Pharmaceutical Discounts Under Federal Law: State Program Opportunities

Transcription

1 Pharmaceutical Discounts Under Federal Law: State Program Opportunities By William H. von Oehsen, III Public Health Institute Pharmaceuticals & Indigent Care Program

2 Pharmaceutical Discounts Under Federal Law: State Program Opportunities May 2001 By: William H. von Oehsen, III Powell, Goldstein, Frazer & Murphy, LLP Washington, DC In conjunction with: Marice Ashe and Kathryn Duke Public Health Institute/ Pharmaceuticals and Indigent Care Program Special Thanks to: Anthony Barrueta, Kaiser Foundation Health Plan Donna Folkemer, National Conference of State Legislatures Joel Hamilton, U.S. General Accounting Office Peter Hansel, California Senate Office of Research John Hansen, U.S. General Accounting Office Freda Mitchem, National Association of Community Health Centers Stephen Schondelmeyer, PRIME Institute, University of Minnesota Supported by a grant from the California HealthCare Foundation. The California HealthCare Foundation, based in Oakland, California, is a nonprofit philanthropic organization whose mission is to expand access to affordable, quality health care for underserved individuals and communities, and to promote fundamental improvements in the health status of the people of California. For additional copies of this publication, please contact Pharmaceuticals and Indigent Care Program; th Street, Suite 810; Oakland, CA 94612; (510) or go to our website PHI 2001 Photocredit: first small image on cover, Family HealthCare Network; Visalia, CA

3 EXECUTIVE SUMMARY Executive Summary: Pharmaceutical Discounts Under Federal Law: State Program Opportunities Summary prepared by: Marice Ashe, JD, MPH and Kathryn Duke, JD, MPH A complex patchwork of federal laws significantly affects opportunities for discount pricing by state pharmacy assistance programs. This paper is a reference tool for anyone evaluating or drafting state legislation to address the pressing needs of consumers, government and institutions for affordable drugs. In particular, this paper focuses on the risks and opportunities that federal regulation of drug prices creates for states interested in designing programs for financially vulnerable patients. States must understand current federal drug pricing regulations, and the discounts they generate for government programs, in order to take full advantage of their unique right to obtain prices that are generally lower than prices available in the private sector. This paper offers guidance to states on several issues, including observing Constitutional and federal law restrictions, taking advantage of the Medicaid best price exemption, ensuring no duplication of discounts, and negotiating sub-ceiling prices. Private Sector Pricing Essentially three models describe the different distribution arrangements that connect prescription drug manufacturers with consumers and how drugs are priced along the way. Cash Customers The first model involves cash customers who either lack prescription drug coverage and therefore pay out of their own pockets, or have indemnity-type insurance that reimburses them after they have made their cash purchases. Cash customers generally pay the highest prices for drugs because they lack the opportunity, let alone the bargaining power, to negotiate discounts from either the retail pharmacy or the manufacturer. They generally pay at or above a drug s average wholesale price (AWP) which is the i manufacturer s list price. Pharmacy Benefit Managers The second model shares the same distribution channel as the first model, but the pricing arrangements are altered because of the discounts negotiated by a PBM on behalf of consumers and their insurers. PBMs are private third parties that manage drug benefits for large groups of individuals, such as enrollees in an insurance plan or employees of a self-insured company. By negotiating both discounts from participating pharmacies and rebates from preferred manufacturers, PBM customers typically pay less than a drug s average manufacturer price (AMP) which is about 20 percent below AWP and as low as 40 percent below AWP. Institutional Purchasers The third distribution and pricing model involves institutional purchasers, such as hospitals and group or staff model HMOs, that own and operate their own pharmacies. Hospitals and HMOs generally receive favorable pricing from manufacturers because they do not have to buy through retail channels and can negotiate directly with manufacturers, either individually or as part of a group purchasing organization. Depending on their volume of pharmaceutical purchases and their ability to move market share in selected therapeutical classes of drugs, institutional purchasers can achieve discounts between 20 and 40 percent below AWP. Federal Drug Discount Programs In contrast to drug sales in the private sector, the prices paid by federal purchasers are subject to a complex array of regulations which generate deeper discounts. There are five federal discount programs of which states should be aware.

4 EXECUTIVE SUMMARY Medicaid Rebate Program Federal Medicaid law requires drug manufacturers to pay state Medicaid agencies a quarterly rebate on brand name drugs equal to 15.1 percent off of AMP or the manufacturer s best price, whichever is lower, plus an additional rebate if the price of the drug has risen faster than the rate of inflation. The 15.1 percent discount off of AMP is the minimum Medicaid price. The Medicaid net price is the effective price paid after the minimum price is reduced further by either the best price or inflationary adjustment, or both. Because Medicaid is entitled to a manufacturer s best price or better, the Medicaid net price will almost always be as good or better than the best prices negotiated in the private sector (whether by a PBM, HMO, GPO or other private purchaser.) Medicaid net price is approximately 40 percent below AWP. 340B Program Many federally-funded clinics, health departments and hospitals are eligible for below-market discounts under section 340B of the Public Health Service Act. This act provides these clinics and hospitals with the same price discounts as Medicaid. However, 340B providers usually pay less than the Medicaid net price because they are able to negotiate sub-ceiling prices. They also save by not paying the drug mark-ups and dispensing fees to retail pharmacies. Average 340B prices are about half of AWP. Federal Supply Schedule The FSS is a schedule of contracts and prices for frequently-used supplies and services available for purchasing by federal agencies and other entities such as the U.S. territories and tribal governments. There are no statutory ceilings on prices, but the government often uses a most favored customer price as a starting point in negotiations to obtain below-market prices. FSS prices are on average slightly above 340B prices. Federal Ceiling Price The Veterans Administration, Department of Defense, Public Health Service, and Coast Guard ( Big 4 ) often get pricing below FSS on brand name drugs because these drugs are subject to a maximum statutory price called the federal ceiling price (FCP). FCP is set at 24 percent below the non-federal AMP, often referred to as non- FAMP. FCP prices are on average slightly below 340B prices. VA Contract Big 4 purchasers also are permitted to negotiate prices below the FCP. The VA has been especially successful in doing this through development and use of a national formulary. VA contract prices can be as low as 65 percent below AWP. Estimated Prices for Selected Public Purchasers, as Percent of AWP 0% 20% 40% 60% 80% 100% AWP 100% AMP 80% Medicaid (Min.) Medicaid Net 60.5% 67.9% FSS 340B FCP 51.7% 49% 47.9% Private Sector Pricing VA contract 44.8% Stephen Schondelmeyer, 0% 20% 40% 60% 80% 100% ii PRIME Institute, University of Minnesota (2001).

