    [House Hearing, 108 Congress]
    [From the U.S. Government Publishing Office]

     MEDICAID PRESCRIPTION DRUG REIMBURSEMENT: WHY THE GOVERNMENT PAYS TOO
                                      MUCH

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                                    HEARING

                                   before the

                                SUBCOMMITTEE ON
                          OVERSIGHT AND INVESTIGATIONS

                                     of the

                        COMMITTEE ON ENERGY AND COMMERCE
                            HOUSE OF REPRESENTATIVES

                          ONE HUNDRED EIGHTH CONGRESS

                                 SECOND SESSION

                                   ----------

                                DECEMBER 7, 2004

                                   ----------

                               Serial No. 108-126

                                   ----------

           Printed for the use of the Committee on Energy and Commerce

     Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                     house

     MEDICAID PRESCRIPTION DRUG REIMBURSEMENT: WHY THE GOVERNMENT PAYS TOO
                                      MUCH

     MEDICAID PRESCRIPTION DRUG REIMBURSEMENT: WHY THE GOVERNMENT PAYS TOO
                                      MUCH

    =======================================================================

                                    HEARING

                                   before the

                                SUBCOMMITTEE ON
                          OVERSIGHT AND INVESTIGATIONS

                                     of the

                        COMMITTEE ON ENERGY AND COMMERCE
                            HOUSE OF REPRESENTATIVES

                          ONE HUNDRED EIGHTH CONGRESS

                                 SECOND SESSION

                                   __________

                                DECEMBER 7, 2004

                                   __________

                               Serial No. 108-126

                                   __________

           Printed for the use of the Committee on Energy and Commerce

     Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                     house

                                   __________

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                        COMMITTEE ON ENERGY AND COMMERCE

                          JOE BARTON, Texas, Chairman

    W.J. ``BILLY'' TAUZIN, Louisiana     JOHN D. DINGELL, Michigan
    RALPH M. HALL, Texas                   Ranking Member
    MICHAEL BILIRAKIS, Florida           HENRY A. WAXMAN, California
    FRED UPTON, Michigan                 EDWARD J. MARKEY, Massachusetts
    CLIFF STEARNS, Florida               RICK BOUCHER, Virginia
    PAUL E. GILLMOR, Ohio                EDOLPHUS TOWNS, New York
    JAMES C. GREENWOOD, Pennsylvania     FRANK PALLONE, Jr., New Jersey
    CHRISTOPHER COX, California          SHERROD BROWN, Ohio
    NATHAN DEAL, Georgia                 BART GORDON, Tennessee
    RICHARD BURR, North Carolina         PETER DEUTSCH, Florida
    ED WHITFIELD, Kentucky               BOBBY L. RUSH, Illinois
    CHARLIE NORWOOD, Georgia             ANNA G. ESHOO, California
    BARBARA CUBIN, Wyoming               BART STUPAK, Michigan
    JOHN SHIMKUS, Illinois               ELIOT L. ENGEL, New York
    HEATHER WILSON, New Mexico           ALBERT R. WYNN, Maryland
    JOHN B. SHADEGG, Arizona             GENE GREEN, Texas
    CHARLES W. ``CHIP'' PICKERING,       KAREN McCARTHY, Missouri
    Mississippi, Vice Chairman           TED STRICKLAND, Ohio
    VITO FOSSELLA, New York              DIANA DeGETTE, Colorado
    STEVE BUYER, Indiana                 LOIS CAPPS, California
    GEORGE RADANOVICH, California        MICHAEL F. DOYLE, Pennsylvania
    CHARLES F. BASS, New Hampshire       CHRISTOPHER JOHN, Louisiana
    JOSEPH R. PITTS, Pennsylvania        TOM ALLEN, Maine
    MARY BONO, California                JIM DAVIS, Florida
    GREG WALDEN, Oregon                  JANICE D. SCHAKOWSKY, Illinois
    LEE TERRY, Nebraska                  HILDA L. SOLIS, California
    MIKE FERGUSON, New Jersey            CHARLES A. GONZALEZ, Texas
    MIKE ROGERS, Michigan
    DARRELL E. ISSA, California
    C.L. ``BUTCH'' OTTER, Idaho
    JOHN SULLIVAN, Oklahoma

                          Bud Albright, Staff Director

                       James D. Barnette, General Counsel

          Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                     ______

                  Subcommittee on Oversight and Investigations

                   JAMES C. GREENWOOD, Pennsylvania, Chairman

    MICHAEL BILIRAKIS, Florida           PETER DEUTSCH, Florida
    CLIFF STEARNS, Florida                 Ranking Member
    RICHARD BURR, North Carolina         DIANA DeGETTE, Colorado
    CHARLES F. BASS, New Hampshire       TOM ALLEN, Maine
    GREG WALDEN, Oregon                  JANICE D. SCHAKOWSKY, Illinois
      Vice Chairman                      HENRY A. WAXMAN, California
    MIKE FERGUSON, New Jersey            EDWARD J. MARKEY, Massachusetts
    MIKE ROGERS, Michigan                JOHN D. DINGELL, Michigan,
    JOE BARTON, Texas,                     (Ex Officio)
      (Ex Officio)

                                      (ii)

                                C O N T E N T S

                                   __________
                                                                       Page

    Testimony of:
        Balland, David J., Associate Commissioner for Medicaid and
          CHIP, Texas Health and Human Services Commission...........   123
        Catlett, Timothy P., Senior Vice President of Sales and
          Marketing, Barr Laboratories, Incorporated.................   155
        Jones, T. Mark, President, Ven-A-Care of the Florida Keys,
          Inc.; and John Lockwood, Vice President, Ven-A-Care of the
          Florida Keys, Inc..........................................    75
        Marrs, Pamela R., Senior Vice President and CFO, DEY, Inc....   150
        Marshall, David, Director of Category Management for
          Generics, CVS Corporation..................................   159
        O'Connell, Patrick J., Texas Attorney General's Office.......   127
        Paoletti, Lesli L., Roxane Laboratories, Inc.................   153
        Reeb, George M., Assistant Inspector General, Centers for
          Medicare and Medicaid Audits, accompanied by Robert Vito,
          Regional Inspector General for Evaluation and Inspections,
          Philadelphia...............................................   115
        Reinhart, Paul, Michigan Medicaid Director...................    94
        Seagrave, Frank, Vice President of Pharmacy, Wal-Mart Stores,
          Incorporated...............................................   160
        Smith, Dennis, Director, Center for Medicaid and State
          Operations, Centers for Medicare and Medicaid Services.....   100
        Stratemeier, Edward H., former Vice President and General
          Counsel, Aventis Pharmaceuticals...........................   147
        Ziebell, John, Category Manager for Pharmacy, Health &
          Wellness, Walgreen Company.................................   160
    Additional material submitted for the record:
        Balland, David J., Associate Commissioner for Medicaid and
          CHIP, Texas Health and Human Services Commission, letter
          dated January 6, 2005, enclosing response for the record...   184
        Michigan Department of Community Health, memorandum dated
          January 3, 2005, enclosing response for the record.........   183
        Paoletti, Lesli L., Roxane Laboratories, Inc., letter dated
          January 18, 2005, enclosing response for the record........   187

                                     (iii)

     MEDICAID PRESCRIPTION DRUG REIMBURSEMENT: WHY THE GOVERNMENT PAYS TOO
                                      MUCH

                                  ----------

                           TUESDAY, DECEMBER 7, 2004

                      House of Representatives,
                      Committee on Energy and Commerce,
                  Subcommittee on Oversight and Investigations,
                                                        Washington, DC.
        The subcommittee met, pursuant to notice, at 10:05 a.m., in
    room 2322, Rayburn House Office Building, Hon. Joe Barton
    (chairman) presiding.
        Members present: Representatives Bilirakis, Walden,
    Ferguson, Rogers, Barton (ex officio), Waxman, Markey, and
    Dingell (ex officio).
        Also present: Representative Stupak.
        Staff present: Mark Paoletta, majority counsel; Andrew
    Snowdon, majority counsel; Brad Conway, majority counsel; Mike
    Abraham, legislative clerk; Edith Holleman, minority counsel;
    and Turney Hall, minority clerk.
        Chairman Barton. The subcommittee will come to order.
        Today we are going to hold a hearing on Medicaid
    Prescription Drug Reimbursement: Why the Government Pays Too
    Much.
        We have got a number of panels and a number of witnesses.
    This is a very important hearing. Medicaid is a program for the
    poorest and sickest people in our country. We in the Congress
    have a responsibility to make sure that every possible dollar
    available under the program goes to those who need it the most.
    We also have an obligation to make sure that the American
    taxpayer gets what he or she is paying for.
        Unfortunately, the current system by which we reimburse
    health care providers for prescription drugs under Medicaid
    flies in the face of both of these principles. The system is
    broken, and it needs to be fixed. The Government pays far too
    much for many prescription drugs under Medicaid, primarily
    because most States continue to use a system that is called
    average wholesale price, or AWP, as the basis for their
    reimbursement.
        For example, during our investigation, the committee has
    obtained documents showing that in the summer of 2002 one drug
    manufacturer's direct sales price of 2,000 20 milligram
    capsules of Fluoxetine, the generic version of the popular
    antidepressant Prozac, was $82.62, while the average wholesale
    price was more than $5,300. Let me repeat that. The generic
    version, $82.62, but the average wholesale price was $5,300.
        I would like to commend the former subcommittee chairman,
    Mr. Jim Greenwood, and the current vice chairman, Mr. Greg
    Walden, who is sitting to my right, for their work on this
    issue over the last year. What they have done is very, very
    important.
        Chairman Greenwood, in particular, was tenacious in the
    pursuit of average wholesale price reform, first in Medicare
    where we did change the system, and now in Medicaid where, so
    far, we have not. In fact, today's hearing is an outgrowth of
    the committee's prior work on AWP drug-based drug reimbursement
    under Medicare.
        During a hearing back in September 2001, Chairman Greenwood
    noted that the term AWP could just as easily be an acronym for
    ``ain't what is paid.'' sadly, this remains true today. As you
    will hear shortly, the Federal Government and, ultimately, the
    American taxpayer could save hundreds or millions or even
    billions of dollars a year if States would bring drug
    reimbursements more in line with what they actually cost the
    pharmacy and other health care providers to purchase these
    drugs.
        Today's hearing, which is a culmination of an extensive
    investigation by the subcommittee staff on a bipartisan basis,
    will focus on systemic problems with the structure and
    administration of prescription drug expenditures under
    Medicaid, as well as abuses of the system.
        The committee's prior AWP work ultimately led to important
    changes in last year's landmark Medicare Modernization Act,
    MMA, changes that will save the Medicare program $15 billion
    over the next 10 years. It is my profound hope that this
    hearing, by exposing some of those same problems and abuses,
    will set the stage for similar Medicaid reform on a bipartisan
    basis in the upcoming Congress.
        Medicaid is supposed to reimburse pharmacists the estimated
    acquisition cost of the drugs, plus a reasonable dispensing
    fee. Over the years, AWP has emerged as a proxy for estimated
    acquisition costs. Currently, all but eight States rely on AWP
    as the basis of Medicaid reimbursement. Unfortunately, and all
    too often, AWP bears little or no resemblance to what these
    providers really pay, particularly in the generic marketplace
    where multiple manufactures compete to sell identical drugs
    that are, for all intents and purposes, a commodity.
        During the course of this investigation the committee has
    uncovered evidence that several manufacturers either inflate
    their AWPs or actively market their products not based on the
    lowest price but on the difference between the price and the
    reimbursement amount, better known in the industry as the
    spread.
        Although the manufacturer's practice of marketing the
    spread appears to have waned in recent years due in large part
    to litigation and the heightened scrutiny generated by the work
    of this committee and others, the existence of substantial
    spreads remains a fixture of Medicaid prescription drug
    reimbursement.
        Let me say that again. The existence of substantial spreads
    remains a fixture of Medicaid prescription drug reimbursement.
        Generic manufacturers initially set the AWP of their
    product at 89.9 percent of the brand name's AWP. In the words
    of one manufacturer, we ``set it and forget it.'' Meanwhile,
    fierce competition drives down the actual sales price of these
    generics, therefore increasing the spread, often dramatically.
        I want to be clear here that the price competition is a
    good thing. Generic drugs have a critical role in play in
    containing soaring drug costs. Concern, however, is that
    because of AWP the Medicaid program all too often misses out on
    these cost savings. Medicaid's use of AWP corrupts the market
    and turns what would otherwise be a positive development,
    namely price competition, into abuse that deprives Medicaid of
    the benefits.
        The primary beneficiaries of the current Medicaid
    reimbursement structure are the retail pharmacies. Data
    obtained by the committee from five of the largest retail
    pharmacy chains reveals that during the period of July 1, 2002,
    to June 30, 2003 the average acquisition cost for seven widely
    prescribed generic drugs was 22 cents, while the average
    Medicaid reimbursement just for those drugs alone was 56 cents,
    more than double the cost; and you can see that on the chart
    that is up on the overheads.
        Indeed, evidence gathered by the committee suggests that
    Medicaid reimbursement is more generous than that of most
    private payors. The pharmacies do not generally deny that they
    reap substantial margins on certain prescription drugs under
    Medicaid. Their argument is that any overpayments for
    prescription drugs are necessary to offset Medicaid dispensing
    fees, which they assert do not cover the true cost of the
    services that they provide to the Medicaid population.
        This situation is analogous to physician-administered drugs
    in Medicare. In the new Medicare law, we have attempted to make
    significant changes to the way that physician-administered
    drugs are reimbursed, scrapping AWP in favor of a new market-
    based average sales price and increasing payments for physician
    services.
        A recent Government Accountability Office study released
    just last week shows that, the appropriateness of the new
    payments here as is in Medicare.
        I believe that we should pay providers fairly for their
    services. I have got absolutely no problem with increasing
    dispensing fees, if that is what we need to do. But we should
    pay them accurately so that we can achieve cost savings while
    ensuring that Medicaid beneficiaries will continue to have
    access to critically important drugs.
        In this context, I am especially pleased to welcome David
    Balland from the Texas Health and Human Services Commission and
    Patrick O'Connell from the Texas Attorney General's Office.
        Texas is one of the States on the forefront of Medicaid
    reform; and the approach that the State of Texas Medicaid
    program has taken to address these problems, an approach that
    should serve as a model to other States, in my opinion, is one
    of flexibility, transparency and fairness.
        Texas has imposed an aggressive reimbursement formula and
    requires manufacturers to provide transaction data as a means
    of verifying acquisition costs, while at the same time having
    one of the highest dispensing fees of any State. These reforms
    have resulted in substantial cost savings for both the State
    and to the Federal Government, yet not one pharmacy has left
    the program as a result of underpayment.
        This is work that was begun under then Attorney General
    John Cornyn, who is now one of our Senators from Texas. I want
    to commend him for his work in that area.
        As the Texas Attorney General in 1999, Senator Cornyn
    identified Medicaid fraud as a priority and created a special
    section devoted entirely to this issue. Senator Cornyn was
    invited to testify here today, but, due to a scheduling
    conflict, he is not available.
        I want to thank all of our witnesses at today's hearings. I
    think that with the amount of money that we are spending on
    prescription drugs under our Medicaid program it is very
    important that we identify reforms to get the biggest bang for
    the buck.
        I want to think the committee staff on both sides of the
    aisle for the strong work that they have done over the last
    year and a half on this issue, and I look forward to this being
    one of the landmark hearings of this subcommittee.
        [The prepared statement of Hon. Joe Barton follows:]

     Prepared Statement of Hon. Joe Barton, Chairman, Committee on Energy
                                  and Commerce

        Medicaid is a program for the poorest and sickest people in this
    country, and we in Congress have a responsibility to make sure that
    every possible dollar available under this program goes to those who
    need it the most. We also have an obligation to make sure that the
    American taxpayer gets what he or she pays for. Unfortunately, the
    current system by which we reimburse health care providers for
    prescription drugs under Medicaid flies in the face of both of these
    principles. The system is broken, and it needs to be fixed.
        The government pays far too much for many prescription drugs under
    Medicaid, primarily because most states continue to use Average
    Wholesale Price, or AWP, as the basis of reimbursement. For example,
    during this investigation, the Committee obtained documents showing
    that in the summer of 2002 one drug manufacturer's direct sales price
    of 2000 20-milligram capsules of fluoxetine--the generic version of the
    popular antidepressant Prozac--was $82.62, while the AWP was more than
    $5,300.
        I would like to commend former Subcommittee Chairman James
    Greenwood and current Vice Chairman Greg Walden for the tremendous work
    that they have done on this very important issue. Chairman Greenwood,
    in particular, has been tenacious in the pursuit of AWP reform, first
    in Medicare and now in Medicaid. In fact, today's hearing is largely an
    outgrowth of the Committee's prior work on AWP-based drug reimbursement
    under Medicare. During a hearing back in September 2001, Chairman
    Greenwood noted that the term AWP could just as easily be an acronym
    for ``ain't what's paid.'' Sadly, this remains true today. As you will
    hear shortly, the federal government--and ultimately the American
    taxpayer--could save hundreds of millions of dollars per year if states
    would bring drug reimbursements more in line with what it actually
    costs pharmacies and other health care providers to purchase these
    drugs.
        Today's hearing, which is the culmination of an extensive
    investigation by Subcommittee staff, will focus on systemic problems
    with the structure and administration of prescription drug expenditures
    under Medicaid, as well as abuses of the system. This Committee's prior
    AWP work ultimately led to important changes in last year's landmark
    Medicare Modernization Act, changes that will save the Medicare program
    approximately $15 billion over the next ten years. It is my profound
    hope that this hearing, by exposing some of these problems and abuses,
    will set the stage for similar Medicaid reforms in the 109th Congress.
        Medicaid is supposed to reimburse pharmacists the estimated
    acquisition cost of the drugs, plus a reasonable dispensing fee. Over
    the years, AWP has emerged as a proxy for estimated acquisition cost:
    currently, all but eight (8) states rely upon AWP as the basis of
    Medicaid reimbursement. Unfortunately, all too often AWP bears little
    or no resemblance to what these providers really pay, particularly in
    the generic marketplace, where multiple manufacturers compete to sell
    identical drugs that are, for all intents and purposes, a commodity.
    During the course of its investigation, the Committee uncovered
    evidence that several manufacturers either inflated their AWP's or
    actively marketed their products not based on the lowest price, but on
    the difference between the price and the reimbursement amount--better
    known as the ``spread.''
        Although the manufacturers' practice of marketing the spread
    appears to have waned in recent years, due in large part to litigation
    and the heightened scrutiny generated by the past work of this
    Committee and others, the existence of substantial spreads remains a
    fixture of Medicaid prescription drug reimbursement. Generic
    manufacturers initially set the AWP of their products at 89.9% of the
    brand-name drug's AWP, and, in the words of one manufacturer: ``We set
    it and forget it.'' Meanwhile, fierce competition drives down the
    actual sales prices of these generics, thereby increasing the spread,
    often dramatically.
        I want to be clear here that price competition is a good thing, and
    generic drugs have a critical role to play in containing soaring drug
    costs. My concern, however, is that because of AWP, the Medicaid
    program all too often misses out on these cost savings. Medicaid's use
    of AWP corrupts the market and turns what would otherwise be a positive
    development--namely price competition--into an abuse that deprives
    Medicaid of the benefits.
        The primary beneficiaries of the current Medicaid reimbursement
    structure are the retail pharmacies. Data obtained by the Committee
    from five of the largest retail pharmacy chains reveals that during the
    period July 1, 2002 to June 30, 2003, the average acquisition cost for
    seven widely-prescribed generic drugs was $0.22, while the average
    Medicaid reimbursement, just for the drugs alone, was $0.56--more than
    double the cost. Indeed, evidence gathered by the Committee suggests
    that Medicaid reimbursement is more generous than that of most private
    payors.
        The pharmacies do not generally deny that they reap substantial
    margins on certain prescription drugs under Medicaid. Rather, they
    argue that any overpayments for prescription drugs are necessary to
    offset Medicaid dispensing fees, which they assert do not cover the
    true cost of the services that they provide to the Medicaid population.
    This situation is analogous to physician-administered drugs in
    Medicare. In the new Medicare law, we made significant changes to the
    way that physician-administered drugs were reimbursed, scrapping AWP in
    favor of a new market-based Average Sales Price and increasing payments
    for physician services. A recent Government Accountability Office study
    released just last week by this Committee confirmed the appropriateness
    of the new payments. Here, as in Medicare, I believe that we should pay
    providers fairly, but accurately, so that we can achieve cost savings
    while ensuring that Medicaid beneficiaries will continue to have access
    to critically important drugs.
        In this context, I am especially pleased to welcome David Balland,
    from the Texas Health and Human Services Commission and Patrick
    O'Connell, from the Texas Attorney General's Office. Texas is one of
    the states on the forefront of Medicaid reform, and the approach that
    the Texas Medicaid program has taken to address these problems--an
    approach that should serve as a model to other states--is one of
    flexibility, transparency, and fairness. Specifically, Texas has
    imposed an aggressive reimbursement formula and requires manufacturers
    to provide transaction data as a means of verifying acquisition costs,
    while at the same time having one of the highest dispensing fees of any
    state. These reforms have resulted in substantial cost savings for both
    the state and the federal government, yet not one pharmacy has left the
    program as a result of underpayment.
        Much of the good work done by Texas Medicaid and the Attorney
    General's Office is due, in no small part, to the foresight and
    dedication of Senator John Cornyn, and I would like to pay Senator
    Cornyn a special tribute here this morning. As the Texas Attorney
    General in 1999, Senator Cornyn identified Medicaid fraud as a priority
    and created a special section devoted entirely to this issue. I invited
    Senator Cornyn to testify here today, but, due to a scheduling
    conflict, he was unfortunately not available. Senator Cornyn did submit
    a written statement for the record that I would like to attach to these
    remarks.
        I want to thank all of the witnesses at today's hearing for taking
    the time to attend today's hearing. Given the tremendous amount of
    money spent on prescription drugs under the Medicaid program, I think
    that this is an issue worthy of the Committee's attention, and I hope
    that this hearing will help to reform a system that is plainly in a
    state of disrepair.

        Chairman Barton. Senator Cornyn has submitted a written
    statement for the record, and we will put that into the record.
        [The prepared statement of Hon. John Cornyn follows:]

     Prepared Statement of Hon. John Cornyn, a United States Senator from
                               the State of Texas

        Thank you, Mr. Chairman, for inviting me to testify today before
    the Subcommittee on Oversight and Investigations concerning government
    payments for Medicaid prescription drug reimbursement. I was
    disappointed my schedule did not permit me to appear in person, but I
    am deeply appreciative of the opportunity to submit these written
    remarks.
        I would also like to thank Patrick O'Connell, Chief of the Civil
    Medicaid Fraud Section of the Texas Attorney General's Office, for his
    comments. I share Mr. O'Connell's pride that Texas was the first state
    to move from AWP based reimbursement to wholesaler cost and that the
    Texas Vendor Drug Program is one of the best Medicaid programs in the
    country, if not the best. I especially applaud the dedication and
    enthusiasm that the current Texas Attorney General Gregg Abbott and
    Chief O'Connell have shown in continuing the work we initiated during
    my tenure as Texas Attorney General combating Medicaid fraud and abuse.
        As you are aware, suspicions of overpayments for prescription drugs
    in Medicaid programs across the nation have been alleged since the
    programs were first implemented. In 1977, the U.S. Congress enacted the
    federal Medicare/Medicaid Anti-Fraud and Abuse Act, which provided
    federal funding to states that established Medicaid fraud and abuse
    control units. In 1997, Texas' ability to combat Medicaid fraud
    improved when the Texas Legislature enacted Senate Bill 30, which
    provided for implementing fraud detection technology, additional
    monitoring of service providers along with administrative penalties,
    civil remedies, and criminal sanctions for fraudulent and abusive
    actions.
        I was sworn in as Texas Attorney General in 1999 and became
    increasingly concerned about overpayments for prescription drugs in the
    Texas Medicaid Program and other specific instances of fraud and abuse.
    In August of 1999, I created the Civil Medicaid Fraud Section within my
    Elder Law Division. Prior to that time, few investigations, and no
    lawsuits, regarding civil Medicaid fraud had been pursued. With the
    creation of this special Section, we dedicated resources and efforts to
    fighting fraud, waste, and abuse in the Medicaid system.
        I was deeply troubled by some of our discoveries. While there are
    several examples upon which I could draw, there is one that continues
    to resonate. In September of 2000, we filed a landmark case against
    three drug companies--DEY, Inc., Roxane Laboratories, Inc., and Warrick
    Pharmaceuticals Corporation--for civil Medicaid fraud as part of a
    complicated scheme to corner the market in respiratory disease
    medications.
        Typically, when a doctor prescribes medication for a Medicaid
    patient, a pharmacy dispenses the medication and then bills Medicaid
    for reimbursement. In order for the drug to be eligible for Medicaid
    reimbursement, the drug manufacturer must certify the prices at which
    it sells the drug in writing with the Texas Department of Health (TDH).
    TDH uses that certification to calculate the amount of reimbursement
    pharmacies will receive. Texas at the time was the only state that
    required drug manufacturers to certify their prices in order to be
    eligible for Medicaid reimbursement.
        These drug companies falsely reported inflated prices for their
    respiratory medications to TDH. Then, they turned around and sold these
    drugs to pharmacies at drastically reduced prices while the pharmacies
    were reimbursed at the inflated price. This scheme ensured that
    pharmacies would dispense the defendants' drugs over other less
    profitable medications. All of this was part of a strategy by the drug
    companies to increase their market share and ``capture'' the market. To
    be blunt, this was tantamount to stealing from taxpayers. Medicaid
    funds should be spent only to provide necessary medical care and
    prescription medications to those who need it. Instead, elaborate
    schemes such as these steal scarce tax dollars to finance corporate
    market strategies and to inflate illegally the bottom line. Plain and
    simple: it is wrong
        Two of the defendants ultimately settled for $45.5 million
    collectively, and the third is set for trial. This lawsuit sent a clear
    signal to participants in Medicaid programs across the country that
    those who try to steal from the Medicaid program may be prosecuted with
    a heavy price inflicted.
        This is but one example. However, it effectively emphasizes the
    importance of remaining vigilant in our efforts for those of us charged
    with protecting the public trust. I commend you, Mr. Chairman, and the
    members of this Subcommittee, for continuing to examine these important
    issues. And, I appreciate the opportunity to share with you some of my
    experiences.
        Thank you.

        Chairman Barton. Now I want to recognize my distinguished
    friend from Massachusetts, one of the members who has been a
    real watchdog on this subcommittee, Mr. Markey of
    Massachusetts, for an opening statement.
        Mr. Markey. Thank you, Mr. Chairman, very much and thank
    you for having this very important hearing today.
        We are going to hear from the Department of Health and
    Human Services Inspector General, indicating that the Federal
    Government is paying far too much for prescription drugs under
    the Medicaid program.
        This is not the first time that such concerns have been
    raised. We have been getting reports of these overpayments
    since the early 1990's. Yet the Centers for Medicare and
    Medicaid Services have continually failed to address their
    international mismanagement and the systematic problems that
    enable drug companies and pharmacies to commit fraud and
    inflate the prices of their drugs.
        Prescription drugs are one of the fastest growing expenses
    for Medicaid. Between 1992 and 2002, expenditures for
    prescribed drugs increased by 19 percent per year, and by 2003
    the Medicaid program spent over $31 billion on prescription
    drugs alone. If we do not address the rising costs of
    prescription drugs, it will drain the Medicaid program of the
    funds needed to provide health care to our Nation's most
    vulnerable populations.
        There are three problems with the current system that I
    hope to hear more about in today's hearing. The first is that
    CMS has been slow to implement simple cost-saving measures
    within the agency. The second problem is that the price the
    States pay for prescription drugs has nothing to do with the
    actual cost of the drug. The third problem is that the Federal
    Government is not allowed to use its market power to negotiate
    lower prices for consumers.
        The Inspector General has identified several simple ways
    that CMS could save money if they were more diligent in their
    administration of the problem. Putting qualified drugs on the
    Federal upper limits list as soon as they are approved, for
    example, could save over $100 million.
        Unfortunately, not all of Medicaid's problems can be solved
    so easily. We also have to address the fact that the current
    reimbursement system practically begs to be exploited.
        The fact that numerous pharmacies and drug companies have
    pled guilty to overcharging Medicaid, lying about their costs,
    taking kickbacks and submitting false claims show the
    vulnerability of the system. We currently have a system where
    companies are asked to simply make up the price that the States
    will pay for their drugs. This price, called the average
    wholesale price, has no relationship to the actual cost of the
    drug, and the companies that set that price do not have to
    provide the States any information about the real costs of
    manufacturing the drugs.
        It is like being asked to pay $50 for a T-shirt without
    having access to any information about what others have paid
    for the same T-shirt. If the vendor tells you that it is a fair
    price but doesn't have to give you any evidence that it is
    reasonable, you have no choice but to trust that seller, that
    that seller is being honest.
        When it comes to spending taxpayer money, we cannot base
    our decisions on trust. We need to base them on evidence. In
    order to ensure that States are not overpaying for prescription
    drugs, they should have access to pricing information and the
    actual costs of the drugs.
        We will hear today about the new program that has been
    successful in actually reducing spending on prescription drugs.
    In April, HHS allowed Michigan, Vermont, New Hampshire, Alaska
    and Nevada to form a purchasing pool. By combining their
    programs, they were able to increase their market power and to
    negotiate better drug prices. At a time when drug prices were
    rising at a rate of almost 20 percent per year, Michigan's drug
    prices actually declined about 1 percent in the first year of
    their pooling program. In response to their success,
    Administrator Mark McClelland stated that pools are a proven
    legal and safe way to lower drug costs.
        However, if evidence suggests that pools work, and CMS
    acknowledges that they are an effective way to lower costs,
    then why is the Federal Government forbidden from creating one
    large pool and using its market power to negotiate the best
    price for Medicaid and Medicare beneficiaries with the drug
    companies across our country?
        Today, we are going to hear from Wal-Mart about how they
    are reducing costs through the purchasing power of their Sam's
    Clubs. But why can't we establish an Uncle Sam's Club that can
    link up all of the States to pool their enormous purchasing
    power of the Federal and State governments to further drive
    down the costs of prescription drugs for every ordinary
    American in our country? Why are they forbidden from pooling
    their resources in order to help those most dependent upon
    prescription drugs who are in fact being tipped upside down and
    having money shaken out of their pockets to pay for
    prescription drugs that every American knows is overpriced to
    those vulnerable consumers of needed prescription drugs?
        In order to preserve this critical health care program, we
    need to find ways to curb the costs of prescription drugs.
    Instead of wasting taxpayers' dollars on overinflated drug
    prices, Medicaid funds could be spent on providing better
    health care to our country's most vulnerable populations, the
    children, the elderly, the poor and the disabled.
        I look forward to hearing from the recommendations of the
    IG, the States and other witnesses, and I am compliment you on
    having this hearing, Mr. Chairman.
        Chairman Barton. Thank you, Mr. Markey.
        We now ask our distinguished vice-chairman of the
    subcommittee, Mr. Walden, for an opening statement.
        Mr. Walden. Thank you very much, Mr. Chairman.
        Let me begin by saying that I, too, share the concerns that
    the States and the Federal Government are paying too much for
    drugs dispensed to our Nation's poorest individuals under the
    Medicaid program. I look forward to learning more about what we
    can do to remedy this situation.
        In September 2001, as you have mentioned, this committee
    held a hearing that addressed similar problems with the
    prescription drug reimbursement under Medicare. The systemic
    problems and abuses brought to light during that hearing helped
    pave the way for significant reforms under the Medicare
    Modernization Act, scrapping Medicare's reliance on the flawed
    average whole price, or AWP.
        And I note in your committee about Mr. Greenwood saying
    ``ain't what is paid.'' I think it is maybe always worst price,
    at least when it comes to the Government.
        We now turn our attention to Medicaid. Despite differences
    between the two programs, there is one common denominator, and
    that is AWP. We have allowed a system to develop where AWP, a
    number not defined by statute or regulation, has become the
    reimbursement standard for the vast majority of Medicaid
    prescription drug programs.
        Because AWP is not, in many cases, reflective of actual
    market prices, it opens the door for the abuses that we will
    hear about today. At the very least, it serves to deny the
    taxpayer the full benefit of price competition in the generic
    marketplace. Let me give you an example.
        Ipratropium Bromide is a popular inhalation drug used to
    treat patients with respiratory problems like bronchitis,
    emphysema, and asthma. Data obtained by this committee during
    this investigation reveals that between 1998 through 2003 the
    AWP for most generic manufacturers in the marketplace for a
    particular size and strength of the drug remained constant at
    $44, while the sales price dropped from the mid teens to the
    low single digits. In mid 2000, however, another competitor
    entered the market with an AWP of $56 for that same drug; and
    internal drug company documents show that the existing
    manufacturers immediately began to lose business because
    pharmacies could make more money off of the higher AWP.
        Data obtained by the committee from five of the largest
    retail pharmacy operations also show how the Medicaid program
    failed to capture the cost savings. In fiscal year 2000, the
    average cost to these pharmacies for a single unit of this
    particular Ipratropium Bromide product was roughly 20 cents,
    while their average Medicaid reimbursement was 41 cents for the
    same product, not including any dispensing fees. And by 2002
    the average cost had dropped to 13 cents, but average Medicaid
    reimbursement remained at 41 cents.
        We will hear today from the Department of Health and Human
    Services Office of Inspector General about the substantial cost
    savings, perhaps totaling hundreds of millions of dollars, that
    could be achieved by eliminating AWP as a reimbursement
    standard, as well as by placing drugs on the Federal upper
    limit in a more timely fashion.
        I am also pleased that Edward Stratemeier, former Vice
    President of Legal, Government Relations and Public Policy at
    Aventis Pharmaceuticals, a manufacturer of brand name drugs,
    has agreed to appear before the committee to discuss problems
    that he and his former employer had identified with the use of
    AWP as a reimbursement standard and the need for AWP reform.
        Medicaid prescription drug costs are enormous. We all know
    that. And they continue to rise. In fiscal year 2002, total
    Medicaid expenditures for prescription drugs exceeded $23
    billion; and the Office of the Actuary at CMS projects that
    Medicaid expenditures will increase at an average of 12.7
    percent per year through 2011. A recent report from the
    National Association of State Budget Officers predicts that in
    2004 States will, for the first time, spend more on Medicaid
    than any other program, including education.
        In light of these soaring drug costs under Medicaid, it is
    imperative that the Federal and State governments do everything
    possible to ensure that drug reimbursement is adequate and fair
    not only to the taxpayers but also to the pharmacies dispensing
    the drugs. To date, the solution adopted by many State Medicaid
    programs to the problem of bloated AWPs has been to modify
    their reimbursement formulas with larger discounts off of AWP.
    This is a band-aid, not a long-term solution.
        A discount off of a bad number is still a bad number, and
    at what point does it simply become nonsensical? AWP minus 15
    percent? AWP minus 50 percent? AWP minus 80 percent? As in the
    case of Medicare, I recognize that, as we consider how to
    reform prescription drug reimbursement under Medicaid, we must
    also consider the impact on the service providers.
        So let me say up front that no one expects pharmacies, or
    any other health care providers, for that matter, to serve the
    Medicaid population at a loss. If the pharmacies are, in fact,
    underpaid for their services, then let's examine that issue
    more fully, analyze the relevant data and take steps to ensure
    they are reimbursed fairly for their services and expenses.
        The answer is not to proceed with the status quo, however,
    making up shorts in one area through overpayments in another
    and hoping at the end of the day everything comes out in the
    wash.
        I would point out, however, that, according to figures
    obtained by the committee, Medicaid dispensing fees are far
    more generous than the pharmacies receive from their largest
    private payors.
        I would also like to thank all of the witnesses for
    appearing here today, and I hope this hearing will serve as a
    springboard for meaningful Medicaid reform in the near future.
    AWP is a convention that has long outlived its usefulness, and
    it is time for us to adopt a reimbursement standard for
    Medicaid that is more reflective of actual market cost.
        AWP, we are told, has been described as the devil we know.
    But I guess I would prefer not to dance with this devil at all.
        Thank you, Mr. Chairman.
        [The prepared statement of Hon. Greg Walden follows:]

     Prepared Statement of Hon. Greg Walden, a Representative in Congress
                            from the State of Oregon

        Let me begin by saying that I too share the concern that the States
    and the federal government are paying too much for drugs dispensed to
    our nation's poorest individuals under the Medicaid program. I look
    forward to learning about what we can do to help remedy this situation
    while still maintaining the quality of care that Medicaid beneficiaries
    deserve.
        In September 2001, this Committee held a hearing that addressed
    similar problems with prescription drug reimbursement under Medicare.
    The systemic problems and abuses brought to light during that hearing
    helped pave the way for significant reforms under the Medicare
    Modernization Act, scrapping Medicare's reliance on the flawed Average
    Wholesale Price, or AWP.
        We now turn our attention to Medicaid. Despite differences between
    the two programs, there is one common denominator: AWP. We have allowed
    a system to develop where AWP--a number not defined by statute or
    regulation--has become the reimbursement standard for the vast majority
    of Medicaid prescription drug programs. Because AWP is not, in many
    cases, reflective of actual market prices, it opens the door for the
    abuses that we will hear about today. At the very least, it serves to
    deny the taxpayer the full benefit of price competition in the generic
    marketplace.
        Ipratroprium bromide--a popular inhalation drug used to treat
    patients with respiratory problems (bronchitis, emphysema, and
    asthma)--serves as an excellent example. Data obtained by the Committee
    during this investigation reveals that from 1998 through 2003, the AWP
    of most generic manufacturers in the marketplace for a particular size
    and strength of the drug remained constant at $44, while the sales
    price dropped from the mid-teens to low single digits. In mid-2000,
    however, another competitor entered the market with an AWP of $56 for
    the same drug, and internal drug company documents show that the
    existing manufacturers immediately began to lose business because
    pharmacies could make more money off of the higher AWP.
        Data obtained by the Committee from five of the largest retail
    pharmacy operations also shows how the Medicaid program failed to
    capture these cost savings. In Fiscal Year 2000 (7/1/00-6/30/01), the
    average cost to these pharmacies for a single unit of this particular
    ipratroprium bromide product was roughly $0.20, while their average
    Medicaid reimbursement was $0.41 for the same product, not including
    any dispensing fees. By FY 2002, the average cost had dropped to $0.13,
    but the average Medicaid reimbursement remained at $0.41.
        We will hear today from the Department of Health and Human Services
    Office of Inspector General about the substantial cost savings--perhaps
    totaling hundreds of millions of dollars per year--that could be
    achieved by eliminating AWP as a reimbursement standard, as well as by
    placing drugs on the Federal Upper Limit in a more timely fashion. I am
    also pleased that Edward Stratemeier, former Vice President of Legal,
    Government Relations and Public Policy at Aventis Pharmaceuticals, a
    manufacturer of brand-name drugs, has agreed to appear before the
    Committee to discuss problems that he and his former employer had
    identified with the use of AWP as a reimbursement standard and the need
    for AWP reform.
        Medicaid prescription drug costs are enormous, and they continue to
    rise. In Fiscal Year 2002, total Medicaid expenditures for prescription
    drugs exceeded $23 billion, and the Office of the Actuary at CMS
    projects that Medicaid prescription drug expenditures will increase at
    an average of 12.7% per year through 2011. A recent report from the
    National Association of State Budget Officers predicts that in 2004,
    states will, for the first time, spend more on Medicaid than any other
    program, including education.
        In light of these soaring drug costs under Medicaid, it is
    imperative that the federal and state governments do everything
    possible to ensure that drug reimbursement is adequate and fair, not
    only to the taxpayers but to the pharmacies dispensing the drugs. To
    date, the solution adopted by many state Medicaid programs to the
    problem of bloated AWPs has simply been to modify their reimbursement
    formulas with larger discounts off of AWP. This is a band-aid, not a
    long-term solution. A discount off of a bad number is still a bad
    number, and at what point does it simply become nonsensical: AWP minus
    15 percent? 50 percent? 80 percent?
        As in the case of Medicare, I recognize that as we consider how to
    reform prescription drug reimbursement under Medicaid, we must also
    consider the impact on the service providers. Let me say up front that
    no one expects pharmacies, or any other health-care providers for that
    matter, to serve the Medicaid population at a loss. If the pharmacies
    are, in fact, underpaid for their services, then let's examine that
    issue more fully, analyze the relevant data, and take steps to ensure
    that they are reimbursed fairly for their services and expenses. The
    answer is not to proceed with the status quo, making up for shortfalls
    in one area through overpayments in another and hoping that, at the end
    of the day, everything comes out in the wash. I would point out,
    however, that according to figures obtained by the Committee, Medicaid
    dispensing fees are far more generous than those that the pharmacies
    receive from their largest private payors.
        I too would like to thank all of the witnesses for appearing here
    today, and I hope that this hearing will serve as a springboard for
    meaningful Medicaid reform in the near future. AWP is a convention that
    has long outlived its usefulness, and it is time for us to adopt a
    reimbursement standard for Medicaid that is more reflective of actual
    market cost. AWP has been described by some as ``the devil we know,''
    but I guess I would prefer not to dance with the devil at all.

