United States Government Accountability Office

GAO Testimony 

Before the Committee on Finance, U.S. 

Senate

PRESCRIPTION DRUGS

An Overview of Approaches 

to Negotiate Drug Prices 

Used by Other Countries 

and U.S. Private Payers and 

Federal Programs 

Statement of John E. Dicken 

Director, Health Care 

For Release on Delivery

Expected at 10:00 a.m. EST 

Thursday, January 11, 2007 

 

GAO-07-358T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

January 11, 2007

PRESCRIPTION DRUGS 

An Overview of Approaches to Negotiate 

Drug Prices Used by Other Countries and 

U.S. Private Payers and Federal Programs 

Highlights of GAO-07-358T, a testimony 

before the Committee on Finance, U.S. 

Senate 

Rising prescription drug spending

has led the United States and other 

countries to seek ways to negotiate 

lower prices with drug

manufacturers. Currently, the 

Medicare Part D benefit, which 

offers outpatient prescription drug

benefits to beneficiaries including 

elderly and certain disabled people, 

comprises competing prescription 

drug plans overseen by the Centers

for Medicare & Medicaid Services. 

The Medicare Prescription Drug, 

Improvement, and Modernization 

Act of 2003 prohibits the Secretary 

of Health and Human Services from

interfering with price negotiations 

between Part D plan sponsors and

drug manufacturers and 

pharmacies. Some Members of 

Congress have proposed amending 

the statute to allow the Secretary of 

Health and Human Services to

negotiate directly with drug 

manufacturers on behalf of Part D 

beneficiaries. 

GAO was asked to describe how

prescription drug prices are 

negotiated. This testimony provides

an overview of such efforts (1) by

governments in other countries; 

(2) by U.S. private payers, such as

employer-based health plans; and

(3) by federal programs other than

Medicare Part D. This testimony is 

based on previous GAO reports 

from 2002 through 2006 on federal 

programs that purchase or cover 

prescription drugs and other 

relevant literature from 

congressional agencies and federal

or international organizations. 

Governments in other countries use a range of approaches to limit the 

amount they pay to acquire drugs: 

• Ceiling prices establish a maximum price manufacturers may charge for 

their products. Purchasers may sometimes negotiate more favorable 

prices directly with drug manufacturers. 

• Reference prices use local or international price comparisons of drugs 

classified in a group as therapeutically similar to determine a single or 

maximum price for all drugs in that group. 

• Profit limits control how much profit a drug manufacturer may earn per 

product or within a specified period of time. 

Other factors—such as scope of coverage and national formularies, which 

are generally lists of preferred drugs—influence drug price negotiations. 

In the U.S. private health insurance market, health plans typically contract 

with pharmacy benefit managers (PBM) to help manage their prescription 

drug benefits. PBMs negotiate rebates or payments with drug manufacturers, 

encourage substitution of generic drugs for therapeutically similar brand 

drugs, and negotiate discounted prices with networks of retail and mailorder pharmacies, passing along at least some of the savings to health plans

and enrollees. PBMs influence price negotiations with manufacturers 

through formulary development and management and through the large 

market share they often represent. 

Approaches for negotiating drug prices vary among federal programs in the 

United States. In part, these approaches depend on whether the programs 

purchase and distribute drugs directly or reimburse retail pharmacies or 

other providers for dispensing or delivering drugs. While the approaches 

used by federal programs in the United States reflect U.S. laws, markets, and 

health care delivery and financing, there are also elements common to some 

of the approaches used by other countries and by private payers. Some 

federal programs set ceiling prices, others establish prices by referencing 

prices negotiated by private payers in the commercial market, and still 

others rely on negotiations with manufacturers, directly or through private 

health plans. For example, the Departments of Veterans Affairs’s and 

Defense’s prices for a prescription drug may be the lowest of a ceiling price,

other established price, or a price negotiated with the manufacturer. State 

Medicaid programs, joint federal-state programs that finance medical

services for certain low-income adults and children, reimburse retail 

pharmacies for drugs dispensed to beneficiaries at set prices. The programs

receive rebates from manufacturers that are meant to take advantage of the 

prices for drugs in the commercial market and are required to reflect 

discounts and rebates negotiated by private payers with manufacturers. For 

health benefits offered to federal employees, retirees, and dependents, 

rather than negotiating with manufacturers, the government contracts with 

participating health plans that typically use PBMs to negotiate drug prices 

and offer other pharmacy benefit, administrative, and clinical services. 

www.gao.gov/cgi-bin/getrpt?GAO-07-358T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact John E. Dicken 

at (202) 512-7119 or dickenj@gao.gov. 
Mr. Chairman and Members of the Committee: 

I am pleased to be here today as you examine approaches for prescription 

drug pricing and negotiations. In the United States and in other countries,

the rising cost of prescription drugs continues to pose significant financial 

burdens on governments, private payers, and individuals responsible for 

paying for drugs. This has led to a wide range of market-based and 

governmental approaches to reduce drug spending. Some of these 

approaches rely on negotiations between payers for prescription drugs 

and drug manufacturers. 

