United States Government Accountability Office

GAO Testimony 

Before the Subcommittee on Health,

Committee on Energy and Commerce,

House of Representatives 

MEDICAID DRUG REBATE

PROGRAM 

Inadequate Oversight Raises 

Concerns about Rebates 

Paid to States 

Statement of Kathleen King 

Director, Health Care

For Release on Delivery 

Expected at 2:00 p.m. EDT 

Wednesday, June 22, 2005 

 

GAO-05-850T
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

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June 22, 2005

MEDICAID DRUG REBATE PROGRAM

Inadequate Oversight Raises Concerns 

Highlights of GAO-05-850T, a testimony about Rebates Paid to States

before the Subcommittee on Health,

Committee on Energy and Commerce,

House of Representatives

To help control Medicaid spending

on drugs, states receive rebates 

from pharmaceutical

manufacturers through the

Medicaid drug rebate program. 

Rebates are based on two prices–

best price and average 

manufacturer price (AMP)–

reported by manufacturers. GAO 

was asked to discuss issues 

relating to the rebate program and 

in February 2005 issued a report, 

Medicaid Drug Reba e Program: 

Inadequate Oversight Ra ses

Concerns about Reba es Paid to

S ates (GAO-05-102). For that 

report, GAO reviewed program

guidance and OIG reports and

conducted an analysis of rebates 

for brand name drugs. This 

testimony is based on the February

2005 report. 

What GAO Recommends

In its February 2005 report, GAO 

recommended that CMS issue

clear, updated guidance on 

manufacturer price determination 

methods and price definitions. It

also recommended that CMS

implement systematic oversight of

manufacturer methods and a plan

to ensure the accuracy of reported

prices and rebates to states. HHS

agreed with the importance of

guidance to manufacturers but did

not agree that the program had 

received inadequate oversight. 

GAO acknowledged HHS oversight

actions but did not believe they 

ensured accurate rebates to states. 

As noted in the February 2005 report, GAO found that rebate program 

oversight does not ensure that manufacturer-reported prices or price 

determination methods are consistent with program criteria specified in the 

rebate statute, rebate agreement, and Centers for Medicare & Medicaid

Services (CMS) program memoranda. In administering the program, CMS 

conducts only limited checks for reporting errors in manufacturer-reported 

drug prices and only reviews price determination methods when 

manufacturers request recalculations of prior rebates. In several reports, the 

Department of Health and Human Services’ (HHS) Office of Inspector 

General (OIG) identified several factors that limited its ability to verify the 

accuracy of manufacturer-reported prices, including a lack of clear guidance

on how AMP should be calculated. GAO noted that although in some cases 

OIG found problems with manufacturers’ price determination methods and 

prices, CMS had not followed up with manufacturers to make sure that 

problems had been resolved. 

GAO also found considerable variation in the methods that manufacturers 

used to determine best price and AMP. In some cases, manufacturers’

assumptions could have lowered rebates; in other cases, their assumptions 

could have raised rebates. Manufacturers are allowed to make assumptions 

when determining best price and AMP, as long as they are consistent with 

the law and the rebate agreement. GAO found that manufacturers made 

varying assumptions about which sales and prices to include and exclude 

from their determinations of best price and AMP. Manufacturers also 

differed in how they accounted for certain price reductions, fees, and other

transactions when determining best price and AMP.

The rebates that manufacturers pay to states are based on prices and 

financial concessions manufacturers make available to entities that purchase 

their drugs but may not reflect certain financial concessions they offer to

other entities. In particular, the rebate program does not clearly address 

certain manufacturer payments negotiated by pharmacy benefit managers 

(PBM) on behalf of third-party payers. These types of financial arrangements 

are relatively new to the market. CMS’s guidance to manufacturers has not 

clearly stated how manufacturers should treat these payments when

determining best price and AMP. Additional guidance on how to account for 

these payments could affect rebates, although whether rebates would 

increase or decrease as a result, and by how much, is uncertain. 

www.gao.gov/cgi-bin/getrpt?GAO-05-850T.

To view the full product, including the scope 

and methodology, click on the link above.

For more information, contact Kathleen King 

at (202) 512-7118.
Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss our report entitled Medicaid Drug

