)epartment of Health and Human Services 
OFFICE  OF 
INSPECTOR  GENERAL 
APPROPRIATENESS  OF  MEDICARE 
PRESCRIPTION  DRUG ALLOWANCES  OFFICE  OF  INSPECTOR  GENERAL 
The  mission  of the  Office of Inspector  General  (OIG),  as mandated  by Public  Law 95-452, as 
amended,  is to protect  the integrity  of the  Department  of Health  and Human  Services (HHS) 
programs  as well as the  health  and welfare  of beneficiaries  served by those  programs.  This 
statutory  mission is carried  out  through  a nationwide  network  of audits,  investigations,  and 
inspections  conducted  by three  OIG  operating  components:  the  Office of Audit  Services,  the 
Office of Investigations,  and the  Office of Evaluation  and Inspections.  The  OIG  also informs 
the  Secretary  of HHS  of program  and management  problems  and recommends  courses  to 
correct  them. 
OFFICE  OF  AUDIT  SERVICES 
The  OIGS  Office of Audit  Services  (OAS)  provides  all auditing  services for HHS,  either  by 
conducting  audits with its own audit  resources  or by overseeing  audit work  done  by others. 
Audits  examine  the  performance  of HHS  programs  and/or  its grantees  and contractors  in 
carrying out  their  respective  responsibilities  and are intended  to provide  independent 
assessments  of HHS  programs  and operations  in order  to reduce  waste,  abuse,  and 
mismanagement  and to promote  economy  and efficiency throughout  the  Department. 
OFFICE  OF  INVESTIGATIONS 
The  OIGS Office of Investigations  (01)  conducts  criminal, civil, and administrative 
investigations  of allegations  of wrongdoing  in HHS  programs  or to HHS  beneficiaries  and of 
unjust  enrichment  by providers.  The  investigative  efforts  of 01  lead to criminal  convictions, 
administrative  sanctions,  or civil money penalties.  The  01  also oversees  State  Medicaid  fraud 
control  units which investigate  and prosecute  fraud  and patient  abuse  in the  Medicaid  program. 
OFFICE  OF  EVALUATION  AND  INSPECTIONS 
The  OIGS Office of Evaluation  and Inspections  (OEI)  conducts  short-term  management  and 
program  evaluations  (called inspections)  that  focus on issues of concern  to the  Department, 
the  Congress,  and the  public.  The  findings and recommendations  contained  in these  inspection 
reports  generate  rapid,  accurate,  and up-to-date  information  on the efficiency, vulnerability, 
and effectiveness  of departmental  programs.  This report  was prepared  in the  Philadelphia 
Regional  Office under  the  direction  of Robert  A. Vito,  Regional  Inspector  General. 
PHILADELPHIA  REGIONAL  STAFF  HEADQUARTERS  STAFF 
Linda  M. Ragone,  Project Leader  Mary Beth  Clarke,  Program Specialist

Shane  Lanzo,  Intern

Vivek Rae,  Intern

To obtain copies of this report, please call the PhiladelphiaRegional Office at (800) 531-9562.  Department of Health and Human Services 
~  OFFICE  OF 
INSPECTOR  GENERAL 
APPROPRIATENESS  OF  MEDICARE

