What is the AWP and Why is it Important?

The AWP, or average wholesale price, of prescription drugs was intended to represent the average price at which wholesalers sell drugs to physicians, pharmacies, and other customers. In practice, it is a figure reported by commercial publishers of drug pricing data, such as First DataBank and Thomson Medical Economics. According to the Red Book, published by Thomson Medical Economics, the pricing information is “based on data obtained from manufacturers, distributors, and other suppliers.”² This pricing information is then sold to government entities, private insurance companies, and other purchasers of prescription drugs.

The AWP has often been equated with a “sticker price” or “list price,” as those terms are used in the automobile industry. It has become an important prescription drug pricing benchmark for payers throughout the health care industry. Payments are typically based on AWP minus some percentage. Despite its name, however, the AWP is not an accurate reflection of actual market prices for drugs. As noted, it is a price derived from self-reported manufacturer data for both branded and generic drugs. There are no requirements or conventions that the AWP reflect the price of any actual sale of drugs by a manufacturer, or that it be updated at established intervals. It is not defined in law or regulation, and it fails to account for the deep discounts available to various payers, including certain federal agencies, providers, and large purchasers, such as HMOs. Consequently, the AWP has been the subject of great criticism and scrutiny.

The AWP has often been equated with a “sticker price” or “list price.”

According to the U.S. General Accounting Office (GAO), the AWP may be neither “average” nor “wholesale.”³ In addition, a recent investigation by the U.S. Department of Justice (DOJ) and the National Association of Medicaid Fraud Control Units (NAMFCU), which involved the collection of actual wholesale pricing information, indicated that some drug manufacturers report inflated average wholesale pricing information.⁴ Because the AWP is part of the reimbursement formula used in Medicare Part B and by many state Medicaid programs, any increase in the published AWP can increase the billions of dollars that federal and state governments pay for prescription drugs. Medicare beneficiaries, who are responsible for 20 percent coinsurance for the drugs covered under Part B, would also bear an increased financial burden.

Some manufacturers argue that they do not set the AWP for their drugs and are therefore not in a position to inflate these prices. They maintain that the commercial publishers of drug pricing data independently assess and report a drug’s AWP. Despite these claims, it is clear that the manufacturers must provide some level of pricing data to commercial publishers to enable them to publish AWP lists.

Medicare

As Congress struggles with proposals to develop an outpatient Medicare prescription drug benefit for seniors,⁵ significant attention has been paid to the high cost of prescription drugs and the mechanisms employed to determine the government reimbursement rate. Though Medicare does not have a comprehensive outpatient prescription drug benefit, Medicare Part B does cover approximately 450 drugs and biologicals.

The following categories of outpatient drugs are covered under Medicare Part B:

• Drugs that are not self-administered⁶ and that are furnished “incident to” a physician’s service, such as prostate cancer drugs.
• Certain self-administered oral cancer and antinausea drugs.
• Certain drugs used as part of durable medical equipment or infusion devices, such as inhalation drugs used with a nebulizer.
• Immunosuppressive drugs, which are used following organ transplants.
• Erythropoietin (EPO), which is the most costly drug for Medicare and is used primarily to treat anemia in patients with end-stage renal disease or cancer.
• Osteoporosis drugs furnished to certain beneficiaries by home health agencies.
• Vaccines for diseases such as influenza, pneumonia, and hepatitis.

These drugs are typically provided in the hospital outpatient setting, dialysis centers, or the doctor’s office, and are purchased directly by the physician or provider.⁷

In 1999, Medicare spent almost $4 billion on outpatient drugs,⁸ with 82 percent of that cost attributable to 35 drugs, primarily cancer, inhalation therapy, and oral immunosuppressive medications. It is clear, therefore, that even a slight inflation in the cost of these drugs can result in significantly higher aggregate spending by the government.

Drugs provided in a physician’s office accounted for over 75 percent of Medicare spending for outpatient drugs in 1999. Three specialties, hematology/oncology, medical oncology, and urology, which bill Medicare primarily for drugs used in the treatment of cancer, represented 80 percent of total Medicare payments to physicians for drugs.⁹ Physicians are also paid under the Medicare physician fee schedule for services associated with drug administration.

