Testimony of 
Janet Rehnquist, Inspector General 
Department of Health and Human Services 
Good morning, Mr. Chairman.  I am Janet Rehnquist, Inspector General for the Department of 
Health and Human Services. I appreciate the opportunity to appear before you today regarding the 
important issue of Medicare reimbursement for prescription drugs. 
We have consistently found that Medicare pays too much for prescription drugsmore than most 
other payers. For example, we found that Medicares authorized payments for 24 leading drugs in 
the year 2000 were $887 million more than actual wholesale prices available to physicians and 
suppliers and $1.9 billion more than prices available through the Federal Supply Schedule. We 
believe that this has occurred because Medicares reimbursement methodology is flawed. Until the 
system is changed, Medicare and its beneficiaries will continue to pay excessive amounts for 
prescription drugs, and the amount of excessive payments will increase every year. 
Medicare Coverage and Payments for Prescription Drugs 
Medicares coverage of outpatient drugs is limited primarily to drugs used in dialysis, organ 
transplantation, and cancer treatment. Medicare also covers certain vaccines and drugs used with 
durable medical equipment such as infusion pumps and nebulizers. Physicians and suppliers 
purchase these drugs, administer or provide them to Medicare beneficiaries, and then submit a bill to 
Medicare for reimbursement. In general, Medicare reimburses physicians and suppliers for 95 
percent of the average wholesale price (AWP) published by the drug manufacturers. Of this amount, 
Medicare beneficiaries are responsible for a 20 percent coinsurance payment. 
Medicares total payments for prescription drugs have risen steadily over the past decade. In 1992, 
Medicare paid about $700 million for prescription drugs; by 2000, it paid $5 billion.  Between 1999 
and 2000 alone, payments increased by $1 billion. 
Excessive Payments 
Since 1997, the Office of Inspector General has produced a number of reports, all of which have 
concluded that Medicare and its beneficiaries pay too much for prescription drugs. Today I am 
issuing three new reports. Two of these are related to Medicare payments for the drugs albuterol and 
ipratropium bromide. The third focuses on Medicaid reimbursement for generic drugs. It shows that 
the Medicaid program faces the same kinds of problems as Medicare when paying for prescription 
drugs. 
The following summarizes the results of our many reports on Medicare payments for prescription 
drugs. 
Medicare Reimbursement for Prescription Drugs. In a January 2001 report, we studied the prices 
for 24 Medicare covered drugs ($3.1 billion of the $3.9 billion in Medicare drug expenditures in 
1999) comparing Medicare reimbursement to prices available to the physician/supplier community, 
the Department of Veterans Affairs, and Medicaid. We found that Medicare and its beneficiaries 
would have saved $1.6 billion for these 24 drugs by paying the VAs Federal Supply Schedule price. 
Senate Committee on Finance 
Hearing  March 14, 2002  Page 1  For half of the drugs, Medicare paid more than double the VA price.  The savings would have been 
$761 million a year by paying the actual wholesale prices available to physicians and suppliers. For 
every drug in our review, Medicare paid more than the wholesale price available to physicians and 
suppliers and the VA Federal Supply Schedule price. We also found that Medicare would have 
saved over $425 million or almost 15 percent a year for the 24 drugs by obtaining rebates similar to 
the Medicaid program. 
In June 2001, we updated the findings of this report with more current drug pricing information. We 
found that Medicare would have saved $1.9 billion of the $3.7 billion it spent for 24 drugs in 2000 if 
the drugs were reimbursed at prices available to the VA. Over $380 million of this savings would 
directly impact Medicare beneficiaries in the form of reduced coinsurance payments. In some cases, 
the VA price for a drug was less than the amount a Medicare beneficiary would pay in coinsurance. 
If Medicare paid the actual wholesale prices available to physicians and suppliers for these 24 drugs, 
the program and its beneficiaries would save $887 million a year. Beneficiaries would pay over 
$175 million less in coinsurance if Medicare paid for these drugs based on catalog prices. The 
potential total savings available to both Medicare and its beneficiaries is probably higher, assuming 
data for all Medicare drugs is similar to that for the 24 we analyzed. 