5 EXECUTIVE SUMMARY Risks and Opportunities for States An understanding of federal drug discounting laws and their impact on the U.S. pharmaceutical market may help states to obtain federal-like discounts for their own drug assistance programs, if properly designed. There are three factors that will shape a state s ability to successfully negotiate the best prices possible. Factor One: The Medicaid Best Price Exemption The Medicaid rebate program discourages brand name manufacturers from giving deep discounts to most customers because any discount below the minimum 15.1 percent will increase manufacturers rebate obligations to state Medicaid agencies under the best price formula. Recognizing the inflationary effect of this formula, Congress excluded from the formula prices paid by the five federal discount programs described above and by state drug assistance programs. States therefore already possess under federal law an opportunity to buy at prices below the best prices available in the private sector. However, outsourcing or bulk purchasing with private entities could jeopardize this opportunity. Factor Two: Price Limits Most existing state drug assistance programs are getting discounts comparable to the Medicaid net price because they obtain rebates comparable to those required under the Medicaid rebate program. Numerous states are considering proposals in order to give them access to lower prices usually FSS, 340B or FCP and at least one state, Maine, has enacted such legislation. Price limits can be set by contract negotiation or statutory mandate, although the latter approach may be vulnerable to a legal challenge under Constitutional or federal law principles Factor Three: Negotiate Sub-Ceiling Prices If a state successfully navigates the legal risks in establishing price limits through legislation rather than contract negotiation, it may be able to negotiate lower prices through use of a formulary. It could do this by negotiating supplemental rebates with preferred manufacturers whose drugs would be included on the formulary. The California Medi-Cal supplemental rebate program is a relevant model. Alternatively, a state could incentivize its seniors or uninsured to seek care and pharmacy services at a 340B clinic or hospital, since these providers have already demonstrated a growing ability to negotiate prices below 340B ceiling prices. Analysis of State Drug Assistance Program Options Eight possibilities are presented for states interested in designing drug assistance programs for low-income and indigent patients. Some of the options maximize the strategies mentioned above, others mix price discounting opportunities offered through federal statutes with other mechanisms to maximize savings, and still others may bring a state into conflict with federal law, and so should be avoided. iii

6 TABLE OF CONTENTS INTRODUCTION 1 I BACKGROUND ON U.S. PHARMACEUTICAL MARKET 2 A. Private Sector Pricing Cash Customers Pharmacy Benefit Managers Institutional Purchasers B. Public Sector Pricing Federal Discounts State Discounts C. A Comparison of Prices II. FEDERAL DRUG DISCOUNT PROGRAMS 12 A. Medicaid Drug Rebate Program B. 340B Drug Pricing Program C. Federal Supply Schedule D. Big 4 Federal Ceiling Prices E. VA National Contract Prices III. INTERSECTION OF FEDERAL AND STATE PROGRAMS: RISKS AND OPPORTUNITIES 19 A. Constitutional Limitations Commerce Clause Federal Preemption Maine Litigation Vermont and Maine 1115 Waivers B. Hitting the Best Price Wall Decline of Private Sector Discounting Staying Within the Best Price Exemption C. Duplicate Discounts and Other Problems D. How To Get Better Than Best Price Element One: Best Price Exemption Element Two: Mandatory Discounts Element Three: Sub-Ceiling Negotiation E. Price Versus Access Issues IV. ANALYSIS OF STATE DRUG ASSISTANCE PROGRAMS OPTIONS 30 A. State Subsidy/Rebate Model B. PBM Outsourcing C. Manufacturer Ceiling Prices D Waiver Expanded Drug Benefit E. Mandatory Pharmacy Discounts F. Buyers Club G. Bulk Purchasing H. Channeling State Drug Assistance Programs Through 340B Covered Entities V. CONCLUSION 38

7 INTRODUCTION 1 I. BACKGROUND ON U.S. PHARMACEUTICAL MARKET 2 A. Private Sector Pricing Cash Customers Pharmacy Benefit Managers Institutional Purchasers B. Public Sector Pricing Federal Discounts State Discounts C. A Comparison of Prices

8 II. FEDERAL DRUG DISCOUNT PROGRAMS 12 A. Medicaid Drug Rebate Program B. 340B Drug Pricing Program C. Federal Supply Schedule D. Big 4 Federal Ceiling Prices E. VA National Contract Prices

9 III. INTERSECTION OF FEDERAL AND STATE PROGRAMS: RISKS AND OPPORTUNITIES 19 A. Constitutional Limitations Commerce Clause Federal Preemption Maine Litigation Vermont and Maine 1115 Waivers B. Hitting the Best Price Wall Decline of Private Sector Discounting Staying Within the Best Price Exemption C. Duplicate Discounts and Other Problems D. How To Get Better Than Best Price Element One: Best Price Exemption Element Two: Mandatory Discounts Element Three: Sub-Ceiling Negotiation E. Price Versus Access Issues

