The FEHBP is the largest employer-sponsored health insurance program in the country. Through it, about 8 million federal employees, retirees, and their dependents received health coverage—including for prescription drugs—in 2008. Coverage is provided under competing plans offered by multiple private health insurers under contract with OPM, which administers the program, subject to applicable requirements. In 2009, 269 health plan options were offered by participating insurers, 10 of which were offered nationally while the remaining health plan options were offered in certain geographic regions. According to OPM, plans must cover all medically necessary prescription drugs approved by the Food and Drug Administration (FDA), but plans may maintain formularies that encourage the use of certain drugs over others. Enrollees may obtain prescriptions from retail pharmacies that contract with the plans or from mail-order pharmacies offered by the plans. In 2005, FEHBP prescription drug spending was an estimated $8.3 billion. Medicare—the federal health insurance program that serves about 45 million elderly and disabled individuals—offers an outpatient prescription drug benefit known as Medicare Part D. This benefit was established by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) beginning January 1, 2006. As of February 2009, Part D provided federally subsidized prescription drug coverage for nearly 27 million beneficiaries. The Centers for Medicare & Medicaid Services (CMS), part of the Department of Health and Human Services (HHS), manages and oversees Part D. Medicare beneficiaries may choose a Part D plan from multiple competing plans offered nationally or in certain geographic areas by private sponsors, largely commercial insurers, under contract with CMS. Part D plan sponsors offer drug coverage either through stand-alone prescription drug plans for beneficiaries in traditional fee-for-service Medicare or through Medicare managed care plans, known as Medicare Advantage. In 2009, there were over 3,700 prescription drug plans offered. Under Medicare Part D, plans can design their own formularies, but each formulary must include drugs within each therapeutic category and class of covered Part D drugs. Enrollees may obtain prescriptions from retail pharmacies that contract with the plans or from mail-order pharmacies offered by the plans. Medicare Part D spending is estimated to be about $51 billion in 2009. The VA pharmacy benefit is provided to eligible veterans and certain others. As of 2006, about 8 million veterans were enrolled in the VA system. In general, medications must be prescribed by a VA provider, filled at a VA pharmacy, and listed on the VA national drug formulary, which comprises 570 categories of drugs. In addition to the VA national formulary, VA facilities can establish local formularies to cover additional drugs. VA may provide nonformulary drugs in cases of medical necessity. In 2006, VA spent an estimated $3.4 billion on prescription drugs. The DOD pharmacy benefit is provided to TRICARE beneficiaries, including active duty personnel, certain reservists, retired uniformed service members, and dependents. As of 2009, there were about 9.4 million eligible TRICARE beneficiaries. In addition to maintaining a formulary, DOD provides options for obtaining nonformulary drugs. Beneficiaries can obtain prescription drugs through a network of retail pharmacies, nonnetwork retail pharmacies, DOD military treatment facilities, and DOD’s TRICARE Mail-Order Pharmacy. In 2006, DOD spent $6.2 billion on prescription drugs. Medicaid, a joint federal-state program, finances medical services for certain low-income adults and children. In fiscal year 2008, approximately 63 million beneficiaries were enrolled in Medicaid. While some benefits are federally required, outpatient prescription drug coverage is an optional benefit that all states have elected to offer. Drug coverage depends on the manufacturer’s participation in the federal Medicaid drug rebate program, through which manufacturers pay rebates to state Medicaid programs for covered drugs used by Medicaid beneficiaries. Retail pharmacies distribute drugs to Medicaid beneficiaries and then receive reimbursements from states for the acquisition cost of the drug and a dispensing fee. Medicaid outpatient drug spending has decreased since 2006 because Medicare Part D replaced Medicaid as the primary source of drug coverage for low-income beneficiaries with coverage under both programs—referred to as dual eligible beneficiaries. In fiscal year 2008, Medicaid outpatient drug spending was $9.3 billion—including $5.5 billion as the federal share—which was calculated after adjusting for manufacturer rebates to states under the