oversight

Audit of Medco Health Solutions, Inc. Contract Years 2000-2002 Franklin Lakes, New Jersey

Published by the Office of Personnel Management, Office of Inspector General on 2009-03-31.

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

                      PHARMACY CLAIM PAYMENTS



•   Excessive Quantities                                                             $45,283

    Medco paid eight claims where the quantity billed exceeded the amount supplied to the
    patient.

•   Non-Covered Enrollment                                                       Procedural

    Medco paid claims for patients not enrolled in the Service Benefit Plan (SBP) and 

    thereby not eligible to receive benefits under this contract. 



                  PROCESSING AND ADMINISTRATIVE FEES

    We determined that the processing and administrative fees charged to the FEHBP by
    Medco were in compliance with the terms of the contract.


                                 PHARMACY REBATES

•   Rebates                                                                      Procedural

    Medco’s 2002 contract with the Association did not require the FEHBP to receive all
    manufacturers rebates earned on FEHBP prescriptions.




                                            ii
                                                           CONTENTS
                                                                                                                                 PAGE

        EXECUTIVE SUMMARY ........................................................................................... i


 I.     INTRODUCTION AND BACKGROUND ..................................................................1

II.     OBJECTIVES, SCOPE, AND METHODOLOGY.......................................................3

III.    AUDIT FINDINGS AND RECOMMENDATIONS ....................................................5

        A.     Pharmacy Claim Payments……………………………………………………...5

               1. Excessive Quantities ........................................................................................5
               2. Non-Covered Enrollment.................................................................................5

        B.     Processing and Administrative Fees.................................................................... 8

        C.     Pharmacy Rebates……………………………………………………………….8

               1. Rebates .............................................................................................................8

IV.     MAJOR CONTRIBUTORS TO THIS REPORT........................................................11

 V.     SCHEDULES

        A.     Contract Charges and Amounts Questioned

APPENDICES:

       Appendix A: BlueCross BlueShield Association reply, dated February 8, 2006
       Appendix B: BlueCross BlueShield Association reply, dated March 24, 2006
       Appendix C: BlueCross BlueShield Association reply, dated May 5, 2006
                     I. INTRODUCTION AND BACKGROUND
INTRODUCTION

This final audit report details the findings, conclusions, and recommendations resulting from our
performance audit of the Service Benefit Plan Federal Employees Health Benefits Program
(FEHBP) mail order pharmacy operations at Medco Health Solutions, Inc. (Medco). Medco’s
headquarters are located in Franklin Lakes, New Jersey.

The audit was performed by the Office of Personnel Management’s (OPM) Office of the
Inspector General (OIG), as established by the Inspector General Act of 1978, as amended.

BACKGROUND

The FEHBP was established by the Federal Employees’ Health Benefits (FEHB) Act (Public
Law 86-382), enacted on September 28, 1959. The FEHBP was created to provide health
insurance benefits for federal employees, annuitants, and dependents. OPM’s Center for
Retirement and Insurance Services has overall responsibility for administration of the FEHBP.
The provisions of the FEHB Act are implemented by OPM through regulations, which are
codified in Title 5, Chapter 1, Part 890 of the Code of Federal Regulations (CFR). Health
insurance coverage is made available through contracts with various health insurance carriers
that provide service benefits, indemnity benefits, or comprehensive medical services.

The BlueCross BlueShield Association (Association), on behalf of participating BlueCross and
BlueShield plans, has entered into a Government-wide Service Benefit Plan contract (CS 1039)
with OPM to provide a health benefit plan authorized by the FEHB Act. The Association has
contracted directly with Medco to manage the delivery and financing of mail order prescription
drug benefits for Service Benefit Plan Standard Option health benefit purchasers.

The Association has established a Federal Employee Program (FEP) Director’s Office, in
Washington, D.C., to provide centralized management for the Service Benefit Plan. The FEP
Director’s Office coordinates the administration of the contract with the Association, Medco, and
OPM.

The Association has also established an FEP Operations Center. The activities of the FEP
Operations Center are performed by CareFirst BlueCross BlueShield, located in Washington,
D.C. These activities include acting as fiscal intermediary between the Association and member
plans, verifying subscriber eligibility, approving or disapproving the reimbursement of local plan
payments of FEHBP claims (using computerized system edits), maintaining a history file of all
FEHBP claims, and maintaining an accounting of all program funds.

Compliance with laws and regulations applicable to the FEHBP is the responsibility of the
Association and Medco management. Also, management of Medco is responsible for
establishing and maintaining a system of internal controls for the mail order prescription drug
program.




                                                1

This is our first audit of Medco. The results of our audit were provided to Medco in written audit
inquiries; were discussed with Medco and/or Association officials throughout the audit; and were
presented in detail in draft reports, dated December 8, 2005, and January 6, 2006. The
Association’s comments offered in response to the draft reports were considered in preparing our
final report and are included as Appendices to this report.




                                                2

               II. OBJECTIVES, SCOPE, AND METHODOLOGY
OBJECTIVES

The objectives of our audit were to determine whether the Plan’s charges to the FEHBP and
services provided to FEHBP members were in accordance with the terms of the contract.
Specifically, our objectives were as follows:

   •   Pharmacy Claim Payments

       To determine whether the Plan complied with contract provisions relative to benefit
       payments.

       To determine if claims were properly adjudicated.

