[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]



   MEDICAID PRESCRIPTION DRUGS: EXAMINING OPTIONS FOR PAYMENT REFORM

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

                                HEARING

                               before the

                         SUBCOMMITTEE ON HEALTH

                                 of the

                    COMMITTEE ON ENERGY AND COMMERCE
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                             JUNE 22, 2005

                               __________

                           Serial No. 109-25

                               __________

      Printed for the use of the Committee on Energy and Commerce


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


                               __________

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                    ------------------------------  

                    COMMITTEE ON ENERGY AND COMMERCE

                      JOE BARTON, Texas, Chairman

RALPH M. HALL, Texas                 JOHN D. DINGELL, Michigan
MICHAEL BILIRAKIS, Florida             Ranking Member
  Vice Chairman                      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
NATHAN DEAL, Georgia                 FRANK PALLONE, Jr., New Jersey
ED WHITFIELD, Kentucky               SHERROD BROWN, Ohio
CHARLIE NORWOOD, Georgia             BART GORDON, Tennessee
BARBARA CUBIN, Wyoming               BOBBY L. RUSH, Illinois
JOHN SHIMKUS, Illinois               ANNA G. ESHOO, California
HEATHER WILSON, New Mexico           BART STUPAK, Michigan
JOHN B. SHADEGG, Arizona             ELIOT L. ENGEL, New York
CHARLES W. ``CHIP'' PICKERING,       ALBERT R. WYNN, Maryland
Mississippi, Vice Chairman           GENE GREEN, Texas
VITO FOSSELLA, New York              TED STRICKLAND, Ohio
ROY BLUNT, Missouri                  DIANA DeGETTE, Colorado
STEVE BUYER, Indiana                 LOIS CAPPS, California
GEORGE RADANOVICH, California        MIKE DOYLE, Pennsylvania
CHARLES F. BASS, New Hampshire       TOM ALLEN, Maine
JOSEPH R. PITTS, Pennsylvania        JIM DAVIS, Florida
MARY BONO, California                JAN SCHAKOWSKY, Illinois
GREG WALDEN, Oregon                  HILDA L. SOLIS, California
LEE TERRY, Nebraska                  CHARLES A. GONZALEZ, Texas
MIKE FERGUSON, New Jersey            JAY INSLEE, Washington
MIKE ROGERS, Michigan                TAMMY BALDWIN, Wisconsin
C.L. ``BUTCH'' OTTER, Idaho          MIKE ROSS, Arkansas
SUE MYRICK, North Carolina
JOHN SULLIVAN, Oklahoma
TIM MURPHY, Pennsylvania
MICHAEL C. BURGESS, Texas
MARSHA BLACKBURN, Tennessee

                      Bud Albright, Staff Director

        David Cavicke, Deputy Staff Director and General Counsel

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

                                 ______

                         Subcommittee on Health

                     NATHAN DEAL, Georgia, Chairman

RALPH M. HALL, Texas                 SHERROD BROWN, Ohio
MICHAEL BILIRAKIS, Florida             Ranking Member
FRED UPTON, Michigan                 HENRY A. WAXMAN, California
PAUL E. GILLMOR, Ohio                EDOLPHUS TOWNS, New York
CHARLIE NORWOOD, Georgia             FRANK PALLONE, Jr., New Jersey
BARBARA CUBIN, Wyoming               BART GORDON, Tennessee
JOHN SHIMKUS, Illinois               BOBBY L. RUSH, Illinois
JOHN B. SHADEGG, Arizona             ANNA G. ESHOO, California
CHARLES W. ``CHIP'' PICKERING,       GENE GREEN, Texas
Mississippi                          TED STRICKLAND, Ohio
STEVE BUYER, Indiana                 DIANA DeGETTE, Colorado
JOSEPH R. PITTS, Pennsylvania        LOIS CAPPS, California
MARY BONO, California                TOM ALLEN, Maine
MIKE FERGUSON, New Jersey            JIM DAVIS, Florida
MIKE ROGERS, Michigan                TAMMY BALDWIN, Wisconsin
SUE MYRICK, North Carolina           JOHN D. DINGELL, Michigan,
MICHAEL C. BURGESS, Texas              (Ex Officio)
JOE BARTON, Texas,
  (Ex Officio)

                                  (ii)




                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Calfee, John, Resident Scholar, American Enterprise Institute    82
    Fuller, Craig L., President and Chief Executive Officer, 
      National Association of Chain Drug Stores..................    52
    Gifford, Kathy D., Principal, Health Management Associates...    72
    Holtz-Eakin, Douglas, Director, Congressional Budget Office..    13
    King, Kathy, Director, Health Care, U.S. Government 
      Accountability Office......................................    63
    Rodgers, Anthony D., Director, Arizona Health Care Cost 
      Containment System.........................................    47
Material submitted for the record by:
    Association for Community Affiliated Plans, prepared 
      statement of...............................................   106
    Fuller, Craig L., President and Chief Executive Officer, 
      National Association of Chain Drug Stores, response for the 
      record.....................................................   101
    Holtz-Eakin, Douglas, Director, Congressional Budget Office, 
      response for the record....................................    92
    King, Kathy, Director, Health Care, U.S. Government 
      Accountability Office, response for the record.............    98
    Pollack, Ronald F., Executive Director, Families USA, 
      prepared statement of......................................   106

                                 (iii)

  

 
   MEDICAID PRESCRIPTION DRUGS: EXAMINING OPTIONS FOR PAYMENT REFORM

                              ----------                              


                        WEDNESDAY, JUNE 22, 2005

                  House of Representatives,
                  Committee on Energy and Commerce,
                                    Subcommittee on Health,
                                                    Washington, DC.
    The subcommittee met, pursuant to other business, at 3:04 
p.m., in room 2123 of the Rayburn House Office Building, Hon. 
Nathan Deal (chairman) presiding.
    Members present: Representatives Deal, Bilirakis, Norwood, 
Cubin, Shimkus, Shadegg, Buyer, Bono, Ferguson, Myrick, 
Burgess, Brown, Waxman, Green, Capps, Allen, Baldwin, and 
Dingell (ex officio).
    Also present: Representative Wilson.
    Staff present: Jeanne Haggerty, majority professional 
staff; Chuck Clapton, chief health counsel; David Rosenfeld, 
majority counsel; Brandon Clark, health policy coordinator; 
Eugenia Edwards, legislative clerk; Bridgett Taylor, minority 
professional staff; Amy Hall, minority professional staff; and 
Jessica McNiece, minority research assistant.
    Mr. Deal. This meeting will come to order. The Chair 
recognizes himself for an opening statement.
    I certainly want to welcome everyone to this hearing today 
and our distinguished panel members. We have two panels that 
you are going to hear from, and they will give various 
perspectives on this issue of Medicaid prescription drugs and 
various payment options--and certainly this is an issue that 
everybody, I suppose, has their own point of view on--Medicaid: 
a system that only a healthcare plan could love, one where 
generic drugs definitely keep Medicaid costs artificially high. 
Generic drugs--and lower costs, but under Medicaid's rules, the 
system has been turned on its head.
    According to a recent CBO report, the largest, single 
factor contributing to the rapid increase in markups on 
prescription drugs under Medicaid was the use of new or generic 
drugs. What is truly outrageous is that these prices are rising 
above--prices of prescription drugs based upon manufacturer 
reporting average wholesale prices, or AWPs. As my former 
colleague has noted several years ago, AWP, which also stands 
for ``ain't what's paid.'' In many instances, AWP bears little 
or no resemblance to what pharmacists really pay for drugs. 
This is especially true for generic drugs.
    In a recent report, CBO estimated the average markup 
between what Medicaid pays the pharmacy for each prescription 
and what the pharmacy or wholesaler actually pays for the drug 
has dramatically increased. They estimated that between 1997 
and 2002, an average markup on generic drugs increased by 
nearly 79 percent per prescription. Generic drugs have a 
critical role to play in containing soaring drug costs. My 
concern, however, is that the cost of AWP, Medicaid is missing 
out on a large portion of these cost savings. I want to 
increase Medicaid's use of generic drugs but not at the expense 
of rapidly increasing drug costs. Pharmacies gain substantial 
Medicaid margins on many generic drugs, but the purpose of this 
hearing is not to vilify pharmacists. Pharmacists believe that 
the current 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 
Medicaid beneficiaries.
    I believe that any effort to reform Medicaid drug 
reimbursement must reflect three basic principles: 
transparency, accuracy, and fairness. Payments for drugs must 
be transparent to the purchaser without hidden payments that 
undermine competition. Payments must also accurately reflect 
the costs pharmacists pay for the drugs. Finally, Medicaid 
reimbursements for both drugs and dispensing fees should fairly 
pay pharmacies for all of the costs of treating Medicaid 
beneficiaries. Fairness is essential so that Medicaid 
beneficiaries continue to get access to community pharmacy 
services.
    Both the Administration and the National Governors 
Association have included changes to prescription drug pricing 
in their Medicaid reform proposals. I hope that this is an 
issue where we can find bipartisan consensus and work together 
to solve the problem.
    I want to thank all of the witnesses, both on this panel 
and the one that will follow, for today's hearing for taking 
time to attend the hearing. It is an important and worthy issue 
of this committee's attention, and I hope the hearing will help 
us in our efforts to reform the system that I believe is 
obviously in need of change.
    Mr. Brown, I recognize you for an opening statement.
    Mr. Brown. Thank you, Mr. Chairman. And welcome, Dr. Holtz-
Eakin, for joining us and other distinguished witnesses on the 
other panel.
    I appreciate your decision, Mr. Chairman, to focus on 
pharmaceutical payment reform under Medicaid. I have actually 
heard rumors that the intent is to focus solely on the 
pharmacists--and from the chairman's opening statements on 
generics--but I am sure that wouldn't be the case. CBO just 
completed a study on drug rebates. I am sure neither side of 
the aisle is going to ignore that analysis in a hearing 
entitled ``Examining Options'', with an ``s'', ``for Payment 
Reform.'' It would make no sense to focus on one small piece of 
the cost puzzle and ignore the bigger ones.
    And the Medicaid debates raise the most notorious cost 
issue of all: drug prices. Prescription drug spending is the 
fastest growing component of health care spending inside and 
outside government programs. Tax dollars are a scarce 
commodity. They should be used wisely. And drug companies 
should be made to charge the government a fair price. That is 
what the rebate program is all about; so while business dollars 
also are a scarce commodity, they should be used wisely, too, 
and drug companies should be made to charge businesses a fair 
price. And American family dollars are scarce, too. Drug 
companies should be made to charge every American a fair price. 
While we do nothing, more and more Americans purchase their 
medicines from Canada, because they can't afford medicines in 
this country, and that is not good for our drug stores, 
frankly.
    The prescription drug industry issue isn't a Medicaid 
issue. It is a health care issue affecting every individual and 
business in our country. So the question is: Will taking action 
to reduce drug prices in Medicaid stifle innovation? Will 
taking steps to reduce drug prices outside Medicaid stifle 
innovation?
    There has been talk recently about weak profitability in 
the drug industry, so we checked on that. According to the most 
recent listing of 2005 profitability, drug makers earn nearly 4 
times, 400 percent, the median for Fortune 500 industries, and 
government analysts, including S&P industry watcher, Herman 
Saphlis, think the outlook for the drug industry is bright. In 
a recent interview, Mr. Saphlis highlighted the drug industry's 
capacity for, get this, repatriating foreign earnings. How 
could the drug industry have ample foreign earnings if the 
price controls that they always talk about in foreign markets 
are so draconian?
    According to a recent study by Donald Light of Columbia 
University in New York that is, in this country, price controls 
in Canada, Britain, and other countries are not too low to 
sustain a brisk pace of R&D. In fact, prices in these countries 
are more than sufficient to cover operating and R&D costs and 
to provide for healthy profits. That is why drug makers sell 
their products in those countries. That is not to say price 
controls can't have a dampening effect on R&D it is to say 
they don't need to have a dampening effect. With careful 
effort, the U.S. can secure lower drug prices and spur 
increased R&D. The drug companies can earn astronomical 
profits, after all, on a single blockbuster product. Maybe they 
will be prompted to reduce their emphasis on those blockbuster 
drugs and further diversify R&D efforts.
    Based on his testimony, Mr. Calfee, our witness from the 
American Enterprise Institute, is not a big fan of price 
controls. Clearly, he is an advocate of free market 
competition. We all are. And he is right that price controls 
distort free market competition. However, no one who 
understands the concept would confuse the prescription drug 
market for a competitive free market. In a free market, you 
would have a large number of small producers, each of which 
charges similar prices reflecting consumer demand. In a free 
market, the government doesn't hinder competition by granting 
patent extensions. Rather than a large number of small 
producers, the drug market is characterized by a small number 
of large producers, each of which has a patent monopoly 
bestowed on them by the much-despised government over the 
products that they make. As a result, drug makers have infinite 
market power, not only to decide how much to charge for 
medicine, but as a practical matter, frankly, in many cases, 
who lives and who dies.
    Indulging the fantasy that the drug market bears any 
resemblance to the idealized college textbook free market is a 
waste of time and money that the American people don't have. Of 
course, we should require the drug industry to charge fair 
prices. That can be our first step, but it shouldn't be our 
only one. We ought to require the drug industry to charge fair 
prices to every American. Medical innovation loses value with 
every person who doesn't have access to it.
    Thank you, Mr. Chairman.
    Mr. Deal. I thank the gentleman.
    Ms. Wilson. Mr. Chairman?
    Mr. Deal. I recognize Ms. Wilson.
    Ms. Wilson. Thank you, Mr. Chairman.
    I would ask unanimous consent to participate and listen to 
the witnesses and ask questions of witnesses.
    Mr. Deal. Is there any objection? Hearing none, so ordered.
    Mr. Bilirakis for an opening statement.
    Mr. Bilirakis. Thank you, Mr. Chairman.
    I am pleased that you have called this hearing to examine 
options for improving the way prescription drugs are paid for 
in the Medicaid program. We are here today to examine possible 
solutions to problems with Medicaid's system of reimbursement 
for prescription drugs, which the Energy and Commerce 
Committee's ONI Subcommittee reviewed extensively last 
December.
    For the past few years, this committee has been examining 
the appropriateness of using the average wholesale price, or 
AWP as we refer to it, payment methodology for reimbursement of 
prescription drugs. We found it to be inaccurate and 
inefficient to Medicare, which ultimately led to the inclusion 
of provisions in the Medicare Prescription Drug Law, which are 
expected to save $15 billion over the next 10 years. The ONI 
Subcommittee's hearing last year was to determine whether the 
Federal Government pays too much for prescription drugs under 
the Medicaid program. The CBO subsequently reported that 
Medicaid's reimbursement system has allowed a growing disparity 
between what States pay for prescription drugs and what it 
actually costs pharmacies to obtain them. These efforts have 
shown definitively that Medicaid pays too much for prescription 
drugs. These overpayments have resulted from a flawed payment 
policy that makes it difficult, if not impossible, to determine 
the actual cost that retailers pay to manufacturers to obtain 
the drugs that they provide.
    The current use of AWP, or the list price of a drug that 
few purchasers actually pay to calculate these costs, falls far 
short of the standard we should demand. It is clear to me that 
the use of AWP-based reimbursement as a payment benchmark under 
Medicaid is fatally flawed. The potential remedies for this 
flawed payment policy are varied and certainly complex. What is 
clear, however, is that States and the Federal Government 
simply cannot continue to pay more than they should for 
prescription drugs under Medicaid. Allowing this inefficient 
practice to continue is costing Medicaid millions and millions 
of dollars that otherwise could be used to help those who rely 
on Medicaid to meet their basic health care needs.
    So I am hopeful, Mr. Chairman, under your tutelage, that 
this committee can craft a fair and efficient policy for the 
reimbursement of prescription drugs under Medicaid, which must 
be part of any comprehensive effort to modernize this valuable 
program. I commend you for focusing our attention on this issue 
and look forward to learning how today's witnesses believe we 
can improve Medicaid's reimbursement of prescription drugs.
    Thank you, Mr. Chairman. I yield back.
    Mr. Deal. I thank the gentleman.
    Ranking Member Dingell, is recognized for an opening 
statement.
    Mr. Dingell. Mr. Chairman, I thank you for holding this 
hearing. It is an important one. I believe that it is clear 
that we can help both beneficiaries and taxpayers by making 
sensible changes to the payment system for Medicaid 
prescription drugs. Currently, drug companies are being 
overpaid. Generic drugs are being underutilized. The taxpayers 
and the beneficiaries of the program are being hurt. But as we 
examine the various options for reforms, I caution my colleague 
the changes that would have the effect of shifting more of the 
cost burden to beneficiaries and providers could be dangerous 
and counterproductive.
    We will hear a good deal today about payments to 
pharmacists. Improvements to their payments could down right 
benefit both the pharmacies and save money for the government, 
but the Medicaid policy is multifaceted, and there are many 
other options for reforms to prescription drug policy that we 
should not ignore. As we hear from the Congressional Budget 
Office, the drug companies, too, have something to offer.
    Medicaid has generally been doing a good job with getting 
rebates from manufacturers. The Medicaid program accounts for 
15 percent of U.S. spending on prescription drugs. With that 
level of purchasing power, Medicaid shouldn't merely get a good 
discount. They should get the best, and I will repeat that. 
They should get the best.
    As the Government Accountability Office will testify, there 
is certainly also need for greater accountability, particularly 
on the part of Centers for Medicaid and Medicare Services, CMS, 
and their administration of the rebate program. CMS has been 
lax in issuing guidelines on how manufacturers should calculate 
the rebates, so that the Inspector General, because of this 
laxity, has been unable to conduct appropriate audits, and that 
is a matter into which we should go today. This, too, could 
save money for the States and the Federal Government, and it 
would not harm the beneficiaries of the program.
    We should also explore ways to increase the use of generic 
medicines, an opportunity to save money for the program without 
compromising beneficiary access to good care. Some States, such 
as Arizona, have done an outstanding job of increasing the use 
of generic drugs. This saves Medicaid and its programs 
significant funds. Other States have not moved far along that 
path. We must see to it that they begin that process.
    But as we consider these changes, we must protect the 
access to medicines for more than 50 million Americans who 
depend on Medicaid for their care. Already one in four adult 
Medicaid patients cannot afford to fill a needed prescription. 
This burden falls disproportionately on the sick in Medicaid 
where more than 40 percent of the patients with two or more 
chronic conditions could not obtain needed medicines because of 
the cost. In States that have implemented multiple cost 
controls, such as prior authorization and preferred drug lists, 
the danger of precluding access is even greater. Given that 
Medicaid was designed to ensure access to medical care for the 
poorest and sickest Americans, what we should be addressing now 
is how to expand rather than to restrict access to needed 
health care by those who are most vulnerable in our society.
    Again I commend you, Mr. Chairman, for holding this 
hearing. I hope we will consider all of the options for 
improving Medicaid prescription drug programs, not just the 
narrow issue of payments to the pharmacists. At the same time, 
we must keep in mind when a benefit is unaffordable for those 
in need; it does nothing for us. Clearly, an unaffordable 
benefit is no benefit at all. Payment reform should not mean 
that those who need care under Medicaid cannot get it.
    I thank you, Mr. Chairman, for the recognition.
    Mr. Deal. I thank the gentleman.
    Dr. Norwood is recognized for an opening statement.
    Mr. Norwood. Thank you, Mr. Chairman.
    You know, I would like to start out by saying and 
recognizing the very good that has been done by prescription 
medicines in this country in reducing health care costs, 
prolonging life, and quality of life.
    That said, the Medicaid program has experienced a rapid 
increase in spending for prescription drugs. A combination of 
factors is driving this growth, including increases in 
beneficiaries' drug utilization and drug prices. Nearly half of 
Medicaid drug costs are for low-income seniors who are dually 
eligible for Medicare and Medicaid. That is important to note 
as dual-eligibles are transferred to part D.
    In recent years, most all States have worked to implement 
pharmacy cost containment measures, but Congress has a 
responsibility to make sure that every dollar under the program 
goes to those citizens who deserve it and need it. We also have 
an obligation to closely guard the taxpayers' dollar.
    Unfortunately, the current reimbursement system doesn't 
always match these goals. States are required and should 
reasonably reimburse pharmacies, yet they lack access to actual 
costs. Because of this, Medicaid reimbursement, based on 
average wholesale price, does not match the price incurred by 
retail pharmacies to purchase the very drugs.
    So I think most can agree that AWP isn't where we need to 
be. Although it was a government idea, it is still not where we 
need to be. But where do we go? It is average sales price. Is 
that it? Well, while ASP does not reflect the retail pharmacy's 
acquisition cost, ASP is likely a better starting point for 
estimating cost. But do we want to simply do better? 
Ultimately, the benefit to States of ASP would depend on how 
well CMS calculates and reports ASP prices. I don't feel that 
should be overlooked. But ASP is an outdated price. It doesn't 
take into account different classes of trade pricing and leaves 
pharmacies at a loss when brand manufacturers raise their 
prices. If ASP had been in effect this year for Medicaid when 
many brand name increased its prices over 6 percent, pharmacies 
would have been significantly affected. This is something to 
note before we risk impacting pharmacies, especially in areas 
where access is already an issue, especially since pharmacies 
in rural areas often take a large amount of Medicaid 
prescriptions.
    I want to be clear that price competition is a very good 
thing. Generic drugs have a critical role to play. My concern 
is that under AWP or ASP retail pharmacies are not given 
incentives to dispense generics. Pharmacies would still make 
more money under an ASP-plus-six system for brands than they 
would for generics. CMS should share with the States the price 
data it collects to develop better estimates of acquisition 
costs.
    I am also interested to hear from our witnesses on how cost 
savings can be found by addressing the disconnect between the 
formula that is used to calculate the rebates and 
reimbursements. I also think States can do a better job 
managing rebate billings and collections. At the end of the 
day, we simply can't go looking to the pharmacies to fix all of 
our problems.
    I will put the rest of it in the record, Mr. Chairman, but 
say we should undertake this hearing with a goal of 
comprehensive reform that works with Governors to reduce 
Medicaid costs for prescription drugs through a multi-pronged 
approach.
    Mr. Deal. I thank the gentleman.
    Mr. Waxman for an opening statement.
    Mr. Waxman. Mr. Chairman, I am pleased the subcommittee is 
holding this hearing today. Reform in the Medicaid payment 
policies for prescription drugs is one of the legitimate areas 
where we potentially can achieve program savings without 
harming beneficiaries or undermining basic protections in this 
program. In my view, however, the savings we achieve in this 
area should be reinvested in Medicaid to help make necessary 
changes in the program to better serve beneficiaries and to 
help States meet the fiscal demands of the program.
    Having said that, let me make just a few points that I hope 
will guide us as we look into appropriate drug payment policy 
reforms.
    First, we need to be sensitive to the impact of the changes 
we make of the access of beneficiaries to needed drugs. To the 
extent we are overpaying for drugs, as in some cases we clearly 
are, we need to fix that. But I am concerned that the proposal 
included in the Administration budget does not accurately 
reflect the acquisition costs for pharmacies, and could in some 
cases result in a loss of access for recipients.
    Second, we need to recognize that increased utilization of 
generics is one of the most effective ways to reduce drug 
expenditures. We must be sure that the reforms we undertake do 
not have the unintended effect of undermining the use of 
generics where they are available. Basing the payment to the 
pharmacist on a percent of the cost of the drug raises some 
serious concerns in this regard.
    Third, we need to remember that most of our drug 
expenditures are for brand name drugs that don't have generic 
versions available. This is where the dollars are, and we 
certainly should ask the brand name companies to contribute to 
the savings we seek in this area. Increasing the rebate should 
be the first option on the table, in my view.
    Fourth, transparency in drug prices would provide 
significant help to the States and hospitals and other members 
of the so-called 340 B Coalition that use the Medicaid discount 
system. If States had access to the best price information, for 
example, I believe they would have in place systems that would 
not result in the overpayments we see with systems based on the 
average wholesale price, which we know is easily manipulated.
    And finally, CMS needs to do a better job of administering 
the best price and rebate system so that we are basing our 
payments on accurate information. The study GAO did at my 
request indicated lack of clarity on the policy and little real 
monitoring by CMS, all of which resulted in inaccurate 
information on which the payments were based. This situation 
allows manipulation of prices by the companies. Further, it 
fails to capture the effect of discounts that PBMs receive. We 
need to change that. Whatever reforms we put into place will 
only be as effective as the accuracy of the information on 
which they are based.
    I look forward to hearing from our witnesses today.
    Mr. Deal. I thank the gentleman.
    It appears we do have a series of at least two votes. If we 
have other opening statements, though, we may try to get one or 
two more in, if they are short. Anyone on the Majority side 
wish to make an opening statement? Dr. Burgess, do you wish to 
make an opening statement?
    Mr. Burgess. Yes, Mr. Chairman. I----
    Mr. Deal. You are recognized for that purpose.
    Mr. Burgess. I was going to submit my opening statement for 
the record, and I will still do that, but I just can't help 
myself after listening to some of the comments that I have 
heard here this morning.
    In the year 2000, when I was away from thinking about 
running for Congress, Congress passed a copyright extension for 
Mickey Mouse for an additional 50 years. I presume that the 
research and development costs on Mickey Mouse had been 
recouped back in the 1930's, but for whatever reason, we have 
extended it to well on into this century. Our patent protection 
in this country for pharmaceuticals runs for 10 years. And we 
can argue whether that is an appropriate time or not. Maybe it 
needs to be a little bit longer, and maybe drug prices could 
come down. But the fact remains that it is the regulation in 
the pharmaceutical environment, in my opinion, that is the 
cause for a great deal of the price inflation that we see in 
our pharmaceuticals in this country. Remember Paul Irlich in 
Germany at the turn of the century was trying to find the 
silver bullet to cure syphilis. Alexander Fleming actually 
found the silver bullet in what he thought was a spoiled Petri 
dish. But it was the Pfizer Corporation that developed the 
commercial production of penicillin that saved lives on the 
battlefield in World War II with newborns in the nursery and 
the Staphylococcus epidemics of the 1950's. And let us not 
forget that those are uniquely American companies. Syntax 
Corporation that discovered the precursor for estrogen in a 
cactus out in west Texas made the commercial production of 
estrogen in compounds available in this country.
    Now Mr. Chairman, I have lived under a system of price 
controls in my previous life, my whole professional career. It 
is called medicine, and we lived under Medicaid and Medicare 
price controls. I don't think Federal price controls are the 
way for us to go, and I would urge this committee to not go 
down that path. Differential pricing and lack of transparency 
in pharmaceuticals have been a big problem in this country, 
certainly in all of my professional career. That has been a 
battle that I have fought. I was grateful 2 years ago or last 
year, actually, when the Medicare Prescription Drug Act was 
passed and we have the discount card that allowed for some 
transparency in drug pricing in the Medicare system, which I 
think allowed drug prices to come down. And I think we could 
work a lot harder in that regard in bringing some transparency 
and some common sense to the marketplace. But I don't think 
Federal price controls, and I don't think punishing 
pharmaceutical companies, are the correct ways to go about 
that.
    I will submit my formal statement for the record.
    Mr. Deal. I thank the gentleman.
    I believe we will suspend on opening statements and come 
back after the votes, but before we do so, Mr. Shadegg, who has 
got a conflict and will not probably be here for the second 
panel, I would recognize him at this time to introduce one of 
our second panel members.
    Mr. Shadegg. Thank you, Mr. Chairman. I will include that 
in my opening remarks.
    I want to thank you for holding this hearing and continuing 
the dialog on Medicaid reform. I also want to thank our witness 
on this panel and our witnesses on the remaining panels. I 
think this is an important discussion, and I applaud you for 
proceeding in this direction.
    I particularly want to thank Anthony Rodgers, who will 
appear on the second panel. He is the Director of the Arizona 
Health Care Cost Containment System, which is Arizona's 
Medicaid program. As the ranking member of the full committee 
already indicated, that program has been widely recognized 
across the country as being a model for reform of the access 
program. Mr. Rodgers is a veteran of the health care industry. 
He has worked both for hospitals and health plans. He was the 
general manager of State sponsored programs for Wellpoint 
Health Networks and was also the CEO of one of California's 
largest health plans, LA Healthcare Plan.
    Today, he successfully directs Arizona's access program, as 
I indicated, which provides coverage to more than 1 million 
Arizonians and I think does it right. Indeed, it has had great 
success in holding down the cost of prescription drugs within 
the program, and it is some of the best. Arizona has been, I 
believe, a pioneer in this area, for more than 20 years ago, we 
embraced the waiver process to create a viable alternative to 
traditional Medicaid. It is a managed care alternative. And 
since that time, access has been nationally recognized for its 
success in containing costs while providing beneficiaries 
access to very high quality care.
    I do want to thank the chairman for this opportunity and 
mention that savings in the prescription drug program alone 
have been outstanding. A 2003 study found that access had the 
lowest pharmacy cost in the entire Medicaid program nationally. 
Not only did the program as a whole cost less, but the per-
member-per-month cost was the lowest in the Nation.
    Again, I welcome Mr. Rodgers to testify here and encourage 
the committee to continue to look carefully at the access 
model.
    Mr. Deal. I thank the gentleman.
    The committee will stand in recess pending completion of 
the votes on the floor.
    [Brief recess.]
    Mr. Deal. The committee will come back to order.
    We will proceed with our opening statements as members 
continue to come back in. And, well, Mr. Allen has come in. Mr. 
Allen, I will recognize you for an opening statement.
    Mr. Allen. Thank you, Mr. Chairman, for calling this 
hearing on examining options for controlling rising drug costs 
in the Medicaid program. We need to examine a wide range of 
options rather than place an undue burden on beneficiaries by 
cutting benefits or raising cost sharing. There needs to be 
sound evidence that any proposed solution will actually achieve 
savings and will not further drive pharmacies from the Medicaid 
program. It seems premature to recommend moving to average 
sales price ``plus some factor.'' What would this factor be and 
how would this be determined? States have been squeezing 
pharmacy-dispensing fees in the last few years, so pharmacies 
in some States, including Maine, are gravely concerned by the 
impact this would have in their ability to serve their 
customers. Fourteen pharmacies have closed in Maine since 
September of 2003.
    I believe that we must increase investment in evidence-
based research on prescription drugs. Last Congress, I 
introduced a bipartisan bill, H.R. 2356, the Prescription Drug 
Comparative Effectiveness Act. It authorized $50 million in 
funding to NIH and $25 million in funding to the Agency for 
Health Care Research and Quality. The bill directed these 
agencies to examine existing research and, if necessary, 
conduct new research, including head-to-head clinical trials in 
order to develop balanced scientific evidence regarding the 
comparative effectiveness, the cost effectiveness, and 
comparative safety relative to other drugs and treatments for 
the same disease or condition.
    My bill would essentially provide a consumer reports for 
prescription drugs, giving doctors and their patients valid, 
evidence-based information on how drugs that treat a particular 
condition compare to one another. Section 1013 of the Medicare 
law makes initial investments in evidence-based research, 
authorizing the Agency for Healthcare Research and Quality to 
conduct outcomes research on prescription drugs and other 
treatments. This provision was not funded at the full $50 
million level but rather at $15 million in fiscal year 2005 and 
2006.
    Facing rapidly rising drug expenditures in large budget 
shortfalls, States have been examining various measures to 
reign in drug spending, including utilizing evidence-based 
reviews of the clinical effectiveness of drugs in the same 
therapeutic class. In 2003, a group of States joined to form 
the Drug Effectiveness Review Project, which funds systematic 
reviews of drug classes. This information can be utilized to 
help State pharmaceutical and therapeutics committees make 
informed coverage decisions for their Medicaid preferred drug 
list. The Drug Effectiveness Review Project, which now has 13 
member States, has completed studies on 15 classes of drugs and 
has 9 more currently scheduled for review. This approach would 
yield, I believe, lower costs and higher quality for our 
prescription drug services under Medicaid.
    So I think we need to build on these State efforts in 
determining comparative effectiveness research, and I certainly 
look forward to hearing from our distinguished panels.
    Thank you, Mr. Chairman.
    Mr. Deal. I thank the gentleman.
    Mr. Ferguson is recognized for an opening statement.
    Mr. Ferguson. Thank you, Mr. Chairman. Thank you for 
holding this hearing, which is one of a series of hearings the 
committee has held on the problems associated with AWP. The 
President's budget, and recently the National Governors 
Association, stated what this committee has discussed in a 
hearing last December, which studied a widely inappropriate 
number to use as a reimbursement mechanism for Federal 
programs. I think everyone here can agree on that.
    I look forward to hearing from our panelists today to help 
the committee craft a plan that will most accurately reflect 
the costs involved in procuring and dispensing drugs to the 
Medicaid population without overcharging the system, as AWP has 
done. I want to stress, however, that it is imperative that we 
choose real reforms that will slow the growth curve of this 
program and not simply increase price controls or impose de 
facto taxes on sectors of the Medicaid program that have become 
the very small share of Medicaid spending in 2006.
    I am encouraged that our committee will be looking into how 
we can save taxpayers' money by updating how States pay for 
prescription drugs. Currently, States are using AWP, which is 
unfortunate, because that is costing our taxpayers a lot of 
money in overpayments. We need to remember, however, that we 
are not talking about how to increase existing burdens on 
specific to Medicaid providers simply to raise money into a 
broken program. As we found in every hearing that we have had 
on this issue, Medicaid is broken, and we have to fix it. We 
have to enact real reform. I am confident that what we will 
ultimately develop is a fair mechanism to pay pharmacists 
adequately so they can secure products to dispense to Medicaid 
beneficiaries.
    Thank you, Mr. Chairman. I yield back.
    Mr. Deal. I thank the gentleman.
    Ms. Baldwin is recognized for an opening statement.
    Ms. Baldwin. Thank you, Mr. Chairman, and thank you to the 
witnesses who will be testifying before us shortly.
    Almost everybody is feeling the effects of rising health 
care costs, including the State Medicaid programs. Just 
yesterday, the Center for Studying Health System Change 
released a study that found that growth in medical costs far 
outpace the gross of wages for the eighth straight year. In 
fact, in 2004, the growth in medical costs was four times the 
growth in wages. And the implications of these rising costs are 
clear: more and more Americans will be unable to afford 
insurance, more and more Americans will either join the ranks 
of the 45 million who are uninsured, or join the ranks of those 
50 million who rely on Medicaid, the safety net, for their 
health care.
    In 2003, gross Medicaid drug expenditures were close to $30 
billion, and States received about $5.6 billion in rebates. 
These are obviously significant amounts of money. If savings 
can be gained through changes in the Medicaid Drug 
Reimbursement System and we conclude that these changes do not 
negatively affect beneficiaries, this is certainly an area that 
we must explore. It seems abundantly clear to me that some of 
the key ingredients prerequisite to reform include accurate 
information and greatly increased transparency from all 
transaction participants.
    I look forward to today's discussion.
    Mr. Deal. I thank the gentlelady.
    Mr. Buyer, do you have an opening statement?
    Mr. Buyer. Mr. Chairman, I want to thank you for this 
hearing.
    This whole idea of how we calculate the average wholesale 
price has always fascinated me and how that is really done and 
how it also can easily be manipulated I think is of a strong 
interest to me.
    I also would like to say that I am very proud of the men 
and women who work in the drug industry. I am proud of them, 
because we have an enterprise whereby we recruit great talent 
all over the world to come here to again press the bounds of 
science, great discoveries that improve the quality of life are 
people. The problem is that everybody then demands it, and the 
social systems of the world think that they are ``entitled to 
it.'' And they then really press us in what I would call real 
trade issues and penalize our companies, parent companies of 
America who also then become multi-national companies.
    So I was a little concerned when I heard this slam when we, 
in the last year, did this initiative to allow these companies 
to repatriate those dollars back to America. I think that was a 
pretty good thing. It was a great move. But now to somehow slam 
that as if saying to these drug companies, ``Oh, I didn't think 
you were making any profits overseas.'' That is one of the 
shallowest things I have ever heard, because a multi-national 
corporation, in order to do business in any country, they have 
to create an entity to do business. So that is why they call it 
multi-national.
    So when you are a big company, if you want to do business 
in another country, you create a what? Subsidiary. And then of 
that subsidiary, whether you want to sell your product in that 
country, you have got to create that entity. So you might be in 
100 countries all over the world and you have got 100 entities 
out there. And of those entities, whether it is by sale, you 
might have warehousing. You might do manufacturing. You might 
do some marketing. Everywhere you create an entity, you, then, 
have a government. You have a taxing authority. And those 
taxing authorities, they have an expectancy that they get an 
allocation of a percentage of the profits based on the business 
enterprise in the life cycle.
    I am just dumbfounded that we have really smart people love 
to just make some simple little attack. That is ridiculous.
    So I am going to end where I finish. I am proud of the men 
and women who work in the drug industry that benefit our 
society and benefit the world, based on their discoveries. And 
I am pleased that they were able to bring back a percentage of 
those profits to America, so we can continue in our new 
discoveries. Our challenge is as we look toward our own 
``social systems'' that we have in our own quasi-free market 
system of America and how we can make improvements.
    I yield back.
    Mr. Deal. I thank the gentleman.
    Ms. Myrick, do you have an opening statement?
    Ms. Myrick. No, I will waive my statement, for questions.
    Mr. Deal. Ms. Cubin, do you have an opening statement?
    Ms. Cubin. I don't have an opening statement.
    Mr. Deal. Mr. Bilirakis, I think we have already recognized 
you for an opening statement. It was so long ago, I can't 
remember.
    Ms. Wilson, you are recognized for an opening statement.
    Ms. Wilson. Thank you, Mr. Chairman. I will waive and for 
the questions.
    Mr. Deal. All right. Dr. Holtz-Eakin, we appreciate your 
patience. He told me, though, that if we were working on the 
legislative branch appropriations bill, for us just to take 
just as long as we needed on the floor, and he wasn't making 
any complaints. So that is, in fact, what the rule was that we 
just voted on.
    We are, indeed, pleased to have you here. As most of the 
members of this committee know, he is a frequent person to 
testify, and we have always appreciated his candor. He is the 
Director of the Congressional Budget Office, and I am pleased 
to recognize you now for your testimony. Your written 
testimony, of course, is a part of the record.

