The Cost of Prescription Drugs for the Uninsured Elderly and Legislative Approaches

The Cost of Prescription Drugs for the Uninsured Elderly and Legislative Approaches

Order Code RL30373
CRS Report for Congress
Received through the CRS Web
The Cost of Prescription Drugs
for the Uninsured Elderly
and Legislative Approaches
Updated January 16, 2001
Transportation and Industry Analysis Section
Resources, Science, and Industry Division
Congressional Research Service ˜ The Library of Congress

The Cost of Prescription Drugs
for the Uninsured Elderly and
Legislative Approaches
Summary
The relatively high prices of prescription drugs was a major issue for the 106th
Congress and will likely remain an issue during the 107th Congress. In particular,
legislative discussion of the issue has focused on the uninsured elderly. High
prescription drug prices can impose significant financial hardship on low-income
seniors who do not have insurance coverage for prescription drugs. Medicare, which
provides health insurance for most of the Nation’s elderly, does not cover most
outpatient prescription drugs.
Various factors play a role in prescription drug pricing, such as the policy of
patenting innovative drugs and the degree to which therapeutically equivalent drugs
are available. Discussions of prescription drug pricing tend to emphasize the ability
of many third party buyers (e.g. health maintenance organizations, hospitals, and
pharmacy benefit managers) to obtain discounted prices for pharmaceuticals. Other
buyers (e.g. many retail pharmacies and uninsured consumers) do not tend to receive
such discounts. The net effect of such discounts is that buyers such as retail
pharmacies and uninsured consumers usually pay the highest prices for drugs while
third-party buyers usually pay lower prices for drugs. Third-party buyers are able to
receive discounts at both the manufacturing level and at the retail pharmacy level,
although third-party payers who do not use a formulary to manage outpatient drug
benefits also pay higher prices for drugs.
Economic analysis of the pharmaceutical market provides some insight into
the reasons third-party buyers are able to obtain lower prices while other buyers are
not. Third-party buyers negotiate prices and can exclude high-priced sellers
(essentially manufacturers) from their portion of the pharmaceutical market.
Conversely, other buyers (including uninsured consumers) do not negotiate over
prices and are therefore unable to exclude sellers from the market. It is the ability to
exclude sellers that tends to determine who pays the lowest prices for prescription
drugs.
Critics of this differential pricing in the pharmaceutical market have raised a
number of issues, including fairness, equity and access to drugs, and how to end the
price discrimination that the elderly face when they must pay for their own
prescription medicines. Congress has been exploring several options for easing the
financial burden that high prescription drug prices can impose on the elderly. One
approach would be to create a drug benefit for the Medicare population. Another
approach is to require pharmaceutical manufacturers to offer discounts on drugs sold
to the uninsured elderly. A third approach is to facilitate the importation of
prescription drugs from countries where prices are lower. This report will be updated
as warranted.

Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Sources of Price Differentiation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Major Third-Party Buyers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Pharmaceutical Manufacturers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Buyer Behavior at the Manufacturing Level. . . . . . . . . . . . . . . . . 7
Retail Pharmacies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Buyer Behavior at the Retail Level. . . . . . . . . . . . . . . . . . . . . . . 9
Why is Differential Pricing a Problem? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Manufacturers, retailers, and price differentiation . . . . . . . . . . . . . . . . . 11
“Cost shifting” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Excessive Profits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Anti-competitive pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Equity Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Policy Approaches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Creating a Prescription Drug Benefit . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Manufacturer Discounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Access to Drugs from Foreign Countries . . . . . . . . . . . . . . . . . . . . . . . 17
Observations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

The Cost of Prescription Drugs
for the Uninsured Elderly and
Legislative Approaches
Introduction
The relatively high prices of prescription drugs receive much attention from
both the press and policymakers. High prices can impose significant financial burdens
on those who do not have health insurance or whose health insurance does not cover
prescription drugs. Although there are uninsured in most, if not all, segments of the
population, particular emphasis has been placed on the effect of higher prices on the
elderly. Most elderly receive their primary health insurance through the government’s
Medicare program, yet Medicare does not provide coverage for most outpatient
prescription drugs. While approximately 65% of the elderly have prescription drug
coverage through some sort of non-Medicare supplement, the remaining elderly
receive no such benefit.1 Even for those seniors who have some form of a
prescription drug benefit, coverage may be insufficient or inadequate given their
medical needs.2 There is also evidence that the scope of their coverage may be
eroding. The high prices of prescription drugs are considered to be particularly hard
on the uninsured elderly because many of the Nation’s elderly live on low, fixed
incomes.
The purpose of this report is to explain why many of those who are least able
to afford high drug costs are those who are most frequently charged the most. To do
this, we examine the causes of pricing differences between the uninsured and third-
party, or “preferred,” buyers in order to better understand marketplace dynamics and
the implications of the various alternatives that have been put forward to reduce such
price differences. This report describes the basic economic theory underlying price
differentiation and, in the context of the pharmaceutical market, analyzes the role and
1Davis, Margaret, et al. “Prescription Drug Coverage, Utilization, and Spending Among
Medicare Beneficiaries. Health Affairs. January/February 1999.
2A study performed for the Henry J. Kaiser Family Foundation found that supplemental
benefits offered by Medicare HMOs (including a prescription drug benefit) varied greatly in
the level of coverage, with some offering very generous coverage while others offered very
limited coverage. See The Henry J. Kaiser Family Foundation, Analysis of Benefits Offered
By Medicare HMOs, 1999: Complexities and Implications. August 1999. Another study by
the National Economic Council states that the only meaningful form of private prescription
drug coverage is retiree drug coverage, and only 25% of the elderly have this type of coverage.
See The White House, National Economic Council. Disturbing Truths and Dangerous
Trends: The Facts About Medicare Beneficiaries and Prescription Drug Coverage. July 22,
1999.

