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

23 FEDERAL DRUG DISCOUNT PROGRAMS controlling drug costs. Namely, they subject nonformulary drugs to a prior authorization procedure which tends to discourage orders due to the administrative burdens placed on providers. Because placement of a drug on a state Medicaid s prior authorization list can reduce sales significantly, California has been able to negotiate with manufacturers to pay supplemental rebates rebates in addition to the mandatory rebates required under OBRA 90 to keep their drugs off the state s prior authorization list. California s supplemental rebate program is unique, because it predates passage of OBRA 90. In OBRA 90, Congress specifically recognized California s pre-existing rebate agreements as in compliance with the Medicaid rebate statute and allowed California to continue negotiating rebate arrangements as long as the state could establish to the satisfaction of HHS that its rebates are at least as large as the rebates otherwise required under federal law. 46 California s program is the only supplemental rebate program in the nation, although it appears that other states are permitted under federal law to create their own supplemental rebate programs. The Medicaid rebate law provides that the Secretary of HHS may authorize a state to enter directly into agreements with a manufacturer in lieu of rebate agreements at the federal level. 47 The deeper discounts achieved through a supplemental rebate program should be exempt from the Medicaid "best price" formula because the definition of "best price" specifically excludes rebates under the Medicaid rebate law which presumably would extend to supplemental Medicaid rebates. 48 B. 340B Drug Pricing Program To understand the genesis of the 340B program, one must begin with OBRA 90 and, in particular, the best price mechanism established by Congress to calculate the rebate amounts for brand name drugs. As a result of the best price mechanism, many pharmaceutical companies had a disincentive to continue giving deep discounts on drugs because they would have to extend the same discounts to the Medicaid program. When manufacturers began raising their prices, the federal and state savings achieved through the Medicaid rebate program were being offset by increased government spending on drugs purchased by other federal- and state-supported providers. To correct this situation, Congress included in the Veterans Health Care Act of 1992 legislation intended to extend relief to other governmental payors of drugs including the Big 4, federal agencies and other purchasers buying off the FSS, and various safety net providers and programs funded by the Public Health Service. 49 One area of statutory relief involved enactment of section 340B of the Public Health Service Act. 50 This program, often referred to as the PHS drug discount program or the 340B program, is administered by the Office of Pharmacy Affairs (OPA) which was called the Office of Drug Pricing until it was renamed in early OPA is located within the Bureau of Primary Health Care (BPHC) which, in turn, is located within the Health Resources and Services Administration (HRSA). OPA, BPHC, and HRSA are all agencies within HHS. OPA is responsible for interpreting, implementing, and overseeing compliance with section 340B. Section 340B requires pharmaceutical manufacturers whose drugs are covered by the Medicaid program to enter into an agreement with the secretary of HHS obligating manufacturers to comply with the terms of section 340B. 51 A parallel provision exists in the Medicaid rebate statute. 52 Under the 340B participation agreement, a manufacturer agrees to provide discounts on covered drugs purchased by specified PHS and government-supported facilities, called covered entities, that serve the nation s most vulnerable patient populations. The amount of these discounts is calculated using the same rebate formulas specified in OBRA 90; however, covered entities are free to negotiate even deeper discounts than the Medicaid rebate amount. 53 The agreement also requires, among other things, that manufacturers check the OPA website each quarter to determine which covered entities are participating in the program. Manufacturers may not charge more than the 340B ceiling price regardless of whether the covered entity purchases pharmaceuticals through a wholesaler or directly from the manufacturer. The definition of covered entities includes certain nonprofit disproportionate share hospitals owned by or under contract with state or local government, as well as specified PHS grantees including certain federally qualified health centers (FQHCs), FQHC look-alikes, state operated AIDS drug assistance programs (ADAPs), the Ryan White CARE Act Title I, Title II, and Title III programs, tuberculosis, black lung, family planning, and sexually transmitted disease clinics, hemophilia treatment centers, public housing primary care clinics, homeless clinics, urban Indian clinics and Native Hawaiian health centers. 54 Some 8,900 eligible covered entities participate in the 340B program. 55 Covered entities participating in the PHS drug discount program are subject to two important restrictions. First, section 340B prohibits the resale or transfer of discounted outpatient drugs to anyone other than a patient of the covered entity. 56 An individual may be considered a patient of a covered entity if he or she 13

24 FEDERAL DRUG DISCOUNT PROGRAMS satisfies a test set forth in OPA guidelines. 57 The penalty for failing to comply with the 340B antidiversion provision is forfeiture of the discounts back to the manufacturer or disqualification from the program. 58 Manufacturers and OPA have the right to audit the records of covered entities to determine whether diversion has occurred. 59 Second, the 340B law states that a drug purchased through the 340B program shall not be subject to both a 340B discount and a Medicaid rebate. 60 The purpose of this restriction is to protect manufacturers from giving duplicate discounts on the same drug a 340B discount up front when the covered entity purchases the drug, plus a Medicaid rebate paid to the state after the drug is billed to Medicaid. OPA has established two mechanisms for covered entities to comply with the 340B prohibition against duplicate discounts. 61 The most common procedure involves covered entities submitting their Medicaid pharmacy numbers to OPA for use by state Medicaid agencies in identifying covered entity pharmacy bills and excluding them from the rebate program. 62 Finally, the 340B program offers a contract pharmacy option for covered entities. When Congress enacted section 340B, Congress did not consider that some covered entities especially FQHCs, city and county health departments, and other small facilities would not be able to participate due to the lack of an in-house pharmacy capable of purchasing and dispensing the discounted drugs. These facilities began complaining to OPA about their inability to participate. OPA responded to these complaints by developing guidelines that allow covered entities to use contract pharmacies to dispense 340B-discounted drugs. 63 The guidelines essentially allow a covered entity to enter into a ship to, bill to arrangement with a community pharmacy or other pharmacy contractor such that the covered entity purchases the 340B drug and the manufacturer bills the entity for the drug purchased, but ships the drug to the contract pharmacy. In addition, the contractor must provide the covered entity quarterly financial statements, a detailed status report of collections, and a summary of receiving and dispensing records. The contractor is also required to establish and maintain a tracking system to prevent diversion of drugs to individuals who are not patients of the covered entity. The contract pharmacy model is primarily used by FQHCs and other smaller covered entities. It is difficult to implement in some states, such as California, because of perceived conflicts with state pharmacy laws. 64 A recent study estimates that, during fiscal year 1997, 1,075 entities purchased outpatient drugs at these discounts with a total net purchase amount between $893 million and $1.2 billion. 65 Estimated purchases in fiscal year 2000 are approximately $1.7 billion. 66 On average, 340B prices are estimated to be 51 percent lower than AWP, 39 percent lower than AMP and 19 percent lower than the Medicaid net price. 67 C. Federal Supply Schedule The federal supply schedule is a schedule of contracts and prices for frequently used supplies and services available for purchasing by federal departments, agencies, institutions, and other kinds of entities such as the District of Columbia, U.S. territorial governments, and numerous Native American tribal governments. Under the federal acquisition regulations, many of these agencies are required to purchase from specified FSS schedules. 68 Once a contract for a particular item is negotiated, specific designated agencies must order their supplies and services from the schedule if the contract applies to their geographic area, with a few exceptions. 69 By combining their purchasing power, these agencies can obtain discounts associated with bulk purchasing. Commercial firms compete for indefinite delivery contracts, agreeing to provide certain supplies and services for certain periods of time. More than 100 schedules are available through the FSS program, covering a wide range of goods and services typically needed by government agencies. Examples of products available through FSS include office supplies, computer equipment, hardware items, automobiles, and aircraft. The General Services Administration (GSA) awards most FSS contracts; however, it may delegate to other agencies its authority to negotiate and award schedule contracts. GSA has delegated such authority to the VA with respect to the medical-related schedules, including Schedule 65 IB for pharmaceuticals. Individual FSS contract prices are determined by negotiations between the manufacturer and the VA contracting officer. Although the government sets certain goals for these negotiations and contracting officers may consult certain general guidelines, there are no statutory ceilings on the prices negotiated by the contracting officer. The government s goal during negotiations is to obtain a discount from the manufacturer that is equal to or greater than the best discount given by the manufacturer to any of its other customers. This is generally referred to as a manufacturer s most favored customer price. This most favored customer price will often be a starting point for negotiations. The manufacturer may argue that the government s terms and conditions make the government so different from their most favored customer that the manufacturer cannot offer the same discounted price to the govern- 14

25 FEDERAL DRUG DISCOUNT PROGRAMS ment. FSS negotiations therefore often revolve around the issue of who is a comparable customer. No rigid guidelines define who is and is not a comparable customer. This is a point left to the contracting officer s discretion and subject to negotiation. Factors that the officer will consider and negotiate around include an entity s size, what the entity does, its volume of sales, the type of payments it makes, its distribution systems, and any other relevant factors. Because the government wants manufacturers to give their most discounted price as their FSS price, manufacturers have an incentive to argue that the VA, combined with the entities for whom it negotiates, is not comparable to the customers receiving the manufacturers best discounts. FSS contracts do contain a price reduction clause; however, it really only applies if the contracting officer and manufacturer agree that the government is comparable to another customer of the manufacturer. If a manufacturer lowers the prices in its pricing documents, or sells the same items to comparable customers at a price lower than the negotiated FSS price, the manufacturer must then give the government an equivalent price reduction on subsequent orders. In some respects, federal procurement of pharmaceuticals through the FSS program is no different from bulk purchasing arrangements commonly found in the private sector. Both involve traditional price negotiations unconstrained by a statutory ceiling price. Several important differences, however, give the government the upper hand in contract negotiations. First, under section 603 of the Veterans Health Care Act, manufacturers are required to list all their brand name drugs on the FSS as a condition for having their drugs covered and reimbursed by the Medicaid program. 70 Given the size of the Medicaid market, this requirement has successfully encouraged virtually every brand name drug company to sell through the FSS and has prevented companies from picking and choosing which drugs to list. Second, offerors under a VA schedule are required to disclose discount and pricing information that allows the VA to analyze and compare prices made available to other customers, and to target prices for negotiation purposes. 71 If some of the disclosed prices are lower than the FSS price, the company must disclose the discounts for all customers or category of customers receiving those prices, as well as any deviations from the discounts. 72 Finally, the VA has substantial audit rights with respect to offerors. The pharmaceutical FSS program contains over 17,000 products available to federal agencies and other entities. According to the VA, during fiscal year 1999, FSS drug sales totaled about $1.5 billion about 1.1 percent of domestic pharmaceutical sales. 73 FSS prices are estimated to be about 48 percent below AWP 74 Compared to AMP and the Medicaid net price, they are estimated to be 35 and 15 percent lower, respectively. 75 D. Big 4 Federal Ceiling Prices In the aftermath of OBRA 90, when pharmaceutical companies stopped giving deep discounts to many of their government purchasers, Congress responded by enacting a number of programs under the Veterans Health Care Act of Besides providing relief to PHS-funded clinics and public hospitals under the 340B program, Congress established a separate drug discount program for the four largest federal purchasers of pharmaceuticals: the VA, DOD, PHS, and Coast Guard. 76 These four agencies, commonly known within federal procurement circles as the Big 4, have the right to purchase their pharmaceuticals from the federal supply schedule, like every other federal agency. FSS prices are not protected under federal law by a ceiling price, so they can climb dramatically depending on market pressures. Congress remedied this problem in 1992 by placing a ceiling price, called the federal ceiling price, on brand name drugs purchased by the Big 4. Under section 603 of the Veterans Health Care Act, a pharmaceutical manufacturer cannot receive payment for the purchase of drugs or biologicals from a state Medicaid plan, the VA, the DOD, the Public Health Service, the Coast Guard, or any entity that receives funds under the Public Health Services Act, unless the manufacturer enters into a master agreement with HHS. 77 Under the master agreement, the manufacturer agrees to enter into a pharmaceutical pricing agreement with the VA requiring a minimum discount on covered drugs sold to the VA equal to 24 percent of the nonfederal average manufacturer price (non FAMP). 78 Manufacturers must extend an additional discount if they raise the price faster than the rate of inflation based on the consumer price index. 79 The FCP discount formula is only available to the VA, the DOD, the Public Health Service (including the Indian Health Service), and the Coast Guard. 80 Other federal agencies must pay normal FSS prices, which are higher if a manufacturer maintains different FCP and FSS prices for the same covered drug, referred to as dual pricing. Manufacturers are given the option of giving dual or single pricing to FSS purchasers and the Big Like OBRA 90 and the 340B statute, the FCP authorizing statute provides detailed definitions of key terms. Familiarity with these definitions is important because they reveal significant differences from the Medicaid rebate and 340B programs. For example, 15