Reimbursement for Medicare Part B prescription drugs has undergone significant change over the years. Prior to use of the AWP as a pricing benchmark, Medicare Part B drugs were reimbursed on the basis of the physician’s acquisition cost. That system was eventually replaced with one based on 100 percent of the AWP, and then to the lower of the estimated acquisition cost (EAC) or 95 percent of the AWP. EAC is often determined by subtracting a percentage discount from a drug’s AWP. Finally, on January 1, 1998, as a result of the Balanced Budget Act of 1997 and in an effort to bring down costs, Medicare Part B began to reimburse covered brand-name drugs at 95 percent of the AWP. For multisource drugs—drugs with generic equivalents or brand-name drugs with at least one competing product—reimbursement is 95 percent of the lower of (a) the median AWP of all generic forms of the drug and (b) the lowest brand-name product’s AWP.¹⁰

A recent report indicated that the drug industry’s published wholesale prices, which serve as the basis for Medicare payments to providers, are significantly higher than the providers’ actual acquisition costs. Physicians are able to obtain Medicare-covered drugs at prices significantly below current Medicare payments. According to a September 2001 GAO report, the average discount from the AWP for most physician-administered drugs ranged from 13 percent to 34 percent; two oncology drugs, in particular—Dolasetron mesylate and Leucovorin—had discounts of 65 percent and 86 percent, respectively.¹¹ As a result of this disparity between the AWP and the providers’ actual cost, providers are able to benefit financially from these transactions. (See Figure 1 for an example of this pricing structure.) In certain instances, drug manufacturers may make even deeper discounts available to providers, in exchange for the providers’ willingness to prescribe their drugs over those of their competitors. The result is a wide range of unknown prices being paid for prescription drugs by providers, who are then reimbursed a fixed amount by Medicare, leading to widely varying profit margins for different doctors.

FIGURE 1

Medicare Payment vs. Provider Cost for Part B Outpatient Prescription Drugs: An Example. Source: Based on information from U.S. General Accounting Office, Medicare: Payments for Covered Outpatient Drugs Exceed Providers’ Cost, September 2001 (GAO-01-1118), (more...)

Providers argue that they need these additional profits to compensate for the lack of adequate payments for the administration of these drugs under the Medicare physician payment system, the RBRVS. Administration of Part B drugs often involves additional costs resulting from special storage, handling, and preparation requirements for these drugs. The president of the American Society of Clinical Oncology (ASCO), Larry Norton, M.D., stated in testimony that the Medicare reimbursement for chemotherapy services is insufficient to adequately cover the cost of furnishing such services. ASCO estimates that the Medicare reimbursement covers approximately 25 percent of the total costs of chemotherapy procedures.¹² The society supports a reduction in Medicare payment for drugs but not without a simultaneous increase in physician payments for related services.

Other nonphysician health care providers and suppliers who provide beneficiaries with covered drugs for infusion and inhalation therapies using durable medical equipment (DME) and with blood clotting factor for hemophilia also claim that the overpayment on the drugs allows them to provide critical administrative and support services to beneficiaries. Those services are otherwise not covered by Medicare.

In response to this issue of provider overpayment, the Health Care Financing Administration (HCFA, now the Centers for Medicare and Medicaid Services, or CMS), in the U.S. Department of Health and Human Services (DHHS) issued a memorandum in September 2000 that authorized the use of reduced prices that more accurately reflected provider acquisition costs for reimbursement of Medicare-covered drugs.¹³ The memo states: “These data are from wholesalers’ catalogs that list the prices at which the wholesaler sells the respective products. The DOJ has indicated that these are more accurate wholesale prices for these drugs.” After significant protest by oncology providers, however, HCFA notified Congress that it would not move forward with its effort to implement revised average wholesale pricing data.

Other Medicare suppliers also purchase drugs at prices that are significantly lower than the AWP. Pharmacy suppliers, who provide two types of drugs—drugs administered through DME and covered oral drugs— were the predominant billers for ten of the high-expenditure and high-volume drugs analyzed by GAO. Discounts for two of these drugs were 78 percent and 85 percent, according to GAO.¹⁴

Medicaid

The increasing cost of prescription drugs is playing a major role in the dismal outlook for state Medicaid budgets across the country. Prescription drugs constitute a rapidly growing component of total Medicaid spending. Although coverage of outpatient prescription drugs is an optional benefit, all Medicaid programs currently offer prescription drug coverage to their Medicaid enrollees.¹⁵ Medicaid drug expenditures grew at an average annual rate of 18.1 percent between 1997 and 2000, which is more than two times the 7.7 percent annual growth in total Medicaid spending. Drug spending accounted for nearly 20 percent of the increase in Medicaid spending for this period.¹⁶

Medicaid payments for outpatient prescription drugs include three components: acquisition costs, dispensing fees, and a rebate. The acquisition costs cover the ingredients, or the drug itself, while the dispensing fee covers the pharmacist’s costs of filling the prescription. The rebate is a mechanism for reducing the effective price of the drug below the traditional acquisition cost.