In the United States, prescription drugs are a particular focus for the 

federal government as Medicare—the federal health insurance program 

that serves nearly 43 million elderly and disabled individuals—begins the 

second year of its voluntary outpatient prescription drug benefit. This 

benefit, known as Medicare Part D, was established by the Medicare 

Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) 

beginning January 1, 2006.1

 Medicare beneficiaries may choose a Part D 

plan from multiple plans offered by private sponsors, largely commercial 

insurers, under contract with the Centers for Medicare & Medicaid 

Services (CMS), the agency within the Department of Health and Human 

Services (HHS) that administers Medicare. These plans differ in the drugs 

they cover, the pharmacies they use, and the prices they negotiate with 

drug manufacturers and pharmacies. In addition, costs to the enrollee for 

the monthly premium, the annual deductible, and copayments for covered 

drugs vary by plan. 

While the Medicare Part D benefit is characterized by multiple competing

prescription drug plans that are overseen by CMS, MMA prohibits the 

Secretary of Health and Human Services from interfering with price 

negotiations between Part D plan sponsors and drug manufacturers and 

pharmacies.2

 Some Members of Congress, contending that the combined 

purchasing power on behalf of all Medicare Part D beneficiaries could be 

used as leverage, have proposed amending the law to provide for the 

 1

Pub. L. No. 108-173, § 101, 117 Stat. 2066, 2071-2152 (codified at 42 U.S.C. §§ 1395w-101 to 

1395w-152). MMA redesignated the previous part D of title XVIII of the Social Security Act 

as part E and inserted a new part D after part C. 

2

Pub. L. No. 108-173, § 101, 117 Stat. 2066, 2098 (codified at 42 U.S.C. § 1395w-11(i)). 

Page 1 GAO-07-358T
Secretary of Health and Human Services to negotiate directly with drug 

manufacturers.3

As Congress considers these issues for Medicare Part D, you asked that we 

broadly describe the variety of approaches used to negotiate drug prices. 

Specifically, my remarks today will provide an overview of the approaches 

used to negotiate drug prices by governments in other countries, by 

private payers in the United States, and by federal programs other than 

Medicare Part D.4

 My remarks are primarily based on our previous reports 

from 2002 through 2006 on federal programs that purchase or cover 

prescription drugs, which were done in accordance with generally 

accepted government auditing standards, as well as other relevant 

literature on approaches in the United States and other countries prepared 

by congressional agencies and international and federal organizations.5

In summary, a wide range of approaches is used by other countries and by

private payers and federal programs in the United States to negotiate drug 

prices. The approaches governments in other countries use include the 

following: 

• Ceiling prices restrict market negotiations by setting maximum prices 

purchasers can pay for drugs. Ceiling prices allow purchasers to negotiate 

lower prices directly with drug manufacturers. 

 3

For example, H.R. 4, the Medicare Prescription Drug Price Negotiation Act of 2007, was 

introduced on January 5, 2007. It would require the Secretary of Health and Human 

Services to negotiate Part D drug prices on behalf of Medicare beneficiaries. 

4

For this testimony, we reviewed information summarizing approaches used by members of 

the Organisation for Economic Co-operation and Development (OECD). The OECD

includes 30 member countries that “share a commitment to democratic government and

the market economy,” and OECD’s work includes developing publications and statistics on 

economic and social issues. http://www.oecd.org (accessed January 9, 2007). As 

appropriate, we present examples of drug pricing approaches used in five OECD member

countries other than the United States. 

5

A list of related GAO products is included at the end of this statement. For additional 

information on approaches used by other countries, U.S. private payers, and federal 

programs, see, for example, Congressional Budget Office, Prices for Brand-Name Drugs 

Under Selected Federal Programs (Washington, D.C., 2005); Congressional Research 

Service, Federal Drug Price Negotiation: Implications for Medicare Part D (Washington,

D.C., 2007); Federal Trade Commission, Pharmacy Benefit Managers: Ownership of MailOrder Pharmacies (Washington, D.C., 2005); and Department of Commerce, International

Trade Administration, Pharmaceutical Price Controls in OECD Countries: Implications 

for U.S. Consumers, Pricing, Research and Development, and Innovation (Washington,

D.C., 2004). 

Page 2 GAO-07-358T
• Reference prices use local or international price comparisons of drugs 

classified in a group as therapeutically similar to determine a single or 

maximum price for all drugs in that group. 

• Profit limits establish controls on drug manufacturers’ profits that require 

manufacturers to pay rebates or lower prices if profits exceed certain 

levels. 

Other key factors—such as scope of coverage and national formularies, 

which are generally lists of preferred drugs—influence drug price 

negotiations. 