   •   Processing and Administrative Fees

       To determine whether processing and administrative fees charged to the FEHBP were in
       compliance with the terms of the contract.

       To determine if the Plan met the contractual performance guarantees.

   •   Pharmacy Rebates

       To determine whether rebates were correctly calculated and returned to the FEHBP.

SCOPE

We conducted our performance audit in accordance with generally accepted government auditing
standards. Those standards require that we plan and perform the audit to obtain sufficient and
appropriate evidence to provide a reasonable basis for our findings and conclusions based on our
audit objectives. We believe that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.

We reviewed the BlueCross BlueShield Service Benefit Plan Annual Accounting Statements as
they pertain to Plan Code 88 for contract years 2000 through 2002. During this period, Medco
paid approximately $3.6 billion in mail order prescription drug charges (See Schedule A).

In planning and conducting our audit, we obtained an understanding of Medco’s internal control
structure to help determine the nature, timing, and extent of our auditing procedures. This was
determined to be the most effective approach to select areas of audit. For those areas selected,
we primarily relied on substantive tests of transactions and not tests of controls. Based on our
testing, we did not identify any significant matters involving Medco’s internal control structure
and its operation. However, since our audit would not necessarily disclose all significant matters
in the internal control structure, we do not express an opinion on Medco’s system of internal
controls taken as a whole.



                                                3

In conducting our audit, we relied to varying degrees on computer-generated data provided by
Medco. Due to time constraints, we did not verify the reliability of the data generated by
Medco’s information systems. However, while utilizing the computer-generated data during
audit testing, nothing came to our attention to cause us to doubt its reliability. We believe that
the data was sufficient to achieve the audit objectives.

We also conducted tests to determine whether Medco had complied with the contract, the
applicable procurement regulations (i.e., Federal Acquisition Regulations and Federal Employees
Health Benefits Acquisition Regulations, as appropriate), and the laws and regulations governing
the FEHBP. The results of our tests indicate that, with respect to the items tested, Medco did not
comply with all provisions of the contract and federal procurement regulations. Exceptions
noted in the areas reviewed are set forth in detail in the “Audit Findings and Recommendations”
section of this audit report. With respect to the items not tested, nothing came to our attention
that caused us to believe that Medco had not complied, in all material respects, with those
provisions.

The audit was performed at Medco’s offices in Franklin Lakes, New Jersey from May 16, 2005
through June 10, 2005. We also worked closely with the Association in our Washington, D.C.
office to complete this audit.

METHODOLOGY

To test Medco’s compliance with the FEHBP health benefit provisions, with the assistance of
ACS-Heritage Information Systems (ACS) we identified universes of claims using various
criteria, including the following:
         • Claims Paid Outside of Eligibility
         • Claims Paid with Suspicious Quantities
         • Claims Paid with Package Size Discrepancies
         • Claims Paid without Prior Approval
         • Non-Covered Drug Claims Paid

Statistical sampling was used for portions of the claim reviews performed due to the large claims
universe. All other samples were judgmental (with or without the use of stratified sampling),
although samples within a stratum could be randomly selected or statistical. We used the
FEHBP contract and the Medco/Association contract to determine if processing and
administrative fees charged to the FEHBP were in compliance with the terms of the contract.
We also used the contracts to determine if rebates were correctly calculated and returned to the
FEHBP.

The claims samples that were statistically-based did project audit results to the entire universe
where irregularities occurred. Other portions of the claims review looked at the entire universe
of claims. The remaining claim samples were judgementally selected. Consequently, the results
related to these samples could not be projected to the universe since it is unlikely that the results
are representative of the universe taken as a whole.




                                                  4

            III. AUDIT FINDINGS AND RECOMMENDATIONS
A. Pharmacy Claim Payments

  1. Excessive Quantities                                                                 $45,283

     Medco paid eight claims where the quantity billed exceeded the amount supplied to the
     patient. The amount over-billed totaled $45,283.

     Contract CS 1039 section 3.2 (b) (1) states “The Carrier may charge a cost to the contract
     for a contract term if the cost is actual, allowable, allocable, and reasonable.” Section 2.3
     (g) states, “If the Carrier or OPM determines that a Member’s claim has been paid in
     error for any reason, the Carrier shall make a diligent effort to recover an overpayment to
     the member from the member or, if to the provider, from the provider.”

     From the claims billed by Medco from January 1, 2000 through December 31, 2002, we
     identified 835 claims where the quantity billed appeared to exceed the amount supplied to
     the patient. Of the 835 claims, we selected the 10 highest dollar claims and requested
     Medco review the claims. Out of the 10 claims, 7 were incorrectly dispensed. Along
     with these claims, Medco also identified an additional claim that was incorrectly
     dispensed.

     Since the claims were incorrectly dispensed, the charges are unallowable. As a result,
     FEHBP was overcharged $45,283.

     Association’s Response

     The Association does not contest this finding and states that the funds were returned to
     the FEHBP on January 25, 2006.

     Recommendation 1

     The Association did return the funds to the FEHBP on January 25, 2006. Consequently,
     no further action is required.

  2. Non-Covered Enrollment                                                           Procedural

     Medco paid claims for patients not enrolled in the Service Benefit Plan (SBP) and
     thereby not eligible to receive benefits under Contract CS 1039. As a result, the FEHBP
     was potentially overcharged more than $3 million for years 2000 through 2002.

