Food Assistance: FNS Could Take Additional Steps to Contain WIC Infant Formula Costs
Published: 2006-03-28T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Special Supplemental Nutrition Program for Women, Infants and Children (WIC) provides food, nutrition education, and health care referrals to close to 8 million low-income pregnant and postpartum women, infants, and young children each year. About a quarter of these participants are served using rebate savings from contracts with infant formula manufacturers. WIC is administered by the Department of Agriculture's Food and Nutrition Service (FNS). To better understand infant formula cost containment, this report provides information on: (1) factors that influence program spending on infant formula, (2) how the level of savings resulting from infant formula cost containment has changed and the implications of these changes for the number of participants served; and (3) steps federal and state agencies have taken to contain state spending on infant formula.
section_title: What GAO Found
paragraphs: Rebates drive state spending on infant formula but use of non-rebated formula increases state costs. In fiscal year 2004, states paid an average of $0.20 per can for milk-based concentrate formula, a savings of 93 percent off the wholesale price. However, states also allow some use of non-rebated formula that can cost states more than 10 times as much as contract formulas. For example, in 2004, 8 percent of infant formula provided to WIC participants was non-rebated. Rebate savings from infant formula cost-containment contracts have allowed WIC to serve an additional 2 million participants per year, but recent increases in the cost per can of formula could lead to reductions in the number of participants served with rebates. Rebate savings have remained near $1.6 billion per year since 1997 after adjusting for inflation, but the amount states pay per can of infant formula has increased since 2002. We estimated that in 2004, if the cost per can of formula increased in every state by as much as it did in two states, approximately 400,000 fewer participants would have been able to enroll in WIC nationwide. State and federal agencies have both taken steps to contain WIC infant formula costs, but FNS also focuses on sustaining the cost-containment system. States have sought to increase their costs savings through their infant formula contracts--for example, by joining coalitions to leverage greater discounts. Some also try to restrict the use of the more expensive non-contract formulas. FNS, in turn, helps states to contain costs through its review of contracts and through policy and guidance. For example, FNS reduced--but did not eliminate--the price increases that can result from the introduction of new, more costly formulas. FNS has also used its oversight authority to ensure that all interested manufacturers can compete for state infant formula contracts in an effort to maintain the long-run sustainability of the infant formula cost-containment system.

section_title: Letter
paragraphs: The Special Supplemental Nutrition Program for Women, Infants and  Children (WIC) provides food, nutrition education, and health care  referrals to close to 8 million low-income pregnant and postpartum  women, infants, and young children each year. The 2 million infants who  receive WIC benefits each year account for about half of infants born in  the United States. Congress allotted just over $5.2 billion to fund the WIC  program for fiscal year 2005, of which approximately 16 percent is  typically used to purchase infant formula, the most expensive item  supplied under the food grant. The U.S. Department of Agriculture’s  (USDA) Food and Nutrition Service (FNS) oversees and provides guidance  to the state and local agencies that implement the WIC program.
States contain the cost of infant formula using a competitive bidding  process that awards sole-source contracts to infant formula  manufacturers. This competitive bidding process allows infant formula  manufacturers to compete for the contracts by offering sizeable discounts  to the states on the infant formula that WIC participants purchase. Three  infant formula companies currently compete and serve WIC participants— Mead Johnson, Ross Laboratories, and Nestlé. With just three  manufacturers competing for WIC contracts, infant formula is among the  most concentrated markets in the United States. State WIC agencies  provide most of their WIC infants with one of the contract manufacturer’s  milk-based or soy-based infant formulas designed for healthy infants.
Infants can also be provided with a “non-contract” infant formula if  prescribed by a medical professional. There are two types of non-contract  infant formula. “Exempt” infant formulas are designed for infants with  specific medical or dietary problems, and “non-contract, non-exempt”  infant formulas are designed for healthy infants but manufactured by a  company other than the contract manufacturer. States do not receive  rebates on non-contract infant formulas.
WIC participants typically purchase infant formula from stores at the full  retail price using a voucher or coupon. The voucher specifies the brand  and amount of infant formula the participant can purchase. The store then  bills the state, and to obtain the price discounts, states then send the  contract manufacturer an invoice listing the number of cans of contract  brand infant formula purchased. The manufacturer, in turn, provides  discounts to the state in the form of rebates for each can of infant formula  purchased.
States use the savings generated by these cost-containment contracts to  serve additional participants. Figure 1 depicts the transactions in the  rebate process.
In recent years, some states have seen their savings from cost-containment  efforts decline, raising concern about the implications that reduced  rebates might have on the WIC program since more than one-quarter of  WIC participants are served with rebates. To better understand factors  that affect state spending on infant formula and the implications of infant  formula cost containment for the WIC program, this report will provide  information on: (1) factors that influence program spending on infant  formula, including the role of rebate savings that states receive through  infant formula cost-containment contracts; (2) how the level of savings  resulting from infant formula cost containment has changed over the past  5 years and the implications of these changes for the number of  participants served; and (3) steps federal and state agencies have taken to  contain state spending on infant formula.
