The Medicare Prescription Drug, Improvement, and Modernization Act (MMA) established a prescription drug benefit for Medicare beneficiaries under Part D, which began on January 1, 2006. The MMA establishes that Medicare beneficiaries will receive the prescription drug benefit through private organizations, typically insurers or similar risk-bearing organizations, that sponsor prescription drug plans (PDPs) or Medicare Advantage managed care plans that offer the prescription drug benefit (MA-PDs). One provision of MMA, the "noninterference" clause, expressly forbids the Secretary of Health and Human Services (HHS) from interfering with drug price negotiation between manufacturers and Medicare drug plan sponsors, and from instituting a formulary or price structure for prescription drugs. The Medicare drug plans (or their agents) negotiate prices with the drug manufacturers. The framework created by the law emphasizes competition among the Medicare drug plans to obtain price discounts. The Medicare drug plans have incentive to provide the drug benefit to beneficiaries as efficiently as possible while simultaneously attracting enrollees through low premiums and cost-sharing requirements. The Democratic party included "Affordable Health Care" as one of the "Six for '06" initiatives. As part of this effort, the House passed H.R. 4 on January 12, 2007, a bill that requires the Secretary of HHS to negotiate prescription drug prices for Medicare beneficiaries. As of this writing, the Senate Finance Committee has not reported a prescription drug negotiation bill in the 110 th Congress. This report discusses what it means for the federal government to "negotiate" drug prices under existing public programs, the arguments for and against such activities, and some implications for the pharmaceutical industry, Medicare beneficiaries, and others if similar federal involvement were to occur on behalf of the Medicare Part D program. There are a number of approaches that the federal government could adopt to affect prescription drug prices and expenditures. A few rely primarily on the power of government to dictate an outcome, such as imposing statutory mandates and setting administered prices. Others emphasize more market-oriented approaches, such as soliciting competitive bids from voluntary participants. A reference pricing approach combines elements of both by dictating some aspects of the price but also allowing market forces to work. Some of these methods are currently employed by federal government programs (see below), while others have been adopted by governments in other countries. Many of the methods are used together. Through statutory mandates, the government could set the reimbursement level or the price that the government would pay for each drug, or require that pharmaceutical manufacturers provide a predetermined discount to government purchasers. The federal ceiling price and federal upper limits under the Medicaid program are examples statutorily mandated discounts. (See discussion below.) The government can set the maximum reimbursement rate for drugs by establishing a price ceiling; drug prices could be less than the ceiling, but not more. The federal ceiling price also falls in this category. Under a reference pricing system, drug reimbursement rates are not directly fixed by the government but are tied through a predetermined manner to another measure that may be dynamic. The reference might be an average price for a group or class of drugs, the average price for a payer or group of payers, or the cost of an alternative treatment. Medicaid's federal upper limit prices and the federal supply schedule both use reference pricing. (See discussion below.) The government can also solicit and receive bids through a competitive acquisition program, where interested parties (pharmaceutical manufacturers) submit confidential bids that include the prices the company is willing to provide for its product(s). The government would then select the winning bid(s) and award contracts. Competitive bidding programs, also known as reverse auctions, are already used as the basis for calculating the national average bid amount for the Part D program and for the setting of payment amounts for durable medical equipment (DME) covered under the Medicare program. In describing the DME competitive acquisition program, the Centers for Medicare and Medicaid Services (CMS) states that "competitive bidding provides a way to harness marketplace dynamics to create incentives for suppliers to provide quality items and services in an efficient manner and at reasonable cost." The MMA also included a provision to establish a competitive bidding demonstration for Medicare managed care beginning in 2010. The typical formulation of a bargaining or negotiation process involves a mutual discussion and arrangement of the terms of a transaction or agreement. In contrast to a competitive acquisition process where most of the power rests with the buyer, bargaining and negotiation can be more dynamic for each party. The outcome of the process will depend in part on the relative strength of each party's position; monopolists (as the sole provider) or monopsonists (as the only buyer) will have more bargaining power when facing providers or buyers who are but one of many. A range of activities that might affect prescription drug prices are currently not available to the Secretary because of the noninterference provision. These include activities that would fall under the scope of explicit and implicit authorities provided in the Medicare statute, but that might face legal challenges if currently attempted by the Secretary, on the basis that they could be construed as "interfer[ing] with the negotiations between drug manufacturers and pharmacies and PDP sponsors," "requir[ing] a particular formulary," or "instituting a price structure." A critical criterion for an efficient market is that buyers and sellers be informed decision-makers. When buyers and