Order Code RS20295
August 9, 1999
CRS Report for Congress
Received through the CRS Web
Outpatient Prescription Drugs: Acquisition and
Reimbursement Policies Under Selected Federal
Heidi G. Yacker
Information Research Specialist
Information Research Division
Varying reimbursement methods determine the payments for outpatient drugs
supplied under different federal programs. The Veterans Health Care Act of 1992 limits
the prices that drug manufacturers can charge the Department of Veterans Affairs (VA);
several other government agencies, including the Department of Defense (DOD), are able
to purchase pharmacy supplies through the VA supply system. The Medicaid program
reimburses providers directly for covered pharmaceuticals, establishing upper payment
limits on approved drugs and receiving rebates from manufacturers. The Medicare
program provides limited coverage for outpatient drugs. For those drugs it covers,
Medicare reimburses providers at the rate of 95% of the average wholesale price. This
report discusses the reimbursement methods used to pay for outpatient prescription
drugs by the VA, DOD, Medicaid, and Medicare. It will be updated as necessary.
The federal government provides coverage for outpatient prescription drugs under
several programs. The largest programs are administered by the Department of Veterans
Affairs; the Department of Defense; Medicaid, the joint federal-state entitlement program
that pays for medical services on behalf of certain groups of low-income persons; and
Medicare, the nation’s health insurance program for the elderly and certain disabled
individuals. The Medicare program provides only limited outpatient drug coverage.
Department of Veterans Affairs (VA)
The VA maintains a system of medical facilities from which all pharmaceutical
supplies, including prescription drugs, are dispensed to beneficiaries. It also supports a
mail service prescription program as part of the outpatient drug benefit. The system serves
Congressional Research Service ˜ The Library of Congress
approximately 3.65 million veterans. According to VA analysts, spending for
pharmaceuticals will be approximately $1.8 billion in FY1999.
The Veterans Health Care Act of 1992 (VHCA, P.L. 102-585) established the
Federal Ceiling Price Program, limiting the price manufacturers could charge for drugs
purchased for the VA, the Department of Defense, the Public Health Service (including
the Indian Health Service), and the Coast Guard. In order to receive reimbursement under
the Medicaid program (as well as from the agencies listed above), manufacturers are
required to provide covered drugs to the four protected agencies at a discount of at least
24% below the non-Federal Average Manufacturers Price (non-FAMP), minus any cash
discounts, rebates, or similar reductions. The non-FAMP is calculated using the weighted
average price paid by non-federal wholesalers over the previous 12 months. Thus, the
Federal Ceiling Price (FCP) is calculated using the following formula:
(0.76 x non-FAMP) - additional discount = FCP
The FCP is the highest price that can be charged to the protected agencies for covered
drugs, which are defined as all products that a drug company holds or markets under an
original New Drug Application (NDA) as approved by the Food and Drug Administration,
including certain single source and innovator multiple source drugs,1 biological products,
and insulin. This provision does not apply to generic drugs.
VHCA also required that, in order to be reimbursed under Medicaid, manufacturers
of brand name drugs must make all their covered pharmaceutical products available on the
Federal Supply Schedule (FSS), a listing of goods available for sale mainly to the federal
government. All federal agencies (and a few other entities) may purchase pharmaceuticals
from the FSS. In FY1996, the VA purchased $922 million in pharmaceuticals from the
FSS.2 The VA’s National Acquisition Center (NAC) is the sole negotiator for the
government with drug manufacturers in establishing the prices for the approximately
23,000 drugs listed on the FSS. The prices must be equal to or better than the best price
charged to the manufacturer’s most favorable comparable customer. Because the VA’s
NAC is not bound in its negotiations with manufacturers to the FCP limits, the Federal
Ceiling Price and Federal Supply Schedule prices are not necessarily the same. In fact,
many prices are more than 50% below the non-FAMP.3 However, if the FSS price is
higher than the FCP, the four protected agencies are not required to pay more than the
Although most purchases are done through the FSS, the VA also negotiates contracts
independent of the FFS. Through Blanket Purchase Agreements (established under FSS
contracts) and other national contracts with manufacturers, the VA guarantees a volume
A multiple source drug is defined as one marketed or sold by two or more manufacturers or
labelers; it can also be a drug marketed or sold by the same manufacturer or labeler under two or
more different proprietary names, or both under a proprietary name and without such a name.