26 FEDERAL DRUG DISCOUNT PROGRAMS whereas the Medicaid rebate and 340B programs impose discounts on brand name and generic drugs, the FCP discounts on Big 4 covered drugs only extends to brand name drugs. 82 Similarly, the FCP pricing calculation is based on a fixed discount off the non-famp, much like the AMP-based discount found in the Medicaid and 340B programs, but lacks anything comparable to the best price formula. 83 There are also slight differences in how the additional discount is calculated to prevent manufacturers raising prices faster than the rate of inflation. 84 Finally, whereas nominal prices (i.e., prices 10 percent or less of AMP) are excluded from non-famp, AMP, and best price, the VA has interpreted the exclusion for nominal prices more narrowly than HCFA. 85 Most drug products covered under section 603 of the Veterans Health Care Act have FSS prices that are above their FCP. As of February 2000, FSS prices were, on average, almost 8 percent above the FCP. 86 About 63 percent of the almost 6,300 products had FSS prices that were above the FCP. 87 For these products, the Big 4 would pay only the FCP. About 14 percent of the products had FSS prices equal to the FCP, and 23 percent had FSS prices that were below the FCP. When the FSS price was lower than FCP, it averaged almost 6 percent below the FCP. 88 FCP is estimated to be 52 percent lower than AWP, 40 percent lower than AMP, and 21 percent lower than Medicaid net price, 89 FCP is slightly lower than 340B prices as well. 90 E. VA National Contract Prices The Big 4 and 340B drug discount programs share an important feature insofar as they both empower their implementing agencies to negotiate subceiling prices. Indeed, of all the federal agencies, the VA has been most successful in exploiting this opportunity. The VA has been able to obtain prices significantly lower than FCP and FSS prices through national contracts with manufacturers for select drugs. It has obtained such prices because it seeks competitive bids from manufacturers for products that it considers to be therapeutically equivalent within specific drug classes. 91 The VA contracts with those manufacturers whose products it believes provide the best value, based on both medical effectiveness and price, in exchange for including their products on the VA s national formulary and committing to use the products throughout the VA s health care system. 92 The VA has been conducting a standardization process for certain pharmaceutical products. Under that process, the VA balances its clinical preferences against its concentrated buying power. The VA competitively selects one or a limited number of contractors to supply all of the VA s requirements for a standardized product. The selected product receives a formulary status, meaning that VA facilities must order the formulary product under the national contract rather than buying a competitor s product under the VA schedules (unless certain waivers are granted). The VA has, for example, entered into national contracts for alpha blockers, ace inhibitors, HMG-CoA reductase inhibitors, and nifedipine. National contracts are usually for a one-year term with four oneyear options to extend the contract. According to VA officials, the winning bids in most cases are the lowest prices offered. 93 During fiscal year 1999, VA purchases under national contracts totaled about $361.3 million, or about 23 percent of its drug expenditures. By February 2000, the VA had 60 national contracts covering about 500 products. 94 The contracts cover both brand name and generic products and include some joint contracts with DOD. For the 308 products that had both a national contract price and an FSS price as of February 14, 2000, the national contract price was, on average, about 33 percent lower than the FSS price. 95 Because national contract prices are lower than FSS prices, the price differences between national contract prices and AWP, in turn, can be quite large. For example, the national contract prices for three cholesterol-lowering drugs that are among the top 50 drug products most commonly used by the elderly were, respectively, 70, 72, and 88 percent lower than AWP. 96 The VA and DOD are increasingly collaborating on how to leverage their combined buying power by jointly procuring a standardized product under a single national contract. 97 Because national contacts cover all of the VA s requirements, the competition for these contracts has been intense, particularly in the pharmaceutical area where every national contract has been the subject of a bid protest

27 Endnotes for Chapter II 32 Omnibus Budget Reconciliation Act of 1990, Pub. L. No , sec. 603, 104 Stat (1990). In Fiscal Year 1999, Medicaid rebates totaled more than $3.3 billion. See GAO Federal Pricing Report, supra note 28, at Although HCFA has issued proposed regulations implementing the Medicaid drug rebate program, final regulations still have not been published U.S.C.A. 1396r-8a (West Supp. 2000). 35 Id. 1396r-8(c)(1). 36 Id. 1396r-8(c)(2). 37 See Table See Table Id. 1396r-8(c)(3). 40 The term manufacturer means any entity which is engaged in (A) the production, preparation, propagation, compounding, conversion, or processing of prescription drug products, either directly or indirectly by extraction from substances of natural origin, or independently by means of chemical synthesis, or by a combination of extraction and chemical synthesis, or (B) in the packaging, repackaging, labeling, relabeling, or distribution of prescription drug products. 42 U.S.C.A. 1396r-8(k)(5) (West Supp. 2000). Such term does not include a wholesale distributor of drugs or a retail pharmacy licensed under state law. Id. 41 The term covered outpatient drug has a lengthy statutory definition. Id. 1396r-8(k)(2). In part, the term includes a prescribed drug (1) which is approved under the Food, Drug, and Cosmetic Act; (2) which was commercially used or sold in the U.S. before enactment of the Federal Food, Drug, and Cosmetic Act; and (3) which has not been the subject of a final determination by the Secretary that it is a New Drug under the Food, Drug, and Cosmetic Act. Also included are identical, similar or related drugs, a biological product which may only be dispensed by prescription, is licensed, and produced by a licensed establishment. The term excludes any drug, biological product, or insulin provided with inpatient hospital services, hospice services, dental services (except where state plan authorizes direct reimbursement to dispensing dentist), physician office visits, outpatient hospital emergency room visits, and outpatient surgical procedures. Finally, nonprescription drugs prescribed by a physician, or other authorized prescriber, may be regarded as covered outpatient drugs U.S.C.A. 1396r-8(c)(l)(C) (West Supp. 2000). 43 Id. 44 Id. 1396r-8(d)(4). 54 Id. 256b(a)(4). 55 See OPA, Entity and Manufacturers List, at U.S.C.A. 256b(a)(5)(B) (West Supp. 1999) Fed Reg. 55,156 (1996) U.S.C.A. 256b(a)(5)(D) (West Supp. 1999). 59 Id. 256b(a)(5)(C). 60 Id. 256(b)(a)(5)(A) Fed. Reg. 34,058 (1993) (rebate exclusion option); 65 Fed. Reg. 13,983 (2000) (Medicaid carve-out option) Fed. Reg. 34,058 (1993) Fed. Reg. 43,549 (1996). 64 This problem would be remedied by legislation introduced by Senator Speier on February 20, S.B Mathematica Policy Research, Inc., Washington, D.C., An Analysis of Purchases, Savings and Participation in the PHS Drug Pricing Program, (Sept. 30, 1999). 66 Telephone Interview with Jim Mitchell, Director of OPA (Apr. 2, 2001). 67 See Table C.F.R. 38 (1992) C.F.R. 38 (1992) U.S.C.A. 256b (West Supp. 1999). 71 GSA Acquisition Regulation (b). 72 The instruction to offerors in GSA Acquisition Regulation Preparation of Offer (Multiple Award Schedule) (Aug. 1997), defines the term discount as a reduction to catalog prices (published or unpublished). Discounts include, but are not limited to, rebates, quantity discounts, purchase option credits, and any other terms or conditions other than concessions) which reduce the amount of money a customer ultimately pays for goods or services ordered or received. Any net price lower than the list price is considered a discount by the percentage difference from the list price to the net price. Id. at (a). The same clause defines the term concession as a benefit, enhancement or privilege (other than a discount), which either reduces the overall cost of a customer s acquisition or encourages a customer to consummate a purchase. Concessions include, but are not limited to freight allowance, extended warranty, extended price guarantees, free installation and bonus goods. Id. 73 GAO Federal Pricing Report, supra note See Table 3 and Chart See Table Id. 1396r-8(d)(4)(C) U.S.C.A 1396r-8(a)(4). 47 Id. 1396r-8(a)(1). 48 Id. 1396r-8(c)(1)(C)(ii)(I). 49 Veterans Health Care Act of 1992, Pub. L. No , 106 Stat (1992). Id. 602 (Codified at 42 U.S.C.A. 256b (West Supp. 1999)). 50 Id U.S.C.A. 256b(a)(1) (West Supp. 1999) U.S.C.A. 1396r-8(a)(1) and 8(a)(5) (West Supp. 2000) U.S.C.A. 256b(a)(2) (West Supp. 1999) Veterans Health Care Act of 1992, sec. 603, Pub. L. No , 106 Stat (1992) (codified at 38 U.S.C.A (West Supp. 2000)). 77 Id. 8126(a)(4). 78 Id. 8126(a)-(c). 79 Id. 8126(a)-(c). 80 Id (a) and (b). 81 Letter from Melbourne A. Noel, Jr., VA Government Trial Attorney to Manufacturers (May 4, 1993) (on file with author). 82 The term covered drug means (1) an innovator multiple source drug; (2) a single source drug; or (3) any biological product identified in 21 C.F.R U.S.C.A. 8126(h)(2). An innovator multiple source drug

28 Endnotes for Chapter II means a multiple source drug that was originally marketed under an original new drug application approved by the Food and Drug Administration, and a single source drug means a covered outpatient drug which is produced or distributed under an original new drug application approved by the Food and Drug Administration, including a drug product marketed by any cross-licensed producers or distributors operating under the new drug application. 42 U.S.C.A. 1396r-8(k)(7)(A)(ii) and (iv). 83 The term non-federal average manufacturer price means with respect to a covered drug and a period of time (as determined by the Secretary), the weighted average price of a single form and dosage unit of the drug that is paid by wholesalers in the United States to the manufacturer, taking into account any cash discounts or similar price reductions during that period, but not taking into account (A) any prices paid by the federal government; or (B) any prices found by the Secretary to be merely nominal in amount. 38 U.S.C.A. 8126(h)(5). 84 The additional discount is the amount equal to the amount by which the change in the non-federal price exceeds the amount equal to (1) the non-federal average manufacturer price of the drug during the 3-month period that ends one year before the last day of the month preceding the month during which the contract for the covered drug goes into effect... multiplied by (2) the percentage increase in the consumer price index for all urban consumers (U.S. city average) between the last month of the period described in paragraph (1) and the last month preceding the month during which the contract goes into effect for which the consumer price index data is available. Id. 8126(c). The net effect of the additional price discount mechanism is to contain the rate of inflation in pharmaceutical prices by providing manufacturers with a disincentive to increase their prices to the VA at rates greater than the general rate of inflation. 85 The VA has interpreted the term nominal pricing as being pricing, usually below cost, designed to benefit the public by financially aiding disadvantaged, non-for-profit covered drug dispensaries or researchers using a drug for an experimental or non-standard purpose. See VA letter to Manufacturers, dated October 7, 1996, paragraph 1 (on file with author). Therefore, manufacturers cannot exclude sales at nominal prices to commercial entities when calculating non-famp. The VA also does not agree that all free goods are exempt from non-famp. The VA believes that free drug samples must be included in non-famp calculations when they are contingent upon any written or verbal commercial agreements. For example, free drugs distributed to a customer as a result of its prior purchases of a certain quantity of drugs (e.g., buy-one, get-one-free arrangement) must be included in non-famp calculations. Id. 86 GAO Federal Pricing Report, supra note at 28, at Id. As of February 14, 2000, the FSS included 17,464 drug products; 6,274 were covered under the Veterans Health Care Act and 11,190 were not covered. Noncovered products are generally generic drugs. VA estimates that about 70 percent of its drug expenditures for fiscal year 1999 were for covered drugs. About 69 percent of the covered drugs with FSS prices above the FCP had FSS prices that were only 1 percent or less above the ceiling. Id. 88 Id. 89 See Table Id. 91 VA also negotiates what is know as blanket purchase agreements with many manufacturers to obtain prices that are lower than listed FSS prices if VA uses specific product amounts. These agreements differ from national committed-use contracts in that they are not competitively bid and most apply to specific VA purchasers, such as one or more VA hospitals. As of February 14, 2000, there were 52 blanket purchase agreements in effect. GAO Federal Pricing Report, supra note 28, at GAO Federal Pricing Report, supra note 28, at 15. See also GAO, Report to Congressional Requesters, VA Health Care: VA s Management of Drugs on its National Formulary (GAO/HEHS-00-34, Dec. 14, 1999). 93 Id. 94 Id. 95 Id. See also Table Id. at 15. For additional information on VA national contracting practices and prices, see GAO, Report to Congressional Requesters, DOD and VA Health Care: Jointly Buying and Mailing Out Pharmaceuticals Could Save Millions of Dollars (GAO/T-HEHS , May 25, 2000). 97 The first joint VA-DOD solicitation for a standardized product is for the drug diltiazem, a calcium channel blocker used primarily in the treatment of hypertension. See also Amendment 1 to VA Solicitation M5-Q1-98, dated June 4, The addition of DOD s requirements to the VA s solicitation increased the amount of projected sales of diltiazem by 50 percent. Should the administration of this joint procurement proceed smoothly, contractors can expect future joint solicitations for some standardized products. 98 With one recent exception, the VA has defended successfully all bid protests filed with the GAO. For a summary of the current successful and unsuccessful protest grounds, see Hoechst Marion Roussel, Inc., B (May 4, 1998). 18