PRESCRIPTION  DRUG ALLOWANCES

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 EXECUTIVE  SUMMARY

PURPOSE 
To  assess  the  appropriateness  of Medicare  Part  B allowances  for  prescription  drugs 
through  a comparison  with  Medicaid  reimbursement  mechanisms. 
BACKGROUND 
While  many  Americans  believe  the  Medicare  program  does  not  cover  prescription 
drugs  as a benefit,  in actuality  the  Medicare  Part  B program  allowed  at least  $1.4 
billion  dollars  for prescription  drugs in 1994.  Between  1992 and  1994, Medicare 
expenditures  for drugs  increased  more  than  100 percent. 
Medicare  does  not  pay for over-the-counter  or many  prescription  drugs  that  are  self-
administered  under  Part  B.  However,  the  program  does  pay for certain  categories  of 
drugs  used  by Medicare  beneficiaries.  Under  certain  circumstances,  Medicare  covers 
drugs  that  are  used  with  durable  medical  equipment  or infusion  equipment.  Medicare 
will cover  certain  drugs  used  in association  with  dialysis or organ  transplantation. 
Drugs  used  for chemotherapy  and  pain  management  in cancer  treatments  are  also 
covered.  The  program  also covers  certain  types  of vaccines  such as those  for flu and 
hepatitis  B. 
We  collected  data  from  three  information  sources  for our  comparison  of Medicare  and 
Medicaid  drug  payment  methodologies.  For  information  on Medicare  prescription 
drug  allowances  in 1994, we compiled  data  from  the  Health  Care  Financing 
Administrations  (HCFA)  National  Claims  History  File.  We  collected  drug  rebate 
data  from  HCFAS Medicaid  Drug  Rebate  Initiative  (MDRI)  System.  We  also 
surveyed  Medicaid  agencies  in all 50 States  and  the  District  of Columbia. 
FINDINGS 
Uiu.ikra dug  rebate program sirnihzrto iWdicaid.y Medicare would have saved $122 
miUion for  17prewnption  drugs  in 1994. 
State  Medicaid  agencies  receive  manufacturer  drug  rebates  according  to Federal  law.
Since  the  enactment  of the  Omnibus  Budget  Reconciliation  Act  of 1990,
manufacturers  are  required  to have  rebate  agreements  with the  Medicaid  program  in
order  to be  eligible  for Medicaid  reimbursement  of their  drug  products.  Medicare  has
no such rebate  program.  If Medicaid  rebate  amounts  were  applied  to Medicare
utilization  data,  the  Medicare  program  would  have  saved  $122 million  or  14.6 percent
of its allowances  for  17 drugs.  If one  applied  the  14.6 percent  savings estimate  to
Medicares  $1.4 billion  in drug  allowances  for  1994, Medicare  could  have  saved  $211
million  in  1994 if a drug  rebate  program  had  been  in effect.
i  Medicare ako  could have saved $144 rniilkm in 1994 had the program employed a 
diwounted AWP  dmg reimbursement forrnuih  like many Medicaid States. 
Medicare  presently  pays for most  prescription  drugs based  on the  Average  Wholesale 
Price  (AWP)  of the  drug product.  State  Medicaid  agencies  have  the  authority  to 
develop  their  own pricing  mechanisms  for prescription  drugs  subject  to upper  payment 
limits  established  by HCFA.  Although  Medicaid  State  programs  used  a number  of 
different  formulas  to determine  drug  reimbursement  in 1994, 40 States  used  some 
form  of discounted  AWP  to determine  drug product  payments  to pharmacies. 
The lack of a national drug co&-based  billingsystem WOUMprevent HCFA @m  taking 
advantage of rmmufacturer dug  rebates and other dkcounted  rehzbumement fomu.dhs. 
Drugs  are  billed  to the  Medicare  program  based  on codes  developed  by HCFA.
These  codes  are  developed  as part  of the  HCFA  Common  Procedure  Coding  System
(HCPCS).  The  codes  define  the  type  of drug  and,  in most  cases,  a dosage  amount.
The  codes  do not  indicate  whether  a brand  or generic  version  of the  drug was
administered.  Unlike  Medicare,  most  drug  suppliers  bill Medicaid  using a national
drug  code  (NDC).  These  NDCS identify  the  manufacturer  or distributor  of the  drug,
the  product  dosage  form,  and  the  package  size.  From  the  NDCS, the  drug  can be
identified  as a specific  brand  or generic  version  and  the  proper  rebates  and  discounted
reimbursement  formulas  can be  applied.
RECOMMENDATION
The  findings  of this report  indicate  that  Medicare  allowances  for prescription  drugs
may not  be  appropriate.  We have  provided  evidence  that  both  a discounted  AWP
reimbursement  formula  and  a rebate  program  for prescription  drugs  could  result  in
significant  savings to the  Medicare  program.  The  magnitude  of these  savings  could
reach  over  one-third  of a billion  dollars.
We believe  the  information  in this report  provides  further  support  for a
recommendation  made  in an OIG  report  entitled  Medicare  Payments  for  Nebulizer

Drugs.  We recommendedthatHCFA reexarnine 
itsMedicaredrugreimbursement 
methodologies,witha goal of reducingpaymentsas appropriate. This 
recommendation  was based  on a review  of several  drugs  used  in conjunction  with 
nebulizers.  In this report,  we have  expanded  the  review  to a larger  number  of drugs. 
The  HCFA  concurred  with the  recommendation  and  is examining  available  options  in 
an  effort  to make  appropriate  drug payment  reductions.  The  HCFA  is also working 
on a crosswalk  between  the  current  coding  system  for prescription  drugs  and  the 
National  Drug  Codes. 
ii  TABLE  OF  CONTENTS

