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Pharmaceutical Discounts under Federal Law
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Pharmaceutical Discounts Under Federal Law: State Program Opportunities

Executive Summary:
Pharmaceutical Discounts Under Federal Law:
State Program Opportunities

William H. von Oehsen, III
Powell, Goldstein, Frazer & Murphy, LLP
Summary prepared by: Marice Ashe, JD, MPH and Kathryn Duke, JD, MPH

A complex patchwork of federal laws significantly affects opportunities for discount pricing by state pharmacy assistance programs. This paper is a primer for anyone evaluating or drafting state legislation to address the pressing needs of consumers, government and institutions for affordable drugs. In particular, this paper focuses on the risks and opportunities that federal regulation of drug prices creates for states interested in designing programs for financially vulnerable patients.

States must understand current federal drug pricing regulations, and the discounts they generate for government programs, in order to take full advantage of their unique right to obtain prices that are generally lower than prices available in the private sector. This paper offers guidance to states on several issues, including taking advantage of the Medicaid "best price" exemption, ensuring no duplication of discounts, and negotiating sub-ceiling prices.

Private Sector Pricing

Essentially three models describe the different distribution arrangements that connect prescription drug manufacturers with consumers and how drugs are priced along the way.

Cash Customers -- The first model involves cash customers who either lack prescription drug coverage and therefore pay out of their own pockets, or have indemnity-type insurance that reimburses them after they have made their cash purchases. Cash customers generally pay the highest prices for drugs because they lack the opportunity, let alone the bargaining power, to negotiate discounts from either the retail pharmacy or the manufacturer. They generally pay at or above a drug’s average wholesale price (AWP) which is the manufacturer’s list price.

Pharmacy Benefit Managers -- The second model shares the same distribution channel as the first model, but the pricing arrangements are altered because of the discounts negotiated by a PBM on behalf of consumers and their insurers. PBMs are private third parties that manage drug benefits for large groups of individuals, such as enrollees in an insurance plan or employees of a self-insured company. By negotiating both discounts from participating pharmacies and rebates from preferred manufacturers, PBM customers typically pay less than a drug’s average manufacturer price (AMP) ­ which is about 20 percent below AWP ­ and as low as 40 percent below AWP.

Institutional Purchasers -- The third distribution and pricing model involves institutional purchasers, such as hospitals and group or staff model HMOs, that own and operate their own pharmacies. Hospitals and HMOs generally receive favorable pricing from manufacturers because they do not have to buy through retail channels and can negotiate directly with manufacturers, either individually or as part of a group purchasing organization. Depending on their volume of pharmaceutical purchases and their ability to move market share in selected therapeutical classes of drugs, institutional purchasers can achieve discounts between 20 and 40 percent below AWP.

Federal Drug Discount Programs

In contrast to drug sales in the private sector, the prices paid by federal purchasers are subject to a complex array of regulations which generate deeper discounts. There are five federal discount programs of which states should be aware.

Medicaid Rebate Program -- Federal Medicaid law requires drug manufacturers to pay state Medicaid agencies a quarterly rebate on brand name drugs equal to 15.1 percent off of AMP or the manufacturer’s best price, whichever is lower, plus an additional rebate if the price of the drug has risen faster than the rate of inflation. The 15.1 percent discount off of AMP is the minimum Medicaid price. The Medicaid net price is the effective price paid after the minimum price is reduced further by either the best price or inflationary adjustment, or both. Because Medicaid is entitled to a manufacturer’s best price or better, the Medicaid net price will almost always be as good or better than the best prices negotiated in the private sector (whether by a PBM, HMO, GPO or other private purchaser.) Medicaid net price is approximately 40 percent below AWP.

340B Program -- Many federally-funded clinics, health departments and hospitals are eligible for below-market discounts under section 340B of the Public Health Service Act. This act provides these clinics and hospitals with the same price discounts as Medicaid. However, 340B providers usually pay less than the Medicaid net price because they are able to negotiate sub-ceiling prices. They also save by not paying the drug mark-ups and dispensing fees to retail pharmacies. Average 340B prices are about half of AWP.

Federal Supply Schedule -- The FSS is a schedule of contracts and prices for frequently-used supplies and services available for purchasing by federal agencies and other entities such as the U.S. territories and tribal governments. There are no statutory ceilings on prices, but the government often uses a "most favored customer" price as a starting point in negotiations to obtain below-market prices. FSS prices are on average slightly above 340B prices.

Federal Ceiling Price -- The Veterans Administration, Department of Defense, Public Health Service, and Coast Guard ("Big 4") often get pricing below FSS on brand name drugs because these drugs are subject to a maximum statutory price called the federal ceiling price (FCP). FCP is set at 24 percent below the non-federal AMP, often referred to as non-FAMP. FCP prices are on average slightly below 340B prices.

VA Contract -- Big 4 purchasers also are permitted to negotiate prices below the FCP. The VA has been especially successful in doing this through development and use of a national formulary. VA contract prices can be as low as 65 percent below AWP.

  Estimated Prices for Selected Public Purchasers,
as Percent of AWP

AWP  100% 
AMP    80%
Medicaid (Min.)    67.9%
Medicaid (Net)    60.5%
FSS    51.7%
340B    49.0%
FCP    34.6%

Opportunities for States

An understanding of federal drug discounting laws and their impact on the U.S. pharmaceutical market should enable states to obtain federal-like discounts for their own drug assistance programs, if properly designed. To get the best prices, states need to take the following three steps.

Step One: Stay Within the Best Price Exemption -- The Medicaid rebate program discourages brand name manufacturers from giving deep discounts to most customers because any discount below the minimum 15.1 percent will increase manufacturers’ rebate obligations to state Medicaid agencies under the best price formula. Recognizing the inflationary effect of this formula, Congress excluded from the formula prices paid by the five federal discount programs described above and state drug assistance programs. States therefore already possess under federal law an opportunity to buy at prices below the best prices available in the private sector. However, outsourcing or bulk purchasing with private entities could jeopardize this opportunity.

Step Two: Set Price Limits -- Most existing state drug assistance programs are getting discounts comparable to the Medicaid net price because they require manufacturers to pay rebates comparable to those required under the Medicaid rebate program. Numerous states are considering proposals that would give them access to lower prices ­ usually FSS, 340B or FCP ­ and at least one state, Maine, has enacted such legislation. Price limits can be set by contract negotiation or statutory mandate.

Step Three: Negotiate Sub-Ceiling Prices -- If a state successfully establishes price limits through legislation rather than contract negotiation, it has an opportunity to negotiate lower prices through use of a formulary. It could do this by negotiating supplemental rebates with preferred manufacturers whose drugs would be included on the formulary. The California Medi-Cal supplemental rebate program is a relevant model. Alternatively, a state could incentivize its seniors or uninsured to seek care and pharmacy services at a 340B clinic or hospital, since these providers have already demonstrated a growing ability to negotiate prices below 340B ceiling prices.

Analysis of State Drug Assistance Program Options

Eight possibilities are presented for states interested in designing drug assistance programs for low-income and indigent patients. Some of the options maximize the strategies mentioned above, others mix price discounting opportunities offered through federal statutes with other mechanisms to maximize savings, and still others may bring a state into conflict with federal law, so should be avoided if possible.

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