To address these research objectives, we analyzed administrative data on  program participation, food costs, and total rebates provided to us by FNS  for the years 1999 through 2004, and information on rebates obtained by  individual states per can of milk-based concentrate infant formula for  fiscal years 2000 through 2005. Using FNS data, we calculated trends in the  average per-can cost of milk-based concentrate infant formula in the   50 states plus the District of Columbia between 2000 and 2005, as well as  trends in total rebates, and trends in the share of participants served using  rebate savings. We also used this data to estimate the potential impact of  reduced rebates on program participation under three alternate scenarios.  To better understand the factors that affect program spending on infant  formula, we surveyed 50 state WIC programs and the District of Columbia  to obtain additional information about their infant formula contracts. We  achieved a 100 percent response rate. We also reviewed literature on  factors that influence infant formula spending, and interviewed several  state and local WIC directors, all three infant formula manufacturers  currently participating in the WIC market, and policy experts with an  interest in WIC infant formula cost containment. We performed this work  between April 2005 and March 2006 in accordance with generally accepted  government auditing standards. See appendix I for additional information  on scope and methodology.
subsections: section_title: Background
paragraphs: The Special Supplemental Nutrition Program for Women, Infants and  Children (WIC) was established in 1972 to provide food, nutrition  education, and health care referrals to low-income pregnant and  postpartum women, infants, and young children. The program is  administered by FNS in conjunction with state and local health  departments and related agencies. WIC is almost entirely federally funded.  WIC is not an entitlement program; Congress does not set aside funds to  allow every eligible individual to participate in the program. Instead, WIC  is a federal grant program for which Congress authorizes a specific  amount of funds each year. USDA provides funding for food and nutrition  services and administration. Both funding and participation have  increased each year since fiscal year 2000. Congress also typically  provides for a contingency fund to ensure that adequate resources are  available for the program if unanticipated costs arise.
subsections: section_title: Infant Formula Rebate Savings
paragraphs: WIC participants typically receive food benefits in the form of vouchers or  coupons that they redeem at authorized retail vendors to obtain, at no cost  to the participants, certain approved foods, including infant formula. State  WIC agencies then reimburse the retail vendors for the food purchased by  WIC participants. Since 1989, state WIC agencies have been required by  law to contain the cost of infant formula using a competitive bidding  process to award sole-source contracts unless they can demonstrate that  an alternative method would yield the same or greater cost savings.  Manufacturers agree to provide a rebate to the state WIC agency for every  can of infant formula purchased under the WIC contract, and the state  awards the contract to the bidder offering the lowest net wholesale price  after subtracting the rebate from the cost of infant formula. In exchange,  the state provides the contract brand of infant formula to most infants  enrolled in the program except those that are breastfeeding exclusively  and those with a medical condition that requires the use of a non-contract  infant formula. Rebates have become an important source of funding for  the WIC program. In 2004, rebates totaled more than $1.6 billion and  funded the benefits provided to about a quarter of WIC participants.
section_title: FNS Review of Contracts
paragraphs: Contracts for WIC infant formula are between states and infant formula  manufacturers. States are responsible for issuing requests for bids and  drafting contract provisions according to state contracting requirements.  Typically, a WIC agency will draft a bid solicitation and obtain state  approval for the contract language. Once the state approves the  solicitation, the WIC agency will submit it to the FNS regional office for  review. The regional office ensures that the contract adheres to all federal  requirements and may suggest ways to improve the contract. FNS  headquarters reviews the contract for final approval. After approval, the  contracting process is conducted by the state.
section_title: Types of Infant Formula
paragraphs: Infant formula comes in three physical forms: liquid concentrate, powder,  and ready-to-feed. Infants may receive up to 31 13-ounce cans of liquid  concentrate per month through WIC, or roughly the equivalent amount of  powdered or ready-to-feed infant formula. Most infants are provided an  infant formula that is covered by the state’s cost-containment contract.  There are three categories of infant formula provided to WIC participants:    Contract brand infant formula is produced by the contract manufacturer  and is suitable for routine use by the majority of healthy full-term infants.  These include milk-based and soy-based infant formulas and could include  milk- and soy-based infant formulas enhanced with DHA and ARA,  lactose-free infant formula, added-rice infant formulas, and easy-to-digest  infant formulas. “Contract brand infant formula” also includes new infant  formulas introduced by the contract manufacturer after the contract is  awarded, with the exception of infant formula under the following  “exempt” category.
Exempt infant formula is represented and labeled for use by infants with  medical conditions such as inborn errors of metabolism, low birth weight,  or other unusual medical or dietary problems that require that they use a  more specialized infant formula.
Non-contract brand non-exempt infant formula is all infant formula  produced by a manufacturer other than the contract manufacturer that is  suitable for routine use by the majority of healthy full-term infants.
FNS regulations require local WIC agencies to obtain medical  documentation to provide all exempt infant formulas and all non-contract,  non-exempt infant formulas. Medical documentation, for these purposes,  is a determination by a licensed health care professional authorized to  write medical prescriptions under state law. A licensed health care  professional must make a medical determination that an infant has a  medical condition that dictates the use of these infant formulas.
section_title: Rebates Drive WIC Infant Formula Costs More Than Any Other Factor, but Use of Non-Contract Infant Formulas also Plays a Role
paragraphs: State spending on infant formula depends on the discounts, in the form of  rebates, that states receive from manufacturers, and use of non-contract  infant formula. Rebates are the most important factor driving state  spending on infant formula because such a large proportion of WIC infant  formula is purchased under cost-containment contracts with  manufacturers. According to infant formula manufacturers, the  attractiveness of a WIC contract depends, at least in part, on factors over  which states have some control, including the extent to which a WIC  contract will help a manufacturer market its products to non-WIC  consumers; state-level administration of WIC contracts; and the provision  of powder, concentrate, and ready-to-feed infant formula to WIC  participants. These factors, in turn, could affect whether or not a  manufacturer bids on a contract and the level of rebates offered by the  manufacturers. The provision of non-rebated infant formula also affects  state spending.
subsections: section_title: States Receive Rebates on Most Infant Formula Purchased through WIC
paragraphs: In 2004, states received rebates on approximately 92 percent of the infant  formula provided to WIC participants, and saved, on average, 93 percent  off the wholesale price. As a result, states paid an average of $0.20 per   13-ounce can of milk-based infant formula with a wholesale price of   $2.60 to $3.57. However, while average rebates were high, rebate levels  varied significantly by state. For example, in 2004, Virginia and South  Carolina were paying as little as $0.07 per can of milk-based concentrate  after rebates, while New York was paying $0.80 per can after rebates.