Nebulizer Drugs. In June 2000, we reported that Medicare pays nearly double the Medicaid price 
and almost seven times more than the VA for one milligram of albuterol, a drug used with a 
nebulizer to treat asthma, emphysema, and other respiratory problems. Nearly every pharmacy we 
contacted sold generic albuterol at prices less than Medicare paid for it. According to our survey 
results, any consumer could buy a monthly supply of albuterol for around $52. For the same 
monthly supply, Medicare and its beneficiaries would pay $120, $96 from Medicare and $24 from 
the beneficiary. The VAs entire monthly payment of $17.50 for albuterol is less than just the 
beneficiarys $24 coinsurance payment under Medicare. 
In a report that we are releasing today, we show that the VA price for albuterol has continued to 
decrease. The VA price for albuterol has fallen by more than 50 percent over the last 3 years, from 
$0.11 per mg in 1998 to $0.05 per mg in 2001. During the same time period, Medicares 
reimbursement amount (based on reported average wholesale prices) has remained constant at $0.47 
per mg. In 2000, published wholesale acquisition costs for albuterol ranged from $0.09 to $0.18 per 
mg. These wholesale acquisition costs were provided by manufacturers to drug compendiums such 
as the Red Book.  The Medicare reimbursement rate of $0.47 per mg was anywhere from three to 
five times the wholesale acquisition costs reported by manufacturers. 
Also in this report, we looked at who actually supplies albuterol to Medicare beneficiaries. We 
found that Medicare reimbursed more than 6,500 pharmaceutical suppliers for albuterol claims in 
2000. However, less than 3 percent of these suppliers (184) accounted for approximately 80 percent 
of albuterol reimbursement. Each of these suppliers had over $150,000 in paid Medicare claims for 
albuterol last year. Thirty-four of these suppliers were each responsible for more than $1 million in 
Medicare reimbursement for albuterol in 2000, with five having between $11 million and $35 
million in reimbursement. Thus, the vast majority of the albuterol supplied to Medicare 
beneficiaries was provided by suppliers that purchase and bill for a large quantity of the product. 
We believe that suppliers that purchase albuterol in such large quantities are likely to receive volume 
discounts similar to those provided to the VA and other large purchasers. 
Senate Committee on Finance 
Hearing  March 14, 2002  Page 2  We are releasing a separate report today in which we found that Medicare and its beneficiaries 
would save $279 million a year if ipratropium bromide were reimbursed at the median price paid by 
the VA. The VAs purchase price has decreased considerably over the last 3 years, from $1.29 per 
mg in 1998 to $0.66 per mg in 2001. In contrast, the Medicare reimbursement amount has remained 
constant at $3.34 per mg. We also found that Medicare would save between $223 million and $262 
million a year if ipratropium bromide were reimbursed at prices available to wholesalers and 
suppliers. The median catalog price available to suppliers was $0.82 per mg, the median supplier 
invoice price was $1.18 per mg, and the median wholesale acquisition cost reported by 
manufacturers was $1.20 per mg. Furthermore, we found that less than 1 percent of the 5,652 
pharmaceutical suppliers that were reimbursed by Medicare for ipratropium bromide accounted for 
the majority of the drugs reimbursement that year. Each of these high-volume suppliers provided 
home-delivery/mail-order services to Medicare beneficiaries. 
Flawed Payment Method 
Our reports have shown time after time that Medicare pays too much for drugs. Why does Medicare 
pay so much?  We believe that it is because Medicares payment methodology is fundamentally 
flawed. By statutory requirement, Medicares payment for a drug is equal to 95 percent of the 
drugs average wholesale price (AWP). However, the AWPs which Medicare uses are not really 
wholesale prices. 
For the most part, AWPs are reported by manufacturers to companies that compile drug pricing data, 
such as First DataBank and Medical Economics, which publishes the Red Book. As our reports have 
indicated, the published AWPs that Medicare uses to establish drug prices bear little or no 
resemblance to actual wholesale prices available to physicians, suppliers, and large government 
purchasers. 
Aside from the obvious problem of inflated AWPs resulting in inappropriate Medicare payments, the 
use of AWP also has other potential adverse implications. For instance, because physicians and 
suppliers get to keep the difference between the actual price they pay for the drug and 95 percent of 
its AWP, this spread serves as an inducement for suppliers or physicians to use one brand of the 
drug over another. Thus, publishing an artificially high AWP is used as a marketing device to 
increase a drug companys market share. Such a tactic increases the profit of the suppliers or 
physicians who purchase the drug because, while not paying the artificially inflated AWP amount, 
they are reimbursed based on that inflated amount. While inflating the published AWP does not 
increase the amount the manufacturer receives for each unit of the drug product, it does increase the 
manufacturers market share because of the higher profits made by physicians and suppliers. This in 
turn increases the profits of the drug company.  All of this occurs at the expense of the Medicare 
program and its beneficiaries. 
