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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. Major contributors to this report were Robin Burke, Martha Kelly, Ann Tynan, Helen Desaulniers, Julian Klazkin, and Jennie Apter.

Summary: 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. 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.