        Chairman Barton. Thank you, Mr. Walden.
        The Chair would note that we have, in order of appearances,
    the distinguished Member from California, Mr. Waxman, and the
    equally----
        Mr. Waxman. The more distinguished gentleman.
        Chairman Barton. They are both equally distinguished. One
    is the ranking member of the full committee, however. We will
    recognize Mr. Dingell for an opening statement.
        Mr. Dingell. Thank you, Mr. Chairman; and I thank my
    colleague. I think he is overly kind to me. And I want to
    express my respect and appreciation to him and also to you, Mr.
    Chairman.
        This morning, we are having a very interesting hearing in
    which we are trying now to figure out what is going to happen
    in the future with regard to drug prices under the legislation
    enacted during the past Congress with regard to Medicare and
    Medicaid and prescription pharmaceuticals. The situation is not
    one in which we can look forward with any particular comfort.
        This committee has been addressing the use of AWP, or the
    average wholesale price, as the basis of reimbursement for
    Federal and State prescription drug programs for several years.
    As we will learn today, the drug reimbursement system for
    Medicaid is built on layers of artificial price structures,
    most of which in no way reflect actual costs.
        It has also created an environment that puts providers in
    situations where they can charge higher drug prices to Federal
    and State governments and also to private insurers. There have
    been piecemeal efforts to address this flawed system and to
    reduce prices. There is a rebate program which covers $7
    billion a year of the $30 billion spent for Medicaid
    prescriptions.
        Since 2001, aggressive U.S. Attorneys and State Attorneys
    General, with the assistance of whistle-blowers such as the
    ones we will hear from today, have uncovered efforts to game
    the system and have recovered over $1 billion in Medicare and
    Medicaid overcharges and fines. These lawsuits will continue,
    with New York City and the State of Pennsylvania filing the
    most recent ones.
        The States are taking their own steps to reduce drug
    prices. My own State of Michigan has been a leader in pooling
    its bargaining power with other States to get lower prices. I
    welcome Paul Rinehart, head of Michigan's Medicaid program, to
    this hearing; and I look forward to his testimony.
        The Texas Vendor Drug program, which obtains actual drug
    acquisition prices from vendors, was recently recommended by an
    expert panel as one that the Centers for Medicare and Medicaid
    Services should consider implementing nationwide. I would ask,
    Mr. Chairman, at this time that the report be placed in the
    record.
        Chairman Barton. Without objection, so ordered.
        Mr. Dingell. Thank you, Mr. Chairman.
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        Mr. Dingell. We also look forward to learning more about
    this program and hearing from our witnesses from Texas.
        But these measures alone are not going to solve the health
    care problems of our poorest citizens. Nor will taking away
    health insurance from the poor to reduce the Medicaid rolls.
        Medicaid is now an essential part of the Nation's health
    care system. In 2003, there were 40.4 million persons covered
    by Medicaid for their health needs, or 13.6 percent of our
    population. If this program did not exist, almost one-third of
    this Nation's total population would be totally uninsured. We
    need to be stepping up our assistance, and billions of dollars
    in tax cuts should not come at the expense of the health of our
    most vulnerable citizens.
        We also need to look at what the Medicare Modernization Act
    will do to the States and the elderly poor. Mr. Rinehart will
    tell us that Michigan may pay more under MMA for drugs than it
    ever did before.
        On Sunday, the New York Times ran a disturbing article
    about the unworkability of the new Medicare drug plan for the
    1.5 million Americans who live in nursing homes, many of them
    in different stages of dementia are receiving drugs through
    feeding tubes, people obviously unable to come to a judgment
    about what plan it is that will serve their interests best.
        These people are not on the Internet studying the various
    drug cards, nor are they able to. It appears that CMS has no
    strategy for serving these people, and I look forward to
    inquiring of CMS about these matters at a suitable time. We
    must address this critical issue then in the next Congress at
    the earliest time.
        Mr. Chairman, I commend you and I thank you for continuing
    to focus on the Medicaid drug pricing issues; and I look
    forward to the testimony from all of our witnesses.
        Chairman Barton. We thank the distinguished gentleman from
    Michigan.
        We would ask our distinguished subcommittee chairman of the
    Health Subcommittee, Mr. Bilirakis of Florida, for an opening
    statement.
        Mr. Bilirakis. Thank you, Mr. Chairman. Good morning to
    all.
        Today's hearing, obviously by now, focuses on an issue of
    great importance, Medicaid prescription drug reimbursement.
    Prescription drug payments are one of the fastest growing
    health care costs. In 2001 alone, Medicaid spent approximately
    $20 billion on drugs; and from 1997 through 2001, Federal
    Government Medicaid expenditures, Federal Medicaid
    expenditures, I emphasize, grew at more than twice the rate of
    total Medicaid spending.
        The Medicaid program is the largest payor for prescription
    drugs nationally, representing about 14 percent of the market.
    The Federal Government contribution ranges from, as we know,
    from 50 to 83 percent in matching payments, depending on the
    State's per capita income.
        Examining the amount of money the Federal Government pays
    for drugs is not an issue--is not a new issue for the Energy
    and Commerce Committee. In both the Medicare and Medicaid
    programs there have been concerns that the Federal Government
    is paying too much for drugs. Congress addressed some of those
    concerns, hopefully, in the Medicare Modernization Act that was
    signed into law last year. But there is still more work to be
    done to ensure that prescription drugs are reimbursed at an
    accurate rate.
        Medicaid reimbursement for prescription drugs is
    complicated, as is already obvious to all of us, and as we will
    see here today varies greatly from State to State. The Federal
    Government sets the maximum drug reimbursement limit.
        But within those Federal parameters each State establishes
    its own estimated acquisition cost formula. This calculation is
    based on data from published drug prices, average wholesale
    price info, and wholesale prices. However, States do not
    necessary have access to the actual price paid for drugs, as
    has already been stated.
        According to a recent Department of HHS Inspector General
    report, the difference between the highest and lowest State
    Medicaid drug payments ranged between 12 to 4,073 percent. At a
    glance, this definitely seems odd, doesn't it? However, there
    are many complicated factors as to why State reimbursement
    policies vary, the most visible being the acquisition price
    formula, but there are other factors as well.
        This subject is, as I think, again, obvious to all of us,
    will be a top priority for this committee in the 109th
    Congress. We all look forward to hearing what our witnesses
    have to say. I believe and hope that the information they share
    with us will help us move forward in the next Congress.
        Thank you, Mr. Chairman. I yield back.
        Chairman Barton. Mr. Waxman,the distinguished gentleman
    from California is recognized for an opening statement.
        Mr. Waxman. Thank you very much. I am pleased that the
    subcommittee is holding this hearing today on issues involving
    Medicaid prescription drug reimbursement.
        Medicaid, as you know, is a critical program for over 52
    million low-income families and children and aged, blind and
    disabled people who rely on it for their health care services.
    It is a program that is costly, and it is a program that
    strains the budgets of the States who are struggling to meet
    the needs of their citizens. It is a program that needs better
    tools to control costs and spend dollars efficiently, and it is
    a program that, frankly, needs increased fiscal support from
    the Federal Government.
        While members of this subcommittee might disagree on the
    best ways to improve and strengthen Medicaid, what surely all
    of us can agree on is that our scarce dollars be spent
    effectively. We should not be wasting dollars by overpaying for
    prescription drugs.
        First, of course, in this program as in Medicare, we should
    be taking all of the steps we can to lower the price for
    prescription drugs. We should be using the bargaining power of
    negotiation in order to get better prices. Medicare represents
    millions of people, Medicaid represents millions of people, as
    does private insurance. We ought to be using that collective
    buying clout to get better prices for the prescription drugs in
    both programs.
        Interestingly enough, Medicaid in some ways has been a
    leader in this effort. In fact, it was in 1990 when we
    established that Medicaid would be given the more favorable of
    the best price for brand name drugs or a minimum rebate of
    dollars off the average manufacturer's price, or AMP.
        Years before Medicare took similar action, we broke away
    from the concept of accepting the average wholesale price, or
    AWP, as the price the program should pay. It was an early
    recognition that the AWP was an essentially bogus price that
    bore little relationship to the actual acquisition police of
    drugs.
        Further, we attempted to ensure competition if there were
    three or more generics on the market by limiting the price the
    program would pay. But we made a critical mistake when these
    policies were developed. Even then, the drug industry was
    powerful, and they succeeded in securing a provision in the
    basic legislation that kept the best price and the AMP
    information a secret.
        Can you imagine that? The Federal Government knew this
    information, but we kept it a secret from the States. This has
    proved to be a costly error. Without this crucial piece of
    information, States who are, after all, responsible for
    establishing the reimbursement rates for prescription drugs
    could not set their reimbursement rates appropriately.
        As a result, they continued to rely on the average
    wholesale price minus some arbitrary amount simply because they
    did not have the information they needed to set a more
    appropriate reimbursement rate. Well, we at the Federal level
    bear responsibility for this, but we can remedy it. We need to
    make the information on the AMP and the best price available to
    the States.
        I would hope this administration would ask for the
    authority to do this and that Members of the majority party
    would support it, even though the pharmaceutical companies
    might well oppose it. It might mean taking on these drug
    companies who seem opposed to transparency, but it makes a lot
    more sense to save money this way than to slash the Federal
    commitment to the people who depend on Medicaid.
        As we will learn today, some States have been very
    aggressive in attempting to get this information and require
    drug companies to provide it. Too often, they have found that
    the Federal Government has undercut their ability to do this.
        There is a further irony in the fact that the so-called
    claw-back provision of the recently passed Medicare
    prescription drug bill is designed so that the States that have
    spent the last few years in aggressive efforts to control
    increases in prescription drug expenditures will be
    disadvantaged for their efforts. They will have their fiscal
    obligation to the Federal Government grow at a higher rate than
    would have been the case if their prescription drug price
    control efforts had continued. This is also wrong, and we
    should fix it.
        I hope this hearing today will shed some light on these
    issues and help show us a way to save money in Medicaid that
    will, in the end, benefit not hurt the millions of Americans
    this program is designed to serve.
        Thank you, Mr. Chairman.
        Chairman Barton. Thank you, Mr. Waxman.
        Not seeing any other members who have not yet made a
    statement, the Chair would ask unanimous consent that all
    members of the subcommittee not present have the requisite
    number of days to put their written statement in the record.
        Hearing no objection, so ordered.
        We now want to welcome our first panel. We have Mr. Mark
    Jones, who is President of Ven-A-Care in Florida, and we have
    Dr. John Lockwood, who is Vice President of that same company
    also in Florida.
        Gentlemen, we welcome you. Your statements are in the
    record in their entirety. We will recognize you, Mr. Jones, and
    then Dr. Lockwood for 7 minutes to elaborate on your statement.
    Welcome to the subcommittee.

        TESTIMONY OF T. MARK JONES, PRESIDENT, VEN-A-CARE OF THE
     FLORIDA KEYS, INC.; AND JOHN LOCKWOOD, VICE PRESIDENT, VEN-A-
                     CARE OF THE FLORIDA KEYS, INC.

        Mr. Jones. Mr. Chairman, members of the committee, good
    morning. My name is Mark Jones. I am President----
        Chairman Barton. Excuse me. This is an oversight hearing. I
    am not used to doing hearings where I have to swear people in.
        It is the tradition of this subcommittee, since it is an
    oversight and investigation subcommittee, to take all testimony
    under oath. Do either of you gentlemen oppose testifying under
    oath?
        Mr. Jones. No.
        Chairman Barton. You also have the right, under the
    Constitution, to be represented by counsel during your
    testimony. Do either of you have counsel here that you wish to
    advise you during your testimony?
        Mr. Jones. No.
        Chairman Barton. Would you then each of you stand and raise
    your right hand.
        [Witnesses sworn.]
        Chairman Barton. Now we can start with you, Mr. Jones, for
    7 minutes.
        Mr. Jones. My name is Mark Jones. I am the President of
    Ven-A-Care of the Florida Keys. I wish to thank you for the
    opportunity to appear before you today to discuss a matter of
    vital importance to the government health care benefit programs
    such as Medicaid.
        Before I go on, this is Dr. John Lockwood, he is the Vice
    President of Ven-A-Care as well.
        Today's hearing focuses on excessive reimbursement for
    pharmaceutical products by the States' Medicaid programs.
    Deceptive price reports by some drug manufacturers are causing
    hundreds of millions in damages to our country's joint State
    and Federal health care programs for the poor. The inflated
    reimbursements resulting from deceptive reports of prices have
    a corruptive effect on our health care system.
        Ven-a-Care has learned this firsthand when it suffered
    economic retaliation for its refusal to enter into a business
    arrangement where inflated reimbursements were used to enrich
    the physicians in order to induce them to increase orders of
    expensive drugs.
        Many Federal and State health care programs establish or
    ultimately determine reimbursement rates for pharmaceuticals,
    either prospectively or retrospectively, using price and sales
    data directly or indirectly furnished by pharmaceutical
    manufacturers.
        The government sets reimbursement with the expectation that
    the data provided are complete and accurate. The knowing
    submission of false, fraudulent or misleading information is
    actionable.
        The difference between the amount a provider is reimbursed
    for a drug and the provider's cost is known as the spread. In
    the context that we are addressing today, it means the
    difference between the cost of the drug to the pharmacy or
    other provider and the amount Medicaid reimburses for the cost
    of the drug. The greater the spread the greater the profit.
        When a manufacturer reports a price that exceeds the price
    at which its drug is selling for in the marketplace, the
    States' Medicaid programs determine a reimbursement amount that
    are higher than the government intends. The participating
    manufactures then engage in conduct known as marketing the
    spread, by means such as the following:
        Some manufacturers take action to increase reimbursement by
    further inflating their reported prices in order to persuade
    customers to buy their drugs. Some manufacturers train their
    sales personnel to pitch the higher reimbursement spreads on
    their drugs as compared to their competitors' drugs.
        Reimbursement spreads on manufacturers' drugs are routinely
    marketed through software programs and data provided by
    wholesalers and group purchasing organizations that show the
    pharmacy the comparative spreads on different manufacturers'
    drugs so that pharmacy can choose the drug with the greatest
    spread.
        Notwithstanding the explicit warnings from the OIG, the
    drug manufacturer executives who report inflated drug prices
    and direct their subordinates to market the spread often
    contend that their deceptive conduct should be blamed on the
    government reimbursement programs themselves. They argue that
    their reported prices are no more than list prices and need not
    be good faith representation of what their drugs actually sell
    for in the marketplace. Executives and other representatives
    from these companies have actually contended that it is the
    industry standard for them to make up any price they choose and
    report it for use by government reimbursement programs, even if
    the reported prices are more than 10 time the true prices they
    know are generally and currently available in the marketplace.
        Such assertions have been rejected by the courts. For
    example, in a recent case involving the drug Lupron, United
    States District Court Judge Stearns spoke directly to such
    preposterous assertions by the drug company defendants.
        Judge Stearns wrote, ``Defendants repeatedly assert that
    they had no duty to disclose what was publicly known to
    everyone, that is, that the Lupron AWP was a sticker price and
    never intended to reflect the drug's true average wholesale
    price. In support of this argument, defendants cite a number of
    government reports acknowledging that published AWPs for
    prescription drugs often exceed their acquisition cost. The
    argument is ultimately unpersuasive. There is a difference
    between a sticker price and a sucker price.''
        Judge Stearns then addressed an argument often made by drug
    manufacturers who are caught reporting inflated prices. They
    argue that the U.S. Congress actually condones and even
    encourages such deception. Judge Stearns wrote again, ``The
    suggestion that Congress would deliberately condone a bribery
    scheme using public funds to enrich drug manufacturers and
    physicians is, to say the least, unusual.''
        It is my hope that my testimony as well as the information
    gathered through this committee's investigation will eliminate
    certain factors and concerns which I believe are critical to
    understanding the Medicaid reimbursement problem. They are:
    Drug manufacturers choose to have their drugs covered by
    Medicaid; they are not required to do so.
        Drug manufacturers know that State Medicaid programs rely
    on the prices that the manufacturer reports directly or through
    their price reporting compendia. As with any system of
    government reimbursement, pharmaceutical reimbursement is based
    upon trust, in this case trust that the drug companies will
    report their prices in good faith.
        The root of the problem of excessive Medicaid reimbursement
    for pharmaceuticals lies with those drug manufacturers who
    choose to deceive rather than tell the truth about their
    prices.
        The excuse that a company will lose market share if it
    reports prices truthfully should not be accepted from
    pharmaceutical manufacturers. Other industries such as banking,
    communications, electrical power and defense manufacturers have
    been faced with similar integrity issues.
        Any legislation directed at improving the Medicaid
    reimbursement system should not inadvertently create a
    potential defense through which manufactures may argue that
    Congress has somehow absolved them from their past
    defalcations.
        Judge Stearns' decision quoted above illustrates that the
    manufacturers who have participated in this scheme seek to
    misconstrue the intent of Congress as somehow approving their
    deceptive conduct.
        In closing, I would ask that this committee consider the
    insidious damage which such deceptive practices have on our
    free market system. The contention by drug manufacturers that
    deception is somehow justified when it becomes widespread in
    their industry reveals a serious and fundamental integrity flaw
    that, if left unaddressed, threatens the taxpayer, the patient
    and the industry itself.
        Mr. Chairman and members, thank you for the chance to
    appear before your committee. Dr. Lockwood and I are happy to
    answer questions.
        [The prepared statement of T. Mark Jones follows:]

       Prepared Statement of T. Mark Jones, President, Ven-A-Care of the
                                  Florida Keys

        Mr. Chairman and Members of the Committee, good morning. I am T.
    Mark Jones, President of Ven-A-Care of the Florida Keys. I wish to
    thank you for the opportunity to appear before you today to discuss a
    matter of vital importance to government health care benefit programs
    such as Medicaid: The diversion of hundreds of millions of taxpayer
    dollars because some pharmaceutical manufacturers report falsely
    inflated prices, knowing that government programs use those reports in
    setting reimbursement amounts. Ven-A-Care's past president, Zachary
    Bentley, appeared before this Committee on September 21, 2001 and
    testified about the impact of the same deceptive practices on the
    Medicare Program. Due in large part to the hard work of this Committee,
    protections against such drug manufacturer misconduct were included in
    the Medicare Modernization Act. I would draw the Committee's attention
    to the extensive evidence presented during the September 2001 hearing
    that exposes how drug manufacturers' deceptive reports of prices has
    damaged the Medicare Program and its elderly and disabled
    beneficiaries. Today's hearing focuses on excessive reimbursement for
    pharmaceutical products by the States' Medicaid Programs, where the
    same kinds of deceptive price reports, by some drug manufacturers, are
    causing wide scale financial harm to our country's joint state and
    federal healthcare program for our poor.
        As the information from this Committee's prior investigations
    revealed, Medicare reimburses pharmacies directly for a limited number
    of drugs, such as the inhalant drug Ipratopium Bromide when
    administered with a nebulizer. However, a very large portion of
    Medicare Part B drug expenditures directly reimburse physicians who
    administer the drug and may receive a direct financial benefit from
    their decision to use a particular drug. State Medicaid Programs, on
    the other hand, reimburse all providers for a much larger number of
    drugs than does Medicare Part B, and the vast majority of Medicaid drug
    expenditures are paid to pharmacies that dispense the drug to the
    Medicaid beneficiary. Accordingly, the manufacturers' marketing of the
    financial inducements, made possible by their false price reports, is
    usually directed at pharmacies when Medicaid reimbursement is at issue.
    As the cost of the War On Terror climbs and our national deficit grows,
    Congress faces increasing pressure to reduce federal contributions to
    State Medicaid Programs. Congressional and Executive Branch scrutiny of
    deceptive price reporting practices by drug manufacturers will do much
    to insure that the scarce dollars remaining are no longer diverted from
    their intended purpose of caring for our poor. Federal and State
    Medicaid funds must not be used as financial incentives that support
    individual drug companies' marketing efforts.
        A brief discussion of Ven-A-Care's history will help put my remarks
    in the proper context. Ven-A-Care is a very small specialty pharmacy
    that was created in the late 1980s to provide infusion, inhalation and
    injectible pharmaceuticals to seriously ill patients, outside of the
    hospital setting, in the Florida Keys. We immediately experienced a
    high demand for our services due to the large numbers of patients
    suffering from HIV related illnesses in Key West. Our early success
    attracted the attention of National Medical Care, then the health care
    subsidiary of WR Grace Corporation, that organized the referring
    physicians in the community into a single venture and attempted to
    recruit Ven-A-Care's principals with promises of making us multi-
    millionaires within a few short years. Our examination of the NMC
    business plan revealed what appeared to be an unlawful arrangement
    where excessive reimbursement for pharmaceuticals would be used to
    generate exorbitant profits. Our concerns about the propriety of the
    venture were elevated by then recent experiences. In one instance, we
    received from Medicare a payment for a cancer therapy in an amount many
    times our cost as a very small pharmacy. Assuming that a mistake had
    been made, we voluntarily returned the money to Medicare. In another
    instance, we became concerned that the Florida Medicaid Program was
    paying excessive amounts for certain infusion therapies and we informed
    the program supervisors. The organizers of the NMC venture made it very
    clear to us that ``success'' would result from using funds generated by
    inflated pharmaceutical reimbursements to financially induce the
    participating physicians to increase their prescriptions, of expensive
    pharmaceutical therapies, many fold beyond that which had previously
    resulted from their best medical judgment. We did not believe that we
    could properly participate and we declined. As a result, the
    participating physicians re-directed their referrals to the new venture
    in which they had an economic interest and Ven-A-Care soon lost
    virtually its entire market. After reporting our concerns to the
    appropriate federal authorities and assisting them in their
    investigations of NMC's business practices, Ven-A-Care brought its
    first action under the Federal False Claims Act which ultimately led to
    the United States recovering nearly $500,000,000 and WR Grace divesting
    itself of its healthcare businesses.
        Our experience with the NMC venture was soon followed by other
    opportunities to share in other business arrangements where excessive
    government reimbursement for pharmaceuticals was used to fund kick-back
    arrangements and increase utilization of expensive drug therapies.
    Again we reported these situations to the government, gathered evidence
    through our own investigations and took other actions to assist the
    United States Department of Justice, the HHS OIG and later the States'
    Attorneys General in their efforts to identify and address the causes
    of the inflated reimbursement that was fueling the kinds of kick-back
    arrangements to which Ven-A-Care had been exposed.
        As an industry insider, Ven-A-Care has had access to information
    that the federal and state governments needed to understand the root
    cause of the inflated Medicaid drug reimbursements. The following
    summarizes what we discovered:

    a.) The United States government's policy has been that Medicaid
            reimbursement for drugs should be based upon the cost of the
            drug to the pharmacy, or other health care provider, who
            purchases the drug in the free marketplace and must not be
            based upon government price controls or government negotiating
            power. This is significantly different from the situation where
            the government agency buys the drug directly, such as for the
            public health service, and gets the benefit of the much lower
            Federal Supply Schedule Prices.
    b.) Medicaid programs pay pharmacies a dispensing fee over and above
            the amount reimbursed for the cost of the drug itself. The drug
            manufacturers' deceptive price reports cause the Medicaid
            Programs to pay excessive reimbursement for the drugs' cost to
            the pharmacy or other provider. All state Medicaid Programs as
            required to limit their reimbursement for the cost of the drug
            itself to an amount no greater then that based upon the
            program's estimate of the acquisition cost (EAC) which in turn
            is to be based upon prices ``generally and currently
            available'' in the marketplace.
    c.) Therefore, ``reimbursement'' in the context of the Medicaid
            pharmacy benefit, is the amount that a state Medicaid Program
            pays the pharmacy, or other provider, for the cost of the drug
            that it dispenses or otherwise provides to a Medicaid
            beneficiary.
    d.) State Medicaid programs look to prices reported directly to them by
            the manufacturer, as in the case of the Texas Program, or
            indirectly through prices the manufacturer causes to be
            reported by the three recognized drug price compendia; Red
            Book, First Data Bank and Medi-Span.
    e.) The manufacturers report prices, and cause prices to be reported by
            the compendia, in three basic formats: Average Wholesale Price
            (AWP)--a representation of the price of the drug from the
            wholesaler to the pharmacy or other provider. Wholesaler
            Acquisition Cost (Cost)--a representation of the cost of the
            drug to the wholesaler from the manufacturer. Direct Price
            (DP)--a representation of the price the manufacturer charges
            the pharmacy when it buys the drug directly from the
            manufacturer.
    f.) The term ``spread'' denotes the difference between one price or
            cost and another. In the context that we are addressing today,
            it means the difference between the cost of the drug to the
            pharmacy or other provider and the amount Medicaid reimburses
            for the cost of the drug. The greater the spread, the greater
            the profit.
    g.) When the manufacturer of a drug reports, or causes the reporting
            of, an AWP, WAC or DP that is materially and deceptively
            greater than the actual prices in the marketplace, it causes
            the Medicaid Programs to calculate an estimated acquisition
            cost that is higher than the cost at which the drug is
            generally and currently available in the marketplace and thus
            reimburse at an inflated amount that causes the spread on the
            drug to be inflated.
    h.) The manufacturers who have chosen to provide deceptive price
            reports have actively, albeit surreptitiously, taken steps to
            counteract government efforts to better estimate drug
            acquisition costs of prudent purchasers in the marketplace.
        --Medicaid reimbursement at a discount off of AWP (eg AWP-15%) is
    counteracted by companies who report AWPs resulting in spreads of
    hundreds and even thousands of a percent.
        --Medicaid reimbursement based upon WAC plus a percent, such as
    that paid by Florida and Massachusetts, is counteracted by companies
    that report, or cause the reporting of, false inflated WACs.
        --Medicaid reimbursement based upon DP, such as that paid for some
    drugs by California, is counteracted by companies that report, or cause
    the reporting of, false inflated DPs.
        --Efforts by states that require direct reporting of prices, such
    as Texas are counteracted by companies that report false prices
    directly to the state program.
        --Efforts by CMS to set caps based on the Federal Upper Limit
    (FUL), are similarly counteracted because FULs are based upon 150% of
    the lowest publicly available price for a generic and FULs are inflated
    when the underlying reported prices are false.
    i.) The participating manufacturers then engage in conduct known as
            ``marketing the spread'' by means such as the following.
        --Some manufacturers will have direct discussions with large
    customers after which they will take action to increase reimbursement
    by further inflating their reported prices in order to persuade the
    large customers to buy their drugs.
        --Some manufacturers will train their sales personnel to pitch the
    higher reimbursement spreads on their drugs, as compared to their
    competitors', directly to the pharmacies.
        --The reimbursement spread on manufacturers' drugs is routinely
    marketed through software programs and data provided by wholesalers and
    group purchasing organizations that show the pharmacy the comparative
    spreads on different manufacturers' drugs so that the pharmacy can
    choose the drug with the greatest spread.
        Over the last several years, Ven-A-Care has been vigilant in
    reporting industry insider information to the United States Department
    of Justice, the HHS OIG and the States' Attorneys General that has
    enabled them to identify and begin to address pharmaceutical pricing
    fraud by drug manufacturers. I am only at liberty to discuss a small
    portion of those efforts in this open proceeding; however, they are
    instructive:

    1.) The United States ex rel. Ven-A-Care v. Bayer: Settled in 2001, the
            ``Bayer 1'' case resulted in the recovery of $14,000,000 by the
            Medicaid program and set the stage for similar actions
            throughout the United States, as well as more focused
            Congressional interest such as this Committee's September 21,
            2001 hearing. The concept of reimbursement based upon Average
            Selling Price (``ASP'') was included in the Bayer settlement
            agreement and later incorporated into the Medicare
            Modernization Act.
    2.) Texas ex rel Ven-Care v. DEY Laboratories and Schering-Plough/
            Warrick: Ven-A-Care brought the first case under the Texas
            False Claims Act against drug manufacturers for reporting
            falsely inflated pricing information in order to cause the
            Texas Medicaid Program to pay inflated reimbursement which was
            in turn used as a marketing tool to induce pharmacies and other
            health care providers to select the manufacturers' drug over
            their competitors. Then Texas Attorney General, now United
            States Senator, John Cornyn, joined with Ven-A-Care and became
            the first State Attorney General to pursue action against
            pharmaceutical manufacturers for such deceptive price reports
            that cause Medicaid to overpay for drugs. To date, DEY
            Laboratories has paid $18,500,000 and Schering Plough has paid
            $27,000,000 to compensate the Texas Medicaid Program.
    3.) Texas ex rel. Ven-Care v. Roxane and Bohringer Ingelheim: In this
            case the Texas Attorney General has joined with Ven-A-Care to
            pursue recoveries of excessive Medicaid reimbursements
            allegedly caused by deceptive pharmaceutical manufacturer price
            reports. This case is currently in active litigation.
    4.) Texas ex rel. Ven-Care v. Abbott Laboratories, Baxter, B. Braun
            McGaw: In this case the Texas Attorney General has joined with
            Ven-A-Care to pursue recoveries of excessive Medicaid
            reimbursements allegedly caused by deceptive pharmaceutical
            manufacturer price reports. This case is currently in active
            litigation.
    5.) California ex rel. Ven-A-Care v. Abbott Laboratories: In this case
            the California Attorney General has joined with Ven-A-Care to
            pursue recoveries of excessive Medicaid reimbursements
            allegedly caused by deceptive pharmaceutical manufacturer price
            reports. This case is currently in active litigation.
    6.) Florida ex rel. Ven-A-Care v. DEY, Schering-Plough and Roxane
            Laboratories: In this case the Florida Attorney General has
            joined with Ven-A-Care to pursue recoveries of excessive
            Medicaid reimbursements allegedly caused by deceptive
            pharmaceutical manufacturer price reports. This case is
            currently in active litigation.
        In addition to the above, the following states have brought similar
    actions against drug manufacturers for deceptively reporting drug
    prices resulting in their Medicaid Programs paying excessive
    reimbursement: New York, Massachusetts, Connecticut, Minnesota,
    Kentucky, Wisconsin, Arkansas, Ohio, Montana, and Nevada.
        Since the settlement of the Bayer 1 case in 2001, approximately
    $2,400,000,000 has been recovered from drug manufacturers in cases,
    brought under the federal and various states' False Claims Acts,
    seeking recovery of excessive reimbursements paid by the Medicare and
    Medicaid Programs or recoveries of amounts underpaid to the Medicaid
    Rebate Program. (See, ``The Role of the False Claims Act in Reducing
    Medicare and Medicaid Fraud by Drug Manufacturers: An Update'',
    prepared for Taxpayers Against Fraud Education Fund by Andy Schneider,
    Principal Medicaid Policy, LLC, November 2004.) Perhaps more
    importantly, the industry insider information provided by Ven-A-Care
    has assisted the HHS OIG to better understand how drug manufacturers'
    deceptive price reports cause immense damage to the Medicare and
    Medicaid Programs. The HHS OIG addressed this in the OIG Compliance
    Program Guidelines for Pharmaceutical Manufacturers, 68 Federal
    Register No. 89, pages 23731-23743 (May 5, 2003). The OIG has made it
    clear that it considers such conduct to be fraudulent and to violate
    the False Claims Act and the anti-kickback laws. I have attached a full
    copy of the OIG's Guidelines. However, the following excerpts are
    directly relevant to today's proceedings:
              ``Integrity of Data Used To Establish or Determine Government
            Reimbursement. Many federal and state health care programs
            establish or ultimately determine reimbursement rates for
            pharmaceuticals, either prospectively or retrospectively, using
            price and sales data directly or indirectly furnished by
            pharmaceutical manufacturers. The government sets reimbursement
            with the expectation that the data provided are complete and
            accurate. The knowing submission of false, fraudulent, or
            misleading information is actionable. A pharmaceutical
            manufacturer may be liable under the False Claims Act if
            government reimbursement (including, but not limited to,
            reimbursement by Medicare and Medicaid) for the manufacturer's
            product depends, in whole or in part, on information generated
            or reported by the manufacturer, directly or indirectly, and
            the manufacturer has knowingly (as defined in the False Claims
            Act) failed to generate or report such information completely
            and accurately. Manufacturers may also be liable for civil
            money penalties under various laws, rules and regulations.
            Moreover, in some circumstances, inaccurate or incomplete
            reporting may be probative of liability under the federal anti-
            kickback statute.''
              Average Wholesale Price. The ``spread'' is the difference
            between the amount a customer pays for a product and the amount
            the customer receives upon resale of the product to the patient
            or other payer. In many situations under the federal programs,
            pharmaceutical manufacturers control not only the amount at
            which they sell a product to their customers, but also the
            amount those customers who purchase the product for their own
            accounts and thereafter bill the federal health care programs
            will be reimbursed. To the extent that a manufacturer controls
            the ``spread,'' it controls its customer's profit.''
              ``Average Wholesale Price (AWP) is the benchmark often used
            to set reimbursement for prescription drugs under the Medicare
            Part B program. For covered drugs and biologicals, Medicare
            Part B generally reimburses at ``95 percent of average
            wholesale price.'' 42 U.S.C. 1395u (o). Similarly many state
            Medicaid programs and other payers base reimbursement for drugs
            and biologicals on AWP. Generally, AWP or pricing information
            used by commercial price reporting services to determine AWP is
            reported by pharmaceutical manufacturers.''
              ``If a pharmaceutical manufacturer purposefully manipulates
            the AWP to increase its customers' profits by increasing the
            amount the federal health care programs reimburse its
            customers, the anti-kickback statute is implicated. Unlike bona
            fide discounts, which transfer remuneration from a seller to a
            buyer, manipulation of the AWP transfers remuneration to a
            seller's immediate customer from a subsequent purchaser (the
            federal or state government). Under the anti-kickback statute,
            offering remuneration to a purchaser or referral source is
            improper if one purpose is to induce the purchase or referral
            of program business. In other words, it is illegal for a
            manufacturer knowingly to establish or inappropriately maintain
            a particular AWP if one purpose is to manipulate the ``spread''
            to induce customers to purchase its product.''
              ``In the light of this risk, we recommend that manufacturers
            review their AWP reporting practices and methodology to confirm
            that marketing considerations do not influence the process.
            Furthermore, manufacturers should review their marketing
            practices. The conjunction of manipulation of the AWP to induce
            customers to purchase a product with active marketing of the
            spread is strong evidence of the unlawful intent necessary to
            trigger the anti-kickback statute. Active marketing of the
            spread includes, for example, sales representatives promoting
            the spread as a reason to purchase the product or guaranteeing
            a certain profit or spread in exchange for the purchase of a
            product.''
        Notwithstanding such explicit warnings from the OIG, the drug
    manufacturer's executives, who report inflated drug prices, often
    contend that their deceptive conduct should be blamed on the government
    reimbursement programs themselves. They argue that their reported
    prices are no more than ``list'' prices and need not be good faith
    representations of what their drugs actually sell for in the
    marketplace. Executives and other representatives from these companies
    have actually gone so far as to represent that it is ``the industry
    standard'' for them to make up any price they choose and report it for
    use by government reimbursement programs no matter how many hundreds
    or, in many cases, thousands of a percent that their represented prices
    exceed the true prices that they know are generally and currently
    available in the marketplace. Such assertions have been rejected by the
    courts. For example, in a recent case, In re Lupron Mktg. & Sales
    Practices Litig., 295 F. Supp. 2d 148 ( D. Mass. 2003), brought to
    recover such price fraud damages for Medicare beneficiaries whose 20
    per cent co-payment had been inflated, United States District Court
    Judge Stearns spoke directly to such preposterous assertions by the
    drug company defendants:
              ``But this is not a case of nondisclosure. Defendants did not
            stand mute. As alleged in the Amended Complaint, defendants
            trumpeted a lie by publishing the inflated AWPs, knowing (and
            intending) them to be used as instruments of fraud.'' Id at
            647.
              ``Defendants repeatedly assert that they had no duty to
            disclose what was publicly known to everyone, that is, that the
            Lupron ' AWP was a ``sticker price'' and never
            intended to reflect the drug's true average wholesale price. In
            support of this argument, defendants cite a number of
            government reports acknowledging that the published AWPs for
            prescription drugs often exceed their acquisition cost. The
            argument is ultimately unpersuasive. There is a difference
            between a sticker price and a sucker price. If one were
            confronting a modest markup of the actual AWP for Lupron
            ' (which 300% is not), intended to make sales of the
            drug for the treatment of Medicare patients commercially viable
            (given the 95% of AWP reimbursement rate), it is unlikely that
            there would have been a government investigation of TAP's
            marketing practices. Similarly, if the same inflated AWP had
            not been used to set reimbursement rates for private purchasers
            and insurers, the Amended Complaint would not have been filed.
            The Blues, in their response to defendants' argument, have it
            exactly right: ``[I]f everything [about Lupron ']
            was known to everybody, why did [d]efendants emphasize
            secrecy?'' Blues Memorandum, at 7. Finally, the recognition on
            the part of government regulators of inefficiencies in the
            administration of Medicare does not, as defendants contend,
            amount to condonation of fraudulent conduct. (Emphasis added)
            Id at 648.
            ``. . . As defendants portray the Congressional purpose in
            setting the reimbursement rate at 95% of AWP, Congress meant to
            turn a blind eye to the inflated AWPs as a means of enticing
            physicians to treat Medicare patients. In other words, Congress
            deliberately invited the very fraud of which defendants are
            accused. As defendants describe it, ``a determination that AWP
            must be set at the actual cost to providers would result in
            lower Medicare payment levels to physicians, prompting many of
            those physicians to stop treating Medicare patients because it
            is not cost-effective for them to do so.'' Defendants'
            Memorandum, at 32. The suggestion that Congress would
            deliberately condone a bribery scheme using public funds to
            enrich drug manufacturers and physicians is, to say the least,
            unusual.'' Id at 648.
        The above excerpts from Judge Stearn's decision illustrate the
    following corrupted logic underlying certain drug companies'
    rationalization that they have no duty to tell the truth about prices:
    government reimbursement systems that trust price representations by
    drug companies are easy to cheat; therefore many companies cheat;
    therefore cheating is the industry standard; therefore cheating isn't
    really cheating. After Judge Stearns rejected the proposition that such
    a complete lack of integrity is somehow excused, if it occurs within
    the pharmaceutical industry, the drug companies in question agreed to
    pay $150,000,000 in damages.
        Like the Defendants in the Lupron case, the manufacturers, who
    choose to have their drugs covered by Medicaid, know that state
    Medicaid Programs are relying on their price reports to estimate the
    drug's cost for reimbursement purposes. For a significant portion of
    the dollars expended by the states' Medicaid Programs, reimbursement is
    based upon reported prices that fairly and reasonably reflect the price
    at which the drug is generally and currently available in the
    marketplace. It is only where the manufacturers choose to falsely
    report their prices that Medicaid pays an inflated amount. This
    inflated ``spread'' is what enables the manufacturers participating in
    this scheme to use the taxpayers' money to arrange financial
    inducements which are then used to persuade customers to purchase their
    drug instead of a competitor's. Moreover, in many cases, the government
    dollars that are diverted in this manner encourage excessive
    utilization of the drug therapy and otherwise have a corruptive
    influence on the healthcare delivery system.
        Testimony and documents secured from employees of pharmaceutical
    companies merely corroborate that the drug manufacturers participating
    in this deceptive practice are fully aware that they are misleading the
    States' Medicaid Programs. We understand that the Committee has also
    been provided with some of this evidence. We hope that it will be
    carefully considered, because it reveals scenarios such as:

    1.) A drug company executive suggesting further inflation of price
            reports, but presented with subordinates' concerns about the
            increased government scrutiny of price reporting practices in
            2000, articulated his conscious decision to risk government
            sanctions in order to maximize sales for as long as he could
            get away with it.
    2.) A drug company executive presented with a competitor, who had
            caused a greater spread on WAC based reimbursement in Florida
            and other states reported admittedly false inflated WAC prices
            to the compendia in an effort to gain greater market share.
    3.) The four most senior executives of a drug company crafted a written
            marketing plan directly based upon creating and marketing
            financial incentives to their customers arising from the
            company's manipulation of Medicare and Medicaid reimbursement
            through false price representations.
    4.) Drug company executives choose to inflate the reported AWPs for
            many of their drugs by several hundred percentage points in
            order to create greater financial incentives for their
            customers and thus avoid price reductions that would otherwise
            occur due to natural market forces.
    5.) Competing drug companies each inflate their price reports for
            generic versions of the same drug and thus cause the FULs set
            by CMS to be themselves inflated because they are based upon
            150% of the lowest publicly available price.
    6.) After a branded drug comes off patent, competing drug companies
            each continually decrease their true price due to competition
            while continually increasing the spread through their inflated
            reported price reports, while utilization of the drug increases
            exponentially.
    7.) Drug company executives testify that they never change the AWP for
            a drug once it is established. The evidence shows that they
            routinely increase AWPs to gain or retain market share.
    8.) Some, but not all, manufacturers fail to report declining AWPs even
            though they know the market price of the drug, to all
            customers, is falling precipitously in the competitive
            marketplace and that their deceptive price reports will deprive
            the Medicaid Program of the benefits of declining prices.
        It is my hope that my testimony, as well as the information
    gathered through this Committee's investigation, will illuminate
    certain factors which I believe are critical to an understanding the
    Medicaid reimbursement problem. They are:

    a.) Drug manufacturers choose to have their drugs covered by Medicaid.
            They are not required to so.
    b.) Drug manufacturers know that Medicaid Programs must estimate the
            acquisition costs of drugs in setting reimbursement. Millions
            upon millions of claims are paid by Medicaid programs each year
            and scarce dollars cannot, and should not, be taken away from
            benefits in order to investigate and determine the individual
            cost of each prescription.
    c.) Drug manufacturers know that the State Medicaid Programs rely on
            the prices the manufacture reports directly or through the
            price reporting compendia.
    d.) As with any system of government reimbursement, pharmaceutical
            reimbursement is based upon trust, in this case trust that drug
            companies will report their prices in good faith.
    e.) The root of the problem of excessive Medicaid reimbursement for
            pharmaceuticals lies with those drug manufacturers who choose
            to deceive rather than tell the truth about their prices.
    f.) Dissembling excuses, such as protestations that a company will lose
            market share if it reports prices truthfully, should not be
            accepted from pharmaceutical manufacturers. Other industries,
            such as banking, communications, electrical power, and defense
            manufacturers have all been faced with similar integrity
            issues.
    g.) Congress addressed the evil of drug manufacturers' false price
            representations in the Medicare Modernization Act by requiring
            manufacturers to report the Average Selling Price for their
            drugs. These prices are in turn published by CMS.
            Unfortunately, similar tools have not been provided to the
            Medicaid Program as evidenced by a comparison of Medicaid FULs
            with Medicare ASPs for certain drugs, such as Ipratopium
            Bromide which are reimbursed by both programs. The drug's
            Medicaid FUL, which is still based on inflated price reports by
            manufacturers, is several times greater than the ASPs now
            reported to Medicare.
    h.) Any legislation directed at improving the Medicaid reimbursement
            system, should not inadvertently create a potential defense
            through which manufacturers may argue that Congress has somehow
            absolved them from their past defalcations. Judge Stearns'
            decision quoted above illustrates that the manufacturers who
            have participated in this scheme seek to misconstrue the intent
            of Congress as somehow approving their deceptive conduct.
    i.) Insuring now that drug manufacturers, that have reported inflated
            prices in the past, face the full consequences of their actions
            under the law, will provide the best assurance that drug
            manufacturers will not misrepresent ASP or other price
            information vital to reimbursement decisions in the future.
        In closing, I would ask that this Committee consider the insidious
    damage that such deceptive practices have on our free market system.
    The contention by drug manufacturers, that deception is somehow
    justified when it becomes widespread in their industry, reveals a
    serious and fundamental integrity flaw that, if left unaddressed,
    threatens the taxpayer, the consumer and the industry itself. The noble
    effort to generate profits must never be permitted to subjugate the
    higher duty to tell the truth.
        Mr. Chairman and Members, thank you for the chance to appear before
    your Committee. I am happy to answer any questions that you may have.