Recent Settlements 
Recent settlements further illustrate some of the problems associated with Medicares current 
reimbursement methodology. Because the price spread is so large and Medicare reimbursement so 
lucrative for the drug albuterol, some mail-order pharmacies have been tempted to capitalize on the 
difference by making illegal kickback payments to durable medical equipment suppliers for patient 
referrals. A civil settlement totaling $10 million was reached with one pharmacy that engaged in 
Senate Committee on Finance 
Hearing  March 14, 2002  Page 3  this conduct. Issues of inflated AWPs were also associated with recent settlements involving Bayer 
Corporation and TAP Pharmaceutical. 
Bayer Corporation.  In January of 2001, the United States settled a qui tam False Claims Act case 
with the Bayer Corporation, a major pharmaceutical manufacturer.  Under the terms of a settlement 
negotiated by a team of Federal and State law enforcement officials, Bayer agreed to pay $14 million 
in order to resolve its liability to the Medicaid program.  This case was investigated and handled by 
a team of Federal and State representatives -- including the OIG, representatives of the Medicaid 
Fraud Control Units of four states and the Texas Attorney Generals Office, the United States 
Attorneys Office for the Southern District of Florida, and the Department of Justice. 
Through this settlement, Bayer resolved its liability under the False Claims Act and the Medicaid 
Rebate Statute for its conduct in connection with six of its drugs between January 1993 and August 
1999. Although Bayer did not admit liability, the United States alleged that Bayer: 1) knowingly set 
and reported AWPs for these drugs at levels far higher than the actual acquisition cost of the 
majority of its customers and caused those customers to receive excess Medicaid reimbursement, 2) 
made misrepresentations to the Medicaid programs of certain States, and 3) knowingly misreported 
and underpaid its Medicaid Rebates for the drugs. 
TAP Pharmaceutical Products, Inc.  In October of last year, the United States announced a major 
global health care fraud settlement with TAP Pharmaceutical Products Inc. (TAP).  TAP agreed to 
pay a total of $875 million to resolve its liability, the largest health care fraud settlement ever. TAP 
also agreed to plead guilty to violating Federal law governing the sale of drug samples. The 
investigation centered on TAPs sales and marketing efforts to physicians who used TAPs prostate 
cancer drug, Lupron. The company routinely provided free samples of Lupron to physicians, 
expecting that those physicians would bill the free samples to the patients and Medicare. TAP also 
allegedly paid kickbacks to physicians, HMOs and others in the form of grants, travel and 
entertainment, and other items to induce them to purchase Lupron. In addition, TAP allegedly set 
and reported AWPs for Lupron at levels far higher than the actual acquisition cost of the majority of 
its customers and caused those customers to receive excess reimbursement from Medicare and 
Medicaid. TAP also allegedly underpaid rebate amounts due to the States under the Medicaid 
Rebate Statute. 
Medicaid Drugs 
Although Medicare is the primary focus of my testimony today, problems resulting from the 
publication of misleading AWPs have also plagued the Medicaid program because the payment 
methods based on AWPs are fundamentally flawed. This is illustrated by a report we are releasing 
today related to Medicaid drug reimbursement. As a follow-up to our previous work, we conducted 
a nationwide review of pharmacy acquisition costs for generic drugs reimbursed under the Medicaid 
prescription drug program.  Since most States use AWP minus a percentage discount, which varies 
by State, as a basis for reimbursing pharmacies for drug prescriptions, the objective of this review 
was to develop an estimate of the discount below AWP at which pharmacies purchase generic drugs. 
We obtained pricing information from 217 pharmacies in 8 States, which resulted in an analysis of 
8,728 invoice prices for generic drug products. We compared each invoice drug price to AWP for 
that drug and calculated the percentage, if any, by which the invoice price was discounted below 
Senate Committee on Finance 
Hearing  March 14, 2002  Page 4  AWP. We estimated that the actual generic drug acquisition cost was a national average of 
65.93 percent below AWP. Our previous estimate, based on calendar year 1994 pricing data, 
showed a discount of 42.45 percent below AWP for generic drugs. As a result, this review showed 
an increase of 55.31 percent in the average discount below AWP for generic drugs from 1994 to 
1999. 
