Food Assistance: FNS Could Take Additional Steps to Contain WIC  
Infant Formula Costs (28-MAR-06, GAO-06-380).			 
                                                                 
The Special Supplemental Nutrition Program for Women, Infants and
Children (WIC) provides food, nutrition education, and health	 
care referrals to close to 8 million low-income pregnant and	 
postpartum women, infants, and young children each year. About a 
quarter of these participants are served using rebate savings	 
from contracts with infant formula manufacturers. WIC is	 
administered by the Department of Agriculture's Food and	 
Nutrition Service (FNS). To better understand infant formula cost
containment, this report provides information on: (1) factors	 
that influence program spending on infant formula, (2) how the	 
level of savings resulting from infant formula cost containment  
has changed and the implications of these changes for the number 
of participants served; and (3) steps federal and state agencies 
have taken to contain state spending on infant formula. 	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-380 					        
    ACCNO:   A50137						        
  TITLE:     Food Assistance: FNS Could Take Additional Steps to      
Contain WIC Infant Formula Costs				 
     DATE:   03/28/2006 
  SUBJECT:   Child nutrition					 
	     Children						 
	     Cost analysis					 
	     Cost control					 
	     Financial analysis 				 
	     Financial management				 
	     Food programs for children 			 
	     Food relief programs				 
	     Government contracts				 
	     Infants						 
	     Program evaluation 				 
	     Program management 				 
	     Women						 
	     Rebates						 
	     Infant formula					 
	     Special Supplemental Nutrition Program		 
	     for Women, Infants and Children			 
                                                                 

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GAO-06-380

     

     * Infant Formula Rebate Savings
     * FNS Review of Contracts
     * Types of Infant Formula
     * States Receive Rebates on Most Infant Formula Purchased thro
     * Use of Non-Contract Infant Formula Increases Formula Costs
     * Total Rebate Savings Have Been Stable but the Amount States
     * Higher Infant Formula Costs Could Reduce Participation by Ne
     * States Have Taken Steps to Reduce Infant Formula Costs
     * FNS Has Taken Steps to Reduce Infant Formula Costs
     * FNS Promotes the Long-Run Sustainability of the Competitive
     * Order by Mail or Phone

Report to Congressional Requesters

United States Government Accountability Office

GAO

March 2006

FOOD ASSISTANCE

FNS Could Take Additional Steps to Contain WIC Infant Formula Costs

GAO-06-380

Contents

Letter 1

Results in Brief 4
Background 6
Rebates Drive WIC Infant Formula Costs More Than Any Other Factor, but Use
of Non-Contract Infant Formulas also Plays a Role 9
Rebate Savings Have Been Used to Serve about a Quarter of All Participants
in Recent Years, but If Rebate Savings Continue to Decline, Fewer People
Will Be Able to Participate 15
State and Federal Agencies Take Steps to Contain Costs; however, FNS also
Focuses on Sustaining the Competitive Bidding System 21
Conclusion 27
Recommendations for Executive Action 27
Agency Comments and Our Evaluation 28
Appendix I Scope and Methodology 30
Appendix II Use of Non-Contract, Non-Exempt and Exempt Infant Formula by
State, Fiscal Year 2004 33
Appendix III GAO Contacts and Staff Acknowledgments 36
Related GAO Products 37

Figures

Figure 1: WIC Infant Infant Formula Rebate Process 3
Figure 2: Type of Infant Formulas and Percentage of All WIC Formula Issued
FY 2004 14
Figure 3: Total Rebate Savings, 1990-2004 16
Figure 4: National Weighted Average Net Price per Can of Milk-Based
Concentrate 17
Figure 5: Change in Net Price Paid under Newly Awarded Contracts 18
Figure 6: Percentage Contract, Exempt, and Non-Contract, Non-exempt Infant
Formula Provided 23

Abbreviations

ARA arachidonic acid DHA docosahexaenoic acid FNS Food and Nutrition
Services FY fiscal year NEATO New England and Tribal Organization
coalition USDA United States Department of Agriculture WIC Special
Supplemental Nutrition Program for Women, Infants, and Children

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separately.

United States Government Accountability Office

Washington, DC 20548

March 28, 2006

The Honorable Tom Harkin Ranking Minority Member Committee on Agriculture,
Nutrition, and Forestry United States Senate

The Honorable Arlen Specter United States Senate

The Honorable George Miller House of Representatives

The Special Supplemental Nutrition Program for Women, Infants and Children
(WIC) provides food, nutrition education, and health care referrals to
close to 8 million low-income pregnant and postpartum women, infants, and
young children each year. The 2 million infants who receive WIC benefits
each year account for about half of infants born in the United States.
Congress allotted just over $5.2 billion to fund the WIC program for
fiscal year 2005, of which approximately 16 percent is typically used to
purchase infant formula, the most expensive item supplied under the food
grant. The U.S. Department of Agriculture's (USDA) Food and Nutrition
Service (FNS) oversees and provides guidance to the state and local
agencies that implement the WIC program.

States contain the cost of infant formula using a competitive bidding
process that awards sole-source contracts to infant formula manufacturers.
This competitive bidding process allows infant formula manufacturers to
compete for the contracts by offering sizeable discounts to the states on
the infant formula that WIC participants purchase. Three infant formula
companies currently compete and serve WIC participants-Mead Johnson, Ross
Laboratories, and Nestle. With just three manufacturers competing for WIC
contracts, infant formula is among the most concentrated markets in the
United States.1 State WIC agencies provide most of their WIC infants with
one of the contract manufacturer's milk-based or soy-based infant formulas
designed for healthy infants. Infants can also be provided with a
"non-contract" infant formula if prescribed by a medical professional.
There are two types of non-contract infant formula. "Exempt" infant
formulas are designed for infants with specific medical or dietary
problems, and "non-contract, non-exempt" infant formulas are designed for
healthy infants but manufactured by a company other than the contract
manufacturer. States do not receive rebates on non-contract infant
formulas.

1A fourth manufacturer, PBM Nutritionals, manufactures infant formula for
sale under store brands. PBM does not compete for WIC contracts.

WIC participants typically purchase infant formula from stores at the full
retail price using a voucher or coupon. The voucher specifies the brand
and amount of infant formula the participant can purchase. The store then
bills the state, and to obtain the price discounts, states then send the
contract manufacturer an invoice listing the number of cans of contract
brand infant formula purchased. The manufacturer, in turn, provides
discounts to the state in the form of rebates for each can of infant
formula purchased.

States use the savings generated by these cost-containment contracts to
serve additional participants. Figure 1 depicts the transactions in the
rebate process.

Figure 1: WIC Infant Formula Rebate Process

In recent years, some states have seen their savings from cost-containment
efforts decline, raising concern about the implications that reduced
rebates might have on the WIC program since more than one-quarter of WIC
participants are served with rebates. To better understand factors that
affect state spending on infant formula and the implications of infant
formula cost containment for the WIC program, this report will provide
information on: (1) factors that influence program spending on infant
formula, including the role of rebate savings that states receive through
infant formula cost-containment contracts; (2) how the level of savings
resulting from infant formula cost containment has changed over the past 5
years and the implications of these changes for the number of participants
served; and (3) steps federal and state agencies have taken to contain
state spending on infant formula.

To address these research objectives, we analyzed administrative data on
program participation, food costs, and total rebates provided to us by FNS
for the years 1999 through 2004, and information on rebates obtained by
individual states per can of milk-based concentrate infant formula for
fiscal years 2000 through 2005. Using FNS data, we calculated trends in
the average per-can cost of milk-based concentrate infant formula in the
50 states plus the District of Columbia between 2000 and 2005, as well as
trends in total rebates, and trends in the share of participants served
using rebate savings. We also used this data to estimate the potential
impact of reduced rebates on program participation under three alternate
scenarios. To better understand the factors that affect program spending
on infant formula, we surveyed 50 state WIC programs and the District of
Columbia to obtain additional information about their infant formula
contracts. We achieved a 100 percent response rate. We also reviewed
literature on factors that influence infant formula spending, and
interviewed several state and local WIC directors, all three infant
formula manufacturers currently participating in the WIC market, and
policy experts with an interest in WIC infant formula cost containment. We
performed this work between April 2005 and March 2006 in accordance with
generally accepted government auditing standards. See appendix I for
additional information on scope and methodology.