sellers have widely disparate levels of information about the market and the transactions, the asymmetry could result in market inefficiency or breakdowns. Through the encouragement, sponsorship, and dissemination of research on the safety and comparative effectiveness of drugs, the Secretary may be able to provide more information about the market that could be used by consumers, health plans, and drug manufacturers in their decisions. However, increased transparency may have the unintended consequence of providing negotiators with the opportunity to collude if too much information is revealed about the results of existing price negotiations. Without the noninterference clause, the Secretary may be able to exert influence over the drug price negotiation process through mass communications or through targeted persuasion. Whether the activity involves the spotlight of the "bully pulpit," "jawboning," or highlighted public scrutiny, the effectiveness of these efforts would depend on the persuasive power of the Secretary or public pressure in addition to the merits of the arguments, combined with the ability or inclination of the organization(s) targeted to resist such pressure or to accede to the influence. The federal government has a track record of active involvement in the determination of drug prices through the experience of the Department of Veterans Affairs in obtaining discounts for VA beneficiaries and through the Medicaid program in obtaining rebates from pharmaceutical manufacturers for states. The VA obtains prescription drugs at discount through several mechanisms, including negotiated contracts and statutory discounts. The Veterans Health Care Act of 1992 ( P.L. 102-585 ) requires the Secretary of Veterans Affairs to enter into Master Agreements, under which manufacturers must offer their covered drugs to the Federal Supply Schedule and also report non-Federal Average Manufacturing Prices (AMP) to the Secretary that are used to establish annual federal ceiling prices. In support of this function, the VA also undertakes many other activities typically associated with pharmacy benefit managers (PBMs) in the private sector, including formulary management. The price the VA pays for a drug is the lowest price as determined through one of four methods, less an additional five percent prime vendor discount. The four approaches available to the VA are: (1) the federal ceiling price, (2) the federal supply schedule, (3) the blanket purchasing agreements/performance-based incentive agreements, or (4) the national standardization contracts. Since pharmaceutical manufacturers have an interest in having their products sold to federal purchasers, almost all FDA approved drugs are included in the list of "covered drugs." Therefore, for these drugs, the VA receives at least a 24% discount off the non-federal average manufacturer price. The FCPs amount to maximum pricing canopies that apply to purchases by the Department of Defense (DOD), the Public Health Service (including the Indian Health Service), and the Coast Guard, in addition to Veterans Affairs. FSS prices are the lowest prices that manufacturers charge their most-favored nonfederal customers under comparable terms and conditions. These prices are sometimes below the Federal Ceiling Price but not always. The FSS is maintained by the VA's National Acquisition Center (NAC) and is available to all federal purchasers. Effective January 1, 2007, all FSS drug prices include a 0.25 percent fee to finance VA's National Acquisition Center. Pharmaceutical manufacturers have a strong incentive to have their products included on the FSS because drug manufacturers can participate in the Medicaid program and receive Medicaid reimbursement for their drugs only if the manufacturers sign a Master Agreement and Pharmaceutical Pricing Agreement with the VA. This requires the manufacturers to offer all their covered drugs to the FSS at prices no higher than FCPs. In practice, almost all FDA-approved drugs are included on the FSS. FSS contracts also include a blanket purchasing agreement that allows the VA to negotiate additional discounts. These contracts can be initiated by either the VA or by pharmaceutical manufacturers and produce an additional 5 to 15% off FSS. Typically, the BPAs include performance thresholds that result in discounts if the VA meets and maintains the threshold of use specified in the BPA for the manufacturer's product(s). These contracts typically produce the greatest discounts (from 10 to 60% off FSS) and are negotiated for individual drugs in closed classes on the VA national formulary. The VA is able to obtain favorable prices for these drugs through competitively bid contracts. Most of VA's contracts are for generic drugs. According to the GAO, generic drugs are easier to contract for because these products are already known to be chemically and therapeutically alike, while there is more difficulty in gaining clinical agreement on the therapeutic equivalence of competing brand name drugs. However, VA has successfully negotiated contracts for non-generic drugs in several drug classes using clinical evidence to outline the requirements of the contract. The VA also obtains an additional discount through its contracts with drug distributors. These organizations, also called wholesalers or prime vendors, purchase the drugs from the manufacturers and deliver them to VA facilities. As of June 2004, the VA contract with the prime vendor provides for an additional 5% discount from the lowest of the four prices described above. There are many practical and legislative steps necessary before federal drug price negotiation for Medicare beneficiaries could take place. Initially, the noninterference clause would need to be repealed. However, repealing the noninterference clause may not, in itself, be sufficient to lead to federally negotiated prices. The current HHS Secretary is reported to have stated that he does not want the power to negotiate and does not