10 IV. ANALYSIS OF STATE DRUG ASSISTANCE PROGRAMS OPTIONS 30 A. State Subsidy/Rebate Model B. PBM Outsourcing C. Manufacturer Ceiling Prices D Waiver Expanded Drug Benefit E. Mandatory Pharmacy Discounts F. Buyer s Club G. Bulk Purchasing H. Channeling State Drug Assistance Programs Through 340B Covered Entities

11 INTRODUCTION PHARMACEUTICAL DISCOUNTS UNDER FEDERAL LAW: STATE PROGRAM OPPORTUNITIES One merely has to scan the website of the National Conference of State Legislatures to appreciate the keen interest among state lawmakers in assisting low-income individuals, especially those who are elderly or disabled, with purchasing their medications. 1 In 2001 alone, more than 100 bills are being considered by state legislatures that would, in one way or another, improve the affordability of pharmaceuticals for state residents. 2 Twenty-six states, to date, have enacted some kind of pharmaceutical assistance program, most of them using state funds and manufacturer rebates to insure low income elderly patients for covered drugs. 3 Other approaches to improving pharmaceutical access ranging from placing caps on manufacturer or pharmacy prices to bulk purchasing to expansion of Medicaid and federal discount programs have also been adopted or proposed by states. Perhaps the most ambitious of the state programs the Maine Rx Program signed into law on May 11, 2000 has been the subject of federal litigation, and the program s rebate and penalty provisions have been temporarily enjoined from being implemented based on alleged violations of federal constitutional law. 4 State experimentation in the area of pharmaceutical assistance is likely to continue, especially if the U.S. Congress enacts President Bush s helping hand proposal of using federal grants to help fund state drug assistance programs in the future. The purpose of this paper is to assess under federal law some of the models that have been proposed and/or adopted at the state level for improving access to pharmaceutical care. The U.S. pharmaceutical market is complex and a large part of its complexity is the result of federal legislation designed to reduce the cost of drugs for federal purchasers, especially the Medicaid program, the Department of Veterans Affairs (VA), Department of Defense (DOD) and the Public Health Service (PHS). Only after studying these federal drug discount programs and their impact on the market can one fully and accurately assess state-based models. Toward this end, we have divided this paper into four parts. The first part provides an overview of the U.S. pharmaceutical market. The second part describes the four federal discount programs currently in existence in the U.S. The third section analyzes the impact of these federal programs on the market and the risks and opportunities relevant to state drug assistance programs under federal law. Finally, these risks and opportunities are used in the fourth section to assess the various approaches that have emerged at the state level. In assessing state-based drug assistance programs, a variety of elements could be scrutinized, including patient eligibility, enrollment procedures, patient cost-sharing arrangements, administrative costs, economic impact, health outcomes, and the like. The focus of this paper is on the cost of the drugs for both the patient and the state. Presumably a state can assist more individuals by spending less per drug, which allows the state to stretch its dollars further in paying for covered drugs. We recognize that other criteria can measure the success of a state drug assistance program, but a discussion of those criteria lies outside the scope of this paper. This paper also focuses on the class of drugs on which states can save the most amount of money through negotiation and carefully crafted regulation, namely brand name drugs used in the outpatient setting. 1

12 I. BACKGROUND ON U.S. PHARMACEUTICAL MARKET U.S. purchasers spent approximately $91 billion on prescription drugs in By 2008, spending is projected to reach $243 billion. 7 The rise in pharmaceutical spending consistently outpaces expenditures on other components of the U.S. health care system. For every year since 1990, the annual percentage change in prescription drug expenditures was significantly greater than the change in hospital and physician expenditures. 8 Since 1970, the rise in pharmaceutical spending exceeded 10 percent for every year except in years 1993 and Patients generally purchase prescription drugs from pharmacies, or institutions that operate pharmacies, which purchase from drug wholesalers or, in some instances, directly from manufacturers. Drug wholesalers, of course, purchase their drugs from manufacturers. At the pharmacy level, there are many different kinds of purchasers. In the private sector, these purchasers include retail pharmacies, supermarkets, hospitals, nursing homes, health maintenance organizations (HMOs), mail order pharmacies, community-based clinics, and physician s offices. In the public sector, one finds primarily institutional buyers hospitals, health departments, nursing homes, prisons, and schools. These institutions may be owned or operated by a unit of federal, state, or municipal government. Most federal purchasers of drugs buy from the federal supply schedule (FSS), although the four largest purchasers the VA, DOD, PHS, and Coast Guard often get better pricing. A breakdown of the U.S. pharmaceutical market, including the distribution channels relied on by the purchasing pharmacy or institution, is depicted in Chart

13 Header Chart 1. Channels of Distribution for Prescription Drugs: 1999 Drug Manufacturers & Marketers 28.2% 6.6% 51.8% 13.2% $40.6 bil. $9.6 bil. $74.5 bil. $19.0 bil. Chain Regional National Warehouse Wholesalers Wholesalers Chain Mass Food & Independent Mail Order Long Term Hospitals Clinic & Health Plan Government Pharmacy Merchant Drug Pharmacy Pharmacy Care Dr. Office Facilities & Pharmacy Pharmacy Pharmacy Other 28.8% 6.8% 6.6% 14.7% 10.1% 3.7% 16.7% 7.0% 1.6% 4.0% $41.4 bil. $9.7 bil. $9.5 bil. $21.1 bil. $14.6 bil. $5.3 bil. $24.0 bil. $10.1 bil. $2.3 bil. $5.7 bil. Stephen Schondelmeyer, PRIME Institute, University of Minnesota (2001). 3

