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 220.127.116.11 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
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)