The CMS Final Covered Outpatient Drug Rule Addresses Many Industry Concerns

February 01, 2016

The rule implementing the Medicaid Drug Rebate Program is less burdensome and costly than what was originally proposed.

In 2010, the Affordable Care Act (ACA) directed the US Centers for Medicare and Medicaid Services (CMS) to publish a rule for calculating Average Manufacturer Price (AMP), which is used to determine both the Medicaid rebate amount and the payment rate for multiple-source drugs. CMS interpreted the ACA mandate as authorizing CMS to address all aspects of the Medicaid Drug Rebate Program (MDRP) treatment of covered outpatient drugs, and on January 21, 2016, nearly four years after publishing its proposed rule, CMS finalized the rule, which will take effect April 1, 2016.[1] The Final Rule implements changes to AMP that the ACA required, replaces the calculation methodology for AMP in the withdrawn Deficit Reduction Act (DRA) rule,[2] and provides additional rules for determining Best Price (BP) reported for innovator drugs and biological products.

The provisions that have the most effect on manufacturers, in terms of rebate liability or operational challenges, are

  • permission for manufacturers to continue presuming that drugs sold to wholesalers are distributed to retail community pharmacies (RCPs) unless chargeback data indicate indirect sales to a different class of trade;
  • the method for calculating AMP for infusion, inhalation, instilled, implanted, and injected drugs generally dispensed through RCPs (5i AMP);
  • inclusion of federal territories in the definition of “United States”;
  • treatment of specialty pharmacies;
  • treatment of generic drugs marketed under a paper New Drug Approval (NDA) or section 505(b)(2);
  • exclusion of prices charged 340B entities from BP;
  • BP treatment of discounts, rebates, and fees provided to multiple parties on the same unit;
  • implementation of the alternative additional rebate for line extensions; and
  • revision of Base Date AMP.

The “Presumed Inclusion” Method for Determining Indirect RCP Sales

AMP is defined to include prices paid to manufacturers by wholesalers for units that the wholesalers distributed to RCPs and prices paid by RCPs that purchased directly from manufacturers. Prior to the ACA, AMP included prices paid by wholesalers for drugs distributed to the retail pharmacy class of trade, which CMS interpreted broadly. Because manufacturers have no visibility into wholesaler resale transactions, except when the resale to a contract customer of the manufacturer generates a wholesaler chargeback claim, since the beginning of the MDRP, CMS permitted manufacturers to presume that wholesaler sales are to retail pharmacies unless a manufacturer can identify and remove nonretail pharmacy sales through chargeback data.

The Final Rule takes a pragmatic approach, recognizing that manufacturers must certify the accuracy of the AMP calculation but lack access to complete, accurate, and verifiable sales data. In addition, if indirect sales to RCPs were not included because they could not be documented, there would likely be substantial under-inclusion, which would skew AMP. These concerns trumped CMS’s initial concern that the “presumed inclusion” method would cause inclusion of some sales distributed to nonretail pharmacy customers. Therefore, the Final Rule does not require manufacturers to build up AMP from identifiable indirect sales to RCPs and exclude sales to wholesalers if they cannot be documented as distributed to RCPs. Operationally, this means that calculating AMP will be easier and identifying gross includable wholesaler sales will not be delayed until the end customer can be identified through wholesaler-provided data. Under the presumed inclusion method, gross wholesaler sales are included in AMP when they occur, with removal of excluded sales lagging behind and applied to current sales through a smoothing mechanism.

Clarity for Calculating 5i AMP Reduces Potential for Erratic Calculations and Inflation Penalties

The statutory definition of AMP excludes discounts and rebates to entities that do not conduct business as a wholesaler or RCP, except for five categories of drugs (infusion, inhalation, instilled, implanted, and injected) that are “not generally dispensed” by RCPs. The Final Rule establishes a methodology for calculating “5i” AMP by separately listing the included and excluded transactions and setting a standard for determining which of the two AMP methodologies apply to a particular drug.

Because AMP must be calculated and reported on a monthly basis, and the percentage of sales through RCPs can vacillate from month to month, the need to repeatedly switch methodologies is incredibly burdensome. Worse, if baseline AMP is calculated using the 5i method and quarterly AMP is later calculated using the retail method because the percentage of retail sales increased, that quarterly AMP will likely be higher, creating the appearance of a price increase when no increase was taken, which unfairly subjects a manufacturer to an inflation penalty. To determine whether a drug is not generally dispensed by RCPs and therefore subject to 5i AMP, the Final Rule establishes a threshold of 70% of units sold to other than RCPs, instead of the proposed 90%. That cushion, the use of units instead of dollars, and the ability to smooth the units over a longer period means that the volume of sales through RCPs is less likely to cross the line.

New Interpretation of “United States” to Include the Territories Will Increase Manufacturers’ Rebate Liability

By statute, the MDRP is implemented through the terms of manufacturer rebate agreements, which set forth CMS’s interpretation of the statutory requirements. Since the program’s inception in 1990, CMS has interpreted the requirements to report prices paid to manufacturers in the United States and provide rebates on prescriptions paid by the United States to mean the 50 states and the District of Columbia. Accordingly, the rebate agreement defines “states” to reflect that interpretation.

