Prescription Drugs: Expanding Access to Federal Prices Could Cause Other
Price Changes (Letter Report, 08/07/2000, GAO/HEHS-00-118).

Pursuant to a congressional request, GAO provided information on the
expansion of Medicare beneficiaries' access to prescription drugs,
focusing on the: (1) federal drug price discounts available to federal
and nonfederal purchasers and the size of those discounts; and (2)
potential effects that extending such discounts to nonfederal purchasers
may have on outpatient drug prices paid by federal and nonfederal
purchasers.

GAO noted that: (1) federal departments and agencies, state Medicaid
programs, and numerous nonfederal public health entities have access to
prescription drugs at substantially lower prices than many other
purchasers; (2) federal entities can purchase drugs from the federal
supply schedule at prices that are the same or lower than those drug
manufacturers charge their most-favored private purchasers; (3) federal
law also specifies that state Medicaid programs and certain nonfederal
purchasers can receive substantial discounts on prescription drug
prices; (4) under the Omnibus Budget Reconciliation Act of 1990, drug
manufacturers must provide rebates to state Medicaid programs for their
outpatient drugs in exchange for Medicaid coverage; (5) the Public
Health Service Act also provides some nonfederal purchasers, such as
community health centers and certain public hospitals, access to drug
prices based on Medicaid rebates; (6) mandating that federal prices for
outpatient prescription drugs be extended to a large group of
purchasers, such as Medicare beneficiaries, could lower the prices they
pay but raise prices for others; (7) such price changes could occur
because drug manufacturers would be required to charge beneficiaries and
federal purchasers the same prices; (8) to protect their revenues,
manufacturers could raise prices for federal purchasers; (9)
furthermore, because federal prices are generally based on prices paid
by nonfederal purchasers, manufacturers would have to raise prices to
these purchasers in order to raise the federal prices; (10) in
particular, large private purchasers that tend to pay lower prices, such
as health maintenance organizations and other insurers, could see their
prices rise; (11) while it is not possible to predict the extent or
timing of any changes in manufacturer pricing strategies if Medicare
beneficiaries gained access to the same prices available to federal
purchasers, the experience following implementation of a Medicaid rebate
suggests that manufacturers would adjust prices quickly; and (12) the
magnitude of these potential effects would vary by drug and would depend
on a number of factors, including the relationship between the specific
federal price extended to Medicare beneficiaries and the price paid by
nonfederal purchasers, as well as the number of Medicare beneficiaries
with access to the federal price.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  HEHS-00-118
     TITLE:  Prescription Drugs: Expanding Access to Federal Prices
	     Could Cause Other Price Changes
      DATE:  08/07/2000
   SUBJECT:  Federal supply systems
	     Prices and pricing
	     Health maintenance organizations
	     Health insurance cost control
	     Health insurance
	     Drugs
	     Pharmaceutical industry
	     Health care programs
IDENTIFIER:  Medicare Program
	     Medicaid Program
	     Medicare Health Maintenance Organizations Program

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GAO/HEHS-00-118

Table 1: Pharmaceutical Pricing Terms 9

Table 2: Prices for Select Prescription Drugs Commonly Used by the Elderly,
February 2000 12

AMP average manufacturer price

AWP average wholesale price

CBO Congressional Budget Office

DOD Department of Defense

FCP federal ceiling price

FSS federal supply schedule

GSA General Services Administration

HCFA Health Care Financing Administration

HMO health maintenance organization

HRSA Health Resources and Services Administration

OBRA Omnibus Budget Reconciliation Act of 1990

NFAMP nonfederal average manufacturer price

PHS Public Health Service

VA Department of Veterans Affairs

Health, Education, and Human
Services Division

B-284570

August 7, 2000

The Honorable Tom Bliley
Chairman
Committee on Commerce
House of Representatives

The Honorable Michael Bilirakis
Chairman, Subcommittee on Health
and Environment
Committee on Commerce
House of Representatives

Federal departments and agencies can purchase prescription drugs at
substantial discounts off market prices through the federal supply schedule
(FSS) for pharmaceuticals. Administered by the Department of Veterans
Affairs (VA), the FSS for pharmaceuticals is a list of products and their
prices that are available to federal entities that purchase prescription
drugs.1 During fiscal year 1999, federal purchasers spent over $2.75 billion
on prescription drugs,2 about $1.5 billion of which was for drugs purchased
from the FSS. Also, federal law guarantees substantial drug price discounts
to state Medicaid programs and specific public health entities that receive
federal assistance.

