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In some cases, Medicare pays significantly more for covered outpatient drugs than the actual costs to the physicians and pharmacy suppliers. Attempts to reduce these payments have been met with provider claims that overpayments for the drugs are needed to cover underpayments for administering or delivering them. Medicare's method for establishing drug payments is flawed. Medicare pays 95 percent of the average wholesale price (AWP), which, despite its name, is neither an average nor a price that wholesalers charge. Instead, it is a number that manufacturers derive using their own criteria. There are no requirements or conventions that AWP reflect the price of actual drug sales. Widely available purchase prices for drugs in 2001 were substantially below AWP. For both physician-billed drugs and pharmacy supplier-billed drugs, Medicare payments often far exceeded widely available prices. Physicians and pharmacy suppliers contend that the excess payments for covered drugs are necessary to offset what they claim are inappropriately low Medicare payments or no such payments for services related to the administration or delivery of these drugs. Although physicians receive an explicit payment for administering drugs, Medicare's payment policies for delivering pharmacy supplier-billed drugs and related equipment are uneven. Pharmacy suppliers billing Medicare receive a dispensing fee for one drug type--inhalation therapy drugs--but not for other covered drugs, such as infusion therapy or covered oral drugs. Other payers and purchasers, such as private health plans and the Department of Veterans Affairs (VA), use different approaches to pay for or buy drugs that may be instructive for Medicare. In particular, VA uses the leverage from the volume of federal drug purchases to secure verifiable data on actual market transactions, and it uses the prices paid by manufacturers' best customers to set Federal Supply Schedule prices.

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