Rebate Program: Inadequate Oversight Raises Concerns about Rebates 

Paid to S a es, which we issued in February 2005.1

 Prescription drug

spending accounts for a substantial and growing share of state Medicaid 

program outlays. The Omnibus Budget Reconciliation Act of 1990

established the Medicaid drug rebate program2 to help control Medicaid

drug spending. Under the rebate program, pharmaceutical manufacturers 

pay rebates to states as a condition for the federal contribution to

Medicaid spending for the manufacturers’ outpatient prescription drugs. In

recent years, the importance of Medicaid rebates to states has grown as

Medicaid spending on prescription drugs has risen. From fiscal year 2000 

to 2003, Medicaid drug spending increased at an annual average rate of 

18 percent, while Medicaid spending as a whole grew 10 percent annually 

during that period. In fiscal year 2003, Medicaid drug expenditures were 

$33.8 billion out of $273.6 billion in total Medicaid spending; under the 

rebate program, manufacturers paid rebates to states of about $6.5 billion 

for covered outpatient drugs.3,4

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Medicaid rebates for brand name outpatient drugs are calculated with two

prices that participating manufacturers must report to the federal

government for each drug: the “best price” and the “average manufacturer 

price” (AMP). Best price and AMP represent prices that are available from 

manufacturers to entities that purchase their drugs. Best price for a drug is 

the lowest price available from the manufacturer to any purchaser, with 

some exceptions. AMP for a drug is the average price paid to a 

manufacturer by wholesalers for drugs distributed to the retail pharmacy 

class of trade. Both best price and AMP must reflect certain financial 

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1

See GAO, Medicaid Drug Reba e Program: Inadequate Oversight Raises Concerns about

Rebates Paid to Sta es, GAO-05-102 (Washington, D.C.: Feb. 4, 2005).

2

Pub. L. No. 101-508, § 4401, 104 Stat. 1388, 1388-143-161 (codified at 42 U.S.C. §1396r-8

(2000)). All states and the District of Columbia participate in the Medicaid drug rebate

program, except for Arizona. 

3

State Medicaid programs do not purchase drugs directly but rather reimburse pharmacies

when they dispense covered outpatient drugs to Medicaid beneficiaries. These payments, 

which include an amount to cover the cost of acquiring the drug as well as a dispensing fee, 

are calculated using state-specific payment formulas. 

4

This rebate amount includes the three types of rebates included in the Medicaid drug

rebate program: the “basic” rebate for brand name drugs, the “additional” rebate for brand 

name drugs, and the rebate for generic drugs. 

Page 1 GAO-05-850T
concessions, such as discounts, that are available to drug purchasers. The 

basic Medicaid rebate for a brand name drug equals the number of units of

the drug paid for by the state Medicaid program multiplied by the basic 

“unit rebate amount” for the drug, which is either the difference between 

best price and AMP, or 15.1 percent of AMP, whichever is greater.

5

 The 

closer best price is to AMP, the more likely the rebate will be based on 

15.1 percent of AMP—the minimum rebate amount. 

The Centers for Medicare & Medicaid Services (CMS) administers and 

oversees the rebate program, entering into rebate agreements with

manufacturers,6

 collecting and reviewing manufacturer-reported best

prices and AMPs, and providing ongoing guidance to manufacturers and

states on the program. The Secretary of Health and Human Services, by 

law, may verify manufacturer-reported prices and has delegated that

authority to the Department of Health and Human Services’ (HHS) Office 

of Inspector General (OIG). 

In this testimony, I will discuss our February 2005 report, in which we 

addressed (1) federal oversight of manufacturer-reported best prices and 

AMPs and the methods manufacturers used to determine those prices, 

(2) how manufacturers’ methods of determining best price and AMP could 

have affected the rebates they paid to state Medicaid programs, and 

(3) how the rebate program reflects financial concessions available in the 

private market.

In carrying out our work, we reviewed the rebate statute, the standard 

rebate agreement between CMS and participating manufacturers, CMS 

program memoranda, OIG reports on the rebate program, and market

literature; interviewed officials from CMS and OIG; and conducted an 

analysis of rebates for brand name drugs, for which we reviewed the 

pricing methodologies for the 13 manufacturers that accounted for the 

highest Medicaid expenditures in the last two quarters of 2000. We

compared manufacturers’ methods of determining best price and AMP to

 5

This testimony focuses on the basic rebate for brand name drugs, not the additional rebate

for brand name drugs—which occurs when a brand name drug’s AMP rises faster than

inflation, as measured by changes in the consumer price index—or the rebate for generics. 

The total unit rebate amount for a brand name drug includes the basic rebate and any 

additional rebate. 

6

The rebate agreement is a standard contract between CMS and each manufacturer that

governs manufacturers’ participation in the rebate program, providing, among other things,

definitions of key terms.

Page 2 GAO-05-850T
the rebate statute, rebate agreement, and relevant CMS program 

memoranda. In addition, we examined sales transaction data provided by 

these manufacturers. We received data for the 10 brand name drugs that

produced the highest Medicaid expenditures for the last two quarters of

2000 for each manufacturer, as well as data for 5 additional frequently 

prescribed brand name drugs—135 drugs in total. We examined the sales 

transaction data to understand how manufacturers implemented their 

price determination methods and to calculate the impact of manufacturer 

practices on rebates. Because we purposely selected manufacturers and 

drugs that accounted for a large share of Medicaid drug spending, the 

results of our analysis cannot be generalized. We performed our work 

from December 2003 through January 2005 in accordance with generally 

accepted government auditing standards. 