believe that he would be able to "do better than an efficient market." In response, some reports suggest that legislative proposals would also include a mandate for the Secretary to actively negotiate drug prices. One option for any forthcoming legislation might be to omit detail or specifics. An aide to the incoming Speaker is reported to have stated that Congress does not need "to hammer out all the details. There are a lot of smart people in the Administration, including the Secretary, who can look at how we're buying drugs ... and figure out the best way of negotiating better prices with drug companies." Should the authority for the Secretary of HHS follow that given to the Secretary of the VA in negotiating drug prices, there is still uncertainty as to whether the activities of HHS will replicate the activities of the VA or whether they would produce similar results. There are substantial differences between Medicare and VA that draw into question whether one experience could be indicative of the other. The VA is a direct provider of care, and has its own health care facilities. As a result, the VA has a national formulary as well as its own warehouses. The VA, through its health care system, is the purchaser of prescription drugs. In contrast, the Medicare program is an insurer that pays for care that is delivered to covered beneficiaries in a myriad of sites. Under the new Part D, which relies on prescription drug plans (PDPs) or Medicare Advantage managed care plans offering a prescription drug benefit (MA-PDs) to provide the drug benefit, Medicare is one step further removed in its relationship with the beneficiary. Cost-sharing is quite different for Medicare beneficiaries compared with VA beneficiaries, with incentives that might lead to corresponding differences in behavior. The VA charges veterans in certain income and eligibility categories an $8 copay for each 30-day-or-less supply of outpatient medication. Also, the VA does not have annual deductible requirements for beneficiaries. As a result, there is no financial incentive for the beneficiary to prefer one drug over another. The Institute of Medicine (IOM) found no adverse health care effects among VA beneficiaries as a result of encouraging providers to use the drugs on the formulary. In contrast, Medicare Part D plans have created more tiers in their Medicare offerings than they have for their non-Medicare business, and instituted varied types of drug utilization management, including step therapy, prior authorization, and quantity limits. These financial incentives are aimed toward influencing the choice of drugs by covered Medicare beneficiaries as well as cost-containment. The VA devotes significant efforts toward the development of its formulary. About 2% of the drug classes on VA's national formulary are designated closed or preferred. For closed classes, VA providers must prescribe and pharmacies must dispense the selected drug, although case-by-case exceptions are allowed. In preferred classes, VA providers and pharmacies are encouraged to prescribe and dispense the preferred drug, but may substitute other drugs in the same class on the formulary without obtaining an exception. These efforts have been successful for the VA, but the implications for Medicare are unclear. Whether CMS would undertake a similar effort and manage the formulary as strictly is uncertain. Finally, the VA relies substantially on dispensing prescription drugs by mail. About three-quarters of the total prescriptions are processed and distributed through the system of seven Consolidated Mail Outpatient Pharmacies (CMOP). Medicare may not be able to achieve a similarly high degree of consolidation through its many private plans. While coverage of outpatient prescription drugs is optional for state Medicaid programs, all states covered outpatient prescription drugs for at least some Medicaid beneficiaries and well over half of the states covered outpatient drugs for all Medicaid beneficiaries in 2006. States have the flexibility to set payment rates for all Medicaid-covered drug products as long as each state's payments for Medicaid prescription drugs do not exceed the lower of (1) its estimated acquisition cost (for the drug itself) plus a dispensing fee (for the professional services in filling and dispensing the prescription), or (2) the provider's usual and customary charge to the public for the drug. In addition, the federal share of payments for those drugs available from multiple sources is subject to a federal upper reimbursement limit (FUL). As a result, the "prices" of prescription drugs as paid by Medicaid programs are determined in a manner different from the price of drugs in most other settings. For most multiple-source drugs (where more than one FDA-approved product is available), the FULs are applied in the aggregate based on a predetermined percentage of a defined reference price. The methodology and basis of the reimbursements changed beginning January 1, 2007, but the underlying concept remains the same. Until January 1, 2007, federal reimbursements for multiple-source drugs were subject to a FUL calculation tied to the average wholesale price (AWP). The FUL is a measure developed by CMS for use by state Medicaid programs in reimbursing drugs that have at least three generic equivalents. The FUL was no more than 150% of the AWP for the least costly therapeutic equivalent. For drugs not subject to a FUL, including most single-source drugs (where there is only one FDA-approved product available for that active ingredient, dosage form, route of administratino, and strength) and drugs for which there are fewer than three equivalents, most states base their calculations for drug reimbursement on the estimated acquisition cost (EAC), typically the AWP less a percentage discount. Beginning January 1, 2007, as a result of the Deficit Reduction Act of 2005 ( P.L. 109-171 ), the AWP will no longer be used as the basis for calculating the FUL. While the