29 III. INTERSECTION OF FEDERAL AND STATE PROGRAMS: RISKS AND OPPORTUNITIES States that embark on creating their own drug assistance programs without an understanding of how those programs intersect with federal law, may discover that their programs are impaired, or even unenforceable, under federal law. In particular, states need to be aware of federal constitutional limitations, the impact of the Medicaid best price formula and non-famp calculations on discounting options, the highly successful discounting strategy employed by the VA national contract program, and how federal and state discount programs affect patient access to pharmaceutical care. Each of these topics is covered in more detail below. A. Constitutional Limitations The U.S. Constitution imposes two principal constraints on state pharmacy discount programs. The first is imposed by the Commerce Clause, which prevents states from formulating their discount programs in ways that regulate prices paid in out-of-state transactions. The second, imposed by the Supremacy Clause, bars discount programs that conflict with federal law. This second constraint is commonly referred to as federal preemption. Both these constraints have nuances that should be understood prior to implementing a drug discount program. 1. Commerce Clause The Commerce Clause of the U.S. Constitution reserves for Congress the power to regulate commerce among the several states. 99 Courts have found that this clause prevents individual states from acting in ways that regulate out-of-state transactions. Courts examine three factors to determine whether a state s law has the unconstitutional effect of regulating out-ofstate transactions. First, courts consider whether the regulation is applied to commerce wholly outside of the State s borders. Second, they examine whether the practical effect of the legislation is to control out-ofstate transactions. Third, they consider what effect the regulation would have on other states regulations, and what would happen if other states adopted similar legislation. 100 These three principles have been applied to strike down state regulations that impact prices charged outside of the state. 101 The fact that the regulated transaction may affect or impact a state does not license that state to regulate commerce which occurs outside of its jurisdiction. 102 Thus, states must try to craft their drug discount laws to prevent them from adversely affecting prices charged in out-of-state transactions. This can be challenging if a manufacturer does not sell directly to purchasers within the state but rather sells its drugs through wholesalers. The Commerce Clause has been applied in a second way that may restrict how state lawmakers design their pharmacy discount programs. The U.S. Supreme Court has struck down laws that tie in-state prices to out-of-state prices. 103 The rationale for striking down these laws is that they may have the practical effect of regulating out-of-state prices. For example, if a large state requires that manufacturers provide it with the lowest price charged to any state in the union, the natural impact of such a regulation is to make manufacturers much more cautious providing discounts in other states. Thus, a manufacturer may choose to raise its selling price for a drug in a small state, in order to avoid having to lower its price in a large state. In determining whether a given discount program may violate the Commerce Clause, it may be important to determine whether the state is simply participating in the market to obtain a discount, or whether it is actually regulating pricing activities. When a state is merely purchasing a product in the market, it is not subject to the restrictions of the interstate Commerce Clause. 104 When, however, a state uses its purchasing power in one area to achieve a goal in another area, courts have found that the state is not merely acting as a purchaser, but is rather using its purchasing power to regulate the market. 105 Thus, when a state pharmacy program ties purchasing of products under one program to discounts for drugs that are not covered under that program, a court may view the purchasing program as an act of regulation and therefore subject to the Commerce Clause restrictions. This is exactly how a federal district court reacted to the Maine Rx Program when the issue was raised in litigation in the year Federal Preemption The Supremacy Clause of the U.S. Constitution states [t]his Constitution, and the Laws of the United States which shall be made in pursuance thereof... shall be the supreme law of the land 107 Federal law preempts state law in three primary ways. First, courts sometimes find that federal regulation in a given area is so extensive that it does not leave any room for state regulation. It is unlikely that this first mode of preemption will be applied to state pharmacy discount programs. Second, if a federal law conflicts with a state law, the state law will be held invalid, as it is preempted by its federal counterpart. 19

30 INTERSECTION OF FEDERAL AND STATE PROGRAMS: RISKS AND OPPORTUNITIES The final manner in which a state law can be preempted is when there is an implied preemption. To determine if a state law is implicitly preempted, the congressional intent of laws regulating the area and the purposes behind those laws must be considered. 108 Determining which federal laws may impact a given pharmacy discount program, and then trying to identify the congressional intent relevant to those laws, can be a somewhat complex undertaking. Further, determining whether or not a given discount program violates congressional intent is, by its nature, an imprecise process. Nevertheless, the process is a necessary prerequisite to designing a state drug assistance program capable of withstanding a legal challenge. If, for example, a state enacts legislation requiring drug companies to disclose their AMP, best price, or non-famp for a given drug, such legislation would probably not withstand a preemption challenge because federal law explicitly protects the confidentiality of these provisions. Less clear is how federal preemption principles should be applied to state efforts to encourage discounts for non-medicaid patients by conditioning Medicaid coverage of a company s drugs on providing those discounts. The Maine case, after it is finally resolved, should give states better guidance on when the design of a state pharmacy assistance program risks violating the U.S. Supremacy Clause. 3. Maine Litigation In October 2000, the U.S. District Court for the District of Maine granted a preliminary injunction to prevent Maine from implementing a pharmacy discount program called the Maine Rx Program. 109 The Maine case illustrates the potential dangers that the Constitution can pose for states attempting to implement drug discount programs. It is important to note, however, that this case is on appeal and that the appellate courts and the courts of other districts may not adopt the precise analysis presented in the district court s opinion. Maine enacted a pharmacy discount program that required all manufacturers whose drugs were sold in Maine through publicly supported pharmaceutical assistance programs such as Medicaid and Maine s Elderly Low Cost Drug Program to enter into a rebate agreement with the state. 110 In order to avoid being placed on the list of Medicaid drugs that require authorization prior to dispensing, manufacturers are required to agree to enter into a rebate agreement. In the rebate agreement, manufacturers are required to agree to provide a discount on drugs sold to any participating residents of Maine (the program contains no age, income or insurance restrictions). Maine s use of the Medicaid prior authorization authority to extract rebates from manufacturers is similar to the California supplemental rebate program, except the rebates in Maine are intended to lower the cost of drugs for non- Medicaid indigent patients whereas the California rebates are used to lower costs for Medi-Cal (i.e. California Medicaid) recipients. The amount of the Maine Rx rebate is pegged to discounts available through the Medicaid rebate and FSS programs. 111 In addition, an antiprofiteering provision was passed which includes a ban on manufacturers rearranging sales or distribution of drugs in Maine in retaliation for the discount program. 112 The district court held that elements of the program violated both the Commerce Clause and the Supremacy Clause. It first found that the vast majority of drug transactions subject to the rebate provision and the antiprofiteering provision occur outside of Maine when the manufacturer sells its drugs to distributors. 113 As such, the court found that the discount program was an effort by Maine to regulate the price of transactions occurring outside of Maine in violation of the Commerce Clause. 114 In reaching this conclusion, the court stated that [I]t is undisputable that the practical effect of what Maine has done here is to limit the revenue an out-of-state manufacturer can obtain when it sells drugs to out-of-state distributors that ultimately send or bring the drugs to Maine. 115 The district court rejected the state s claim that Maine was merely involved in purchasing and thus its actions were not subject to Commerce Clause limitations. The court reasoned that the rebate program involved more than simply a state purchasing program. Rather, the court found that the rebate program involved regulatory action because Maine was trying to use its leverage [in the Medicaid program] to achieve a social regulatory goal elsewhere to reduce the price of prescription medications for Maine citizens who do not participate in Medicaid and who do not have private insurance. 116 The court concluded that because Maine was acting in a regulatory manner, its drug discount program was subject to and void under the Commerce Clause. The district court also found that federal law implicitly preempts the discount program. The focus of the preemption analysis was the requirement that the drugs of manufacturers who do not sign a Maine Rx rebate agreement must be added to the list of Medicaid drugs that require prior authorization. The court found that Congress s intent was that states only restrict drug distribution to Medicaid recipients in a way that is in the best interest of those recipients. 117 It was not the intent of Congress, the court found, that the Medicaid program be used to further the interests of non- Medicaid recipients. 118 In addition, the court stated Maine can point to no Medicaid purpose in the new 20

31 INTERSECTION OF FEDERAL AND STATE PROGRAMS: RISKS AND OPPORTUNITIES prior authorization requirement. 119 Because the court found the prior authorization requirement is an obstacle to accomplishing Congress s goals for the Medicaid program, it found the rebate program was preempted Vermont 1115 Waiver The pharmaceutical industry has challenged another state drug assistance program under federal law. 121 On November 3, 2000, HCFA granted a request by the Vermont Medicaid program to waive certain federal requirements applicable to state Medicaid plans in order to extend the state s Medicaid prescription drug benefit to more than 70,000 Vermont residents who would otherwise be ineligible for Medicaid benefits. 122 The request was approved under section 1115 of the Social Security Act which permits HCFA to waive any federal Medicaid requirement for any experimental, pilot, or demonstration project which, in the judgment of the Secretary of HHS, is likely to assist in promoting the objectives of Medicaid. 123 Although Medicaid 1115 waivers are commonly used by states to expand eligibility to individuals who do not meet federal eligibility requirements, the Vermont waiver is unique in that it makes only the Medicaid drug benefit available to this new category of beneficiaries. Other Medicaid-covered services and items such as hospital care, physician services, home health and long term care are not expanded under the waiver. The waiver is also unique in that the program expansion is not funded by either federal or state revenue. Rather, it is funded by patient co-payments and the manufacturer rebates required under OBRA 90. Federall Medicaid llaw requiring only nominal patient co-payments would therfore also be waived in Vermont. The Vermont waiver model has already withstood one legal challenge by the pharmaceutical industry, but litigation over this scheme is far from over. 124 Industry argues that because the state Medicaid agency makes no payments to pharmacies under the program, the 1115 waiver violates the federal Medicaid statute by not complying with federal/state cost sharing requirements. The state asserts that HCFA s decision to grant the waiver was a reasonable interpretation of the law and therefore should receive judicial deference under the Chevron case. 125 Theoretically every state in the union could replicate this model as a way to give individuals lacking prescription drug coverage instant access to Medicaid rebate prices. This model should be especially attractive to small drug assistance programs that may have trouble obtaining discounts at the Medicaid rebate levels due to insufficient volume. On January 19, 2001, HCFA approved a similar 1115 request from Maine covering an estimated 225,000 residents without prescription drug coverage. 126 In sum, there are important constitutional limitations relevant to state drug assistance programs. A discount program cannot succeed unless it is structured to comply with these limits. While it may be difficult to assess the precise limits for a given program in advance, a thorough examination of the constitutional implications of the discount program prior to its final implementation will likely lessen the danger that the program will subsequently be struck down as unconstitutional or inconsistant with federal law. B. Hitting the Best Price Wall Besides navigating potential federal constitutional barriers, state lawmakers must be careful not to squander the opportunity of securing discounts below Medicaid best price for their drug assistance clients. Congress created a huge opportunity for state drug assistance programs to obtain some of the best prices in the country by exempting their prices from the Medicaid best price formula. 127 This is a benefit that, besides state drug assistance initiatives, only the Medicaid rebate, 340B, FSS, and FCP programs enjoy. It means that, state drug assistance programs have the potential to command deeply discounted pricing comparable to the discounts available to these federal programs. A quick glance back at Chart 4 gives a rough estimate of how much states can save. Assuming, for example, a state drug assistance program achieves discounts equivalent to FSS, it would pay 15 percent less than the Medicaid rebate net price, which is better than any price that can be negotiated in the private sector. 128 Put another way, the state could serve at least 15 percent more patients than a private program could ever hope to serve with the same amount of money. If state discounts climb to 340B or FCP levels, the state program could serve an estimated 20 percent more patients. 129 The savings would be even greater if the state compares its prices to an average price negotiated in the private sector, that is, the AMP. In this case, the state could serve an estimated 35 percent more patients if it obtains discounts similar to FSS, and 40 percent more patients if its discounts are comparable to 340B or FCP. 130 The significance of the best price exemptions under OBRA 90 cannot be overstated. Without the exemption, a purchaser cannot hope to negotiate a price better than Medicaid best price. If the purchaser could, its discounted price would, by definition, become the new Medicaid best price. The manufacturer would then have to pay larger rebates to the entire Medicaid program. The net effect is that, for each brand name marketed in the U.S., best price becomes a floor on price negotiations for every purchaser save those whose prices have been statutorily excluded from best price. Of course, the mere existence of the best price exemption 21