As the Congress considers adding a prescription drug benefit to Medicare,
there is increased interest in understanding the ways that government
purchasers have controlled their costs for prescription drugs and whether
these methods can be used to reduce prescription drug costs for Medicare
beneficiaries. One proposal before the Congress would allow Medicare
beneficiaries to purchase drugs from pharmacies at the same prices that are
available to federal purchasers or state Medicaid programs. Because of your
interest in the issue of expanding Medicare beneficiaries' access to
prescription drugs, you asked us to provide you with information on (1) the
federal drug price discounts available to federal and nonfederal purchasers
and the size of those discounts, and (2) the potential effects that
extending such discounts to nonfederal purchasers may have on outpatient
drug prices paid by federal and nonfederal purchasers.

To address these issues, we obtained information on the drug purchasing
methods and prices available to the federal departments and agencies that
spend the most on prescription drugs--VA, DOD, and the Public Health Service
(PHS). We also obtained information from the Health Care Financing
Administration (HCFA) on the rebates state Medicaid programs receive through
the Medicaid drug rebate program. In addition, we contacted officials of the
Health Resources and Services Administration's (HRSA) Office of Drug Pricing
to determine the drug price discounts available to public health entities
that receive federal assistance.3 Further, we reviewed several studies
relevant to the potential impact of expanding the availability of government
drug price discounts to nonfederal purchasers. We conducted our study
between December 1999 and June 2000 in accordance with generally accepted
government auditing standards.

Federal departments and agencies, state Medicaid programs, and numerous
nonfederal public health entities have access to prescription drugs at
substantially lower prices than many other purchasers. Federal entities can
purchase drugs from the FSS at prices that are the same or lower than those
drug manufacturers charge their most-favored private purchasers. Under
federal law, drug manufacturers must list their brand-name drugs on the FSS
to receive reimbursement for drugs covered by Medicaid.4 Manufacturers must
also sell brand-name drugs listed on the FSS to four federal purchasers--VA,
DOD, PHS, and the Coast Guard--at a price at least 24 percent lower than the
nonfederal average manufacturer price (NFAMP), a ceiling price that is lower
than the FSS price for many drugs.5 In addition, VA has obtained some drug
prices that are even lower than FSS prices through national contracts based
on a competitive-bid process. On average, these contracts have resulted in
prices that are about one-third lower than corresponding FSS prices. Federal
law also specifies that state Medicaid programs and certain nonfederal
purchasers can receive substantial discounts on prescription drug prices.
Under the Omnibus Budget Reconciliation Act of 1990 (OBRA), drug
manufacturers must provide rebates to state Medicaid programs for their
outpatient drugs in exchange for Medicaid coverage.6 For brand-name drugs,
the minimum rebate is 15.1 percent of the average manufacturer price (AMP).7
During fiscal year 1999, the rebates state Medicaid programs collectively
received amounted to about 19 percent of overall payments for prescription
drugs. The Public Health Service Act also provides some nonfederal
purchasers, such as community health centers and certain public hospitals,
access to drug prices based on Medicaid rebates.

Mandating that federal prices for outpatient prescription drugs be extended
to a large group of purchasers, such as Medicare beneficiaries, could lower
the prices they pay but raise prices for others. Such price changes could
occur because drug manufacturers would be required to charge beneficiaries
and federal purchasers the same prices. To protect their revenues,
manufacturers could raise prices for federal purchasers. Furthermore,
because federal prices are generally based on prices paid by nonfederal
purchasers, manufacturers would have to raise prices to these purchasers in
order to raise the federal prices. In particular, large private purchasers
that tend to pay lower prices, such as health maintenance organizations
(HMO) and other insurers, could see their prices rise. While it is not
possible to predict the extent or timing of any changes in manufacturer
pricing strategies if Medicare beneficiaries gained access to the same
prices available to federal purchasers, the experience following
implementation of a Medicaid rebate suggests that manufacturers would adjust
prices quickly. The magnitude of these potential effects would vary by drug
and would depend on a number of factors, including the relationship between
the specific federal price extended to Medicare beneficiaries and the price
paid by nonfederal purchasers, as well as the number of Medicare
beneficiaries with access to the federal price.

Prescription drug expenditures have increased substantially in recent
years.8 From 1993 to 1998, prescription drug spending grew at an average
rate of 12.4 percent per year, compared with a 5 percent average annual
growth rate for health care expenditures overall. As a result, prescription
drugs account for a growing share of total health care spending, rising from
5.6 percent in 1993 to 7.9 percent in 1998. This dramatic rise in drug
outlays has occurred for a number of reasons, including greater utilization
of drugs, the substitution of higher-priced new drugs for lower-priced
existing ones, and more direct-to-consumer advertising of drugs by
manufacturers.