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behavior of pharmacy benefit managers (PBMs), pharmaceutical manufacturers, and
retail pharmacies, respectively. It also looks at a number of the criticisms that have
been made of the practice of differential pricing. Finally, this report discusses various
policy approaches aimed at assisting the elderly to purchase prescription drugs.
Sources of Price Differentiation
Differential pricing has emerged as a major issue in the debate over the cost
of drugs for the uninsured. In this section, the concept of differential pricing is
discussed and its application to various groups of buyers of goods and services is
described. The prescription drug market is characterized by differential pricing. In
recent years, differential pricing has emerged as a major issue because of the dramatic
increase in the segment of the market that is controlled by third-party buyers. The
behavior of third-party buyers, manufacturers, and retail pharmacies all have an
impact on uninsured consumers. These impacts are the subject of the various
subsections that follow the discussion of price differentiation.
Price differentiation, or price discrimination, is a common business practice
in markets with diverse buyer groups. Its effects can sometimes be beneficial in an
economic sense, but F.M. Scherer and David Ross note:
“Price discrimination causes a redistribution of income toward the
discriminator and away from its customers. In the absence of legal quirks,
no firm with market power has to discriminate. It will do so only if a system
of discriminatory prices yields higher expected profits than uniform pricing,
ceteris paribus.”3
The charging of different prices to different consumers occurs in many industries in
the U.S. economy.4 For example, airlines charge different fares to business travelers
than to leisure travelers, as well as different fares within each group. Long distance
telephone companies also charge different rates depending on the time of day that the
phone call is made. Student discounts at movies and senior discounts at restaurants
are also frequently cited cases in which lower prices are offered to groups that are
relatively more price sensitive. Some magazines offer low introductory rates or free
trial issues to new subscribers, while existing subscribers may have to pay full price
for the same issue. Universities offer financial aid or academic scholarships to some
students which effectively lowers the price of their education. In all of these
situations, the good or service sold is identical and each consumer is purchasing the
same amount, yet the prices vary by consumer or by time of purchase. Thus, such
3F.M. Scherer and David Ross, Industrial Market Structure and Economic Performance. 3rd
ed., 1990. p. 494.
4Throughout this paper, “differential pricing” or “price differentiation” will be used to refer
to what economists call price discrimination. Price discrimination refers to any non-cost
based difference in pricing for different units of a good or service. The phrase “price
discrimination” carries with it a negative connotation among the press and policymakers.
However, it is very important to note that (unlike other forms of discrimination) price
discrimination is an economic term and is neutral.

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price differences are not related to differences in costs nor differences in the volume
purchased; rather, the price differences are caused by some other factor, such as the
sensitivity of readily identifiable groups of consumers to prices.5
Differential pricing is a characteristic of the prescription drug market. It is
likely that, here too, the observed price differences may not be due to cost or volume
differences. Instead, relatively lower prices are charged because manufacturers are
able to differentiate among types of consumers. In this case, third party buyers are
likely to go elsewhere (i.e., substituting therapeutic equivalents) or may be willing to
forgo the purchase of prescription drugs altogether (i.e., not providing coverage for
certain drugs) while the uninsured have a limited ability to go elsewhere and are much
less likely to be willing to forgo the purchase of prescription drugs. Uninsured
consumers are therefore likely to be charged relatively higher prices. This point can
be restated as follows: Manufacturers and retailers of prescription drugs are able to
differentiate with ease between third party buyers (who represent insured consumers)
and uninsured consumers. The resulting price discrimination yields higher profits for
any party with market power who is willing to establish a system that distinguishes
among classes of customers. Scherer and Ross (1990) note that the type of price
differentiation present in the pharmaceutical marketplace (third-degree price
discrimination6) “redistributes income away from consumers in the low price elasticity
groups, who normally pay a higher price than under simple monopoly, toward
consumers in high-price elasticity groups, who pay lower prices.7
Do conditions for price discrimination exist in the pharmaceutical market?
The answer would appear to be unambiguously affirmative. Sellers of prescription
drugs have control over prices, although the extent of this is difficult to measure and
varies within and across the pharmaceutical market. Sellers in the pharmaceutical
market can segment buyers and gauge how much various classes of buyers are willing
to pay. Manufacturers differentiate between third-party buyers and retail pharmacies.
Retail pharmacies differentiate between third-party buyers and uninsured consumers.
In both segments of the market, sellers gauge how much third-party buyers are willing
to pay through one-on-one negotiations with third-party buyers. Sellers charge
separate (generally, non-discounted) prices to retail pharmacies and uninsured
consumers.
5Two conditions must be present for non-cost based differential pricing. First, the seller must
have some control over price. In perfectly competitive markets (which are extremely rare),
price differentiation cannot take place. Second, the seller must be able to segment the demand
for the product. That is, the seller must have some way of distinguishing which buyers are
willing to pay a higher price and which buyers are willing to pay only a lower price. If the
seller has no way of distinguishing among buyers, then he or she must set a single price for
all buyers. For example, very hungry customers may be willing to pay more at a restaurant
than less hungry customers, but because the restaurant cannot distinguish between the two
types, it must charge a single price.
6According to Hal Varian, “Third degree price discrimination occurs when the monopolist
sells different units of output to different people for different prices, but every unit of output
sold to a given person sells for the same price.” Varian, Hal R. Intermediate
Microeconomics: A Modern Approach. 4th Ed.. New York: W.W. Norton, 1996.
7Ibid.

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Major Third-Party Buyers
The major third-party buyers in the pharmaceutical market are health
maintenance organizations (HMOs) and pharmacy benefit managers (PBMs).8 These
two groups have grown in importance over the last decade.9 In 1990, HMOs and
PBMs handled approximately 25% of prescriptions; it is estimated that in 1999 these
two groups will handle approximately 70% of prescriptions.10 Standard & Poor’s has
projected that third-party insurers will handle close to 90% of all pharmacy sales in
2000.11
PBMs are contracted by employers and health plans to administer a
prescription drug benefit. The objective of the PBM is to reduce the expenditures
associated with operating a prescription drug benefit and to pass on those savings to
the employer or health plan. It is estimated that PBMs contracted by health plans in
the Federal Employees Health Benefits Program (FEHBP) saved those health plans
20%-27% on their drug benefit.12
One way that PBMs (as well as other third-party buyers) achieve such cost
savings is through negotiated discounts with pharmaceutical manufacturers and retail
pharmacies. An important cost-saving mechanism used by third-party buyers is the
formulary. A formulary is a list of preferred drugs developed by PBMs, HMOs, and
other third-party buyers. Drugs are added to formularies based on various criteria,
such as efficacy, side effects, and price. Third-party buyers exercise market power
through their ability to include or exclude prescription medicines from their
formularies. As will be discussed, manufacturers place great importance on having
their drugs included in formularies and often offer discounts to third-party buyers in
exchange for inclusion in formularies.
Formularies can play an important role in the operations of PBMs and other
third-party buyers. Health plans may encourage contracted physicians to prescribe
formulary drugs over non-formulary drugs. If a health plan member is prescribed a
non-formulary drug by a physician, then a health plan’s PBM may contact the
physician and have the prescription changed to a therapeutically equivalent drug that
8PBMs frequently negotiate on behalf of HMOs.
9Unless otherwise noted, third-party buyers in this paper exclude government buyers such as
the Veterans Administration or the Department of Defense. Although they often negotiate in
a manner similar to private third-party buyers, they are guaranteed a certain discount under
the Veterans Health Care Act (P.L. 102-585).
10Robert Pear, “Tracking Just What the Doctor Ordered: Medicare Changes Would Bolster
Prescription Management Services,” New York Times, July 13, 1999.
11Standard & Poor’s. Industry Surveys. “Supermarkets and Drugstores.” June 18, 1999. p.
8.
12U.S. General Accounting Office. Pharmacy Benefit Managers: FEHBP Plans Satisfied
With Savings and Services, but Retail Pharmacies Have Concerns. GAO/HEHS-97-47,
February 1999, p. 2.

