Order Code RL33782
Federal Drug Price Negotiation:
Implications for Medicare Part D
January 5, 2007
Jim Hahn
Health Economist
Domestic Social Policy Division
Federal Drug Price Negotiation:
Implications for Medicare Part D
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.
The incoming Speaker and the Democratic Party have included “Affordable
Health Care” as one of the “Six for ’06” initiatives. As part of this effort, they
propose to give the Secretary of HHS the authority to negotiate prescription drug
prices for Medicare beneficiaries. The majority leader has been reported as stating
that the issue will come before the House for a vote on January 12, 2007.
There are a number of approaches that the federal government could adopt to
affect prescription drug prices. A few rely on the power of government to dictate an
outcome, such as imposing statutory mandates or establishing price ceilings. Others
emphasize 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.
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. 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.
This report will be updated.
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Conceptual Framework for Federal Involvement
in Determining Drug Prices and Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Statutory Mandates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Price Ceilings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Reference Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Competitive Acquisition/Bidding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Bargaining and Negotiation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Federally Determined Drug Prices and Costs in Practice . . . . . . . . . . . . . . . . . . . 3
Department of Veterans Affairs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Federal ceiling price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Federal supply schedule (FSS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Blanket Purchasing Agreements/Performance-based
Incentive Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
National Standardization Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
The VA Experience and Medicare Part D . . . . . . . . . . . . . . . . . . . . . . . 5
Medicaid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Federal Upper Limit (FUL) and
Estimated Acquisition Cost (EAC) . . . . . . . . . . . . . . . . . . . . . . . . 7
The Medicaid Experience and Medicare Part D . . . . . . . . . . . . . . . . . . 8
Consequences of Federal Involvement in the Determination
of Drug Prices and Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Ability to Achieve Discounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Drug Availability for Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Innovation and New Drug Development . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Impact on Other Sectors of the Pharmaceutical Industry . . . . . . . . . . . . . . . 13
Effect on Drug Prices in Other Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Federal Drug Price Negotiations:
Implications for Medicare Part D
Introduction
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.1 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 incoming Speaker and the Democratic party have included “Affordable
Health Care” as one of the “Six for ’06” initiatives. As part of this effort, they
propose to give the Secretary of HHS the authority to negotiate prescription drug
prices for Medicare beneficiaries. The majority leader has been reported as stating
that the issue will come before the House for a vote on January 12, 2007.2
This report discusses what it means for the federal government to “negotiate”
drug prices under existing public programs,3 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.
1 Section 1860D (i) reads, “NONINTERFERENCE. — In order to promote competition
under this part and in carrying out this part, the Secretary — (1) may not interfere with the
negotiations between drug manufacturers and pharmacies and PDP sponsors; and (2) may
not require a particular formulary or institute a price structure for the reimbursement of
covered Part D drugs.” The conference report adds that “Conferees expect PDPs to
negotiate price concessions directly with manufacturers” (H.Rept. 108-391, p. 461).
2 CQ Today, “Hoyer Lays Out More Details of House Agenda,” Jan. 3, 2007.
3 Most of the federal government’s activities regarding the pricing of prescription drugs for
public programs would not be characterized as negotiations, where the parties are engaged
in a process to determine terms of mutual agreement.
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Conceptual Framework for Federal Involvement
in Determining Drug Prices and Costs
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. 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.4 Many
of the methods are used together.
Statutory Mandates
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 is an example of a statutorily mandated
discount. (See discussion below.)
Price Ceilings
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.
Reference Pricing
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.)
Competitive Acquisition/Bidding
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.
4 For more information about drug pricing in other countries, see CRS Report RL33781,
Pharmaceutical Costs: An International Comparison of Government Policies, by Gretchen
A. Jacobson.
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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, 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.”5 The MMA also included a
provision to establish a competitive bidding demonstration for Medicare managed
care beginning in 2010.
Bargaining and Negotiation
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.
Federally Determined Drug Prices
and Costs in Practice
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.
