Medicaid Drug Rebate Program: Inadequate Oversight Raises	 
Concerns about Rebates Paid to States (04-FEB-05, GAO-05-102).	 
                                                                 
To help control Medicaid spending on drugs, states receive	 
rebates from pharmaceutical manufacturers through the Medicaid	 
drug rebate program. Rebates are based on two prices--best price 
and average manufacturer price (AMP)--reported by manufacturers. 
Both reflect manufacturers' prices to various entities, 	 
accounting for certain financial concessions like discounts.	 
Concerns have been raised about rising Medicaid drug spending.	 
GAO studied (1) federal oversight of manufacturer-reported best  
prices and AMPs and the methods used to determine them, (2) how  
manufacturers' determinations of those prices could have affected
rebates, and (3) how the rebate program reflects financial	 
concessions in the private market.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-102 					        
    ACCNO:   A16936						        
  TITLE:     Medicaid Drug Rebate Program: Inadequate Oversight Raises
Concerns about Rebates Paid to States				 
     DATE:   02/04/2005 
  SUBJECT:   Drugs						 
	     Health care cost control				 
	     Health insurance					 
	     Pharmaceutical industry				 
	     Prices and pricing 				 
	     Data integrity					 
	     Manufacturing industry				 
	     Rebates						 
	     Medicaid						 
	     Medicaid Drug Rebate Program			 

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GAO-05-102

United States Government Accountability Office

GAO

                       Report to Congressional Requesters

February 2005

MEDICAID DRUG REBATE PROGRAM

       Inadequate Oversight Raises Concerns about Rebates Paid to States

GAO-05-102

February 2005

MEDICAID DRUG REBATE PROGRAM

Inadequate Oversight Raises Concerns about Rebates Paid to States

  What GAO Found

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

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

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

United States Government Accountability Office

Contents

  Letter 1

Results in Brief 4
Background 6
Current Program Oversight Does Not Ensure That Manufacturer-

Reported Prices or Price Determination Methods Are Consistent
with Program Criteria 10
Manufacturer Price Determination Methods Varied: Some Could
Have Led to Lower Rebates 15
Rebate Program Does Not Clearly Address Certain Financial

Concessions Negotiated by PBMs 19
Conclusions 23
Recommendations for Executive Action 23
Agency and Industry Comments and Our Response 23

Appendix I	Comments from the Department of Health and Human Services

  Appendix II GAO Contact and Staff Acknowledgments 32

GAO Contact 32
Acknowledgments 32

  Figure

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

                 Page i GAO-05-102 Medicaid Drug Rebate Program

Abbreviations

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

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protection in the United States. It may be reproduced and distributed in
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separately.

                Page ii GAO-05-102 Medicaid Drug Rebate Program

United States Government Accountability Office Washington, DC 20548

February 4, 2005

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

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

Prescription drug spending accounts for a substantial and growing share
of state Medicaid program outlays.1 The Omnibus Budget Reconciliation
Act of 1990 established the Medicaid drug rebate program2 to help control
Medicaid drug spending. Under the rebate program, pharmaceutical
manufacturers pay rebates to states as a condition for the federal
contribution to Medicaid spending for the manufacturers' outpatient
prescription drugs. In fiscal year 2002, Medicaid drug expenditures were
$29.3 billion out of $258.2 billion in total Medicaid spending;3 under the
rebate program, manufacturers paid rebates to states of about $5.6 billion
for covered outpatient drugs.4 In recent years, concerns have been raised
about increasing Medicaid spending on prescription drugs. Medicaid drug
spending increased at an annual average rate of 19 percent from fiscal
year

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

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

3State 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.

4This 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.

Page 1 GAO-05-102 Medicaid Drug Rebate Program

2000 to 2002, while Medicaid spending as a whole grew 12 percent annually
during that period.5

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

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

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

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

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

8The 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.

                 Page 2 GAO-05-102 Medicaid Drug Rebate Program

conducts audits, evaluations, and investigations pertaining to HHS
programs.