In brief, we reported in February 2005 that rebate program oversight does 

not ensure that manufacturer-reported prices or price determination 

methods are consistent with program criteria as specified in the rebate 

statute, rebate agreement, and CMS program memoranda. We found that

CMS conducts only limited checks for reporting errors in manufacturerreported drug prices and only reviews price determination methods when 

manufacturers request recalculations of prior rebates. In addition, OIG 

reported that its review efforts were hampered by unclear CMS guidance 

on how manufacturers are to determine AMP and by a lack of

manufacturer documentation. Although OIG in some cases identified 

problems with manufacturers’ price determination methods and reported 

prices, CMS had not followed up with manufacturers to make sure that

those problems had been resolved. We also found considerable variation 

in the methods that the manufacturers we reviewed used to determine 

best price and AMP. In some cases, manufacturers’ assumptions could 

have lowered rebates; in other cases, their assumptions could have raised 

rebates. Manufacturers are allowed to make reasonable assumptions when 

determining best price and AMP, as long as those assumptions are 

consistent with the law and the rebate agreement. We found that

manufacturers made varying assumptions about which sales and prices to

include and exclude from their determinations of best price and AMP. We 

also found that manufacturers differed in how they accounted for certain 

price reductions, fees, and other transactions when determining best price 

and AMP. Finally, we found that the rebates that manufacturers pay to

states are based on prices and financial concessions that manufacturers 

make available to entities that purchase their drugs but may not reflect 

certain financial concessions they offer to other entities in today’s 

complex market. In particular, the rebate program does not clearly 

address certain concessions that are negotiated by pharmacy benefit 

Page 3 GAO-05-850T
managers (PBM) on behalf of third-party payers—concessions that are a 

relatively new development in the market. 

We concluded that although the rebate program relies on manufacturerreported prices to determine the level of rebates that manufacturers pay to

states, CMS has not provided clear program guidance for manufacturers to 

follow when determining those prices; in addition, oversight by CMS and

OIG has been inadequate to ensure that manufacturer-reported prices and 

methods are consistent with the law, rebate agreement, and CMS program 

memoranda. We recommended that CMS take several steps to improve 

program guidance and oversight, namely, to issue clear guidance on 

manufacturer price determination methods and the definitions of best

price and AMP; update such guidance as additional issues arise; and 

implement, in consultation with OIG, systematic oversight of the price 

determination methods employed by pharmaceutical manufacturers and a 

plan to ensure the accuracy of manufacturer-reported prices and rebates 

to states. HHS agreed with the importance of guidance to manufacturers,

but disagreed with our conclusion that there has been inadequate program 

oversight. We acknowledged HHS’s oversight actions, but stated that HHS 

oversight does not adequately ensure the accuracy of manufacturerreported prices and rebates paid to states. Some of the manufacturers that

supplied data for the report raised concerns about our discussion of

certain methods they used to determine rebates, and we clarified our

discussion of manufacturers’ price determination methods. 

The Medicaid drug rebate program provides savings to state Medicaid

programs through rebates for outpatient prescription drugs that are based 

on two prices per drug that manufacturers report to CMS: best price and 

AMP. These manufacturer-reported prices are based on the prices that

manufacturers receive for their drugs in the private market and are 

required to reflect certain financial concessions such as discounts. 

Background 

Pharmaceutical manufacturers sell their products directly to a variety of

purchasers, including wholesalers, retailers such as chain pharmacies, and 

health care providers such as hospitals that dispense drugs directly to

patients. The prices that manufacturers charge vary across purchasers. 

The amount a manufacturer actually realizes for a drug is not always the 

same as the price that is paid to the manufacturer at the time of sale. 

Manufacturers may offer purchasers rebates or discounts that may be

realized after the initial sale, such as those based on the volume of drugs 

the purchasers buy during a specified period or the timeliness of their 

payment. The private market also includes PBMs, which manage 

Page 4 GAO-05-850T
prescription drug benefits for third-party payers and may also operate

mail-order pharmacies.7

The statute governing the Medicaid drug rebate program and the standard 

rebate agreement that CMS signs with each manufacturer define best price

and AMP and specify how those prices are to be used to determine the

rebates due to states. In the absence of program regulations,8

 CMS has

issued program memoranda9

 in order to provide further guidance to

manufacturers regarding how to determine best price and AMP.10 The 

rebate agreement states that in the absence of specific guidance on the 

determination of best price and AMP, manufacturers may make 

“reasonable assumptions” as long as those assumptions are consistent

with the “intent” of the law, regulations, and the rebate agreement.11 As a 

result, price determination methods may vary across manufacturers, 

particularly with respect to which transactions they consider when 

determining best price and AMP. 