In the face of increasing drug expenditures, large purchasers attempt to
control their drug costs, in part, by negotiating lower prices with
manufacturers. Some purchasers deal directly with manufacturers while other
purchasers have representatives that act on their behalf. For example,
pharmacy benefit managers negotiate drug prices for many

HMOs and insurers, while group purchasing organizations representing
thousands of the nation's hospitals do the same. The leverage purchasers
bring to negotiations is based largely on their ability to increase the
volume used of a particular drug through mechanisms that influence
physicians' prescribing and enrollees' purchasing practices. Using these
mechanisms, they can offer manufacturers a larger volume of sales in
exchange for bigger discounts.

To control which specific drug products they will purchase and the volume
used, HMOs and other insurers frequently create a formulary. A formulary is
a list of drugs, grouped by therapeutic class, that a purchaser prefers its
physicians to prescribe because of the drugs' medical value and price.
Because there are often similar products competing for a share of the
market, the greater the purchaser's ability to determine which products it
will include on its formulary, the more leverage the purchaser has to exact
lower prices from manufacturers.9 The purchaser can influence utilization by
encouraging physicians to prescribe lower-cost formulary drugs over both
higher-cost formulary and nonformulary drugs. The purchaser may also provide
financial incentives, such as reduced copayments, to encourage its health
plan members to request that physicians prescribe lower-cost formulary
drugs, including generics.10

Are Significant for Federal and Nonfederal Purchasers

Federal law enables the federal government to use its leverage as a large
purchaser of prescription drugs to secure some of the lowest prices
available for pharmaceuticals. Through the FSS and the Medicaid rebate
programs, manufacturers must provide many of their drugs at significantly
discounted prices in exchange for having their drugs covered by Medicaid.
Federal law also sets a ceiling price on FSS brand-name drugs purchased by
select federal purchasers and extends prices based on Medicaid rebates to
many public health entities that receive federal assistance. In addition, VA
has been able to obtain some prices even lower than FSS prices through
national contracts with drug manufacturers that channel utilization to
specific products.11 Table 1 describes various federal drug prices available
to federal and nonfederal purchasers and their relationship to benchmark
prices.

          Price                              Definition
                         The price charged by retail pharmacies to
 Retail price            individuals without insurance, known as
                         "cash-paying" customers.
                         The average list price that a manufacturer
                         suggests wholesalers charge pharmacies. AWP is
                         typically less than the retail price, which will
                         include the pharmacy's own price markup. AWP is
                         referred to as a sticker price because it is not
 Average wholesale price the actual price that large purchasers normally
 (AWP)                   pay. For example, in a study of prices paid by
                         retail pharmacies in 11 states, the average
                         acquisition price was 18.3 percent below AWP.a
                         Discounts for HMOs and other large purchasers can
                         be even greater. AWP information is publicly
                         available.
                         The average price paid to a manufacturer by
                         wholesalers for drugs distributed to retail
                         pharmacies. FSS prices and prices associated with
                         direct sales to HMOs and hospitals are excluded.
 AMP                     AMP was a benchmark created by OBRA in 1990 to use
                         in determining Medicaid rebates and is not
                         publicly available. The Congressional Budget
                         Office (CBO) estimated AMP to be about 20 percent
                         less than AWP for more than 200 drug products
                         frequently purchased by Medicaid beneficiaries.b
                         The average price paid to a manufacturer by
 NFAMP                   wholesalers for drugs distributed to nonfederal
                         purchasers. NFAMP is not publicly available.
                         The price available to all federal purchasers for
                         drugs listed on the FSS. FSS prices are intended
                         to equal or better the prices manufacturers charge
 FSS                     their "most-favored" nonfederal customers under
                         comparable terms and conditions. Because terms and
                         conditions can vary by drug, the most-favored
                         customer price may not be the lowest price in the
                         market. FSS prices are publicly available.
                         The maximum price manufacturers can charge for
 Federal ceiling price   FSS-listed brand-name drugs to VA, DOD, PHS, and
 (FCP)                   the Coast Guard, even if the FSS price is higher.
                         FCP must be at least 24 percent off NFAMP. FCP is
                         not publicly available.
                         The effective outpatient drug price after
                         manufacturer rebates to state Medicaid programs.
                         The basic rebate on brand-name drugs is the
                         greater of 15.1 percent of the AMP or the
                         difference between AMP and the lowest or "best"
 Medicaid rebate net     price the manufacturer charges any purchaser other
 price                   than Medicaid. Rebates for generic drugs are 11
                         percent of the AMP. Rebates are larger for
                         brand-name drugs whose AMP increases exceed
                         inflation in the consumer price index. Information
                         on rebate amounts is publicly available; AMP and
                         best price are not.
                         The price VA has obtained through competitive bids
 VA national contract    from manufacturers for select drugs in exchange
 price                   for their inclusion on the VA formulary. Contract
                         prices are publicly available.

aSee Office of the Inspector General, Medicaid Pharmacy−Actual
Acquisition Cost of Prescription Drug Products for Brand Name Drugs
(Washington, D.C.: HHS, Apr. 1997).

bSee CBO Papers: How the Medicaid Rebate on Prescription Drugs Affects
Pricing in the Pharmaceutical Industry (Washington, D.C.: CBO, Jan. 1996, p.
20).