32 INTERSECTION OF FEDERAL AND STATE PROGRAMS: RISKS AND OPPORTUNITIES does not force manufacturers to give such deep discounts to states. Manufacturers are keenly aware of what their best price is for each brand name drug and are reluctant to discount below that price absent a compelling business reason. Manufacturers often have the upper hand because they are not required to disclose their best price to states and because there often are no good substitutes for brand name drugs that states can use for bargaining purposes. Nonetheless, if a state can muster sufficient political or economic power to obtain discounts below best price either through formulary use, volume discounting, and/or legally enforceable price control legislation then the exemption is essential for the state to realize its full potential in reducing the cost of pharmaceuticals for residents lacking drug coverage. 1. Decline of Private Sector Discounting In 1996, the Congressional Budget Office (CBO) released a report analyzing the impact of the Medicaid best price mechanism on the price of brand name drugs following passage of OBRA Recall that, under the basic rebate formula, manufacturers must give to states rebates amounting to at least 15.1 percent of a brand name drug s AMP. The basic rebate is often higher than this amount because, if a drug company has given a deeper discount than 15.1 percent to any of its customers (apart from an exempted government purchaser), then the states are entitled to the deeper discount. Indeed, state Medicaid agencies are entitled under OBRA 90 to the company s deepest discounts on brand name drugs (again subject to the best price exemptions) which can be significantly larger than the minimum 15.1 percent discounts off AMP. The total rebate owed can be even larger if the price of the drug has increased faster than the rate of inflation, triggering requirement of an additional rebate. After reviewing manufacturer best price data for 1991 through 1994, CBO calculated that best price discounts had fallen from an average of 36 percent of AMP in 1991 to an average of 19 percent in And whereas 32 percent of brand name drugs had a best price discount as high as 50 percent in 1991, only 9 percent had discounts of this size in There is no evidence that this trend has reversed itself, which means that industry, on average, has been giving smaller discounts to its best customers since passage of OBRA 90. Based on these findings, CBO concluded that, since Medicaid constitutes approximately 10 to 15 percent of the market for outpatient prescription drugs, pharmaceutical companies are much less willing to give large private purchasers steep discounts when they also have to give Medicaid access to the same low prices. 134 Manufacturers may still have incentives to give discounts in excess of 15.1 percent of AMP if they 22 can increase sales as a result. However, the cost of giving a deeper discount is much higher as a result of the best price mechanism. When the discount exceeds 15.1 percent, unit revenues decline on sales to Medicaid recipients as well as to the manufacturer s new customers. If the new business resulting from the deeper discount is equivalent to the volume of sales to Medicaid, then the best price provision ends up doubling the manufacturer s cost of offering the discount in excess of 15.1 percent. 135 According to CBO, the best price provision of the Medicaid rebate should have had the biggest impact on those purchasers that were getting the lowest prices often those that strictly enforce a formulary and had a very large patient base. 136 These include the private institutional purchasers described in section I.A.3: hospitals, HMOs, and GPOs. The rebate program may have somewhat diminished the rewards available to these large purchasers that undertake the cost of organizing their patient base and using a strict formulary. The best price provision of the Medicaid rebate program may also have strengthened the bargaining position of pharmaceutical manufacturers in their pricing negotiations with private institutional purchasers. Manufacturers can credibly claim that deep discounts are no longer feasible since they are required to give the same discount to the entire Medicaid market. Institutional purchasers are at somewhat of a disadvantage because they cannot assess the size of their discounts relative to the manufacturer s AMP, since that price is known only by the manufacturer and HCFA Staying Within the Best Price Exemption Congress established several exemptions to the best price formula when it amended the Medicaid rebate statute under section 601 of the Veterans Health Care Act of One of those exemptions is for any prices used under a state pharmaceutical assistance program. 139 State drug assistance programs need to be designed carefully to make sure that they fall within their best price exemption properly, because the consequences of exceeding the scope of the exemption are dire. As previously mentioned, the cost of financing the program could increase significantly if prices cannot be negotiated below the Medicaid best price floor. With respect to the traditional state-funded pharmacy assistance programs implemented in more than a dozen states, application of the best price exemption is noncontroversial. Most of these states collect rebates from manufacturers which reduce the ultimate price of drugs dispensed to drug assistance patients. These rebate-discounted prices are exempt from best price calculations so states are free to nego-

33 INTERSECTION OF FEDERAL AND STATE PROGRAMS: RISKS AND OPPORTUNITIES tiate (and manufacturers are free to give) large rebates without creating a risk that the manufacturers rebate obligations to Medicaid will increase. However, interpretation of the best price exemption is less clear if a state contracts with a PBM or other private company to administer its pharmacy assistance program, including the negotiation of manufacturer rebates. If, for example, the PBM negotiates rebates for multiple drug insurance plans, including private plans or those otherwise having nothing to do with state pharmacy assistance programs, then the negotiated rebate amount could be attributable to a volume of drugs that exceed those dispensed to state assistance clients. In this case, HCFA could decline to exempt the rebate discounts from best price. The same risk arises if a state implements a bulk purchasing program that purchases on behalf of entities other than state pharmacy assistance programs, for example, if the purchasing cooperative extends to state hospitals, schools, prisons, state employees, county or city agencies, or even private purchasers. On the other hand, it may be possible for a PBM to structure its rebate arrangements with manufacturers to fall outside best price calculations other than by relying on the exemption for state pharmaceutical assistance programs. HCFA has stated in a program release dated June 2, 1977, that where a PBM s arrangement with a manufacturer reduces actual drug prices at the wholesale or retail levels through discounts, chargebacks, or rebates, then these price reductions must be included in best price calculations. 140 Other arrangements presumably would not affect best price calculations. Hence, it appears that a manufacturer s payment of a rebate to a PBM can fall outside the manufacturer s best price calculations if the rebate does not adjust actual prices paid by the PBM s customers for the manufacturer s drugs. This creates a potential strategy for states to outsource their drug assistance programs without losing their best price exemption. Appended to HCFA s June 1977 release is a helpful chart addressing calculation of best price and AMP under the Medicaid drug rebate program. 141 This chart, which is reprinted below as Chart 5, lists which Chart 5. Average Manufacturer Price/Best Price Calculations SALES Included in Included in Rebates Additional AMP BP Due Information Direct hospital sales No Yes Note 1 HMOs (drugs dispensed under capitated rate) No Yes No HMOs (drugs dispensed under fee-for service) No Yes Yes Mail order pharmacy Yes Yes Yes Retail pharmacy Yes Yes Yes PHS covered entities No No No State-funded only pharmacy assistance programs No No No VA/DOD excluded sales No No No Federal supply schedule sales No No No Nursing home primary/ contract pharmacy sales Yes Yes Yes Sales to other manufacturers who repackage/relabel under the purchaser s NDC No No No Sales to other manufacturers who do not repackage/ relabel under the purchaser s NDC Yes Yes Yes Wholesalers Note 2 Note 2 Note 2 Sales discussed in this chart may be affected by subsequent sales to an excluded/included entity for AMP/BP purposes. Note 1 Yes, if the drug is used in the outpatient pharmacy and the Hospital bills Medicaid for reimbursement for dispensing the outpatient drug. Otherwise, no. Note 2 Yes except for sales to wholesalers which can be identified with adequate documentation as being subsequently sold to any of the excluded sales categories. Additional note All pricing adjustments affecting the price of any sales must be taken into account if the sales were included in the calculation of AMP/BP. 23 Department of Health and Human Services, Office of the Assistant Secretary for Planning and Evaluation (2000)

34 INTERSECTION OF FEDERAL AND STATE PROGRAMS: RISKS AND OPPORTUNITIES prices are included in both Medicaid best price and AMP, and it also clarifies which sales transactions trigger an obligation for manufacturers to pay rebates. What is notable about Chart 5 is the qualification that pharmacy assistance programs be state-funded only. This raises the question of whether program discounts would lose their exemption if the program is partially funded by a county, city, employer, or even the patient. Similarly, programs that simply attempt to give clients access to lower-priced drugs as a result of manufacturer or pharmacy discounts without any state subsidies, might also fall outside the exemption. In preparing this report, the author requested clarification of the above issues in a communication to HCFA dated January 19, To date, HCFA has not responded. States would be well advised to follow up directly with HCFA if they seek answers to the above questions or otherwise need clarification of the scope of the best price exemptions. C. Duplicate Discounts and Other Problems In addition to the Medicaid best price formula, purchasers of prescription drugs face other potential federal impediments to negotiating deep discounts that could affect state drug assistance programs. These potential obstacles relate to interactions between the state drug assistance program and (1) the 340B program and (2) the Big 4 drug discount program. You may recall that in section II.B, we described how Congress anticipated the risk of unfairly forcing manufacturers to give two discounts on the same drug when it enacted the 340B statute. The risk arises when a covered entity dispenses a 340B-discounted drug to a Medicaid patient and the state Medicaid agency requests a manufacturer rebate after being billed for the drug. Without a mechanism in place to prevent a duplicate discount, the manufacturer would be required under section 340B to give an up front discount to the covered entity and then a second discount to the state in the form of a rebate under the Medicaid rebate law. Congress remedied this problem by directing HHS to develop program guidelines that prevent duplicate discounts from occurring. Just as the risk of a duplicate discount arises because of an overlap between the 340B and Medicaid rebate programs, the same risk occurs if a patient of a state drug assistance program uses the pharmacy of a 340B provider. The manufacturer gives the first discount at the time of purchase and the second after the state has been billed and requests a rebate. The only difference is that the rebate is required under a state non-medicaid law rather than the federal Medicaid rebate law. Accordingly, states should be careful to adopt a mechanism that prevents duplicate discount problems from occurring. Like the federal mechanism, states need to identify drug claims submitted by participating 340B covered entitles and exclude those claims from their Medicaid rebate request files. That way manufacturers only give the up front discount to the covered entity. Another potential 340B problem that state policymakers face involves a provision in the 340B statute prohibiting participating disproportionate share hospitals from obtaining covered outpatient drugs through a group purchasing organization or other group purchasing arrangement. 142 Violation of this prohibition leads to disqualification of the hospital from the 340B program. 143 Accordingly, states need to be careful not to inadvertently raise the price of drugs for 340B hospitals by including them in bulk purchasing programs or other group purchasing activities. It may be tempting to include these hospitals in a state bulk purchasing program because many are state- or county-owned and command significant volume. However, any savings achieved through bulk purchasing could be offset by the loss of 340B discounts to the participating hospitals. Another problematic federal-state interaction relates to how manufacturers calculate the nonfederal average manufacturer price for purposes of complying with the federal ceiling price requirement applicable to brand name drugs sold to the Big 4. As explained in section II.D, the Big 4 are entitled to 24 percent off non- FAMP for brand name drugs. Hence, to the extent that state-discounted prices are included in non-famp, non- FAMP will be reduced, thereby increasing the discounts that manufacturers must give to the Big 4. To understand how the non-famp formula can affect the pricing available to state drug assistance programs, one can begin by examining the formula s impact on discounts available to covered entities under the 340B program. After analyzing whether non-famp should include the discounted prices charged to federally funded clinics and disproportionate share hospitals participating in the 340B program, the VA adopted a policy that HHS, 340B participants, and even the American Bar Association uniformly oppose. 144 Namely, according to the VA s master agreement with pharmaceutical manufacturers, 340B ceiling prices are excluded from non-famp calculations but subceiling prices are included. The rationale for this policy, according to the VA, is that whereas 340B ceiling prices are federally mandated and therefore fall within the non-famp exclusion for federal prices, 340B subceiling prices are considered commercial or profit-making sales that fall outside this exclusion. 145 The VA s interpretation of non-famp creates a disincentive for manufacturers to give subceiling prices to PHS covered entities. Group purchasing efforts by covered entities, especially through the 340B prime vendor program, have encountered signifi- 24

