Bargaining for Drugs

Can federal agencies follow a formula for lower-priced medicines?

Lawmakers this winter launched into debate over prescription drug pricing in Medicare's Part D benefit, one of the Democrats' priorities in their 100 hours agenda. Advocates for seniors would like to see the Health and Human Services Department's Centers for Medicare and Medicaid Services empowered to negotiate directly with drug companies and secure deals using the Medicare Program's considerable market heft.

"Basic economics tells me that, if I'm negotiating a price with a manufacturer and I have a larger market share, then I can negotiate," Sen. Ben Cardin, D-Md., argued at a January budget hearing. "Rather than having 40 companies negotiating nationwide for the private companies . . . if we had one [negotiator], that in and of itself would generate a more favorable opportunity for the taxpayer."

As a model for how such negotiation could work, many point to the Veterans Affairs Department, which gets some of the lowest drug prices on the market. For VA, those stellar savings come primarily from two sources: a three-tier formulary system that provides program officials with a powerful bargaining chip, and legislation that governs the prices drug companies offer vets.

VA's formulary, used by the department's nationwide network of doctors, categorizes drugs into three groups: The small "closed" group consists of medications for which only the specified drug may be used, while a larger list of "preferred" medications offers a nonbinding suggestion to doctors and the "open" list can be ordered from at will.

VA also relies on statutory language and negotiated agreements that deliver low prices. Drug makers are required to give VA an immediate discount of 24 percent below their average wholesale price. The Federal Supply Schedules sometimes knock prices below those rates, and VA can negotiate even lower prices with blanket purchase agreements and committed-use contracts, in which companies will establish a fixed price for certain products if the agency commits to using them to treat patients.

Overall, the system works. Families USA, a group in Washington that advocates giving Medicare greater bargaining power, found that among the top 20 drugs prescribed to seniors, the lowest price charged to Medicare was significantly higher than the lowest VA price, with a median difference of 58 percent. For example, VA was able to obtain Zocor, a popular lipid-lowering drug, for $127.44 for a year's treatment, more than $1,300 less than Medicare's best price of $1,485.96.

It's not hard to understand why groups are keen to reverse the law that prevents CMS from negotiating drug prices. But the nonpartisan Congressional Budget Office, among others, has said merely letting officials negotiate is unlikely to have an impact on prices.

"Price negotiation by itself is unlikely to produce any significant cost savings, because you don't have either of the tools that the Veterans Administration and some other government programs use to get price reductions," CBO Director Peter Orszag told lawmakers in January. "If you were to apply those kinds of tools in the Medicare program, there would be other consequences that would need to be weighed very carefully," he added.

One concern is if Medicare won the right to buy at VA prices, drug companies would raise prices for everyone to make up the difference. In 2005, VA accounted for about 2 percent of drug purchases. With the Medicare Part D benefit in place, the new program now accounts for about a quarter of overall drug purchases, according to Orszag. Experts from CBO and the Government Accountability Office warn that extending VA pricing to the much larger Part D pool would affect the drug companies' bottom lines, and there's no reason to think they would not adjust prices to absorb the impact.

Another argument against extending the VA model is that introducing a national formulary to the Part D program would restrict seniors' choices. "To get prices even lower in Part D, the government would have to take new steps to walk away and restrict access to drugs," argues a fact sheet published by a collection of think tanks, including the Heritage Foundation and the American Enterprise Institute. "That would mean seniors would have fewer of the medicines they need."

But advocates including Gail Shearer, director of health policy analysis for Consumers Union, say that argument is misleading because the private providers that seniors sign up with for Part D benefits generally use their own formularies. "The question is whether it's based on medical evidence of effectiveness," like the VA formulary, or other factors like price negotiations, she says. "What baffles me is why we need to have thousands of different formularies" from the individual plans, rather than rely on a central, medically based list, she says. Heritage, AEI and others in the group opposed to price negotiation authority argue that the basic structures of the VA and Medicare drug programs are different, with VA separately funding pharmacy and administrative costs through its budget, while they are incorporated directly into drug prices for Part D.

In fact, the entire VA medical model is different from that used by Medicare, relying on department-run services ranging from hospitals to drug purchasing and distribution through veteran-only channels. Medicare's Part D, in contrast, is highly decentralized, with some states offering dozens of different private plans. To craft a solution that would graft VA's preferential pricing to Medicare's diverse, commercially based prescription program could tax the creativity and political will of a polarized Congress.

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