     In both the 1999 contract (Section 2.4) and the 2002 contract (Section 1.2) between the
     Association and Medco, it states that the contracts are subject to Chapter 89 of Title 5 of
     the United States Code, and to the provisions of CS 1039. It is further stated in the
     contracts that nothing shall contravene the rights and obligations of either party under
     those provisions.




                                               5

Contract CS 1039, Section 3.2(b) (1) states “The Carrier may charge a cost to the contract
for a contract term if the cost is actual, allowable, allocable, and reasonable.” Section
3.2(b)(2)(i) states “Benefit costs consist of payments made and liabilities incurred for
covered health care services on behalf of FEHBP subscribers .…” In addition, Section
2.3 (g) states, “If the Carrier or OPM determines that a Member's claim has been paid in
error for any reason, the Carrier shall make a diligent effort to recover an overpayment to
the member from the member or, if to the provider, from the provider.”

The contracts between the Association and Medco (Schedule D, Sections 7.6.1.1 and
7.6.2 of the 1999 contract and Schedule D, Sections 1.1(a) and 1.1(b) of the 2002
contract) state that for each claim, Medco will determine if the individual receiving
benefits is a member who is eligible for coverage on the date the prescription was
dispensed. If the claim is not for an eligible member, Medco will deny the claim.

The Association provided the SBP eligibility files for the period January 1, 2000 through
December 31, 2002, which contained membership effective dates and termination dates.
We compared the patient’s effective and termination dates against 100 percent of the
claims data to identify claims that were paid outside of the dates where a patient had
eligibility. This resulted in 25,625 potentially ineligible subscribers with a total amount
paid of $4,590,589. The review took into consideration the 30 day grace period of
temporary continuing coverage following termination of eligibility.

Out of the 25,625 claims, we reviewed a statistical sample of 320 claims, with a total
amount paid of $48,243, to determine if the patient was eligible for benefits. Our review
identified 217 claims, with a total amount paid of $33,296, where the patient receiving
benefits was not eligible for coverage at the time of the claim. There were two categories
of ineligible claims:

•   Incorrect member eligibility determination by Medco

    Medco incorrectly determined the eligibility for 58 claims, resulting in overcharges to
    FEHBP of $5,609. The majority of the 58 claims were for over-aged dependents.
    Projecting the error rate over the claims paid, the incorrect member eligibility
    determination by Medco resulted in a possible overcharge to the FEHBP of $533,627
    from years 2000 through 2002.

    Association’s Response

    The Association stated that given the high volume of prescriptions dispensed by
    Medco and the exceptionally high accuracy rate of their eligibility determiniations,
    these were good faith erroneous benefit payments and fall within the definition of
    allowable charges to the FEHBP under contract CS 1039 (section 2.3g). The
    Association further stated that the extrapolated error amount represented only 0.01
    percent of the total dollar value of FEHBP claims processed by Medco from 2000
    through 2002.




                                         6

   OIG Comments:

   We understand that Medco processes a high volume of prescription claims within any
   given year. However, we contend that its claims system edits should be structured in
   such a way that claims with ineligible members are detected and removed prior to the
   payment of the claim. Medco receives regular eligibility updates from the
   Association, and it was this information that we utilized for our analysis.

   Finally, while our review showed that 11.8 percent of the statistical sample of claims
   reviewed were paid incorrectly, the OIG does not intend to question the projected
   amount. In order to recover these funds, the Association would need to know exactly
   which claims were paid in error. Due to the fact that this would involve reviewing
   the entire universe of 25,625 claims, it would be costly and extremely time
   consuming to identify each claim that was paid in error to begin the recovery process.

•	 Ineligible claims correctly processed by Medco but subsequently determined to
   be ineligible because of retroactive enrollment change.

   As a result of retroactive enrollment changes Medco paid claims for 159 ineligible
   enrollees totaling $27,686. Projecting the error rate over the claims paid, retroactive
   enrollment changes resulted in a possible overcharge to the FEHBP of $2,633,879
   from 2000 through 2002.

   Association’s Response:

   The Association stated that during the period 2000 through 2002, it and Medco had
   worked to improve identification of enrollment changes. However, despite the efforts
   by the Association and Medco, they were hampered due to the lag time in receiving
   updates from the subscribers payroll offices. As a result, retroactive enrollment
   termination dates can reach back months, and sometimes years, from the date of
   receipt by the Association.

   The Association stated that claim errors resulting from retroactive terminations are
   common, however the industry has not devised a good way to accommodate the time
   lags that necessarily occur if the member is to be afforded time to notify their
   employment office of an enrollment change due to a qualifying life event.

   OIG Comments:

   The OIG agrees that the Association is not completely culpable for retroactive
   enrollment errors that occur. However, we also believe that given the substantial
   losses to the Program that continue to occur, efforts must be undertaken to address
   this issue and implement better controls, before millions more are lost.




                                        7

      Recommendation 2

      We recommend that the contracting officer instruct the Association to develop a
      corrective action plan for identifying claims that were paid for ineligible patients so that
      the BCBS plans can initiate recovery efforts and recover overpayments in a timely
      manner.

B. Processing and Administrative Fees

      We determined that the processing and administrative fees charged to the FEHBP by
      Medco were in compliance with the terms of the contract.