Medicaid drug rebate program. FEHBP uses competition among health plans as the primary measure to control prescription drug spending and other program costs. Under an annual “open season,” enrollees may remain enrolled in the same plan or select another competing plan based on benefits, services, premiums, and other such factors. Thus, plans have the incentive to try to retain or increase their market share by providing the benefits sought by enrollees along with competitive premiums. In turn, the larger a plan’s market share, the more leverage it has for obtaining favorable drug prices on behalf of its enrollees and controlling prescription drug spending. Similar to most private employer-sponsored or individually purchased health plans, most FEHBP plans contract with pharmacy benefit managers (PBMs) to help them administer the prescription drug benefit and control drug spending. In a 2003 report reviewing the use of PBMs by three plans representing about 55 percent of total FEHBP enrollment, we found that the PBMs used three key approaches to achieve savings for the health plans: negotiating rebates with drug manufacturers and passing some of the savings to the plans; obtaining drug price discounts from retail pharmacies and dispensing drugs at lower costs through mail-order pharmacies operated by the PBMs; and using other intervention techniques that reduce utilization of certain drugs or substitute other, less costly drugs. For example, under generic substitution PBMs substituted less expensive, chemically equivalent generic drugs for brand-name drugs; under therapeutic interchange PBMs encouraged the substitution of less expensive formulary brand-name drugs for more expensive nonformulary drugs within the same drug class; under prior authorization PBMs required enrollees to receive approval from the plan or PBM before dispensing certain drugs that are high cost or meet other criteria; and under drug utilization review PBMs examined prescriptions at the time of purchase or retrospectively to assess safety considerations and compliance with clinical guidelines, including appropriate quantity and dosage. The PBMs were compensated by retaining some of the negotiated savings. The PBMs also collected fees from the plans for administrative and clinical services, kept a portion of the payments from FEHBP plans for mail-order drugs in excess of the prices they paid manufacturers to acquire the drugs, and in some cases retained a share of the rebates that PBMs negotiated with drug manufacturers. While OPM does not play a role in negotiating prescription drug prices or discounts, it does attempt to limit prescription drug spending through its leverage with participating health plans in annual premium and benefit negotiations. Each year, OPM negotiates benefit and rate proposals with participating plans and announces key policy goals for the program, including those relating to spending control. For example, in preparation for benefit and rate negotiations for the 2007 plan year, OPM encouraged proposals from plans to continue to explore the appropriate substitution for higher cost drugs with lower cost therapeutic alternatives, such as generic drugs, and the use of tiered formularies or prescription drug lists. OPM also sought proposals from plans to pursue the advantages of specialty pharmacy programs aimed at reducing the high costs of infused and intravenously administered drugs. In preparation for 2010 benefit and rate negotiations, OPM reiterated its desire for proposals from plansto substitute lower cost for higher cost therapeutically equivalent drug s, adding emphasis to using evidence-based health outcome measures. Medicare Part D uses a competitive model similar to FEHBP, while other federal programs use other methods, such as statutorily mandated prices or direct negotiations with drug suppliers. Medicare Part D follows a model similar to the FEHBP by relying on competing prescription drug plans to control prescription drug spending. As with the FEHBP, during an annual open season Part D enrollees may remain enrolled in the same plan or select from among other competing plans based on benefit design, premiums, and other plan features. To attract enrollees, plans have the incentive to offer benefits that will meet beneficiaries’ prescription drug needs at competitive premiums. The larger a plan’s market share, the more leverage it has for obtaining favorable drug prices on behalf of its enrollees and controlling prescription drug spending. As a result, Part D plans vary in their monthly premiums, the annual deductibles, and cost sharing for drugs. Plans also differ in the drugs they cover on their formulary and the pharmacies they use. Part D uses competing sponsors to generate