   STATEMENT OF DOUGLAS HOLTZ-EAKIN, DIRECTOR, CONGRESSIONAL 
                         BUDGET OFFICE

    Mr. Holtz-Eakin. Thank you, Mr. Chairman, Mr. Brown, and 
members of the committee.
    The CBO is very pleased to be here today to testify on this 
important topic. We have submitted for the record two reports 
that we have done recently on payments for prescription drugs 
in Federal programs in general, Medicaid in particular. And I 
thought I would devote my time at the outset to an overview of 
the payment system and the places where those reports address 
payments and the findings of those reports. And to do so, I 
thought I would walk through this diagram that we have got on 
the screen and which I hope is in front of you for easy 
viewing. And the basic notion is to review the kinds of payment 
flows that are in the Medicaid system.
    [Slide.]
    So the blue arrows are the easy ones. They are the traffic 
that takes prescription drugs from the drug manufacturer 
through a wholesale and pharmacy chain and to a Medicare 
beneficiary. That is the delivery of the healthcare itself. The 
remainder of the discussion is about the smaller green arrows, 
which is the set of transactions, financial transactions that 
support the delivery of the pharmaceuticals. And there is one 
small caveat that I will offer at the outset, which is that 
this is a stylized depiction of many different State systems, 
and it will fit no individual State exactly. For details on 
individual States, we would be happy to work with you. This is 
a broad overview.
    In terms of the financial payments, a small footnote from 
the point of view of where testimony today is the fact that 
beneficiaries may be responsible for a minor co-payment and the 
pharmacy might collect that from that. I will leave that to the 
side and instead focus on the triangle of payments that 
connects the program pharmacies and the drug manufacturer.
    Now in the conduct of this business, pharmacies and 
wholesalers negotiate with drug manufacturers for the price at 
which they will acquire the drugs to deliver to beneficiaries. 
And those market-based prices are the foundation of the 
business transaction by which they acquire these drugs.
    In turn, they get a tiny bit of money from the co-payment, 
as I mentioned, and a reimbursement from the Medicaid program 
itself to cover the cost of acquiring these drugs for 
beneficiaries.
    The formula differs by State, but really has two 
components. One component is a dispensing fee, usually a fixed 
amount of $3 to $5 meant to cover the cost of storage and 
consultation and dispensing. And the remainder is an attempt to 
compensate, through some proxy, for typical market price at 
which the pharmacy might acquire those drugs. As has been 
widely noted in the opening statements, the proxy is currently 
the AWP, the average wholesale price, and that is a list price, 
a sticker price that does not correspond to any particular 
transaction. And in recognition of the fact that it is higher 
than typical market transactions, a typical reimbursement will 
be 15 or 20 percent, say, below the AWP. Those monies are sent 
from the Medicaid program to the pharmacy in compensation for 
acquisition of the drugs. That is one part of this chain.
    The second part is the negotiation with the drug 
manufacturer. And then the third part is the fact that everyone 
in this system recognizes that on the whole, these transactions 
are above yet what it really costs the entire system to deliver 
these drugs. And so there is a requirement that manufacturers, 
in order to have the drugs considered, provide rebates to the 
Medicaid program as a whole. And that is the third part of the 
triangle, payments from drug manufacturers back to the Medicaid 
program.
    Now as with all of the considerations today, there are 
differences between those drugs which are brand name drugs and 
those drugs which are generics. In the payment from Medicaid 
programs to pharmacies, the list price for brand name drugs 
tracks pretty well on a closed basis to the kinds of things 
that might on in the market, whereas the list prices, the AWPs 
for generics, does not. And in recognition of this, there have 
been a series of payment limits put on, the FULs at the Federal 
level, or a maximum price that will be compensated by the 
States. Again, in the rebates from drug manufacturers back to 
the program as a whole, there will be a distinction between 
rebates on brand name drugs, which average about 30 percent, 
and rebates on generics, which average about 11 percent.
    That set of transactions is the heart of the CBO report, 
and the second two slides summarize the two key findings that 
we have. The first is to compare payments that go out from the 
Medicaid program to the pharmacies with payments that actually 
come into the drug manufacturer. The payment coming into the 
drug manufacturer is what I will call the acquisition price. 
The payment going out would be the total payment to pharmacies. 
And everything in between is, by definition, called the markup. 
This covers all parts of the distribution chain, including 
wholesalers, where appropriate.
    [Slide.]
    So if we go to the second slide, you can see that in 2002, 
an overall average for all drugs in the system, Medicaid paid 
$60, almost $61, per prescription. That can be broken into 
these two pieces. Money is actually flowing into the 
manufacturer, $47, and monies which are to cover markups by 
pharmacies, about $14.
    Now there is a big difference that you can see between the 
generic drugs and the brand name patented drugs. Brand name 
drugs are much more expensive on the whole, $97 on average; new 
generics, those which have just been introduced, $46; older 
ones, about $14. And there is a big difference in the pieces of 
those overall prices as well. For the brand name drugs, the 
acquisition costs, payment to manufacturers, the bulk of the 
cost, the markup, a much smaller percentage. In contrast, for 
new generics, the acquisition cost is relatively low, and the 
markup is $32, a much higher piece of the overall price.
    Now one of the things to note in this in thinking about the 
incentives involved is that because of this high markup, there 
is a clear incentive to, where possible, steer beneficiaries to 
a new generic drug. And from the point of view of the system as 
a whole, this may be desirable because the total cost is much 
lower. And those incentives should be an important part of the 
thinking in any reforms that the committee might want to 
consider.
    [Slide.]
    And then I will close with the final slide, which shows the 
second piece of the CBO analysis, which is after consideration 
of rebates, how much does the manufacturer actually reap from 
delivering prescription drugs to different types of Federal 
buyers. Here, you can see a diversity of bottom line results, 
which are detailed in our report. I will highlight just one 
item that is of interest when thinking about reforms and that 
is, for example, the fact that while the Medicaid net 
manufacturer price is a bit higher than the VA average price, 
this is reflective of the ability of an entity like the VA to 
control its formulary to deliver not just to beneficiaries but 
also doctors in training and provide a variety of incentives 
for manufacturers to give them a better deal. Thinking about 
those private sector incentives in reforming the Medicaid 
system as a whole is also an important part of the debate.
    There is a lot of material in the reports. That was a 
pretty high-speed overview. We are happy to be here today. I 
look forward to your questions.
    [The prepared statement of Douglas Holtz-Eakin follows:]

