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Recent U.S. free trade agreements have included language regulating the way in which member countries manage their pharmaceutical drug coverage and reimbursement programs.  The U.S.-Australia agreement was the first to such provisions, followed by the U.S.-Korea agreement which expanded upon the language included in the Australia agreement.  Currently U.S. Trade Representatives are negotiating the Trans Pacific Partnership (TPP) agreement, which is likely to include language very similar to that in the Korea agreement.

The restrictions contained in the Korea agreement apply to health care programs operated at the “central level of government,” defined as “entities that are part of or have been established by a Party’s central level of government to operate or administer its health care programs.”[1] Applicable health care programs are “programs in which the health care authorities of a Party’s central level of government make the decisions regarding” coverage and reimbursement of pharmaceuticals.

The agreement requires that when an applicable health care program has procedures for “listing” or “setting the amount of reimbursement” for pharmaceuticals or medical devices, the reimbursement be based on “competitive market-derived prices.”[2] If, however, the reimbursement amount is not market-derived, then a member country must calculate the reimbursement in a way that will “appropriately recognize the value of the patented pharmaceutical product,” and must permit manufacturers to apply for increased reimbursement based on clinical data and provide an opportunity for manufacturers to appeal the reimbursement decisions.

Yet these agreements are not one-sided—programs operated by all of the signing parties’ governments must comply with the provisions.  Unfortunately, in the U.S. three very important health care programs do not—Medicaid, 340B and Medicare Part B—because the reimbursement amounts are not “competitive market-derived,” nor do they “appropriately value” patented drugs.[3]

Medicaid Penalizes Branded Drug Manufacturers for Price Increases

Under the Medicaid program, the government does not directly purchase drugs.  Instead, the program reimburses pharmacies for prescriptions dispensed to Medicaid beneficiaries, and in turn bills the drug company for the “discount” amount for each drug dispensed.  That discount (paid as a rebate to states) is calculated using a federally mandated formula.[4] The rebate amount is a percentage of the drug’s “average manufacturer price” (AMP, which is also calculated using a federally mandated formula) as calculated each calendar quarter.  For branded drugs, the rebate percentage is 23.1% of AMP, and for generic drugs it is 13% of AMP.  In addition, if the commercial market price of a branded drug increases by more than inflation for a given period, the manufacturer must pay Medicaid the difference between the new price and the price “allowed” when adjusted for inflation.  This inflation penalty begins accruing when the drug is first launched, so by the time a generic version is introduced, that inflation penalty can be quite large.

This practice fails to “appropriately recognize the value of patented” drugs, not only by requiring deeper discounts for branded medications, but also by imposing a penalty if the commercial market price of a branded drug increases by more than allowed by the Medicaid program.  This penalty limits a drug manufacturer’s discretion in determining a competitive market price because an increase in the commercial market price could greatly increase its liability to the Medicaid program.

In addition, because the formula for calculating the rebate amount is federally mandated, manufacturers do not have the opportunity to apply for an increased reimbursement amount (in the form of a lower rebate amount).  The sole way a manufacturer can control the Medicaid reimbursement amount is through its commercial market price.

The 340B Prescription Drug Program Uses the Same Price Controls as Medicaid

Unlike Medicaid, the federal government does not directly reimburse for drugs under the 340B program.  However, 340B still falls under the parameters of the Korea FTA because direct reimbursement is not required by the agreement—only that decisions regarding drug coverage and reimbursement under the program are made at the central level of government.

To have their products covered by entities participating in the 340B program, drug manufacturers are required to enter into a contract with the Secretary of HHS, agreeing to offer the required discount to qualifying entities.  The discount amount for each covered drug is calculated using the formula defined in the statute, the components of which are derived from the federal Medicaid discount calculation.[5] The required discounts are provided to covered entities when they purchase the drugs from pharmaceutical wholesalers.  The wholesaler is then reimbursed for the discount in the form of a rebate from the drug manufacturer.