14 BACKGROUND ON U.S. PHARMACEUTICAL MARKET Just as there are different kinds of pharmacies and institutions that buy drugs, different revenue sources pay for drugs. Although some customers pay out of their own pocket for pharmaceuticals, most medications are paid for by private insurance companies, pharmacy benefit managers (PBMs), employers, or the government. Chart 2 compares payment sources for prescription drugs at retail pharmacies between 1990 and 1998, broken down into cash customers, third party payment, and Medicaid. 11 Chart 2. Payment Sources for Prescription Drug Purchases, % of Prescriptions at Retail Pharmacies 63% 26% 11% % 56% 51% 45% 28% Although third party coverage of prescription drugs has significantly increased over the last decade, as many as a quarter of all prescriptions are still paid out of pocket. 12 The largest government payor of drugs is the Medicaid program, which is jointly funded and administered by states and the federal government. Approximately 11 percent of prescription drug purchases at retail pharmacies are paid for by Medicaid. 13 A. Private Sector Pricing Essentially three models describe the different distribution arrangements that connect prescription drug manufacturers with consumers and how drugs are priced along the way. 14 The first model involves cash customers who either lack prescription drug coverage and therefore pay out of their own pockets, or have indemnity-type insurance that reimburses them after they have made their cash purchases. Cash customers generally pay the highest prices for drugs because they lack the opportunity, let alone the bargaining power, to negotiate discounts from either the retail pharmacy or the manufacturer. 38% 30% 35% 42% 49% % 29% 25% 55% 60% 65% 13% 14% 15% 13% 13% 12% 11% 11% Year Cash Customer Third Party Payment Medicaid Department of Health and Human Services, Office of the Assistant Secretary for Planning and Evaluation (2000) The second model shares the same distribution channel as the first model, but the pricing arrangements are altered because of the discounts negotiated by a PBM on behalf of consumers and their insurers. PBMs are private third parties that manage drug benefits for large groups of individuals, such as enrollees in an insurance plan or employees of a selfinsured company. The third distribution and pricing model involves institutional purchasers, such as hospitals and group or staff model HMOs, that own and operate their own pharmacies. 15 Hospitals and HMOs generally receive favorable pricing from manufacturers because they do not have to buy through retail channels and can negotiate directly with manufacturers, either individually or as part of a group purchasing organization (GPO). On average, consumers pay different prices for their prescription drugs depending on the distribution and pricing model involved. Chart 3 illustrates the average prices for each of these models based on a composite of several commonly prescribed brand name drugs for a typical quantity of pills. 16

15 BACKGROUND ON U.S. PHARMACEUTICAL MARKET Chart 3. Example of Pricing for Brand Name Prescription Drugs Cash Customers Federal Payer (No 3rd Party Payment Insurers and HMOs c Medicaid Supply at Point of Sale) PBMs Schedule Sector Private List price (AWP) $50 $50 $50 $50 $50 Manufacturer's price (manufacturer to $40 $40 b $34 $40 b $24 wholesaler or (AWP-20%) (AWP-20%) (AWP-33%) (AWP-52%) other entity) Acquisition price (wholesaler to $41 $41 $41 pharmacy) Retail price at pharmacy (total of amounts paid by $52 $46 b $41 +$2.50 customer and (AWP+ 4%) (AWP-13% reimbursed by 3rd +$2.50) party payer) n/a a Retail price, less n/a a $30 to $44 $30 to $37 typical manufacturer s (5% to 35% (15.1% to 30% rebate rebate) rebate) Ultimate (net) amount $52 $30 to $44 $34 (avg.) $30 to $37 $ 24 paid by final purchaser $34 (avg.) and/or consumer a. n/a = not applicable b. without rebate c. This column refers only to HMOs that buy directly from manufacturers A more detailed description of each model is set forth below. 1. Cash Customers The prices paid by cash customers are established through a series of transactions involving manufacturers, wholesalers, and retail pharmacies. Manufacturers sell their drugs to wholesalers at a price influenced by whether the drug is generic or brand name, its strength, and its package size. Some wholesalers receive discounts from manufacturers for bulk purchases or to reward prompt payment. Generic drugs may also be sold at a discount to induce the purchaser to select the manufacturer s product over a competitor s. The average price paid for a drug to a manufacturer is called the average manufacturer price (AMP). Wholesalers then sell the drugs to retail pharmacies. The price from the wholesaler to retailer represents the wholesaler s acquisition cost plus a markup. Manufacturers provide a suggested or list 5 Public n/a a Department of Health and Human Services, Office of the Assistant Secretary for Planning and Evaluation (2000) price for their drugs, commonly called the average wholesale price (AWP), but wholesalers are free to sell at lower prices and typically do. AWP is approximately 20 percent higher than the wholesaler s acquisition cost. 17 The final retailer-to-customer price represents the retailer s acquisition cost plus a second markup and a dispensing fee. Retail markups vary widely based on factors including whether the drug is a maintenance or acute care medication, and whether it is commonly or seldom used. 18 The estimated average retail markup over acquisition cost is 20 to 25 percent Pharmacy Benefit Managers The PBM pricing structure is somewhat related to the above cash customer model insofar as both models rely on retail pharmacies for resale to the customer. A fundamental difference between the two models is that whereas the cash customer has virtually no negotiating leverage with either the retail pharmacy or the manufacturer to lower prices, the PBM acquires such

