DEPARTMENT OF HEALTH &. HUMAN SERVICES 	 Office of Inspector General 

Washington, D.C. 20201 

NOV 172010 

TO: 	 Donald M. Berwick, M.D. 

Administrator 

Centers for Medicare & Medicaid Services 

FROM: Stuart Wright 

Deputy Inspector General 

for Evaluation and Inspections 

SUBJECT: 	 Memorandum Report: Medicare Part D Pharmacy Discounts for 2008, 

OEI-02-10-00120 

This memorandum report provides information about how sponsors negotiate discounts with 

pharmacies, how these discounts differ among brand-name and generic drugs, and whether 

sponsors are passing these discounts on to beneficiaries and the Government. Prior to this 

review, little information was available about pharmacy discounts. This information is critical 

for the Part D program because these discounts directly affect the amount that beneficiaries and 

the Government pay for Part D drugs. 

We found that for all six sponsors we reviewed, pharmacy benefit managers (PBM) negotiated 

lower drug prices with pharmacies in exchange for the pharmacies being in the sponsors' 

networks. We also found that the pharmacy discounts for brand-name drugs were based on 

average wholesale prices, whereas the discounts for generic drugs were based on prices 

established by PBMs. Finally, we found that for five ofthe six sponsors, pharmacy discounts 

were not always passed on to beneficiaries and the Government. These results provide valuable 

information about how PBMs negotiate with pharmacies for lower Part D drug prices and about 

the pricing methods sponsors use to pay for these drugs. These results further highlight the 

importance of sponsors ensuring that they are receiving the pharmacy discounts they negotiated 

and that they are passing these discounts on to beneficiaries and the Government. 

OEI-02-10-00120 Medicare Part D Pharmacy Discounts for 2008 
Page 2 – Donald M. Berwick, M.D. 

BACKGROUND 

The Medicare Prescription Drug Benefit 

The Medicare prescription drug program, known as Medicare Part D, provides an optional drug 

benefit to Medicare beneficiaries.1 The Centers for Medicare & Medicaid Services (CMS) 

contracts with private insurance companies, known as Part D sponsors, to provide the drug 

benefit to beneficiaries who choose to enroll in the program. 

Under Medicare Part D, sponsors may offer stand-alone prescription drug plans or they may 

offer prescription drug coverage as part of a managed care plan. At a minimum, Part D sponsors 

are required to offer a basic prescription drug benefit that is either the standard prescription drug 

benefit or is “actuarially equivalent” to the standard benefit.2 Most beneficiaries are responsible 

for certain costs, which may include a monthly premium, an annual deductible, and coinsurance 

or copayments. However, low-income beneficiaries are eligible to receive assistance to pay 

some or all of these costs.3

Pharmacy Discounts 

CMS requires that Part D sponsors develop a network of pharmaciesto dispense drugs to 

beneficiaries enrolled in their plans.4 Sponsors generally contract with third-party entities, 

known as PBMs, to develop their pharmacy networks.5 CMS requires these pharmacy networks 

to be geographically diverse and to include different types of pharmacies, such as retail 

pharmacies and long-term care pharmacies.6 

Sponsors also contract with PBMs to negotiate discounts with pharmacies. These pharmacy 

discounts affect the prices that beneficiaries and the Government pay for Part D drugs. In 

addition to negotiating lower drug prices with network pharmacies, PBMs also negotiate 

dispensing fees, which are payments provided to pharmacies for each drug dispensed. 

It is important to note that pharmacy discounts are distinct from drug manufacturer rebates. 

Discounts negotiated with pharmacies are typically reflected in the price that the beneficiary 

pays at the pharmacy, whereas rebates are typically lump-sum payments made by drug 

manufacturers to sponsors. Drug manufacturers provide rebates to sponsors when they 

encourage beneficiaries to use certain drugs. 

1 The Medicare Prescription Drug, Improvement, and Modernization Act of 2003, P.L. 108-173. 

2 42 U.S.C. § 1395w-102, 42 CFR §§ 423.104(d) and (e). “Actuarially equivalent” means that the plan’s benefits must be of a 

dollar value equivalent to that of the standard benefit. 

3 42 CFR §§ 423.780 and 423.782. 

4 42 U.S.C. § 1395w-104(b)(1), 42 CFR § 423.120(a). 

5 PBMs can provide a number of services to sponsors, including processing prescription drug claims, contracting with 

pharmacies, and managing formularies. Sponsors may also perform these services themselves. 

6 Long-term care pharmacies provide specialized services, such as a comprehensive inventory of drugs commonly used in 

long-term care settings, specialized packaging, 7-day-a-week delivery, and emergency medications. 