Representatives of the three infant formula manufacturers identified  several factors that influence how “attractive” they find a state contract.  The attractiveness of a contract, in turn, could influence whether a  manufacturer bids on a contract and the size of the rebate offered. Many of  the factors cited by manufacturers are things over which states have at  least some control.
Shelf space and product placement: WIC-brand infant formulas may  get more shelf space than competing brands, particularly in stores that  serve areas with large concentrations of WIC participants. Because WIC  participants purchase such a large share of infant formula in some stores,  retailers tend to stock more of the WIC brand of infant formula. In  addition to shelf space, WIC-brand products may be placed at eye level so  that they are easy to spot.
All three infant formula manufacturers noted the importance of shelf  space and product placement to their marketing strategies. In addition,   31 of the 51 state WIC directors that responded to our survey felt that shelf  space was moderately, very, or extremely important to manufacturers in  determining how much they bid on an infant formula contract. While WIC  agencies do not have direct control over shelf space and product  placement, some include stocking requirements in their contracts with  vendors.
State policies regarding authorization of WIC vendors can also impact  manufacturers’ access to non-WIC consumers. Some states have  authorized WIC vendors that sell exclusively or primarily to WIC  participants. Manufacturers have less access to non-WIC consumers if  more WIC participants purchase their infant formula at these “WIC-only”  stores. In those cases, retailers that serve the non-WIC population in the  area may be less likely to focus on product placement or devoting shelf  space to the WIC brand—two factors that benefit manufacturers in their  drive to reach non-WIC consumers.
Physician and Hospital Recommendations: Having WIC contracts  could also benefit manufacturers through physician recommendations.  State WIC programs often work with physicians to educate them about the  program and the requirement that most WIC participants use the contract  brand of infant formula. Physicians may decide to recommend the WIC  brand of infant formula to all patients to avoid having to differentiate  between those enrolled and not enrolled in WIC. Similarly, some hospitals  agree to provide WIC-brand infant formula to new mothers so that they  won’t have to switch infant formulas after they leave the hospital. It may  be easier for hospitals to provide the WIC-brand infant formula to all new  mothers. Moreover, two of the infant formula companies that participate  in the WIC market are divisions of pharmaceutical companies that  primarily market their products directly to physicians and hospitals while  also marketing, though to a lesser extent, directly to consumers. States  vary in the extent to which they emphasize doctor and hospital outreach.
Product Innovation: All three manufacturers cited the central role of  product innovation in their business strategies. Manufacturers seek to  compete on the basis of product innovation and product quality despite  the fact that infant formula is a relatively homogeneous product.  Manufacturers said that certain state practices could make it more difficult  to pursue their core strategy of innovation, and the development,  distribution, and marketing of new products. These practices include the  use of long-term contracts, requirements that manufacturers notify states  of product changes in advance of introducing new products into the  market, provisions that allow states to unilaterally extend contracts  without requesting the consent of the manufacturer, state restrictions on  the ways in which manufacturers market their infant formula, and  restrictions on their interactions with physicians. While these state  practices could inhibit innovation, many are put in place to protect states  from increases in infant formula costs.
State Billing Systems: All three manufacturers cited the accuracy of  state billing systems as a key factor they consider when developing bids,  and all stated that the vast majority of state billing systems need  improvement. One manufacturer said that most states rely on antiquated  information technology that is prone to costly billing errors. According to  FNS officials, disputes over billing for infant formula rebates have long  been a problem in the WIC program. In the past, some states requested  reimbursement from infant formula manufacturers for every can of infant  formula listed on redeemed vouchers. However, some WIC participants  did not purchase every can of infant formula listed on the voucher. In  these instances, the manufacturers claimed they were being billed for  purchases that were never made. Partly in response to these disputes, a  new provision was included in the Child Nutrition and WIC  Reauthorization Act of 2004 that requires states to bill only for infant  formula actually purchased.
Contract size: State WIC directors said they believe that contracts that  cover more infants yield higher rebates; however, the manufacturers said  that the largest contracts may not draw their highest bids. A few state WIC  directors expressed concerns that new provisions in the Child Nutrition  and WIC Reauthorization Act of 2004 limiting the size of state coalitions  and requiring separate contracts for milk-based and soy-based infant  formula could reduce the size of contracts and the size of rebates.  However, manufacturers noted that costly shifts in demand occur when  very large states or coalitions change contractors. Manufacturers must be  able to respond to these shifts by quickly increasing or decreasing  production, and must, therefore, consider their own production capacity  when they bid on very large contracts.
Contract Provisions: Manufacturers noted that states sometimes include  contract provisions that manufacturers consider complex, ambiguous, and  extraneous and inclusion of these provisions could affect rebates. For  example, manufacturers cited provisions that increase the potential  liabilities of manufacturers, give states control over manufacturer  activities, or require manufacturers to provide products or services not  directly related to the sale of infant formula—such as sponsoring  conferences, providing literature on nutrition education, or providing free  infant formula—as particularly unattractive.  Because states rarely modify  contract provisions in response to manufacturer concerns, manufacturers  may respond to these provisions by either not bidding on contracts or  offering lower rebates.
