Medicaid Drug Rebate Program: Inadequate Oversight Raises Concerns about Rebates Paid to States
Published: 2005-02-04T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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. Both reflect manufacturers' prices to various entities, accounting for certain financial concessions like discounts. Concerns have been raised about rising Medicaid drug spending. GAO studied (1) federal oversight of manufacturer-reported best prices and AMPs and the methods used to determine them, (2) how manufacturers' determinations of those prices could have affected rebates, and (3) how the rebate program reflects financial concessions in the private market.
section_title: What GAO Found
paragraphs: Current 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. In addition, CMS only reviews the price determination methods when manufacturers request recalculations of prior rebates. In four reports issued from 1992 to 2001, 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 drug prices reported by manufacturers, including a lack of clear guidance on how AMP should be calculated. In some cases, OIG found problems with manufacturers' price determination methods and reported prices. However, CMS has not followed up with manufacturers to make sure that the identified problems with prices and methods have been resolved. There was considerable variation in the methods that manufacturers used to determine best price and AMP, and some methods could have reduced the rebates state Medicaid programs received. 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. The assumptions often involve the treatment of discounts and other price reductions in best price and AMP. Some manufacturers combined price reductions associated with particular sales in their price determination methods, while others accounted for the reductions separately. Separate treatment of the reductions resulted in rebates to states that in some cases were lower than they would have been had the reductions been considered together. Some manufacturers made assumptions that diverged from the rebate agreement and CMS program memoranda that could have raised rebates. States could have to repay any excess rebates if manufacturers revise their assumptions and request recalculations of prior rebates. 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 that are negotiated by pharmacy benefit managers (PBM) on behalf of third-party payers such as employer-sponsored health plans and other health insurers. 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 in their determinations of best price and AMP. Within the current structure of the rebate formula, additional guidance on how to account for these 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.

section_title: Letter
paragraphs: 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 program 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 fiscal year 2002, Medicaid drug expenditures were  $29.3 billion out of $258.2 billion in total Medicaid spending; under the  rebate program, manufacturers paid rebates to states of about $5.6 billion  for covered outpatient drugs. In recent years, concerns have been raised  about increasing Medicaid spending on prescription drugs. Medicaid drug  spending increased at an annual average rate of 19 percent from fiscal year  2000 to 2002, while Medicaid spending as a whole grew 12 percent  annually during that period.
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  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. 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), an agency of the  Department of Health and Human Services (HHS), administers and  oversees the rebate program, entering into rebate agreements with  manufacturers, 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 HHS’s Office of Inspector General (OIG). OIG regularly  conducts audits, evaluations, and investigations pertaining to HHS  programs.
Recent litigation has highlighted the importance of the accuracy of prices  manufacturers report to CMS and the rebates they pay to states. Since  2002, several manufacturers have agreed to make payments to settle  allegations that they underpaid rebates to states by reporting inaccurate  prices.
You asked us to study the Medicaid drug rebate program. We are reporting  on (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.
To report on the oversight of manufacturer-reported prices and methods,  we reviewed the rebate statute, the standard rebate agreement, CMS  program memoranda, and OIG reports on the rebate program. We also  interviewed officials from CMS and OIG. To assess how manufacturers’  price determination methods could have affected rebate amounts, 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 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. To examine  how the rebate program reflects financial concessions available in the  private market, we reviewed the rebate statute, the standard rebate  agreement, and CMS program memoranda; market literature; and recent  financial statements of three large pharmacy benefit managers (PBM),  which manage prescription drug benefits for third-party payers.