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

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

To report on the oversight of manufacturer-reported prices and methods, we
reviewed the rebate statute, the standard rebate agreement, CMS program
memoranda, and OIG reports on the rebate program. We also interviewed
officials from CMS and OIG. To assess how manufacturers' price
determination methods could have affected rebate amounts, we reviewed the
pricing methodologies for the 13 manufacturers that accounted for the
highest Medicaid expenditures in the last two quarters of 2000. We
compared manufacturers' methods of determining best price and AMP to the
rebate statute, rebate agreement, and relevant CMS program memoranda. In
addition, we examined sales transaction data provided by these
manufacturers. We received data for the 10 brand name drugs that produced
the highest Medicaid expenditures for the last two quarters of 2000 for
each manufacturer, as well as data for 5 additional frequently prescribed
brand name drugs-135 drugs in total. We examined the sales transaction
data to understand how manufacturers implemented their price determination
methods and to calculate the impact of manufacturer practices on rebates.
Because we purposely selected manufacturers and drugs that accounted for a
large share of Medicaid drug

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

                 Page 3 GAO-05-102 Medicaid Drug Rebate Program

spending, the results of our analysis cannot be generalized. To examine
how the rebate program reflects financial concessions available in the
private market, we reviewed the rebate statute, the standard rebate
agreement, and CMS program memoranda; market literature; and recent
financial statements of three large pharmacy benefit managers (PBM), which
manage prescription drug benefits for third-party payers.

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

                                Results in Brief

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

                 Page 4 GAO-05-102 Medicaid Drug Rebate Program

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

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

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

                 Page 5 GAO-05-102 Medicaid Drug Rebate Program

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

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.

Background

                            Features of the Private
                             Pharmaceutical Market

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

The amount a manufacturer actually realizes for a drug is not always the
same as the price that is paid to the manufacturer at the time of sale.
Manufacturers may offer purchasers rebates or discounts that may be

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

Page 6 GAO-05-102 Medicaid Drug Rebate Program

realized after the initial sale, such as those based on the volume of
drugs the purchasers buy during a specified period or the timeliness of
their payment. In some cases, purchasers negotiate a price with the
manufacturer that is below what a wholesaler pays the manufacturer for a
given drug. In such a circumstance, a wholesaler may sell the drug to the
purchaser at the lower negotiated price and then request from the
manufacturer a "chargeback"-the difference between the price the
wholesaler paid for the drug and the purchaser's negotiated price.

    The Medicaid Drug Rebate Program

The statute governing the Medicaid drug rebate program and the standard
rebate agreement that CMS signs with each manufacturer define best price
and AMP and specify how those prices are to be used to determine the
rebates due to states. In the absence of program regulations,11 CMS has
issued program memoranda12 in order to provide further guidance to
manufacturers regarding how to determine best price and AMP, some of which
were in response to questions that arose regarding the methods that
manufacturers were using to determine those prices.13 The rebate agreement
states that in the absence of specific guidance on the determination of
best price and AMP, manufacturers may make "reasonable assumptions" as
long as those assumptions are consistent with the "intent" of the law,
regulations, and the rebate agreement.14 As a result, price determination
methods may vary across manufacturers, particularly with respect to which
transactions they consider when determining best price and AMP.

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

12As 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.

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

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

                 Page 7 GAO-05-102 Medicaid Drug Rebate Program

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

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

15See 42 U.S.C. S: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.

16Sales 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.

17See 42 U.S.C. S: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."

18Under 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).

                 Page 8 GAO-05-102 Medicaid Drug Rebate Program

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

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

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

19See 42 U.S.C. S:1396r-8(c)(1).

Page 9 GAO-05-102 Medicaid Drug Rebate Program

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

2004, limits the time for manufacturers to report any price adjustments to
3 years after the quarter for which the original price was reported.20

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

    CMS's Review of Manufacturer-Reported Prices Is Limited

As part of the agency's administration of the Medicaid drug rebate
program, CMS reviews drug prices submitted by approximately 550
manufacturers that participate in the program. Each quarter, CMS conducts
automated data edit checks on the best prices and AMPs for about 25,000
drugs to identify reporting errors. These checks are intended to allow CMS
to make sure all drugs for which manufacturers report prices are in its
database of Medicaid-covered drugs and to ensure that those prices are
submitted in the correct format. The agency's automated data checks also
are intended to ensure that the correct price is used when there are
multiple prices for the same drug. When data checks indicate a

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

                Page 10 GAO-05-102 Medicaid Drug Rebate Program

potential reporting error, CMS sends an edit report to the manufacturer
asking for corrected drug prices. However, CMS does not have a mechanism
in place to track whether, in fact, manufacturers submit corrected prices.

