Medicare: Considerations for Adding a Prescription Drug Benefit

Published by the Government Accountability Office on 1999-06-23.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                           United States General Accounting Office

GAO                        Testimony
                           Before the Committee on Finance, U.S. Senate

For Release on Delivery
Expected at 10:00 a.m.
Wednesday, June 23, 1999

                           Considerations for Adding a
                           Prescription Drug Benefit
                           Statement of Laura A. Dummit, Associate Director
                           Health Financing and Public Health Issues
                           Health, Education, and Human Services Division

Medicare: Considerations for Adding a
Prescription Drug Benefit

               Mr. Chairman and Members of the Committee:

               I am pleased to be here today as you consider a prescription drug benefit
               for Medicare beneficiaries. Over the past several months, this Committee
               has held a series of hearings on Medicare reform issues to determine the
               nature and extent of changes needed to modernize the program and
               control its impact on the federal budget. These discussions come at an
               important juncture in the program’s history—the Congress passed
               landmark legislation in the Balanced Budget Act of 1997 (BBA) that has the
               potential to improve the financial underpinnings of the program. Yet, more
               work remains to ensure Medicare’s continued financial viability. Budget
               projections show health care consuming ever-larger shares of the federal
               dollar, thus threatening to crowd out funding for other valued government
               programs and activities. At the same time, many believe that Medicare’s
               current benefit structure should be updated to include a prescription drug

               Studies suggest that broadening Medicare coverage to include prescription
               drugs could add between 7.2 and 10 percent to Medicare costs. Such an
               expansion would occur at a time when Medicare’s rolls are growing and
               are projected to increase rapidly with the aging of the baby boom
               generation and during a time of major technological advances in medicine
               and biotechnology. Currently, some Medicare beneficiaries face a
               significant financial burden for outpatient prescription drugs. The policy
               dilemma before you today is that, on the one hand, Medicare’s lack of a
               prescription drug benefit may impede access to certain treatment
               advances, whereas on the other, the cost implications of including a
               prescription drug benefit will be substantial. These additional costs would
               serve to erode the projected financial condition of the Medicare program,
               which, according to the Medicare trustees, is already unsustainable in its
               present form.

               My remarks today will focus on the factors contributing to the growth in
               prescription drug spending for both the general population and Medicare
               beneficiaries and efforts to control that growth. I will also discuss benefit
               design and implementation issues to be considered in deliberations about
               adding a new prescription drug benefit. My comments are based on
               analyses of recent data and our body of completed work on prescription

               In summary, proposals to add prescription drug coverage to Medicare’s
               benefits come during a period of rapid growth in national spending for

               Page 1                                                       GAO/T-HEHS-99-153
Medicare: Considerations for Adding a
Prescription Drug Benefit

pharmaceuticals and transformations in the prescription drug market.
Increased coverage of drugs by health plans and insurers, advances in
drug treatments, and aggressive marketing have spurred the growth in the
use of pharmaceuticals, while the use of formularies, pharmacy benefit
managers, and generic substitutions as cost control approaches have
dramatically changed the nature of the market in which prescription drugs
are purchased.

What remains unchanged since 1965, however, is the absence of coverage
for outpatient prescription drugs by traditional Medicare. A third of the
Medicare population lacks the supplemental drug coverage provided to
most beneficiaries through employer-sponsored plans, managed care
organizations, Medicaid, or Medigap insurance. Moreover, high drug
utilization among the Medicare population translates into a potentially
daunting financial burden.