        Chairman Barton. Dr. Lockwood, you don't have a statement
    that you----
        Mr. Lockwood. No, I don't.
        Chairman Barton. Okay. The Chair would recognize himself
    for 10 minutes.
        Dr. Lockwood or Mr. Jones, explain in layman's terms what
    average wholesale price should be. What should it mean?
        Mr. Lockwood. Average wholesale price has been a benchmark
    for the industry for over 30 years, and for brand drugs AWP is
    a fairly reliable benchmark. About 80 percent--at least based
    on our studies and government studies and talking to Medicaid
    program directors, about 80 percent of the Medicaid dollars are
    paid on brand drugs and are fairly accurately reimbursed.
        Chairman Barton. But I want to--I don't want to know what
    the tradition is. I want, in layman's terms, average
    wholesale--I am trying to think, if I go out and I grow cotton,
    I know what it costs me for the seed. I know what it costs me
    for the tractor. I know what it costs me to own the land, if I
    am paying on it, or to rent the land if I don't own it.
        And when I--when that cotton crop is ready to go to market,
    I have got a pretty good idea what my costs are. And I add some
    profit margin, which is a little bit based on the market and
    demand and supply, and that is my average wholesale price, I
    think.
        So, in drugs, all of these different manufacturers who tend
    to be running around like we didn't know what average wholesale
    price is, it is some number that we can stick out there, and
    the higher the better, because it increases the spread that we
    can then discount to encourage the pharmacies to use our drug,
    because they get a bigger markup on it.
        What should it be? I mean, how--if we wanted to set some
    sort of a Federal standard in law for average wholesale price,
    what should it be? That is my question.
        Mr. Lockwood. We believe that average wholesale price
    should be a number that is reflective of the underlying
    marketplace that the drug manufacturer sees when they look at
    their own books.
        Chairman Barton. It is----
        Mr. Lockwood. Some people interpret it--because AWP is not
    defined--but they have sometimes interpreted average to mean
    usual, meaning the average or usual wholesale price.
        Traditionally, it has been 20 percent higher than the
    invoice price that the wholesaler gets. So that when a drug
    manufacturer sells to a wholesaler, there is an invoice price.
        Chairman Barton. It is not a cost-based price? It is not
    based on the cost of the manufacturer of the drug to actually
    produce and market that drug? It is not a cost-based price? It
    is a market-based demand price?
        Mr. Lockwood. It is a marked-based price. In this country,
    we have never instituted price controls. And my partner and I
    are certainly capitalists, and we don't believe in price
    controls. We believe drug companies should be able to set their
    own prices. But we think those prices should be reflective of
    their underlying marketplace.
        We don't want to get into the business of manufacturers. If
    they can produce something for $1 and sell it in the market for
    $10, that is their business. But they shouldn't report to the
    government that when they are selling--actually selling it for
    $10 that they are selling it for $100. And that is what is
    happening with AWP, is that they are saying that this drug
    costs a hundred dollars, while everyone in the market is buying
    it for $10.
        Chairman Barton. So we ought to do away--I mean, if it is
    okay for the manufacturers to set the price wherever they want,
    what we should do from the Federal Government perspective is
    whatever you actually sell it for is what you report it for?
    You sell it for $1,000, you report it. If you sell it for 10
    cents, you report it. But don't say I am going to sell it for
    $1,000, and I am really selling it for $10.
        Mr. Lockwood. Correct. We believe in capitalism. We think
    that drug companies should be able to set their prices. They
    just need to report them in an accurate, fair and responsible
    way, much like the OIG has recommended in their compliance
    guidelines.
        Chairman Barton. Are the people that are setting this
    average wholesale price, is that the manufacturer or is that a
    middleman that sets that price?
        Mr. Lockwood. Well, there has been argument about that. But
    I don't think anyone argues that compendia certainly use prices
    they get directly from manufacturers to calculate AWP.
        In some circumstances, manufacturers send the AWP directly
    to the compendia and tell them that is their price. In other
    circumstances, they send a price that they know the compendia
    are going to mark up 20 percent, for instance, which has been a
    common industry amount. So they know that when they send a
    price of $100 that the compendia are going to make an AWP of
    $120. There is no confusion there.
        What is more, our investigations have shown that all of the
    compendia send a report to the drug manufacturers every year
    and ask them to verify that the prices they are reporting are,
    in fact, correct, accurate, appropriate, and if they are not
    right, they need to be changed.
        Chairman Barton. Well, if we have some manufacturers
    testify later and I ask them what is wrong with reporting what
    you really--what your true selling price is, what is wrong with
    that? What is it that is so scary or so negative toward their
    continued existence as a for-profit entity that they can't
    report what the real selling price is?
        Mr. Lockwood. Transparency seems to scare them
    dramatically. Exactly why, you may need to ask them. I can
    speculate, but----
        Chairman Barton. Well, speculate.
        Mr. Lockwood. We believe that the real market prices may
    actually become lower as a result of transparency. My point
    being that if you have a drug that you are selling at a high
    AWP, you may actually be able to sell that drug for more money
    than your competitor because you have a better spread.
        Look, I don't want to confuse you, but if you are selling a
    drug for $10 and your spread, your AWP is $100, you might be
    able to get $10; whereas another company might be selling the
    drug for $5, but because their AWP is $50, nobody is buying
    their drug, so that high AWPs help drag up, in some
    circumstances, the transaction prices.
        Chairman Barton. But if we switch to a system where they
    actually report real selling price and document and verify it,
    not price controls, but some sort of--like we have in the
    natural gas market or the oil market or any other market where
    there is buy and sell and some sort of a commodity function,
    over time, everybody is going to know what the true prices are,
    at least at the selling price, not the proprietary cost, but
    the actual selling price, and the best win. Right?
        Mr. Lockwood. Absolutely. We believe that is fair and
    appropriate. We think they have that obligation now. There is
    some disagreement on that. But we believe that the government
    should be benefiting from transparency in price transactions.
    That will lead to a true marketplace. Currently, Medicaid,
    Medicare--until your recent bill--and consumers are price-
    shielded from true competition that's occurring in the
    marketplace. We are seeing these AWPs but not seeing the real
    marketplace.
        Chairman Barton. But if we did that, if we went to a
    requirement for true price reporting, gave some flexibility on
    the dispensing fee for pharmacies so that, if their cost of
    dispensing the prescription for Medicaid is truly high or
    something, they get reimbursed for that; implement that, have a
    transition period, a year, 2 years, to go from the old system
    to the new system, is there any reason that that wouldn't work
    and result in significant savings to both State and Federal
    coffers for Medicaid and to the consumers from the copayment
    side if they have a Medicaid co-payment?
        Mr. Lockwood. We believe it would work, and we believe it's
    ideal. It preserves capitalism in the marketplace, and it
    fosters competition, and it's what should be happening in this
    market.
        Chairman Barton. Is there anything I haven't asked you that
    I should in the next 10 seconds before my time expires?
        Mr. Lockwood. We need more than 10 seconds probably.
        Chairman Barton. Okay. My time has expired.
        I recognize the gentleman from Massachusetts, Mr. Markey,
    for 10 minutes.
        Mr. Markey. Thank you, Mr. Chairman, very much.
        So what you have got here is a situation where a drug
    company makes a drug, they are selling 100 pills for $100
    wholesale to a company, and so it looks like the price is $100
    for 100 pills. But, actually, there's a 10 percent discount to
    the wholesaler, so it's really only $90 for 100 pills to the
    wholesaler, and then the wholesaler can further try to make a
    profit as a wholesaler on their sale down the chain.
        Meanwhile, the report to Medicaid is that it actually costs
    $125 for the 100 pills, which is then the price which the
    Federal Government and the taxpayer has to pay, although we
    know that the actual price is $90 for 100 pills, because that
    is the real world. The made-up number, the average wholesale
    price, is the price that we have to pay, Americans have to pay
    for these pills.
        Now, how do they make up this average wholesale price,
    which is perhaps 35 percent higher than the actual cost to an
    actual wholesaler to purchase these drugs? How do they make up
    that number?
        Mr. Jones. I think more importantly than how they make it
    up is what they are doing with it. Basically, in the generic
    marketplace right now, manufacturers are--they are always in
    control of their prices. They own every price that is ever
    published; it's theirs. They are taking those published prices,
    using the difference between what they are selling them for and
    what the end buyer that is going to build a program gets
    reimbursed for as their marketing tool to sell their drugs. So
    that is called the spread. A manufacturer reports price; $125
    is the AWP. Medicaid uses that $125 to reimburse whomever is
    billing it, yet they sell it for $90. Well, the difference
    between $90 and $125 is the spread. That is the financial
    incentive that these companies use to sell their drugs, because
    you are talking about a generic market. You are talking about a
    marketplace in general where this is 7 or 8 different
    manufacturers of the same drug.
        Mr. Markey. Okay. Well, we held our first hearing on
    average wholesale price in 2001. The drug companies have paid
    over $2 billion in fines, penalties, reimbursements to the
    Federal and State governments. Now, that's a lot of money. But
    has anything really changed in the marketing of prescription
    drugs to the retailer since 2001?
        Mr. Jones. Well, I think, for those manufacturers that have
    participated in paying that money, it has changed.
        Mr. Markey. Okay. How about for the marketplace in general?
        Mr. Jones. I think the marketplace obviously has an
    awareness of what they are doing. I mean, maybe a little
    anecdotal evidence here: Over the time period that we have been
    investigating this, we have heard drug manufacturers first
    claim that they didn't know where AWP came from; it wasn't
    their number. And then that evolved into, yes, we set the AWPs.
    And then we heard drug manufacturers say, we don't know
    anything about marketing the spread. We are not interested in
    marketing the spread; we are only interested in the price that
    we charge our customer. But we finally evolved into, yes, there
    is a spread out there, and, yes, we do market it. And, now, we
    are at the point with this industry where they are saying,
    look, it is so messed up, everybody wants to buy drugs based
    solely on the spread value, and we can't stop it even if we
    want to.
        Mr. Markey. So has the spread between the average wholesale
    price paid by the retailers been reduced, or is the average
    wholesale price as false as it always was?
        Mr. Jones. Well, obviously, depending on the drugs, because
    different drugs have different methods of being--you know,
    pricing. But I think----
        Mr. Markey. Which drugs still have a false price?
        Mr. Jones. The generic industry drugs. Basically, your
    generic drugs. That's how they are marketing them in this
    country right now.
        Mr. Markey. So the industry argues that they still need a
    very high average wholesale price whether it is openly marketed
    or not. Is that correct?
        Mr. Jones. Yes.
        Mr. Markey. That's their argument. Now, is it a justified
    argument?
        Mr. Jones. Absolutely not.
        Mr. Markey. Why not?
        Mr. Jones. Because they are using precious government funds
    as the incentive for selling their drugs, to market their drugs
    with.
        Mr. Markey. So one of the witnesses on the third panel will
    testify that the real acquisition costs for wholesalers is the
    reported wholesale acquisition cost plus 5 percent. Is that a
    good base price to use for reimbursements?
        Mr. Lockwood. Well, for some brand drugs, that is an
    accurate number. But for a whole host of other drugs, the
    wholesale acquisition cost has been altered over time and is no
    longer an accurate number. We discovered that in Texas
    certainly. Texas has paid off of a price to the wholesaler, and
    we have found essentially that there is fraud in the WAC
    marketplace as well.
        Mr. Markey. So what is your view of the Federal upper
    limits set on drugs by CMS, by the Federal Government? Do they
    reflect the real cost of the drug?
        Mr. Lockwood. The Federal upper limit has been an attempt
    by the government to ensure prudent purchasing in generic
    drugs, and they essentially are saying, this is a ceiling
    price, we are not going to pay anything more than this. The
    problem with the FUL is that it is based on reported prices and
    that, if a manufacturer or a whole host of manufactures are
    reporting inflated prices, whether it be WAC, direct price or
    average wholesale price, if those are inflated, the resulting
    FUL is inflated.
        Mr. Markey. FUL means?
        Mr. Lockwood. Federal upper limit. It's an upper limit
    price that CMS creates to limit reimbursement on generics. So
    that the lowest generic price reported, if it's $100, the FUL
    basically says, we are not going to ever pay more than $150.
        Mr. Markey. Well, a markup of a spread of 25 to 35 percent
    seems incredibly high and unreasonable to me for a markup in a
    commodity marketplace. Don't you agree?
        Mr. Lockwood. We agree with that. We are proponents of
    average sales price.
        Mr. Markey. So if every wholesaler is able to reap a 25 to
    35 percent spread, doesn't that suggest that there isn't real
    price competition in the prescription drug market?
        Mr. Lockwood. Well, in fact, wholesalers don't receive
    those kind of benefits. Generally speaking, wholesalers are
    probably making 1 or 2 or 3 percent.
        Mr. Markey. How about the pharmacies? The pharmacists are
    then taking advantage of their spreads. And, you know, we are
    not against paying pharmacists appropriately and fairly. Do the
    pharmacies deserve to get a 25 to 35 percent markup in the
    price of drugs to grandma who is standing there in front of the
    counter? Do they deserve that kind of markup?
        Mr. Jones. Medicaid is trying to estimate acquisition cost;
    30 percent markups over acquisition costs are not realistic in
    the Medicaid program.
        Mr. Markey. So what is the fix then? How do you make sure
    that grandma isn't digging through her pocketbook standing
    there to pay a 25 to 35 percent markup for a drug that we all
    know is nowhere near that cost in terms of its manufacture and
    delivery right to that counter? Why should she, knowing she
    should have to take that pill in a half an hour, have to pay
    that money? And how do we fix that problem at that counter?
        Mr. Lockwood. In fact, your 25 and 30 percent is very low.
    If we could bring up slide number 6, perhaps, this will give
    you an idea. And it is in your binder under number 4. If you
    will look at it, you can see that there are huge, huge spreads
    involved in some of these common generic drugs. In the case of
    Fluoxetine, we are talking about an AWP of $259.85, and the
    current cost last week is $4.25 for that bottle, for the whole
    thing. And even the FUL isn't capturing this.
        Mr. Markey. So we have got a situation here where the
    pharmacist is saying that, for grandma, she has to pay--that
    is, the Federal Government or the States have to pay--25 to 35
    percent more for the drugs. But the States could be using that
    money to lower the cost for grandma to be in a nursing home, to
    lower the cost for more children to be covered by a medical
    program that would increase the health of the children in that
    State. And yet the pharmacy is saying, we won't give this drug
    to grandma unless you give us this 25 to 35 percent markup.
        So what we need from you in 30 seconds is, how do you fix
    that? What do you recommend to fix that at that counter to make
    sure that the drugs are what--are a price that they should be,
    so that all the rest of the money could then be used to help
    grandma and the children in that community to have a higher
    level of health care?
        Chairman Barton. And the gentleman's time has expired. We
    will let the witnesses answer the question, and then we are
    going to have to go to Mr. Walden.
        Mr. Lockwood. I think we like average sales price. The GAO
    study that just came out I think 6 days ago, I think, has
    verified that average sales price is an effective way of
    estimating drug costs. And then, by all means, taking care of
    the pharmacies, paying them a reasonable dispensing fee for
    their services. They have to make a profit. They have to stay
    in business. They have to help distribute our drugs.
        Mr. Markey. In other words, use the Medicare system to
    determine the price, rather than this system that Medicaid is
    now using, because the Medicaid system allows for the taxpayer
    and grandma to get ripped off in terms of the benefits they
    receive. Is that correct?
        Mr. Lockwood. We like the ASP system.
        Mr. Markey. You like the Medicare system better than the
    Medicaid system.
        Mr. Lockwood. The new Medicare system, yes, sir. Yes, sir.
        Mr. Markey. Thank you.
        Chairman Barton. I would like to point out before we
    recognize Mr. Walden that we have changed in Medicare to the
    average sales price in this MMA, the Medicare Modernization
    Act. CBO says that should save about $15 billion over the next,
    I think, 10 years. So I am not saying we have got it right in
    Medicare, but we are moving in the right direction. And the
    purpose of this hearing is to see if we can't do a similar
    thing in Medicaid. And we obviously see that there are lots of
    areas we can improve in.
        With that, we would recognize Mr. Walden for 10 minutes.
        Mr. Walden. Thank you, Mr. Chairman. And before I start
    asking questions, I would just like to move that the documents
    that are contained in the exhibit binder be made a part of the
    official record.
        Chairman Barton. Without objection, so ordered.
        Mr. Walden. Thank you, Mr. Chairman.
        You know, gentlemen, it seems to me like this is the
    proverbial $500 toilet seat of Medicaid, the AWP is. And I am
    wondering what the FUL is, because if you look at your chart
    there, the Federal upper limit doesn't seem to be a standard
    that works either, compared to the price that is being paid. Is
    that correct?
        Mr. Jones. Unfortunately, it's a price that is determined
    off of the manufacturer's reported prices. So it is as
    vulnerable to price manipulation as any other.
        Mr. Lockwood. Could we bring up slide 8?
        Mr. Walden. I was just going to go to slide 8. Indeed.
    There you are. All right. Go ahead.
        Mr. Lockwood. This slide is based on current prices, and
    the ASP plus 6 from the second quarter of 2004. So I don't--we
    are mixing apples and oranges a little bit here. The current
    cost price is listed in the column that is highlighted.
        Mr. Walden. Okay. So let us take Ipatropium; $3.50 is the
    current price?
        Mr. Lockwood. Yes, sir.
        Mr. Walden. As of when?
        Mr. Lockwood. About 3 days ago.
        Mr. Walden. And the Federal upper limit is as of a year
    ago?
        Mr. Lockwood. Yes.
        Mr. Walden. And why is that price from November 2, 2003?
        Mr. Lockwood. Well, that was the date the FUL was changed.
        Mr. Walden. And isn't that another issue that we face, is
    updating the FUL list?
        Mr. Lockwood. Yes, we do. But I don't know if the reported
    prices have changed or not. In fact, they may not have changed
    in the past year. If the manufacturers are continuing to report
    the same prices they did at that time, the FUL won't change.
        Mr. Walden. Well, I think there is also an issue in the
    IG's report about how often these prices get adjusted, once it
    is determined there are generics on the market, that there is a
    continuing problem there that may date back a decade it seems
    like or at least a half a decade if not more. Well, how current
    is the AWP? Is that the same issue?
        Mr. Lockwood. The AWPs are current now.
        Mr. Walden. So the $44.10 AWP for Ipatropium is a current
    price?
        Mr. Lockwood. Yes, sir.
        Mr. Walden. So you are looking at more than 10 times the
    price. The spread is more than 10 times the actual price.
        Mr. Lockwood. Yes, sir.
        Mr. Walden. And who is pocketing that difference?
        Mr. Lockwood. In general, the pharmacies, the providers.
        Mr. Jones. And manufacturers are also benefiting by market
    share.
        Mr. Walden. Getting market share. So there is a marketplace
    working here. Isn't there?
        Mr. Lockwood. Absolutely.
        Mr. Walden. It's just not to the benefit of the person
    paying the bill. And generally, in America, marketplaces we
    like are the ones that benefit the buyer. Isn't that how you
    foster competition?
        Mr. Jones. The consumer is not benefiting here.
        Mr. Walden. The consumers are losing. The States are
    losing. The Federal Government is losing, and the people in
    between are making at least what would appear to be a tidy
    profit.
        Now, we also have to recognize that this AWP isn't
    necessarily the price being paid. Right?
        Mr. Lockwood. That's correct.
        Mr. Walden. Because they will discount off of that.
        Mr. Lockwood. And it would default to the FUL for most
    State Medicaid programs.
        Mr. Walden. And are these FUL current cost AWP prices, are
    they fairly representative of all the drugs, or are these the
    worst-case examples?
        Mr. Lockwood. These are not the worst cases. In fact, I
    have--I've included a couple of charts over a wide range of
    drugs.
        Mr. Walden. Do you want to reference those?
        Mr. Lockwood. It's in your binder under number 4. And these
    represent drugs that are antidepressants, inhalant drugs,
    antibiotics, cancer drugs, such as tamoxifen used in breast
    cancer, and high blood pressure drugs. So this is over
    virtually the entire drug marketplace; it's not just one little
    niche where this is occurring.
        Mr. Walden. Now, you are seeing some--I will probably not
    pronounce this correctly, but Ranididine.
        Mr. Lockwood. Ranididine.
        Mr. Walden. I got that wrong.
        Mr. Lockwood. It's a drug used to control stomach acid that
    is now actually over-the-counter.
        Mr. Walden. And we're paying $44.90; well, the current cost
    is $44.92 over-the-counter?
        Mr. Lockwood. That's for a bottle of 1,000 pills, the
    current cost is $44.92.
        Mr. Walden. And the AWP is $1,480?
        Mr. Lockwood. Yes, sir.
        Mr. Walden. And that is a current AWP?
        Mr. Lockwood. Yes, sir.
        Mr. Walden. All right. Have you done any analysis of how
    good a job these Federal upper limits do in capturing cost
    savings?
        Mr. Lockwood. Well, they certainly reduce, as you can see
    in that drug. If the government is paying $341 instead of
    $1,480, that's a significant cost savings. But when you compare
    the FUL, if you look at the FUL spread on that column, you can
    still see that there is a huge, huge profit involved there. And
    it is because the FUL is based on reported prices that
    manufacturers do what--seem to do what they want with.
        Mr. Walden. What I have struggled with is why this isn't
    considered some sort of fraudulent billing practice.
        Mr. Lockwood. I believe we consider it fraud.
        Mr. Walden. Why?
        Mr. Lockwood. Because of--actually, the OIG probably did a
    much better job of explaining it than I could. I am not an
    attorney. But the OIG really set down the guidance to
    manufacturers in 2003, and they point out that these type
    behaviors may be actionable under the False Claims Act and
    under the Anti-kickback Statute. And I am no attorney, but I am
    relying on them.
        Mr. Walden. Can you--well, several drug manufacturers have
    asserted in their written statements that the current Medicaid
    reimbursement system effectively puts them between a rock and a
    hard place. They can't lower their AWP to make it more
    reflective of actual market prices without losing all of their
    business. How do you respond to that argument? And I have got
    some e-mail traffic from one agency that indicates very clearly
    there is enormous market pressure to raise the AWP or you lose
    market share.
        Mr. Jones. Certainly they use the reported prices to gain
    market share in the generic marketplace. Off the top of my
    head, when I think about that statement, they corrupted the
    system. They are the ones that are responsible for reporting
    the prices. Those prices come from them, and the selling prices
    come from them. So, now, they find themselves in that untenable
    position of not being able to adjust or correct a system that
    they have already corrupted.
        Mr. Lockwood. They can't stop the fraud.
        Mr. Jones. They did too good of a job educating the
    consumers who are going to build the programs, the pharmacists
    or the doctors or whomever is receiving the benefit of selling
    that drug. They have educated them so well, they have----
        Mr. Walden. They are marketing the spread.
        Mr. Jones. Absolutely.
        Mr. Walden. And the idea is that the bigger spread, the
    more the take.
        Mr. Jones. The higher the utilization in certain
    circumstances.
        Mr. Lockwood. Manufacturers will tell you they can't quit
    doing this unless everyone stops at once.
        Mr. Walden. Which is why it is up to us to make that
    change. Isn't it?
        Mr. Lockwood. Because if there is a half a dozen companies
    in the market and one of them stops----
        Mr. Walden. They are out of business.
        Mr. Lockwood. They are out of business. Now, Abbott
    Laboratories did some significant price changes in 2001 that
    significantly lowered their prices in the marketplace, and I
    think they should be commended for it.
        Mr. Walden. And what was the impact of that? How are they
    doing?
        Mr. Lockwood. Well, they lowered AWPs on a whole host of
    drugs enormously. Now, I don't have that information in front
    of me, but they made a substantial change in their price
    reporting on a whole host of drugs.
        Mr. Walden. Can you turn to tab 5 in your binder there,
    please, sir, in the final minute and a half I have here. This
    exhibit is information on pricing from a company called
    Innovatix--is that right? Innovatix, your home infusion
    specialists. And I am intrigued, because this would seem to be
    a document available--how? Through prescription service or
    something?
        Mr. Lockwood. To members, it's available over the Internet.
        Mr. Walden. Members of?
        Mr. Lockwood. Innovatix.
        Mr. Walden. Okay. And it lists the AWP spread, the AWP.
    It's pretty hard to read on this graph. And then the contract
    price, right?
        Mr. Lockwood. Yes, sir.
        Mr. Walden. Doesn't this give us the data where we could
    make more informed decisions about actual costs of drugs being
    sold out on the market?
        Mr. Jones. These reflect prices in the marketplace.
        Mr. Walden. And isn't that what Medicaid and Medicare and
    other consumers should be paying based on that?
        Mr. Jones. Absolutely.
        Mr. Lockwood. We believe that.
        Mr. Walden. Now, there are some who would make an argument
    that, if you just add a percentage to this price, say contract
    price plus 6 percent for overhead, you are going to distort the
    market as well and just continue to try and drive up price to
    get the higher percentage. How do we wrestle with that?
        Mr. Lockwood. Those are difficult issues. It's hard unless
    you have a prospective payment program like Medicare has for
    hospitals to control every cost. I think our effort has been to
    try to get to real market prices and then deal with that.
        Mr. Walden. Because what we don't want to do here is create
    another AWP, another system that functions in an inverted way,
    if you will. So, appreciate your testimony today. Thank you,
    Mr. Chairman.
        Chairman Barton. Before we go to the next panel, the key
    though is the government reimbursement rate has got to be based
    on an actual price that somebody pays, not on some artificial
    posted price.
        Mr. Lockwood. Yes, sir.
        Chairman Barton. We have got to change like we have in
    Medicare from some sort of a, I won't say a made-up price, but
    a--just a sticker price to what somebody who is actually going
    to use the drug is paying.
        Mr. Jones. Something that has a basis in reality in the
    marketplace.
        Chairman Barton. And that has to be transparent. It has got
    to be verifiable, and there has to be some ability for willing
    buyers and willing sellers to have some degree of certainty
    that that is a real price that is available to anybody that
    meets the terms and conditions of quantity and deliverability
    and things like that.
        We want to thank you for your testimony. There may be some
    written questions for the record, and we would ask that you
    reply as quickly as possible because we are going to attempt to
    legislate in this area in the next Congress.
        Mr. Walden. Trust but verify, Mr. Chairman.
        Chairman Barton. Trust but verify. I have heard that
    somewhere. But thank you, gentlemen. You are excused.
        We would now like to have our second panel come forward. We
    have Mr. George Reeb, who is the assistant inspector general,
    Centers for Medicare & Medicaid Audits. He is accompanied by
    Mr. Robert Vito, regional inspector general for evaluations and
    inspections, from the Philadelphia region.
        We also have Mr. Dennis Smith, who is the director of the
    Center for Medicaid & State Operations, Center for Medicare and
    Medicaid Services here in Washington.
        We have Mr. Patrick O'Connell, who is the assistant
    attorney general for civil Medicaid fraud in the Texas Attorney
    General's Office in Austin, Texas.
        Mr. David Balland, who is the associate commissioner for
    Medicaid and CHIP, the Texas Health and Human Services
    Commission in Austin.
        And Mr. Paul Reinhart, who is the Medicaid director for the
    State of Michigan in Lansing, Michigan.
        Welcome, gentlemen. It is the tradition of this
    subcommittee to take all testimony under oath. Do any of you
    object to testifying under oath?
        You also have the right to be advised by counsel during
    your testimony. Do any of you have counsel with you that you
    wish to also swear in?
        Will you all please rise and raise your right hand.
        [Witnesses sworn.]
        Chairman Barton. Your testimony is in the record in its
    entirety. We are going to start with you, Mr. Reinhart, and we
    are just going to go right down the row and give each of you
    gentlemen that wish to elaborate on your testimony 7 minutes to
    do so. So welcome to the subcommittee, Mr. Reinhart.

    TESTIMONY OF PAUL REINHART, MICHIGAN MEDICAID DIRECTOR; DENNIS
      SMITH, DIRECTOR, CENTER FOR MEDICAID AND STATE OPERATIONS,
      CENTERS FOR MEDICARE AND MEDICAID SERVICES; GEORGE M. REEB,
    ASSISTANT INSPECTOR GENERAL, CENTERS FOR MEDICARE AND MEDICAID
    AUDITS, ACCOMPANIED BY ROBERT VITO, REGIONAL INSPECTOR GENERAL
    FOR EVALUATION AND INSPECTIONS, PHILADELPHIA; DAVID J. BALLAND,
    ASSOCIATE COMMISSIONER FOR MEDICAID AND CHIP, TEXAS HEALTH AND
      HUMAN SERVICES COMMISSION; AND PATRICK J. O'CONNELL, TEXAS
                       ATTORNEY GENERAL'S OFFICE

        Mr. Reinhart. Thank you. Good morning, Mr. Chairman, and
    members of the subcommittee.
        Chairman Barton. Pull that microphone directly toward you,
    sir, please. Thanks.
        Mr. Reinhart. Good morning, Mr. Chairman, and members of
    the subcommittee. Thank you for this opportunity to discuss
    Medicaid prescription drug policies. My name is Paul Reinhart,
    and I am the director of the Michigan Medicaid program.
        While we work very hard to constrain cost increases in all
    areas of the Medicaid program, Michigan's pharmacy cost
    containment efforts have been particularly effective.
    Unfortunately, one aspect of the Medicare Modernization Act
    will increase Medicaid pharmacy costs, at least in the short
    term.
        The Michigan Medicaid program utilizes many strategies to
    hold down the cost of the pharmacy benefit. The three major
    initiatives we have used in Michigan are: Preferred drug lists;
    the multi-State prescription drug purchasing pool; and limiting
    reimbursements to pharmacists to their actual acquisition drug
    costs. These strategies have been quite successful and have
    produced savings not only for Michigan but also for the Federal
    Government. In fiscal year 2003, the first year of our
    preferred drug list program, per script cost increases declined
    to 4 percent from the 11 percent increases that routinely
    occurred in prior years.
        Similarly, in fiscal year 2004, the first year of our
    multi-State purchasing initiative, per beneficiary costs for
    prescription drugs actually declined by about 1 percent. We
    believe our aggressive cost containment programs saved us $130
    million in fiscal year 2004.
        The Michigan Medicaid program, like a growing number of
    States, uses a preferred drug list or PDL to discourage
    physicians from prescribing high-cost drugs when lower-cost but
    equally effective drugs are available. Here is how the PDL
    works.
        A committee of physicians and pharmacists and Medicaid
    staff use evidence-based information and cost to decide which
    drugs will be included on the preferred list. Drugs not on the
    list are available, but the prescribing physician must secure
    prior authorization from our pharmacy benefit manager. This
    program has substantially increased the use of low-cost generic
    drugs.
        The ability of the preferred drug list to generate savings
    is greatly enhanced by our multi-State pharmacy purchasing
    program. When Governor Granholm began her term in January 2003,
    she directed the Medicaid agency to develop a multi-State
    pharmaceutical purchasing program. She believed that
    manufacturers would be willing to give State Medicaid programs
    a better price for their products in exchange for access to a
    larger market. And she was right. In mid 2003, Michigan and
    Vermont began a joint purchasing program for Medicaid
    prescription drugs and asked the Centers for Medicare and
    Medicaid Services for permission to add additional States to
    the program.
        After a series of delays, in April 2004, CMS finally
    authorized Michigan, Vermont, Nevada, Alaska and New Hampshire
    to create an even larger pool and jointly negotiate better
    prices from pharmaceutical manufacturers. This larger pool will
    save Michigan an additional $13 million this year. CMS has also
    recently authorized Minnesota and Hawaii to join the pool,
    which should increase savings even more.
        We have also generated substantial savings in Michigan by
    limiting Medicaid payments to pharmacists to their actual
    acquisition costs. We do this by significantly discounting
    payments for brand-name drugs and through daily adjustments of
    our payments for generic drugs to the best price available that
    day from pharmaceutical distributors.
        Finally, while the Medicare Modernization Act certainly has
    many positive aspects, one component of that act is likely to
    increase costs for States that have effectively managed the
    drug benefit for dual eligibles. Michigan has been able to hold
    down the rate of growth in pharmacy spending to well below 5
    percent, but the MMA's mandatory State contribution will be
    determined using much higher inflation factors. Even after
    adjusting for the declining contribution percentage, we
    estimate that the clawback will increase Michigan's costs by
    about $20 million in fiscal year 2006 and $30 million in fiscal
    year 2007.
        Conclusion: I hope my remarks today demonstrate that, at
    least in Michigan, we are not paying too much for the
    pharmaceutical products used by Medicare beneficiaries.
        [The prepared statement of Paul Reinhart follows:]

    Prepared Statement of Paul Reinhart, Representing the State of Michigan

        Good morning Mr. Chairman and distinguished members of the
    Subcommittee. I want to thank you for this opportunity to discuss the
    Michigan Medicaid pharmacy program. My name is Paul Reinhart and I am
    the director of the Michigan Medicaid program. Prior to working in this
    capacity in Governor Granholm's Administration, I served as the
    Director of the Office of Health and Human Services in Governor
    Engler's Department of Management and Budget.
        While we work very hard to constrain cost increases in all areas of
    the Medicaid program, our pharmacy cost containment efforts have been
    particularly effective and I appreciate the opportunity to tell you
    about them. I would also like to discuss the effect the Medicare
    Modernization Act will have on our ability to constrain Medicaid costs.

    Pharmacy Cost Containment Programs
        As you know, each state chooses a reimbursement methodology for its
    Medicaid program. The Michigan Medicaid program utilizes many
    strategies to hold down the costs of the pharmacy benefit, but the
    three major initiatives we have used in Michigan are:

     A preferred drug list;
     The multi-state prescription drug purchasing pool; and
     Limiting reimbursements to pharmacists to their actual drug
            acquisition costs
        These initiatives have been extremely successful in constraining
    our prescription drug costs, producing savings not only for Michigan,
    but also for the federal government..
        In fiscal year 2003, the first year of our preferred drug list
    program, our per-script cost increase declined from 11% to only 4%. In
    fiscal year 2004, the first year of the multi-state purchasing
    initiative, per-beneficiary costs for prescription drugs actually
    declined about 1%. We believe our aggressive cost containment programs
    reduced pharmacy spending in fiscal year 2004 from $770 million to $640
    million, a savings of $130 million.
        I have attached some charts at the back of this presentation that
    detail these trends.

    Preferred Drug List
        The Michigan Medicaid program, like a growing list of states, uses
    a preferred drug list (PDL) to discourage physicians from prescribing
    high cost drugs when lower cost, but equally effective, drugs are
    available. Michigan instituted the PDL in the last quarter of fiscal
    year 2002. A ``Pharmacy and Therapeutics Committee'' of physicians and
    pharmacists appointed by the Governor uses evidence-based information
    to decide which drugs will be included on the preferred list. Drugs not
    on the list are, of course available, but the prescribing physician
    must secure prior authorization from our pharmacy benefit manager or
    from one of the physicians employed by the Medicaid agency. This
    program has substantially increased the use of generic drugs. Generic
    drugs now account for well over 50% of the drugs paid for by the
    Michigan Medicaid program.

    Multi-State Prescription Drug Purchasing Pool
        The ability of the preferred drug list to generate savings is
    greatly enhanced by our multi-state pharmaceutical purchasing program.
    When Governor Jennifer Granholm began her term in January of 2003, she
    directed the Michigan Medicaid agency to develop a multi-state
    pharmaceutical purchasing program. She felt that manufacturers would be
    willing to give state Medicaid programs a better price for their
    products in exchange for access to a larger market. And she was right.
        In mid-2003, Michigan and Vermont began a joint purchasing program
    for Medicaid prescription drugs and asked the Centers for Medicare and
    Medicaid Services (CMS) for permission to add additional states to the
    program. After a frustrating series of delays, in April of 2004, CMS
    finally authorized Michigan, Vermont, Nevada, Alaska and New Hampshire
    to create an even larger pool and jointly negotiate better prices from
    pharmaceutical manufacturers. This new larger pool generated price
    discount proposals from over 40 manufacturers (when only two states
    were involved in FY03, 26 pharmaceutical manufacturers submitted
    discounted price proposals). These new prices are estimated to save
    Michigan an additional $13 million per year on prescription drugs. CMS
    has also recently authorized Minnesota and Hawaii to join the pool,
    which should produce further savings when prices are renegotiated with
    pharmaceutical manufacturers next year.
        We strongly encourage CMS to expedite approvals of additional
    states that want to enter the pool. This will allow additional cost
    savings to both state and federal governments.

    Limiting Product Reimbursements to Pharmacists
        In addition to the efforts just discussed, we have generated
    substantial savings in Michigan by limiting product reimbursements paid
    to pharmacists to the pharmacist's actual product acquisition cost.
        We accomplish this in two ways. First, our payment for brand name
    drugs is set at the AWP, or ``average wholesale price'' less 13.5%-
    15.5% depending on the size of the pharmacy. Any pharmacist who is
    willing to accept this level of reimbursement is able to participate in
    the Medicaid program. This practice has been in place since fiscal year
    2000.
        Second, we use a contractor to adjust payments for generic drugs on
    a daily basis to the actual acquisition costs for that day. This is a
    practice also known as ``maximum allowable cost, or ``MAC'' pricing.
    Michigan began aggressive daily MAC pricing in October 2004.
        Michigan's successful program was recognized by the 2004 Department
    of Health and Human Services' Office of Inspector General report that
    concluded Michigan had the lowest product reimbursement costs in the
    country.

    Medicare Modernization Act
        I would now like to briefly discuss how the Medicare Modernization
    Act (MMA) will impact state Medicaid programs' ability to constrain
    prescription drug cost increases. Not surprisingly, we had hoped that a
    Medicare pharmacy benefit would relieve states of the responsibility of
    paying for the drugs used by Medicaid-Medicare dual eligibles--or at
    the very least that the benefit would not increase our pharmacy costs
    for these dual eligibles. While the MMA certainly contains many
    positive aspects, we have concluded that it, unfortunately, will
    increase our costs in Michigan.
        The MMA requires states to continue subsidizing the pharmacy
    benefit for dual eligibles. While prescription drug costs for dual
    eligibles will be covered by Medicare Part D, states will be
    responsible for making monthly payments back to the Department of
    Health and Human Services for a large portion of the drug expenditures
    for these individuals. This financing mechanism is also known as the
    ``clawback,'' or what some call a ``reverse block grant.'' States will
    be required to pay the federal government for 90 percent of the state
    portion of dual elgibles' pharmacy costs in 2006, 88.333 percent in
    2007, and this amount continues to gradually decline to 75% in 2014.
    The Department of Health and Human Services (HHS) will determine the
    state payment amount and base part of the formula on double digit
    growth factors (National Health Expenditures and then average per-
    capita expenditures for Part D drugs) which will be considerably higher
    than the low, single digit growth rates we have been able to achieve in
    Michigan for prescription drugs. We estimate that the clawback will
    increase state costs by $20 million in fiscal year 2006 and $30 million
    in fiscal year 2007 (see attached chart). In Michigan, this is quite a
    blow because we have been so effective managing these costs.
        Additionally, since Medicare will manage the pharmacy benefit for
    dual eligibles, the size of our multi-state purchasing pool will be
    significantly reduced, which means our ability to leverage better
    Medicaid pharmaceutical prices from manufacturers will be reduced. The
    other states in our pool will find that their Medicaid savings will be
    greatly affected too.
        I hope my remarks today demonstrate that, at least in Michigan, we
    are not paying too much for the pharmaceutical products used by our
    beneficiaries, but rather, we have been very proactive, aggressive, and
    successful in our cost containment initiatives. Thank you for the
    opportunity to share our experiences. I would be happy to answer any
    questions.

    [GRAPHIC] [TIFF OMITTED] T7275.060

    [GRAPHIC] [TIFF OMITTED] T7275.061

        Mr. Walden [presiding]. Thank you.
        Mr. Smith.

                        TESTIMONY OF DENNIS SMITH

        Mr. Smith. Thank you, Mr. Chairman. I appreciate the
    opportunity to appear before the subcommittee today.
        I will have a full statement for the record. I did also
    want to provide for the subcommittee a broader picture of
    Medicaid drug purchasing as a whole. We are providing to the
    subcommittee a number of charts that show that, indeed, there
    is variation State by State within drug classes, et cetera. We
    hope this information will be helpful to the subcommittee as it
    is looking at the issues of Medicaid prescription drugs.
        There are a number of underlying assumptions that we all
    are faced with in terms of looking at the cost of prescription
    drugs in the Medicaid program.
        First, that the States themselves operate within a Federal
    reimbursement framework. But just as States set reimbursement
    for hospitals, nursing homes, and physicians, they also are the
    ones at the front line to set reimbursement levels for
    prescription drugs. We have a large number of pharmacies that
    participate in the Medicaid program. States are looking at
    guaranteeing access to coverage for low-income individuals,
    many of them with special needs. We have great participation
    rates among the Nation's pharmacies in the Medicaid program. So
    the States and the Federal Government are looking at balancing
    different interests between access for the Medicaid beneficiary
    and being prudent purchasers of the services themselves.
        So, first, we start off with the fact that Medicaid is a
    matching program, a shared cost between the States and the
    Federal Government. And as the first line of that program the
    States, when they have their dollars at risk, indeed have a
    basic incentive to be prudent purchasers for the Medicaid
    program. The framework sort of broadens from there in terms of
    the different options that the Medicaid program has to set
    prices for prescription drugs, including the Federal upper
    limit, which we have focused on a lot here this morning
    already, and that I know is something the subcommittee is very
    much interested in.
        But States also have an option to adopt what is called the
    ``maximum allowable costs'' or a MAC. And a number of States do
    that. Those MACs are generally more stringent than the Federal
    upper limits. So, again, we are looking at a Federal framework
    that says a State cannot pay more than this amount, but the
    States have great flexibility underneath those amounts as I
    mentioned, again, in relationship to other types of payers as
    well.
        The Federal statute that was adopted, I believe was alluded
    to earlier, back in 1990. The statute requires manufacturers
    who want coverage of their products to enter into an agreement
    with CMS to provide rebates for the prescription drugs paid for
    through the rebate plan. So we have a different way of looking
    at getting the best price and the lowest price, and best value
    for the taxpayers for the Medicaid program. The acquisition of
    the drug itself is part of it, but the rebate is another part
    of it as well.
        Obviously, in the Medicaid program, there are a number of
    different types of purchasers and providers involved in the
    decisionmaking itself when you are looking at the overall cost
    of the Medicaid program. Pharmacies, physicians, and the
    consumers themselves all have a role in ultimately determining
    what the price that Medicaid will pay for a prescription.
    Approximately 550 pharmaceutical companies participate in the
    rebate program and in fiscal year 2003, the manufacturers paid
    rebates of about $6.4 billion for outpatient drugs.
        In terms of the focus over the last few years of how CMS is
    helping States to find ways to be more prudent purchasers of
    prescription drugs, our focus has been through the various
    State plan amendments which Mr. Reinhart alluded to. States
    have adopted a variety of different approaches with the help of
    CMS. We have more States than ever before negotiating
    supplemental rebates with the manufacturers. There is the
    national rebate, and States are negotiating further rebates on
    top of that. More States than ever before are doing those
    supplemental rebates. Other tools, such as prior authorization,
    are an important key at the point of access with the physician
    to help educate physicians about being price-sensitive in the
    Medicaid program. A number of States have adopted prior
    authorization in recent years as well. So the focus has been on
    several different areas, not just one particular area, to help
    States negotiate lower prices for the Medicaid program.
        Mr. Reinhart referred to the purchasing pool that had never
    existed before this administration approved it and expanded it
    to help States pool the lives that are involved in order to get
    deeper discounts for the programs. I think that a lot of the
    discussion this morning is about information, and I think we
    are taking further steps, steps that had not been taken ever
    before, about making that information available to the general
    public as a whole.
        With the prescription discount card under Medicare, the
    administration took the unprecedented step of actually putting
    on the Web site price comparisons to give the general public
    access to information. We believe that information is indeed an
    important component. In the marketplace, people having access
    to that information is obviously a very important part of
    making marketplace work successfully.
        I see my time is ready to expire. I appreciate the
    opportunity to appear before this subcommittee and ask that my
    entire statement be included in the record.
        [The prepared statement of Dennis Smith follows:]

     Prepared Statement of Dennis Smith, Director, Center for Medicaid and
          State Operations Centers for Medicare and Medicaid Services

        Mr. Chairman, members of the subcommittee, thank you for your
    invitation to appear this morning to discuss Medicaid prescription drug
    reimbursement. Coverage of outpatient prescription drugs is an optional
    benefit for Medicaid programs. All states currently provide
    prescription drug coverage, which is critically important to Medicaid
    beneficiaries. However, this benefit is one of the greatest costs for
    the states. In fiscal year 2002, Medicaid drug expenditures were $29.3
    billion out of $258.2 billion in total Medicaid spending or 11.3
    percent. In addition, Medicaid drug spending increased at an annual
    average rate of 19 percent from fiscal years 2000 to 2002, while
    Medicaid spending as a whole grew 12 percent annually during that
    period. In 2003, Medicaid spent more than $34 billion on prescription
    drugs (See Chart 1). Of this amount, 23 percent was spent on drugs
    commonly prescribed to treat mental health conditions (See Chart 2).
    Furthermore, spending varies based on the specific medication
    prescribed. For example, under analgesics and anesthetics, the mean
    reimbursement for Celebrex is $112 per prescription, compared to $12
    for ibuprofen (See Chart 3). In addition, the 29 most commonly
    prescribed drugs account for 25% of Medicaid spending on prescription
    drugs (Chart 4). Spending on prescription drugs claims varies by state.
    The average claim ranges from approximately $40 to more than $60 (See
    Chart 5). Therefore, it is important that both the Federal government
    and the states ensure that Medicaid programs pay for prescription drugs
    appropriately.

    States Determine Payment to Providers
        Medicaid operates as a provider payment program. States may pay
    health care providers directly on a fee-for-service basis, or states
    may pay for Medicaid services through various prepayment arrangements,
    including payments to managed care plans. Within Federally imposed
    upper limits and specific restrictions, each State has broad discretion
    in determining the payment methodology and payment rate for
    prescription drugs, and what to pay pharmacists in dispensing fees.
    Generally, payment rates must be sufficient to enlist enough providers
    to ensure covered services are available at least to the extent that
    comparable care and services are available to the general population
    within a geographic area. Providers participating in Medicaid must
    accept Medicaid payment rates as payment in full. It also is important
    to note that prices have increased between 5 percent and 7 percent in
    recent years. An increase in utilization, as well as an increase in the
    Medicaid population has helped to increase the mean reimbursement per
    prescription (See Chart 6).