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

    Price Determination Methods Are Reviewed Only When Manufacturers Request
    Recalculations

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

                Page 11 GAO-05-102 Medicaid Drug Rebate Program

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

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

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

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

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

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

                Page 12 GAO-05-102 Medicaid Drug Rebate Program

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.24 OIG found it could not evaluate the methods these
manufacturers used to determine AMP because neither the rebate statute nor
CMS had provided sufficiently detailed instructions on methods for
calculating AMP. OIG therefore advised CMS that it planned no future AMP
data audits until CMS developed a specific written policy on how AMP was
to be calculated. CMS disagreed, saying that the rebate statute and rebate
agreement had already established a methodology for computing AMP, and
stressed that this methodology was clarified, at manufacturer request, on
an as-needed basis through conversations with

25

individual manufacturers.

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

In its third review, conducted in 1997, OIG attempted to review a
manufacturer's recalculation request but again reported that it was unable
to complete its evaluation because of a lack of specific guidance on
determining AMP and a lack of manufacturer documentation supporting its
revised AMP. In the absence of guidance from CMS, OIG defined retail

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

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

26OIG reports on individual manufacturers are not publicly available.

                Page 13 GAO-05-102 Medicaid Drug Rebate Program

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.27 As of October
2004, CMS had not required any revision of this manufacturer's AMP
determinations.

In its fourth review of manufacturer-reported prices issued in 2001, OIG
investigated how manufacturers were treating repackagers-entities such as
HMOs that repackage or relabel drugs under their own names-in their best
price determinations. The work followed up on previous work OIG conducted
in response to a congressional inquiry in 1999. The rebate statute states
that HMO sales are required to be included in best price determinations.
CMS's June 1997 program memorandum stated that sales to other
manufacturers that repackage the drugs are to be excluded from best price
determinations. However, the rebate statute, rebate agreement, and CMS
program memoranda did not address how HMOs should be treated when they act
as repackagers. In a letter issued in response to the 1999 congressional
request, OIG reported that excluding drug sales to two HMOs that acted as
repackagers from best price determinations lowered state rebate amounts by
$27.8 million in fiscal year 1998.28 In July 2000, CMS issued an
additional program memorandum to manufacturers stating that sales to an
HMO should be considered in best price determinations

27In 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.

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

                Page 14 GAO-05-102 Medicaid Drug Rebate Program

regardless of whether the HMO was a repackager.29 In 2001, OIG issued its
fourth review, reporting that states lost $80.7 million in rebates in
fiscal year 1999 due to improperly excluded drug sales to HMO
repackagers.30 In September 2004, a CMS official told us that CMS planned
to release a program memorandum instructing manufacturers to revise prior
rebates for which they had excluded sales to HMOs from best price.
However, CMS does not have a mechanism in place to track that
manufacturers have made these rebate adjustments and therefore cannot
verify that manufacturers have made or will make these adjustments.

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

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

We found considerable variation in the methods that manufacturers used to
determine best price and AMP. Manufacturers are allowed to make reasonable
assumptions when determining best price and AMP, as long as those
assumptions are consistent with the law and the rebate agreement. The
assumptions often pertain to the transactions, including discounts or
other price reductions, that are considered in determining best price and
AMP. We found that in some cases manufacturers' assumptions could have led
to lower rebates and in other cases to higher rebates. Manufacturers

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

30See Department of Health and Human Services, Office of Inspector
General, Medicaid Drug Rebates: Sales to Repackagers Excluded from Best
Price Determinations, A-06-0000056 (Washington, D.C.: March 2001).

                Page 15 GAO-05-102 Medicaid Drug Rebate Program

can later revise their assumptions and request recalculations of
previously paid rebates, which can result in states repaying any excess
rebates.

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

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

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

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

                Page 16 GAO-05-102 Medicaid Drug Rebate Program

order portion of their business resemble a volume-based discount that
adjusts the price actually realized. Some manufacturers told us that they
accounted for the portion of administrative fees paid to PBMs associated
with the PBMs' mail-order pharmacies in their determinations of best price
or AMP. In contrast, others said they did not incorporate this portion of
any administrative fees paid to PBMs in either best price or AMP. Some of
those manufacturers characterized these fees as payments for services
rather than adjustments to prices.

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

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

                Page 17 GAO-05-102 Medicaid Drug Rebate Program

incorporate the effect of both price reductions when determining best
price and AMP. Some of these manufacturers indicated that they did not
combine these price reductions because the price reductions occurred in
two unrelated transactions to two separate purchasers.

