transaction data to understand how 
manufacturers implemented their price determination methods and to 
calculate the impact of manufacturer practices on rebates. Because we 
purposely selected manufacturers and drugs that accounted for a large 
share of Medicaid drug spending, the results of our analysis cannot be 
generalized. To examine how the rebate program reflects financial 
concessions available in the private market, we reviewed the rebate 
statute, the standard rebate agreement, and CMS program memoranda; 
market literature; and recent financial statements of three large 
pharmacy benefit managers (PBM), which manage prescription drug 
benefits for third-party payers.

We determined that the manufacturers' sales transaction data were 
sufficiently reliable for the purposes of this report. To assess the 
reliability of the data, we (1) confirmed that the data included the 
elements we requested and were consistent with provided documentation; 
(2) reviewed related documentation, including each manufacturer's price 
determination methods; and (3) worked with individual manufacturers' 
Medicaid drug rebate program personnel to identify any data problems. 
We also compared the prices we calculated from the sales transaction 
data to the prices manufacturers reported to CMS for the relevant 
quarter. It was not feasible to compare the reported sales transaction 
data with their source documentation, such as invoices, because of the 
large volume of sales transactions associated with the drugs in our 
sample. We do not report data in a manner that would allow the 
identification of a specific manufacturer or drug. We performed our 
work from December 2003 through January 2005, in accordance with 
generally accepted government auditing standards.

Results in Brief:

Current rebate program oversight does not ensure that manufacturer- 
reported prices or price determination methods are consistent with 
program criteria as specified in the rebate statute, rebate agreement, 
and CMS program memoranda. CMS conducts only limited checks for 
reporting errors in manufacturer-reported drug prices. Furthermore, the 
agency does not generally review the methods and underlying assumptions 
that manufacturers use to determine best price and AMP. Rather, CMS 
reviews manufacturers' price determination methods only when they 
request recalculations of prior rebates. In four reports issued from 
1992 to 2001, OIG stated that its review efforts were hampered by 
unclear CMS guidance on how manufacturers were to determine AMP, by a 
lack of manufacturer documentation, or by both. In some cases, OIG 
found problems with manufacturers' price determination methods and 
reported prices. However, CMS has not followed up with manufacturers to 
make sure that the identified problems with prices and price 
determination methods have been resolved.

There was considerable variation in the methods that manufacturers used 
to determine best price and AMP, and some methods could have reduced 
rebates to state Medicaid programs. Manufacturers are allowed to make 
reasonable assumptions when determining best price and AMP, as long as 
those assumptions are consistent with the law and the rebate agreement. 
The assumptions often pertain to the transactions, including discounts 
and other price reductions, that are considered when determining best 
price and AMP. In determining best price and AMP, some manufacturers 
did not combine the price reductions associated with certain 
transactions involving prompt payment discounts. This resulted in 
rebates to states that in some cases were lower than they would have 
been had these manufacturers combined such price reductions as other 
manufacturers did. In addition, some manufacturers made assumptions 
that diverged from the rebate agreement and CMS program memoranda that 
could have raised rebates. States may have to repay any excess rebates 
if manufacturers later revise their assumptions and request 
recalculations of prior rebates.

The rebates that manufacturers pay to states are based on a range of 
prices and financial concessions that they make available to entities 
that purchase their drugs but may not reflect certain financial 
concessions they offer to other entities in today's complex market. In 
particular, the rebate program does not clearly address certain 
manufacturer payments that are negotiated by PBMs on behalf of third- 
party payers such as employer-sponsored health plans and other health 
insurers. These types of financial arrangements are a relatively new 
development in the market. CMS's guidance to manufacturers has not 
clearly stated how manufacturers should treat these payments in their 
determinations of best price and AMP. Within the current structure of 
the rebate formula, additional CMS guidance on how to account for these 
payments to PBMs could affect the rebates paid to states, although 
whether rebates would increase or decrease as a result, and by how 
much, is uncertain.

To help ensure that the Medicaid drug rebate program is achieving its 
objective of controlling states' Medicaid drug spending, we recommend 
that the Administrator of CMS issue clear guidance on manufacturer 
price determination methods and the definitions of best price and AMP, 
and update such guidance as additional issues arise. We also recommend 
that the Administrator implement, in consultation with OIG, systematic 
oversight of the price determination methods employed by pharmaceutical 
manufacturers and a plan to ensure the accuracy of manufacturer- 
reported prices and rebates to states.

In its comments on a draft of this report, HHS agreed with the 
importance of guidance to manufacturers, but disagreed with our 
conclusion that there has been inadequate program oversight. While the 
draft report cited oversight activities HHS has undertaken, we believe 
that its oversight does not adequately ensure the accuracy of 
manufacturer-reported prices and rebates paid to states. The 
manufacturers that supplied data for this report reviewed sections of 
the draft report and provided oral comments. Some of the manufacturers 
raised concerns about our discussion of certain methods they used to 
determine rebates. In response to the manufacturers' concerns, we 
clarified our discussion of manufacturers' price determination methods.

Background:

The Medicaid drug rebate program provides savings to state Medicaid 
programs through rebates for outpatient prescription drugs that are 
based on two prices per drug that manufacturers report to CMS: best 
price and AMP. These manufacturer-reported prices are based on the 
prices that manufacturers receive for their drugs in the private market 
and are required to reflect certain financial concessions such as 
discounts.

Features of the Private Pharmaceutical Market:

Pharmaceutical manufacturers sell their products directly to a variety 
of purchasers, including wholesalers, retailers such as chain 
pharmacies, and health care providers such as hospitals that dispense 
drugs directly to patients. The prices that manufacturers charge vary 
across purchasers. The private market also includes PBMs, which manage 
prescription drug benefits for third-party payers such as employer- 
sponsored health plans and other health insurers.[Footnote 10] PBMs may 
negotiate payments from manufacturers to help reduce third-party 
payers' costs for prescription drugs; those payments may be based on 
the volume of drugs purchased by the payers' enrollees. PBMs also may 
operate mail-order pharmacies, purchasing drugs from manufacturers and 
delivering them to their clients' enrollees.

The amount a manufacturer actually realizes for a drug is not always 
the same as the price that is paid to the manufacturer at the time of 
sale. Manufacturers may offer purchasers rebates or discounts that may 
be realized after the initial sale, such as those based on the volume 
of drugs the purchasers buy during a specified period or the timeliness 
of their payment. In some cases, purchasers negotiate a price with the 
manufacturer that is below what a wholesaler pays the manufacturer for 
a given drug. In such a circumstance, a wholesaler may sell the drug to 
the purchaser at the lower negotiated price and then request from the 
manufacturer a "chargeback"--the difference between the price the 
wholesaler paid for the drug and the purchaser's negotiated price.

The Medicaid Drug Rebate Program:

The statute governing the Medicaid drug rebate program and the standard 
rebate agreement that CMS signs with each manufacturer define best 
price and AMP and specify how those prices are to be used to determine 
the rebates due to states. In the absence of program 
regulations,[Footnote 11] CMS has issued program memoranda[Footnote 12] 
in order to provide further guidance to manufacturers regarding how to 
determine best price and AMP, some of which were in response to 
questions that arose regarding the methods that manufacturers were 
using to determine those prices.[Footnote 13] The rebate agreement 
states that in the absence of specific guidance on the determination of 
best price and AMP, manufacturers may make "reasonable assumptions" as 
long as those assumptions are consistent with the "intent" of the law, 
regulations, and the rebate agreement.[Footnote 14] As a result, price 
determination methods may vary across manufacturers, particularly with 
respect to which transactions they consider when determining best price 
and AMP.