Private payers in the United States, including employer-based health plans 

and private insurers, typically contract with pharmacy benefit managers 

(PBM). PBMs negotiate rebates or payments with manufacturers and 

prices with retail pharmacies, and they provide other related 

administrative and clinical services. PBMs compete in the private market 

based on their ability to negotiate reduced prices and contain costs, and 

PBMs may receive compensation from health plans and from retaining 

some of the savings they negotiate with pharmacies or manufacturers. 

PBMs influence price negotiations with manufacturers through formulary 

development and management and through the large number of health 

plan enrollees they typically represent. 

Approaches for negotiating drug prices vary among federal programs in 

the United States. Factors contributing to this variation include the use of

formularies and whether the programs purchase and distribute drugs, 

reimburse retail pharmacies or other providers for drugs dispensed and 

delivered, or contract with private health plans that provide and manage 

pharmacy benefits. For example, the Department of Veterans Affairs (VA) 

and the Department of Defense (DOD) often purchase drugs from 

suppliers, then distribute drugs to beneficiaries through internal facilities 

or mail-order pharmacies. State Medicaid programs, on the other hand, 

reimburse retail pharmacies for drugs dispensed to beneficiaries at set 

prices. While the approaches used by federal programs in the United 

States reflect the laws governing them, markets, and health care delivery 

and financing, there are also elements common to some of the approaches

used by other countries and by private payers. Some federal programs set 

ceiling prices, others establish prices by referencing prices negotiated by 

private payers in the commercial market, and still others rely on 

negotiations with manufacturers, either directly or through private health

plans. For example, VA’s and DOD’s prices for particular prescription 

drugs included on their formularies may be the lowest of a ceiling price, a 

Page 3 GAO-07-358T
price listed on a federal supply schedule (FSS), or the price negotiated 

with a manufacturer. For health benefits offered to federal employees, 

retirees, and their dependents, the federal government uses a different 

approach, modeled after other large U.S. employers’ health benefits. Under 

this approach, rather than the government negotiating with manufacturers, 

the government contracts with participating health plans that typically use

PBMs to negotiate drug prices, manage formularies, and offer other 

pharmacy benefit, administrative, and clinical services. 

Prescription drug spending, paid for by a mix of public and private payers, 

has outpaced total health care spending in the United States and other 

countries in recent years. In the United States, federal programs either 

directly purchase and distribute prescription drugs or reimburse 

pharmacies or other providers for drugs dispensed or delivered. 

According to the Organisation for Economic Co-operation and 

Development (OECD), drug spending in member countries (including the 

United States) increased on average by about 6 percent a year from 1998 

through 2003.6

 On average, growth in drug spending outpaced the growth 

in spending for total health expenditures. Among OECD member 

countries, the share of public and private spending for prescription drugs 

varies, but in 2004 public sources accounted for the bulk of spending in 

most countries. 

In the United States, rising prescription drug prices and increased 

spending have been a concern to federal and state governments and to 

private payers, including private insurers and employer-based health 

plans. CMS reports that total national spending by all public and private 

payers for prescription drugs from retail outlets increased on average by

about 11 percent a year from 1998 through 2005—faster than the average 

7 percent a year increase in total U.S. health expenditures for the same 

period.7 CMS also reports that national spending by all public and private 

Background 

Prescription Drug 

Spending and Cost 

Containment Strategies in 

Other Countries and the 

United States 

 6

Growth in drug spending for these nations includes both prescription and over-the-counter

drugs.

7

Centers for Medicare & Medicaid Services, Trustees, National Health Expenditure,

Historical Data (Baltimore, MD: Centers for Medicare & Medicaid Services, 2007), 

http://www.cms.hhs.gov/NationalHealthExpendData/02_NationalHealthAccountsHistorical.

asp (accessed January 9, 2007). These figures reflect spending on prescription drugs

through retail outlet sales, but do not account for nonretail outlet sales, such as those for

drugs dispensed in inpatient hospital or nursing home facility settings. 

Page 4 GAO-07-358T
payers for prescription drugs from retail outlets totaled about $201 billion 

in 2005. Nearly three-quarters (73 percent) of this spending came from 

private funds—including private insurance and out-of-pocket payments—

while the remaining share came from public sources. The public share 

includes the federal government’s share of total spending for prescription 

drugs from retail outlets. Federal spending for prescription drugs was 

about 16 percent of the total, or $33 billion, in 2005. However, these data

precede the 2006 establishment of Medicare Part D, which increased 

public and federal shares of prescription drug expenditures. 

In the face of rising prescription drug spending, the governments of other 

countries, U.S. private payers, and federal programs have applied both 

demand- and supply-side measures to contain prescription drug spending. 

Demand-side measures are aimed at wholesalers, retailers, doctors, and 

patients and include such strategies as prescribing guidelines, generic 

substitution policies, and fixed and tiered copayments. Supply-side 

measures are aimed at limiting the cost of prescription drugs by 

negotiating prices and by requiring or encouraging the use of certain drugs 

through formularies established by a government, health plan, or federal 

program. Formularies have long been used to control the cost and 

utilization of prescription drugs. Some formularies are more restrictive 

than others; open formularies provide coverage for both listed and 

nonlisted drugs, and closed formularies generally provide coverage only 

for drugs that are included on the list. Many other formulary approaches 

fall somewhere in between, encouraging the use of listed drugs by 

charging higher copayments for those not listed. Under a tiered costsharing approach, for example, generic and preferred drugs require lower 

copayments than brand and nonpreferred drugs. Health plans that use 

formularies typically have provisions that enable enrollee access to 

nonformulary drugs when they are medically necessary and allow patients 

to appeal coverage decisions. 