Under the rebate statute, best price is the lowest price available from the 

manufacturer to any wholesaler, retailer, provider, health maintenance 

organization (HMO), or nonprofit or government entity, with some

exceptions.12 Best price is required to be reduced to account for cash 

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7

See GAO, Federal Employees’ Hea th Benefits: Effects of Using Pharmacy Benef t 

Managers on Health Plans, Enro ees, and Pharmacies, GAO-03-196 (Washington, D.C.: Jan.

10, 2003). 

8

In 1995, CMS issued a proposed rule for implementation of the drug rebate program, which 

included provisions regarding best price, AMP, and manufacturer reporting requirements. 

See 60 Fed. Reg. 48442 (1995). Only a portion of that rule—concerning the length of time

manufacturers are able to report price adjustments to CMS and how long they must retain 

documentation of their reported prices—has been issued in final form. See 69 Fed. Reg.

68815 (2004), 68 Fed. Reg. 51912 (2003). 

9

As of October 2004, CMS had issued a total of 65 program memoranda—also called 

“program releases”—to manufacturers to provide guidance on a range of issues relating to

the rebate program. 

10CMS also responds to questions from individual manufacturers on a case-by-case basis. In

addition, the agency provides an operational training guide and training for manufacturers

and states on resolving disputes over state-reported drug utilization information used to 

calculate rebate amounts.

11The rebate agreement also requires manufacturers to maintain records of their

assumptions. 

12See 42 U.S.C. §1396r-8(c)(1)(C). The rebate agreement further defines best price as the 

lowest price at which the manufacturer sells the drug to any purchaser in any pricing 

structure, including capitated payments, with some exceptions. 

Page 5 GAO-05-850T
discounts, free goods that are contingent on purchase requirements, 

volume discounts and rebates (other than rebates under this program), as 

well as—according to the rebate agreement and a CMS program 

memorandum—cumulative discounts and any other arrangements that

subsequently adjust the price actually realized. Prices charged to certain 

federal purchasers,13 eligible state pharmaceutical assistance programs and

state-run nursing homes for veterans, and certain health care facilities—

including those in underserved areas or serving poorer populations—are 

not considered when determining best price. Prices available under 

endorsed Medicare discount card programs, as well as those negotiated by 

Medicare prescription drug plans or certain retiree prescription drug 

plans, are similarly excluded from best price. Nominal prices—prices that

are less than 10 percent of AMP—also are excluded from best price. 

AMP is defined by statute as the average price paid to a manufacturer for 

the drug by wholesalers for drugs distributed to the retail pharmacy class 

of trade.14 The transactions used to calculate AMP are to reflect cash 

discounts and other reductions in the actual price paid, as well as any 

other price adjustments that affect the price actually realized, according to 

the rebate agreement and a CMS program memorandum.

15 Under the 

rebate agreement, AMP does not include prices to government purchasers 

based on the Federal Supply Schedule, prices from direct sales to

hospitals or HMOs, or prices to wholesalers when they relabel drugs they

purchase under their own label.

The relationship between best price and AMP determines the unit rebate

amount and thus the size of the rebate that states receive for a brand name

drug. The basic unit rebate amount is the larger of two values: the 

difference between best price and AMP, or 15.1 percent of AMP.

16 The 

 13Sales made through the Federal Supply Schedule are not considered in determining best

price, nor are single-award contract prices of any federal agency, federal depot prices, and 

prices charged to the Department of Defense, Department of Veterans Affairs, Indian

Health Service, and Public Health Service. 

14See 42 U.S.C. §1396r-8(k)(1). The statute states that customary prompt payment discounts

are to be subtracted from prices used to calculate AMP. There is no definition in the statute

for “retail pharmacy class of trade.”

15Under the rebate agreement, AMP is calculated as net sales divided by units sold,

excluding free goods (i.e., drugs or any other items given away, but not contingent on any 

purchase requirements).

16See 42 U.S.C. §1396r-8(c)(1).

Page 6 GAO-05-850T
closer best price is to AMP, the more likely the rebate for a drug will be 

based on the minimum amount—15.1 percent of AMP—rather than the 

difference between the two values. A state’s rebate for a drug is the 

product of the unit rebate amount and the number of units of the drug paid

for by the state’s Medicaid program. 

Manufacturers pay rebates to states on a quarterly basis. They are required

to report best price and AMP for each drug to CMS within 30 days of the 

end of each calendar quarter. Once CMS receives this information, the 

agency uses the rebate formula to calculate the unit rebate amount for the 

smallest unit of each drug, such as a tablet, capsule, or ounce of liquid. 

CMS then provides the unit rebate amount to the states. Each state 

determines its Medicaid utilization for each covered drug—as measured by

the total number of the smallest units of each dosage form, strength, and 

package size the state paid for in the quarter—and reports this information 

to the manufacturer within 60 days of the end of the quarter. The 

manufacturer then must compute and pay the rebate amount to each state 

within 30 days of receiving the utilization information. 