Under the rebate statute, best price is the lowest price available from 
the manufacturer to any wholesaler, retailer, provider, health 
maintenance organization (HMO), or nonprofit or government entity, with 
some exceptions.[Footnote 15] Best price is required to be reduced to 
account for cash discounts, free goods that are contingent on purchase 
requirements, volume discounts and rebates (other than rebates under 
this program), as well as--according to the rebate agreement and a CMS 
program memorandum--cumulative discounts and any other arrangements 
that subsequently adjust the price actually realized. Prices charged to 
certain federal purchasers,[Footnote 16] eligible state pharmaceutical 
assistance programs and state-run nursing homes for veterans, and 
certain health care facilities--including those in underserved areas or 
serving poorer populations--are not considered when determining best 
price. Prices available under endorsed Medicare discount card programs, 
as well as those negotiated by Medicare prescription drug plans or 
certain retiree prescription drug plans, are similarly excluded from 
best price. Nominal prices--prices that are less than 10 percent of 
AMP--also are excluded from best price.

AMP is defined by statute as the average price paid to a manufacturer 
for the drug by wholesalers for drugs distributed to the retail 
pharmacy class of trade.[Footnote 17] The transactions used to 
calculate AMP are to reflect cash discounts and other reductions in the 
actual price paid, as well as any other price adjustments that affect 
the price actually realized, according to the rebate agreement and a 
CMS program memorandum.[Footnote 18] Under the rebate agreement, AMP 
does not include prices to government purchasers based on the Federal 
Supply Schedule, prices from direct sales to hospitals or HMOs, or 
prices to wholesalers when they relabel drugs they purchase under their 
own label.

The relationship between best price and AMP determines the unit rebate 
amount and, thus, the size of the rebate that states receive for a 
brand name drug. The basic unit rebate amount is the larger of two 
values: the difference between best price and AMP, or 15.1 percent of 
AMP.[Footnote 19] The closer best price is to AMP, the more likely the 
rebate for a drug will be based on the minimum amount--15.1 percent of 
AMP--rather than the difference between the two values. A state's 
rebate for a drug is the product of the unit rebate amount and the 
number of units of the drug paid for by the state's Medicaid program. 
In 2000, rebates were based on the minimum amount for about half of the 
brand name drugs covered under the rebate program; for the remaining 
drugs, rebates were based on the difference between best price and AMP.

Manufacturers pay rebates to states on a quarterly basis. They are 
required to report best price and AMP for each drug to CMS within 30 
days of the end of each calendar quarter. Once CMS receives this 
information, the agency uses the rebate formula to calculate the unit 
rebate amount for the smallest unit of each drug, such as a tablet, 
capsule, or ounce of liquid. CMS then provides the unit rebate amount 
to the states. Each state determines its Medicaid utilization for each 
covered drug--as measured by the total number of the smallest units of 
each dosage form, strength, and package size the state paid for in the 
quarter--and reports this information to the manufacturer within 60 
days of the end of the quarter. The manufacturer then must compute and 
pay the rebate amount to each state within 30 days of receiving the 
utilization information.

Manufacturers are required to report price adjustments to CMS when 
there is a change in the prices they reported for a prior quarter. 
These adjustments may result from rebates, discounts, or other price 
changes that occur after the manufacturers submit prices to CMS. 
Manufacturers also may request that CMS recalculate the unit rebate 
amounts using revised prices if they determine that their initially 
reported prices were incorrect due to, for example, improper inclusion 
or exclusion of certain transactions. In 2003, CMS issued a final rule 
that, effective January 1, 2004, limits the time for manufacturers to 
report any price adjustments to 3 years after the quarter for which the 
original price was reported.[Footnote 20]

Current Program Oversight Does Not Ensure That Manufacturer-Reported 
Prices or Price Determination Methods Are Consistent with Program 
Criteria:

The minimal oversight by CMS and OIG of manufacturer-reported prices 
and price determination methods does not ensure that those prices or 
methods are consistent with program criteria, as specified in the 
rebate statute, rebate agreement, and CMS program memoranda. CMS 
conducts limited reviews of prices and only reviews price determination 
methods when manufacturers request recalculations of prior rebates. OIG 
has issued four reports on audits of manufacturer-reported prices since 
the program's inception in 1991. OIG reported that, in the course of 
its work, its efforts were hampered both by unclear CMS guidance on 
determining AMP and by a lack of manufacturer documentation. In some 
instances, OIG found problems with manufacturers' price determination 
methods and reported prices. However, CMS has not followed up with 
manufacturers to make sure that the identified problems with prices and 
price determination methods have been resolved.

CMS's Review of Manufacturer-Reported Prices Is Limited:

As part of the agency's administration of the Medicaid drug rebate 
program, CMS reviews drug prices submitted by approximately 550 
manufacturers that participate in the program. Each quarter, CMS 
conducts automated data edit checks on the best prices and AMPs for 
about 25,000 drugs to identify reporting errors. These checks are 
intended to allow CMS to make sure all drugs for which manufacturers 
report prices are in its database of Medicaid-covered drugs and to 
ensure that those prices are submitted in the correct format. The 
agency's automated data checks also are intended to ensure that the 
correct price is used when there are multiple prices for the same drug. 
When data checks indicate a potential reporting error, CMS sends an 
edit report to the manufacturer asking for corrected drug prices. 
However, CMS does not have a mechanism in place to track whether, in 
fact, manufacturers submit corrected prices.

CMS sometimes identifies other price reporting errors when it 
calculates the unit rebate amount for a drug, but the agency does not 
follow up with manufacturers to verify that errors have been corrected. 
CMS will notify a manufacturer of any missing price data for drugs in 
its database or any large deviations from previous unit rebate amounts. 
For example, CMS would send a report to a manufacturer that had a unit 
rebate amount for a drug that deviated from that of the prior quarter 
by more than 50 percent. It would be up to that manufacturer to 
indicate whether or not the underlying reported prices were, in fact, 
correct. If a manufacturer determined that there were problems with the 
reported price for a drug--such as incorrect unit pricing or 
typographical errors like misplaced decimals--it would send corrected 
data to CMS prior to or with future price submissions. In this 
situation, the manufacturer also would recalculate the unit rebate 
amount and, once invoiced by the states with total utilization for the 
drug paid for by Medicaid, would send the rebate payment to those 
states based on the recalculated unit rebate amount. If a manufacturer 
did not send revised pricing data to CMS, then the unit rebate amount 
would remain the same. In 2000, CMS generated approximately 150 reports 
detailing these 50 percent deviations, according to an agency official. 
The agency did not track how many unit rebate amounts were changed as a 
result or any effect on rebates.

Price Determination Methods Are Reviewed Only When Manufacturers 
Request Recalculations:

CMS does not generally review the methods and underlying assumptions 
that manufacturers use to determine best price and AMP, even though 
these methods and assumptions can have a substantial effect on rebates. 
While the rebate agreement requires manufacturers to maintain 
documentation of the assumptions underlying their price determination 
methods, CMS does not verify that such documentation is kept and rarely 
requests it. Furthermore, CMS does not generally check to ensure that 
manufacturers' assumptions and price determination methods are 
consistent with the rebate statute and rebate agreement.