In the U.S. private market, PBMs offer health plans a variety of

prescription drug management services, including negotiating rebates with 

manufacturers, negotiating price discounts with retail pharmacies, 

operating mail-order prescription services, managing drug formularies, 

and processing claims. PBMs also provide health plans with clinical 

services, such as formulary development and management, prior 

authorization and drug utilization reviews to screen prescriptions for such 

issues as adverse interactions or therapy duplication, and substitution of 

Page 5 GAO-07-358T
generic drugs for therapeutically equivalent brand drugs.8

 Health plans pay 

PBMs fees for these administrative and clinical services as well as for 

retail and mail-order drug costs. PBMs may also retain savings from or 

have other financial incentives to negotiate lower drug prices and rebates.

In 2004, an estimated 200 million people, or about 68 percent of the U.S. 

population, were enrolled in private health plans that used PBMs.9

Beyond Medicare Part D, a range of federal programs, established by 

statute, in the United States offer drug benefits to individuals meeting 

various eligibility criteria. These programs cover a broad and varying array 

of prescription brand and generic drugs.10 These drugs are made available

to beneficiaries through multiple approaches, ranging from direct 

purchase and provision by federal programs to contracts with private 

insurers and PBMs to provide drug coverage. 

The VA pharmacy benefit is provided to eligible veterans and certain 

others. In general, medications must be prescribed by a VA provider, filled 

at a VA pharmacy or through a VA Consolidated Mail Outpatient 

Pharmacy, and listed on the VA national drug formulary, which comprises 

570 categories of drugs. In addition to the VA national drug formulary, VA 

facilities can establish local formularies to cover drugs not on the national

formulary. VA may provide nonformulary drugs in cases of medical 

necessity.11 In 2005, VA spent $4.2 billion on drugs and medicines. 

Federal Programs 

 8

Therapeutically equivalent drug products can be substituted with the full expectation that

they will produce the same clinical effect as the prescribed drugs. 

9

PricewaterhouseCoopers. The Value of Pharmacy Benefit Management and the National

Cost Impact of Proposed PBM Legislation. A report prepared at the request of 

Pharmaceutical Care Management Association. July 2004. 

10Brand drugs are single-source and multisource drugs that are marketed under a 

proprietary, trademark-protected name. Single-source drugs include those brand drugs that

have no generic equivalent on the market and are generally available from only one 

manufacturer. Brand multisource drugs include those brand drugs that have generic 

equivalents available from multiple manufacturers and are marketed under a proprietary

name. Generic drugs include multisource drugs that are chemically identical to their

branded counterparts and are generally marketed by multiple manufacturers under a

nonproprietary name. 

11In a 2000 report, the Institute of Medicine characterized the VA formulary as “not overly

restrictive.” 

Page 6 GAO-07-358T
The DOD pharmacy benefit is provided to TRICARE beneficiaries,12

including active duty and retired uniformed service members. In addition 

to maintaining a formulary, DOD provides options for obtaining 

nonformulary drugs. Beneficiaries can get prescription drugs through 

network retail pharmacies, nonnetwork retail pharmacies, DOD military 

treatment facilities, and DOD’s TRICARE Mail Order Pharmacy. In 2005, 

DOD spent $5.4 billion on prescription drugs. 

Medicaid is the joint federal-state program that finances medical services 

for certain low-income adults and children. While some benefits are 

federally required, prescription drug coverage is an optional benefit that 

all states have elected to offer. State Medicaid programs, though varying in 

design, cover both brand and generic drugs. Drug coverage depends on the 

manufacturer’s participation in the Medicaid drug rebate program, through 

which manufacturers pay rebates to state Medicaid programs for covered 

drugs used by Medicaid beneficiaries. Retail pharmacies distribute drugs 

to Medicaid beneficiaries, then receive reimbursements from states for the 

acquisition cost of the drug and a dispensing fee. In 2004, Medicaid 

outpatient drug spending peaked at $31 billion—including $19 billion as 

the federal share—which was calculated after adjusting for manufacturer 

rebates to states under the Medicaid drug rebate program. Medicaid 

spending on outpatient prescription drugs is expected to decrease with the 

transition of prescription drug coverage for dual eligibles—those eligible

for both Medicaid and Medicare—to the Medicare Part D program. 

