Medicaid Drug Rebate Program: Inadequate Oversight Raises	 
Concerns about Rebates Paid to States (22-JUN-05, GAO-05-850T).  
                                                                 
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. 
GAO was asked to discuss issues relating to the rebate program	 
and in February 2005 issued a report, Medicaid Drug Rebate	 
Program: Inadequate Oversight Raises Concerns about Rebates Paid 
to States (GAO-05-102). For that report, GAO reviewed program	 
guidance and OIG reports and conducted an analysis of rebates for
brand name drugs. This testimony is based on the February 2005	 
report. 							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-850T					        
    ACCNO:   A27517						        
  TITLE:     Medicaid Drug Rebate Program: Inadequate Oversight Raises
Concerns about Rebates Paid to States				 
     DATE:   06/22/2005 
  SUBJECT:   Data integrity					 
	     Drugs						 
	     Health care cost control				 
	     Health insurance					 
	     Manufacturing industry				 
	     Medicaid						 
	     Pharmaceutical industry				 
	     Prices and pricing 				 
	     Rebates						 
	     Medicaid Drug Rebate Program			 

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GAO-05-850T

     

     * Background
     * Program Oversight Does Not Ensure That Manufacturer-Reported
     * Manufacturer Price Determination Methods Varied: Some Could
     * Rebate Program Does Not Clearly Address Certain Financial Co
     * Concluding Observations
     * Contact and Staff Acknowledgments
          * Order by Mail or Phone

Testimony

Before the Subcommittee on Health, Committee on Energy and Commerce, House
of Representatives

United States Government Accountability Office

GAO

For Release on Delivery Expected at 2:00 p.m. EDT

Wednesday, June 22, 2005

MEDICAID DRUG REBATEPROGRAM

Inadequate Oversight Raises Concerns about Rebates Paid to States

Statement of Kathleen King

Director, Health Care

GAO-05-850T

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
Saes, 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 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 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

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.

1See GAO, Medicaid Drug Rebae Program: Inadequate Oversight Raises
Concerns aboutRebates Paid to Staes, GAO-05-102 (Washington, D.C.: Feb. 4,
2005).

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.

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).

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.

5This 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.

6The 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 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

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 memoranda9 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.

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.

7See GAO, Federal Employees' Heath Benefits: Effects of Using Pharmacy
Beneft Managers on Health Plans, Enroees, and Pharmacies, GAO-03-196
(Washington, D.C.: Jan. 10, 2003).

8In 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).

9As 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.

10CMS 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.

11The rebate agreement also requires manufacturers to maintain records of
their assumptions.

12See 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.

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.

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.

13Sales 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.

14See 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."

15Under 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).

16See 42 U.S.C. S: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

17The 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.

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.

18In 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.

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

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.

19See HHS OIG, Medicaid Drug Rebates The Health Care Financing
Administration Needsto Provide Additional Guidance to Drug Manufacturers
to Beter Implemen the Program, A-06-91-00092 (Washington, D.C.: November
1992).

20Although 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 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.

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.

21OIG reports on individual manufacturers are not publicly available.

22In 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.

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.

23Letter from HHS OIG to Ranking Minority Member, Committee on Government
Reform, House of Representatives, November 22, 1999.

24Medicaid Drug Rebate Program Release No. 47, July 2000.

25See HHS OIG, Medicad Drug Rebates Sales to RepackagersExcluded from Best
Price Determinations, A-06-00-00056 (Washington, D.C.: March 2001).

 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

26One 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.

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.

27 GAO-03-196 .

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.

28 GAO-03-196 .

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

30Medicaid 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

                            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.

31A 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.

32A 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.

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.

                       Contact and Staff Acknowledgments

For further information about this testimony, please contact Kathleen King
at (202) 512-7118. Debra Draper, Robin Burke, and Ann Tynan also made key
contributions to this statement.

(290477)

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Highlights of GAO-05-850T , a testimony before the Subcommittee on Health,
Committee on Energy and Commerce, House of Representatives

June 22, 2005

MEDICAID DRUG REBATE PROGRAM

Inadequate Oversight Raises Concerns about Rebates Paid to States

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. GAO was asked to discuss issues relating
to the rebate program and in February 2005 issued a report, Medicaid Drug
Rebae Program: Inadequate Oversight RasesConcerns about Rebaes Paid
toSates (GAO-05-102). For that report, GAO reviewed program guidance and
OIG reports and conducted an analysis of rebates for brand name drugs.
This testimony is based on the February 2005 report.

What GAO Recommends

In its February 2005 report, GAO recommended that CMS issue clear, updated
guidance on manufacturer price determination methods and price
definitions. It also recommended that CMS implement systematic oversight
of manufacturer methods and a plan to ensure the accuracy of reported
prices and rebates to states. HHS agreed with the importance of guidance
to manufacturers but did not agree that the program had received
inadequate oversight. GAO acknowledged HHS oversight actions but did not
believe they ensured accurate rebates to states.

As noted in the February 2005 report, GAO found that rebate program
oversight does not ensure that manufacturer-reported 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 and only reviews price determination methods when
manufacturers request recalculations of prior rebates. In several reports,
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 manufacturer-reported prices, including a lack of
clear guidance on how AMP should be calculated. GAO noted that although in
some cases OIG found problems with manufacturers' price determination
methods and prices, CMS had not followed up with manufacturers to make
sure that problems had been resolved.

GAO also found considerable variation in the methods that manufacturers
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 assumptions
when determining best price and AMP, as long as they are consistent with
the law and the rebate agreement. GAO found that manufacturers made
varying assumptions about which sales and prices to include and exclude
from their determinations of best price and AMP. Manufacturers also
differed in how they accounted for certain price reductions, fees, and
other transactions when determining best price and AMP.

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 negotiated by pharmacy
benefit managers (PBM) on behalf of third-party payers. 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 when determining best price and AMP. Additional guidance on how
to account for these payments could affect rebates, although whether
rebates would increase or decrease as a result, and by how much, is
uncertain.
*** End of document. ***