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.