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

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

Page 18 GAO-05-102 Medicaid Drug Rebate Program

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

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

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

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

Certain manufacturer financial concessions that are negotiated by PBMs on
behalf of their third-party payer clients, such as employer-sponsored
health plans and other health insurers, are not clearly reflected in best
price or AMP. PBMs, in one of the roles they play in the market, may
negotiate payments from manufacturers to help reduce their third-party

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

                Page 19 GAO-05-102 Medicaid Drug Rebate Program

payer clients' costs for prescription drugs.34 (In these circumstances,
the third-party payer does not purchase drugs directly from the
manufacturer but instead covers a portion of the cost when its enrollees
purchase drugs from pharmacies.35) The basis of these PBM-negotiated
manufacturer payments varies.36 For example, manufacturers may make a
payment for each unit of a drug that is purchased by third-party payer
enrollees or may vary payment depending on a PBM's ability to increase the
utilization, or expand the market share, of a drug.37 The payment may be
related to a specific drug or a range of drugs offered by the
manufacturer.

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

34GAO-03-196.

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

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

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

                Page 20 GAO-05-102 Medicaid Drug Rebate Program

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,38
contributing to a market that is much more complex, particularly with
respect to the types of financial arrangements involving manufacturers.
PBMs now commonly negotiate with manufacturers for payments on behalf of
their clients, in addition to providing other services.39 Although
complete data on the prevalence and magnitude of PBM-negotiated
manufacturer payments are not readily available, PBM officials and
industry experts have said that these and other manufacturer payments to
PBMs are a large portion of PBMs' earnings;40 further, recent public
financial information suggests that manufacturer payments to PBMs as a
whole are substantial and key to PBMs' profitability.41

CMS has acknowledged the complexity that arrangements between
manufacturers and PBMs introduce into the rebate program but has not
clearly addressed how these arrangements should be reflected in
manufacturer-reported prices. In 1997, CMS issued program memoranda that
noted new types of arrangements involving manufacturer payments to PBMs
and attempted to clarify whether those arrangements should be

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

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

40GAO-03-196.

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

                Page 21 GAO-05-102 Medicaid Drug Rebate Program

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

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

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

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

44A 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.

45A 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.

                Page 22 GAO-05-102 Medicaid Drug Rebate Program

Conclusions

Recommendations for Executive Action

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

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

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

o  Implement, in consultation with OIG, systematic oversight of the price

  Agency and Industry Comments and Our Response

determination methods employed by pharmaceutical manufacturers and a plan
to ensure the accuracy of manufacturer-reported prices and rebates paid to
states.

We received written comments on a draft of this report from HHS, which
incorporated comments from CMS and OIG. (See app. I.) HHS concurred, in
part, with our recommendation that CMS issue clear guidance on price
determination methods, noting agreement that such guidance would help
manufacturers, particularly with regard to accounting for sales to PBMs.
HHS stated that those issues would be examined and an assessment made
about where more guidance was needed. HHS noted that effort had been
devoted to providing guidance and that CMS would examine the resources
allocated to its review capabilities. In responding to our discussion of
the changing pharmaceutical market, however, the comments noted that
guidance could not address all current and potential arrangements in the

Page 23 GAO-05-102 Medicaid Drug Rebate Program

pharmaceutical market and therefore case-by-case guidance would continue
to be necessary to address specific situations. In responding to our
discussion of manufacturers' price determination methods, the comments
stated that a response to our conclusion that some manufacturers'
practices could lower or raise rebates was not possible because we did not
provide sufficient information on manufacturers' practices. We believe
that accurate and timely guidance could reduce the need for case-by-case
determinations. Although we cannot present the detailed assumptions that
various manufacturers made in interpreting and implementing program
guidance, because that information is proprietary, we did provide examples
of the different price determination methods and assumptions that can
affect best price and AMP and, therefore, rebates.

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

                Page 24 GAO-05-102 Medicaid Drug Rebate Program

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

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

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

                Page 25 GAO-05-102 Medicaid Drug Rebate Program

As agreed with your offices, unless you publicly announce its contents
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after its
date. We will then send copies of this report to the Secretary of Health
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Human Services, the Administrator of CMS, the Acting Inspector General
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If you or your staffs have any questions about this report, please call
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listed in appendix II.

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

                Page 26 GAO-05-102 Medicaid Drug Rebate Program

Page 27 GAO-05-102 Medicaid Drug Rebate Program

                Page 28 GAO-05-102 Medicaid Drug Rebate Program

                Page 29 GAO-05-102 Medicaid Drug Rebate Program

                Page 30 GAO-05-102 Medicaid Drug Rebate Program

                Page 31 GAO-05-102 Medicaid Drug Rebate Program

Appendix II: GAO Contact and Staff Acknowledgments

GAO Contact Marjorie Kanof, (202) 512-7114

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

            (290343) Page 32 GAO-05-102 Medicaid Drug Rebate Program

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