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




 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


 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


                               __________

                    U.S. GOVERNMENT PRINTING OFFICE
97-275                      WASHINGTON : 2005
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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.
    [The information referred to follows:]

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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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