PAGE 
EXECUTIVESUMMARY  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..i

INTRODU(XION  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...1
FINDINGS  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...7
.  Drugrebates  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...7
 Discounted  AWP  reimbursement  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...8

NDC-based  billingsystem  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...9
RECOMMENDATION  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...10

APPENDICES 
f%  Description  of17HCPCS  Codes  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..A-1
B:	 State  Medicaid  Reimbursement  Formulas  for Outpatient  Drugs 
Billed  withNDC  Codes  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..B-I  Medicaid Coverage and Payment for fiexription  DnJgs 
Prescription  drug  coverage  under  the  Medicaid  program  is an optional  benefit.  Each 
State  program  can  choose  whether  to provide  recipients  with prescription  drug 
coverage.  At  the  present  time,  a1150 States  and  the  District  of Columbia  have  chosen 
to provide  a prescription  drug benefit. 
Each  State  Medicaid  agency  has the  authority  to develop  itsown  reimbursement 
mechanism  for prescription  drugs  subject  to upper  payment  limits  establishedby 
HCFA.  Unlike  Medicare,  most  drug  suppliers  bill Medicaid  for reimbursement  using 
a national  drug  code  (NDC).  These  NDCS identify  the  manufacturer  or distributor  of 
the  drug,  the  product  dosage  form,  and  the  package  size.  From  the  NDCS, the  drug 
can be  identified  as a brand  or generic  version.  Each  drug  manufactured  or 
distributed  for sale in the  United  States  has its own unique  NDC  code. 
State  Medicaid  agencies  also receive  manufacturer  drug  rebates  according  to Federal 
law (Section  1927 of the  Social  Security  Act).  With  the  enactment  of the  Omnibus 
Budget  Reconciliation  Act  of 1990 (OBRA  90), pharmaceutical  manufacturers  are 
required  to have  rebate  agreements  with the  Medicaid  program  for  drugs  dispensed  to 
recipients.  Manufacturers  are  required  to have  these  rebate  agreements  in order  to 
be  eligible  for Medicaid  reimbursement  of their  drug  products. 
In 1994, the  quarterly  rebate  for brand  name  drugs was based  on the  greater  of 15.4 
percent  of Average  Manufacturer  Price  (AMP)  or the  difference  between  the  AMP 
and  the  Best  Price.  The  AMP  is the  average  price  paid  by wholesalers  for products 
distributed  to the  retail  class or trade.  Best  Price  is the  lowest  price  paid  by any 
purchaser  exclusive  of depot  prices  and  single-award  contract  prices  as defined  by any 
Federal  agency.  For  generic  drugs,  the  quarterly  rebate  amount  for  1994 was  11 
percent. 
The  drug  rebate  program  significantly  reduces  Medicaid  expenditures  for prescription 
drugs.  The  Medicaid  program  collected  more  than  $2.4 billion  in drug  rebates 
between  1991 and  1993.  In 1993 alone,  Medicaid  collected  approximately  $1.41 billion 
in drug  rebates  based  on payments  of nearly  $8 billion. 
METHODOLOGY 