OEI-02-10-00120 Medicare Part D Pharmacy Discounts for 2008 
Page 3 – Donald M. Berwick, M.D. 

Payment to Pharmacies for Part D drugs 

PBMs pay the pharmacies for drugs on behalf of the sponsors, and the sponsors later reimburse 

the PBMs for those drugs. The amount that the sponsor pays the PBM varies depending upon 

the pricing approach. Sponsors may contract with the PBM using what is known as “lock-in 

pricing” or “pass-through pricing.” 

When lock-in pricing is used, the sponsor pays the PBM a set amount for its drugs. The PBM 

then negotiates with pharmacies for the best possible price, which may vary from the price the 

sponsor agrees to pay the PBM. If the PBM negotiates a lower price for a drug, then the PBM 

keeps the difference between the price the sponsor agreed to pay and the amount that the PBM 

actually pays the pharmacy. Conversely, when pass-through pricing is used, the sponsor 

reimburses the PBM the same amount that the PBM pays the pharmacy. The pass-through price 

is often lower than the lock-in price.7 

METHODOLOGY 

This memorandum report describes pharmacy discounts in the 2008 plan year. It is based on a 

review of contracts from six selected sponsors and their PBMs and structured interviews with 

officials from these six selected sponsors and their PBMs. 

We selected a purposive sample of six Part D sponsors based on the number of beneficiaries 

enrolled in their plans and the PBMs they contracted with to get a variety of sponsors and PBMs 

for our review.8 Each of the six sponsors contracted with at least one PBM. These six sponsors 

represented more than 25 percent of all Part D beneficiaries in 2008. These are the same six 

sponsors that we reviewed in a forthcoming report entitled Concerns With Rebates in the 

Medicare Part D Program.9 

Review of Contracts 

For each of these 6 sponsors, we selected a purposive sample of 10 contracts that the PBM had 

with network pharmacies. To select these contracts, we first requested a list from each sponsor 

of all of the contracts it or its PBM had with pharmacies in 2008. From these lists, we selected 

10 contracts from each sponsor. We selected a mix of contracts that covered retail and long-term 

care pharmacies as well as chain and independent pharmacies. In total, we received and 

reviewed 60 contracts. We reviewed these contracts for information about the nature and extent 

of pharmacy discounts and any associated dispensing fees. 

 

7 The lock-in price includes a “risk premium” which the sponsor pays to the PBM to mitigate market risk and shield the 

Part D sponsor from price variability between pharmacies. 74 Fed. Reg. 1494, 1505 (Jan. 12, 2009). Beginning 

January 1, 2010, CMS required Part D sponsors to use the price received by the pharmacy to calculate beneficiary cost 

sharing and total drug costs. 74 Fed. Reg. 1506, 1544 (Jan. 12, 2009). 

8 These six sponsors were selected from a universe of 258 Part D sponsors. 

9 Office of Inspector General, Concerns With Rebates in the Medicare Part D Program, OEI-02-08-00500, forthcoming. 

OEI-02-10-00120 Medicare Part D Pharmacy Discounts for 2008 
Page 4 – Donald M. Berwick, M.D. 

We also requested and reviewed all of the contracts that the six selected sponsors had with PBMs 

in 2008.10 We reviewed these contracts to determine the nature of the contractual relationships 

between the sponsors and their PBMs and how discounts were passed on to beneficiaries and the 

Government. 

Structured Interviews 

We conducted structured in-person or telephone interviews with officials from each of the six 

selected sponsors. We interviewed these officials to gain a better understanding of their 

pharmacy networks and discounts and their contractual relationships with PBMs. We requested 

that representatives from the PBM also be included in the interviews. In some cases, the 

representatives from the PBMs requested that we speak to them without the sponsors present 

because of the confidential nature of the information. 

Our questions focused on how discounts were negotiated with pharmacies, the size of their 

pharmacy networks, the nature and extent of pharmacy discounts, and any associated dispensing 

fees. We also asked questions about the contractual relationships between the sponsors and their 

PBMs. For some questions, such as how discounts were negotiated with pharmacies, PBMs 

answered on behalf of the sponsors. Our questions focused on the 2008 plan year. We 

conducted these interviews between December 2008 and April 2009. 

Limitations 

The information in this memorandum report is from six selected sponsors and is not 

generalizable to all sponsors. In addition, because of the proprietary nature of the data on 

discounts, we presented general information and did not include specific data for the individual 

sponsors. 

Standards 

This study was conducted in accordance with the Quality Standards for Inspections approved by 

the Council of the Inspectors General on Integrity and Efficiency. 

RESULTS

For All Six Sponsors, PBMs Negotiated Lower Drug Prices With Pharmacies in Exchange 

for the Pharmacies Being in the Sponsors’ Networks 

Each of the six sponsors we reviewed relied on PBMs to negotiate drug prices with pharmacies. 