Manufacturers are required to report price adjustments to CMS when there 

is a change in the prices they reported for a prior quarter. These 

adjustments may result from rebates, discounts, or other price changes 

that occur after the manufacturers submit prices to CMS. Manufacturers 

also may request that CMS recalculate the unit rebate amounts using 

revised prices if they determine that their initially reported prices were

incorrect because of, for example, improper inclusion or exclusion of

certain transactions. In 2003, CMS issued a final rule that, effective 

January 1, 2004, limits the time for manufacturers to report any price 

adjustments to 3 years after the quarter for which the original price was 

reported.17

 17The 2003 final rule addressed the time frame for reporting price adjustments to CMS and 

the time frame for retaining documentation of reported prices. See 68 Fed. Reg. 51912, 

55527 (2003). 

Page 7 GAO-05-850T
As we reported in February 2005, the minimal oversight by CMS and OIG 

of manufacturer-reported prices and price determination methods does 

not ensure that those prices or methods are consistent with program

criteria, as specified in the rebate statute, rebate agreement, and CMS 

program memoranda. CMS conducts limited reviews of prices and only

reviews price determination methods when manufacturers request

recalculations of prior rebates. In addition, OIG reported that its review

efforts had been hampered by unclear CMS guidance on how to determine

AMP and by a lack of manufacturer documentation. Although OIG in some

cases identified problems with manufacturers’ price determination 

methods and reported prices, CMS had not followed up with

manufacturers to make sure that those problems were resolved. 

Program Oversight 

Does Not Ensure That

ManufacturerReported Prices or 

Price Determination 

Methods Are 

Consistent with 

Program Criteria 

CMS reviews drug prices submitted by approximately 550 manufacturers 

that participate in the program. Each quarter, CMS conducts automated 

data edit checks on the best prices and AMPs for about 25,000 drugs to

identify reporting errors. These checks are intended to allow CMS to 

ensure that, for example, prices are submitted in the correct format and

that the reported prices are for drugs covered by Medicaid. When data 

checks indicate a potential reporting error, CMS asks the manufacturer for 

corrected drug prices, but CMS does not have a mechanism in place to 

track whether the manufacturer submits corrected prices. CMS sometimes

identifies other price reporting errors when it calculates the unit rebate 

amount for a drug, but the agency does not follow up with manufacturers 

to verify that errors have been corrected. For example, CMS notifies a 

manufacturer if the unit rebate amount for a drug deviates from that of the 

prior quarter by more than 50 percent. It would be up to that manufacturer 

to indicate whether the underlying reported prices were correct. If the 

manufacturer determined that there were problems with the reported

price—for example, typographical errors such as misplaced decimals—it 

would send corrected data to CMS.18 If the manufacturer did not send 

revised pricing data to CMS, then the unit rebate amount would remain the 

same. 

CMS does not generally review the methods and underlying assumptions 

that manufacturers use to determine best price and AMP, even though 

these methods and assumptions can have a substantial effect on rebates. 

 18In this situation, the manufacturer also would recalculate the unit rebate amount and,

once invoiced by the states with total utilization for the drug paid for by Medicaid, would 

send the rebate payment to those states based on the recalculated unit rebate amount. 

Page 8 GAO-05-850T
Furthermore, CMS does not generally check to ensure that manufacturers’

methods are consistent with the rebate statute and rebate agreement, but

rather reviews the methods only when manufacturers request 

recalculations of prior rebates. A manufacturer may request a 

recalculation of a prior rebate any time it changes the methods it uses to 

determine best price or AMP. CMS requires the manufacturer to submit

both its original and its revised methods when requesting a recalculation 

of prior rebates so that the agency can evaluate whether the revised 

methods are consistent with the rebate statute, rebate agreement, and 

program memoranda. Recalculations can involve substantial amounts of

money; for example, six approved recalculations we examined reduced 

prior rebates to states by a total of more than $220 million. 

In reports on its audits of manufacturer-reported prices, OIG stated that its 

efforts were hampered by unclear CMS guidance on determining AMP and 

by a lack of manufacturer documentation. In its first review of

manufacturer-reported prices in 1992, OIG found that it could not verify 

the AMPs reported by the four manufacturers it reviewed.19 OIG could not

evaluate manufacturers’ methods for determining AMP because neither 

the rebate statute nor CMS had provided sufficiently detailed instructions

on methods for calculating AMP. OIG therefore advised CMS that it 

planned no future AMP data audits until CMS developed a specific written 

policy on how AMP was to be calculated. CMS disagreed, saying that the

rebate statute and rebate agreement had already established a 

methodology for computing AMP and stressed that this methodology was 

clarified, at manufacturer request, on an as-needed basis through 

conversations with individual manufacturers.20

In its second review of manufacturer-reported prices, in 1995 OIG 

attempted to verify one manufacturer’s recalculation request. While OIG 

reported that it could not complete its analysis because of inadequate

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19See HHS OIG, Medicaid Drug Rebates The Health Care Financing Administration Needs

to Provide Additional Guidance to Drug Manufacturers to Bet er Implemen the Program,

A-06-91-00092 (Washington, D.C.: November 1992). 