AWP is meant to reflect the average price at which wholesalers sell a product to retail pharmacies, the AWP is not defined in law or regulation, and as a result, the OIG found that the AWPs used by states to calculate Medicaid drug reimbursement rates were often higher than the prices retail pharmacies pay to purchase the drugs. Instead, the FUL now will be calculated to equal 250% of the "average manufacturer price" (AMP), the average price at which manufacturers sell a drug product to wholesalers. This data is reported to CMS by manufacturers. In principle, the Medicaid program obtains prescription drugs at the "best price" available from drug manufacturers. As a condition for reimbursement under Medicaid, the Omnibus Budget Reconciliation Act of 1990 (OBRA 1990, P.L. 101-508 ) requires drug manufacturers to enter into agreements with the Secretary of HHS to provide rebates to the states that reflect the lowest price that manufacturers offer to other purchasers for their drugs. The best price calculation is based on discounts provided to any purchaser, excluding the Department of Veterans Affairs (and on behalf of the Department of Defense, the Indian Health Service, and the Public Health Service), state pharmaceutical assistance programs, any depot prices and single award contract prices, as defined by the Secretary, of any agency of the federal government, and Medicare Part D plans. Data on prescription drug prices are reported to the Secretary, and rebates are calculated to ensure that Medicaid pays the lowest price. In return for entering into agreements with the Secretary, state Medicaid programs are required to cover the drugs marketed by those manufacturers. In 2003, there were reported to have been more than 550 manufacturers participating in the Medicaid drug rebate program. In 2004, federal rebates amounted to 22% of total Medicaid spending on prescription drugs before rebates. The cost-saving mechanisms and experiences of the Medicaid program differ significantly from those of the VA, but also hold lessons for the Medicare program. First, the Medicaid program obtains significant discounts through the FUL and rebate programs that are de facto mandatory. Cost savings are obtained through statutory authority with little or no bargaining involved, and minimum percentage discounts are specified in statute. The Medicare Part D program is not currently structured for the federal government to impose similar discounts or to establish administered prices for drugs, nor for price negotiations regarding prescription drugs. The Medicare program does collect information about rebates from Part D plans, but has not used the data for purposes of obtaining lower drug prices from the plans. Second, in contrast to the explicit prohibition in the non-interference provision against federally established formularies for Medicare beneficiaries, states are allowed to establish "open" formularies for beneficiaries not enrolled in Medicaid managed care plans. All drugs offered by manufacturers with a drug rebate agreement must be covered, and all drugs must be available through a review process unless they are on the list of excluded categories. In addition, states are permitted to subject to prior authorization any covered outpatient drug. Using this authority, some states have instituted prior authorization programs using preferred drug lists, requiring that non-preferred drugs be subject to prior authorization. Litigation over states' use of preferred drug lists has occurred; however, courts have rejected arguments that Medicaid preferred drug lists are in essence formularies that do not meet the requirements of the Medicaid statute. In upholding the use of preferred drug lists for prior authorization programs, courts have noted that such lists do not place any drugs in a non-covered category, the essence of a "formulary," and that the Medicaid statute specifically provides that "[a] prior authorization program established by a State under paragraph (5) is not a formulary." If the non-interference provision and formulary and price setting restrictions are repealed, the Secretary must still decide whether or not to adopt a formulary and decide how restrictive it might be. At the national level, these decisions would be much more difficult and problematic. If the formulary prohibition is not repealed and other forms of negotiating leverage are not provided, then the bargaining power of the Secretary would reflect the leverage available to the Secretary through authority granted elsewhere in statute—for instance, his ability to encourage, conduct, and disseminate research on drug prices and their comparative effectiveness, the ability to review and approve plan bids, and the strength of the Secretary's influence through persuasion, as well as other credible threats. If the Secretary were to engage in activities that affect drug prices on behalf of Medicare Part D beneficiaries, the implications could be wide-ranging and potentially quite significant. The direct effects on beneficiaries, drug companies, wholesalers, pharmacy benefit managers are potentially great, but the long-term and secondary effects on the overall population and the industry may also be significant and are important to consider. The main argument advanced by advocates for granting the federal government the power to negotiate is that lower prices for prescription drugs might be obtained from pharmaceutical manufacturers and passed on to Medicare beneficiaries. By using the market power of roughly 43.7 million Medicare beneficiaries, proponents argue that the pharmaceutical companies would provide deep discounts to the federal government in order to prevent the loss of a significant portion of their market. A Government Accountability Office (GAO) study based on data from the mid-1990s found that average VA-negotiated prices are less than 50% of the non-federal average manufacturer's price. In 2000, GAO reported that the prices paid by the Department