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Drug Prices Used by Other Countries and U.S. Private Payers and Federal 
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Testimony: 

Before the Committee on Finance, U.S. Senate: 

United States Government Accountability Office: 

GAO: 

For Release on Delivery Expected at 10:00 a.m. EST: 

Thursday, January 11, 2007: 

Prescription Drugs: 

An Overview of Approaches to Negotiate Drug Prices Used by Other 
Countries and U.S. Private Payers and Federal Programs: 

Statement of John E. Dicken Director, Health Care: 

GAO-07-358T: 

GAO Highlights: 

Highlights of GAO-07-358T, a testimony before the Committee on Finance, 
U.S. Senate 

Why GAO Did This Study: 

Rising prescription drug spending has led the United States and other 
countries to seek ways to negotiate lower prices with drug 
manufacturers. Currently, the Medicare Part D benefit, which offers 
outpatient prescription drug benefits to beneficiaries including 
elderly and certain disabled people, comprises competing prescription 
drug plans overseen by the Centers for Medicare & Medicaid Services. 
The Medicare Prescription Drug, Improvement, and Modernization Act of 
2003 prohibits the Secretary of Health and Human Services from 
interfering with price negotiations between Part D plan sponsors and 
drug manufacturers and pharmacies. Some Members of Congress have 
proposed amending the statute to allow the Secretary of Health and 
Human Services to negotiate directly with drug manufacturers on behalf 
of Part D beneficiaries. 

GAO was asked to describe how prescription drug prices are negotiated. 
This testimony provides an overview of such efforts (1) by governments 
in other countries; (2) by U.S. private payers, such as employer-based 
health plans; and (3) by federal programs other than Medicare Part D. 
This testimony is based on previous GAO reports from 2002 through 2006 
on federal programs that purchase or cover prescription drugs and other 
relevant literature from congressional agencies and federal or 
international organizations. 

What GAO Found: 

Governments in other countries use a range of approaches to limit the 
amount they pay to acquire drugs: 
* Ceiling prices establish a maximum price manufacturers may charge for 
their products. Purchasers may sometimes negotiate more favorable 
prices directly with drug manufacturers.
* Reference prices use local or international price comparisons of 
drugs classified in a group as therapeutically similar to determine a 
single or maximum price for all drugs in that group. 
* Profit limits control how much profit a drug manufacturer may earn 
per product or within a specified period of time. Other factors—such as 
scope of coverage and national formularies, which are generally lists 
of preferred drugs—influence drug price negotiations. 

In the U.S. private health insurance market, health plans typically 
contract with pharmacy benefit managers (PBM) to help manage their 
prescription drug benefits. PBMs negotiate rebates or payments with 
drug manufacturers, encourage substitution of generic drugs for 
therapeutically similar brand drugs, and negotiate discounted prices 
with networks of retail and mail-order pharmacies, passing along at 
least some of the savings to health plans and enrollees. PBMs influence 
price negotiations with manufacturers through formulary development and 
management and through the large market share they often represent. 

Approaches for negotiating drug prices vary among federal programs in 
the United States. In part, these approaches depend on whether the 
programs purchase and distribute drugs directly or reimburse retail 
pharmacies or other providers for dispensing or delivering drugs. While 
the approaches used by federal programs in the United States reflect 
U.S. laws, markets, and health care delivery and financing, there are 
also elements common to some of the approaches used by other countries 
and by private payers. Some federal programs set ceiling prices, others 
establish prices by referencing prices negotiated by private payers in 
the commercial market, and still others rely on negotiations with 
manufacturers, directly or through private health plans. For example, 
the Departments of Veterans Affairs’s and Defense’s prices for a 
prescription drug may be the lowest of a ceiling price, other 
established price, or a price negotiated with the manufacturer. State 
Medicaid programs, joint federal-state programs that finance medical 
services for certain low-income adults and children, reimburse retail 
pharmacies for drugs dispensed to beneficiaries at set prices. The 
programs receive rebates from manufacturers that are meant to take 
advantage of the prices for drugs in the commercial market and are 
required to reflect discounts and rebates negotiated by private payers 
with manufacturers. For health benefits offered to federal employees, 
retirees, and dependents, rather than negotiating with manufacturers, 
the government contracts with participating health plans that typically 
use PBMs to negotiate drug prices and offer other pharmacy benefit, 
administrative, and clinical services. 

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-358T]. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact John E. Dicken at (202) 
512-7119 or dickenj@gao.gov. 

[End of Section] 

Mr. Chairman and Members of the Committee: 

I am pleased to be here today as you examine approaches for 
prescription drug pricing and negotiations. In the United States and in 
other countries, the rising cost of prescription drugs continues to 
pose significant financial burdens on governments, private payers, and 
individuals responsible for paying for drugs. This has led to a wide 
range of market-based and governmental approaches to reduce drug 
spending. Some of these approaches rely on negotiations between payers 
for prescription drugs and drug manufacturers. 