We determined that the manufacturers’ sales transaction data were  sufficiently reliable for the purposes of this report. To assess the reliability  of the data, we (1) confirmed that the data included the elements we  requested and were consistent with provided documentation; (2) reviewed  related documentation, including each manufacturer’s price determination  methods; and (3) worked with individual manufacturers’ Medicaid drug  rebate program personnel to identify any data problems. We also  compared the prices we calculated from the sales transaction data to the  prices manufacturers reported to CMS for the relevant quarter. It was not  feasible to compare the reported sales transaction data with their source  documentation, such as invoices, because of the large volume of sales  transactions associated with the drugs in our sample. We do not report  data in a manner that would allow the identification of a specific  manufacturer or drug. We performed our work from December 2003  through January 2005, in accordance with generally accepted government  auditing standards.
subsections: section_title: Background
paragraphs: 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.
subsections: section_title: Features of the Private Pharmaceutical Market
paragraphs: 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 private market also includes PBMs, which manage prescription drug  benefits for third-party payers such as employer-sponsored health plans  and other health insurers. PBMs may negotiate payments from  manufacturers to help reduce third-party payers’ costs for prescription  drugs; those payments may be based on the volume of drugs purchased by  the payers’ enrollees. PBMs also may operate mail-order pharmacies,  purchasing drugs from manufacturers and delivering them to their clients’  enrollees.
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. In some cases, purchasers negotiate a price with the  manufacturer that is below what a wholesaler pays the manufacturer for a  given drug. In such a circumstance, a wholesaler may sell the drug to the  purchaser at the lower negotiated price and then request from the  manufacturer a “chargeback”—the difference between the price the  wholesaler paid for the drug and the purchaser’s negotiated price.
section_title: The Medicaid Drug Rebate Program
paragraphs: 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, CMS has  issued program memoranda in order to provide further guidance to  manufacturers regarding how to determine best price and AMP, some of  which were in response to questions that arose regarding the methods that  manufacturers were using to determine those prices. 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. 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. Best price is required to be reduced to account for cash  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, 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. 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. 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. The  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. In 2000, rebates were based on the  minimum amount for about half of the brand name drugs covered under  the rebate program; for the remaining drugs, rebates were based on the  difference between best price and AMP.
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 due to, 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.
section_title: Current Program Oversight Does Not Ensure That Manufacturer- Reported Prices or Price Determination Methods Are Consistent with Program Criteria
paragraphs: 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. OIG has  issued four reports on audits of manufacturer-reported prices since the  program’s inception in 1991. OIG reported that, in the course of its work,  its efforts were hampered both by unclear CMS guidance on determining  AMP and by a lack of manufacturer documentation. In some instances,  OIG found problems with manufacturers’ price determination methods  and reported prices. However, CMS has not followed up with  manufacturers to make sure that the identified problems with prices and  price determination methods have been resolved.
subsections: section_title: CMS’s Review of Manufacturer-Reported Prices Is Limited
paragraphs: As part of the agency’s administration of the Medicaid drug rebate  program, 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 make sure all drugs for which manufacturers report  prices are in its database of Medicaid-covered drugs and to ensure that  those prices are submitted in the correct format. The agency’s automated  data checks also are intended to ensure that the correct price is used when  there are multiple prices for the same drug. When data checks indicate a  potential reporting error, CMS sends an edit report to the manufacturer  asking for corrected drug prices. However, CMS does not have a  mechanism in place to track whether, in fact, manufacturers submit  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. CMS will notify a  manufacturer of any missing price data for drugs in its database or any  large deviations from previous unit rebate amounts. For example, CMS  would send a report to a manufacturer that had a unit rebate amount for a  drug that deviated from that of the prior quarter by more than 50 percent.  It would be up to that manufacturer to indicate whether or not the  underlying reported prices were, in fact, correct. If a manufacturer  determined that there were problems with the reported price for a drug— such as incorrect unit pricing or typographical errors like misplaced  decimals—it would send corrected data to CMS prior to or with future  price submissions. In 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. If a  manufacturer did not send revised pricing data to CMS, then the unit  rebate amount would remain the same. In 2000, CMS generated  approximately 150 reports detailing these 50 percent deviations, according  to an agency official. The agency did not track how many unit rebate  amounts were changed as a result or any effect on rebates.
section_title: Price Determination Methods Are Reviewed Only When Manufacturers Request Recalculations
paragraphs: 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.  While the rebate agreement requires manufacturers to maintain  documentation of the assumptions underlying their price determination  methods, CMS does not verify that such documentation is kept and rarely  requests it. Furthermore, CMS does not generally check to ensure that  manufacturers’ assumptions and price determination methods are  consistent with the rebate statute and rebate agreement.