prescription drug savings for beneficiaries, in part through their ability to negotiate prices with drug manufacturers and pharmacies. To generate these savings, sponsors often contract with PBMs to negotiate rebates with drug manufacturers, discounts with retail pharmacies, and other price concessions on behalf of the sponsor. MMA specifically states that the Secretary of HHS may not interfere with negotiations between sponsors and drug manufacturers and pharmacies. Even though CMS is not involved in price negotiations, it attempts to determine whether beneficiaries are receiving the benefit of negotiated drug prices and price concessions when it calculates the final plan payments. Sponsors must report the price concession amounts to CMS and pass price concessions onto beneficiaries and the program through lower cost sharing, lower drug prices, or lower premiums. Similar to OPM, CMS also negotiates plan design with participating plans and announces key policy goals for the program, including those relating to spending control. For example, in preparation for 2010 benefit and rate negotiations, CMS noted that one of its goals is to establish a more transparent process so that beneficiaries will be able to better predict their out-of-pocket costs. Part D sponsors or their PBMs also use other methods to help contain drug spending similar to FEHBP plans. For example, most plans assign covered drugs to distinct tiers, each of which carries a different level of cost sharing. A plan may establish separate tiers for generic drugs and brand-name drugs—with the generic drug tier requiring a lower level of cost sharing than the brand-name drug tier. Plans may also require utilization management for certain drugs on their formulary. Common utilization management practices include requiring physicians to obtain authorization from the plan prior to prescribing a drug; step therapy, which requires beneficiaries to first try a less costly drug to treat their condition; and imposing quantity limits for dispensed drugs. Additionally, all Part D plans must meet requirements with respect to the extent of their pharmacy networks and the categories of drugs they must cover. Plan formularies generally must cover at least two Part D drugs in each therapeutic category and class, except when there is only one drug in the category or class or when CMS has allowed the plan to cover only one drug. CMS has also designated six categories of drugs of clinical concern for which plans must cover all or substantially all of the drugs. While FEHBP and Medicare Part D use competition between health plans to control prescription drug spending, VA and DOD rely on statutorily mandated prices and discounts and further negotiations with drug suppliers to obtain lower prices for drugs covered on their formularies. VA and DOD have access to a number of prices to consider when purchasing drugs, paying the lowest available. Federal Supply Schedule (FSS) prices. VA’s National Acquisition Center negotiates FSS prices with drug manufacturers, and these prices are available to all direct federal purchasers. FSS prices are intended to be no more than the prices manufacturers charge their most-favored nonfederal customers under comparable terms and conditions. Under federal law, drug manufacturers must list their brand-name drugs on the FSS to receive reimbursement for drugs covered by Medicaid. All FSS prices include a fee of 0.5 percent of the price to fund VA’s National Acquisition Center. Blanket purchase agreements and other national contracts. B purchase agreements and other national contracts with drug manufacturers allow VA and DOD—either separately or jointly—to negotiate prices below FSS prices. The lower prices may depend on the volume of specific drugs being purchased by particular facilities, such as VA or military hospitals, or on being ass OD’s respective national formularies. D igned preferred status on VA’s and In a few cases, individual VA and DOD medical centers have obtained lower prices through local agreements with suppliers than they could through the national contracts, FSS prices, or federal ceiling prices. In addition, VA’s and DOD’s use of formularies, pharmacies, and prime vendors can further affect drug prices and help control drug spending. Both VA and DOD use their own national, standard formulary to obtain more competitive prices from manufacturers that have their drugs listed on the formulary. VA and DOD formularies also encourage the substitution of lower cost drugs determined to be as or more effective than hig drugs. VA and DOD use prime vendors, which are preferred drug distributors, to purchase drugs from manufacturers and deliver the drugs to VA or DOD facilities. VA and DOD receive discounts from