of Defense (DOD) and VA for 21 brand-name drugs with no generic equivalents were 27% and 30% lower on average than those certified to the Health Care Financing Administration (HCFA, now the Centers for Medicare and Medicaid Services) as "best price." However, there is uncertainty about the potential effectiveness of the federal government in obtaining drug price discounts that are greater than those currently negotiated by private Medicare Part D plans. The first year of experience with the Medicare prescription drug benefit has produced lower-than-expected program expenditures, which supporters of the program attribute to the lower drug prices that drug plans have been able to negotiate in response to strong competition. Critics counter that the lower expenditures are a result of lower-than-expected enrollment and a preference among enrolled beneficiaries for plans with lower premiums and less generous drug coverage. The argument that the size of the Medicare market would provide federal negotiators with an advantage over private plans in obtaining discounts from pharmaceutical manufacturers has been questioned. Large PBMs, such as Advance PCS (75 million covered individuals), Medco Health Solutions (65 million) and Express Scripts (57 million) have significant market power and an established track record in negotiating prescription drug discounts for large populations. The size of the market itself is not as important as the ability to influence and direct the consumption patterns of that market. Much of the PBMs' ability to achieve price concessions from manufacturers reflects their ability to influence drug consumption behavior and to potentially move market share through financial incentives involving varying cost-sharing tiers, formularies that offer the possibility that certain products will be excluded and drug management strategies including step therapy. For these reasons and others, critics claim that PBMs with large numbers of Medicare Part D enrollees would be able to negotiate discounts and produce savings at least as great as anything that the federal government could negotiate. The Congressional Budget Office (CBO), at the request of congressional leaders, examined the effect of striking the "noninterference" provision and estimated that it would have a negligible effect on federal spending. Similarly, the Chief Actuary at CMS concluded that giving the Secretary the ability to directly negotiate prescription drug prices might not produce additional savings over what private plans negotiate. Both CBO and the CMS Chief Actuary determined that the price concessions extracted by the federal government might not exceed those that private plans might achieve. The magnitude of any discounts resulting from federal negotiation on behalf of Medicare beneficiaries would depend critically on a number of variables and would likely vary depending on the drug. As the VA's experience illustrates, larger discounts are more likely to be achieved for drugs in classes in which there are many alternatives. This is where the VA's greatest discounts are achieved. For single-source drugs, the government may still be able to obtain substantial discounts, but it may depend on what specific bargaining power is available to the Secretary. As noted above, all pharmaceutical companies have an incentive to have their products listed on the FSS because participation is tied to eligibility for Medicaid reimbursement. Proponents of a market-based, decentralized approach believe that by having a variety of organizations negotiating different prices, more choices will be available to Medicare beneficiaries and, therefore, better patient outcomes. Instead of being limited to the discounted drugs Medicare negotiates, they say, discounts for the plentitude of organizations offering prescription drug plans will result in a broader range of drugs being discounted. In this view, beneficiaries will then be able to choose the plan that best meets their individual prescription drug needs and acquire them at competitive market prices. One study claims that the number of drugs available under the VA formulary is more restrictive than those available from private Medicare Part D plans. The report also claims that the drugs on the VA formulary are older than drugs on formularies used by private plans. However, these assertions and their underlying logic have been challenged by the VA and others. The VA's formulary is not necessarily more restrictive than those of private insurers and the claim that VA formulary drugs may be older is not necessarily an indication that VA beneficiaries are receiving lower-quality health care. The data also show that there is a sizeable discrepancy in the number of drugs on the formularies of private plans and that the VA offerings are in line with those of many private Part D plans. For FY2006, the VA reports that 1,294 drug entries are listed on the VA national formulary (VANF), encompassing different dosage strengths. In contrast, a survey of national PDPs in 2006 showed that the number of drugs offered ranged from 626 (WellCare) to 2,773 (Aetna MedicareRx Premier). Similarly, older drugs are not necessarily inferior drugs. A recent study based on a randomized controlled trial showed that older, less expensive anti-psychotic drugs were just as effective and safe in treating schizophrenia as newer drugs that were much more expensive. The VA claims that the decisions that go into managing the formulary are based on a careful review of the scientific evidence, and that the choice of drugs is not solely determined by the lowest price. The VA cites its comparative experience with Vioxx as an example of the effectiveness of its process; the VA never included the drug on its national formulary because of concerns about the scientific evidence regarding the drug's safety. The effect of decreased revenues on the short-and long-term development of new drugs is an issue of ongoing debate. Pharmaceutical manufacturers