Provision of Powder, Concentrate and Ready-to-Feed Infant  Formulas: All three manufacturers cited the importance of state policies  governing the provision of powder, concentrate, and ready-to-feed infant  formulas. Historically, the WIC program has issued more concentrate than  powder, but there has been an increase in the use of powder in the WIC  program since 2000. Because ready-to-feed infant formula is the most  expensive, WIC regulations allow WIC agencies to provide it only in  certain circumstances Twenty-nine states were able to provide us with  data on their use of the different forms of infant formula in both 2000 and  2004. In 2000, 55 percent of all infant formula issued in those states was in  the form of liquid concentrate. By 2004, liquid concentrate represented  only a third of all infant formula provided to WIC participants in those  states. Powder use may have increased because it can be more convenient  for mothers who are partially breastfeeding because mothers can  reconstitute small amounts of powdered infant formula at a time, whereas  liquid concentrate must be diluted all at once. Manufacturers did not  provide information on how the provision of different forms of infant  formula might affect their bids on infant formula contracts. However, if  concentrate is more profitable, the shift to powder could reduce  manufacturer profits—and the rebates they offer to states. Alternatively, if  powder is more profitable or there are no differences in the profitability of  different forms, the shift to powder might not affect rebates.
section_title: Use of Non-Contract Infant Formula Increases Formula Costs
paragraphs: Although non-contract infant formula, including both exempt and non- contract, non-exempt infant formula, accounts for less than 10 percent of  infant formula purchased through WIC, its use can have a significant  impact on total infant formula spending because it can cost as much as   10 to 20 times more per can than rebated formula. Among the 27 states  that were able to provide us with data on their use of contract, exempt,  and non-contract, non-exempt formulas in both 2000 and 2004, use of  exempt formula increased and use of non-contract, non-exempt formula  decreased over the 4-year period. Figure 2 shows the average share of  each type of formula provided to WIC participants in 43 states in 2004.
section_title: Rebate Savings Have Been Used to Serve about a Quarter of All Participants in Recent Years, but If Rebate Savings Continue to Decline, Fewer People Will Be Able to Participate
paragraphs: Rebate savings have remained relatively stable since 1997 after adjusting  for inflation, but if recent increases in the amount states pay for each can  of infant formula they purchase through WIC continue, fewer participants  will likely be served with rebates in the future. About a quarter of all WIC  participants are served using rebate savings. However, over the past   5 years, the amount states pay for infant formula has increased somewhat,  particularly among states that have awarded new contracts. There is some  concern that if the price states must pay for infant formula continues to  increase, fewer participants will be served using rebates. We estimated  that in 2004, if all states had paid as much per can of infant formula as the  two states with the lowest rebates, approximately 400,000 fewer children  would have been able to enroll in WIC nationwide.
subsections: section_title: Total Rebate Savings Have Been Stable but the Amount States Pay Per Can of Infant Formula Has Increased Since 2002
paragraphs: After increasing substantially in the years prior to 1997, the total amount  that states received from manufacturers in infant formula rebates has  remained relatively constant since that time. As shown in figure 3, rebate  savings have remained at about $1.6 billion per year after adjusting for  inflation.
The percent of participants that have been served using rebates has also  remained relatively stable over the past 5 years, at about 25 percent. In  2004, some 2 million participants were served using rebate dollars.
Although both total rebate savings and the share of participants served  using rebate savings has changed little in recent years, we found that the  amount states pay per can of infant formula, after taking rebates into  account, has increased over the past few years. The average net price  states paid per can of milk-based concentrate infant formula increased  from $0.15 in fiscal year 2002 to $0.21 in fiscal year 2005 after adjusting for  inflation.
Because most contracts lock in the price states pay for infant formula for  up to 5 years, average prices tend to move slowly. The price increases are  more apparent among contracts that were newly awarded each fiscal year.  Among newly awarded contracts, there was a fourfold increase in the  average net price of a can of infant formula over the 3-year period, from  $0.10 in 2002 to $0.43 in 2005. Figure 4 shows rebates for newly awarded  contracts between fiscal year 2000 and fiscal year 2005.
Although the amount states pay for infant formula varies by state, the  increases in the average net price were not driven by large increases in  just a few states, but reflect higher wholesale prices and lower rebates  nationwide. Eight of the 9 states that implemented a new contract in 2002  did so at either the same net price as under their previous contract or at a  lower net price. This trend shifted over the next few years. By 2004, a  majority of states implementing new contracts saw their net price  increase, and in 2005, every state that implemented a new contract did so  at a higher net price than under its previous contract.
The extent to which net prices increased among newly awarded contracts  varied, but most states did not experience significant price increases.  Among states that implemented new contracts in 2005, the average net  price for a can of milk-based concentrate was $0.43 after rebates. This  represented a discount of about 87 percent off the wholesale price. In a  few states, however, the net price states paid for milk-based concentrate  under their contracts was significantly higher than the average. New York  implemented a contract in 2004 that provided milk-based concentrate for a  net price of $0.80 per can, a discount of 75 percent off the wholesale price.
Similarly, North Dakota implemented a contract in 2005 that provided a  net price of 0.83 per can, a discount of 77 percent off the wholesale price.
The impact of reduced rebates per can of infant formula was exacerbated  by an increase in the use of more expensive types of infant formulas. Since  the early 1990s, infant formula manufacturers have diversified their  product lines to include a greater number of infant formula types, all of  which have higher wholesale prices than traditional unenhanced milk- and  soy-based infant formulas. The most significant change in infant formulas  came with the introduction of DHA and ARA enhanced infant formulas  starting in 2002. All three manufacturers have introduced DHA and ARA  enhanced infant formulas at prices that are higher than the unenhanced  versions. At the time of our survey in mid-2005, 23 states reported that  they issue enhanced infant formula as their primary contract brand; only   8 states reported that they do not approve enhanced infant formula. In  addition, four of the five most recent contracts to be awarded specified the  enhanced infant formulas as the primary contract brand. The increased  use of infant formulas with a higher wholesale price may have contributed  to the increase in the net price of infant formula under new cost- containment contracts if infant formula companies sought higher  compensation for their more expensive products.