                                Results in Brief

State spending on infant formula is determined primarily by the discounts,
in the form of rebates, that manufacturers offer, but the use of infant
formula not covered by contracts with manufacturers can also affect state
spending on infant formula. Over 90 percent of infant formula provided
through the WIC program is covered by cost-containment contracts with
manufacturers. In fiscal year 2004, states paid, on average, $0.20 after
rebates per can for milk-based concentrate infant formula with a wholesale
price of $2.60 to $3.57. The amount states pay can vary significantly-from
as low as $0.07 per can of milk-based concentrated infant formula to as
high as $0.80 per can. The amount of rebate savings depends primarily on
the rebates offered to states by manufacturers. The rebates manufacturers
offer, in turn, can be affected by factors that states have some control
over, including the extent to which a WIC contract will help a
manufacturer market its products to non-WIC consumers and the accuracy of
state systems used to bill manufacturers for infant formula purchased by
WIC participants. State spending on infant formula is also affected by
spending on non-contract infant formulas for which states do not receive
rebates, including exempt infant formulas and non-exempt infant formulas
produced by another manufacturer. Non-contract infant formulas can cost
states more than 10 times as much as contract infant formulas; therefore,
even modest use can drive up state costs. Over the past 5 years, the use
of non-contract, non-exempt infant formulas has fallen somewhat, but use
of exempt infant formulas has risen.

The total amount of money state WIC agencies have saved on infant formula
through their cost-containment contracts has been relatively stable since
1997, but if recent increases in the average price states pay per can of
infant formula continue, the number of participants that can be served
with rebate savings is likely to fall. Total savings from rebates, which
increased from about $800 million in 1990 to more than $1.6 billion in
1997, have remained near $1.6 billion per year since that time after
adjusting for inflation. In 2004, rebate savings enabled the WIC program
to serve an additional 2 million people-about a quarter of all
participants. In recent years, the average amount states pay per can of
infant formula purchased through WIC increased as the rebates
manufacturers offered declined and manufacturers introduced new, more
expensive infant formulas. Both of these trends contributed to an increase
in the price states pay for a can of milk-based concentrated infant
formula from $0.15 per can in 2002 to $0.21 per can in 2005, on average,
even after adjusting for inflation. When states pay more per can, they
cannot serve as many participants. We estimated that if the average rebate
states received per can had fallen to 75 percent of wholesale price in
2004-requiring states to pay approximately $0.89 for a can of milk-based
concentrate with a wholesale price of $3.57-approximately 400,000 fewer
participants would have been able to enroll in WIC nationwide.

State and federal administrators have taken steps to contain the costs of
infant formula, but federal efforts also focus on maintaining the long-run
sustainability of the competitive bidding system by ensuring that all
interested infant formula manufacturers can compete for WIC contracts.
States have sought to minimize the cost of infant formula through their
contracting and infant formula provision practices. For example, 30
states2 have joined coalitions made up of two or more state WIC agencies
in an effort to maximize cost savings by sharing the costs of
administering WIC contracts and leverage greater discounts. In addition,
recognizing the high cost of non-rebated infant formula, 12 states do not
provide non-contract, non-exempt infant formula to WIC participants. Other
states rely on the federal regulation requiring medical documentation to
limit the use of these more expensive infant formulas. Despite these
efforts, use of non-rebated infant formulas varies significantly by state,
from a low of 0 to a high of 25 percent. FNS has also taken steps to
contain infant formula costs. For example, FNS established a regulation
requiring manufacturers to provide states with the same percent discount
on all infant formulas covered by the contract, even new, more costly
infant formulas introduced while a contract is in effect. This requirement
helps, but does not entirely prevent states from incurring cost increases
when manufacturers introduce infant formulas with higher wholesale prices.
Because infant formulas with higher wholesale prices continue to cost more
per can, state costs can escalate if manufacturers replace more commonly
used infant formulas with more expensive ones during a contract as they
did in some states and localities according to state and local WIC
directors. To ensure the long-run sustainability of the cost-containment
system, FNS has also used its oversight authority to ensure that all
manufacturers can compete for state infant formula contracts regardless of
their share of the market. For example, FNS does not approve contract
provisions designed to increase state cost savings when it concludes that
the provisions could limit competition by giving one or more companies a
competitive advantage.

2The 30 states includes the District of Columbia, but does not include
Indian Tribal Organizations.

To help states preserve rebate savings generated through infant formula
cost containment, we recommend that the Secretary of the Department of
Agriculture consider providing guidance related to product changes to
ensure that state costs do not increase when infant formula manufacturers
replace the most commonly used infant formulas with new, more expensive
infant formulas during a contract. In addition, we recommend that the
Secretary consider ways to more effectively restrict issuance of
non-rebated infant formulas to WIC participants.

                                   Background

The Special Supplemental Nutrition Program for Women, Infants and Children
(WIC) was established in 1972 to provide food, nutrition education, and
health care referrals to low-income pregnant and postpartum women,
infants, and young children. The program is administered by FNS in
conjunction with state and local health departments and related agencies.
WIC is almost entirely federally funded. WIC is not an entitlement
program; Congress does not set aside funds to allow every eligible
individual to participate in the program. Instead, WIC is a federal grant
program for which Congress authorizes a specific amount of funds each
year. USDA provides funding for food and nutrition services and
administration. Both funding and participation have increased each year
since fiscal year 2000. Congress also typically provides for a contingency
fund to ensure that adequate resources are available for the program if
unanticipated costs arise.

Infant Formula Rebate Savings

WIC participants typically receive food benefits in the form of vouchers
or coupons that they redeem at authorized retail vendors to obtain, at no
cost to the participants, certain approved foods, including infant
formula.3 State WIC agencies then reimburse the retail vendors for the
food purchased by WIC participants. Since 1989, state WIC agencies have
been required by law to contain the cost of infant formula using a
competitive bidding process to award sole-source contracts unless they can
demonstrate that an alternative method would yield the same or greater
cost savings.4 Manufacturers agree to provide a rebate to the state WIC
agency for every can of infant formula purchased under the WIC contract,
and the state awards the contract to the bidder offering the lowest net
wholesale price after subtracting the rebate from the cost of infant
formula.5 In exchange, the state provides the contract brand of infant
formula to most infants enrolled in the program except those that are
breastfeeding exclusively and those with a medical condition that requires
the use of a non-contract infant formula. Rebates have become an important
source of funding for the WIC program. In 2004, rebates totaled more than
$1.6 billion and funded the benefits provided to about a quarter of WIC
participants.

FNS Review of Contracts

Contracts for WIC infant formula are between states and infant formula
manufacturers. States are responsible for issuing requests for bids and
drafting contract provisions according to state contracting requirements.
Typically, a WIC agency will draft a bid solicitation and obtain state
approval for the contract language. Once the state approves the
solicitation, the WIC agency will submit it to the FNS regional office for
review. The regional office ensures that the contract adheres to all
federal requirements and may suggest ways to improve the contract. FNS
headquarters reviews the contract for final approval. After approval, the
contracting process is conducted by the state.

3Two states, Vermont and Mississippi, operate a direct distribution system
whereby WIC supplemental foods are distributed directly to participants
from state-operated warehouses. In these two states, WIC participants do
not use the retail system. These states do, however, negotiate sole-source
contracts with infant formula manufacturers and purchase WIC infant
formula from the manufacturer at a discounted price.

4Pub. L. No. 101-147 (1989). Under the law, state agencies are required to
procure infant formula using a competitive bidding system or an
alternative method of cost containment that yields savings equal to or
greater than those produced by a competitive bidding system.

5The net wholesale price is calculated by subtracting the rebate per can
from the lowest national wholesale cost per unit for a full truckload of
infant formula. The net wholesale price of the primary contract infant
formula remains fixed over the contract period. The net wholesale price
does not reflect any additional mark-ups imposed by retailers. Because
state WIC agencies reimburse WIC vendors for the full retail price of
infant formulas sold to WIC participants using WIC vouchers, the actual
cost to the state for each can of infant formula is the "net retail
price," or the retail price charged by the vendor less the rebate provided
by the manufacturer. States generally do not track retail prices of infant
formula. In this report, we use the term "net price" to refer to the net
wholesale price.