their prime vendors that also reduce the prices that they pay for drugs. For DOD, the discounts vary among prime vendors and the areas they serve. As of June 2004, VA’s prime vendor discount was 5 percent, while DOD’s discounts averaged about 2.9 percent within the United States. Additionally, si to FEHBP and Medicare Part D, DOD uses utilization management methods to limit drug spending including prior authorization, dispensin limitations, and higher cost sharing for nonformulary drugs and drugs dispensed at retail pharmacies. Unlike VA and DOD, Medicaid programs do not negotiate drug prices with il manufacturers to control prescription drug spending, but reimburse reta pharmacies for drugs dispensed to beneficiaries at set prices. CMS sets aggregate payment limits—known as the federal upper limit (FUL)—for certain outpatient multiple-source prescription drugs. CMS also provides guidelines regarding drug payment. States are to pay pharmacies the lower of the state’s estimate of the drug’s acquisition cost to the pharmacy, pl a dispensing fee, or the pharmacy’s usual and customary charge to the general public; for certain d costs may apply if lower. rugs the FUL or the state maximum allowable In addition to these retail pharmacy reimbursements, Medicaid programs also control prescription drug spending through the Medicaid drug rebate program. Under the drug rebate program, drug manufacturers are required to provide quarterly rebates for covered outpatient prescription drugs purchased by state Medicaid programs. Under the rebate program, states take advantage of the prices manufacturers receive for drugs in the commercial market that reflect the results of negotiations by private payers such as discounts and rebates. For brand-name drugs, the rebates are based on two price benchmarks per drug that manufacturers report to CMS: best price and average manufacturer price (AMP). The relationship between best price and AMP determines the unit rebate amount and thus the overall size of the rebate that states receive. The basic unit rebate amount is the greater of two values: the difference between best price and AMP or 15.1 percent of AMP. If the brand-name drug’s AMP rises faster than inflation as measured by the change in the consumer price index, the manufacturer is required to provide an additional rebate to the state Medicaid program. In addition to brand-name drugs, states also receive rebates for generic drugs. For generic drugs, the basic unit rebate amount is 11 percent of the AMP. A state’s rebate for a drug is the product of the unit rebate amount plus any applicable additional rebate amount and the number of units of the drug paid for by the state’s Medicaid program. In addition to the rebates mandated under the drug rebate program, states can also negotiate additional rebates with manufacturers. Like FEHBP and Medicare Part D participating plans, Medicaid programs also use other utilization management methods to control prescription drug spending including prior authorization and utilization review programs, dispensing limitations, and cost-sharing requirements. Mr. Chairman, this concludes my prepared remarks. I would be happy to answer any questions that you or other members of the Subcommittee may have. For future contacts regarding this testimony, please contact John E. Dicken at (202) 512-7114 or at dickenj@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this testimony. Randy DiRosa, Assistant Director; Rashmi Agarwal; William A. Crafton; Martha Kelly; and Timothy Walker made key contributions to this statement. Federal Employees Health Benefits Program: Enrollee Cost Sharing for Selected Specialty Prescription Drugs. GAO-09-517R. Washington, D.C.: April 30, 2009. Medicare Part D Prescription Drug Coverage: Federal Oversight of Reported Price Concessions Data. GAO-08-1074R. Washington, D.C.: September 30, 2008. DOD Pharmacy Program: Continued Efforts Needed to Reduce Growth in Spending at Retail Pharmacies. GAO-08-327. Washington, D.C.: April 4, 2008. DOD Pharmacy Benefits Program: Reduced Pharmacy Costs Resulting from the Uniform Formulary and Manufacturer Rebates. GAO-08-172R. Washington, D.C.: October 31, 2007. Military Health Care: TRICARE Cost-Sharing Proposals Would Help Offset Increasing Health Care Spending, but Projected Savings Are Likely Overestimated. GAO-07-647. Washington, D.C.: May 31, 2007. Federal Employees Health Benefits Program: Premiums Continue to Rise, but Rate of Growth Has Recently Slowed. GAO-07-873T. Washington, D.C.: May 18, 2007. Prescription Drugs: Oversight of Drug Pricing in Federal Programs. GAO-07-481T. Washington, D.C.: February 9, 2007. Prescription Drugs: An Overview of Approaches to Negotiate Drug Prices Used by Other Countries and U.S. Private Payers and Federal Programs. GAO-07-358T. Washington, D.C.: January 11, 2007. Medicaid Outpatient Prescription Drugs: Estimated 2007 Federal Upper Limits for Reimbursement Compared with Retail Pharmacy Acquisition Costs. GAO-07-239R. Washington, D.C.: December 22, 2006. Federal Employees Health Benefits Program: Premium Growth Has Recently Slowed, and Varies among Participating Plans. GAO-07-141. Washington, D.C.: December 22, 2006. Medicaid: States’ Payments for Outpatient Prescription Drugs. GAO-06-69R. Washington, D.C.: October 31, 2005.