We  collected  data  from  three  information  sources  for our  comparison  of Medicare  and 
Medicaid  drug  payment  methodologies.  For  information  on Medicare  allowances  for 
prescription  drugs, we compiled  statistics  from  HCFAS National  Claims  History 
(NCH)  File.  We  collected  drug rebate  data  from  HCFAS  Medicaid  Drug  Rebate 
Initiative  (MDRI)  System.  We  also surveyed  Medicaid  agencies  in all 50 States  and 
the  District  of Columbia. 
2
 Medicare Allowance  Data 
Todetermine  thetotal  Medicare  allowance  forprescription  drugsin  1994, we 
compiled  a list of HCPCS  codes  that  represent  all of the  drugs which  Medicare 
reimburses.  The  drug  code  list primarily  contained  HCPCS  codes  beginning  with  a J 
(known as J codes)  which represent  mainly  injectable  drugs  or drugs  used  in 
conjunction  with durable  medical  equipment.  Also included  in our  list of drugs  were 
K codes  which  usually  represent  immunosuppressive  drugs,  Q codes  which  represent 
mainly  drugs  used  for End  Stage  Renal  Disease,  several  A codes  that  represent  drugs 
used  for  diagnostic  imaging,  and  immunization  or vaccine  codes  that  are  represented 
by a six digit numeric  code. 
We  then  retrieved  NCH  allowance  and  utilization  data  using HCFAS Part  B Extract 
and  Summary  System  (BESS).  We  aggregated  the  allowance  for each  code  to 
calculate  Medicares  total  prescription  drug  allowance  for  1994. 
Rebate  Calculation 
To  calculate  potential  drug rebate  savings to Medicare,  we focused  on drugs
representing  a large  percentage  of the  total  drug  allowance.  Therefore,  we selected
for our  review  drug  codes  for which Medicare  allowed  more  than  $10 million  in  1994.
We  determined  that  24 drug  codes  had  allowances  over  $10 million.
We  excluded  7 of the  24 codes  from  our review.  We  excluded  two codes  for drugs
used  in conjunction  with nebulizers  (J7620,  J7670)  since  our  office  recently  released  a
report  on these  drugs,  We also removed  two codes  representing  unclassified  drugs
(J3490,  J7699)  because  these  codes  can  represent  drugs  of various  descriptions.  We
omitted  two vaccine  codes  (90724, 90732) from  our list since  they  are  not  eligible  for
rebates.  Lastly, we removed  one  anti-hemophilia  drug  code  (J7190)  due  to difficulty  in
determining  dosage  requirements.  After  making  these  exemptions,  we analyzed  the
remaining  17 drug  codes  for review.  The  17 HCPCS  codes  and  drug  descriptions  are
provided  in Appendix  A.
In order  to calculate  the  potential  rebate  saving for each  HCPCS  code,  we applied  the
appropriate  Medicaid  rebate  amount  to Medicares  utilization  data.  Since  Medicaid
rebate  amounts  are  based  on individual  NDC  codes,  we needed  to link Medicares
HCPCS  codes  to NDC  codes.  This involved  matching  the  drug  product  and  dosage
defined  by the  HCPCS  code  with the  corresponding  NDC  codes  for  all available  brand
and  generic  versions  of the  drug.
We  used  information  from  several  sources  to create  a comprehensive  list of NDC
codes  for each  of the  17 HCPCS  codes.  We reviewed  drug  information  in Drug  Topics