The implications of adding prescription drug coverage to Medicare’s
benefit package depend on the choices made regarding details such as its
scope and financing. Its design and implementation will also shape the
impact of this benefit on beneficiaries, Medicare spending, and the
pharmaceutical market. Recent experience provides at least two
approaches for implementing a drug benefit. One would involve the
Medicare program obtaining price discounts from manufacturers. Such an
arrangement could be modeled after Medicaid’s drug rebate program.
While the discounts in aggregate would likely be substantial, this approach
lacks the flexibility to achieve the greatest control over spending. It cannot
effectively influence or steer utilization because it does not include
incentives that would encourage beneficiaries to make cost-conscious
decisions. The second approach would draw from private sector
experience in negotiating price discounts from manufacturers in exchange
for shifting market share. Some plans and insurers employ pharmacy
benefit managers (PBM) to manage their drug benefits, including claims
processing, negotiating with manufacturers, establishing lists of drug
products that are preferred because of price or efficacy, and developing
beneficiary incentive approaches to control spending and use. Applying
these techniques to the Medicare program, however, would be difficult
due to its size, the need for transparency in its actions, and the imperative
for equity for its beneficiaries.

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                                    Medicare: Considerations for Adding a
                                    Prescription Drug Benefit

                                    Extensive research and development over the past 10 years have led to the
Many Factors Have                   introduction of new prescription drug therapies and improvements over
Spurred Prescription                existing therapies that, in some instances, have replaced other health care
Drug Spending and                   interventions. The growing importance of prescription drugs as part of
                                    health care has made the inclusion of drug benefits an attractive policy
Fostered Market                     feature to consumers with a choice among health insurance products.
Changes                             Most commercial private health insurance products, Medicare+Choice1
                                    plans, and all Medicaid programs provide their beneficiaries with an
                                    outpatient prescription drug benefit. Health plans have found that
                                    including prescription drugs as a covered benefit helps attract members
                                    and is valuable to their beneficiaries. Prescription drug expenditures have
                                    outpaced other components of health care spending in recent years due to
                                    several factors. At the same time, the use of new approaches to dampen
                                    these expenditures is reshaping the prescription drug market.

Rise in Prescription Drug           Over the past 5 years, prescription drug expenditures have grown
Spending                            significantly, both in total and as a share of all health expenditures.
                                    Prescription drug spending grew, on average, from 1992 to 1997 by
                                    11 percent a year compared with a 5 percent average growth rate for
                                    health expenditures overall. (See table 1.) Drug spending during that same
                                    period also consumed a larger share of total health care spending—rising
                                    from 5.6 percent to 7.2 percent.

Table 1: National Expenditures on
Prescription Drugs, 1992-97                                                              Annual growth in         Annual growth in all
                                                              Prescription drug          prescription drug                health care
                                                               expenditures (in              expenditures               expenditures
                                    Year                               millions)                 (percent)                  (percent)
                                    1997                                  $78,888                          14                          5
                                    1996                                   69,111                          13                          5
                                    1995                                   61,060                          11                          5
                                    1994                                   55,189                           9                          5
                                    1993                                   50,632                           9                          7
                                    1992                                   46,598                          11                          9
                                    Average annual
                                    growth, 1992-97                                                        11                          5
                                    Source: Health Care Financing Administration (HCFA), Office of the Actuary.

                                     As an alternative to traditional Medicare fee-for-service, beneficiaries in Medicare+Choice plans
                                    (formerly Medicare risk health maintenance organizations) obtain all their services through a managed
                                    care organization and Medicare makes a monthly capitation payment to the plan on their behalf.

                                    Page 3                                                                         GAO/T-HEHS-99-153
Medicare: Considerations for Adding a
Prescription Drug Benefit

While total drug expenditures depend both on the prices paid and the
volume used, the recent spending increases appear to have more to do
with stepped up volume than price. A precise determination of how much
is due to volume versus price increases is not possible since only data on
the retail pharmaceutical prices are widely available. The actual prices
paid are often lower than retail levels, as insurers, PBMs, and other
purchasers negotiate significant discounts from manufacturers and other
suppliers. Market changes in recent years have likely altered the size of
those discounts.

Several factors have contributed to increased prescription drug use and
the resulting spending increases: namely, more individuals have
third-party drug coverage, new drug therapies have been introduced into
the market, and manufacturers have marketed drugs more aggressively
through advertising directly to consumers.