Summary: Millions of individuals receive prescription drugs through federal programs. The increasing cost of prescription drugs has put pressure to control drug spending on federal programs such as the Federal Employees Health Benefits Program (FEHBP), Medicare Part D, the Department of Veterans Affairs (VA), the Department of Defense (DOD), and Medicaid. Prescription drug spending within the FEHBP in particular, which provides health and drug coverage to about 8 million federal employees, retirees, and their dependents, has been a significant contributor to FEHBP cost and premium growth. The Office of Personnel Management (OPM), which administers the FEHBP, predicted that prescription drugs would continue to be a primary driver of program costs in 2009. GAO was asked to describe approaches used by the FEHBP to control prescription drug spending and summarize approaches used by other federal programs. This testimony is based on prior GAO work, including Prescription Drugs: Oversight of Drug Pricing in Federal Programs (GAO-07-481T) and Prescription Drugs: An Overview of Approaches to Negotiate Drug Prices Used by Other Countries and U.S. Private Payers and Federal Programs (GAO-07-358T) and selected updates from relevant literature on drug spending controls prepared by other congressional and federal agencies. FEHBP uses competition among health plans to control prescription drug spending, giving plans an incentive to rein in costs and leverage their market share to obtain favorable drug prices. Most FEHBP plans contract with pharmacy benefit managers (PBMs) to help administer the prescription drug benefit. In a 2003 report, GAO found that the PBMs reduced drug spending by: negotiating rebates with drug manufacturers and passing some of the savings to the plans; obtaining drug price discounts from retail pharmacies and dispensing drugs at lower costs through mail-order pharmacies operated by the PBMs; and using other techniques that reduce utilization of certain drugs or substitute other, less costly drugs. While OPM does not negotiate drug prices or discounts for FEHBP, it attempts to limit spending through annual premium and benefit negotiations with plans, including the encouragement of spending controls such as generic substitution. Other federal programs use a range of approaches to control prescription drug spending. (1) Medicare--the federal health insurance program for the elderly and disabled--offers an outpatient prescription drug benefit known as Medicare Part D that uses competition between plan sponsors and their PBMs to limit drug spending, in part through the ability to negotiate prices and price concessions with drug manufacturers and pharmacies. Plans are required to report these negotiated price concessions to the Centers for Medicare & Medicaid Services (CMS), to help CMS determine the extent to which they are passed on to beneficiaries. (2) VA and DOD pharmacy benefit programs for veterans, active duty military personnel, and others may use statutorily mandated discounts as well as negotiations with drug suppliers to limit drug spending. VA and DOD have access to a number of prices to consider when purchasing drugs--including the Federal Supply Schedule prices that VA negotiates with drug manufacturers--paying the lowest of all available prices. (3) The Medicaid program for low-income adults and children is subject to aggregate payment limits and drug payment guidelines set by CMS. Medicaid does not negotiate drug prices with manufacturers, but reimburses retail pharmacies for drugs dispensed to beneficiaries at set prices. An important element of controlling Medicaid drug spending is the Medicaid drug rebate program, under which drug manufacturers are required by law to provide rebates for certain drugs covered by Medicaid. Under the rebate program, states take advantage of prices manufacturers receive for drugs in the commercial market that reflect discounts and rebates negotiated by private payers. In addition, Part D, VA and DOD, and Medicaid use techniques similar to FEHBP to limit drug spending, such as generic substitution, prior authorization, utilization review programs, or cost-sharing requirements.