Red  Book:  Phairnacyh  Fundamental  Reference,  First DataBank5  Blue Book:  Essential

Directoty  of Pharmaceuticals,  Physicians  Desk  Reference,  and Drug  Facts  and

Comparisons.  We  also received  additional  information  from  First  DataBanks
computer  database  of drugs.
3  For10  of the  17codes,  theprocess  oflinking  the  HCPCScode  tith  corresponding 
NDC  codes  was relatively  easy to accomplish  since  the  HCPCS  codes  represented 
single-source  drugs where  only one  brand  name  drug was available.  For  these  drugs, 
we collected  NDC  codes  that  matched  the  drug  dosage  requirement  outlined  in the 
HCPCS  code  description.  For  the  remaining  seven  drug  codes,  we needed  to 
determine  all of the  versions  (both  brand  and  generic)  of the  drugs  produced  by 
different  manufacturers  that  met  the  HCPCS  dosage  requirement.  The  number  of 
NDC  codes  for  each  of these  drugs ranged  from  two codes  to nine  separate  NDC 
codes. 
We  then  extracted  pricing  and  utilization  summary  data  from  HCFAS MDRI  system. 
Included  in this information  were  the  rebate  amounts  paid  per  unit  of drug  for  each 
quarter  of 1994.  We  chose  to apply  the  lowest  quarterly  rebate  amount  to Medicare 
utilization  since  this would  yield the  most  conservative  savings estimate.  In the  few 
instances  where  the  dosage  listed  in the  MDRI  system  did not  match  exactly with the 
HCPCS  dosage,  we applied  a conversion  factor  to come  up with the  correct  rebate 
amount  for the  HCPCS  code  dosage  unit. 
To  quantify  potential  rebate  savings for the  10 single-source  drug  codes,  we applied 
the  Medicaid  rebate  amount  per  unit  to  drugs  units  that  Medicare  reimbursed  in 1994. 
To  quantify  the  potential  rebate  savings for the  seven  multiple-source  drugs, we first 
determined  the  percentage  of utilization  for each  NDC  code.  Since  Medicares 
HCPCS  codes  do not  indicate  whether  a brand  or generic  drug  is supplied,  we needed 
to develop  an equitable  way to apply  rebates  to the  HCPCS  codes  representing 
multiple  NDC  codes,  We  decided  to apply  Medicaids  utilization  patterns  for brand 
and  generic  drugs  to Medicares  usage  data.  We  acknowledge  that  Medicare  and 
Medicaid  utilization  patterns  may differ  due  to the  populations  they  serve.  However, 
we believe  our  method  was more  appropriate  than  applying  random  or arbitrary  usage 
percentages  to various  products  representing  a single HCPCS  code. 
We  performed  several  calculations  to determine  rebate  savings for each  of the  seven 
codes  representing  multiple  products.  We  provide  an example  describing  the  steps 
taken  to calculate  the  savings for a HCPCS  code  representing  three  NDC  codes. 
These  steps  are  presented  in equation  form  in the  table  on page  5. 
Step  1) Medicaid  utilization  data  (units  of drugs  Medicaid  reimbursed)  for  each  NDC 
code  was extracted  from  the  MDRI  System  and  then  aggregated  to calculate  a 
Medicaid  utilization  total  for the  drug  products  represented  by the  HCPCS  code, 
Step  2) The  utilization  for each  NDC  code was divided  by the  total  Medicaid 
utilization  to  determine  the  percentage  of total  utilization  that  each  NDC  code 
represented. 
Step  3) The  percentage  of utilization  for each  NDC  code  was multiplied  by the  total 
Medicare  utilization  for the  HCPCS  code  to calculate  Medicares  utilization  for  each 
NDC  code. 
4
 Step  4) These  utilization  figures  were  multiplied  by the  rebate  amount  established  for 
each  NDC  code  to determine  the  rebate  savings for the  NDC  codes, 
Step  5) The  rebate  savings for all three  individual  NDC  code  were  then  added  to 
obtain  the  total  Medicare  rebate  savings for the  HCPCS  code. 
U  =  Medicaid  utilization  for each NDC  code
MU  = Total  Medicaid  utilization  for all three  NDC  codes
P  = Percentage  of total  Medicaid  utilization  that  each NDC  code represents
TM  = Total  Medicare  Utilization  for HCPCS  code
MU  = Medicare  Utilization  for each NDC  code
$R = Corresponding rebate amount for each NDC code
RS = Rebate  savings for each NDC  code
=  Each  letter  represents  one of the  three  individual  NDC  codes
qb,c 
After  calculating  potential  rebate  savings for each  of the  seven  multiple-source  codes, 
we added  the  individual  rebate  savings from  all  17 codes  to determine  the  overall 
rebate  savings to Medicare. 
Medicaid Survey Data 
We distributed  surveys requesting  drug reimbursement  and  rebate  information  to all 
State  Medicaid  agencies  and  the  District  of Columbia.  We  solicited  information  on 
each  States  payment  strategies  for prescription  drugs  billed  with both  NDC  codes  and 
HCPCS  codes.  Since  Arizona  and  Tennessee  provide  pharmaceutical  coverage 
through  managed  care  demonstration  projects,  information  on drug  reimbursement 
was not  available  from  these  States. 
For  comparison  purposes  between  Medicaid  and  Medicare  reimbursement,  we only 
considered  payment  for the  drug product  or ingredients  and  not  any additional 
dispensing  or administration  fees  that  Medicaid  and  Medicare  pay to suppliers  and 
physicians. 
The  calculation  of potential  savings to Medicare  if the  program  utilized  Medicaid 
payment  methodologies  was determined  by using the  most  frequently  cited  drug 
reimbursement  formula.  We  created  a distribution  of each  States  discounted  AWP 
J  percentage.  Weusedthe  mode  (most  frequently  cited  percentage)  ofthis  distribution 
in our  savings calculation.  However,  even  if we had  selected  the  median  or mean 
statistic,  the  savings calculation  would  not  have  differed  substantially  since  the  mean  of 
the  distribution  was less than  one  percentage  point  different  from  the  mode  and  the 
median  statistic  was equal  to the  mode.  We  applied  the  mode  discounted  AWP 
percentage  to Medicares  total  expenditure  for prescription  drugs  in  1994 to calculate 
the  potential  savings to the  program  if payment  mechanisms  similar  to Medicaids 
were  utilized. 
6 FINDINGS