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is included in the formulary.13 Adding to complexity is the use of “open” and “closed”
formularies. When a plan uses an open formulary, it covers all prescription drugs,
regardless of whether they are included in the formulary. When a plan uses a closed
formulary, it refuses to cover drugs that are not included in the formulary. Under a
closed formulary, if a plan member is prescribed a non-formulary drug, then that plan
member must either pay for the drug out-of-pocket or have his or her physician
change the prescription to a therapeutically equivalent drug that is included in the
formulary. Whether a plan uses an open or closed formulary could affect the level of
savings that can be achieved.
In a study based on an examination of managed, fee-for-service plans using
open formularies, the U.S. Congressional Budget Office (CBO) concluded “[m]uch
of the savings that PBMs achieve appear to come from the lower prices paid to
pharmacies rather than from the rebates offered by drug manufacturers.”14 The CBO
findings were in turn based on a General Accounting Office (GAO) study which
examined the cost savings achieved by three health plans participating in the Federal
Employees Health Benefits Program (FEHBP).15 CBO notes that the GAO study
found that 50% to 70% of the cost savings of the FEHBP plans resulted from paying
less at the retail pharmacy level than what those plans would have paid without
contracting with a PBM. CBO also notes that the GAO study found that 2% to 21%
of the savings achieved by the FEHBP plans were the result of manufacturer rebates
obtained by the PBM.
Some critics discount CBO’s findings on the grounds that the GAO study does
not represent typical private health plans and that FEHBP fee-for-service plans are not
comparable to HMO or other managed care plans that are more likely to use closed
formularies. They argue that HMOs and plans that utilize a closed formulary will
achieve a higher percentage of savings attributable to manufacturer rebates than is the
case for FEHBP fee-for-service plans and that these rebates will exceed retail
pharmacy discounts.
It is possible that the percentage of overall savings attributed to manufacturer
rebates could exceed the percentage of savings attributed to pharmacy discounts.
However, CRS is unable to determine whether manufacturer rebates exceed retail
pharmacy discounts under a closed formulary or for other types of health plans
because data on manufacturer rebates and pharmacy discounts for HMOs and other
private health plans are proprietary (i.e., not available to the public). Nevertheless,
it would appear that whether a plan uses an open or closed formulary, discounts come
from either the manufacturer or the retailer, or from both.
13Therapeutic equivalents are drugs that perform the same function even though they may be
different chemically. For example, the anti-depressant medications Prozac, Zoloft and Paxil
belong to the same therapeutic class.
14U.S. Congressional Budget Office. How Increased Competition from Generic Drugs Has
Affected Prices and Returns in the Pharmaceutical Industry. July 1998, p. 8.
15GAO, 1997.

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Pharmaceutical Manufacturers
The structure of the pharmaceutical manufacturing industry creates conditions
for industry control over prices and, consequently, price differentiation. The brand-
name pharmaceutical manufacturing industry is characteristic of an oligopoly.16 First,
there are relatively few firms that develop and manufacture pharmaceuticals. When
one limits the pharmaceutical market to drugs that are therapeutically equivalent,
there are even fewer firms. In some cases, there are no therapeutical equivalents for
a brand-name drug; in such instances, the market resembles that of a monopoly.17
Firms with a virtual monopoly over a therapeutic class will probably not tend to offer
discounts or rebates to any group of buyers. Second, there are certain barriers to
entry that limit the extent to which new firms can enter the market and the extent to
which existing firms can introduce competing products. One such barrier is the patent
system, which protects the innovator of a drug from competition from identical
products.18 Another barrier is the high fixed cost associated with developing and
marketing new pharmaceuticals.
Pharmaceutical manufacturers generally differentiate their prices among chain
and independent retail pharmacies, hospitals, managed care facilities, health plans, and
PBMs. A Standard & Poor’s Industry Survey describes manufacturers’ pricing
policies in the following way:
In general, drugs sold to wholesale distributors and pharmacy chains for the
individual/physician market are priced at the high-end of the manufacturer’s
price scale. Hospital chains and other large institutional and managed care
customers that buy directly from manufacturers pay prices well below the list
price, as a result of heavy discounting and negotiated arrangements.19
Manufacturers are able to price differentiate because they have control over
prices. The ability of manufacturers to set prices is constrained by the bargaining
power exercised by HMOs, PBMs, and other preferred customers. When competition
exists in a therapeutic class, manufacturers are frequently forced to extend discounts
to those buyers with market power (third-party buyers). Third-party buyers tend to
receive the lowest prices because they have the ability to exclude certain
manufacturers from a significant portion of the market. Retail pharmacies, however,
16Scherer, F.M. Industry Structure, Strategy, and Public Policy. New York: Harper Collins,
1996, p. 5. In the spectrum of market structures, an oligopoly is the closest market structure
to a monopoly. Oligopolies are characterized by relatively few firms (but more than one) and
barriers to entry. Firms operating in an oligopolistic market have some control over prices,
and thus have the ability to price differentiate.
17Ibid.
18It is important to note that although other producers cannot offer chemically identical
products, they can introduce products that are therapeutically equivalent. Therapeutic
equivalents often compete with one another. Thus, the patent does not necessarily protect the
innovator from all competition.
19Standard and Poor’s. Industry Surveys. “Supermarkets and Drugstores.” September 14,
1998. p. 19.