U.S. General Accounting Office. Effects of Opening the Pharmaceutical Schedule Are
Uncertain. GAO/T-HEHS-95-171, July 10, 1997. p. 1.
Ibid, p. 4.
purchase (either for their beneficiaries exclusively or for beneficiaries in additional federal
programs) in exchange for discounts below the FSS prices.
In addition to these contracts for goods, the VA also awards a contract for
distribution under the Pharmaceutical Prime Vendor Distribution Program. Under the
current award, with very few exceptions, all drugs are distributed by one company. This
contract included a negative 2.25% service fee for drugs distributed through facilities, and
a negative 2.9% for VA’s Consolidated Mail Outpatient Pharmacies.
Department of Defense (DOD)
DOD provides drugs to approximately eight million active duty personnel, retirees,
and their families through three points of service: military treatment facility (MTF)
outpatient pharmacies, TRICARE managed care contractor retail pharmacies, and the
National Mail Order Pharmacy Program (NMOP). The pharmacy benefit is generally not
available to Medicare-eligible retirees. As described above, DOD is covered by the
Federal Ceiling Price Program established by VHCA.
Although some purchases of pharmaceuticals are made through the FSS, DOD
negotiates independent contracts for the majority of their purchases. The pharmaceutical
group of the Defense Supply Center in Philadelphia (DSCP) is the single entity which
negotiates DOD’s distribution and pricing agreements (DAPAs) with over 200 drug
manufacturers. Their starting point for negotiations is the 24% discount on the nonFAMP which is required under VHCA. DOD estimates that DAPA negotiated prices for
drugs are approximately 24% to 70% below the average wholesale price (AWP).5 DSCP
contracts directly with a wholesale prime vendor to store drugs and deliver requested
pharmaceuticals directly to MTFs. In FY1997, MTF pharmacies dispensed approximately
55 million prescriptions at a cost of approximately $1 billion.6
The National Mail Order Pharmacy Program (NMOP) delivers up to 90-day supplies
of drugs directly to beneficiaries at their homes for patients with long-term or chronic
conditions. The DAPA prices, once only available to MTFs, are now used when
purchasing drugs for the mail-order program.
Under TRICARE programs, insurers under contract with DOD provide prescription
drug coverage to enrolled beneficiaries. In FY1997, the NMOP and TRICARE contractor
retail pharmacy programs spent approximately $245 million for prescription drugs.7
Under Medicaid federal requirements, outpatient prescription drug coverage is an
optional service. However, all 50 states and the District of Columbia provide some level
The average wholesale price (AWP) is the price reported by the Red Book or other national
U.S. General Accounting Office. Fully Integrated Pharmacy System Would Improve Service and
Cost-Effectiveness. GAO/HEHS-98-176, June 1998. p.3.
of coverage. Unlike the VA and DOD, the federal Medicaid program does not directly
negotiate contracts to purchase drugs from manufacturers. Instead, in most cases, the
federal government establishes price limits that are used by states for drug reimbursement.
Manufacturers provide rebates to states based on their Medicaid sales in that state during
specified time periods. According to the Health Care Financing Administration (HCFA),
in FY1996, Medicaid served approximately 36.1 million beneficiaries and paid $10.7
billion in prescription drug benefits.
Payment for multiple source outpatient drugs is made subject to upper limits
established by HCFA, plus a reasonable dispensing fee established by the state. Upper
payment limits will be established only if (1) all formulations of the drug approved by the
Food and Drug Administration (FDA) are evaluated as therapeutically equivalent, and (2)
the drug is listed by at least three suppliers in current cost compendia of those drugs
available for sale nationally. The upper payment level for these drugs is 150% of the
published price (as listed in any of the published drug pricing compendia) for the least
costly therapeutic equivalent, plus a reasonable dispensing fee.
Guidelines also exist for “other drugs.” These are brand name drugs certified by a
physician as medically necessary for a particular recipient, or a drug other than a multiple
source drug for which a limit has been established. In these cases, Medicaid applies a
payment level which is the lower of:
(1) the estimated acquisition cost plus a reasonable dispensing fee, or
(2) the provider’s usual and customary charges to the general public.
Within federal limits, states can design their own prescription drug programs and attempt
to limit their expenditures.