C. Pharmacy Rebates

   1. Rebates                                                                          Procedural

      Medco’s 2002 contract with the Association did not require the FEHBP to receive all

      manufacturer rebates earned on FEHBP prescriptions. 


      The 2002 Mail Service Prescription Drug Benefit Contract (the Contract) between the 

      Association and Medco, Schedule C.1.1, states that “The total price for Prescriptions

      Reimbursed and services rendered each Contract Year under the Mail Service Pharmacy

      Program is: (a) the lesser of (i) the amount calculated under the AWP Formula, in 

      accordance with Section 1.2.a) of this Schedule, or (ii) the amount based on the Net

      Effective Rate Formula, calculated in accordance with Section 1.2.b) of this Schedule ....” 


      The Contract, in Schedule C.2.1(a), also states that “In the event that the AWP Formula is

      used to calculate the Total Price for Prescriptions Reimbursed and Services Rendered,

      Medco shall pay a Rebate Guarantee Amount equal to              per Prescription for a

      Brand Name Drug that is on the SBP Formulary, excluding Specialty Drugs.”


      Additionally, Section 1.2 of the Contract subjects the Contract to Chapter 89 of Title 5 of

      the United States Code, and to the provisions of CS 1039 and further states that nothing

      shall contravene the rights and obligations of either party under those provisions. 


      Finally, 48 CFR 31.201-5, which is incorporated as part of the prime contract between 

      the Association and OPM, requires that the applicable portion of any income, rebate, 

      allowance, or other credit relating to any allowable cost, and received by or accruing to

      the contractor, shall be credited to the Government either as a cost reduction or by cash 

      refund.


      Medco provided documentation showing that in 2002 they received $93,327,351 in 

      rebates from the pharmaceutical manufacturers, but they credited FEHBP with only

      $72,381,325 on the Annual Statement of Costs. To arrive at the amount credited, Medco 

      multiplied the number of brand name formulary prescriptions             by the

      guaranteed amount per prescription        . Therefore, Medco retained over $20 





                                                8

million in rebates that were earned on the FEHBP prescriptions ($93,327,351 –
$72,381,325).

While Medco did comply with the 2002 contract they signed with the Association,
because the contract was a negotiated competitive contract, mere contract compliance
does not always show the complete picture. Medco only provided information for rebates
on brand name formulary prescriptions. Without having access to the manufacturer
contracts with Medco, we can not know how much money Medco received from the
manufacturers on all drugs. Additionally, negotiated contracts that lack the necessary
transparency as to terms and pricing make it extremely difficult to assess their
reasonableness. Consequently, without access to the manufacturers contracts and an
understanding of the monies received by Medco as a direct result of FEHBP drug
utilization, we cannot determine whether contracting in this manner was in the FEHBP’s
best interest.

Association’s Response:

“We contest this finding in its entirety. It is BCBSA’s position that Medco has no legal
obligation to credit $10,843,955 to BCBSA under either the plain and unambiguous terms
of the 2002 Contract between BCBSA and Medco or through application of the FAR
Credits Clause. In applying the AWP formula for compensating Medco for its services
under the Contract, BCBSA was to receive a rebate equal to            per Prescription for a
rebateable Brand Name Drug on the SBP Formulary. The $10,843,955 sought by the
Draft Audit Report (purportedly under the Credits Clause) represents the difference
between all ‘SBP Rebates’ received by Medco from pharmaceutical manufacturers and
the         per rebateable Prescription that Medco credited BCBSA. But because Medco
had no contractual obligation to credit BCBSA more than            per rebateable
Prescription, and because BCBSA did not receive any greater rebate sum from Medco,
the Credits Clause has no application. Equally important, the 2005 amendments to CS
1039 support this position.”

OIG Comments:

As stated above, the 2002 contract (Section 1.2), between the Association and Medco,
states that the contract is subject to Chapter 89 of Title 5 of the United States Code, and
to the provisions of CS 1039. It further states in the contract that nothing shall
contravene the rights and obligations of either party under those provisions.

The OIG acknowledges that per the Association’s contract with Medco, it has no
obligation to credit the FEHBP with more than           per rebatable prescription.
Nevertheless, 48 CFR 31.201-5 requires that the applicable portion of any income, rebate,
allowance, or other credit relating to any allowable cost, and received by or accruing to
the contractor, shall be credited to the Government either as a cost reduction or by cash
refund. The FEHBP should, therefore, be entitled to all rebates received by Medco from
pharmaceutical manufacturers.




                                          9

Recommendation 3

We recommend that the contracting officer require the Association, when contracting
with Pharmacy Benefit Managers on behalf of OPM, to ensure that the contracts do not
contravene its obligations under its contract with OPM. This would include requiring
that all monies earned as a result of FEP pharmacy claims be returned to the FEHBP, as
well as requiring increased transparency as to the contract’s terms and pricing
components.