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must carry the widest possible range of inventory to meet the needs of their customers
and have limited leverage in winning discounts from manufacturers.
Buyer Behavior at the Manufacturing Level. To obtain higher profits
through price differentiation, a firm must be able to distinguish which consumers are
willing to pay relatively high prices and which are willing to pay only relatively low
prices for its products. Usually, this works through what is known as the
“chargeback” system. Most buyers of pharmaceuticals obtain their products from
wholesalers at the same price. However, preferred buyers receive negotiated rebates
from the manufacturers. In the pharmaceutical market, this is achieved through
negotiations with preferred customers, who generally pay lower effective prices than
retail pharmacies. Some large retail pharmacy chains might also receive rebates, but
they would tend to be less than those of the preferred buyers. In the case of some
health plans or PBMs, the buyer does not actually take physical possession of the
drugs. Rather, the health plan’s members obtain their drugs from a retail or mail-
order pharmacy. However, the health plan or PBM may still receive a rebate directly
from the manufacturer for certain drugs. Thus, the effective price, net of any rebates,
still tends to be lower for preferred buyers than for retail pharmacies.
As mentioned earlier, HMOs, PBMs, and other third party buyers utilize
formularies. Manufacturers place great value on being included in a formulary. This
is particularly true when there is more than one drug in a therapeutic class. Inclusion
in a formulary essentially means that a drug will be used more often than (or even
exclusively over) competing drugs with the same therapeutic function. Moreover, if
preliminary evidence is correct, particular drugs will be used more widely precisely
because they are listed on a formulary.20 Such inclusion is thought to promote the
adoption of a drug by other formularies or by organizations that do not use a
formulary at all.
Formularies provide preferred buyers with some degree of leverage and flexibility
in response to price increases. A manufacturer could, for example, refuse to offer a
rebate or offer a rebate that is less than that offered by a competing manufacturer for
a therapeutically equivalent drug. However, the preferred buyer could refuse to
include the lower-rebated (and hence higher-priced) product in the formulary and
replace it with the therapeutically equivalent product of a manufacturer who would
be willing to offer a larger rebate. The lower-rebated (higher priced) manufacturer
would be denied the benefits of being included on a formulary. Thus, the ability of the
formulary to potentially exclude a manufacturer from a significant portion of the
market provides the manufacturer with an incentive to offer rebates to preferred
buyers. The manufacturer may prefer not to offer lower prices (which might have
taken the form of rebates), effectively charging a higher price. However, the forgone
benefits of being included in the formulary could outweigh the revenue from higher
prices.
20See Berndt, Ernst R., Robert S. Pindyck, and Pierre Azoulay, “Network Effects and
Diffusion in Pharmaceutical Markets: Antiulcer Drugs,” National Bureau of Economic
Research, Working Paper 7024, March 1999.

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Relative to third-party buyers, retail pharmacies have a more limited flexibility
in their purchasing decisions. Unlike the third-party buyers, retail pharmacies do not
have any exclusionary mechanisms such as a formulary, nor would such a mechanism
be economically sensible. The determination of which drugs consumers will obtain
from the retail pharmacy is made by the physician (or by the physician and the health
plan in the case of an insured customer) and depends heavily on the preferences of
that physician. For example, Physician A may prefer to prescribe Prozac for a patient
with depression while Physician B may prefer to prescribe Paxil for another patient
with similar symptoms. Both patients may choose to have their prescriptions filled at
the same pharmacy. That pharmacy would either have to stock both drugs or have
to turn down the patronage of one of the patients. Turning down customers would
result in lost revenue. This is true for independent pharmacies and chain pharmacies
alike. Although manufacturers have no incentive to provide drugstores with a
preferred buyer discount, chain drugstores may obtain volume-based discounts for
some prescription drugs. However, these volume-based discounts would likely be
smaller than the rebates obtained by preferred third-party buyers.
Retail Pharmacies
Retail pharmacies may offer discounts and rebates to third-party buyers to gain
access to their large memberships. Uninsured (cash paying) consumers are not
offered similar discounts and, therefore, tend to pay relatively higher prices than those
covered by plans using third-party buyers. The apparent willingness of retail
pharmacies to offer discounts and rebates to these preferred customers indicates that
retailers, in some instances, exercise some control over prices. Recent Standard and
Poor’s Industry Surveys suggest that the drugstore industry tends to be highly
competitive.21 A number of forces have converged to squeeze pharmacy margins,
including the rapid growth of managed care plans, competition with supermarket
pharmacies, mail-order pharmacies, and other non-traditional suppliers of prescription
drugs.
Third-party buyers generally are not willing to pay the same prices as other
buyers for the use of retail pharmacy services. In their drive to control costs, health
plans and other third-party buyers pay drug retailers a wholesale drug reimbursement
rate (generally, the average wholesale price (AWP)) for the cost of the drugs, plus a
fixed dispensing fee. As pharmacy sales have shifted from a cash basis to one in
which an insurance plan covers some or all of its members’ prescription drug costs,
continuing efforts by insurers to cut costs have had a significant impact on
pharmacies. According to one survey, drugstores’ “gross margins on prescription
sales have fallen significantly from what they once were.”22 This survey goes on to
note that reimbursement rates based on the AWP leave drug retailers with little if any
profit.23
21Standard and Poor’s, 1998 and 1999.
22Standard and Poor’s. Op.Cit. p. 19.
23Ibid.

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Thus, pharmacies are placed in a situation not unlike that faced by
pharmaceutical manufacturers: in order to gain access to a large customer base
controlled by third-party buyers, pharmacies are forced to differentiate between those
buyers who can demand discounts and those who cannot. Standard & Poor’s
Industry Survey explains in plain language the extent to which sellers (in this case,
drugstores) exercise control over prices:
For much of this decade, the PBMs’ rules were simple: they offered drugstore
chains predetermined, take-it-or-leave-it rates to dispense third-party prescriptions
under the programs that they administered. Pharmacies that didn’t agree to these
terms risked losing access to existing and potential customers who were members
of that plan; those that acceded to the rate dictates risked losing money on each
prescription.24
One response of the retail pharmacy sector has been to purchase PBMs.
Walgreen, CVS, Rite-Aid, Eckerd, and American Stores each operate PBMs that are
able to deliver prescription drugs through their extensive networks of retail outlets.
Drugstores have also retaliated against low margins by dropping unprofitable third-
party contracts.25
Buyer Behavior at the Retail Level. At the retail level, individual consumers
appear to be the predominant buyer of prescription medicines. However, of the
individuals who patronize retail pharmacies, some are cash-paying customers and
others are clients of third-party buyers. As in the manufacturing segment of the
pharmaceutical market, third-party buyers in the retail segment are not willing to pay
the same prices as other buyers, namely uninsured consumers. Third-party buyers
will, therefore, attempt to obtain the best price possible, and in some cases, they can
refuse to reimburse members who use pharmacies that are outside of their plan.
Price is one important factor influencing an individual consumer’s decision to
patronize a pharmacy. In addition, consumers tend to purchase goods and services
that are aligned with their individual tastes and preferences. For example, an
individual consumer may prefer to patronize a pharmacy located a few blocks from
his or her home over another pharmacy that is located farther away. Another
preference that may lead a consumer to patronize a particular pharmacy is whether
he or she knows the pharmacist personally.
Other consumers may have very different sets of preferences. For example, an
uninsured elderly person on a fixed income may prefer to travel some distance to
purchase a prescription drug, if that drug is offered at a substantially lower price. If
the drug has to be taken on a regular basis, this may solidify the preference for
traveling further to acquire the medicine at lower cost. It is difficult to generalize
about the individual tastes and preferences of all uninsured consumers and, although
economic theory suggests that the possibility that a consumer may prefer a store with
higher prescription prices to one with lower prices if certain non-price or non-drug
factors are important, there is little in the way of empirical evidence that demonstrates
24Ibid.
25Ibid., p. 20.