In the United States, prescription drugs are a particular focus for the 
federal government as Medicare--the federal health insurance program 
that serves nearly 43 million elderly and disabled individuals--begins 
the second year of its voluntary outpatient prescription drug benefit. 
This benefit, known as Medicare Part D, was established by the Medicare 
Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) 
beginning January 1, 2006.[Footnote 1] Medicare beneficiaries may 
choose a Part D plan from multiple plans offered by private sponsors, 
largely commercial insurers, under contract with the Centers for 
Medicare & Medicaid Services (CMS), the agency within the Department of 
Health and Human Services (HHS) that administers Medicare. These plans 
differ in the drugs they cover, the pharmacies they use, and the prices 
they negotiate with drug manufacturers and pharmacies. In addition, 
costs to the enrollee for the monthly premium, the annual deductible, 
and copayments for covered drugs vary by plan. 

While the Medicare Part D benefit is characterized by multiple 
competing prescription drug plans that are overseen by CMS, MMA 
prohibits the Secretary of Health and Human Services from interfering 
with price negotiations between Part D plan sponsors and drug 
manufacturers and pharmacies.[Footnote 2] Some Members of Congress, 
contending that the combined purchasing power on behalf of all Medicare 
Part D beneficiaries could be used as leverage, have proposed amending 
the law to provide for the Secretary of Health and Human Services to 
negotiate directly with drug manufacturers.[Footnote 3] 

As Congress considers these issues for Medicare Part D, you asked that 
we broadly describe the variety of approaches used to negotiate drug 
prices. Specifically, my remarks today will provide an overview of the 
approaches used to negotiate drug prices by governments in other 
countries, by private payers in the United States, and by federal 
programs other than Medicare Part D.[Footnote 4] My remarks are 
primarily based on our previous reports from 2002 through 2006 on 
federal programs that purchase or cover prescription drugs, which were 
done in accordance with generally accepted government auditing 
standards, as well as other relevant literature on approaches in the 
United States and other countries prepared by congressional agencies 
and international and federal organizations.[Footnote 5] 

In summary, a wide range of approaches is used by other countries and 
by private payers and federal programs in the United States to 
negotiate drug prices. The approaches governments in other countries 
use include the following: 

* Ceiling prices restrict market negotiations by setting maximum prices 
purchasers can pay for drugs. Ceiling prices allow purchasers to 
negotiate lower prices directly with drug manufacturers. 

* Reference prices use local or international price comparisons of 
drugs classified in a group as therapeutically similar to determine a 
single or maximum price for all drugs in that group. 

* Profit limits establish controls on drug manufacturers' profits that 
require manufacturers to pay rebates or lower prices if profits exceed 
certain levels. 

Other key factors--such as scope of coverage and national formularies, 
which are generally lists of preferred drugs--influence drug price 
negotiations. 

Private payers in the United States, including employer-based health 
plans and private insurers, typically contract with pharmacy benefit 
managers (PBM). PBMs negotiate rebates or payments with manufacturers 
and prices with retail pharmacies, and they provide other related 
administrative and clinical services. PBMs compete in the private 
market based on their ability to negotiate reduced prices and contain 
costs, and PBMs may receive compensation from health plans and from 
retaining some of the savings they negotiate with pharmacies or 
manufacturers. PBMs influence price negotiations with manufacturers 
through formulary development and management and through the large 
number of health plan enrollees they typically represent. 

Approaches for negotiating drug prices vary among federal programs in 
the United States. Factors contributing to this variation include the 
use of formularies and whether the programs purchase and distribute 
drugs, reimburse retail pharmacies or other providers for drugs 
dispensed and delivered, or contract with private health plans that 
provide and manage pharmacy benefits. For example, the Department of 
Veterans Affairs (VA) and the Department of Defense (DOD) often 
purchase drugs from suppliers, then distribute drugs to beneficiaries 
through internal facilities or mail-order pharmacies. State Medicaid 
programs, on the other hand, reimburse retail pharmacies for drugs 
dispensed to beneficiaries at set prices. While the approaches used by 
federal programs in the United States reflect the laws governing them, 
markets, and health care delivery and financing, there are also 
elements common to some of the approaches used by other countries and 
by private payers. Some federal programs set ceiling prices, others 
establish prices by referencing prices negotiated by private payers in 
the commercial market, and still others rely on negotiations with 
manufacturers, either directly or through private health plans. For 
example, VA's and DOD's prices for particular prescription drugs 
included on their formularies may be the lowest of a ceiling price, a 
price listed on a federal supply schedule (FSS), or the price 
negotiated with a manufacturer. For health benefits offered to federal 
employees, retirees, and their dependents, the federal government uses 
a different approach, modeled after other large U.S. employers' health 
benefits. Under this approach, rather than the government negotiating 
with manufacturers, the government contracts with participating health 
plans that typically use PBMs to negotiate drug prices, manage 
formularies, and offer other pharmacy benefit, administrative, and 
clinical services. 