CMS reviews the methodologies employed to determine best price and AMP 
only when manufacturers request recalculations of prior rebates. A 
manufacturer may request a recalculation of a prior rebate any time it 
changes the methods it uses to determine best price or AMP.[Footnote 
21] CMS requires the manufacturer to submit both its original and its 
revised methods for determining those prices when requesting a 
recalculation of prior rebates, so that it can evaluate whether the 
revised methods are consistent with the rebate statute, rebate 
agreement, and program memoranda. Six approved recalculations, for 
which we could obtain data,[Footnote 22] reduced prior rebates to 
states by a total of more than $220 million.[Footnote 23] An additional 
approved recalculation required the manufacturer to pay states an 
additional $388,000.

OIG Reports That Its Efforts Have Been Limited by Unclear Program 
Guidance:

OIG has issued four reports on audits of manufacturer-reported prices 
since the program's inception in 1991. Three of the four OIG reports 
documented limitations to OIG's ability to verify drug prices. OIG 
reported that its efforts were hampered by unclear CMS guidance on 
determining AMP, by a lack of manufacturer documentation, or by both. 
In particular, OIG found that a lack of specificity on how the "retail 
pharmacy class of trade" was defined limited its efforts to verify AMP. 
Both the rebate statute and rebate agreement define AMP as the average 
price paid by wholesalers for drugs distributed to the retail pharmacy 
class of trade, with some exceptions. OIG officials told us that 
program memoranda issued by CMS have not provided sufficient guidance 
on AMP to allow OIG to audit manufacturers' methods for determining 
AMP. Despite these limitations, in some instances OIG was able to 
identify some problems with the accuracy of manufacturers' reported 
prices; however, CMS has not followed up with manufacturers to make 
sure that these problems with prices and price determination methods 
have been resolved.

In its first review of manufacturer-reported prices in 1992, OIG found 
that it could not verify the AMPs reported by the four manufacturers it 
reviewed.[Footnote 24] OIG found it could not evaluate the methods 
these manufacturers used to determine AMP because neither the rebate 
statute nor CMS had provided sufficiently detailed instructions on 
methods for calculating AMP. OIG therefore advised CMS that it planned 
no future AMP data audits until CMS developed a specific written policy 
on how AMP was to be calculated. CMS disagreed, saying that the rebate 
statute and rebate agreement had already established a methodology for 
computing AMP, and stressed that this methodology was clarified, at 
manufacturer request, on an as-needed basis through conversations with 
individual manufacturers.[Footnote 25]

In its second review of manufacturer-reported prices, OIG, in 1995, 
attempted to verify one manufacturer's recalculation request. While the 
OIG reported that it could not complete its analysis because of 
inadequate manufacturer documentation,[Footnote 26] it was able to 
identify some manufacturer errors in determining AMP. In its review, 
OIG found that the manufacturer had miscalculated its revised AMP 
because it included "free goods" specifically excluded in the rebate 
agreement, miscalculated cash discounts, and improperly included sales 
rebates applicable to a period other than the quarter being audited. 
OIG recommended that CMS have the manufacturer revise its AMP data. 
Although CMS agreed with OIG's recommendations, as of October 2004, it 
had not required any such revision of the audited manufacturer's AMP 
determinations.

In its third review, conducted in 1997, OIG attempted to review a 
manufacturer's recalculation request but again reported that it was 
unable to complete its evaluation because of a lack of specific 
guidance on determining AMP and a lack of manufacturer documentation 
supporting its revised AMP. In the absence of guidance from CMS, OIG 
defined retail pharmacy class of trade for this audit to include only 
independent and chain pharmacies that sold drugs directly to the 
public. Therefore, OIG recommended that CMS ask the manufacturer to 
exclude from the calculation of AMP transactions that OIG determined 
were to nonretail entities such as mail-order pharmacies, nursing home 
pharmacies, independent practice associations, and clinics. OIG also 
found that the manufacturer used a flawed methodology to identify 
certain sales that it had included in the retail class of trade, and 
thus AMP. As a result, OIG recommended that CMS ask the manufacturer to 
exclude those sales from AMP unless the manufacturer could provide 
additional documentation to support the inclusion of those sales in 
AMP. Although CMS did not agree with OIG's definition of retail 
pharmacy class of trade, CMS concurred with OIG's recommendation to ask 
the manufacturer to recalculate AMP.[Footnote 27] As of October 2004, 
CMS had not required any revision of this manufacturer's AMP 
determinations.

In its fourth review of manufacturer-reported prices issued in 2001, 
OIG investigated how manufacturers were treating repackagers--entities 
such as HMOs that repackage or relabel drugs under their own names--in 
their best price determinations. The work followed up on previous work 
OIG conducted in response to a congressional inquiry in 1999. The 
rebate statute states that HMO sales are required to be included in 
best price determinations. CMS's June 1997 program memorandum stated 
that sales to other manufacturers that repackage the drugs are to be 
excluded from best price determinations. However, the rebate statute, 
rebate agreement, and CMS program memoranda did not address how HMOs 
should be treated when they act as repackagers. In a letter issued in 
response to the 1999 congressional request, OIG reported that excluding 
drug sales to two HMOs that acted as repackagers from best price 
determinations lowered state rebate amounts by $27.8 million in fiscal 
year 1998.[Footnote 28] In July 2000, CMS issued an additional program 
memorandum to manufacturers stating that sales to an HMO should be 
considered in best price determinations regardless of whether the HMO 
was a repackager.[Footnote 29] In 2001, OIG issued its fourth review, 
reporting that states lost $80.7 million in rebates in fiscal year 1999 
due to improperly excluded drug sales to HMO repackagers.[Footnote 30] 
In September 2004, a CMS official told us that CMS planned to release a 
program memorandum instructing manufacturers to revise prior rebates 
for which they had excluded sales to HMOs from best price. However, CMS 
does not have a mechanism in place to track that manufacturers have 
made these rebate adjustments and therefore cannot verify that 
manufacturers have made or will make these adjustments.

OIG officials told us that, despite the program releases issued by CMS, 
they remain unable to evaluate AMP because of the lack of clear CMS 
guidance, particularly related to the retail pharmacy class of trade 
and treatment of PBM transactions. In October 2004, OIG officials told 
us that they were working with CMS to review four manufacturers' 
recalculation requests and as part of this work were evaluating the 
methods manufacturers have used to determine prices. OIG officials also 
told us that they may conduct additional audits because of the number 
of recent manufacturer recalculation requests--18 requests received 
between September and December of 2003--and the significant financial 
impact the potential rebate adjustments would have on state Medicaid 
programs. However, in light of OIG's remaining concerns about CMS 
guidance, OIG officials told us that their current audits--and any 
future audits--likely would be limited to descriptions of how inclusion 
and exclusion of certain sales in price determinations would affect 
rebates.

Manufacturer Price Determination Methods Varied: Some Could Have Led to 
Lower Rebates:

We found considerable variation in the methods that manufacturers used 
to determine best price and AMP. Manufacturers are allowed to make 
reasonable assumptions when determining best price and AMP, as long as 
those assumptions are consistent with the law and the rebate agreement. 
The assumptions often pertain to the transactions, including discounts 
or other price reductions, that are considered in determining best 
price and AMP. We found that in some cases manufacturers' assumptions 
could have led to lower rebates and in other cases to higher rebates. 
Manufacturers can later revise their assumptions and request 
recalculations of previously paid rebates, which can result in states 
repaying any excess rebates.