The 340B drug pricing program gives more than 12,000 entities of various 

types—community health centers, AIDS clinics, and disproportionate 

share hospitals13 among them—access to discounted drug prices, called 

340B ceiling prices.14 These entities must enroll in the program, which is 

administered by the Health Resources and Services Administration. The 

program requires drug manufacturers to offer covered drugs to enrolled 

 12DOD provides health care through TRICARE—a regionally structured program that uses 

contractors to maintain provider networks to complement health care provided at military 

treatment facilities. 

13Disproportionate share hospitals are hospitals that serve a relatively large volume of lowincome patients and are eligible for payment adjustments under Medicare’s prospective 

payment system or under Medicaid. 

14The 340B drug pricing program is named for the statutory provision that authorizes it, 

section 340B of the Public Health Service Act (codified at 42 U.S.C. § 256b). 

Page 7 GAO-07-358T
entities at or below 340B ceiling prices.15 Enrolled entities establish their 

own formularies and may dispense drugs through in-house pharmacies, 

dispensing physicians, or contracted retail pharmacies. Enrolled entities 

spent an estimated $3.4 billion on drugs in 2003. 

Medicare, the federal health insurance program that serves the nation’s 

elderly and certain disabled people, in addition to the outpatient 

prescription drug benefit offered in Part D, covers certain other drugs 

through Part B.16 Drugs covered by Part B are typically administered by 

physicians or other medical professionals rather than by patients 

themselves. These drugs include, for example, those furnished in 

conjunction with dialysis services or durable medical equipment. In 2005, 

Medicare paid more than $9 billion for drugs covered under Part B. 

The Federal Employees Health Benefits Program (FEHBP) is the largest 

employer-sponsored health insurance program in the country. Through it, 

about 8 million federal employees, retirees, and their dependents receive 

prescription drug coverage through participating private health insurance 

plans. Most of these plans contract with PBMs to manage their drug 

benefits. The drugs covered vary by plan, but are typically part of 

relatively broad formularies of drugs. In general, beneficiaries have several 

options for obtaining drugs, including through retail or mail-order 

pharmacies. In 2005, FEHBP prescription drug spending was an estimated 

$8.3 billion.

 15Drug manufacturers must participate in the 340B drug program in order to get their drugs

covered by Medicaid. 

16The Medicare Part B program covers a broad range of medical services, including 

physician, laboratory, and hospital outpatient department services and durable medical 

equipment. 

Page 8 GAO-07-358T
According to the OECD, member countries that offer subsidized drug 

programs are grappling with how to manage increased drug spending 

given limited budgets. These countries have three main approaches to 

limiting the amount they pay to acquire drugs: 

• ceiling prices, 

Approaches Used by 

Other Countries for 

Negotiating Drug 

Prices 

• reference prices, and 

• profit limits.

Ceiling prices. Ceiling prices restrict market negotiations by setting 

maximum prices purchasers can pay for drugs. Ceiling prices allow 

purchasers to negotiate lower prices directly with drug manufacturers. 

One approach is for a government to set prices for drugs and prohibit sales 

at greater prices. In France and Australia, for example, a government 

committee sets the prices at which drugs must be purchased and 

reimbursed. Alternatively, a government may set a price ceiling and allow 

purchasers to negotiate more favorable prices with manufacturers 

directly. In Canada, the Patented Medicines Prices Review Board sets the 

maximum price a manufacturer can charge direct purchasers. It can 

impose fines on any manufacturer that attempts to sell a drug at a price 

greater than the established ceiling. An additional method used to control 

prices is for a government to set reimbursement rates for new drugs at low 

levels; because any price above the set reimbursement rate would be an

out-of-pocket expense to the consumer, the reimbursement rate effectively 

becomes the market price. 

Reference prices. Reference prices use local or international price 

comparisons of drugs classified in the same therapeutic group to 

determine a single or maximum price for all drugs in that group. The 

therapeutic group of drugs can encompass old and new drugs, including 

brand or generic drugs. The lowest priced drug may then establish the 

maximum price for the entire therapeutic group. Germany, for example, 

sets such prices based on local price comparisons of drugs classified in the 

same therapeutic group.

Profit limits. Profit limits control the amount of profit a drug 

manufacturer may earn on a product or within a specified period of time. 

If the established threshold is exceeded, the manufacturer is required to

accept a price cut or pay rebates to the government. In the United 

Kingdom, for example, there are limits on the profits that a drug 

manufacturer can earn on sales to the National Health Service. 

Page 9 GAO-07-358T
Several other key factors can influence drug price negotiations in OECD 

countries. Unlike the United States, many OECD countries, such as 

Australia and France, have universal health care systems that allow a 

mandated, relatively more unified approach to drug pricing. While these 

countries vary in their government’s respective share of drug spending, 

some set national, uniform maximum prices to be paid by all purchasers, 

including private payers. Many countries also establish national 

formularies that define which drugs are to be covered by all purchasers. 