                                       10

             IV. MAJOR CONTRIBUTORS TO THIS REPORT


Special Audits Group

            Team Leader

              , Auditor

               , Auditor
___________________________________________________________

                 , Chief, Experience-Rated Audits Group

               Deputy Assistant Inspector General for Management

                 , Chief, Special Audits Group (




                                            11

                                                                                          Appentlis C




                                                                   A n :LssocictLion of lndepende~~t
                                                                   Iilue Cross and Dlui: Shield Plms




                                                                   Federal Employee Program
                                                                   13 10 Q Street, N.W.
                                                                   Washiligtou, D.C. 20005
                                                                   202.942.1000
                                                                   Fax 202.942.1 125
May 5,2006

Mr. Michael R. Esser
Assistant lnspector General for Audits
U. S. Office of Personnel Management
Office of the Inspector General
1900 E Street, N.W, Room 6400
Washington, DC 20415

Reference: 	 OIG DRAFT AUDIT REPORT
             Medco Health Solutions, Inc.
             Plan Code 088
             Audit Report Number I A - I 0-91 -06-033
             (Report Dated and Received January 6,2006)

Dear Mr. Esser:

This letter responds to the above-referenced US. Office of Personal Management
(OPM) Office of lnspector General (OIG) Draft Audit Report related to the OIG audit
of Federal Employees Health Benefits Program (FEHBP) operations at Medco
Health Solutions, Inc. (Medco), previously Merck-Medco Managed Care, L-L-C. Our
comments in response to the findings in the report are as fotlows.


1.    Executive Summary

The OPM OIG issued Draft Audit Report No. I A-10-91-06-033 to the Blue Cross and
Blue Shield Association (BCBSA or Association) on January 6, 2006. The report
relates to BCBSA payments to Medco for pharmacy benefit management (PBFvf)
services during the period 2000 through 2002 under two Service Benefit Plan (SBP)
Mail Service Prescription Drug Benefit contracts. There are two Audit Findings: 1)
                     Deleted by the OIG                          I BCBSA "did not
credit the FEHBP with all credits [i.e,, rebates] received by Medco as required by
Contract CS 1039." BCBSA contests both Audit Findings.

As a . steward of FEHBP funds, BCBSA takes great measure to ensure that its
contracts with providers are fairiy and reasonably priced and that BCBSA, in turn,
only charges reasanabie costs to the FEHBP. See48 C.F.R. S 15.402(a).
Mr. Michael R. Esser
May 5, 2006
Page 2


Negotiated price contracts for commercial items, such as pharmaceuticals and PBM
s e r i e s are generally exempt from cost and pricing data submission and analysts
See 48 C F R % 15 403-1 (c)(3). BCBSA therefore undertook price analysis prior to
execution of the Medco contracts to discern the reasonableness of Medco's pricing
Price analysis is the process of examining and evaluating ^ P ^ ^ ^ f ^
evaluating its separate cost elements and proposed profit. See 48 C . F R.48 C . F . R .
r 5 404-1 (b)           Examples of types of price analysis that establish price
reasonableness include, but are not limited to: (i) adequate competrt.on, (..)
comparison of prior pricing and commercial contract prices for similar items
 nrcomoarison with independent cost estimates; (iv) field pricing mformation and
o t r T e p o r t s 48 C.F.R. § 15.404-1 (b)(2). BCBSA's thorough analysis of Medco's
 proposed pricing for the 1999-2001 contract and vigorous competitionfor the2002
 - 2004 contract both fall within the realm of "reasonable price analysis under the
 Federal Acquisition Regulation (FAR).

 Moreover the FAR recognizes that where cost and pricing data is not required, such
 a s for commercial or competed contracts (like the Medco contracts), collection and
 analysis of cost and pricing data, including profitability c a r J ^ to'ncreas,ed costs
 for the contractor and, ultimately, the Government. See 48 C.F.R. § 15.402(a)(3)
 ("Contracting Officers must not require unnecessarily the submission of cost and
 pricing data because it leads to increased proposal preparation costs, generally
 extends acquisition lead time, and consumes additional contractor and Government
  resources ') Thus, by cooperating with the OIG and addressing Medco s self-
 S s e d profitability solely in the context of this audit, BCBSA does not concede
 SatatsesslnTprice reasonableness requires it to request and analyze profitability
  data from its providers or other vendors before or after entering into fixed-pnce
  contracts Indeed, "a firm fixed-price contract provides for a price that is not subject
  to any adjustment on the basis of the contractor's cost experience ,n performing| the
  contort" 48 C F.R. §16.202-1 (emphasis added). Accordingly, «t is BCBSAs
   position that the price analysis it undertook for its contracts with Medco sufficiently
   established price reasonableness. See Section ll.B.




                                            Deleted by the O I G
                                      Not Relevant to the Final Report




         Pricing date includes profit appiicabie to the contract. See 48 C.F.R. § 15.401.
  Mr. Michael R. Esser
  May 5, 2006
  Page 3




                                                       Deleted by the O I G 

                                                 Not Relevant to the Final Report 





  BCBSA also contests the OIG's second Audit Finding that all rebates received by
 Medco from pharmaceutical manufacturers must be passed on to BCBSA and then
 to the FEHBP pursuant to the FAR and FEHBAR Credits Clauses, thus ignoring the
 terms of BCBSA s contracts with Medco. First, these Credits Clauses do not apply
 to firm fixed-price contracts. Although BCBSA's contract with OPM CS 1039
 incorporates the FAR and FEHBAR Credits Clauses by reference, under these
 regulations BCBSA is not obligated to pay the FEHBP any rebates other than those
 D C D S A IS entitled to receive under its contracts with Medco. Neither the Credit
 Clauses, nor any other law, regulation or guidance, or CS 1039 requires Medco to
 pass through to BCBSA (and ultimately FEHBP) all rebates Medco receives from
 pharmaceutical manufacturers. BCBSA acknowledges, however, that it is required
           6   r e       u , a t i o n s   t o   s n a r e
 ooio?        9                   a" rebates it actually receives from Medco and
 BCtJbA is confident it has complied with this requirement.