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that uninsured consumers on fixed incomes allow non-price factors to predominate
in their choice of which store or other prescription source to patronize.
Nevertheless, it is quite possible that some consumers will maintain long-standing
relationships with higher-priced stores rather than switch to a store that offers less
service or no personal relationship with a pharmacist. Indeed, one has only to observe
that the choices and behavior of insured consumers are usually influenced primarily
by the preferences of the insurer and not by their own preferences to understand that
such preferences are not immutable. Given the rapidity with which third-party buying
has become a commonplace in the United States, it is worth noting that preferences
are subject, after all, to market forces.
There is little reason to believe that third-party buyers have non-price
preferences–although their insured consumers (their members) may well have such
preferences. Third-party buyers are not likely to be willing to pay higher prices in
exchange for non-price benefits such as better service or closer location. A
straightforward example of a type of pharmacy that offers little in the way of non-
price benefits is the mail-order pharmacy. Members who use mail-order pharmacies
must wait longer to receive their prescriptions than they would at a retail pharmacy.
Members also do not come in direct contact with a pharmacist when they use a mail-
order pharmacy, which may affect the perceived level of service that the member
receives. That some health plans and PBMs aggressively encourage their members
to use mail-order pharmacies suggests that the non-price benefits of purchasing from
a local pharmacy are more important to many of the insured than the potential savings
they might realize through use of mail-order prescriptions.
Many consumers (members of health plans as well as the uninsured) may
purchase prescriptions at the same pharmacy. Health plan members will probably care
about some of the non-price characteristics of the pharmacy–even if their insurer or
third-party payer does not. One could speculate that location and relationship with
a pharmacist might be as important to some insured consumers as to uninsured
consumers.
What about uninsured individuals? Are they less likely to be responsive to the
price of a good than to non-price characteristics (such as store location or quality of
service)? If the uninsured were provided benefits similar to those available to
consumers enrolled in insurance plans or HMOs, one might expect that the uninsured
would behave in the same manner as insured individuals. However, not all consumers
are alike. While preferences for non-price benefits lead some consumers to stay put,
others may shop around; there will inevitably be some consumers who are very
sensitive to prices. For these consumers, price will be the most important factor in
choosing a pharmacy and, to the extent that they can, they will shop around until they
find the lowest-priced pharmacy.
In the absence of detailed studies of the specific behavior and preferences of
uninsured consumers, policymakers will have difficulty predicting their responses to
various proposals to make prescriptions available to the uninsured. While consumer
response may be difficult to predict with any certainty, economists and non-
economists alike have sought to determine how proposed changes in policies on

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prescription drugs and the uninsured might affect the ability of manufacturers,
retailers, and insurers to participate in a system characterized by differential pricing.
Why is Differential Pricing a Problem?
A number of concerns have been raised with respect to price differentiation. One
major concern is whether it is manufacturers or retail pharmacies which are chiefly
responsible for charging significantly higher prices to the uninsured, including many
seniors. A second concern has to do with allegations that manufacturers charge the
elderly more than they otherwise might to compensate for discounts that they give to
preferred buyers. A third concern is that price differentiation allows manufacturers
to reap excessive profits. Fourth, critics argue that price differentiation is a form of
anti-competitive pricing that harms competitors and consumers. Finally, price
differentiation is considered by some critics to be a principal source of inequity in a
system in which the poorest consumers pay the highest prices. Each of these issues
will be briefly examined.
Manufacturers, retailers, and price differentiation
Price differentiation in the pharmaceutical industry has been heavily criticized by
the press and by some policymakers. Pharmaceutical manufacturers are the target of
much of the criticism of differential pricing, although retail pharmacies have not been
entirely immune from criticism. Some observers believe that pharmaceutical
manufacturers are responsible for most of the differential between prices paid by third-
party buyers and those paid by uninsured consumers. This was the conclusion of two
recent studies.26 Using information found in a GAO study, however, the CBO
determined that several fee-for-service federal health plans (FEHBP) achieved greater
savings from pharmacy discounts than from manufacturer discounts.27 Whether the
GAO study is applicable to most private health plans is debatable. While evidence
suggests that manufacturers and retail pharmacies have the ability to use price
differentiation, it would be difficult to draw any definitive conclusions without further
detailed studies that examine pharmaceutical pricing data that are not generally
available to the public.
26See the studies prepared by the minority staff of the House Committee on Government
Reform and Oversight: “Prescription Drug Pricing in the United States: Drug Companies
Profit at the Expense of Older Americans,” Updated October 20, 1998, and “Prescription
Drug Pricing in the 29th Congressional District in California: Drug Companies Profit at the
Expense of Older Americans,” October 19, 1999. One of these reports covers a small sample
of commonly used prescription medicines in selected locations around the United States; the
other study examined pricing for the same drugs in California’s 29th Congressional District,
which includes parts of Los Angeles.
27CBO, 1998, and GAO, 1997.

