DOD, Medicaid, and Medicare Part D use different methods to pay for prescription drugs dispensed in retail pharmacies based on program design differences and statutory requirements. Specifically, DOD reimburses retail pharmacies directly for drugs dispensed to its beneficiaries, state Medicaid programs reimburse pharmacies and then receive federal matching funds for a portion of these expenditures, and Medicare Part D pays pharmacies indirectly through plan sponsors. Under the Medicare Part D program, beneficiaries may choose from competing prescription drug plans offered by plan sponsors (primarily private health insurers), and those plan sponsors are responsible for paying pharmacies. In addition, DOD and Medicaid are statutorily entitled to certain refunds or rebates from drug manufacturers for drugs dispensed to their beneficiaries, while Medicare Part D plan sponsors negotiate with manufacturers for rebates and other price concessions. In fiscal year 2011, DOD provided prescription drug coverage to about 9.7 million beneficiaries through retail pharmacies, its military treatment facilities, and its mail order pharmacy. Active duty service members (including activated National Guard and Reserve members) are not charged for covered prescriptions. For all other beneficiaries, the beneficiary-paid amount (i.e., the amount they pay to the pharmacy when filling a prescription) varies based on the type of medication and where the prescription is filled. For certain drugs dispensed to beneficiaries at retail pharmacies after January 28, 2008, DOD is statutorily entitled to pay the federal ceiling price (FCP), which also pertains to its directly-purchased drugs. In practice, DOD obtains these prices through post-purchase refunds paid by the manufacturers of certain drugs—primarily brand-name drugs. In fiscal year 2011, DOD’s prescription drug spending totaled about $7.48 billion, according to DOD officials, representing about 8.9 percent of federal spending for prescription drugs. In fiscal year 2011, Medicaid provided prescription drug coverage to about 71.5 million low income beneficiaries. Prescription drug coverage is an optional benefit under federal Medicaid law that all states and the District of Columbia provide. States establish and administer their own Medicaid programs within broad federal guidelines. Thus, Medicaid programs vary from state to state. Most states require a nominal beneficiary copayment for prescription drugs. State Medicaid programs reimburse retail pharmacies for drugs dispensed to Medicaid beneficiaries and then report these payments to CMS. The federal government provides matching funds to state programs to cover a portion of these costs. Federal law requires manufacturers to pay rebates to state Medicaid agencies for drugs dispensed to Medicaid beneficiaries. These statutorily mandated rebates are calculated based on two prices manufacturers must report to CMS—the average manufacturer price (AMP) and the “best price.” For brand-name drugs: the rebate equals the greater of 23.1 percent of the AMP or the difference between the AMP and the best price. If the AMP rises faster than inflation as measured by the change in the consumer price index, the manufacturer is required to provide an additional rebate to the state Medicaid program. The rebate is capped at 100 percent of AMP. For generic drugs: the rebate equals 13 percent of AMP. Best price is not a factor and there are no additional rebates or caps. In addition, most state Medicaid programs negotiate additional rebates— known as state supplemental rebates—from drug manufacturers. In fiscal year 2011, total federal and state Medicaid net spending on prescription The federal share was $8.6 billion, accounting drugs was $13.7 billion.for about 10.3 percent of federal drug expenditures. In 2011, about 33.2 million Medicare beneficiaries were enrolled in the Medicare Part D program. Medicare beneficiaries can obtain coverage for outpatient prescription drugs by choosing from multiple competing plans offered by plan sponsors—primarily private health insurers—that contract with CMS to offer the prescription drug benefit. The plan sponsors are responsible for reimbursing retail pharmacies for drugs dispensed to Medicare Part D beneficiaries. Drug plans may differ in the premiums charged to CMS and beneficiaries; beneficiary deductibles and copayments (i.e., beneficiary-paid amounts); the drugs covered; pharmacies available to beneficiaries for filling prescriptions; and the drug prices, rebates, and other price concessions negotiated with manufacturers and pharmacies. Although Medicare Part D plans can design their own formularies, CMS generally requires that each formulary include at least two drugs within each therapeutic class and has also designated six categories of clinical concern for which plans must cover all or substantially all of the drugs. As we previously reported, plan sponsors have indicated that these formulary requirements limit their ability to negotiate lower prices for some drugs. Medicare Part D beneficiaries fill prescriptions at retail or mail