In addition to these price limits, states receive rebates from drug manufacturers under
the Medicaid Drug Rebate Program established by the Omnibus Budget Reconciliation Act
of 1990 (P.L. 101-508). Under this program, in order to be eligible for federal Medicaid
matching funds, pharmaceutical manufacturers must enter into national rebate agreements
(as opposed to the pricing agreements established by the VA and DoD) with the Secretary
of Health and Human Services on behalf of the states (although the Secretary can
authorize states to enter into contracts directly with manufacturers). The formula for
calculating the multiple source drug rebate is:
the total number of units of each dosage form and strength paid for under the
state plan in the rebate period, multiplied by
the greater of:
(1) the difference between the average manufacturer price (AMP)8 and
the best price9 or
(2) 15.1% of the AMP.
An additional rebate is given by the manufacturer for any price increase which is higher
than the increase in the consumer price index (CPI).
Rebates for “other drugs” are determined by multiplying the total number of units of
each dosage form and strength paid for under the state plan in the rebate period by 11%
of the AMP.
Rebates are not required for Medicaid managed care plans.
Drugs are reimbursed in the following manner. Beneficiaries submit prescriptions to
their pharmacy. The pharmacy submits a claim for reimbursement to the state Medicaid
program. The claim indicates the manufacturer of the drug and the dosage dispensed. The
state Medicaid office reimburses the pharmacist using the payment levels described above.
Data accumulated by the state Medicaid office is submitted quarterly to each participating
manufacturer holding a rebate agreement with Medicaid. The data include the total number
of dosage units of each of the manufacturer’s drugs that has been dispensed to Medicaid
beneficiaries in that state during the quarter. This information is used to calculate the
rebate (using the formula described above), which the manufacturer remits to the state.
The Medicare program generally does not provide coverage for outpatient
prescription drugs. For those that it does cover (see below), payments are made under
Part B of the program. Like Medicaid, Medicare does not contract with manufacturers
to acquire prescription drugs for its beneficiaries. Rather, it reimburses the providers of
these drugs. According to HCFA, in FY1997, Medicare, which covered approximately
38 million beneficiaries, paid $2.75 billion for outpatient prescription drugs.
Medicare makes payments directly to physicians for drugs which cannot be selfadministered and are “incident to” a physician’s professional service. Coverage is
generally limited to those drugs which are administered by injection.
The average manufacturer price is the average price paid to a manufacturer by retail pharmacies,
or by wholesalers, for drugs distributed to the retail pharmacy class of trade.
The best price is defined as the lowest price available from a manufacturer during the rebate
period to any wholesaler, retailer, provider, HMO, nonprofit entity, or government entity (excluding
prices charged under VHCA, prices charged under the Federal Supply Schedules, prices used under
state pharmaceutical assistance programs, and depot prices or single award prices of federal
Despite the general limitation on coverage for outpatient drugs, the law specifically
authorizes coverage for certain classes of drugs: those used in conjunction with home
infusion or inhalation equipment, those used for the treatment of anemia in dialysis
patients, immunosuppressive drugs for patients who have received organ transplants under
Medicare, certain oral cancer and associated anti-nausea drugs, and certain immunizations.
For these drugs, Medicare pays the physician or supplier (e.g., pharmacist) directly.
Drugs are identified using codes from HCFA’s Common Procedure Coding System
(HCPCS) that define the type of drug and a standard dosage amount where applicable.
However, unlike the NDCs used under the federal ceiling price program, HCPCS do not
identify specific drugs.
Medicare enters into contracts with local carriers and the four regional durable
medical equipment carriers (DMERCs) to establish Medicare allowed amounts for covered
drugs. There are no national limits set. The Balanced Budget Act of 1997 provided that
the maximum allowable payment for outpatient prescription drugs is 95% of the average
wholesale price (AWP). Carriers determine the AWP using such sources as the Red Book
or other publications or databases used by the pharmaceutical industry. Prior to 1999, if
a drug had both brand and generic sources available, reimbursement was based on 95%
of the median AWP for generic sources. In some cases, however, a brand name product’s
AWP is lower than the median generic price. Therefore, in 1999, Medicare began
calculating the AWP for multiple source drugs at the lower of the median generic AWP,
or the lowest brand-name AWP.10
U.S. Department of Health and Human Services. Office of the Inspector General. Comparing
Drug Reimbursement: Medicare and the Department of Veterans Affairs. November 1998. p.