35 INTERSECTION OF FEDERAL AND STATE PROGRAMS: RISKS AND OPPORTUNITIES cant hardships in negotiating subceiling prices as a result of the VA s interpretation of non-famp. Efforts by HRSA to modify the VA s non-famp policy have been unsuccessful to date. 146 States may encounter the same difficulties as PHS covered entities in negotiating discounts with manufacturers because state drug assistance prices, like 340B subceiling prices, are not exempt from non- FAMP calculations. Traditional state subsidy programs are unharmed because they receive their discounts in the form of rebates paid directly by manufacturers. VA only includes rebates in non-famp calculations if they are processed through wholesalers rather than paid directly to states. However, with respect to bulk purchasing proposals or other models involving rebates or chargebacks through wholesalers, the non-famp formula should make discounts more difficult to negotiate with manufacturers. This problem should be more acute for larger state programs because their discounts will bring the non-famp average down lower which, in turn, will increase the discounts that manufacturers pay to the Big 4. It is important to note that the VA s interpretation of non-famp is much less likely than the Medicaid best price formula to deter manufacturers from giving deep discounts to private customers. Non-FAMP is an average calculation, so the inclusion of state drug assistance prices in the calculation will only bring down the average slightly. State pharmaceutical assistance programs comprise a tiny percent of the total U.S. prescription drug market. The potential therefore of such a small volume of drugs to reduce the average manufacturer price for the entire nonfederal market is limited, no matter how deeply discounted the drugs may be. By contrast, the potential effect of deeply discounted prices on the best price calculation is independent of volume. Theoretically, all that is needed to increase the size of every Medicaid rebate for a given brand name drug paid during a given quarter is one of those drugs being sold at a price below the manufacturer s existing best price. D. How to Get Better than Medicaid Best Price Although definitive statements about how the prices of one direct purchaser compare to those of another purchaser are made at one s own peril, most experts would agree that, with respect to the drugs covered by the VA s national contract awards, the VA has been able to negotiate, on average, the best prices in the country. According to the GAO, a sample of VA national contract prices are on average 33 percent lower than FSS prices. 147 Compared to Medicaid net price, AMP, and AWP, the sampled VA national contract prices are lower by 43, 57, and 65 percent, respectively. 148 An analysis of how the VA has been able to achieve such deep discounts on so many drugs should be informative to state policymakers. The VA s success appears to flow from the combination of three important factors. First, national contract prices are exempt from best price. Second, national contract prices for brand name drugs are prohibited by law from exceeding a specified ceiling price. Third, the VA has the authority and tools to negotiate subceiling prices. Each of these three factors is discussed more fully below. 1. Element One: Best Price Exemption The first reason why the VA has been so successful in negotiating deep discounts on its national contracts relates to the exemption that these prices enjoy from Medicaid best price calculations. The Medicaid definition of best price was amended under section 601 of the Veteran s Health Care Act of 1992 to exclude certain government prices including any prices charged on or after October 1, 1992, to the Department of Veterans Affairs 149 The VA s national contract prices are among the prices that were exempted from best price under this legislation. 150 VA national contract prices are also excluded from non- FAMP because these prices are generated by federal sales which are by definition excluded from non-famp. The statutory definition of non-famp specifically excludes any prices paid by the Federal Government. 151 As previously mentioned, all of the entities whose sales have been excluded from the Medicaid best price formula enjoy pricing that is below Medicaid best price levels. 152 So do many state drug assistance programs. 153 Accordingly, most state drug assistance programs already possess under federal law the first element of being able to buy prescription drugs cheaply: an exemption from best price. In experimenting with different drug assistance models, states should be aware of the risks of exceeding the scope of the exemption as interpreted by HCFA. As previously mentioned, the models that appear to be most at risk of falling outside the exemption are those in which the state outsources its program to a PBM or purchases cooperatively with other states and state programs. Buyers clubs probably also fall outside the exemption because they are generally open to any individual and not financed by the state. And while it is true that, depending on how states design their pharmacy assistance programs, a manufacturer s non- FAMP calculations may discourage discounted pricing, such adverse effects are minor compared to those associated with the best price mechanism. 25

36 INTERSECTION OF FEDERAL AND STATE PROGRAMS: RISKS AND OPPORTUNITIES Element Two: Mandatory Discounts The second reason that the VA enjoys an advantage in purchasing pharmaceuticals is that manufacturers are prohibited from selling to the VA brand name drugs above a certain price, namely, the federal ceiling price. The FCP, you may recall, applies to any brand name drug sold to the Big 4, which includes the VA. It is calculated by subtracting 24 percent from the drug s non-famp. The penalty for manufacturers that choose to sell innovator drugs at prices above the FCP is exclusion of that manufacturer s entire product line from coverage by Medicaid. Because Medicaid accounts for approximately 11 percent of domestic retail drug sales, a manufacturer could lose substantial revenues if it does not comply with the FCP ceiling price requirement. A state s ability to establish a mandatory discount on sales to its drug assistance program is a more challenging task than exempting those prices from the Medicaid best price formula. Whereas the best price exemption already exists under federal law, mandatory discounts for state drug assistance programs need to be established at the state level, either by statute, administrative action, or contractual negotiation. Among the dozen or so state programs that pay for all or part of an eligible individual s drugs, all of them receive manufacturer rebates that offset the cost of the drugs. Most of these rebate obligations are mandated by state legislatures for manufacturers that choose to participate and are calculated in a manner similar to the Medicaid rebate formula. 154 Others are negotiated by PBMs that have been hired by states to manage their drug programs and to obtain manufacturer rebates. 155 Other state approaches that are being tested or considered include bulk purchasing, formation of buyer clubs, and conditioning Medicaid coverage of a company s drugs on its payment of rebates, both with and without a federal Medicaid waiver in place. 156 Although states have a range of options in how to arrive at a discount price for participating manufacturers, they have fewer options in formulating penalties that will discourage manufacturers from choosing not to participate. The most common penalty is that the state drug assistance program will not cover a manufacturer s drugs unless the manufacturer agrees to give the program the discount or rebate specified in law or contract. 157 Or, the program may cover the drugs, but subject their coverage to prior authorization requirements. 158 Either way, these penalties may be inadequate if the volume of purchases that are likely to result from participation is small, or if the program is unable to move market share through formulary use and management. This is why states like Maine and Vermont have raised the stakes, and subjected themselves to legal challenges by requiring participation in their drug assistance programs as a condition for Medicaid coverage of a company s drugs. 159 As Medicaid recipients tend to outnumber drug assistance patients by ten times or more, a drug company is much less likely to tolerate loss of its Medicaid business in a given state than the loss of potential sales to drug assistance customers. Bulk purchasing may be another way to give states sufficient volume and leverage to be able to negotiate manufacturer discounts, although developing and abiding by a common formulary may be difficult for the various programs involved. 3. Element Three: Subceiling Negotiation Finally, the VA s national contract program has been successful because it has the ability to negotiate subceiling prices. The FCP imposes a ceiling not a floor on VA prices. Accordingly, the VA is free to negotiate prices below FCP. Manufacturers are not required to give subceiling prices, but are enticed into doing so because of the VA s ability to move market share to preferred vendors. The VA manages a common formulary with good compliance by VA doctors and pharmacists. This allows the VA to commit up front to a significant volume of drugs sold by manufacturers who successfully bid to be included on the VA s national formulary. If the VA did not command sufficient volume or failed to comply with its market share commitments, then its ability to negotiate subceiling prices would be impaired. To date, the VA has established a strong record of meeting its sales volume commitments. The VA has the additional advantage of serving as a primary training ground for young physicians. Manufacturers are often willing to give discounts to teaching hospitals because of the long term value of exposing residents and interns to the company s product line. Of the three elements used by the VA to negotiate its substantial national contract discounts, the third element subceiling negotiation is the most difficult to achieve. It essentially gives the VA another bite at the apple, since the starting point for negotiations, namely the FCP, already represents a deep discount. From a state perspective, subceiling negotiation is only possible if the mandatory discount described above is established by statute or regulation. If the discount is arrived at through contract negotiation, it is hard to imagine any manufacturer entering a contract that provides for a second round of negotiations to give the state an even deeper discount. This rules out the bulk purchasing and PBM outsourcing models because they rely on contract negotiations to establish manufacturer ceiling prices which, in turn, eliminates an opportunity for subceiling negotiation. On the other hand, legislating or regulating the