The increase in private insurance coverage for prescription drugs is a
likely factor accounting for the rise in utilization. In the decade between
1987 and 1997, the share of prescription drug expenditures paid by private
health insurers rose from almost a third to more than half. (See fig. 1.) The
development of new, more expensive drug therapies—including new drugs
that replace old drugs and new drugs that treat disease more
effectively—also contributed to the drug spending growth. The average
number of new drugs entering the market each year has grown from 24 at
the beginning of the 1990s to 33 now. Similarly, biotechnology advances
and a growing knowledge of the human immune system are significantly
shaping the discovery, design, and production of drugs. Advertising
pitched to the lay consumer has also likely upped consumers’ use of
prescription drugs. Between March 1998 and March 1999, industry
spending on advertising grew 16 percent, to $1.5 billion.

Page 4                                                     GAO/T-HEHS-99-153
                                         Medicare: Considerations for Adding a
                                         Prescription Drug Benefit

Figure 1: Comparison of National Drug Expenditures, 1987 and 1997

1987 National Drug Expenditures by Payer Type               1997 National Drug Expenditures by Payer Type
                                         Medicare                                   1% 2%                          Other Public
                0% 3%                    Other Public

                                         Total Medicaid
                                                                                             17%                   Total Medicaid

                                                                         51%                                       Private Health
                      30%                Private Health                                                            Insurance

       54%                               Out-of-Pocket                                       29%                   Out-of-Pocket
                                         Paymentsa                                                                 Paymentsa

                                          Out-of-pocket expenditures include direct spending by consumers for all health care goods and
                                         services, such as coinsurance, deductibles, and any amounts not covered by insurance.
                                         Out-of-pocket premiums paid by individuals are not counted here.

                                         Source: Health Care Financing Administration, Office of the Actuary.

Current Medicare                         Prescription drugs are an important component of medical care for the
Beneficiary Drug Coverage                elderly because of the greater prevalence of chronic and other health
                                         conditions associated with aging. In 1995, Medicare beneficiaries had on
                                         average more than 18 prescriptions filled. This varies substantially across
                                         beneficiaries, however, reflecting the presence of chronic and other
                                         conditions that respond to drug treatment and also financial
                                         considerations such as third-party prescription drug coverage. In 1995,
                                         annual drug costs were $600 for the elderly, compared to just over $140 for
                                         the nonelderly population. For some, spending is considerably higher. In
                                         1999, an estimated 20 percent of Medicare beneficiaries will have total
                                         drug costs of $1,500 or more—a substantial sum for those lacking some
                                         form of insurance to subsidize the purchase.

                                         This financial burden is due, in part, to gaps in insurance coverage for
                                         prescription drugs. One third of the Medicare population lacks drug

                                         Page 5                                                                     GAO/T-HEHS-99-153
                           Medicare: Considerations for Adding a
                           Prescription Drug Benefit

                           coverage altogether. Those with third-party protections often face
                           deductibles, cost sharing, or limits on total benefit payments. The vast
                           majority of the approximately 17 percent of Medicare beneficiaries
                           enrolled in a Medicare+Choice plan have drug coverage, as do retirees
                           who have employer-sponsored insurance. All beneficiaries who are
                           enrolled in Medicaid receive drug coverage. Other beneficiaries may
                           purchase Medigap policies that provide drug coverage, although Medigap
                           policies involve significant cost sharing, impose annual limits, may contain
                           significant exclusions, and can be expensive. A Medigap policy with drug
                           coverage can cost $1,500 more per year than an otherwise comparable

                           Medicare beneficiaries with drug coverage use more prescription drugs
                           and have higher overall drug expenditures than those without drug
                           coverage. This may be because beneficiaries with higher prescription drug
                           needs may be more likely to obtain third-party protections. Alternatively,
                           the lack of coverage for some may inhibit appropriate drug utilization.

Cost Control Approaches    During this period of growth in the volume of prescription drugs used,
Reshaping Pharmaceutical   third-party payers, which have been the primary purchasers, have pursued
Market                     various approaches to controlling spending. These efforts have initiated a
                           transformation of the pharmaceutical market. A world in which insured
                           individuals purchase drugs at retail pharmacies at retail prices and then
                           seek reimbursement is giving way to third-party payers influencing which
                           drug is purchased, how much is paid for a drug, and where it is purchased.