Background: 

Prescription drug spending, paid for by a mix of public and private 
payers, has outpaced total health care spending in the United States 
and other countries in recent years. In the United States, federal 
programs either directly purchase and distribute prescription drugs or 
reimburse pharmacies or other providers for drugs dispensed or 
delivered. 

Prescription Drug Spending and Cost Containment Strategies in Other 
Countries and the United States: 

According to the Organisation for Economic Co-operation and Development 
(OECD), drug spending in member countries (including the United States) 
increased on average by about 6 percent a year from 1998 through 
2003.[Footnote 6] On average, growth in drug spending outpaced the 
growth in spending for total health expenditures. Among OECD member 
countries, the share of public and private spending for prescription 
drugs varies, but in 2004 public sources accounted for the bulk of 
spending in most countries. 

In the United States, rising prescription drug prices and increased 
spending have been a concern to federal and state governments and to 
private payers, including private insurers and employer-based health 
plans. CMS reports that total national spending by all public and 
private payers for prescription drugs from retail outlets increased on 
average by about 11 percent a year from 1998 through 2005--faster than 
the average 7 percent a year increase in total U.S. health expenditures 
for the same period.[Footnote 7] CMS also reports that national 
spending by all public and private payers for prescription drugs from 
retail outlets totaled about $201 billion in 2005. Nearly three- 
quarters (73 percent) of this spending came from private funds-- 
including private insurance and out-of-pocket payments--while the 
remaining share came from public sources. The public share includes the 
federal government's share of total spending for prescription drugs 
from retail outlets. Federal spending for prescription drugs was about 
16 percent of the total, or $33 billion, in 2005. However, these data 
precede the 2006 establishment of Medicare Part D, which increased 
public and federal shares of prescription drug expenditures. 

In the face of rising prescription drug spending, the governments of 
other countries, U.S. private payers, and federal programs have applied 
both demand-and supply-side measures to contain prescription drug 
spending. Demand-side measures are aimed at wholesalers, retailers, 
doctors, and patients and include such strategies as prescribing 
guidelines, generic substitution policies, and fixed and tiered 
copayments. Supply-side measures are aimed at limiting the cost of 
prescription drugs by negotiating prices and by requiring or 
encouraging the use of certain drugs through formularies established by 
a government, health plan, or federal program. Formularies have long 
been used to control the cost and utilization of prescription drugs. 
Some formularies are more restrictive than others; open formularies 
provide coverage for both listed and nonlisted drugs, and closed 
formularies generally provide coverage only for drugs that are included 
on the list. Many other formulary approaches fall somewhere in between, 
encouraging the use of listed drugs by charging higher copayments for 
those not listed. Under a tiered cost-sharing approach, for example, 
generic and preferred drugs require lower copayments than brand and 
nonpreferred drugs. Health plans that use formularies typically have 
provisions that enable enrollee access to nonformulary drugs when they 
are medically necessary and allow patients to appeal coverage 
decisions. 

In the U.S. private market, PBMs offer health plans a variety of 
prescription drug management services, including negotiating rebates 
with manufacturers, negotiating price discounts with retail pharmacies, 
operating mail-order prescription services, managing drug formularies, 
and processing claims. PBMs also provide health plans with clinical 
services, such as formulary development and management, prior 
authorization and drug utilization reviews to screen prescriptions for 
such issues as adverse interactions or therapy duplication, and 
substitution of generic drugs for therapeutically equivalent brand 
drugs.[Footnote 8] Health plans pay PBMs fees for these administrative 
and clinical services as well as for retail and mail-order drug costs. 
PBMs may also retain savings from or have other financial incentives to 
negotiate lower drug prices and rebates. In 2004, an estimated 200 
million people, or about 68 percent of the U.S. population, were 
enrolled in private health plans that used PBMs.[Footnote 9] 

Federal Programs: 

Beyond Medicare Part D, a range of federal programs, established by 
statute, in the United States offer drug benefits to individuals 
meeting various eligibility criteria. These programs cover a broad and 
varying array of prescription brand and generic drugs.[Footnote 10] 
These drugs are made available to beneficiaries through multiple 
approaches, ranging from direct purchase and provision by federal 
programs to contracts with private insurers and PBMs to provide drug 
coverage. 