We found that manufacturers made varying assumptions about which sales 
to include and exclude from their calculations of AMP. For example, 
some included sales to a broad range of facilities in AMP, excluding 
only transactions involving facilities explicitly excluded by the law, 
rebate agreement, or CMS program memoranda. In contrast, others 
included sales to a narrower range of purchasers--only those purchasers 
explicitly included in AMP by the law, rebate agreement, or CMS program 
memoranda. Manufacturers also differed in how they treated certain 
types of health care providers that are not explicitly addressed by the 
law, rebate agreement, or CMS program memoranda. For example, some 
manufacturers included sales to physician groups in AMP, while others 
did not. These assumptions can affect the reported prices and, in turn, 
the size of rebates paid to states.

Some manufacturers did not account for certain "administrative fees" 
paid to PBMs when determining best price or AMP. The statute and rebate 
agreement require that best price incorporate volume-based discounts. 
Further, according to the rebate agreement and a CMS program 
memorandum, both best price and AMP are to account for cumulative 
discounts or other arrangements that subsequently adjust the prices 
actually realized.[Footnote 31] While CMS has acknowledged that not all 
PBM arrangements will affect best price and AMP, the agency has advised 
manufacturers that administrative fees, incentives, promotional fees 
and chargebacks, as well as all discounts and rebates provided to 
purchasers, should be considered in determinations of best price and 
AMP when they are associated with sales that are to be considered in 
those prices.[Footnote 32] When a PBM acts as a mail-order pharmacy and 
takes possession of drugs, it is a purchaser. We found that while the 
basis for the administrative fees paid to PBMs varied among the 
manufacturers we reviewed, the fees often were based on a utilization 
measure, such as the sales volume of drugs used by the enrollees of the 
PBM's clients. To the extent that PBMs' purchases for their mail-order 
pharmacies contributed to the utilization measures used to determine 
their administrative fees, the fees for the mail-order portion of their 
business resemble a volume-based discount that adjusts the price 
actually realized. Some manufacturers told us that they accounted for 
the portion of administrative fees paid to PBMs associated with the 
PBMs' mail-order pharmacies in their determinations of best price or 
AMP. In contrast, others said they did not incorporate this portion of 
any administrative fees paid to PBMs in either best price or AMP. Some 
of those manufacturers characterized these fees as payments for 
services rather than adjustments to prices.

Excluding administrative fees from the determination of best price or 
AMP could have reduced rebates below what they would have been had the 
manufacturers included them when determining those prices. For one 
manufacturer, for example, if administrative fees paid to PBMs 
associated with their mail-order pharmacy purchases had been included 
in the manufacturer's determination of best price and AMP, rebates for 
11 drugs would have been up to 16 percent higher in the third quarter 
of 2000 and up to 12 percent higher in the fourth quarter of 2000. The 
ultimate impact on rebates to states depends on how many manufacturers 
excluded these fees from reported prices, the volume of those 
manufacturers' sales to PBM mail-order pharmacies, as well as the 
prices and utilization of the relevant drugs.

Manufacturers also differed in how they accounted for certain 
transactions involving prompt payment discounts. Both the rebate 
agreement and an applicable CMS program memorandum specify that best 
price and AMP are to reflect cumulative discounts or other arrangements 
that subsequently adjust the prices actually realized. In examining 
manufacturers' practices, we found that they generally provided a 
prompt payment discount of 2 percent of the purchase price to 
wholesalers and others that purchased drugs from them directly, when 
they paid within a specified period. In most cases, when the 
manufacturers we reviewed sold a drug directly to a purchaser, they 
reduced the purchaser's price by any applicable prompt payment discount 
when determining best price and AMP. When the transaction also involved 
a chargeback arrangement, manufacturers' methods differed. A chargeback 
involves one drug passing from a manufacturer through a wholesaler to a 
purchaser, so the chargeback amount and the prompt payment discount 
together affect the amount the manufacturer actually realizes for the 
drug. (See fig. 1.) Some manufacturers calculated the net price as 
their price to the wholesaler, reduced by both the prompt payment 
discount and the chargeback amount for those drugs, when determining 
best price and AMP. Other manufacturers, however, considered any prompt 
payment discount given to the wholesaler separately from any chargeback 
amount and thus did not incorporate the effect of both price reductions 
when determining best price and AMP. Some of these manufacturers 
indicated that they did not combine these price reductions because the 
price reductions occurred in two unrelated transactions to two separate 
purchasers.

Figure 1: Example of How Prompt Payment Discounts in Chargeback 
Situations Affect the Net Amount Realized by a Manufacturer:

[See PDF for image]

[End of figure]

In some cases, not accounting for the effect of both price reductions-
-the prompt payment discount and the chargeback--in the determination 
of best price and AMP reduced rebates below what they otherwise would 
have been. For example, rebates for three drugs in our sample would 
have been 3 to 5 percent higher had the manufacturers considered the 
effects of both price reductions when determining the best prices and 
AMPs; for seven other drugs, rebates would not have changed. The 
ultimate impact on rebates to states depends on how many manufacturers 
adopted this approach as well as the sales prices and utilization of 
the relevant drugs.

When determining best price and AMP, some manufacturers adopted methods 
that could have raised rebates. For example, although the rebate 
agreement excludes from AMP sales through the Federal Supply Schedule 
and direct sales to hospitals and HMOs, which often involve relatively 
low prices, one manufacturer included these sales in its calculations. 
However, the manufacturer used list prices in the calculation of AMP 
instead of the actual prices associated with the sales that were to be 
excluded from the calculation.[Footnote 33] This approach, which 
diverged from the rebate agreement and applicable CMS program 
memoranda, could have resulted in artificially high AMPs, which in turn 
could have raised rebates.

In addition, some manufacturers included in the determination of best 
price the contract prices they had negotiated with purchasers, even if 
they made no sales at those prices during the reporting quarter. This 
practice resulted in a lower best price in some cases, which may have 
increased rebates to states. One manufacturer, however, indicated that 
it later might revise this practice and request recalculations to 
recoup any excess rebates it had already paid. Manufacturers have up to 
3 years to make such revisions.

Rebate Program Does Not Clearly Address Certain Financial Concessions 
Negotiated by PBMs:

The rebates that manufacturers pay to states are based on a range of 
prices and financial concessions that manufacturers make available to 
entities that purchase their drugs, but may not reflect certain 
financial concessions manufacturers offer to other entities in today's 
complex market. In particular, the rebate program does not clearly 
address certain concessions that are negotiated by PBMs on behalf of 
third-party payers. The rebate program did not initially address these 
types of concessions, which are relatively new to the market. CMS's 
subsequent guidance to manufacturers has not clearly stated how 
manufacturers should treat these concessions in their determinations of 
best price and AMP.

Certain manufacturer financial concessions that are negotiated by PBMs 
on behalf of their third-party payer clients, such as employer- 
sponsored health plans and other health insurers, are not clearly 
reflected in best price or AMP. PBMs, in one of the roles they play in 
the market, may negotiate payments from manufacturers to help reduce 
their third-party payer clients' costs for prescription drugs.[Footnote 
34] (In these circumstances, the third-party payer does not purchase 
drugs directly from the manufacturer but instead covers a portion of 
the cost when its enrollees purchase drugs from pharmacies.[Footnote 
35]) The basis of these PBM-negotiated manufacturer payments 
varies.[Footnote 36] For example, manufacturers may make a payment for 
each unit of a drug that is purchased by third-party payer enrollees or 
may vary payment depending on a PBM's ability to increase the 
utilization, or expand the market share, of a drug.[Footnote 37] The 
payment may be related to a specific drug or a range of drugs offered 
by the manufacturer.