Under a drug rebate program similizrto Mtzlicaidh, Medicare wouki have saved $122 
millwn for  17prescription  dregs in 1994. 
Medicare  allowed  $835 million  in 1994 for the  17 drugs  reviewed.  These  drugs 
represented  nearly  60 percent  of Medicares  total  reimbursement  for prescription  drug 
products  in  1994.  If Medicaid  rebate  amounts  were  applied  to Medicare  utilization 
data,  the  Medicare  program  would  have  saved  $122 million  or  14.6 percent  of its 
allowances  for these  drugs.  The  table  below  outlines  the  rebate  savings that  would 
have  been  achieved  for each  of these  17 drugs. 
PotentialRebate Savingsfor 17 Drugs 
J9217  Leuprolide  Acetate  $381,212,580  $63,038,028 
J0640  Leucovorin  Calcium  $74,353,182  $4,473,991 
J2405  Ondansetron  Hydrochloride  $49,741,503  $6,114,430 
J9202  Goserelin  Acetate  Implant  $47,113,521  $5,430,229 
I 
J1440  Filgrastim,  per 300 mcg.  $39,577,902  I  $5,811,460 
J9045  Carboplatin  $38,522,742  $7,990,478 
J9265  Paclitaxel  $34,606,593  $4,397,292 
J1561  Immune  Globulin  $27,063,770  $2,048,880 
J1441  Filgrastim,  per 480 mcg.  $22,874,450  $3,307,050 
J9182  Etoposide,  100 mg.  $21,756,729  $7,723,477 
J9000  Doxorubicin  HCL,  10 mg.  $16,494,331  $773,294 
J9293  [ Mitoxantrone  Hydrochloride  I  $16.418.285  I  $1.134,595 
J9181  Etoposide,  10 mg.  $15,936,362  $4,610,449 
J9031  BCG  (Intravesical)  $14,528,214  $1,652,236 
K0121  Cyclosporine  $12,995,037  $1,736,715 
J0205  Alglucerase  $11,140,854  $1,398,010  Although  oursavings  calculation  was basedon  17drugs,  the  14.6 percent  savings 
estimate  could  bereasonably  applied  to Medicare's  total  prescription  drug  benefit.  A 
recent  extramural  research  report  released  by HCFAS Office  of Research  and 
Demonstrations  supports  this conclusion.  The  report  stated  that  rebate  payments  had 
resulted  in a 17 percent  reduction  in 1993 drug  expenditures  in the  Medicaid 
program.1  The  report  also noted  that  after  dispensing  fee  payments  were  subtracted 
from  Medicaids  total  drug payments  for  1992 and  1993, rebate  amounts  were  found  to 
be  approximately  14 to  15 percent  of drug product  payment  amounts.  Based  on the 
support  of these  findings,  if one  applied  the  14.6 percent  savings estimate  to 
Medicares  $1.4 billion  in drug  allowances  for  1994, Medicare  could  have  saved  $211 
million  in  1994 if a drug  rebate  program  had  been  in effect. 
J&z&are  could hoe  saved an additional $144 million in 1994 had the program 
employed a discounted AW  dmg reimbunwment formula  like many Medicaid States. 
If Medicare  implemented  a discounted  AWP  reimbursement  formula  similar  to many
Medicaid  States,  the  Medicare  program  could  save approximately  $144 million  dollars
in drug  allowances  per  year.2  Although  Medicaid  State  programs  used  a number  of
different  formulas  to determine  drug reimbursement  in 1994, 40 States  used  some
form  of discounted  AWP  to determine  drug  product  payments  to pharmacies.
Seventy-eight  percent  of these  States  used  a formula  discounting  AWP  by 9 to  12
percent  in 1994,
The  States  which  didnt report  using a discounted  AWP  in their  reimbursement
formulas  employed  wholesale,  actual,  or estimated  acquisition  costs of the  drug  in their
payment  equations.  A few States  reimburse  at the  AWP  level.  Other  States  contract
with  companies  to supply wholesale  acquisition  cost data.  Still other  States  survey