section_title: Higher Infant Formula Costs Could Reduce Participation by Nearly 400,000
paragraphs: Increases in the cost of infant formula have not yet had a significant  impact on the share of participants served with rebate savings, but if infant  formula costs were to continue to increase, it is likely that fewer  participants would be served using rebate savings in the future absent  funding increases. To illustrate how infant formula prices can affect WIC  participation, we considered how three different scenarios would have  affected participation in WIC during fiscal year 2004. We estimated the  number of WIC participants that would have been served using rebate  savings if the average rebate in 2004 had been 90 percent of the wholesale  price of infant formula—slightly less than the actual discount of   93 percent. We also considered scenarios reflecting larger reductions in  rebates, to 85 percent and 75 percent of the wholesale price of infant  formula. We compared our estimates to the actual number served using  rebates in fiscal year 2004.
We found that with even a modest reduction in rebates across all states,  fewer participants could be served:  If rebates were equal to 90 percent of the wholesale price in all states in  2004, about 70,000 fewer participants would have received WIC benefits.
If rebates were equal to 85 percent of the wholesale price in all states in  2004, about 175,000 fewer participants would have received WIC benefits.
If rebates had fallen to 75 percent of the wholesale price in all states in  2004, the program would have been able to serve about 400,000 fewer  participants.
Because most states are still under existing contracts negotiated in prior  years, it would take some time for the impact of reduced rebates to be  fully realized. Many states will be under their current contracts through  2006 and 2007 and many have contracts that continue through 2008 or  2009 if they opt to extend their contracts as permitted. State WIC directors  in 45 of 51 states reported that their infant formula contracts allow for  extensions ranging from 1 year to 4 years. However, if the recent decline in  rebates continues, there could be an impact on the number of participants  served using rebates within the next few years.
section_title: State and Federal Agencies Take Steps to Contain Costs; however, FNS also Focuses on Sustaining the Competitive Bidding System
paragraphs: While both states and FNS try to contain costs, FNS also works to sustain  the competitive bidding system while states work to maximize their own  savings. State WIC agencies have taken a variety of actions to promote  cost containment. For example, some have joined coalitions or barred the  provision of non-contract, non-exempt infant formula. Similarly, FNS  promotes cost savings through a requirement that infant formula  manufacturers provide the same percent discount for all infant formulas,  even new infant formulas introduced when a contract is already in effect.  However, FNS attempts to balance its efforts to promote cost containment  with its larger goal of sustaining the competitive bidding system. For  example, in some cases, FNS did not approve provisions in cost- containment contracts that would save states money if FNS believed these  provisions would reduce competition.
subsections: section_title: States Have Taken Steps to Reduce Infant Formula Costs
paragraphs: Through their infant formula contract bid solicitations, states have taken  steps to promote cost containment. For example, by including provisions  they believe manufacturers might find favorable or by omitting provisions  they believe would have a negative impact on their rebate savings, states  have sought to maximize their savings. As other examples:     Thirty states have joined coalitions in an effort to share streamline the  bidding process and leverage greater bargaining power when negotiating  contracts with manufacturers.
Some states allow contract extensions only if both the state and the infant  formula contractor agree, rather than providing for unilateral contract  extensions at state option.
States have also taken steps to limit the amount they spend on non- contract infant formulas:    Sixteen states purchase some or all of the exempt infant formula that is  provided to participants directly from manufacturers or from low-cost  providers.
Twelve states do not provide more expensive non-contract brand, non- exempt infant formula to WIC participants, and nine states limit statewide  use of non-contract, non-exempt infant formula to a specified share of all  infant formula provided. In addition, 27 states limit the amount of time that  non-contract, non-exempt infant formulas can be issued to participants.
Eight states do not provide more expensive enhanced infant formula.
Despite these state efforts to contain costs, opportunities remain for more  states to further reduce the use of non-rebated infant formulas. Use of  non-contract, non-exempt infant formula varies. Twelve states reported  that they have policies in place not allowing the use of non-contract, non- exempt infant formula.  Of the 43 states that provided complete  information on their average monthly usage of contract, exempt, and non- contract, non-exempt infant formulas in 2004, 27 states reported that  between 0.3 percent and 4 percent of infant formula provided is non- contract, non-exempt, and 8 states reported use between 4.5 percent and   9 percent. As required by the Infant Formula Act, infant formula is a  relatively homogeneous product. Consequently, it is unlikely that large  discrepancies among states in the use of non-contract, non-exempt infant  formulas designed for use by healthy infants can be explained by  differences in health conditions of infants receiving WIC infant formula in  these states. There are also large discrepancies in the use of exempt infant  formula designed to treat infants’ medical conditions. State provision of  exempt infant formula ranges from a low of 0 percent to a high of about   23 percent. (See app. II for information on use of non-contract, non- exempt and exempt infant formula by state.) Again, as with non-contract,  non-exempt infant formula, it is not clear how infants’ medical needs  could vary so significantly among states. Figure 6 shows the minimum,  median, and maximum use of each type of infant formula in 2004.