                           A common technique to manage pharmacy care and control costs is to use
                           a formulary. A formulary is a list of prescription drugs, grouped by
                           therapeutic class, that a health plan or insurer prefers and may encourage
                           to be prescribed for its enrollees. Decisions about which drugs to include
                           on a formulary are based on their medical value and their price. Both
                           inclusion of a drug on a formulary and its cost can affect how frequently it
                           is prescribed and purchased and, therefore, can affect its market share.

                           Formularies can be open, incentive-based, or closed. Open formularies are
                           often referred to as “voluntary” because enrollees are not penalized if
                           their physicians prescribe nonformulary drugs. Incentive-based
                           formularies generally offer enrollees lower copayments for the preferred
                           formulary or generic drugs. Incentive-based or managed formularies are
                           becoming more popular because they combine flexibility and greater
                           cost-control features than open formularies. A closed formulary limits

                           Page 6                                                     GAO/T-HEHS-99-153
                        Medicare: Considerations for Adding a
                        Prescription Drug Benefit

                        insurance coverage to formulary drugs only and requires enrollees to pay
                        the full cost of nonformulary drugs prescribed by their physician.

                        Many health plans or insurers also contract with a PBM to administer and
                        manage their prescription drug benefit. PBMs offer a range of services,
                        including prescription claims processing, mail-service pharmacy,
                        formulary development and management, pharmacy network
                        development, generic substitution incentives, and drug utilization review.
                        PBMs have successfully negotiated discounts and rebates on prescription
                        drugs with manufacturers.

                        Policymakers considering proposals for including a prescription drug
Issues to Consider in   benefit in the Medicare program are facing a myriad of options. Assessing
Benefit Design and      the merits of whether and how to implement these reforms will depend, in
Administration          large measure, on whom the benefit covers and how it is financed. In such
                        an assessment, it may be appropriate to recall the criteria that the
                        Comptroller General enunciated before this Committee in testimony on
                        March 10. These criteria could guide deliberations on expanding coverage
                        to include prescription drugs: (1) affordability—a benefit should be
                        evaluated in terms of its impact on the sustainability of program
                        expenditures for the long term; (2) equity—a benefit should be fair across
                        groups of beneficiaries and to providers; (3) adequacy—a benefit should
                        foster cost-effective and clinically meaningful innovations, furthering
                        Medicare’s tradition of technology development; (4) feasibility—a benefit
                        should incorporate such administrative essentials as implementation and
                        monitoring techniques; and (5) acceptance—a benefit should account for
                        the need to educate beneficiary and provider communities about its costs
                        and the realities of trade-offs required when significant policy changes

                        Although the Congress will likely examine a number of alternative benefit
                        designs and administrative options, I would like to briefly discuss two
                        approaches that may be considered. One would be similar to how drug
                        benefits are provided in state Medicaid programs, which rely on federal
                        authority to lower drug prices through rebates paid by drug manufacturers
                        to control spending. The other would be modeled after approaches
                        adopted by private sector health plans in which PBMs are typically used to
                        administer various techniques to control pharmacy benefit costs. Each
                        approach has some advantages and disadvantages.

                        Page 7                                                    GAO/T-HEHS-99-153
                         Medicare: Considerations for Adding a
                         Prescription Drug Benefit

Medicaid Programs Rely   Before the enactment of the Medicaid drug rebate program as part of the
on Discounts, Limited    Omnibus Budget Reconciliation Act of 1990 (OBRA), state Medicaid
Utilization Controls     programs paid close to retail prices for outpatient drugs. As the largest
                         government payer for prescription drugs, Medicaid drug expenditures
                         comprised about 13 percent of the domestic pharmaceutical market. Other
                         purchasers, such as health maintenance organizations (HMO) and hospitals,
                         negotiated discounts with manufacturers and paid considerably less.