Medicaid Rebates

To fully understand Medicaid reimbursement for prescription drugs, it is important to understand the Medicaid Drug Rebate Program and the pricing mechanisms on which it is based. In response to concern about the increasing cost of prescription drugs for Medicaid beneficiaries, the Medicaid Drug Rebate Program was implemented as part of the Omnibus Budget Reconciliation Act of 1990. This program requires drug manufacturers to sign a rebate agreement with the federal government in order to receive payment for outpatient prescription drugs provided to Medicaid beneficiaries. In exchange, states must cover all Food and Drug Administration-approved prescription drug products manufactured by a company that has signed a drug rebate agreement.²⁸ This process imitates what occurs with large private purchasers, who negotiate discounts in exchange for the placement of particular drugs on their formularies.

The Medicaid rebate amounts are established by federal statute and differ for brand-name and generic drugs. They are determined as follows: For brand-name drugs, reimbursement requires (a) a rebate that is the greater of 15.1 percent of the average manufacturer’s price (AMP) or the difference between the AMP and the manufacturer’s “best price”²⁹ and (b) an additional rebate for any product whose price increased by more than the Consumer Price Index (CPI-U) since July 1, 1990 (see Figure 2 for an example of Medicaid drug reimbursement). AMP is the average price paid to manufacturers by wholesalers (after all discounts, including manufacturer rebates) for a particular dosage form and strength of a prescription drug distributed solely to the retail pharmacy class of trade. The AMP is not a published price. It is calculated by the manufacturer and submitted to CMS for purposes of calculating the Medicaid rebate. The government holds it confidentially, to protect the proprietary nature of the deals negotiated between manufacturers and their best customers. AMP is subject to government audits, making manufacturers accountable for its accuracy. As noted later in the “Reform Options” section, President Bush’s 2003 budget contains a proposal that would replace the AMP with the AWP in the Medicaid rebate calculation. The “best price” was intended to represent the lowest price offered to any other customer, excluding Federal Supply Schedule (FSS) prices, prices to state pharmaceutical assistance programs, and prices for certain other purchasers. In an industry with a proliferation of complex relationships and financing arrangements, however, many question whether the “best price” truly captures the myriad discounts and rebates that exist.

FIGURE 2

Medicaid Drug Reimbursement Example. Assumptions: ■A state Medicaid reimbursement formula of AWP minus 10%.■No state “usual or customary” standard for drug reimbursement.■A dispensing fee of $3.00.■The difference (more...)

The combined effect of the minimum rebate and the best-price provision guarantees a larger rebate to the government for those drugs for which the best customers are receiving a particularly favorable price. However, it does not actually provide Medicaid with the same low price the best private customers pay. Medicaid’s net price after the rebate is higher because its payment to the phar macy, which is based on the “AWP minus x” formula, is higher than the AMP. A “best price” rebate based on the difference between the best price and the AMP leaves a higher net price. For generic drugs, reimbursement requires a rebate of 11 percent of each product’s AMP.³⁰

Other Public and Quasi-Public Programs

Private Payers

Private payers, especially large-volume purchasers, are able to negotiate deep discounts with drug manufacturers. Many private payers, including employers and managed care organizations, often contract with pharmacy benefit managers (PBMs) to manage prescription drug benefits for their enrollees. PBMs serve as intermediaries between these third-party payers and drug manufacturers, retail pharmacies, pharmacists, and wholesalers.³³ PBMs base their pharmacy reimbursements on the AWP for brand-name drugs. While they do not actually purchase drugs, except in the case of mail-order business, PBMs are able to negotiate discounts with retail pharmacies and provide incentives for pharmacists’ use of less costly generics and on-formulary drugs. They also negotiate with wholesalers for mail-order services and drug manufacturers, who are eager to ensure that their products are included in drug formularies and to encourage the use of their drugs over their competitors’ drugs.³⁴ The main streams of revenue for PBMs are manufacturer rebates and the difference between their drug acquisition costs and sales costs for mail-order prescription drugs. PBMs contract with drug manufacturers for rebates that range between 2 percent and 20 percent of a drug’s AWP.³⁵

Private payers are able to negotiate deep discounts with drug manufacturers.