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    Mr. Deal. Thank you, Doctor, and I will begin the 
questions.
    As I understand it, according to your report and other 
reports, Medicaid pays the pharmacies based on the average 
wholesale price----
    Mr. Holtz-Eakin. Yes.
    Mr. Deal. [continuing] but the rebates are calculated on 
the average manufacturers price.
    Mr. Holtz-Eakin. Yes.
    Mr. Deal. Obviously when we use different scales to judge 
things, it gets more complicated for everybody to understand. 
Is there any advantage, if any, for going to using one price to 
calculate both the rebates and the payment to pharmacists? And 
what are the pros and cons of that?
    Mr. Holtz-Eakin. If one thinks about the AWP, the intent, 
one can broadly say, would be to have some sort of price index, 
AWP or AMP or some of the other of the alphabet soup that is 
out there. And it is meant to indicate the typical price of a 
market transaction that Medicaid can then use as a proxy for 
reimbursement. In moving to some other index, instead of AWP, 
which is convenient, because it is a list price and out there, 
easily accessible, there are probably three different things to 
consider.
    The first is the degree to which it is readily available. 
One of the advantages of AWP is it is always available. It is 
updated by the manufacturers. It is available in a timely 
fashion. So would the proxy be available in a regular fashion?
    The second is the degree to which that would be the correct 
comparison group for whomever you are trying to reimburse. Who 
are the correct comparisons for pharmacies, for example? Is it 
the VA? Is it hospitals? Or is it closer to the kinds of retail 
pharmacy transactions that you see in the private market?
    And then the third would be the impact that going to a new 
index would have on private sector bargaining. If you went to a 
different index and manufacturers new that that was going to 
affect reimbursements, it might change the way they cut the 
deal with their other customers.
    So those three things will come up regardless of whether 
you go to AMP or an average sales price or whatever it may be.
    Mr. Deal. The testimony that we heard from the National 
Governors Association last week reiterated something that I 
think many committee members have said, both publicly and 
privately, and that is that we do not want to make changes that 
are going to adversely affect the pharmacists, because many of 
those really are the point of contact for health consultations 
within small rural communities, in particular.
    The current structure, which as you outlined, I think, on 
your second chart, indicates that the markup for newer brand 
name generics is the highest category of markup, which, I 
presume the pharmacist gets to keep that markup. Is that right?
    Mr. Holtz-Eakin. The pharmacist and whoever else might be 
in that chain. The wholesalers get some.
    Mr. Deal. Okay. But it would still be more profitable in 
this scenario for a pharmacist to be able to fill a 
prescription with a new generic. Is that right?
    Mr. Holtz-Eakin. Yes.
    Mr. Deal. Is that an appropriate incentive, in your 
opinion?
    Mr. Holtz-Eakin. It is clear that if you look at the total 
cost of the system, the new generic is a cheaper total cost to 
the system than is a brand name drug. If they are 
therapeutically equivalent, that would seem to be the kind of 
incentives you want to embed in the system. Whether it has to 
be that big, I think, is the question of the hour.
    Mr. Deal. Right. Okay. In your December-of-last-year 
report, you highlighted that some of the largest markups happen 
in the new single source generics, and that is one of the areas 
that you focused on. Could you go through how the average 
markups on each of these various levels are arrived at? And how 
does this discrepancy happen in those variations?
    Mr. Holtz-Eakin. Well, the computations are the same in 
each case. You will take the list price, the AWP, and take 15 
or 20 percent of it, and that will be the appropriate 
reimbursement. The real action is in the degree to which the 
actual transaction between a pharmacist and a manufacturer 
differs greatly below that list price. And there is a far 
greater aggressive negotiation on the part of the new generic 
entry, the single source generic drug, where their list price 
might be up here, they are willing to discount to get it into 
the market, and that provides a clear incentive for adoption by 
the pharmacists. And as a result, you get this disparity 
between those single source generics and then, say, older ones 
that are in the table where you don't see a big discount from 
the list.
    Mr. Deal. But even in spite of that, as your chart 
indicates, there is still significant savings to the system to 
go that route?
    Mr. Holtz-Eakin. Yes. Yes.
    Mr. Deal. All right. Well, thank you.
    Mr. Brown, you are recognized for questions.
    Mr. Brown. Thank you, Mr. Chairman.
    It is my understanding, Dr. Holtz-Eakin, that it is unclear 
whether authorized generics are included with generic drugs or 
brand name drugs in the data base you use for the markup study. 
For those unfamiliar with the term, authorized generics refer 
to brand name drugs repackaged by their manufacturer as a 
generic and priced just below, in a shadow sort of way, the 
brand price. It is a way for brand companies to undermine the 
incentive for true generic competitors into the market. So if 
you include them with the brand names, it skews it down, if you 
will, the average price. If you put them with generics, it 
skews up the average generic price so that, either way, the 
drug industry wins. Am I correct about that?
    Mr. Holtz-Eakin. I, to be honest, don't know how we class 
that, but certainly to the extent this is an issue, and we will 
get back to you with a clear answer about how the computations 
were done for our study, one thing that we will do is check the 
sensitivity of the results to classifying them one way or 
another. It is a very straightforward thing to check. And the 
second is to just provide the overall caveat that is true in 
this area, which is our results are for particular years and 
for the rules that were in place in those years. And results 
are going to differ as new drugs----
    Mr. Brown. But could one----
    Mr. Holtz-Eakin. We can check on that in detail.
    Mr. Brown. Okay. Because I mean it is hard for me to think 
it doesn't skew the results depending on which one you 
classified it with. It is just mathematics, and it would skew 
the results.
    Mr. Holtz-Eakin. Oh, it will matter, there is no question, 
but the matter of magnitude, I don't know.
    Mr. Brown. Okay. Let me shift to something else.
    Many individuals don't realize there are two distinct areas 
in Medicaid drug payments for Congress to achieve savings. The 
first deals with the payments by States to pharmacists, which 
we will discuss at some length. The second deals with the 
rebates or mandatory discount given to States by drug 
manufacturers, as we have discussed, because they are such 
large purchasers of drugs. I would like you to tell me how much 
money could be saved increasing the rebate paid from the 
statutory 15.1 to say 20 percent. And I ask that, and before 
you answer, and that will be my last question, it is pretty 
clear from what we have seen with the profitability of the drug 
industry, as I pointed out in my opening statement, the 400 
percent profit is larger than other companies in other 
industries, and the fact that, as Mr. Buyer so politely pointed 
out, that drug companies are repatriating profits, profits that 
they always seem to disclaim because they say that those price 
controlled prices in Europe and around the world, they can't 
make any money from that. So tell me, one, what you think of 
moving it from 15.1 to 20 percent, if you are willing to do 
that, but maybe more importantly, tell me what kind of money it 
would save by increasing the rebate.
    Mr. Holtz-Eakin. Well, the basic rebate being moved from 15 
to 20 percent would save about $600 million in 2006 and a bit 
over $3 billion over the 5-year budget window. So those are the 
magnitudes of the monies involved. The rebate structure has two 
pieces: the basic rebate and then an additional rebate for 
those drug prices that rise more rapidly than inflation. And I 
think it is best to think about the sort of desirability of 
modifying the rebate structure and thinking about all of the 
pieces and not just one in isolation. Those are the monies that 
would be involved in any proposal that you might go in that 
direction.
    Mr. Brown. Can the drug industry continue its research and 
development, and can you comment on that?
    Mr. Holtz-Eakin. I----
    Mr. Brown. Would this mean less research and development 
for the drug industry?
    Mr. Holtz-Eakin. One of the central questions in this area 
for the past several years has been the tradeoff between the 
sort of any year reduction in prices, given the production 
costs are actually a small fraction of things, and then the 
incentives over time for the development of new chemical 
entities, new drugs that will be beneficial. And this is 
something about which we have been deeply interested in, and 
which we are actually working on at this time. I won't prejudge 
the outcome of our looking at that, but we are working on the 
links between retail pricing and R&D, and it is something that 
we will continue to work with years after.
    Mr. Brown. Do they spend more on marketing or do they spend 
more on research?
    Mr. Holtz-Eakin. I don't know the exact numbers off the top 
of my head, but it is, again, something that as we finish, I 
would be happy to----
    Mr. Brown. I am not looking for exact numbers. I just said 
do they spend more on marketing or on research? It is hard to 
think the CBO doesn't know the answer to that question.
    Mr. Holtz-Eakin. Well, the question is which data source 
you go to, sir. And----
    Mr. Brown. Do you think accurate data, data not coming from 
the drug industry, might be a start?
    Mr. Holtz-Eakin. Why don't we get back to you?
    Mr. Brown. Okay. Thank you.
    Mr. Deal. Mr. Bilirakis is recognized for questions.
    Mr. Bilirakis. Doctor, again, our apologies for making you 
wait so long, as we usually do at these hearings while you have 
to listen to our rhetoric up here.
    We have AWP. We have AMP. We have ASP. We have rebates. We 
have markups. We have measuring of markups. I could just go on 
and on and on here. All of these years, we have never been able 
to simplify this process or get a handle on it. So I would have 
maybe one question to you in three or four parts.
    States, as I understand it, can currently negotiate 
pharmacy reimbursement rates. So one question is why does 
Medicaid continue, then, to overpay for drugs if the States 
already have the ability to negotiate lower prices? Continuing 
on, can't we make this process more simple? We are going to 
hear from the next panel how Arizona relies on health plans to 
negotiate drug prices for Medicaid beneficiaries, and they 
reportedly get some of the lowest prices in the market. So I 
guess could we have more States follow the Arizona model and 
have health plans handle these negotiations? And I guess does 
having the government handle these negotiations just 
unnecessarily complicate the process?
    So if you are able to kind of get a handle on all of those 
questions, I am talking about simplicity here. We have got more 
darn acronyms up here than you could shake a stick at and 
complications in trying to solve AWP and all of that stuff. But 
is it really truly necessary in order to be able to get the 
best price for the drugs?
    Mr. Holtz-Eakin. Well, first of all, I want to share my 
sympathy with all of the acronyms. I am new to this area, and I 
found it absolutely frightening.
    I think that it is useful to think about it in really three 
steps. Step No. 1 is do the private entities, and in my simple 
diagram, pharmacies versus drug manufacturers, do the private 
entities have sufficient incentives and abilities to negotiate 
hard for low prices? And that is a question about whether you 
are happy with the power of the pharmacies and the wholesalers 
relative to the drug companies in cutting a good deal. And if 
those incentives and tools are in place, that should be 
sufficient in a market economy. If not, then you might want to 
bring the government in with extra leverage.
    Second, can you see those transactions? Are they 
transparent, reported to CMS, or even reported publicly? And if 
so, how will that influence the level of negotiation and the 
satisfaction of the people of the price that is received? And 
then given the ability to see them, it is very easy to 
reimburse.
    And so there are really three different steps there. No. 1 
is power from the negotiation. Step two, who gets to see the 
negotiation? And then step three, having been able to see it 
directly or have to approximate it, the problem with the AWP is 
it is a bad approximation to the market deal, how do you do the 
reimbursement? With the wide diversity of experience in the 
States, I think that is a great laboratory to really look and 
see where it seems to be the most successful. And the Arizona 
model is one that certainly stands out. It doesn't look like 
most of the other Medicaid programs, and accounting for all of 
the differences, the heavy reliance on managed care, for 
example, is something that we would be interested in working 
with you on.
    Mr. Bilirakis. Well, why aren't the States taking a good 
look at the Arizona model, or are they? And what do you think, 
is coming down the pike? Florida, for instance, my Governor is 
concerned about this problem. Is he familiar with it, do you 
know? I suppose I should ask him.
    Mr. Holtz-Eakin. I don't know.
    Mr. Bilirakis. And is he trying to put that into effect in 
Florida or take a look at it, or maybe some sort of a pilot 
project? You don't know the answers, though?
    Mr. Holtz-Eakin. I don't know the answer to that one.
    Mr. Bilirakis. Okay. Is it right, on newer generic drugs, 
that there be approximately a 70 percent markup?
    Mr. Holtz-Eakin. It is a clear outcome of the reimbursement 
formula and the incentives of the manufacturers and the 
pharmacists. There is no way around it.
    Mr. Bilirakis. And the States can't do a better job in 
negotiating the----
    Mr. Holtz-Eakin. Change the reimbursement formula and, as a 
result, alter the scale of that markup, but given the nature of 
reimbursement based on AWP, incentives for entry into the 
market by new generics----
    Mr. Bilirakis. Well, why are we fooling around? I mean, my 
time is up, but again, here we go. AWP and ASP. You know, we 
have got a free market in this country. We take pride in it, 
and yet we are not really letting it work, I don't think.
    Okay. My time is up. Thanks, Mr. Chairman. Thank you, 
Doctor.
    Mr. Deal. Thank you.
    Mr. Allen.
    Mr. Allen. Thank you, Doctor, for being here.
    I wanted to ask you a couple questions, but to start with 
an issue related to the dual-eligibles, those people who 
qualify for both Medicare and Medicaid. The Medicare 
Modernization Act includes a provision by which the States must 
pay back to the Federal Government a portion of the savings 
that they receive from the transition of low-income Medicare 
beneficiaries, who get their prescription drugs from Medicaid, 
over to the Medicare drug benefit. Under that law, the base 
year for determining the payments is 2003. And my State, among 
others, has taken significant steps to save prescription drug 
costs under Medicaid in the interim. In Maine, what we have 
done is we have used prior authorization and we have used prior 
authorization requirements, so essentially what would happen, 
those States like Maine would not get credit for those savings, 
and we would be overpaying the Federal Government for the so-
called savings that we would have. And I wonder if the CBO has 
examined this issue and whether or not, if you have given any 
thought to the cost implications if Congress were to move the 
base year from 2003 to 2004?
    Mr. Holtz-Eakin. We have looked at this a little bit. The 
key issue is the way it is calculated starts with a spending 
per beneficiary, and then you find out how many beneficiaries 
and what fraction the State pays, and then there is a 
percentage of phaseout. So the starting point is the key, 
spending per beneficiary. And if one were to move the base year 
from 2003 to 2004 for that number, it would actually not make 
it easier for the States. In fact, it would go the other 
direction. But it will differ by State. And so I don't know the 
particular experience with Maine, but for the system as a 
whole, that wouldn't be the case.
    Mr. Allen. Well, obviously my constituents care a lot about 
what happens to Maine. I raise it as an issue, a real 
challenge, I think.
    And one other quick issue I just want to mention, and I 
don't expect you to deal with this, but I am very concerned 
about the transition under the new Medicare law of the dual-
eligibles. In 6 weeks, starting January 1, 2006, we are 
expected to move 6 million Americans, who now get their 
prescription drugs through Medicaid, to Medicare plans, which 
they don't know about yet, we don't know about yet, we don't 
know if their drugs are going to be covered. I would just 
suggest that that is an area both Jay Rockefeller and I have 
legislation to deal with it, but it is a very serious potential 
problem.
    But let me come back to one more point. The CBO report on 
Medicaid reimbursements to pharmacies, as you have indicated, 
indicates this dramatic difference, and maybe it would be 
worthwhile putting up your second chart again, if we could have 
that. The pharmacies' profit margin has been increasing 
significantly, as you pointed out, on newer generic drugs. And 
in response to Mr. Bilirakis' question, you referred to 
incentives of the manufacturers. And I wanted to have you 
elaborate, if you could, a little bit on the incentives of the 
manufacturers. I mean, my information is that the inflation of 
the list price to the pharmacies is driven, in part, by the 
manufacturers' desire to expand their market share. And they 
know the pharmacies will make more if they keep their list 
prices higher. Could you confirm that, deny it, comment on it?
    Mr. Holtz-Eakin. I think you have characterized the 
calculation and the incentive very clearly. I mean, there is a 
computation that delivers what we have labeled the markup to a 
pharmacy. That computation is between what you actually sell it 
and what the list price is. So the manufacturer who wishes to 
have lots of beneficiaries use their drug has a clear incentive 
to make that gap as large as possible to give the pharmacists 
an incentive to use that generic drug. And that is an outcome 
of basic economic incentives and the way the reimbursements are 
structured.
    Mr. Allen. I mention it because on this chart, which is on 
the screen, it shows the markup for newer generic drugs to be 
$32.10 and the markup for older generics to be $9.90. And you 
know, when we think there is a markup, when we talk about a 
markup, generally, we would think it is the pharmacists who are 
doing the markup, but in this case, there is a profound and 
strong incentive for the manufacturer to have a higher list 
price for the reason you indicated.
    I see my time has run out. I thank you and yield back.
    Mr. Deal. I thank the gentleman.
    Ms. Cubin.
    Ms. Cubin. Thank you, Mr. Chairman.
    The more I listen to this, the more ridiculous this system 
sounds, and I think it probably is. If we can't do better than 
this, then we all need to have our heads examined. This is just 
one of the worst examples of government gone awry that I think 
I have ever seen.
    Now I want to ask you a question, Doctor. In theory, the 
AWP is the price that the drug manufacturers suggest that the 
wholesalers charge retail pharmacists, right?
    Mr. Holtz-Eakin. Yes.
    Ms. Cubin. But you testified that that varies greatly. Has 
the CBO uncovered any information as to AWP variance related to 
the socioeconomic makeup of a region? In other words, is there 
any regional connection between what that price might be?
    Mr. Holtz-Eakin. I am unaware of anything like that. We 
haven't looked for that, specifically. These are national list 
prices.
    Ms. Cubin. Okay. I am interested in understanding further 
the relationship between pharmacy reimbursement rates and 
Medicaid beneficiaries' access to pharmacies, particularly in 
rural areas, because rural areas have the least opportunity to 
have a choice in where they go to get their drugs and so on. 
Can you please discuss what the implications would be on 
beneficiary access by moving to a pharmacy reimbursement 
payment based on ASP?
    Mr. Holtz-Eakin. I think it will depend exactly what is 
meant by ASP. ASP, at the moment, exists only under Medicare 
part B, and whether that particular calculation is the one that 
you would want to use for reimbursement of pharmacies when it 
is really not completely comparable to the kinds of 
transactions that the pharmacies are going to make under 
Medicaid. So you might want to have a different measure of 
sales, a different set of retail sales put into that index. And 
so that would be, probably, the first thing that would be 
important. And the second of the issues that I mentioned 
earlier----
    Ms. Cubin. The three issues, yeah.
    Mr. Holtz-Eakin. [continuing] how quickly will this be 
available? Can you do this? And how will the use of these 
transaction prices change the kinds of transactions that are 
actually done and reported?
    Ms. Cubin. Yes. It just seems to me that doing something 
simpler could outweigh those three things, because I just think 
this is so unnecessarily complicated. And maybe when I 
understand the issue better I won't feel that way about it.
    You have discussed a number of potential methods for 
cutting Medicaid prescription drug costs, each of which 
essentially put the onus of cost savings on pharmacies or drug 
manufacturers. I would like to hear your thoughts on the matter 
of increased co-payment system. Has CBO studied the feasibility 
of a sliding scale system based on somebody's means?
    Mr. Holtz-Eakin. We have looked, not just in this area, at 
the issue of cost sharing with beneficiaries in the health 
programs, and you run into the fact that additional cost 
sharing provides incentives for not undertaking unnecessary 
care, or in this case, purchases, looking for the lower cost 
source of necessary care. And the flip side of that is the 
concern that people will skip care which is desirable and 
necessary, and as a result, has bad either financial or worse 
health consequences. And we are trying to investigate, in all 
areas of our work, what we can learn about those tradeoffs. And 
I don't think there is anything definitive we have to offer at 
this moment, but it is a very important issue.
    Ms. Cubin. And I appreciate your observations. I just think 
it has to be weighed with the fact that people have to be 
responsible for their own health and that they have to play a 
responsible part in what they do and how they spend their 
money.
    Mr. Chairman, I yield back. Thank you so much.
    Mr. Deal. I thank the gentlelady.
    Ms. Baldwin, questions.
    Ms. Baldwin. Thank you, Mr. Chairman.
    Dr. Holtz-Eakin, I am looking at the table on page four and 
five of your report, the June 2005 report, on the prices for 
brand name drugs under selected Federal programs. This chart is 
very informative, and one thing I would note is that we do not 
yet have a box on that chart for the prices paid by Medicare. 
As we all know, Medicare will begin its prescription drug 
benefit in 6 months. And I am wondering whether the 
Congressional Budget Office plans to update this chart to 
reflect the discounts off average wholesale price received by 
Medicare.
    Mr. Holtz-Eakin. We will certainly work with the Congress 
and provide them anything that is requested. We don't have a 
specific plan to do that at the moment, and we did feel it was 
appropriate to leave that issue out of this report. Given the 
transition at the moment, it would be impossible to do a fair 
job on that. But that is something we would be happy to 
continue to work with this committee on, if it becomes 
important.
    Ms. Baldwin. I think it is going to be vital for Congress 
to understand where Medicare will fall in the spectrum of 
Federal programs that purchase drugs. I am wondering what sort 
of information the Congressional Budget Office will need in 
order to provide such an analysis. And as a follow-up, you can 
tackle both at the same time, whether you are sufficiently able 
to get that information from CMS, or whether you require any 
legislative change to derive the information that you will need 
to inform us in this regard.
    Mr. Holtz-Eakin. We were able to do the report that we have 
with the cooperation of CMS, and we thank them for that. And to 
the best of my understanding, CMS will require drug plans under 
the Medicare program to make public the prices they negotiate. 
And that will be an important element in being able to analyze 
it. There are some details about the delivery of that 
information that may not make it possible to do it in a way 
that is exactly comparable to this, but we will work with CMS 
and see if we can't get the information necessary to do that. 
But I think, from what we know right now, there is every 
indication that the data will be public. It may not be 
calculated in exactly the same, and we will work with them.
    Ms. Baldwin. Thank you.
    I yield back.
    Mr. Deal. I thank the gentlelady.
    Ms. Myrick.
    Ms. Myrick. Thank you, Mr. Chairman.
    I am new to the committee, so I am digesting all of this, 
and I actually agree with Barbara that it sure is convoluted 
the way all of this is put together. So I hope this process 
will help to simplify some of that.
    But I do have a question I wanted to ask you, because I 
keep hearing from people who come into my office and talk to me 
about people who are involved in Medicaid one way or the other. 
And they say that moving to an ASP system would really come at 
the expense of the retail pharmacists. And I wanted to ask you, 
and again it follows a little bit on what she was talking 
about, but is ASP plus 6 percent really unfair to retail 
pharmacists?
    Mr. Holtz-Eakin. Let us talk about the ASP and the plus 6 
separately.
    Ms. Myrick. Okay.
    Mr. Holtz-Eakin. The ASP, as it is currently configured, 
the concern is that those folks who are using the ASP in the 
Medicare program, have a greater ability to negotiate with the 
manufacturers and get lower prices than would retail pharmacies 
who have to provide a wide array of drugs. They can't limit the 
formulary. They have to provide the drugs that beneficiaries 
are prescribed when they walk in.
    Ms. Myrick. Okay.
    Mr. Holtz-Eakin. And so there may be a differential ability 
to negotiate. So that is sort of piece one on whether the ASP 
is a good comparison as it is currently configured. The plus 6 
changes incentives, as well, because there 6 percent of a brand 
name drug could be a potentially large number, if you look at 
our charts, whereas 6 percent of a generic drug would be much 
smaller. And incentives will come into play, and the question 
would be is it desirable to shift incentives in that way and 
move people toward brand name drugs, which might be more 
expensive from the system, as a whole.
    Ms. Myrick. Right. The other thing is, and again, I am just 
trying to understand this, the difference between a pharmacy's 
ability to negotiate prices for drugs from manufacturers 
compared to physicians and hospitals, et cetera, can you just 
briefly----
    Mr. Holtz-Eakin. You can think of the mechanics of these 
negotiations. You go to the manufacturer and say, ``Look, if 
you give me a good deal, all of my guys are going to use your 
drug and your drug only, and I have got lots.''
    Ms. Myrick. Like 600 people or whatever.
    Mr. Holtz-Eakin. And so it is an ideal chance for a good 
deal. Lots of quantity and ``exclusive'' use of that 
manufacturer's drug. If you have got an obligation to provide 
whatever drug is on the prescription when someone walks in the 
door, you can't make that same promise. You may not be in the 
same position when the bargaining takes place, and it will be a 
different outcome as a result.
    Ms. Myrick. Thank you.
    Mr. Deal. I thank the gentlelady.
    Ms. Capps.
    Ms. Capps. Thank you, Mr. Chairman. And thank you for your 
testimony, Dr. Holtz-Eakin.
    The topic I wish to discuss is one that is proposed by the 
President, which is to move from a system where States pay 
pharmacists based on average wholesale price, essentially the 
manufacturer's list price for a drug, to a system where States 
pay pharmacists based off the average sales price, an average 
of prices paid by certain purchasers. I have heard concerns, 
which I would like to hear you address, that average sales 
price is not representative of the price that pharmacies 
actually are able to purchase medicines for, because the ASP 
includes prices from hospitals and other organizations that get 
deeper discounts than pharmacies get. Could you address this 
concern?
    Mr. Holtz-Eakin. This is the issue that Ms. Myrick just 
raised. It isn't, obviously, a fair, at all, apples to apples 
comparison, as the ASP is currently configured, that----
    Ms. Capps. The pharmacist isn't at a disadvantage based on 
the large quantities that hospitals----
    Mr. Holtz-Eakin. May be at a disadvantage. It would not be 
the same for the pharmacist in a large hospital. The hospital 
would have a better negotiating position and would be able to 
strike a better deal.
    Ms. Capps. So why is this an advantage for pharmacies, 
then, to be enthused about----
    Mr. Holtz-Eakin. A disadvantage.
    Ms. Capps. It is a----
    Mr. Holtz-Eakin. Yes.
    Ms. Capps. It is a disadvantage? So the way that is 
structured, that is----
    Mr. Holtz-Eakin. Other things equal, yeah.
    Ms. Capps. The President is proposing something that might 
not resonate too well with one segment of the drug dispensing 
industry that is very central to Medicaid and Medicare, too.
    Okay. I will move to another concern of the President's 
average sale price based proposal, and that is that it would 
pay asp plus 6 percent and that 6 percent would be intended to 
fully or partially compensate pharmacies for dispensing, 
stocking, counseling patients, and other activities. However, 6 
percent of a $100 drug is much more than 6 percent of a $10 
drug, and so on. And as best as I can tell, that flat 6 percent 
has no relationship to what the pharmacist is actually doing or 
what the pharmacy's actual overhead costs may be. And I am 
concerned that such a concept would provide perverse 
incentives, for example, for pharmacies to actually dispense 
the more expensive prescriptions, medicines, not the least 
expensive ones, because it would be in their interest to do so, 
which would drive prices up all of the way around. Do you have 
comments to say on this?
    Mr. Holtz-Eakin. I think the first point I would like to 
emphasize is that the question whether the 6 percent or a fixed 
dispensing fee covers the pharmacists' costs. That is something 
that we were unable to address in our report. I want to be 
clear about that. We don't have a comprehensive measure of 
their cost of dispensing a prescription. We tried to get some 
proxies for growth in their costs by looking at the wages of 
the kinds of people who would be in the pharmacies. But we 
couldn't, in any scientific way, say that number is big enough 
to cover their costs. The second piece of the----
    Ms. Capps. Excuse me, but do you know what it was based on?
    Mr. Holtz-Eakin. The 6 percent?
    Ms. Capps. Yes.
    Mr. Holtz-Eakin. I do not. It is the President's proposal. 
And then, I think you have summarized the incentives we have 
heard discussed earlier, 6 percent of a more expensive drug is 
more than 6 percent of a cheaper drug. And again, other things 
being the same, the incentive to get a larger reimbursement 
would push you toward the more expensive drug.
    Ms. Capps. Yes. We have heard discussed today some of the 
concerns about attempts now with the proposals, the roll-outs 
of proposals, that there are efforts to restrict cost, and 
that, as a couple of my colleagues have said on the other side, 
certain populations, for example in rural areas, might be 
really unduly restricted by, or at least have no choice, when 
it comes down to the actual medications that they need, for 
example, the national Medicaid buying pool, which attempts to 
bring a large number of Medicaid populations in several States, 
in order to negotiate deeper discounts, and some of this might 
result in hampering beneficiaries from receiving the 
medications that they need, and we are not talking about 
frivolous medications. Many times, we are talking about life-
saving medications. This is a situation that I would like to 
hear you comment on. I am really concerned that we now are 
finding a situation, not just with Medicaid patients, but one 
in two uninsured, for example, one in three publicly insured, 
and one in six privately insured working age adults, with at 
least one chronic condition, have reported not purchasing all 
of their prescription drugs because of cost concerns. And this 
reporting is increased from 16.1 percent in 2001 to 18.3 
percent. So the number of people reporting these kinds of 
concerns is not diminishing. Is there any way of seeing the end 
result of what is being proposed as addressing this at all?
    Mr. Holtz-Eakin. Not from what we have in front of us 
today. The studies that we put together are national studies. 
They used national prices. They are typical outcomes across 
States, which do have differences, and they will differ both in 
urban and regional dimensions. But they do reflect the basic 
notion that the pharmaceutical market is a national market and 
that the ability to manufacture and distribute it is not a 
regional phenomenon, that that is a national phenomenon. So we 
think these are sensible studies to do. If there are important 
regional differences that you would like to pursue, we would be 
happy to work with you on that.
    Ms. Capps. Okay. Thank you very much.
    Mr. Deal. I thank the gentlelady.
    Dr. Burgess is recognized for questions.
    Mr. Burgess. Thank you, Mr. Chairman.
    Thank you, Doctor, for being here and staying with us so 
long.
    Just to go back for a minute to the average wholesale price 
and then the average manufacturers' price: included in the 
average manufacturer's price, do we include the cost for 
research and development, or is that simply the cost for the 
active ingredient and the vehicle and then the gelatin capsule?
    Mr. Holtz-Eakin. The average wholesale price is the list 
price.
    Mr. Burgess. Yes.
    Mr. Holtz-Eakin. The average manufacturing price is a 
transaction price and reflects just the outcome of the 
negotiation and the transaction of the pharmaceutical itself.
    Mr. Burgess. So the nomenclature of the use of the word 
``manufacture'' in there is, in fact, not erroneous, but it is 
actually a negotiated price, so it wouldn't necessarily reflect 
just the cost of manufacturing the pill?
    Mr. Holtz-Eakin. Right. It is the manufacturer's sale 
price, and presumably they are going to not sell in a way which 
makes them unable to cover their full costs and recover those 
costs.
    Mr. Burgess. So research and development would be included 
in that on something that was still covered under patent and 
presumably not included on something that had left the coverage 
from the patent protection?
    Mr. Holtz-Eakin. From the manufacturer's point of view, you 
have a clear incentive to cover all of your costs, research and 
development, manufacturing, distribution, marketing, whatever 
they may be. The flip side of that is, of course, the other 
side of the negotiation who wants the low prices. And this is 
the outcome, but it is hard to imagine that there wouldn't be a 
price that didn't recover costs, if at all possible.
    Mr. Burgess. But is it your opinion that drugs that are now 
off of the protection from the patent, are they always sold at 
just about the cost of manufacture or are there healthy profit 
margins built in?
    Mr. Holtz-Eakin. We haven't done a particular analysis of 
profit margins. What one sees is the not terribly surprising 
result that with the loss of patent protection, the entry of 
generic competition, retail prices tend to come down from 
single-source, patent protected drugs. But how that price is 
relative to production costs and the margins as a result is 
something that is not covered here.
    Mr. Burgess. On the bar graph that you showed us, you ran 
through very quickly the difference between the Federal supply 
schedule price and the VA average price, and you referenced 
that the VA has a tighter control of its formulary. Could you 
just run through that again for us?
    Mr. Holtz-Eakin. I was trying to spare the committee a bar-
by-bar description, and I will do that again. But you just saw 
the Medicaid bars----
    Mr. Burgess. Spare us nothing.
    Mr. Holtz-Eakin. Be careful what you wish for.
    If one just looks at the Medicaid bar and looks at the VA 
bar and they are not the same, and you raise the question, 
``Gee, why wouldn't they be? They are both government programs. 
Why don't we get the same price?'' And the answer is the VA 
carries with it into its negotiation some clout that the 
Medicaid program cannot, because it has the ability to pick a 
formulary and deliver that formulary to the veterans and, as a 
result, negotiate strongly with the manufacturers to have their 
drug included in the formulary. It is a training ground for 
doctors, and so they can go to the manufacturer and say, ``We 
can expose these young physicians to your products,'' and that 
is an advantage to manufacturers. So those dimensions to the 
negotiation matter, and that is one reason why you might see 
those bars be different, because the programs, while they are 
both Federal programs on the face, differ in their substance.
    Mr. Burgess. I thank you for explaining that so clearly.
    Do you have an opinion--as you have heard from several of 
us up here today--that this is not the system that any one of 
us would hope to construct if we were setting up today to build 
the system? Do you have an opinion as to what type of system 
that Congress ought to aspire to?
    Mr. Holtz-Eakin. I think that the consensus of the 
committee that I have heard today is that when the system was 
designed to use a sticker price to proxy the actual market 
transactions between pharmacies, wholesalers, and 
manufacturers, it failed to do so, and that the rough justice 
adjustments that came after the fact, discounts from AWP 
rebates, fail to capture the actual cost of transactions. The 
harder question, to which I think there is no single answer, is 
how to better reimburse based on market transactions, get 
closer to what it actually costs, and do that in a way that 
does not destroy the incentives for the pharmaceutical market 
as a whole to negotiate hard and have low prices. If you just 
say, ``We are only going to reimburse for the lowest price ever 
found in the United States,'' that is a clear incentive to not 
drive down too hard in other transactions, and all prices will 
drift up. That is the tradeoff you face.
    Mr. Burgess. All right. I see my time is up. Thank you very 
much.
    Mr. Deal. I thank the gentleman.
    I recognize Mr. Waxman for questions.
    Mr. Waxman. Thank you, Mr. Chairman.
    Dr. Holtz-Eakin, the 2005 CBO budget options book says that 
allowing States to increase cost sharing from $3 for adults and 
$0 for children to $5 and $3 respectively will result in $1.9 
billion savings over 5 years. The budget option book also 
states that a potential drawback of this proposal is that a 
``reduction in the use of appropriate healthcare services could 
also result.'' For instance, previous research has shown that 
poorer individuals facing higher co-payments displayed worse 
health on some measures. Another example of the introduction of 
a co-payment for prescription drugs in several State Medicaid 
programs was found to lead to many beneficiaries going without 
their medications. Is it the case that some portion of the $1.9 
billion that is saved is a result of Medicaid beneficiaries 
foregoing necessary and appropriate medical care and services, 
including prescription drugs, due to the higher co-payment?
    Mr. Holtz-Eakin. It is certainly the concern. There is 
evidence that it happens as part of the reaction to higher co-
pays. What fraction that would be passing up desirable medical 
treatment, we don't know, but it is an element of the 
behavioral response.
    Mr. Waxman. And so therefore, a portion of that savings is 
really people foregoing needed medical care?
    Mr. Holtz-Eakin. Yes. This is the ultimate attention in 
everything the CBO produces, which is the programs are there 
for the benefits. We measure the costs and exclusive reliance 
in the costs misses the flipside of the program's desirability.
    Mr. Waxman. And you don't think CBO can factor in how much 
is coming from that respect?
    Mr. Holtz-Eakin. It is not currently feasible for us to 
draw a line between those parts of the cost reduction, which 
are just better shopping and skipping luxuries from those parts 
of the cost reduction which are skipping things you shouldn't.
    Mr. Waxman. Well, we appreciate the work that you have done 
on this issue and hope you will continue to look at it.
    Dr. Holtz-Eakin, many of us are concerned about the 
transition of the dual-eligibles, those individuals who are 
enrolled in both Medicare and Medicaid, to the new Medicare 
prescription drug benefit in 2006. In particular, many dual-
eligibles have chronic illnesses and take multiple prescription 
drugs. Those living with mental illness, for example, are 
already stabilized on a particular drug regime, and an abrupt 
change in their medication could cause great harm. They could 
no longer get their medicines through Medicaid. They will have 
to go through Medicare's drug plan. Medicare's prescription 
drug plan may not include all medicine that that individual 
needs under formulary. There are some individuals who get 
involved in these plans without any consideration to what the 
medicine may be or the cost they will be paying out of pocket 
may be may insurmountable to may of these individual. A number 
of us are interested in exploring ways to use fluid continuity 
of treatment for these elderly and disabled individuals. And 
example of one option might be to require Medicaid drug plan to 
cover all medicine an individual was taking prior to the 
transition to Medicare for a certain period of time, so that 
you can change to a more appropriate plan or find another way 
to continue taking their medicines if unable to switch to 
another product. Has the CBO examined this issue? Do you have 
any sense of the magnitude of costs or even potential savings 
associated with such a beneficiary protection?
    Mr. Holtz-Eakin. We have looked at this to the extent that 
we have tried to understand the transition to the new drug 
benefit in our baseline, and there are aspects of the 
transition that have features like the ones you mentioned 
where, for certain classes of drugs, the formulary requires 
that all of the drugs be available, that the dual-eligibles can 
switch plans as necessary, perhaps, because they don't have the 
drug they have been stabilized on. There is an appeals process. 
So there are aspects of this transition, which are in the 
current CBO baseline, because that is the current CMS 
procedure. We have not done anything beyond that to look at the 
cost or the impact of more expansive guarantees during the 
transition period.
    Mr. Waxman. It doesn't sound like it would be all that much 
different than what you have already looked at if you are 
suggesting that they have some of these drugs available to 
people.
    Mr. Holtz-Eakin. In some cases the anti-psychotics and 
things, it doesn't sound like it would be very different at 
all, but there may be examples where it is different and we 
just haven't run across those yet. So if there are some 
particulars that you want to bring to our attention, we would 
be happy to take a look.
    Mr. Waxman. Well, if, perhaps, you could look at this kind 
of option if we spelled it out to see how much an additional 
savings we might find.
    Mr. Holtz-Eakin. Okay.
    Mr. Waxman. But this might be a way to help those people 
who would be affected by an abrupt cutoff in the drugs that 
they are already conditioned to using and won't be able to 
afford otherwise.
    Mr. Holtz-Eakin. There is also another feature of this. 
There is a provision for advanced refills and extended supplies 
to literally take the current Medicaid program and use it as 
the bridge to the new drug plan, and to the extent that that 
helps it, that is already built in. But that may not cover the 
entire universe, and if there are more that you would like us 
to look at, we would be happy to do it.
    Mr. Waxman. Okay. Thank you.
    Mr. Deal. The gentleman's time has expired.
    Mr. Ferguson, you are recognized for questions.
    Mr. Ferguson. Thank you, Mr. Chairman.
    Dr. Holtz-Eakin, we certainly appreciate you being here, 
and thank you for your candid answers to so many of our 
questions.
    Just before my questions, some have suggested, and some on 
this committee have suggested, that some of the drug 
manufacturers actually spend more in advertising than they do 
in research and development. That, of course, is absurd. The 
drug companies spend enormous amounts of capital and make 
enormous investments in research and development. Perhaps 
sometimes the television advertisements that people see on TV 
are a little bit more obvious than the countless people in labs 
and scientists and researchers and clinicians and others who 
make up the investments that go into finding the new cures and 
the new treatments and the new drugs, but just to clear the air 
and to clear the record, it is absurd to suggest that companies 
spend more on advertising than they do for research and 
development of these drugs.
    My question--and some have suggested that raising the 
rebate from 15.1 to 20 percent as a way to raise more money--is 
there a policy rationale for that? In my estimation, that is 
not reform; that is simply changing some of the numbers of the 
system as it is currently in place, to try and raise additional 
revenue. But if we are talking about reforming the system, 
trying to fix some of the problems that we face, in your 
estimation with CBO, is there any policy rationale, reform 
rationale, for raising the rebate to 20 percent?
    Mr. Holtz-Eakin. We didn't originate the proposal. You 
would have to talk to those who are interested in doing this 
for their rationale. The economics, I think, set up an 
incentive system where the rebate is a lower net received by 
the manufacturer. That is what that does. It lowers the price 
they get. But they still have the opportunity to access a large 
client pool by entering the Medicaid program. And so it is the 
tradeoff of being in versus being out versus getting a higher 
or lower price once you are in. And that is the tradeoff 
underneath all of these kinds of policies.
    Mr. Ferguson. Doesn't it amount to a tax on the 
manufacturer?
    Mr. Holtz-Eakin. You could label this anything. It is a 
lower price to the manufacturer.
    Mr. Ferguson. I could think of a lot of things to label it, 
but I am just trying to be accurate.
    Mr. Holtz-Eakin. I am a sufficiently good economist that I 
could call it a negative subsidy. I could call it a tax. It is 
a lower price to the manufacturer.
    Mr. Ferguson. But there is no, as far as you can see, 
reform-minded rationale, policy rationale for this; it is 
simply looking for money in a system which isn't producing 
enough money?
    Mr. Holtz-Eakin. The proposers would be best positioned to 
answer that question.
    Mr. Ferguson. Fair enough. The prescription drug component 
of Medicaid amounts to about 15 percent of the program. Is that 
correct?
    Mr. Holtz-Eakin. We will check the number and get the exact 
number back to you.
    Mr. Ferguson. More or less? I am not asking for a specific 
decimal point. The estimates that I have seen have said that 
after the drug benefit for Medicare goes into effect, because 
of dual-eligibles, obviously, and other things, that the 
prescription drug component for Medicaid will drop much lower 
than that.
    Mr. Holtz-Eakin. Yes.
    Mr. Ferguson. Perhaps by two-thirds down to maybe 6 
percent. Does this seem like, to you, from a budget standpoint, 
talking about raising the rebate now to 20 percent, if we are 
going to try and raise the rebate on a shrinking portion of the 
Medicaid program, isn't it rational to think that that the 
amount that that raises is going to continue to fall if more 
dual-eligibles and others are going to be covered by the 
Medicare program?
    Mr. Holtz-Eakin. Well, the estimates that we provided for 
this proposal would recognize the transition, and so it would 
be built off a base that recognized the duals heading into the 
Medicare program and out of Medicaid. So the numbers you have 
got are consistent with that. The more general point is that 
with the shifting, the population mix impacts in the Medicaid 
program that spill over to private sector outcomes, prices 
negotiated, and things like that, will be smaller in the future 
than they have been in the past, and that will be something we 
will have to think about in looking at the response of 
manufacturers, pharmacies, beneficiaries to different 
incentives that come up in the payment system.
    Mr. Ferguson. But as you have acknowledged and as you have 
said your study included, it is a much smaller portion, and it 
is a shrinking portion----
    Mr. Holtz-Eakin. Going forward.
    Mr. Ferguson. [continuing] of the Medicaid program going 
forward.
    Mr. Holtz-Eakin. Yes.
    Mr. Ferguson. I think of that as squeezing water from a 
rock, a shrinking rock, perhaps.
    Mr. Deal. The gentleman's time has expired.
    Mr. Ferguson. Thank you, Mr. Chairman.
    Mr. Deal. Mr. Shimkus, you are recognized for questions.
    Mr. Shimkus. Thank you, Mr. Chairman.
    I will try to be really brief. I know you have been here 
for a long time, and I appreciate the second panel we still 
have to listen to.
    Your report states that there is currently an incentive for 
pharmacists to dispense generics because of the markup. Since 
we already have this incentive to dispense generics, how do we 
increase generic utilization by changing from average wholesale 
price to another reimbursement model?
    Mr. Holtz-Eakin. Ask the question again. I am not sure I 
understood. How do you increase it?
    Mr. Shimkus. Right. I mean, the intent has been to increase 
generic utilization, but I mean, your report says the markup 
does that.
    Mr. Holtz-Eakin. Yes. Other things equaled. There is a 
clear incentive to supply the newer generic drugs.
    Mr. Shimkus. But if we move to another model, will there 
still be that incentive?
    Mr. Holtz-Eakin. That is far from obvious. I guess one of 
the examples that came up was providing ASP plus 6 where you 
would have to worry about undermining the incentive for 
generics and moving the balance back toward incentives to 
provide brand name drugs, so I think that that is an important 
thing to keep your eye on if you go forward with changing the 
payments mechanism.
    Mr. Shimkus. Based on the current incentives, shouldn't we 
already have high rates of utilization when generics are 
available?
    Mr. Holtz-Eakin. The ultimate utilization is going to 
depend on, first and foremost, the medicine and whether it is 
the right medicine and then second the relative prices and the 
incentives to deliver it. And so without knowing what the 
nature of the underlying prescription necessarily is, you can't 
really answer that.
    Mr. Shimkus. Okay. Great.
    Thank you, Mr. Chairman. I yield back.
    Mr. Deal. I thank the gentleman.
    And Mr. Brown suggested we lock the doors before any other 
members come in and want to ask any more questions. We are not 
going to do that; but Dr. Holtz-Eakin, we do appreciate your 
patience to bet with us today and for your testimony, as 
always. And we will let you get back to doing some of the 
scoring that some of us are interested in on some other issues 
as well. But thank you. As always, a great witness.
    Mr. Holtz-Eakin. I appreciate it. Thank you.
    Mr. Deal. And we will ask the second panel if they will 
come forward.
    Once again, I thank this panel for your patience as well. A 
very distinguished group, and I will make a very brief 
introduction so we can hear your testimony as quickly as 
possible.
    Our first witness is Mr. Anthony Rodgers. We already heard 
a rather in-depth introduction from Mr. Shadegg. He, of course, 
is the Director of the Arizona Health Care Cost Containment 
System. Mr. Craig Fuller is President and Chief Executive 
Officer of the National Association of Chain Drug Stores. Ms. 
Kathy King is the Director of Health Care at the U.S. 
Government Accountability Office. And Ms. Kathy D. Gifford is 
Principal of the Health Management Associates of Indianapolis, 
Indiana. And Mr. Jack Calfee is the Resident Scholar of the 
American Enterprise Institute. A very distinguished panel, and 
we will start with you, Mr. Rodgers.
    I would add that all of your written testimony is a part of 
the record.

STATEMENTS OF ANTHONY D. RODGERS, DIRECTOR, ARIZONA HEALTH CARE 
 COST CONTAINMENT SYSTEM; CRAIG L. FULLER, PRESIDENT AND CHIEF 
 EXECUTIVE OFFICER, NATIONAL ASSOCIATION OF CHAIN DRUG STORES; 
      KATHY KING, DIRECTOR, HEALTH CARE, U.S. GOVERNMENT 
  ACCOUNTABILITY OFFICE; KATHY D. GIFFORD, PRINCIPAL, HEALTH 
   MANAGEMENT ASSOCIATES; AND JOHN CALFEE, RESIDENT SCHOLAR, 
                 AMERICAN ENTERPRISE INSTITUTE

    Mr. Rodgers. Thank you, Mr. Chairman.
    I will be talking about the Arizona model, especially the 
results that we have been able to achieve related to our 
pharmacy benefit.
    [Slide.]
    What you have on our slides, and go to the next slide, 
shows a little bit about how we started. We started as a 
Medicaid waiver back in 1982, 23 years ago. We still are a 
waiver program. The waiver does allow us to operate a 
Statewide, mandatory, Medicaid managed care program that 
requires the members to enroll in a contracted health plan. The 
members receive their Medicaid services, including pharmacy 
benefits, through their health plan. Now access reviews the 
actuarial models for each health plan, and we set our rates and 
establish a PMPM capitation. And what is important about this 
is that this is the nature of aligning the financial incentives 
for the health plans, because they compete against each other 
on quality and on service, but they also compete in a way that 
relates to their capitation. If one health plan is out of 
alignment in capitation, we can see this. And those health 
plans are able to play off of that and keep our costs down. So 
the managed competition model works very well for Arizona.
    Go to the next slide.
    [Slide.]
    Our model is a full risk model. It creates a strong 
motivator on the part of plans to operate cost-effectively to 
come up with innovative ways to control costs and prescription 
drug benefits. That is one area that our plan has been very 
innovative. Our plans also are in competition for the members, 
and they compete by their networks, the networks they offer the 
members, and they compete by a reputation, whether they get a 
reputation as a good plan. And oftentimes, that is dependent on 
how the physicians as well as other members describe a plan. So 
a lot of our plan growth is due to choice, and there is a lot 
of loyalty to plans.
    Next.
    [Slide.]
    We have no single State Medicaid formulary. The State 
contracts with the plans. They establish a formulary. And this 
allows the plans to negotiate very good prices. Each plan 
develops a specific formulary, and there is always concern, 
``Well, will the plans develop an appropriate formulary?'' 
Well, they are at risk for the whole medical cost. And so what 
they are managing is not just a formulary, but what happens to 
that member if they don't get access to their medication. And I 
think that is going to be reflected in some of the later slides 
in terms of the results that we have been able to achieve.
    If you look at this concept, it is very similar to what you 
are trying to do with part D Medicare, and that is you are 
having Medicare plans as well as pharmacy plans compete for 
members based on their formulary that they offer as well as to 
maintain their costs. And so the Federal Government potentially 
can get benefit from that kind of competition.
    The keys to our success are simple. Our plans negotiate 
with input from their providers on their formulary design. They 
have contractual relationships between the providers and the 
plans, and this is extremely important, because our plans are 
responsible for assigning each member to a primary care 
physician. It is the physician who is key to controlling your 
prescription costs. Once they get on board, they control the 
generic use. They can help you with controlling your costs. And 
having a good primary care network is also key.
    Non-formulary drugs are allowed and prescribed with prior 
authorization. So if you look at our generic performance, you 
will see that our generic performance is very high, over 70 
percent, and that in most cases, when a generic is available, 
the physician will prescribe the generic. So we have a very 
high generic dispensing rate, when those are available.
    Next slide, please. The slide after that. Next one.
    [Slide.]
    These are some of the tools that the plans use to control 
prescription costs, including step therapy, which means try the 
generic first. If that doesn't work, then go to a brand or a 
different drug. And this is in consultation with the provider. 
Because they are assigned to a primary care provider, that 
relationship is key to controlling costs. Prior authorization 
procedures are also another tool, establishing appropriate 
quantity limits so that the plan can see if a member is 
shopping, so to speak, for drugs. And those limits allow the 
plan then to interface with the member. This is why our case 
management system by our plans is so important. When they see a 
member who is over-utilizing medications, they can then talk to 
that member. But they are still at risk for any negative 
consequences with that member not getting access to their 
medications.
    Each of our plans has a closed pharmacy network, which 
means they contract with their pharmacy network. They are not 
required to offer any willing pharmacy provider, but all of our 
pharmacists and pharmacies are covered in our State.
    And then finally, as a tool, we also have a mandatory 
generic use as the first option for services.
    Next slide, please.
    [Slide.]
    So a couple of things about our managed care program. There 
are no limits on prescriptions, as some States have established 
to control costs. We have no limits. There are very few quality 
issues or complaints of the 1,200 quality issues we 
investigated last year. Only 1 percent had to do with 
medications. And quality issues are everything from a physician 
prescribing the wrong dose for a child that has to be 
addressed, and the plans pick these up. And so those are part 
of the quality issues we oftentimes will evaluate. Exceptions 
to the process are considered and physicians are able to 
request non-formulary drugs as well.
    And then we have a highly competitive environment, and this 
has been due to the fact that, as access, the Arizona Health 
Care Cost Containment System, we are a part of the competitive 
environment in Arizona, and so it has established, not only 
with providers but with pharmacies, a very good competitive 
environment for our Medicaid, for Medicare, as well as for 
commercial.
    Next slide.
    [Slide.]
    This is basically the bottom line results that we see, and 
this is why everybody is very interested in the Arizona model. 
Now I have run health plans, started health plans. I have run 
hospitals, county hospitals, clinics, and one of the things 
about Arizona, it is known in the industry as uniquely managing 
the population well. In fact, even the Arizona citizens voted 
to expand access to more people in Arizona in 2002 because of 
the results that they saw.
    I would like to just bring your attention to a couple of 
things. In our acute care program, our generic use is 93 
percent for drugs that compare to other States. We took drugs 
on our formularies as well as drugs on other State formularies 
to compare, and so that is not all of the drugs, but that was 
those drugs we could compare. The average prescription cost, 
though, is significantly lower because of our generic use and 
the ability to plan and negotiate good prices. Long-term care, 
you see the same results: very high generic use and a very low 
overall cost per prescriptions. And if you look at our taniff 
population--and this was one population that is always 
sensitive to us about drugs and drug use--our per-member-per-
month cost for drugs is lower than both other States' managed 
care as well as fee for service, and that is due to the 
maturing of our program. That doesn't happen right away. But as 
your program matures, you can really get good results.
    Next slide.
    [Slide.]
    What I asked my Director of Pharmacy to do was to look at 
where we were today. We have a report that was done by the 
Lewin Group that really established Arizona as a model in terms 
of the data that they found with other programs, so I asked my 
Chief Pharmacist to check again to see how we are doing, and 
these are the results a month ago that he got: 70 percent 
generic use as compared to the other States that he was able to 
get information. Our dispensing fee is $2, which might be low 
compared to other States, but again, we have a very competitive 
environment in Arizona, and so when you have competition, you 
have that benefit. That occurs from that. And we don't have co-
pays. And I think that that is a very important thing, because 
our plans can manage and get us the results that we need 
without establishing co-pays.
    The next slide.
    [Slide.]
    Mr. Deal. Summarize, if you would, please.
    Mr. Rodgers. Okay. Let me go to the last slide.
    The last slide basically tells you what our strategic focus 
is: controlling medical cost inflation, improving quality 
health care and accessibility of primary care services, 
reducing the number of uninsured in our State, reducing the 
fragmentation of services, and assuring that there is adequate 
infrastructure to oversee our programs. It is important to know 
that the success of this program has been due to Arizona 
learning how to manage managed care, and I think that is the 
key to our success.
    I want to thank you, Mr. Chairman.
    [The prepared statement of Anthony D. Rodgers follows:]

Prepared Statement of Anthony D. Rodgers, Director, Arizona Health Care 
                        Cost Containment System

    Mr. Chairman, Members of the Subcommittee, thank you for the 
opportunity to meet with you today on behalf of the Arizona Health Care 
Cost Containment System (AHCCCS). I am appreciative for the opportunity 
to share how Arizona's Medicaid program has been successful in keeping 
the cost of prescription drugs significantly lower than other states' 
Medicaid programs.