The amount of financial gain PBMs receive from these negotiated 
payments also varies. A PBM may pass on part or all of a manufacturer's 
payment to a client, depending on the terms of their contractual 
relationship. When a PBM passes on the entire manufacturer payment, the 
manufacturer may pay the PBM a fee to cover the costs of administering 
the program under which the payments are made. A PBM also may negotiate 
a manufacturer payment for each unit of the drug purchased that 
includes a fee, and the PBM may retain a part of that payment as 
compensation. Some PBM clients may receive smaller discounts on drug 
prices at the pharmacy in exchange for receiving all or a larger share 
of the manufacturer payments, while other clients may receive greater 
discounts on drug prices in exchange for the PBM retaining a larger 
share of the manufacturer payment. Manufacturers may not be parties to 
the contracts that PBMs have with their clients and so may not know the 
financial arrangements between the PBMs and their clients.

These types of financial arrangements between manufacturers and PBMs 
are a relatively new development in the market. When the program began 
in 1991, PBMs played a smaller role in the market, managing fewer 
covered lives and providing a more limited range of services--such as 
claims processing--for their clients. Since then, PBMs' role has grown 
substantially,[Footnote 38] contributing to a market that is much more 
complex, particularly with respect to the types of financial 
arrangements involving manufacturers. PBMs now commonly negotiate with 
manufacturers for payments on behalf of their clients, in addition to 
providing other services.[Footnote 39] Although complete data on the 
prevalence and magnitude of PBM-negotiated manufacturer payments are 
not readily available, PBM officials and industry experts have said 
that these and other manufacturer payments to PBMs are a large portion 
of PBMs' earnings;[Footnote 40] further, recent public financial 
information suggests that manufacturer payments to PBMs as a whole are 
substantial and key to PBMs' profitability.[Footnote 41]

CMS has acknowledged the complexity that arrangements between 
manufacturers and PBMs introduce into the rebate program but has not 
clearly addressed how these arrangements should be reflected in 
manufacturer-reported prices. In 1997, CMS issued program memoranda 
that noted new types of arrangements involving manufacturer payments to 
PBMs and attempted to clarify whether those arrangements should be 
reflected in best price and AMP.[Footnote 42] However, in a program 
memorandum issued shortly thereafter, CMS stated that there had been 
confusion concerning the intent of the previous program memoranda and 
that the agency had "intended no change" to program 
requirements.[Footnote 43] At the time, CMS said that staff were 
reexamining the issue and planned to shortly clarify the agency's 
position. As of January 2005, CMS had not issued such clarifying 
guidance. When we asked how PBM-negotiated manufacturer payments should 
be reflected in best price and AMP when PBMs have negotiated on behalf 
of third parties, CMS officials with responsibility for issuing program 
memoranda advised us that they could comment only on specific 
situations. They stated that financial arrangements among entities in 
the market are complex and always changing; in their view, the market 
is too complicated for them to issue general policy guidance that could 
cover all possible cases. Rather, these officials told us that they 
make determinations about PBM payments on a case-by-case basis, but 
only when manufacturers contact them regarding this issue.

Within the current structure of the rebate formula, additional guidance 
on how to account for manufacturer payments to PBMs could affect the 
rebates paid to states, although whether rebates would increase or 
decrease as a result, and by how much, is uncertain. Because of the 
structure of the rebate formula, any change in the determination of 
best price and AMP could raise or lower rebates for any given drug, 
depending on how the change affects the relationship between those 
prices. Incorporating PBM-negotiated manufacturer payments into the 
rebate determination could decrease the unit rebate amount for a drug 
if, for example, it reduced AMP but had no effect on best 
price.[Footnote 44] Alternatively, if such a change increased the 
difference between AMP and best price for a drug, the unit rebate 
amount could increase.[Footnote 45]

Conclusions:

The importance of Medicaid rebates to states has grown as Medicaid 
spending on prescription drugs has risen. To determine the level of 
rebates that manufacturers pay to states, the rebate program relies on 
manufacturer-reported prices, which are based on the prices and 
financial concessions available in the private pharmaceutical market. 
CMS, however, has not provided clear program guidance for manufacturers 
to follow when determining those prices. This has hampered OIG's 
efforts to audit manufacturers' methods and reported prices. 
Furthermore, as the private market has continued to evolve, the rebate 
program has not adequately addressed how more recent financial 
arrangements, such as those between manufacturers and PBMs, should be 
accounted for in manufacturers' reported prices. In addition, oversight 
by CMS and OIG has been inadequate to ensure that manufacturer-reported 
prices and methods are consistent with the law, rebate agreement, and 
CMS program memoranda. Because rebates rely on manufacturer-reported 
prices, adequate program oversight is particularly important to ensure 
that states receive the rebates to which they are entitled.

Recommendations for Executive Action:

To help ensure that the Medicaid drug rebate program is achieving its 
objective of controlling states' Medicaid drug spending, we recommend 
that the Administrator of CMS take the following two actions:

* Issue clear guidance on manufacturer price determination methods and 
the definitions of best price and AMP, and update such guidance as 
additional issues arise.

* Implement, in consultation with OIG, systematic oversight of the 
price determination methods employed by pharmaceutical manufacturers 
and a plan to ensure the accuracy of manufacturer-reported prices and 
rebates paid to states.

Agency and Industry Comments and Our Response:

We received written comments on a draft of this report from HHS, which 
incorporated comments from CMS and OIG. (See app. I.) HHS concurred, in 
part, with our recommendation that CMS issue clear guidance on price 
determination methods, noting agreement that such guidance would help 
manufacturers, particularly with regard to accounting for sales to 
PBMs. HHS stated that those issues would be examined and an assessment 
made about where more guidance was needed. HHS noted that effort had 
been devoted to providing guidance and that CMS would examine the 
resources allocated to its review capabilities. In responding to our 
discussion of the changing pharmaceutical market, however, the comments 
noted that guidance could not address all current and potential 
arrangements in the pharmaceutical market and therefore case-by-case 
guidance would continue to be necessary to address specific situations. 
In responding to our discussion of manufacturers' price determination 
methods, the comments stated that a response to our conclusion that 
some manufacturers' practices could lower or raise rebates was not 
possible because we did not provide sufficient information on 
manufacturers' practices. We believe that accurate and timely guidance 
could reduce the need for case-by-case determinations. Although we 
cannot present the detailed assumptions that various manufacturers made 
in interpreting and implementing program guidance, because that 
information is proprietary, we did provide examples of the different 
price determination methods and assumptions that can affect best price 
and AMP and, therefore, rebates.

HHS concurred, in part, with our recommendation that CMS should 
implement systematic oversight of manufacturers' price determination 
methods and a plan to ensure the accuracy of reported prices and 
rebates. While the comments noted that requests from manufacturers to 
revise their price determination methods were reviewed for adherence to 
current policies, the comments disagreed with our conclusion that 
current oversight does not ensure that prices or methods are consistent 
with program criteria. The comments stated that CMS subjects 
manufacturer-supplied data to systematic edits, that CMS has increased 
its referrals to OIG to examine recalculation requests, and that a 
regulation limiting the time frames for recalculations and 
recordkeeping has been published. The comments also referred to 
previous OIG reviews of manufacturer practices and the plans to 
continue such reviews. In our draft, we noted the data edits that CMS 
conducts, which help ensure the completeness of the data. The 
systematic edits, however, do not ensure the accuracy of the data. 
Specifically, while the edits address, for example, whether price data 
are submitted in the correct format, they do not ensure that prices are 
consistent with program criteria or that corrected prices are submitted 
when necessary. We also noted OIG's ongoing work on the Medicaid drug 
rebate program. However, CMS's referrals to OIG are made only when a 
manufacturer requests that its rebates be recalculated, so there is no 
ongoing review of the methods used by manufacturers. Finally, we also 
noted in the draft the recently issued regulation, which did not 
address all aspects of the program, such as determinations of best 
price and AMP. The actions cited in the HHS comments do not constitute 
adequate oversight of a program that relies on manufacturer-submitted 
data to determine substantial rebates owed to state Medicaid programs.