37 INTERSECTION OF FEDERAL AND STATE PROGRAMS: RISKS AND OPPORTUNITIES price of drugs carries constitutional and legal risks described in section III.A. If states can successfully navigate these legal risks, subceiling negotiation is a theoretical possibility, even for the traditional state drug assistance programs that offer and fund a pharmacy benefit for seniors and other pharmaceutically uninsured populations using manufacturer rebates similar to the Medicaid program. The relevant model, described in section II.A, is the California supplemental rebate program for outpatient drugs covered under Medicaid. In this program, California negotiates supplemental rebates in exchange for not placing the manufacturer s drugs on the Medicaid prior authorization list. No other state has created a supplemental drug rebate program for its Medicaid program, let alone for a non-medicaid program. The success of the California supplemental rebate program may be based in large part on the fact that Medi-Cal has the largest Medicaid enrollment in the country and that, because of this volume, manufacturers are willing to pay supplemental rebates to keep their drugs off the state s prior authorization list. State drug assistance programs are only a fraction of the size of most state Medicaid plans, so the likelihood of a state drug assistance program having the clout to launch its own supplemental rebate initiative is unclear. State drug assistance programs may look for ways to negotiate supplemental rebates by increasing volume, although these supplemental rebate models are untested. For example, a state drug assistance program could adopt the formulary and prior authorization list used by its state Medicaid program so that, when the state approaches manufacturers about giving supplemental rebates, it would be doing so on behalf of both the Medicaid and the state drug assistance programs. To increase volume further, this bulk purchasing model could theoretically be extended to include other state Medicaid and drug assistance programs, although the ability of multiple states to harmonize their formularies and prior authorization lists is more challenging. If a state wanted to include other programs and drug purchasers (e.g., state employees, prisoners, etc.), it would have to be careful not to sacrifice its best price exemption. Alternatively, the volumes of a state s Medicaid and drug assistance programs could be combined through a federal 1115 waiver, similar to the 1115 programs approved by HCFA for Vermont and Maine, although the legality of this approach, as previously mentioned, is currently being litigated. Under this approach, a state s drug assistance patients are converted into Medicaid recipients for purposes of prescription drug coverage. If the legality of this model is upheld by the courts, a state could attempt to negotiate supplemen- 27 tal rebates for both its traditional Medicaid population and its newly eligible drug-only Medicaid recipients. California could file a similar waiver application and build upon its existing supplemental rebate program to acquire additional rebates for the newly eligible Medi- Cal recipients. Other states, especially large ones, could to try supplemental rebate programs as well. Another model that offers a promising opportunity for subceiling negotiation is still untested. It involves channeling drug assistance enrollees to FQHCs and other safety net providers participating in the 340B drug discount program. In so doing, states would be assured of paying no more than the 340B-discounted price for covered outpatient drugs. In many instances they would pay less because PHS covered entities are expressly authorized under the 340B act to negotiate subceiling prices, and many of the entities do. More than one out of three disproportionate share hospitals, for example, have been successful in negotiating subceiling prices over the past four years. 160 Average subceiling savings during this period were slightly less than $400,000 per hospital. 161 A few states have considered bills that seek to capitalize on the deep discounts available to 340B covered entities. These include Vermont, New Mexico, Connecticut, and Rhode Island. 162 The major drawback to this approach is that many providers may be ineligible to participate in the 340B program. For those that are eligible, the participating covered entity may not dispense the discounted drugs to anyone other than its own patients. Patients served by non-eligible entities would not have access to 340B drugs. Despite these limitations, this may be an option for other states, too. E. Price Versus Access Issues In section I of this paper, we described the various distribution channels through which patients purchase and receive drugs in the United States. We made the point that when the distribution system involves the use of retail pharmacies, the prices paid by the patient or the patient s payor tends to be higher than when the drug is distributed directly to a purchaser that owns and operates its own pharmacies, such as a hospital or HMO. This suggests that states should choose an institutional/direct purchase model over a retail/rebate model in designing their state pharmaceutical assistance programs. Accordingly, steering patients to 340B covered entities for pharmacy services appears to be a common sense approach. A recent Office of Inspector General (OIG) report focusing on the cost of AIDS drugs for AIDS Drug Assistance Programs (ADAPs) serves as a good illustration of how rebate-based drug assistance programs are less successful in reducing the cost of pharmaceuticals

38 INTERSECTION OF FEDERAL AND STATE PROGRAMS: RISKS AND OPPORTUNITIES than programs that purchase and dispense drugs without the use of retail pharmacies. 163 Each state has an ADAP that is funded by grants under Title II of the Ryan White CARE Act. 164 The ADAPs provide medications to low-income individuals living with HIV or AIDS who have limited or no coverage from private insurance or Medicaid. 165 Overall, federal contributions have risen dramatically from the original appropriation of $52 million in FY1996 to $528 million in the FY2000 budget. Although ADAPs are eligible to participate in the 340B drug discount program, their level of savings from the program varies depending on how the ADAP s purchasing program is structured. According to the OIG report, 23 ADAPs receive their 340B discounts at the time of purchase because they purchase drugs directly from manufacturers through a state health department pharmacy, purchasing agent, or public hospital or other institution. 166 Twenty-four state ADAPs receive their discounts in the form of rebates because they rely on retail pharmacy networks and/or PBMs to serve their clientele. 167 Although the OIG concluded that both direct purchase ADAPs and rebate ADAPs could save more if they had access to FCP discounts, rebate ADAPs would save more because they spend $25 million more for HIV drugs than direct purchase ADAPs. 168 The OIG offered several reasons why rebate ADAPs pay more for drugs than direct purchase ADAPs. According to the OIG, the higher amount that rebate ADAPs pay for drugs is related to the reimbursement model they utilize. 169 Rebate ADAPs typically reimburse pharmacies at AWP, minus a pharmacy discount. The OIG s data showed a range of pharmacy discounts of 10 to 16 percent. The average discount obtained was 12.2 percent. 170 In addition to these pharmacy discounts, rebate ADAPs receive the 340B rebate amount from manufacturers on a quarterly basis. Direct purchase ADAPs also receive the 340B discount on the cost of drugs, but it is subtracted from the lower AMP prior to the drug purchase. 171 Based on these findings, OIG recommended, among other things, that HRSA and OPA develop ways for rebate ADAPs to purchase their drugs directly in order to capitalize on the deeper discounts available under the direct purchase model. 172 Although not discussed in the OIG report, another reason why direct purchase ADAPs may be more economical is because they are better able to move market share through formulary management than rebate ADAPs. The drawback to the direct purchase model, of course, is that exclusion of retail pharmacies from a state drug assistance program may have a negative impact on patient access. When drug assistance program clients go to pick up their discounted drugs, they may be forced to travel long distances to find a participating institutional pharmacy. If the customer resides in a rural area or lacks adequate transportation, the travel distance may be further. Concerns about patient access to pharmacy services are compounded if the institutional providers used in the program are PHS covered entities. In section II.B, we mentioned that the 340B statute prohibits covered entities from dispensing or otherwise transferring discounted drugs to anyone other than their own patients. This means not only that drug assistance enrollees may have to travel further to receive their discounted drugs, they may be turned away unless they are bona fide patients of the 340B covered entity by having received health care services at the institution. Hence, if a state is attracted to the 340B model, it will have to devise a mechanism to encourage enrollees to shift their care to the 340B provider, in whole or in part. It could do this, for example, through patient education, charging higher co-pays for drugs dispensed by non-340b pharmacies, or building a seniors or disease management program around the 340B providers. Plus the PHS provider can take certain steps to improve access, such as developing a mail order program for patients or contracting with retail pharmacies pursuant to the 340B contract pharmacy guidelines. Another option is for the state to combine the 340B model with a traditional state subside/rebate program utilizing retail pharmacies. 28

39 Endnotes for Chapter III 99 U.S. Const. art. I, 8, cl. 3. (West 1987). 100 Healy v. The Beer Institute, 491 U.S. 324, 336 (1989). 101 See Baldwin v. G.A.F. Seelig, Inc., 279 U.S. 511, 528 (1935); Schwegmann Bros. Giant Super Markets v. Louisiana Milk Comm n, 365 F. Sup. 1144, 1156 (M.D. La. 1973), aff d 416 U.S. 922 (1974). 102 Dean Foods Co. v. Brancel, 187 F.3d 609, (7th Cir. 1999). 103 Healy, 491 U.S. at PhRMA v. Maine, supra note 4, at Id. 106 Id. 107 U.S. Const. art. VI. (West 1987). 108 See PhRMA v. Maine, supra note 4, at 11, infra, citing Pacific Gas v. State Energy Resources Conserv. & Dev. Comm n, 461 U.S. 190, (1983); Massachusetts Ass n of HMOs v. Ruthhardt, 194 F.3d 176, 178 (1st Cir. 1999); O Brian v. Massachusetts Bay Trans. Auth., 162 F.3d 40, 43 (1st Cir. 1998); and French v. Pan Am Express, Inc., 869 F.2d 1, 5 (1st Cir. 1989). 109 PhRMA v. Maine, supra note NCSL Senior Drug Programs, supra note 3, at Id. 112 Id. 113 PhRMA v. Maine, supra note 4, at 3-4, Id. at 4, PhRMA v. Maine, supra note 4, at Id. at Id. at Id. at Id. at 3-4; Id. 121 Pharm Research & Mfr s of America v. Shalala, D.D.C., Civ. Action No (Jan. 17, 2001) [hereinafter PhRMA v. Shalala ]. 122 NCSL Senior Drug Programs, supra note 3, at U.S.C.A (West 1999). 124 PhRMA v. Shalala, supra note Chevron U.S.A. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). 126 NCSL Senior Drug Programs, supra note 3, at U.S.C.A. 1396r-8(c)(1)(c) (West Supp. 1999) U.S.C.A. 1396r-8(c)(1)(C) (West Supp. 2000). 140 HCFA Medicaid Drug Rebate Program Release No. 29 at 2-3 (June 2, 1977). 141 Id. at Appendix U.S.C.A. 256b(4)(L)(iii) (West 1999). 143 Id. (prohibition is one of three criteria defining 340B-eligible disproportionate share hospitals). 144 Letter from HRSA to VA (November 1, 1994); OIG, AIDS Drug Assistance Cost Containment Strategies (Sept. 2000) (on file with author); Letter from Gregory Allen Smith to Gary J. Krump, Deputy Assistant Secretary, VA of the American Bar Association Section of Public Contract Law (October 30, 2000) (on file with author). 145 Letter from Albert Patterson, VA to Dr. Ciro Sumaya, HRSA (March 1, 1995) (on file with author). 146 Id. 147 GAO Federal Pricing Report, supra note 28, at See Table Veterans Health Care Act of 1992, Pub. L. No , 106 Stat (codified at 42 U.S.C.A. 256b (West (1999)). 150 Although less important, VA national contract prices are also exempt from AMP and non-famp. With respect to AMP, the Medicaid statute defines this term as the average price paid to a manufacturer by wholesalers for drugs distributed to the retail pharmacy class of trade after deducting customary prompt pay discounts. See 42 U.S.C.A. 1396r-8(k)(I). VA national contract prices do not fall within the retail pharmacy class of trade. Moreover, in HCFA s 1997 AMP chart, VA sales are specifically excluded. See Chart U.S.C.A. 8126(h)(5)(A). 152 See Table 3 and Chart GAO State Pharmacy Report, supra note 27, at (describing state rebates as comparable to Medicaid rebates). 154 GAO State Pharmacy Report, supra note 27, at Id. at 17 (citing Illinois and Michigan). 156 NCSL 2001 Legislative Report, supra note 1, at 2-3; NCSL Senior Drug Programs, supra note GAO State Pharmacy Report, supra note 27, at Id. 159 NCSL Senior Drug Programs, supra note 3, at 4, Public Hospital Pharmacy Coalition, Annual Survey of Drugs Purchased Below the Public Health Services 340B Ceiling Prices (Nov. 2000). 161 Id. 128 See Table 3. This is because the Medicaid net price is at least as good as best price. 129 See Table Id. 131 CBO, How the Medicaid Rebate on Prescription Drugs Affects Pricing in the Pharmaceutical Industry (Jan. 1996) [hereinafter CBO Report ]. 132 Id. at Id. at CBO Report, supra note 131, at ix. 135 Id. at Id. at Id. 138 Veteran s Health Care Act of 1992, Pub. L. No , 106 Stat (codified at 42 U.S.C.A. 256b (West 1999)) NCSL 2001 Legislative Report, supra note 1, at 2; NCSL 2000 Legislative Report, supra note 1, at OIG, AIDS Drug Assistance Program Cost Containment Strategies (Sept. 2000) U.S.C.A. 300ff-11 (West Supp. 2000). 165 Id. 166 OIG, AIDS Drug Assistance Program Cost Containment Strategies 9 (Sept. 2000). 167 Id. 168 Id. at Id. at Id. 171 Id. 172 Id. at

40 IV. ANALYSIS OF STATE DRUG ASSISTANCE PROGRAM OPTIONS Having reviewed the risks and opportunities under federal law relevant to state drug assistance programs, we can now turn to the specific task of evaluating different state models based on our findings. The focus of these evaluations is on the state s ability to obtain deep discounts on covered drugs. As previously mentioned, the size of a state s discounts is not the only measure of success, but it is certainly an important factor. We do not attempt in this paper to analyze other indicators of success. After reviewing the broad spectrum of state legislation intended to reduce the cost of drugs for pharmaceutically uninsured individuals, we categorized the various laws and bills into eight models. These eight models are: (A) traditional state subsidies of a pharmacy benefit underwritten in part by manufacturer rebates; (B) a subsidy/rebate program similar to the first model except administration of the program is outsourced to a PBM or other private company; (C) a subsidy/rebate program like the model one except the discount is tied to Medicaid, FSS, or most favored customer discounts; (D) a similar model except the target population has been qualified as Medicaid recipients under a HCFA 1115 waiver; (E) an alternative model that focuses on pharmacy discounts rather than manufacturer discounts; (F) a buyers club available on a voluntary basis to individuals without state funding; (G) bulk purchasing of a state drug assistance program with other governmental purchasers both within and between states; and (H) channeling clients to 340B covered entities. 173 Clearly, certain forms of legislative relief do not fall within these eight categories, such as those focused on tax relief, disclosure of manufacturer advertising costs, and coordination of manufacturer free drug programs. 174 We selected the eight models based on a combination of factors, especially their prevalence among states and our assessment of their potential to yield significant savings for states. The most prevalent models are models (A) and (E). A summary of our analysis of each option based on the federal issues discussed in the previous section is set forth in Chart 6. 30