CMS reviews the methodologies employed to determine best price and  AMP 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 for determining those prices when requesting a recalculation of  prior rebates, so that it can evaluate whether the revised methods are  consistent with the rebate statute, rebate agreement, and program  memoranda. Six approved recalculations, for which we could obtain  data, reduced prior rebates to states by a total of more than $220  million. An additional approved recalculation required the manufacturer  to pay states an additional $388,000.
section_title: OIG Reports That Its Efforts Have Been Limited by Unclear Program Guidance
paragraphs: OIG has issued four reports on audits of manufacturer-reported prices  since the program’s inception in 1991. Three of the four OIG reports  documented limitations to OIG’s ability to verify drug prices. OIG reported  that its efforts were hampered by unclear CMS guidance on determining  AMP, by a lack of manufacturer documentation, or by both. In particular,  OIG found that a lack of specificity on how the “retail pharmacy class of  trade” was defined limited its efforts to verify AMP. Both the rebate statute  and rebate agreement define AMP as the average price paid by wholesalers  for drugs distributed to the retail pharmacy class of trade, with some  exceptions. OIG officials told us that program memoranda issued by CMS  have not provided sufficient guidance on AMP to allow OIG to audit  manufacturers’ methods for determining AMP. Despite these limitations, in  some instances OIG was able to identify some problems with the accuracy  of manufacturers’ reported prices; however, CMS has not followed up with  manufacturers to make sure that these problems with prices and price  determination methods have been resolved.
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. OIG found it could not evaluate the methods these  manufacturers used to determine 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.
In its second review of manufacturer-reported prices, OIG, in 1995,  attempted to verify one manufacturer’s recalculation request. While the  OIG reported that it could not complete its analysis because of inadequate  manufacturer documentation, 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.  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 such  as HMOs that repackage or relabel drugs under their own names—in their  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. 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. In 2001, OIG issued its  fourth review, reporting that states lost $80.7 million in rebates in fiscal  year 1999 due to improperly excluded drug sales to HMO repackagers. 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.
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. In October 2004, OIG officials told us that  they were working with CMS to review four manufacturers’ recalculation  requests and as part of this work were evaluating the methods  manufacturers have used to determine prices. OIG officials also told us  that they may conduct additional audits because of the number of recent  manufacturer recalculation requests—18 requests received between  September and December of 2003—and the significant financial impact the  potential rebate adjustments would have on state Medicaid programs.  However, in light of OIG’s remaining concerns about CMS guidance, OIG  officials told us that their current audits—and any future audits—likely  would be limited to descriptions of how inclusion and exclusion of certain  sales in price determinations would affect rebates.
section_title: Manufacturer Price Determination Methods Varied: Some Could Have Led to Lower Rebates
paragraphs: We found considerable variation in the methods that manufacturers 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.
We found that manufacturers made varying assumptions about which  sales to include and exclude from their calculations of 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.