The FSS for pharmaceuticals contains over 17,000 products available to
federal departments, agencies, institutions, and several other entities,
such as the District of Columbia, U.S. territorial governments, and numerous
Native American tribal governments. VA is responsible for administering the
FSS and is also the schedule's largest purchaser--about $1.2 billion in
fiscal year 1999, representing almost 83 percent of all sales at FSS prices.

According to VA, during fiscal year 1999, FSS drug sales totaled about $1.5
billion--about 1.1 percent of domestic pharmaceutical sales.12

Although manufacturers are not required to list their drug products on the
FSS, they have financial incentives to do so despite the FSS's relatively
low prices. Manufacturers are required to list their brand-name products on
the FSS if they wish to receive reimbursement for their drugs under the
Medicaid program. Because Medicaid accounts for almost 10 percent of
domestic pharmaceutical sales, a manufacturer could lose substantial
revenues if it did not have access to this segment of the market.13 Also,
because sales under the FSS represent only a small segment of the domestic
pharmaceutical market, overall revenues are not greatly affected by offering
these prices to federal customers. Furthermore, being on the FSS is
significant to manufacturers because it enhances the likelihood that their
products will be used in VA hospitals, where many of the nations' physicians
receive part of their medical training.14

FSS prices are based on the prices that drug manufacturers charge their
"most-favored" private customers. Specifically, under General Services
Administration (GSA) procurement regulations, the FSS price is intended to
equal or better the price that the manufacturer offers its most-favored
nonfederal customer under comparable terms and conditions.15 To help VA
determine the most-favored customer price, manufacturers are required to
provide VA information on price discounts and rebates offered to domestic
customers and the terms and conditions involved, such as length of contract
periods and ordering and delivery practices. GSA regulations recognize that
because the terms and conditions of commercial sales vary, there may be
legitimate reasons why the government does not always obtain the
most-favored customer price. Hence, under the regulations, VA may accept a
higher price if it determines that (1) the price offered to the government
is fair and reasonable, and (2) awarding the contract is otherwise in the
best interest of the government.

VA and several other purchasers may actually pay a lower price than the
listed FSS price for many drugs, under a provision of the Veterans Health
Care Act of 1992.16 Specifically, in exchange for having their drugs covered
by Medicaid, manufacturers must sell their brand-name drugs on the FSS to
four federal purchasers--VA, DOD, PHS, and the Coast Guard--at a price that
is no higher than 76 percent of the nonfederal average manufacturer price,
known as the "federal ceiling price" or FCP. The FSS price for these drugs
for other federal purchasers may be higher than this ceiling.

Most drug products covered under the Veterans Health Care Act have FSS
prices that are slightly above their FCP. As of February 2000, the FSS
prices for products covered under the act were, on average, almost 8 percent
above the FCP. About 63 percent of the almost 6,300 products covered under
the act17 had FSS prices that were above the FCP.18 For these products, the
four purchasers protected under the act would pay only the FCP. About 14
percent of the products covered under the act had FSS prices equal to the
FCP, and 23 percent had FSS prices that were below the FCP. When the FSS
price was lower than the ceiling, it averaged almost 6 percent below the
FCP.

FSS prices can also be well below the average wholesale prices that
manufacturers suggest wholesalers charge retail pharmacies.19 Recent FSS
prices for 10 drugs commonly prescribed for the elderly were considerably
lower than AWP (see table 2).

                                                           Difference
 Brand-name                           AWPa      FSSb       between AWP and
 drug         Therapeutic category                         FSS prices
                                      (dollars) (dollars)
                                                           (percentage)
 Lanoxin      Cardiac glycoside       $20.51    $10.05     51%

 Norvasc      Calcium channel blocker 122.86    61.27      50
              (high blood pressure)
 K-Dur 20     Potassium replacement   49.98     23.73      53
 Lipitor      Cholesterol-lowering    169.08    102.28     40
 Lanoxin
 (different   Cardiac glycoside       20.51     10.20      50
 strength)
 Prilosec     Gastrointestinal        119.57    58.73      51
 Pepcid       Gastrointestinal        53.13     18.39      65
 Glucophage   Oral antidiabetic       64.62     30.60      53
 Fosamax      Osteoporosis            60.89     33.74      45
 Synthroid    Thyroid                 $30.84    $20.91     32%

Note: These are the 10 most frequently prescribed drugs in the Pennsylvania
Pharmaceutical Assistance Contract for the Elderly in 1999. Several of these
drugs have generic versions.

aMedical Economics Company, Red Book February 2000 Update, vol. 19, no. 2
(Feb. 2000).

bDepartment of Veterans Affairs, Pharmacy Benefits Management Strategic
Healthcare Group, http://www.vapbm.org (cited Feb. 14, 2000).