Types of Infant Formula

Infant formula comes in three physical forms: liquid concentrate, powder,
and ready-to-feed. Infants may receive up to 31 13-ounce cans of liquid
concentrate per month through WIC, or roughly the equivalent amount of
powdered or ready-to-feed infant formula. Most infants are provided an
infant formula that is covered by the state's cost-containment contract.
There are three categories of infant formula provided to WIC participants:

           o  Contract brand infant formula is produced by the contract
           manufacturer and is suitable for routine use by the majority of
           healthy full-term infants. These include milk-based and soy-based
           infant formulas and could include milk- and soy-based infant
           formulas enhanced with DHA and ARA,6 lactose-free infant formula,
           added-rice infant formulas, and easy-to-digest infant formulas.7
           "Contract brand infant formula" also includes new infant formulas
           introduced by the contract manufacturer after the contract is
           awarded, with the exception of infant formula under the following
           "exempt" category.

           o  Exempt infant formula is represented and labeled for use by
           infants with medical conditions such as inborn errors of
           metabolism, low birth weight, or other unusual medical or dietary
           problems that require that they use a more specialized infant
           formula.8 
           o  Non-contract brand non-exempt infant formula is all infant
           formula produced by a manufacturer other than the contract
           manufacturer that is suitable for routine use by the majority of
           healthy full-term infants.

           FNS regulations require local WIC agencies to obtain medical
           documentation to provide all exempt infant formulas and all
           non-contract, non-exempt infant formulas.9 Medical documentation,
           for these purposes, is a determination by a licensed health care
           professional authorized to write medical prescriptions under state
           law. A licensed health care professional must make a medical
           determination that an infant has a medical condition that dictates
           the use of these infant formulas.

           State spending on infant formula depends on the discounts, in the
           form of rebates, that states receive from manufacturers, and use
           of non-contract infant formula. Rebates are the most important
           factor driving state spending on infant formula because such a
           large proportion of WIC infant formula is purchased under
           cost-containment contracts with manufacturers. According to infant
           formula manufacturers, the attractiveness of a WIC contract
           depends, at least in part, on factors over which states have some
           control, including the extent to which a WIC contract will help a
           manufacturer market its products to non-WIC consumers; state-level
           administration of WIC contracts; and the provision of powder,
           concentrate, and ready-to-feed infant formula to WIC participants.
           These factors, in turn, could affect whether or not a manufacturer
           bids on a contract and the level of rebates offered by the
           manufacturers. The provision of non-rebated infant formula also
           affects state spending.

           In 2004, states received rebates on approximately 92 percent of
           the infant formula provided to WIC participants, and saved, on
           average, 93 percent off the wholesale price. As a result, states
           paid an average of $0.20 per 13-ounce can of milk-based infant
           formula with a wholesale price of $2.60 to $3.57. However, while
           average rebates were high, rebate levels varied significantly by
           state. For example, in 2004, Virginia and South Carolina were
           paying as little as $0.07 per can of milk-based concentrate after
           rebates, while New York was paying $0.80 per can after rebates.

           Representatives of the three infant formula manufacturers
           identified several factors that influence how "attractive" they
           find a state contract. The attractiveness of a contract, in turn,
           could influence whether a manufacturer bids on a contract and the
           size of the rebate offered. Many of the factors cited by
           manufacturers are things over which states have at least some
           control.

           Shelf space and product placement: WIC-brand infant formulas may
           get more shelf space than competing brands, particularly in stores
           that serve areas with large concentrations of WIC participants.
           Because WIC participants purchase such a large share of infant
           formula in some stores, retailers tend to stock more of the WIC
           brand of infant formula. In addition to shelf space, WIC-brand
           products may be placed at eye level so that they are easy to spot.

           All three infant formula manufacturers noted the importance of
           shelf space and product placement to their marketing strategies.
           In addition, 31 of the 51 state WIC directors that responded to
           our survey felt that shelf space was moderately, very, or
           extremely important to manufacturers in determining how much they
           bid on an infant formula contract. While WIC agencies do not have
           direct control over shelf space and product placement, some
           include stocking requirements in their contracts with vendors.

           State policies regarding authorization of WIC vendors can also
           impact manufacturers' access to non-WIC consumers. Some states
           have authorized WIC vendors that sell exclusively or primarily to
           WIC participants. Manufacturers have less access to non-WIC
           consumers if more WIC participants purchase their infant formula
           at these "WIC-only" stores. In those cases, retailers that serve
           the non-WIC population in the area may be less likely to focus on
           product placement or devoting shelf space to the WIC brand-two
           factors that benefit manufacturers in their drive to reach non-WIC
           consumers.

           Physician and Hospital Recommendations: Having WIC contracts could
           also benefit manufacturers through physician recommendations.
           State WIC programs often work with physicians to educate them
           about the program and the requirement that most WIC participants
           use the contract brand of infant formula. Physicians may decide to
           recommend the WIC brand of infant formula to all patients to avoid
           having to differentiate between those enrolled and not enrolled in
           WIC. Similarly, some hospitals agree to provide WIC-brand infant
           formula to new mothers so that they won't have to switch infant
           formulas after they leave the hospital. It may be easier for
           hospitals to provide the WIC-brand infant formula to all new
           mothers. Moreover, two of the infant formula companies that
           participate in the WIC market are divisions of pharmaceutical
           companies that primarily market their products directly to
           physicians and hospitals while also marketing, though to a lesser
           extent, directly to consumers. States vary in the extent to which
           they emphasize doctor and hospital outreach.

           Product Innovation: All three manufacturers cited the central role
           of product innovation in their business strategies. Manufacturers
           seek to compete on the basis of product innovation and product
           quality despite the fact that infant formula is a relatively
           homogeneous product.10 Manufacturers said that certain state
           practices could make it more difficult to pursue their core
           strategy of innovation, and the development, distribution, and
           marketing of new products. These practices include the use of
           long-term contracts, requirements that manufacturers notify states
           of product changes in advance of introducing new products into the
           market, provisions that allow states to unilaterally extend
           contracts without requesting the consent of the manufacturer,
           state restrictions on the ways in which manufacturers market their
           infant formula, and restrictions on their interactions with
           physicians. While these state practices could inhibit innovation,
           many are put in place to protect states from increases in infant
           formula costs.

           State Billing Systems: All three manufacturers cited the accuracy
           of state billing systems as a key factor they consider when
           developing bids, and all stated that the vast majority of state
           billing systems need improvement. One manufacturer said that most
           states rely on antiquated information technology that is prone to
           costly billing errors. According to FNS officials, disputes over
           billing for infant formula rebates have long been a problem in the
           WIC program. In the past, some states requested reimbursement from
           infant formula manufacturers for every can of infant formula
           listed on redeemed vouchers. However, some WIC participants did
           not purchase every can of infant formula listed on the voucher. In
           these instances, the manufacturers claimed they were being billed
           for purchases that were never made. Partly in response to these
           disputes, a new provision was included in the Child Nutrition and
           WIC Reauthorization Act of 2004 that requires states to bill only
           for infant formula actually purchased.

           Contract size: State WIC directors said they believe that
           contracts that cover more infants yield higher rebates; however,
           the manufacturers said that the largest contracts may not draw
           their highest bids. A few state WIC directors expressed concerns
           that new provisions in the Child Nutrition and WIC Reauthorization
           Act of 2004 limiting the size of state coalitions and requiring
           separate contracts for milk-based and soy-based infant formula
           could reduce the size of contracts and the size of rebates.
           However, manufacturers noted that costly shifts in demand occur
           when very large states or coalitions change contractors.
           Manufacturers must be able to respond to these shifts by quickly
           increasing or decreasing production, and must, therefore, consider
           their own production capacity when they bid on very large
           contracts.

           Contract Provisions: Manufacturers noted that states sometimes
           include contract provisions that manufacturers consider complex,
           ambiguous, and extraneous and inclusion of these provisions could
           affect rebates. For example, manufacturers cited provisions that
           increase the potential liabilities of manufacturers, give states
           control over manufacturer activities, or require manufacturers to
           provide products or services not directly related to the sale of
           infant formula-such as sponsoring conferences, providing
           literature on nutrition education, or providing free infant
           formula-as particularly unattractive. Because states rarely modify
           contract provisions in response to manufacturer concerns,
           manufacturers may respond to these provisions by either not
           bidding on contracts or offering lower rebates.