    CMS Involvement with Medicaid Drug Pricing
        While the States are largely responsible for managing their
    prescription drug benefit, Federal law authorizes CMS to ensure the
    Federal government receives a good price for prescription drugs. For
    example, the Medicaid Drug Rebate Program affords Medicaid programs the
    opportunity to pay for drugs at discounted prices, which are similar to
    those offered by pharmaceutical manufacturers to other large
    purchasers. In addition, Medicaid programs have a number of options to
    set prices for prescription drugs, including the Federal Upper Limit
    (FUL), maximum allowable cost (MAC), and wholesale acquisition cost
    (WAC) programs.

    Medicaid Drug Rebate Program Controls Costs
        Federal statute requires manufacturers to enter into an agreement
    with the Secretary of Health and Human Services, on behalf of the
    states, to provide rebates for covered outpatient prescription drug
    products paid for by Medicaid through the Medicaid Drug Rebate Program.
    Manufacturers that do not sign an agreement are not eligible for
    Federal Medicaid coverage of their product(s). Except for some
    statutory limitations, if a Medicaid program opts to cover prescription
    drugs for their beneficiaries, it must provide coverage and
    reimbursement for all covered outpatient drug products manufactured by
    companies that have entered into a rebate agreement with CMS, as
    Congress has guaranteed access to the Medicaid market for those drug
    manufacturers that provide rebates. Approximately 550 pharmaceutical
    companies participate in this program. Currently, 49 states and the
    District of Columbia participate in the Medicaid Drug Rebate Program
    (Arizona has an 1115 waiver that exempts it from participating in the
    Medicaid Drug Rebate Program).
        Manufacturers submit their Average Manufacturer Price (AMP) and
    Best Price (BP) to CMS. Using the AMP and BP, CMS calculates the rebate
    amount and informs the states. The rebate is calculated differently
    depending on the type of drug. For generic drugs, the rebate is 11
    percent of AMP. For brand-name prescription drugs, the rebate is
    calculated in two ways. Basic rebates for brand-name drugs are the
    greater of 15.1 percent of the AMP or AMP minus BP. In addition, if the
    price of a drug increases at a rate faster than the consumer price
    index from a base year, the manufacturer would owe the state the
    difference dollar for dollar. States receive rebates from manufacturers
    based on states' quarterly data on the utilization of the
    manufacturers' drugs. The Drug Rebate Program was enacted out of
    concern for the costs the Medicaid program was paying for outpatient
    drugs. In FY 2003, manufacturers paid rebates to states of about $6.4
    billion for covered outpatient drugs. The program gives Medicaid
    programs the opportunity to obtain discounted prices similar to those
    offered by pharmaceutical manufacturers to other large purchasers.
        States that wish to pursue Medicaid supplemental rebates in
    addition to rebates already received under the National Drug Rebate
    Agreement have the option to negotiate such rebates with drug
    manufacturers as specified in Federal law. In recent years, CMS has
    approved plan amendments that allow states to negotiate additional
    state-specific supplemental rebates for their Medicaid population or
    participate in a multi-state pooling supplemental rebate agreement.
    Rebates received under state supplemental agreements are shared with
    the Federal government at the same rate as the national rebates.
        Currently, 33 states have Medicaid supplemental rebates, including
    those states in multistate pooling arrangements. Twenty-six states have
    negotiated rebates on their own. For example, Florida began collecting
    state-only supplemental rebates in 2001 in conjunction with the
    establishment of its Preferred Drug List (PDL). Currently, the state
    receives supplemental rebates on brand name drugs, but not on generics.
    The state received rebates of $51 million in FY 2003 and does not
    expect to lose participation from any of the approximately 80
    manufacturers that currently pay supplemental rebates.

    Medicaid Federal Upper Limit Cuts Costs
        One proven method to reduce drug costs for States and to ensure the
    government is a prudent purchaser of prescription medications is the
    use of generic medications instead of more expensive brand name
    pharmaceuticals. As you know, Mr. Chairman, generic drugs are typically
    significantly less expensive than their brand-name counterparts (See
    Chart 7). This is achieved through the use of the Federal Upper Limit
    (FUL), a program that caps Medicaid payments for brand name drugs that
    have therapeutically equivalent generic medications available. As a
    result, the FUL program, which achieves savings by taking advantage of
    current market prices, helps to significantly reduce pharmacy costs for
    both the states and the Federal government.
        Through the FUL program, CMS sets an upper limit reimbursement
    amount for drugs that meet certain criteria. However, not all drugs are
    subject to the FUL pricing. To establish the FUL for a drug, CMS
    examines the FDA's Orange Book data to determine whether all the
    formulations of a drug product approved by the FDA are therapeutically
    equivalent. When all of the versions of that drug are not
    therapeutically equivalent, there must be at least three
    therapeutically equivalent drug products. Once a product has met the
    FDA criteria, CMS verifies that it meets the necessary compendium
    criteria by consulting the national drug-pricing compendium (Red Book,
    First Data Bank, and Medi-Span) to verify that there are at least three
    suppliers of the drug listed. If there are three suppliers, CMS sets
    the FUL at 150 percent of the lowest price (Average Wholesale Price,
    Wholesale Acquisition Cost, or Direct Price). A state's aggregate
    payment for all Medicaid prescription drugs with a FUL must not exceed,
    in the aggregate, the payment levels established by the FUL program.
    The aggregate cap allows states to increase or decrease the cost of
    individual prescription drugs in accordance with state or local markets
    while maintaining the overall savings created by the FUL program.
    States may exceed the FUL price for individual prescription drugs as
    long as their aggregate expenditures do not exceed the amounts that
    would have otherwise been spent by applying the FUL limit plus a
    reasonable dispensing fee.
        CMS uses a 150 percent mark-up so that FUL prices are high enough
    to ensure that pharmacists can stock an equivalent product without a
    loss on acquisition costs. The mark-up also assures that FUL prices are
    low enough so that Medicaid will not pay too much for a prescription
    drug that is included on the list. The 150 percent mark-up is intended
    to balance the interests of both pharmacists and the government in
    achieving efficiency, economy, and quality of care. In addition, to
    ensure the most accurate prescription drug pricing data, CMS has
    actively worked with the publishers of the compendium to resolve FUL
    pricing issues and to encourage the collection of accurate data.
    Because of the complexity and volatility of the drug marketplace, it is
    impossible to be certain that pricing or the inclusion of a drug on the
    FUL list is 100 percent accurate. CMS has an on-going process in place
    to ensure that any necessary revisions to the list can be identified
    and completed. As new information becomes available, CMS compiles a
    list of changes that is released periodically to the agency's regional
    offices. The regions provide the information to the states, which
    notify providers. CMS also posts the changes on its website at
    www.cms.hhs.gov/medicaid/drugs/drug10.asp.
        We greatly appreciate the various reports of the Office of
    Inspector General on its review of prescription drug prices and the FUL
    program. While we value their work, in regards to the FUL program, it
    must be examined in its entirety. Specifically CMS must establish a
    drug product's eligibility for the FUL list that includes verification
    with the suppliers of the drugs that are necessary to assure
    availability.

    Utilizing Maximum and Wholesale Costs
        Maximum Allowable Cost (MAC) programs are designed to ensure
    Medicaid programs pay appropriate prices for generic and multi-source
    brand drugs. Typically, States administering the MAC programs will
    publish lists of selected multi-source and generic drugs with the
    maximum price at which Medicaid will reimburse for those medications.
    Pharmacies generally will not receive payments that are higher than the
    MAC price. These programs differ from the FUL list, as states have more
    discretion in determining what drugs to include on the MAC list.
    Instead of the MAC, some states use wholesale acquisition costs (WAC),
    which is the listed price supposedly paid by a wholesaler for drugs
    purchased from the wholesaler's supplier, typically the manufacturer of
    the drug.

    Additional Tools Are Available to States to Address High Prescription
            Drug Costs
        In addition to the rebate program, and as a result of increasing
    prescription drug costs, State Medicaid programs have implemented a
    variety of cost-containment mechanisms in their drug programs over the
    past few years. These mechanisms have allowed States to reduce their
    pharmacy expenditures and maintain beneficiary access to a vital part
    of their overall health care. While some of the pharmacy techniques
    employed by the States represent prudent management of program costs,
    the Medicaid drug benefit remains a State option with benefits and
    limitations that vary from State to State. CMS can provide consultation
    and support to assist states in using these and other methods to lower
    their drug costs without compromising quality of care. However, aside
    from federal regulations, most Medicaid cost containment decisions
    ultimately are made at the state level. States use a variety of methods
    to pay for prescription drugs. In addition, they use a variety of cost
    control measures. For example, the use of copayments, generic
    substitution, and disease management programs are handled at the state
    level (See Chart 8).

    Copayments Contribute to Cost Containment
        At their discretion, states may impose nominal deductibles,
    coinsurance, or copayments on some Medicaid beneficiaries for certain
    services. Nominal copayments are a tool available to states as a cost
    containment measure. The use of copayments for prescription drugs
    varies from state to state. Nineteen states have no copayment, and the
    vast majority of the remaining states require a copayment ranging from
    50 cents for generic drugs to $3.00 for brand-name prescriptions. Cost
    sharing limits are set by Federal regulation and have not changed in
    many years. In addition, some groups are totally exempt from cost-
    sharing by law. Pregnant women, children under age 18, and hospital or
    nursing home patients who are expected to contribute most of their
    income to institutional care are exempt from cost-sharing.

    States' Aggressive Generic Substitution Saves Money
        Generic drugs account for more than half of all prescriptions in
    the United States. Many private health plans have generic drug use
    rates of more than 90 percent, but generics are not as widely used in
    some Medicaid programs. The low prices of generic drugs in the United
    States are an important potential source of savings for states. The
    potential cost-savings by the use of generic drugs has prompted 39
    states to require that the generic version of a drug be dispensed to
    Medicaid beneficiaries when available. Under these mandatory generic
    substitution policies, the brand name drug remains available to
    beneficiaries through prior authorization. Examples of ``best
    practices'' involving generic drugs include Minnesota and Idaho. For
    example, Minnesota has had a mandatory generic substitution policy in
    place for nearly a decade. This saves the State $10 million annually.
    Idaho also has a mandatory generic substitution policy, which increased
    the percentage of generic drugs dispensed from 46.7 percent in fiscal
    year 2002 to 53 percent in fiscal year 2003. Idaho's policy saved $11.7
    million in State and Federal funds.

    Drug Utilization Review Protects Patients and Reduces Costs
        Congress created the Medicaid Drug Utilization Review (DUR) Program
    through the Omnibus Budget Reconciliation Act of 1990. The program
    promotes patient safety by an increased review and awareness of
    outpatient prescribed drugs. Under the law, states are required to
    complete annual reports, which provide an excellent measurement tool to
    assess how well states have implemented the DUR program and the effect
    DUR has had on patient safety, provider prescribing habits and dollars
    saved. In addition to promoting patient safety and positive health
    outcomes, the DUR program serves as a cost savings strategy by avoiding
    problems such as adverse drug interactions, drug-disease interactions,
    therapeutic duplication and over-prescribing by providers.

    State Medicaid Disease Management Programs Reduce Expenses
        Disease management programs are an emerging strategy for states to
    improve care and are designed to reduce overall expenditures, including
    drug expenditures, through more appropriate medication use for Medicaid
    beneficiaries with chronic illnesses. Both North Carolina and
    Washington have instituted successful disease management programs. For
    instance, North Carolina's Pharmacy Management Initiative has lowered
    drug costs of participants by 22 percent through use of a preferred
    drug list and is expected to save $9 million in 2004 through its
    pharmacy program that reviews the drug regime of nursing home residents
    and recommends changes consistent with appropriate prescribing
    practices.

    States' Additional Techniques to Control Costs
        States use a number of additional techniques to control Medicaid
    prescription drug costs.

     Approximately 9 states have strict limits on the number of brand name
            prescriptions that can be filled.
     About 37 states employ refill and/or monthly or annual prescription
            limits.
     Virtually all states (50 with the exception of Tennessee but
            including DC) report using day supply limits ranging from about
            a 30 to 100 day supply.
     About 32 states have fail-first or step therapy programs in place.
            Fail-First policies require that the patient fail on at least
            one other medication as a prerequisite for authorization of a
            specific, often non-formulary, medication. Step Therapy is a
            prescription pattern based on the state of illness that
            involves using the drug believed to be the most cost-effective
            first, followed by more expensive therapies.

    Approaches for Cost Containment in Medicaid and the Private Sector
            Differ
        The private sector utilizes a number of techniques to control their
    prescription drug costs, including significant consumer cost sharing,
    which would not be appropriate in the Medicaid setting. For example,
    private health plans use tiered copayments, which vary depending on
    whether the drug is generic, preferred, brand-name, or not included on
    a plan's formulary. Utilizing a range of copayments encourages patients
    to select lower-cost options. State Medicaid programs, however, may
    institute only a nominal copayment or coinsurance for prescription
    drugs, as Federal regulation sets a mandated $3 limit or a 5 percent
    coinsurance limit. Furthermore, as mentioned above, by law states
    cannot require prescription drug copayments for pregnant women,
    children under age 18, and hospital or nursing home patients who are
    expected to contribute most of their income to institutional care.
        Some private insurers also require their members to obtain their
    prescriptions solely through mail-order pharmacies to control costs. In
    Medicaid, there is freedom of choice of provider and any willing
    provider. While Medicaid programs could apply for a waiver to use mail-
    order pharmacies to dispense medications to those with chronic
    conditions, states do not have the authority to restrict people with
    Medicaid to mail-order pharmacies for all their prescriptions.
        Private insurers use formularies with tiered cost sharing and
    exclusion of certain drugs as a cost saving strategy. However, Medicaid
    must cover all FDA-approved drugs for every manufacturer that has a
    national rebate agreement, with some exceptions. States may utilize a
    preferred drug list, which would exclude certain drugs, but Federal law
    requires these excluded drugs be made available through prior
    authorization. In addition, private insurers may not cover particular
    drugs, such as oral contraceptives and antihistamines, topical nasal
    products, and cough/cold products. These drugs account for 4 percent of
    Medicaid spending on prescription drugs (See Chart 9).

    Conclusion
        Mr. Chairman, members, thank you again for the opportunity to
    testify. CMS will continue to assist all states in adopting safe,
    proven approaches to lowering drug costs while providing access to
    prescription drugs and quality care. In addition, CMS will fulfill its
    role as a partner through the Federal Upper Limit and Medicaid Drug
    Rebate programs to ensure the government is a prudent purchaser of
    prescription medications. Thank you again for hearing my testimony, and
    I am happy to answer any questions you might have.

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        Mr. Walden. It will be. Thank you, Mr. Smith.
        Mr. Reeb, thank you for being with us.

                       TESTIMONY OF GEORGE M. REEB

        Mr. Reeb. Good morning, Mr. Chairman. I am George Reeb; I
    am assistant inspector general for the Centers of Medicare and
    Medicaid Audits within the HHS Office of Inspector General.
    Robert Vito, regional inspector general for evaluations and
    inspections in Philadelphia, accompanies me. We appreciate the
    opportunity to appear before you today.
        In short, the Medicaid program continues to pay too much
    for prescription drugs. My written statement describes the
    OIG's work, showing that the Medicaid drug program could save
    money if it is improved on four particular fronts.
        First, States need better methods for estimating pharmacy
    acquisition costs. Second, CMS must ensure that qualified drugs
    are placed on the Federal upper limit lists in a timely manner.
    Third, States must do a better job of accounting for their
    billing and collections of the rebates from the rebate
    collection process. And, fourth, CMS, we believe, should seek
    legislation to correct the inconsistencies which exist between
    the rebate and the reimbursement calculations.
        Most States have used and continue to use the average
    wholesale price to estimate pharmacies' acquisition costs of
    drugs. The published AWPs that States use to establish their
    Medicaid drug reimbursements generally bear little resemblance
    to the prices incurred by retail pharmacies to purchase drugs.
    In prior audit reports that we issued in 2001 and 2002, we
    estimated that pharmacies' actual acquisition costs for brand-
    name drugs in 1999 was an average of 21 percent below AWP and
    for generic drugs was an average of 65 percent below AWP. The
    effect of the difference between the pharmacy invoice costs and
    the amount Medicaid would have paid for those drugs was about
    $1.5 billion, a spread from which the States could have derived
    savings through better reimbursement methods.
        After additional analyses based on both State and industry
    interests, we recommend that, if States continue to use a
    reimbursement system based on AWP, they should consider
    adopting a four-tiered payment system that is described in my
    written statement.
        Next, I would like to mention our findings with regard to
    the Federal upper limit program. For multiple-source drugs,
    Medicaid limits reimbursement to Federal upper limit amounts if
    at least three generic equivalents are available and certain
    other requirements are met. Medicaid misses savings
    opportunities when qualified drugs are not placed on the
    Federal upper limit list in a timely manner. In a report we
    issued in February of this year, we estimated that Medicaid
    could have saved $123 million in 2001 if CMS had added just 55
    more products to the Federal upper payment list.
        As a follow-up to that report, your committee requested
    that OIG conduct additional work on this subject. Today, we are
    releasing the results of that work. Again, we found that
    qualified drugs needed to be added more timely to the Federal
    upper limit list. Delays in adding the drugs we reviewed cost
    the Medicaid program an estimated $167 million between 2001 and
    2003.
        Another area we reviewed is the extent to which States vary
    in their Medicaid reimbursements for the same drugs. We
    estimated that, overall, Medicaid could have saved as much as
    $86 million in fiscal year 2001 if the 42 States that we
    reviewed had reimbursed at the same price as the lowest paying
    price--lowest paying State for each of the selected drugs.
    Overall, we believe that States could reduce their spending on
    prescription drugs by adopting various strategies that other
    States have successfully used to contain costs.
        States also spend too much on prescription drugs because
    they do not adequately manage their Medicaid rebate billings
    and collections process. We recently completed audits at the
    rebate programs in 48 States and the District of Columbia. We
    found that rebate accounting systems were inadequate, and
    information submitted to CMS was unreliable, thereby
    undermining CMS' ability to oversee the drug reimbursement
    rebate process.
        My written statement also describes concerns we have about
    the negative effect of inconsistencies between the key values
    that are used for calculating rebates and reimbursements. We
    estimate that, if rebates and reimbursements had been
    calculated using the same value, Medicaid would have achieved a
    substantial increase in added rebates. Audit work in progress
    confirms that Medicaid continues to overspend because of this
    inconsistency in the rebate and the reimbursement processes.
    Medicaid reimbursement should reliably reflect the actual cost
    of the drugs to the pharmacy. We do not believe that occurs
    now, and States need assistance in strengthening their ability
    to make reasonable payments for the drugs they do cover.
        Mr. Chairman, this concludes my testimony, and we welcome
    any questions you may have.
        [The prepared statement of George M. Reeb follows:]

     Prepared Statement of George M. Reeb, Assistant Inspector General for
       the Centers for Medicare and Medicaid Audits, Office of Inspector
             General, U.S. Department of Health and Human Services

        Good morning, Mr. Chairman. I am George M. Reeb, Assistant
    Inspector General for the Centers for Medicare and Medicaid Audits at
    the U.S. Department of Health and Human Services' Office of Inspector
    General (OIG). Robert Vito, Regional Inspector General for Evaluation
    and Inspections in Philadelphia, accompanies me. We appreciate the
    opportunity to appear before you today to present information regarding
    Medicaid's payments to pharmacies for prescription drugs.
        In short, the Medicaid program continues to pay too much for
    prescription drugs. My testimony provides a brief overview of OIG's
    body of work over the last several years related to Medicaid-covered
    drugs that provides the basis for our belief that Medicaid is paying
    too much for prescription drugs and offers suggestions for controlling
    Medicaid spending.
        The testimony describes OIG's findings regarding (1) pharmacy
    acquisition costs and average wholesale price, (2) the Federal upper
    limit program, (3) State variations in reimbursements for the same
    drugs, and (4) the Medicaid drug rebate program. I am also providing
    additional analytical information on pharmacy acquisition costs,
    highlights of Medicaid-related settlements with pharmaceutical
    manufacturers and chain drug stores, and a list of selected OIG reports
    and other guidance that are available on our Web site at http://
    www.oig.hhs.gov.
        The Centers for Medicare & Medicaid Services estimated that
    calendar year 2003 Medicaid expenditures for prescription drugs totaled
    more than $31 billion, triple the $9.4 billion spent in 1994. Both the
    States and the Federal Government share these expenditures. Under
    Federal law, States have wide latitude in setting their reimbursement
    rates for prescription drugs. Federal regulations require that each
    State's reimbursement for a drug not exceed, in the aggregate, the
    lower of estimated acquisition cost plus a reasonable dispensing fee or
    the providers' usual and customary charge to the public for the drug.
    For certain multiple-source (generic) drugs, Medicaid regulations set
    Federal upper limits that are contained on a list published by CMS.
    Within this general framework, the States use a variety of different
    pricing mechanisms when setting reimbursement amounts.
        States must reasonably reimburse pharmacies for prescription drugs
    provided to Medicaid beneficiaries; yet, they lack access to
    pharmacies' actual acquisition costs. Due to this lack of data, they
    rely on estimates to determine Medicaid reimbursement. These estimates
    include formulas for estimating pharmacy acquisition cost, pharmacies'
    ``usual and customary'' charges, Federal upper limits, and State
    maximum allowable costs.
             pharmacy acquisition costs and average wholesale price
        Most States have used and continue to use the average wholesale
    price (AWP) to estimate pharmacies' acquisition costs of drugs. For the
    most part, AWP's (which are not clearly defined by law or regulation)
    are compiled in drug compendia such as Medical Economics' Red Book. As
    our audit findings have demonstrated, the published AWPs that States
    use to establish their Medicaid drug reimbursements generally bear
    little resemblance to the prices incurred by retail pharmacies to
    purchase drugs.
        Until the passage of the Medicare Prescription Drug, Improvement,
    and Modernization Act of 2003, Medicare also used AWP as the basis for
    most drug reimbursements. Although the Congress recently took action to
    help lower excessive payment levels for Medicare, Medicaid's
    reimbursement methodology continues to be based largely on the same
    inflated AWPs that had plagued Medicare.
        To compare actual pharmacy acquisition costs to AWP, for calendar
    year 1999 we obtained from 217 pharmacies in 8 States pricing
    information that included thousands of invoice prices for both brand
    and generic drug products. We compared each invoice drug price to the
    AWP for that drug and calculated the percentage, if any, by which the
    invoice price was discounted below AWP. We estimated that pharmacy
    acquisition costs for brand name drugs in 1999 were an average of 21.8
    percent below AWP and for generic drugs were an average of 65.9 percent
    below AWP. Both estimates were higher than our previous studies of 1994
    data that showed 18.3 percent below AWP for brands and 42.4 percent
    below AWP for generics.
        Our comparisons of pharmacy acquisition costs to AWP for 1999 did
    not adjust the invoice prices for the net effect of discounts available
    to most pharmacies, such as volume discounts, prompt pay discounts, and
    related rebates provided to pharmacies by manufacturers and/or
    wholesalers that would further lower the total pharmacy acquisition
    costs. For that one year, 1999, we estimated that the combined pharmacy
    invoice costs alone for brand name and generic drugs may have been as
    much as $1.5 billion lower than Medicaid would have paid for those
    drugs using the States' national average discount from AWP of 10.3
    percent. This $1.5 billion constitutes a spread from which States could
    have derived savings through better reimbursement methods. We used a
    single average discount in the calculation because, in 1999, most
    States used the same discount for brand name drugs as they did for the
    generics that did not have an upper limit.
        In the audit of 1999 data, we did not attempt to assess the
    adequacy of dispensing fees paid by the States to pharmacies. Based on
    information available from CMS, it appears that States have
    significantly varying amounts of dispensing fees.
        In 2002, in response to requests by the industry and the States'
    interest in having more information on pharmacy purchase prices for
    additional categories of drugs, the OIG conducted an additional
    analysis of the 1999 data. That analysis provided a more comprehensive
    breakdown of percentages for a variety of drug categories. The analysis
    demonstrated a wide range of discounts from AWP for pharmacy purchases,
    depending on the category of drug that was being purchased. We
    concluded that the common method of reimbursing for brand name drugs
    and certain generic drugs using a single percentage discount does not
    adequately consider the large fluctuations in actual discounts between
    brands and generics. We recommended that, if States continue to use a
    reimbursement system based on AWP, they should consider adopting a
    four-tiered payment system. More information about the additional
    analysis and the recommended four-tiered payment system is provided in
    Appendix A.
        States continue to use a discounted AWP for estimating pharmacy
    acquisition costs. However, many have established separate discounts
    for brand name and generic drugs. CMS estimated that for the year 2003,
    for brand drugs, the States' discounts from AWP ranged from 5 percent
    to 16 percent. For generic drugs, CMS estimated that the States'
    discounts from AWP ranged from 5 percent to 50 percent. A small number
    of States use wholesale acquisition cost rather than AWP when
    estimating the acquisition cost.
        One reason States continue to rely on AWP, despite its widely
    recognized deficiencies, is that States lack access to alternative,
    more accurate price information. One option that could be studied is
    the feasibility of developing a base payment methodology that uses
    actual pharmacy invoice prices adjusted, if necessary, for a
    profitability factor after netting post-invoice discounts and other
    considerations.

                              FEDERAL UPPER LIMITS

        For multiple-source (generic) drugs, Medicaid limits reimbursement
    to Federal upper limit amounts if at least three generic equivalents
    are available and certain other requirements are met. The Federal upper
    limits restrict the amount that Medicaid can reimburse for drugs that
    have available generic equivalents (42 CFR  447.332). Medicaid misses
    savings opportunities when qualified drugs are not placed on the
    Federal upper limit list in a timely manner.
        To quantify the missed savings opportunities, we obtained a list of
    the top 200 multiple-source drugs based on retail sales for the year
    2001 and determined whether the drugs were on CMS's November 2001
    Federal upper limit list. In a report issued in February 2004, we
    reported that 90 drugs were not included on the list despite meeting
    the established criteria. We estimated that Medicaid could have saved
    $123 million in 2001 if CMS had added just 55 of these 90 products to
    the Federal upper limit list. Four products alone accounted for 71
    percent of the $123 million in potential savings. Subsequently, CMS
    added 9 of the 90 products to the Federal upper limit list. Seven of
    the nine products accounted for $94 million of the $123 million in
    savings we calculated for 2001.
        As a follow-up to this report, your Committee requested that OIG
    conduct additional work to answer the following questions:

     Since 2001, how many generic drugs have met the criteria for
            inclusion on the Federal upper limit list?
     How many of these drugs have been included on the Federal upper limit
            list?
     How long, on average, did it take CMS to add newly qualified drugs to
            the list?
     How much does lag time between when a drug meets the criteria and its
            inclusion on the Federal upper limit list cost the Medicaid
            program?
        Today, we are releasing the results of our work related to the
    Committee's request. Again, we found that CMS does not consistently add
    qualified drugs to the Federal upper limit list in a timely manner. Of
    the 252 first-time generic drugs approved between 2001 and 2003, 109
    products met the statutory and regulatory criteria for inclusion on the
    list. CMS had added only 25 of the 109 drugs to the list as of July 15,
    2004 (date of analysis), and very few of these were included in a
    timely manner. It took CMS an average of 36 weeks to place these
    products on the list once they met the statutory and regulatory
    criteria for inclusion. Only 3 of the 25 drugs were included on the
    list when they first became qualified. The longest delay was for two
    versions of Metformin Hydrochloride, which were qualified for 102 weeks
    before being added in March 2004.
        An additional 84 of the 109 drugs we reviewed had still not been
    added to the Federal upper limit list as of July 15, 2004. The delay in
    adding these 84 drugs averaged 55 weeks as of that date.
        Delays in adding the reviewed drugs cost the Medicaid program an
    estimated $167 million between 2001 and 2003. A majority of the losses
    were attributable to delays in adding just eight drugs, which accounted
    for 85 percent ($143 million) of the estimated losses. The product with
    the highest losses for Medicaid, Fluoxetine 20 mg capsules (brand name
    Prozac), illustrates the potential effect of not adding drugs to the
    Federal upper limit list in a timely manner. Fluoxetine met all
    criteria for inclusion on the Federal upper limit list by April 1,
    2002. However, CMS did not place Fluoxetine on the list until December
    1, 2002. We estimate that this delay in adding the 20 mg dosage size of
    Fluoxetine capsules cost Medicaid an estimated $57 million dollars. The
    Federal share of the loss on Fluoxetine was approximately $32.6
    million. The Federal share of the $167 million loss on all the drugs we
    reviewed was approximately $95.5 million.
        Based on the findings of this report, we recommended that CMS
    establish an administrative procedure and schedule to govern the
    determination and publication of Federal upper limits. We also
    suggested that CMS focus its resources on ensuring that high-volume
    drugs that have recently come off patent are added to the list
    expeditiously. The report is available on OIG's Web site today under
    ``What's New,'' and I have provided the report to the Committee.

             STATE VARIATIONS IN REIMBURSEMENTS FOR THE SAME DRUGS

        As previously mentioned, States have wide latitude in setting their
    reimbursement amounts for prescription drugs. In September 2004, we
    issued a report of a study in which we assessed the extent to which
    States vary in their Medicaid reimbursement for the same drugs. We
    analyzed fiscal year 2001 State Medicaid prescription drug
    reimbursement data for a sample of 28 national drug codes. A national
    drug code is a numeric identifier issued by the Food and Drug
    Administration (FDA) for each drug. The code indicates the manufacturer
    of the drug, the product dosage amount, and the package size. Forty-two
    States agreed to participate in our review and provided us with their
    total ingredient reimbursement amount (excluding dispensing fees) and
    the total units reimbursed for each of the 28 national drug codes.
    Using the data supplied by States, we calculated an average unit price
    per drug and found substantial variations in States' payments for the
    same drugs. These variations translate into overspending by Medicaid.
        Based on State data, we estimated that, overall, Medicaid could
    have saved as much as $86.7 million in fiscal year 2001 if all 42
    States had reimbursed at the same price as the lowest paying State for
    each of the drugs reviewed. In fact, Medicaid could have cut its
    spending by more than half if all States had paid the same price as the
    lowest paying State for just 9 of the 28 drugs. These savings estimates
    derive from only 28 national drug codes that were randomly selected
    from 600 national drug codes for which there were substantial Medicaid
    outlays. Medicaid covers over 50,000 national drug codes, implying a
    potential for even greater program savings.
        We believe savings could be achieved if CMS would: (1) share with
    the States the various types of price data it collects to help States
    develop better estimates of pharmacy acquisition costs, (2) conduct
    further research on the factors that affect States' drug prices to be
    able to advise States more effectively on ways to set their
    reimbursement levels, and (3) annually review the States' drug prices
    in order to share comparative State prices and methods to reduce costs.

                          MEDICAID DRUG REBATE PROGRAM

    State Accounting for Rebate Billings and Collections
        In addition to paying too much up front for Medicaid prescription
    drugs, States exacerbate their overspending of State and Federal funds
    by poor management of their rebate billings and collections. Pursuant
    to the Medicaid Drug Rebate Statute, States collect rebates from drug
    manufacturers for drug purchases made under the Medicaid program. The
    drug rebate program allows Medicaid to receive pricing benefits
    commensurate with its position as a high-volume purchaser of
    prescription drugs.
        The statutory drug rebate program became effective in January 1991.
    After a start-up period, we audited the effectiveness of the new
    program in eight States. In June 1993, we reported that CMS had not
    ensured that States had established proper accountability and controls
    over the billing and collection of drug rebates. In addition, CMS could
    not develop a nationwide total of the uncollected portion of Medicaid
    drug rebates because States were only required to report the rebates
    that were collected. We replicated our review recently on a national
    scale, using 2002 information, and found that, while accountability had
    improved since our 1993 report, improvements are needed in most States.
    Weaknesses included the following:

     Rebate accounting systems were inadequate.
     Information submitted to CMS was unreliable, undermining CMS's
            ability to oversee the program.
     Accounting for interest on late rebate payments was improper.
     The dispute resolution and collection processes were inadequate.
        We are in the process of developing a national roll-up report. The
    individual final reports for each State and the District of Columbia
    are currently available on our Web site.

    Drug Rebate Calculations
        Additional Medicaid overspending occurs because of an inconsistency
    between the key values used for calculating rebates and reimbursements.
    Currently, Medicaid requires that rebates be based on a specifically
    designated value, average manufacturer price (AMP), while, at the same
    time, allowing reimbursements to be calculated using other values
    (usually a discounted AWP). This creates a situation whereby
    fluctuations in reimbursements do not result in a corresponding
    adjustment in the associated rebates. When a State increases its
    payments for a drug, it would not receive a correspondingly higher
    rebate on that drug purchase because there is currently no connection
    between the reimbursement and rebate calculations. Legislation is
    needed to establish a connection.
        In a 1998 audit report, we recommended that CMS seek legislation
    requiring drug manufacturers to pay Medicaid drug rebates on the same
    basis that States determine reimbursements. The recommendation was
    supported by our review of data for calendar years 1994 through 1996
    for 100 brand name drugs that had the greatest amount of Medicaid
    reimbursement in that period. We estimated that if rebates had been
    based on AWP (instead of on the statutorily required AMP) for that
    period, Medicaid would have achieved over $1 billion in added rebates.
    We used AWP to calculate the rebates for the period because most States
    were basing drug reimbursements on AWP minus a percentage discount.
    According to information States have reported to CMS, most States
    continue to use AWP in their reimbursement methodologies. Audit work in
    progress confirms that Medicaid continues to overspend because of the
    inconsistent bases used for reimbursement and rebates.

    Manufacturers' Calculation of AMP
        AMP is supposed to represent the price at which the manufacturers
    sell their drugs to wholesalers for use in the retail class of trade.
    In addition to the situation described above, our work at selected
    manufacturers has shown they are making inconsistent interpretations as
    to what components are included in AMP. The inconsistencies have
    included how to treat Medicaid sales and accounting for sales and price
    concessions that flow through organizations that represent both retail
    and non-retail customers. It is important that all manufacturers report
    consistent and accurate information in order for the rebate process to
    work as intended. We therefore suggest that additional clarification of
    the definition of AMP be provided by CMS. This would both improve the
    rebate process and assist States that may consider the use of AMP data
    in estimating pharmacy acquisition costs for reimbursement purposes.

                                   CONCLUSION

        All States could reduce their spending on prescription drugs by
    adopting various strategies that other States have successfully used to
    contain costs. The savings could be even greater if states had better
    access to accurate pricing information. Reimbursement should reliably
    reflect the actual costs of the drug to the pharmacy and be grounded in
    information that can be validated. There is an urgent need for the
    Medicaid policymaking community to assist States in strengthening their
    ability to make reasonable payments for the drugs they cover. This
    concludes my testimony, and I welcome your questions.

                                   Appendix A

    ADDITIONAL ANALYSIS OF PHARMACY ACQUISITION COSTS AND AVERAGE WHOLESALE
                                     PRICE

        OIG collected brand name and generic drug acquisition costs for
    calendar year 1999 and compared those costs to the average wholesale
    price (AWP) for each drug. After issuing separate reports on brand name
    and generic drugs, we conducted an additional analysis that provided a
    more comprehensive breakdown of percentages for a variety of drug
    categories. We found that:

     For single source innovator drugs, pharmacies purchased the drugs at
            an estimated discount of 17.2 percent below AWP.
     For all drugs without Federal upper limits (single source innovator,
            multiple source innovator, and multiple source non-innovator),
            pharmacies purchased the drugs at an estimated discount of 27.2
            percent below AWP.
     For multiple source drugs without Federal upper limits, pharmacies
            purchased the drugs at an estimated discount of 44.2 percent
            below AWP. A further breakdown of these drugs showed the
            estimated discount for innovator multiple source drugs to be
            24.4 percent and 54.2 percent for non-innovator multiple source
            drugs.
     For multiple source drugs with Federal upper limits, pharmacies
            purchased the drugs at an estimated discount of 72.1 percent
            below AWP.
        These percentages do not consider discounts available to most
    pharmacies, such as volume discounts, prompt pay discounts, and related
    rebates that would further reduce acquisition costs.
        The analysis shows that there is a wide range of discounts from AWP
    for pharmacy purchases depending on the category of drug that is being
    purchased. We concluded that, if States continue to use a reimbursement
    system based on AWP, CMS should encourage States to consider adopting a
    four-tiered payment system consisting of a percentage discount off AWP
    for:

    (1) single source brand name drugs;
    (2) innovator multiple-source drugs without a Federal upper limit; and
    (3) non-innovator multiple-source drugs without a Federal upper limit.
    (4) The fourth tier would be to pay the Federal upper limit price for
            qualified multiple source drugs.
        As in the audits on which this additional analysis was based, we
    focused our efforts on evaluating the pharmacy's acquisition costs for
    the drugs and offer no opinion on the adequacy of the dispensing fees
    being paid.

                                   Appendix B

                 MEDICAID-RELATED PRESCRIPTION DRUG SETTLEMENTS

    Settlements with Pharmaceutical Manufacturers
        Recent Federal investigations of pharmaceutical manufacturers that
    led to settlements involving Medicaid prescription drug cases serve to
    illustrate weaknesses and vulnerabilities in the Medicaid drug
    reimbursement arena. Following are descriptions of some, but not all,
    relevant cases. Both the United States and individual States have
    negotiated other settlements that are not mentioned here.
            The OIG's ``Compliance Program Guidance for Pharmaceutical
            Manufacturers'' is available on the OIG Web site at http://
            www.oig.hhs.gov/fraud/complianceguidance.html.
        Schering-Plough Corporation. Recently, ScheringPlough Corporation
    agreed to pay $345.5 million as part of a global settlement with the
    Government and entered a 5year corporate integrity agreement (CIA) with
    the OIG. As part of the settlement, Schering-Plough agreed to pay $293
    million to resolve its civil and administrative liabilities in
    connection with illegal and fraudulent pricing of its allergy drug
    Claritin under the Medicaid drug rebate program. The civil portion of
    the case focused on ScheringPlough's alleged failure to include the
    value of certain incentives offered to two managed care organizations
    in Schering-Plough's determination of the best price reported for
    purposes of the Medicaid drug rebate program. By failing to include the
    value of the incentives in its determination of best price,
    ScheringPlough allegedly underpaid rebates due to the States and
    overcharged entities (such as community health centers) that purchased
    drugs at ceiling prices that are based on Medicaid drug rebate prices.
    With regard to the criminal portion of the case, a subsidiary of
    ScheringPlough, the Schering Sales Corporation, pled guilty to a
    kickback charge and was sentenced to pay a $52.5 million criminal fine.
    Schering Sales Corporation was charged with paying a kickback of almost
    $2 million in order to keep Claritin on the formulary of a managed care
    organization.
        Pfizer Inc. As part of a fiscal year 2004 global settlement of $430
    million plus interest, Pfizer Inc. (Pfizer), Warner-Lambert Company LLC
    (Warner-Lambert), and the Parke-Davis Division agreed to pay $190
    million in a civil False Claims Act settlement relating to Warner-
    Lambert's promotion of the drug Neurontin. Pfizer acquired Warner-
    Lambert and its Parke-Davis Division in June 2000. Between July 1995
    and June 2001, Neurontin was approved by FDA only for use in treating
    epilepsy, but Warner-Lambert allegedly engaged in a wide-ranging
    program to promote Neurontin for other uses. The Government alleges
    that these activities caused the submission of false and/or fraudulent
    claims to Medicaid. To resolve its criminal liability, Warner-Lambert
    pled guilty to violating the Federal Food, Drug and Cosmetic Act and
    agreed to pay a $240 million criminal fine. Pfizer entered a
    comprehensive 5-year corporate integrity agreement with OIG.
        AstraZeneca Pharmaceuticals, LP and Zeneca Inc. In June 2003, the
    United States announced a global settlement with AstraZeneca. The
    company agreed to pay a total of almost $355 million and enter a 5-year
    CIA with OIG to resolve its criminal and civil liabilities relating to
    the marketing and pricing of its prostate cancer drug, Zoladex.
    AstraZeneca pled guilty to conspiracy to violate the Prescription Drug
    Marketing Act by causing the submission of reimbursement claims for
    Zoladex that had been provided free of charge as samples. The
    Government also alleged that AstraZeneca paid illegal remuneration (in
    various forms including grants, travel, and entertainment) to induce
    the purchase of Zoladex; that AstraZeneca created and marketed an
    average wholesale price (AWP) spread between the Medicare reimbursement
    for Zoladex and its cost; and that AstraZeneca misreported and
    underpaid Medicaid rebates for Zoladex. AstraZeneca also agreed to
    enter separate settlements with the States.
        Bayer Corporation. In April 2003, Bayer Corporation agreed to pay
    $257.2 million in criminal fines and civil assessments to settle a
    False Claims Act case relating to the Medicaid drug rebate program.
    Bayer agreed to plead guilty to charges that it violated Federal law by
    failing to report certain information to FDA. The case focused on
    Bayer's failure to include certain sales to Kaiser Permanente Medical
    Care (an HMO) in its calculation of Best Price reported for purposes of
    the Medicaid drug rebate program. The Medicaid drug rebate program
    requires drug manufacturers to report their Best Prices to CMS and to
    pay rebates to the State Medicaid programs based on those reported
    prices.
        GlaxoSmithKline. Also in April 2003, GlaxoSmithKline settled a
    Medicaid drug rebate case for almost $88 million, based on facts
    similar to the Bayer matter discussed above. In connection with the
    settlement, GlaxoSmithKline entered a 5-year CIA with OIG.
    GlaxoSmithKline also agreed to enter into separate settlement
    agreements with the States.
        Pfizer, Inc. In October 2002, the United States settled a Medicaid
    drug rebate case with Pfizer, Inc., Warner-Lambert Company and the
    Parke-Davis Division. The Government alleged that Warner-Lambert failed
    to include the value of certain unrestricted educational grants in the
    best price reported for purposes of the Medicaid drug rebate program
    and, as a result, underpaid rebates due. The government alleged that
    Warner-Lambert paid the grants to a managed care organization in order
    to obtain unrestricted formulary status for the cholesterol-lowering
    drug, Lipitor. As part of the settlement, Pfizer paid $49 million and
    entered a five-year CIA with OIG.
        TAP Pharmaceutical Products, Inc. In October 2001, the United
    States announced a major global health care fraud settlement with TAP
    Pharmaceutical Products Inc. TAP agreed to pay a total of $875 million
    to resolve its Medicare and Medicaid liability. TAP agreed to plead
    guilty to violating Federal law governing the use of drug samples. In
    addition, TAP allegedly set and reported AWPs for its prostate cancer
    drug, Lupron, at levels far higher than the actual acquisition cost of
    the majority of its customers (such as physicians) and caused those
    customers to receive excess reimbursement from Medicare and Medicaid.
    TAP also allegedly underpaid rebate amounts due to the States under the
    Medicaid drug rebate statute.
        Bayer Corporation. In February 2001, the United States entered a
    $14 million settlement with Bayer Corporation in connection with
    Bayer's AWP pricing and Medicaid drug rebate practices relating to six
    drugs. The Government alleged that Bayer set and reported AWPs for the
    drugs at levels far higher than the actual acquisition costs of the
    products; that Bayer made misrepresentations to the Medicaid programs
    of certain States; and knowingly misreported and underpaid Medicaid
    rebates for the drugs. As part of the settlement, Bayer entered a five-
    year CIA with OIG.
    Settlements with Chain Drug Stores
        Rite Aid Corporation. In 2004, Rite Aid Corporation agreed to pay
    $7 million and enter a 4year CIA to resolve its civil and
    administrative liability relating to the submission of claims to
    Medicaid and other Government health care programs for partially-filled
    prescriptions for drugs that were not delivered to the beneficiaries
    and, in some instances, were ultimately returned to stock. In addition
    to the settlement with the Federal Government, Rite Aid entered
    settlements with 28 States and the District of Columbia to resolve
    alleged liability to the States for the Medicaid damages.
        Wal-Mart Stores, Inc. In 2004, Wal-Mart Stores, Inc., agreed to pay
    almost $2.87 million and enter a 4-year CIA to resolve alleged civil
    and administrative liabilities relating to the submission of claims for
    partially filled prescriptions between 1990 and 2000. The settlement
    resolved a False Claims Act qui tam suit alleging that Wal-Mart
    submitted false claims each time it dispensed only a portion of a
    prescription to a customer yet billed Medicaid, TRICARE, or the Federal
    Employee Health Benefits Program for the full amount of the
    prescription.
        Eckerd Corporation. In May 2002, Eckerd Corporation entered a
    settlement with the United States and a group of States for $9 million.
    Eckerd also entered into a 5-year CIA with OIG. The Government alleged
    that Eckerd submitted false claims each time it dispensed only a
    portion of a prescription to the customers but billed for the full
    amount of the prescription. The claims at issue were submitted to
    Medicaid, TRICARE, and the Federal Employee Health Benefits Program
    between 1986 and 2000. Previously, ECK M.D., Inc., an affiliate of
    Eckerd, pled guilty to submitting false claims to Medicaid and to
    violating certain record-keeping requirements of the Controlled
    Substances Act.
        CVS Corporation. In July 2001, the U.S. Department of Justice and
    the OIG, working jointly with representatives of the States, reached
    settlement in a qui tam action against CVS Corporation, involving
    allegations that the company submitted claims for partially filled
    prescriptions to Medicaid, TRICARE, and the Federal Employee Health
    Benefits Program. In addition to paying $4 million to the Government,
    CVS also agreed to a 4-year CIA.
        Walgreen Co. In 1999, the Federal and State governments (through
    the Medicaid Fraud Control Units) entered the first settlement with a
    major retail pharmacy chain for conduct involving partially filled
    prescriptions billed to Medicaid and other Federal health care
    programs. Walgreen Co. paid $7.6 million and entered a 4-year CIA to
    resolve its liability.