                         The rebate program required drug manufacturers to give state Medicaid
                         programs rebates for outpatient drugs. The rebates were based on the
                         lowest or “best” prices they charged other purchasers. In return for the
                         rebates, state Medicaid programs maintain open formularies that permit
                         reimbursement for all drugs manufactured by pharmaceutical companies
                         that entered into rebate agreements with the Health Care Financing

                         After the rebate program’s enactment, a number of market changes
                         occurred that affected other purchasers of prescription drugs and the
                         amount of the rebates Medicaid programs received. For example, the
                         prices many large private purchasers, such as HMOs, paid for outpatient
                         drugs increased substantially. Moreover, the lowest prices in the market
                         increased faster than the drugs’ average prices as drug manufacturers
                         significantly reduced the price discounts they offered private purchasers.
                         As a result, within 2 years the rebates paid to state Medicaid programs fell
                         to the minimum amount required by OBRA.

                         Although states have received billions of dollars in rebates from drug
                         manufacturers since the enactment of OBRA 1990, state Medicaid directors
                         have expressed concerns about the rebate program. The principal concern
                         involves OBRA’s requirement for open formularies, which limits the
                         utilization controls Medicaid programs can use at a time when
                         prescription drug expenditures are rapidly increasing. Although they can
                         require recipients to obtain prior authorization for particular drugs and
                         impose monthly limits on the number of covered prescriptions, other
                         techniques to steer recipients to less expensive drugs are not available to
                         them. These approaches can add to the administrative burden on state
                         Medicaid programs, lead to purchasing more expensive drugs, and create
                         access problems for certain individuals.

Other Payers Employ      Other payers, such as private employer health plans, Medicare+Choice
Various Techniques to    plans, and insurance products for federal employees have taken a different
Control Expenditures     approach to managing their prescription drug benefits. They use

                         Page 8                                                     GAO/T-HEHS-99-153
Medicare: Considerations for Adding a
Prescription Drug Benefit

formularies and copayments to control drug utilization and obtain better
prices by concentrating purchases on selected drugs. In many cases, these
plans or insurers retain the services provided by a PBM to implement their
pharmacy benefit.

Beneficiary cost sharing has had a central role in attempting to influence
drug utilization. Copayments frequently are structured to both influence
the choice of a drug and purchasing arrangements. While formulary
restrictions can channel purchases to preferred drugs, closed formularies,
which provide reimbursement only for preferred drugs, have generated
significant consumer dissatisfaction. As a result, many plans link their cost
sharing requirements and formulary lists. The fastest growing trend today
is to maintain an open formulary in which all drugs receive some coverage,
with beneficiaries paying different levels of cost sharing for different
drugs—typically a smaller copayment for generic drugs, a larger one for
preferred drugs, and an even larger one for all other drugs. Reducing the
required copayments may also encourage enrollees using maintenance
drugs for chronic conditions to use particular suppliers, like a mail-order

Plans and insurers have turned to PBMs for their expertise in establishing
formulary lists, negotiating prices with manufacturers and suppliers, and
processing beneficiary claims, as well as a variety of clinical services, such
as drug utilization review. PBMs bring expertise and economies of scale to
these tasks that individual plans or insurers may not have. In addition,
they often may have more leverage than individual plans in negotiating
prices as they combine the purchasing power of multiple purchasers.

Traditional fee-for-service Medicare has generally established
administrative prices for services like physician or hospital care and then
processed and paid claims with few utilization controls. Adopting some of
the techniques used by private plans and insurers might have the potential
for better control of costs. However, how to adopt those techniques to
deal with the unique characteristics and enormity of the Medicare program
raises many questions.

Negotiated or competitively determined prices would be superior to
administered prices only if Medicare could employ some of the utilization
controls that come from having a formulary and differential beneficiary
cost sharing. In this manner, Medicare would be able to negotiate
significantly discounted prices by promising to deliver a larger market
share for a manufacturers’ product. Manufacturers would have no

Page 9                                                      GAO/T-HEHS-99-153
               Medicare: Considerations for Adding a
               Prescription Drug Benefit

               incentive to offer a deep discount if all drugs in a therapeutic class were
               covered on the same terms. Without a promised share of the Medicare
               market, these manufacturers may reap greater returns from higher prices
               and concentrating marketing efforts on physicians and consumers to
               influence prescribing patterns.