           Provision of Powder, Concentrate and Ready-to-Feed Infant
           Formulas: All three manufacturers cited the importance of state
           policies governing the provision of powder, concentrate, and
           ready-to-feed infant formulas. Historically, the WIC program has
           issued more concentrate than powder, but there has been an
           increase in the use of powder in the WIC program since 2000.
           Because ready-to-feed infant formula is the most expensive, WIC
           regulations allow WIC agencies to provide it only in certain
           circumstances11 Twenty-nine states were able to provide us with
           data on their use of the different forms of infant formula in both
           2000 and 2004. In 2000, 55 percent of all infant formula issued in
           those states was in the form of liquid concentrate. By 2004,
           liquid concentrate represented only a third of all infant formula
           provided to WIC participants in those states. Powder use may have
           increased because it can be more convenient for mothers who are
           partially breastfeeding because mothers can reconstitute small
           amounts of powdered infant formula at a time, whereas liquid
           concentrate must be diluted all at once. Manufacturers did not
           provide information on how the provision of different forms of
           infant formula might affect their bids on infant formula
           contracts. However, if concentrate is more profitable, the shift
           to powder could reduce manufacturer profits-and the rebates they
           offer to states. Alternatively, if powder is more profitable or
           there are no differences in the profitability of different forms,
           the shift to powder might not affect rebates.

           Although non-contract infant formula, including both exempt and
           non-contract, non-exempt infant formula, accounts for less than 10
           percent of infant formula purchased through WIC, its use can have
           a significant impact on total infant formula spending because it
           can cost as much as 10 to 20 times more per can than rebated
           formula. Among the 27 states that were able to provide us with
           data on their use of contract, exempt, and non-contract,
           non-exempt formulas in both 2000 and 2004, use of exempt formula
           increased and use of non-contract, non-exempt formula decreased
           over the 4-year period.12 Figure 2 shows the average share of each
           type of formula provided to WIC participants in 43 states in 2004.

6Docosahexaenoic acid (DHA) and arachidonic acid (ARA) are fatty acids
found in breastmilk.

7If a state agency elects to solicit separate bids for milk-based and
soy-based infant formulas, all infant formulas issued under each contract
are considered the contract brand infant formula (see 7 C.F.R.
S:246.16a(c)(1)(ii)). For example, all of the milk-based infant formulas
issued by a state agency that are produced by the manufacturer that was
awarded the milk-based contract are considered contract brand infant
formulas. Similarly, all of the soy-based infant formulas issued by a
state agency that are produced by the manufacturer that was awarded the
soy-based contract are also considered to be contract brand infant
formulas.

8See 21 U.S.C. S:350a(h)) and the regulations at 21 C.F.R. parts 106 and
107.

 Rebates Drive WIC Infant Formula Costs More Than Any Other Factor, but Use of
                 Non-Contract Infant Formulas also Plays a Role

States Receive Rebates on Most Infant Formula Purchased through WIC

9Participants must also provide medical documentation to receive certain
types of contract brand infant formulas such as low-iron infant formula.

10The Infant Formula Act of 1980 requires infant formula manufacturers to
follow specific guidance on quality, manufacturing practices, and nutrient
requirements See 21 U.S.C. S:350a.

11Ready-to-feed infant formula can be provide when (1) the participant has
unsanitary or restricted water supply or poor refrigeration; (2) the
participant may have difficulty in correctly diluting liquid concentrate
or reconstituting powder; or (3) ready-to-feed infant formula is the only
form available.

Use of Non-Contract Infant Formula Increases Formula Costs

12These 27 states account for 62 percent of WIC participants.

Figure 2: Type of Infant Formulas and Percentage of All WIC Formula Issued
FY 2004

 Rebate Savings Have Been Used to Serve about a Quarter of All Participants in
 Recent Years, but If Rebate Savings Continue to Decline, Fewer People Will Be
                              Able to Participate

Rebate savings have remained relatively stable since 1997 after adjusting
for inflation, but if recent increases in the amount states pay for each
can of infant formula they purchase through WIC continue, fewer
participants will likely be served with rebates in the future. About a
quarter of all WIC participants are served using rebate savings. However,
over the past 5 years, the amount states pay for infant formula has
increased somewhat, particularly among states that have awarded new
contracts. There is some concern that if the price states must pay for
infant formula continues to increase, fewer participants will be served
using rebates. We estimated that in 2004, if all states had paid as much
per can of infant formula as the two states with the lowest rebates,
approximately 400,000 fewer children would have been able to enroll in WIC
nationwide.

Total Rebate Savings Have Been Stable but the Amount States Pay Per Can of
Infant Formula Has Increased Since 2002

After increasing substantially in the years prior to 1997, the total
amount that states received from manufacturers in infant formula rebates
has remained relatively constant since that time. As shown in figure 3,
rebate savings have remained at about $1.6 billion per year after
adjusting for inflation.

Figure 3: Total Rebate Savings, 1990-2004

The percent of participants that have been served using rebates has also
remained relatively stable over the past 5 years, at about 25 percent. In
2004, some 2 million participants were served using rebate dollars.

Although both total rebate savings and the share of participants served
using rebate savings has changed little in recent years, we found that the
amount states pay per can of infant formula, after taking rebates into
account, has increased over the past few years. The average net price
states paid per can of milk-based concentrate infant formula increased
from $0.15 in fiscal year 2002 to $0.21 in fiscal year 2005 after
adjusting for inflation.13

13These figures are adjusted for inflation using the Producer Price Index
for drugs and pharmaceuticals.

Figure 4: National Weighted Average Net Price per Can of Milk-Based
Concentrate

Because most contracts lock in the price states pay for infant formula for
up to 5 years, average prices tend to move slowly. The price increases are
more apparent among contracts that were newly awarded each fiscal year.
Among newly awarded contracts, there was a fourfold increase in the
average net price of a can of infant formula over the 3-year period, from
$0.10 in 2002 to $0.43 in 2005. Figure 4 shows rebates for newly awarded
contracts between fiscal year 2000 and fiscal year 2005.14

14Because the number of states implementing new contracts is different
each year, the figures shown reflect a simple, not a weighted average for
each fiscal year.

Figure 5: Change in Net Price Paid under Newly Awarded Contracts

Although the amount states pay for infant formula varies by state, the
increases in the average net price were not driven by large increases in
just a few states, but reflect higher wholesale prices and lower rebates
nationwide. Eight of the 9 states that implemented a new contract in 2002
did so at either the same net price as under their previous contract or at
a lower net price. This trend shifted over the next few years. By 2004, a
majority of states implementing new contracts saw their net price
increase, and in 2005, every state that implemented a new contract did so
at a higher net price than under its previous contract.

The extent to which net prices increased among newly awarded contracts
varied, but most states did not experience significant price increases.
Among states that implemented new contracts in 2005, the average net price
for a can of milk-based concentrate was $0.43 after rebates. This
represented a discount of about 87 percent off the wholesale price. In a
few states, however, the net price states paid for milk-based concentrate
under their contracts was significantly higher than the average. New York
implemented a contract in 2004 that provided milk-based concentrate for a
net price of $0.80 per can, a discount of 75 percent off the wholesale
price. Similarly, North Dakota implemented a contract in 2005 that
provided a net price of 0.83 per can, a discount of 77 percent off the
wholesale price.15

The impact of reduced rebates per can of infant formula was exacerbated by
an increase in the use of more expensive types of infant formulas. Since
the early 1990s, infant formula manufacturers have diversified their
product lines to include a greater number of infant formula types, all of
which have higher wholesale prices than traditional unenhanced milk- and
soy-based infant formulas. The most significant change in infant formulas
came with the introduction of DHA and ARA enhanced infant formulas
starting in 2002. All three manufacturers have introduced DHA and ARA
enhanced infant formulas at prices that are higher than the unenhanced
versions. At the time of our survey in mid-2005, 23 states reported that
they issue enhanced infant formula as their primary contract brand; only 8
states reported that they do not approve enhanced infant formula.16 In
addition, four of the five most recent contracts to be awarded specified
the enhanced infant formulas as the primary contract brand.17 The
increased use of infant formulas with a higher wholesale price may have
contributed to the increase in the net price of infant formula under new
cost-containment contracts if infant formula companies sought higher
compensation for their more expensive products.