16 BACKGROUND ON U.S. PHARMACEUTICAL MARKET leverage by negotiating on behalf of large groups of customers, such as enrollees of an insurance plan, network or IPA model HMO or other managed care plan, or employees of a large self-insured company. Retail pharmacies, anxious to do business with the PBM s customer base, are usually willing to give discounts in order to participate in the PBM s pharmacy network. PBMs estimate retail pharmacy acquisition costs, and then negotiate a price that is lower than the typical cash customer price. 20 A PBM can also avoid the increased costs associated with retail pharmacies by shipping drugs directly to patients by mail order, although a mail order program can be difficult to implement for certain medications and for certain populations. Plus, rebates from manufacturers reduce the total amount that PBMs spend on drugs. These savings can be passed along to the insurer, employer, or beneficiary whose drug benefit is managed by the PBM. To achieve significant manufacturer rebates, PBMs often purchase selectively based on a formulary, which is a list of preferred drugs for enrollees in the plan. PBMs receive preferred pricing often in the form of rebates from drug manufacturers whose products are chosen for the formulary. A large share of these rebates, which can sometimes reach 35 percent or more off the manufacturer s typical selling price, are generally passed on to the PBM s customers to help underwrite the cost of the pharmacy benefit Institutional Purchasers The third pricing structure that one finds in the private drug market does not involve retail pharmacies at all because the purchaser of the drugs generally owns and operates its own pharmacies. Hospitals and large group and staff model HMOs, such as Kaiser Permanente, are the best examples of these non-retail institutional purchasers. By owning their own pharmacies, these institutions are able to cut costs on two fronts. They save on the overhead and profit margins that are usually built into retail prices. They also can steer business to preferred manufacturers through the use of formularies in exchange for discounts from the manufacturers. These manufacturer discounts can be substantial if the institutions are effective in encouraging physicians to prescribe according to a common formulary and if the institutions purchase in large volume. Control over physician prescribing patterns and the significant volume of purchases are the two ingredients that allow institutions to move market share. To increase volume, hospitals and other institutions often join a group purchasing organization (GPO) and buy as a group. Plus, these institutions often purchase drugs directly from the manufacturer rather than through a wholesaler, and thus save on the wholesaler mark-up. Table 1 provides a list of average discounts that several kinds of institutions enjoy compared to retail pharmacies for the 100 top-selling brand name drugs in Table 1. Average Invoice Price Paid for 100 Top-Selling Brand Name Drugs, 1994 Average Invoice Price Institution Compared to Retail Pharmacies (percentages) Retail pharmacies 100% Hospitals 91% Long-term care facilities 95% Health maintenance organizations 82% Federal facilities 23 58% Clinics 91% Department of Health and Human Services, Office of the Assistant Secretary for Planning and Evaluation (2000) 6

17 BACKGROUND ON U.S. PHARMACEUTICAL MARKET B. Public Sector Pricing In some respects, the distribution and pricing of prescription drugs in the public sector mirrors the practices described above for the private sector. For example, many federal, state, and local purchasers of pharmaceuticals are institutions, like hospitals, health departments, and prisons. Like their private counterparts, these facilities have their own pharmacies and negotiate discounts using formularies and group purchasing arrangements. In fact, at least one GPO the Minnesota Multistate Contracting Alliance is comprised exclusively of state and local institutions. 24 In other respects, however, the purchase and distribution of drugs in the public sector are unique. The Medicaid program covers most outpatient drugs and, like private PBMs, receives discounts from participating retail pharmacies and rebates from drug manufacturers. But unlike PBMs, Medicaid receives these price breaks as a matter of law, not by negotiating discounts through the aggressive use of formularies and free market competition. Moreover, the average cost of prescription drugs is almost always lower for the government. Both Table 1 and Chart 3 illustrate this point by comparing average federal and Medicaid prices with average prices paid by private sector retail customers, PBMs, and hospitals Federal Discounts Federal legislation has created four distinct drug discount programs designed to reduce manufacturer prices. The largest of them, the Medicaid drug rebate program, mandates that manufacturers pay rebates to state Medicaid agencies based on a statutory discount off AMP or, with respect to brand name drugs, the manufacturer s best price for a given drug, plus an additional rebate if the price of the drug has increased at a rate greater than inflation. The 340B program uses the same statutory formula to extend discounts to PHS-funded clinics and disproportionate share hospitals, although these covered entities sometimes get better prices by negotiating below the 340B ceiling price. The other two federal drug discount programs are administered by the VA and involve the federal supply schedule (FSS). The FSS program allows federal agencies, the District of Columbia, U.S. territories, and related entities to buy off common contracts that require manufacturers to match the prices of their most favored customers. In 1992, however, Congress established a federal ceiling price (FCP) for the four largest federal purchasers the VA, DOD, PHS, and Coast Guard commonly referred to as the Big 4 by federal procurement specialists. FCP is calculated by reducing a manufacturer s non-federal average manufacturer price (non-famp) by 24 percent. Non-FAMP is comparable to AMP except sales to federal facilities have been excluded. Although the FCP is at least as good as the FSS price, and usually better, the VA has been able to negotiate discounts below both the FSS and FCP prices through its national contract program. Each of these federal discount programs is described in more detail in section II. 2. State Discounts States are considering legislation that would create a wide variety of drug assistance programs and, in twenty-six states, laws have already been enacted to help seniors. 26 Most of the enacted state laws have created state-operated insurance programs that, like the Medicaid rebate program, reimburse participating retail pharmacies at rates tied to AWP and then collect rebates from manufacturers for drugs dispensed to eligible clients. Although the discounts obtained by these state programs have never been tracked and tabulated as a group, some state statutes mandate payment of rebates equal to the Medicaid rebate and, for the other states, the U.S. General Accounting Office (GAO) estimates that the rebates are comparable to those collected by Medicaid. 27 Other approaches being explored at the state level include outsourcing with PBMs, capping a manufacturer s price at FSS or some other discounted price, expanding the Medicaid drug benefit under a federal waiver, requiring pharmacies to give discounted rates, establishing voluntary buyers clubs, bulk purchasing, and integrating 340B covered entities into drug assistance programs. All but the last of these approaches rely on (1) retail pharmacies for distributing drugs and (2) manufacturer rebates and/or pharmacy discounts to lower drug costs. The 340B-related approach is more like the institutional purchasing model because it builds on the network of safety net providers participating in the 340B program. Unfortunately, pricing data for these alternative state options are not generally available. Each of these approaches is analyzed in more detail in sections III and IV. C. A Comparison of Prices This paper has already used multiple pricing terms in describing the U.S. pharmaceutical market. The most important terms to understand are AWP, AMP, non-famp, Medicaid rebate net price, and best price, FSS, 340B, FCP, and the VA national contract price. Only AWP, FSS, and VA national contract prices are published. To assist in understanding these different pricing terms, we refer the reader to Table