order pharmacies affiliated with their plans; these pharmacies then submit claims to the plan sponsors for reimbursement. Plan sponsors often negotiate point-of-sale and post-purchase rebates and other price concessions with manufacturers and pharmacies; these must be reported to CMS each year at the national drug code (NDC) level in the DIR reports. In 2011, federal spending on Medicare Part D totaled approximately $55.2 billion, accounting for about 65.9 percent of total federal drug expenditures. Medicaid paid a lower average net unit price—that is, the price after subtracting any beneficiary-paid amounts and post-purchase price adjustments—than DOD and Medicare Part D across the entire sample of 78 prescription drugs and the subsets of brand-name and generic drugs. Specifically, Medicaid’s average net price for the entire sample was $0.62 per unit, while Medicare Part D paid an estimated 32 percent more ($0.82 per unit) and DOD paid 60 percent more ($0.99 per unit). (See fig. 1.) Similarly, Medicaid’s average net price for the subset of brand- name drugs in our sample was $1.57 per unit, the lowest among the three programs, while DOD paid 34 percent more ($2.11 per unit), and Medicare Part D paid an estimated 69 percent more ($2.65 per unit). Medicaid also paid the lowest net price for the subset of generic drugs in our sample ($0.28 per unit), while Medicare Part D paid 4 percent more ($0.29 per unit) and DOD paid 50 percent more ($0.42 per unit). When we examined the net prices that each program paid for the individual drugs in the sample after subtracting all reported beneficiary- paid amounts and post-purchase price adjustments, we found that Medicaid paid the lowest prices for 25 brand-name and 3 generic drugs, while DOD paid the lowest net price for 5 brand-name and 22 generic drugs, and Medicare Part D paid the lowest estimated net price for 3 brand-name and 20 generic drugs. We found that multiple factors affected the net prices paid by each program, including the amount of post-purchase price adjustments each program received, the gross prices paid to pharmacies, the beneficiary- paid amounts, and market dynamics. Of these, a key factor for the entire sample and for the brand-name subset was the amount of manufacturer post-purchase price adjustments received. (See fig. 2.) On average across the entire sample, these price adjustments ranged from about 15 percent of the gross price for Medicare Part D to about 31 percent for DOD, and nearly 53 percent for Medicaid. For the brand-name subset of the sample, these rebates ranged from about 19 percent of the gross price for Medicare Part D to nearly 39 percent for DOD and 62 percent for Medicaid. The statutory framework allowing each program to obtain post-purchase price adjustments contributes to the wide range of percentages observed. Medicaid’s federally mandated rebates apply to virtually all drugs, while DOD’s refunds only apply to certain drugs (i.e., primarily brand-name drugs). Furthermore, we found that even when DOD received a refund for a given drug, DOD’s per-unit refund amount was less than Medicaid’s per-unit rebate for most of the drugs in our sample even though we applied only the federally mandated (i.e., URA-based) rebates for the calculation of Medicaid net prices. If we had been able to accurately apply the Medicaid state supplemental rebates, the per-unit Medicaid rebate amounts would be even larger (i.e., a greater percentage of the gross unit price) than we report. Finally, we found that Medicare Part D obtained the lowest per-unit price adjustments among the three programs. In contrast to the statutory authority allowing DOD and Medicaid to collect specific refunds and rebates, Medicare Part D plan sponsors rely on independent negotiations to obtain price concessions from drug manufacturers. As we have previously reported, plan sponsors have noted limitations on their ability to negotiate price concessions for some drugs due to formulary requirements set by CMS, lack of competitors for some drugs, or low utilization for some drugs that limit incentives for manufacturers to provide price concessions. The gross unit prices paid to retail pharmacies by each program and the magnitude of beneficiary-paid amounts also contributed to the differences in net prices, although to a lesser degree than post-purchase price adjustments. As shown in figure 2, each of the three programs paid the lowest gross unit price to pharmacies for one of the groups of sample drugs: Medicare Part D for the sample as a whole, DOD for the subset of brand-name drugs, and Medicaid for the subset of generic drugs. These different gross unit prices act as a “starting point” for determining net prices paid by the programs—a lower gross price negotiated between the program and the pharmacy makes it easier for the program to achieve a lower net unit price after accounting for beneficiary-paid amounts and post-purchase price adjustments. Beneficiary-paid amounts also affected the net prices paid by each program; larger beneficiary payments contributed to lower net prices paid by the agency.