Higher Infant Formula Costs Could Reduce Participation by Nearly 400,000

Increases in the cost of infant formula have not yet had a significant
impact on the share of participants served with rebate savings, but if
infant formula costs were to continue to increase, it is likely that fewer
participants would be served using rebate savings in the future absent
funding increases. To illustrate how infant formula prices can affect WIC
participation, we considered how three different scenarios would have
affected participation in WIC during fiscal year 2004. We estimated the
number of WIC participants that would have been served using rebate
savings if the average rebate in 2004 had been 90 percent of the wholesale
price of infant formula-slightly less than the actual discount of 93
percent. We also considered scenarios reflecting larger reductions in
rebates, to 85 percent and 75 percent of the wholesale price of infant
formula.18 We compared our estimates to the actual number served using
rebates in fiscal year 2004.19

15At the beginning of fiscal year 2006, Vermont implemented a new contract
under which the state is paying $1.11 per can of milk-based concentrate.
Vermont operates a home delivery system. As a result, the state does not
receive rebates from the manufacturer. It purchases infant formula
directly from the manufacturer at a reduced price.

16Twenty-three states reported that they provided enhanced infant formula
to all participants, or provide it to all participants unless non-enhanced
infant formula is requested. The remaining states provide enhanced infant
formula under certain circumstances such as when a prescription is
provided or when other non-enhanced infant formulas are not available in
retail outlets.

17The Child Nutrition Act and WIC Reauthorization Act of 2004 requires
state agencies to provide, as the infant formula of first choice, the
primary contract infant formula specified in the manufacturer's bid. As a
result, state agencies have no choice but to issue the higher-cost DHA/ARA
enhanced infant formulas if manufacturers identify these as their primary
contract infant formulas.

We found that with even a modest reduction in rebates across all states,
fewer participants could be served:

           o  If rebates were equal to 90 percent of the wholesale price in
           all states in 2004, about 70,000 fewer participants would have
           received WIC benefits.

           o  If rebates were equal to 85 percent of the wholesale price in
           all states in 2004, about 175,000 fewer participants would have
           received WIC benefits.

           o  If rebates had fallen to 75 percent of the wholesale price in
           all states in 2004, the program would have been able to serve
           about 400,000 fewer participants.

           Because most states are still under existing contracts negotiated
           in prior years, it would take some time for the impact of reduced
           rebates to be fully realized. Many states will be under their
           current contracts through 2006 and 2007 and many have contracts
           that continue through 2008 or 2009 if they opt to extend their
           contracts as permitted. State WIC directors in 45 of 51 states
           reported that their infant formula contracts allow for extensions
           ranging from 1 year to 4 years. However, if the recent decline in
           rebates continues, there could be an impact on the number of
           participants served using rebates within the next few years.

           While both states and FNS try to contain costs, FNS also works to
           sustain the competitive bidding system while states work to
           maximize their own savings. State WIC agencies have taken a
           variety of actions to promote cost containment. For example, some
           have joined coalitions or barred the provision of non-contract,
           non-exempt infant formula. Similarly, FNS promotes cost savings
           through a requirement that infant formula manufacturers provide
           the same percent discount for all infant formulas, even new infant
           formulas introduced when a contract is already in effect.20
           However, FNS attempts to balance its efforts to promote cost
           containment with its larger goal of sustaining the competitive
           bidding system. For example, in some cases, FNS did not approve
           provisions in cost-containment contracts that would save states
           money if FNS believed these provisions would reduce competition.

           Through their infant formula contract bid solicitations, states
           have taken steps to promote cost containment. For example, by
           including provisions they believe manufacturers might find
           favorable or by omitting provisions they believe would have a
           negative impact on their rebate savings, states have sought to
           maximize their savings. As other examples:

           o  Thirty states have joined coalitions in an effort to share
           streamline the bidding process and leverage greater bargaining
           power when negotiating contracts with manufacturers.

           o  Some states allow contract extensions only if both the state
           and the infant formula contractor agree, rather than providing for
           unilateral contract extensions at state option.

           States have also taken steps to limit the amount they spend on
           non-contract infant formulas:

           o  Sixteen states purchase some or all of the exempt infant
           formula that is provided to participants directly from
           manufacturers or from low-cost providers.

           o  Twelve states do not provide more expensive non-contract brand,
           non-exempt infant formula to WIC participants, and nine states
           limit statewide use of non-contract, non-exempt infant formula to
           a specified share of all infant formula provided. In addition, 27
           states limit the amount of time that non-contract, non-exempt
           infant formulas can be issued to participants.

           o  Eight states do not provide more expensive enhanced infant
           formula.

           Despite these state efforts to contain costs, opportunities remain
           for more states to further reduce the use of non-rebated infant
           formulas. Use of non-contract, non-exempt infant formula varies.
           Twelve states reported that they have policies in place not
           allowing the use of non-contract, non-exempt infant formula. Of
           the 43 states that provided complete information on their average
           monthly usage of contract, exempt, and non-contract, non-exempt
           infant formulas in 2004, 27 states reported that between 0.3
           percent and 4 percent of infant formula provided is non-contract,
           non-exempt, and 8 states reported use between 4.5 percent and 9
           percent.21 As required by the Infant Formula Act, infant formula
           is a relatively homogeneous product. Consequently, it is unlikely
           that large discrepancies among states in the use of non-contract,
           non-exempt infant formulas designed for use by healthy infants can
           be explained by differences in health conditions of infants
           receiving WIC infant formula in these states. There are also large
           discrepancies in the use of exempt infant formula designed to
           treat infants' medical conditions. State provision of exempt
           infant formula ranges from a low of 0 percent to a high of about
           23 percent. (See app. II for information on use of non-contract,
           non-exempt and exempt infant formula by state.) Again, as with
           non-contract, non-exempt infant formula, it is not clear how
           infants' medical needs could vary so significantly among states.
           Figure 6 shows the minimum, median, and maximum use of each type
           of infant formula in 2004.22

18We selected these percentages based on rebates offered to states over
the past 5 years and included scenarios representing a modest decrease (90
percent of wholesale price), a moderate decrease (85 percent of wholesale
price) that was approximately equal to the discount offered on newly
awarded contracts in fiscal year 2004, and a larger decrease (75 percent
of wholesale price) that was similar to the discount received in two
states during fiscal years 2004 and 2005.

19By confining our estimates to 2004, we were able assume that all else
remained as it was in 2004 and thereby isolate the impact of rebates from
other factors that can affect the number of participants served, such as
changes in the retail prices of WIC foods, changes in breastfeeding rates,
and changes in the size and composition of the caseload. These estimates
do not take into consideration the availability of the WIC contingency
fund that can be drawn down to maintain participation when food costs
increase more quickly than anticipated. Similarly, the estimates do not
take into account the possibility that supplemental appropriations could
make up any funding shortfall to maintain participation.

State and Federal Agencies Take Steps to Contain Costs; however, FNS also
              Focuses on Sustaining the Competitive Bidding System

States Have Taken Steps to Reduce Infant Formula Costs

207 C.F.R. S:246.16A(c)(5)(i).

21Eight of the states with policies in place to not allow non-contract,
non-exempt infant formula reported providing 0 percent of this type of
infant formula. Three states with these policies indicated that they
provided between 1.6 percent and 3 percent non-contract, non-exempt infant
formula per month. One state with these policies did not provide data on
use of non-contract, non-exempt formula.

22Forthy-three states provided information on their use of contract,
exempt, and non-contract, non-exempt infant formulas in 2004.

Figure 6: Percentage Contract, Exempt, and Non-Contract, Non-exempt Infant
Formula Provided

Most states reported that they require participants to obtain medical
documentation for non-rebated infant formula, as required by FNS. However,
some local WIC directors said there are instances in which doctors do not
diagnose a medical condition but still write a prescription at the request
of the participant. Local WIC agency staff told us that they identify
these cases only by confirming diagnoses with each physician which not all
agencies have the resources to do. As a result, some WIC participants may
be receiving non-rebated infant formula even though they do not have a
medical condition requiring such infant formula.

FNS Has Taken Steps to Reduce Infant Formula Costs

In its oversight capacity, FNS has helped states increase their
cost-containment savings by providing technical assistance to states as
they develop their cost-containment contracts, and by implementing
regulations that help states achieve cost savings. For example, FNS
requires manufactures to provide the same discount on all infant formulas
after state costs rose with the introduction of a new infant formula. In
1993, one company introduced a lactose-free infant formula to accommodate
infants with intolerance for milk-based infant formula.23 When this
company introduced its lactose-free infant formula, it provided a
significantly lower rebate amount on this infant formula than it provided
on its milk-based infant formula covered by the existing contract, even
though the wholesale price of the new infant formula was higher per can.
As a result, states received a much lower discount on the new infant
formula than they received on the original contract infant formula. At the
same time, prescriptions for the lactose-free infant formula increased
because the company marketed the infant formula directly to doctors. The
cost savings states achieved through rebates began to erode. To maintain
competition by ensuring that all manufacturers could bid on contracts and
to help preserve rebate savings, FNS in 2000 established the requirement
that infant formula manufacturers provide the same percent discount for
all infant formulas, even those introduced when a contract is already in
effect.