The VA pharmacy benefit is provided to eligible veterans and certain 
others. In general, medications must be prescribed by a VA provider, 
filled at a VA pharmacy or through a VA Consolidated Mail Outpatient 
Pharmacy, and listed on the VA national drug formulary, which comprises 
570 categories of drugs. In addition to the VA national drug formulary, 
VA facilities can establish local formularies to cover drugs not on the 
national formulary. VA may provide nonformulary drugs in cases of 
medical necessity.[Footnote 11] In 2005, VA spent $4.2 billion on drugs 
and medicines. 

The DOD pharmacy benefit is provided to TRICARE beneficiaries,[Footnote 
12] including active duty and retired uniformed service members. In 
addition to maintaining a formulary, DOD provides options for obtaining 
nonformulary drugs. Beneficiaries can get prescription drugs through 
network retail pharmacies, nonnetwork retail pharmacies, DOD military 
treatment facilities, and DOD's TRICARE Mail Order Pharmacy. In 2005, 
DOD spent $5.4 billion on prescription drugs. 

Medicaid is the joint federal-state program that finances medical 
services for certain low-income adults and children. While some 
benefits are federally required, prescription drug coverage is an 
optional benefit that all states have elected to offer. State Medicaid 
programs, though varying in design, cover both brand and generic drugs. 
Drug coverage depends on the manufacturer's participation in the 
Medicaid drug rebate program, through which manufacturers pay rebates 
to state Medicaid programs for covered drugs used by Medicaid 
beneficiaries. Retail pharmacies distribute drugs to Medicaid 
beneficiaries, then receive reimbursements from states for the 
acquisition cost of the drug and a dispensing fee. In 2004, Medicaid 
outpatient drug spending peaked at $31 billion--including $19 billion 
as the federal share--which was calculated after adjusting for 
manufacturer rebates to states under the Medicaid drug rebate program. 
Medicaid spending on outpatient prescription drugs is expected to 
decrease with the transition of prescription drug coverage for dual 
eligibles--those eligible for both Medicaid and Medicare--to the 
Medicare Part D program. 

The 340B drug pricing program gives more than 12,000 entities of 
various types--community health centers, AIDS clinics, and 
disproportionate share hospitals[Footnote 13] among them--access to 
discounted drug prices, called 340B ceiling prices.[Footnote 14] These 
entities must enroll in the program, which is administered by the 
Health Resources and Services Administration. The program requires drug 
manufacturers to offer covered drugs to enrolled entities at or below 
340B ceiling prices.[Footnote 15] Enrolled entities establish their own 
formularies and may dispense drugs through in-house pharmacies, 
dispensing physicians, or contracted retail pharmacies. Enrolled 
entities spent an estimated $3.4 billion on drugs in 2003. 

Medicare, the federal health insurance program that serves the nation's 
elderly and certain disabled people, in addition to the outpatient 
prescription drug benefit offered in Part D, covers certain other drugs 
through Part B.[Footnote 16] Drugs covered by Part B are typically 
administered by physicians or other medical professionals rather than 
by patients themselves. These drugs include, for example, those 
furnished in conjunction with dialysis services or durable medical 
equipment. In 2005, Medicare paid more than $9 billion for drugs 
covered under Part B. 

The Federal Employees Health Benefits Program (FEHBP) is the largest 
employer-sponsored health insurance program in the country. Through it, 
about 8 million federal employees, retirees, and their dependents 
receive prescription drug coverage through participating private health 
insurance plans. Most of these plans contract with PBMs to manage their 
drug benefits. The drugs covered vary by plan, but are typically part 
of relatively broad formularies of drugs. In general, beneficiaries 
have several options for obtaining drugs, including through retail or 
mail-order pharmacies. In 2005, FEHBP prescription drug spending was an 
estimated $8.3 billion. 

Approaches Used by Other Countries for Negotiating Drug Prices: 

According to the OECD, member countries that offer subsidized drug 
programs are grappling with how to manage increased drug spending given 
limited budgets. These countries have three main approaches to limiting 
the amount they pay to acquire drugs: 

* ceiling prices, 

* reference prices, and: 

* profit limits. 

Ceiling prices. Ceiling prices restrict market negotiations by setting 
maximum prices purchasers can pay for drugs. Ceiling prices allow 
purchasers to negotiate lower prices directly with drug manufacturers. 
One approach is for a government to set prices for drugs and prohibit 
sales at greater prices. In France and Australia, for example, a 
government committee sets the prices at which drugs must be purchased 
and reimbursed. Alternatively, a government may set a price ceiling and 
allow purchasers to negotiate more favorable prices with manufacturers 
directly. In Canada, the Patented Medicines Prices Review Board sets 
the maximum price a manufacturer can charge direct purchasers. It can 
impose fines on any manufacturer that attempts to sell a drug at a 
price greater than the established ceiling. An additional method used 
to control prices is for a government to set reimbursement rates for 
new drugs at low levels; because any price above the set reimbursement 
rate would be an out-of-pocket expense to the consumer, the 
reimbursement rate effectively becomes the market price. 