Department of Veterans Affairs
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) authorizes the Secretary of Veterans Affairs to negotiate
prices for covered drugs on behalf of DOD, the Public Health Service (including the
Indian Health Service), and the Coast Guard, in addition to Veterans Affairs. 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.6
5 CMS Overview, Competitive Acquisition for Durable Medical Equipment, Prosthetics,
Orthotics, and Supplies (DMEPOS). Accessed at [http://www.cms.hhs.gov/CompetitiveAcq
forDMEPOS/].
6 Pharmacy benefit managers (PBMs) are companies that administer prescription drug
benefits for health care plans. Administrative services include adjudicating claims and
managing costs. In addition to formulary management, PBMs typically provide and manage
networks of pharmacies willing to accept negotiated discounts on drug prices and dispensing
(continued...)
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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.7
Federal ceiling price. Since all pharmaceutical manufacturers have an
interest in having their products sold to federal purchasers, all FDA approved drugs
are included in the list of “covered drugs.” Therefore, for all drugs, the VA receives
at least a 24% discount off the non-federal average manufacturer price.8
Federal supply schedule (FSS). 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. All FSS prices include a 0.5 percent fee to
finance VA’s National Acquisition Center.
Pharmaceutical manufacturers have a strong incentive to have their products
included on the FSS because Medicaid reimbursement for drugs is contingent on
having the drugs on the FSS.9 In practice, virtually 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.
Blanket Purchasing Agreements/Performance-based Incentive
Agreements. These contracts can be initiated by either the VA or by
pharmaceutical manufacturers and produce an additional 5 to 15% off FSS. The VA
obtains discounts by guaranteeing a high volume of use for the manufacturer’s
product.
National Standardization Contracts. 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.10 Most of the VA’s
contracts are for generic drugs. According to the GAO, generic drugs are easier to
6 (...continued)
fees and may encourage the use of mail-service pharmacies as a cost reduction technique.
Clinical services include drug utilization review to prevent potentially dangerous drug
interactions.
7 Much of the information about VA drug pricing was obtained in a briefing for CRS staff
by the Pharmacy Benefits Management Strategic Healthcare Group, Department of Veterans
Affairs, December 12, 2006.
8 38 U.S.C. § 8126(a)(2).
9 38 U.S.C. § 8126(a)(4).
10 The VA selects from among confidential bids submitted by pharmaceutical manufacturers
and announces the winning bid. Thus, the process more resembles a round of silent bids
rather than a negotiation through which each party bargains with offers and counteroffers.
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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.11
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.
The VA Experience and Medicare Part D. 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.”12 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.”13
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
11 VA and DOD Health Care: Factors Contributing to Reduced Pharmacy Costs and
Continuing Challenges, GAO-02-969T, July 22, 2002.
12 Pear, R., “Power Shift in Congress Revives Health Debate,” New York Times, January 2,
2007.
13 Pear, op. cit.
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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.14 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.15 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.16 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.17
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.
Medicaid
While coverage of outpatient prescription drugs is optional for state Medicaid
programs, all states covered outpatient prescription drugs for at least some Medicaid
14 Some higher-priority veterans (Groups 2 - 6) have annual co-payment caps of $960 in
2006. There are no copay caps for veterans in the lowest-priority groups consisting of
higher-income veterans (Groups 7 and 8) . For additional information, refer to the U.S.
Department of Veteran Affairs, “Medicare Part D and VA Prescription Drug Benefits
Frequently Asked Questions (FAQs),” accessible at [http://www.va.gov/healtheligibility/
Library/FAQs/MedicareDFAQ.asp#vacharge].
15 Blumenthal, D., and Herdman, R., eds., Description and Analysis of the VA National
Formulary, IOM, Division of Health Care Services, VA Pharmacy Formulary Analysis
Committee (Washington, DC: National Academy Press, 2000).
16 Step therapy typically requires the use of a more cost-effective drug before filling a
prescription for a less cost-effective drug, as determined by the insurer.
17 The VA has undergone a lengthy transition from numerous local formularies to the
adoption of a single national formulary. Prior to 2001, each of the 173 medical centers had
its own formulary. In 2001, the VA abolished the local formularies and adopted 22 regional
formularies, one for each Veterans Integrated Service Network (VISN). In 2007, the VA is
to abolish the regional formularies in favor of the single national formulary.