The requirement that manufacturers provide the same percent discount for
infant formulas introduced during a contract slows but does not completely
stem increases in state spending on infant formula. Even with the
requirement, states must still pay more for each can of newly-introduced
infant formula when the wholesale price of the infant formula is higher.
As a result, manufacturers still have a financial incentive to introduce
and market more expensive infant formula because they charge a higher
price per can.

By 2003, all three manufacturers introduced new infant formulas enhanced
with the fatty acids DHA and ARA. Like other newly-introduced infant
formulas, these enhanced infant formulas were more expensive. Two state
officials told us that the manufacturers replaced the milk-based infant
formula the state was providing to WIC participants in some parts of the
state with the enhanced infant formula. Retail outlets stopped stocking
the original milk-based infant formula; as a result, states had to
purchase the enhanced infant formula. In contrast, when manufacturers
introduced new infant formulas in the past, states had a choice not to
provide the new infant formulas or to limit their use because the original
milk-based infant formula was still available. At least one state has
since introduced a contract provision that requires manufacturers to
charge the same price per can for newly-introduced products when those
products replace the primary contract infant formula.

23Until 1993, infants with intolerance for milk-based infant formula were
provided with either soy infant formula or an exempt infant formula that
did not contain lactose. Since the introduction of lactose-free infant
formula, companies have further diversified the products they produce for
healthy infants. New products include added-rice infant formula, DHA and
ARA enhanced infant formula, and a variety of other infant formulas.

FNS Promotes the Long-Run Sustainability of the Competitive Bidding System

Recognizing the history and dynamics of the infant formula market and the
importance of competition to the cost-containment goals of the WIC
program, FNS has attempted to ensure that all manufacturers can compete
for state infant formula contracts regardless of their share of the
market. Infant formula manufacturers operate within a highly concentrated
industry. Beginning in the 1970s, three manufacturers-Wyeth-Ayerst, Mead
Johnson, and Ross Laboratories-dominated the infant formula market. By the
1990s, the industry had shifted. Wyeth-Ayerst exited the domestic infant
formula market in 1996. By then Nestle had begun selling infant formula
and had at least one state WIC contract. By 2000, Nestle still had the
smallest market share of the three companies.

In order to ensure the sustainability of competitive bidding, FNS has not
allowed provisions in cost-containment contracts that would have boosted
state savings when FNS believed those provisions would reduce competition:

           o  For example, during negations FNS held with New England and
           Tribal Organization (NEATO) coalition from January 1995 through
           February 1996, FNS disapproved a contract provision that would
           have required that manufacturers demonstrate that they had the
           production capacity sufficient not only to meet infant formula
           contract commitments they had with NEATO, but also commitments
           they had made with other states and those to be awarded. NEATO
           included this provision, in part, because its contractor at the
           time had run out of infant formula, and, as a result, smaller
           states in the coalition did not have enough infant formula. FNS
           rejected the requirement that manufacturers prove they could
           fulfill contracts commitments with others states, which it viewed
           as intrusive and which it felt hindered fair and open competition.

           o  Similarly, in 2005, FNS did not approve a contract provision
           that would have allowed Wisconsin to continue with its current
           contractor if the bids it received differed by $10,000 or less.
           Under the provision, the state could have avoided expenses
           associated with switching contracts. FNS did not approve the
           provision because it believed it would give the current contract
           holder an advantage over the other two competitors.

           Several state WIC directors we interviewed questioned FNS' role in
           the infant formula contracting process. Three state WIC directors
           pointed out that infant formula cost containment was initiated by
           states. In addition, a few state WIC directors noted that the
           manufacturers have stayed in the WIC market for years, even though
           some say that providing infant formula under these contracts is
           not profitable. FNS officials, however, pointed out that Wyeth
           stopped bidding on WIC contracts, and that competition would
           decrease if any other manufacturers stop bidding on WIC contracts.

           The Child Nutrition and WIC Reauthorization Act of 200424contained
           two provisions that promote competition among infant formula
           manufacturers by limiting the size of contracts and coalitions to
           ensure all manufacturers can bid on contracts regardless of their
           capacity:

           o  A requirement that states or coalitions serving more than
           100,000 infants request separate bids for milk-based and soy-based
           infant formulas.

           o  Limits on the size of state coalitions.

           The act also addressed manufacturers' concerns about how WIC
           agencies implement their infant formula contracts:

           o  A requirement that states provide participants, as the infant
           formula of first choice, the infant formula designated by the
           contract manufacturer as its "primary contract infant formula."25

           o  A requirement that manufacturers not only raise the rebates
           they provide to states in response to any increase in wholesale
           price, but also lower the rebates they provide to states by an
           amount equal to any decreases in wholesale price.

           o  A requirement that states accurately account for the number of
           cans of infant formula purchased, not just the number of vouchers
           redeemed at retailers.

           Although states developed and implemented measures to contain the
           cost of infant formula, FNS has played an increasingly important
           role in balancing the goals of containing infant formula costs and
           maintaining competition among infant formula manufacturers. FNS
           actions have not always maximized the cost savings of individual
           states, but by ensuring that all interested manufacturers can
           compete for WIC contracts, it has helped to ensure the long-run
           sustainability of the WIC cost-containment system. However, if
           manufacturers continue to emphasize a business strategy focused on
           innovation and product differentiation, WIC cost-containment
           savings are likely to erode further despite existing measures to
           protect state cost savings. By providing manufacturers with a
           higher per-can reimbursement for newly introduced, more expensive
           products, and by allowing states to issue non-contract, non-exempt
           infant formulas to participants with physician prescriptions,
           federal regulations encourage manufacturers to diversify their
           product lines and charge more for infant formula, even within a
           contract period. Unless FNS takes additional steps to safeguard
           rebate savings, total rebates could continue to erode and the
           number of participants who can be served by WIC will likely fall.

           To help states preserve rebate savings generated through infant
           formula cost containment and reduce costs associated with the
           purchase of non-rebated infant formula, we recommend that the
           Secretary of the Department of Agriculture take the following two
           actions:

           o  Consider providing additional guidance related to product
           changes so that state costs do not increase when infant formula
           manufacturers introduce new or improved infant formulas by
           encouraging all states to include in their contracts a provision
           that requires manufacturers to provide new and improved products
           marketed under a different name at the net wholesale price
           specified in the contract when the new product replaces the
           product the manufacturer designated as its "primary contract
           infant formula." We recommend that the Secretary consider
           implementing a regulatory provision if necessary to ensure that
           states implement the guidance.

           o  Provide guidance or technical assistance to state agencies on
           ways to reduce the use of non-rebated infant formulas in states
           where use of these infant formulas is high.

           On March 13, 2006, we met with FNS officials to discuss their
           comments. The officials said they generally agreed with our
           recommendations. They stated that they will provide guidance
           related to product changes to assist state agencies in minimizing
           cost increases when infant formula manufacturers introduce a new
           infant formula that replaces the primary contract infant formula.
           Officials agree that a regulatory change would be necessary to
           require that state agencies include provisions in their contracts
           to accomplish this goal. They cautioned, however, that they have
           limited influence over the recent increases in infant formula
           costs attributable to manufacturers' price and product changes.
           While we agree that FNS is constrained in its ability to affect
           manufacturer marketing and pricing decisions, we believe the
           agency should take any steps available to contain infant formula
           costs given the importance of cost-containment savings to serving
           as many eligible women, infants, and children as possible.