41 Chart 6. Analysis of State Drug Assistance Options Under Federal Law Model Best Price Manufacturer Sub ceiling Duplicate Discount Non-FAMP Access Exemption? Discounted Price? Negotiation? Problem? Problem? Issues? (A) State subsidy/ Yes Yes, manufacturer No, unless state Yes, if clients also No, unless rebates No, assuming rebate model sales price minus has sufficient receive discounted are processed adequate state rebate leverage to drugs from through wholesalers participation of negotiate 340B providers rather than paid retail pharmacies and supplemental directly to state clinically appropriate rebates like formularies California (B) PBM outsourcing Unclear if manufacturer Yes, manufacturer No Same as above Same as above Same as above rebates are based on sales price minus PBM s business beyond PBM rebate just state program (C) Manufacturer ceiling Yes, if the program Yes, assuming that No, unless state has Same as above Same as above Same as above price tied to FSS, etc. is state-funded the ceiling price is sufficient leverage enforceable without to negotiate violating U.S. supplemental Constitution rebates like (e.g., Maine case) California (D) 1115 waiver Yes, although the legality Yes, Medicaid Same as above Same as above No Same as above expanded benefit of this model is being rebate discount litigated (Vermont case) (E) Pharmacy discounts No No No No No Same as above (F) Buyer s club No Yes, plan s negotiated No Yes, if clients also No Same as above prices with receive discounted manufacturers drugs from 340B providers (G) Bulk purchasing Unclear if purchasing Yes, cooperative s No Same as above Yes, unless negotiated Same as above cooperative includes negotiated prices with discounts take the entities other than manufacturers form of rebates paid state-funded drug directly to state assistance programs (H) Steering clients to Yes Yes, 340B ceiling price Yes Yes, if state also Yes Yes, unless mail order, 340B covered entities receives rebates for contract pharmacy 340B-discounted drugs arrangements included and clinically appropriate formularies are used 31

42 ANALYSIS OF STATE DRUG ASSISTANCE PROGRAM OPTIONS A more detailed discussion of these models is set forth below. A. State Subsidy/Rebate Model Most existing state drug assistance programs in the U.S. fall within this category. 175 They are similar to the federal Medicaid rebate program insofar as they use public funds to subsidize drug coverage and receive discounts from both participating retail pharmacies and manufacturers. Manufacturer discounts are obtained through the payment of rebates to the state. Although no data are available quantifying the rebates that states are able to collect, it is estimated that these rebates are comparable in size to those obtained by the Medicaid program. 176 States that have already established these subsidy/rebate programs include Connecticut, Delaware, Illinois, Maine, Maryland, Massachusetts, Michigan, Minnesota, New Jersey, New York, North Carolina, Pennsylvania, Rhode Island, Wyoming, and Vermont. 177 Many of these programs predate the Medicaid drug rebate program. The obvious advantage of the state subsidy/rebate model is that it is widely used. States considering their options in reducing drug costs to elderly and other pharmaceutically uninsured residents can consult the collective experience of the dozen or so states that have already implemented this approach. By allowing program enrollees to fill their prescriptions at retail pharmacies, this model poses no access problems, assuming there is adequate participation of retail chains and independent drug stores in the program s network and the program uses a resonable formulary. Manufacturer rebates are typically paid directly to states so the non-famp formula should not discourage manufacturers from paying larger rebates. States need to be careful, however, to avoid subjecting manufacturers to an obligation of paying two discounts on the same drug if, for example, program clients receive discounted drugs from hospitals and clinics participating in the 340B program. The ability of a state subsidy/rebate program to command deeply discounted pricing is a more complicated issue. Assuming that these programs can obtain rebates comparable in size to Medicaid rebates, the net price paid by the programs will generally be as good as the price paid by private PBMs or HMOs. 178 How much the state pays its participating pharmacies with respect to dispensing fees and drug markups will also affect the net price paid. The price the state pays the manufacturer (after rebates) will be about 20 percent higher than the prices available to the Big 4 and 340B covered entities. 179 If a state wants to achieve discounts of this magnitude, it will have to consider creating a supplemental rebate program similar to the Medi-Cal supplemental rebate program in California. This, in turn, would require the state to pool the purchasing volume of its drug assistance program with other state programs and purchasers in order to gain sufficient volume and leverage to move market share. Although no state has tried this approach, a state could expect to encounter operational challenges in developing and using a common formulary and in limiting its bulk purchasing program to only those entities that enjoy an exemption from Medicaid best price. B. PBM Outsourcing States interested in establishing a subsidy/rebate program have the option of outsourcing the administration of the program to a private company, generally a PBM. Nevada just recently launched its SenioRx program which is outsourced to a PBM owned by Fidelity Security Life Insurance. 180 Massachusetts just released a request for proposal seeking bids by private PBMs to manage its Prescription Advantage Plan. 181 Based on their existing pharmacy networks and experience in managing pharmacy benefits, private PBMs may be an attractive option, especially for states concerned about whether they have the internal infrastructure to successfully administer their own program. Compared to the state subsidy/rebate model, the PBM outsourcing approach offers no clear advantages or disadvantages with respect to the duplicate discount and non-famp issues and ensuring adequate access to program clients. It may, however, have more difficulty in achieving better discounts. Such difficulties flow from two conditions. First, a PBM-based model may generate discounts that are not exempt from best price because HCFA may not view such discounts as relating to a state pharmaceutical assistance program. This risk is greater if the discounts are negotiated by the PBM based on business that goes beyond just the state program. Second, in the event that the manufacturer s discounted prices (including rebates) are established through negotiation with the PBM, it is unlikely that manufacturers will agree to a second round of negotiations in order to give subceiling discounts. If, on the other hand, the PBM s prices can be kept within the best price exemption, and if the manufacturer s discounts and rebates are established by statute or regulation, the PBM may have an opportunity to negotiate supplemental rebates if it has the tools to move market share. Indeed, PBMs generally have more experience in negotiating prices based on formularies, so they may be better equipped than states to undertake a supplemental rebate program. 32

43 ANALYSIS OF STATE DRUG ASSISTANCE PROGRAM OPTIONS C. Manufacturer Ceiling Prices States have explored a variety of approaches for capping the prices that manufacturers may charge for drugs dispensed to low income and elderly clients. The most common approach is capping the price at the Medicaid rebate amount as previously described in connection with the state subsidy/rebate model. States have also considered tying manufacturer prices to FSS pricing or to the prices of the manufacturer s most favored customer. Examples of the former include Arizona and Massachusetts, and of the latter, New York and South Dakota. 182 Arkansas, New Jersey, and other states have also considered legislation prohibiting manufacturers from charging above manufacturer prices available in Canada, Mexico, and other foreign countries. 183 To date, Maine is the only state that has established a program that caps manufacturer prices at a level lower than the Medicaid rebate discount. 184 The Maine Rx Program seeks to FSS pricing or better. 185 Implementation of this provision is currently tied up in litigation, however. 186 Moreover, other attempts to tie program prices to out-of-state discounts are vulnerable to legal challenges under the Commerce Clause. The Maine approach to pharmaceutical pricing is being carefully watched by other states because it offers the possibility of generating discounts better than the Medicaid rebate discounts available through traditional state subsidy/rebate programs. It also scores as well on the duplicate discounts, non-famp and access issues previously discussed. The feasibility of this model is in doubt, however, depending on the ultimate outcome of the Maine litigation. Manufacturers are unlikely to participate in price-controlled drug assistance programs if anticipated sales through the program are small. This is especially true if states seek discounts comparable to FSS or foreign prices. The State of Maine tried to remedy this problem by conditioning Medicaid coverage of a manufacturer s drugs on the company s participation in the Maine Rx Program. If the district court decision striking down this provision is upheld, then states may find it difficult to enforce manufacturer participation in such programs because they offer insufficient market share to make participation attractive. These programs also are no better equipped to negotiate subceiling discounts than traditional subsidy/rebate programs. D Waiver Expanded Drug Benefit As mentioned in section III.A.4, the states of Vermont and Maine have been granted 1115 waivers by HCFA allowing them to extend their Medicaid prescription drug benefit to state residents who would otherwise be ineligible for Medicaid benefits. 187 Although Medicaid 1115 waivers are commonly used by states to 33 expand eligibility to individuals who do not meet federal eligibility requirements, the Vermont and Maine waivers are unique in that they make only the Medicaid drug benefit available to this new category of beneficiaries. Other Medicaid-covered services and items such as hospital care, physician services, home health and long term care are not expanded under the waiver. The waiver is also unique in that the program expansion is not funded by either federal or state revenue. Rather, they are funded by patient co-payments and the manufacturer rebates required under OBRA 90. At first glance, the 1115 waiver model does not appear to offer any significant advantages over the state subsidy/rebate model. Like the Maine Rx Program, the 1115 waiver approach is in litigation and, for this reason, its legality is unclear. Most subsidy/ rebate programs are already getting rebates comparable to those required under OBRA 90. Smaller states having trouble getting the full Medicaid rebate may find the 1115 model more effective. The resources necessary to prepare and implement an 1115 waiver program are probably less demanding too. This model may also have an edge in providing patients access to discounted drugs because most retail pharmacies already participate in Medicaid. State planners would not have to worry about the possibility of not being able to recruit adequate numbers of pharmacies to participate in their drug assistance program. On the duplicate discount and non-famp problems, the 1115 model and the subsidy/rebate model score the same. Probably the strongest advantage associated with the 1115 waiver model is a theoretical advantage that has not yet been tested. By converting a state s drug assistance clients into Medicaid recipients, an 1115-based program allows the state to combine the volumes of both programs more quickly and efficiently than through a bulk purchasing arrangement. Armed with a common formulary and prior authorization list, the state is in a better position to negotiate supplemental rebates with manufacturers. If the combined volume is still insufficient to move market share, the only real advantage may be the increased administrative effectiveness of combining the state s Medicaid and non-medicaid drug programs. E. Mandatory Pharmacy Discounts Pharmacy discount programs are the second most popular model of state drug assistance programs currently in operation. At least four states currently operate such programs: California, Florida, Vermont, and West Virginia. 188 These programs prohibit pharmacies from charging program enrollees, generally seniors without prescription drug coverage, more than the established Medicaid price or other discounted rate for covered drugs.