In the United States, private payers represent the largest source of 

prescription drug spending. These payers, including employer-based 

health plans and private health insurers, typically contract with PBMs to 

help manage their prescription drug benefits. PBMs employ several cost 

containment strategies for lowering drug prices for the health plans and 

enrollees they represent. PBMs negotiate rebates or payments with 

manufacturers and prices with networks of retail and mail-order 

pharmacies, passing along at least some of the savings to health plans and

enrollees. Manufacturers and pharmacies agree to these price concessions 

in exchange for both the large number of enrollees PBMs represent and 

the ability of PBMs to influence enrollee choice of drugs and pharmacies. 

One of the key ways PBMs influence price negotiations with 

manufacturers is through formulary development and management. PBMs 

may assist health plans in developing or managing a formulary that the 

health plan will cover. Health plans often provide financial incentives, 

such as lower enrollee cost-sharing, to encourage use of preferred drugs 

listed on the formulary.17 Since PBMs represent a large number of 

enrollees, manufacturers have a strong interest in having their drugs listed 

on plan formularies. Manufacturers pay PBMs through rebates or other 

payments to be included on plan formularies and to capture greater 

market shares for their drugs. For example, many mail-order pharmacies 

are owned by PBMs, and PBMs can obtain greater manufacturer rebates or 

payments by dispensing a high volume of the manufacturer’s drug. 

The extent to which pharmacy discounts and manufacturer rebates or 

payments are shared with health plans and enrollees depends on 

contractual arrangements with the health plan and the plan’s benefit 

Approaches Used by 

U.S. Private Payers 

for Negotiating Drug 

Prices 

 17In some cases, a plan may charge more or may not provide coverage for drugs not listed 

on the plan’s formulary. 

Page 10 GAO-07-358T
design. For example, PBMs negotiate contracts with health plans and their 

networks of pharmacies separately, which means that health plans may 

pay PBMs higher prices for drugs than the PBM negotiated between itself 

and the pharmacy. Similarly, PBMs often set up contractual arrangements 

with manufacturers based on manufacturers’ entire line of products rather 

than per drug. Further, PBMs may retain a portion of the rebates or 

payments they receive associated with individual health plans or all the 

health plans they represent. PBMs may also obtain additional rebates or 

payments from manufacturers for administering formularies or providing 

certain services, such as encouraging the use of one therapeutically similar 

drug over another. 

Approaches for negotiating drug prices vary among federal programs in 

the United States. While these approaches reflect the laws that govern 

them, markets, and health care delivery and financing, there are also 

elements common to some of the approaches used by other countries and 

by private payers. Some federal programs set ceiling prices, others 

establish prices by referencing prices negotiated by private payers in the 

commercial market, and still others rely on negotiations with 

manufacturers, either directly or through private health plans. For 

example, VA’s and DOD’s prices for particular prescription drugs may be 

the lowest of an FSS price, a ceiling price, or the price that each agency 

can negotiate directly with the manufacturer. The FEHBP uses a different 

approach, modeled after other large U.S. employers’ health benefits; health 

plans participating in the FEHBP typically contract with PBMs to negotiate 

drug prices and offer other pharmacy benefit, administrative, and clinical 

services. Further, like many of the other OECD countries, U.S. federal 

programs use a mix of strategies to contain prescription drug spending. 

Many federal programs have formularies that define which drugs are to be

covered. While some federal programs’ formularies are comprehensive 

and some are more restrictive than others, the programs use lists of 

covered drugs as the basis for negotiations with drug manufacturers. 

VA and DOD have several options available to obtain favorable prices for 

drugs covered on their formularies. Both agencies pay the lowest of 

several prices available for a given drug, and both can negotiate with 

suppliers to receive additional discounts. In addition, both have adopted 

certain practices that affect negotiations, such as the use of formularies, or 

that otherwise contribute to lower costs, such as the use of mail-order 

pharmacies. 

Approaches Used by 

U.S. Federal 

Programs for 

Negotiating Drug 

Prices 

VA and DOD 

Page 11 GAO-07-358T
VA and DOD have access to a number of prices to consider when 

purchasing drugs. 

• FSS prices. VA’s National Acquisition Center negotiates FSS prices with 

drug manufacturers. These prices are available to all federal purchasers. 

FSS prices are intended to be no more than the prices manufacturers 

charge their most-favored nonfederal customers under comparable terms 

and conditions. Under federal law, drug manufacturers must list their 

brand drugs on the FSS to receive reimbursement for drugs covered by

Medicaid.18 All FSS prices include a fee of 0.5 percent of the price to fund 

VA’s National Acquisition Center. 

• Federal ceiling prices. Federal ceiling prices, also called Big Four prices, 

are available to VA, DOD, the Public Health Service, and the U.S. Coast 

Guard. These prices are mandated by law to be 24 percent lower than 

nonfederal average manufacturer prices.19

• Blanket purchase agreements. Blanket purchase agreements are national 

contracts with drug manufacturers that allow VA and DOD—either 

separately or jointly—to negotiate prices below FSS prices. The lower 

prices may depend on the volume of specific drugs being purchased by

particular facilities, such as VA or military hospitals, or on being assigned 

preferred status on VA’s and DOD’s respective national formularies. 