The AHCCCS Model
    Arizona's Medicaid program operates under a Section 1115 Research 
and Demonstration Waiver granted by CMS in 1982. This waiver allows 
Arizona to operate a statewide managed care system and requires that 
all Medicaid members enroll in a contracted health plan. AHCCCS pays 
the health plans an actuarially determined per-member, per-month (PMPM) 
capitation for each enrolled member. Under this model of contracting, 
the health plans assume the financial risk of delivering the full range 
of health care services for each member. The current Acute Care 
Medicaid program and State Children's Health Insurance Program (SCHIP) 
includes over 1 million low-income members.
    In Arizona, the capitation paid to the health plans is for the 
provision of all Medicaid services, including the prescription drug 
benefit. The inclusion of the prescription drug benefit in the managed 
care capitation rate disqualifies AHCCCS from participation in the 
Medicaid Rebate Program. Nonetheless, this factor has not had a 
negative impact on AHCCCS. This exclusion makes our health plans 100% 
at risk for the cost of prescription drugs, creating a strong motivator 
for them to deliver a cost effective prescription drug benefit focusing 
on the use of generics.

Benefits to health plans for being at-risk for delivering prescription 
        drug services
    Because AHCCCS' health plans assume full financial risk for 
delivering the entire range of Medicaid health care services, including 
prescription drugs, AHCCCS allows each health plan, or Managed Care 
Organization (MCO), to develop its own plan-specific formulary and 
prescription drug benefit management tools. In addition to this 
inherent financial incentive, the health plans also have a constant 
incentive to maintain quality services because they must compete for 
membership enrollment. Thus, the health plans work to meet the needs of 
the members and to provide a cost-effective benefit. With this in mind, 
there is no single, statewide Medicaid formulary. The health plans 
develop formularies based on input of their provider network, often 
locally or regionally, that are reinforced with contractual 
relationships with providers for compliance.
    AHCCCS health plans utilize a variety of tools to maintain cost 
efficiency. The most significant factor may be that AHCCCS health plans 
mandate generic drug utilization. The overall AHCCCS dispensing rate 
average for generics is 70+%. When generic drugs are available, our 
health plans average 98 + % generic dispensing rate. Our experience has 
been that using generic drugs is more cost effective for Arizona than 
using brand drugs and receiving a rebate.
    In addition, health plans have the ability to develop closed 
pharmacy provider networks, which routinely provide aggressive Average 
Wholesale Price (AWP) discounts and are negotiated in highly 
competitive environments (15-17% for brand and 15-50% or greater for 
generics). Maximum Allowable Cost (MAC) pricing for generics is also 
used. The dispensing fees are very low compared to other states, 
averaging less than $2 per RX.
    In addition to the mandated generic utilization and the closed 
pharmacy provider networks, health plans utilize other management tools 
to keep their prescription drug costs low. These tools in and of 
themselves are not exceptional and are widely used:

 Step Therapy/Treatment Guidelines which look for evidence of failure 
        to achieve desired treatment outcomes with less costly, generic 
        or over the counter drugs and develop compliance with standards 
        of care or medical specialty developed treatment guidelines;
 Prior Authorization Procedures;
 Quantity Limits such as early refill edits and maximum monthly 
        quantities; and
 Disease Management Program/Specialty Case Management for members with 
        Diabetes, Asthma, Heart Disease and others.
    When used in conjunction with the emphasis on generic drug use, and 
motivated health plans, these tools become a significant factor in 
quality care and cost savings.

Benefits to AHCCCS Members When Pharmacy Services are Well Managed
    AHCCCS is the largest single health insurer in the state with 
membership at almost 20% of Arizona's population. Strong utilization 
management by our health plans and monitoring of quality benchmarks 
have kept costs under control so that the members enjoy no limits on 
the number of prescriptions or, when necessary, brand name 
prescriptions which they can receive per month. AHCCCS carefully 
monitors our managed care plans to ensure that members receive the 
services they need. Very few quality of care issues are related to drug 
therapy. Out of an estimated 1,200 Quality of Care issues annually, 
less than 1% is related to prescription drugs.

Arizona Model Produces Cost Savings
    A recent study done by the Centers for Health Care Studies (CHCS) 
and the Lewin Group compared prescription drug costs of the aged, blind 
and disabled population enrolled in AHCCCS' Acute Care Program to 
similar populations of other states. By definition, these populations 
are heavy utilizers of prescription drugs. The CHCS/Lewin evaluation 
found that AHCCCS' prescription drug costs provided through the managed 
care model are more cost effective than other states' fee-for-service 
models. AHCCCS' 2002 per member per month (PMPM) prescription drug 
utilization cost was $112.21, which is 38% below the National Average 
of $181.01 and is 11% below the next most cost-competitive state 
(Michigan). This is even more impressive when one considers that these 
savings were achieved without the benefit of rebates.
    The following table illustrates the various elements of both 
AHCCCS' prescription drug benefit in a managed care model and other 
states' prescription drug benefit in a fee-for-service model. The data 
was self-reported by the State Medicaid pharmacy program administrators 
from each state in response to a national survey.


--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                  Prior
                State                   Generic  Utilization    Reimbursement  Formula  Dispensing  Copayment      Max Days Supply      Monthly    Auth
                                                                                            Fee                                          Limit   Program
--------------------------------------------------------------------------------------------------------------------------------------------------------
Az..................................  70%....................  AWP-15-17% (negotiated          $2        $0    Greater of 30 days or      None       Yes
                                                                by each health plan).                           100 units.
Ak..................................  42%....................  AWP-5%.................    $$3-$11        $2    30 days...............     None       Yes
Ca..................................  51%....................  AWP-17%................   $7.25-$8        $0    100 days..............        6       Yes
Mi..................................  Not reported...........  AWP-13.5% (independent       $3.77        $1    Maintenance meds--3        None       Yes
                                                                pharmacies) and AWP-                            months: all others 34
                                                                15% for chain                                   days.
                                                                pharmacies.
NJ..................................  48%....................  AWP-12%................      $3.69        $0    Greater of 34 days or      None       Yes
                                                                                                                100 units.
Pa..................................  51%....................  AWP-10%................         $4        $1    Greater of 34 days or      None       Yes
                                                                                                                100 units.
--------------------------------------------------------------------------------------------------------------------------------------------------------

Challenges to Lowering Prescription Drug Costs for Non-Managed Care 
        Population
    While the Arizona model of Medicare managed care has been a success 
story for our state, it must be acknowledged that it may be difficult 
to convert from a fee-for-service program to a Medicaid Managed care 
model. While commitment to the model has paid off relating to both 
cost-efficiency and quality of care, the first 5 years of operating the 
AHCCS program were difficult.

Conclusion
    There are several points I would like to leave you with today to 
assist you as you identify strategies to reduce Medicaid prescription 
drug costs. The first is a paradox. By improving compliance and 
utilization of prescription drug regimens, drug spending may actually 
rise. However, this may lead to improvements in health status and 
decreased overall health care spending. While this is the ultimate goal 
we are still striving to meet, it sometimes makes it more difficult to 
evaluate the ``success'' of ``cost-containment initiatives.
    Secondly, the ability to have common data elements and the ability 
to analyze data that cuts across health plans, and across state 
Medicaid programs, is critical to ensuring that prescription drugs are 
having the maximum effect of improving health status. Quality 
performance indicators and benchmarks can be set for managed care 
organizations and health plans without compromising their ability to 
deliver health care services. Another challenge that will affect 
states' ability to manage prescription drug costs is the implementation 
of Medicare Part D under the Medicare Modernization Act of 2003 (MMA) 
on January 1, 2006. Due to the fact that the states will no longer be 
providing coverage to the dual eligible population (members eligible 
for both Medicaid and Medicare), states are losing critical purchasing 
power. Arizona is concerned that the phased-down payments will not be 
indicative of the savings that have been achieved in providing a 
prescription drug benefit. This will be especially true if the trend to 
provide brand name drugs over generics is realized. At the same time, 
the MMA creates the opportunity for states to enhance the coordination 
of care for the dual eligible population through collaboration with 
Part D Plan Sponsors. By providing incentives for plans to become 
Medicare Advantage-Prescription Drug Plans designated as Special Needs 
Plans, members will be able to access both their Medicaid and Medicare 
services through one health plan, allowing for greater coordination of 
care and coordination of benefits. AHCCCS has collaborated with six of 
its contracted health plans pursuing such designation. The provision of 
all of the member's services by one health plan supports the notion of 
person vs. program and allows the maximum opportunity for members to 
receive quality, coordinated care without navigating two delivery 
systems.
    Another challenge Medicaid faces is the cost of providing long-term 
care services. Arizona provides long-term care services through a 
managed care model, the Arizona Long-Term Care System (ALTCS). ALTCS 
controls the cost of providing long-term care services by utilizing a 
Pre-Admission Screening document allowing only those members at risk of 
institutionalization to enroll in ALTCS rather than Acute Care 
Medicaid. The managed care model allows for imposition of network 
standards and case management standards that enhance the quality of 
services members receive. Members may choose to receive Home and 
Community Based Services (HCBS) rather than enter an institution, which 
is a savings for Medicaid as well as an effective way to allow members 
to direct their own care.
    I am available to take any questions you may have and want to thank 
you again for the opportunity to highlight how our program is working 
for the benefit of Arizonans.

    Mr. Deal. Thank you.
    Mr. Fuller.

                  STATEMENT OF CRAIG L. FULLER

    Mr. Fuller. Thank you, Mr. Chairman, Mr. Brown. I represent 
the National Association of Chain Drug Stores. We have over 200 
retail members with over 35,000 stores and 120,000 pharmacists 
across the country. This is a very, very important issue to us, 
and we are grateful for the chance to testify.
    My statement went on at some length about a variety of 
issues. I would like to give you some highlights with some very 
quick charts. If we could turn to the reform principles on the 
next page.
    [Slide.]
    I think it is important, as you look at alternatives, to 
think about three principles. One, the Medicaid payment system 
reforms should reflect current market prices. They should be 
prices, as I think you said, Mr. Chairman, that are 
transparent, that are known, and verifiable. Second, the 
savings that you seek in the program should somehow be 
proportionate to the program's expenditures, and I will explain 
that in a minute. And finally, behavior in Medicaid that 
supports the policy objectives you are seeking should be 
rewarded.
    [Slide.]
    The next slide just gives you a very quick picture of our 
view of retail pharmacy today where a little over 15 percent of 
what is happening in our stores is related to Medicaid, which 
makes it a very important segment. I should add that in rural 
communities, this number is larger, and in some urban 
communities, this number is larger, which puts more pressure on 
both rural pharmacies as well as urban pharmacies.
    [Slide.]
    The next slide is really a recap of, I think, some things 
that have been said. Medicaid drug program spending is up 
because there are more Medicaid recipients using prescription 
drugs, there are more prescription drugs being used per 
recipient, which, in my view, is a good thing, because the 
value of medication today is very important in terms of the 
overall healthcare costs. The cost of the prescriptions is up 
partly because of the ingredient costs and we will show you, we 
think, not so much because of the dispensing fees.
    [Slide.]
    In fact, the next slide shows you 22 years' experience of 
what the average prescription cost where today, or in 2002, the 
average prescription, both generic as well as brand, was about 
$57. That has risen over time. The cost of dispensing has 
stayed rather low.
    [Slide.]
    And the next slide actually demonstrates how over that 22-
year period the dispensing fee paid has actually gone down.
    [Slide.]
    This next slide is complicated, but it is terribly 
important. The green bars are the product costs, the drug costs 
associated with prescriptions dispensed under Medicaid as 
projected by CMS as well as CBO from 2005 to 2010. That is the 
product cost of the medication. The bar just to the left in 
each case of that green bar is the gross margin that the 
pharmacy receives. We take exception to CBO, we have sent them 
a letter, and it is appended to your material, this notion that 
there is a markup. There is a cost associated with dispensing, 
and it is that gross margin that has to cover that cost, the 
cost of stocking the medication, paying the pharmacists, doing 
the transactions, and that sort of thing. That leaves that 
small yellow bar, which is the net margin.
    In the proposal that is before you, to use ASP as a reform 
mechanism to save money, the red bar just to the left of the 
yellow bar is, in each case from 2006 to 2010, slightly larger 
than the yellow bar, and what this suggests to us, using the 
government's numbers, is that the utilization of ASP pricing, 
as it has been proposed to save money for retail pharmacy, 
would actually seek to save more money than retail pharmacy 
actually makes by dispensing a drug, or said another way, we 
will lose money every time we dispense a Medicaid prescription. 
And that, as some say, you can't make up for in volume. And 
that is going to provide an access problem, because retail 
pharmacies simply won't be able to provide the level of service 
or won't, in fact, be able to participate in the program at 
all.
    [Slide.]
    The next slide--and I am going to cover this quickly, 
because ASP has been discussed. But the next slide just 
mentions some of our concerns about ASP. First of all, it 
doesn't really recognize classes of trade. This is very 
important. We don't negotiate with brand manufacturers on 
price. We buy the medication at the price it is sold to our 
retailers at, usually through a wholesaler. In retail pharmacy, 
we pay a higher price than other people buying exactly the same 
drug--hospitals, PBMs, or others. So any average for us puts us 
at a disadvantage, because we are paying a higher price, given 
the ``class of trade'' that retail pharmacy is in. It is also 
outdated. It is two or three quarters behind and does lack 
transparency. It also discourages generic dispensing.
    [Slide.]
    The next slide talks about AWP. We are all interested in 
moving off of that. It also references, and we represent to the 
committee, that using wholesale acquisition cost, or WAC, is 
actually a number that exists in nature. I know you have heard 
a lot of acronyms, but this is actually a published price that 
you can go to and look up, and it is updated frequently. And if 
you are looking for a way to peg a number as to what retail 
pharmacy is paying today, that, we believe, is a good way of 
doing it.
    [Slide.]
    The next slide mentions ASP. I have referred to that. It 
talks about the average manufacturers' price. Again, this is 
not a price that exists in nature, so to speak. It is a 
calculated price, and there are delays associated with it.
    [Slide.]
    The next slide, the goal is a pharmacy payment reform, and 
I want to skip over it, because I made the point that we really 
do recommend WAC pricing be used for brands.
    [Slide.]
    But we also, if you go to the next slide, want to emphasize 
the importance of generics. I think that was just brought out 
by Mr. Rodgers' statements, but this is what we are spending 
today on the three types of drugs that are dispensed in 
Medicaid, $122 for a patented brand drug, $65 for an off-patent 
brand, and $20 for a generic. I think you can see why it is 
desirable to increase generic utilization.
    [Slide.]
    If you go to the next slide, what that says today is that 
we have, on the left, over 50 percent of the prescriptions 
being filled with generic drugs. But there is a way to go, 
because 83 percent of the money is actually spent on buying 
drugs.
    [Slide.]
    The next slide simply shows how this works with one type of 
disease state, gastrointestinal disease. I am not sure exactly 
why we picked this, but the fact is there are three brands up 
there. There is one of a generic Prilosec that is lower than 
the three brands, but the generic brand is $0.56, giving you a 
fairly dramatic savings.
    [Slide.]
    The next slide comes from data that we received for the 
first quarter of this year. I better find out why Arizona isn't 
better represented on this chart, but it looks at dispensing 
rates by State. And we have provided in your packet a list of 
all 50 States. The average in the first quarter from the NDC 
Health numbers was 51 percent generic dispensing. What this 
shows you is there is a wide range in the country, from the 40-
percent group to the 60-percent group. If you move generic 
dispensing up to or closer to 60 percent, as several States 
have achieved, or as Arizona has achieved at 70 percent, 
literally, our calculations are there would be a $3.5 billion 
savings per year.
    [Slide.]
    The next to the last slide talks just briefly about tiered 
co-pays. I know that that is something that is of interest. We 
need to make one important point. There are tiered co-pays 
today, between 50 cents and $3. The problem is that we can't 
collect those co-pays from many patients. Indeed, some States 
actually promote the fact that the law doesn't allow 
pharmacists to collect that money. There are two big problems. 
To the pharmacy, that is simply a lost 50 cents or $1 or $3 per 
prescription. That does add up, and it is significant to us. We 
eat that cost. For you, the payer, it is a difference between 
our prescribing a $20 drug or a $120 drug. So the payers' cost, 
by losing this tool, could easily be $100 per prescription.
    So if you are going to look at co-pays, tiered co-pays, and 
we think that is a reasonable thing to do, it is very important 
that that tool not be turned to but then negated by making it a 
matter of law, something that we can't collect.
    We do believe, in conclusion, that we are and want to be 
part of the solution. We do believe the disproportionate 
savings from pharmacy is going to reduce the access to 
patients, because pharmacies just won't be able to participate 
in this program, and we do strongly believe that part of the 
solution has to be found in rewarding behavior on the part of 
the pharmacy as well as the patient to pursue the kinds of 
objectives you are seeking.
    Thank you, Mr. Chairman.
    [The prepared statement of Craig L. Fuller follows:]

    Prepared Statement of Craig Fuller, President and CEO, National 
                    Association of Chain Drug Stores

    Mr. Chairman and Members of the Subcommittee, My name is Craig 
Fuller, I am President and CEO of the National Association of Chain 
Drug Stores (NACDS), and I am very pleased to provide to you with our 
organization's views regarding Medicaid payment reform options for 
prescription drugs. NACDS represents more than 200 chain pharmacy 
companies that operate more than 35,000 community-based retail 
pharmacies, where the majority of all Medicaid prescriptions are 
dispensed. Issues and policies that affect Medicaid reimbursement for 
prescription drugs are of critical importance to our association and 
our membership.

       I. CRITERIA FOR MEDICAID PRESCRIPTION DRUG PAYMENT REFORM

    We encourage the Subcommittee to keep the following three points in 
mind as Medicaid prescription drug payment reform options are 
considered:

 Use Current, Market-Oriented, Retail-Based Prices: Any reforms made 
        to the current AWP-based payment system for Medicaid 
        prescription drugs must result in reimbursement that reflects 
        current, market-based prices at which pharmacies purchase both 
        brand and generic drugs. Reimbursement methods that use 
        retrospectively-determined prices, or are not reflective of the 
        prices paid by the retail class of trade, will underpay 
        pharmacies for Medicaid prescriptions and may create access 
        problems for Medicaid recipients. Moreover, pharmacies must be 
        paid adequately to dispense these prescriptions to Medicaid 
        recipients.
 Encourage Generic Drug Dispensing: Payment policies should encourage 
        pharmacy providers to dispense lower-cost generic drugs when 
        possible and appropriate. Every time a pharmacist dispenses a 
        generically equivalent drug instead of the off patent brand 
        name counterpart, the Medicaid program saves an average of 
        about $45. Every time a pharmacist receives permission from the 
        physician to dispense a generic drug that is therapeutically 
        equivalent to a brand name single source drug, the Medicaid 
        program saves an average of about $100.
 Require Proportional Cost Containment Contribution: For the purposes 
        of this year's budget reconciliation bill, each sector 
        contributing costs to the Medicaid prescription drug program 
        must make a proportional contribution to cost control. This 
        includes pharmaceutical manufacturers, pharmacists and Medicaid 
        recipients.
    States have already taken hundreds of millions of dollars out of 
Medicaid pharmacy reimbursement over the past several years. Yet 
Medicaid prescription drug spending continues to escalate because 
reducing pharmacy reimbursement does little to slow the growth of drug 
spending. That is because drug spending is being driven by increasing 
drug product costs and increasing drug use, not dispensing fee or 
pharmacy payments. Medicaid pays pharmacies for both the drug product 
dispensed, as well as the cost of dispensing. Pharmacies have no 
control over 80 percent of the costs of brand name drug prescriptions, 
which is the cost of the drug products we buy from manufacturers.
    Reimbursement reductions reduce pharmacy payments only, not the 
costs of goods. It is unfair to place 100 percent of the cost 
containment burden on only 20 percent of the cost of the program; that 
is, retail pharmacy gross margins.

   II. CURRENT STATUS OF MEDICAID PRESCRIPTION DRUG PAYMENT POLICIES

    Total Medicaid pharmacy payments are based on two components: drug 
product reimbursement and dispensing fee. Consistent with the 
flexibility given to states, some states have higher reimbursement 
rates for pharmaceutical products and lower dispensing fees, while 
others have lower reimbursement rates for products and higher 
dispensing fees. The bottom line is that the total payment made has to 
be adequate to pay pharmacies to cover their costs of buying the drug, 
dispensing the drug, and earning a reasonable return on a Medicaid 
prescription.
    Moreover, when policymakers consider whether a particular level of 
Medicaid reimbursement is ``adequate'' they often overlook other 
important factors that have an impact on revenues that a provider 
actually derives from Medicaid. For example, many states charge co-
payments for Medicaid prescriptions, ranging from 50 cents to $3 per 
prescription. NACDS supports the use of reasonable Medicaid 
prescription co-payments as a way of making individuals take more 
responsibility for their health care. However, we also know that there 
are many recipients that truly cannot pay, even these small amounts. 
Pharmacies must provide Medicaid recipients with their prescriptions, 
even if a recipient cannot or will not pay the co-payment. Moreover, 
federal law prohibits Medicaid from reimbursing pharmacies for unpaid 
co-payments, so unpaid co-payments reduce pharmacies' revenues.
    Because many states have been imposing steeper co-payments on 
recipients over the past few years, the rate of non-collection by 
pharmacies has been increasing, affecting the overall revenues that 
pharmacies derive from Medicaid prescriptions. Pharmacies should not 
shoulder the burden of these uncollected co-payments.
    The net profit margin of community retail pharmacies is only about 
2 percent. Pharmacies are low-margin health care providers, and even 
small changes in pharmacies' revenue streams can mean the difference 
between whether the pharmacy's doors remain open or have to close. 
Thus, it is vitally important that pharmacy payment rates be adequate 
to maintain Medicaid recipients' access to pharmacy services.
A. Pharmacies Working With States to Achieve Medicaid Pharmacy Cost 
        Savings
    Pharmacy providers are working successfully with many state 
Medicaid programs to help implement cost savings and quality 
improvement options that have helped save tens of millions of dollars 
for states and the Federal government. These include programs to 
increase use of lower-cost generic medications, disease management 
programs, step therapy programs, prior authorization and preferred drug 
list programs, and others.
    We view ourselves as partners with the states in achieving savings, 
although these programs come with significant administrative costs to 
pharmacies and pharmacists, and little compensation.
    Federal policymakers should encourage the appropriate use of lower-
cost generic drugs. There is significant room for growth for generics 
in Medicaid. Generic drugs account for over half of all prescriptions 
dispensed in Medicaid, but only about 17 percent of all Medicaid 
prescription expenditures. This discrepancy is due to the significant 
difference in average reimbursement paid by Medicaid for patented brand 
name medications relative to generics. In 2004, the average 
reimbursement for a patented brand name drug was $122, while the 
average reimbursement for a generic was only about $20, less than one-
sixth the amount for patented brands. Even the generally larger rebates 
on brand drugs cannot make up such a large difference.
    Twenty-three (23) of the top 25 generic products dispensed by 
Medicaid programs in 2004 had an average reimbursement of $20 or less 
per prescription. Sixteen (16) of these medications were reimbursed at 
an average of less than $15 per prescription and 12 were reimbursed at 
under $10 per prescription. For these reasons, we encourage 
policymakers to recognize the importance of maintaining incentives 
within Medicaid to dispense generic-equivalents drugs.
    Despite the tremendous cost savings possible from the use of 
generic drugs, generic dispensing rates in states vary widely. Data 
from the first quarter of 2005 found that the average state Medicaid 
generic dispensing rate was about 51 percent. However, the top 5 states 
were Washington (60.5%), Oregon (59.5%), Alabama (59%), New Mexico 
(58.9%), and Hawaii (58.3%). On the opposite end of the spectrum, 
however, the Medicaid generic dispensing rates were lowest in 
Connecticut (47.1%), California (46.9%), Texas (46.4%), Louisiana 
(44.5%) and New Jersey (42.4%). These stark differences in generic 
dispensing rates--18 percent between the highest and lowest states--can 
be explained by a number of factors. However, if all states were able 
to increase their generic dispensing rates to 60.5% like Washington, 
the Medicaid program would save an estimated $3.5 billion this year. A 
complete analysis of state Medicaid generic dispensing rates is 
appended to this statement.
    Researchers consistently find that increased use of generic drugs 
for off-patent brand name drugs could provide considerable savings to 
consumers and plan sponsors, including states and the federal 
government. In fact, as the budget reconciliation process moves 
forward, policymakers should consider whether increased use of generic 
drugs in Medicaid will generate most of the savings that might be 
needed for the budget target. For example:

 A study published in this month's Annals of Internal Medicine 
        examines generic substitution for a large, nationally 
        representative sample of adults. This study found that although 
        over half of this group's outpatient prescriptions from 1997-
        2000 were for multiple source drugs, only 61 percent were 
        dispensed as generics. If generic equivalent drugs had been 
        dispensed in every instance where an off-patent brand name drug 
        was dispensed, national savings could have been around $8.8 
        billion per year.1
---------------------------------------------------------------------------
    \1\ Haas, et al., Potential Savings from Substituting Generic Drugs 
for Brand Name Drugs: MEPS, 1997-2000; Annals of Internal Medicine, 
June 2005
---------------------------------------------------------------------------
      For dual eligibles at least age 65, the savings from substitution 
        of generic-equivalent drugs was $1.7 billion per year, while 
        for the under-65 Medicaid population, the savings was $388 
        million per year.
 A study published in 2003 by the journal Health Services Research 
        estimated that Medicaid could have saved up to $229 million in 
        2000 if generic equivalent drugs had been broadly substituted 
        for off-patent brand name drugs.2
---------------------------------------------------------------------------
    \2\ Fisher, et al., Economic Consequences of Under Use of Generic 
Drugs: Evidence from Medicaid and Implications for Prescription Drug 
Benefit Plans, Health Services Research, 2003; 38: 1051-63.
---------------------------------------------------------------------------
    These studies all focus on substitution of generic equivalent 
products for off-patent brand name products. Even greater savings could 
be achieved if patients were able to use a generic drug or lower cost 
brand name drug that provided similar therapeutic benefit in place of a 
higher-cost patented, sole source brand name drug.
B. Medicaid Benefits from Generic Price Competition Generated by Retail 
        Pharmacy
    Medicaid benefits from the intense generic drug price competition 
and price transparency generated by retail pharmacies. The purchasing 
leverage of retail pharmacy forces competition among generic drug 
makers to earn a pharmacy's business. This lowers generic prices to 
pharmacies, and these lower generic prices are passed along to 
consumers.
    Medicaid also benefits from generic drug price competition between 
retail pharmacies because Medicaid programs typically reimburse 
pharmacies the ``lower of'' the program's payment formula for a generic 
drug (i.e., FUL plus dispensing fee or MAC plus dispensing fee) or the 
pharmacy's ``usual and customary'' charge to the cash paying public. In 
many cases the Medicaid program pays a pharmacy's lower ``usual and 
customary'' price rather than the amount determined by the generic 
payment formula. As a result of competitive forces in the generic 
marketplace, the average generic prescription reimbursement in Medicaid 
has only increased by about $7 per prescription over the last 7 years, 
from $13 in 1998 to $20 today, while the average brand name 
prescription reimbursement has almost doubled from $63 in 1998 to $122 
today. Clearly, Medicaid is benefiting from the price competition for 
generic drugs generated by retail pharmacy at multiple levels in the 
distribution chain.
    Almost 60 percent of all Medicaid generic prescriptions have 
Federal Upper Limits (FULs), meaning that the pharmacy is reimbursed 
the same amount for a generic medication regardless of the price of the 
product purchased by that pharmacy. The FUL is set at 150 percent of 
the lowest price published in the national pharmaceutical pricing 
compendia for a generic version of a drug product. A FUL is established 
once there are three nationally-available sources of supply for the 
generic. The current FUL system, while not perfect, works well in 
balancing the needs of pharmacies to have sufficient economic 
incentives to dispense generics to Medicaid recipients, coupled with 
Medicaid's desire to not overpay for generics.
    The FUL gives pharmacies the incentives to drive down the prices of 
generics below the FUL so the pharmacies do not lose money. Medicaid 
benefits from this price competition.
    At the same time, the fact that the pharmacy can retain any small 
margin between the FUL and its acquisition cost gives it an incentive 
to drive a hard bargain with the generic companies, as well as 
compensates for a dispensing fee component that may be inadequate. In 
our view, the current incentives are aligned appropriately for both 
pharmacies and Medicaid to dispense generics.
    However, if pharmacy reimbursement were to be based on some markup 
of actual ``acquisition costs,'' the incentives would change for 
pharmacy providers in terms of generic dispensing. For example, if 
Medicaid adopted Medicare Part B's policy to pay for covered drugs at 
ASP (Average Sales Price) plus 6 percent, a pharmacy will derive more 
revenue from dispensing a brand name drug with an ASP of $100 ($106) 
than it would derive from dispensing a generic with an ASP of $20.00 
($21.20). Thus, the economic incentives built into the ASP system would 
actually raise Medicaid costs by encouraging the dispensing of more 
expensive brand name drugs.
C. Competition Works for Drugs without Payment Limits
    Even in cases where a FUL or MAC (Maximum Allowable Cost) is not 
established for a generic drug, or is not established as soon as 
multiple sources of supply become available, competitive forces at the 
retail level help to lower overall Medicaid costs for generics. A good 
case in point is what occurred when Prozac (known generically as 
fluoxetine) became available in generic form in August 2001. Medicaid 
was paying $2.86 per capsule total reimbursement for brand name Prozac 
in August 2001, and the price of the first generic (which had an FDA-
granted six-month exclusivity period) was $2.46.
    During the six-month period of exclusivity, when only one generic 
version can be sold as a result of government policy, pharmacies are 
essentially ``price takers''--we have little leverage over a single 
source of supply of a generic drug. However, when there are multiple 
sources of supply for a generic drug, pharmacies become ``price 
makers.'' We can create competition between the multiple sellers of 
these generic products.
    After the exclusivity period for the first fluoxetine generic 
expired in early 2002 and multiple generics came to the market, 
Medicaid reimbursement for generic fluoxetine decreased rapidly. 
According to data we have analyzed, the average generic reimbursement 
for fluoxetine is now about $0.66 per capsule, or almost 75 percent 
less than the reimbursement paid when the product first became 
available generically. The rapid reduction in the reimbursement 
Medicaid pays for this generic resulted from market forces and generic 
competition that drove down the overall price of generic fluoxetine. 
Medicaid benefits each and every day from this continued competition. 
Medicaid's paying $0.66 per capsule total reimbursement for fluoxetine 
is much less than the current reimbursement rate of $3.37 per capsule 
for brand name Prozac.
D. Policymakers Should Consider Reimbursement for Total ``Market 
        Basket''
    We think it is both fair and good public policy to consider the 
adequacy of reimbursement paid to pharmacies by looking at their entire 
Medicaid ``market basket'' of drugs provided by pharmacies, by not 
singling out the reimbursement paid for certain medications.
    With 56,000 community retail pharmacies and upwards of 60,000 
individual drug products available in the marketplace, the pharmacy 
reimbursement system is built on a series of averages and estimates. 
These include the average discount paid by the average pharmacy on the 
average wholesale price for prescription products and the average cost 
of dispensing a prescription at the average pharmacy. Such a system 
will have inherent highs and lows in the various components. But in the 
end, Medicaid and pharmacy providers need to strike a fair balance that 
would assure--in the aggregate--that Medicaid does not overpay or 
underpay, and that providers are adequately compensated for the 
``market basket'' of drugs they provide.
    In this regard, we sometimes hear criticism that pharmacies are 
making excessive markups on Medicaid generic drugs. Pharmacies do not 
``mark up'' the prices on prescriptions dispensed to Medicaid 
recipients. Payment amounts are based on formulas developed by the 
state using Federal guidelines. Here are some of our perspectives on 
this issue:

 Considering Margins Based on Percentages is Misleading: First, the 
        perceptions about these so-called ``excessive markups'' are 
        fueled by the use of ``percentages'' to express the ``markup'' 
        that the pharmacy retains on generic drugs, rather than 
        considering the absolute dollar margin involved. Using 
        percentages unfairly make the payments made by Medicaid look 
        excessive. For example, if a state paid a pharmacy $5 for a 
        generic that cost the pharmacy $1 to purchase, the markup would 
        be only $4, yet the percentage markup would be 500%. In 
        contrast, if the state paid the pharmacy $110 for a brand name 
        drug that cost the pharmacy $100, the markup would only be 10%, 
        but the absolute difference would be $10, greater than the 400% 
        markup on the lower-cost product.
 Generic Dispensing Incentives are Necessary and Appropriate: Because 
        the drug product cost for a generic prescription is lower than 
        a brand, policy makers should be sure that the gross margin 
        made by the pharmacy on a generic prescription is equal to or 
        greater than that made on a brand. Otherwise, the pharmacy may 
        be economically indifferent as to whether a brand or generic is 
        dispensed because the pharmacy would make the same gross margin 
        revenue regardless of the product dispensed. It matters to 
        Medicaid because the state saves close to $45 each time a 
        generic equivalent is dispensed for an off-patent brand.
 Many Generics are Dispensed at a Loss: In 2004, twelve of the top 25 
        generic prescription medications paid for by Medicaid were 
        reimbursed at an average of less than $8 per prescription. With 
        a pharmacy's average cost to dispense a prescription estimated 
        to be around $9.45 per prescription, pharmacies are losing 
        money each time they dispense one of these medications to a 
        Medicaid recipient. These prescription reimbursement losses are 
        offset by other prescriptions where the reimbursement may be 
        higher than the pharmacy's overall costs to dispense.
    If this current system based on ``averages'' were to change, 
fundamental changes in other parts of the system would also be 
necessary--such as substantial increases in pharmacy dispensing fees--
to assure that pharmacies are adequately reimbursed and that they are 
still able to provide pharmacy services to Medicaid recipients.
    We are also appending to this statement a letter than NACDS sent to 
the Congressional Budget Office (CBO) last year that raised issues and 
concerns with a paper that examined Medicaid reimbursement 
policies.3 We believe that the paper overlooked many 
important factors about the current Medicaid pharmacy reimbursement 
system, and was overly critical of the payments made to pharmacies for 
generic drugs. We urge that policymakers read the NACDS response to the 
paper.
---------------------------------------------------------------------------
    \3\ Medicaid Reimbursements to Pharmacies for Prescription Drugs: 
CBO, December 2004.
---------------------------------------------------------------------------
         III. MEDICAID PRESCRIPTION DRUG PAYMENT REFORM OPTIONS

    With that background regarding the current Medicaid pharmacy 
reimbursement system, it is now important to consider the implications 
of various other alternatives to AWP (Average Wholesale Price) to 
reimburse pharmacies under Medicaid. These alternatives include ASP 
(Average Sales Price), AMP (Average Manufacturers Price), and WAC 
(Wholesale Acquisition Cost).
A. Use of Average Sales Price (ASP) as Medicaid Prescription Drug 
        Payment Option
    To achieve some of its Federal budget savings targets for the next 
5 years, the Administration has proposed using ASP, rather than AWP to 
reimburse pharmacies for Medicaid prescriptions. In fact, unlike most 
states that reimburse pharmacies for both the cost of the prescription 
drug and a reasonable dispensing fee, the administration proposes to 
reimburse pharmacies ASP plus 6 percent for drug and dispensing costs. 
This proposal would generate $5.2 billion in Federal savings over the 
next 5 years, or a combined savings of $9.2 Federal and state savings. 
This amount represents almost 23 percent of pharmacy's Medicaid gross 
margins over this time period, a significant reduction by any measure.
    Policymakers should understand that all of the savings under this 
policy would be achieved at the expense of pharmacists. None of the 
savings would come from reducing the pharmacy's costs of prescription 
drugs, which account for 80 percent of the program's total costs, 
because pharmacies have no upstream leverage with brand name 
manufacturers. We cannot force brand name drug manufacturers to lower 
their charges to us for the cost of goods.
    Reducing pharmacy Medicaid gross margin prescription revenues by 23 
percent could result in significant access problems for Medicaid 
recipients, as pharmacies may have to reduce hours or close stores in 
response to this significant loss of gross margin revenues. ASP has 
other problems as well, which are described below.

