)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 OIG’S 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 OIG’S 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


# SERWCE$ 

~d+ ~oq 

~w JUNE GIBBS BROWN

:

% Inspector General 

% 

‘%++ $ 

MAY 19%


0EI-03-95-O0420
 ‘+dga 
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 selfadministered 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 

Administration’s (HCFA) National Claims History File. We collected drug rebate 

data from HCFA’S 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�

Medicare’s $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 reexarnin
 e its Medicare drugreimbursement 

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 HCFA’S 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 HCFA’S Part B Extract 

and Summary System (BESS). We aggregated the allowance for each code to 

calculate Medicare’s 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 Medicare’s utilization data. Since Medicaid�

rebate amounts are based on individual NDC codes, we needed to link Medicare’s�

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 DataBank’s�

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 HCFA’S 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 Medicare’s 

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 Medicaid’s utilization patterns for brand 

and generic drugs to Medicare’s 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 Medicare’s 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�

qb,c = Each letter represents one of the three individual NDC codes�

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 State’s 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 Medicare’s total expenditure for prescription drugs in 1994 to calculate 

the potential savings to the program if payment mechanisms similar to Medicaid’s 

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 Medicare’s 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 

J1440 Filgrastim, per 300 mcg. I $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 HCFA’S 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 Medicaid’s 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 

Medicare’s $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 didn’t 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 Medicare’s 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 

manufacturer’s 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 physician’s 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 itsMedicare drugreimbursement


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 Medicare’s payment for prescription drugs. We urge readers to�

review our prior report for the full text of HCFA’S 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 Medicare’s 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 Medicaid’s 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 Medicare’s 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 Secretary’s 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 

IIKansas 

r

Kentucky 

E

Maine 

I EAC = AWP - 10% 

— 

B-2 
B-3 
Texas 

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�

II