Some manufacturers did not account for certain “administrative fees” paid  to PBMs when determining best price or AMP. The statute and rebate  agreement require that best price incorporate volume-based discounts.  Further, according to the rebate agreement and a CMS program  memorandum, both best price and AMP are to account for cumulative  discounts or other arrangements that subsequently adjust the prices  actually realized. While CMS has acknowledged that not all PBM  arrangements will affect best price and AMP, the agency has advised  manufacturers that administrative fees, incentives, promotional fees and  chargebacks, as well as all discounts and rebates provided to purchasers,  should be considered in determinations of best price and AMP when they  are associated with sales that are to be considered in those prices. When  a PBM acts as a mail-order pharmacy and takes possession of drugs, it is a  purchaser. We found that while the basis for the administrative fees paid  to PBMs varied among the manufacturers we reviewed, the fees often  were based on a utilization measure, such as the sales volume of drugs  used by the enrollees of the PBM’s clients. To the extent that PBMs’  purchases for their mail-order pharmacies contributed to the utilization  measures used to determine their administrative fees, the fees for the mail- order portion of their business resemble a volume-based discount that  adjusts the price actually realized. Some manufacturers told us that they  accounted for the portion of administrative fees paid to PBMs associated  with the PBMs’ mail-order pharmacies in their determinations of best price  or AMP. In contrast, others said they did not incorporate this portion of  any administrative fees paid to PBMs in either best price or AMP. Some of  those manufacturers characterized these fees as payments for services  rather than adjustments to prices.
Excluding administrative fees from the determination of best price or AMP  could have reduced rebates below what they would have been had the  manufacturers included them when determining those prices. For one  manufacturer, for example, if administrative fees paid to PBMs associated  with their mail-order pharmacy purchases had been included in the  manufacturer’s determination of best price and AMP, rebates for 11 drugs  would have been up to 16 percent higher in the third quarter of 2000 and  up to 12 percent higher in the fourth quarter of 2000. The ultimate impact  on rebates to states depends on how many manufacturers excluded these  fees from reported prices, the volume of those manufacturers’ sales to  PBM mail-order pharmacies, as well as the prices and utilization of the  relevant drugs.
Manufacturers also differed in how they accounted for certain  transactions involving prompt payment discounts. Both the rebate  agreement and an applicable CMS program memorandum specify that best  price and AMP are to reflect cumulative discounts or other arrangements  that subsequently adjust the prices actually realized. In examining  manufacturers’ practices, we found that they generally provided a prompt  payment discount of 2 percent of the purchase price to wholesalers and  others that purchased drugs from them directly, when they paid within a  specified period. In most cases, when the manufacturers we reviewed sold  a drug directly to a purchaser, they reduced the purchaser’s price by any  applicable prompt payment discount when determining best price and  AMP. When the transaction also involved a chargeback arrangement,  manufacturers’ methods differed. A chargeback involves one drug passing  from a manufacturer through a wholesaler to a purchaser, so the  chargeback amount and the prompt payment discount together affect the  amount the manufacturer actually realizes for the drug. (See fig. 1.) Some  manufacturers calculated the net price as their price to the wholesaler,  reduced by both the prompt payment discount and the chargeback amount  for those drugs, when determining best price and AMP. Other  manufacturers, however, considered any prompt payment discount given  to the wholesaler separately from any chargeback amount and thus did not  incorporate the effect of both price reductions when determining best  price and AMP. Some of these manufacturers indicated that they did not  combine these price reductions because the price reductions occurred in  two unrelated transactions to two separate purchasers.
In some cases, not accounting for the effect of both price reductions—the  prompt payment discount and the chargeback—in the determination of  best price and AMP reduced rebates below what they otherwise would  have been. For example, rebates for three drugs in our sample would have  been 3 to 5 percent higher had the manufacturers considered the effects of  both price reductions when determining the best prices and AMPs; for  seven other drugs, rebates would not have changed. The ultimate impact  on rebates to states depends on how many manufacturers adopted this  approach as well as the sales prices and utilization of the relevant drugs.
When determining best price and AMP, some manufacturers adopted  methods that could have raised rebates. For example, although the rebate  agreement excludes from AMP sales through the Federal Supply Schedule  and direct sales to hospitals and HMOs, which often involve relatively low  prices, one manufacturer included these sales in its calculations. However,  the manufacturer used list prices in the calculation of AMP instead of the  actual prices associated with the sales that were to be excluded from the  calculation. This approach, which diverged from the rebate agreement  and applicable CMS program memoranda, could have resulted in  artificially high AMPs, which in turn could have raised rebates.