 ASP Does Not Represent Prices at Which Retail Pharmacies Purchase 
        Drugs: ASP is calculated as a ``weighted average sales price'' 
        across all payors (except direct Federal sales) for a 
        particular pharmaceutical, net of various discounts and rebates 
        given by the manufacturer to the purchaser. However, retail 
        pharmacies are generally charged higher prices than other 
        pharmaceutical purchasers, and don't have access to the same 
        discounts, rebates, and price concessions of other purchasers. 
        This would mean that pharmacies would buy drugs at a higher 
        price than they would be reimbursed under ASP.
 ASP does not Account for Other Costs to Pharmacies: There are other 
        costs involved in getting the drug to the pharmacy that ASP 
        does not account for, such as the pharmacy's costs to manage an 
        inventory, the costs of getting the drug to the local pharmacy 
        site, and the costs of complying with state and Federal 
        pharmaceutical regulations. Even adding a markup factor to the 
        ASP amount (e.g. ASP +6 percent) may not make a pharmacy whole 
        just for acquiring the drug, no less the costs of storing, 
        inventory, warehousing, and distribution of the drug. This 
        could force participating pharmacies to provide these products 
        at a loss, and create potential access problems for Medicaid 
        recipients.
 ASP is Not Based on Current Market Prices: ASP is an outdated price, 
        since it is calculated on data that is two calendar quarters 
        old. Thus, it would not reflect the current prices at which 
        retail pharmacies are purchasing prescription drugs. If ASP had 
        been in effect on January 1, 2005 for Medicaid, community 
        retail pharmacies would have been significantly disadvantaged 
        in terms of Medicaid reimbursement for brand name drugs. That 
        is because many brand name manufacturers increased prices in 
        excess of 6 percent at the beginning of the year. Because the 
        first quarter 2005 ASP rates would have been based on third 
        quarter 2004 (July-September) sales data reported by the 
        manufacturers, retail pharmacies would have to absorb any price 
        increases after September 2004, the end of the third quarter 
        2004, all the way through March 2005.
 ASP Proposal Does Not Envision Higher Medicaid Pharmacy Dispensing 
        Fees: The President's budget proposal does not include 
        additional funds for pharmacy dispensing fees that would 
        compensate for reductions in payment for drug products 
        resulting from the new ASP methodology. Medicare Part B moved 
        in January to an ASP plus 6 percent reimbursement for the few 
        oral drugs covered by Medicare Part B, but CMS is paying a 
        supplying fee of $24 per prescription. This was because CMS 
        recognized that the move to an ASP-based system requires a 
        significant increase in the pharmacy's dispensing fee, or 
        Medicare beneficiaries would have a hard time finding a retail 
        pharmacy that would fill their Part B prescriptions.
 ASP Does Not Encourage Generic Dispensing: Retail pharmacies are not 
        given incentives to dispense lower-cost generics under an ASP-
        based system. Because generics have a lower cost basis that 
        brand name drugs, an ASP-based system gives pharmacies 
        incentives to dispense brands because they would make more 
        money under an ASP plus 6% system for brands than generics 
        (i.e. 6% of a $100 brand is $6, but 6% of a $20.00 generic is 
        only $1.20).
    We are encouraged that some members of Congress and other 
policymakers are recognizing that the use of ASP as an alternative 
reimbursement metric to the current formula may create more issues than 
it solves.
B. Use of Average Manufacturers Price (AMP) as Medicaid Prescription 
        Drug Payment Option
    The use of ``Average Manufacturers Price'' (AMP) as a potential 
Medicaid payment or reimbursement option has similar problems to the 
use of ASP. AMP is defined as the average price paid to manufacturers 
by wholesalers for drugs distributed to the retail class of trade. AMP 
was created in OBRA 90 for the purpose of calculating the Medicaid drug 
rebates paid by manufacturers to states. However, there are several 
problems that exist with the use of AMP as a reimbursement metric.

 AMP Reflects Manufacturer's Sales, Not Pharmacy's Purchasing Costs: 
        Like ASP, AMP is a measure of a manufacturer's revenue for a 
        particular drug in a particular calendar quarter, and does not 
        represent the prices at which retail pharmacies purchase drugs 
        from wholesalers, or reflect the costs that pharmacies incur in 
        purchasing and maintaining a pharmaceutical inventory. Thus, to 
        approximate a pharmacy's acquisition costs for Medicaid drugs, 
        AMP would have to be increased by a significant percentage.
 AMP Does Not Account for Manufacturers' Price Increases: If AMP had 
        been in effect on January 1, 2005 for Medicaid, community 
        retail pharmacies would have been significantly disadvantaged 
        regarding Medicaid reimbursement for brand name drugs because 
        many brand name manufacturers increased prices in excess of 6 
        percent at the beginning of the year. Because the first quarter 
        2005 AMP rates would have been based on third quarter 2004 
        (July-September) sales data reported by the manufacturers, 
        retail pharmacies would have to absorb any price increases 
        after September 2004, the end of the third quarter 2004, all 
        the way through March 2005.
 AMP includes Mail Order Sales: Unlike ASP, AMP is calculated for the 
        retail class of trade only; however, like ASP, AMP is a 
        retrospectively determined price and can be up to six months 
        outdated. AMP includes both sales to retail pharmacies and mail 
        order pharmacies, and retail pharmacies do not have access to 
        the same discounts and rebates that mail order pharmacies do. 
        As a result, using AMP may mean that retail pharmacies will be 
        underpaid for Medicaid prescriptions because the reimbursement 
        will be calculated off a ``blended'' base, including mail order 
        sales. This would mean that the AMP basis used to reimburse 
        pharmacies would be lower than if just true retail community 
        pharmacy sales had been used to calculate AMP.
 Significant Variation Exists in AMP Calculations: Many government 
        reports, including a recent report from the GAO, indicate that 
        there is wide variation among the manufacturing community in 
        calculating AMP. Final rules have never been published by CMS 
        regarding the exact methodology that manufacturers should use 
        in calculating the AMP values for their drug products. 
        Therefore, in some cases, manufacturers may be calculating an 
        AMP value that would underpay pharmacies for Medicaid 
        prescriptions. Guidelines should be published that help 
        manufacturers better understand how to calculate AMP so the 
        rebate payments they make to states are accurate.
 AMP Discourages Generic Dispensing: Like ASP, using AMP would 
        discourage the use of generics. Because generics have a lower 
        cost basis than brand name drugs, an AMP-based system gives 
        pharmacies incentives to dispense brands because they would 
        make more money under an AMP plus 6 percent system for brands 
        than generics (i.e. 6 % of a $100 brand is $6, while 6% of a 
        $20.00 generic is $1.20). An AMP system does not encourage 
        pharmacies to dispense generic drugs. Moreover, in some 
        calendar quarters, the AMP for a particular generic might be a 
        negative number. That can happen if the manufacturer's 
        discounts and rebates for a given year were paid out 
        disproportionately in a particular calendar quarter. It would 
        be difficult to base a reimbursement amount to pharmacies on a 
        negative number.
C. Retail Pharmacy Encourages WAC-Based Reimbursement for Brand Drugs
    NACDS has developed an alternative payment method for Medicaid 
prescription drugs that is transparent and reliable, reflects current, 
real-time prices that pharmacies pay for prescription medications, and 
will be fair to pharmacy and Medicaid. This new model will meet or 
exceed the Administration's cost-cutting goal by encouraging dispensing 
of lower-cost generic drugs.
    Brand Name Drugs: Unlike ASP or AMP, wholesale acquisition cost, 
known as WAC, is a published, transparent, real-time price that 
reflects the prices at which wholesalers buy from manufacturers the 
brand name drugs that they sell to independent and chain operated 
pharmacies.
    The actual amount paid to pharmacies by Medicaid, however, should 
be some percentage markup on WAC (i.e., WAC plus a percentage) because 
WAC represents the wholesaler's costs to buy the drugs. Retail 
pharmacies have additional costs of acquiring drugs from wholesalers or 
manufacturers, such as overhead in maintaining a costly pharmaceutical 
inventory, delivering the drugs to their stores or warehouses, and 
complying with state and Federal regulations, such as board of pharmacy 
and DEA requirements. We believe that ``WAC plus a percentage'' would 
be an appropriate substitute for AWP, ASP, or AMP in determining 
reimbursement for brand name drugs.
    Generic Drugs: The CMS Federal Upper Limit (FUL) list has been an 
effective tool in saving Medicaid money on generic drugs. Several 
hundred generic products currently have a FUL. States can vary these 
FUL rates consistent with local market conditions, but Medicaid will 
pay states no more than the FUL amounts for this market basket of 
generic drugs with FULs. NACDS has worked closely with CMS over the 
past several years to make the FUL list more effective in terms of 
assuring that Medicaid pays a fair price for generics, but also that 
the generic reimbursements simultaneously encourage pharmacies to 
dispense generic drugs.
    In lieu of WAC, ASP or AMP for multiple source generics, we believe 
that policymakers should retain the use of this type of list for 
generic drug reimbursement under Medicaid. However, we encourage that 
certain changes be made to the way that the list is developed. By using 
a FUL list or a minimum ``federal generic reimbursement level'' (FGRL) 
for all versions of a particular generic, Medicaid assures that 
pharmacies have an incentive to buy the lowest cost generic available.
    This FGRL would be set at a percentage of the median or other 
market prices for the generic sufficient to encourage generic 
dispensing. This approach would allow pharmacies to retain some of the 
difference between the cost of that generic and the FGRL. This creates 
incentives for pharmacies to dispense generics.
    Payment of Adequate Dispensing Fees: NACDS believes that any 
Medicaid payment reform system that seeks to pay pharmacies closer to 
their acquisition costs for prescription drugs should pay a higher 
dispensing fee than currently paid by states. In our view, payment for 
the drug product plus the dispensing fee must be considered in tandem 
in order to determine whether reimbursement is adequate. Moreover, we 
strongly urge that a minimum state Medicaid pharmacy dispensing fee be 
determined at the Federal level, with provisions made for annual 
updates. We also urge that states be allowed to increase the fee to 
account for local concerns, such as assuring adequate access to 
pharmacy services in rural areas.
    The Center for Pharmacoeconomic Studies at the University of Texas 
at Austin recently conducted a survey of national and regional chain 
pharmacies to estimate the current costs related to dispensing a 
medication within those stores. Confidential operational and financial 
data from the most recent corporate fiscal year was provided to the 
Center by 40 separate pharmacies representing five geographically-
diverse chain pharmacy companies.
    The data were collected using a modified survey instrument based 
upon a financial reporting format that has been used within community 
pharmacy for well over 20 years. The particular sample used for the 
analysis was comprised of both high and low-volume Medicaid dispensing 
pharmacies across the country, representing 13 different states. This 
sampling method begins to provide us with a description of the broad 
range of the costs involved in dispensing prescriptions within a chain 
pharmacy.
    Overall, the statistical range of costs of dispensing fell between 
$8.50 and $10.41 per prescription, with the average within this 
particular sample being $9.45 per prescription. Given that current 
payments for dispensing fees fall well below this estimate, the results 
from this preliminary analysis confirm that more widespread studies are 
needed to estimate the actual costs of dispensing medications to 
patients. However, policymakers should consider these findings as any 
payment system reform proceeds forward, as well as provide for annual 
updates to the dispensing fees to keep pace with increasing costs to 
operate a pharmacy, especially pharmacy labor costs.

                             IV. CONCLUSION

    Mr. Chairman, we look forward to working with you and the Members 
of the Subcommittee to make sure that the Medicaid prescription drug 
payment system is reliable, transparent, and reflects the current 
market prices that retail pharmacies pay for prescription drugs. We 
want to assure that the system encourages generic dispensing, as well 
as continues to make pharmacy services available to Medicaid recipients 
in their communities. This is especially important in urban and rural 
areas where many Medicaid recipients live.
    We also want to work with you to make the Medicaid program in 
general, and the drug program in particular, financially sustainable in 
the long run. Over 50 million Americans rely on Medicaid for health 
care services. Drug coverage is an important part of these needed 
health care services. Pharmacists can be partners with the Federal 
Medicaid program and the states in trying to deliver the most cost-
effective drug benefit possible. We appreciate your considering these 
views as you move forward with these efforts.

    Mr. Deal. Thank you.
    Ms. King.

                   STATEMENT OF KATHLEEN KING

    Ms. King. Mr. Chairman and members of the subcommittee, 
thank you for inviting me to be here today to discuss GAO's 
report on the Medicaid Prescription Drug Rebate Program. The 
hour is late, and I am going to try to be very brief.
    There has been a lot of talk here today about how Medicaid 
reimbursement is based on the AWP, but I want to talk for a 
moment on how the rebate is calculated. It is calculated as the 
difference between the best price, which is defined as the 
lowest price to any manufacturer, and the AMP, the average 
manufacturer price, which we have talked about today, which is 
the lowest price--I am sorry, the average price paid to a 
manufacturer by wholesalers for drugs distributed to the retail 
pharmacy class of trade. So the rebate is calculated as the 
difference between those two, or 15.1 percent, whichever is 
greater.
    The Drug Rebate Program is administered by CMS. And we were 
asked to conduct a study on that, and we focused mostly on the 
oversight of the program, and we had three basic findings. One, 
we found that CMS's oversight does not ensure that the 
manufacturer-reported prices of drugs or the price 
determinations that are set are consistent with the rebate 
wall, the agreement entered into with manufacturers, or the 
guidance developed by CMS.
    In administering the program, we found that CMS conducted 
only limited checks for reporting errors in the prices that 
manufacturers reported. And in addition, CMS only reviews the 
manufacturers' price determination methods when they ask for 
recalculations of prior rebates. The OIG, the Office of the 
Inspector General, has also issued a number of reports on the 
rebate program. They identified a number of factors that 
limited their ability to verify the accuracy of drug prices, 
including a lack of clear guidance by CMS on how the AMP should 
be calculated. In some cases, the OIG also found problems with 
manufacturers' price determination methods and reported prices. 
We found that CMS had not followed up with manufacturers to 
make sure that the problems identified by the OIG had been 
resolved.
    Our second finding is that we found considerable variation 
in the methods that manufacturers use to determine the best 
price and the AMP. And I should tell you that under the law, 
manufacturers are allowed to make certain assumptions, 
differing assumptions when determining the best price in the 
AMP. We found that manufacturers made varying assumptions about 
which sales and prices to include and exclude from their 
calculations and that manufacturers differed in how they 
accounted for certain price reductions, fees, and other 
transactions in determining the best price in the AMP. In some 
cases, the manufacturers' assumptions could have lowered 
rebates and in some cases, they could have raised the rebates.
    Our third finding is that the rebates that the 
manufacturers paid to States may not reflect certain financial 
concessions that operate in today's complex market. For 
example, the role of pharmacy benefit managers, which was not 
envisioned to the same extent in 1990 when the rebate law was 
passed. The guidance that CMS has provided does not clearly 
identify how the PBMs have to deal with price concessions.
    As a result of our report, we made two recommendations.
    The first is that we recommended that CMS issue clear 
guidance on how manufacturers should determine their prices and 
the definitions of the best price in the AMP. And we also have 
recommended they update this guidance as additional issues 
arise. This is important in a market that is changing quickly.
    Our second recommendation is that CMS implement, in 
consultation with the OIG, systematic oversight of the price 
determination methods employed by pharmaceutical manufacturers 
and a plan to ensure the accuracy of the prices that 
manufacturers report. HHS agreed with us on the importance of 
guidance to manufacturers but disagreed with our conclusion 
that they had exercised inadequate oversight.
    This concludes my prepared statement. Thank you.
    [The prepared statement of Kathleen King follows:]

  Prepared Statement of Kathleen King, Director, Health Care, United 
                States Government Accountability Office

    Mr. Chairman and Members of the Subcommittee: I am pleased to be 
here today to discuss our report entitled Medicaid Drug Rebate Program: 
Inadequate Oversight Raises Concerns about Rebates Paid to States, 
which we issued in February 2005.1 Prescription drug 
spending accounts for a substantial and growing share of state Medicaid 
program outlays. The Omnibus Budget Reconciliation Act of 1990 
established the Medicaid drug rebate program 2 to help 
control Medicaid drug spending. Under the rebate program, 
pharmaceutical manufacturers pay rebates to states as a condition for 
the federal contribution to Medicaid spending for the manufacturers' 
outpatient prescription drugs. In recent years, the importance of 
Medicaid rebates to states has grown as Medicaid spending on 
prescription drugs has risen. From fiscal year 2000 to 2003, Medicaid 
drug spending increased at an annual average rate of 18 percent, while 
Medicaid spending as a whole grew 10 percent annually during that 
period. In fiscal year 2003, Medicaid drug expenditures were $33.8 
billion out of $273.6 billion in total Medicaid spending; under the 
rebate program, manufacturers paid rebates to states of about $6.5 
billion for covered outpatient 
drugs.3,4
---------------------------------------------------------------------------
    \1\ See GAO, Medicaid Drug Rebate Program: Inadequate Oversight 
Raises Concerns about Rebates Paid to States, GAO05102 (Washington, 
D.C.: Feb. 4, 2005).
    \2\ Pub. L. No. 101-508,  4401, 104 Stat. 1388, 1388-143-161 
(codified at 42 U.S.C.  1396r-8 (2000)). All states and the District 
of Columbia participate in the Medicaid drug rebate program, except for 
Arizona.
    \3\ State Medicaid programs do not purchase drugs directly but 
rather reimburse pharmacies when they dispense covered outpatient drugs 
to Medicaid beneficiaries. These payments, which include an amount to 
cover the cost of acquiring the drug as well as a dispensing fee, are 
calculated using state-specific payment formulas.
    \4\ This rebate amount includes the three types of rebates included 
in the Medicaid drug rebate program: the ``basic'' rebate for brand 
name drugs, the ``additional'' rebate for brand name drugs, and the 
rebate for generic drugs.
---------------------------------------------------------------------------
    Medicaid rebates for brand name outpatient drugs are calculated 
with two prices that participating manufacturers must report to the 
federal government for each drug: the ``best price'' and the ``average 
manufacturer price'' (AMP). Best price and AMP represent prices that 
are available from manufacturers to entities that purchase their drugs. 
Best price for a drug is the lowest price available from the 
manufacturer to any purchaser, with some exceptions. AMP for a drug is 
the average price paid to a manufacturer by wholesalers for drugs 
distributed to the retail pharmacy class of trade. Both best price and 
AMP must reflect certain financial concessions, such as discounts, that 
are available to drug purchasers. The basic Medicaid rebate for a brand 
name drug equals the number of units of the drug paid for by the state 
Medicaid program multiplied by the basic ``unit rebate amount'' for the 
drug, which is either the difference between best price and AMP, or 
15.1 percent of AMP, whichever is greater.5 The closer best 
price is to AMP, the more likely the rebate will be based on 15.1 
percent of AMP--the minimum rebate amount.
---------------------------------------------------------------------------
    \5\ This testimony focuses on the basic rebate for brand name 
drugs, not the additional rebate for brand name drugs--which occurs 
when a brand name drug's AMP rises faster than inflation, as measured 
by changes in the consumer price index--or the rebate for generics. The 
total unit rebate amount for a brand name drug includes the basic 
rebate and any additional rebate.
---------------------------------------------------------------------------
    The Centers for Medicare & Medicaid Services (CMS) administers and 
oversees the rebate program, entering into rebate agreements with 
manufacturers,6 collecting and reviewing manufacturer-
reported best prices and AMPs, and providing ongoing guidance to 
manufacturers and states on the program. The Secretary of Health and 
Human Services, by law, may verify manufacturer-reported prices and has 
delegated that authority to the Department of Health and Human 
Services' (HHS) Office of Inspector General (OIG).
---------------------------------------------------------------------------
    \6\ The rebate agreement is a standard contract between CMS and 
each manufacturer that governs manufacturers' participation in the 
rebate program, providing, among other things, definitions of key 
terms.
---------------------------------------------------------------------------
    In this testimony, I will discuss our February 2005 report, in 
which we addressed (1) federal oversight of manufacturer-reported best 
prices and AMPs and the methods manufacturers used to determine those 
prices, (2) how manufacturers' methods of determining best price and 
AMP could have affected the rebates they paid to state Medicaid 
programs, and (3) how the rebate program reflects financial concessions 
available in the private market.
    In carrying out our work, we reviewed the rebate statute, the 
standard rebate agreement between CMS and participating manufacturers, 
CMS program memoranda, OIG reports on the rebate program, and market 
literature; interviewed officials from CMS and OIG; and conducted an 
analysis of rebates for brand name drugs, for which we reviewed the 
pricing methodologies for the 13 manufacturers that accounted for the 
highest Medicaid expenditures in the last two quarters of 2000. We 
compared manufacturers' methods of determining best price and AMP to 
the rebate statute, rebate agreement, and relevant CMS program 
memoranda. In addition, we examined sales transaction data provided by 
these manufacturers. We received data for the 10 brand name drugs that 
produced the highest Medicaid expenditures for the last two quarters of 
2000 for each manufacturer, as well as data for 5 additional frequently 
prescribed brand name drugs--135 drugs in total. We examined the sales 
transaction data to understand how manufacturers implemented their 
price determination methods and to calculate the impact of manufacturer 
practices on rebates. Because we purposely selected manufacturers and 
drugs that accounted for a large share of Medicaid drug spending, the 
results of our analysis cannot be generalized. We performed our work 
from December 2003 through January 2005 in accordance with generally 
accepted government auditing standards.
    In brief, we reported in February 2005 that rebate program 
oversight does not ensure that manufacturer-reported prices or price 
determination methods are consistent with program criteria as specified 
in the rebate statute, rebate agreement, and CMS program memoranda. We 
found that CMS conducts only limited checks for reporting errors in 
manufacturer-reported drug prices and only reviews price determination 
methods when manufacturers request recalculations of prior rebates. In 
addition, OIG reported that its review efforts were hampered by unclear 
CMS guidance on how manufacturers are to determine AMP and by a lack of 
manufacturer documentation. Although OIG in some cases identified 
problems with manufacturers' price determination methods and reported 
prices, CMS had not followed up with manufacturers to make sure that 
those problems had been resolved. We also found considerable variation 
in the methods that the manufacturers we reviewed used to determine 
best price and AMP. In some cases, manufacturers' assumptions could 
have lowered rebates; in other cases, their assumptions could have 
raised rebates. Manufacturers are allowed to make reasonable 
assumptions when determining best price and AMP, as long as those 
assumptions are consistent with the law and the rebate agreement. We 
found that manufacturers made varying assumptions about which sales and 
prices to include and exclude from their determinations of best price 
and AMP. We also found that manufacturers differed in how they 
accounted for certain price reductions, fees, and other transactions 
when determining best price and AMP. Finally, we found that the rebates 
that manufacturers pay to states are based on prices and financial 
concessions that manufacturers make available to entities that purchase 
their drugs but may not reflect certain financial concessions they 
offer to other entities in today's complex market. In particular, the 
rebate program does not clearly address certain concessions that are 
negotiated by pharmacy benefit managers (PBM) on behalf of third-party 
payers--concessions that are a relatively new development in the 
market.
    We concluded that although the rebate program relies on 
manufacturer-reported prices to determine the level of rebates that 
manufacturers pay to states, CMS has not provided clear program 
guidance for manufacturers to follow when determining those prices; in 
addition, oversight by CMS and OIG has been inadequate to ensure that 
manufacturer-reported prices and methods are consistent with the law, 
rebate agreement, and CMS program memoranda. We recommended that CMS 
take several steps to improve program guidance and oversight, namely, 
to issue clear guidance on manufacturer price determination methods and 
the definitions of best price and AMP; update such guidance as 
additional issues arise; and implement, in consultation with OIG, 
systematic oversight of the price determination methods employed by 
pharmaceutical manufacturers and a plan to ensure the accuracy of 
manufacturer-reported prices and rebates to states. HHS agreed with the 
importance of guidance to manufacturers, but disagreed with our 
conclusion that there has been inadequate program oversight. We 
acknowledged HHS's oversight actions, but stated that HHS oversight 
does not adequately ensure the accuracy of manufacturer-reported prices 
and rebates paid to states. Some of the manufacturers that supplied 
data for the report raised concerns about our discussion of certain 
methods they used to determine rebates, and we clarified our discussion 
of manufacturers' price determination methods.

                               BACKGROUND

    The Medicaid drug rebate program provides savings to state Medicaid 
programs through rebates for outpatient prescription drugs that are 
based on two prices per drug that manufacturers report to CMS: best 
price and AMP. These manufacturer-reported prices are based on the 
prices that manufacturers receive for their drugs in the private market 
and are required to reflect certain financial concessions such as 
discounts.
    Pharmaceutical manufacturers sell their products directly to a 
variety of purchasers, including wholesalers, retailers such as chain 
pharmacies, and health care providers such as hospitals that dispense 
drugs directly to patients. The prices that manufacturers charge vary 
across purchasers. The amount a manufacturer actually realizes for a 
drug is not always the same as the price that is paid to the 
manufacturer at the time of sale. Manufacturers may offer purchasers 
rebates or discounts that may be realized after the initial sale, such 
as those based on the volume of drugs the purchasers buy during a 
specified period or the timeliness of their payment. The private market 
also includes PBMs, which manage prescription drug benefits for third-
party payers and may also operate mail-order pharmacies.7
---------------------------------------------------------------------------
    \7\ See GAO, Federal Employees' Health Benefits: Effects of Using 
Pharmacy Benefit Managers on Health Plans, Enrollees, and Pharmacies, 
GAO03196 (Washington, D.C.: Jan. 10, 2003).
---------------------------------------------------------------------------
    The statute governing the Medicaid drug rebate program and the 
standard rebate agreement that CMS signs with each manufacturer define 
best price and AMP and specify how those prices are to be used to 
determine the rebates due to states. In the absence of program 
regulations,8 CMS has issued program memoranda 9 
in order to provide further guidance to manufacturers regarding how to 
determine best price and AMP.10 The rebate agreement states 
that in the absence of specific guidance on the determination of best 
price and AMP, manufacturers may make ``reasonable assumptions'' as 
long as those assumptions are consistent with the ``intent'' of the 
law, regulations, and the rebate agreement.11 As a result, 
price determination methods may vary across manufacturers, particularly 
with respect to which transactions they consider when determining best 
price and AMP.
---------------------------------------------------------------------------
    \8\ In 1995, CMS issued a proposed rule for implementation of the 
drug rebate program, which included provisions regarding best price, 
AMP, and manufacturer reporting requirements. See 60 Fed. Reg. 48442 
(1995). Only a portion of that rule--concerning the length of time 
manufacturers are able to report price adjustments to CMS and how long 
they must retain documentation of their reported prices--has been 
issued in final form. See 69 Fed. Reg. 68815 (2004), 68 Fed. Reg. 51912 
(2003).
    \9\ As of October 2004, CMS had issued a total of 65 program 
memoranda--also called ``program releases''--to manufacturers to 
provide guidance on a range of issues relating to the rebate program.
    \10\ CMS also responds to questions from individual manufacturers 
on a case-by-case basis. In addition, the agency provides an 
operational training guide and training for manufacturers and states on 
resolving disputes over state-reported drug utilization information 
used to calculate rebate amounts.
    \11\ The rebate agreement also requires manufacturers to maintain 
records of their assumptions.
---------------------------------------------------------------------------
    Under the rebate statute, best price is the lowest price available 
from the manufacturer to any wholesaler, retailer, provider, health 
maintenance organization (HMO), or nonprofit or government entity, with 
some exceptions.12 Best price is required to be reduced to 
account for cash discounts, free goods that are contingent on purchase 
requirements, volume discounts and rebates (other than rebates under 
this program), as well as--according to the rebate agreement and a CMS 
program memorandum--cumulative discounts and any other arrangements 
that subsequently adjust the price actually realized. Prices charged to 
certain federal purchasers,13 eligible state pharmaceutical 
assistance programs and state-run nursing homes for veterans, and 
certain health care facilities--including those in underserved areas or 
serving poorer populations--are not considered when determining best 
price. Prices available under endorsed Medicare discount card programs, 
as well as those negotiated by Medicare prescription drug plans or 
certain retiree prescription drug plans, are similarly excluded from 
best price. Nominal prices--prices that are less than 10 percent of 
AMP--also are excluded from best price.
---------------------------------------------------------------------------
    \12\ See 42 U.S.C.  1396r-8(c)(1)(C). The rebate agreement further 
defines best price as the lowest price at which the manufacturer sells 
the drug to any purchaser in any pricing structure, including capitated 
payments, with some exceptions.
    \13\ Sales made through the Federal Supply Schedule are not 
considered in determining best price, nor are single-award contract 
prices of any federal agency, federal depot prices, and prices charged 
to the Department of Defense, Department of Veterans Affairs, Indian 
Health Service, and Public Health Service.
---------------------------------------------------------------------------
    AMP is defined by statute as the average price paid to a 
manufacturer for the drug by wholesalers for drugs distributed to the 
retail pharmacy class of trade.14 The transactions used to 
calculate AMP are to reflect cash discounts and other reductions in the 
actual price paid, as well as any other price adjustments that affect 
the price actually realized, according to the rebate agreement and a 
CMS program memorandum.15 Under the rebate agreement, AMP 
does not include prices to government purchasers based on the Federal 
Supply Schedule, prices from direct sales to hospitals or HMOs, or 
prices to wholesalers when they relabel drugs they purchase under their 
own label.
---------------------------------------------------------------------------
    \14\ See 42 U.S.C.  1396r-8(k)(1). The statute states that 
customary prompt payment discounts are to be subtracted from prices 
used to calculate AMP. There is no definition in the statute for 
``retail pharmacy class of trade.''
    \15\ Under the rebate agreement, AMP is calculated as net sales 
divided by units sold, excluding free goods (i.e., drugs or any other 
items given away, but not contingent on any purchase requirements).
---------------------------------------------------------------------------
    The relationship between best price and AMP determines the unit 
rebate amount and thus the size of the rebate that states receive for a 
brand name drug. The basic unit rebate amount is the larger of two 
values: the difference between best price and AMP, or 15.1 percent of 
AMP.16 The closer best price is to AMP, the more likely the 
rebate for a drug will be based on the minimum amount--15.1 percent of 
AMP--rather than the difference between the two values. A state's 
rebate for a drug is the product of the unit rebate amount and the 
number of units of the drug paid for by the state's Medicaid program.
---------------------------------------------------------------------------
    \16\ See 42 U.S.C.  1396r-8(c)(1).
---------------------------------------------------------------------------
    Manufacturers pay rebates to states on a quarterly basis. They are 
required to report best price and AMP for each drug to CMS within 30 
days of the end of each calendar quarter. Once CMS receives this 
information, the agency uses the rebate formula to calculate the unit 
rebate amount for the smallest unit of each drug, such as a tablet, 
capsule, or ounce of liquid. CMS then provides the unit rebate amount 
to the states. Each state determines its Medicaid utilization for each 
covered drug--as measured by the total number of the smallest units of 
each dosage form, strength, and package size the state paid for in the 
quarter--and reports this information to the manufacturer within 60 
days of the end of the quarter. The manufacturer then must compute and 
pay the rebate amount to each state within 30 days of receiving the 
utilization information.
    Manufacturers are required to report price adjustments to CMS when 
there is a change in the prices they reported for a prior quarter. 
These adjustments may result from rebates, discounts, or other price 
changes that occur after the manufacturers submit prices to CMS. 
Manufacturers also may request that CMS recalculate the unit rebate 
amounts using revised prices if they determine that their initially 
reported prices were incorrect because of, for example, improper 
inclusion or exclusion of certain transactions. In 2003, CMS issued a 
final rule that, effective January 1, 2004, limits the time for 
manufacturers to report any price adjustments to 3 years after the 
quarter for which the original price was reported.17
---------------------------------------------------------------------------
    \17\ The 2003 final rule addressed the time frame for reporting 
price adjustments to CMS and the time frame for retaining documentation 
of reported prices. See 68 Fed. Reg. 51912, 55527 (2003).
---------------------------------------------------------------------------
PROGRAM OVERSIGHT DOES NOT ENSURE THAT MANUFACTURER-REPORTED PRICES OR 
    PRICE DETERMINATION METHODS ARE CONSISTENT WITH PROGRAM CRITERIA