                                                       Deleted by the OIG 

                                                 Not Relevant to the Final Report 





                                                                            r o f i , a b i , i t   f o r   t h e
OPM OIG onknE 91 Jnrtf TL          V     ^       T*      ^      P        y       P ^ o d 2000 - 2002 to
fmT*i      r         P
                     '           Profitability information contained in this response differs slightly
from the information presented on April 21, 2006, as it reflects the completed work of BCBSA
consultant, Beers & Cutler.
Mr. Michael R. Esser
May 5, 2006
Page 4




                        Pages 4-14 deleted by the O I G 

                       Not Relevant to the Final Report 

Mr. Michael R. Esser
May 5, 2006
Page 15




                                Deleted by the O I G 

                          Not Relevant to the Final Report 





III.   BCBSA Did Not Fail To Credit Rebates To The FEHBP

       A.    The OIG's Draft Finding and Recommendations

The Draft Audit Report found that *'[t]he Association did not credit the FEHBP with all
credits received by Medco," and thus recommended that BCBSA should "credit the
FEHBP approximately $211 million for formulary and non-formulary rebates." The
Draft Audit Report also recommends that BCBSA "credit FEHBP with the applicable
portion of any income, rebate, allowance, or other credit to any allowable cost and
received by or accruing to Medco."

       B.     Summary of BCBSA's Response

It is BCBSAs position that it has no legal obligation to credit $211 million to the
FEHBP through application of the FAR Credits Clause or under the plain and
unambiguous terms of the 1999 or 2002 Contract between BCBSA and Medco. The
$211 million sought by the Draft Audit Report under the Credits Clause represents
the OIG's estimated difference between the total of all rebates (formulary and non-
formulary) earned by Medco in 2000-2002 and the total rebates already credited to
the FEHBP program for that time period. Because Medco had no contractual
obligation to credit rebates to BCBSA in excess of the amount required in the 1999
Mail Service Prescription Drug Benefit Contract between BCBSA and Medco (1999
Contract) or the 2002 Mail Service Prescription Drug Benefit Contract between
BCBSA and Medco (2002 Contract) (collectively referred to as "the Contracts"), and
because BCBSA did not receive any greater rebate sum from Medco, the Credits
Mr. Michael R. Esser
May 5, 2006
Page 16


Clause has no application. Equally Important, the 2005 amendments to CS 1039
support this position.

      C. The OIG Misapplies the Credits Clause

The Federal Acquisition Regulation ("FAR") Credits Clause requires that:

              The applicable portion of any income, rebate,
              allowance, or other credit relating to any allowable cost
              and received by or accruing to the contractor shall be
              credited to the Government either as a cost reduction or
                                 9
              by cash refund.

48 C.F.R. § 31.201-5 (emphasis added). The OIG finding appears to read into the
FAR requirement that BCBSA must receive and credit to the FEHBP any and all
rebates earned by Medco, irrespective of the parties' negotiated provider agreement.
Not only does this reading ignore the plain words of the Credits Clause but it also
overlooks the fact that the Credits Clause only applies to cost-based contracts.

               1.	    The Credits Clause is not applicable to a firm fixed-price
                      provider contract such as the 1999 and 2002 Contracts

While the Credits Clause applies to BCBSA's obligations under CS 1039, it does not
flow down to the provider's obligations to BCBSA unless specifically called for in the
provider's contract. As long recognized by OPM, Medco is a provider and not a CS
1039 subcontractor. The 1999 and 2002 Contracts between BCBSA and Medco are
firm fixed-price provider contracts, and Part 31 of the FAR (including the Credits
Clause) thus does not apply to Medco unless Medco and BCBSA have expressly
                                                                                       10
made the Credits Clause applicable to Schedule C, which they have not.            The
Credits Clause therefore cannot be applied to the 1999 or 2002 Contracts.

"A firm fixed-price contract provides for a price that is not subject to any adjustment
on the basis of the contractor's cost experience in performing the contract." 48
C.F.R. § 16.202-1 (emphasis added). FAR Part 31 consists entirely of principles
and procedures to be used in cost based contracting. See 48 C.F.R. 31.000. As a
result, the applicability of FAR Part 31 (including the Credits Clause) to fixed-price
9
       The FAR Credits Clause, 48 C.F.R. § 31.201-5, is made applicable to the Federal Employee
Program ("FEP") through the Federal Employees Health Benefits Acquisition Regulation ("FEHBAR"),
31 C.F.R. § 1631.201-70.
1 0
        The only instance in which the Credits Clause applies to the Contracts is where BCBSA
purchases additional services that are not priced under Schedule C and that requires Medco to
submit supporting cost or pricing data to BCBSA. See, e.g., 2002 Contract, Article 9.
Mr. Michael R. Esser
May 5, 2006
Page 17


contracts is limited to fixed-price contracts that require cost analysis either under the
terms of the contract or as a means of determining the price to be paid.          Neither
the 1999 Contract nor the 2002 Contract calls for cost analysis to determine pricing
                12
or payments Payments and credits between Medco and BCBSA were negotiated
between the parties and are solely dictated by Schedule C to the 1999 and 2002
Contracts. Thus, even the limited situation in which Part 31 principles might be
 brought to bear on a firm fixed-price contract is inapplicable to the 1999 and 2002
 Contracts and this Audit Finding. Given the inapplicability of FAR Part 31 to the
 1999 and 2002 Contracts, BCBSA is only entitled to, and can only credit the FEHBP,
 those rebates allowed by the express terms of the 1999 and 2002 Contracts.