Reference prices. Reference prices use local or international price 
comparisons of drugs classified in the same therapeutic group to 
determine a single or maximum price for all drugs in that group. The 
therapeutic group of drugs can encompass old and new drugs, including 
brand or generic drugs. The lowest priced drug may then establish the 
maximum price for the entire therapeutic group. Germany, for example, 
sets such prices based on local price comparisons of drugs classified 
in the same therapeutic group. 

Profit limits. Profit limits control the amount of profit a drug 
manufacturer may earn on a product or within a specified period of 
time. If the established threshold is exceeded, the manufacturer is 
required to accept a price cut or pay rebates to the government. In the 
United Kingdom, for example, there are limits on the profits that a 
drug manufacturer can earn on sales to the National Health Service. 

Several other key factors can influence drug price negotiations in OECD 
countries. Unlike the United States, many OECD countries, such as 
Australia and France, have universal health care systems that allow a 
mandated, relatively more unified approach to drug pricing. While these 
countries vary in their government's respective share of drug spending, 
some set national, uniform maximum prices to be paid by all purchasers, 
including private payers. Many countries also establish national 
formularies that define which drugs are to be covered by all 
purchasers. 

Approaches Used by U.S. Private Payers for Negotiating Drug Prices: 

In the United States, private payers represent the largest source of 
prescription drug spending. These payers, including employer-based 
health plans and private health insurers, typically contract with PBMs 
to help manage their prescription drug benefits. PBMs employ several 
cost containment strategies for lowering drug prices for the health 
plans and enrollees they represent. PBMs negotiate rebates or payments 
with manufacturers and prices with networks of retail and mail-order 
pharmacies, passing along at least some of the savings to health plans 
and enrollees. Manufacturers and pharmacies agree to these price 
concessions in exchange for both the large number of enrollees PBMs 
represent and the ability of PBMs to influence enrollee choice of drugs 
and pharmacies. 

One of the key ways PBMs influence price negotiations with 
manufacturers is through formulary development and management. PBMs may 
assist health plans in developing or managing a formulary that the 
health plan will cover. Health plans often provide financial 
incentives, such as lower enrollee cost-sharing, to encourage use of 
preferred drugs listed on the formulary.[Footnote 17] Since PBMs 
represent a large number of enrollees, manufacturers have a strong 
interest in having their drugs listed on plan formularies. 
Manufacturers pay PBMs through rebates or other payments to be included 
on plan formularies and to capture greater market shares for their 
drugs. For example, many mail-order pharmacies are owned by PBMs, and 
PBMs can obtain greater manufacturer rebates or payments by dispensing 
a high volume of the manufacturer's drug. 

The extent to which pharmacy discounts and manufacturer rebates or 
payments are shared with health plans and enrollees depends on 
contractual arrangements with the health plan and the plan's benefit 
design. For example, PBMs negotiate contracts with health plans and 
their networks of pharmacies separately, which means that health plans 
may pay PBMs higher prices for drugs than the PBM negotiated between 
itself and the pharmacy. Similarly, PBMs often set up contractual 
arrangements with manufacturers based on manufacturers' entire line of 
products rather than per drug. Further, PBMs may retain a portion of 
the rebates or payments they receive associated with individual health 
plans or all the health plans they represent. PBMs may also obtain 
additional rebates or payments from manufacturers for administering 
formularies or providing certain services, such as encouraging the use 
of one therapeutically similar drug over another. 

Approaches Used by U.S. Federal Programs for Negotiating Drug Prices: 

Approaches for negotiating drug prices vary among federal programs in 
the United States. While these approaches reflect the laws that govern 
them, markets, and health care delivery and financing, there are also 
elements common to some of the approaches used by other countries and 
by private payers. Some federal programs set ceiling prices, others 
establish prices by referencing prices negotiated by private payers in 
the commercial market, and still others rely on negotiations with 
manufacturers, either directly or through private health plans. For 
example, VA's and DOD's prices for particular prescription drugs may be 
the lowest of an FSS price, a ceiling price, or the price that each 
agency can negotiate directly with the manufacturer. The FEHBP uses a 
different approach, modeled after other large U.S. employers' health 
benefits; health plans participating in the FEHBP typically contract 
with PBMs to negotiate drug prices and offer other pharmacy benefit, 
administrative, and clinical services. Further, like many of the other 
OECD countries, U.S. federal programs use a mix of strategies to 
contain prescription drug spending. Many federal programs have 
formularies that define which drugs are to be covered. While some 
federal programs' formularies are comprehensive and some are more 
restrictive than others, the programs use lists of covered drugs as the 
basis for negotiations with drug manufacturers. 