Most states reported that they require participants to obtain medical  documentation for non-rebated infant formula, as required by FNS.  However, some local WIC directors said there are instances in which  doctors do not diagnose a medical condition but still write a prescription  at the request of the participant. Local WIC agency staff told us that they  identify these cases only by confirming diagnoses with each physician  which not all agencies have the resources to do. As a result, some WIC  participants may be receiving non-rebated infant formula even though they  do not have a medical condition requiring such infant formula.
section_title: FNS Has Taken Steps to Reduce Infant Formula Costs
paragraphs: In its oversight capacity, FNS has helped states increase their cost- containment savings by providing technical assistance to states as they  develop their cost-containment contracts, and by implementing  regulations that help states achieve cost savings. For example, FNS  requires manufactures to provide the same discount on all infant formulas  after state costs rose with the introduction of a new infant formula. In  1993, one company introduced a lactose-free infant formula to  accommodate infants with intolerance for milk-based infant formula.  When this company introduced its lactose-free infant formula, it provided  a significantly lower rebate amount on this infant formula than it provided  on its milk-based infant formula covered by the existing contract, even  though the wholesale price of the new infant formula was higher per can.  As a result, states received a much lower discount on the new infant  formula than they received on the original contract infant formula. At the  same time, prescriptions for the lactose-free infant formula increased  because the company marketed the infant formula directly to doctors. The  cost savings states achieved through rebates began to erode. To maintain  competition by ensuring that all manufacturers could bid on contracts and  to help preserve rebate savings, FNS in 2000 established the requirement  that infant formula manufacturers provide the same percent discount for  all infant formulas, even those introduced when a contract is already in  effect.
The requirement that manufacturers provide the same percent discount  for infant formulas introduced during a contract slows but does not  completely stem increases in state spending on infant formula. Even with  the requirement, states must still pay more for each can of newly- introduced infant formula when the wholesale price of the infant formula  is higher. As a result, manufacturers still have a financial incentive to  introduce and market more expensive infant formula because they charge  a higher price per can.
By 2003, all three manufacturers introduced new infant formulas enhanced  with the fatty acids DHA and ARA. Like other newly-introduced infant  formulas, these enhanced infant formulas were more expensive. Two state  officials told us that the manufacturers replaced the milk-based infant  formula the state was providing to WIC participants in some parts of the  state with the enhanced infant formula. Retail outlets stopped stocking the  original milk-based infant formula; as a result, states had to purchase the  enhanced infant formula. In contrast, when manufacturers introduced new  infant formulas in the past, states had a choice not to provide the new  infant formulas or to limit their use because the original milk-based infant  formula was still available. At least one state has since introduced a  contract provision that requires manufacturers to charge the same price  per can for newly-introduced products when those products replace the  primary contract infant formula.
section_title: FNS Promotes the Long- Run Sustainability of the Competitive Bidding System
paragraphs: Recognizing the history and dynamics of the infant formula market and the  importance of competition to the cost-containment goals of the WIC  program, FNS has attempted to ensure that all manufacturers can compete  for state infant formula contracts regardless of their share of the market.  Infant formula manufacturers operate within a highly concentrated  industry. Beginning in the 1970s, three manufacturers—Wyeth-Ayerst,  Mead Johnson, and Ross Laboratories—dominated the infant formula  market. By the 1990s, the industry had shifted. Wyeth-Ayerst exited the  domestic infant formula market in 1996. By then Nestlé had begun selling  infant formula and had at least one state WIC contract. By 2000, Nestlé still  had the smallest market share of the three companies.
In order to ensure the sustainability of competitive bidding, FNS has not  allowed provisions in cost-containment contracts that would have boosted  state savings when FNS believed those provisions would reduce  competition:    For example, during negations FNS held with New England and Tribal  Organization (NEATO) coalition from January 1995 through February  1996, FNS disapproved a contract provision that would have required that  manufacturers demonstrate that they had the production capacity  sufficient not only to meet infant formula contract commitments they had  with NEATO, but also commitments they had made with other states and  those to be awarded. NEATO included this provision, in part, because its  contractor at the time had run out of infant formula, and, as a result,  smaller states in the coalition did not have enough infant formula. FNS  rejected the requirement that manufacturers prove they could fulfill  contracts commitments with others states, which it viewed as intrusive  and which it felt hindered fair and open competition.
Similarly, in 2005, FNS did not approve a contract provision that would  have allowed Wisconsin to continue with its current contractor if the bids  it received differed by $10,000 or less. Under the provision, the state could  have avoided expenses associated with switching contracts. FNS did not  approve the provision because it believed it would give the current  contract holder an advantage over the other two competitors.
Several state WIC directors we interviewed questioned FNS’ role in the  infant formula contracting process. Three state WIC directors pointed out  that infant formula cost containment was initiated by states. In addition, a  few state WIC directors noted that the manufacturers have stayed in the  WIC market for years, even though some say that providing infant formula  under these contracts is not profitable. FNS officials, however, pointed out  that Wyeth stopped bidding on WIC contracts, and that competition would  decrease if any other manufacturers stop bidding on WIC contracts.
The Child Nutrition and WIC Reauthorization Act of 2004contained two  provisions that promote competition among infant formula manufacturers  by limiting the size of contracts and coalitions to ensure all manufacturers  can bid on contracts regardless of their capacity:    A requirement that states or coalitions serving more than 100,000 infants  request separate bids for milk-based and soy-based infant formulas.
Limits on the size of state coalitions.
The act also addressed manufacturers’ concerns about how WIC agencies  implement their infant formula contracts:    A requirement that states provide participants, as the infant formula of  first choice, the infant formula designated by the contract manufacturer as  its “primary contract infant formula.”
A requirement that manufacturers not only raise the rebates they provide  to states in response to any increase in wholesale price, but also lower the  rebates they provide to states by an amount equal to any decreases in  wholesale price.