                                   Appendix C

     SELECTED MEDICAID DRUG REPORTS AVAILABLE ON THE OIG WEB SITE (HTTP://
                                WWW.OIG.HHS.GOV)

    A-06-91-00092: HCFA Needs to Provide Additional Guidance to Drug
            Manufacturers To Better Implement the Medicaid Drug Rebate
            Program. 1992. (Inconsistencies in manufacturers methods used
            to determine AMP.)
    A-06-91-00102: Improvements Needed in HCFA's Procedures To Implement
            the Medicaid Drug Rebate Program. 1992. (Errors in AMP and best
            price.)
    A-06-92-00029: Management Controls Over the Medicaid Drug Rebate
            Program. 1993. (Inadequate State controls and accountability
            over billing and collection of rebates.)
    A-06-96-00030: Medicaid Pharmacy: Actual Acquisition Cost of
            Prescription Drug Products for Brand Name Drugs. 1997. (Based
            on invoices, in 1994 pharmacy acquisition costs for brand name
            drugs averaged 18.3 percent below AWP.)
    A-06-97-00011: Medicaid Pharmacy--Actual Acquisition Cost of Generic
            Prescription Drug Products. 1997. (Based on invoices, in 1994
            pharmacy acquisition costs for generic drugs averaged 42.5
            percent below AWP.)
    A-06-97-00052: Need to Establish Connection Between the Calculation of
            Medicaid Drug Rebates and Reimbursement for Medicaid Drugs.
            1998. (Increases in reimbursement do not trigger corresponding
            increases in rebates.)
    A-06-00-00023: Actual Acquisition Cost of Brand Name Prescription Drug
            Products. 2001. (Based on invoices, in 1999 pharmacy
            acquisition costs for brand name drugs averaged 21.84 percent
            below AWP.)
    A-06-01-00053: Medicaid Pharmacy--Actual Acquisition Cost of Generic
            Prescription Drug Products. 2002. (Based on invoices, in 1999
            pharmacy acquisition costs for generic drugs averaged 65.93
            percent below AWP.)
    A-06-02-00041: Medicaid Pharmacy--Additional Analyses of the Actual
            Acquisition Cost of Prescription Drug Products. 2002. (A 4-tier
            discounting methodology would bring reimbursement more in line
            with acquisition costs.)
    OEI-05-99-00611: Containment of Medicaid HIV/AIDS Drug Expenditures.
            2001. (Comparison of Medicaid payments to other pricing
            methods.)
    OEI-03-01-00010: Medicaid's Use of Revised Average Wholesale Prices.
            2001. (States' use of price revisions by First Databank.)
    OEI-05-02-00080: Medicaid's Mental Health Drug Expenditures. 2003.
            (Comparison of Medicaid payments to 4 other Federal payers.)
    OEI-05-02-00680: State Strategies to Contain Medicaid Drug Costs. 2003.
            (Review of States' methods to control spending on drugs.)
    OEI-03-02-00670: Omission of Drugs from the Federal Upper Limit List in
            2001. 2004. (CMS did not ensure timely placement of drugs on
            the FUL list.)
    OEI-03-02-00660: Medicaid Rebates for Physician-Administered Drugs.
            2004. (Some States' systems are inadequate to ensure rebate
            collections.)
    OEI-05-02-00681: Variation in State Medicaid Drug Prices. 2004.
            (States' reimbursements vary widely for the same drugs.)
    OEI-03-04-00320: Addition of Qualified Drugs to the Medicaid Federal
            Upper Limit List. 2004. (CMS did not ensure timely placement of
            drugs on the FUL list.)

        Mr. Walden. Thank you, Mr. Reeb.
        Mr. Vito, do you have any comments? No.
        Mr. O'Connell, or Mr. Balland.

                      TESTIMONY OF DAVID J. BALLAND

        Mr. Balland. Good morning, Mr. Chairman. Mr. O'Connell has
    agreed to allow me to go first as his statement will follow
    logically after mine.
        Good morning, Mr. Chairman. Thank you for having Texas
    attend this very important hearing. I am David Balland, the
    associate commissioner for the Medicaid and Children's Health
    Insurance Program for the State of Texas, and I appreciate this
    opportunity to be with you today.
        Mr. Walden. Thank you for being here.
        Mr. Balland. Our main goal in setting reimbursement for the
    Texas Medicaid Prescription Drug Program, referred to as the
    Vendor Drug Program, is to make the reimbursement formula as
    fair as possible to all parties involved by reimbursing as
    close as possible to the pharmacy's actual cost and the
    pharmacies--allowing the pharmacies to set an adequate fee to
    cover their costs to dispense that product and working with the
    pharmacies. We do this in a proactive and transparent manner.
        In Texas, we spend approximately $2 billion a year on
    prescription drugs for Medicaid clients. Most States currently
    use private companies to access prescription drug pricing
    information by drug in order to set reimbursement levels for
    their pharmacies for prescription drugs dispensed in their
    Medicaid programs. These companies request pricing information
    from manufacturers by drug, and then make this unregulated
    pricing information available to their clients for a fee.
    Unlike most other States, Texas does not solely rely on the
    pricing information provided by these private companies to set
    our reimbursement for prescription drug products. We take the
    proactive approach and do this due to the potential inaccuracy
    of the reported information and the actual cost of the product
    to the pharmacies.
        Texas Medicaid used similar pricing services as most States
    until the early 1980's when the Texas Vendor Drug Program
    studied ways to more accurately pay for drug products paid to
    pharmacy providers since we were having problems obtaining
    accurate pricing information. Once we recognized that the
    average wholesale price was greater than the amount that Texas
    pharmacies paid the wholesaler for a drug product, we decided
    to do this. In other words, Texas Medicaid was reimbursing our
    pharmacies at a higher amount than the pharmacies' actual price
    to purchase the drug product.
        Texas started requiring drug manufacturers to fill out an
    application and questionnaire in the early 1980's for their
    products to be considered for the Texas Medicaid list of
    covered prescription drugs. We required drug manufacturers to
    provide pricing information on a number of different kinds of
    actual prices for each prescription drug product in order to
    determine the appropriate reimbursement level for those
    products purchased from different sources, including the
    average wholesale price, the wholesale acquisition cost, the
    chain warehouse price, the direct price to the pharmacy, and
    similar pricing information. Our Vendor Drug Program took
    specific steps to further refine the reimbursement amount paid
    to our pharmacies, including putting into place targeted
    prescription drug audits and pharmacy invoice audits and
    requesting additional pricing information directly from drug
    manufacturers.
        Based on information from some out-of-State pharmacies and
    our Texas Medicaid regional pharmacists, Texas Medicaid Vendor
    Drug Program initiated two targeted audits--drug invoice, one
    in early 2000 and one in early 2001. We selected drug products
    with the greatest estimated discrepancy in pricing from drug
    manufacturers to review during these audits, including over 300
    brand-name and generic prescription drug products. The audits
    found significant discrepancies between Texas Medicaid vendor
    drug reimbursement to our pharmacies and the amount the
    pharmacies were actually paying for most of the 300-plus
    products reviewed.
        As a result of these two targeted audits, we updated the
    base reimbursement amount for most of these specific drug
    products. The reimbursement updates to pharmacies for most of
    the products reviewed saves Texas Medicaid an estimated annual
    $20 million in all funds.
        Additionally, we completed an invoice audit of more than
    674 pharmacies in 2001 through 2002. This audit also indicated
    that Texas was reimbursing the pharmacies at a significantly
    higher amount than the pharmacies' costs. We proposed to change
    the prescription drug reimbursement formula after this audit.
    Unfortunately, the program was unable to proceed with the
    proposed changes due to legal challenges by the pharmacy
    association. This proposed rule was estimated to save Texas
    Medicaid millions of dollars annually due to setting more
    accurate reimbursement levels for prescription drugs.
        In addition to moving toward a more accurate reimbursement
    for product cost, we are working to determine the most accurate
    dispensing fee that our program should pay the pharmacy. An
    August 2002 study completed by Myers and Stauffer L.C.
    Indicated that the actual statewide median cost of dispensing a
    drug in Texas Medicaid is estimated at about 90 cents higher
    than the current dispensing expense.
        Texas will continue to develop tools and request additional
    pricing information that will assist us in setting the most
    accurate reimbursement fee for our pharmacies. We will proceed
    with the following activities: One, continue developing
    aggressive State maximum allowable costs; two, require drug
    manufacturers to also report average manufacturer price; three,
    further define the accuracy of the price the wholesaler pays
    the manufacturer; and, four, analyze the feasibility of
    implementing a more accurate dispensing fee.
        These additional price points will allow Texas to cross-
    check all the reported pricing information to reach the most
    accurate product cost and dispensing fee for a product.
        In conclusion, Mr. Chairman, again, thank you, members of
    the committee, for giving Texas Medicaid an opportunity to be a
    part of this important panel. Texas Medicaid works very closely
    with our partners, drug manufacturers and pharmacies in a
    transparent manner, in a proactive way, and has tried to
    establish a fair process that works for all parties involved.
        [The prepared statement of David J. Balland follows:]

      Prepared Statement of David J. Balland, Associate Commissioner for
    Medicaid and the Children's Health Insurance Program, Texas Health and
                           Human Services Commission

        My name is David J. Balland, Associate Commissioner for Medicaid
    and the Children's Health Insurance Program (CHIP) at the Texas Health
    and Human Services Commission.
        Before I begin my testimony, I would like to thank you, Mr.
    Chairman, and the members of the Committee for inviting Texas to speak
    on such an important topic. We look forward to sharing our prescription
    drug reimbursement best practices with our federal and state partners.
        Our main goal in setting reimbursement for the Texas Medicaid
    prescription drug program, referred to as the Vendor Drug Program, is
    to make the reimbursement formula as fair as possible to all parties
    involved by reimbursing as close as possible to the pharmacies' actual
    cost of buying prescription drugs. Texas then works with the pharmacies
    to set an adequate fee to cover their costs to dispense that product to
    Medicaid recipients. In Texas, we spend about two billion dollars a
    year on prescription drugs for Medicaid clients (in state and federal
    dollars).
        Current Pricing System: Most states currently use private companies
    to access prescription drug pricing information by drug in order to set
    reimbursement levels for their pharmacies for prescription drugs
    dispensed in their Medicaid programs. These companies request pricing
    information from drug manufacturers by drug and then make this
    unregulated pricing information available to their clients for a fee.
        Unlike most other states, Texas does not solely rely on the pricing
    information provided by these private companies to set our
    reimbursement for prescription drug products due to the potential
    inaccuracy of the reported information and the actual cost of the
    product to the pharmacies.
        Problems with Earlier Pricing Systems: Texas Medicaid used similar
    pricing services as most states until the early 1980's when the Texas
    Vendor Drug Program studied ways to more accurately pay for drug
    products paid to pharmacy providers. The Texas Vendor Drug Program had
    long recognized that the average wholesale price in the commercial
    price database was greater than the amount that Texas pharmacies
    actually paid the wholesaler for a drug product. In other words, Texas
    Medicaid was reimbursing our pharmacies at a higher amount than the
    pharmacies actual price to purchase the drug product.
        In the early 1980's, Texas started requiring drug manufacturers to
    fill out an application (later referred to as a questionnaire) for
    their products to be considered for the Texas Medicaid list of covered
    prescription drugs (otherwise known as a formulary). In the
    questionnaire, drug manufacturers are asked to provide pricing
    information on a number of different kinds of actual prices for each
    prescription drug product in order to determine the appropriate
    reimbursement level for products purchased from different sources
    including:

     Average price pharmacies paid for product from a wholesaler, known as
            Average Wholesale Price;
     Price paid for product by the wholesaler and/or prescription drug
            distributor, known as Wholesaler Acquisition Cost;
     Chain warehouse price;
     Direct price to the pharmacy; and
     Similar pricing information.
        Steps Taken to Further Refine Pricing: The Texas Vendor Drug
    Program took specific steps to further refine the reimbursement amount
    paid to our pharmacies including:

    1. We put into place targeted prescription drug audits and pharmacy
            invoice audits; and
    2. We requested additional pricing information directly from drug
            manufacturers.
        Based on information from some out of state pharmacies and our
    Texas Medicaid regional pharmacists, who gather acquisition cost
    information in the public sector out-patient pharmacy market, Texas
    Medicaid Vendor Drug Program initiated two targeted drug invoice
    audits, one in early 2000 and the other in early 2001. Texas selected
    drug products with the greatest estimated discrepancy in pricing from
    drug manufacturers to review during the audits, including over 300
    brand name and generic prescription drug products.
        The audits found significant discrepancies between Texas Medicaid
    Vendor Drug Program reimbursement to our pharmacies and the amount the
    pharmacy was actually paying for most of the 300-plus products
    reviewed.
        Texas Medicaid Vendor Drug Program Targeted Audit Savings: As a
    result of these two targeted audits, the Texas Medicaid Vendor Drug
    Program updated the base reimbursement amount for most of these
    specific drug products. The reimbursement updates to pharmacies for
    most of the products reviewed saved Texas Medicaid an estimated annual
    savings of over $20 million in state and federal funds.
        In addition to the targeted specific product audits, Texas Medicaid
    Vendor Drug Program also completed an invoice audit of more than 670
    pharmacies in 2001-2002. This audit also indicated that Texas was
    reimbursing the pharmacies at a significantly higher amount than the
    pharmacies' cost to purchase their products from drug manufacturers or
    prescription drug wholesalers. Even though Texas Medicaid Vendor Drug
    Program proposed to change the prescription drug reimbursement formula
    after this audit, the program was unable to proceed with proposed
    changes due to legal challenges by the pharmacy association. This
    proposed rule was estimated to save Texas Medicaid millions of dollars
    annually due to setting more accurate reimbursement levels for
    prescription drugs.
        Dispensing Fee: In addition to moving towards a more accurate
    reimbursement for product cost, the Texas Medicaid Vendor Drug Program
    is also working to determine the most accurate dispensing fee that our
    program should pay the pharmacy.
        An August 2002 study completed by Myers and Stauffer L.C. indicated
    that the actual statewide median cost of dispensing a drug in Texas
    Medicaid is estimated at about 90 cents higher than the current
    dispensing expense. The dispensing costs were especially higher with
    specialty and urban pharmacies.
        Next Steps: Texas will continue to develop tools and request
    additional pricing information that will assist us in setting the most
    accurate reimbursement for our pharmacies. Texas Medicaid Vendor Drug
    Program will proceed with the following activities:

     Continue with developing aggressive state maximum allowable cost
            (MAC) on certain products;
     Require drug manufacturers to also report average manufacturer price
            (AMP) for products in the Texas questionnaire;
     Further define the accuracy of the price the wholesaler pays the
            manufacturer, known as Wholesaler Acquisition Cost, and
     Analyze the feasibility of implementing a dispensing fee that
            reflects actual cost to pharmacies in Texas.
        These additional price points will allow the Texas Medicaid Vendor
    Drug Program to cross check all the reported pricing information to
    reach the most accurate product cost and dispensing fee for a product.
        Conclusion: Thank you, Mr. Chairman and members of the Committee,
    for giving Texas Medicaid and opportunity to be part of this important
    panel. Texas Medicaid works very closely with our partners, drug
    manufacturers and pharmacies, and has tried to establish a fair process
    that works for all parties involved.
        In addition, we will proceed to be as flexible as possible while
    maintaining the best prescription drug prices for the state and federal
    government in the Texas Medicaid program. We must continue to seek the
    best value in order to be able to sustain this program that is so
    essential to the health of our vulnerable clients.

        Mr. Walden. Thank you. And I always try and do whatever I
    can to help Texas. It is important. My chairman appreciates
    that, too.
        Mr. O'Connell, thanks for being here.

                    TESTIMONY OF PATRICK J. O'CONNELL

        Mr. O'Connell. Thank you, Mr. Chairman. My name is Patrick
    O'Connell; I am an assistant attorney general and chief of the
    civil and Medicaid fraud section of the Texas Attorney
    General's Office. We thank you very much for giving us the
    opportunity to testify today.
        In 1999, then Texas Attorney General, now United States
    Senator John Cornyn, became concerned about fraud against the
    Texas Medicaid program and created a special Civil Medicaid
    Fraud Section within our Attorney General's Office. Our section
    utilizes the Texas Medicaid Fraud Prevention Act to initiate
    civil litigation to recover funds wrongfully taken from Texas
    Medicaid.
        One of the first cases we received was filed by a small
    Florida pharmacy, Ven-A-Care of the Florida Keys, whom you
    heard from today. Ven-A-Care brought information to us showing
    that certain drug manufacturers--not all--but certain drug
    manufacturers violated Texas law by intentionally reporting
    prices to the Medicaid program that did not remotely equal the
    prices they really charged for their products. As Mr. Balland
    has indicated, unlike most other States which derive their
    pricing information from third parties, Texas requires the
    manufacturers who want their products to be eligible for
    Medicaid reimbursement in Texas to fill out this questionnaire
    for each drug they wish placed on the formulary. When Texas
    relies upon an inflated price report in calculating a
    provider's estimated acquisition cost, the resulting
    reimbursement to providers is well above the provider's actual
    acquisition cost, thus providing pharmacies with unintended
    windfall profits.
        Based on the information that we received from Ven-A-Care
    as well as information we discovered in our own preliminary
    investigations, General Cornyn authorized us to intervene
    against three defendants in September 2000. This Texas lawsuit
    was the first ever State intervention in a qui tam case
    involving pharmaceutical manufacturer pricing fraud.
        The evidence we discovered in our lawsuits and
    investigation shows that some manufacturers make conscious
    deliberate business decisions to create enhanced spreads and to
    market the sale of their products based on those spreads. For
    example, we found that some manufacturers have engaged in the
    following activities: Purposefully reporting false and inflated
    wholesale prices to the Medicaid program in Texas; deliberately
    failing to report prices to certain classes of trade in
    violation of Texas law; instructing their sales personnel to
    market spreads to customers; creating spread sheets showing
    pharmacies how much more profit they can make off of Medicaid
    when purchasing one manufacturer's product over another; and
    tying sales personnel compensation to success in marketing the
    spread.
        We also found that some manufacturers actually kept two
    sets of computer records with prices, one with the inflated
    prices that were reported to their price reporting services and
    to Texas Medicaid, and another with their real contract prices
    that are used in their everyday business transactions with the
    manufacturers' customers.
        As of May 2004, we have settled with two defendants in our
    lawsuit for a recovery for the State and the Federal Government
    of $45.5 million. In both cases, Texas recovered more than two
    times the actual damages to the Medicaid program plus our
    costs, our attorneys' fees, and the attorneys' fees of the
    relater. It's important for the committee to remember that
    these were Texas State settlements only. Texas is approximately
    8 percent of the national Medicaid budget. So if you multiply
    it by 10 or 12, I think you can see the numbers involved.
        Our office continues to provide assistance to those
    authorities in other jurisdictions who are pursuing these
    defendants and other companies. We have developed close and
    cooperative working relationships with the United States
    Department of Justice and with the other State attorneys
    general who have initiated similar litigation. So far, 13 other
    States have followed Texas' lead and have sued various drug
    companies for false price reporting.
        The litigation in Texas is still pending against one of the
    three defendants we sued in 2000, and we are scheduled to go to
    trial against that manufacturer in the fall of next year. We
    have also intervened against three new additional defendants.
    The cases against those three defendants is in the discovery
    phase, and we anticipate trial in those cases to be reached in
    the spring of 2006.
        Despite our efforts, some unscrupulous manufacturers
    continue to devise ways to defraud our Texas Medicaid program,
    and we are doing everything in our power to bring those
    companies to justice. Our current Texas Attorney General Greg
    Abbott has committed the resources of the agency to these
    efforts.
        I would like to make clear that while Texas is pleased to
    have recovered these significant sums of money in the qui tam
    cases, litigation is clearly not the most efficient way to run
    this system. Our Texas Medicaid program has been required to
    spend thousands of man hours responding to discovery requests
    and preparing for hearings and preparing for and attending
    depositions in our litigation. The program could have used
    those hard earned tax dollars to provide more and better
    services if the Vendor Drug Program personnel were not tied up
    in the litigation caused by the very manufacturers who have
    been gaming our system. Thank you for your attention, and I
    will be available for questions.
        [The prepared statement of Patrick J. O'Connell follows:]

    Prepared Statement of Patrick J. O'Connell, Chief, Civil Medicaid Fraud
                Section, Office of the Attorney General of Texas

        Mr. Chairman and members of the Subcommittee: Good morning. My name
    is Patrick O'Connell. I am an Assistant Attorney General and Chief of
    the Civil Medicaid Fraud Section of the Texas Attorney General's
    Office. Thank you for inviting us to testify this morning. In my
    remarks, I will describe for you the efforts undertaken by the Texas
    Attorney General to identify and vigorously litigate against those
    persons and companies that defraud the Medicaid system in Texas.
        As you are aware, the federal False Claims Act has been in place
    since the Civil War. Texas adopted our version of the FCA in 1995. Our
    statute, the Texas Medicaid Fraud Prevention Act, is specific to fraud
    against the Medicaid Program. In 1999, then Texas Attorney General, now
    United States Senator, John Cornyn became concerned about fraud against
    the Texas Medicaid Program and created a special Civil Medicaid Fraud
    Section within the AG's office. Our Civil Medicaid Fraud Section
    utilizes the Texas statute to initiate civil litigation to recover
    funds defrauded from Texas Medicaid. One of the first cases we received
    was filed by a small Florida pharmacy, Ven-A-Care of the Florida Keys,
    Inc., who you heard from earlier today.
        Ven-A-Care brought information to us showing that certain drug
    manufacturers violated Texas law by intentionally reporting prices to
    the Texas Medicaid Program that did not bear a reasonable relationship
    to the prices for their products that were generally and currently
    available in the market place. Unlike most other states which derive
    pricing information from third party price reporting services like
    First Data Bank, Texas requires manufacturers who want their products
    to be eligible for Medicaid reimbursement to fill out a questionnaire
    for each drug they wish placed on the Texas Medicaid formulary. For
    each drug, the manufacturer must report its prices to various classes
    of trade: e.g., its AWP; its price to wholesaler and/or distributor;
    its direct price; special price to chain warehouse, etc. A drug company
    representative is required to sign the form and certify that the
    information included in it is accurate. Texas law also requires drug
    companies to update the Medicaid Program with any changes in reported
    pricing within 15 days of the change.
        When Texas relies upon an inflated price report in calculating a
    provider's estimated acquisition cost (``EAC''), the resulting
    reimbursement to providers is well above the providers' actual
    acquisition cost, thus providing pharmacies with windfall profits. The
    information brought to us by Ven-a-Care indicated that certain drug
    companies may have knowingly and purposefully misrepresented their
    reported prices to Texas in order to enhance or drive up the
    reimbursement to their provider customers.
        Under the Texas statute, we have broad powers to compel document
    production and testimony of potential witnesses. In 1999 and 2000, we
    used these civil investigative demand powers to require several
    manufacturers to produce documents. We also took examinations under
    oath of several industry representatives. Based on the information that
    we received from Ven-a-Care, as well as the information we received
    pursuant to the CID process, General Cornyn authorized us to intervene
    against threeVAC defendants in September 2000. The Texas lawsuit was
    the first state intervention in a qui tam case involving pharmaceutical
    manufacturer pricing fraud.
        The evidence we have discovered in our investigations shows that
    some manufacturers make conscious, deliberate business decisions to
    create enhanced spreads and to market the sale of their products based
    on the spreads. For example, we found that some manufacturers engaged
    in the following activities:

     purposefully reported false and inflated prices to Texas Medicaid--as
            well as to third party price reporting services--in order to
            create enhanced spreads;
     deliberately failed to report prices to certain classes of trade in
            violation of Texas law;
     instructed their sales personnel to market spreads to customers;
     created spread sheets showing pharmacies how much more profit they
            can make off Medicaid when purchasing one product over another;
     tied sales personnel compensation to success in marketing the spread.
        We also found that some manufacturers actually kept two sets of
    computer records with prices: one, with inflated prices that are
    reported to the price reporting services like First Data Bank, or in
    Texas' case, directly to the Medicaid Program; and another with real
    contract prices that are used in every day business transactions with
    the manufacturer's customers.
        In June 2003, we settled our case with one defendant drug company
    for $18.5 Million, and in May 2004, we settled with another for $27
    Million. The total recovery in both settlements was $45.5 Million. In
    both cases, Texas recovered more than two times the actual damages to
    the Medicaid Program, plus our costs and attorneys' fees. Since the
    federal government supplies approximately 62 cents of every dollar
    spent on Medicaid in Texas, so approximately 62% of the net settlements
    went to the United States Treasury.
        It is important to remember that these were Texas State settlements
    only. My office continues to provide assistance to those authorities in
    other jurisdictions who are pursuing these and other companies. We have
    developed close and cooperative working relationships with the United
    States Department of Justice and with other state attorneys general who
    have instituted similar litigation. So far, California, Kentucky,
    Florida, Minnesota, Connecticut, New York, Ohio, Arkansas, Wisconsin,
    West Virginia, Massachusetts, and Nevada have sued drug companies for
    false price reporting.
        Litigation in Texas is still pending against one of the defendants
    we sued in September 2000, and we are scheduled to go to trial against
    that manufacturer in the fall of next year. We have also intervened
    against three additional defendants. The case against these three
    defendants is in the discovery phase where we are taking depositions
    and exchanging documents. That trial is scheduled to begin in the
    Spring of 2006.
        I would like to briefly follow-up on the remarks from the Texas
    Medicaid Program. We have consistently found over the last five years
    of litigation that our Vendor Drug Program in Texas is one of the best,
    if not the best, program in the country. Texas is the only state thus
    far to require drug companies to report and certify their prices
    directly to our Medicaid administrators. This distinguishes Texas from
    all other Medicaid programs, which derive their pricing information
    from third party publishing services like First Data Bank. In addition,
    as you heard, Texas was the first state to move from AWP based
    reimbursement to wholesaler cost and the first to differentiate
    payments to chain pharmacies. In addition to these efforts, our Texas
    Program continues to search for new ways to improve. They have passed a
    law requiring drug companies to report their AMP to Texas Medicaid, and
    they intend to use the AMP as another benchmark for comparison with the
    prices reported by manufacturers. Unfortunately, to date, only 16% of
    manufacturers are reporting their AMPs.
        Despite our efforts, some unscrupulous manufacturers continue to
    devise ways to defraud Texas Medicaid, and we are doing everything in
    our power to bring those companies to justice. Our current Texas
    Attorney General, Greg Abbott, has committed the resources of the
    agency to these efforts. Through his leadership and vision, we have
    obtained the funding to increase our staffing to 8 lawyers plus support
    staff. With this additional staffing, we will be pursuing every
    manufacturer that we find has engaged in this type of activity.
        I would like to make clear that, while Texas is pleased to have
    recovered significant sums of money in these qui tam cases, litigation
    is not the most efficient way to run this system. The Texas VDP has
    been required to spend thousands of man hours responding to discovery
    requests and preparing for and attending depositions in our litigation.
    The program could have used our hard earned tax dollars to provide more
    and better services if VDP personnel were not tied up in litigation
    caused by manufacturers who game the system. In addition, without the
    help of relators like Ven-A-Care, who took great personal and financial
    risks to present their allegations, we would not have been able to
    obtain the significant recoveries in the DEY and Schering. We hope that
    you will ensure that, in whatever system implemented in the future by
    Congress, the States and the Department of Justice continue to have
    laws with strong penalties to force compliance.
        My time is about up. Thank you for your attention. I am happy to
    answer any questions.