Like Medicaid, the reimbursement amount for 340B program does not recognize the value of patented drugs.  Because the discount calculation is the same as that for Medicaid, the 340B program presents the same commercial market pricing challenges as Medicaid.  Also like Medicaid, there are no direct opportunities to increase reimbursement amounts for particular drugs under the 340B program.[6]

Medicare Part B Drug Pricing Does Not Accurately Reflect Market Price

Medicare Part B covers physicians’ services, outpatient care, and home health services, and covers a limited number of outpatient drugs.[7] Most drugs administered in the hospital or in the doctor’s office are generally paid for in a bundle with the payment for the services provided, however Part B separately covers certain medications, such as pneumonia, hepatitis B and flu vaccines, immune globulin and nutrition IVs and oral anti-cancer and anti-emetic drugs.

Medicare uses the Healthcare Common Procedure Coding System (HCPCS) to reimburse for products, supplies and services used in treating a patient.[8] For pharmaceuticals, the appropriate HCPCS code describes the drug by the ingredients and unit size, but does not identify a specific manufacturer.  As such, brand name drugs without generic alternatives typically have their own HCPCS codes, and drugs with multiple generic alternatives share HCPCS codes.  CMS generally reimburses providers for prescription drugs at a rate of 106% of Average Selling Price (ASP).  Drug manufacturers calculate quarterly ASP for each of its individual drugs.  This calculation includes all of the manufacturer’s commercial market sales of that product during the applicable quarter.[9]

However, as discussed above, Medicare does not reimburse providers at the NDC level–it uses HCPCS codes.  In the case of a HCPCS code which encompasses drugs from multiple manufacturers or multiple NDCs, CMS uses a weighted ASP calculation which includes the ASP for all NDCs within the HCPCS, averaged based on utilization of each NDC.

While this reimbursement calculation method may reflect the competitive market-derived price for brand and generic drugs more accurately than Medicaid and 340B, the pricing lags behind by two quarters.[10] This lag can lead to reimbursement amounts which do not reflect the current market price for a particular drug.  Specifically, when a lower-priced generic alternative is introduced into the market, its price will not be factored into the reimbursement calculation until six months later.  As a result, during those six months, providers are purchasing the drugs at a lower cost, but are being reimbursed by Medicare at a higher level.

Further, while the existing ASP calculation may “recognize the value of the patented” drugs, the calculation does not meet the two other alternatives to market-derived reimbursement requirements:  allowing manufacturers to apply for increased reimbursement and to appeal reimbursement decisions.   The Part B program offers an appeals process for providers and patients, but not drug manufacturers.  A manufacturer is responsible for calculating its own ASP, but if CMS finds that a manufacturer has provided “false” information in reporting its APS calculations, the company can be fined up to $100,000.[11]

Continuing Inclusion of Pharmaceutical Chapters Jeopardize U.S. Health Care Programs

Each of the programs discussed in this paper are very important in serving the health care needs of America’s low-income and elderly population.  With budget constraints already challenging the viability of the programs, any modification to the existing intricate price controls could have tremendous impact throughout the programs.  In addition, if Congress continues on its path to require that Medicare Part D drug prices be negotiated by the federal government, that program too would fall under the regulation of the Australia, Korea and TPP free trade agreements, potentially negating some of the savings to result from that transition.

[1] U.S. – Korea Free Trade Agreement, Chapter Five, available at

[2] Id. at Article 5.2(b).

[3] Footnote 3 of the Korea free trade agreement does exempt Medicaid.  However, if the TPP agreement does not contain a similar carve-out, Medicaid would be required to comply with the provisions of that agreement

[4] See 42 U.S.C. § 1396r-8 (2011).

[5] See Id. at § 1396r-8(c).

[6] This paper does not address the Prime Vendor program because that process is a means for manufacturers to offer additional discounts—or lower the reimbursement amount—not increase it.

[7] The Medicare Part D program provides outpatient prescription drug coverage for beneficiaries and is generally managed by individual health plans, operating within parameters set by CMS.

[8] See CMS HCPCS Coding Questions

[9] 42 U.S.C. § 1395w-3a(c).  Also exempt are sales which are “nominal” in amount, as defined in the Medicaid statute.

[10] See U.S. Dept. of Health and Human Servs., Office of Inspector General, Medicare Payments for Newly Available Generic Drugs, i (2011).

[11] Supra note 4 at (b)(3)(C).