In addition, 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  resulted in a lower best price in some cases, which may have increased  rebates to states. One 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.
section_title: Rebate Program Does Not Clearly Address Certain Financial Concessions Negotiated by PBMs
paragraphs: 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 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.  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.
Certain manufacturer financial concessions that are negotiated by PBMs  on behalf of their third-party payer clients, such as employer-sponsored  health plans and other health insurers, 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. (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. When a PBM passes on the entire manufacturer payment, the  manufacturer may pay the PBM a fee to cover the costs of administering  the program under which the payments are made. A PBM also may  negotiate a manufacturer payment for each unit of the drug purchased that  includes a fee, and the PBM may retain a part of that payment as  compensation. Some PBM clients may receive smaller discounts on drug  prices at the pharmacy in exchange for receiving all or a larger share of  the manufacturer payments, while other clients may receive greater  discounts on drug prices in exchange for the PBM retaining a larger share  of the manufacturer payment. 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  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  PBM-negotiated 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; 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. 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. 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. When we asked 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.
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. Alternatively, if  such a change increased the difference between AMP and best price for a  drug, the unit rebate amount could increase.
section_title: Conclusions
paragraphs: The importance of Medicaid rebates to states has grown as Medicaid  spending on prescription drugs has risen. To determine the level of rebates  that manufacturers pay to states, the rebate program relies on  manufacturer-reported prices, which are based on the prices and financial  concessions available in the private pharmaceutical market. CMS,  however, has not provided clear program guidance for manufacturers to  follow when determining those prices. This has hampered OIG’s efforts to  audit manufacturers’ methods and reported prices. Furthermore, as the  private market has continued to evolve, the rebate program has not  adequately addressed how more recent financial arrangements, such as  those between manufacturers and PBMs, should be accounted for in  manufacturers’ 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. Because rebates rely on manufacturer-reported prices,  adequate program oversight is particularly important to ensure that states  receive the rebates to which they are entitled.
section_title: Recommendations for Executive Action
paragraphs: To help ensure that the Medicaid drug rebate program is achieving its  objective of controlling states’ Medicaid drug spending, we recommend  that the Administrator of CMS take the following two actions:  Issue clear guidance on manufacturer price determination methods and  the definitions of best price and AMP, and update such guidance as  additional issues arise.  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  paid to states.
section_title: Agency and Industry Comments and Our Response
paragraphs: We received written comments on a draft of this report from HHS, which  incorporated comments from CMS and OIG. (See app. I.) HHS concurred,  in part, with our recommendation that CMS issue clear guidance on price  determination methods, noting agreement that such guidance would help  manufacturers, particularly with regard to accounting for sales to PBMs.  HHS stated that those issues would be examined and an assessment made  about where more guidance was needed. HHS noted that effort had been  devoted to providing guidance and that CMS would examine the resources  allocated to its review capabilities. In responding to our discussion of the  changing pharmaceutical market, however, the comments noted that  guidance could not address all current and potential arrangements in the  pharmaceutical market and therefore case-by-case guidance would  continue to be necessary to address specific situations. In responding to  our discussion of manufacturers’ price determination methods, the  comments stated that a response to our conclusion that some  manufacturers’ practices could lower or raise rebates was not possible  because we did not provide sufficient information on manufacturers’  practices. We believe that accurate and timely guidance could reduce the  need for case-by-case determinations. Although we cannot present the  detailed assumptions that various manufacturers made in interpreting and  implementing program guidance, because that information is proprietary,  we did provide examples of the different price determination methods and  assumptions that can affect best price and AMP and, therefore, rebates.