        Mr. Walden. Thank you very much, Mr. O'Connell. I want to
    thank all of the panelists. Your testimony has been very
    helpful in our process here.
        Mr. Reinhart, I want to start with you with a question,
    because I think I heard you say in your testimony that Michigan
    updates its list of prices on a daily basis?
        Mr. Reinhart. For generic drugs, we do.
        Mr. Walden. And how do you do that?
        Mr. Reinhart. Well, our agency has significant staff
    constraints, so we have hired an outside entity that also is a
    pharmacist, and they monitor the market, they--each of the
    distributors, and they will adjust prices accordingly. If a
    pharmacist--and we do this all over the Internet. So if a
    pharmacist indicates that they couldn't find the drug for that
    price, our consultant will send them back and tell them two
    places where they can get it.
        Mr. Walden. And is this a nationwide service that you
    subscribe to, or is this a Michigan-only creation?
        Mr. Reinhart. This is a Michigan firm.
        Mr. Walden. Do you know if they work in other States?
        Mr. Reinhart. Not to my knowledge.
        Mr. Walden. All right. But you are able to update your
    pricing, then, on a daily basis?
        Mr. Reinhart. Well, we do that for generic drugs.
        Mr. Walden. Right.
        Mr. Reinhart. We still have the more traditional--for
    brand-name drugs, we do use the average wholesale price.
        Mr. Walden. And do you know what cost that is to the State
    to have that service, to utilize that service?
        Mr. Reinhart. It is minor. I think that component of--you
    know, I mentioned a $130 million savings. That component
    contributes about $40 million, and this service is less than a
    half a million.
        Mr. Walden. Per year?
        Mr. Reinhart. It's very modest. Right.
        Mr. Walden. Mr. Smith, why does it take CMS so long in some
    cases, as identified by Mr. Reeb and his colleague Mr. Vito, to
    update these lists when these generics come out? And how many
    people do you have dedicated and at what cost?
        Mr. Smith. Right now, there are about 700 drugs on the
    Federal upper limit. The last full update, I believe, was in
    2001. We have updated on a specific basis when drugs come on.
    And it is not just one drug, but we have to assure that there
    are three.
        Mr. Walden. Right.
        Mr. Smith. That is part of it. We have done 13 updates
    since 2001 to advise that these drugs would be put on the FUL.
        I think part of the delay is waiting for three. Part of the
    intensity is that we actually have to go back and do a
    verification ourselves to make sure that those prices are
    indeed available at that price.
        Mr. Walden. Would you admit that the system that's being
    used today or has been in use up until today simply isn't
    functioning as well as it should for the taxpayers?
        Mr. Smith. I would agree that we have done it on a
    historical basis, and it's time to update what we are doing and
    how we are doing it. And, as I said in my opening statement, a
    lot of our activity has been involved with providing other
    tools to the States. Obviously, this is an operational one. But
    we appreciate----
        Mr. Walden. I know. But I go back to--I've read through the
    IG's draft report and the testimony today, and it just seems
    that the problem remains, despite repeated suggestions. And I
    am not picking on you, but it is just something we all need to
    get involved in and figure out from our end what we need to
    fix, and I think from CMS's end, specifically Fluoxetine--there
    were 8 or 9 generics in the market the day that the exclusivity
    period ended, and yet it took a considerable length of time to
    update the list. Right?
        Mr. Smith. Again, that update was our own verification that
    those prices----
        Mr. Walden. And how long did it take to update?
        Mr. Smith. It took approximately a year to do that
    verification.
        Mr. Walden. And do you know how much loss to the taxpayer
    occurred during that period?
        Mr. Smith. I have not calculated it.
        Mr. Walden. Compared to if an update had been done quicker?
        Mr. Smith. I think this has shown us that we need to update
    our internal procedures.
        Mr. Walden. One of the findings in the OIGs report--or
    recommendations--is that there is a new group of generics about
    to come onto the market that could have--there are substantial
    costs associated with them. And so it seems clear to me as a
    business owner that it is going to be important from a business
    standpoint that your agency be ready to go to put those on the
    upgraded list. What assurance can you give our committee that
    that will happen short of a year or 10 months?
        Mr. Smith. We are looking at that in itself and understand
    windows will be coming into the market, and we will move
    quickly. But again, it is incumbent on us to do that
    verification that they are available as well. But we will do
    that.
        Mr. Walden. Do you need better notification from FDA when
    generics are going to come on the market? Do you get that
    today?
        Mr. Smith. I think we use the same resources that all
    purchasers have available to them. This information is
    available. We look at three different commercial products that
    are available just as other purchasers and insurers do as well.
        Mr. Walden. I want to go to that. Mr. Reeb, Mr. Vito, maybe
    you can tell me. I am told that some of the big purchasers on
    the private side, on the insurance side, move pretty rapidly
    when generics come to market in terms of adjusting their price
    structures. Are you familiar with that?
        Mr. Vito. We are not, sir.
        Mr. Walden. Do you agree with what Mr. Smith says in terms
    of the problems associated with trying to update? I mean, I
    have read your recommendations. It seems like there is a real
    issue here in terms of being able to move swifter than we are;
    is that correct?
        Mr. Vito. We believe there is a problem. We believe that it
    can be resolved by having a dedicated effort on CMS's part. We
    understand the amount of significant work that is involved in
    maintaining the list, adding the products to the list and
    deleting them. But it is certainly manageable if the FTEs are
    applied to it, the resources are applied to it that are
    necessary. It is our estimation that if you put these resources
    to that goal, the savings to the program, both the Medicaid and
    the Federal Government, will far exceed the cost that you
    would----
        Mr. Walden. That is what seems obvious to me is, wow, you
    are talking about literally hundreds of millions, if not
    billions of dollars, and we have got a big hole in the bucket
    draining out all those savings quickly. How difficult would it
    be to update this on a more timely basis? How many people do
    you think it would take?
        Mr. Vito. In our estimation, I think that would be better
    answered by CMS. However we can say that if it is 1, 2, 3 FTEs,
    whatever those numbers are, the cost of those FTEs will be
    certainly outweighed by the savings that can be achieved to the
    program.
        Mr. Walden. I want to make sure I am not mixing the
    proverbial apples and oranges here. Is the price updating
    information that Michigan is doing using this outside service
    comparable to what we are talking about for updating these
    lists?
        Mr. Vito. I am not familiar with what Michigan is using. I
    could tell you, though, that it appears that they are doing
    more than just looking at the red book and the blue book and
    the MediSpan, the drug compendiums; is that correct?
        So it would be different.
        Mr. Walden. It would be different in terms of their
    resources to identify the prices?
        Mr. Vito. I believe that the Medicaid program, they are
    required to use the drug compendiums to identify the lowest-
    priced product and then add 150 percent to that. I believe that
    is what CMS does.
        Mr. Walden. Is that correct, Mr. Smith?
        Mr. Smith. That is correct. The rebate provision of the
    Medicaid law itself, established the parameters that we work
    with.
        Mr. Walden. So that is where we need to come into focus
    here to fix that if that is indeed the problem.
        Let me ask about the rebates AWP versus AMP because it
    looks like we are paying at one schedule and reimbursing based
    on a different price. Is that correct, Mr. Reeb and Mr. Vito?
        Mr. Reeb. We issued a report a couple of years ago exactly
    saying that. We estimated that about a billion dollars could
    have been saved over a 3-year period had the rebates been paid
    using AWP. We don't like AWP, but if you are going to reimburse
    under AWP, then it doesn't seem to make sense to us to have a
    rebate process that uses average manufacturers price. You are
    using two different sets of numbers to basically try to bring a
    little bit more----
        Mr. Walden. So how much are we losing as a result of this
    mismatched pricing?
        Mr. Reeb. We estimated about a billion dollars for a 3-year
    period ending around 1997 or so, but we are updating the data
    presently, and it is at least that much in present day----
        Mr. Walden. I would think with the growth in the percentage
    of Medicaid that is prescription drugs, it would be at least
    that, if not significantly more, when you look at the rapid
    escalation in costs in the last few years.
        Mr. Reeb. We believe--and again, we are not supporting AWP
    as necessarily being a good basis, but if you are going--most
    States use that in some form in their reimbursement process.
    Then, if in the rebate process you use that, it would at least
    bring another pressure point on the system, the industry, as
    to--if you are going to raise AWP, then you run the risk of
    making the spread greater to the best price which is how the
    rebate calculation uses those two sets of numbers.
        Mr. Walden. And just quickly, in your report from a couple
    of years ago, you also looked at Oregon's Medicaid system and
    found that it wasn't operating appropriately and some $20
    million in problems there. Do you know if they have responded
    in a positive way to your recommendations?
        Mr. Reeb. I don't know specifically, sir.
        Mr. Walden. Okay. I will get back to you on that.
        Mr. Stupak, I would like to turn to you now for 10 minutes.
        Mr. Stupak. Thank you, Mr. Chairman. I am sorry, most of
    this hearing I was in another hearing. But it is good to be
    here and to welcome Mr. Rinehart from Michigan. I did read your
    testimony.
        A couple of questions, Mr. Rinehart, if I may. How much do
    you estimate that Michigan saves each year under the preferred
    drug list that you have been using?
        Mr. Rinehart. It's difficult to precisely partition--the
    preferred drug list and the multi-State work hand in hand. I
    said it earlier that our pricing strategies save about $40
    million. So this other component will be about $90 million.
        Mr. Stupak. Has anyone lost their prescription drug benefit
    as you saved this money?
        Mr. Rinehart. No. No one has lost money.
        Mr. Stupak. Michigan has been very aggressive in cutting
    their Medicaid prescription drug costs, particularly in the
    generic area. Do you think that your maximum allowable cost or
    MAC is more aggressive than most States?
        Mr. Rinehart. I think it is. I think the daily component
    and the use of technology to convey those prices to pharmacists
    is a little more aggressive.
        Mr. Stupak. The daily component, you said you MAC change
    your prices every day?
        Mr. Rinehart. We do.
        Mr. Stupak. In your testimony you outlined how Michigan has
    benefited from prescription drug pooling purchase. The
    purchasing pool plan was approved in April; correct?
        Mr. Rinehart. April 22.
        Mr. Stupak. Okay. And I know you have explained the
    clawback in your testimony as part of your Medicare
    prescription drug bill. Can you please briefly explain it
    again? Specifically what does it mean to Michigan, the clawback
    prevision in the Medicare bill?
        Mr. Rinehart. Sure. States are required to help finance the
    drug benefit for dual eligibles. And our contribution will be
    calculated using our 2003 per person expenditures, per capita
    expenditures, inflated through 2006, and the index that most
    people cite, it's an 11 or 12 percent annual increase. And as I
    tried to argue earlier, our annual increases are below 5
    percent currently because we have been so aggressive in
    managing the benefit. So even though in 2006, when the
    declining percentage will pay 90 percent of that per capita
    amount, it is still more than we think we could have managed
    the benefit to because of our lower growth rates.
        Mr. Stupak. Sure. Because you are below that 11 percent,
    and making an assumption on 11, you are doing it at 4;
    therefore, you are going to have to pick up that 6, if you
    will?
        Mr. Rinehart. Yes.
        Mr. Stupak. How does this compare to other items in
    Michigan's Medicaid budget?
        Mr. Rinehart. The pharmacy expenditure line grew at a much
    lower rate than the balance of the program. I included a chart
    in my written testimony that shows the caseload. The caseload
    has dramatically increased in Michigan. So everything is
    growing, but this particular line grew at a rate somewhat below
    the balance of the program.
        Mr. Stupak. Is it fair to see that the clawback provision
    is going to cost Michigan about $30 million in 2007?
        Mr. Rinehart. On a full-year basis, in 2007, $30 million
    State resources, yes.
        Mr. Stupak. What about other States? Do you have any idea
    what will happen there?
        Mr. Rinehart. In talking to my colleagues, States that have
    been aggressive in constraining the growth in pharmacy
    spending, if they started in 2002, 2003, and I think it is
    likely they will also increase, my colleague from Ohio was
    talking about an $80 million figure.
        Mr. Stupak. So the States that have been aggressive in
    trying to provide prescription drug coverage underneath the
    Medicaid plan, but still trying to save taxpayers money
    underneath the so-called Medicare reform bill that was passed
    are actually going to be punished now with the clawback
    provision?
        Mr. Rinehart. At least initially. The State percentage
    declines to 75 percent. So at some point, perhaps we will reach
    a break-even point, but certainly initially, we feel costs will
    exceed what we would have spent.
        Mr. Stupak. Mr. Balland, you are a much bigger State than
    Michigan. Do you agree with that that the clawback provision
    will cost States money, and if so, how much in your State?
        Mr. Balland. Yes, sir. I do agree it will cost--the
    estimate in Texas, I am not certain what that figure is.
        Mr. Stupak. Mr. Rinehart, Michigan's annual increases in
    prescription drug expenditures are below the national average
    than the other States. So when you get to this clawback, the
    only thing we can do to relieve you of that is to repeal that
    part of the bill?
        Mr. Rinehart. You could--I would have----
        Mr. Stupak. Are there any other ways you can think of----
        Mr. Rinehart. You could accelerate immediately to the 75
    percent.
        Mr. Stupak. As opposed to the 90?
        Mr. Rinehart. As opposed to the 90. That would be very
    helpful. Or 100 percent.
        Mr. Stupak. 100 percent, I am sure, would be better. Let me
    ask you in a different area, Sunday there was an article in The
    New York Times that CMS has no plan for moving elderly nursing
    home patients on Medicaid to the new Medicare drug benefit
    program, and that it is possible for these patients to select a
    drug card. How is Michigan going to do that, because that is
    that dual eligible again?
        Mr. Rinehart. Sure. That is very important and we are very
    concerned about that. We are working hard. Michigan was one of
    the States that did receive a grant from CMS for education and
    outreach. Recently, I know Mr. Smith has indicated, that there
    will be an open enrollment period prior to December. But in
    December, States will be allowed for those that haven't
    selected--I think this is true--States would be allowed to
    automatically enroll beneficiaries into a card. So that at
    least should avoid an interval with no coverage, but it will be
    a fair amount of work.
        Mr. Stupak. Mr. Balland, do you care to comment on that
    aspect of it about selecting the card there?
        Mr. Balland. I am sorry. Say that again, sir.
        Mr. Stupak. Sure. The article--I don't know if you saw it--
    in The New York Times this past Sunday. It was about that CMS
    has no plan for moving the elderly nursing home patients on
    Medicaid to the new Medicare drug benefit program, and that it
    is impossible for these patients to select drug cards. So how
    would Texas approach this? You have no longer dual eligibility
    underneath the Medicare reform bill that has passed.
        Mr. Balland. No. And we would have to analyze that further
    to see exactly what the impact would be on Texas.
        Mr. Stupak. Mr. Reeb, if I can ask you a question. In a
    2001 report on Medicaid's use of the average wholesale price,
    the OIG concluded that the reliance on the reported average
    wholesale price as a basis for drug reimbursement was
    fundamentally flawed and CMS said it would look for solutions.
    In its October 2003, report, the OIG recommended that CMS--and
    I am quoting now--``review the current reimbursement
    methodology, work with States to find a method that more
    accurately estimates pharmacies' acquisition costs and initiate
    a review of Federal Medicaid rebates.'' Did CMS ever do this?
        Mr. Reeb. I don't think any action, as such, directly has
    been taken, but I believe CMS has brought the issue up to the
    States as a part of normal operations. I don't believe, as
    such, a fundamental change in the process has a occurred yet,
    but perhaps, Mr. Smith----
        Mr. Stupak. I was going was going to say, Mr. Smith, could
    you comment on that? Can you tell us why CMS has not worked to
    develop a more accurate acquisition cost for the States to work
    with?
        Mr. Smith. I think we have provided updates to the full
    list. I think much of our attention has been on helping States
    find other ways, such as the purchasing pools and prior
    authorization, et cetera. So I think we have had a great deal
    of activity with the States in helping them to find ways to
    save money in the Medicaid program.
        Mr. Stupak. But the report which said it was fundamentally
    flawed really looked at CMS and the way the drug reimbursement
    was done, and they said it was fundamentally flawed, and you
    said you would look for solutions. Other than working with
    States have you come up with any solutions?
        Mr. Smith. Wgain, we have to work within a framework of
    making certain that there are at least three alternatives and
    to validate that they are available at those prices. That is an
    intensive process. And as I stated earlier, we are looking
    internally at how we can improve the way we do update the FUL
    on a quicker basis.
        Mr. Stupak. Yes. But the way you base it upon they said was
    fundamentally flawed. So even if you are doing all of this,
    unless you take care of the fundamental basis of it--I mean, is
    there any logic to States reimbursing on the average wholesale
    price while the rebates are actually based on the average
    manufacturing price, and that is not really shared with the
    States? So, I mean, where is the logic here?
        Mr. Smith. Mr. Stupak, in terms of that basis, that comes
    from Title XIX itself. That comes from the law wherein Congress
    established how we do it back in 1990, in terms of having those
    two different standards.
        Mr. Stupak. So wouldn't CMS recommend to the Congress
    having to change the law so you would have a real good basis,
    not an average wholesale price, but the average manufacturing
    price which would save everyone a lot of money?
        Mr. Smith. I believe we have twice put in the President's
    budget recommendations to address the pricing. On the pricing
    itself also I would like to----
        Mr. Stupak. But in the President's budget that won't change
    it unless we change the law.
        Mr. Smith. That is correct.
        Mr. Stupak. So shouldn't you really come to Capitol Hill
    and ask us to change the law on that so you could use the
    average price?
        Mr. Smith. Certainly Congress has to take that action
    itself.
        Mr. Stupak. Did CMS recommend that----
        Mr. Smith. We did not submit legislation, no.
        Mr. Stupak. Did you recommend that they do it in the
    Medicare reform bill last August?
        Mr. Smith. In Medicare, I believe it went to the average
    sales price instead. In terms of the consideration of changing
    Medicaid at the same time, I don't know to what extent that----
        Mr. Stupak. And we should do it for Medicare and Medicaid;
    right? We shouldn't have two different systems?
        Mr. Smith. We do have two different systems. We do have
    different systems on acquisition and in the rebate programs. I
    don't think that Medicare has the rebate program that Medicaid
    does. I know we have focussed a lot on the manufacture side,
    but I do want to at least bring to the subcommittee's
    attention, when you talk about AWP, it has an impact on the
    pharmacy as well. The pharmacy is being paid not only for its
    acquisition, but also storage and counseling the Medicaid
    patient as well. Most States price their purchase on an AWP
    minus 10 percent to AWP minus 15 percent but they also add on a
    dispensing fee. That dispensing fee has large variation among
    the States. So when you look at the price that a State says in
    its State plan, ``This is what I want to reimburse our
    pharmacies for,'' they are looking not just at the cost of
    acquisition, but also counseling that Medicaid patient. Many
    argue that the Medicaid recipient needs additional time at the
    pharmacy, and you are compensating the pharmacy for that as
    well. And in addition, again, how Medicaid differs----
        Mr. Walden. I understand the gentleman has one more
    question.
        Mr. Stupak. Yes, one more question if I can. While I have
    you here, the CHIPS program, as you know, back on September 30,
    2004, more than a billion dollars of funding under the CHIPS
    program was reverted back to Treasury. This money is money that
    States could have used for coverage. A number of States have
    insufficient funding this year, and over the next 3 years, more
    than 17 States are projected to have inadequate funds to cover
    their current children population. There is bipartisan
    legislation in the House and Senate to address this matter, but
    the way I understand it, the administration objected, publicly
    stating he wanted to spend the money to do more outreach
    instead. My question is if the State doesn't have enough money
    to cover the kids they currently cover, what good does it do to
    do more outreach to bring more people in a program when you
    don't have enough money to cover the kids to start with?
        Mr. Smith. Sure. First, the money that expired, that money
    expired when Congress created S-CHIP. We created it on the
    basis that States would have 3 years to spend their allotments.
    The authority to spend the money dated back to 1998, 1999, and
    2000. That money was unspent because the States themselves
    didn't have enough kids covered so that they needed those
    resources.
        In terms of 2005, Congress gave the Secretary the authority
    to redistribute unspent allotments. You are taking from one
    State that didn't use the money to give it to another State.
    That, in itself, we project and the States project, will be
    sufficient funding through the end of 2005, because you are
    adding that money plus 3 years of allotments including the new
    2005 allotments.
        In terms of the legislation that was introduced that was
    based on a formula, that formula, in itself, would have left
    States with shortfalls in the long term. It did not solve all
    the problems.
        Mr. Stupak. We are not saying it is going to solve all the
    problems. We are saying States that don't have enough money to
    cover the kids, we wanted the money--a bipartisan group wanted
    the money to go back to the States to cover kids. Instead, the
    administration said no, we are going to use it for outreach to
    bring more kids in the program. We don't have enough money to
    cover the kids in the program. Why bring more kids in? A lot of
    us saw it as sort of the way of administration saying we will
    give it to you next year but only if we can block grant the
    Medicaid program back to the States, which would leave the
    States even further underfunded.
        Mr. Smith. Well, I think what the President announced was
    that we should use money that the States themselves said ``We
    aren't going to use this money based on coverage.'' The first
    step to increasing insurance is to actually enroll kids for
    programs they are already eligible for. And the second part of
    that was that Congress should come back and reauthorize the S-
    CHIP program. It has done great things. We are at record levels
    in coverage for kids and we want to do more.
        Mr. Walden. Thank you, Mr. Stupak.
        Mr. Stupak. Thank you, Mr. Chairman.
        Mr. Walden. I am going to turn now to the chairman of the
    full committee, Mr. Barton, for questions.
        Chairman Barton. Thank you, Mr. Chairman. Before I go into
    questions, I have got a point of personal privilege. I would
    like to introduce my wife, Terry Barton, who is right behind
    me; my district director, Ron Wright from Arlington, Texas; and
    his wife, Susan Wright. I introduce them to the committee. Just
    a little bit of a personal break.
        I am going to direct most of my questions to our two
    friends from Texas who have testified. And I am going to start
    by reading part of the statement that Mr. O'Connell has already
    put into the record. On Page 3 of his statement he talks about
    some of the things that the State of Texas did in their
    investigation, and I am going to read a part of it and then ask
    Mr. O'Connell a question.
        ``the evidence that we discovered in our investigation
    shows that some manufacturers made conscious, deliberate
    business decisions to create enhanced spreads and to market the
    sale of their products based on these spreads.
        For example, we found that some manufacturer engaged in the
    following practices: One, purposefully reported false and
    inflated prices to Texas Medicaid as well as to third-party
    price reporting services in order to create enhanced spreads;
    two, deliberately failed to report prices to certain classes of
    trade in violation of Texas law; three, instructed their sales
    personnel to market spreads to customers; four, created
    spreadsheets showing pharmacies how much more profit they can
    make off Medicaid when purchasing one product over another;
    five, tied sales personnel compensation to success in marketing
    the spread.
        We also found that some manufacturers actually kept two
    sets of computer records with prices. One with inflated prices
    that are reported to the price reporting services like First
    DataBank or, in Texas's case, directly to the Medicaid program
    and another with real contract prices that are used in everyday
    business transactions with the manufacturers' customers.'' Mr.
    O'Connell, because of these results of the investigations that
    Texas attorney general's office found, what was the result of
    the lawsuits that were brought by the Texas Attorney General?
        Mr. O'Connell. As I indicated earlier Mr. Chairman, so far
    we have collected $45.5 million, and that is more than twice
    the amount of what we believe were the damages incurred by the
    Texas Medicaid program. And in addition, we recovered the
    attorneys' fees and costs of the Attorney General as well as
    related----
        Chairman Barton. Are there any lawsuits that are still
    pending?
        Mr. O'Connell. Yes. We have one still pending against
    Roxane Pharmaceuticals, which will be taking place in fall of
    2005, and then we have also sued three other manufacturers:
    Abbott Laboratories, Braun/McGaw Pharmaceuticals, as well as
    Baxter.
        Chairman Barton. So the only lawsuits that have been
    concluded that the State of Texas has won, and you've got four
    other pending lawsuits?
        Mr. O'Connell. And we have settled two. One with DEY
    Laboratories; one with Warwick, a division of Schering. And we
    have four others. And then Senator Cornyn, when he was Attorney
    General, made clear that there were other investigations going
    on, and we are proceeding as quickly as we can with the
    staffing that we have.
        MChairman Barton. Is it reasonable to expect that the
    lawsuits that haven't been settled that are still pending, the
    outcome is going to be similar to what has already occurred?
        Mr. O'Connell. We certainly expect so, yes, sir.
        Chairman Barton. That would be obvious--that is what I
    would think. What has Texas done to change its Medicaid system
    as a result of these same investigations? Have there been
    changes in the way Texas administers its part of Medicaid that
    deals with prescription drug reimbursement?
        Mr. O'Connell. Absolutely. And Mr. Balland may be able to
    speak to it more than I. But I do know that because of the
    prices that we have found in our investigations, they have
    conducted audits, spent significant sums of money to conduct
    these audits, which I don't believe they should have had to do,
    in order to get the real pricing that the pharmacies and
    wholesalers are paying for these products. They then lowered
    the reimbursement rates in Texas for those particular prices.
    And in addition, and more importantly, the maximum allowable
    cost that was referred to earlier that Texas maintains in those
    MACs were lowered significantly as well. And in most cases, my
    understanding is the Texas MAC is significantly lower than the
    Federal upper limit that is currently in place.
        Chairman Barton. Mr. Balland, do you want to elaborate on
    the changes that Texas has made in its system?
        Mr. Balland. Yes, sir. Thank you, Mr. Chairman. That is
    correct. We--75 percent of the time, Texas pays lower than the
    Federal upper limit. Also, we have refined the pricing
    methodology in the State to make it much more accurate. We also
    have three points that we feel makes the vendor drug program in
    Texas unique, and that is, No. 1, we have a pricing system that
    is proactive and transparent in determining the most accurate
    prices; No. 2, we have within our vendor drug program a
    formulary unit which is dedicated and focused to determining
    the most accurate of prices; and then No. 3, we are the only
    State that has a questionnaire that we require the
    manufacturers to answer with specific pricing points that help
    us refine those true prices.
        Chairman Barton. Is there any manufacturer or distributor
    that because of the changes that Texas has made or because of
    these lawsuits has chosen to not serve Texas? Has somebody
    backed out and said we don't want to play in that market
    anymore?
        Mr. Balland. No.
        Mr. O'Connell. Not only that, Mr. Chairman, the number of
    pharmacies that are participating in the Medicaid program have
    gone up over the last number of years instead of gone down.
        There was one thing that the Medicaid program did that I
    think was particularly important, I think, and that is that a
    rule was passed requiring manufacturers to report their AMPs
    directly to Texas. The rule required that the AMPs maintain
    confidential--as you know, CMS gets those AMPs but they are not
    provided to the States. So far, only 16 percent of the
    manufacturers have complied with that rule and we have a
    problem when----
        Chairman Barton. The AMP is the average manufacturing
    product----
        Mr. O'Connell. The actual manufacture price for the
    previous quarter, which would be akin to the average sale price
    that you have instituted in Medicare. Only 16 percent of the
    manufacturers have cooperated with us so far in that regard.
        Chairman Barton. I just want to recapitulate because I am
    about to run out of time. The Texas Attorney General, who is
    now the United States Senator from Texas, decided that there
    was reason to believe that fraud or corruption was occurring in
    the Medicaid program in terms of prescription drug payments in
    Texas; so he instigated an investigation that has so far
    resulted in several lawsuits being successfully concluded and
    the State and the Federal Government have recouped over $45
    million. We have got 3 or 4 lawsuits that are currently
    pending. In addition, the State of Texas has changed the way it
    administers the Medicaid program. Because of those changes,
    there are significant cost savings. No provider has chosen not
    to provide so that so far it is a win-win for everybody in
    terms of honesty and good government.
        My last question is, is there any reason to believe that
    some system similar to what the State of Texas has instigated
    would not work at the Federal level if we did something
    similar?
        Mr. O'Connell. In my opinion, no. Obviously the concern
    that we have is Texas has spent a tremendous amount of money to
    institute this system, and I think most States, certainly the
    smaller States, probably don't have the funds to do that. And
    the more money you spend trying to get the number right, the
    less money you have to spend on your beneficiaries.
        Chairman Barton. But the two representatives from Texas
    think that what Texas is doing in a similar way, obviously
    would have to be massaged to some extent, could be used in
    other States?
        Mr. Balland. Absolutely.
        Chairman Barton. All right. I want to ask Mr. Rinehart, who
    I think is from Michigan, do you agree with that? Do you think
    that what Texas is doing might be useful in Michigan?
        Mr. Rinehart. Yes, I do.
        Chairman Barton. Mr. Smith, Mr. Reeb, Mr. Vito, do you all
    see any reason to believe that something similar to what we're
    doing in Texas couldn't be used at the Federal level and other
    State levels? Anybody?
        Mr. Smith. I think, Mr. Chairman, it goes back to part of
    the fundamentals of Medicaid. The Federal Government is working
    with upper limits and frameworks. You've heard two good
    examples today, of how the States themselves are involved in
    getting prices lower than what the Federal upper limits would
    have allowed. So that's the way Medicaid works.
        Chairman Barton. But I mean does anybody on this panel,
    before we turn it back because I have got about a minute left,
    fundamentally think we ought to just maintain the status quo?
    Is everybody in agreement that we ought to change the status
    quo and if it is necessary to do that by Federal statute that
    we ought to do that, we ought to actually change the Federal
    law? And I'm not saying we go to exactly what Texas is doing,
    but to go to some system that really is based on actual sales
    prices with auditing and backup so that we have a transparency
    in the system so that anybody that has an interest can find out
    what's really going on? Is there anybody that disagrees with
    that? Let the record show that all the heads are saying they--
    --
        Mr. Smith. I think everybody wants better than what we
    have.
        Chairman Barton. All right. With that, Mr. Chairman, I
    yield back the balance of my time.
        Mr. Walden. The gentleman yields back the balance of his
    time.
        The Chair now recognizes the gentleman from Michigan, Mr.
    Rogers.
        Mr. Rogers. Thank you, Mr. Chairman. I want to commend
    Chairman Barton for holding the hearing. One thing I have found
    through this whole process is when you look at the monumental
    occasion that happened here not so long ago, the first time
    ever under Medicaid trying to provide a prescription drug
    benefit, and hopefully apply some common sense, it was so big,
    we have some problems. And I know my good friend, Mr. Stupak
    from Michigan, was talking about why don't we fix the Medicaid
    portion of it. We're still trying to figure out if we exactly
    got reimbursement right for oncology, and we're really talking
    about pharmacies in the Medicaid and trying to figure that out.
    We still have issues that we have to work out. It is a
    complicated, complicated--too complicated obviously. I think we
    have decided that. Better transparency, better availability for
    information.
        Mr. Rinehart, I want to congratulate you in the State of
    Michigan. You have been aggressive and you have certainly given
    credence to the old saying that no good deed goes unpunished,
    at least in the first couple of years. But I want to make sure
    we are comparing apples and apples. I think you have
    acknowledged that when it gets down to that 75 percent mark,
    that is going to be a true savings for Michigan that is in this
    bill.
        And as I understand your numbers, you didn't add in that 28
    percent subsidy that is being paid to a State like Michigan to
    its retiree benefits. So there is a big chunk of money that is
    being able to be applied to Medicaid or any other issue the
    State decides.
        Mr. Rinehart. That is true. No, I did not. I just focussed
    on Medicaid----
        Mr. Rogers. So it's not really a true loss. What is really
    deceptive here is we have got the two best, I think, in the
    State. I think you are No. 1 and No. 2 for keeping your costs
    down. I have imagined if we put all the States in a hat and
    drew two out, we'd have a whole different story here about cost
    containment on Medicaid prescription drugs. This has kind of
    given us a bit of a distorted view on why we're at and I think
    why that formula was there.
        I will offer you this commitment, that I will work with
    Chairman Barton to make sure that we institute at least a
    little fairness and not punish the States that have been
    aggressive about keeping their costs down. But I would caution
    that next year's an estimate for you. You've done a great job.
    You've come down. The numbers over the last few years were very
    impressive. That is wonderful. We just want to make sure that
    number continues, because it is a guess right now, and you are
    making a best guess, and we want to make sure we're accurate.
    We don't want to punish you for doing great things, but we
    don't want to give you extra money for having a little bit of
    progress and falling back either.
        So as you can imagine, with 48 States in the mix, it is
    pretty complicated for us to get to the right conclusion. These
    hearings are incredibly important for us to understand how we
    tweak this thing and make it better and more service-oriented,
    especially in cases exactly like this.
        And just to CMS, I'll throw you under the bus. I am
    hoping--you've really enjoyed that today. I can tell by that
    expression and the sweat on your brow that you love that. I
    mean I hope that we are going to allow--and my understanding
    and reading of this and through staff consultations is that
    there is a little wiggle room that is not hard, fast, and
    certain, that CMS will have some ability to make some judgments
    to look at how their costs--how they're charging back on that
    clawback provision; is that correct?
        Mr. Smith. Offhand, I'm not certain what wiggle room you
    might be referring to. But I think overall, the way the State
    contribution, as we call it, is calculated, is off of a base
    year. Congress enacted this a year ago. They had to establish
    something as a base so 2003 was the calendar year that they
    used because that way the expenditures were what they were. It
    was set, instead of basing it on estimates. And then it was
    indexed by national health expenditures.
        That, in itself, historically, is of benefit to States
    because the growth in prescription drugs in the Medicaid
    program is generally higher and historically higher than
    national health expenditures. So right off the bat, Congress
    provided a way for the States to save money by doing a lower
    rate of growth.
        When you get States like Michigan and Texas that then have
    become more aggressive than what the national health
    expenditures have been, that is to the good on both sides
    because then they are saving that much money for the rest of
    the Medicaid program as well. So I don't see----
        Mr. Rogers. You mean projected growth sayings is what you
    are saying over time?
        Mr. Smith. Correct. Because they are saving that for the
    entire population, not just----
        Mr. Rogers. So even States like Michigan and Texas, and I
    heard Ohio mentioned, at the end of the day at the 10-year--
    they are all reaping rewards from this bill.
        Mr. Smith. Yes. They all, compared to the baseline, will be
    spending less than what they would be doing.
        Mr. Rogers. Which is a benefit. And, Mr. Rinehart, again, I
    congratulate what you are doing. I know in November you went to
    this outside contractor. I think that's a great way to do it.
    As I looked at it, and I would just be interested in your
    thoughts on it, but one of the immediate issues I guess that I
    looked at that raised my eyebrow was that you are only dealing
    with distributors. So there may be even a better way to do it.
    And I'm not condemning what you did. I think it's a great
    thing. But have you look at other ways to try to do that?
    Because you are contracting with a firm who is taking
    distributor prices. As you sat through the net and through
    other places, can you tell me cost savings, can you tell me a
    better way to do it?
        Mr. Rinehart. The savings on this firm we estimate that
    about $40 million in 2004. I have learned a lot today about--we
    are dealing with a distributor, and there's a step before that
    that I think could be done. I don't know how Michigan could do
    it by itself, but get better pricing information at that level.
    We still use the average wholesale price for brand name drugs,
    and that's half of our spending. So any attempts to--any
    efforts to improve the accuracy of that, that would be very
    helpful as well.
        Mr. Rogers. I appreciate it. Mr. Smith, I just want to go
    back to this New York Times article, and I didn't get a chance
    to read the whole thing, but my understanding is they are not
    ineligible, they are just worried about their capacity in order
    to have access; is that correct?
        Mr. Smith. That's correct. Most definitely they are
    eligible, and most definitely they will be enrolled. The issue
    is really trying to take the overarching concept of competition
    among plans and applying it to a specialty market in long-term
    care. So, this is something that we believe we are making great
    progress on, and when the final rule is developed, I think
    people will see that the concern has been alleviated. But most
    definitely we are going to be auto-enrolling all these
    individuals who are dual-eligibles so they will become eligible
    and matching them up with a plan that will do what they do
    today for low-income seniors. It's kind of a specialty market
    with the long term-care pharmacy providers themselves and
    helping them to work with the plan sponsors, developing the
    product that will meet the needs of low-income citizens.
        Mr. Rogers. And as I understand it, please correct me if
    I'm wrong, but there was kind of a loose framework there under
    Medicaid that they hope will have a better management structure
    under Medicare, just getting an understanding of the cost. It
    doesn't mean it is going to diminish the services, doesn't mean
    it's going to diminish what they are certainly eligible for.
    But it is forcing us to go through an understanding of exactly
    how we implement it, which means we will have a better idea of
    what cost and what it truly and accurately costs us to take
    care of those patients.
        Mr. Smith. I think you are correct, yes, sir.
        Mr. Rogers. Is that correct?
        Mr. Smith. Yes.
        Mr. Rogers. So this isn't--we're not pulling a rabbit out
    of a hat. There is already a system under Medicaid. Now we have
    some transfer, some mechanism to Medicare; is that correct?
        Mr. Smith. That's correct.
        Mr. Rogers. So this isn't an insurmountable the sky is
    falling----
        Mr. Smith. We do not believe it is insurmountable at all.
    And we believe that we will come up with models that guarantee
    access and provide quality of treatment that people in nursing
    homes need at a competitive price. It's a specialty market and
    I think that when the final rule comes up people will be very
    pleased with what we come out with.
        Mr. Rogers. Thank you. I don't have too much further other
    than I just want to thank you so much. If we can be of any
    assistance as we move forward on this, again, I'd like to see
    States like Texas and Michigan get rewarded. Being that you are
    from Michigan, it is easy to say I think all those other 48
    ought to pay for the difference. I'm sure I have a lot of help
    here from that.
        Mr. Walden. The gentleman's time has expired.
        Mr. Rogers. But we do appreciate--especially Oregon. We do
    appreciate your efforts. I think we need to be cautious
    sometimes about some of what we have heard from the State
    administration. At the end of the day, this will save Michigan
    money in a very large way. And I think it is counterproductive
    for this sparring, I think even with the administration, about
    the cost of this. There are some things that we can fix and
    make it better. Absolutely no doubt. And this is a good thing
    for Michigan and they will save significant amounts of money,
    and I look forward to working with you. Thank you, and I yield
    back.
        Mr. Walden. I thank the gentleman from Michigan.
        Mr.  Stupak. Mr. Chairman, in response to Mr. Rogers'
    questions, Mr. Smith said they have a plan that they have ready
    to fix this nursing home thing. Could he submit that to the
    committee for the record so we would have it so we can look at
    it.
        Mr. Walden. I'm sure we can ask him for that.
        Mr. Stupak. This plan that you have in response to Mr.
    Rogers' questions?
        Mr. Smith. The final rule on how the long-term care
    pharmacies and the plan sponsors themselves will be working
    together to deliver the benefit.
        Mr. Stupak. But when you have that plan ready, could you
    submit it to the committee before the final rule?
        Mr. Smith. Before the final rule?
        Mr. Stupak. Yes.
        Mr. Smith. The proposed regs are already out. We are going
    through all the comments, et cetera, and expect to publish the
    final regs in early January.
        Mr. Stupak. Send those proposed rules up, would you please?
        Mr. Smith. The proposed, absolutely. Absolutely.
        [The material referred to appears in the Federal Register
    of Tuesday, August 3, 2004, Parts II and III.]
        Mr. Stupak. Thank you.
        Mr. Walden. Thank you. I'm going to dismiss this panel now.
    Thank you very much for your testimony and for your good work.
    It is most helpful in our committee's deliberations. We
    appreciate your sticking with us today. I know other committee
    members may have questions they may want to submit to you for a
    response along the way.
        Now I would like to call forward our final panel of
    witnesses today. Mr. Edward H. Stratemeier, former Vice
    President and General Counsel of Aventis Pharmaceuticals; Ms.
    Pamela R. Marrs, Senior Vice President and CFO of DEY, Inc.;
    Ms. Lesli Paoletti, Roxane Laboratories, Inc.; Mr. Timothy
    Catlett, Senior Vice President of Sales and Marketing, Barr
    Laboratories, Incorporated; David Marshall, R.Ph., director of
    Category Management for Generics, CVS Corporation; John
    Ziebell, R.Ph., Category Manager for Pharmacy, Health &
    Wellness, Walgreen Company; and Frank Seagrave, Vice President
    of Pharmacy, Wal-Mart Stores, Incorporated.
        You are all aware the committee is holding an investigative
    hearing and when doing so, has had the practice of taking
    testimony under oath. Do any of you have an objection to
    providing your testimony under oath? Let's start with Mr.
    Seagrave. Do you have any objection to----
        Mr. Seagrave. No.
        Mr. Walden. Mr. Ziebell?
        Mr. Ziebell. No.
        Mr. Walden. Mr. Marshall?
        Mr. Marshall. No.
        Mr. Walden. Mr. Catlett?
        Mr. Catlett. We need one more chair.
        Mr. Walden. If we can get you a chair, that would be
    helpful. We need one more chair at the witness table.
        Ms. Paoletti, do you object?
        Ms. Paoletti. I have no objections.
        Mr. Walden. Ms. Marrs?
        Ms. Marrs. No objection.
        Mr. Walden. Mr. Stratemeier?
        Mr. Stratemeier. No objection.
        Mr. Walden. Okay. The Chair then advises you that under the
    rules of the House Rules Committee, you're entitled to be
    advised by counsel. Do any of you desire to be advised by
    counsel?
        Mr. Seagrave? Counsel? Do you want to be advised by
    counsel?
        Mr. Ziebell. Yes, I do.
        Mr. Walden. You do? Could you identify your counsel,
    please?
        Mr. Ziebell. Mr. Frederick Robinson. Mr. Walden. Mr.
    Frederick Robinson, right there. Okay. Mr. Marshall?
        Mr. Marshall. No counsel.
        Mr. Walden. Mr. Catlett?
        Mr. Catlett. Mr. Mark Young.
        Mr. Walden. Mr. Mark Young. Okay, thank you.
        Ms. Paoletti?
        Ms. Paoletti. Yes. Ed Miller.
        Mr. Walden. Ed Miller is your counsel.
        Ms. Marrs?
        Ms. Marrs. Yes. Paul Doyle.
        Mr. Walden. Paul Doyle. And Mr. Stratemeier?
        Mr. Stratemeier. No, your honor.
        Mr. Walden. ``Chairman'' is okay, as opposed to ``your
    honor.''
        [Witnesses sworn].
        Mr. Walden. You're now under oath and you may give a 5-
    minute summary of your written statement.
        I'm going to have Mr. Rogers take over the Chair for just a
    moment, but please proceed, and Mr. Stratemeier, we will begin
    with you. Thank you again for being here.

     TESTIMONY OF EDWARD H. STRATEMEIER, FORMER VICE PRESIDENT AND
     GENERAL COUNSEL OF AVENTIS PHARMACEUTICALS; PAMELA R. MARRS,
     SENIOR VICE PRESIDENT AND CFO, DEY, INC.; LESLI L. PAOLETTI,
      ROXANE LABORATORIES, INC.; TIMOTHY P. CATLETT, SENIOR VICE
         PRESIDENT OF SALES AND MARKETING, BARR LABORATORIES,
     INCORPORATED; DAVID MARSHALL, DIRECTOR OF CATEGORY MANAGEMENT
     FOR GENERICS, CVS CORPORATION; JOHN ZIEBELL, CATEGORY MANAGER
     FOR PHARMACY, HEALTH & WELLNESS, WALGREEN COMPANY; AND FRANK
        SEAGRAVE, VICE PRESIDENT OF PHARMACY, WAL-MART STORES,
                              INCORPORATED

        Mr. Stratemeier. Thank you, Mr. Chairman, Members of
    Congress. My name is Edward Stratemeier. Until recently, I was
    senior Vice President of Aventis Pharmaceuticals. My
    responsibilities included legal matters, government relations,
    and public policy in North America.
        Aventis is a global pharmaceutical company that has just
    been acquired by Sanofi-Synthelabo to form Sanofi-Aventis. As a
    result of that merger, I left the company. I'm here today at
    the committee's request as a private citizen. I understand that
    the purpose of today's hearing is to address issues relating to
    AWP-based reimbursement of prescription drugs under Medicaid.
        I have been asked to discuss with the committee the policy
    positions developed by Aventis during my tenure with respect to
    AWP reimbursement for prescription drugs. And as much as I am
    no longer employed by Sanofi-Aventis, I cannot say whether the
    company still supports the policy positions taken during my
    tenure, nor can I speak to what the company will do in the
    future with respect to these matters. I joined Marion
    Laboratories, one of the predecessor companies of Aventis, in
    1982. Over the past 20 years, I've been actively engaged in the
    prescription pharmaceutical industry as an attorney and a
    senior executive. It was in my capacity as head of government
    relations and public policy that I oversaw the development of
    Aventis's position on reimbursement for pharmaceuticals under
    Medicare and Medicaid.
        The pharmaceutical industry has seen many changes since I
    joined Marion. The complexity, potency, and value of the
    products the industry develops have changed as had the entire
    distribution system for those products. One thing, however, has
    not changed: the reliance on AWP as a reimbursement benchmark
    by both government and private payors. To understand this
    reliance, one has to look back nearly 40 years. In the late
    1960's, about the only people who did not pay for prescription
    drugs out of their own pockets were employees of the
    pharmaceutical companies and people who qualified for Medicaid.
        Therefore, it fell to Medicaid to try to build systems to
    meet the task of paying for these drugs. I think it is
    important to remember that in the 1960's, a computer with as
    much computing power today as today's notebooks had not been
    built and would have filled an entire building. Medicaid needed
    simple manual systems. As a result, the concept of average
    wholesale price, or AWP, was created by the director of
    Medical, the California Medicaid Agency. The idea was that
    rather than having a pharmacist report what he had paid to
    purchase a product and then going through some type of audit
    procedure to make sure that that was in fact the case, it would
    be administratively simpler to always pay the same amount for a
    given drug. At the time it was established, AWP was not
    intended to be what was actually paid by the pharmacist to the
    wholesaler, but it was a good surrogate for administrative
    efficiency.
        Beginning in 1969, Medical reimbursed pharmacies for
    Medicaid patients' prescriptions by paying AWP plus a
    dispensing fee. As third-party coverage of prescription drug
    costs became more widespread by both government and private
    payers, the reliance on AWP became more invasive.
        Let me fast forward through two of the major trends in the
    pharmaceutical industry that have made AWP a problematic
    reimbursement benchmark. These trends are consolidation in the
    wholesale drug industry and the rise of managed care, including
    pharmacy benefit managers. For branded prescription drugs, AWP
    typically reflects a 20 to 25 percent markup over the wholesale
    acquisition cost, the manufacturer's list price to wholesalers,
    also known as WAC. This markup roughly corresponded to the
    wholesalers' markup in early days of AWP. However, drug
    wholesalers have seen technological change that has
    dramatically increased the efficiency of scale in that
    industry. The change fostered incredible competition and led to
    consolidation of the industry. Three companies now account for
    over 90 percent of the wholesale drug business and they do it
    on gross margins of less than 5 percent. That means that an AWP
    that remains static at a 20 to 25 markup over WAC began to
    overstate the price paid by the retail pharmacist.
        The 1980's saw the rise of managed care and PBMs. Whatever
    else they may have done, they forced big pharmaceutical
    companies to aggressively compete on price. They did this by
    limiting the number of drugs a drug plan would pay for and then
    negotiating with the manufacturers for rebates to be on the
    preferred known as a formulary. They also forced pharmacies to
    compete on price by requiring pharmacists to sign contracts if
    they wanted to serve the population covered by the plan.
        I should point out that all of these agreements used AWP as
    a benchmark price. While these trends were occurring, there was
    tremendous pressure to maintain AWP at a fixed markup from WAC.
    AWP had been codified as the benchmark price by statute or
    regulation in the public sector and by contract in the private
    sector. As the difference between AWP and real prices paid by
    pharmacists and providers began to increase, that difference
    was used to compensate for lack of payment for services. A
    change in the current well-known relationship of AWP to WAC
    would have had far-reaching effects on the provision of health
    care services.
        In 1990, Congress recognized that private sector payers
    were able to negotiate substantial discounts from
    pharmaceutical manufacturers. To take advantage of these
    negotiations for Medicaid, Congress included provisions in the
    Omnibus Budget Reconciliation Act, requiring pharmaceutical
    manufacturers to pay a rebate on Medicaid purchases that was
    based on the best price negotiated by private sector payers.
        The 2002 policy document which was provided by Aventis to
    the committee reflects the result of an effort to point out the
    problems associated with relying on AWP benchmarking and
    government reimbursement of prescription drugs given the
    reality of the changed environments in which those products
    were used. It was Aventis's view that appropriate methodology
    needed to reimburse providers for the drugs they dispensed at
    or near their cost to acquire those drugs while also fully and
    appropriately paying them for the professional services they
    provided in connection with dispensing those products.
        I appreciate the opportunity to appear before the committee
    today and would be happy to answer your questions regarding the
    use of AWP as a basis for reimbursement.
        [The prepared statement of Edward H. Stratemeier follows:]

               Prepared Statement of Edward H. Stratemeier, Esq.

        Mister Chairman, Members of Congress, my name is Edward
    Stratemeier. Until recently I was Senior Vice President of Aventis
    Pharmaceuticals. My responsibilities included legal matters, government
    relations and public policy in North America. Aventis is a global
    pharmaceutical company that has just been acquired by Sanofi-Synthelabo
    to form Sanofi-Aventis. As a result of the merger I left the company.
        I am here today at the Committee's request as a private citizen. I
    understand that the purpose of today's hearing is to address issues
    relating to AWP-based reimbursement of prescription drugs under
    Medicaid. I have been asked to discuss with the Committee the policy
    position developed by Aventis during my tenure there with respect to
    AWP based reimbursement for prescription drugs.
        I joined Marion Laboratories, one of the predecessor companies of
    Aventis in 1982. Over the past twenty years I have been actively
    engaged in the prescription pharmaceutical industry as an attorney and
    a senior executive. It was in my capacity as head of government
    relations and public policy that I oversaw the development of Aventis'
    position on reimbursement for pharmaceuticals under Medicare and
    Medicaid.
        The pharmaceutical industry has seen many changes since I joined
    Marion. The complexity, potency and value of the products the industry
    develops have changed, as has the entire distribution system for those
    products. One thing, however, has not changed: the reliance on AWP as a
    reimbursement benchmark by both government and private payers. To
    understand this reliance, one has to look back nearly 40 years.
        In the late 1960's, about the only people who did not pay for
    prescription drugs out of their own pockets were employees of
    pharmaceutical companies and people who qualified for Medicaid.
    Therefore it fell to Medicaid to try to build systems to meet the task.
    I think it is important to remember that in the 60's, a computer with
    as much computing power as today's notebooks had not been built and
    would have filled a large building. Medicaid needed simple manual
    systems.
        As a result, the concept of Average Wholesale Price or AWP was
    created by the director of Medi-Cal, the California Medicaid Agency.
    The idea was that rather than having a pharmacist report what he had
    paid to purchase a product (and then going through some type of audit
    procedure to verify that he had truly paid such a price) it would be
    administratively simpler to always pay the same amount for a given
    drug. At the time it was established, AWP was not intended to be what
    was actually paid by the pharmacist to the wholesaler, but it was a
    good surrogate for administrative efficiency. Beginning in 1969, Medi-
    Cal reimbursed pharmacies for Medicaid patients' prescriptions by
    paying AWP plus a dispensing fee. As third party coverage of
    prescription drug costs became more widespread--both by government and
    private payers--the reliance on AWP became more pervasive.
        Let me fast-forward through two of the major trends in the
    pharmaceutical industry that have made AWP a problematic reimbursement
    benchmark. These trends are consolidation in the wholesale drug
    industry and the rise of managed care including Pharmacy Benefit
    Managers (PBM's.)
        For branded prescription drugs, AWP typically reflects a 20% to 25%
    mark up over the Wholesale Acquisition Cost (the manufacturer's list
    price to wholesalers also known as WAC.) This mark up roughly
    corresponded to the wholesaler's mark up in the early days of AWP.
    However, drug wholesalers have seen technological change that has
    dramatically increased the efficiency of scale in that industry. That
    change fostered incredible competition and led to consolidation of the
    industry. Three companies now account for over ninety percent of the
    wholesale drug business and they do it on gross margins of less than
    five percent. That means that an AWP that remained static at a twenty
    to twenty-five percent markup over WAC began to overstate the price
    paid by the retail pharmacist.
        The 1980's saw the rise of managed care and PBM's. Whatever else
    they may have done, they forced big pharmaceutical companies to
    aggressively compete on price. They did this by limiting the number of
    drugs that a drug plan would pay for and then negotiating with the
    manufacturers for rebates to be on the preferred list (known as a
    formulary.) They also forced pharmacies to compete on price by
    requiring pharmacists to sign contracts if they wanted to serve the
    population covered by the plan. I should point out that all of these
    agreements used AWP as the benchmark price.
        While these trends were occurring, there was tremendous pressure to
    maintain AWP at a fixed markup from WAC. AWP had been codified as the
    benchmark price, by statute or regulation in the public sector and by
    contract in the private sector. As the difference between AWP and the
    real prices paid by pharmacists and providers began to increase, the
    difference was used to compensate for lack of payments for services. A
    change in the current, well-known relationship of AWP to WAC would have
    far reaching effects on the provision of health care services.
        In 1990, Congress recognized that private sector payers were able
    to negotiate substantial discounts from pharmaceutical manufacturers.
    To take advantage of these negotiations for Medicaid, Congress included
    provisions in the Omnibus Budget Reconciliation Act requiring
    pharmaceutical manufacturers to pay a rebate on Medicaid purchases that
    was based on the ``Best Price'' negotiated by private sector payers.
        In 2001, the Office of the Inspector General of the Department of
    Health and Human Services and the General Accounting Office both issued
    reports that found that Medicare providers were paying substantially
    less than AWP to obtain the drugs they dispensed to patients and
    recommended government reimbursements to providers for drugs be brought
    more in line with acquisition costs. As committee staffs were
    considering the question, Aventis met with them to recommend adopting
    acquisition cost as the amount for reimbursement. This recommendation
    was formally adopted by Aventis management in 2002.
        The 2002 Aventis policy document, which was provided by Aventis to
    the Committee, reflects the result of an effort to point out the
    problems associated with relying on AWP benchmarking in government
    reimbursement of prescription drugs given the realities of the changed
    environment in which those products are used. It was Aventis' view that
    an appropriate reimbursement methodology needed to reimburse providers
    for the drugs they dispensed at or near their cost to acquire those
    drugs, while also fully and appropriately paying them for the
    professional services they provided in connection with dispensing those
    products.
        I appreciate the opportunity to appear before the Committee today,
    and will be happy to answer your questions regarding the use of AWP as
    a basis for reimbursement.

        Mr. Rogers [presiding]. Thank you for your testimony.
        Ms. Marrs.