have stated that research and development will suffer if retail prices are diminished and returns from investment are squeezed. While this is undoubtedly true in the extreme, the evidence that quantifies the degree to which reductions in retail prices would lead to fewer new products being introduced is controversial and reflects a wide range of potential responses. Some research claims that the consequence of decreased revenue and profits resulting from low negotiated prices will be reduced investment in research and development, declining innovation, and fewer new drugs brought to market. Other studies indicate that there has not been a strong relationship between the amount of research and development funds expended by the pharmaceutical industry and the introduction of new drug applications to the FDA. One report claims that government-mandated negotiations would reduce the development of new, life-saving drugs by about a dozen annually, and estimates that "federal price negotiations would yield a loss of 5 million life-years annually, an adverse effect that can be valued conservatively at about $500 billion per year." Other research suggests that the relationship between pharmaceutical research and development costs and new drugs is not so sensitive. GAO found that over the last decade, the increase in research and development expenditures as reported by the pharmaceutical industry has not been matched by the growth in the number of new drug applications (NDAs). GAO examined all NDAs submitted to the FDA between 1993 and 2004 and found that "despite increasing expenditures on research and development, new drug development, and in particular, development of new molecular entities (NMEs)—potentially innovative drugs containing ingredients that have never been marketed in the United States—has become stagnant." Another potential consequence of the federal government negotiating drug prices is that prices might become more consistent and less variable across beneficiaries. Medicare Part D beneficiaries who belong to different PDP/MA-PD plans face different prices, depending on what the individual organizations negotiate and pass on to beneficiaries in savings. In response to the panoply of Medicare drug plans available, some observers, including patient advocacy groups, have suggested that that the plethora of choices is not universally viewed by beneficiaries as a positive outcome. A growing body of research suggests that individuals faced with many choices may find that having more alternatives can be counterproductive. One study found that plans that offered more 401(k) options had lower participation rates compared to plans that offered only a handful of choices; "every ten funds added, other things equal, is associated with a 1.5% to 2% drop in [the] participation rate." Another study found that while grocery store consumers were initially more attracted to a booth displaying 24 jam choices, a higher percentage of consumers who saw only six choices subsequently purchased the jam by a factor of 10. Related work also showed that ex post satisfaction was higher among those who had fewer than those who had more choices. As a consequence, some legislators have suggested placing limits on the number of Medicare Part D plans to alleviate the difficulties some beneficiaries have had in choosing from among such a broad set of plans. The effect of lower drug prices on overall health care costs and population health is varied. If lower prices lead to a higher rate of filled prescriptions among beneficiaries who previously under-used needed medications, then the increase in prescription drug use may lead to improved outcomes. There is also the potential savings if the increased drug treatments are substitutes for more expensive and less effective care—for instance, if hypertension can be managed with medicines that obviate the need for surgical interventions. Alternatively, higher out-of-pocket prices for prescription drugs have been found to reduce the use of drugs by patients consistently. Recent research suggests that this effect may also persist over time, with implications for higher overall health care costs. One study found that beneficiaries facing higher out-of-pocket costs for prescription drugs not only use fewer drugs contemporaneously, but the reduction persists and is stronger in the second year. Overall, the expenditure savings on prescription drugs are largely offset by increases in spending for outpatient services, which tend to increase in response. Federal negotiations on drug prices through the VA and the Medicaid programs have had noticeable effects on the industry. The Medicare program, with a similarly large number of beneficiaries who consume more drugs per capita, might have even more dramatic effects. The function of wholesalers is often overlooked in discussions about the pharmaceutical industry, but they play an important role in the experience of the VA. Although the VA solicits bids that have allowed for multiple wholesalers, in recent years the VA has awarded the contract to a single company. Recent estimates place the value of the contract at $3 billion a year for the selected contractor. To illustrate the importance of the VA contract and how significant industry observers consider it to be, the share values of the drug distributor AmerisourceBergen Corporation fell 11.6% and the company lowered its 2004 earnings estimate by almost 10% after losing the contract to the McKesson Corporation. The Medicare market for prescription drugs is significantly larger than the VA market, and if structured similarly, the federal contracts with the Medicare program stand to carry similar or greater impacts for the industry. Because of the complex relationships in drug prices across different types of buyers, the effect of changing one price, such as negotiating a discount for Medicare beneficiaries, may have indirect consequences on other prices. While drug prices paid by Medicare beneficiaries