               Implementing a formulary and other utilization controls could prove
               difficult for Medicare. Developing a formulary involves determining which
               drugs are therapeutically equivalent so that several from each class can be
               selected as preferred. Plans and PBMs currently make those determinations
               privately—something that would not be tolerable for Medicare, which
               must have transparent policies that are determined openly. Given the
               stakes involved in being selected, one can imagine the intensive efforts to
               offer input to and scrutinize the selection process.

               Medicare may also find it impossible to delegate this task to a PBM or
               multiple PBMs. A single PBM contractor would likely be subject to the same
               level of scrutiny as the program. Such scrutiny may compromise the
               flexibility PBMs have utilized to generate savings. An alternative would be
               to grant flexibility to multiple PBMs that are responsible only for a share of
               the market. Contracting with multiple PBMs, though, raises other issues. If
               each PBM had exclusive responsibility for a geographic area, beneficiaries
               who need certain drugs could be advantaged or disadvantaged merely
               because they live in a particular area. If multiple PBMs operated in each
               area, beneficiaries would choose one to administer their drug benefit.
               Then, how to inform beneficiaries of the differences in each PBM’s policies
               and the possible need to risk adjust payments to PBMs for differences in
               health status of beneficiaries using them would become issues.

               Adding prescription drug coverage to the Medicare program would have a
Concluding     substantial impact on the costs of the program, in addition to the financial
Observations   well being and health of many of its beneficiaries. The challenge will be in
               designing and implementing drug coverage to minimize the financial
               implications for Medicare while maximizing the positive effect of such
               coverage on Medicare beneficiaries. Most importantly, this substantial
               benefit reform must be consistent with efforts to ensure the sustainability
               of the program so that Medicare does not consume an unreasonable share
               of our productive resources and does not encroach on other public
               programs or private sector activities. Reconciling these needs will take the
               kind of leadership and creativity demonstrated by the Congress as it

               Page 10                                                      GAO/T-HEHS-99-153
                   Medicare: Considerations for Adding a
                   Prescription Drug Benefit

                   designed and implemented the BBA reforms that extended Medicare’s
                   financial viability.

                   It may also be instructive to return to lessons learned in implementing the
                   BBA reforms. From those efforts, it is clear that major changes to the
                   Medicare program need to be effective, flexible, and steadfast.
                   Effectiveness must include the collection of necessary data to assess
                   impact—separating the transitory from the permanent and the trivial from
                   the important. Flexibility is critical to make changes and refinements
                   when conditions warrant and when actual outcomes differ substantially
                   from the expected ones. Steadfastness is needed when particular interests
                   pit the primacy of their needs against the more global interests of
                   preserving Medicare.

                   Mr. Chairman, this concludes my prepared statement. I will be happy to
                   answer any questions you or other Members of the Committee may have.

                   For future contacts regarding this testimony, please call Laura A. Dummit
GAO Contact and    at (202) 512-7119 or John Hansen at (202) 512-7105. Other individuals who
Acknowledgements   made key contributions include Tricia Spellman, Kathryn Linehan, and
                   Hannah Fein.

                   Page 11                                                   GAO/T-HEHS-99-153
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              Prescription Drugs and the Elderly: Many Still Receive Potentially Harmful
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              Prescription Drugs: Spending Controls in Four European Countries
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              Prescription Drugs: Companies Typically Charge More in the United States
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              Medicaid: Outpatient Drug Costs and Reimbursements for Selected
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              Prescription Drug Prices: Analysis of Canada’s Patented Medicine Prices
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              Medicaid: Changes in Drug Prices Paid by HMOs and Hospitals Since
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              Prescription Drugs: Companies Typically Charge More in the United States
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              Prescription Drugs: Changes in Prices for Selected Drugs (GAO/HRD-92-128,
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              Medicaid: Changes in Drug Prices Paid by VA and DOD Since Enactment
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(101865)      Page 12                                                    GAO/T-HEHS-99-153
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