                      TESTIMONY OF PAMELA R. MARRS

        Ms. Marrs. Good morning, Mr. Chairman and distinguished
    members of this committee. Thank you for the opportunity to
    appear before you today.
        For the past 15 years, I have been the Chief Financial
    Officer of DEY LP. Founded in 1978 and located in Napa
    California, DEY is a specialty pharmaceutical company focused
    on the development, manufacturing, and marketing of
    prescription drugs for the treatment of respiratory diseases
    and respiratory-related allergies. In addition to our facility
    in Napa, we also have a distribution center in Allen, Texas.
        Last year Congress and the administration took important
    steps to reform and improve Medicare reimbursement policy when
    it passed the Medicare Modernization Act. As you know, the
    system of reimbursement using a percentage of AWP badly needed
    to be reformed and many in the pharmaceutical industry
    including DEY supported reform. Medicaid reimbursement has
    typically had a spread between the cost of the drug paid by the
    provider and the reimbursement amendment. That spread goes to
    the provider, not to the manufacturer. Until the mid 1990's, my
    understanding is that it was not unusual for salespeople when
    speaking to customers to compare their spreads with those of
    their competitors. Beginning in the late 1990's as a result of
    litigation, government investigations, and the OIG compliance
    program guidance, my understanding is that the industry has
    become sensitive to this practice and has largely stopped. At
    DEY we have developed and implemented a major compliance
    program over the last few years designed to ensure that our
    sales force is compliant with the OIG guidance.
        Is the spread still meaningful to providers? Yes. Because
    they often depend on the spread to cover their cost of
    dispensing which often exceeds the dispensing fees they receive
    from Medicaid.
        How does DEY set AWP for generics? At DEY, our historical
    practice for generic drugs has been to set the generic AWP as a
    percentage off of the brand's AWP when the product is launched.
    Usually that percentage has been around 10 percent. After that,
    our practice has been not to change AWP on generics.
        Why doesn't DEY lower its AWP on generic drugs? The simple
    answer is that given the system that now exists, our customers
    won't buy from us if we lower our AWP. This was confirmed about
    a year and a half ago when a reporting service lowered their
    published AWP for our drugs without consulting. Our customers
    told us they would stop buying from us with the lower AWP. This
    could have put many of our employees out of work overnight. So
    we went to court and the court issued a temporary restraining
    order.
        Why do we need AWP at all? At this point the current system
    is based on AWP, and customers rely on it and won't buy a
    product without it. As evidence of this, about 2 years ago,
    because of the litigation, we tried to market a new drug with
    no AWP. Our customers said they would not buy it. So we set an
    AWP which happened to be lower than those of our competitors.
    As a direct result of this lower AWP, we sold almost nothing of
    a drug for which we had projected to have sales of $6 million.
        These experiences taught us that reimbursement reform has
    to come from the government and be applied to the whole
    industry. If a generic company, especially a small one like
    ours, tries to buck the AWP system on its own, it can being be
    forced out of a whole business line.
        Do our profits on generic drugs increase as the spread
    increases? In DEY's case, the answer is no. First, it is
    important to keep in mind that the drugs manufacturers don't
    get the money from the spread. The money realized from the
    spread goes to providers. Second, in the case of generic drugs,
    a larger spread actually means a lower profit for the
    manufacturer.
        Because generic drugs are a commodity, price competition is
    fierce. If the spread for a particular generic drug is getting
    larger, it almost always is because AWP is remaining the same
    while the actual selling price is getting lower. At the same
    time, our costs are increasing and our margins declining. This
    situation has shown dramatically in the case of Albuterol,
    which has been repeatedly cited in CMS reports as having some
    of the largest spreads of any drug. For the last 10 years, the
    spread on Albuterol, which is one of DEY's biggest generic
    products in terms of volume, has been getting larger and larger
    as the price drops because of competition.
        Have our profits increased as the spread has grown? No. At
    the current time, we are actually close to breaking on
    Albuterol due to the continuing erosion of the market price.
        As I said at the outset, I am the Chief Financial Officer
    of DEY. I have held that position since 1989. Most of the
    documents I was asked about and my staff interview or that came
    to me afterwards came out of our sales and marketing
    department, and with some exceptions where I was copied or was
    the addressee, I saw them for the first time during this
    litigation. Having said that, I hasten to add that I have
    learned a lot about AWP in these documents from the litigation
    and I will try to be as helpful as I can when answering
    questions. Thank you for your time and I'd be pleased to answer
    any questions.
        [The prepared statement of Pamela Marrs follows:]

      Prepared Statement of Pamela Marrs, Chief Financial Officer, DEY, LP

        Good morning, Mr. Chairman and distinguished members of this
    Committee. Thank you for the opportunity to appear before you today.
    For the past 15 years, I have been the Chief Financial Officer of DEY,
    L.P. Founded in 1978 and located in Napa, California, DEY is a
    specialty pharmaceutical company focused on the development,
    manufacturing and marketing of prescription drug products for the
    treatment of respiratory diseases and respiratory-related allergies. In
    addition to our facility in Napa, we also have a distribution center in
    Allen, Texas.
        Last year Congress and the Administration took important steps to
    reform and improve Medicare reimbursement policy when it passed the
    Medicare Modernization Act.
        As you know, the system of reimbursement using a percentage of
    average wholesale price, or AWP, badly needed to be reformed and many
    in the pharmaceutical industry, including DEY, supported reform.
        Medicaid reimbursement has typically had a spread between the cost
    of the drug paid by the provider and the reimbursement amount. That
    spread goes to the provider, not the manufacturer. Until the mid
    1990's, my understanding is that it was not unusual for sales people,
    when speaking to customers, to compare their spreads with those of
    their competitors. Beginning in the late 1990's, as a result of
    litigation, government investigations and the OIG Compliance Program
    Guidance for Pharmaceutical Manufacturing issued in 2003, my
    understanding is that the industry has become sensitive to this
    practice and it has largely stopped. At DEY, we have developed and
    implemented a major compliance program over the last few years designed
    to ensure that our sales force is compliant with the OIG Guidance.
        We have also seen many changes on the government side that are
    reducing the emphasis on AWP. Last year's Medicare law will, by 2006,
    virtually eliminate AWP as a basis for Medicare reimbursement under
    Part B. The new Medicare Part D drug benefit will not use AWP as a
    basis for government payment for drugs. So, both by industry practice
    and government action, the situation is changing.
        Is the spread still meaningful to providers?
        Yes, because they often depend on the spread to cover their costs
    of dispensing, which often exceed the small dispensing fees they
    receive from Medicaid.
        How does DEY set AWP for generics?
        At DEY, our historical practice for generic drugs has been to set
    the generic AWP as a percentage off of the brand's AWP when the product
    is launched. Usually that percent has been about 10%. After that, our
    practice has been not to change AWP on generics.
        Why doesn't DEY lower its AWP on generic drugs?
        The simple answer is that, given the system that now exists, our
    customers won't buy from us if we lower our AWP. This was confirmed
    about a year and a half ago when a reporting service lowered their
    published AWP for our drugs without consulting us. Our customers told
    us they would stop buying from us with the lower AWP. This could have
    put many of our employees out of work overnight. So we went to court
    and the court issued a temporary restraining order stopping the
    service's action.
        Why do we need an AWP at all?
        At this point, the current system is based on AWP and customers
    rely on it and won't buy a product without it. As evidence of this,
    about two years ago, because of the litigation, we tried to market a
    new drug with no AWP. Our customers said they wouldn't buy it so we set
    an AWP which happened to be lower than those of our competitors. As a
    direct result of the lower AWP, we sold almost nothing of a drug for
    which we had projected to have sales of $6 million. These experiences
    taught us that reimbursement reform has to come from the government and
    be applied to the whole industry. If a generic company--especially a
    small one like ours--tries to buck the AWP system on its own, it can be
    forced out of whole business lines.
        Do our profits on generic drugs increase as the spread increases?
        In DEY's case, the answer is no.
        First, it is important to keep in mind that the drug manufacturers
    don't get the money which comes from the spread. Money realized from
    the spread goes to the providers.
        Second, in the case of generic drugs, a larger spread actually
    means a lower profit margin for the manufacturer. Because generic drugs
    are a commodity, price competition is fierce. If the spread for a
    particular generic DEY drug is getting larger, it is almost always
    because the AWP of the drug is remaining the same, while the actual
    selling price is getting lower. At the same time, our costs are
    increasing and our margins are declining.
        This situation is shown dramatically in the case of albuterol,
    which has been repeatedly cited in CMS reports as having some of the
    largest spreads of any drug.
        For the last ten years, the spread on albuterol, which is one of
    DEY's biggest generic products in terms of volume sold, has been
    getting larger and larger as the price drops because of competition.
    Have our profits increased as the spread has grown? No. At the current
    time, we are close to breakeven on albuterol due to continuing erosion
    of the market price.
        Why doesn't the industry get together and agree on a solution to
    the AWP problem?
        It is not within the purview of the industry to make such a change.
    We at DEY are anxious to provide information and assistance so we can
    help the government bodies that will effect such changes. We have
    provided written comments on multiple occasions to CMS as that body has
    worked toward reform of the current AWP-based system in an effort to
    assist with this process.
        As I said at the outset, I am the Chief Financial Officer of DEY.
    I've held that position since 1989. Most of the documents I was asked
    about in my staff interview or afterwards came out of the sales and
    marketing department and, with some exceptions where I was copied or
    was the addressee, I saw them for the first time during the litigation.
        Having said that, I hasten to add that I have learned a lot about
    AWP and these documents from the litigation and I'll try to be as
    helpful as I can in answering your questions about them. q
        Thank you for your time. I would be pleased to answer any questions
    you may have.

        Mr. Walden. Thank you, Ms. Marrs. We appreciate you being
    here.
        Ms. Paoletti. Thank you.

                     TESTIMONY OF LESLI L. PAOLETTI

        Ms. Paoletti. Mr. Chairman and members of the subcommittee,
    my name is Leslie Paoletti. I am appearing today on behalf of
    Roxane Laboratories, where I am senior product manager. I am
    here today at your request to assist you in your efforts to
    examine Medicaid reimbursement.
        Roxane is a leader in the development, manufacture and
    marketing of generic pharmaceutical products. We are proud to
    produce medicines that extend and improve the quality of
    patient lives while reducing reliance on more expensive
    alternative treatment options, including hospitalization stays,
    invasive medical procedures, and more expensive prescription
    products. We are committed to continuing to provide lower cost
    pharmaceuticals to meet the health care needs of Americans.
        As you know, Roxane is one of 26 manufacturers from whom
    the subcommittee requested documents in connection with its
    investigation into reimbursements and rebates under Medicaid.
    Roxane voluntarily produced several thousand pages of documents
    and provided witnesses for informal interviews on two separate
    occasions.
        Roxane understands the importance of the congressional
    oversight process in determining the need for, and establishing
    a basis for, legislation improving the Medicaid system. We
    therefore agreed to the subcommittee's request that we appear
    today to answer any questions on which members believe we can
    provide useful information.
        We have been advised that the Energy and Commerce Committee
    may develop legislative recommendations to reform Medicaid
    reimbursement policies, which we understand currently are
    established on a State-by-State basis under a variety of
    complex formulas. As you know, as a manufacturer of multisource
    products, our revenues come exclusively from purchases by our
    customers who, in turn, sell to parties or patients. We do not
    sell prescription pharmaceutical products directly to patients,
    nor do we receive any payments from Medicaid. However, we would
    support any effort by Congress to bring greater efficiencies
    and simplicity to the system, including much-needed guidance
    from the government.
        We believe any reform should maintain an incentive for
    using generic drugs and ensure that an appropriate and viable
    economic framework remains in place for health care providers
    to serve patients.
        I would be pleased to answer any of the questions on issues
    you have identified and on the materials we have previously
    provided to you. Roxane looks forward to working with you as
    you address these issues.
        [The prepared statement of Lesli L. Paoletti follows:]

       Prepared Statement of Lesli L. Paoletti, Roxane Laboratories, Inc.

        Chairman Barton and Members of the Subcommittee, my name is Lesli
    Paoletti. I am appearing today on behalf of Roxane Laboratories, Inc.,
    where I am Senior Product Manager. I am here today at your request to
    assist you in your efforts to examine Medicaid reimbursement.
        Roxane is a leader in the development, manufacture and marketing of
    generic pharmaceutical products. We are proud to produce medicines that
    extend and improve the quality of patient lives while reducing reliance
    on more expensive alternative treatment options, including hospital
    stays, invasive medical procedures, and more expensive prescription
    products. We are committed to continuing to provide lower cost
    pharmaceuticals to meet the health care needs of Americans.
        As you know, Roxane is one of 26 drug manufacturers from whom the
    Subcommittee requested documents in connection with its investigation
    into pharmaceutical reimbursements and rebates under Medicaid. Roxane
    voluntarily produced several thousand pages of documents and provided
    witnesses for informal interviews on two separate occasions. Roxane
    understands the importance of the congressional oversight process in
    determining the need for, and establishing a basis for, legislation
    improving the Medicaid system. We therefore agreed to the
    Subcommittee's request that we appear today to answer any questions on
    which Members believe we can provide useful information.
        We have been advised that the Energy and Commerce Committee may
    develop legislative recommendations to reform Medicaid reimbursement
    policies, which we understand currently are established on a state-by-
    state basis under a variety of complex formulas. As you know, as a
    manufacturer of multisource products, our revenues come exclusively
    from purchases by our customers who, in turn, sell to other parties or
    patients. We do not sell prescription pharmaceutical products directly
    to patients, nor do we receive any payments from Medicaid. However, we
    would support any effort by Congress to bring greater efficiencies and
    simplicity to the system, including much needed guidance from the
    government. We believe any reform should maintain an incentive for
    using generic drugs and ensure that an appropriate and viable economic
    framework remains in place for health care providers to serve patients.
        I would be pleased to answer any questions on the issues you have
    identified and on the materials we previously have provided to you.
        Roxane looks forward to working with you as you address these
    issues.

        Mr. Walden. Thank you for being here today.
        Mr. Catlett, thank you for being here.

                     TESTIMONY OF TIMOTHY P. CATLETT

        Mr. Catlett. Thank you, Mr. Chairman and members of the
    subcommittee. I am Tim Catlett, Senior Vice President of Sales
    and Marketing of Barr Laboratories. We are a leading
    manufacturer of generic pharmaceuticals.
        Mr. Chairman, I know that you and others want to reduce the
    cost of prescription drugs for Medicaid patients. Your goal and
    Barr's business objectives are well aligned. Barr's generic
    drug business is designed to offer the same medicines as
    branded companies, but at a lower cost.
        The products we manufacture and sell are mostly in tablet
    and capsule form. They are dispensed to patients by others, not
    Barr. Barr does not receive reimbursements under Medicaid.
        Like other generic manufacturers, Barr does offer a vehicle
    for reducing Medicaid costs. When a pharmacy dispenses a
    generic drug to a Medicaid patient, the reimbursement to
    Medicaid is usually lower, and often substantially lower, than
    it would be for a branded product. In that way, promoting the
    use of generic products helps to reduce Medicaid costs. For any
    drug reimbursement system, providing incentives to pharmacies
    to dispense generic drugs is vital to achieving cost
    reductions.
        Generic drugs, by definition, are second to market, not
    first. Pharmacies must be convinced to stock and dispense our
    products as the alternative to a branded product which has been
    on their shelves for years. If the drug reimbursement systems,
    including Medicaid, do not create incentives to dispense
    generic drugs, substantial cost savings will be lost.
        I know the subcommittee has questions about AWP, or average
    wholesale price. As HHS found years ago, AWP does not represent
    an actual wholesale price or an average of actual prices.
    Instead, as set out in my written testimony, AWP is simply a
    publicly available reference price.
        Many drug reimbursement systems, including some State
    Medicaid agencies, use AWP in certain instances as a reference
    point to calculate reimbursement levels for those who dispense
    drugs to patients. Because they recognize that AWP is not an
    actual acquisition price, these agencies reimburse at a
    percentage off AWP.
        If a generic manufacturer lowered its AWP unilaterally in a
    multisource generic environment, pharmacists might choose to
    dispense a competitor's generic product.
        I would be pleased to answer any questions the subcommittee
    may have, and thank you for your consideration.
        [The prepared statement of Timothy P. Catlett follows:]

      Prepared Statement of Timothy P. Catlett, Senior Vice-President of
                  Sales and Marketing, Barr Laboratories, Inc.

        Mr. Chairman, thank you for inviting me to testify today. My name
    is Tim Catlett, and I am Senior Vice-President of Sales and Marketing
    at Barr Laboratories, Inc. Barr is pleased to have the opportunity to
    answer any questions the Subcommittee may have on the company's role as
    a manufacturer of generic pharmaceuticals in the context of the
    Medicaid program.
        I would like to make two key points:
        First, Barr is in business to offer its customers the same
    medicines as brand name drug manufacturers but at a significantly lower
    cost, and we do. As a result, when Medicaid patients receive a generic
    prescription product, they receive the same medicine as the counterpart
    branded product, but at a cost to the Medicaid system that usually is
    substantially lower.
        Second, Medicaid and other prescription drug reimbursement programs
    should encourage the maximum utilization of lower-cost generic drugs.
    Any proposed changes must be carefully examined to ensure that they
    include appropriate incentives for pharmacies to stock and dispense
    generic products.

        AN INTRODUCTION TO BARR LABORATORIES, A GENERIC PHARMACEUTICAL
                                 MANUFACTURER.

        Barr is one of America's leading manufacturers of generic
    drugs.1 A generic drug is a product determined by the Food
    and Drug Administration (``FDA'') to contain the same active
    ingredients, and provide the same therapeutic value, as its brand-name
    counterpart. The FDA bases its sameness determination on detailed
    scientific criteria, including clinical studies. These criteria include
    showing that the generic product is pharmaceutically equivalent to the
    branded product (i.e., contains the same amount of the same active
    ingredient); and that the generic product is bioequivalent to the
    branded product (i.e., has the same rate and extent of absorption in
    the human body).
    ---------------------------------------------------------------------------
        \1\ More information about Barr and its role in the development of
    the generic drug industry can be found at http://www.barrlabs.com.
    ---------------------------------------------------------------------------
        When the FDA determines that a generic product is therapeutically
    equivalent to its branded counterpart, the FDA grants the generic what
    is called an ``AB'' rating. The rating means that the generic product
    is interchangeable with the branded counterpart. Once an AB rating is
    granted, the generic product can be substituted for the brand at the
    pharmacy level, even in response to a prescription written for the
    branded product, unless the physician writes ``dispense as written.''
    When a pharmacy dispenses a generic prescription product to a Medicaid
    patient, the pharmacy provides the patient with the same medicine as
    the branded product, but usually at a significantly lower cost to the
    Medicaid system.
        Barr's generic pharmaceutical research, development, and marketing
    efforts focus on specialty products that are difficult to manufacture
    or otherwise require our unique development skills. Often, Barr makes
    available the first low-cost generic alternative for a pharmaceutical
    product, either by developing generic pharmaceuticals to compete with
    branded drugs no longer under patent, or by challenging patents on
    branded products under the Hatch-Waxman Act when those patents appear
    to be invalid, unenforceable, or not infringed by our
    product.2
    ---------------------------------------------------------------------------
        \2\ Drug Price Competition and Patent Term Restoration Act of 1984,
    21 U.S.C.  355 (1999 & Supp.).
    ---------------------------------------------------------------------------
        Patent challenges brought by generic manufacturers under the Hatch-
    Waxman Act have resulted in $27 billion in prescription drug cost
    savings.3 Barr brought several of these cost-saving patent
    challenges, including the one that resulted in the first marketing of a
    lower-cost generic form of Prozac more than two years prior to patent
    expiry. When Barr successfully develops a generic substitute, other
    manufacturers are thereby encouraged to bring generic products to
    market when allowed by law. The resulting vigorous generic
    pharmaceutical competition brings even lower prices and greater cost-
    savings for consumers and their insurers.
    ---------------------------------------------------------------------------
        \3\ See Kathleen D. Jaeger, Presentation to the HHS Task Force of
    Drug Importation, April 5, 2004, available at http://
    www.gphaonline.org/policy/pdf/2004-04-05-testimony.pdf.
    ---------------------------------------------------------------------------
        Currently, Barr manufactures and distributes more than 70 generic
    products in core therapeutic categories, including oncology, female
    healthcare (including hormone therapy and oral contraceptives),
    cardiovascular, anti-infective, pain management, and
    psychotherapeutics. All of Barr's generic products are in tablet,
    capsule or oral suspension dosage form. We do not sell our generic
    pharmaceutical products directly to physicians or their patients.
    Rather, our ``customers'' for these products are pharmaceutical
    wholesalers, who in turn sell to pharmacies; large chains with
    distribution centers and pharmacy operations; mail-order pharmacies;
    federal, state, and local government institutions; and managed care
    organizations. Our customers then either dispense our products to
    patients or sell our products to pharmacies, which then dispense our
    products to patients pursuant to prescriptions written by physicians.
        The growth of generic pharmaceutical manufacturers over the last
    thirty years has resulted in substantial prescription drug cost savings
    for consumers, private insurers, and public insurers. For example,
    during the third quarter of 2004, the average prescription cash price
    to a consumer of a branded pharmaceutical medication was $97.52, as
    compared with an average price of only $26.35 for a generic
    prescription.4
    ---------------------------------------------------------------------------
        \4\ IMS Health, National Prescription Audit, November 2004.
    ---------------------------------------------------------------------------
        Congress and federal agencies recognize that use of generic
    pharmaceuticals should continue to be promoted, given the magnitude of
    savings that already have been realized. According to the Centers for
    Medicare & Medicaid Services (``CMS''), generic substitution is a
    ``best practice'' for lowering prescription drug costs.5
    When Congress passed the Medicare Prescription Drug, Improvement, and
    Modernization Act of 2003, Pub. L. 108-173, Title IX 1101-1104, it
    closed loopholes in Hatch-Waxman that delayed the development and
    marketing of generic products. According to the Congressional Budget
    Office, these statutory reforms ``would accelerate the availability of
    generic versions of prescription drugs'' and ``result in lower total
    drug spending within the United States by $7 billion over the 2004-2013
    period.'' 6
    ---------------------------------------------------------------------------
        \5\ Centers for Medicare and Medicaid Services, Safe and Effective
    Approaches to Lowering State Prescription Drug Costs: Best Practices
    Among State Medicaid Drug Programs, available at http://
    www.cms.hhs.gov/medicaid/drugs/strategies.pdf.
        \6\ See, Congressional Budget Office, Analysis of Changes to the
    Hatch-Waxman Act, August 27, 2003, available at http://www.cbo.gov/
    ftpdocs/45xx/doc4513/Hatch-WaxmanLtr.pdf.
    ---------------------------------------------------------------------------
    Pharmaceutical Price Data.
        Brand and generic manufacturers provide pricing data to independent
    publishers, including Red Book, First DataBank, and others, which
    compile the data for drug manufacturers, wholesalers, retailers, and
    third-party payors, including state governments and the federal
    government. These data are used as reference points for numerous
    purposes, including calculating reimbursement levels under Medicaid and
    other public and private health insurance programs.
        Average Wholesale Price. It is generally known in the
    pharmaceutical industry and related government agencies that average
    wholesale price (``AWP'') is a reference price only, and does not
    represent the actual selling price charged by a manufacturer for its
    products. The Department of Health and Human Services has repeatedly
    recognized that AWP does not reflect an actual wholesale
    price.7 A recent General Accounting Office report confirms
    that ``AWP is not necessarily the price paid by a purchaser,'' and that
    it is ``often described as a `list price' [or] `sticker price.' ''
    8 A generic manufacturer typically establishes the AWP for
    the generic product at 90% of the corresponding brand AWP.
    ---------------------------------------------------------------------------
        \7\ See Report, Title XIX of the Social Security Act, Limitation on
    Payment or Reimbursement for Drugs, Medicaid Transmittal No. 84-12,
    reprinted in Medicare & Medicaid Guide (CCH0  34,157, at 10,193 (Sept.
    1984); Report, Use of Average Wholesale Prices in Reimbursing
    Pharmacies in Medicaid and the Medicare Prescription Drug Program, A-
    06-89-0037 (Oct. 1989), reprinted in Medicare & Medicaid Guide (CCH)
    38,215 (1990).
        \8\ United States General Accounting Office, Report to
    Congressional Committees GAO-01-1118, Medicare: Payments for Covered
    Outpatient Drugs Exceed Providers' Cost, 9 (September 2001).
    ---------------------------------------------------------------------------
        Wholesale Acquisition Cost. Wholesale acquisition cost (``WAC'') is
    the price that wholesalers and distributors pay on the invoice for a
    given product, although discounts may be provided after invoice, for
    prompt-pay or periodic volume purchasing incentives, or as rebates.
        Average Manufacturer Price. Average manufacturer price (``AMP'') is
    the average per tablet price for a product sold to a CMS-designated
    class of purchasers including wholesalers, retail chains, and mail
    order pharmacies for resale in the retail pharmacy market after all
    discounts and rebates to customers are taken into account.
    Manufacturers report AMP to CMS on a quarterly basis. For generic
    products, the manufacturer then pays a unit rebate amount of 11% of the
    AMP to the state Medicaid programs based on utilization of the product
    by each state Medicaid program. States can readily calculate AMP for a
    generic product from the unit rebate data they receive from CMS.
    Prescription Reimbursements Under Medicaid.
        Pharmaceutical manufacturers, including Barr, do not seek or
    receive any reimbursements under the Medicaid program. It is pharmacies
    that are reimbursed, under the contracts they negotiate with state
    Medicaid agencies, for the Medicaid prescriptions they fill.
        Because CMS ``note[s] the shortcomings of using AWP as a basis for
    reimbursement,'' the agency has agreed to ``strongly encourage states
    to reevaluate their reimbursement methodology for drugs' and to
    ``continue to encourage states to look for an alternate basis for
    reimbursement.'' 9 Despite these admonitions, many States,
    like many private insurers, choose to use AWP to establish the
    reimbursement formula for Medicaid prescriptions that they negotiate
    with retailers during each contract period. Notably, these formulae
    usually subtract a percentage ``off'' of AWP (different States
    negotiate different percentages), reflecting the understanding that AWP
    is a reference price.10
    ---------------------------------------------------------------------------
        \9\ Letter from Thomas A. Scully, Administrator to Janet Rehnquist,
    Inspector General (March 7, 2002) (Commenting on Department of Health
    and Human Services Office of Inspector General, Medicaid Pharmacy--
    Actual Acquisition Cost of Generic Prescription Drug Products, A-06-01-
    00053 (March 2002)).
        \10\ Quarterly reports of state reimbursement formulae are
    available at http://www.cms.hhs.gov/medicaid/drugs/prescriptions.asp.
    ---------------------------------------------------------------------------
        CMS can and sometimes does cap the reimbursement of Medicaid
    prescriptions with a Federal Upper Limit (``FUL''). Because CMS does
    not always move to set a FUL when additional competitors enter the
    market, thirty-eight states have established maximum allowable cost
    (``MAC'') programs to cap reimbursement under Medicaid even absent a
    FUL. As soon as a FUL or a MAC is set, other reimbursement methods and
    reference price data--including AWP and WAC--diminish in significance.

               THE IMPORTANCE OF INCENTIVES FOR GENERIC DRUG USE

        In order for Barr and other generic manufacturers to continue
    providing these dramatic cost-savings, generic medicines must be
    stocked and dispensed by pharmacies. As a practical matter,
    wholesalers, drug chains with distribution centers, and pharmacies
    stock or maintain access to essentially all branded pharmaceutical
    products. If a physician writes a prescription for a branded product
    for which no generic exists, or if a physician writes ``brand medically
    necessary,'' the pharmacy must be able to dispense the branded product.
        Because a full catalogue of brand products already must be stocked
    or accessible, pharmacies incur extra costs when they stock any generic
    products. Consequently, pharmacies must have an economic incentive to
    carry and dispense generic products. Such an incentive exists when the
    pharmacy can purchase the generic product for sufficiently less than
    the branded product and then dispense the generic product at a lower
    price than the branded product and still make a ``profit'' on the
    generic product that is greater than the pharmacy could make on the
    branded product. If the profit to the pharmacy is greater on the
    branded product than on the generic product, the pharmacy is not likely
    to stock or sell the generic product. Moreover, because prices on
    generic products are almost always lower than prices on the equivalent
    branded products, third-party payors (including Medicaid) will almost
    always pay a lower reimbursement amount for the generic product even
    though the pharmacy makes a larger ``profit'' on that generic product.
        As long as Medicaid agencies or other third party reimbursers
    continue to use AWP-based reimbursement systems, AWP could be a factor
    in a pharmacy's decision as to which generic manufacturer's product to
    purchase and dispense. If a generic manufacturer unilaterally reduced
    its AWP for a given product relative to the AWPs of other generic
    manufacturers for the same product, pharmacies would have an incentive
    to purchase another manufacturer's drug that did not reduce its AWP.
        If any changes to Medicaid prescription reimbursement are
    considered, these changes must maintain Medicaid's practice of
    promoting the use of lower cost, therapeutically equivalent, generic
    drugs by providing pharmacies with financial incentives to carry and
    dispense generic drugs.
    Barr's Fluoxetine Product.
        Barr incurred millions of dollars in costs and years of patent
    infringement litigation in order to bring a low-cost Prozac substitute
    to market. When Barr ultimately prevailed in the litigation, we were
    entitled to 180 days of exclusivity for our fluoxetine product under
    the Hatch-Waxman Act, because we were the first to file an Abbreviated
    New Drug Application challenging the patents on Prozac.11
    Barr brought this important generic medication to market more then two
    years prior to patent expiry.
    ---------------------------------------------------------------------------
        \11\ Press Release, Indiana District Court Clears Way for Barr's
    Generic Prozac(R) Launch, available at http://www.barrlabs.com/pages/
    nprpr.html.
    ---------------------------------------------------------------------------
        As is customary for generic products, Barr's fluoxetine was a
    lower-cost alternative to the brand, Prozac. This provided pharmacies
    with an incentive to purchase and dispense generic fluoxetine. The
    incentive Barr provided was effective: by the end of the exclusivity
    period, generic fluoxetine products had gained more then 80% of the
    prescription market for 20 mg Prozac. The early introduction of a
    generic fluoxetine, and the incentives provided to pharmacies through a
    lower purchase price for the generic medication, encouraged
    substitution of the generic for the brand.
        The day that Barr's fluoxetine exclusivity period ended, nine other
    generic manufacturers entered the market, each establishing virtually
    the same AWP for fluoxetine as Barr's. Prices for generic fluoxetine
    dropped quickly and dramatically. Of course, the establishment of a FUL
    or a MAC for fluoxetine immediately following the launch of multiple
    generics (January 29, 2002) would have effectively eliminated the use
    of AWP as a reference point for reimbursement. Notably, this is exactly
    what did happen with private third party payors (which account for
    approximately 87% of the market), almost all of which placed a MAC on
    generic fluoxetine either before or immediately after January 29, 2002.
    CMS did set a FUL for Prozac on December 1, 2002.12
    ---------------------------------------------------------------------------
        \12\ Centers for Medicare and Medicaid Services, Federal Upper
    Limit (FUL) Changes to Transmittal No. 37 at 17. (showing that CMS
    added fluoxetine hydrochloride to the FUL product list for
    implementation on December 1, 2002). See also Department of Health and
    Human Services Office of Inspector General, Ommission Of Drugs From The
    Federal Upper Limit List in 2001, OEI-03-02-00670 (discussing delays in
    establishing FULs in a timely manner.)
    ---------------------------------------------------------------------------
    Conclusion.
        Barr is proud to be part of a highly competitive industry that
    offers generic products at a lower cost than the brands. In 2003,
    through the enactment of Hatch-Waxman reforms, Congress recognized the
    importance of generic drugs and their role in easing the financial
    strain that prescription drug costs often impose on the budgets of many
    in our society, including federal and state budgets under Medicaid. For
    the very same reasons, Congress should ensure that any potential
    changes to Medicaid reimbursement will encourage, rather than
    discourage, the continued substitution of generic drugs.

        Mr. Walden. Thank you, Mr. Catlett. We appreciate your
    being here.
        Mr. Marshall.

                       TESTIMONY OF DAVID MARSHALL

        Mr. Marshall. Mr. Chairman and distinguished
    Representatives, on behalf of CVS Corporation I would like to
    thank the committee for inviting CVS to appear today to
    participate in this important hearing.
        CVS shares the committee's goal of reducing the cost of
    prescription drugs for all of our customers. The single most
    effective action that can be taken to achieve that goal is to
    promote the use of generic drugs wherever possible. It is my
    responsibility at CVS to purchase generic drugs at the lowest
    possible cost.
        I am pleased to have the opportunity to answer your
    questions to the best of my ability today. Thank you.
        Mr. Walden. Thank you, Mr. Marshall.
        Mr. Ziebell, your comments.

                        TESTIMONY OF JOHN ZIEBELL

        Mr. Ziebell. I have no comment, but I am ready to answer
    any questions you may have.
        Mr. Walden. Thank you for being here.
        Mr. Seagrave.

                       TESTIMONY OF FRANK SEAGRAVE

        Mr. Seagrave. Thank you, Mr. Chairman.
        My name is Frank Seagrave. I am a registered pharmacist in
    Louisiana, Colorado, and Mississippi. I am currently the Vice
    President of Pharmacy for Wal-Mart Stores, Incorporated.
        I am familiar with the struggle that many States are
    currently having with their Medicaid expenditures. The Medicaid
    business at Wal-Mart represents about 11 percent of our
    prescription business. I believe that Wal-Mart and our 11,500
    pharmacists are part of the solution.
        Currently, retail pharmacy Medicaid reimbursement is based
    on a formula consisting of two parts, estimated acquisition
    costs, plus a dispensing fee. Everyday low price, or EDLP as we
    call it, is a core belief of our company. It greatly benefits
    the Medicaid program in many States because our EDLP is often
    below the Medicaid allowable price. When this happens, the
    State gets charged the lower price. Wal-Mart's EDLP, therefore,
    is a value to the Medicaid program.
        I believe that generic drugs are the best opportunity for
    savings in the Medicaid program. The average price of a
    Medicaid prescription that was filled with a brand name drug at
    Wal-Mart in 2002 was $88.53. When a Medicaid prescription was
    filled with a generic drug, the average price was $20.25, a
    savings of $68.28. Therefore, the average Medicaid price of a
    prescription filed with a brand name drug was 439 percent
    higher.
        Generics are deemed to be bioequivalent and therapeutically
    equivalent and should be mandatory when they are available. At
    Wal-Mart, we dispense generic drugs over 94 percent of the time
    when one is available. Wal-Mart is able to effectively
    negotiate good costs on generic drugs because generics are
    available from multiple manufacturers and are therefore
    commodities.
        This is not the case with brand name drugs. Wal-Mart has no
    greater leverage for branded drug products than any other
    retail class of trade pharmacy provider. There is great
    disparity between what brand name drug manufacturers charge
    retail pharmacies and the lower prices they charge other
    classes of trades, such as hospitals, mail order pharmacies and
    HMOs. Thus, an average sales price, or ASP, model for drugs
    dispensed to Medicaid recipients would be inequitable for
    retail pharmacies.
        Wal-Mart currently accepts all endorsed Medicare discount
    cards. We have been aggressive in providing educational
    literature regarding the discount cards to our customers. The
    program has been a success at Wal-Mart. We look forward to the
    opportunity to serve the needs of our Medicare customers when
    the Medicare drug benefit starts.
        Wal-Mart pharmacists and all retail pharmacists are a
    valuable part of the health care system and the communities
    that we serve. Pharmacists routinely consult with customers and
    answer questions about prescription and over-the-counter drugs
    as well as general health care issues. Pharmacists are
    consistently regarded as the one of the Nation's most trusted
    professionals.
        In summary, Wal-Mart is committed to continue to provide
    the best service to our Medicaid customers in any reimbursement
    system as long as it provides fair payment for the service and
    product delivered, protects the customer's safety, and allows
    the Nation's retail pharmacies to fairly participate. Thank
    you.
        [The prepared statement of Frank Seagrave follows:]
           Prepared Statement of Frank Segrave, Wal-Mart Stores, Inc.

                                  INTRODUCTION

        Mr. Chairman and members of the Committee, your efforts to gain
    more information about pharmaceutical reimbursements under Medicaid are
    well advised.
        I am a registered pharmacist. I joined Wal-Mart Stores, Inc. (Wal-
    Mart) in 1986, and after various roles in operations and merchandising,
    became Vice President of Wal-Mart's Pharmacy Division based in
    Bentonville, Arkansas. Part of my role includes ensuring that
    ``Everyday Low Price'' (EDLP) is practiced within the Pharmacy
    Division. In its purest form EDLP is as it sounds: the same low price
    every time you visit the store. EDLP begins with ``Everyday Low Cost''
    (EDLC). Purchasing at the best cost along with being a low cost
    operator and using technology to be efficient allows us to sell at
    EDLP.
        As a Medicaid pharmacy provider in 49 states, our job is to get the
    right medications to the patients who need them. As a retail pharmacy
    provider, we must stock and dispense the majority of medications that
    are commonly prescribed. It is noteworthy that ``pharmacies'' do not
    practice pharmacy; it is the face-to-face interaction with the 11,500
    Wal-Mart pharmacists that benefit Medicaid recipients.
        Our pharmacies operate in large urban locations and small rural
    towns across America. Of our nearly 3,500 pharmacies, over 1,200
    operate in rural areas with a population of less than 50,000. Medicaid
    patients in both rural and urban areas value their relationship with
    their Wal-Mart or Sam's Club pharmacist. Wal-Mart's focus is on our
    retail pharmacy patients and their healthcare outcomes. To this end,
    our pharmacists are advocates for the Medicaid patients they serve.
    This advocacy includes: working with prescribers to select less
    expensive alternative medications; immediate conversion of brand
    medications to lower cost generics when they become available; and
    treatment with less expensive OTC medications. Wal-Mart pharmacists
    seek to limit ``preventable'' events by maximizing patient adherence to
    prescribed treatments. ``Pharmacy is about relationships'' has become
    the unofficial mantra of the Pharmacy Division's Associates.
        Wal-Mart purchases most drugs centrally through its own pharmacy
    distribution centers. We are described as a ``self-warehousing'' chain.
    Whenever possible, Wal-Mart buyers order directly from manufacturers,
    who ship products directly to Wal-Mart pharmacy distribution centers.
        Wal-Mart's purchasing decisions for generic products are
    straightforward. If ``AB rated'' generic products--which mean products
    determined by the FDA to be identical to the brand drug--are available
    from multiple manufacturers, Wal-Mart will purchase the drug product
    with the lowest acquisition cost. Product availability is also a
    factor, because a reliable supply of product is essential to satisfy
    our patients.
        Wal-Mart does not take into account the amount of Medicaid
    reimbursement, known or anticipated, in determining whether to stock or
    sell any particular branded or generic drug product. We first and
    foremost follow our core tenet--``ALWAYS LOW PRICES.'' Lower drug
    product prices to patients are made possible through lower acquisition
    costs and operational efficiencies.
        State Medicaid program beneficiaries represent an important patient
    population to Wal-Mart. These patients represent 11% of our pharmacy
    business revenue. Wal-Mart values its role as a Medicaid provider and
    has never withdrawn from participation in any program, in the Medicaid
    system, or threatened to do so. Wal-Mart competes for Medicaid patients
    based on service. While we never provide a blanket waiver of Medicaid
    co-payments for our patients, we do not collect the nominal co-payment
    when a Medicaid patient is unable to pay it.
        We do not sponsor a Medicare Discount Card Program, but accept all
    Medicare-endorsed drug discount cards. Wal-Mart has been aggressive in
    providing educational literature regarding these discount cards and
    these approved discount cards have been a success at Wal-Mart. The
    Pharmacy Division also strongly supports and participates significantly
    in manufacturer-sponsored patient assistance programs, such as
    TogetherRx.
        My testimony today addresses two issues. First, the importance of
    ensuring access to Wal-Mart's retail pharmacies by America's most
    needy, the elderly and the poor. Second, how can Wal-Mart partner with
    the states to have an effective Medicaid drug program?
    The importance of ensuring access to Wal-Mart's retail pharmacies.
        On a daily basis, our 11,500 pharmacists take care of patients in
    the Medicaid program, fill their prescriptions that are subject to
    complex rules and regulations, and provide the best patient-focused
    care.
        When prescription-only products move to the over-the-counter (OTC)
    market, their prices drop sharply. Wal-Mart pharmacists routinely
    consult with patients who have OTC medication questions. This includes
    options such as our cost-effective private label Equate '
    brand OTC products, for patients when therapeutically appropriate. Wal-
    Mart's private label diabetic testing and treatment products sold under
    the ReliOn ' diabetes brand are considered the best value
    brand in the United States. All state Medicaid programs should include
    these products on their formularies and provide reimbursement for them.
    Many states do this today.

    Usual and Customary Charges (U&C)
        Revenue from Wal-Mart's ``cash'' pharmacy business for drug
    products is significantly larger than its revenue from Medicaid. Retail
    cash price or ``U&C'' is defined as the usual and customary charge for
    a drug product offered to cash paying patients. Because this U&C is
    often lower than the reimbursement formula for Medicaid, this benefits
    both cash-paying patients and the Medicaid programs. Individual Wal-
    Mart pharmacies have the ability to lower, but not increase, drug
    product prices (U&C) within their marketplace as they see fit. Thus,
    Wal-Mart's U&C (EDLP) is often lower than the formula driven payment
    set by the state Medicaid programs. Our estimates indicate that many
    times Medicaid prescriptions were reimbursed at Wal-Mart's lower U&C.
    The impact of our aggressive lowering of U&C is represented on the
    attached graphs and Fact Sheet.

    Generic Utilization at Wal-Mart
        When a generic is available for a prescribed branded product, Wal-
    Mart pharmacies dispense that generic over 94% of the time. This is
    true for all payers. Consumers need to know when generic options are
    available and that they are as safe and effective as brand name drugs,
    but at a fraction of the cost. Wal-Mart pharmacists play an important
    role in educating patients about their drug treatment. Our pharmacists
    help patients understand generic options and whether more affordable
    generics might be right for them.
        In summary, Wal-Mart has low prescription and OTC drug prices
    everyday for cash-paying patients and Medicaid benefits directly from
    this. Our pharmacists also recommend generic drugs and shift patients
    to more cost-effective drug therapies.

    How can the Wal-Mart partner with the states to have an effective
            Medicaid drug program?
        One of the main reasons for the continuing rise in Medicaid drug
    expenditures and the failure of cost-containment measures, is the
    introduction of new, more expensive brand name drugs. Drugs within a
    therapeutic class may be similar, but their prices often vary
    substantially. Several state Medicaid programs took a major step in
    passing legislation mandating a permanent commission to research and
    report on the comparative effectiveness of medications and prices. Wal-
    Mart encourages other states to implement similar tools.
        Reimbursement mechanisms for generics should aim for price
    competition as the main priority. To Wal-Mart, multi-source generics
    represent a commodity. Generics save everyone money. The following
    charts demonstrate Wal-Mart's experience in Medicaid reimbursement for
    2002.

    [GRAPHIC] [TIFF OMITTED] T7275.071

        While almost half of the prescriptions are written for generic
    drugs, they account for less than 20% of total Medicaid expenditures.
    Switching from expensive brand drugs to lower cost generics can help
    alleviate this problem. Wal-Mart is strongly committed to encouraging
    the use of AB rated generics--the exact same drugs at a much lower
    cost. Generic substitution provides tremendous savings at the same
    time. Generic drugs mean competition, and competition means lower
    prices, both to the pharmacy and to the patient. Focusing on generics
    to reduce Medicaid prescription drug costs is not the answer, because
    the largest expense lies in the over-utilization and high cost of
    single source brand drugs. The chart below provides the average total
    reimbursement received by Wal-Mart from Medicaid programs for each type
    of drug.

    [GRAPHIC] [TIFF OMITTED] T7275.072

        Wal-Mart endorses the continued adoption maximum allowable cost
    (MAC), with frequent audits/updates, for multi-source generic drugs
    under Medicaid.
        For branded drug products, Wal-Mart has little or no ability to
    negotiate discounts below the published wholesale acquisition cost
    (WAC). Wal-Mart has no greater leverage for branded drug products than
    any other retail class of trade pharmacy provider.
        There is a great disparity between what drug manufacturers charge
    retail pharmacies and the significantly lower prices they charge other
    classes of trade such as hospitals, mail order pharmacies, and health
    maintenance organizations. Thus, an average sales price (ASP, as
    defined in the Prescription Drug Improvement and Modernization Act
    (PDIM)) reimbursement model for drugs dispensed to Medicaid
    beneficiaries would be inequitable for retail pharmacies. ASP is
    intended to represent volume-weighted, average selling price to all
    purchasers, excluding certain federal purchasers.
    Conclusion
        Wal-Mart supports any reimbursement system that provides fair
    payment for the service and product delivered, protects the patient's
    safety, and permits the nation's retail pharmacies to fairly
    participate. Wal-Mart's motto--Always low prices--is carried out in its
    pharmacy operations. Actual substantial savings come from market shifts
    to more cost-effective therapies. Wal-Mart and its pharmacists, as a
    low cost pharmacy provider, are on the front line to effectuate such
    shifts.
        Thank you for the opportunity to appear today. As always, Wal-Mart
    is willing to work with state Medicaid programs to be part of the
    solution.