A requirement that states accurately account for the number of cans of  infant formula purchased, not just the number of vouchers redeemed at  retailers.
section_title: Conclusion
paragraphs: Although states developed and implemented measures to contain the cost  of infant formula, FNS has played an increasingly important role in  balancing the goals of containing infant formula costs and maintaining  competition among infant formula manufacturers. FNS actions have not  always maximized the cost savings of individual states, but by ensuring  that all interested manufacturers can compete for WIC contracts, it has  helped to ensure the long-run sustainability of the WIC cost-containment  system. However, if manufacturers continue to emphasize a business  strategy focused on innovation and product differentiation, WIC cost- containment savings are likely to erode further despite existing measures  to protect state cost savings. By providing manufacturers with a higher  per-can reimbursement for newly introduced, more expensive products,  and by allowing states to issue non-contract, non-exempt infant formulas  to participants with physician prescriptions, federal regulations encourage  manufacturers to diversify their product lines and charge more for infant  formula, even within a contract period. Unless FNS takes additional steps  to safeguard rebate savings, total rebates could continue to erode and the  number of participants who can be served by WIC will likely fall.
section_title: Recommendations for Executive Action
paragraphs: To help states preserve rebate savings generated through infant formula  cost containment and reduce costs associated with the purchase of non- rebated infant formula, we recommend that the Secretary of the  Department of Agriculture take the following two actions:    Consider providing additional guidance related to product changes so that  state costs do not increase when infant formula manufacturers introduce  new or improved infant formulas by encouraging all states to include in  their contracts a provision that requires manufacturers to provide new and  improved products marketed under a different name at the net wholesale  price specified in the contract when the new product replaces the product  the manufacturer designated as its “primary contract infant formula.” We  recommend that the Secretary consider implementing a regulatory  provision if necessary to ensure that states implement the guidance.
Provide guidance or technical assistance to state agencies on ways to  reduce the use of non-rebated infant formulas in states where use of these  infant formulas is high.
section_title: Agency Comments and Our Evaluation
paragraphs: On March 13, 2006, we met with FNS officials to discuss their comments.   The officials said they generally agreed with our recommendations. They  stated that they will provide guidance related to product changes to assist  state agencies in minimizing cost increases when infant formula  manufacturers introduce a new infant formula that replaces the primary  contract infant formula. Officials agree that a regulatory change would be  necessary to require that state agencies include provisions in their  contracts to accomplish this goal. They cautioned, however, that they have  limited influence over the recent increases in infant formula costs  attributable to manufacturers’ price and product changes. While we agree  that FNS is constrained in its ability to affect manufacturer marketing and  pricing decisions, we believe the agency should take any steps available to  contain infant formula costs given the importance of cost-containment  savings to serving as many eligible women, infants, and children as  possible.
Agency officials also stated that they will continue to provide guidance to  state agencies related to the issuance of non-contract infant formula for  those states where the use of these infant formulas appears high.  However, officials expressed concern that some states may have  misreported their use of exempt and non-contract, non-exempt infant  formulas due to confusion over terminology and interpretation of the  survey instrument.  Officials noted that since some state agencies may  require the same medical documentation for exempt infant formulas, non- contract, non-exempt infant formulas, and certain contract infant formulas  other than the primary contract brand, some states may have  misunderstood the distinction between the three types of infant formula  we identified and misreported use of the different types of infant formula.  We believe that the survey provided sufficient examples to allow states to  distinguish between the three infant formula types we identified. We  pretested our survey with officials in five states, in which we discussed  their understanding of each question and the terms we used, and all of the  officials we spoke with understood the differences between the categories  of infant formula we identified. However, we acknowledge that because  states are not required to track infant formula use by the categories we  used or by the technical categories defined in the Infant Formula Act, our  estimates of the use of the three types of infant formula may not be  consistent across all states.
Agency officials also expressed concern over the fact that we requested  data for non-contract and exempt infant formulas by the average monthly  percentage of total cans issued rather than by average monthly percentage  of participation. Agency officials stated that some state agencies capture  their data in terms of percentage of participation and this may have  contributed to misreporting. In our discussions with state officials, we  were told that because information on the number of cans provided  through WIC is usually used to bill manufacturers for infant formula  rebates, most states track the number of cans of infant formula provided  to WIC participants.
In 2003, GAO reported similar findings related to use of non-contract  infant formula based on a survey that used different terminology and a  different measure of use. The consistency between the findings in the two  reports reinforces the ongoing importance of ensuring that states clearly  understand the distinction between the different types of non-contract  infant formula, monitoring the use of different types of infant formula, and  providing technical assistance to state agencies where use of non-contract  infant formula is high.
Agency officials also provided technical comments, which we  incorporated into the report where appropriate. This included revising  data that had been provided by two states that had reported particularly  high use of non-contract, non-exempt infant formula.
We are sending copies of this report to the Secretary of USDA, relevant  congressional committees, and others who are interested. Copies will be  made available to others upon request, and this report will also be  available on GAO’s Web site at http://www.gao.gov.
If you or your staff have any questions about this report, please contact me  on (202)512-7215 or fagnonic@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. GAO staff who made major contributions to this report are  listed in appendix III.
section_title: Appendix I: Scope and Methodology
paragraphs: This appendix provides a detailed description of the scope and  methodology we used to determine (1) what factors influence program  spending on infant formula, including the role of rebates that states  receive through infant formula cost-containment contracts; (2) how the  level of savings resulting from infant formula cost containment has  changed over the past 5 years and the implications of these changes for  the number of participants served; and (3) how federal and state policies  and guidance have influenced state spending on infant formula.
To assess what factors influence program spending on infant formula,  including federal and state policies, we surveyed state directors of the  Special Supplemental Nutrition Program for Women, Infants, and Children  (WIC) in all 50 states and the District of Columbia. All 51 survey recipients  responded to our survey, but not all respondents provided answers to  every question. Where fewer than 51 responses were provided, we noted in  the text the number of respondents on which the finding was based. We  pretested the survey questionnaire with state WIC officials in five states.  During these pretests, we administered the questionnaire and asked the  officials to fill it out as they would if they had received it in the mail. After  completing the questionnaire, we interviewed the respondents to ensure  that the questions were clear and unbiased, the data we requested were  feasible to collect, and the questionnaire did not place an undue burden on  the agency officials completing it. To encourage respondents to complete  the questionnaire, we sent one follow-up mailing containing the full survey  instrument to nonrespondents approximately 3 weeks after the initial  mailing and a second follow-up letter about 2 weeks later.