                2.	      The Credits Clause only requires Medco to credit BCBSA with
                         rebates expressly dictated by the terms of the 1999 and 2002
                         Contracts

But even were this not the law, and the Credits Clause were found applicable to the
1999 and 2002 Contracts, it would not give the OIG the result it seeks. The Credits
Clause does not require a contractor to credit all rebates received by a
subcontractor to the Government regardless of the terms of the contract between
the contractor and its subcontractor. The Credits Clause states, "me applicable
portion" of any rebate "received by or accruing to the contractor shall be
credited to the Government." (Emphasis added.) Accordingly, for the Government
to be entitled to additional rebates from Medco beyond those negotiated in the 1999
and 2002 Contracts, those rebates must (1) relate to an allowable cost under the
contract and (2) be received by or credited to BCBSA. See Colorado Dental
 Service! ASBCA No. 2466, May 28, 1982, 82-2 BCA H 15836 ("The [Credits] clause
 restricts the right of Government recovery to refunds, rebates, or credits accruing to
 or received by a contractor.") (citing Grumman Aerospace Corp. v. United States,
 587 F.2d 498 (CI, Ct. 1978) (emphasis added)).

 The additional rebates sought by the Draft Audit Report do not meet this two-part
 test First, the FAR limits "allowable costs" to "only" those costs that comply with the
 "terms of the contract" and the other applicable cost principles of the FAR." 48
 C F R § 31 201-2. In the 1999 and 2002 Contracts, the parties negotiated a fixed-
 rate pricing arrangement, in which the price to BCBSA was tied to AWP, rather than
 a cost reimbursement calculation. See 1999 Contract, Schedule C, Section 1.1;

 11
           48 C F R § 31 102 ("iPjart 31 shall be used in the pricing of fixed-price contracts whenever
 (a) cost analysis is performed, or (b) a fixed-price contract requires the determination or negotiation of
 costs.").
 1 2
         Moreover the FAR is clear that the possible "application of cost principles to fixed-price
 contracts and subcontracts shall not be construed as a requirement to negotiate agreements on
 individual elements of cost in arriving at agreement on the total price.' Id.
Mr. Michael R. Esser
May 5, 2006
Page 18


2002 Contract, Schedule C, Section 1.2. Additionally, both Contracts fixed the
amount of rebate to be credited to BCBSA, and subsequently the FEHBP. See 1999
Contract, Schedule C, Section 1.2.5; 2002 Contract, Schedule C, Section 2.1.
Neither Contract calls for all rebates to be credited to BCBSA.

As explained in the FAR, it is the very nature of a firm fixed-price contract that the
contractor (here Medco) solely bears the financial benefit or burdens of the deal.
See 48 C.F.R. 16.202-1 ("This contract type places upon the contractor maximum
risk and responsibility for all costs and resulting profit or loss."); see also 48 C.F.R.
15.404-4(d)(1)(ii)(B) ("The Contractor assumes the greatest cost risk in a closely
priced firm fixed-price contract under which it agrees to perform a complex
undertaking on time and at a pre-determined price."). When entering into the 1999
and 2002 firm fixed-price Contracts, Medco assumed the risk that its costs might
exceed the fixed rate it promised to BCBSA, thus insulating BCBSA (and thus the
FEHBP) from any costs above the fixed rate. Conversely, and again under the
terms of the 1999 and 2002 Contracts, BCBSA was not to share in any savings
beyond the fixed rate, or in rebates other than those specifically included by the
AWP Pricing Formula. See 1999 Contract, Schedule C, Section 1.1; 2002 Contract,
Schedule C, Section 1.2.

Applying the second part of the test above, the FEHBP, under the Credits Clause, is
only entitled (via CS 1039) to rebates "accruing to or received by the contractor."
Thus, because the additional rebates sought by the OIG, by the very terms of the
Contracts between Medco and BCBSA, do not accrue to BCBSA, the FEHBP cannot
claim them via the Credits Clause. Quite simply, "applicable credits" under the FAR
does not mean "al! rebates" accruing to Medco.

The 2005 amendments to CS 1039 recognize and apply this understanding of the
Credits Clause. Under Section 1.26, the carrier must ensure that a number of
"standards" are included in new, renewing, or amended contracts with its PBM. One
of the Transparency Standards" requires PBMs to agree:

              to credit to the Health Plan either as a price reduction or
              by cash refund al! Manufacturer Payments to the extent
              negotiated, if such an arrangements exists between
              the Carrier and the PBM. Manufacturer Payments are
              any and all compensation or remuneration the PBM
              receives from a pharmaceutical manufacturer, including
              but not limited to, discounts; credits; rebates, regardless
              of how categorized; market share incentives;
              commissions; mail service purchase discounts; and
              administrative or management fees.
Mr. Michael R. Esser
May 5, 2006
Page 19


CS 1039, Section 1.26(a)(2) (emphasis added). The Transparency Standards aiso
state that "if the Carrier has negotiated with the PBM to receive all or a portion
of Manufacturer Payments" as described above, "the PBM will provide the Carrier
with quarterly and annual Manufacturer Payment Reports."       CS 1039, Section
1.26(a)(2) (emphasis added).