        Mr. Walden. Thank you. I appreciate your comments, Mr.
    Seagrave.
        I just want to say at the outset that we don't want to do
    anything here that would create a disincentive to generic use.
    I think we all agree that that is an important component of
    holding down costs and giving consumers choice. But we do need
    to make sure that the taxpayer benefits from the savings, and I
    think--so we can take care of those who need help that today
    are, frankly, robbed of that help because, in some cases, of
    lack of funds. So I want to start by getting at this issue of
    the AWP with this panel. Do each of you believe that the AWP
    reflects the actual selling price that you charge for your
    products?
        If we can get kind of a yes-or-no answer. Mr. Stratemeier.
        Mr. Stratemeier. No, it does not.
        Ms. Marrs. No.
        Ms. Paoletti. No.
        Mr. Catlett. No.
        Mr. Marshall. No.
        Mr. Ziebell. No.
        Mr. Seagrave. No.
        Mr. Walden. So all of you agree that it is not a legitimate
    selling price, reflection of your selling price.
        Do you adjust the AWPs of your products after you have set
    them; and, if so, under what circumstances? Mr. Stratemeier.
        Mr. Stratemeier. Well, in the brand industry, AWP generally
    reflects a 20 to 25 percent markup over wholesale acquisition
    cost, WAC. So as WAC is increased, AWP goes up accordingly.
        Mr. Walden. You do adjust your AWP then on a regular basis?
        Mr. Stratemeier. I can't say that companies adjust the AWP.
    The reported AWP by the reporting services, put out the AWP.
    Most companies, including Aventis do not set an--most brand
    companies do not set an AWP.
        Mr. Walden. Okay. Ms. Marrs.
        Ms. Marrs. In our case, in the case of generics, we
    historically have not had a practice of raising AWP. For the
    brand products, we have increased AWP as the WAC has increased.
        Mr. Walden. Okay.
        Ms. Paoletti. Generally, we do not change our AWPs once
    they are established. We have changed some AWPs for one reason
    or another.
        Mr. Walden. Why wouldn't you adjust them to reflect the
    market?
        Ms. Paoletti. Why wouldn't we?
        Mr. Walden. Yes.
        Ms. Paoletti. It is generally a standard in the generic
    industry that you set your price for AWP and you don't adjust
    it.
        Mr. Walden. All right. Mr. Catlett.
        Mr. Catlett. An instance where I can think that AWPs are
    increased in our business would be in a sole-source generic
    situation. We are the only generic on the market. If there was
    a brand price increase and we felt there might be an
    opportunity and we would make a decision to raise our generic
    price, we would raise both our AWP and our price to maintain.
        I think we heard earlier today that generally there is a 90
    percent difference between the brand and the generic price.
    That is the incident I can think where AWP might increase, sir.
        Mr. Walden. Let me go to your testimony. I am going quote
    it here, Mr. Catlett. You said, ``It is generally known in the
    pharmaceutical industry and related government agencies that
    average wholesale price, AWP, is a reference price only and
    does not represent the actual selling price charged by the
    manufacturer for its products.''
        I would like you to--they don't have the notebook, do
    they--to turn to Tab 1. Do we have--we don't have that. They
    can't turn to Tab 1. There you go.
        In our exhibit binder there, you will see OIG compliance
    program guidelines for pharmaceutical manufacturers. And on the
    bottom of page 23,733, it says, ``The government sets
    reimbursement with the expectation that the data provided are
    complete and accurate, and, where appropriate, manufacturer's
    reported prices should accurately take into account price
    reductions, cash discounts and free goods,'' et cetera.
        In light of these ongoing--these OIG guidelines, if you
    report an AWP, aren't you required to make sure that it is up
    to date and accurate?
        Mr. Catlett. Are you directing that question to me?
        Mr. Walden. To you and Ms. Paoletti and Ms. Marrs.
        Mr. Catlett. I will take the question first, sir.
        The practice in the industry is to report AWP as a
    reference price. I believe what is reported that is updated is
    we do provide our AMP, which is our average manufacturer's
    price, which does take into account all of those.
        Mr. Walden. But given that AWP is also used as a
    reimbursement mechanism, shouldn't it be accurate to the
    market? I mean, to--shouldn't it represent something?
        Mr. Catlett. It has been industry practice and the practice
    at Barr that it is strictly a reference price and it is in
    relation to the branded price.
        Mr. Walden. Ms. Paoletti.
        Ms. Paoletti. I would agree with that. And there really is
    no clear guidance for us to follow that tells us how to
    calculate that number.
        Mr. Walden. Ms. Marrs.
        Ms. Marrs. I would agree with my colleagues.
        I think we have heard many times here today the system is
    broken. There is no statutory definition of AWP. To the extent
    that there is clear guidance, as the gentleman from Barr said,
    we have been reporting AMP. But the industry practice as it is
    and the lack of statutory guidance, industry practice has
    prevailed.
        Mr. Walden. All right. I want to go--turn to Tab 37, if you
    would, Ms. Paoletti. This is document number 01999-02002. The
    second page of the document, 02000, states that Roxane's bids
    for Furosomide business were rejected not because the sales
    price was too high but solely because the AWP was too low. Our
    AWP and reimbursement factors in negotiations with retail
    customers.
        Do you want to talk about that, that document?
        Ms. Paoletti. Furosomide was a very unique situation for us
    in that there were some changes in the market that allowed
    opportunities for us to potentially gain new business.
        When we tried to gain the new business, we were repeatedly
    told that our AWPs were out of line with our competitors and,
    upon looking at that, discovered that they were significantly
    below our competitors such that, regardless of how low our
    contract price was, no one would buy the product.
        Mr. Walden. So AWP--I mean, okay. I guess what I see here
    is that AWP is how you get market share. The higher it is, the
    better chance you have to get market share. Because somebody is
    making money on the spread, and the people making the money are
    the purchasers. Right?
        Ms. Paoletti. I would disagree with that. I think it is
    in--in our experience, it has been a rare occasion that
    customers have discussed any of that with us; and, in this
    occasion, it is my impression that the only reason it was
    discussed was because we were out of line. They weren't asking
    us to increase the spread over where the current market was.
    They were just asking us to be on a level playing field.
        Mr. Walden. Okay. We will try and tell you what tab this
    one is.
        But there is--Tab 39, if you will go to that. And it says
    here--this is to Judy Waterer from Anthony Tavolero. It says,
    Judy, as you know, Caremark had shown interest with our
    Furosomide back in April. After review of our AWPs on the
    product, the opportunity was dead. Our AWPs are 78 percent
    below the rest of the industry. I am not aware of any
    competitor where the AWP is below $100 for bottles of 40
    milligram thousands. Miline and Zenith are approximately $120,
    ours is $29. Caremark has commented that they could not
    possibly award the product to us unless we increased our AWPs.
    Janet Miller also added that Roxane has a history of having
    AWPs out of sync with the rest of the industry.
        I don't know why we have to wait until our customers
    complain before we adjust an AWP. Major customers--Walgreen,
    Wal-Mart, CVS, MEDCO, Caremart--expect their leading suppliers
    to maintain their AWPs. Not executing this core competency
    reflects negatively on Roxane and promotes a perception of
    Roxane not understanding industry dynamics. I hope this helps.
        This would appear to me to reference more than just
    Furosomide. Does it appear that way to you?
        Ms. Paoletti. Well, he does say that we have a history. I
    am not sure what he is basing that on. Typically, we set our
    pricing and we don't monitor it. We don't monitor AWPs once
    they are set.
        Mr. Walden. Then why would he say, I don't know why we have
    to wait until our customers complain until we adjust an AWP?
        Ms. Paoletti. In this case, he is referencing Furosomide.
    And we aren't able to get business. Actually, we were on the
    verge of discontinuing the product because we couldn't gain
    customers, and it was based on the fact that our AWP was so far
    out of line with where the rest of the market was.
        Mr. Walden. Okay. And then if you would turn to Tab 38 in
    the binder. This document also notes that when AWP is out of
    line with the rest of the market it a bigger issue than a
    straight price. But this e-mail goes on to mention concerns
    associated with the decision to raise AWP, including scrutiny
    and consumer backlash. Can you discuss those concerns?
        Ms. Paoletti. Any time pharmaceutical companies do a price
    increase, it is scrutinized, AWP in particular, because that is
    one of the prices that is publicly available for every one to
    see.
        Mr. Walden. But it appears, in this case at least, in order
    to get market share--am I missing it? In order to get market
    share, you are having to increase your AWP?
        Ms. Paoletti. We were having to bring it in line with our
    competitors, yes. They weren't asking us to raise it above our
    competitors. That was not my impression.
        Mr. Walden. What effect does raising the AWP have on the
    price that they pay for that product?
        Ms. Paoletti. That the customers pay? It would not have an
    impact on the price that they paid.
        Mr. Walden. What is the benefit to them of a higher AWP set
    by you, which I assume would be an arbitrarily set AWP?
        Ms. Paoletti. Well, in this case, they weren't buying our
    product. They were buying another competitor's product, who was
    much higher. So, in that case, there would not have been an
    impact on what they were currently buying versus what----
        Mr. Walden. No, my point is, your incentive to raise the
    AWP is to get market share, is it not?
        Ms. Paoletti. In this case, it was to bring ourselves in
    line so that we could actually compete on a contract price
    basis.
        Mr. Walden. Right. To get more market share.
        Ms. Paoletti. Sure.
        Mr. Walden. It doesn't cost the purchaser any more and it
    doesn't cost you anything to have a higher AWP?
        Ms. Paoletti. True.
        Mr. Walden. So the loser in this is the government, right,
    the taxpayers?
        Ms. Paoletti. Well, I wouldn't agree with that.
        Mr. Walden. Why?
        Ms. Paoletti. Because at the time they were already buying
    one of our competitor's products that was already at that--at
    that level. My changing that price didn't advantage----
        Mr. Walden. Right. Okay. But your company would benefit by
    changing if it allowed you to get market share.
        I guess the point is not to pick on Roxane specifically. I
    don't mean to do that necessarily, other than as an example of
    the pressures within the marketplace that drive a higher AWP in
    order to get market share. The actual price paid by the
    purchaser is no more. You have indicated that. The AWP, you
    just all are competing up here to see who has got the highest,
    because that creates the biggest spread?
        Ms. Paoletti. I am not sure that is the way that it is
    really done.
        Mr. Walden. How is it done?
        Ms. Paoletti. In our case, we set the AWP and we don't
    monitor AWPs of our competitors. We typically don't change our
    AWPs.
        Mr. Walden. In this case, you were monitoring and had all
    of the data. It is in the e-mail.
        Ms. Paoletti. Well, in this case, we weren't monitoring it.
    It was so far out of line that our competitors were bringing it
    to our attention that, hey, even if you have the best supply
    and the lowest contract price, I can't pay your product because
    you are not in line on this other reference price.
        Mr. Walden. The other reference price does what for them?
        Ms. Paoletti. It would have put us in line with----
        Mr. Walden. No, it creates the spread, right? The AWP
    creates the spread with the actual purchase price. Correct?
        Ms. Paoletti. It would be one of the factors that their
    reimbursement is based on, yes.
        Mr. Walden. All right. My time has expired. Thanks for the
    patience of the committee.
        Mr. Stupak.
        Mr. Stupak. Thanks, Mr. Chairman.
        Well, going along that line, Exhibits 37, 38, 39, Mr.
    Catlett, your testimony on page 8 says, if a generic
    manufacturer unilaterally reduces its AWP for a given product
    relative to the AWPs of other generic manufacturers for the
    same product, pharmacies would have an incentive to purchase
    another manufacturer's drug that did not reduce its AWP.
        So basically what is going on here, if you keep the AWP
    high, then the pharmacies make more money off it, right?
        Mr. Catlett. I believe what I tried to say in my written
    testimony is that the AWPs are set as a reference price. If a--
    in a multi-source situation, if there are multiple competitors,
    I believe that if a company such as Barr was to unilaterally
    reduce its AWP and if we are still in a situation where it is
    not an FUL or not a MAC in place and we are dealing with AWP
    reimbursement formulas, while I have no example or any
    experience and could you give you an example of it, my fear
    might be that it would put a situation in place where we may
    have that type of decision.
        Mr. Stupak. Well, Ms. Marrs, you testified that you had a
    product and you lowered your AWP and you couldn't get any
    customers to buy it, right?
        Ms. Marrs. We have had a couple of situations. We tried to
    launch a product without AWP.
        Mr. Stupak. You established an AWP. It was lower than the
    rest, and your customers wouldn't buy it?
        Ms. Marrs. That is correct.
        In the other situation, we did not lower our AWP, but one
    of the reporting services chose to do so without our knowledge.
    And, as a result of that, we got many calls from pharmacists
    basically saying that they wouldn't be able to buy our products
    in the future if that situation was not changed.
        Mr. Stupak. So if we lower the AWP, why won't the
    pharmacies buy the drugs? If there is a lower AWP, you are
    paying a lower price, you could pass that savings on to your
    customers, as you claim you like to do. So why wouldn't you buy
    a drug at a lower AWP? Mr. Marshall? Mr. Ziebell? Mr. Seagrave?
        Mr. Marshall. As I stated earlier, my responsibility to CVS
    is to purchase the lowest-possible-cost generic product. I do
    not focus on the AWP value in negotiations. The market is very
    fluid and dynamic and a highly competitive marketplace.
        Mr. Stupak. That is not what these people are saying. They
    are all saying you keep your AWP at the market standard. It is
    not fluctuating. If you would bring it lower, you don't get
    customers. You are the customers. You are the pharmacists.
    Isn't it true the reason why you don't want to lower AWP is if
    you have a lower AWP your reimbursement from the government and
    from the insurance companies is discounted off of that AWP? So,
    therefore, if the AWP is lower, your profit is lower on that
    drug. Isn't that true?
        Mr. Marshall. Again, I don't focus on the AWP. My
    initiative or my----
        Mr. Stupak. How about just a yes or no? I don't care if you
    focus on it or not. Doesn't it stand to logic if you have a
    lower AWP and you are reimbursed--and that AWP is discounted by
    Medicaid and by the big insurance companies, the lower the AWP,
    the lower the profit for the pharmacy? Yes or no?
        Mr. Marshall. Yes, if the reimbursement were based on AWP.
    Correct.
        Mr. Stupak. Are you telling me it is not?
        Mr. Marshall. No, I am agreeing with you, that that would
    be the case.
        Mr. Stupak. Sure.
        How about Mr. Ziebell? Would you agree with that? Lower AWP
    means lower profit to--who do you represent? CVS or Walgreens?
        Mr. Ziebell. It would depend on whether or not the product
    is reimbursed based on AWP. If it were, than the profit would--
    --
        Mr. Stupak. Well, Medicaid is reimbursed based on AWP?
        Mr. Ziebell. In some situations, yes. There are Federal
    upper limit and MAC situations put on by the Federal Government
    and the individual States. But if it was based strictly on AWP,
    if you lower AWP, the reimbursement would be lower.
        Mr. Stupak. Well, we are looking at the list right here.
    Medicaid prescription reimbursement information by State. It is
    all based upon an AWP, plus a little bit more. So the lower the
    AWP, the lower the profit to you. So if you are really
    concerned about the price the customer pays, wouldn't you want
    to buy your drugs from these manufacturers here who have a
    lower AWP to pass that savings on to your customers?
        Mr. Ziebell. I haven't had a situation presented to me
    where the AWP has been lower.
        Mr. Stupak. Well, not you personally. But I mean to your
    company.
        Mr. Ziebell. Well, I am the purchaser of generic
    pharmaceuticals. And that is the case, that no one has been----
        Mr. Stupak. You represent what company?
        Mr. Ziebell. Walgreens.
        Mr. Stupak. So this e-mail then that they referred to, I
    believe Exhibit 38: I don't know why we have to wait until our
    customers complain before we adjust an AWP. Major customers--
    Walgreens, Wal-Mart, CVS, MEDCO, Caremart--expect their leading
    suppliers to maintain their AWPs.
        I guess you are mentioned in this one.
        Mr. Ziebell. Well, from the manufacturer's standpoint. I
    have never indicated that direction to any manufacturer.
        Mr. Stupak. Okay. Mr. Seagrave, do you care to comment? If
    you lower your AWP, you could lower the price for the customer,
    right?
        Mr. Seagrave. I would agree with the other two gentlemen.
    If reimbursement is based upon the AWP only, then our
    reimbursement would be less if it was based on AWP.
        I would comment, though, that we heard testimony on the
    previous panel from some gentlemen from Michigan and in Texas
    where they indicated that they do have maximum allowable costs
    in place, and they base their reimbursement off of that and not
    off of AWP.
        Mr. Stupak. Well, how can this side of the table over
    here--Mr. Stratemeier, Ms. Marrs, Ms. Paoletti, Mr. Catlett--be
    saying they can't sell any unless it is based on a stable AWP,
    which is higher price? You are saying that is not the only
    reason? I mean, what side of the table is right here, left or
    right?
        Ms. Marrs. I think the issue is there needs to be a level
    playing field. I don't think the manufacturer is as concerned
    with exactly what the reimbursement rate is. The issue is it
    has to be the same for all manufacturers competing with that
    specific product.
        Mr. Stupak. Well, a manufacturer wouldn't be concerned,
    because you are trying to get part of market share. It makes
    sense, you would lower your AWP to get a bigger market share.
    But if the customers, the pharmacies won't buy it unless you
    maintain a higher AWP, because that is what their profit is
    based upon--so the system really is broken.
        Ms. Marrs. The system is broken. There really needs to be a
    reimbursement rate set by somebody outside of manufacturing so
    it is a level playing field for all of the manufacturers.
        Mr. Stupak. Let me ask you this question, and go right down
    the line. We have known for years and we have heard again today
    that the average wholesale price, or AWP, and the WAC, or
    wholesale acquisition cost, on which most States base their
    Medicaid drug reimbursement formulas are fictitious numbers.
    You know it, Congress knows it, CMS knows it, and the States
    know it. As the $2 billion in fines and settlement indicate,
    the manufacturers have benefited from an AWP system, but so
    have the providers. The big losers been the taxpayers and the
    poor who are most vulnerable to losing their health care when
    there are budget crunches. Sicker, uninsured, and untreated
    people don't benefit any of us. The systems need to be changed.
    But any changes, any change needs to be fair, transparent,
    efficient and effective.
        The CMS expert panel recommends that reimbursement be based
    on actual acquisition costs to the pharmacies. Aventis made
    this recommendation in 2002. So I would like to hear from each
    of you how would you change the system. Mr. Stratemeier.
        Mr. Stratemeier. Well, as we said in our policy statement,
    that we think that actual acquisition cost is the best way to
    start your structure, your reimbursement system.
        Mr. Stupak. Then you can still put in a dispensing fee and
    a copay?
        Mr. Stratemeier. If a pharmacist dispenses drugs, there
    would be a dispensing fee. For physician office drugs, there
    would be a physician services fee. That needs to be adequately
    dealt with in its own right. But the key is the actual
    acquisition.
        Mr. Stupak. The key is for the pharmaceuticals to use the
    actual acquisition cost.
        Ms. Marrs.
        Ms. Marrs. I agree that it should be cost based, and a
    reasonable service fee should be provided.
        In the case of getting the cost from the manufacturer, I
    just would caution the committee that, in our case, most of our
    sales are to wholesalers and distributors. So when we report an
    average selling price that may not be reflective of what the
    pharmacy is actually paying. That needs to be considered in
    developing the methodology.
        Ms. Paoletti. I would agree that any system that is put in
    place needs to encourage the use of generic, lower cost
    generics, and it needs to take into account all of the issues
    that impact all of the parties--the manufacturers, the
    pharmacies, the patients, and the government.
        I am not sure that we can sit here today and put forth a
    proposal.
        Mr. Catlett. I think the important issue here and what you
    are getting at is, in a situation where we have many
    competitors entering the market and we are seeing a dramatic
    decrease in acquisition price by our customers, that an AWP-
    based reimbursement system may not be the best solution.
        I think that is the really the key issue here there needs
    to be reliance upon.
        Mr. Marshall. We would, at CVS, be open to dialog to
    discuss a program that would provide coverage for Medicaid
    patients, would offer a program that covered the cost and
    adequately covered the dispensing fees associated with filling
    a prescription; and, again, just to reiterate, that would
    promote the lower cost generics.
        Mr. Ziebell. I think that is the most important part, is
    you don't want to take away the incentive to dispense the
    generic over the brand. The focus here has really been on the
    markups on generic pharmaceuticals, but not much attention has
    been paid to the small markup that results from the
    calculations based on brand-name pharmaceuticals. So I think
    you have to keep that in mind, also.
        Mr. Stupak. Mr. Seagrave.
        Mr. Seagrave. Well, I think there are a lot of
    possibilities and a lot of things that we can talk about and
    ways to fix the system.
        I think primarily what we would want to do is focus on the
    increased use of generic drugs, and then I think we need to
    come up with a fair and equitable formula where we address the
    adequate dispensing fee, the adequate cost of goods and
    services, and we will offer our support into finding that
    solution.
        Mr. Walden. Thank you.
        The gentleman from Michigan, Mr. Rogers.
        Mr. Rogers. Thank you, Mr. Chairman.
        Wow, was it a great day when I got the health care
    committee in Energy and Commerce. You know, I went to a
    reference point to make sure we were taking about the same rule
    of law. I went to page 23,733. I don't know how you all do it.
        And when I look at the fact that there is really no
    guidance in this AWP, if we have found an enemy in this whole
    thing, it is us, the U.S. Congress. To create a system that has
    a perverse incentive in it for the customers of these
    manufacturers to try to establish a price point that says,
    look, I know they are not going to cover my proper dispensing
    costs so I have got to build that in, and I am going to make
    sure that obviously we make a little bit on the drug itself and
    the dispensing costs. So I have got to try to figure out how to
    bump up this AWP to make sure, of which they are not giving me
    credit for, I get credit for when I am building in my profit
    margin on running a pharmacy. Holy mackerel.
        I don't know how we got here. But this is broke. I
    appreciate you all being here. Where there is profit, there is
    normally confusion--or where there is confusion, there is
    normally profit.
        I would venture to guess that most of you have been subject
    to lawsuits on pricing. Has any of you experienced a lawsuit on
    pricing?
        Let the record reflect that I think everybody on the panel
    has been shaking their head. The only people smiling are your
    counselors on the other side of you.
        I mean, this thing is absolutely amazing. And, Ms.
    Paoletti, can you explain to me--I mean, what--when this
    lawsuit happens to your company, based on confusion of which I
    think the Federal Government is a big part of this problem,
    what does that do? What does that cost structure do to the cost
    of your product, to your time and talents dedicated to trying
    to run a business and getting low-cost drugs to the market?
        Ms. Paoletti. It takes a tremendous amount of our
    resources, both time and money, that, frankly, would be much
    better spent reducing our prices and our costs.
        Mr. Rogers. Do you have any idea--probably not a fair
    question, but do you have any idea--I mean, what percentage
    cost--is there any way I can get anywhere close to a figure of
    what--the lawsuit problem of your cost structure? You build it
    in every year, I imagine.
        Ms. Paoletti. I am sure that we can provide it for you.
        Mr. Rogers. That would be helpful.
        Anyone else? Obviously, some of even the bigger pharmacies,
    have you been subject to these suits as well?
        Mr. Ziebell. I am not personally aware of that. I am in the
    purchasing department, and I try to keep the costs as low as
    possible. I am not aware of pricing lawsuits.
        Mr. Rogers. I think we all know the answer to the question.
    This is a significant cost. It is a confusion that we have
    created for you to try to have to deal with. And I agree. I
    appreciate you all being here. We are going to have to do
    something about this. This is absolutely nuts.
        Let me ask you this. Could you go to a Medicare pricing
    system, ASP plus 6, fill in the blank? I mean, this--is this
    something that is a structure that seems to be a little bit
    closer to taking into account your costs of distribution and
    the costs of the drug and the ability for you to keep your
    doors and lights on and pay people? Any thoughts?
        Nobody wants to commit to a pricing structure. That is very
    smart. I can see your lawyers tugging on the back of you. If
    you do, don't do that. That means no bonus this year.
        Quite obviously, this pricing structure thing is a problem.
    Let me ask you this other question. You can sense my
    frustration. I certainly sense yours, and trying to go through
    this and understand it.
        By the way, that first 22,000 pages was riveting. Loved it.
        Would it be--what problem would it cause for you--and I
    will address this to Ms. Paoletti--to provide your pricing
    structure to the States? Is that a problem?
        Ms. Paoletti. We would provide whatever information was
    required by the States, as we currently do.
        Mr. Rogers. For DEY as well?
        Ms. Marrs. We would be fine with providing pricing
    information to the States. We would hope that it would be kept
    confidential from our customers.
        Mr. Rogers. Obviously. I am not sure that is the right
    answer. But if I have learned nothing today, that we have got,
    A, a transparency problem, availability of information problem,
    and this god-awful system of which we have created to build in
    these perverse incentives for people to start dealing against
    each other, not for lowering prices in a free market
    competition but to try to jack them up a little bit to cover
    costs that we haven't recognized at the Federal Government, is
    a real issue for you and your operations.
        That is an issue that I hope, if nothing else, that we walk
    away from this hearing today and try to deal with that very,
    very serious issue. And I, again, I appreciate you all being
    here and your forthrightness, and trying to get us to this
    answer.
        Again, I have found this out in this oncology issue that we
    have created a really bad system, and then we blamed people for
    trying to participate in applying any business sense that they
    could possibly muster in this god-awful system that we created,
    and then we come back a few years later and said, how could do
    you that? That is awful. It is a system that we created.
        Thanks for having the patience to hang in there and trying
    to offer low-cost drugs to your customers. Hopefully, we will
    have some relief on this lawsuit side of it as well. I know
    that is just an absolute waste of money in our healthcare
    system. We have got to fix it.
        And hopefully, Mr. Chairman, we can work to eliminate what
    is obviously a very confusing, large, ugly system, trying to
    develop and implement rules and regulations so you all know
    what you doing.
        With that, I yield back, Mr. Chairman.
        Mr. Walden. The Chair now recognizes the gentleman from New
    Jersey, Mr. Ferguson, for questions.
        Mr. Ferguson. Thank you, Mr. Chairman. I appreciate you
    holding this hearing. I don't have any questions at this time,
    but I share many of my colleagues' concerns about AWP.
        Clearly, this is an issue that is going to continue to draw
    a lot of attention from folks on this panel, folks on our
    committee. And I really look forward to engaging in that
    debate, because clearly there are many problems which need to
    be addressed, and I thank the chairman and the committee for
    holding this hearing.
        Mr. Walden. Appreciate your participation.
        Mr. Marshall, I want to come back on some questions. I
    would like to turn your attention to Tab 37. In the exhibit
    binder, pages 2001, 2002, purportedly quote a voice mail left
    by a CVS buyer, Matt Leonard. Do you know who Mr. Leonard is,
    Mr. Marshall?
        Mr. Marshall. Yes.
        Mr. Walden. Who is he?
        Mr. Marshall. I replaced Matt Leonard. He was the person in
    my position prior to me taking the current role.
        Mr. Walden. Is he still with the company?
        Mr. Marshall. Yes, he is.
        Mr. Walden. And what role does he have now?
        Mr. Marshall. He is the Vice President of Pharmacy
    Merchandising.
        Mr. Walden. So where is he in the hierarchy with you?
        Mr. Marshall. I report to Matt.
        Mr. Walden. So you report to Mr. Leonard.
        This is a voice mail supposedly left by him in June, July
    2000, concerning Furosomide. And it says, and I quote, CVS
    would award Roxane the product if we, Roxane, would adjust our
    AWPs to reflect where the other generic companies are.
    Otherwise, CVS would award to Zenith Gold Line.
        Does CVS emphasize AWP or reimbursement when negotiating
    with these folks?
        Mr. Marshall. Okay. I have not seen this document prior to
    this time, and it was my understanding that counsel had spoken
    with counsel for the committee, that documents that had not
    been reviewed previously would not be reviewed today. I would
    just like to verify that.
        Mr. Walden. Who did your counsel speak to on the committee
    about that?
        Mr. Marshall. I believe it was Mr. Stone.
        Mr. Walden. My understanding is there was not an agreement
    like that. They tried to show you all of the documents that we
    got.
        Mr. Marshall. I would be more than willing to review this
    document and come back to you with a response.
        Mr. Walden. Why don't you take your time right now to take
    a look at it, if you don't mind.
        Because it says: CVS is looking for a Furosomide vendor.
    Apparently, the HICFA MACs are changing shortly, and they are
    not happy with the margins. And their current supplier--they
    did not have the new MACs available to share with me, but,
    being public record, I am sure that we should have them
    somewhere. In fact, I think Bob has them on his desk.
        In the past, CVS has asked for AWP less 55 percent to be
    competitive on generics. I am not sure how the MAC impacts
    this. I would like to discuss this with Bob or Anthony before
    we bid. For now, I have listed the requested bid price, AWP
    less 50.
        And then it says: ML, CVS would award Roxane the product if
    we would adjust our AWPs to reflect where other generic
    companies are. Otherwise, would award it to Zenith Gold Line.
        If you look at Tab 38----
        Mr. Marshall. Okay.
        Mr. Walden. [continuing] Tab 38, you will see that the
    document there, which I am told you have been made aware of
    prior to this hearing, is almost identical in its language or
    reference points to this issue.
        Have you seen that document before, Tab 38? It is a set of
    e-mails. My counsel indicates that you were made aware of this
    document.
        Mr. Marshall. I have seen the lower portion of that page.
    Yes.
        Mr. Walden. And for the record, this is an e-mail from
    Steve Snyder to Judy Waterer at Roxane, right? It says: Gang,
    CVS is looking for a Furosomide vendor. Apparently, the HICFA
    MACs are changing shortly. And I just read most of this. That
    goes on to say, can I request that we discuss this Thursday or
    Friday, et cetera, et cetera, which is very similar to the
    document on page Tab 36.
        So I guess the issue is, do you know if Mr. Leonard or
    you--do you ever look at AWPs?
        Mr. Marshall. As I mentioned earlier, regarding negotiation
    of lowest cost, to the extent that a manufacturer provides me
    with a published AWP or their AWP and references that AWP in a
    conversation or in a proposal, very often I will use that AWP
    value as a point of negotiation, not to instruct or ask that
    the value be changed in any way, shape or form, but, to the
    extent that I am offered a discount off of AWP, for example,
    that a manufacturer indicates they would sell it to CVS for AWP
    less 40 percent, I may say, well, gee, I would like to have it
    at AWP minus 60 percent as a good negotiating tool, all within
    the context of that value having been provided to me but for no
    other purpose other than to derive a lower cost of goods.
        Mr. Walden. I thought earlier you testified that you didn't
    look at AWP as a negotiating point?
        Mr. Marshall. I believe I testified that I do not consider
    AWP as far as requesting any changes to that value. But to the
    extent that it is presented to me by a manufacturer, I will use
    that as a point of leverage to try to get a lower----
        Mr. Walden. Do you ever inquire about AWP, what it is and
    what--how much off you are being offered?
        Mr. Marshall. As a standard, the AWP is provided when a
    proposal is provided to me for a new product.
        Mr. Walden. So it is something that you look at then?
        Mr. Marshall. I am aware of it.
        Mr. Walden. Do you require it to be provided to you when
    you are looking at purchasing a product?
        Mr. Marshall. We require it to put in into our systems.
        Mr. Walden. Okay. So you are asking for AWP, the pricing on
    AWP, right?
        Mr. Marshall. Yes, I am asking for the value.
        Mr. Walden. Why do you ask for that?
        Mr. Marshall. We need it to set up an item in our current
    systems at CVS.
        Mr. Walden. What purpose does it serve in your current
    system then? It is to determine the spread?
        Mr. Marshall. No. I am not certain, But it may have some
    role in third-party processing downstream. But I am not sure as
    to the purpose we need it.
        Mr. Walden. You don't know what use it has in your company?
        Mr. Marshall. I need to have that value to set up a new
    item. Correct.
        Mr. Walden. I guess I am--but you don't know why you need
    it? You just know you need it?
        Mr. Marshall. It is a value that I need to populate in our
    purchasing system.
        Mr. Walden. But you don't know what role it plays in the
    purchasing system?
        Mr. Marshall. I believe that downstream it may be used in
    our third-party processing systems.
        Mr. Walden. And that third-party processing system does
    what? Is that the billing system to the government?
        Mr. Marshall. The third-party system would be responsible
    for managing our third-party claims.
        Mr. Walden. And who are third-party claims?
        Mr. Marshall. Private as well as Medicaid.
        Mr. Walden. So this does play a relationship then in the
    billing to Medicaid?
        Mr. Marshall. Yes, as far as me populating that value, and
    ultimately downstream it may be used for that purpose.
        Mr. Walden. But you are telling me you don't negotiate that
    AWP value----
        Mr. Marshall. That is correct.
        Mr. Walden. [continuing] when you are making a purchase.
        Mr. Marshall. That is correct. I may negotiate a discounted
    purchase price.
        Mr. Walden. Let me be clear. I realize that you don't
    necessarily set the AWP. But you negotiate a percentage off of
    that AWP, is that right?
        Mr. Marshall. In some instances when I am presented with a
    price by a manufacturer and it is referenced as a discount off
    of an AWP. For example, the price we are willing to sell this
    to CVS is at 40 percent off of our established AWP. As a good
    negotiator, I may ask for 50 percent of AWP in that
    circumstance.
        Mr. Walden. But you have never asked them to raise an AWP
    or said it is hard to buy your product because your AWP is so
    low?
        Mr. Walden. That is correct.
        Mr. Walden. Ms. Paoletti, I am curious then--hold on just a
    minute. I am sorry.
        Mr. Marshall, can you go to Tab 42? You should have seen
    this, I am told by counsel.
        This is an e-mail--is that correct? I will let you get
    there.
        Mr. Marshall. Yes.
        Mr. Walden. This is e an e-mail to Matthew J. Leonard,
    subject Roxane, cyclofosfamide.
        It says, Matt, I thought an e-mail might be a little
    quicker and easier than trying to exchange voice mails on this.
    We spoke about cyclofosfamide a week or so ago. You indicated
    that our spread was not significant enough to pique your
    interest.
        I would like to approach by company about what it might
    take to get CVS on board. Can you provide me with CVS's annual
    volume of the 25 milligram and 50 milligram product? Also, pass
    me the volume that you believe CVS would sway to the generic if
    I can bring you a 50 to 60 percent spread via a contract price.
    Thanks, Steve Snyder, National Account Manager, Eastern
    Midwest.
        Does this not also reference the spread being important,
    AWP versus what you pay?
        Mr. Marshall. Yes. In this case, just to clarify, my
    interpretation is the spread here is the established AWP of the
    manufacturer and a requested price to CVS.
        Again, I can't comment on something that was written by
    another individual. But my interpretation would be it would be
    similar to what I had described earlier as far as a lever in
    negotiating a lower purchase price when you are presented with
    an AWP value.
        Mr. Walden. All right. Ms. Paoletti, if you could turn to
    Tab 36. This is an e-mail to Judy Waterer from Robert Socora, I
    believe. And it lists the AWPs for, I assume, your competitors.
    Is that correct?
        Ms. Paoletti. That is correct.
        Mr. Walden. They are like 151.90, 141, 151, 140. And then
    Roxane is at 45.
        Ms. Paoletti. Correct.
        Mr. Walden. How did your AWP get so out of line with the
    others?
        Ms. Paoletti. Again, we set our pricing, typically, when we
    launch the product, and then we don't revisit the AWP. It is
    typically set as a standard off of the brand in the generic
    industry, and we wouldn't typically readdress it. In this case,
    I can't say why the other competitors were higher.
        Mr. Walden. Sure. Did you readdress it in this case,
    Furosomide?
        Ms. Paoletti. We had to.
        Mr. Walden. Why?
        Ms. Paoletti. Because our AWP was so far out of line, as
    you can see with our competitors, that they wouldn't want the
    product.
        Mr. Walden. I am confused between you and Mr. Marshall
    here. Because he says AWP--he doesn't set it. He is going to
    negotiate off of it for your purchase price, right? And you are
    saying it is not high enough. We are talking about CVS here in
    the middle.
        Ms. Paoletti. I think we are talking about a very rare
    occasion. You know, we might talk about----
        Mr. Walden. But I think it is indicative of a practice in
    the industry.
        Ms. Paoletti. I am not sure that it is. This is a situation
    where it was so far out of line with our competitors that----
        Mr. Walden. What would be the purpose being of raising it?
        Ms. Paoletti. Our purpose was to just put us on a level
    playing field.
        Mr. Walden. And for what purpose did you need to be on a
    level playing field?
        Ms. Paoletti. Because the----
        Mr. Walden. To get market share?
        Ms. Paoletti. Absolutely.
        Mr. Walden. For market share you needed to raise your AWP,
    which you said you didn't normally do once it is set?
        Ms. Paoletti. That is true. Again, this is a very unique
    situation. We were faced with discontinuing the product because
    nobody would buy it, because no matter--even if our contract
    price was on a level playing field with our competitors and our
    service level and we were a-graded, the AWP, which is one
    additional factor, was so far out of line, again, that----
        Mr. Walden. Right. It was out of line because the spread
    matters to those buying the product.
        Ms. Paoletti. In some cases, I would assume that is true.
        Mr. Walden. I would assume in every case, although it may
    not be as dramatic as this. If spread plays into it here, tell
    me why it wouldn't play into it everywhere else?
        Ms. Paoletti. I think as long as you are relatively in the
    same ballpark, it hasn't been our experience that it is
    something that is dwelled on. AWP is generally a reference
    price that is sometimes, primarily in new launch products, used
    as a--just as a reference point in contract negotiations.
        Mr. Walden. But it is a reference point that is used?
        Ms. Paoletti. Yes.
        Mr. Walden. So, I mean--I am having trouble believing that
    it is not an important part of this discussion.
        Ms. Paoletti. I am sure it is an important factor in some
    decisions. I don't know that it is something that is dwelled on
    in every case.
        Mr. Walden. So you don't think it is a big deal, AWP?
        Ms. Paoletti. Absolutely. I think AWP and the issues need
    to be addressed. Is it something--is reimbursement something
    that we discuss in normal discussions with our customers? No.
        Mr. Walden. All right. This will be a question to the
    representatives from the various pharmacies. Medicaid
    dispensing fees vary fairly widely from State to State. I think
    we have heard the national average for Medicaid dispensing fees
    appears to be somewhere in the neighborhood of $4 per
    prescription.
        By way of comparison, the committee obtained data showing
    what the pharmacies receive in the way of dispensing fees from
    some of their larger third-party payors. One pharmacy chain
    also submitted data showing the average dispensing fees for all
    of its retail customers. These data showed an average of
    approximately $2.25 per prescription on the private side.
        Why should Medicaid being paying more in the way of
    dispensing fees than private payors? Mr. Marshall, shall we
    start with you?
        Mr. Marshall. Sure. I understand the data that you have
    presented to me. My understanding, there are two components to
    reimbursement. There is a negotiated formula component, which
    may involve the AWP or Federal upper limit or a MAC price.
    There is also the dispensing fee.
        So I take your information at face value, but I really
    couldn't come to a conclusion as to, you know, whether we would
    be paying for Medicaid versus the private plans, other than on
    that absolute value of the dispensing fee.
        Mr. Walden. Are the numbers correct, from your perspective,
    on the dispensing fee?
        Mr. Marshall. I believe. I am not as closely tied to this
    in my current role. I knew that it was, you know, that Medicaid
    was a little higher than $3 and on the private a little higher
    than $2.
        Mr. Walden. So we are in the ballpark here, from your
    historical background?
        Mr. Marshall. Yes.
        Mr. Walden. You can't comment as to why Medicaid should be
    paying more as a dispensing fee than other third-party payors?
        Mr. Marshall. No. Again, I think you need to consider the
    entire equation as far as the overall reimbursement.
        Mr. Walden. Mr. Ziebell.
        Mr. Ziebell. I am not really familiar with the figures
    presented or how they apply to Walgreens, but I would agree you
    have to--you can't look just at the dispensing fee. You have to
    figure the cost component and how that figures in the
    calculation also.
        Mr. Walden. All right. Mr. Seagrave.
        Mr. Seagrave. I think your numbers are fairly accurate. But
    I will tell you that when we look at reimbursement, we don't
    look at one segment of the formula. We look at the ingredient
    costs as well as the dispensing fee. We look at the total
    reimbursement. We don't look at one component or the other.
        I will mention that, with respect to our Medicaid and
    Medicare business, it is not a business that we would negotiate
    as we do with the commercial payors such as the PBMs and the
    HMOs. So when we are looking at the business we look at it in
    total. We look at total reimbursement.
        Mr. Walden. I appreciate that.
        In fact, based upon the data provided by the pharmacies,
    Medicaid actually pays slightly more for ingredient costs, I am
    told.
        And I guess--what I want to make sure of is that, as we
    move forward on the policy side here, is that we do the best we
    can to get it right, that we don't have a situation where we
    are paying more for drugs than we should and more than private
    payors are paying or others. We ought to pay what is fair. I
    don't believe AWP is fair. Then we are just guessing off of a
    percentage off AWP. There is all of these different systems.
        I also want to make sure, though, that pharmacists are
    properly compensated so that if we change how you are being
    paid or how this system functions that we don't shortchange it
    and pharmacists suddenly write to all our constituents and say
    we are not going to dispense any more because those miserly
    turkeys in Congress changed the formula.
        But I don't think it's right, either, to have a formula
    that ends up overcompensating on the drug side and
    undercompensating on dispensing or overcompensating on both. We
    need to try and figure out how to get it right, because the
    costs are exploding around us, and I would like to see a
    marketplace work, work honestly, work ethically.
        I think Aventis got at this issue a bit when they realized
    AWP was going to become a tar baby for the industry. And I
    commend you for noticing that and for taking action, because I
    am amazed that AWP prior to this hasn't been blown out of the
    water and, after seeing what we went through on Medicare, that
    something didn't change for Medicaid prior to this.
        Turn to the gentleman from Michigan, Mr. Stupak.
        Mr. Stupak. Thank you, Mr. Chairman.
        Mr. Catlett, if I can go back to you. The statement you
    made in your testimony states that, again, if a generic
    manufacturer unilaterally reduced its AWP for a given product
    relative to the AWPs of other generic manufacturers for the
    same product, pharmacies would have an incentive to purchase
    another manufacturer's drug that did not reduce its AWP. Why
    did you say in your testimony?
        Mr. Catlett. I believe that potentially could happen. I
    mean, I could not think of an instance where it has happened. I
    think I mentioned that earlier. But my fear, if there was a
    great disparity, that--between AWPs of generic products, that
    potentially the company that had the lowest AWP may not be in a
    position to sell their product in a system where there is AWP-
    based reimbursement in terms of how that's how the system's
    being based.
        Mr. Stupak. Has your company ever had the lowest AWP and
    had it purchased by the pharmacies? Have you lowered your AWP
    to be lowest and had that happen, where they had purchased your
    AWP?
        Mr. Catlett. No, I have no recollection of that.
        Mr. Stupak. Ms. Marrs, if the pharmacies would purchase at
    a lower AWP, could you lower your AWPs on your products and
    stay in business?
        Ms. Marrs. As I mentioned before, I think key to this, and
    similar to what Ms. Paoletti said, there has to be a level
    playing field. The manufacturer has no incentive to keep their
    AWPs high. We are just trying to compete in a fair market. So
    whatever the government chooses as their reimbursement system,
    we want there to be a level playing field for all manufacturers
    of the same product.
        Mr. Stupak. Sure. But the point is, you could lower all
    your AWPs and still stay in business, couldn't you?
        Ms. Marrs. Probably not. As I've testified, we had a
    similar experience to Ms. Paoletti.
        Mr. Stupak. And the reason why you couldn't, because they
    wouldn't purchase it, right?
        Ms. Marrs. I don't believe they would.
        Mr. Stupak. Okay.
        Ms. Marrs. In fact, the product I mentioned when we had a
    lower AWP, we did not raise our AWP. We no longer sell the
    product because we could not compete.
        Mr. Stupak. And only because no one would purchase it.
        Ms. Marrs. Correct.
        Mr. Stupak. But if they would purchase at a lower AWP, you
    could probably lower all your AWPs of the products you sell and
    still stay in business as long someone would purchase your
    product. Right?
        Ms. Marrs. Correct.
        Mr. Stupak. And in your testimony--and why wouldn't they
    purchase your product?
        Ms. Marrs. Well, because they are being reimbursed at a
    much lower rate for our product than somebody else's in this
    particular case.
        Mr. Stupak. Correct. So the company wouldn't make as much
    money; and, again, the taxpayer/customers wouldn't have to pay,
    right?
        Ms. Marrs. Correct.
        Mr. Stupak. Thank you.
        I have nothing further, Mr. Chairman.
        Mr. Walden. Thank you, Mr. Stupak.
        We don't have anything else at this time for the committee.
    We greatly appreciate your insights and your patience, and we
    will look forward to staying in communication with all of you.
        With this, the third panel is dismissed. The record will
    remain open for ample opportunity for members to submit other
    questions or testimony; and, with that, the subcommittee is
    adjourned.
        [Whereupon, at 2:02 p.m., the subcommittee was adjourned.]
        [Additional material submitted for the record follows:]

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