area  wholesalers  for cost data.  A complete  list of State  drug  reimbursement  formulas
for  drug  suppliers  is presented  in Appendix  B.
lU .S. Department  of Health  and  Human  Services,  Health  Care  Financing 
Administration,  Office  of Research  and  Demonstrations,  Impact  of the  Medicaid  Drug 
Rebate  ProRram,  Extramural  Research  Report  funded  by the  Health  Care  Financing 
Administration  and  prepared  by the  Institute  for Health  Services  Research  at  the 
University  of Minnesota  (Baltimore,  MD:  U.S. Department  of Health  and  Human 
Services,  August  1995). 
2Based on  applying  a formula  of AWP  minus  10 percent  to Medicares  1994 total 
drug  allowance.  Ten  percent  is the  amount  most  often  used  by States  in discounting 
AWP  for reimbursement  purposes. 
8  The lack of a national thug code-based  bilhkg system wouki prevent HCFA jiom  taking 
advantage of manufacturer thug rebatm and other discounted reimbwement  fomudas. 
Because  the  Medicare  program  pays for drugs billed  with HCPCS  codes,  it reimburses 
based  on a drug  category  and  not  on the  specific  drug  product  supplied.  Since  NDC 
codes  are  not  used  to bill Medicare  for drugs,  the  program  does  not  know which 
brand  or generic  form  of the  drug has been  supplied.  Information  on the  specific  drug 
supplied  would  be  necessary  for the  implementation  of any rebate  or discounting 
program  by Medicare.  The  HCFA  has recognized  this and  is currently  developing  a 
method  for conversion  to an NDC  system. 
The  importance  of an NDC  system  in implementing  rebates  or discounted 
reimbursement  formulas  is demonstrated  by the  difficulty Medicaid  agencies  face  in 
implementing  such methods  in the  absence  of NDCS.  This is commonly  the  case  for 
prescription  drugs billed  to the  Medicaid  program  by physicians.  Although  most  drugs 
billed  to the  Medicaid  program  are  dispensed  by pharmacies,  physicians  can bill for 
drugs  that  they  administer  such as injectable  drugs.  Most  States  do not  require  NDCS 
to be  used  as the  billing  code  for drugs  administered  by physicians.  Therefore, 
physicians  bill Medicaid  for drugs  administered  by using either  HCPCS  (most 
common),  Physicians  Common  Procedure  Terminology  (CPT),  or State-specific  codes. 
Since  many  of these  codes  are  not  easily linked  to an NDC  code,  most  of the  drugs 
administered  by physicians  and  reimbursed  by Medicaid  never  receive  a 
manufacturers  rebate.  More  than  three-quarters  of the  State  Medicaid  programs 
report  that  they  do not  routinely  seek  manufacturers  rebates  for drugs  administered 
by physicians. 
Not  only do some  States  handle  rebates  differently  for physician-administered  drugs, 
they  also apply  different  reimbursement  formulas  to these  drugs  billed  without  NDC 
codes.  Only nine  States  use the  same  discounted  formula  for reimbursing  both 
pharmacy-dispensed  and  physician-administered  drugs.  About  one-third  of States  pay 
physicians  based  on AWP  or AWP  plus  a percentage.  Some  States  base  their 
payments  on Medicare  rates  for HCPCS  codes.  Still others  pay the  physicians  invoice 
price  for the  drug  or a percentage  of the  charge  billed  by the  physician. 
Thus,  the  NDC  system  provides  the  foundation  for payment  strategies  such  as rebates 
or discounted  formulas.  Without  it, such strategies  are  extremely  difficult  to 
implement. 
9 RECOMMENDATION