18 BACKGROUND ON U.S. PHARMACEUTICAL MARKET Price AWP AMP Non-FAMP Medicaid Rebate Net Price and "Best Price" FSS 340B FCP Definition Table 2. Pharmaceutical Pricing Terms 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 the actual price that large purchasers normally 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 was a benchmark created by OBRA b in 1990 to use in determining Medicaid rebates and is not publicly available. The Congressional Budget Office estimated AMP to be about 20 percent less than AWP for more than 200 drug products frequently purchased by Medicaid beneficiaries. c The average price paid to a manufacturer by wholesalers for drugs distributed to nonfederal purchasers. Non-FAMP is not publicly available. The effective outpatient drug price after manufacturer rebates to state Medicaid programs. The basic rebate for brand name drugs is the greater of 15.1 percent of the AMP, or the difference between AMP and the lowest price the manufacturer charges any purchaser other than Medicaid, known as "best price." 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 available to all federal purchasers for drugs listed on the FSS. FSS prices are intended to equal or better the prices manufacturers charge 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 that manufacturers can charge "covered entities," which include disproportionate share hospitals owned by or under contract with state or local governments and eleven categories of facilities or programs funded by the Health Resource & Services Administration, including federally qualified health centers, AIDS drug assistance programs, etc. The 340B discount is calculated using the Medicaid rebate formula and is deducted from the manufacturer s selling price rather than paid as a rebate. The maximum price manufacturers can charge for FSS-listed brand name drugs to VA, DOD, PHS, and the Coast Guard, even if the FSS price is higher. FCP must be at least 24 percent off non-famp. FCP is not publicly available. The price VA has obtained through competitive bids from manufacturers for select drugs in exchange for their inclusion on the VA formulary. Contract prices are publicly available. VA National Contract Price a. See footnote 28. b. Omnibus Budget Reconciliation Act of c. See footnote 28. It is difficult to quantify the differences between these prices because of confidentiality issues and the enormity of data that would have to be collected and analyzed. As a substitute, we refer you to Chart 3, which is based on a composite of several commonly prescribed brand name drugs. 29 Table 3 represents another attempt to quantify the different kinds of discounts found in the drug market. 30 It estimates and compares average industry prices in relative terms rather than in absolute terms. Each price is expressed as a percentage of AWP, AMP, Medicaid net price, and FSS. 8

19 BACKGROUND ON U.S. PHARMACEUTICAL MARKET Table 3: Estimated Relationship Among Key Price Terms for Evaluating Manufacturer Rebates & Discounts Drug Product Prices Abbr. Relative % of % of % of % of Price AWP AMP Medicaid Net FSS Average Wholesale Price 1 AWP $ % 125.0% 165.3% 193.4% Average Manufacturer Price 2 AMP $ % 100.0% 132.2% 154.7% AMP - Min. Medicaid Rebate 3 Medicaid $ % 84.9% 112.2% 131.4% (Min.Rebate) Non-FAMP 4 Non-FAMP $ % 78.7% 104.1% 121.8% Medicaid Net Price 5 Medicaid Net $ % 75.6% 100.0% 117.0% Federal Supply Schedule 6 FSS $ % 64.6% 85.4% 100.0% 340B Price 7 340B $ % 61.3% 81.0% 94.8% Federal Ceiling Price 8 FCP $ % 59.8% 79.1% 92.6% VA Wt. Average Price 9 VA wt. avg. $ % 56.0% 74.1% 86.7% VA Contracts 10 VA contracts $ % 43.3% 57.3% 67.0% Free (Samples, Indigent Programs) 11 Free 1. AWP is the average wholesale price; here AWP is set at $1.00 to illustrate the value of other prices in relation to AWP. 2. AMP is 20% less than AWP (Prescription Drugs: Expanding Access to Federal Prices Could cause Other Price Changes (GAO HEHS , August 2000, p.9)). 3. The minimum rebate for innovator multiple source drugs under Medicaid is 15.1% less than AMP (42 U.S.C 1396r-8(c)(l)). 4. FCP is 76% of Non-FAMP as required by statute. (38 U.S.C. 8126). 5. Medicaid rebates in 1999 were 19% of total pharmacy payments or 24.4% of drug product costs (drug product costs are about 78% of pharmacy payments) (GAO HEHS , p. 5). The Medicaid Net Price is AMP less the minimum rebate and any best price rebate or inflation adjustment payment, if appropriate. 6. Comparison of FSS prices to AWP for 172 commonly used drug products showed FSS prices to be 51.7% of AWP. (Stephen Schondelmeyer, PRIME Institute, University of Minnesota (2001)). 7. Comparison of 340B prices to AWP for 171 commonly used drug products showed 340B prices to be 49.0% of AWP. (Stephen Schondelmeyer, PRIME Institute, University of Minnesota (2001)). 8. FSS was reported as 8% above FCP, therefore FCP was calculated as FSS divided by 1.08 (GAO HEHS , p.11). 9. VA weighted average price is calculated based on 77% of purchases at FCP and 23% of purchases at the lower VA contract prices (GAO HEHS , p.15). 10. VA contract prices in 2000 were approximately 33% less than FSS prices (GAO HEHS , p.15). 11. Free drug products includes free goods provided to decrease the net product price, free samples to encourage providers to prescribe a drug, and manufacturer patient assistance programs. Source: Stephen Schondelmeyer, PRIME Institute, University of Minnesota (2001). Data derived from Prescription Drugs: Expanding Access to Federal Prices Could Cause Other Price Changes, U.S. General Accounting Office, GAO/HEHS , August 2000 and How the Medicaid Rebate on Prescription Drugs Affects Pricing in the Pharmaceutical Market, Congressional Budget Office Papers, January