In the Final Rule, CMS suddenly reversed itself and expanded the scope of the program to encompass the territories of Puerto Rico, the Virgin Islands, the Northern Mariana Islands, Guam, and American Samoa. The expanded volume of prescriptions on which Medicaid rebates are due will increase manufacturers’ liability, but the new requirement to include transactions in the territories in the determination of AMP and BP will have a far greater impact. Prices in the territories are affected by laws and regulations inapplicable to the states, including single-payer systems and price controls, pricing structures that reflect foreign market considerations, and distribution arrangements that differ from those in the states.

Although the small percent of low-priced sales from the territories is unlikely to significantly affect a manufacturer’s average price, even a single very low-priced transaction in a territory could establish a new BP for the relevant quarter. Thus, the differential between AMP and BP based on a single transaction in the territories could increase the unit rebate amount applicable to use in all 50 states and the District of Columbia. However, in recognition of serious manufacturer concerns relating to identification and inclusion of sales to the territories in manufacturer government pricing calculations (including the possibility that related transaction data might not currently reside in a manufacturer’s government pricing systems or even its US sales systems), CMS has delayed implementation of this aspect of the Final Rule for one year, until April 1, 2017. The one-year delay also affords manufacturers sufficient time to revisit pricing strategies in the territories to minimize the increase in Medicaid rebate liability likely to occur.

Exclusion of Specialty Pharmacies from the Definition of RCP

The definition of RCP excludes pharmacies that dispense primarily through the mail. Some drugs, particularly those with risk evaluation and mitigation strategies, are distributed primarily through specialty pharmacies. Although CMS was concerned that some drugs that are not 5i drugs would have no AMP if specialty pharmacies are excluded from RCP, the Final Rule does not permit manufacturers to treat specialty pharmacies as RCPs unless they meet the statutory definition of RCP, even if AMP is based on a few number of sales. Although the Final Rule does not define what “primarily through the mail” means, manufacturers may reasonably assume it means a majority of their prescriptions. Further, for purposes of determining which AMP methodology to apply to 5i drugs, units sold to specialty pharmacies would be considered RCPs in computing the percentage of sales dispensed by RCPs only to the extent that they meet the statutory definition. Thus, manufacturers could consider specialty pharmacies that distribute a majority of drugs by mail to be nonretail in determining which methodology to use. Manufacturers must develop a means to reasonably identify whether specialty pharmacies, home health agencies, and similar providers qualify as RCPs.

Generic Drugs Marketed Under Paper NDAs and Certain 505(b)(2) Applications

The Medicaid rebate statute imposes fewer burdens and lower rebate percentages on noninnovator drugs than on Single-Source Drugs and Innovator Multiple-Source Drugs, defined as drugs “originally marketed under an original New Drug Application.” Between 1962 and 1984, new duplicate drugs and drugs that rely on data not developed by an applicant were approved by the US Food and Drug Administration (FDA) using a process involving fewer requirements than the NDA process applied to the first application for that drug (so-called paper NDAs). This process was replaced, pursuant to the Hatch-Waxman Act, by the 505(b)(2) process that expressly permits FDA to rely on data not developed by the applicant, and the Abbreviated New Drug Application (ANDA) process under 505(j) for approval of duplicate drugs.

Although CMS previously interpreted the statute’s definition of “Noninnovator Multiple-Source Drug” or “N Drug” as including drugs approved under both paper NDAs and NDAs approved under 505(b)(2), the Final Rule excludes both types of drugs from the definition of an N Drug. Drug Efficacy Study Implementation (DESI) drugs that have gone through the FDA approval process and received NDAs are also excluded; however, ANDAs that rely on DESI notices and were approved under section 505(b) of the Federal Food, Drug, and Cosmetic Act prior to enactment of 505(j) will be treated as ANDAs if FDA so classifies them. In creating these distinctions, CMS interpreted an “original NDA” to be any NDA that the FDA approved for marketing, and “originally marketed” under an NDA to mean a drug that was initially marketed as a Single-Source Drug.

Notwithstanding its position on generic drugs approved under NDAs, CMS acknowledged that there might be circumstances under which drugs not marketed under ANDAs might be more appropriately treated as N Drugs. CMS specifically identified drugs approved under a paper NDA prior to the enactment of the Hatch-Waxman Amendments of 1984 and drugs approved under certain types of literature-based 505(b)(2) NDA approvals as candidates for application of this exception. Accordingly, manufacturers seeking application of the exception may submit materials to CMS for review and confirmation in writing that the product at issue can be treated as an N Drug. If a manufacturer is currently marketing a generic drug under some form of an NDA but treats it as an N Drug, CMS indicated that it will give the manufacturer four quarters after the Final Rule’s effective date to apply for an exception before CMS will take administrative action for any noncompliance.