    As we reported in February 2005, the minimal oversight by CMS and 
OIG of manufacturer-reported prices and price determination methods 
does not ensure that those prices or methods are consistent with 
program criteria, as specified in the rebate statute, rebate agreement, 
and CMS program memoranda. CMS conducts limited reviews of prices and 
only reviews price determination methods when manufacturers request 
recalculations of prior rebates. In addition, OIG reported that its 
review efforts had been hampered by unclear CMS guidance on how to 
determine AMP and by a lack of manufacturer documentation. Although OIG 
in some cases identified problems with manufacturers' price 
determination methods and reported prices, CMS had not followed up with 
manufacturers to make sure that those problems were resolved.
    CMS reviews drug prices submitted by approximately 550 
manufacturers that participate in the program. Each quarter, CMS 
conducts automated data edit checks on the best prices and AMPs for 
about 25,000 drugs to identify reporting errors. These checks are 
intended to allow CMS to ensure that, for example, prices are submitted 
in the correct format and that the reported prices are for drugs 
covered by Medicaid. When data checks indicate a potential reporting 
error, CMS asks the manufacturer for corrected drug prices, but CMS 
does not have a mechanism in place to track whether the manufacturer 
submits corrected prices. CMS sometimes identifies other price 
reporting errors when it calculates the unit rebate amount for a drug, 
but the agency does not follow up with manufacturers to verify that 
errors have been corrected. For example, CMS notifies a manufacturer if 
the unit rebate amount for a drug deviates from that of the prior 
quarter by more than 50 percent. It would be up to that manufacturer to 
indicate whether the underlying reported prices were correct. If the 
manufacturer determined that there were problems with the reported 
price--for example, typographical errors such as misplaced decimals--it 
would send corrected data to CMS.18 If the manufacturer did 
not send revised pricing data to CMS, then the unit rebate amount would 
remain the same.
---------------------------------------------------------------------------
    \18\ In this situation, the manufacturer also would recalculate the 
unit rebate amount and, once invoiced by the states with total 
utilization for the drug paid for by Medicaid, would send the rebate 
payment to those states based on the recalculated unit rebate amount.
---------------------------------------------------------------------------
    CMS does not generally review the methods and underlying 
assumptions that manufacturers use to determine best price and AMP, 
even though these methods and assumptions can have a substantial effect 
on rebates. Furthermore, CMS does not generally check to ensure that 
manufacturers' methods are consistent with the rebate statute and 
rebate agreement, but rather reviews the methods only when 
manufacturers request recalculations of prior rebates. A manufacturer 
may request a recalculation of a prior rebate any time it changes the 
methods it uses to determine best price or AMP. CMS requires the 
manufacturer to submit both its original and its revised methods when 
requesting a recalculation of prior rebates so that the agency can 
evaluate whether the revised methods are consistent with the rebate 
statute, rebate agreement, and program memoranda. Recalculations can 
involve substantial amounts of money; for example, six approved 
recalculations we examined reduced prior rebates to states by a total 
of more than $220 million.
    In reports on its audits of manufacturer-reported prices, OIG 
stated that its efforts were hampered by unclear CMS guidance on 
determining AMP and by a lack of manufacturer documentation. In its 
first review of manufacturer-reported prices in 1992, OIG found that it 
could not verify the AMPs reported by the four manufacturers it 
reviewed.19 OIG could not evaluate manufacturers' methods 
for determining AMP because neither the rebate statute nor CMS had 
provided sufficiently detailed instructions on methods for calculating 
AMP. OIG therefore advised CMS that it planned no future AMP data 
audits until CMS developed a specific written policy on how AMP was to 
be calculated. CMS disagreed, saying that the rebate statute and rebate 
agreement had already established a methodology for computing AMP and 
stressed that this methodology was clarified, at manufacturer request, 
on an as-needed basis through conversations with individual 
manufacturers.20
---------------------------------------------------------------------------
    \19\ See HHS OIG, Medicaid Drug Rebates: The Health Care Financing 
Administration Needs to Provide Additional Guidance to Drug 
Manufacturers to Better Implement the Program, A-06-91-00092 
(Washington, D.C.: November 1992).
    \20\ Although CMS disagreed with OIG, it said it would further 
clarify AMP calculation in a forthcoming drug rebate program 
regulation. As of October 2004, the regulation had not been issued; as 
we reported, CMS officials told us that the agency had no plans to 
promulgate any such regulation in the near future. Instead, CMS has 
issued several program memoranda intended to provide guidance on how 
manufacturers should calculate AMP.
---------------------------------------------------------------------------
    In its second review of manufacturer-reported prices, in 1995 OIG 
attempted to verify one manufacturer's recalculation request. While OIG 
reported that it could not complete its analysis because of inadequate 
manufacturer documentation,21 it was able to identify some 
manufacturer errors in determining AMP. In its review, OIG found that 
the manufacturer had miscalculated its revised AMP because it included 
``free goods'' specifically excluded in the rebate agreement, 
miscalculated cash discounts, and improperly included sales rebates 
applicable to a period other than the quarter being audited. OIG 
recommended that CMS have the manufacturer revise its AMP data. 
Although CMS agreed with OIG's recommendations, as of October 2004, it 
had not required any such revision of the audited manufacturer's AMP 
determinations.
---------------------------------------------------------------------------
    \21\ OIG reports on individual manufacturers are not publicly 
available.
---------------------------------------------------------------------------
    In its third review, conducted in 1997, OIG attempted to review a 
manufacturer's recalculation request but again reported that it was 
unable to complete its evaluation because of a lack of specific 
guidance on determining AMP and a lack of manufacturer documentation 
supporting its revised AMP. In the absence of guidance from CMS, OIG 
defined retail pharmacy class of trade for this audit to include only 
independent and chain pharmacies that sold drugs directly to the 
public. Therefore, OIG recommended that CMS ask the manufacturer to 
exclude from the calculation of AMP transactions that OIG determined 
were to nonretail entities such as mail-order pharmacies, nursing home 
pharmacies, independent practice associations, and clinics. OIG also 
found that the manufacturer used a flawed methodology to identify 
certain sales that it had included in the retail class of trade and 
thus AMP. As a result, OIG recommended that CMS ask the manufacturer to 
exclude those sales from AMP unless the manufacturer could provide 
additional documentation to support the inclusion of those sales in 
AMP. Although CMS did not agree with OIG's definition of retail 
pharmacy class of trade, CMS concurred with OIG's recommendation to ask 
the manufacturer to recalculate AMP.22 As of October 2004, 
CMS had not required any revision of this manufacturer's AMP 
determinations.
---------------------------------------------------------------------------
    \22\ In response to OIG recommendations, CMS said it would provide 
the manufacturer with a copy of recent guidance on AMP: Medicaid Drug 
Rebate Program Release No. 29, June 1997. This document, released to 
all manufacturers at the time OIG was conducting the 1997 review, in 
some cases differed from OIG's definition of retail pharmacy class of 
trade. It stated, for example, that sales to nursing home and mail-
order pharmacies are to be included in AMP, while OIG's definition 
excluded these entities.
---------------------------------------------------------------------------
    In its fourth review of manufacturer-reported prices, issued in 
2001, OIG investigated how manufacturers were treating repackagers--
entities like HMOs that repackage or relabel drugs under their own 
names--in their best price determinations. The work followed up on 
previous work OIG conducted in response to a congressional inquiry in 
1999. The rebate statute states that HMO sales are required to be 
included in best price determinations. CMS's June 1997 program 
memorandum stated that sales to other manufacturers that repackage the 
drugs are to be excluded from best price determinations. However, the 
rebate statute, rebate agreement, and CMS program memoranda did not 
address how HMOs should be treated when they act as repackagers. In a 
letter issued in response to the 1999 congressional request, OIG 
reported that excluding drug sales to two HMOs that acted as 
repackagers from best price determinations lowered state rebate amounts 
by $27.8 million in fiscal year 1998.23 In July 2000, CMS 
issued an additional program memorandum to manufacturers stating that 
sales to an HMO should be considered in best price determinations 
regardless of whether the HMO was a repackager.24 In 2001, 
OIG reported that states lost $80.7 million in rebates in fiscal year 
1999 because of improperly excluded drug sales to HMO 
repackagers.25 In September 2004, a CMS official told us 
that CMS planned to release a program memorandum instructing 
manufacturers to revise prior rebates for which they had excluded sales 
to HMOs from best price. However, CMS does not have a mechanism in 
place to track that manufacturers have made these rebate adjustments 
and therefore cannot verify that manufacturers have made or will make 
these adjustments.
---------------------------------------------------------------------------
    \23\ Letter from HHS OIG to Ranking Minority Member, Committee on 
Government Reform, House of Representatives, November 22, 1999.
    \24\ Medicaid Drug Rebate Program Release No. 47, July 2000.
    \25\ See HHS OIG, Medicaid Drug Rebates: Sales to Repackagers 
Excluded from Best Price Determinations, A-06-00-00056 (Washington, 
D.C.: March 2001).
---------------------------------------------------------------------------
    As we reported, OIG officials told us that, despite the program 
releases issued by CMS, they remain unable to evaluate AMP because of 
the lack of clear CMS guidance, particularly related to the retail 
pharmacy class of trade and treatment of PBM transactions.
manufacturer price determination methods varied: some could have led to 

                             LOWER REBATES

    As we reported, we found considerable variation in the methods that 
the manufacturers we reviewed used to determine best price and AMP. 
Manufacturers are allowed to make reasonable assumptions when 
determining best price and AMP, as long as those assumptions are 
consistent with the law and the rebate agreement. The assumptions often 
pertain to the transactions, including discounts or other price 
reductions, that are considered in determining best price and AMP. We 
found that in some cases manufacturers' assumptions could have led to 
lower rebates and in other cases to higher rebates. Manufacturers can 
later revise their assumptions and request recalculations of previously 
paid rebates, which can result in states repaying any excess rebates.
    We found that manufacturers made varying assumptions about which 
sales and prices to include and exclude from their determinations of 
best price and AMP. For example, some included sales to a broad range 
of facilities in AMP, excluding only transactions involving facilities 
explicitly excluded by the law, rebate agreement, or CMS program 
memoranda. In contrast, others included sales to a narrower range of 
purchasers--only those purchasers explicitly included in AMP by the 
law, rebate agreement, or CMS program memoranda. Manufacturers also 
differed in how they treated certain types of health care providers 
that are not explicitly addressed by the law, rebate agreement, or CMS 
program memoranda. For example, some manufacturers included sales to 
physician groups in AMP, while others did not. These assumptions can 
affect the reported prices and, in turn, the size of rebates paid to 
states.
    We also found that manufacturers also differed in how they 
accounted for certain price reductions, fees, and other transactions 
when determining best price and AMP. For example, manufacturers 
differed in how they accounted for certain transactions involving 
prompt payment discounts. In some cases, manufacturers' assumptions 
could have reduced rebates below what they otherwise would have been. 
In other cases, manufacturers' methods could have raised rebates. For 
example, some manufacturers included in the determination of best price 
the contract prices they had negotiated with purchasers, even if they 
made no sales at those prices during the reporting quarter. This 
practice could have increased rebates to states.26
---------------------------------------------------------------------------
    \26\ One manufacturer, however, indicated that it later might 
revise this practice and request recalculations to recoup any excess 
rebates it had already paid. Manufacturers have up to 3 years to make 
such revisions.
---------------------------------------------------------------------------
 REBATE PROGRAM DOES NOT CLEARLY ADDRESS CERTAIN FINANCIAL CONCESSIONS 
                           NEGOTIATED BY PBMS

    As we reported, the rebates that manufacturers pay to states are 
based on a range of prices and financial concessions that manufacturers 
make available to entities that purchase their drugs, but they may not 
reflect certain financial concessions manufacturers offer to other 
entities in today's complex market. In particular, the rebate program 
does not clearly address certain concessions that are negotiated by 
PBMs on behalf of third-party payers, such as employer-sponsored health 
plans and other health insurers. The rebate program did not initially 
address these types of concessions, which are relatively new to the 
market. CMS's subsequent guidance to manufacturers has not clearly 
stated how manufacturers should treat these concessions in their 
determinations of best price and AMP. Within the current structure of 
the rebate formula, additional guidance on how to account for 
manufacturer payments to PBMs could affect the rebates paid to states, 
although whether rebates would increase or decrease as a result, and by 
how much, is uncertain.
    Certain manufacturer financial concessions that are negotiated by 
PBMs on behalf of their third-party payer clients are not clearly 
reflected in best price or AMP. PBMs, in one of the roles they play in 
the market, may negotiate payments from manufacturers to help reduce 
their third-party payer clients' costs for prescription 
drugs.27 (In these circumstances, the third-party payer does 
not purchase drugs directly from the manufacturer but instead covers a 
portion of the cost when its enrollees purchase drugs from pharmacies.) 
The basis of these PBM-negotiated manufacturer payments varies. For 
example, manufacturers may make a payment for each unit of a drug that 
is purchased by third-party payer enrollees or may vary payment 
depending on a PBM's ability to increase the utilization, or expand the 
market share, of a drug. The payment may be related to a specific drug 
or a range of drugs offered by the manufacturer. The amount of 
financial gain PBMs receive from these negotiated payments also varies. 
A PBM may pass on part or all of a manufacturer's payment to a client, 
depending on the terms of their contractual relationship. Manufacturers 
may not be parties to the contracts that PBMs have with their clients 
and so may not know the financial arrangements between the PBMs and 
their clients.
---------------------------------------------------------------------------
    \27\ GAO03196.
---------------------------------------------------------------------------
    These types of financial arrangements between manufacturers and 
PBMs are a relatively new development in the market. When the program 
began in 1991, PBMs played a smaller role in the market, managing fewer 
covered lives and providing a more limited range of services--such as 
claims processing--for their clients. Since then, PBMs' role has grown 
substantially, contributing to a market that is much more complex, 
particularly with respect to the types of financial arrangements 
involving manufacturers. PBMs now commonly negotiate with manufacturers 
for payments on behalf of their clients, in addition to providing other 
services. Although complete data on the prevalence and magnitude of 
PBM-negotiated manufacturer payments are not readily available, PBM 
officials and industry experts have said that these and other 
manufacturer payments to PBMs are a large portion of PBMs' earnings; 
28 further, recent public financial information suggests 
that manufacturer payments to PBMs as a whole are substantial and key 
to PBMs' profitability.
---------------------------------------------------------------------------
    \28\ GAO03196.
---------------------------------------------------------------------------
    CMS has acknowledged the complexity that arrangements between 
manufacturers and PBMs introduce into the rebate program but has not 
clearly addressed how these arrangements should be reflected in 
manufacturer-reported prices. In 1997, CMS issued program memoranda 
that noted new types of arrangements involving manufacturer payments to 
PBMs and attempted to clarify whether those arrangements should be 
reflected in best price and AMP.29 However, in a program 
memorandum issued shortly thereafter, CMS stated that there had been 
confusion concerning the intent of the previous program memoranda and 
that the agency had ``intended no change'' to program 
requirements.30 At the time, CMS said that staff were 
reexamining the issue and planned to shortly clarify the agency's 
position. As of January 2005, CMS had not issued such clarifying 
guidance on how PBM-negotiated manufacturer payments should be 
reflected in best price and AMP when PBMs have negotiated on behalf of 
third parties. CMS officials with responsibility for issuing program 
memoranda advised us that they could comment only on specific 
situations. They stated that financial arrangements among entities in 
the market are complex and always changing; in their view, the market 
is too complicated for them to issue general policy guidance that could 
cover all possible cases. Rather, these officials told us that they 
make determinations about PBM payments on a case-by-case basis, but 
only when manufacturers contact them regarding this issue.
---------------------------------------------------------------------------
    \29\ Medicaid Drug Rebate Program Release No. 28, April 1997, and 
Medicaid Drug Rebate Program Release No. 29, June 1997.
    \30\ Medicaid Drug Rebate Program Release No. 30, September 1997.
---------------------------------------------------------------------------
    Within the current structure of the rebate formula, additional 
guidance on how to account for manufacturer payments to PBMs could 
affect the rebates paid to states, although whether rebates would 
increase or decrease as a result, and by how much, is uncertain. 
Because of the structure of the rebate formula, any change in the 
determination of best price and AMP could raise or lower rebates for 
any given drug, depending on how the change affects the relationship 
between those prices. Incorporating PBM-negotiated manufacturer 
payments into the rebate determination could decrease the unit rebate 
amount for a drug if, for example, it reduced AMP but had no effect on 
best price.31 Alternatively, if such a change increased the 
difference between AMP and best price for a drug, the unit rebate 
amount could increase.32
---------------------------------------------------------------------------
    \31\ A change in guidance regarding how PBM payments should be 
reflected in best price would not necessarily affect the best price for 
every drug because best price can be determined by a transaction that 
is not related to PBM payments.
    \32\ A greater difference between best price and AMP would not 
always yield a larger rebate. For example, if the difference between 
the two prices increased but remained less than 15.1 percent of AMP, 
the unit rebate amount would still be based on the 15.1 percent of AMP 
minimum.
---------------------------------------------------------------------------
                        CONCLUDING OBSERVATIONS

    As we stated in our report, because the rebate program relies on 
manufacturer-reported prices, adequate program oversight is important 
to ensure that states receive the rebates to which they are entitled. 
However, CMS has not provided clear program guidance for manufacturers 
to follow when determining prices, and this has hampered OIG's efforts 
to audit manufacturers' methods and reported prices. In addition, 
oversight by CMS and OIG has been inadequate to ensure that 
manufacturer-reported prices and methods are consistent with the law, 
rebate agreement, and CMS program memoranda. As a result, we 
recommended that CMS take several steps to improve program guidance and 
oversight, namely, to issue clear guidance on manufacturer price 
determination methods and the definitions of best price and AMP; update 
such guidance as additional issues arise; and implement, in 
consultation with OIG, systematic oversight of the price determination 
methods employed by pharmaceutical manufacturers and a plan to ensure 
the accuracy of manufacturer-reported prices and rebates to states. We 
believe that these actions could help ensure that the Medicaid drug 
rebate program achieves its objective of controlling states' Medicaid 
drug spending. HHS agreed with the importance of guidance to 
manufacturers, but disagreed with our conclusion that there has been 
inadequate program oversight. We acknowledged HHS's oversight actions, 
but stated that HHS oversight does not adequately ensure the accuracy 
of manufacturer-reported prices and rebates paid to states. Some of the 
manufacturers that supplied data for the report raised concerns about 
our discussion of certain methods they used to determine rebates, and 
we clarified our discussion of manufacturers' price determination 
methods.
    Mr. Chairman, this concludes my prepared statement. I would be 
happy to respond to any questions you or other Members of the 
Subcommittee may have.

    Mr. Deal. Thank you, Ms. King.
    Ms. Gifford, I understand you are under some time 
constraints. We will be pleased to hear from you.

                STATEMENT OF KATHLEEN D. GIFFORD

    Ms. Gifford. Thank you, Mr. Chairman and members of the 
committee.
    My name is Kathy Gifford. I am a former State Medicaid 
Director myself, and am now a Principal of Health Management 
Associates. Along with my colleague, Sandy Kramer, I recently 
prepared a report that discusses potential Federal options to 
help contain Medicaid drug costs, and I would like to share 
some of those options with you today.
    I think maybe you can go right to slide four.
    [Slide.]
    As you know, drug spending is a significant cost driver in 
the health system generally and a particular burden for 
Medicaid programs. Virtually all States have implemented 
pharmacy cost containment measures, and while the Federal 
Government has been generally supportive, more could be done, I 
believe, at the Federal level to assist States and promote 
efficiencies across the country.
    I want to touch very briefly on four general areas: first, 
as has been discussed here a lot already, assisting States to 
be more prudent purchasers at the retail level; second, 
maximizing manufacturer rebates, reducing the ongoing cost 
burden on States in the new Medicare drug benefit; and finally, 
promoting the delivery of evidence-based cost effective 
pharmaceutical care.
    Now we have already talked a lot about the issues with AWP, 
and those have been clearly stated for the committee already. I 
think the Federal Government could be more proactive in 
providing States with better data on actual drug acquisition 
costs, and I sum it up in three categories. One, come up with a 
new data source, and that is what we have been talking about, 
ASP. Two, improve the accuracy and reliability of AWP data 
potentially by linking it to the Medicaid drug rebate. Or 
three, changing Federal law to allow a limited release to 
States of confidential drug pricing data that is currently 
available to CMS for purposes of the Medicaid Rebate Program.
    Now please note that the first option, ASPs, implementing 
that would, in my opinion, be no small undertaking. For all 
States to benefit, the Federal Government would need to handle 
the data collection and timely pricing for tens of thousands of 
drug codes used by a typical Medicaid program compared to the 
relatively small number of drug codes that are currently 
subject to ASP pricing under Medicare part B. Ultimately, the 
benefit to States will depend heavily upon the effectiveness of 
the Federal Government in calculating and reporting the ASP 
prices.
    Next slide. And one more slide.
    [Slide.]
    The Federal Government could assist States to maximize 
manufacturer rebates by increasing the federally required 
minimum rebate, as was recently suggested by the NGA. Doing so 
could help States compensate for the loss of market leverage 
they will experience in their supplemental rebate programs when 
the new Medicare drug benefit takes effect next year.
    The last option on that slide I will touch on briefly 
relates to the budget proposal to eliminate the best price 
requirement from the Medicaid rebate formula. While no one 
really knows what the fiscal impact of this would be, I am 
concerned that in the short run, dropping the best price 
requirement could undermine existing State preferred drug lists 
to the detriment of States from both a fiscal and 
administrative standpoint.
    Next slide.
    [Slide.]
    I have included Federal policy options relating to the new 
Medicare drug benefit, because States will be directly affected 
by Clawback formula by growth in the part D spending. I have 
therefore suggested removing the MMA non-interference provision 
preventing HHS from negotiating better drug pricing. Even if 
HHS chose not to negotiate for better prices, I think the 
repeal of this provision may, nevertheless, promote better drug 
pricing for Medicare, as drug manufacturers may be more likely 
to exercise restraint in their pricing decisions to avoid 
provoking a response from HHS.
    Next slide, please.
    [Slide.]
    And finally, let me turn to what I suggest presents the 
greatest hope for long-term drug cost containment, and that is 
the ability to manage drug utilization using evidence-based 
tools, basically making sure that the right drug is made 
available to the right person at the right time and in the 
right amount, all health payers, public and private, would 
benefit from an expansion of the existing base of evidence-
based research. Few States, however, earn a position on their 
own to undertake the needed research efforts to fill in the 
gaps. We have already discussed, I believe, Section 1013 of the 
MMA that recognized this need, and $50 million was authorized 
for this purpose in 2004, but only $15 million was actually 
budgeted in 2005, and a like amount was proposed in the budget 
for 2006 by the President. I believe a greater investment in 
comparative effectiveness research now would reap substantial 
long-term savings.
    And that concludes my testimony, Mr. Chairman.
    [The prepared statement of Kathleen D. Gifford follows:]

    Prepared Statement of Kathleen D. Gifford, Sandy Kramer, Health 
                         Management Associates

    Spending on prescription drugs is a major cost driver in the health 
care system generally and a particular burden for state Medicaid 
programs that provide vital health care coverage for many of the 
nation's most medically vulnerable individuals. Medicaid accounts for 
nearly one in five dollars spent on prescription drugs in the United 
States, and nearly half of those expenditures are for low-income 
seniors who are dually eligible for Medicare and Medicaid (``dual 
eligibles'').1 In recent years, almost all states have 
worked to implement pharmacy cost containment measures that preserve 
access to the vital drug therapies upon which Medicaid beneficiaries 
rely. The federal government has been generally supportive of state 
efforts, but has initiated few of its own. More could be done at the 
federal level to assist states and promote efficiencies across the 
country. This paper discusses federal options that would assist states 
to (a) purchase prescription drugs more effectively at the retail 
level, (b) maximize manufacturer rebates, (c) reduce the ongoing cost 
burden on states of the new Medicare drug benefit, and (d) promote the 
delivery of evidence-based, cost-effective pharmaceutical care.
---------------------------------------------------------------------------
    \1\ Brian Bruen and Arunabh Ghosh, ``Medicaid Prescription Drug 
Spending and Use,'' June 2004, Washington, D.C., Kaiser Commission on 
Medicaid and the Uninsured, Pub. No. 7111.
---------------------------------------------------------------------------
                               BACKGROUND

    Since FY 2004, state revenue collections have been slowly 
recovering from the most severe fiscal downturn in 60 
years.2 Despite improving economic conditions, state revenue 
remains below its 2000 peak (after adjusting for inflation and 
population growth) 3 and budgets continue to be strained by 
Medicaid spending growth that exceeds revenue growth in many states. 
The long-term outlook offers little hope for a Medicaid spending 
reprieve. Both the Congressional Budget Office and the Centers for 
Medicare and Medicaid Services (CMS) project that over the next decade, 
federal Medicaid spending will grow at an average annual rate of more 
than eight percent.4
---------------------------------------------------------------------------
    \2\ National Governors Association, National Association of State 
Budget Officers, ``The Fiscal Survey of States,'' December 2004.
    \3\ D. Boyd et al, ``State and Local Governments Face Continued 
Fiscal Pressure,'' The Rockefeller Institute of Government Fiscal 
Studies Program, January 2005.
    \4\ Congressional Budget Office, ``The Budget and Economic Outlook: 
Fiscal Years 2006 to 2015,'' January 2005, and Stephen Heffler, et al., 
``U.S. Health Spending Projections for 2004--2014,'' Health Affairs Web 
Exclusive, February 23, 2005.
---------------------------------------------------------------------------
    Over the past four years, state Medicaid officials have cited 
prescription drugs as one of the top three Medicaid cost drivers along 
with enrollment growth and rising medical care costs 
generally.5 Indeed, prescription drugs are one of the 
fastest growing Medicaid service categories; expenditures doubled 
between 1998 and 2002, and have quadrupled since 1992. As a result, 
prescription drugs grew from 8 percent of total Medicaid expenditures 
in 1998 to over 11 percent in 2002.6 In CY 2003, Medicaid 
spending for prescription drugs grew by 17.5 percent, similar to growth 
in the previous two years.7 A combination of factors drove 
this growth including increases in the number of beneficiaries, drug 
utilization growth (i.e., more prescriptions per person), the 
substitution of newer, more costly drugs for older, less expensive 
drugs, and increases in drug prices. Medicaid drug spending growth is 
projected to decelerate to 7.1 percent in CY 2004 due in large part to 
state drug cost containment efforts.8 While this is below 
the overall rate of drug cost growth (11.9 percent), it is still high 
and more can and should be done.
---------------------------------------------------------------------------
    \5\ V. Smith et al, ``The Continuing Medicaid Budget Challenge: 
State Medicaid Spending Growth and Cost Containment in Fiscal Years 
2004 and 2005,'' October 2004, Washington, D.C., Kaiser Commission on 
Medicaid and the Uninsured, Pub. No. 7190.
    \6\ B. Bruen and A.Ghosh, June 2004.
    \7\ C. Smith et al., ``Health Spending Growth Slows in 2003,'' 
Health Affairs, 24, no. 1 (2005): 185-194.
    \8\ S. Heffler, et al., ``U.S. Health Spending Projections for 
2004-2014,'' Health Affairs Web Exclusive, February 23, 2005.
---------------------------------------------------------------------------
    Net Medicaid spending on drugs reflects payments made to pharmacies 
at the retail level and rebates paid to states by manufacturers. States 
have considerable discretion in setting retail pharmacy payments, which 
must recognize both drug costs and a dispensing fee. For sole-source 
brand name drugs, states must pay the lower of the pharmacy's ``usual 
and customary charge'' to the public or the drug's ``estimated 
acquisition cost'' (EAC) plus a dispensing fee. Each state determines 
its own EAC formula (usually based on the ``average wholesale price''), 
and sets its own dispensing fee. The EAC and the dispensing fee amount 
vary significantly from state to state. Generic products are often 
subject to different pricing rules. Some are subject to a ``federal 
upper limit'' (FUL) set by CMS for drugs with generic equivalents that 
meet certain criteria. Most states have also chosen to set their own 
``maximum allowable cost'' prices for generics, which can be lower than 
the FUL and sometimes apply to generics not covered by the FUL.
    States struggling with the rapid growth of Medicaid drug spending 
hoped that a new Medicare pharmacy benefit would provide significant 
state fiscal relief. Instead, to help finance the new drug benefit that 
begins in January 2006, the Medicare Prescription Drug, Improvement, 
and Modernization Act of 2003 9 (the ``MMA'') requires CMS 
to recoup from states much of the savings that states would otherwise 
have realized from shifting prescription drug coverage for dual 
eligibles to Medicare. This recoupment is commonly referred to as the 
``Clawback.'' The MMA provides for a ten-year partial phase-down of the 
Clawback amount starting at 90 percent in 2006 (in other words, 
allowing the states to retain 10 percent of the calculated savings), 
and decreasing to 75 percent in 2015 and thereafter. There is, however, 
no end to the state Clawback obligation. In practice, many states 
believe the Clawback formula is flawed and may result in a negative 
state fiscal impact rather than a savings.
---------------------------------------------------------------------------
    \9\ Pub. L. 108-173
---------------------------------------------------------------------------
  STATE ACTIONS TO CONTROL MEDICAID PRESCRIPTION DRUG SPENDING GROWTH