These negotiations resulted in pharmacies charging lower drug prices for Part D beneficiaries 

than the prices they would charge their cash-paying customers. Pharmacies generally accepted 

these lower prices because participating in sponsors’ networks increased the number of 

beneficiaries who used their pharmacies. Each of the 6 sponsors reported that their pharmacy 

network consisted of at least 55,000 pharmacies; 1 sponsor had more than 63,000 network 

pharmacies. 

10 In total, the six sponsors had nine contracts with PBMs. Two of the sponsors had contracts with more than one PBM. 

OEI-02-10-00120 Medicare Part D Pharmacy Discounts for 2008 
Page 5 – Donald M. Berwick, M.D. 

The PBMs for the six selected sponsors reported that they prepare standard contracts for various 

types of pharmacies, such as retail pharmacies and long-term care pharmacies. These contracts 

dictated the discounts that pharmacies had to accept in order to be part of the sponsor’s network. 

Several PBMs reported that it was rare for pharmacies to participate in their networks if the 

pharmacies refused to accept the discounts in these standard contracts. However, in some cases, 

the PBM was willing to negotiate smaller discounts if, for example, the PBM needed a particular 

pharmacy to ensure sufficient geographic coverage in the pharmacy network.11 

For All Six Sponsors, Pharmacy Discounts for Brand-Name Drugs Were Based on Average 

Wholesale Prices and Varied by the Length of Supply, Pharmacy Type, and Geographic 

Location 

For brand-name drugs, PBMs negotiated discounts based upon a fixed percentage that is 

subtracted from the drug’s average wholesale price (AWP).12 In the contracts we reviewed, this 

percentage is applied to all brand-name Part D drugs and varied by several factors, including the 

length of the supply, the pharmacy type, and geographic location. 

Notably, in the contracts we reviewed, different discounts were often provided to retail 

pharmacies for an extended supply of drugs, such as a 3-month supply, versus a short-term 

supply of drugs.13 When this occurred, the discounts for an extended supply were greater and 

generally ranged from 18 percent to 22 percent of AWP. This compares to 15 percent to 

17 percent of AWP for a short-term supply of drugs. In addition, these contracts often 

established higher dispensing fees for an extended supply of drugs. The average dispensing fee 

for an extended supply was $2.20, compared to an average of $1.90 for a short-term supply. 

In a number of contracts, the pharmacy was given a separate option to participate in the 

sponsor’s network for providing extended supplies of drugs. In these cases, the discounts for 

providing extended supplies were high—for example, 23 percent of AWP—and there was often 

no dispensing fees provided to the pharmacy. Only 9 of the 16 pharmacies that were offered this 

option chose to participate in the sponsors’ extended supply network. 

Further, discounts for drugs dispensed by long-term care pharmacies were generally smaller than 

those for drugs dispensed by retail pharmacies. In the contracts we reviewed, the discounts for 

drugs dispensed by long-term care pharmacies generally ranged from 12 percent to 14 percent, 

compared to 15 percent to 17 percent for retail pharmacies. In addition, long-term care 

pharmacies generally received higher dispensing fees. For example, in one contract we 

11 Sponsors must include enough pharmacies in their network to ensure that all beneficiaries have convenient access. 

42 CFR § 423.120. 

12 The contracts also specified that PBMs would not pay the pharmacies more than the prices that they charge their 

cash-paying customers. As one contract noted, “AWP does not represent a true wholesale price, but rather is a fluctuating 

benchmark.” Therefore, it is possible for the discounted prices to exceed the standard prices paid by cash-paying customers. 

This provision of the contract, commonly called a usual and customary provision, ensures that the PBM pays the lesser of the 

cash price or the discount based on AWP. 

13 The length of supply could be either a short-term supply or an extended supply. The number of days included in a 

 short-term supply was generally 1 month or less. An extended supply was generally more than 1 month and up to 3 months. 

OEI-02-10-00120 Medicare Part D Pharmacy Discounts for 2008 
Page 6 – Donald M. Berwick, M.D. 

reviewed, long-term care pharmacies received dispensing fees that were twice as much as the 

dispensing fees provided to retail pharmacies. 

Discounts also sometimes differed for certain geographic locations. For example, five of the six 

selected sponsors reported that their discounts were less substantial in certain areas, such as 

Alaska, Hawaii, the U.S. Virgin Islands, and Puerto Rico. One contract we reviewed for a 

pharmacy in Alaska set the discount at 5 percent of AWP. This contract also included a 

dispensing fee of almost $8. One sponsor noted that these pharmacies often have higher costs 

because of their remote locations. 