Many entities that receive federal assistance also obtain significant drug
discounts through federal laws. The most notable are state Medicaid
programs, which receive discounts in the form of rebates. Under OBRA, as
amended, drug manufacturers must provide all state Medicaid programs a
rebate on outpatient prescription drugs in order to have them covered by
Medicaid.20 For all brand-name products, the rebate is the greater of either
15.1 percent of AMP, or 100 percent of the difference between the AMP and
the manufacturer's best price. The best price is essentially the lowest
price offered any domestic purchaser other than state Medicaid programs.21
Rebates for generic and over-the-counter drugs must be at least 11 percent
of AMP. To protect against substantial price increases, an additional rebate
is required for a brand-name product if its AMP increases more than the
consumer price index, a measure of overall inflation. During fiscal year
1991, state Medicaid programs paid about $5.4 billion to pharmacies for
prescription drugs and received about $553 million in rebates from
manufacturers. By fiscal year 1999, drug payments had reached about $17
billion, with rebates in excess of $3.3 billion.22

Since 1992, federal law has also required drug manufacturers to offer
certain nonfederal entities access to outpatient drugs at discounted prices
as a condition for Medicaid coverage of their outpatient drugs.23
Specifically, under Section 340B of the Public Health Service Act,24
manufacturers must provide covered entities such drugs at or below a price
equal to AMP reduced by the applicable Medicaid rebate percentage.25
Entities eligible for the price discount include hospitals that serve a
disproportionate share of Medicaid recipients; community health centers; and
health centers that serve migrant, homeless, public housing, and Native
American populations.26 A recent study estimates that, during fiscal year
1997, 1,075 entities purchased outpatient drugs at these discounts with a
total net purchase amount between $893 million and $1.2 billion.27

VA has been able to obtain prices even lower than FSS prices through
national contracts with manufacturers for select drugs. VA has obtained such
prices because it seeks competitive bids from manufacturers for products
that are therapeutically equivalent within specific drug classes.28 VA then
contracts with those manufacturers whose products it believes provide the
best value, based on both medical effectiveness and price, in exchange for
including their products on VA's national formulary and committing to use
the products throughout VA's health care system.29 According to VA
officials, the winning bids in most cases are the lowest prices offered.
During fiscal year 1999, VA purchases under national contracts totaled about
$361.3 million, or about 23 percent of its drug expenditures. By February
2000, VA had 60 national contracts covering about 500 products.30 For the
308 products that had both a national contract price and an FSS price as of
February 14, 2000, the national contract price was, on average, about 33
percent lower than the FSS price. Because national contract prices are lower
than FSS prices, the price differences between national contract prices and
AWP, in turn, can be quite large. For example, the national contract prices
for three cholesterol-lowering drugs that are among the top 50 drug products
most commonly used by the elderly were, respectively, 70, 72, and 88 percent
lower than AWP.31

Extending federal prices for outpatient prescription drugs to a large group
of purchasers, such as Medicare beneficiaries, could lower the prices these
purchasers pay, but could raise prices to federal and other purchasers. Drug
manufacturers could respond to a mandate that they extend federal prices to
a larger share of purchasers by adjusting their prices to others. The larger
the group that would be newly entitled to receive a federal price, the
greater the incentive for drug manufacturers to raise that price. The
Medicaid rebate experience suggests how federal and nonfederal drug price
discounts could change if Medicare beneficiaries had access to the same
price discounts available to federal purchasers. Following enactment of the
rebate program, discounts for outpatient drugs decreased significantly
because manufacturers raised the prices they charged large private
purchasers.

Drug manufacturers have traditionally sold the same product at different
prices to distinct groups or segments of purchasers, such as HMOs, private
insurers, hospitals, and retail pharmacies. Manufacturers can segment the
market in this manner because the purchasers who receive the lower prices do
not, in turn, resell these products to other purchasers. As long as the
groups remain independent in this way, manufacturers can tailor the price
charged each group. This helps to explain why customers without drug
coverage, or cash-paying customers, typically face higher prices at a retail
pharmacy than HMOs or other large private purchasers pay.