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beneficiaries and well over half of the states covered outpatient drugs for all
Medicaid beneficiaries in 2006.18 Federal regulations require that each state’s
reimbursement for Medicaid prescription drugs 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.19 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.
Federal Upper Limit (FUL) and Estimated Acquisition Cost (EAC).
Drug reimbursement costs under Medicaid are calculated differently for single source
(where there is only one FDA-approved product available for that active ingredient,
dosage form, route of administration, and strength) and multiple-source drugs (where
more than one FDA-approved product is available). However, for both types of
drugs, state reimbursements are determined in 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 will
remain the same.
Until January 1, 2007, Medicaid reimbursement for multiple-source drugs was
based on the federal upper limit (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 or on the
estimated acquisition cost (EAC) for the drug. The FUL was no more than 150% of
the AWP for the least costly therapeutic equivalent. For drugs where CMS does not
calculate a FUL, including single-source drugs and drugs for which there are fewer
than three equivalents, most states base their calculations for drug reimbursement on
the EAC, typically the AWP less a percentage discount.20
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
or the EAC. 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.21 Instead, the FUL now will be calculated to
equal 250% of the “average manufacturer price” (AMP), the average price at which
18 While all states provide outpatient prescription drug coverage for the categorically needy,
not all states extend this coverage to the medically needy Medicaid beneficiaries. Most
states also cover some over-the-counter (OTC) medications. For more information, see CRS
Report RL30726, Prescription Drug Coverage Under Medicaid, by Jean Hearne.
19 Office of Inspector General, HHS, Medicaid Drug Price Comparison: Average Sales
Price to Average Wholesale Price, OEI-03-05-00200, June 2005.
20 Office of Inspector General, HHS, Medicaid Pharmacy — Additional Analyses of the
Actual Acquisition Cost of Prescription Drug Products, A-06-02-00041.
21 Office of Inspector General, HHS, Variations in State Medicaid Drug Prices, OEI-05-02-
00681.
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manufacturers sell a drug product to wholesalers. This data is reported to CMS by
manufacturers.
The Medicaid Experience and Medicare Part D. Though not as involved
as the VA’s efforts in obtaining drug discounts, the experience of the Medicaid
program also holds lessons for the Medicare program. In contrast to the explicit
prohibition in the non-interference provision against federally established formularies
for Medicare beneficiaries, states are allowed to establish formularies for
beneficiaries not enrolled in Medicaid managed care plans.22 If the non-interference
provision is repealed, CMS 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,
then the bargaining power of the Secretary and CMS would be diminished in the
absence of the threat of formulary exclusion.
Consequences of Federal Involvement
in the Determination of Drug Prices and Costs
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.
Ability to Achieve Discounts
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.23 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, or CMS) as “best price.”24
22 Medicaid managed care plans are allowed to have their own formulary.
23 GAO, Drug Prices: Effects of Opening Federal Supply Schedule for Pharmaceuticals Are
Uncertain, Washington, June 1997, GAO/HEHS-97-60.
24 Drug Prices Paid by DOD and VA are, on Average, Lower Than Those Certified to HCFA
(continued...)
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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.25 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. For these
reasons, 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.26 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.27 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
24 (...continued)
as Best Price, GAO-01-175R, Oct. 31, 2000.
25 See, for example, Enthoven, A., and Fong, K., “Medicare: Negotiated Drug Prices May
Not Lower Costs,” Brief Analysis No. 575, National Center for Policy Analysis, Dec. 18,
2006.
26 One counter argument to this point is that while large PBMs may cover more individuals
than the Medicare program, Medicare beneficiaries consume more prescription drugs per
capita than those under 65, and so the Medicare market represents a greater share, and
therefore more “clout.”
27 Letter from CBO to the Honorable William H. Frist, M.D., Estimate of the Effect of
Striking the “Noninterference” Provision as Added by P.L. 108-173, the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003, Jan. 23, 2004
[http://www.cbo.gov/showdoc.cfm?index=4986&sequence=0].
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listed on the FSS because participation is tied to eligibility for Medicaid
reimbursement.