20Although CMS disagreed with OIG, it said it would further clarify AMP calculation in a

forthcoming drug rebate program regulation. As of October 2004, the regulation had not 

been issued; as we reported, CMS officials told us that the agency had no plans to

promulgate any such regulation in the near future. Instead, CMS has issued several

program memoranda intended to provide guidance on how manufacturers should calculate 

AMP. 

Page 9 GAO-05-850T
manufacturer documentation,21 it was able to identify some manufacturer

errors in determining AMP. In its review, OIG found that the manufacturer 

had miscalculated its revised AMP because it included “free goods” 

specifically excluded in the rebate agreement, miscalculated cash 

discounts, and improperly included sales rebates applicable to a period 

other than the quarter being audited. OIG recommended that CMS have 

the manufacturer revise its AMP data. Although CMS agreed with OIG’s 

recommendations, as of October 2004, it had not required any such

revision of the audited manufacturer’s AMP determinations. 

In its third review, conducted in 1997, OIG attempted to review a 

manufacturer’s recalculation request but again reported that it was unable 

to complete its evaluation because of a lack of specific guidance on

determining AMP and a lack of manufacturer documentation supporting

its revised AMP. In the absence of guidance from CMS, OIG defined retail

pharmacy class of trade for this audit to include only independent and 

chain pharmacies that sold drugs directly to the public. Therefore, OIG 

recommended that CMS ask the manufacturer to exclude from the 

calculation of AMP transactions that OIG determined were to nonretail

entities such as mail-order pharmacies, nursing home pharmacies,

independent practice associations, and clinics. OIG also found that the 

manufacturer used a flawed methodology to identify certain sales that it

had included in the retail class of trade and thus AMP. As a result, OIG 

recommended that CMS ask the manufacturer to exclude those sales from 

AMP unless the manufacturer could provide additional documentation to

support the inclusion of those sales in AMP. Although CMS did not agree 

with OIG’s definition of retail pharmacy class of trade, CMS concurred 

with OIG’s recommendation to ask the manufacturer to recalculate AMP.22

As of October 2004, CMS had not required any revision of this

manufacturer’s AMP determinations. 

In its fourth review of manufacturer-reported prices, issued in 2001, OIG 

investigated how manufacturers were treating repackagers—entities like 

HMOs that repackage or relabel drugs under their own names—in their 

 21OIG reports on individual manufacturers are not publicly available. 

22In response to OIG recommendations, CMS said it would provide the manufacturer with a 

copy of recent guidance on AMP: Medicaid Drug Rebate Program Release No. 29, June 

1997. This document, released to all manufacturers at the time OIG was conducting the 

1997 review, in some cases differed from OIG’s definition of retail pharmacy class of trade.

It stated, for example, that sales to nursing home and mail-order pharmacies are to be 

included in AMP, while OIG’s definition excluded these entities. 

Page 10 GAO-05-850T
best price determinations. The work followed up on previous work OIG 

conducted in response to a congressional inquiry in 1999. The rebate

statute states that HMO sales are required to be included in best price 

determinations. CMS’s June 1997 program memorandum stated that sales 

to other manufacturers that repackage the drugs are to be excluded from 

best price determinations. However, the rebate statute, rebate agreement, 

and CMS program memoranda did not address how HMOs should be

treated when they act as repackagers. In a letter issued in response to the 

1999 congressional request, OIG reported that excluding drug sales to two 

HMOs that acted as repackagers from best price determinations lowered 

state rebate amounts by $27.8 million in fiscal year 1998.23 In July 2000, 

CMS issued an additional program memorandum to manufacturers stating 

that sales to an HMO should be considered in best price determinations 

regardless of whether the HMO was a repackager.24 In 2001, OIG reported 

that states lost $80.7 million in rebates in fiscal year 1999 because of

improperly excluded drug sales to HMO repackagers.25 In September 2004, 

a CMS official told us that CMS planned to release a program

memorandum instructing manufacturers to revise prior rebates for which 

they had excluded sales to HMOs from best price. However, CMS does not 

have a mechanism in place to track that manufacturers have made these 

rebate adjustments and therefore cannot verify that manufacturers have

made or will make these adjustments. 

As we reported, OIG officials told us that, despite the program releases

issued by CMS, they remain unable to evaluate AMP because of the lack of

clear CMS guidance, particularly related to the retail pharmacy class of 

trade and treatment of PBM transactions. 

 

i :

23Letter from HHS OIG to Ranking Minority Member, Committee on Government Reform, 

House of Representatives, November 22, 1999. 

24Medicaid Drug Rebate Program Release No. 47, July 2000. 

25See HHS OIG, Medica d Drug Rebates Sales to Repackagers Excluded from Best Price 

Determinations, A-06-00-00056 (Washington, D.C.: March 2001).

