Testimony of 
GEORGE REEB 
Assistant Inspector General 
Centers for Medicare and Medicaid Audits 
Department of Health and Human Services 
Good morning, Madam Chairman.  I am George Reeb, Assistant Inspector General for the Centers 
for Medicare and Medicaid Audits within the Department of Health and Human Services. I am 
accompanied by Robert Vito, Regional Inspector General for Evaluation and Inspections, 
Philadelphia. We appreciate the opportunity to appear before you today regarding the important 
issue of Medicare payments for currently covered prescription drugs.  I am here to describe the 
findings of several Office of Inspector General (OIG) reports showing that Medicare and Medicaid 
pay too much for prescription drugs. This occurs largely because of the use of the average 
wholesale price (AWP) as the basis for calculating reimbursements to physicians and suppliers, 
including  pharmacies.  We have consistently found that the AWPs which Medicare and Medicaid 
use are not really wholesale prices. I will also describe settlements of two cases which included the 
issue of manufacturers use of the AWP as a marketing tool, at unnecessarily high costs to taxpayers 
and beneficiaries. 
Background 
For the most part, AWPs (which are not clearly defined by law or regulation) are compiled in drug 
compendia such as Medical Economics Red Book.  As our reports have indicated, the published 
AWPs that Medicare and Medicaid use to establish drug reimbursement bear little or no resemblance 
to actual wholesale prices available to physicians, suppliers, and large government purchasers. 
In general, Medicare reimburses physicians and suppliers at the published AWP less a discount of 5 
percent (i.e., 95 percent of the AWP). Of this amount, Medicare beneficiaries are responsible for a 
20 percent coinsurance payment. Similarly, most state Medicaid agencies reimburse pharmacies 
based on the AWP of a drug less a discount which averages about 10.3 percent nationally.  Federal 
regulations require that each States reimbursement for a brand name or certain other drugs not 
exceed, in the aggregate, the lower of estimated acquisition costs or the providers usual and 
customary charge to the public for the drug.1  Some states require a small copayment for each 
prescription filled by a pharmacy. 
The current cost to Medicare and Medicaid for currently covered drugs is in the billions.  Medicares 
total payments for prescription drugs have risen steadily over the past decade. In 1992, Medicare 
paid about $700 million for prescription drugs; by 2001, it paid $6.5 billion.  Between 2000 and 
2001 alone, payments increased by $1.5 billion. Unlike Medicare which currently covers a narrow 
range of drugs, Medicaid covers most outpatient prescription drugs.  Medicaid payments for 
1  Medicaid regulations limit reimbursement of multiple source (generic) drugs to federal 
upper limit amounts (FUL) if at least three generic equivalents are available. The FULs restrict 
the amount that Medicaid can reimburse for drugs that have available generic equivalents (42 
CFR 447.332). The FULs are established by the Centers for Medicare & Medicaid Services. 
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Hearing: October 3, 2002  Page 1
 prescription drugs totaled almost $24 billion in FY 2001. Our reports, which I am summarizing in 
this testimony, have shown time after time that Medicare and Medicaid pay too much for drugs . 
Medicare Pays Too Much  OIG Reports 
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. 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. 
Over the past 5 years, the OIG has issued a number of reports, all of which have reached the 
conclusion that Medicare and its beneficiaries pay too much for prescription drugs. For example, 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. 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. 
Subsequently, we updated the findings of this report with more current drug pricing information and 
estimated that, of the $3.7 billion Medicare spent for 24 drugs in 2000, the program would have 
saved $1.9 billion if the drugs had been reimbursed at prices available to the VA. Over $380 million 
of this savings would have directly impacted 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. Further, we estimated that, 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. If Medicare paid for these drugs based on catalog 
prices, beneficiaries would pay over $175 million less in coinsurance.  The potential total savings 
available to both Medicare and its beneficiaries is probably higher than our estimates, assuming data 
for all Medicare drugs is similar to that for the 24 we analyzed. 
In other reviews, 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 chain 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 from Internet pharmacies for around $63.  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.  The VA price for albuterol has fallen by 
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 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. 
We also 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. 
Aside from the obvious problem that AWPs can be arbitrarily inflated, resulting in inappropriate 
Medicare payments, the use of AWP as a basis for reimbursement in Medicare has other potential 
adverse side-effects. 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 can serve as 
an inducement for suppliers or physicians to use one brand of the drug over another. Thus, 
publishing an artificially high AWP can be 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, the higher profits available to physicians and suppliers 
may lead them to purchase one brand of drug over another, thereby increasing a manufacturers 
market share. This in turn increases the profits of the drug company. All of this occurs at the 
expense of the Medicare program and its beneficiaries. 
Medicaid Pays Too Much  OIG Reports 
Although this hearing pertains to Medicare, I would like to mention our work in the Medicaid 
program because it confirms that the average wholesale price (AWP) is not a realistic basis for drug 
reimbursements. Our Medicaid work also serves as a red flag that, if Medicare is expanded to cover 
more prescription drugs, particularly those that beneficiaries can obtain from pharmacies, it would 
be unwise for Medicare to reimburse pharmacies at Medicare's current rate of AWP minus 5 percent 
(i.e., 95 percent of AWP) . 
In Medicaid, we found there is a significant difference between pharmacy acquisition costs for both 
brand and generic drugs and the basis for most states reimbursement for drugsthe average 
wholesale price (AWP). We believe if states would reimburse pharmacies for Medicaid patient 
prescriptions more in line with the actual acquisition costs of the drugs, substantial savings could be 
realized by the Medicaid program. 
As a follow-up to our previous work, we conducted nationwide reviews of pharmacy acquisition 
costs for both brand name and generic drugs reimbursed under the Medicaid prescription drug 
program during Calendar Year (CY) 1999. 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 
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 these reviews were to develop an estimate of the discount below AWP at which pharmacies purchase