VA and DOD: 

VA and DOD have several options available to obtain favorable prices 
for drugs covered on their formularies. Both agencies pay the lowest of 
several prices available for a given drug, and both can negotiate with 
suppliers to receive additional discounts. In addition, both have 
adopted certain practices that affect negotiations, such as the use of 
formularies, or that otherwise contribute to lower costs, such as the 
use of mail-order pharmacies. 

VA and DOD have access to a number of prices to consider when 
purchasing drugs. 

* FSS prices. VA's National Acquisition Center negotiates FSS prices 
with drug manufacturers. These prices are available to all federal 
purchasers. FSS prices are intended to be no more than the prices 
manufacturers charge their most-favored nonfederal customers under 
comparable terms and conditions. Under federal law, drug manufacturers 
must list their brand drugs on the FSS to receive reimbursement for 
drugs covered by Medicaid.[Footnote 18] All FSS prices include a fee of 
0.5 percent of the price to fund VA's National Acquisition Center. 

* Federal ceiling prices. Federal ceiling prices, also called Big Four 
prices, are available to VA, DOD, the Public Health Service, and the 
U.S. Coast Guard. These prices are mandated by law to be 24 percent 
lower than nonfederal average manufacturer prices.[Footnote 19] 

* Blanket purchase agreements. Blanket purchase agreements are national 
contracts with drug manufacturers that allow VA and DOD--either 
separately or jointly--to negotiate prices below FSS prices. The lower 
prices may depend on the volume of specific drugs being purchased by 
particular facilities, such as VA or military hospitals, or on being 
assigned preferred status on VA's and DOD's respective national 
formularies. 

In a few cases, individual VA and DOD medical centers have obtained 
lower prices through local agreements with suppliers than they could 
have through the national contracts, FSS prices, or federal ceiling 
prices. 

In addition, VA's and DOD's use of formularies, pharmacies, and prime 
vendors can further affect drug prices. VA and DOD formularies 
encourage the substitution of lower-cost drugs determined to be as 
effective or more effective than higher-cost drugs. Both VA and DOD use 
prime vendors, which are preferred drug distributors, to purchase drugs 
from manufacturers and deliver the drugs to VA or DOD 
facilities.[Footnote 20] VA and DOD receive discounts from their prime 
vendors that also reduce the prices that they pay for drugs. For DOD, 
the discounts vary among prime vendors and the areas they serve. As of 
June 2004, VA's prime vendor discount was 5 percent, while DOD's 
discounts averaged about 2.9 percent within the United States. 

Medicaid: 

Unlike VA and DOD, state Medicaid programs do not negotiate drug prices 
with manufacturers, but reimburse retail pharmacies for drugs dispensed 
to beneficiaries at set prices. Under the Medicaid drug rebate 
program,[Footnote 21] drug manufacturers provide quarterly rebates for 
covered outpatient prescription drugs purchased by state Medicaid 
programs. The rebates are meant to take advantage of the prices 
manufacturers receive for drugs in the commercial market and are 
required to reflect the results of negotiations by private payers such 
as discounts and rebates. 

The rebates are based on two prices per drug that manufacturers report 
to CMS: best price[Footnote 22] and average manufacturer price 
(AMP).[Footnote 23] The relationship between best price and AMP 
determines the unit rebate amount and thus the overall size of the 
rebate that states receive for a brand drug. The basic unit rebate 
amount is the greater of two values: the difference between best price 
and AMP or 15.1 percent of AMP. If the drug's AMP rises faster than 
inflation, the manufacturer is required to provide an additional rebate 
to the state Medicaid program.[Footnote 24] A state's rebate for a 
brand drug is the product of the unit rebate amount plus any applicable 
additional rebate amount and the number of units of the drug paid for 
by the state's Medicaid program. 

The 340B Drug Pricing Program: 

Entities eligible for the 340B drug pricing program can purchase 
covered outpatient prescription drugs from manufacturers at or below 
statutorily defined prices, known as 340B ceiling prices, that take 
advantage of discounts resulting from the Medicaid drug rebate program. 
These prices are the maximum amount eligible entities can pay for 
covered drugs, and the program allows for eligible entities to 
negotiate more favorable prices directly with drug manufacturers. As 
such, the 340B drug pricing program offers covered entities access to a 
prime vendor with which they can contract to negotiate discounts at or 
below the mandatory 340B ceiling price. 

State AIDS drug assistance programs (ADAP) are examples of entities 
eligible for the 340B drug pricing program. ADAPs participating in the 
340B program use either the 340B direct purchase option or the 340B 
rebate option. Under the direct purchase option, ADAPs purchase drugs 
from drug manufacturers or through a third party, such as a drug 
purchasing agent, and ADAPs receive the 340B price discount up front. 
In addition, ADAPs using this option can access the prime vendor 
program to assist in negotiating discounts at or below the mandatory 
340B ceiling price. Under the rebate option, ADAPs typically contract 
with entities such as a pharmacy network or PBM for the purchase of 
covered drugs and later request a 340B rebate directly from the drug 
manufacturers. ADAPs using the rebate option do not have access to the 
prime vendor program. 