Page 11 GAO-05-850T
As we reported, we found considerable variation in the methods that the

manufacturers we reviewed used to determine best price and AMP. 

Manufacturers are allowed to make reasonable assumptions when 

determining best price and AMP, as long as those assumptions are 

consistent with the law and the rebate agreement. The assumptions often

pertain to the transactions, including discounts or other price reductions, 

that are considered in determining best price and AMP. We found that in

some cases manufacturers’ assumptions could have led to lower rebates 

and in other cases to higher rebates. Manufacturers can later revise their 

assumptions and request recalculations of previously paid rebates, which 

can result in states repaying any excess rebates. 

Manufacturer Price 

Determination 

Methods Varied: Some

Could Have Led to 

Lower Rebates 

We found that manufacturers made varying assumptions about which 

sales and prices to include and exclude from their determinations of best

price and AMP. For example, some included sales to a broad range of

facilities in AMP, excluding only transactions involving facilities explicitly

excluded by the law, rebate agreement, or CMS program memoranda. In

contrast, others included sales to a narrower range of purchasers—only

those purchasers explicitly included in AMP by the law, rebate agreement,

or CMS program memoranda. Manufacturers also differed in how they

treated certain types of health care providers that are not explicitly

addressed by the law, rebate agreement, or CMS program memoranda. For 

example, some manufacturers included sales to physician groups in AMP, 

while others did not. These assumptions can affect the reported prices

and, in turn, the size of rebates paid to states. 

We also found that manufacturers also differed in how they accounted for 

certain price reductions, fees, and other transactions when determining

best price and AMP. For example, manufacturers differed in how they

accounted for certain transactions involving prompt payment discounts. In

some cases, manufacturers’ assumptions could have reduced rebates 

below what they otherwise would have been. In other cases, 

manufacturers’ methods could have raised rebates. For example, some

manufacturers included in the determination of best price the contract

prices they had negotiated with purchasers, even if they made no sales at

those prices during the reporting quarter. This practice could have 

increased rebates to states.26

 26One manufacturer, however, indicated that it later might revise this practice and request

recalculations to recoup any excess rebates it had already paid. Manufacturers have up to 3 

years to make such revisions. 

Page 12 GAO-05-850T
As we reported, the rebates that manufacturers pay to states are based on 

a range of prices and financial concessions that manufacturers make 

available to entities that purchase their drugs, but they may not reflect 

certain financial concessions manufacturers offer to other entities in

today’s complex market. In particular, the rebate program does not clearly 

address certain concessions that are negotiated by PBMs on behalf of 

third-party payers, such as employer-sponsored health plans and other 

health insurers. The rebate program did not initially address these types of

concessions, which are relatively new to the market. CMS’s subsequent 

guidance to manufacturers has not clearly stated how manufacturers 

should treat these concessions in their determinations of best price and 

AMP. Within the current structure of the rebate formula, additional 

guidance on how to account for manufacturer payments to PBMs could 

affect the rebates paid to states, although whether rebates would increase 

or decrease as a result, and by how much, is uncertain. 

Rebate Program Does 

Not Clearly Address 

Certain Financial 

Concessions 

Negotiated by PBMs 

Certain manufacturer financial concessions that are negotiated by PBMs

on behalf of their third-party payer clients are not clearly reflected in best 

price or AMP. PBMs, in one of the roles they play in the market, may 

negotiate payments from manufacturers to help reduce their third-party 

payer clients’ costs for prescription drugs.27 (In these circumstances, the 

third-party payer does not purchase drugs directly from the manufacturer 

but instead covers a portion of the cost when its enrollees purchase drugs 

from pharmacies.) The basis of these PBM-negotiated manufacturer 

payments varies. For example, manufacturers may make a payment for 

each unit of a drug that is purchased by third-party payer enrollees or may 

vary payment depending on a PBM’s ability to increase the utilization, or

expand the market share, of a drug. The payment may be related to a 

specific drug or a range of drugs offered by the manufacturer. The amount

of financial gain PBMs receive from these negotiated payments also varies. 

A PBM may pass on part or all of a manufacturer’s payment to a client, 

depending on the terms of their contractual relationship. Manufacturers 

may not be parties to the contracts that PBMs have with their clients and 

so may not know the financial arrangements between the PBMs and their 

clients. 

These types of financial arrangements between manufacturers and PBMs 

are a relatively new development in the market. When the program began 

in 1991, PBMs played a smaller role in the market, managing fewer 

 27GAO-03-196. 

Page 13 GAO-05-850T
covered lives and providing a more limited range of services—such as 

claims processing—for their clients. Since then, PBMs’ role has grown

substantially, contributing to a market that is much more complex,

particularly with respect to the types of financial arrangements involving 

manufacturers. PBMs now commonly negotiate with manufacturers for 

payments on behalf of their clients, in addition to providing other services. 