The prices that manufacturers establish for different groups depend on how
price sensitive each group is--that is, the extent to which the group would
change the amount of a product it buys if the price rises or falls. For
example, HMOs are more price sensitive than retail pharmacies because HMOs
exercise control over the particular products they purchase through the use
of formularies and other mechanisms that influence physicians' prescribing
practices. Conversely, retail pharmacies have limited ability to determine
which drugs they must have available because physicians' prescribing
practices are largely outside their influence. Retail pharmacies must,
therefore, stock a wide range of drug products that meet the needs of all of
their customers, regardless of changes in price for those products.

If manufacturers were required to provide their drug products to both retail
pharmacies and HMOs at the same prices, these two market segments would no
longer be independent. Manufacturers would have to decide whether to provide
retail pharmacies the same prices they have typically provided HMOs, or
raise their prices to HMOs to minimize the negative impact on their profits.
To assess the potential impact on profits, manufacturers would need to
assess how much of their revenue they would lose by charging retail
pharmacies the lower HMO prices, versus any losses in sales due to raising
the prices to HMOs and other large private purchasers. Manufacturers would
recognize that raising prices to these large purchasers could result in
decreased sales. Manufacturers would likely temper their price changes
depending on how price sensitive large purchasers were. If large purchasers
were very price sensitive, sharply restricting their purchases as prices
rose, manufacturers might restrain their price increases. If large
purchasers were less price sensitive, manufacturers could raise prices more
while experiencing the loss of fewer sales. The net result of requiring that
retail pharmacies and large purchasers pay the same prices would likely be
higher prices for those who had previously benefited from lower prices and
lower prices for those who had not.

Extending federal prices to a large group of purchasers, such as Medicare
beneficiaries, could have similar pricing implications. Large groups of
purchasers that pay very different prices based on their price sensitivity
would be combined and manufacturers would be required to charge everyone in
the enlarged combined group the same price. The magnitude of the price
effects would depend considerably on which federal price was provided and
the number of beneficiaries that would now purchase drugs at that federal
price.32 For example, if the FSS price were extended to Medicare
beneficiaries, the market segments that included FSS purchasers and
cash-paying retail Medicare customers would be combined. In this case, the
federal price would be based on prices paid by manufacturers' most-favored
customers, and the volume of sales at the FSS price would be significantly
larger than at present. Depending on the number of Medicare beneficiaries
that would purchase their drugs at FSS prices, sales at FSS

prices could be between 6 and 20 times larger than the current level.33 How
much manufacturers might charge would vary by product, depending
considerably on whether there were competing products, as well as the price
sensitivity of the manufacturers' other customers. However, for those
products whose retail and most-favored customer prices were considerably
different, manufacturers would have the incentive to charge a new price that
would likely fall somewhere between the two to offset any reduction in
revenues. In these cases, extending the FSS price to Medicare beneficiaries
could result in important out-of-pocket savings, particularly for
cash-paying beneficiaries.34 However, it could also raise the prices paid by
private and federal purchasers, as increases in the prices manufacturers
charged their best customers would, in turn, increase FSS prices.

Federal efforts to provide state Medicaid programs discounts on prescription
drugs demonstrate the potential price effects of mandating a federal price
or discount that, in effect, combines purchasers from different market
segments. Before the Medicaid rebate program was enacted, state Medicaid
programs were paying near-retail prices for outpatient drugs, although
collectively they were the largest single purchaser of prescription drugs.
OBRA required that manufacturers provide rebates to state Medicaid programs
on outpatient drugs based on the lowest prices they charged other
purchasers. After the rebate program's enactment, the discounts that large
private purchasers, such as HMOs and hospitals,

received for many outpatient drugs dropped substantially.35 Within 2
years,we found that the average best-price discount for the drugs they
purchased was no greater than 15.3 percent of AMP--about the mandated
minimum rebate for Medicaid programs.36 This was confirmed by a CBO analysis
that concluded that manufacturers were much less willing to give steep
discounts to large purchasers when they had to give the same discounts to
Medicaid.37

By using its purchasing power, principally derived from the large purchases
covered by the Medicaid program, the federal government obtains
significantly discounted prices for prescription drugs from drug
manufacturers for both federal and select nonfederal entities. Extending
federal prices to Medicare beneficiaries could result in their paying less
for drugs. However, these lower prices could come with a trade-off--federal
and nonfederal purchasers might pay more if drug manufacturers raise prices
to them to offset revenue losses resulting from extending federal prices to
Medicare beneficiaries. The extent to which prices would change would vary
by drug and would depend on many factors, including the number of Medicare
beneficiaries affected, whether a drug had competition, and the price
sensitivity of private purchasers. The decrease in price discounts following
enactment of the Medicaid rebate program demonstrated the potential effects
of reducing manufacturers' ability to differentiate among purchasers and
charge some purchasers higher prices than others.