The  findings  of this report  indicate  that  Medicare  allowances  for prescription  drugs
may not  be  appropriate.  We  have  provided  evidence  that  both  a discounted  AWP
reimbursement  formula  and  a rebate  program  for prescription  drugs  could  result  in
significant  savings to the  Medicare  program.  The  magnitude  of these  savings could
reach  over  one-third  of a billion  dollars.
We believe  the  information  in this report  provides  further  support  for  a
recommendation  made  in an OIG  report  entitled  Medicare  Payments  for  Nebulizer

Drugs.  We recommendedthatHCFA reexamine itsMedicaredrugreimbursement

methodologies,with a goal of reducingpaymentsas appropriate. This
recommendation  was based  on a review  of several  drugs  used  in conjunction  with
nebulizers.  In this report,  we have  expanded  the  review  to a larger  number  of drugs.
The  HCFA  concurred  with  the  recommendation  and  is examining  available  options  in
an effort  to make  appropriate  drug  payment  reductions.  The  HCFA  is also working
on a crosswalk  between  the  current  coding  system  for prescription  drugs  and  the
National  Drug  Codes.
We  hope  the  additional  information  we have  provided  in this report  is helpful  to
HCFA  as it explores  new strategies  for prescription  drug  payment.
For  our  readers  convenience,  we repeat  here  the  options  contained  in our  prior
report  for  changing  Medicares  payment  for prescription  drugs.  We  urge  readers  to
review  our  prior  report  for the  full text  of HCFAS comments  in response  to  our
earlier  recommendation  and  this listing of options  for change.
Discounted  Wholesale  Price
Many  State  agencies  use a discounted  AWP  to establish  drug  prices.  Medicare  should
have  a similar  option.  Medicare  could base  its drug payment  on the  lower  of a
discounted  AWP  or the  median  of the  AWP  for all generic  sources,  whichever  results
in the  lower  cost to Medicare  and  its beneficiaries.  To implement  this
recommendation,  HCFA  would  have  to revise  Medicares  claims  coding  system  which
does  not  identify  the  manufacturer  or indicate  if the  drug  is a brand  name  or a generic
equivalent,  information  that  is needed  to discount  the  AWP  and  obtain  a rebate  for  a
specific  drug.  Medicaid  uses the  NDC  in processing  drug  claims.  The  NDC  identifies
the  manufacturer  and  reflects  whether  the  drug  is a brand  name  or a generic
equivalent.
Manufacturers  Rebates
Medicare  could  develop  a legislative  proposal  to establish  a mandated  manufacturers
rebate  program  similar  to Medicaids  rebate  program.  We  recognize  that  HCFA  does
10  not  have  the  authority  to simply establish  a mandated  manufacturers  rebate  program 
similar  to the  program  used  in Medicaid.  Legislation  was required  to establish  the 
Medicaid  rebate  program,  and would  also be required  to establish  a Medicare  rebate 
program.  We  have  not  thoroughly  assessed  how a Medicare  rebate  program  might 
operate,  what  administrative  complexities  it might  pose,  or how a Medicare  rebate 
program  might  differ  from  a Medicaid  rebate  program.  We believe,  however,  the 
legislative  effort  would  be worthwhile.  The  same  manufacturers  that  provide  rebates 
to Medicaid  make  the  drugs  that  are  used  by Medicare  beneficiaries  and  paid  for by 
the  Medicare  program. 
Competitive  Bidding 
Medicare  could  develop  a legislative  proposal  to allow it to take  advantage  of its 
market  position.  While  competitive  bidding  is not  appropriate  for every  aspect  of the 
Medicare  program  or in every geographic  location,  we believe  that  it can  be  effective 
in many  instances,  including  the  procurement  of drugs.  Medicare  could  ask 
pharmacies  to compete  for business  to provide  Medicare  beneficiaries  with 
prescription  drugs.  All types  of pharmacies  could  compete  for Medicare  business, 
including  independents,  chains,  and  mail-order  pharmacies. 
Inherent  Reasonableness 
Since  Medicares  guidelines  for  calculating  reasonable  charges  for drugs  result  in 
excessive  allowances,  the  Secretary  can use her  inherent  reasonableness  authority  to 
set  special  reasonable  charge  limits.  If this option  is selected,  however,  it will not  be 
effective  unless  the  Secretarys  authority  to reduce  inherently  unreasonable  payment 
levels  is streamlined.  The  current  inherent  reasonableness  process  is resource 
intensive  and  time  consuming,  often  taking  two to four years  to implement.  Medicare 
faces  substantial  losses  in potential  savings--certainly  in the  millions  of dollars--if 
reduced  drug  prices  cannot  be placed  into  effect  quickly. 
Acquisition  Cost 
Medicare  could  base  the  payment  of drugs  on the  EAC.  The  DMERCS  and  carriers 
currently  have  this option;  however,  HCFA  has been  unsuccessful  in gathering  the 
necessary  data  to fully implement  it.  Once  the  problem  of gathering  the  necessary 
data  is overcome,  the  use  of the  EAC  would  result  in lower  allowed  amounts.  A 
variation  of this option  is to use  actual  rather  than  estimated  acquisition  cost.  APPENDIX  B 
State  Medicaid  Reimbursement  Formulas  for 
Outpatient  Drugs Billed With NDC  Codes 
B-1  L 
r
IIKansas 
I EAC = AWP - 10% 
Kentucky 
E
Maine 
 
B-2  B-3  IITexas 
Utah 
Vermont 
Virginia 
Washington 
*  Pennsylvania chose not to provide us with drug reimbursement formulas.  The information in 
this table for Pennsylvania was taken from Pharmaceutical  Benejits  Under State Medical 
Assistance  Programs published by the National Pharmaceutical Council. 
B-4