Although complete data on the prevalence and magnitude of PBMnegotiated manufacturer payments are not readily available, PBM officials 

and industry experts have said that these and other manufacturer

payments to PBMs are a large portion of PBMs’ earnings;28 further, recent 

public financial information suggests that manufacturer payments to PBMs

as a whole are substantial and key to PBMs’ profitability. 

CMS has acknowledged the complexity that arrangements between 

manufacturers and PBMs introduce into the rebate program but has not

clearly addressed how these arrangements should be reflected in 

manufacturer-reported prices. In 1997, CMS issued program memoranda 

that noted new types of arrangements involving manufacturer payments to 

PBMs and attempted to clarify whether those arrangements should be 

reflected in best price and AMP.29 However, in a program memorandum 

issued shortly thereafter, CMS stated that there had been confusion 

concerning the intent of the previous program memoranda and that the 

agency had “intended no change” to program requirements.30 At the time, 

CMS said that staff were reexamining the issue and planned to shortly 

clarify the agency’s position. As of January 2005, CMS had not issued such 

clarifying guidance on how PBM-negotiated manufacturer payments

should be reflected in best price and AMP when PBMs have negotiated on 

behalf of third parties. CMS officials with responsibility for issuing 

program memoranda advised us that they could comment only on specific

situations. They stated that financial arrangements among entities in the 

market are complex and always changing; in their view, the market is too 

complicated for them to issue general policy guidance that could cover all 

possible cases. Rather, these officials told us that they make

determinations about PBM payments on a case-by-case basis, but only

when manufacturers contact them regarding this issue. 

 28GAO-03-196. 

29Medicaid Drug Rebate Program Release No. 28, April 1997, and Medicaid Drug Rebate

Program Release No. 29, June 1997. 

30Medicaid Drug Rebate Program Release No. 30, September 1997. 

Page 14 GAO-05-850T
Within the current structure of the rebate formula, additional guidance on 

how to account for manufacturer payments to PBMs could affect the 

rebates paid to states, although whether rebates would increase or 

decrease as a result, and by how much, is uncertain. Because of the 

structure of the rebate formula, any change in the determination of best 

price and AMP could raise or lower rebates for any given drug, depending 

on how the change affects the relationship between those prices. 

Incorporating PBM-negotiated manufacturer payments into the rebate 

determination could decrease the unit rebate amount for a drug if, for

example, it reduced AMP but had no effect on best price.31 Alternatively, if 

such a change increased the difference between AMP and best price for a

drug, the unit rebate amount could increase.32

As we stated in our report, because the rebate program relies on

manufacturer-reported prices, adequate program oversight is important to

ensure that states receive the rebates to which they are entitled. However, 

CMS has not provided clear program guidance for manufacturers to follow

when determining prices, and this has hampered OIG’s efforts to audit

manufacturers’ methods and reported prices. In addition, oversight by 

CMS and OIG has been inadequate to ensure that manufacturer-reported 

prices and methods are consistent with the law, rebate agreement, and 

CMS program memoranda. As a result, we recommended that CMS take 

several steps to improve program guidance and oversight, namely, to issue 

clear guidance on manufacturer price determination methods and the 

definitions of best price and AMP; update such guidance as additional

issues arise; and implement, in consultation with OIG, systematic

oversight of the price determination methods employed by pharmaceutical 

manufacturers and a plan to ensure the accuracy of manufacturer-reported 

prices and rebates to states. We believe that these actions could help 

ensure that the Medicaid drug rebate program achieves its objective of 

controlling states’ Medicaid drug spending. HHS agreed with the 

importance of guidance to manufacturers, but disagreed with our 

conclusion that there has been inadequate program oversight. We 

Concluding

Observations 

 31A change in guidance regarding how PBM payments should be reflected in best price 

would not necessarily affect the best price for every drug because best price can be

determined by a transaction that is not related to PBM payments. 

32A greater difference between best price and AMP would not always yield a larger rebate. 

For example, if the difference between the two prices increased but remained less than 

15.1 percent of AMP, the unit rebate amount would still be based on the 15.1 percent of 

AMP minimum.

Page 15 GAO-05-850T
acknowledged HHS’s oversight actions, but stated that HHS oversight does 

not adequately ensure the accuracy of manufacturer-reported prices and

rebates paid to states. Some of the manufacturers that supplied data for 

the report raised concerns about our discussion of certain methods they

used to determine rebates, and we clarified our discussion of

manufacturers’ price determination methods. 

Mr. Chairman, this concludes my prepared statement. I would be happy to

respond to any questions you or other Members of the Subcommittee may 

have. 

For further information about this testimony, please contact Kathleen King 

at (202) 512-7118. Debra Draper, Robin Burke, and Ann Tynan also made

key contributions to this statement. 

Contact and Staff 

Acknowledgments 

(290477) Page 16 GAO-05-850T
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