    In almost all states, prescription drugs have been the focus of 
ongoing, sustained efforts to slow multi-year double-digit cost growth. 
In 2004, 47 states and the District of Columbia reported implementing 
prescription drug cost containment measures and 43 reported plans to 
take additional steps in 2005.10 These measures include 
imposing prior authorization requirements and step therapy protocols, 
limiting the number of brand prescriptions per month, new or higher 
copay requirements and reductions in retail pharmacy reimbursement 
policies. States have also hoped to better control drug utilization by 
implementing disease management and case management programs and 
provider profiling and counter-detailing initiatives.
---------------------------------------------------------------------------
    \10\ V. Smith et al, October 2004.
---------------------------------------------------------------------------
    Figure 1 below illustrates the results of a 2003 survey of state 
Medicaid programs comparing drug cost containment measures reported in 
2003 to those reported in 2000.11 Among other things, the 
survey results demonstrate the widespread adoption of multiple policies 
over a relatively short period of time.
---------------------------------------------------------------------------
    \11\ Jeffrey S. Crowley et al, ``Medicaid Outpatient Prescription 
Drug Benefits: Findings from a National Survey, 2003,'' December 2003, 
Washington, D.C., Kaiser Commission on Medicaid and the Uninsured, Pub. 
No. 4164.
---------------------------------------------------------------------------
    A rapidly growing number of states have also chosen to implement 
preferred drug lists (PDLs) and negotiate for supplemental rebates from 
pharmaceutical manufacturers: 37 states have implemented or plan to 
implement a PDL and 33 states currently receive supplemental 
rebates.12 More recently, a number of states have joined 
multi-state pooling arrangements to increase their market leverage to 
maximize supplemental rebates. In April 2004, Health and Human Services 
(HHS) Secretary Tommy Thompson approved plans by five states (Michigan, 
Vermont, New Hampshire, Alaska, and Nevada) to pool their collective 
purchasing power and Minnesota, Hawaii, Montana, Kentucky and Tennessee 
subsequently joined this pool. In May 2005, HHS Secretary Mike Leavitt 
approved a new multi-state purchasing pool comprised of Louisiana, 
Maryland and West Virginia. Over the next year, it is likely that more 
states will join a multi-state purchasing pool motivated, in part, by 
the January 2006 implementation of the new Medicare drug benefit that 
will cut in half direct state Medicaid pharmacy expenditures. (States 
will continue to indirectly pay for drug coverage for dual eligibles 
through the Clawback.) Since greater volume translates to greater 
leverage to negotiate supplemental rebates, states may be forced to 
join multi-state pools just to retain their current level of 
supplemental rebates after 2006.
---------------------------------------------------------------------------
    \12\ Data compiled by the National Conference of State Legislatures 
and accessed at http://www.ncsl.org/programs/health/medicaidrx.htm; 
Testimony of Dennis Smith, Director of the Center for Medicaid and 
State Operations, Centers for Medicare and Medicaid Services, presented 
at a hearing on ``Medicaid Prescription Drug Reimbursement: Why the 
Government Pays Too Much,'' before the Subcommittee on Oversight and 
Investigations, Energy and Commerce Committee, U.S. House of 
Representatives, December 7, 2004.
---------------------------------------------------------------------------
    States and the federal government jointly fund Medicaid, and 
therefore rising Medicaid prescription drug costs also have adverse 
fiscal consequences for the federal budget. In recent years, CMS has 
taken some steps to assist and support states with their pharmacy cost 
containment activities. In 2002, CMS issued guidance to states 
supporting supplemental rebate programs.13 In 2004, CMS 
approved requests from a number of states to form a multi-state 
purchasing pool. Also, CMS identified selected best practices for 
Medicaid pharmacy savings and offered assistance to those states that 
have not implemented these effective mechanisms.14 While 
these efforts are laudable, more could be done at the federal level to 
assist states and promote efficiencies across the country.
---------------------------------------------------------------------------
    \13\ Dear State Medicaid Director letter dated September 18, 2002 
accessed at http://www.cms.hhs.gov/states/letters/smd91802.pdf.
    \14\ Included were (1) the long-standing practice of many states to 
prior authorize brand name equivalents to generic drugs, (2) 
negotiation of manufacturer supplemental rebates, (3) implementation of 
disease management programs, and (4) efforts to promote e-prescribing. 
Safe and Effective Approaches to Lowering State Prescription Drug 
Costs: Best Practices Among State Medicaid Drug Programs (9/9/04), 
www.cms.hhs.gov/medicaid/drugs/strategies.pdf.
---------------------------------------------------------------------------
                 PRUDENT PURCHASING AT THE RETAIL LEVEL

    States largely operate ``in the dark'' in setting drug cost 
reimbursement without access to the actual drug acquisition costs paid 
by pharmacies. States typically cover over 50,000 National Drug Codes--
each with its own price that can change unpredictably. It is therefore 
a challenge to find adequate current information to set drug 
reimbursement rates at levels that fairly compensate pharmacies without 
overpaying.
    While states often set their own maximum allowable cost prices for 
generics and selected brand name drugs, they rely on national firms to 
supply electronic drug pricing files for most drugs. States then 
determine the pharmacy reimbursement rate by taking a discount from the 
reported ``Average Wholesale Price'' (AWP), or by assigning a mark-up 
to the reported ``Wholesale Acquisition Cost'' (WAC), and adding a 
dispensing fee.15 Reimbursement formulas vary significantly 
from state to state. Similar pricing policies are used by private 
sector plans, but their rates are often lower than Medicaid.
---------------------------------------------------------------------------
    \15\ For example, a state may reimburse a pharmacy at AWP minus 10 
to 15 percent plus a fixed dispensing fee of $3 to $5.
---------------------------------------------------------------------------
    Recent reports by the HHS Office of Inspector General (OIG) have 
highlighted the millions of dollars lost to states and the federal 
government each year due to Medicaid overpricing.16 One of 
the main culprits for the overpricing is the AWP. The AWP is 
essentially a nationally published list price (largely set by 
manufacturers) that bears little resemblance to a pharmacy's actual 
acquisition cost. Manufacturers may even raise an AWP to artificially 
create a larger spread between AWP and actual acquisition cost to 
increase retail pharmacy profits, thereby making the product more 
attractive to pharmacies. Widely viewed as inflated and flawed, the AWP 
was recently abandoned by Medicare Part B (in the MMA) in favor a new 
``Average Sales Price'' (ASP) methodology.
---------------------------------------------------------------------------
    \16\ Department of Health and Human Services, Office of Inspector 
General, ``Variation in State Medicaid Drug Prices,'' September 2004, 
OEI-05-02-00681; see also, testimony presented at hearing on ``Medicaid 
Prescription Drug Reimbursement: Why the Government Pays Too Much'' 
before the Subcommittee on Oversight and Investigations, Energy and 
Commerce Committee, U.S. House of Representatives, December 7, 2004.
---------------------------------------------------------------------------
    Federal policy could assist states in becoming more prudent 
purchasers at the retail pharmacy level. Proposals 1 through 3 below 
present alternatives that would each provide states with better 
information to set retail pharmacy reimbursement policies by (1) 
providing a new source of drug pricing data (ASPs), (2) improving the 
accuracy and reliability of the drug pricing data most commonly used 
today (AWPs), or (3) releasing (on a limited basis) drug pricing data 
that is currently confidential (AMPs). The fourth proposal calls for 
improvements in the current federal FUL program that establishes prices 
for certain multi-source drugs.
1. Provide states with accurate and timely ASPs for Medicaid covered 
        drugs.
    For drugs covered under Medicare Part B,17 the MMA 
requires Medicare to use an ASP plus 6 percent payment methodology. 
``AS'' is the weighted average of all non-federal sales from 
manufacturers to wholesalers (net of chargebacks, discounts, rebates, 
and other benefits tied to the purchase of the drug product), and is 
based on quarterly pricing data supplied to CMS by drug manufacturers. 
While some critics argue that the ASP does not accurately reflect a 
retail pharmacy's actual acquisition cost, the ASP is likely a better 
starting point for estimating that cost than the AWP.
---------------------------------------------------------------------------
    \17\ Part B drugs include drugs furnished incident to a physician's 
service, durable medical equipment drugs, and other drugs covered by 
statute, such as oral immunosuppressive, cancer, and antinausea drugs.
---------------------------------------------------------------------------
    Moving to an ASP methodology in Medicaid, however, would be a 
significant and costly undertaking that would be difficult for states 
to accomplish on their own. To enable all states to benefit from this 
methodology, the federal government (acting through CMS) would need to 
handle the data collection and timely pricing of the over 50,000 
National Drug Codes commonly covered by state Medicaid programs. 
(Currently, CMS collects manufacturer data on only 5,700 National Drug 
Codes to price 550 Part B drugs.) States would also need to rely upon 
CMS for timely pricing information on new drugs entering the market and 
for manufacturer price adjustments that occur from time to time. 
(Currently, CMS provides only quarterly updates for Part B drugs 
subject to ASP pricing.) Ultimately, the benefit to states of moving to 
an ASP methodology would depend heavily upon the effectiveness of CMS 
in calculating and reporting the ASP prices.
    President Bush's 2006 federal budget proposal would require states 
to adopt an ASP plus 6 percent payment methodology (consistent with 
Medicare Part B) and estimates federal savings of $542 million in 2006 
and $5.4 billion over five years. (The proposal, however, does not 
address whether CMS would be responsible for the accurate and timely 
calculation of the ASP prices.) While states would benefit from 
accurate and reliable ASP pricing information to use in place of the 
current inflated and artificial AWP prices, it would likely be 
advantageous to allow states to retain some flexibility to revise 
payment methodologies as the need for improvements becomes obvious or 
necessary over time and to respond to local state conditions.
2. Incentivize manufacturers to set more realistic AWP prices by 
        linking them to the statutory Medicaid rebate formula.
    Created by the Omnibus Budget Reconciliation Act of 1990, the 
Medicaid Drug Rebate Program requires a drug manufacturer to enter into 
a national rebate agreement with the secretary of HHS in order for that 
manufacturer's drugs to be covered under Medicaid. CMS calculates 
rebate amounts using a statutory formula based on the ``average 
manufacturer price'' (AMP), defined as the average price paid by 
wholesalers for drugs distributed to the retail class of trade. Using 
the same benchmark (AWP) for both the rebate formula (instead of AMP) 
and pharmacy reimbursement policy would provide an incentive for 
manufacturers to establish lower, more realistic AWPs and reduce the 
ability of manufacturers to ``game the spread'' between AWP and the 
actual acquisition cost. Another way to achieve a similar result would 
be to apply a rebate penalty if the difference between AWP and AMP 
exceeded 20 percent. Medicare Part B uses a similar technique to 
validate ASPs by comparing ASP to AMP. By law, AMPs are confidential 
and therefore state Medicaid agencies are unable to implement this type 
of reasonableness test for AWPs on their own.
3. Change federal law to allow the release of AMP information to the 
        states.
    The AMP data provided to CMS by drug manufacturers to support the 
Medicaid Drug Rebate Program is likely the most accurate drug pricing 
data currently available to CMS for non-Medicare Part B drugs. A 
limited disclosure of this data to states could be required by federal 
law to help states set drug cost reimbursement at appropriate levels, 
as has been recommended by the Department of Health and Human Services 
Office of the Inspector General.18
---------------------------------------------------------------------------
    \18\ Department of Health and Human Services, Office of Inspector 
General, ``Variation in State Medicaid Drug Prices,'' September 2004, 
OEI-05-02-00681.
---------------------------------------------------------------------------
4. Improve the process for placing multi-source drugs on the ``Federal 
        Upper Limit'' (FUL) list.
    The FUL program, administered by CMS, limits Medicaid payments for 
drugs with generic equivalents that meet certain criteria: there must 
be three therapeutically equivalent drug products and CMS must verify 
that there are at least three suppliers. If these criteria are met, the 
FUL is set at 150 percent of the published AWP price for the least 
costly therapeutically equivalent product. This formula implemented in 
the late 1980s should be revised to reflect actual market pricing 
trends and to use strategies based on AMP markups. Also, in a recent 
OIG HHS report, CMS was criticized for failing to add many qualified 
drugs to the list and adding others too slowly.19 As the OIG 
recommended, CMS at a minimum could focus its resources on high-volume 
brand name drugs that are coming off patent that could be placed on the 
FUL list and result in significant Medicaid savings.
---------------------------------------------------------------------------
    \19\ Ibid. See also, testimony of George M. Reeb, Assistant 
Inspector General, presented at hearing on ``Medicaid Prescription Drug 
Reimbursement: Why the Government Pays Too Much'' before the 
Subcommittee on Oversight and Investigations, Energy and Commerce 
Committee, U.S. House of Representatives, December 7, 2004.
---------------------------------------------------------------------------
                    MAXIMIZING MANUFACTURER REBATES

    The methodology for the required rebate that drug manufacturers 
must pay to participate in Medicaid has not been modified for over 12 
years, despite rapid growth in prices and costs (see Table 1 below.) 
This has forced a growing number of states to seek supplemental 
rebates, which can sometimes be difficult for a state to enact. 
Proposals 1 through 3 below describe federal policy changes to the 
current rebate formula that would increase rebate revenues to states. 
The fourth proposal calls for improvements in the administration of the 
rebate program and the fifth proposal raises a concern with the rebate 
formula modification proposed in the Bush administration's 2006 budget 
proposal.

[GRAPHIC] [TIFF OMITTED] T2985.016

    20 Centers for Medicare & Medicaid Services, Medicaid 
Drug Rebate Program, Operational Training Guide, September 2001.
1. Increase the minimum federally required rebate.
    When the new Medicare prescription drug benefit is implemented in 
2006, direct state Medicaid drug expenditures will be cut in half. The 
lost prescription volume will likely decrease the market leverage that 
states have to negotiate supplemental rebates. An updated minimum 
rebate would help states compensate for the loss of market leverage and 
ensure that all states, as well as the federal government, pay a fair 
price for prescription drugs covered by Medicaid. The National 
Governors Association, on a bipartisan basis, supports increasing the 
rebate.21
---------------------------------------------------------------------------
    \21\ National Governors Association. 2004. EC-3. Medicaid Drug 
Rebate Program. http://www.nga.org/nga/legislativeUpdate/
1,1169,C_POLICY_POSITIOND_3716,00.html
---------------------------------------------------------------------------
2. Implement an indexed best price calculation in the rebate formula.
    To discourage manufacturers from raising AMP amounts, the rebate 
formula contains a penalty for AMP price increases that exceed the 
consumer price index for urban consumers (CPI-U). The penalty is equal 
to the amount that AMP increased over and above the CPI-U. A similar 
penalty, however, is not applied for increases in the ``best price'' 
component of the formula even though drug manufacturers have 
consistently increased best price in excess of the CPI-U since the 
inception of the Medicaid Drug Rebate Program.22 Indexing 
the best price component of the rebate calculation would therefore 
increase drug rebates for many brand name drugs.
---------------------------------------------------------------------------
    \22\ Department of Health and Human Services, Office of the 
Inspector General, Cost-Saver Handbook, ``2004 Red Book.''
---------------------------------------------------------------------------
3. Add an inflation-related adjustment to the federal rebate formula 
        for generic drugs.
    Unlike the current rebate formula for brand name drugs, the current 
formula for generic drugs contains no penalty adjustment for AMP price 
increases that exceed the CPI-U. Adding such a penalty could increase 
rebate revenues to states, but would also discourage generic 
manufacturers from increasing prices in excess of the rate of 
inflation.
4. Implement systematic oversight of self-reported manufacturer pricing 
        data to assure the accuracy of Medicaid drug rebates.
    Currently, the calculation of Medicaid drug rebates relies upon 
self-reported AMP and ``best price'' data supplied to CMS by drug 
manufacturers. In recent years, a number of drug manufacturers have 
agreed to pay millions of dollars in legal settlements to resolve 
allegations involving the underpayment of Medicaid rebates arising from 
the failure to properly report best price. A recent report from the 
Government Accountability Office (GAO) also found that current rebate 
program oversight by CMS does not assure that manufacturer-reported 
drug prices are consistent with applicable laws and program 
policies.23 Consistent with GAO recommendations, CMS should 
implement a plan to systematically scrutinize AMP and best price data 
reported by manufacturers to enforce the accurate payment of Medicaid 
drug rebates to states.
---------------------------------------------------------------------------
    \23\ United States Government Accountability Office, ``Medicaid 
Drug Rebate Program: Inadequate Oversight Raises Concerns about Rebates 
Paid to States,'' February 2005, GAO-05-102.
---------------------------------------------------------------------------
5. Maintain the ``best price'' calculation in the current rebate 
        formula.
    The president's 2006 budget recommendations propose to eliminate 
the best price requirement from the Medicaid drug rebate formula and 
replace it with a budget neutral flat rebate to allow private 
purchasers to negotiate lower prices from manufacturers. Flat rebates, 
however, could dramatically affect the structure of state PDLs and the 
savings they currently generate for states. PDL savings are based on 
shifting utilization to those drugs with the lowest net cost after 
federal and supplemental rebates. If federal rebates change, preferred 
products may no longer be cost effective compared to non-preferred 
drugs within a class and cost increases could result.

                  IMPACT OF THE MEDICARE DRUG BENEFIT

    When the Medicare prescription drug benefit takes effect in January 
2006, state Medicaid programs will no longer provide drug coverage for 
dual eligibles but will continue to help finance a substantial portion 
of the new Medicare drug coverage through the Clawback. States will 
therefore lose the ability to manage the prescription drug benefit for 
duals, even as they must continue to finance it. The Clawback formula 
includes future annual adjustments based upon per capita spending 
growth for the Medicare drug benefit. Thus, states have a direct 
interest in how the Medicare drug program is managed: higher per capita 
growth in Medicare drug spending means a larger Clawback obligation for 
states.
    The first two proposals below describe steps that the federal 
government could take to constrain the growth in per capita Medicare 
drug spending, and thereby directly benefit states by moderating future 
growth in the Clawback. Proposals 3 and 4 suggest that the MMA should 
be amended to eventually require the federal government to assume the 
full financial cost of the Part D benefit for dual eligibles.
1. Eliminate the MMA prohibition preventing CMS from negotiating for 
        better pharmaceutical pricing.
    Section 1860D-11(i) of the Social Security Act, as added by the 
MMA, bars the secretary of HHS from interfering with the negotiations 
between drug manufacturers and pharmacies and sponsors of prescription 
drug plans, or from requiring a particular formulary or price structure 
for covered Part D drugs. The CBO has estimated that there would be 
negligible savings if this provision was struck,24 but 
others disagree. They point to the substantial discounts obtained by 
other countries who negotiate on behalf of their citizens and by the 
U.S. Veteran's Administration as compelling evidence of the savings 
potential for Medicare.25 Even if HHS chose not to exercise 
its authority to negotiate for better prices (or exercised its 
authority poorly), the repeal of Section 1860D-11(i) may, nevertheless, 
promote better drug pricing for Medicare by changing the context in 
which drug pricing decisions are made--pharmaceutical manufacturers may 
be more likely to exercise restraint in their pricing decisions to 
avoid provoking a response from HHS.
---------------------------------------------------------------------------
    \24\ CBO Letter dated January 23, 2004 to the Honorable William H. 
Frist, M.D. accessed at http://www.cbo.gov/
showdoc.cfm?index=4986&sequence=0.
    \25\ See Families U.S.A., Another Hole in the Medicare Drug 
Benefit, March 2004 accessed at http://www.familiesusa.org/site/
DocServer/Another_Hole.pdf?docID=2885.
---------------------------------------------------------------------------
2. Hold states harmless from the cost of future changes to the Medicare 
        drug benefit that have the effect of driving up the rate of 
        Medicare drug spending growth.
    State officials are all too familiar with the phenomenon of special 
interest groups advocating, often successfully, at the state level for 
state insurance laws mandating specific benefits. The likelihood of 
this happening at the federal level with regard to the new Medicare 
drug benefit is surely high. Because the Clawback calculation is based 
on a comprehensive Medicaid drug benefit that is likely to be more 
generous than the basic Medicare benefit offered in 2006, states should 
not be forced to pay twice if future federal actions are taken to 
enhance the Medicare benefit in any way that would increase costs to 
states under the Clawback formula. For example, many states exclude 
certain classes of drugs (such as mental health drugs) from their PDLs 
and prior authorization programs. The Clawback obligation for these 
states will include the cost of this open access policy even though 
dual eligibles may not have the same open access to these drugs under 
the new Medicare benefit. If a mandate for open access to certain drugs 
or drug--classes is added to the Medicare benefit in the future, the 
cost of that mandate could increase the cost of the Clawback obligation 
to states forcing some states to pay for open access a second time.
3. Eliminate the MMA exclusion of certain drug classes from the 
        Medicare Part D drug benefit.
    The MMA excludes coverage for a number of drug classes that are 
optional but commonly covered under Medicaid, including over-the-
counter drugs, barbiturates used for seizures and benzodiazepines for 
anxiety. According to a recent study, more than half of dually eligible 
nursing home residents will be affected by the excluded drugs provision 
in the law because they are currently receiving at least one medication 
that will be excluded from coverage under Medicare Part D.26 
The exclusion of benzodiazepines and barbiturates has been identified 
as a particular concern due to their widespread use in elderly 
populations and the potential for therapeutic destabilization if 
discontinued.
---------------------------------------------------------------------------
    \26\ R. Stefancacci, ``The Cost of Being Excluded: Impact of 
Excluded Medications under Medicare Part D on Dually Eligible Nursing 
Home Residents,'' Health Policy Institute at the University of the 
Sciences in Philadelphia, February 16, 2005, citing an analysis 
conducted by Omnicare, Inc., a national long-term care pharmacy 
provider.
---------------------------------------------------------------------------
    For dual eligibles who need one of these excluded medications after 
January 1, 2006, they must either turn to Medicaid for coverage or 
prescribers will be forced to use alternative medications that will be 
less effective, more costly and, for some patients, even 
toxic.27 Thus, states will either bear the cost of providing 
the excluded drugs or incur greater nursing home or other costs due to 
adverse health consequences. For these reasons, the MMA should be 
amended to provide coverage for these excluded drug classes, at least 
for dual eligibles and other persons receiving Part D low-income 
subsidies.
---------------------------------------------------------------------------
    \27\ Ibid.
---------------------------------------------------------------------------
4. Amend the MMA to phase out the Clawback obligation completely.
    The MMA currently provides for a ten-year partial phase-down of the 
Clawback amount starting at 90 percent in 2006 and decreasing to 75 
percent in 2015 and thereafter. The timing of the phase-down could be 
accelerated or continued beyond 2015 with the goal of completely 
eliminating this unprecedented Medicare financing mechanism and fiscal 
obligation on states.

                       COMPARATIVE EFFECTIVENESS

    Advances in technology are transforming the delivery of health care 
in the United States but are also the most important long-term driver 
of health care costs. While the growth in prescription drug costs has 
recently moderated, this could turn out to be a temporary ``lull'' 
rather than a long-term trend due to technology advances.28 
Efforts to assist states to become more prudent Medicaid purchasers 
must therefore go beyond improved pricing strategies (such as changing 
from an AWP to an ASP-based pricing system), to also include the 
creation of new evidence-based tools that will assist states in 
appropriately controlling utilization.
---------------------------------------------------------------------------
    \28\ According to a recent study from the Tufts Center for Study of 
Drug Development, advances in biotechnology research and development 
will result in nearly 50 new biotech medicines receiving market 
approval from the U.S. Food and Drug Administration. Tufts Center for 
Study of Drug Development, March 7, 2005 press release, ``Biotechnology 
Advance have Improved R&D Success Rates, According to Tufts CSDD.''
---------------------------------------------------------------------------
    After four years of widespread, continuous efforts to cut Medicaid 
spending growth, an increasing number of states are turning to 
evidence-based disease management and case management programs with the 
hope that improving the quality of care will result in lower long-term 
costs for care. In the pharmacy arena, a consortium of 15 
organizations, including 13 states, has formed to create the Drug 
Effectiveness Review Project (DERP) whose purpose is to carry out 
systematic reviews of drug classes to inform state drug coverage 
decisions, usually in connection with a state's Medicaid PDL. These 
systematic reviews, conducted by Evidence-based Practice Centers 
(mostly university-based), array, evaluate and summarize the aggregate 
results of published and unpublished studies pertaining to the drug 
class under review. The DERP reports its findings concerning safety and 
effectiveness, but does not make policy or coverage recommendations. By 
September 2004, the DERP had completed twelve reviews and a number of 
review updates and had ten reviews in progress.
    At the federal level, interest in evidence-based health care 
management continues to grow as well. Most recently, Section 1013 of 
the MMA requires the HHS secretary to set priorities and target areas 
where evidence is needed to improve the quality, effectiveness and 
efficiency of health care provided by Medicare, Medicaid, and the State 
Children's Health Insurance Program (SCHIP). The HHS secretary is 
directed to:
        ``. . . conduct and support research to meet the priorities and 
        requests for scientific evidence and information identified by 
        such programs with respect to''
                  (i) the outcomes, comparative clinical effectiveness, 
                and appropriateness of health care items and services 
                (including prescription drugs); and
                  (ii) strategies for improving the efficiency and 
                effectiveness of such programs, including the ways in 
                which such items and services are organized, managed, 
                and delivered under such programs.''
    The MMA language recognizes the need to synthesize existing 
scientific research to inform policy and coverage decisions in public 
programs, but also recognizes that there are gaps in the current 
research base. In a recent article, the director of the Agency for 
Healthcare Research and Quality summarized the challenge as follows:
          ``For many policy issues, there is too little evidence to be 
        of much help. The challenge now is to ensure that clinicians 
        and policymakers can easily find out what we do know, support 
        research to answer what we do not know, and promote change in 
        the health care system that will continue to narrow the gap 
        between what we know and what we do.'' 29
---------------------------------------------------------------------------
    \29\ Carolyn M. Clancy and Kelly Cronin, ``Evidence-Based Decision 
Making: Global Evidence, Local Decisions,'' Health Affairs, 24, no. 1 
(2005): 161.
---------------------------------------------------------------------------
    State Medicaid programs and beneficiaries would benefit greatly 
from an expansion in the base of evidence-based research. In 
particular, this information could be used to help further define 
``smart'' PDLs rather than states relying too heavily on price 
considerations when making PDL coverage policies. Few if any states, 
however, are in a position, on their own, to undertake the needed 
research efforts. Clearly, it is more appropriate for the federal 
government to call upon its considerable technical, policy and fiscal 
resources to tackle this challenge for the benefit of all federal, 
state and private health care payers, purchasers and patients. While 
the federal government has taken steps in this direction, it has not 
gone far enough in light of the enormity of the health care fiscal 
challenges that loom ahead, and therefore the proposal below calls upon 
the federal government to commit greater resources to this effort.

Commit greater federal resources and leverage greater private resources 
        to carry out the purposes of Section 1013 of the MMA.
    Federal, state and private efforts in recent years have expanded 
the information base available to policymakers making health policy and 
coverage decisions, but a greater investment is needed to keep up with 
the pace of technological change. While the MMA authorized $50 million 
in FY 2004 to carry out Section 1013, only $15 million was actually 
budgeted for this effort in 2005 and the president's 2006 budget 
maintains funding at the $15 million level. At a minimum, funding to 
carry out Section 1013 should be increased to the amount authorized by 
the MMA. Greater investments would likely lead to greater cost 
containment benefits in the future.

                               CONCLUSION

    Medicaid spending growth is straining both state and federal 
budgets and growth in prescription drug spending continues to be a 
major culprit in that overall growth. While states have made great 
strides in reforming their prescription drug programs and have achieved 
significant savings, more could be done at the federal level to assist 
states. The federal government can help states obtain better drug 
pricing information and can also assist states in maximizing 
manufacturer rebates by adjusting the current rebate formula and better 
enforcing rebate program requirements. By ensuring the cost-effective 
management of the Medicare Part D drug benefit, the federal government 
can also mitigate the future growth of the states' Clawback 
obligations. Finally, like all payers, Medicaid's greatest hope for 
long-term cost containment benefits lies in the ability to manage drug 
utilization using evidenced-based tools. The federal government can 
play an instrumental role in supporting research efforts that will fill 
in the gaps in the existing research base and by supporting efforts to 
synthesize and analyze currently available research to better inform 
coverage decisions.

    Mr. Deal. I thank you, Ms. Gifford.
    Mr. Calfee.

              STATEMENT OF JOHN ``JACK'' E. CALFEE

    Mr. Calfee. Thank you, Mr. Chairman, for inviting me to 
testify at today's hearing. I will briefly summarize the main 
points in my written testimony, which I have submitted for the 
record.
    We all know that government reimbursement mechanisms often 
create vested interests, inefficiencies, and unexpectedly high 
costs. What seems reasonable when a program is created 
eventually becomes unreasonable as conditions change and the 
various parties take advantage of opportunities to reduce costs 
or increase compensation. One of the most common problems is 
the growth of cross-subsidies. These can be difficult to reduce 
or eliminate, regardless of how adverse their consequences may 
be. In the end, however, the only reasonable solution is to 
rework the program or eliminate cross-subsidies and replace 
them with a transparent system of direct, cost-based 
reimbursement.
    The Medicare part B reimbursement plan for oncology drugs 
is an example of how systems can go astray and how difficult it 
can be to fix things. In Medicare part B, overcompensation 
occurred largely because reimbursement was based on AWP. As 
drug sellers competed by lowering prices far below AWP, the 
resulting distortions finally compelled Congress to legislate a 
cost-based reimbursement system as part of the Medicare 
Modernization Act of 2003.
    More recently, Medicaid reimbursement for drugs obtained 
through retail pharmacies had begun to move along a similar 
path toward excessive reimbursement for filling prescriptions, 
especially prescriptions, as we have heard, for newer and more 
expensive generic drugs. We have heard about the recent CBO 
report, which documented the average pharmacy markup today in 
Medicaid is approximately $32 for newer generic drugs in the 
year 2002 compared to $10 for older generic drugs and $14 for 
old drugs. This pattern appears to reflect the oddities of an 
AWP-based reimbursement system rather than differences in 
actual cost.
    I urge Congress and CMS to change the current Medicaid 
pharmacy reimbursement plan to one that focuses more directly 
on covering reasonable costs. One way to do this would be to 
use the average sales price, or ASP, as defined in the Medicare 
Modernization Act, assuming this is a reasonable measure of 
drug acquisition costs by pharmacies. Another would be to use a 
suitably defined AMP, or average manufacturer price. Either 
approach would probably be superior to the highly artificial 
AWP prices now used.
    This change should be combined with reasonable compensation 
to pharmacies for the services they perform in filling Medicaid 
prescription. Although a fixed percentage market might be 
appropriate in some cases, such a plan, as we have heard, 
carries the danger of distorting incentives yet again, in 
effect rewarding pharmacies for filling more expensive 
prescriptions. Something closer to a fixed payment per 
prescription may be a better solution.
    I believe that new reductions of what Medicaid pays drug 
manufacturers would be inadvisable. Even today, those amounts 
are typically well below the lowest prices in the private 
sector. We should beware, I would suggest, of yet more 
reductions in the payoffs to research firms for developing the 
kinds of drugs that are most useful to Medicaid beneficiaries. 
As valuable as today's drugs are, it is perfectly clear that 
Medicaid patients desperately need a new generation of such 
crucial tools as anti-psychotics, anti-depressants, and 
diabetes treatments.
    Finally, I urge Congress and the States to make reasoned 
use of co-payments in order to control drug costs. Of course, 
such a tool should take account of the limited resources of 
patients who, for the most part, are served by Medicaid 
precisely because they lack substantial income and assets, but 
a nuance co-payment program, drawing on the extensive 
experience of the private sector, would control the overuse of 
some drugs without impeding the use of essential drugs whose 
value both to patients and the Medicaid system greatly exceeds 
their costs.
    That concludes my oral statement, Mr. Chairman.
    [The prepared statement of John ``Jack'' E. Calfee 
follows:]

  Prepared Statement of John E. Calfee, American Enterprise Institute

    I am honored to testify in these hearings on ``Medicaid 
Prescription Drugs: Examining Options for Payment Reform,'' held by the 
Committee on Energy and Commerce's Subcommittee on Health. I am a 
Resident Scholar at the American Enterprise Institute for Public Policy 
Research, where I have conducted research on pharmaceutical markets and 
other topics. The views I present are my own and do not necessarily 
represent those of the American Enterprise Institute.

 1. GOVERNMENT REIMBURSEMENT PROGRAMS OFTEN CREATE CROSSSUBSIDIES AND 
                           OTHER DISTORTIONS

    It is only natural that the details of federal reimbursement 
programs will reflect the specific circumstances in which those 
programs are created. Such details will inevitably create vested 
interests among both payers (who may realize savings not offered by the 
marketplace) and recipients (who may do better than they would in a 
competitive market). As conditions change, the program's essential 
features may persist because of these vested interests, even if a very 
different arrangement would emerge if the program were to be re-created 
under current conditions. As events proceed, very large inefficiencies 
can become very difficult to dismantle.
    A common feature of such hide-bound systems is crosssubsidies, in 
which one set of parties receives compensation or reimbursement in 
excess of reasonable levels at the expense of other parties, whose own 
reimbursements may be enlarged to compensate for the cross-subsidies. 
Another common feature is that suppliers and other parties act in 
economically rational ways to take advantage of crosssubsidies, to 
reduce the burden of funding crosssubsidies, and so on. Over time, 
these reactions can substantially increase the scope and magnitude of 
distortions including crosssubsidies.

2. CROSSSUBSIDIES AND SIMILAR MECHANISMS GREATLY COMPLICATE THE TASK OF 
         SETTING REASONABLE AND EFFICIENT REIMBURSEMENT LEVELS

    In reasonably competitive private markets, affected parties tend to 
eliminate or contain crosssubsidies and similar distortions, or reduce 
their effects to manageable levels. Inefficient government 
reimbursement methods, however, often persist despite growing 
inefficiencies. As systems become more complex, essential elements 
become difficult or impossible to measure. Administrative costs in 
health care systems, for example, may change radically in the face of 
new technology, altered patient or physician preferences, and 
innovative organizational methods. The task of disentangling subsidies, 
crosssubsidies, and straight-forward reimbursement may become nearly 
impossible. Even the most competent analysts may find it impossible to 
construct accurate measurements of the magnitude or even the direction 
of crosssubsidies.