Representatives from all the manufacturers that supplied us data were 
invited to review and provide oral comments on portions of the draft 
report, including the background and our discussion of manufacturers' 
price determination methods. Representatives from five of the 
manufacturers indicated that administrative fees that manufacturers pay 
to PBMs do not necessarily need to be considered in the determination 
of best price and AMP. Some argued that the fee is a payment for 
services rendered and not a discount or rebate that would affect 
prices. Some manufacturers also noted that we did not address payments 
to PBMs when they are not acting as mail-order pharmacies. Others noted 
that CMS's guidance with respect to payments to PBMs is particularly 
unclear and that CMS's guidance has not addressed recent changes in the 
pharmaceutical market. Six of the manufacturers took issue with our 
discussion of the treatment of prompt payment discounts involving a 
chargeback arrangement. Several stated that CMS has not indicated that 
the prompt payment discount must be accounted for in the manner we 
described. Some manufacturers noted that they treat the situation we 
highlighted as two unrelated transactions to two separate purchasers, 
so they do not need to combine both price reductions when determining 
best price and AMP. Finally, six commented on the lack of clear 
guidance on various aspects of determining best price and AMP. Some 
manufacturers stated that program memoranda, which are a common CMS 
method of issuing guidance for the rebate program, do not have to be 
followed because they are not regulations.

In response to manufacturers' comments, we clarified our discussion of 
administrative fees paid to PBMs when they act as a mail-order 
pharmacies. We state that administrative fees may resemble volume-based 
discounts when PBMs take possession of drugs. The manufacturers did not 
have the opportunity to review our discussion of the changing 
pharmaceutical market, which addresses the broader role of PBMs in 
negotiating for third-party payers. With respect to our discussion of 
prompt payment discounts involving a chargeback arrangement, we 
observed in the draft that manufacturers differed in how they accounted 
for price reductions when determining best price and AMP, and we have 
clarified and expanded that discussion based on the comments we 
received.

Both HHS and the manufacturers also provided technical comments, which 
we incorporated as appropriate.

As agreed with your offices, unless you publicly announce its contents 
earlier, we plan no further distribution of this report until 30 days 
after its date. We will then send copies of this report to the 
Secretary of Health and Human Services, the Administrator of CMS, the 
Acting Inspector General of Health and Human Services, and other 
interested parties. We will also provide copies to others upon request. 
In addition, the report will be available at no charge on the GAO Web 
site at http://www.gao.gov.

If you or your staffs have any questions about this report, please call 
Marjorie Kanof at (202) 512-7114. Major contributors to this report are 
listed in appendix II.

Signed by: 

Laura A. Dummit: 
Director, Health Care--Medicare Payment Issues:

[End of section]

Appendix I: Comments from the Department of Health and Human Services: 

DEPARTMENT OF HEALTH & HUMAN SERVICES: 
Office of Inspector General:

Ms. Laura A. Dummit:
Director, Health Care-Medicare Payment Issues: 
U.S. Government Accountability Office: 
Washington, DC 20548:

Dear Ms. Dummit:

Enclosed are the Department's comments on your draft report entitled, 
"Medicaid Drug Rebate Program-Inadequate Oversight Raises Concerns 
About Rebates Paid to States" (GAO-05-102). The comments represent the 
tentative position of the Department and are subject to reevaluation 
when the final version of this report is received.

The Department provided several technical comments directly to your 
staff.

The Department appreciates the opportunity to comment on this draft 
report before its publication. 

Sincerely,

Signed by: 

Daniel R. Levinson: 
Acting Inspector General:

Enclosure:

The Office of Inspector General (OIG) is transmitting the Department's 
response to this draft report in our capacity as the Department's 
designated focal point and coordinator for Government Accountability 
Office reports. OIG has not conducted an independent assessment of 
these comments and therefore expresses no opinion on them.

COMMENTS OF THE DEPARTMENT OF HEALTH AND HUMAN SERVICES ON THE U.S. 
GOVERNMENT ACCOUNTABILITY OFFICE'S DRAFT REPORT, "MEDICAID DRUG REBATE 
PROGRAM-INADEQUATE OVERSIGHT RAISES CONCERNS ABOUT REBATES PAID TO 
STATES" (GAO-OS-102):

The Department of Health and Human Services (HHS) appreciates the 
opportunity to review the U.S. Government Accountability Office's 
(GAO's) draft report. This report looks at the Medicaid drug rebate 
program that requires participating drug manufacturers to submit to the 
Centers for Medicare & Medicaid Services (CMS) the "average 
manufacturer price" (AMP) and for brand name drugs, the "best price" 
(BP) of drugs on a quarterly basis. Specifically, the report examines: 
(1) Federal oversight of manufacturer-reported AMPs and BPs; (2) how 
manufacturers' methods of determining AMP and BP could have affected 
the rebates they paid to State Medicaid programs; and (3) how the 
rebate program reflects financial concessions available in the private 
market.

As discussed in the report, section 4401 of the Omnibus Budget 
Reconciliation Act of 1990 added section 1927 to the Social Security 
Act under which drug manufacturers must sign rebate agreements for 
their outpatient drugs to be covered under the Medicaid Program.

The national rebate agreement requires manufacturers to provide certain 
pricing information to CMS, and in turn, CMS reports a unit rebate 
amount to the States. The manufacturers receive information from the 
States on the total number of dosage units of each covered outpatient 
drug paid by the State under the Medicaid State plan during the 
quarter. The manufacturers then remit to the State a rebate payment 
based on the number of units paid for and the unit rebate amount.

GAO Recommendation 1:

To help ensure that the Medicaid drug rebate program is achieving its 
objective of controlling States' Medicaid drug spending, we recommend 
that the Administrator of CMS take the following two actions:

* Issue clear guidance on manufacturer price determination methods and 
the definitions of BP and AMP, and update such guidance as additional 
issues arise.

HHS Response l:

We concur in part. While substantial time and effort have gone into 
providing accurate and timely policy guidance, CMS agrees that 
clarifying existing guidance, including addressing sales to Pharmacy 
Benefit Managers (PBMs) in calculating AMP and BP, will be helpful to 
manufacturers. Going forward, we will be examining these issues in 
greater detail. We will work to assess where more guidance is needed by 
examining those instances where manufacturers did not follow the 
current guidance.

GAO Recommendation 2:

* Implement, in consultation with OIG, systematic oversight of the 
price determination methods employed by pharmaceutical manufacturers 
and a plan to ensure the accuracy of manufacturer-reported prices and 
rebates paid to States.

HHS Response 2:

We concur in part. As the GAO report notes, the Office of the Inspector 
General (OIG) has ongoing responsibility for audits for the Medicaid 
program. While we currently review requests from manufacturers to 
revise their methodologies for determining AMP and BP, this is a review 
of adherence to the current policy. We continue to work with OIG to 
provide policy guidance to them to conduct audits of manufacturers' 
calculations of AMP and BP. We defer to OIG concerning the number and 
level of audits that are possible given their resources. CMS will also 
examine its own current allocation of resources pertaining to verifying 
the accuracy of AMPS and BPs for drugs. It would be of assistance to 
CMS in examining its internal resource allocation if GAO could provide 
additional detail in the final report information about the time it 
took it to review records on 135 drugs, and the additional time it 
believes it would have taken to conduct a review detailed enough to 
draw conclusions about the accuracy of the AMPS and BPs reported for 
these drugs.