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“Cost shifting”
Another criticism of price differentiation is that it leads to “cost shifting,” which
purportedly occurs when sellers raise the prices they charge the uninsured in order to
compensate for discounts given to third-party buyers. It is claimed that this occurs
mostly at the manufacturing level, although at least one study claims that it occurs at
the retail pharmacy level as well.28
The concept of cost shifting (whether from third-party buyers to uninsured
consumers, from HMOs to retail pharmacies, or from foreign buyers to U.S.
consumers) is a hotly debated topic. Many economists reject the “cost shifting” idea.
They maintain that sellers in the pharmaceutical market price differentiate by dividing
buyers into separate markets based on the price sensitivity of buyers. Then sellers
choose the optimal price in each market, and these optimal prices are unrelated to
each other. If any firm raises the price of a good above its optimal level, it will sell
fewer goods and, as a result, earn a lower profit.29 Thus, if a seller in the
pharmaceutical market charges a lower price to a third-party buyer, it does so because
that buyer is part of a different market and has different demand sensitivity. In theory,
the seller offers third-party buyers a lower price and charges a separately determined
higher price to buyers in other markets. Each buyer is thus segmented into groups
and pays the price dictated by his or her price sensitivity.30
Studies have suggested that the high prices that the uninsured pay relative to the
lower prices available to the customers of third-party buyers amount to cost-shifting.31
28Serafini claims that cost shifting occurs at the manufacturing level. Marilyn Werber
Serafini, “Bitter Pills,” National Journal, October 31, 1998; Kolassa, of the University of
Mississippi, claims that cost shifting occurs at the retail pharmacy level. E.M. Kolassa,
“Analysis of the Minority Report on Pharmaceutical Prices,” Mimeo, no date; Sager and
Socolar claim that cost shifting from foreign countries to U.S. consumers occurs. Alan Sager
and Deborah Socolar, “Affordable Medications for Americans (AMA): Problem, Causes, and
Solutions.” Presented to the Prescription Drug Task Force, U.S. House of Representatives.
July 27, 1999.
29A well established economic principle, the law of demand, states that as price increases,
quantity purchased decreases. Thus, as firms raise prices above the optimal level, the quantity
decrease offsets the price increase.
30CBO, 1998, p. 24. CBO’s conclusion is based on the analysis of price differentiation found
in Jean Tirole, The Theory of Industrial Organization. Cambridge, MA: The MIT Press,
1988, pp. 137-139.
31U.S. Congress. Committee on Government Reform. “Prescription Drug Pricing in the
United States: Drug Companies Profit at the Expense of Older Americans.” Minority Staff
Report Prepared for Rep. Henry A. Waxman. Updated Nov. 9, 1999; Schondelmeyer,
Stephen W., “Competition and Pricing Issues in the Pharmaceutical Market,” PRIME
Institute, University of Minnesota, August 1994. A critique of the 1998 update of the
Government Reform Committee minority staff report was released by the Pharmaceutical
Research and Manufacturers Association of America (Phrma) in April 1999: Danzon,
Patricia. “Price Comparisons for Pharmaceuticals: A Review of U.S. and Cross National
Studies,” The Wharton School, University of Pennsylvania, April 1999. A link to this study
(continued...)

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And while economists are in broad agreement that cost shifting could make the seller
worse off, information and data concerning the private decisions of sellers in the
pharmaceutical marketplace are unavailable. If we assume that economic theory is
correct and cost shifting does not take place between segmented groups of buyers, the
lack of information on how groups are segmented or prices set makes it difficult to
know what specifically is determining the observed price differentials. An
unexplainably wide price differential, without further information, is not dispositive
of whether cost shifting is occurring.
Excessive Profits
Another criticism of price differentiation is that it sustains high profits for
pharmaceutical manufacturers.32 According to economic theory, a firm will not price
differentiate unless doing so maximizes its profits. Thus, because pharmaceutical
manufacturers choose to price differentiate, one could infer that they earn higher
profits than they would if they were to charge a uniform price.
Price differentiation may be a less successful profit-maximizing strategy for retail
pharmacies. Some retail pharmacies reportedly are choosing to end price
differentiation by refusing to deal with third-party buyers because of the relatively low
reimbursement rates paid by some third-party buyers -- rates that sometimes fall
below pharmacies’ costs.33 Thus, some pharmacies have chosen to stop segmenting
groups of customers into the insured and the uninsured because some third-party
buyers are unwilling to pay the full cost of the drug.
While price differentiation may be a profit-maximizing strategy, there is no
established relationship between the absolute level of company profits and the use of
price differentiation. High profitability is not necessarily related to price
differentiation.
Anti-competitive pricing
Price differentiation has also been criticized on the grounds that it is anti-
competitive. Indeed, the Robinson-Patman Act (15 U.S.C. §§13, 13a, 13b, 21a)
outlaws unjustified price differentiation related to interstate commerce. However,
31(...continued)
may be found at http://www.phrma.org/press/newsreleases//1999-04-19.40.phtml. See also:
Government Reform Committee Minority Staff, “A Response to Patricia Danzon, Price
Comparisons for Pharmaceuticals: A Review of U.S. and Cross National Studies,” April 22,
1999.
32Text of H.R. 664, the Prescription Drug Fairness for Seniors Act of 1999.
33Low reimbursement rates by private third-party buyers are causing some independents to
deal only with cash-paying customers (see Terry Pristin, “Rebelling Against Managed Care:
A Small Pharmacy Stops Accepting Insurance Plans,” New York Times, June 4, 1998). Low
reimbursement by Medicaid is causing some large chains to quit filling Medicaid prescriptions
in some areas (see Robert Berner, “Medicine Chess: Pharmacies Say Rates Paid By Rite Aid
Unit Are Doing Them In,” Wall Street Journal, June 30, 1999).

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price differentiation does not violate the Robinson-Patman Act if the price differences
are related to differences in cost or if the price differences are the result of a seller
meeting the competition of another seller.34 In 1994, a civil class action suit was filed
by thousands of retail pharmacies against 25 pharmaceutical manufacturers, seven
wholesalers, and one mail-order pharmacy. The retail pharmacies alleged that the
industry’s differential pricing practices were anti-competitive.35 Most of the
defendants settled the case. However, a directed verdict was entered in favor of those
defendants that did not settle. The court found that price differentiation by
manufacturers and wholesalers did not violate federal antitrust laws.36
A 1999 staff report by the Federal Trade Commission (FTC) raised numerous
concerns that price differentiation in pharmaceuticals has the potential to be anti-
competitive.37 The report “suggests that antitrust authorities need to apply the
standard case-by-case approach to antitrust analyses of vertical and horizontal issues
that arise in this industry.”38 Differential pricing potentially raises competitive
concerns, but the authors of the report concede that careful evaluation of alternative
efficiency explanations needs to be completed before challenging pricing or other
strategies at issue.
Price differentiation is not necessarily inconsistent with competition; it may occur
when the consumer can choose among four or five products, or in monopolistic
markets, so long as entry is easy. The FTC report concludes that in order to assess
whether pharmaceutical price differentiation harms competition, one must evaluate
the extent to which firms can enter or expand in the market. Price differentiation is
also criticized on the grounds that it harms consumers. The FTC report describes a
number of scenarios that may give rise to anticompetitive behavior that is harmful to
consumers, but it does not analyze the consequences of price differentiation at a level
of detail adequate to reach firm conclusions.
Equity Considerations
Several other criticisms of price differentiation have been put forth. These
criticisms, which are tied to notions of equity and public health, identify serious flaws
in a system that would allow separate markets to be constructed in which those least
able to afford expensive prescription medications are those who must pay the highest
34For more information on the Robinson-Patman Act, see CRS Report 94-726 A,
Discriminatory Pricing and the Robinson-Patman Act: An Overview; Some Exceptions, by
Janice E. Rubin.
35For an economic analysis of the case, see F.M. Scherer, “How US Antitrust Can Go Astray:
The Brand Name Prescription Drug Litigation,” International Journal of the Economics of
Business, vol. 4, no. 3, 1997.
36See In re Brand Name Prescription Drugs Antitrust Litigation, N.D. Ill., No. 94 C 897,
1/19/99.
37Federal Trade Commission. Bureau of Economics. The Pharmaceutical Industry: A
Discussion of Competitive and Antitrust Issues in an Environment of Change. Staff Report,
March 1999. See: http://www.ftc.gov/reports/pharmaceutical/drugrep.pdf
38Ibid., p. xii.