In a few cases, individual VA and DOD medical centers have obtained 

lower prices through local agreements with suppliers than they could have 

through the national contracts, FSS prices, or federal ceiling prices. 

In addition, VA’s and DOD’s use of formularies, pharmacies, and prime 

vendors can further affect drug prices. VA and DOD formularies encourage 

the substitution of lower-cost drugs determined to be as effective or more 

effective than higher-cost drugs. Both VA and DOD use prime vendors, 

which are preferred drug distributors, to purchase drugs from 

manufacturers and deliver the drugs to VA or DOD facilities.20 VA and DOD 

 18See 38 U.S.C. § 8126(a)(4). 

19See 38 U.S.C. § 8126(a)(2). The nonfederal average manufacturer price is the weighted 

average price of a single form and dosage unit paid by wholesalers to a manufacturer, 

taking into account cash discounts or similar price reductions. Big Four prices, in general,

do not apply to generic drugs.

20As of June 2004, VA used one prime vendor, while DOD used five prime vendors that

serviced different geographic areas. 

Page 12 GAO-07-358T
receive discounts from their prime vendors that also reduce the prices that 

they pay for drugs. For DOD, the discounts vary among prime vendors and 

the areas they serve. As of June 2004, VA’s prime vendor discount was 

5 percent, while DOD’s discounts averaged about 2.9 percent within the 

United States. 

Unlike VA and DOD, state Medicaid programs do not negotiate drug prices 

with manufacturers, but reimburse retail pharmacies for drugs dispensed 

to beneficiaries at set prices. Under the Medicaid drug rebate program,21

drug manufacturers provide quarterly rebates for covered outpatient 

prescription drugs purchased by state Medicaid programs. The rebates are 

meant to take advantage of the prices manufacturers receive for drugs in 

the commercial market and are required to reflect the results of 

negotiations by private payers such as discounts and rebates.

The rebates are based on two prices per drug that manufacturers report to 

CMS: best price22 and average manufacturer price (AMP).23 The 

relationship between best price and AMP determines the unit rebate 

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

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

difference between best price and AMP or 15.1 percent of AMP. If the 

drug’s AMP rises faster than inflation, the manufacturer is required to 

provide an additional rebate to the state Medicaid program.24 A state’s 

rebate for a brand drug is the product of the unit rebate amount plus any 

applicable additional rebate amount and the number of units of the drug 

paid for by the state’s Medicaid program. 

Medicaid 

 21See 42 U.S.C. § 1396r-8. 

22Best price is the lowest price available from the manufacturer to any wholesaler, retailer, 

provider, health maintenance organization, or nonprofit or government entity, with some

exceptions. Among other things, sales made through the FSS, single-award contract prices

of any federal agency, federal depot prices, and prices charged to DOD, VA, Indian Health 

Service, and Public Health Service are not considered in determining best price.

23AMP is defined by statute as the average price paid to a manufacturer for a drug by

wholesalers for drugs distributed to the retail pharmacy class of trade. Under the rebate

agreement manufacturers negotiate with HHS, AMP does not include prices to government 

purchasers based on the FSS, prices from direct sales to hospitals or health maintenance 

organizations, or prices to wholesalers when they relabel drugs they purchase under their

own label. 

24State Medicaid programs receive an additional rebate for brand drugs when a drug’s AMP 

rises faster than inflation, as measured by changes in the consumer price index. 

Page 13 GAO-07-358T
The 340B Drug Pricing 

Program 

Entities eligible for the 340B drug pricing program can purchase covered 

outpatient prescription drugs from manufacturers at or below statutorily 

defined prices, known as 340B ceiling prices, that take advantage of 

discounts resulting from the Medicaid drug rebate program. These prices

are the maximum amount eligible entities can pay for covered drugs, and 

the program allows for eligible entities to negotiate more favorable prices 

directly with drug manufacturers. As such, the 340B drug pricing program 

offers covered entities access to a prime vendor with which they can 

contract to negotiate discounts at or below the mandatory 340B ceiling 

price. 

State AIDS drug assistance programs (ADAP) are examples of entities 

eligible for the 340B drug pricing program. ADAPs participating in the 

340B program use either the 340B direct purchase option or the 340B 

rebate option. Under the direct purchase option, ADAPs purchase drugs 

from drug manufacturers or through a third party, such as a drug 

purchasing agent, and ADAPs receive the 340B price discount up front. In

addition, ADAPs using this option can access the prime vendor program to 

assist in negotiating discounts at or below the mandatory 340B ceiling 

price. Under the rebate option, ADAPs typically contract with entities such 

as a pharmacy network or PBM for the purchase of covered drugs and 

later request a 340B rebate directly from the drug manufacturers. ADAPs 

using the rebate option do not have access to the prime vendor program. 