           Agency officials also stated that they will continue to provide
           guidance to state agencies related to the issuance of non-contract
           infant formula for those states where the use of these infant
           formulas appears high. However, officials expressed concern that
           some states may have misreported their use of exempt and
           non-contract, non-exempt infant formulas due to confusion over
           terminology and interpretation of the survey instrument. Officials
           noted that since some state agencies may require the same medical
           documentation for exempt infant formulas, non-contract, non-exempt
           infant formulas, and certain contract infant formulas other than
           the primary contract brand, some states may have misunderstood the
           distinction between the three types of infant formula we
           identified and misreported use of the different types of infant
           formula. We believe that the survey provided sufficient examples
           to allow states to distinguish between the three infant formula
           types we identified. We pretested our survey with officials in
           five states, in which we discussed their understanding of each
           question and the terms we used, and all of the officials we spoke
           with understood the differences between the categories of infant
           formula we identified. However, we acknowledge that because states
           are not required to track infant formula use by the categories we
           used or by the technical categories defined in the Infant Formula
           Act, our estimates of the use of the three types of infant formula
           may not be consistent across all states.

           Agency officials also expressed concern over the fact that we
           requested data for non-contract and exempt infant formulas by the
           average monthly percentage of total cans issued rather than by
           average monthly percentage of participation. Agency officials
           stated that some state agencies capture their data in terms of
           percentage of participation and this may have contributed to
           misreporting. In our discussions with state officials, we were
           told that because information on the number of cans provided
           through WIC is usually used to bill manufacturers for infant
           formula rebates, most states track the number of cans of infant
           formula provided to WIC participants.

           In 2003, GAO reported similar findings related to use of
           non-contract infant formula based on a survey that used different
           terminology and a different measure of use. The consistency
           between the findings in the two reports reinforces the ongoing
           importance of ensuring that states clearly understand the
           distinction between the different types of non-contract infant
           formula, monitoring the use of different types of infant formula,
           and providing technical assistance to state agencies where use of
           non-contract infant formula is high.

           Agency officials also provided technical comments, which we
           incorporated into the report where appropriate. This included
           revising data that had been provided by two states that had
           reported particularly high use of non-contract, non-exempt infant
           formula.

           We are sending copies of this report to the Secretary of USDA,
           relevant congressional committees, and others who are interested.
           Copies will be made available to others upon request, and this
           report will also be available on GAO's Web site at
           http://www.gao.gov .

           If you or your staff have any questions about this report, please
           contact me on (202)512-7215 or [email protected] . Contact points
           for our Offices of Congressional Relations and Public Affairs may
           be found on the last page of this report. GAO staff who made major
           contributions to this report are listed in appendix III.

           Cynthia M. Fagnoni Managing Director, Education, Workforce, and
           Income Security

           This appendix provides a detailed description of the scope and
           methodology we used to determine (1) what factors influence
           program spending on infant formula, including the role of rebates
           that states receive through infant formula cost-containment
           contracts; (2) how the level of savings resulting from infant
           formula cost containment has changed over the past 5 years and the
           implications of these changes for the number of participants
           served; and (3) how federal and state policies and guidance have
           influenced state spending on infant formula.

           To assess what factors influence program spending on infant
           formula, including federal and state policies, we surveyed state
           directors of the Special Supplemental Nutrition Program for Women,
           Infants, and Children (WIC) in all 50 states and the District of
           Columbia. All 51 survey recipients responded to our survey, but
           not all respondents provided answers to every question. Where
           fewer than 51 responses were provided, we noted in the text the
           number of respondents on which the finding was based. We pretested
           the survey questionnaire with state WIC officials in five states.
           During these pretests, we administered the questionnaire and asked
           the officials to fill it out as they would if they had received it
           in the mail. After completing the questionnaire, we interviewed
           the respondents to ensure that the questions were clear and
           unbiased, the data we requested were feasible to collect, and the
           questionnaire did not place an undue burden on the agency
           officials completing it. To encourage respondents to complete the
           questionnaire, we sent one follow-up mailing containing the full
           survey instrument to nonrespondents approximately 3 weeks after
           the initial mailing and a second follow-up letter about 2 weeks
           later.

           We also conducted a review of literature on infant formula cost
           containment and spoke with officials from the U.S. Department of
           Agriculture's (USDA) Food and Nutrition Service (FNS); state WIC
           directors in Illinois, Massachusetts, Minnesota, New Jersey, New
           York, Pennsylvania, and Washington; and local WIC directors from
           Belford, New Jersey; Chicago, Illinois; Odessa, Texas; Salt Lake
           City, Utah; and Tempe, Arizona. These state and local WIC
           directors were selected based on recommendations of the National
           WIC Association and FNS and represent several different geographic
           areas. We included states that belong to contracting coalitions as
           well as those that contract themselves, and those that had rebid
           their infant formula contracts recently as well as those that last
           rebid their contracts several years ago. We also interviewed
           individuals with expertise related to WIC and infant formula cost
           containment from the National WIC Association and the Center on
           Budget and Policy Priorities. In addition, we interviewed
           representatives from Nestle, Mead Johnson, and Ross Products to
           understand the perspectives of the infant formula manufacturers.

           To assess trends in rebate savings and in the number of
           participants served with rebate savings, we analyzed
           administrative data we received from FNS on WIC program
           participation, food costs, and total rebates from 1990 through
           2005. We assessed the reliability of the data by reviewing
           existing information about the data and the system that produced
           them and interviewing agency officials knowledgeable about the
           data. We determined that the data were sufficiently reliable for
           the purposes of this report. We adjusted the rebate figures for
           inflation using the producer price index for pharmaceuticals.
           Infant formula is marketed in a way that is similar to
           pharmaceuticals.

           To estimate the impact of reduced rebates on the number of
           participants served with rebate savings, we used data we received
           from FNS on total rebates for 2004. This allowed us to estimate
           the share of infant formula spending that was spent on rebated
           infant formula and the share that was spent on non-rebated infant
           formula including exempt and non-contract, non-exempt infant
           formulas. We then held spending on non-rebated infant formulas
           constant, and estimated the reduction in total rebates that would
           have resulted if the average rebate states received through their
           cost-containment contracts in 2004 had been lower than the actual
           average discount of 93 percent of the wholesale price of
           milk-based concentrate. We considered three scenarios to represent
           recent trends in infant formula rebates, either nationwide or in
           individual states:

           o  A reduction in rebates from 93 percent of the wholesale price
           of infant formula to 90 percent of the wholesale price of infant
           formula, a modest decrease to rebate levels experienced by states
           in 2000.

           o  A moderate decrease to 85 percent of the wholesale price of
           infant formula, the average rebate on newly awarded contracts in
           2004.

           o  A larger decrease to 75 percent of the wholesale price of
           infant formula, a decrease similar to that experienced by two
           states.1

           To estimate trends in the per-can cost of infant formula, we also
           analyzed information we received from FNS on the rebates
           individual states received per can of milk-based concentrate
           infant formula from fiscal years 2000 to 2005. We used this data
           to calculate trends in state infant formula costs.

           Table 1: Non-contract, Non-exempt Infant Formula as a Share of All
           Infant Formula Issued, Monthly Average, Fiscal Year 2004

           Source: GAO survey of state WIC directors.

           aThe following states did not provide us with information on their
           use of non-contract, non-exempt infant formula: Indiana, Missouri,
           Montana, New Hampshire, Rhode Island, South Carolina, South
           Dakota, and Tennessee.

           Table 2: Exempt Infant Formula as a Share of All Infant Formula
           Issued, Monthly Average, Fiscal Year 2004

           Source: GAO survey of state WIC directors.

           aThe following states did not provide us with information on their
           use of exempt infant formula: Florida, Indiana, Michigan,
           Missouri, Montana, New Hampshire, North Dakota, Rhode Island,
           South Carolina, South Dakota, and Tennessee.

           Cynthia M. Fagnoni (202) 512-7215, [email protected]

           Kay Brown, Assistant Director; Carol Bray; Kathryn Larin; Lise
           Levie; Lynn Milan; Marc Molino; Luann Moy; Susan Pachikara; Tovah
           Rom; and Daniel Schwimer made significant contributions to this
           report.

           Breastfeeding: Some Strategies Used to Market Infant Formula May
           Discourage Breastfeeding; State Contracts Should Better Protect
           Against Misuse of WIC Name. GAO-06-282 . Washington, D.C.:
           February 8, 2006.

           Means-Tested Programs: Information on Program Access Can Be an
           Important Management Tool. GAO-05-221 . Washington, D.C.: April
           11, 2005.

           Nutrition Education: USDA Provides Services through Multiple
           Programs, but Stronger Linkages among Efforts Are Needed.
           GAO-04-528 . Washington, D.C.: April 27, 2004.