The PBM Transparency Standards clearly recognize the conditional nature of the
                                       14
applicability of the Credits Clause. It is only applicable "to the extent negotiated, if
such an arrangement exists between the Carrier and the PBM." BCBSA submits
that the Transparency Standards incorporate the proper understanding and
application of the Credits Clause and the PBM's and Carrier's obligations with
respect to rebate sharing. If the parties choose not to negotiate rebates, and/or the
contract states that the PBM shall retain all or some rebates, then CS 1039, which
incorporates the Credits Clause by reference, does not require the PBM to credit
such rebates to the Carrier and thus to the FEHBP.

        D.	    The OIG's Application of the 2004 10K Percentages Cannot Be
               Used To Estimate Total Rebates on FEHBP Prescriptions Earned
               by Medco During 2000-2002

As the prior discussion establishes, the FEHBP is not legally entitled to all rebates
received by Medco. Without wavering from that argument, it should be noted that
the OIG's calculation of $211 million due is a gross estimate that may be wholly
inaccurate. Medco's 2002 10K reports that Medco retained an average of 50% of
the pharmaceutical manufacturers' rebates for fiscal year 2002. The OIG appears to
have used this percentage to determine that the amount of rebate credited to the
FEHBP on Medco's Annual Statements in 2000 through 2002 is 50% of the total
SBP manufacturer rebates received by Medco. As such, the OIG appears to assert
that the FEHBP is entitled (under the OIG's flawed Credit's Clause analysis) to
double the rebates it received for the entire audit period. See Audit Inquiry regarding
Excess Profits, p.2.



 , 3
         For example, as Medco reported to BCBSA oh its 2002 Annual Statement, $93,327,351
represents all Service Benefit Plan ("SBP") Rebates received by Medco during 2002. While Medco
was required to "fully disclose all SBP Rebates received by Medco during a Contract Year" pursuant
to Article 7 3 of the 2002 Contract, there is no provision in the 2002 Contract entitling BCBSA to
receive all "SBP Rebates." The significance and inclusion of all the SBP Rebates in the 2002
Contract is only to provide BCBSA with certain defined data and audit rights. See 2002 Contract,
Article 8.
 1 4
         Although, as explained above, the Credits Clause does not apply to PBM contracts by
 operation of law. OPM may, and has chosen to, apply the Credits Clause to such contracts through
 amendment to CS 1039.
    Mr. Michael R. Esser
    May 5, 2006
    Page 20


    The OIG's application of the average rebate amount retained in fiscal year 2002 to 

           C O           C            e x p e r             e n       e   u n d e r                   ITS S
    RS th/ iS           i l            B P contracts is fatally flawed for L o reasons. 

               t h e    1 0 }         r e           r t s    t h e
    !" .       5 P°            average rebate amount retained across all lines of
                                                S       B     P                   t           h       6        1 9 9 9          a n d    2       0   0    2      C 0 n t r a c t s               T h i s
    a
    andT indeed
           E £ there
                 7 £ is no evidence
                              ^                               -
                                     that, Medco did not pay BCBSA    ^all
                                                                        e sSBP
                                                                            no Rebates
                                                                               mean
    due under the Contracts. Further, average rebates retained has little bearinfon the
    pnce reasonableness of the Contracts, as rebates are but one consideratton in
    establishing fa.r and reasonable pricing. Second, the 10K reports the average
                                                                                                           2    0   0     2             T h i S            t 0         h a S       M   e    b e a r i n    V

    i>BP                             n
         Kebates paid BCBSA for calendar      "
                                            years 2000,° 2001, and 2002
                                                                     9 on t h ar*»
                                                                        which e thPS
    reporting periods for Medco's Annual Statements.



                                 Conclusion

The O P M O I G could not expect to amend the rebate sharing formula and require
                             P    8    t h          U
nrSw      H f     K ? "                  B C B S A (and thus credit B C B I A w H h T r
                                                                  a       R   E       B   A   T   6    S   T 0



greater rebates - both as to type and total dollar value - than ever n e s t e d
                              ^ s t a n d i n g that the va!ue of the r e b a t e s "
                                                                              6           d       S C 0 U n t           o f f    A   W       P           t h a t       M   e   d   c   o   i s    wil|
BTR?A                  Th«!         j *, '                                i n g to provide
BCBSA.                 The economic deal as a whole must be considered. Thus if Medco must

    he A W P discount. As shown above "Government regulations" do not require that
    all rebates and credits should be returned to the Program" asthe O G^ asserts
                                                                                                                                                                           S   P   B   M
rebate's to L FEHBPT          T    *? ^          **** *                     ^ cS?5
rebates to the F E H B P . To the contrary, both CS 1039, the F A R , and the F E H B A R
simply require that those rebates due to                                                                                      BCBSA                           under the term of ts^Contracts

^          ^            ^                   ^                 * *"                                                               ^                            «*   M
                                                                                                                                                                                       ^          ^        —

We appreciate the opportunity to provide our response to this Draft Audit Report and
request- that our comments be included in their entirety as part of the Find Audft