Medicare Part B: 

Like Medicaid, Medicare does not purchase drugs but rather reimburses 
physicians for drugs covered under Part B. The maximum Medicare 
reimbursement for covered Part B drugs is statutorily defined using the 
average sales price (ASP) plus 6 percent.[Footnote 25] ASP is the 
average price for a drug based on a manufacturer's sales to all 
purchasers in the United States, with certain exceptions. Under this 
reimbursement methodology, Medicare takes advantage of the prices 
negotiated by private payers, as ASP is required to reflect the 
discounts and rebates they negotiate.[Footnote 26] 

FEHBP: 

The FEHBP is generally modeled after other large U.S. employers' health 
benefits, including that participating health plans typically rely on 
PBMs to negotiate drug prices and offer other pharmacy benefit, 
administrative, and clinical services. In a 2003 report[Footnote 27] 
that reviewed the use of PBMs by three FEHBP plans representing about 
55 percent of FEHBP enrollment, we found that the PBMs used three key 
approaches to achieve savings for FEHBP participating health plans: 

* passing on certain rebates negotiated with manufacturers to the 
plans; 

* obtaining drug price discounts from retail pharmacies and dispensing 
drugs at lower costs through mail-order pharmacies; and: 

* using intervention techniques that reduce utilization of certain 
drugs or substitute other, less costly drugs. 

The FEHBP plans we reviewed also had formularies that include most 
therapeutic categories, and these formularies had few restrictions on 
which drugs enrollees could obtain. Each plan also provided enrollees 
access to nonformulary drugs, although sometimes with higher cost- 
sharing requirements than for the preferred formulary drugs. 

The PBMs were compensated through various methods, including retaining 
some portion of the negotiated savings rather than passing the full 
portion to the FEHBP plans. These compensation methods also included 
collecting fees from FEHBP plans for administrative and clinical 
services; retaining a portion of the payments from the FEHBP plans for 
mail-order drugs in excess of the prices negotiated with manufacturers 
to acquire the drugs; and in some cases retaining a share of the 
rebates the PBMs negotiated with drug manufacturers. 

Mr. Chairman, this concludes my prepared remarks. I would be happy to 
answer any questions that you or other Members of the Committee may 
have. 

Contacts and Acknowledgments: 

For future contacts regarding this testimony, please contact John E. 
Dicken at (202) 512-7119 or at dickenj@gao.gov. Contact points for our 
Offices of Congressional Relations and Public Affairs may be found on 
the last page of this testimony. Martha Kelly, Assistant Director; 
Rashmi Agarwal; and Timothy Walker made key contributions to this 
statement. 

[End of section] 

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Managers on Health Plans, Enrollees, and Pharmacies. GAO-03-196. 
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Use and Expenditures. GAO-03-161. Washington, D.C.: November 8, 2002. 

FOOTNOTES 

[1] Pub. L. No. 108-173, § 101, 117 Stat. 2066, 2071-2152 (codified at 
42 U.S.C. §§ 1395w-101 to 1395w-152). MMA redesignated the previous 
part D of title XVIII of the Social Security Act as part E and inserted 
a new part D after part C. 

[2] Pub. L. No. 108-173, § 101, 117 Stat. 2066, 2098 (codified at 42 
U.S.C. § 1395w-11(i)). 

[3] For example, H.R. 4, the Medicare Prescription Drug Price 
Negotiation Act of 2007, was introduced on January 5, 2007. It would 
require the Secretary of Health and Human Services to negotiate Part D 
drug prices on behalf of Medicare beneficiaries. 

[4] For this testimony, we reviewed information summarizing approaches 
used by members of the Organisation for Economic Co-operation and 
Development (OECD). The OECD includes 30 member countries that "share a 
commitment to democratic government and the market economy," and OECD's 
work includes developing publications and statistics on economic and 
social issues. http://www.oecd.org (accessed January 9, 2007). As 
appropriate, we present examples of drug pricing approaches used in 
five OECD member countries other than the United States. 

[5] A list of related GAO products is included at the end of this 
statement. For additional information on approaches used by other 
countries, U.S. private payers, and federal programs, see, for example, 
Congressional Budget Office, Prices for Brand-Name Drugs Under Selected 
Federal Programs (Washington, D.C., 2005); Congressional Research 
Service, Federal Drug Price Negotiation: Implications for Medicare Part 
D (Washington, D.C., 2007); Federal Trade Commission, Pharmacy Benefit 
Managers: Ownership of Mail-Order Pharmacies (Washington, D.C., 2005); 
and Department of Commerce, International Trade Administration, 
Pharmaceutical Price Controls in OECD Countries: Implications for U.S. 
Consumers, Pricing, Research and Development, and Innovation 
(Washington, D.C., 2004). 