20 BACKGROUND ON U.S. PHARMACEUTICAL MARKET Chart 4 is a bar graph comparing these key prices to AWP. 31 Chart 4. Estimated Relative Price Compared to AWP for Prescription Drugs at Manufacturer Level 0% 20% 40% 60% 80% 100% AWP 100% AMP 80% Medicaid (Min.) Non-FAMP Medicaid Net 67.9% 63% 60.5% FSS 340B FCP VA wt. avg. VA contract 51.7% 49% 47.9% 44.8% 34.6% Private Sector Pricing Free 0% Source: Stephen Schondelmeyer, PRIME Institute, University of Minnesota (2001). Data derived from Prescription Drugs: Expanding Access to Federal Prices Could Cause Other Price Changes, U.S. General Accounting Office, GAO/HEHS , August 2000 and How the Medicaid Rebate on Prescription Drugs Affects Pricing in the Pharmaceutical Market, Congressional Budget Office Papers, January

21 Endnotes for Chapter 1 1 National Conference of State Legislatures, 2001 Prescription Drug Discount, Bulk Purchasing and Price Control Legislation, at (updated Apr. 12, 2001) (listing bills introduced in 2001) [hereinafter NCSL 2001 Legislative Report ]. See also National Conference of State Legislatures, 2000 Prescription Drug Discount, Bulk Purchasing and Price Control Legislation, at (updated Apr. 5, 2001) (listing bills introduced in 1999 and 2000). [hereinafter NCSL 2000 Legislative Report ]. 2 NCSL 2001 Legislative Report, supra note 1, at National Conference of State Legislatures, State Senior Pharmaceutical Assistance Programs, at (updated Apr. 23, 2001) (listing enacted state drug assistance programs) [hereinafter NCSL Senior Drug Programs ]. 4 Pharm. Research Mfr s of America v. Comm n Maine Dep t of Human Serv s, Civ. No B-H (D. Me. 2000)[hereinafter PhRMA v. Maine ]. 5 Brand name drugs, also known as innovator drugs, have been approved by the Food and Drug Administration (FDA) under the new drug application procedures and most have also been patented. Generic drugs, by contrast, lack patent protection and are approved by the FDA through the abbreviated new drug application process. In general, brand name drugs are significantly more expensive than generic drugs because they face less competition. 6 The Kaiser Family Foundation, Prescription Drug Trends: A Chartbook 20 (July 2000). 7 Id. 8 Id. at Id. 10 Prepared by Stephen Schondelmeyer, PRIME Institute, University of Minnesota, from data found in DDD Annual Class of Trade Analysis (Plymouth Meeting, PA: IMS, 1999). 11 U.S. Department of Health and Human Services, Office of the Assistant Secretary for Planning and Evaluation, Report to the President: Prescription Drug Coverage, Spending, Utilization and Prices, 99 available at (Apr. 2000) (Figure 3-1) [hereinafter ASPE Report ]. Data used in this chart is from IMS Health Retail Method-of- Payment (1999). Id. 12 Id. 13 Id. 14 These three models were identified in the ASPE Report, supra note 11, at The physicians participating in a group or staff model HMO typically treat HMO enrollees exclusively. Staff model HMOs employ their physicians and own the facilities in which the physicians provide care. Group model HMOs contract with physician groups that have their own offices and facilities. Network and IPA model HMOs are similar to group model HMOs except the participating physicians have independent practices that do not involve treating HMO patients. In contrast to group and staff model HMOs, network and IPA model HMOs do not typically own and operate their own pharmacies. They generally fall under the PBM model rather than the institutional purchaser model. Unless otherwise identified, references to HMOs in this paper are generally intended to mean group or staff model HMOs. 16 ASPE Report, supra note 11, at 98. Prices are based on a composite of several commonly prescribed brand name drugs for a typical quantity of pills. For some cells in the table, the relative relationships have been calculated based on relationships reported in Congressional Budget Office, How Increased Competition from Generic Drugs Has Affected Prices and Returns in the Pharmaceutical Industry (1998), and on other relationships widely reported by industry sources. These prices are used for illustrative purposes only and do not represent any type of overall average. Prices reported in this table include both amounts paid by third-party payers and amounts paid by the consumer at cost sharing. Id. 17 ASPE Report, supra note 11, at Id. at Id. 20 ASPE Report, supra note 11, at Id. at ASPE Report, supra note 11, at 107; see also Congressional Budget Office, How Increased Competition from Generic Drugs Has Affected Prices and Returns in the Pharmaceutical Industry (July 1998). 23 Federal facilities include the Department of Veterans Affairs, the Defense Department, the Indian Health Service, and the Public Health Service. 24 NCSL 2000 Legislative Report, supra note 1, at ASPE Report, supra note 11, at 98 and NCSL Senior Drug Programs, supra note GAO, Report to Congressional Requesters, State Pharmacy Programs: Assistance Designed to Target Coverage and Stretch Budgets (Sept. 2000) [hereinafter GAO State Pharmacy Report ]. 28 Table 2 subnotes: (a) U.S. Department of Health and Human Services, Office of the Inspector General, Medicaid Pharmacy-Actual Acquisition Cost of Prescription Products for Brand Name Drugs (Apr. 1997) and (c) Congressional Budget Office Papers: How the Medicaid Rebate on Prescription Drugs Affects Pricing in the Pharmaceutical Industry 20 (Jan. 1996). This table is a modified version of a chart prepared by GAO. See GAO, Report to Congressional Requesters, Prescription Drugs: Expanding Access to Federal Prices Could Cause Other Price Changes 9 (August 2000) [hereinafter GAO Federal Pricing Report ]. The references to 340B prices have been added. 29 ASPE Report, supra note 11, at Prepared by Stephen Schondelmeyer, PRIME Institute, University of Minnesota, from data derived from GAO Federal Pricing Report and Congressional Budget Office Papers: How the Medicaid Rebate on Prescription Drugs Affects Pricing in the Pharmaceutical Industry (Jan. 1996). 31 Id. 11

