Report 2004-033 Summary - May 2005

Pharmaceuticals: State Departments That Purchase Prescription Drugs Can Further Refine Their Cost Savings Strategies


Our review of the State's procurement and reimbursement practices as they relate to the purchase of drugs for or by state departments revealed the following:


Chapter 938, Statutes of 2004, requires the Bureau of State Audits (bureau) to report on the State's procurement and reimbursement practices as they relate to the purchase of drugs for or by state departments. This report examines the purchasing strategies of the three primary departments that contract for prescription drugs— the Department of General Services (General Services), the Department of Health Services (Health Services), and the California Public Employees' Retirement System (CalPERS). These departments procured more than $5 billion in prescription drugs during fiscal year 2003-04. These costs would be higher without the savings they obtain through manufacturers' discounts, federal and state supplemental rebates, co-payments, and third-party payments. We compared these three departments' relative performance on cost savings for the following three types of prescription drug costs in fiscal year 2003-04: drug ingredient cost, the cost of the drug itself; net drug ingredient cost, the drug ingredient cost minus any rebates or additional discounts, if applicable; and state cost, the net drug ingredient cost plus dispensing fees and minus any co-payments or third-party payments, if applicable.

However, our analysis does not address the clinical management or formulary decisions made by the departments and entities they contract with to provide drug coverage nor does it reflect their decisions related to product mix such as encouraging the use of generic over brand name drugs or shifting from older to newer drugs. Therefore, the data that the bureau presents may not represent the best value for each drug. In addition, as described more fully in the Introduction, one CalPERS entity selected for review did not work cooperatively with the bureau to allow access to its proprietary and confidential drug pricing information and strategies. This entity represents roughly one third of CalPERS' membership, and thus, the exclusion of its data could materially skew CalPERS' results in this report. Further, under General Services' bulk drug purchasing program, agencies can purchase some of their drugs at the prime vendor's wholesale acquisition costs rather than the reimbursement prices Health Services' and CalPERS' entities pay to retail pharmacies. Also, unlike CalPERS and Health Services the pricing information used for General Services in this analysis does not include any of the state agencies' costs associated with dispensing the prescription drugs, nor any co-payments these agencies may collect.

In this comparison, General Services generally got the best prices for the drug ingredient cost because of its up-front discounts through contract negotiations with manufacturers of high-cost brand name drugs and through competitively bidding contracts for high-volume generic drugs. More important, putting rebates, dispensing fees, and co-payments into other cost calculations, we found that Health Services' prices are far lower than either of the other two departments for the net drug ingredient cost and state cost for 95 percent and 72 percent, respectively, of the drugs common to all three departments because it receives substantial federal Medicaid program (Medi-Cal) and state supplemental rebates.

In contrast, General Services' net drug ingredient cost and state cost are high compared with those Health Services obtains. Although rebates are the key to Health Services' lower net drug ingredient cost and state cost, General Services receives a rebate for only one prescription drug product class. General Services says it prefers to focus on obtaining the up-front discounts from drug manufacturers rather than seeking rebates, which require state departments to tie up funds needed for other drug purchases. General Services' net ingredient cost and state cost remained the same because under its bulk drug purchasing program agencies' costs of dispensing drugs and any co-payments they receive are not reflected in the prime vendor's invoice data. Still, General Services has the highest state cost of the three departments we studied.

CalPERS receives rebates, but only through entities it contracts with to provide pharmacy services to its members. In some instances CalPERS receives rebates under a pass-through method. In the pass-through method, the entity negotiates rebates and contracts with pharmaceutical manufacturers so that rebate payments between the manufacturer and the entity are based on historical and prospective pharmacy utilization data for all of the members of the health care plan that the entity administers. The entity then collects and passes through to plan sponsors, such as CalPERS, either a percentage or the entire amount of the rebates earned by the sponsors based on their member utilization. Typically, these entities prohibit CalPERS from having access to any information that would cause them to breach the terms of any contract with the pharmaceutical manufacturers to which they are a party. Because CalPERS does not have access to the entities' rebate contracts with the manufacturers, CalPERS cannot directly verify that it is receiving all of the rebates to which it is entitled. According to CalPERS, this rebate practice between the entity and the manufacturer is an industry practice and is not unique to it. CalPERS intends to continue to pursue greater disclosure requirements in future contracts with its contracting entities.