[6] Growth in drug spending for these nations includes both 
prescription and over-the-counter drugs. 

[7] Centers for Medicare & Medicaid Services, Trustees, National Health 
Expenditure, Historical Data (Baltimore, MD: Centers for Medicare & 
Medicaid Services, 2007), [Hyperlink, 
http://www.cms.hhs.gov/NationalHealthExpendData/02_NationalHealthAccount
sHistorical.asp] (accessed January 9, 2007). These figures reflect 
spending on prescription drugs through retail outlet sales, but do not 
account for nonretail outlet sales, such as those for drugs dispensed 
in inpatient hospital or nursing home facility settings. 

[8] Therapeutically equivalent drug products can be substituted with 
the full expectation that they will produce the same clinical effect as 
the prescribed drugs. 

[9] PricewaterhouseCoopers. The Value of Pharmacy Benefit Management 
and the National Cost Impact of Proposed PBM Legislation. A report 
prepared at the request of Pharmaceutical Care Management Association. 
July 2004. 

[10] Brand drugs are single-source and multisource drugs that are 
marketed under a proprietary, trademark-protected name. Single-source 
drugs include those brand drugs that have no generic equivalent on the 
market and are generally available from only one manufacturer. Brand 
multisource drugs include those brand drugs that have generic 
equivalents available from multiple manufacturers and are marketed 
under a proprietary name. Generic drugs include multisource drugs that 
are chemically identical to their branded counterparts and are 
generally marketed by multiple manufacturers under a nonproprietary 
name. 

[11] In a 2000 report, the Institute of Medicine characterized the VA 
formulary as "not overly restrictive." 

[12] DOD provides health care through TRICARE--a regionally structured 
program that uses contractors to maintain provider networks to 
complement health care provided at military treatment facilities. 

[13] Disproportionate share hospitals are hospitals that serve a 
relatively large volume of low-income patients and are eligible for 
payment adjustments under Medicare's prospective payment system or 
under Medicaid. 

[14] The 340B drug pricing program is named for the statutory provision 
that authorizes it, section 340B of the Public Health Service Act 
(codified at 42 U.S.C. § 256b). 

[15] Drug manufacturers must participate in the 340B drug program in 
order to get their drugs covered by Medicaid. 

[16] The Medicare Part B program covers a broad range of medical 
services, including physician, laboratory, and hospital outpatient 
department services and durable medical equipment. 

[17] In some cases, a plan may charge more or may not provide coverage 
for drugs not listed on the plan's formulary. 

[18] See 38 U.S.C. § 8126(a)(4). 

[19] See 38 U.S.C. § 8126(a)(2). The nonfederal average manufacturer 
price is the weighted average price of a single form and dosage unit 
paid by wholesalers to a manufacturer, taking into account cash 
discounts or similar price reductions. Big Four prices, in general, do 
not apply to generic drugs. 

[20] As of June 2004, VA used one prime vendor, while DOD used five 
prime vendors that serviced different geographic areas. 

[21] See 42 U.S.C. § 1396r-8. 

[22] Best price is the lowest price available from the manufacturer to 
any wholesaler, retailer, provider, health maintenance organization, or 
nonprofit or government entity, with some exceptions. Among other 
things, sales made through the FSS, single-award contract prices of any 
federal agency, federal depot prices, and prices charged to DOD, VA, 
Indian Health Service, and Public Health Service are not considered in 
determining best price. 

[23] AMP is defined by statute as the average price paid to a 
manufacturer for a drug by wholesalers for drugs distributed to the 
retail pharmacy class of trade. Under the rebate agreement 
manufacturers negotiate with HHS, AMP does not include prices to 
government purchasers based on the FSS, prices from direct sales to 
hospitals or health maintenance organizations, or prices to wholesalers 
when they relabel drugs they purchase under their own label. 

[24] State Medicaid programs receive an additional rebate for brand 
drugs when a drug's AMP rises faster than inflation, as measured by 
changes in the consumer price index. 

[25] See 42 U.S.C. § 1395w-3a. 

[26] The MMA also required HHS to implement a competitive acquisition 
program (CAP) for certain Medicare Part B drugs. The CAP is a voluntary 
program, which began in July 2006, that offers physicians the option to 
acquire many drugs they use in their practice from an approved CAP 
contractor. 

[27] Federal Employees' Health Benefits: Effects of Using Pharmacy 
Benefit Managers on Health Plans, Enrollees, and Pharmacies. GAO-03-
196. Washington, D.C.: January 10, 2003. 

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