           Food Assistance: Potential to Serve More WIC Infants by Reducing
           Formula Cost. GAO-03-331 . Washington, D.C.: February 12, 2003.

           Food Assistance: WIC Faces Challenges in Providing Nutrition
           Services. GAO-02-142 . Washington, D.C.: December 7, 2001.

           Food Assistance: Research Provides Limited Information on the
           Effectiveness of Specific WIC Nutrition Services. GAO-01-442 .
           Washington, D.C.: March 30, 2001.

           FNS: Special Supplemental Nutrition Program for Women, Infants and
           Children: Requirements for and Evaluation of WIC Program Bid
           Solicitations for Infant Formula Rebate Contracts. OGC-00-65.
           Washington, D.C.: September 18, 2000.

           Food Assistance: Financial Information on WIC Nutrition Services
           and Administrative Costs. RCED-00-66 . Washington, D.C.: March 6,
           2000.

           Food Assistance: Efforts To Control Fraud and Abuse in the WIC
           Program Can Be Strengthened. RCED-99-224 . Washington, D.C.:
           August 30, 1999.

           Food Assistance: Information on WIC Sole-Source Rebates and Infant
           Formula Prices. RCED-98-146 . Washington, D.C.: May 11, 1998.

           Food Assistance: Information on Selected Aspects of WIC.
           T-RCED-98-128 . Washington, D.C.: March 17, 1998.

           Food Assistance: WIC Program Issues. T-RCED-98-125 . Washington,
           D.C.: March 17, 1998.

           Food Assistance: A Variety of Practices May Lower the Costs of
           WIC. RCED-97-225 . Washington, D.C.: September 17, 1997.

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24Pub. L. No. 108-265.

25The primary contract infant formula is the infant formula on which
contract bids are evaluated. Therefore, the bidder who offers the lowest
net wholesale price on the infant formula they designate as their primary
contract infant formula becomes the contract manufacturer, regardless of
rebates provided for other infant formulas covered by the contract. The
requirement that states offer the primary contract infant formula as their
first choice ensures that the primary contract infant formula is provided
before any other infant formula covered by the contract.

                                   Conclusion

                      Recommendations for Executive Action

                       Agency Comments and Our Evaluation

Appendix I: Scope and Methodology Appendix I: Scope and Methodology

1Between 2004 and 2005, three states received rebate bids that were lower
than those of most existing contracts. New York received a winning bid
equal to 76 percent of the wholesale price of infant formula and North
Dakota received a winning bid equal to 77 percent of the wholesale price
of infant formula. Vermont received a winning bid equal to 66 percent of
the wholesale price of infant formula.

Appendix II: Use of Non-Contract, Non-Exempt and Exempt Infant Formula by
State, Fiscal Year 2004 Appendix II: Use of Non-Contract, Non-Exempt and
Exempt Infant Formula by State, Fiscal Year 2004

Statea               Non-contract Brand non-exempt infant formula 
                                                                     
                                                           (percent) 
Virginia                                                        0 
Arkansas                                                        0 
District of Columbia                                            0 
Louisiana                                                       0 
Mississippi                                                     0 
New Mexico                                                      0 
Pennsylvania                                                    0 
Vermont                                                         0 
Alaska                                                        0.3 
Arizona                                                       0.4 
Maryland                                                      0.6 
Massachusetts                                                 0.8 
Oklahoma                                                      1.0 
California                                                    1.2 
Texas                                                         1.3 
New Jersey                                                    1.6 
Ohio                                                          1.7 
New York                                                      1.9 
Nevada                                                        2.0 
Minnesota                                                     2.3 
Georgia                                                       2.3 
Iowa                                                          2.4 
Maine                                                         2.4 
Michigan                                                      2.7 
Hawaii                                                        2.8 
Alabama                                                       3.0 
Nebraska                                                      3.0 
North Carolina                                                3.0 
Washington                                                    3.0 
Colorado                                                      3.7 
Illinois                                                      3.9 
Oregon                                                        3.9 
Delaware                                                      4.0 
West Virginia                                                 4.0 
Wisconsin                                                     4.0 
Florida                                                       4.5 
Wyoming                                                       4.7 
Utah                                                          5.0 
Connecticut                                                   6.0 
Kansas                                                        6.0 
North Dakota                                                  6.5 
Kentucky                                                      8.3 
Idaho                                                         9.0 

Statea               Exempt infant formula 
                                              
                                    (percent) 
District of Columbia                   1.0 
Nevada                                 1.0 
California                             1.7 
Washington                             2.0 
Georgia                                2.0 
Vermont                                2.5 
Connecticut                            3.0 
Idaho                                  3.0 
Kansas                                 3.0 
Wisconsin                              3.0 
Arizona                                3.4 
New Jersey                             3.6 
Colorado                               3.8 
Texas                                  4.2 
Iowa                                   4.6 
North Carolina                         5.0 
Illinois                               5.5 
Hawaii                                 5.7 
Oklahoma                               6.0 
Minnesota                              6.5 
Alaska                                 7.0 
New Mexico                             7.0 
Maryland                               7.4 
Maine                                  7.5 
Alabama                                8.0 
Mississippi                            8.0 
West Virginia                          8.0 
New York                               8.2 
Kentucky                               8.3 
Virginia                               9.0 
Oregon                                 9.1 
Delaware                              10.0 
Nebraska                              10.0 
Louisiana                             11.3 
Utah                                  12.0 
Massachusetts                         16.5 
Arkansas                              17.3 
Wyoming                               20.1 
Ohio                                  21.0 
Pennsylvania                          23.1 

Appendix III: GAOA Appendix III: GAO Contacts and Staff Acknowledgments

GAO Contact

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Highlights of GAO-06-380 , a report to congressional requesters

March 2006

FOOD ASSISTANCE

FNS Could Take Additional Steps to Contain WIC Infant Formula Costs

The Special Supplemental Nutrition Program for Women, Infants and Children
(WIC) provides food, nutrition education, and health care referrals to
close to 8 million low-income pregnant and postpartum women, infants, and
young children each year. About a quarter of these participants are served
using rebate savings from contracts with infant formula manufacturers. WIC
is administered by the Department of Agriculture's Food and Nutrition
Service (FNS). To better understand infant formula cost containment, this
report provides information on: (1) factors that influence program
spending on infant formula, (2) how the level of savings resulting from
infant formula cost containment has changed and the implications of these
changes for the number of participants served; and (3) steps federal and
state agencies have taken to contain state spending on infant formula.

What GAO Recommends

GAO recommends that the Secretary of Agriculture consider providing
guidance to help prevent infant formula costs from rising when
manufacturers introduce more costly formulas during a contract, and that
the Secretary consider ways to more effectively restrict use of
non-rebated formulas by WIC participants.

Rebates drive state spending on infant formula but use of non-rebated
formula increases state costs. In fiscal year 2004, states paid an average
of $0.20 per can for milk-based concentrate formula, a savings of 93
percent off the wholesale price. However, states also allow some use of
non-rebated formula that can cost states more than 10 times as much as
contract formulas. For example, in 2004, 8 percent of infant formula
provided to WIC participants was non-rebated.

Rebate savings from infant formula cost-containment contracts have allowed
WIC to serve an additional 2 million participants per year, but recent
increases in the cost per can of formula could lead to reductions in the
number of participants served with rebates. Rebate savings have remained
near $1.6 billion per year since 1997 after adjusting for inflation, but
the amount states pay per can of infant formula has increased since 2002.
We estimated that in 2004, if the cost per can of formula increased in
every state by as much as it did in two states, approximately 400,000
fewer participants would have been able to enroll in WIC nationwide.

State and federal agencies have both taken steps to contain WIC infant
formula costs, but FNS also focuses on sustaining the cost-containment
system. States have sought to increase their costs savings through their
infant formula contracts-for example, by joining coalitions to leverage
greater discounts. Some also try to restrict the use of the more expensive
non-contract formulas. FNS, in turn, helps states to contain costs through
its review of contracts and through policy and guidance. For example, FNS
reduced-but did not eliminate-the price increases that can result from the
introduction of new, more costly formulas. FNS has also used its oversight
authority to ensure that all interested manufacturers can compete for
state infant formula contracts in an effort to maintain the long-run
sustainability of the infant formula cost-containment system.

National average net price per can of milk-based concentrate, 2000-2005
*** End of document. ***