HHS concurred, in part, with our recommendation that CMS should  implement systematic oversight of manufacturers’ price determination  methods and a plan to ensure the accuracy of reported prices and rebates.  While the comments noted that requests from manufacturers to revise  their price determination methods were reviewed for adherence to current  policies, the comments disagreed with our conclusion that current  oversight does not ensure that prices or methods are consistent with  program criteria. The comments stated that CMS subjects manufacturer- supplied data to systematic edits, that CMS has increased its referrals to  OIG to examine recalculation requests, and that a regulation limiting the  time frames for recalculations and recordkeeping has been published. The  comments also referred to previous OIG reviews of manufacturer  practices and the plans to continue such reviews. In our draft, we noted  the data edits that CMS conducts, which help ensure the completeness of  the data. The systematic edits, however, do not ensure the accuracy of the  data. Specifically, while the edits address, for example, whether price data  are submitted in the correct format, they do not ensure that prices are  consistent with program criteria or that corrected prices are submitted  when necessary. We also noted OIG’s ongoing work on the Medicaid drug  rebate program. However, CMS’s referrals to OIG are made only when a  manufacturer requests that its rebates be recalculated, so there is no  ongoing review of the methods used by manufacturers. Finally, we also  noted in the draft the recently issued regulation, which did not address all  aspects of the program, such as determinations of best price and AMP. The  actions cited in the HHS comments do not constitute adequate oversight of  a program that relies on manufacturer-submitted data to determine  substantial rebates owed to state Medicaid programs.
Representatives from all the manufacturers that supplied us data were  invited to review and provide oral comments on portions of the draft  report, including the background and our discussion of manufacturers’  price determination methods. Representatives from five of the  manufacturers indicated that administrative fees that manufacturers pay  to PBMs do not necessarily need to be considered in the determination of  best price and AMP. Some argued that the fee is a payment for services  rendered and not a discount or rebate that would affect prices. Some  manufacturers also noted that we did not address payments to PBMs when  they are not acting as mail-order pharmacies. Others noted that CMS’s  guidance with respect to payments to PBMs is particularly unclear and  that CMS’s guidance has not addressed recent changes in the  pharmaceutical market. Six of the manufacturers took issue with our  discussion of the treatment of prompt payment discounts involving a  chargeback arrangement. Several stated that CMS has not indicated that  the prompt payment discount must be accounted for in the manner we  described. Some manufacturers noted that they treat the situation we  highlighted as two unrelated transactions to two separate purchasers, so  they do not need to combine both price reductions when determining best  price and AMP. Finally, six commented on the lack of clear guidance on  various aspects of determining best price and AMP. Some manufacturers  stated that program memoranda, which are a common CMS method of  issuing guidance for the rebate program, do not have to be followed  because they are not regulations.
In response to manufacturers’ comments, we clarified our discussion of  administrative fees paid to PBMs when they act as a mail-order  pharmacies. We state that administrative fees may resemble volume-based  discounts when PBMs take possession of drugs. The manufacturers did  not have the opportunity to review our discussion of the changing  pharmaceutical market, which addresses the broader role of PBMs in  negotiating for third-party payers. With respect to our discussion of  prompt payment discounts involving a chargeback arrangement, we  observed in the draft that manufacturers differed in how they accounted  for price reductions when determining best price and AMP, and we have  clarified and expanded that discussion based on the comments we  received.
Both HHS and the manufacturers also provided technical comments,  which we incorporated as appropriate.
As agreed with your offices, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days after its  date. We will then send copies of this report to the Secretary of Health and  Human Services, the Administrator of CMS, the Acting Inspector General  of Health and Human Services, and other interested parties. We will also  provide copies to others upon request. In addition, the report will be  available at no charge on the GAO Web site at http://www.gao.gov.
If you or your staffs have any questions about this report, please call  Marjorie Kanof at (202) 512-7114. Major contributors to this report are  listed in appendix II.
section_title: Appendix I: Comments from the Department of Health and Human Services
section_title: Appendix II: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Acknowledgments
paragraphs: Major contributors to this report were Robin Burke, Martha Kelly, Ann  Tynan, Helen Desaulniers, Julian Klazkin, and Jennie Apter.