We note, however, that GAO did not develop firm conclusions about the 
accuracy of AMPs and BPs of the 135 drugs for the 13 manufacturers for 
the last two quarters of 2000. GAO neither reviewed nor provided an 
estimate of the resources that would be needed to review the full 
compliment of Medicaid drugs on an ongoing basis.

The following are HHS's responses to the GAO Findings in the draft 
report:

GAO Finding: Current Program Oversight does not ensure that 
manufacturer-reportedprices or price determination methods are 
consistent with program criteria.

GAO concludes that CMS's and OIG's oversight of manufacturer-reported 
price determination methods does not ensure that those prices or 
methods are consistent with program criteria. CMS disagrees with this 
conclusion. CMS applies systematic edits to data received from 
manufacturers and seeks correction of data that fail these edits.

As a growing number of manufacturers have proposed to modify their 
methodologies for calculating the AMP and BP in recent years, CMS has 
increased the number of manufacturers referred to OIG for potential 
onsite reviews. We also published a regulation to impose a 3-year time 
limitation for manufacturers to recalculate and report data to CMS on 
AMP and BP and to establish a 10-year recordkeeping requirement for 
manufacturers to retain pricing records under the Medicaid drug rebate 
program.

GAO Finding: Manufacturer price determination methods varied. Some 
could have lead to lower rebates.

GAO concludes that there is considerable variation in the methods that 
manufacturers use to determine AMP and BP. The GAO draft report does 
not provide specific discussion regarding the varying assumptions that 
were made by manufacturers or whether the manufacturers requested a 
clarification of their assumptions from CMS. Without more information 
from GAO, it is impossible for CMS to respond to this finding.

GAO also noted that in some cases manufacturers made assumptions that 
could have caused manufacturers to overstate their rebate liability. 
However, absent sufficient and specific information to review such 
assumptions, we find that there is insufficient information to question 
the reasonableness of these assumptions.

GAO Finding: The rebate program does not clearly address certain 
financial concessions negotiated by PBMs.

The report notes that pharmacy benefit manager (PBM) price concessions 
are a recent development in drug pricing and concludes that the current 
program instructions do not clearly address certain financial 
concessions by PBMs. In particular, the report states that the rebate 
program does not clearly address certain concessions that are 
negotiated by PBMs on behalf of third parties. As noted in the GAO 
report, CMS has issued program releases and guidance regarding the 
appropriate treatment of PBMs.

As stated above in our response to GAO's first recommendation, we agree 
that further guidance would be helpful. In fact, we are developing such 
guidance. We are concerned, however, that even the best general 
guidance cannot address all current and potential arrangements and that 
it will continue to be necessary for us to look at situations on a case-
by-case basis.

GAO Conclusion:

In addition, oversight by CMS and OIG has been inadequate to ensure 
that manufacturer-reported prices and methods are consistent with the 
law, rebate agreement and program guidance. Because rebates rely on 
manufacturer-reported prices, adequate program oversight is 
particularly important to ensure that states receive the rebates to 
which they are entitled.

OIG has done a great deal of work on the Medicaid drug rebate program, 
with a particular emphasis on manufacturer-reported data and methods. 
Recommendations were made accordingly. Our fiscal year 2005 work plan 
shows that work continues on this topic with a number of reviews 
planned and underway. We note, too, that OIG does not exercise program- 
operating responsibilities with respect to securing consistent 
manufacturer-reported prices and methods, so it would be misleading to 
imply that OIG can "ensure" such program compliance.

[End of section]

Appendix II: GAO Contact and Staff Acknowledgments:

GAO Contact:

Marjorie Kanof, (202) 512-7114:

Acknowledgments:

Major contributors to this report were Robin Burke, Martha Kelly, Ann 
Tynan, Helen Desaulniers, Julian Klazkin, and Jennie Apter.

FOOTNOTES

[1] Medicaid is a jointly funded federal-state health care program that 
covers certain low-income families and low-income individuals who are 
aged or disabled. States have latitude within federal guidelines to 
design their individual Medicaid programs with respect to eligibility, 
services, and payment. Although prescription drug coverage is included 
at states' discretion, all state Medicaid programs include drug 
coverage.

[2] Pub. L. No. 101-508, §4401, 104 Stat. 1388, 1388-143-161 (codified 
at 42 U.S.C. §1396r-8 (2000)). All states and the District of Columbia 
participate in the Medicaid drug rebate program, except for Arizona.

[3] State Medicaid programs do not purchase drugs directly but rather 
reimburse pharmacies when they dispense covered outpatient drugs to 
Medicaid beneficiaries. These payments, which include an amount to 
cover the cost of acquiring the drug as well as a dispensing fee, are 
calculated using state-specific payment formulas. 

[4] This rebate amount includes the three types of rebates included in 
the Medicaid drug rebate program: the "basic" rebate for brand name 
drugs, the "additional" rebate for brand name drugs, and the rebate for 
generic drugs. 

[5] Since fiscal year 1995, the amount that manufacturers have paid in 
rebates has risen along with the increase in Medicaid drug spending; 
rebates, as a percentage of Medicaid drug spending, fluctuated from 
about 17 percent to just over 19 percent of spending between fiscal 
years 1995 and 2002.

[6] This report focuses on the basic rebate for brand name drugs, not 
the additional rebate for brand name drugs--which occurs when a brand 
name drug's AMP rises faster than inflation, as measured by changes in 
the consumer price index--or the rebate for generics. The total unit 
rebate amount for a brand name drug includes the basic rebate and any 
additional rebate. 

[7] CMS was known as the Health Care Financing Administration until 
July 1, 2001. In this report, we refer to the agency as CMS when 
discussing agency actions.

[8] The rebate agreement is a standard contract between CMS and each 
manufacturer that governs manufacturers' participation in the rebate 
program, providing, among other things, definitions of key terms.

[9] For example, according to the Department of Justice (DOJ), in 2003 
one manufacturer agreed to pay $88 million to settle allegations raised 
by DOJ under the False Claims Act that it had underpaid Medicaid 
rebates due to states by reporting inaccurate best price information 
for two of its drugs. In 2004, another manufacturer agreed to pay $345 
million in connection with allegations that it had underpaid rebates 
for one of its drugs by failing to properly report best price. 

[10] See GAO, Federal Employees' Health Benefits: Effects of Using 
Pharmacy Benefit Managers on Health Plans, Enrollees, and Pharmacies, 
GAO-03-196 (Washington, D.C.: Jan. 10, 2003). 

[11] In 1995, CMS issued a proposed rule for implementation of the drug 
rebate program, which included provisions regarding best price, AMP, 
and manufacturer reporting requirements. See 60 Fed. Reg. 48442 (1995). 
Only a portion of that rule--concerning the length of time 
manufacturers are able to report price adjustments to CMS and how long 
they must retain documentation of their reported prices--has been 
issued in final form. See 68 Fed. Reg. 51912 (2003). 

[12] As of October 2004, CMS had issued a total of 65 program 
memoranda--also called "program releases"--to manufacturers to provide 
guidance on a range of issues relating to the rebate program. 