We obtained comments on the draft report from VA officials associated with
pharmaceutical purchasing and pharmacy benefit management, including the
Executive Director and Chief Operating Officer of the National Acquisition
Center and the Chief Consultant for the Pharmacy Benefits Management
Strategic Healthcare Group. We also obtained comments from two nationally
known researchers on pharmaceutical pricing issues. The reviewers agreed
with our findings and provided technical comments, which we have
incorporated where appropriate.

As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from
the date of this letter. At that point, we will send copies to interested
congressional committees and Members and agency officials, and will make
copies available to others on request. If you or your staffs have any
questions about this report, please call me at (202) 512-7114, or John
Hansen at (202) 512-7105. Others who made major contributions to this report
include Joel Hamilton, Elsie Picyk, and George Bogart.

Laura A. Dummit
Associate Director, Health Financing
and Public Health Issues

(201017)

Table 1: Pharmaceutical Pricing Terms 9

Table 2: Prices for Select Prescription Drugs Commonly Used by the Elderly,
February 2000 12
  

1. The FSS may list the same drug in different dosage amounts and package
sizes. Each listing is considered an individual item or product.

2. This total includes all FSS sales to federal purchasers, as well as
non-FSS sales associated with contracts VA and the Department of Defense
(DOD) have with drug manufacturers.

3. The Office of Drug Pricing is now called the Office of Pharmacy Affairs.

4. See 38 U.S.C. sec. 8126, as added by the Veterans Health Care Act of 1992
(P.L. 102-585, sec. 603).

5. The NFAMP is the weighted average price of each single form and dosage
unit of a drug that is paid to a manufacturer by wholesalers for nonfederal
purchasers, taking into account any cash discounts or similar price
reductions.

6. See P.L. 101-508, sec. 4401.

7. The AMP is the weighted average price of each form and dosage unit of a
drug that is paid to a manufacturer by wholesalers for drugs distributed to
the retail pharmacy class of trade, taking into account cash discounts or
similar price reductions. FSS prices and prices associated with direct sales
to HMOs and hospitals are excluded from this calculation.

8. See Prescription Drugs: Increasing Medicare Beneficiary Access and
Related Implications (GAO/T-HEHS/AIMD-00-100 , Feb. 16, 2000). From 1993 to
1998, national expenditures for prescription drugs grew from about $50.6
billion to about $90.6 billion.

9. Competition can exist between brand-name drugs that are therapeutically
equivalent, between brand-name drugs and generic substitutes, and between
generic versions of the same drug. Brand-name or innovator drugs generally
have a patent on their chemical formulation or on their manufacturing
process. While under patent protection, they are called single-source drugs
because only the company that holds the patent produces them. After the
patent has expired, generic copies of the exact chemical formulation usually
become available and the drugs are then referred to as multiple-source
drugs.

10. Because generic drugs are not patented and can be copied by different
manufacturers, they often face intense competition, which usually results in
much lower prices than brand-name drugs.

11. VA refers to these as committed-use contracts.

12. According to IMS America, a private vendor of pharmaceutical
information, in 1999 the U.S. pharmaceutical market totaled about $142.4
billion in sales, including sales to federal and nonfederal entities.

13. According to HCFA, Medicaid payments minus rebates for prescription
drugs for fiscal year 1999 totaled about $13.7 billion. This figure may
slightly overstate the actual market represented by Medicaid sales because
Medicaid payments to pharmacies may be greater than the actual amounts
pharmacies pay for drugs.

14. For further discussion of the FSS and how FSS prices are determined, see
Drug Prices: Effects of Opening Federal Supply Schedule for Pharmaceuticals
Are Uncertain (GAO/HEHS-97-60 , June 11, 1997).

15. See 48 C.F.R. sec. 538.270.

16. See P.L. 102-585, sec. 603, codified at 38 U.S.C., sec. 8126. The
provision covers innovator multiple-source drugs, insulin, and biological
products such as vaccines and antitoxins. The provision does not cover
noninnovator multiple-source or generic drugs.

17. As of February 14, 2000, the FSS included 17,464 drug products; 6,274
were covered under the Veterans Health Care Act and 11,190 were not covered.
Noncovered products are generally generic drugs. VA estimates that about 70
percent of its drug expenditures for fiscal year 1999 were for drugs covered
under the Act.

18. About 69 percent of the covered drugs with FSS prices above the FCP had
FSS prices that were only 1 percent or less above the ceiling.

19. Because AWP reflects prices charged the retail level of trade, it is
typically higher than average manufacturer prices--AMP and NFAMP--which are
charged at the wholesale level.

20. Rather than directly purchasing drugs, Medicaid reimburses pharmacies
for drugs purchased by Medicaid beneficiaries. Based on a formula set by the
state, pharmacies are reimbursed an amount to cover a drug product's
ingredient cost, subject to HCFA upper limits, plus a dispensing fee.