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prices. Because of equity issues, legislation has been introduced in the 106th
Congress that seeks to solve the problems faced by the uninsured elderly. Some have
pointed to price differentiation as one of the major factors contributing to high drug
prices for uninsured and under-insured seniors. Uninsured consumers, particularly the
elderly, pay far higher prices than third-party buyers and often are the least able to
afford the higher prices they are charged. For some, the decision to purchase
medicine may reduce their ability to buy other necessities.
Policy Approaches
Several policy approaches have been under consideration to address the issue of
prescription drug pricing. One approach is to create a prescription drug benefit for
Medicare beneficiaries. Another approach would require manufacturers to grant
discounts to individual consumers that are equivalent to those achieved by large,
third-party buyers. A third, more limited approach, which was enacted by Congress
and signed by President Clinton (P.L. 106-387) in October 2000, would attempt to
lower prescription drug prices by facilitating the importation of pharmaceuticals from
foreign countries.
Creating a Prescription Drug Benefit
The policy approach that has received the most attention among policymakers
is the creation of an outpatient prescription drug benefit for Medicare beneficiaries.
Currently, Medicare does not provide coverage for most outpatient prescription
drugs. This approach would target the elderly, a segment of the population that tends
to use the most drugs. All of the proposals put forth thus far would use private
entities, likely pharmacy benefit managers (PBMs) to manage the benefit.39 However,
the proposals differ over whether the government or private entities would bear the
risk of coverage (and thus pay for expenses incurred by beneficiaries). There is also
debate about which seniors should be covered under such a benefit, what cost-sharing
arrangements should be adopted, and the amount that should be covered.40
Supporters of using private entities to manage a prescription drug benefit note
several advantages. First, the government would have access to the same prices as
large, third-party buyers without having to resort to administered prices. This would
allow prices to be determined via market forces, much the way prices are determined
between PBMs and sellers of prescription drugs in the private sector. Second, PBMs
tend to adopt systems that track patients’ medications. These systems can alert
pharmacists to potential contraindications and allergies that the patient might
39 For a discussion of pharmacy benefit managers, and their role under a prescription drug
benefit for the elderly, see CRS Report RL30754 Pharmacy Benefit Managers, by
Christopher J. Sroka.
40 For a discussion of the major legislative proposals introduced in the 106th Congress, see
CRS Report RL30584 Medicare: Selected Prescription Drug Proposals in the 106th
Congress, by Jennifer O’Sullivan.

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experience. Arguably, the tracking systems that PBMs implement could increase the
quality of pharmaceutical care that seniors receive.
There are some challenges to using private entities to manage a prescription drug
benefit for the Medicare population. The most cited challenge involves the way
PBMs control costs. PBMs often restrict patient access to certain drugs and certain
pharmacies in order to obtain savings. These practices, which already generate some
controversy when used in the private sector, may lead to a public backlash if
implemented under a public program. However, many elderly already receive health
services from some sort of managed care organization, so they already have
experience with the implementation of cost control mechanisms.
Manufacturer Discounts
Another approach to address prescription drug prices is to expand manufacturer
discounts to the uninsured and elderly. Proposals using this approach have taken
different forms. At the federal level, some have proposed mandating discounts
equivalent to those already granted to “favored” buyers. In May 2000, Maine enacted
a law that would allow the state to negotiate discounts on behalf of the uninsured;
however, a federal court issued an injunction prohibiting the state from implementing
the law.41 Vermont enacted a law that extends Medicaid drug discounts to seniors
and low-income individuals who do not otherwise qualify for Medicaid drug
coverage.42
Supporters of plans to extend manufacturer discounts point out that this
approach does not incur a cost to the government. They also believe that lower
prescription drug prices would save taxpayers additional money because increased
drug use would reduce the use of more expensive treatments, many of which would
be paid by Medicare or Medicaid.
However, the pharmaceutical industry opposes plans to extend manufacturer
discounts, and contends such proposals constitute price controls. The industry argues
that extending discounts would reduce research and development (R&D), leading to
the introduction of fewer new drugs. Supporters of manufacturer discounts argue
that the industry, the most profitable by certain measures, can afford to offer
discounts while still maintaining current levels of R&D spending.
41 The injunction is currently under appeal. The federal district court ruled that the Maine law
was unconstitutional because it interfered with interstate commerce. See “Federal Judge
Prohibits State From Enforcing New Drug Price Control Law,” Health Care Policy Report,
BNA Inc., October 30, 2000.
42 This law is currently being challenged in federal court. In order for Vermont to extend those
discounts, the state needed a waiver from the U.S. Department of Health and Human Services
and the Health Care Financing Administration. The pharmaceutical industry, represented by
the Pharmaceutical Research and Manufacturers of America (PhRMA) claims the waiver is
illegal because Vermont’s program does not comply with federal Medicaid law. For more
information, see Dana A. Elfin, “Drug Industry Sues to Block State From Implementing
Discount Drug Plan,” Daily Report for Executives, BNA Inc., December 15, 2000.