Like Medicaid, Medicare does not purchase drugs but rather reimburses 

physicians for drugs covered under Part B. The maximum Medicare 

reimbursement for covered Part B drugs is statutorily defined using the 

average sales price (ASP) plus 6 percent.25 ASP is the average price for a 

drug based on a manufacturer’s sales to all purchasers in the United 

States, with certain exceptions. Under this reimbursement methodology, 

Medicare takes advantage of the prices negotiated by private payers, as 

ASP is required to reflect the discounts and rebates they negotiate.26

Medicare Part B 

 25See 42 U.S.C. § 1395w-3a. 

26The MMA also required HHS to implement a competitive acquisition program (CAP) for

certain Medicare Part B drugs. The CAP is a voluntary program, which began in July 2006,

that offers physicians the option to acquire many drugs they use in their practice from an

approved CAP contractor. 

Page 14 GAO-07-358T
The FEHBP is generally modeled after other large U.S. employers’ health 

benefits, including that participating health plans typically rely on PBMs to 

negotiate drug prices and offer other pharmacy benefit, administrative, 

and clinical services. In a 2003 report

27 that reviewed the use of PBMs by 

three FEHBP plans representing about 55 percent of FEHBP enrollment, 

we found that the PBMs used three key approaches to achieve savings for

FEHBP participating health plans: 

• passing on certain rebates negotiated with manufacturers to the plans; 

• obtaining drug price discounts from retail pharmacies and dispensing 

drugs at lower costs through mail-order pharmacies; and 

• using intervention techniques that reduce utilization of certain drugs or 

substitute other, less costly drugs. 

The FEHBP plans we reviewed also had formularies that include most 

therapeutic categories, and these formularies had few restrictions on 

which drugs enrollees could obtain. Each plan also provided enrollees 

access to nonformulary drugs, although sometimes with higher costsharing requirements than for the preferred formulary drugs.

The PBMs were compensated through various methods, including 

retaining some portion of the negotiated savings rather than passing the 

full portion to the FEHBP plans. These compensation methods also 

included collecting fees from FEHBP plans for administrative and clinical 

services; retaining a portion of the payments from the FEHBP plans for 

mail-order drugs in excess of the prices negotiated with manufacturers to 

acquire the drugs; and in some cases retaining a share of the rebates the 

PBMs negotiated with drug manufacturers. 

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

answer any questions that you or other Members of the Committee may 

have. 

FEHBP 

 27Federal Employees’ Health Benefits: Effects of Using Pharmacy Benefit Managers on

Health Plans, Enrollees, and Pharmacies. GAO-03-196. Washington, D.C.: January 10,

2003. 

Page 15 GAO-07-358T
For future contacts regarding this testimony, please contact John E. 

Dicken at (202) 512-7119 or at dickenj@gao.gov. Contact points for our 

Offices of Congressional Relations and Public Affairs may be found on the 

last page of this testimony. Martha Kelly, Assistant Director; Rashmi 

Agarwal; and Timothy Walker made key contributions to this statement. 

Contacts and 

Acknowledgments 

Page 16 GAO-07-358T
Page 17 GAO-07-358T

Related GAO Products 

Medicare Part B Drugs: CMS Data Source for Setting Payments Is 

Practical but Concerns Remain. GAO-06-971T. Washington, D.C.: 

July 13, 2006.

Ryan White CARE Act: AIDS Drug Assistance Programs, Perinatal HIV 

Transmission, and Partner Notification. GAO-06-681T. Washington, D.C.: 

April 26, 2006. 

Ryan White CARE Act: Improved Oversight Needed to Ensure AIDS Drug

Assistance Programs Obtain Best Prices for Drugs. GAO-06-646. 

Washington, D.C.: April 26, 2006. 

Medicaid: States’ Payments for Outpatient Prescription Drugs. 

GAO-06-69R. Washington, D.C.: October 31, 2005.

Medicaid Drug Rebate Program: Inadequate Oversight Raises Concerns

about Rebates Paid to States. GAO-05-850T. Washington, D.C.: 

June 22, 2005. 

Mail Order Pharmacies: DOD’s Use of VA’s Mail Pharmacy Could 

Produce Savings and Other Benefits. GAO-05-555. Washington, D.C.: 

June 22, 2005. 

Medicaid Drug Rebate Program: Inadequate Oversight Raises Concerns

about Rebates Paid to States. GAO-05-102. Washington, D.C.: 

February 4, 2005. 

Contract Management: Further Efforts Needed to Sustain VA’s Progress 

in Purchasing Medical Products and Services. GAO-04-718. Washington, 

D.C.: June 22, 2004. 

Medicare: Observations on Program Sustainability and Strategies to 

Control Spending on Any Proposed Drug Benefit. GAO-03-650T. 

Washington, D.C.: April 9, 2003. 

Federal Employees’ Health Benefits: Effects of Using Pharmacy Benefit 

Managers on Health Plans, Enrollees, and Pharmacies. GAO-03-196. 

Washington, D.C.: January 10, 2003. 

VA Health Care: Expanded Eligibility Has Increased Outpatient 

Pharmacy Use and Expenditures. GAO-03-161. Washington, D.C.: 

November 8, 2002. 

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