Drug Availability for Beneficiaries
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 finds that the number of drugs available under the VA formulary is
more restrictive than those available from private Medicare Part D plans.28 The
report also claims that the drugs on the VA formulary are older than drugs on other
privately developed formularies. However, this result is not necessarily an indication
that VA beneficiaries are receiving lower-quality health care. 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.29 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.30 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.31
28 Lichtenberg, F., Older Drugs, Shorter Lives? An Examination of the Health Effects of the
Veterans Health Administration Formulary, Medical Progress Report No. 2, Manhattan
Institute, October 2005.
29 Jones, P., et al., “Randomized Controlled Trial of the Effect on Quality of Life of Second-
vs. First-Generation Antipsychotic Drugs in Schizophrenia,” Archives of General
Psychiatry. Vol. 63, No. 10, October 2006, pp. 1079-87.
30 Briefing by the Pharmacy Benefits Management Strategic Healthcare Group of the
Department of Veterans Affairs, December 12, 2006.
31 Vioxx is a prescription COX-2 selective, non-steroidal anti-inflammatory drug (NSAID)
that was approved by FDA in May 1999 for the relief of the signs and symptoms of
osteoarthritis, for the management of acute pain in adults, and for the treatment of menstrual
symptoms. Merck & Co., Inc. announced a voluntary withdrawal of Vioxx (rofecoxib) from
the U.S. and worldwide market on September 30, 2004, due to safety concerns of an
increased risk of cardiovascular events (including heart attack and stroke) in patients on
Vioxx. On November 5, 2004, the medical journal The Lancet published a meta-analysis of
the available studies on the safety of rofecoxib (Jüni et al., 2004) in which the authors
concluded that rofecoxib should have been withdrawn several years earlier. For additional
information, see the FDA Web page on COX-2 selective NSAIDs at [http://www.fda.gov/
cder/drug/infopage/COX2/default.htm].
CRS-11
Innovation and New Drug Development
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.”32
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.”33
Consistency and Manageable Choice
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.
32 Zycher, B., The Human Cost of Federal Price Negotiations: The Medicare Prescription
Drug Benefit and Pharmaceutical Innovation. Center for Medical Progress, Manhattan
Institute.
33 New Drug Development: Science, Business, Regulatory, and Intellectual Property Issues
Cited as Hampering Drug Development Efforts, GAO-07-49, November 2006.
CRS-12
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.” 34 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.35 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.36
Effect on Overall Costs and Population Health
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.37 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.38
34 G. Huberman and W. Jiang. “Offerings vs. Choice by 401(k) Plan Participants: Equity
Exposure and Number of Funds,” Journal of Finance, to appear.
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=646601].
35 S.S. Iyengar and M.R. Lepper “When Choice Is Demotivating: Can One Desire Too
Much of a Good Thing?” Journal of Personality and Social Psychology, vol. 79, pp.
995-1006, 2000.
36 For more information, see CRS Report RL33300, Standardized Choices: Medigap
Lessons for Medicare Part D, by Jim Hahn.
37 See, for example, Goldman, D. et al., “Pharmacy Benefits and the Use of Drugs by the
Chronically Ill,” JAMA: The Journal of the American Medical Association, May 2004, Vol.
291, No. 19, 2344-2350, and Huskamp, H. et al., “The Effect of Incentive-based Formularies
on Prescription Drug Use and Spending,” New England Journal of Medicine, December
2003, Vol. 349, No. 23, 2224-2232.
38 Gaynor, M., Li, J., and Vogt, W., “Is Drug Coverage A Free Lunch? Cross-Price
Elasticities and the Design of Prescription Drug Benefits,” National Bureau of Economic
(continued...)
CRS-13
Impact on Other Sectors of the Pharmaceutical Industry
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. This contract is highly
lucrative; 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, 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.39 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.
Effect on Drug Prices in Other Markets
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. In the long run, while
drug prices paid by Medicare beneficiaries may fall, overall drug prices may increase
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.
38 (...continued)
Research Working Paper 12758, December 2006.
39 “McKesson Wins Government Drug Contract,” New York Times, January 1, 2004.