may fall in the short run, overall drug prices may increase in the long run for other consumers, specifically for the under-65 population. Under this argument, pharmaceutical companies might increase the prices they charge to other buyers in response to the lower prices negotiated by the federal government for Medicare beneficiaries. Similarly, as the "best price" increases, the prices for other buyers who calculate reimbursements that are referenced to the "best prices" would also rise, potentially affecting both VA prices and Medicaid prices. Finally, those who oppose government involvement in prescription drug price negotiations claim that the government would be setting prices, not negotiating. They cite the experience in other parts of the Medicare program, where provider reimbursement under Parts A and B are set by the Medicare program, and claim that the federal government would impose a similarly rigid pricing schedule on the prescription drug market. Whether this comes to pass depends on the specifics of how the legislation and subsequent regulations are written, and which approach is chosen to implement any given authority to affect drug prices on behalf or Medicare beneficiaries. On January 12, 2007, the House passed H.R. 4 , the Medicare Prescription Drug Price Negotiation Act of 2007. This bill would amend the Social Security Act by (1) striking section 1860D—11(i) (relating to noninterference), (2) add language that would require the Secretary of HHS to negotiate prescription drug prices, and (3) maintain the prohibition against the establishment of a formulary by the Secretary while (4) allowing prescription drug plans to obtain discounts or price reductions below those negotiated by the Secretary. The bill would also require the Secretary to submit a report "on negotiations conducted by the Secretary to achieve lower prices for Medicare beneficiaries, and the prices and price discounts achieved by the Secretary as a result of such negotiations" to the committees on Ways and Means, Energy and Commerce, and Oversight and Government Reform of the House of Representatives and the Committee on Finance of the Senate beginning no later than June 1, 2007, and every six months thereafter. The bill would take effect on the date of enactment and would first apply to negotiations and prices for plan years beginning on January 1, 2008. CBO has scored the bill as having "a negligible effect on federal spending." CBO anticipates that "the Secretary would be unable to negotiate prices across the broad range of covered Part D drugs that are more favorable than those obtained by PDPs under current law." Specifically, the absence of the authority to establish a formulary would limit the Secretary's ability to influence the outcome of negotiations, as bargaining leverage would be limited. CMS actuaries have also concluded that H.R. 4 would not produce lower drug prices or any additional savings. On April 11, 2007, the Senate Finance Committee passed an amended version of S. 3 that repeals the noninterference provision but does not mandate that the Secretary negotiate for lower prescription drug prices. The bill also includes additional provisions to increase transparency in the Part D program by making some data available to congressional support agencies and to prioritize comparative effectiveness research on drugs. The bill as passed by the Finance Committee would allow data collected by the Secretary on PDPs and MA-PDs to be used by congressional support agencies (the Congressional Budget Office, or CBO; the Congressional Research Service, or CRS; the Government Accountability Office, or GAO; and the Medicare Payment Advisory Commission, or MedPAC) to fulfill their duties. Upon request, the Secretary would make available to any of the congressional support agencies aggregate data on negotiated prices including discounts, subsidies, and rebates; drug claims data; reinsurance payments paid to plans; and the adjustments of payments to plans as a result of the risk corridors established under MMA. In addition, CBO would be able to obtain non-aggregated information about negotiated rebates, discounts, and other price concessions by drug and by contract or plan. The congressional support agencies would be prohibited from disclosing the information in any manner that would result in the disclosure of trade secrets, and where the disclosure, report, or release of the information would permit the identification of a specific prescription drug plan, MA-PD plan, pharmacy benefit manager, drug manufacturer, drug wholesaler, drug, or individual enrolled in a prescription drug plan or an MA-PD plan. S. 3 would also require the CBO to study the effect of market competition on prices for drugs under Part D. The study would (1) examine the number and extent of discounts and other price concessions received by prescription drug plans and MA-PD plans for covered Part D drugs, (2) examine the relationship between discounts and price concessions and drug utilization, (3) compare the Medicare Part D discounts and price concessions with those obtained under the Medicaid program, and (4) examine the extent to which the efforts of the Secretary of Health and Human Services would have an effect upon payers in non-Medicare markets. A report on this study would be due a year after enactment. The bill would also require the Secretary to make public the data on the prices charged for each covered part D drug under each prescription drug plan and MA-PD plan to individuals enrolled in the plan. The data would reflect actual prices posted on the website of the Centers for Medicare and Medicaid Services, and would be made available in a manner that permits linkage of the data to data contained in other public prescription drug plan and MA-PD plan data files. S. 3 would also instruct the Secretary of HHS to develop a new prioritized list of comparative clinical effectiveness studies on prescription drugs covered under Part D. The list is to