CRS-17
Access to Drugs from Foreign Countries
It is generally accepted that prescription drug prices are lower in many foreign
countries than in the United States. Several factors explain this phenomena: foreign
governments often impose price controls on prescription drugs, income varies among
countries, and liability laws differ among countries.43 Recently, anecdotal accounts
have appeared in the press describing seniors’ trips to Canada or Mexico to buy
prescription drugs at lower prices.
Until October 2000, however, federal law and Food and Drug Administration
(FDA) policy made it difficult for large quantities of drugs to be imported into the
United States. All drugs sold in the U.S., including imported drugs, must be
manufactured in compliance with what FDA considers “good manufacturing
practices.” The FDA’s policy was to assume that, unless the importer has proof to
the contrary, imported drugs were not produced using good manufacturing
practices.44 Compliance with FDA’s good manufacturing practices was seen as
burdensome for importers because the foreign seller of the drug might not have
accurate documentation proving that the drug was produced in an FDA-approved
facility using FDA-approved methods. The restrictions on importation affected
mostly trade in large quantities; for imports of a small quantity (limited to a 90-day
supply), the policy generally was not strictly enforced.
As the policy debate over prescription drug prices intensified, many policymakers
began to see large-scale drug importation as a way of lowering prescription drug
prices. Under this approach, wholesalers and pharmacies would be allowed to import
large quantities of drugs at lower, foreign prices. These entities would then distribute
and sell these drugs to American consumers at reduced cost. This approach would
not limit access solely to the elderly; all Americans would have access to imported
drugs, although the elderly in particular could benefit since they consume a large
portion of medications. The pharmaceutical industry opposes this approach, stating
that it would expand foreign price controls to the U.S. market. Furthermore, the
industry expresses concerns that drug importation could open up the possibility that
unsafe or adulterated drugs could enter the country. Supporters of this approach,
however, argue that sufficient precautions could be adopted to minimize the
likelihood that unsafe or adulterated products could enter the country. Moreover,
supporters of this approach argue that it is unfair that Americans pay the highest
prices for prescription drugs. Americans, supporters claim, are subsidizing research
and development for the rest of the world.
43 One researcher found that differences in liability laws explain a significant amount of the
price differences between the United States and Canada. Because it is easier for consumers
in the United States to sue if a drug leads to harmful effects, U.S. drug prices are higher to
compensate manufacturers for this risk. See Richard L. Manning, “Products Liability and
Prescription Drug Prices in Canada and the United States,” The Journal of Law and
Economics, April 1997.
44See “Information on Importation of Drugs,” prepared by the Division of Import Operations
and Policy, U.S. Food and Drug Administration. Available at
http://www.fda.gov/ora/import/pipinfo.htm.

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In October 2000, as part of the FY2001 Agricultural Appropriations bill (P.L.
106-387), an amendment to the Federal Food, Drug, and Cosmetic Act (FFDCA) was
enacted to facilitate the importation and reimportation of prescription drugs.45
Members of Congress who opposed the bill argued that its provisions could not be
effectively implemented. Among other things, the legislation requires the Secretary
of Health and Human Services (HHS) to promulgate regulations allowing pharmacists
and wholesalers to import prescription drugs. The legislation allows the Secretary to
adopt rules to ensure that the public health is protected. The legislation also requires
importers to report certain information about the imported shipments, including
information about their origin and destination. Under the legislation, manufacturers
are prohibited from entering into explicit agreements or contracts with wholesalers
that prevent importation. Several other provisions were included in the legislation,
such as testing of shipments to determine if the imported drugs are safe. The
legislation contained $23 million in conditional funds to cover implementation costs
in the first year. In order for the legislation to be implemented, the Secretary was
required to demonstrate that the importation does not pose additional risks to the
public and that importation would result in significant reduction in pharmaceutical
costs.
However, it is not clear whether the amendment will be implemented. On
December 26, 2000, Health and Human Services Secretary Donna E. Shalala
announced that she would not issue rules to implement the legislation.46 She stated
that flaws and loopholes in the legislation make it impossible to demonstrate that the
importation legislation would be safe or lower costs. Secretary Shalala characterized
three provisions as such loopholes. First, the legislation allows manufacturers to deny
importers access to FDA-approved labeling, which is required for all drugs sold in the
United States.47 Second, the law does not prevent manufacturers from indirectly
interfering with importation, such as requiring foreign distributors to charge higher
prices, limit supplies, or treat U.S. importers less favorably than foreign buyers.
Third, the law is set to expire in five years, and this may discourage the private sector
from investing in the necessary testing and distribution system. Moreover, according
to Secretary Shalala, the taxpayer costs of implementing new safety monitoring would
not offset savings from lower drug prices.
Observations
The issue of prescription drug pricing, which received much attention during the
106th Congress and in the 2000 congressional and presidential elections, is likely to
45 For more information on P.L. 106-387, see CRS Report RS20750, The Prescription Drug
Import Provisions of the FY2001 Agriculture Appropriations Act, P.L. 106-387, by Donna
U. Vogt and Blanchard Randall IV.
46 “HHS Secretary Declines to Implement New Pharmaceutical Reimportation Law,” Health
Law Reporter, BNA, Inc., January 4, 2001.
47 Many times, labeling on drugs sold in foreign countries does not meet FDA requirements
for sale in the United States. To import drugs, importers would need the FDA-approved
labeling that manufacturers place on the product when it is sold domestically.

CRS-19
continue to command attention during the 107th Congress. The complexities of
ensuring access to affordable prescription drugs has so far prevented the emergence
of a consensus. Many recent policy initiatives toward consumers with no prescription
drug coverage have focused on the elderly.
Of the three policy initiatives outlined above, the creation of an outpatient
prescription drug benefit under Medicare would potentially be the most far-reaching.
While such a benefit would greatly reduce out-of-pocket expenditures for the elderly,
there is a lack of agreement over whether government or private entities would bear
the risk of coverage; which seniors should be covered; what cost-sharing
arrangements would be adopted; and what level of expenditures would be covered.
The second approach, manufacturer rebates, would require that manufacturers
provide discounts to pharmacies for prescriptions sold to seniors. Such discounts
would be related to existing Medicaid discounts. Unlike the prescription drug plan
for Medicare beneficiaries, the cost of the plan to government would not be an issue.
However, pharmaceutical companies have opposed manufacturer rebates, arguing that
lower revenues would lead to reduced revenues for research and development. Critics
suggest that the level of research could be maintained if pharmaceutical firms spent
less on advertising or accepted lower profits.
Finally, the 106th Congress passed a law allowing cheaper foreign drugs to be
imported from foreign countries. The Clinton Administration refused to implement
the law, arguing that the public could be exposed to additional risks, and that the cost
of implementing the legislation would outweigh its benefits. As the 107th Congress
considers these and other approaches, the debate will likely focus on how best to
achieve affordable prices, safe products, new and innovative medicines, access to
needed drugs, and an equitable distribution of the costs among the various parties
(government,. manufacturers, insurers, pharmacies, and consumers).