22 II. FEDERAL DRUG DISCOUNT PROGRAMS Although most people are aware that the federal government receives better pricing on pharmaceuticals than other segments of the drug market, few understand that since 1992, there are actually four federal drug discount programs in existence today. These programs significantly affect how manufacturers price their products for non-federal purchasers, so an understanding of how these programs work, and their effect on the drug market, is essential for policymakers interested in designing drug assistance programs at the state level. Each of the four federal drug discount programs is described below. Because of the success of the VA in negotiating deep discounts through its national contract program, this program is separately described below as well, even though the VA relied on existing authority to initiate the program. A. Medicaid Drug Rebate Program The Omnibus Budget Reconciliation Act of 1990 (OBRA 90) is the enabling legislation for the Medicaid drug rebate program which saves state Medicaid programs more than $3 billion each year. 32 The Medicaid drug rebate program is administered by the Health Care Financing Administration (HCFA), an agency within the Department of Health and Human Services (HHS). 33 Congress s goal in creating the rebate program was to ensure that federal and state taxpayers, who fund the Medicaid program, are not paying more for pharmaceuticals than any other U.S. purchaser. It achieves this goal by contractually obligating each pharmaceutical manufacturer to pay state Medicaid programs a quarterly rebate for each covered outpatient drug reimbursed by Medicaid. Although participation in the drug rebate program is optional for manufacturers, they have a strong incentive to enter into rebate agreements with the government since Medicaid is prohibited under OBRA 90 from reimbursing any drug manufactured by a company that refuses to execute a rebate agreement. 34 For brand name drugs, the rebate is based on the greater of either (1) a 15.1 percent discount off the drug s AMP, or (2) the difference between the AMP and the manufacturer s best price for that drug. 35 In either case, an additional rebate is due if the drug s AMP increases more than the consumer price index, a measure of inflation. 36 The Medicaid rebate net price is the net price paid to a manufacturer after deducting the statutory rebate amount from the original price of the drug. 37 On average, the Medicaid rebate net price for brand name drugs is 39 percent below AWP and 24 percent below AMP. 38 Because the Medicaid net price 12 for a brand name drug is at least as good as the best price for that drug, the Medicaid net price should generally be better than any price available in the private sector (except for nominal prices which are defined as 10 percent or less of AMP). With respect to generic and over-the-counter drugs, the rebate is 11 percent of the drug s AMP. 39 The Medicaid drug rebate statute defines many of the key terms contained in the law s language. For example, based on the statute s definition of manufacturer, the rebate obligations extend to not only traditional producers of pharmaceuticals but also to drug repackagers and relabelers. 40 Virtually every drug company participates in the program as a result. Under the statute s definition of covered outpatient drug, the class of drugs subject to rebates includes both prescription and nonprescription drugs and prescription biological products, depending on the setting in which they are used. 41 The term best price is also defined. In calculating best price, a manufacturer must (1) include cash discounts, free goods that are contingent on any purchase requirement, volume discounts, and rebates (other than rebates under this section); (2) determine the price without regard to special packaging, labeling, or identifiers on the dosage form or product or package; and (3) not take into account prices that are merely nominal in amount. 42 On the other hand, manufacturers must exclude from their best price calculations any prices charged to (1) the Big 4, (2) a covered entity participating in the 340B drug discount program, (3) state drug assistance programs, and (4) FSS purchasers. 43 Although state Medicaid agencies generally use formularies to control drug spending, the formularies are looser than those typically employed by PBMs and institutional purchasers, both public and private. Under OBRA 90, Congress prohibited states from refusing to cover the drugs of any manufacturer that had signed a rebate agreement. Congress changed this provision three years later, though. As a result, states may sometimes refuse coverage of a drug if it is therapeutically equivalent to another drug on the formulary. 44 Under the supervision of a committee made up of pharmacists and doctors, the states can exclude from their formulary any drug that does not have a significant, clinically meaningful therapeutic advantage in terms of safety, effectiveness, or clinical outcome of such treatment for such populations over other drugs in the formulary. 45 With such a rigid test for denying coverage of therapeutically equivalent drugs, most states have adopted a second strategy for