BP Excludes All Prices Available to 340B Covered Entities

The Medicaid statute expressly exempts from BP any price available to an entity that meets the definition of covered entity in section 340B of the Public Health Service Act.[3] The exemption is not limited to drugs sold to these entities under the 340B program. Prior to expanding the 340B program in the ACA, the US Congress clarified its intent by indicating that drugs sold to 340B-eligible hospitals for inpatient use were exempt from BP, even though these drugs are not covered by the 340B program. The Final Rule applies that logic to all prices available to any entity described in section 340B, whether or not the drugs are purchased outside the 340B program, such as drugs provided to individuals who do not qualify as patients and orphan drugs, which the ACA excluded from the 340B program for newly added categories of hospitals. Administratively, this policy provides welcome relief to manufacturers because it will ease the burden of subclassifying purchases by 340B entities. For covered entities, it also removes a significant impediment to receiving discounts on non-340B drugs.

Improved Guidance on Treatment of Administrative Fees Paid to Third Parties

Group Purchasing Organizations (GPOs) and Pharmacy Benefit Managers (PBMs) negotiate prices and provide services to manufacturers but do not purchase drugs. Fees paid to these entities reduce a manufacturer’s realization on a sale; however, they are not necessarily intended to reduce the price paid for the drug by a provider that is the beneficiary of the GPO or PBM agreement. Treatment of these fees is a particular concern for BP and 5i AMP, which do not exempt PBM rebates or prices paid by institutions under GPO agreements.

The Final Rule clarifies that price concessions are aggregated in BP only if provided to the same entity and that fees paid to third parties are only price concessions to the purchasers if they are passed through in whole or in part to the purchasers. Importantly, the Final Rule reconciles its guidance on Bona Fide Service Fees, which are exempt from AMP and BP, with its guidance on the treatment of these fees in the calculation of Average Sales Price under Medicare Part B. Accordingly, for all pricing calculations, manufacturers may presume such fees are not passed through to a customer or client of the recipient absent evidence or notice to the contrary. Otherwise, administrative fees paid to third parties would artificially reduce the amount actually paid by these providers. Nevertheless, there remain issues with respect to allocation of fees, agreements that reserve pass-through rights, and fees paid to entities with close corporate affiliations with providers. Manufacturers should consult with counsel before making reasonable assumptions in these areas.

Alternative Additional Rebate Formula Needs Clarity

rior to enacting the ACA, Congress was concerned that manufacturers were reformulating innovator drugs as extended release versions to extend the patent life and increase the price. To discourage this practice, the ACA required manufacturers to use an alternative additional rebate calculation (based on the original drug price increase) as an inflation penalty for line extensions of innovator oral solid drugs (defined to mean extended release formulations) if that method yielded a higher rebate amount than the normal calculation.

However, the Final Rule does not decide whether the term “line extension” is limited to extended release formulations. The Proposed Rule proposed to apply the term to all changes to an oral solid drug requiring FDA approval (except a new strength), including changes that provide real health benefits and reduce medication costs, such as improved delivery systems, abuse-deterrent formulations, combination drugs, and drugs approved under section 505(b)(2). Although the Final Rule did not resolve this issue, it did limit application of the requirements to manufacturers that report AMP for the original drug. Thus, companies acquiring the right to sell a new formulation need not obtain quarterly AMP from the company that continues to sell the old formulation.

Manufacturers May Recalculate Base Date AMP to Reflect Final Rule Changes

One principal purpose of the ACA’s revision of the AMP calculation was to increase AMP. The effects of this included not only an increase in basic Medicaid rebates paid by manufacturers but also an increase in the inflation penalty paid for Single-Source Drugs and Innovator Multiple-Source Drugs because of the false appearance of price inflation created by the revised AMP definition. To account for this, the Final Rule adopts the Proposed Rule’s provision for reporting revised ACA Base Date AMPs. This provision permits manufacturers to submit revised Base Date AMP calculations to CMS within the first four full calendar quarters following April 1, 2016. The Final Rule limits the scope of the recalculation to revisions to AMP as provided for in the Final Rule’s definition of AMP. Manufacturers may choose to recalculate Base Date AMP on a product-by-product basis, but must use actual and verifiable pricing records in these recalculations. The decision to revise Base Date AMP depends on several factors, but manufacturers should consider the option before it expires.


The Final Rule contains numerous other provisions that affect manufacturers’ policies and procedures for reporting prices for covered drugs. We recommend that manufacturers promptly review and update existing policies and procedures, document reasonable assumptions in implementing the Final Rule, and obtain advice of counsel where necessary to ensure compliance on the effective date.


If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Washington, DC
Donna Lee Yesner
Stephen E. Ruscus

[1] This document was published in the Federal Register on February 1, 2016 and is available online at Some provisions in the Final Rule, such as extension of the MDRP to the territories, have later effective dates.

[2] CMS withdrew portions of the DRA rule following the ACA’s enactment.

[3] 42 U.S.C. §1396r-8(c)(1)(C)(i)(I).