Litigation

In addition to significant attention by federal government agencies, drug company pricing practices have also come under attack within the court system. The issue of AWP manipulation can be found in several noteworthy legal actions. These cases will undoubtedly have an impact on future discussions of this issue.

• Bayer Corporation, in September 2000, agreed to pay $14 million to the United States and 47 states to settle allegations under the federal False Claims Act. The allegations contend that beginning in the early 1990s, Bayer falsely inflated its AWPs, causing physicians, pharmacists, and home health companies to submit fraudulently inflated reimbursement claims to the state Medicaid programs.
• TAP Pharmaceutical Products, Inc., agreed in October 2001 to pay $875 million to resolve criminal and civil liabilities in connection with its alleged fraudulent drug pricing and marketing conduct with regard to Lupron, a prostate cancer drug. In its case against TAP, the U.S. Government alleged that TAP set its AWP of Lupron far higher than the price for which wholesalers or distributors actually sold the drug, resulting in falsely inflated prices. As part of its settlement agreement, TAP also agreed to report to the OIG, on a quarterly basis, its average sales price (ASP) for all of its products reimbursed by the government.
• The Nevada attorney general filed suit against 12 drug companies, alleging that the companies engaged in deceptive trade practices by manipulating or misstating their drugs’ AWPs, leading states, consumers, and others to significantly overpay for drugs.
• The Montana attorney general filed suit against 18 drug companies on February 25, 2002, alleging that they illegally misstated the average wholesale prices of their medications. The attorney general alleges that the drug companies engaged in Medicaid fraud, caused false claims to be made to the state, and participated in deceptive trade practices by manipulating or misstating the average wholesale price of drugs, causing the state, consumers, and others to grossly overpay for prescription drugs.
• A coalition of consumer groups filed suit in December 2001 against 28 drug companies for manipulating the AWP of drugs covered by Medicare. The lawsuit charges that, since 1993, the companies have engaged in “a pattern and practice” of selling drugs to physicians at prices well below the reimbursement cost charged to Medicare, resulting in violations of consumer laws and racketeering statutes. The plaintiffs estimate that Medicare and individual consumers using the drugs were over-charged more than $800 million in 2000 alone.

Prescription Drug Pricing Reform

Experts caution that any attempt to change the current reimbursement system for prescription drugs and, in particular, reliance on the AWP as a pricing benchmark, must be done with careful consideration of the many policy implications. The AWP is utilized across many different settings, and changes in the use of this benchmark are likely to produce varying results in each setting. Policymakers and legislators are considering several questions as they contemplate AWP reform. These include the following:

• How will each stakeholder—purchaser, pharmacy, provider, PBM, drug manufacturer, wholesaler, and patient—benefit or be negatively affected by this change?
• What types of incentives would be created if a new prescription drug pricing benchmark were to be used?
• What is the potential for manipulation of any proposed benchmark?
• Will the proposed system rely on data that can be audited? Who will be responsible for such audits? Are there sufficient resources?
• How, and how often, will these data be updated?
• How can accountability be assured without requiring drug manufacturers to divulge proprietary pricing information?
• What are the implications of making the AMP public?
• To whom will any potential discounts flow?
• How can government and consumer savings be assured?
• What will be the impact on other related payment systems, for example, RBRVS and diagnosis-related group, or DRG? Should the reform of these systems also be contemplated?
• What administrative costs and burdens will be associated with an alternative pricing mechanism?

Changes in the use of the AWP are likely to produce varying results in each setting.

Conclusion

The AWP, a pricing mechanism that by most accounts is seriously flawed and not widely understood, plays a pivotal role in the overall prescription drug pricing and reimbursement systems. It has become a critical benchmark for key stakeholders, despite its inability to accurately reflect the “true cost” of drugs. Yet, as we have seen, the true cost of a given drug depends on the various discounts, rebates, and reimbursement formulas available to a particular purchaser—both public and private. Other alternatives to the AWP may suffer from similar flaws, namely, being subject to manipulation and not closely aligned with real market transaction prices. The creation of an appropriate payment mechanism for prescription drugs, therefore, will need to involve a careful balance between protecting the proprietary nature of drug pricing information and ensuring the accuracy of, and accountability for, the information on which such a payment mechanism is based.

The AWP has become a critical benchmark for key stakeholders, despite its inability to accurately reflect the true cost of drugs.