For All Six Sponsors, Pharmacy Discounts for Generic Drugs Were Based on Prices 

Established by PBMs and Were Often Accompanied by Higher Dispensing Fees and 

Benchmarks To Encourage Generic Drug Use 

Pharmacy discounts for generic drugs were negotiated differently than the discounts for 

brand-name drugs. For each of the six selected sponsors, the PBM developed a list of generic 

drugs—known as the Maximum Allowable Cost (MAC) list—which established a maximum 

amount that the sponsor will pay for each drug on this list.14 

Several PBMs noted that prices on their MAC lists change frequently, sometimes on a weekly or 

even a daily basis. PBMs also noted that pharmacies were not routinely provided access to the 

MAC lists. Most PBMs in our review provided their MAC lists (or a portion of their MAC list) 

to pharmacies only under limited circumstances, and one PBM would not share its MAC list 

under any circumstances. The pharmacies agreed to accept the prices on the MAC list without 

knowing what these prices were until they submitted their claims. 

Further, in the contracts we reviewed, PBMs often established larger dispensing fees for generic 

drugs to encourage generic drug use. These fees were an average of 30 cents higher than the 

dispensing fees for brand-name drugs. Several of the contracts also allowed for additional 

payments to be made to the pharmacy if the pharmacy achieved certain levels of generic drug use 

among its Part D beneficiaries. 

In addition, several sponsors’ contracts included benchmarks that must be met by their PBMs. 

These benchmarks—which are often called generic effective rates—required the PBM to provide 

a minimum average discount among its network pharmacies for generic drugs. For example, one 

contract specified that average generic drug prices not exceed the AWP less 62 percent. If the 

discounts negotiated by the PBM did not meet this benchmark, the PBM had to reimburse the 

sponsor the difference. These benchmarks help to encourage generic drug use among Part D 

beneficiaries. 

14 For generic drugs not included on the MAC list, the contracts specified that the sponsor would receive a discount based on 

the drug’s AWP. The contracts also specified that the sponsor would not pay the pharmacy more than the prices they charge 

their cash-paying customers. 

OEI-02-10-00120 Medicare Part D Pharmacy Discounts for 2008 
Page 7 – Donald M. Berwick, M.D. 

OEI-02-10-00120 Medicare Part D Pharmacy Discounts for 2008 

For Five of the Six Sponsors, Pharmacy Discounts Were Not Always Passed on to 

Beneficiaries and the Government 

Five of the six selected sponsors reported using lock-in pricing for at least some drugs in 2008. 

In some cases, sponsors used lock-in pricing for some plans and not for others. In other cases, 

they used lock-in pricing only for certain types of drugs, such as generic drugs. 

When lock-in pricing was used, beneficiaries and the Government did not always receive the full 

benefit of the pharmacy discounts negotiated by PBMs. This was because the lock-in prices—

rather than the actual pharmacy discounts negotiated by PBMs—were used to calculate both the 

beneficiaries’ and the Government’s share of the drug costs. Because lock-in prices tend to be 

higher than the actual pharmacy discounts negotiated by PBMs,this pricing method increases the 

overall cost of these drugs for beneficiaries and the Government.15 

Beginning in 2010, CMS required sponsors to provide the full benefit of pharmacy discounts to 

beneficiaries and the Government. CMS issued new regulations requiring sponsors that use 

lock-in pricing to include all pharmacy discounts negotiated by PBMs to calculate beneficiaries’ 

and the Government’s share of the drug costs.16 

CONCLUSION 

Pharmacy discounts are an effective tool for lowering the costs of Part D drugs. We found that 

for all six sponsors we reviewed, PBMs negotiated lower drug prices with pharmacies in 

exchange for the pharmacies being in the sponsors’ networks. We also found that the pharmacy 

discounts for brand-name drugs were based on average wholesale prices, whereas the discounts 

for generic drugs were based on prices established by PBMs. Finally, we found that for five of 

the six sponsors, pharmacy discounts were not always passed on to beneficiaries and the 

Government. These results provide valuable information about how PBMs negotiate with 

pharmacies for lower Part D drug prices and about the pricing methods sponsors use to pay for 

these drugs. These results further highlight the importance of sponsors ensuring that they are 

receiving the pharmacy discounts they negotiated and that they are passing these discounts on to 

beneficiaries and the Government. 

This report is being issued directly in final form because it contains no recommendations. If you 

have comments or questions about this report, please provide them within 60 days. Please refer 

to report number OEI-02-10-00120 in all correspondence. 

15 74 Fed. Reg. 1505, 1544 (Jan. 12, 2009). 

16 42 CFR § 423.100, 74 Fed. Reg. 1544 (Jan. 12, 2009). See also 74 Fed. Reg. 1505–1506 (Jan. 12, 2009).