MEDICAID SAVINGS : Law Mandating Drug Discounts to Cut Spending by $3.5 Billion : Many bulk purchasers already have negotiated special prices. California will retain its reduced rates.

For years, the government has paid top dollar to buy medicines for poor people while other large purchasers of prescription medications have received hefty discounts from pharmaceutical companies.

This will soon change. One of the less-noticed provisions of the final five-year budget package announced in Congress’ tumultuous close-of-session will cut $3.5 billion in federal and state spending on Medicaid over the next five years through “prudent pharmaceutical purchasing.”

The billions will be saved by gaining for Medicaid the same advantages a free market offers other bulk purchasers--a lower price.

“The big drug companies have been stiffing Medicaid,” complains Rep. Ron Wyden (D-Ore.), who sponsored the measure. “We’ve finally made our case for how outrageous this is.”

BACKGROUND: Last year, Medicaid (called Medi-Cal in California) spent $5 billion in federal funds and $4 billion in state funds on prescription drugs. In fact, Medicaid spends more money on prescription drugs than on physician payments, making it the third highest category of Medicaid expenditure, after nursing homes and hospitals.

Prescription drug prices have increased rapidly over the last several years--climbing at a pace three times the rate of inflation. Some argue that Medicaid’s policy of paying full price for those medicines has actually fueled the increases and, indirectly, contributed to the reluctance of private insurers to cover prescription drugs.

In the last few years many large purchasers of prescription medications have negotiated--and won--bulk-purchase discounts from pharmaceutical firms. Private hospitals and HMOs as well as government agencies such as the Veterans Administration and the Department of Defense have received discounts ranging from 10% to 70%. But until now, Medicaid has paid full price.

KEY ISSUES: When Sen. David Pryor (D-Ark.) introduced legislation on the issue last May, he unleashed a raucous policy debate.

Pharmaceutical companies argued vehemently against the idea of mandatory rebates. They called the proposal “price-fixing” and warned that lower prices would reduce the funds available for research and development of new medications.

Moreover, they warned that provisions in the original legislation to require substitution of generic equivalents would create a “two-tier” system where wealthy patients could get any medication they needed but poor people would be restricted to lower-priced and potentially inferior medicines.

Even state Medicaid administrators were hesitant to endorse the federal initiative. Some states, like California, had already negotiated their own Medicaid discounts from drug manufacturers and feared a federal measure might jeopardize those hard-won contracts.

In September, a compromise bill was introduced by Sen. Pryor and Reps. Wyden and Jim Cooper (D-Tenn.). It was passed, after some modifications, in the closing blitz of legislation from Capitol Hill.

OUTLOOK: The law requires manufacturers to give Medicaid the same “best price” they offer to other bulk purchasers, a minimum rebate of 13% in the first two years and 15% thereafter. If a drug manufacturer raises the price of any medication faster than the rate of inflation, the additional price increase will be automatically added to the Medicaid discount.

However, drug manufacturers also won something in the compromise. Currently, state Medicaid agencies have the right to exclude expensive or medically sensitive medications from the list of drugs they make available to Medicaid patients. Under the new system, states would be required to reimburse prescriptions for all drugs marketed by a drug manufacturer whose rebates meet the legislated criteria.

And while states can still require prior approval from a state review board before dispensing some sensitive medications, they will have to respond to requests within 24 hours and make an emergency, 72-hour dose available immediately.

Moreover, the final legislation dropped the mandate to use generic drugs--the provision that drew the greatest objection from drug manufacturers.

Jim Parks, chief of the discount drug program for Medi-Cal, said he is pleased that the federal rules will allow him to retain the lucrative contracts he has negotiated for California over the last few years. “This is something that will help states continue to provide coverage to the Medicaid population,” he said.

And Christopher Jennings, deputy staff director to the Senate’s special committee on aging which helped draft the measure, also expressed his satisfaction. “More drugs for less money,” he said, “--that’s a rare kind of proposal to get up here (on Capitol Hill).”