reflect studies most critical to advancing value-based purchasing of covered Part D drugs. The bill would also establish an advisory committee to provide advice on setting priorities for comparative clinical effectiveness studies. The committee would include a diverse range of public and private experts, stakeholders, and interests from industry, patients and representatives of patients, researchers, and government with no group having a majority of members. Within one year of the enactment of the act, the Secretary would be required to submit a report to Congress that would include (1) the prioritized list of comparative clinical effectiveness studies and plans for the conduct of the studies; (2) a summary of the four factors the Secretary would be required to take into account in constructing the list; and (3) an explanation of how the Secretary took into account each of the four factors in developing the list and preparing the report. The Secretary would be required to make the report publicly available. Finally, S. 3 would also instruct pharmacy and therapeutic (P&T) committees to consider comparative clinical effectiveness studies in developing and reviewing formularies for Medicare prescription drug plans, if relevant. Currently, guidelines for Medicare Part D formularies require the inclusion of two drugs in each therapeutic class, except if only one drug is available, coverage of "all or substantially all" drugs in six protected classes. Plans can neither change their formularies without CMS approval nor drop coverage for persons currently using the drug, except at the beginning of the calendar year. CBO's evaluation of S. 3 is very similar to its assessment of H.R. 4 . In a letter dated April 10, 2007, CBO wrote that modifying the noninterference provision would have a negligible effect on federal spending because we anticipate that under the bill the Secretary would lack the leverage to negotiate prices across the broad range of covered Part D drugs that are more favorable than those obtained by PDPs under current law. Without the authority to establish a formulary or other tools to reduce drug prices, we believe that the Secretary would not obtain significant discounts from drug manufacturers across a broad range of drugs. CBO's letter also noted that the provisions of the bill that would permit Congressional support agencies access to Part D data and establish a prioritized list of potential studies of the comparative clinical effectiveness of drugs covered under Part D "would have no effect on direct spending." On April 18, 2007, the Senate did not invoke cloture on S. 3 . This report will be updated.

Summary: The Medicare Prescription Drug, Improvement, and Modernization Act (MMA) established a prescription drug benefit for Medicare beneficiaries under Part D, which began on January 1, 2006. One provision of MMA, the "noninterference" clause, expressly forbids the Secretary of Health and Human Services (HHS) from interfering with drug price negotiation between manufacturers and Medicare drug plan sponsors, and from instituting a formulary or price structure for prescription drugs. The framework created by the law emphasizes competition among the Medicare drug plans to obtain price discounts. Approaches that the federal government could adopt to affect prescription drug prices range from dictating an outcome, such as imposing statutory mandates or establishing price ceilings, to more market-oriented approaches such as soliciting competitive bids from voluntary participants. A reference pricing approach combines elements of both. Some of these methods are currently employed by the Department of Veterans Affairs (VA) and the Medicaid program. The price the VA pays for a drug is the lowest price as determined through one of four methods, less an additional 5% prime vendor discount: (1) the federal ceiling price, (2) federal supply schedule, (3) performance-based incentive agreement, or (4) national standardization contract. Drug reimbursement costs under Medicaid are calculated differently for single-source (only one Food and Drug Administration-approved product) and multiple-source drugs (more than one FDA-approved product). However, for both types of drugs, state reimbursements are determined in aggregate based on either the federal upper limit price (FUL)—a predetermined percentage of a defined reference price—or the estimated acquisition cost. Drug manufacturers also enter into agreements with the Secretary of HHS and provide rebates to the states that reflect the lowest price that manufacturers offer to other purchasers of their drugs. There are many practical and legislative steps necessary before federal drug price negotiation for Medicare beneficiaries could take place. Repealing the noninterference clause is a necessary first step, but may not be sufficient to lead to federally negotiated prices. If the Secretary were to engage in activities that affect drug prices on behalf of Medicare Part D beneficiaries, there might be consequences that affect the price of drugs for Medicare beneficiaries as well as other public and private patients, the number and types of drugs that would be available to Part D beneficiaries, the amount of research and development and innovation by pharmaceutical companies, and other sectors of the industry. Both H.R. 4 and S. 3 would strike the noninterference provision in MMA while maintaining the prohibition against price setting and the establishment of a formulary, but H.R. 4 would also require the Secretary of HHS to negotiate prescription drug prices. Because the absence of a formulary would limit the Secretary's bargaining leverage, CBO has scored each bill as having "a negligible effect on federal spending." On January 12, 2007, the House passed H.R. 4, the Medicare Prescription Drug Price Negotiation Act of 2007, and on April 18, 2007, the Senate did not invoke cloture on S. 3, the Medicare Fair Prescription Drug Price Act of 2007. This report will be updated.