21. Some prices are excluded in the determination of best price, such as FSS
prices, prices charged entities covered under the Veterans Health Care Act,
prices to state pharmaceutical assistance programs, prices that are nominal
in amount, and single-award contract prices charged any federal agency.

22. Rebates in the earlier years of the rebate program were based on a
different percentage of AMP. Also, according to HCFA officials, payments for
fiscal year 1999 may be understated because states do not typically submit
all payment data to HCFA by the end of the fiscal year.

23. See Office of Drug Pricing, The Drug Pricing Program Established by
Section 340B of the Public Health Service Act: Information Document
(Washington, D.C., Feb. 1999). The Office of Drug Pricing (now called the
Office of Pharmacy Affairs), which is within HRSA's Bureau of Primary Health
Care, is responsible for administering the Section 340B program.

24. As added by sec. 602 of the Veterans Health Care Act of 1992.

25. The rebate percentage is the total per-unit Medicaid rebate during a
calendar quarter divided by the AMP for the quarter. HRSA's Office of Drug
Pricing indicates that the ceiling price does not exceed AMP minus 15.1
percent for brand-name drugs and 11 percent for generic and over-the-counter
drugs. An additional rebate is required if any brand-name product's price
exceeds the increase in the consumer price index for all items. In addition,
covered entities must ensure that drugs are not double discounted--that is,
that manufacturers do not pay a Medicaid rebate on drugs already sold to the
entities at a discounted price under Section 340B.

26. See P.L. 102-585, sec. 602.

27. See An Analysis of Purchases, Savings and Participation in the PHS Drug
Pricing Program (Mathematica Policy Research, Inc., Washington, D.C., Sep.
30, 1999).

28. VA also negotiates what is known as "blanket purchase agreements" with
many manufacturers to obtain prices that are lower than listed FSS prices if
VA uses specific product amounts. These agreements differ from national
committed-use contracts in that they are not competitively bid and most
apply to specific VA purchasers, such as one or more VA hospitals. As of
February 14, 2000, there were 52 blanket purchase agreements in effect.

29. See VA Health Care: VA's Management of Drugs on Its National Formulary
(GAO/HEHS-00-34 , Dec. 14, 1999).

30. The contracts cover both brand-name and generic products and include
some joint contracts with DOD.

31. For additional information on VA national contracting practices and
prices, see DOD and VA Health Care: Jointly Buying and Mailing Out
Pharmaceuticals Could Save Millions of Dollars (GAO/T-HEHS-00-121 , May 25,
2000).

32. For further discussion of the potential effects of extending FSS prices
to nonfederal purchasers, see GAO/HEHS-97-60 (June 11, 1997).

33. In 1996, Medicare beneficiaries with drug coverage spent an average of
$769 on prescription drugs; beneficiaries without coverage spent an average
of $463. If the approximate 12 million beneficiaries that lacked drug
coverage had access to FSS prices and those prices were lower than the
prices they would pay otherwise, it could increase the volume of drugs they
would purchase. Therefore, if their drug spending at FSS prices increased to
about the same amount as those with coverage, sales at FSS prices would be
about $9.2 billion, or over six times greater than total FSS sales in fiscal
year 1999. If all 39 million beneficiaries had access to FSS prices and
spent an annual average of $769 on drugs, FSS sales would be about $30
billion or about 20 times greater than total FSS sales in fiscal year 1999.
Based on data from the 1996 Medicare Current Beneficiary Survey. See J.A.
Poisal and G.S. Chulis, "Medicare Beneficiaries And Drug Coverage," Health
Affairs (Mar./Apr. 2000), p. 252.

34. Other beneficiaries with drug coverage, such as those enrolled in
Medicare HMOs, may already receive drugs at discounted prices.

35. See Medicaid: Changes in Best Price for Outpatient Drugs Purchased by
HMOs and Hospitals (GAO/HEHS-94-194FS , Aug. 5, 1994). Also, see Medicaid:
Changes in Drug Prices Paid by HMOs and Hospitals Since Enactment of Rebate
Provisions (GAO/HRD-93-43 , Jan. 15, 1993).

36. This is average percentage that the best price was below the AMP. The
average best price discount decreased because the average best price
increased faster than the AMP during the 2-year period.

37. See CBO Papers: How the Medicaid Rebate on Prescription Drugs Affects
Pricing in the Pharmaceutical Industry (Washington, D.C., Jan. 1996). CBO
also noted that many FSS prices increased significantly, perhaps because FSS
prices were initially considered with private-sector prices in calculating
rebates. In 1992, in the Veterans Health Care Act, the Congress exempted all
drug prices paid by federal entities from rebate calculations.
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