CalPERS achieves additional cost savings from co-payments members pay for their prescription drugs, deducting those co-payments from its costs when its contracting entities reimburse the participating pharmacies. Such co-payments could reduce Health Services' state cost, but most of the stakeholders of the governor's Medi-Cal Redesign efforts, which are aimed at containing Medi-Cal costs, largely dismissed deducting co-payments from its pharmacy reimbursement rate because they believed that many beneficiaries would not be able to afford them.

In contrast to the other two departments, General Services' cost savings strategies are more varied and have more potential for improving the bottom line. General Services has broad authority to explore strategies for reducing prescription drug costs for the departments participating in its program. For example, General Services is in the early stages of direct negotiations with manufacturers to achieve reduced drug costs. In a 2002 audit report, we recommended that General Services thoroughly analyze how it could improve its procurement strategies, working to place more individual prescription drugs under contract with manufacturers and considering the advantages of joining a larger, multistate pharmacy alliance or contracting directly with a group-purchasing organization. Although General Services has made some progress, it realizes it can do more to reduce the State's prescription drug costs and has hired a contractor to identify those opportunities. General Services is working with the contractor to award a new prime vendor contract, to award a pharmacy benefits manager contract to provide pharmaceuticals to those parolees who continue to receive mental health treatment as a condition of their parole, and to negotiate new and renegotiate existing contracts with certain manufacturers. General Services stated that, as resources become available, it intends to solicit bids to contract directly with a group-purchasing organization to determine if additional savings can be realized beyond the savings generated under its current contract with an alliance.

Chapter 938, Statutes of 2004, also requires the bureau, to the extent possible, to compare the State's cost to those of other appropriate entities such as the federal government and Canadian government, and private payers. We compared 57 prescription drugs, excluding any generics, across the Canadian, U.S., and California governments and found that Canada's governmental entities got the lowest prices about 58 percent of the time. Canada's Patented Medicine Prices Review Board (Review Board) partly accounts for these savings. Canada's Patent Act and the Review Board's regulations limit the prices of patented drugs in Canada. In the United States, federal laws ensure that drug manufacturers extend favorable prices to federal agencies and certain public sector purchasers of prescription drugs. These discounted prices account for the U. S. government getting the lowest prices for 32 percent of our comparison sample. California got the lowest prices for only 10 percent, or six of the 57 prescription drugs in our sample, because of Health Services' federal and state supplemental rebates.

California and other states have tried to reduce prescription drug costs by considering or implementing importation programs. In 2004, the California Legislature passed a bill allowing General Services to purchase prescription drugs from authorized Canadian pharmacies and sources. The governor vetoed that bill. The federal Food and Drug Administration (FDA) maintains that federal law would preempt any state law legalizing the importation of prescription drugs in contravention of the federal Food, Drug, and Cosmetic Act (Drug Act). Federal law strictly limits the importation of prescription drugs through the Drug Act, whose stringent requirements for approving, labeling, and dispensing drugs generally exclude any drugs made for foreign markets. The Drug Act also prohibits anyone other than the original domestic manufacturer from reimporting prescription drugs. In addition, state departments generally do not have access to federal procurement methods.


The Legislature should consider enacting legislation that would allow CalPERS to obtain relevant documentation to ensure that it is receiving all rebates to which it is entitled to lower the prescription drug cost of health benefits program established by the Public Employees' Medical and Hospital Care Act.

CalPERS should continue to explore various contract negotiation methods that would yield more rebates for the drugs it purchases and that would allow it to achieve greater disclosure requirements to verify that it is receiving all of the rebates to which it is entitled.

To ensure that state departments purchasing drugs through General Services' contracts are obtaining the lowest possible drug prices, General Services should:


General Services agrees with our recommendations and intends to take appropriate action to address them. Health Services agrees with most of our recommendations, but disagrees with two that were designed to address problems associated with the accuracy of its pharmacy reimbursement claim data. CalPERS asserts that the cost comparisons contained in our report do not yield reliable results because of differences in the methods the three departments use to procure drugs for state beneficiaries. Our comments follow Health Services' and CalPERS' responses.