brand and generic drugs.

We obtained pricing information from 217 pharmacies in 8 states, which resulted in an analysis of

thousands of  invoice prices that included both brand and 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 AWP. Our estimates were that pharmacy acquisition costs for brand

name drugs in 1999 was an average of 21.84 percent below AWP and for generic drugs an average

of 65.93 percent below AWP. These estimates were both higher than our previous 1994 studies of

18.30 for brands and 42.45 for generics.

In each of these reports, 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 both brand and generic drug products.

In response to comments made by both state Medicaid officials and industry representatives, we

further analyzed the results of our studies of CY 1999 expenditures. This additional information was

a breakdown of discount percentages for various brand and generic drug categories from single

source innovator through drugs with and without federal upper limits.  Based on the results of our

additional analyses, if states continue to reimburse for drugs based on AWP, we recommended that

CMS encourage the states to consider using a multi-tiered reimbursement methodology. These tiers

should be oriented to the significant differences in pharmacy acquisition costs depending on the

drugs category of brand, generic, subject to federal upper limits, etc.  The current method used by

most states for reimbursing for brand name drugs and non-federal upper limit multiple source drugs

using a single percentage discount does not consider these large differentials found during our

additional analysis.

The discount percentages in this report ranged from 17.2 to 72.1 percent below AWP. These

percentages do not consider discounts available to most pharmacies such as volume discounts,

prompt pay discounts, and related rebates. The Medicaid program, unlike the Medicare program,

includes a rebate component that is based, in part, on the average manufacturers price (AMP). 

However, our report does not address the disconnect caused by basing Medicaid reimbursements on

AWP while basing rebates on the AMP. That practice could result in higher cost and lower rebates

for the States under Medicaid. In an earlier report we recommended tying the rebate to the AWP

rather than the AMP. 

Recent Settlements 
Recent settlements further illustrate some of the problems associated with Medicares current 
reimbursement methodology. Because of 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 this conduct.  Issues of inflated AWPs were also associated with recent settlements 
involving Bayer Corporation and TAP Pharmaceutical Products Inc. 
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Hearing: October 3, 2002  Page 4
 Bayer Corporation. In January 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 representativesincluding 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 use 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, debt forgiveness, 
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. 
Conclusion 
A drug reimbursement system should be based on real prices available in the marketplace. 
Physicians and suppliers, including pharmacies, 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. We recognize that some physician groups have raised concerns 
about Medicares attempts to lower reimbursement for prescription drugs. Specifically, 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. 
This concludes my testimony. I appreciate the opportunity to address this important issue with you 
today. I welcome your questions. 
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 References: 
Medicare Reimbursement of Prescription Drugs

OEI-03-00-00310  January 2001

http://oig.hhs.gov/oei/reports/oei-03-00-00310.pdf

Response to Request from The Honorable C.W. Tauzin

OEI-03-01-00490  June 2002 (Not on Internet)

Medicare Reimbursement of Albuterol

OEI-03-00-00311  June 2000

http://oig.hhs.gov/oei/reports/oei-03-00-00311.pdf

Excessive Medicare Reimbursement for Albuterol

OEI-03-01-00410  March 2002

http://oig.hhs.gov/oei/reports/oei-03-01-00410.pdf

Excessive Medicare Reimbursement for Ipratropium Bromide

OEI-03-01-00411  March 2002

http://oig.hhs.gov/oei/reports/oei-03-01-00411.pdf

Medicaid Pharmacy-Additional Analyses of the Actual Acquisition Cost of Prescription Drug Products 

A-06-02-00041  September 2002 

http://oig.hhs.gov/oas/reports/region6/60200041.pdf 

Medicaid Pharmacy-Actual Acquisition Cost of the Generic Prescription Drug Products 

A-06-01-00053  March 2002 

http://oig.hhs.gov/oas/reports/region6/60100053.pdf 

Medicaid Pharmacy-Actual Acquisition cost of Brand Name Prescription Drug Products 

A-06-00-00023  August 2001 

http://oig.hhs.gov/oas/reports/region6/60000023.pdf

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Hearing: October 3, 2002  Page 6