Unlike brand name drugs for which Medicaid reimbursement is based predominately on a 
discounted AWP, reimbursement for generic drugs can be limited by Federal upper limit amounts. 
Taking the discounts below AWP, as well as those generic drugs for which upper limits could be 
applied, we calculated that as much as $470 million could have been saved for the 200 generic drugs 
with the greatest amount of Medicaid reimbursements in CY 1999, if reimbursement had been based 
on the discount percentages below AWP as identified in this report. Accordingly, we recommended 
that the Centers for Medicare & Medicaid Services (CMS) require the States to bring pharmacy 
reimbursement more in line with the actual acquisition cost of generic drug products, which we 
identified as being 65.93 percent below AWP. 
Similarly, in August 2001 we issued a report on pharmacy acquisition costs for brand name drugs 
reimbursed under the Medicaid prescription drug program.  The objective of the review was to 
develop an estimate of the discount below AWP at which pharmacies purchase brand name drugs. 
We estimated that nationally, pharmacy actual acquisition cost was an average of 21.84 percent 
below AWP. Our previous estimate, based on CY 1994 pricing data, showed a discount of 18.30 
percent below AWP for brand name drugs. Therefore, this review showed that from 1994 to 1999 
there was an increase of 19.3 percent in the average discount below AWP for brand name drugs. We 
estimated that the Medicaid program could have saved as much as $1.08 billion if reimbursement 
had been based on a 21.84 percent average discount below AWP. 
Correcting the Current Payment System 
I believe a number of factors need to be considered when deciding how to correct Medicares 
reimbursement method for prescription drugs. These factors provide a basis for considering how to 
change the Medicare drug payment system. 
Market Prices.  A drug reimbursement system should be based on real prices available in the 
marketplace. Physicians and suppliers should be fairly reimbursed and at levels that ensure that the 
drugs are accessible.  If reimbursement is set too low, some beneficiaries may not be able to obtain 
needed prescription drugs. 
Data Availability and Reliability. We need a practical way to obtain data which can be used to set 
reimbursement. Further, there needs to be confidence that the data are reliable and cannot be 
misrepresented. 
Periodic Updates. Reimbursement needs to be periodically updated to reflect market changes. This 
will also impact how monitoring is conducted to ensure that access problems do not occur, and how 
payment revisions are made if this does occur or if individual payments continue to be inflated. 
Proprietary Information.  We need to consider how to protect proprietary data. 
Senate Committee on Finance 
Hearing  March 14, 2002  Page 5  Physician Practice Costs. Finally, we recognize that some physician groups have raised concerns 
about Medicares attempts to lower reimbursement for prescription drugs. For example, some 
oncologists have stated that Medicare does not adequately reimburse physicians for the practice 
costs associated with providing treatment to cancer patients. These physician groups say that 
overpayments for prescription drugs simply make up for inadequate payments for their practice 
costs. We agree that physicians need to be properly reimbursed for patient care. However, we do 
not believe that the payment of artificially inflated drug prices is an appropriate mechanism to 
compensate them.  The Medicare program already has a procedure for determining the amount 
physicians should be reimbursed for their practice costs.  If the current calculations are incorrect, 
they should be modified. Physicians deserve fair reimbursement for their valuable services. 
Conclusion 
Our reports, including the ones that I am releasing today, contain numerous options to reform 
Medicares drug pricing method. Each has its own advantages and disadvantages. We recognize 
that there may not be one perfect solution to solving all of Medicares drug pricing issues. We hope 
that these are helpful as the Congress and the Administration move forward to address this pressing 
problem. 
Mr. Chairman, this concludes my testimony. I appreciate the opportunity to address this important 
issue with you today. Medicares current payment methodology for prescription drugs adversely 
affects the Medicare trust fund and Medicares beneficiaries, who are responsible for 20 percent of 
the allowed amounts. The payment system is based on the AWP, a list price reported by the drug 
manufacturers that is neither average nor wholesale and bears little or no resemblance to the actual 
wholesale prices available to physicians and suppliers who participate in the Medicare program. 
Until this problem is corrected, Medicare and its beneficiaries will unnecessarily pay more and more 
each year. I welcome your questions. 
Senate Committee on Finance 
Hearing  March 14, 2002  Page 6