44 ANALYSIS OF STATE DRUG ASSISTANCE PROGRAM OPTIONS A drug assistance program that simply requires participating pharmacies to discount their prescription drug prices to program patients does not seem like an effective model for obtaining deeply discounted drugs. The entire burden of making drugs more affordable is shouldered by the pharmacies, where profit margins are already squeezed. Indeed, by not even attempting to lower manufacturer prices, this model wastes an opportunity to procure brand name and generic drugs at prices below Medicaid best price. A traditional subsidy/rebate program, whether outsourced or not, should give better results because it at least attempts to negotiate discounts from manufacturers, not just from pharmacies. The only advantages to the pharmacy discount model appear to be the relative ease in administering the program, the avoidance of the duplicate discount problem (since it does not involve obtaining discounts from manufacturers), and the unlikelihood of it being challenged on Constitutional grounds. Another potential problem with the pharmacy discount model is its disparate impact on participating pharmacies. Medicaid reimbursement for outpatient prescriptions is more generous in some states than others. Hence, if the retail discount is tied to the state s Medicaid payment rate, the loss of revenue suffered by pharmacies will range from tolerable to catastrophic. Moreover, some state Medicaid agencies reimburse hospital and nonretail pharmacies at lower rates than retail pharmacies. There is little reason why nonretail pharmacies should give deeper discounts to drug assistance patients than retail pharmacies. This problem is especially acute for pharmacies based in disproportionate share hospitals and other safety net providers participating in the 340B program. 340B covered entities are usually required to bill Medicaid at acquisition cost for discounted drugs in order to protect manufacturers from paying duplicate discounts. Rather than supporting these pharmacies, the pharmacy discount model would end up penalizing them by dramatically reducing their payment rates. F. Buyers Club Although the buyers club model has not been implemented in any state yet, at least three states Iowa, Oklahoma, and Washington are planning on launching such programs in the future. 189 Legislation is generally not required to authorize such programs since they are not funded by state revenue. Rather, they are private cooperatives that individuals can sign up for to purchase drugs at a discount. Given that this model would probably not be considered by HCFA to be a state-funded pharmaceutical assistance program, its prices would probably not qualify for the Medicaid best price exemption. Moreover, apart from the volume that a buyers club may offer manufacturers, this model is not well equipped to establish significant manufacturer discounts either by establishing a ceiling price or by subceiling negotiation. G. Bulk Purchasing The largest existing state pharmacy assistance program the Pennsylvania PACE program has an enrollment of just over 200,000 beneficiaries. 190 Most state programs have enrollments below 100,000. These state programs generate just a fraction of the sales governed by the federal drug discount program discussed in section II. As a result, they do not have the volume necessary to negotiate deep discounts by moving market share. Bulk purchasing is the obvious solution to this problem and several states, especially smaller ones, have already considered legislation authorizing bulk purchasing arrangements. Numerous states are poised to launch bulk purchasing programs including Massachusetts, 191 Maine, 192 and other New England states. 193 Under this model, the state increases its bargaining power with manufacturers by combining the anticipated sales volume of its drug assistance program with other state drug purchasing programs, such as those for Medicaid recipients, state employees, patients of state hospitals and health departments, state university students, and prisoners. Bulk purchasing programs can also include private entities. 194 To increase volume even further, states are forming multistate buying consortiums that combine purchasing volumes across state lines. Examples include the Northern New England Tri-State Coalition (Maine, New Hampshire, and Vermont), 195 the Northeast Legislative Association on Prescription Drug Pricing (Connecticut, Maine, Massachusetts, New Hampshire, New York, Pennsylvania, Rhode Island, and Vermont), 196 and a new group of states recently convened by the West Virginia Public Employees Insurance Agency (Alabama, Georgia, the Carolinas, Washington, and West Virginia). 197 Because the bulk purchasing model is still untested, it is unclear whether this approach will be successful in giving states access to deep federal discounts on pharmaceuticals. There are several reasons to be skeptical. First, if the buying cooperative includes entities other than state-funded drug assistance programs, then the prices negotiated by the group may not be exempt from Medicaid best price calculations. Further guidance from HCFA is required. Second, a buying cooperative needs more than volume to negotiate 34

45 ANALYSIS OF STATE DRUG ASSISTANCE PROGRAM OPTIONS discounts. It also needs to establish a common formulary and to manage prescriber decisions to conform to the formulary. This is a labor-intensive task that may be difficult to achieve, especially across state lines. Third, even if the cooperative is successful in negotiating substantial manufacturer discounts, such discounts will be established through contractual negotiations that preclude the group from engaging in subceiling negotiations. Fourth, because the discounts negotiated by the cooperative would likely be processed as chargebacks by wholesalers (rather than paid directly to the group in the form of rebates), the negotiated prices would likely be included in non-famp calculations. Finally, because 340B hospitals are prohibited from engaging in group purchasing, inclusion of these hospitals in a state bulk purchasing program could inadvertently disqualify them from 340B-discounted pricing. Notwithstanding the above concerns, bulk purchasing may be a useful tool for state drug assistance programs in another way. Namely, bulk purchasing may be a strategy used in models (A), (C) and (D) to achieve deeper discounts through subceiling negotiation. The purpose of such negotiation would be to collect supplemental rebates beyond the initial manufacturer rebates required under state law (or federal law in the case of model (C)). To be successful though, states would still have to address the operational and clinical challenges of managing a common formulary, as well as overcome potential best price and non-famp problems. H. Channeling State Drug Assistance Programs through 340B Covered Entities The last model being explored by states for improving pharmaceutical access to elderly and low income patients involves piggybacking on the federal 340B program. Essentially, the state would build its program around the FQHCs, disproportionate share hospitals, health departments, and other safety net providers participating in the PHS drug discount program. This way, the state is assured of having access to the 340B discounts on covered drugs dispensed to program-eligible clients. Because these providers already serve a large Medicaid patient base, their outpatient pharmacies are accustomed to being paid at discounted rates. Most would be satisfied with being paid at the going Medicaid rate. Hence, the 340B piggy-back model gives states access to 340B discounts on manufacturer prices and Medicaid-like discounts on pharmacy reimbursement rates. This model has been proposed in Connecticut, New Mexico, Rhode Island, and Vermont but has not been implemented in any state to date B prices are better than the Medicaid rebate net price because, as institutional purchasers that generally own and operate their own pharmacies, 340B providers do not have to pay retail markups and dispensing fees. 199 Accordingly, this model will generate better pricing than the pricing available through the subsidy/rebate model, with the possible exception of a supplemental rebate arrangement similar to the one in California. Moreover, unlike many of the other models considered and, in some cases, enacted by state legislatures, the 340B-based program offers an opportunity for negotiating subceiling prices. The 340B statute explicitly authorizes covered entities to negotiate prices below the PHS ceiling prices. Many covered entities have had success in negotiating subceiling prices. Disproportionate share hospitals especially have had success because of their large volume of sales, strict use of formularies, and broad use of residents and interns. Indeed, the market appeal of these providers to manufacturers is similar to that of the VA hospital system. 340B subceiling discounts should grow deeper and be available to FQHCs and other covered entities as the 340B prime vendor program matures, although non- FAMP calculations will continue to deter manufacturers from giving subceiling discounts. States would need to examine the formularies employed by 340B providers to ensure that patient access to medications is not being unreasonably restricted. The primary drawback to the 340B model relates to its limited ability to make discounted drugs available to all individuals participating in the state assistance program. In particular, the 340B statute expressly prohibits covered entities from dispensing or otherwise transferring the discounted drugs to anyone other than their own patients. This means that drug assistance clients would need to use 340B providers for more than just filling their prescriptions. They would also need to receive all or part of their health care from these providers. While indigent patients may well already have a relationship with a 340B hospital or clinic, senior clients probably do not, and this population may be reluctant to change providers. One way to solve this problem is for a state to limit drug assistance eligibility to individuals who already receive medical care from PHS providers or who are willing to switch. This approach may be more palatable if a client is not required to use the 340B entity for all health care services. Rather, the client may use the providers for select services, such as disease management or other programs built around the drug benefit. Such programs may be designed to appeal to senior clients as well. A less restrictive (but more costly) approach would involve the state combin- 35

46 ANALYSIS OF STATE DRUG ASSISTANCE PROGRAM OPTIONS ing a 340B model with a traditional subsidy/rebate program (or similar scheme) to give program enrollees the choice of keeping their current provider or switching to a 340B provider. Because drugs dispensed by the latter provider group are less expensive, the state may want to give enrollees an incentive to use 340B entities as if they were preferred providers. Such incentives may include lower co-payments and deductibles on pharmaceuticals or other incentive arrangements commonly found in preferred provider organizations. 340B covered entities may also be able to expand access through the use of mail order pharmacies or community pharmacies pursuant to the 340B contract pharmacy guidelines, although 340B antidiversion requirements would still have to be observed. If a state pursues a hybrid 340B state subsidy/rebate model, it will have to be careful to avoid duplicate discounts. When clients of the rebate program use 340B providers to fill their prescriptions, manufacturers will end up paying two discounts on the same drug an up front discount under 340B and a rebate to the state. The problem can be avoided by adopting the same measures currently in place to prevent duplicate discounts arising out of overlap between the 340B and Medicaid rebate programs. 36

47 Endnotes for Chapter IV 173 Virtually all of these categories overlap with the models identified by the National Conference of State Legislatures. See NCSL 2001 Legislative Report, supra note 1, at Id. 175 For a summary of the 26 state drug assistance programs, see NCSL Senior Drug Programs, supra note 3, and GAO State Pharmacy Report, supra note GAO State Pharmacy Report, supra note NCSL Senior Drug Programs, supra note See Chart See Table NCSL Senior Drug Programs, supra note 3, at Id. at NCSL 2001 Legislative Report, supra note 1, at 4, 9, 13 and Id. at 4 and NCSL Senior Drug Programs, supra note 3, at Id. 186 PhRMA v. Maine, supra note NCSL Senior Drug Programs, supra note 3, at 4 and NCSL Senior Drug Programs, supra note 3, at 2-3 and NCSL Senior Drug Programs, supra note 3, at 2-3 and Id. at NCSL 2000 Legislative Report, supra note 1, at Id. at Id. at 19 (listing two New England groups). 194 Id. at 8 (citing Maine Rx Program). 195 Id. at Id. 197 Justin Bachman, States Explore Drug-Buying Pool as Leverage on Controlling Costs, Associated Press (Mar. 23, 2001). 198 NCSL 2001 Legislative Report, supra note 1 at 2, 12 and 17 (citing New Mexico and Vermont bills); NCSL 2000 Legislative Report supra note 1, at 2, 5 and 15 (citing Connecticut and Rhode Island bills). 199 See Table 3 and Chart 4. 37

48 V. CONCLUSION The purpose of this paper is to assess the strengths and weaknesses of the various discounting options available to state drug assistance programs in light of the complex array of federal laws and programs affecting state efforts to expand access to pharmaceuticals. Toward this end, we provided background information on the U.S. pharmaceutical market, outlining the significant differences in pharmaceutical pricing, purchasing, and distribution between the private and public sectors. We then summarized each of the four federal drug discount laws and analyzed the various ways in which federal and state programs intersect. Substantial attention was directed toward federal obstacles and opportunities relevant to state discounting efforts. Finally, the risks and opportunities identified under federal law were used to assess the various approaches that have emerged at the state level. We analyzed eight different models that have been either adopted or considered by states in reducing the cost of pharmaceuticals for pharmaceutically uninsured populations. We found that there are advantages and disadvantages to each of these models. For example, state collaboration with FQHCs, disproportionate share hospitals, and other 340B providers holds the most promise in giving states access to the best discounts possible. As indicated in chart 4, 340B ceiling prices represent some of the best discounts in the public sector, let alone the private sector. Moreover, PHS covered entities (especially the hospitals) have demonstrated a growing ability to negotiate subceiling prices which would give states access to even deeper discounts. However, because 340B eligibility is limited to certain safety net providers which in turn are prohibited from dispensing 340B-discounted drugs to anyone other than their own patients, this model raises access issues. With respect to traditional state subsidy/rebate programs, manufacturer ceiling price models, and the Vermont/Maine 1115 waiver model, states have already proven an ability to obtain rebates comparable in size to the Medicaid rebates required under OBRA 90. These rebate amounts, however, are not as advantageous as 340B ceiling prices. More importantly, an opportunity for subceiling negotiations will generally not be available unless the state commands sufficient volume and control over a formulary to negotiate supplemental rebates similar to the California Medi-Cal program. Bulk purchasing may be a way for states to increase volume, but they face significant operational and clinical challenges in establishing and using a common formulary in order to move market share. State efforts to compel drug manufacturers to give lower prices are also vulnerable to legal challenges, especially if those prices are tied to out-of-state discounts or the state s approach is inconsistent with federal law. In sum, states need to study their options carefully in order to understand their interaction with existing federal law and programs. Hopefully this paper has achieved its goal of not only describing the relevant federal laws and programs but also explaining the opportunities and risks associated with each option against the back drop of federal authority. By: William H. von Oehsen, III Powell, Goldstein, Frazer & Murphy, LLP 1001 Pennsylvania Avenue, N.W. Suite 600 Washington, DC

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