[13] Several memoranda address whether prices to certain types of 
health care providers should be considered in determining best price or 
AMP, for example. CMS also responds to questions from individual 
manufacturers on a case-by-case basis. In addition, the agency provides 
an operational training guide and training for manufacturers and states 
on resolving disputes over state-reported drug utilization information 
used to calculate rebate amounts.

[14] The rebate agreement also requires manufacturers to maintain 
records of their assumptions. 

[15] See 42 U.S.C. §1396r-8(c)(1)(C). The rebate agreement further 
defines best price as the lowest price at which the manufacturer sells 
the drug to any purchaser in any pricing structure, including capitated 
payments, with some exceptions. 

[16] Sales made through the Federal Supply Schedule are not considered 
in determining best price, nor are single-award contract prices of any 
federal agency, federal depot prices, and prices charged to the 
Department of Defense, Department of Veterans Affairs, Indian Health 
Service, and Public Health Service. 

[17] See 42 U.S.C. §1396r-8(k)(1). The statute states that customary 
prompt payment discounts are to be subtracted from prices used to 
calculate AMP. There is no definition in the statute for "retail 
pharmacy class of trade."

[18] Under the rebate agreement, AMP is calculated as net sales divided 
by units sold, excluding free goods (i.e., drugs or any other items 
given away, but not contingent on any purchase requirements).

[19] See 42 U.S.C. §1396r-8(c)(1).

[20] The 2003 final rule, which covered only two issues raised in the 
1995 proposed rule, addressed the time frame for reporting price 
adjustments to CMS and the time frame for retaining documentation of 
reported prices. See 60 Fed. Reg. 48442 (1995), 68 Fed. Reg. 51912 
(2003), 68 Fed. Reg. 55527 (2003). In this final rule, CMS required 
that a manufacturer retain written or electronic records documenting 
reported prices for 3 years after those prices are submitted to CMS or 
for a longer period if the records are the subject of an audit or a 
government investigation, of which the manufacturer is aware, relating 
to best price or AMP. However, just after the final rule became 
effective in January 2004, CMS issued an interim final rule that 
replaced the 3-year recordkeeping requirement with a 10-year 
recordkeeping requirement for calendar year 2004; manufacturers still 
are required to retain records for a longer period if the records are 
the subject of an audit or government investigation. 69 Fed. Reg. 508 
(2004). At the same time, CMS issued a proposed rule that would make 
the 10-year requirement permanent. 69 Fed. Reg. 565 (2004). 

[21] Manufacturers may request a rebate recalculation, for example, 
after a merger, if the merging manufacturers need to reconcile 
different price determination methods. 

[22] We asked CMS officials to provide information on all recalculation 
requests since the program's inception in 1991. CMS officials told us 
that they do not have data on all of the recalculation requests prior 
to September 2000. 

[23] States refund rebate payments to manufacturers by having the 
future rebate payments they receive from manufacturers reduced. 

[24] See Department of Health and Human Services, Office of Inspector 
General, Medicaid Drug Rebates: The Health Care Financing 
Administration Needs to Provide Additional Guidance to Drug 
Manufacturers to Better Implement the Program, A-06-91-00092 
(Washington, D.C.: November 1992).

[25] Although CMS disagreed with OIG, it said it would further clarify 
AMP calculation in a forthcoming drug rebate program regulation. As of 
October 2004, the regulation had not been issued and CMS officials told 
us that the agency had no plans to promulgate any such regulation in 
the near future. Instead, the agency has issued several program 
memoranda intended to provide guidance on how manufacturers should 
calculate AMP. 

[26] OIG reports on individual manufacturers are not publicly available.

[27] In response to OIG recommendations, CMS said it would provide the 
manufacturer with a copy of recent guidance on AMP: Medicaid Drug 
Rebate Program Release No. 29, June 1997. This document, released to 
all manufacturers at the time OIG was conducting the 1997 review, in 
some cases differed from OIG's definition of retail pharmacy class of 
trade. It stated, for example, that sales to nursing home and mail- 
order pharmacies are to be included in AMP, while OIG's definition 
excluded these entities.

[28] Letter from OIG to Ranking Minority Member, Committee on 
Government Reform, House of Representatives, November 22, 1999.

[29] Medicaid Drug Rebate Program Release No. 47, July 2000.

[30] See Department of Health and Human Services, Office of Inspector 
General, Medicaid Drug Rebates: Sales to Repackagers Excluded from Best 
Price Determinations, A-06-00-00056 (Washington, D.C.: March 2001).

[31] Medicaid Drug Rebate Program Release No. 2, August 1991.

[32] See Medicaid Drug Rebate Program Release No. 14, December 1994, 
regarding administrative fees, and Medicaid Drug Rebate Program 
Releases No. 28, April 1997, and No. 29, June 1997, regarding PBM 
arrangements. 

[33] Citing limitations in its data systems, this manufacturer used the 
wholesale acquisition cost, which is the manufacturer's list price for 
wholesalers or other direct purchasers before any rebates, discounts, 
allowances, or other price concessions. 

[34] GAO-03-196.

[35] PBMs often manage the transactions that take place between third- 
party payers and pharmacies. For example, in some cases, when an 
enrollee purchases a drug at a retail pharmacy, the pharmacy collects 
from the enrollee the appropriate cost sharing amount and then submits 
a claim to the PBM for reimbursement. The PBM pays the pharmacy and 
collects reimbursement from its third-party payer client. 

[36] Some PBMs operate mail-order pharmacies and, when doing so, may 
separately negotiate rebates or discounts with manufacturers for the 
drugs they purchase for that component of their business. 

[37] In managing pharmacy benefit plans for their clients, PBMs can 
influence the utilization of drugs using several approaches, such as 
formularies--lists of drugs that are approved for reimbursement by the 
PBM's clients--and tiered copayment systems that use financial 
incentives to encourage enrollees to select certain drugs. 

[38] In 2004, according to a study prepared for a national association 
representing PBMs, an estimated 200 million people, or about 68 percent 
of the U.S. population, were in private plans that used PBMs. See 
PricewaterhouseCoopers, The Value of Pharmacy Benefit Management and 
the National Cost Impact of Proposed PBM Legislation (July 2004), 
http://www.pcmanet.org/research.asp (downloaded January 18, 2005).

[39] For example, PBMs now design pharmacy benefit plans--working with 
clients on issues such as which drugs to cover and how much of a drug's 
cost will be paid by enrollees--and provide clinical support such as 
disease management programs for enrollees with specific illnesses.

[40] GAO-03-196.

[41] For example, according to financial reports filed with the 
Securities and Exchange Commission, three large PBMs together received 
over $4.3 billion in total fiscal year 2002 payments from 
manufacturers. These payments can include payments related to PBM 
negotiations on behalf of clients as well as other payments such as 
fees. For one of the PBMs we reviewed, manufacturer payments totaled 7 
percent of its revenue. (Comparable information on manufacturer 
payments was not available from the other PBMs' financial reports.) All 
three PBMs stated in their financial reports that manufacturer payments 
were important to their profitability.

[42] Medicaid Drug Rebate Program Release No. 28, April 1997, and 
Medicaid Drug Rebate Program Release No. 29, June 1997. 

[43] Medicaid Drug Rebate Program Release No. 30, September 1997. 

[44] A change in guidance regarding how PBM payments should be 
reflected in best price would not necessarily affect the best price for 
every drug because best price can be determined by a transaction that 
is not related to PBM payments. 

[45] A greater difference between best price and AMP would not always 
yield a larger rebate. For example, if the difference between the two 
prices increased but remained less than 15.1 percent of AMP, the unit 
rebate amount would still be based on the 15.1 percent of AMP minimum.

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