  3. ELIMINATING OR MINIMIZING CROSSSUBSIDIES IS GENERALLY A GOOD IDEA

    Because managing the inefficiencies arising from crosssubsidies and 
related distortions in public reimbursement programs usually proves 
impossible in the long run, the best strategy is to eliminate 
crosssubsidies altogether. Assuming that private markets are not an 
alternative, a suitable goal is to assure that each party is reimbursed 
for acquisition and administrative costs in the most reasonable and 
feasible manner.

4. FEDERAL MEDICARE AND MEDICAID DRUG REIMBURSEMENT PROGRAMS ILLUSTRATE 
                             THESE PROBLEMS

    It became apparent more than a decade ago that the Medicare Part B 
program, which among other things reimburses physicians for infusion 
drugs (mainly cancer treatments), systematically over-compensated 
physicians and clinics.1 This engendered attempts by all 
parties to take advantage of the system, and even discouraged superior 
drug development because infusion products became favored over home-
injectibles or even simple pills. A striking feature of this system was 
that sellers competed to provide products at less than the list prices 
upon which reimbursement rates were based, and employed marketing tools 
to make physicians aware of the benefits of prescribing brands with 
large reimbursement margins. The list prices that underpinned 
reimbursement rates were obtained from the ``Average Wholesale Price'' 
(or AWP) lists now published by Thomson Micromedex's Red Book and First 
DataBank's Blue Book: Essential Directory of Pharmaceuticals. All this 
was widely known at the time. A series of public hearings and reports 
starting in 1989 (U.S. Senate 1989), along with TV and other news 
stories (e.g., NBC News, Jan. 15, 1997), and a 1997 radio address by 
President Clinton, repeatedly highlighted the basic dynamics of a 
situation in which vested interests made it difficult to dismantle a 
crosssubsidy system. Only in the past year has Congress provided means 
for CMS to adopt a more direct cost-based reimbursement mechanism (CBO, 
December 2004; Federal Register, Jan. 7, 2004).
---------------------------------------------------------------------------
    \1\ Useful sources include: MEDPAC 2003 (especially chap. 9); USGAO 
2001; and USGAO 2002.
---------------------------------------------------------------------------
    Recent reports from the Congressional Budget Office (December 2004 
and June 2005a), the Government Accountability Office (February 2005), 
and the USDHHS Office of the Inspector General (September 2004) have 
made clear that similar trends have come to characterize Medicaid 
reimbursement for pharmaceuticals obtained by patients through retail 
pharmacies. Among these trends are increasing pharmacy margins. This in 
itself does not necessarily indicate a problem, but margins appear to 
have become unreasonably large for generic drugs, especially newer 
generics. This can be seen in Table 1, which is based on the December 
2004 CBO report. Whereas average markups or margins increased from 
$8.70 in 1997 to $13.80 in 2002, prescriptions for newer generics 
involved average margins of $32.10 in 2002. Such large disparities 
appear to make little sense because the actual costs of filling 
prescriptions are relatively consistent across the bulk of generic and 
branded drug.

                                                     Table 1
 Medicaid's Prescription Drug Reimbursements, Wholesalers' and Pharmacies'' Acquisition Costs, and Margins, 1997
                                                    and 2002
                                    (all amounts in dollars per prescription)
----------------------------------------------------------------------------------------------------------------
                                   Reimbursements to           Acquisition costs                Margins
                                      Pharmacies         -------------------------------------------------------
                             ----------------------------
                                  1997          2002          1997          2002          1997          2002
----------------------------------------------------------------------------------------------------------------
All drugs...................         37.00         60.90         28.30         47.10          8.70         13.80
Generic drugs
  Newer.....................           N/A         45.70           N/A         13.60           N/A         32.10
  Older.....................         11.90         14.20          4.30          4.40          7.60          9.90
Brand-name drugs............         61.90         97.30         52.20         83.40          9.80         13.80
----------------------------------------------------------------------------------------------------------------
Source: All data are taken from Congressional Budget Office, ``Medicaid's Reimbursements to Pharmacies for
  Prescription Drugs,'' December 2004, Table 1.
N/A = not estimated because most ``newer'' generics were unavailable in 1997.

    The June 2005 CBO report (CBO 2005a, p. 3) documents that the 
source of the large and growing disparities in pharmacy margins is the 
widespread practice among the states of basing reimbursement upon the 
same AWP lists that used to be the basis for Medicare Part B 
reimbursement. Although AWP price lists may once have been bona fide 
attempts to describe common transaction prices from wholesalers, it is 
well known that current list prices are often substantially above 
acquisition costs. As long as pharmacy reimbursement is based upon AWP, 
however, we can expect generic manufacturers whose drugs are available 
at prices substantially below AWP to make pharmacies aware of this fact 
and to encourage the filling of prescriptions with high-margin 
generics. The December 2004 CBO report indicates that this tendency is 
increasing, with substantial potential impact on overall Medicaid 
costs.

           5. ALTERNATIVES TO AWP FOR REIMBURSEMENT PURPOSES

    I urge Congress and the states to reform the Medicaid drug 
reimbursement process to more closely reflect costs. Adopting a more 
accurate measure of drug acquisition costs is an essential part of 
this. The government reports cited above describe alternative 
acquisition cost indicators in some detail. The most promising appears 
to be ``average sales price,'' or ASP. According to the June 2005 CBO 
report (n. 6), ASP is defined in the Medicare Modernization Act of 2003 
as the average price charged to nonfederal buyers, taking into account 
volume discounts, prompt-pay discounts, cash discounts, free goods that 
are contingent on any purchase requirement, chargebacks, and rebates 
other than those paid under the Medicaid rebate program. Some of these 
adjustments, however, such as rebates and chargebacks, may be 
relatively unimportant for generics. Such adjustments are probably 
largely confined to the on-patent branded drug market, where large gaps 
between prices and manufacturing and marketing costs encourage private 
bargaining that can yield a substantial variation in prices among 
buyers of the same drug (cf. Frank 2001). In any case, however, the ASP 
measure, unlike AWP, is clearly tethered to actual market transactions 
and thus is not nearly as artificial as AWP prices. Basing 
reimbursement for drug acquisition on ASP prices would probably be a 
substantial improvement over the current system.

                       6. PHARMACY REIMBURSEMENT

    The changes just outlined would require changes in how pharmacies 
are reimbursed for filling Medicaid prescriptions. Again, I suggest 
basing reimbursement largely on reasonable costs. In some situations, a 
simple percentage add-on may be appropriate. But a percentage markup 
can seriously distort incentives because the effect is to generate 
larger pharmacy margins for more expensive drugs regardless of the 
costs of filling prescriptions. This could distort Medicaid generic 
drug usage toward higher cost drugs with little or no off-setting 
benefit. It might make more sense to explore some mix of percentage and 
fixed-amount reimbursement if that can be achieved without introducing 
new and even larger distortions.

7. PHARMACEUTICAL ACQUISITION PRICES IN MEDICAID ARE ALREADY LOW ENOUGH

    I also urge Congress and the states to avoid making further cuts in 
the prices paid by Medicaid to drug manufacturers. A series of measures 
in the past two decades has already pushed most of these prices below 
even the lowest private sector prices. This is because manufacturers, 
if they are to participate in Medicaid at all, must sell their drugs at 
prices that are usually adjusted below the ``best price'' in private 
sector sales--(cf. CBO June 2005a, p. 11, and CBO June 21, 2005 on the 
increasing magnitude of ``additional rebates'' beyond meeting best-
price levels in the private sector). This arrangement causes the 
Medicaid system to provide minimal payoffs for developing drugs to be 
used by the Medicaid population. In the long run, this could prove 
unfortunate. Certain conditions, notably schizophrenia, 
disproportionately afflict the Medicaid population (indeed, 
schizophrenia may be a prime reason why some people enter the Medicaid 
system in the first place). New drug development for these conditions 
is sorely needed. Even existing medicines can be costeffective in the 
sense of moderating or even reducing overall Medicaid costs, and they 
may improve beneficiaries' lives in ways that are otherwise difficult 
to achieve with patients who often defy traditional treatment. Steady 
reductions in the rewards for drug development for the Medicaid 
population are therefore inimical to advances in public health.

                            8. COST-CONTROL:

    The fact that Medicaid pays relatively little for pharmaceuticals 
reduces the potential gains to be had from additional measures to 
control drug costs. Nonetheless, co-payments offer an obvious tool for 
cost control. Congress might consider granting the states expanded 
authority to use this tool. It would make sense to borrow from what has 
been learned by the private sector in its extensive experimentation 
with drug co-pays. Given that lower than normal co-pays would be 
appropriate for the typical Medicaid beneficiary, a nuanced approach 
could be useful. For some drugs, a significant co-pay on the order of 
three to ten dollars might cause patients to consider whether an 
expensive anti-histamine, pain reliever, or anti-ulcer drug is worth 
the extra cost. For other drugs (such as anti-psychotics, perhaps, in 
addition to obvious candidates like vaccines), the Medicaid system 
might be better off if patients are encouraged by zero co-pays to fill 
their prescriptions and stick with their therapies.

                               References

    Clinton, Pres. William J. (1997) Radio address of Dec. 13, 1997.
    Congressional Budget Office (2004) ``Medicaid's Reimbursements to 
Pharmacies for Prescription Drugs,'' December 2004.
    Congressional Budget Office (2005a) ``Prices for Brand-Name Drugs 
Under Selected Federal Programs,'' June 2005.
    Congressional Budget Office (2005b) ``The Rebate Medicaid Receives 
on Brand-Name Prescription Drugs,'' June 21, 2005 (letter to Sen. 
Charles E. Grassley).
    Federal Register, Jan. 7, 2004, p. 1084-1132, Department of Health 
and Human Services, Centers for Medicare & Medicaid Services, 42 CFR 
Parts 405 and 414, ``Medicare Program: Changes to Medicare Payment for 
Drugs and Physician Fee Schedule Payments for Calendar Year 2004; 
Interim Final Rule.''
    Frank, Richard G. (2001) ``Prescription Drug Prices: Why Do Some 
Pay More Than Others Do?'' Health Affairs, v. 20, n. 2 (March-April), 
p. 115-128. Available (for subscribers) at content.healthaffairs.org/
cgi/reprint/20/2/115.pdf
    MEDPAC (Medicare Payment Advisory Commission) Variation and 
Innovation in Medicare, June 2003.
    NBC News, Jan. 15, 1997, ``Fleecing of America.''
    U.S. Department of Health and Human Services, Office of the 
Inspector General (2004) ``Variation in State Medicaid Drug Prices,'' 
September 2004.
    U.S. Government Accounting Office (GAO, 2000) ``Expanding Access to 
Federal Prices Could Cause Other Price Changes,'' GAO/HEHS 00-118, 
August.
    U.S. Government Accounting Office (GAO) (2001) ``Medicare Physician 
Fee Schedule: Practice Expense Payments to Oncologists Indicate Need 
for Overall Refinements,'' GAO-02-53, October.
    U.S. General Accounting Office (USGAO) (2002) ``VA and DOD Health 
Care: Factors Contributing to Reduced Pharmacy Costs and Continuing 
Challenges,'' testimony before the Subcommittee on National Security, 
Veterans Affairs, and International Relations, Committee on Government 
Reform, House of Representatives, July 22, 2002.
    U.S. Government Accountability Office (2005), ``Medicaid Drug 
Rebate Program:
    Inadequate Oversight Raises Concerns about Rebates Paid to 
States,'' February 2005.
    United States Senate, Special Committee on Aging (1989), Senate 
Majority Staff Report, ``Prescription Drug Prices: Are We Getting our 
Money's Worth?''

    Mr. Deal. Thank you very much.
    Very impressive panel. Let me start off with the 
questioning, and I will say, on Ms. Gifford's behalf, she had 
to leave to catch an airplane, and I don't think anybody 
anticipated that she would have to rush before the hearing was 
over with to catch the airplane, but that is what has happened 
today.
    Mr. Rodgers, we have been hearing great things about 
Arizona from Mr. Shadegg for a very long time, and I am 
beginning to understand now why he has been saying that. Let me 
just sort of review a few things. I mean, it seems like that 
all we really need to do is sort of patent the Arizona model 
and it would work for the rest of the country. Let me review 
what you said. You have the highest generic usage in the 
country, apparently, and that is one of the things we have been 
trying to encourage is greater generic use. You have a very 
high degree of patient satisfaction, less than 1 percent 
attributable to the pharmaceutical part of the complaints. You 
are doing it in an environment in which you have no co-pays, 
which is certainly one of the concerns that the pharmacies have 
as we talk about the idea of maybe raising co-pays, of the 
collectability of that and whether or not that is going to just 
have to be absorbed by the local pharmacist who never really 
effectively can collect that. You don't have that problem, 
because you don't have co-pays. And you don't have to deal with 
this issue that we are talking about whether to raise the 
rebates or not raise the rebates. You don't get any rebates. Am 
I correct on all of those features?
    Mr. Rodgers. Yes, you are.
    Mr. Deal. Well, there has got to be something, other than 
the good air, in Arizona that makes it all work. Let me ask a 
few questions that come to my mind.
    You are doing it through private plans. How many different 
plans do you have in the State?
    Mr. Rodgers. We have seven different acute care plans. We 
have six long-term care plans. And these are both for-profit, 
non-profit, as well as public plans. Some of our public 
organizations, counties, have their own plan.
    Mr. Deal. And I believe I understood you to say that all of 
your pharmacies are included in some plan. Is that correct?
    Mr. Rodgers. That is correct.
    Mr. Deal. So there is nobody left out of this approach?
    Mr. Rodgers. That is correct.
    Mr. Deal. Okay. Mr. Fuller, I guess I will ask you the next 
question, then. Are there any chain drug stores that don't go 
into Arizona because they have this plan in place that you know 
of?
    Mr. Fuller. I am certain that no one is staying out of 
Arizona because of this plan, and indeed, I think most of them, 
if not all of them, are participating in the plan.
    Mr. Deal. What is your reaction to the $2 payment to the 
pharmacists for filling the prescription? I would assume that 
in addition to that there is compensation through the plans 
back to the pharmacists in addition to the filling of the 
prescription. Is that right, Mr. Rodgers?
    Mr. Rodgers. The dispensing fee is a flat fee that the 
plans pay, but depending on what they have negotiated and 
rates, there may be dollars in there with the pharmacy, retail 
pharmacy. It is a negotiation, so different plans have 
different negotiations.
    Mr. Deal. And they may even include incentives if they use 
a higher proportion of generics, I assume, is one of the, 
maybe, incentives that are there?
    Mr. Rodgers. Well, actually, it is the physicians that 
determine the generic use.
    Mr. Deal. Okay. All right.
    Mr. Fuller, what is your reaction to that arrangement?
    Mr. Fuller. Very good question, and we have recently seen 
work completed out of the University of Texas that amalgamated 
information from, I think, 40 different chains on what the cost 
of prescribing was in these programs. Now it is important to 
understand that there is a lot of flexibility that the States 
have, as you heard about in Arizona. But the ranges of costs in 
prescribing were from $8.50 to about $10.50. The average is 
$9.45, so in another way, the pharmacy has to recover the cost 
of what it paid for the drug, and it probably has to find a way 
to recover about $9.45, or it is losing money. That doesn't 
mean that the dispensing fee has to be $9.45, because there are 
other ways of getting there. I think the one concern I would 
have would be if it was interpreted to mean that simply a $2 
dispensing fee covered the pharmacists' costs that would be an 
error.
    Mr. Deal. Right.
    Mr. Fuller. There has got to be a mechanism in place for 
the----
    Mr. Deal. Which is part of that negotiation that Mr. 
Rodgers----
    Mr. Fuller. Exactly.
    Mr. Deal. [continuing] referred to.
    Mr. Fuller. Well, it is not to say that it is not fair, but 
pharmacies can only participate, and I have already said they 
do participate in this, if they can recover their costs, the 
cost that they paid for the product, recover the cost of 
dispensing the medication, and make some small margin, and the 
profit margin is very, very small.
    Mr. Deal. You are probably not prepared to do this today, 
but would you give me a follow-up on what your pharmacists in 
Arizona have to say about the plan that they participate in and 
their degree of satisfaction? I think that would be a very 
interesting item.
    Mr. Fuller. Certainly, Mr. Chairman.
    Mr. Deal. And I might just close in my 10 seconds. Ms. 
Baldwin asked the question of CBO about how do you make any 
relationship to what we can predict in Medicare part D. I think 
you have made the point in your presentation that if we want 
some comparisons as to what to expect in Medicare part D--yours 
is a very good example of that--and if that is an example, you 
are currently 38 percent below the national average on 
pharmaceutical cost, as understand it. And in fact, you are 11 
percent below the next most cost-effective State, that being 
Michigan. So I suppose we sort of produce an answer to say that 
if we want some degree of speculation, maybe the Arizona plan 
would be a good way to reach that conclusion. Would that be an 
accurate statement?
    Mr. Rodgers. I think Arizona is unique because of the fact 
that we have managed care, and the MMA plan anticipates managed 
care as well as managed pharmacy benefits. So our members are 
already used to that. The key is that, again, the provider is 
the one who gets the leverage to prescribe brand or prescribe 
generic, and the key is will the providers' behavior change 
because they are in MMA? We don't know yet, but that is our 
concern.
    Mr. Deal. Thank you. My time has expired.
    Mr. Brown.
    Mr. Brown. Mr. Rodgers, thank you for explaining obviously 
a very good system.
    In spite of facts to the contrary, there is a pretty strong 
ideological bias on this committee that the private sector 
always does things better and can be counted on to deliver darn 
near anything to the public, and serving the public interests. 
I appreciate your comments about what you have done with 
managed care in Arizona with for-profits and not-for-profits. 
Do you just turn these programs over to the private sector for-
profits and not-for-profits and let them go to work? Or what 
kind of oversight do you have to make sure that they are 
serving the people of Arizona?
    Mr. Rodgers. Thank you for that question. No, I think the 
role that the State plays is to assure that the member first is 
getting the services that they are supposed to get. We contract 
with our health plans to assure that services are rendered, so 
we have a significant oversight responsibility. What we gain 
from the health plans is their negotiating power. They have 
information, and they can position in a way that oftentimes is 
difficult for a single State to position themselves. So we have 
been able to take advantage of that, but the reality is that 
the State has to be part of this as a public-private 
partnership, and that is how we refer to ourselves, as a 
public-private partnership, taking the best of what health 
plans have to offer, public, non-profit, as well as for-profit, 
as well as the best of what the State can offer in terms of 
assuring that things are done according to our requirements.
    Mr. Brown. Thank you. In the interest of Mr. Burgess and 
Mr. Bilirakis, and I think the chairman wants to try to finish 
before we go vote, because you would all have to wait for 
another 45 minutes to an hour, and my guess is you probably 
don't want to do that, let me just kind of go less than my 5 
minutes. I appreciate what you said about Arizona not having 
co-pays. I think that is very significant, especially in light 
of the fact that the Governors came in here saying that we 
needed co-pays and that we needed to up the co-pays. And there 
is all kind of evidence that that drives people out of the 
system and ends up often costing the system more, because they 
don't get health care when they need it; they get it at more 
expensive times. So I just wanted to thank you for your 
comments about that, and I think you can be used as an example 
for a whole lot of us in a whole lot of places.
    Thank you, Mr. Chairman.
    Mr. Deal. Thank you, Mr. Brown. I appreciate your 
cooperation on that.
    Mr. Bilirakis.
    Mr. Bilirakis. Thank you.
    Mr. Deal. We are going to try to finish, by the way----
    Mr. Bilirakis. Yes.
    Mr. Deal. [continuing] because we have about five votes.
    Mr. Bilirakis. Yes, we will try to get this thing done.
    Ms. King, does Medicaid overpay? Briefly.
    Ms. King. I can't answer that question based on the study 
that we conducted.
    Mr. Bilirakis. Okay.
    Ms. King. It is not an issue we have looked at.
    Mr. Bilirakis. What does GAO think of the Arizona plan? Is 
it working? Is the quality there? Is there good customer 
satisfaction, et cetera?
    Ms. King. I hate to give you another ``I don't know'', but 
we haven't evaluated it.
    Mr. Bilirakis. Oh, you have not evaluated it? That is not 
something you are charged to do, though, is it?
    Ms. King. Typically, we do our work at request of Members 
of Congress.
    Mr. Bilirakis. Yes, and you have not been requested to do 
it.
    Mr. Fuller, how do your pharmacists like the Arizona plan, 
the pharmacists in Arizona?
    Mr. Fuller. Well, I think it is a plan they certainly 
participate in, and it is certainly meeting the needs of many 
people in Arizona. It is a managed care plan. Some are 
speculating that the Medicare programs may, in fact, move to 
managed care, because you are really working on all of the 
healthcare costs associated with that patient. There do have to 
be incentives, clearly, to drive generic utilization, and I 
think understanding how those incentives work inside of managed 
care is important, particularly if there is a desire to turn 
away from the co-payments. The stand-alone plans that don't 
have some of the incentives that managed care would provide, 
would have a----
    Mr. Bilirakis. You are giving me a lawyer's answer. Your 
pharmacists, are they relatively happy with the plan or is it 
just that that is the only thing that is available?
    Mr. Fuller. It is hard to find pharmacists that are 
relatively happy today. I would say they are participating in 
the program, and the economic model is one that, clearly, most 
can live with. I don't think there is a problem with 
participation. I do promise to get back to the chairman and 
through him to the committee on a little bit more analytical 
document there.
    Mr. Bilirakis. And I would like to ask--there will be a 
number of inquiries coming at you all, which you would be 
responding in writing. I would also like to get the chain drug 
stores' comments on the rebate system. What do you think about 
the rebate system, and do you like it, and that sort of thing?
    In the interest of time, I will just go ahead and yield 
back for Mr. Burgess, Dr. Burgess. Thank you.
    Mr. Deal. Dr. Burgess.
    Mr. Burgess. Thank you, Mr. Chairman.
    Mr. Rodgers, I must admit, when you started your testimony, 
there were several things you said that sent cold chills down 
my spine and the step therapy. Of course, my familiarity with 
that is as a physician. When an insurance company did step 
therapy, they were basically practicing medicine without a 
license, but it sounds like, in your models, as that concept 
was developed further, that you do have buy-in from your 
providers. And I think that the chairman's enthusiasm for your 
program is well founded, but the key there is apparently how 
you treat your providers and how you use the word leverage. 
Break that down for the committee, and tell us how you have 
managed to do that.
    Mr. Rodgers. Really quickly, managed care has gotten a bad 
reputation because of how it has been managed, if you will. And 
it has, oftentimes, inappropriately leveraged providers by 
lowering rates and creating additional hassle. The key to 
controlling Medicaid cost is really having your providers buy 
into how your medical models work. And so we don't balance our 
budget on the back of our provider rates. But because we save 
in so many other areas, including in-patient utilization, 
emergency room utilization, the pharmacy costs, we are able to 
then allow our providers, especially our primary care 
physicians, who are so important, to have appropriate rates. 
And so that is the first premise of the program.
    I think the other is the fact that we have multiple plans 
allows the provider to choose between plans. If they don't like 
a particular plan, if they feel that plan has too many hassle 
factors, if you will, they can choose to contract with a 
different plan. And many of them do. They have their plans they 
like and two or three that they will contract with. Then the 
member chooses the plan based on the provider networks. So it 
is a balanced approach to the market. It allows the member to 
make a choice based on provider network and to choose a 
provider within the plan. It allows the provider to choose the 
plan they want to contract with. And the plans themselves then 
compete for both providers as well as members.
    Mr. Burgess. And Mr. Chairman, I would just point out that 
I think the State of Arizona is very fortunate to have Mr. 
Rodgers in charge of that plan. I suspect it would not work as 
well without his steady hand on the helm, and perhaps we ought 
to see if we can steal him away. It is time for you to shine at 
the national level.
    As far as the issue of co-pays go----
    Mr. Rodgers. My Governor is in town. I----
    Mr. Burgess. I understand. As far as the issue of co-pays 
goes, I, too, am grateful, and I understand the issue of co-
pays. I do think we have to be careful to completely abandon 
the concept, though I feel that the community pharmacists' 
pain, or the chain store pharmacists' pain that if the co-pay 
is not paid, you are essentially the one who is paying that. 
And of course, that would be true at the physician or hospital 
level as well.
    Mr. Calfee, just so that we are sure to include you in 
this, your neighbor there, Ms. Gifford, who had to leave, made 
the statement that one of the things that she thought would be 
important would be for the Director of HHS to be able to 
negotiate drug prices. Do you have an opinion about that?
    Mr. Calfee. Yes. I think that would be a bad idea. I think 
we are much better off if we have a situation more like the one 
that was just described in Arizona where you have competing 
buyers and competing sellers. If you have only one buyer, the 
danger is that you are going to start forcing prices down 
toward marginal costs, and what that does is it reduces the 
payoff from research and development, and at some point, you 
are going to start to dry up the supply of innovative drugs.
    Mr. Burgess. Thank you. And then, Mr. Fuller, just one last 
point, and you might get to the committee. We weren't supposed 
to use any more three-letter acronyms, but you brought us a new 
one with your wholesale acquisition cost. And that seems to be, 
as you used the term, a real world representation of what 
things actually cost. And you might just provide the committee 
a little bit more information about that, and perhaps, Mr. 
Chairman, that is something we should look into as well. So I 
thank you for bringing that to our attention.
    Mr. Fuller. We certainly will do so.
    Mr. Deal. Well, thank you. I appreciate the members' 
cooperation, and I certainly appreciate, once again, the 
participation of this panel. It really is one of the better 
hearings I think we have had on this issue. We are beginning to 
broach the subject, as you can tell, and try to educate 
ourselves, and you have been very helpful in that endeavor. And 
we thank each of you.
    We apologize again for the time delay. You may very well be 
asked to respond to some written questions that the committee 
members may have, and we would appreciate your doing that as 
well.
    Thank you again for your presence. This hearing is 
adjourned.
    [Whereupon, at 6:09 p.m., the subcommittee was adjourned.]
    [Additional material submitted for the record follows:]

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  Prepared Statement of The Association for Community Affiliated Plans
    The Association for Community Affiliated Plans (ACAP) is pleased to 
submit this statement for the record to the House Energy and Commerce 
Committee on the topic of the hearing entitled Medicaid Prescription 
Drugs: Examining Options for Payment Reform. ACAP represents 19 
Medicaid-focused managed care plans that serve over two million 
Medicaid beneficiaries in states across the country. The mission of our 
organization is to improve the health of vulnerable populations through 
the support of Medicaid-focused community-affiliated health plans 
committed to these populations and the providers who serve them.
    ACAP is supporting a policy change that will help Federal and State 
governments save billions of dollars on prescription drugs provided to 
Medicaid beneficiaries enrolled in Medicaid health plans. This policy 
change would give Medicaid health plans direct access to the Medicaid 
drug rebate. The following statement outlines the history of the drug 
rebate and the justification for the policy change.
    Created by the Omnibus Budget Reconciliation Act (OBRA) of 1990, 
the Medicaid Drug Rebate Program requires a drug manufacturer to have a 
rebate agreement with the Secretary of the Department of Health and 
Human Services for States to receive federal funding for outpatient 
drugs dispensed to Medicaid patients. At the time the law was enacted, 
managed care organizations were excluded from access to the drug rebate 
program. In 1990, only 2.8 million people were enrolled in Medicaid 
managed care and so the savings lost by the carve-out were relatively 
small. Today, 12 million people are enrolled in capitated managed care 
plans.
    Under the drug rebate, States receive between 18 and 20% discount 
on brand name drug prices and between 10 and 11% for generic drug 
prices. At the time the rebate was enacted, many of the plans in 
Medicaid were large commercial plans who believed that they could get 
better discounts than the federal rebate. Today, Medicaid-focused plans 
are the fastest growing sector in Medicaid managed care. According to a 
study by the Lewin Group, Medicaid-focused MCOs typically only receive 
about a 6% discount on brand name drugs and no discount on generics. 
Because many MCOs (particularly smaller Medicaid-focused MCOs) do not 
have the capacity to negotiate deeper discounts with drug companies, 
Medicaid is overpaying for prescription drugs for enrollees in Medicaid 
health plans.
    The Lewin Group estimates that this proposal could save the federal 
and state governments and plans up to $2 billion over 10 years. This 
legislation has been endorsed by organizations representing both state 
government and the managed care industry, including the National 
Association of State Medicaid Directors, the Association for Community 
Affiliated Plans, Medicaid Health Plans of America, the National 
Association of Community Health Centers, and now, the National 
Governors Association.
    As Congress is forced to make tough choices to control the costs of 
the Medicaid program, this proposal offers a ``no-harm'' option to 
control costs and ensure that there is not a prima facie pharmacy cost 
disadvantage to states using managed care as a cost effective 
alternative to Medicaid fee-for-service. We urge Congress to implement 
it as part of any Medicaid reform proposal that moves forward.
                                 ______
                                 
 Prepared Statement of Ronald Pollack, Executive Director, Families USA

    Thank you for allowing us to submit this statement for the record. 
Families USA is a ational organization for health care consumers. Our 
mission is ti ensure that all Americans have access to high-quality 
affordable health care. Like everyone at the hearing, we aer deeply 
concerned about the future of the Medicaid progran and look forward to 
working with the Energy and Commerce Committee to strengthen and 
impr4ovr Medicaid on behalf of the 53 million vulnerable children, 
seniors and people with disabilitieswho rely on the program for their 
health care needs.
    As you know, the Budget Resolution requires the Senate Finance 
Committee to identify $10 billion in budget cuts over the next 5 years. 
Similarly, it requires the House Energy and Commerce Committee to 
propose $14.7 billion in cuts over the same periob. Although the Budget 
Resolution does not explicitly direct these cuts to come from any 
specific programs, Medicaid has clearly been targeted and, in large 
part, that is why we are all here today.
    First, it is important to emphasize that there is no requirement to 
cut as much as $10 billion from Medicaid. The cuts can occur through 
savings in other programs and as much of these expected savings as 
possible should come from programs not targeted toward low-income 
Americans. What is more, the budget process is not an appropriate forum 
for a conversation about ``reforming' or in any way restructuring 
Medicaid. The program should be thoughtfully scrutinized to see if 
there are ways to make it more cost-effective and efficient--and if so, 
those changes should be enacted.
    There is, however,, one area where most agree some savings can be 
found without reducing services essential to those enrolled in the 
program. That is the area of prescription drug spending. There is 
widespread agreement that Medicaid pays too . . .
    . . . in front of this Committee last week contains several very 
helpful recommendations regarding prescription drugs. We look forward 
to working with the Governors on their proposed improvements aimed at 
decreasing the costs of prescription drugs that are purchased by 
Medicaid.
    There are lots of specific changes that could be instituted to help 
the federal government and the states reduce the rapidly increasing 
costs of prescription drugs. Such policies would need to be crafted 
carefully with appropriate safeguards to ensure that people are able to 
get the drugs they need and Medicaid gets the best price possible for 
drugs, and to encourage responsible prescribing, dispensing, and 
utilization of drugs. Strategies that may be worth considering include: 
changing the formula for calculating Medicaid ``best price'' and 
Medicaid rebates; changing the reimbursement rates to pharmacists for 
dispensing drugs; and improving the management of the prescription drug 
rebate program.
    Families USA looks forward to working with this Committee to 
achieve as many savings as possible from prescription drugs. However, 
to the extent that Congress seeks budget savings from the other parts 
of the Medicaid program, certain principles should guide its work. 
Those principles include the following:
    Health and long-term care coverage must continue to be guaranteed 
for those who qualify for Medicaid. Like Medicare, Medicaid assures 
that people who qualify must be enrolled and not be placed on waiting 
lists. Any changes in this basic principle would leave vulnerable 
people without access to health care, undermining the very purpose of 
the Medicaid program.
    Financing should continue to be fully shared between the federal 
government and the states without caps. Today, the federal government 
guarantees to states that it will pay at least half of Medicaid's 
costs. Policies that shift costs and risks to the states or that impose 
caps on federal payments to the states (such as block grants) will lead 
to fiscal burdens on the states that they cannot afford and will result 
in significant cutbacks of coverage and a weakening of the health care 
system.
    Benefits and cost-sharing should reflect the needs and economic 
circumstances of the people served by Medicaid. The Medicaid benefit 
package should be comprehensive and ensure that people are able to 
access benefits they need. Needed medical services should be available 
and affordable to the elderly, children, people with disabilities, and 
other adults covered by the program whose low incomes make it 
impossible for them to afford significant out-of-pocket costs. Changes 
that would effectively deny access to needed care or saddle low-income 
people and their families with costs they cannot afford to pay are 
counterproductive and inconsistent with the program's mission.

                                 
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