We also conducted a review of literature on infant formula cost  containment and spoke with officials from the U.S. Department of  Agriculture’s (USDA) Food and Nutrition Service (FNS); state WIC  directors in Illinois, Massachusetts, Minnesota, New Jersey, New York,  Pennsylvania, and Washington; and local WIC directors from Belford, New  Jersey; Chicago, Illinois; Odessa, Texas; Salt Lake City, Utah; and Tempe,  Arizona. These state and local WIC directors were selected based on  recommendations of the National WIC Association and FNS and represent  several different geographic areas. We included states that belong to  contracting coalitions as well as those that contract themselves, and those  that had rebid their infant formula contracts recently as well as those that  last rebid their contracts several years ago. We also interviewed  individuals with expertise related to WIC and infant formula cost  containment from the National WIC Association and the Center on Budget  and Policy Priorities. In addition, we interviewed representatives from  Nestlé, Mead Johnson, and Ross Products to understand the perspectives  of the infant formula manufacturers.
To assess trends in rebate savings and in the number of participants  served with rebate savings, we analyzed administrative data we received  from FNS on WIC program participation, food costs, and total rebates  from 1990 through 2005. We assessed the reliability of the data by  reviewing existing information about the data and the system that  produced them and interviewing agency officials knowledgeable about the  data. We determined that the data were sufficiently reliable for the  purposes of this report. We adjusted the rebate figures for inflation using  the producer price index for pharmaceuticals. Infant formula is marketed  in a way that is similar to pharmaceuticals.
To estimate the impact of reduced rebates on the number of participants  served with rebate savings, we used data we received from FNS on total  rebates for 2004. This allowed us to estimate the share of infant formula  spending that was spent on rebated infant formula and the share that was  spent on non-rebated infant formula including exempt and non-contract,  non-exempt infant formulas. We then held spending on non-rebated infant  formulas constant, and estimated the reduction in total rebates that would  have resulted if the average rebate states received through their cost- containment contracts in 2004 had been lower than the actual average  discount of 93 percent of the wholesale price of milk-based concentrate.   We considered three scenarios to represent recent trends in infant formula  rebates, either nationwide or in individual states:      A reduction in rebates from 93 percent of the wholesale price of infant  formula to 90 percent of the wholesale price of infant formula, a modest  decrease to rebate levels experienced by states in 2000.
A moderate decrease to 85 percent of the wholesale price of infant  formula, the average rebate on newly awarded contracts in 2004.
A larger decrease to 75 percent of the wholesale price of infant formula, a  decrease similar to that experienced by two states.
To estimate trends in the per-can cost of infant formula, we also analyzed  information we received from FNS on the rebates individual states  received per can of milk-based concentrate infant formula from fiscal  years 2000 to 2005. We used this data to calculate trends in state infant  formula costs.
section_title: Appendix II: Use of Non-Contract, Non-Exempt and Exempt Infant Formula by State, Fiscal Year 2004
section_title: Appendix III: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Acknowledgments
paragraphs: Kay Brown, Assistant Director; Carol Bray; Kathryn Larin; Lise Levie;   Lynn Milan; Marc Molino; Luann Moy; Susan Pachikara; Tovah Rom; and  Daniel Schwimer made significant contributions to this report.
section_title: Related GAO Products
paragraphs: Breastfeeding: Some Strategies Used to Market Infant Formula May  Discourage Breastfeeding; State Contracts Should Better Protect Against  Misuse of WIC Name. GAO-06-282. Washington, D.C.: February 8, 2006.
Means-Tested Programs: Information on Program Access Can Be an  Important Management Tool. GAO-05-221. Washington, D.C.: April 11,  2005.
Nutrition Education: USDA Provides Services through Multiple  Programs, but Stronger Linkages among Efforts Are Needed. GAO-04-528.  Washington, D.C.: April 27, 2004.
Food Assistance: Potential to Serve More WIC Infants by Reducing  Formula Cost. GAO-03-331. Washington, D.C.: February 12, 2003.
Food Assistance: WIC Faces Challenges in Providing Nutrition Services.  GAO-02-142. Washington, D.C.: December 7, 2001.
Food Assistance: Research Provides Limited Information on the  Effectiveness of Specific WIC Nutrition Services. GAO-01-442.  Washington, D.C.: March 30, 2001.
FNS: Special Supplemental Nutrition Program for Women, Infants and  Children: Requirements for and Evaluation of WIC Program Bid  Solicitations for Infant Formula Rebate Contracts. OGC-00-65.  Washington, D.C.: September 18, 2000.
Food Assistance: Financial Information on WIC Nutrition Services and  Administrative Costs. RCED-00-66. Washington, D.C.: March 6, 2000.
Food Assistance: Efforts To Control Fraud and Abuse in the WIC  Program Can Be Strengthened. RCED-99-224. Washington, D.C.: August  30, 1999.
Food Assistance: Information on WIC Sole-Source Rebates and Infant  Formula Prices. RCED-98-146. Washington, D.C.: May 11, 1998.
Food Assistance: Information on Selected Aspects of WIC. T-RCED-98- 128. Washington, D.C.: March 17, 1998.
Food Assistance: WIC Program Issues. T-RCED-98-125. Washington, D.C.:  March 17, 1998.
Food Assistance: A Variety of Practices May Lower the Costs of WIC.  RCED-97-225. Washington, D.C.: September 17, 1997.