Earlier this week, the President signed into law the National Defense Authorization Act for Fiscal Year 2008 (DAA), which includes a section intended to enable the Department of Defense (DoD) to access deeply discounted government pricing for innovator drugs and biologics dispensed at retail pharmacies to members of the U.S. armed forces, their dependents, and military retirees. The DAA applies to prescriptions dispensed on or after the date of its enactment.

The President rejected an earlier version of the legislation late last year, having objected to provisions that were unrelated to the new Tricare retail pharmacy program. The section relating to the retail program was left intact in the revised version of the DAA; it continues to require DoD to modify its regulations to implement the program by December 31, 2007.

Section 703, titled “Inclusion of Tricare Retail Pharmacy Program in Federal Procurement of Pharmaceuticals,” provides:

(a) In General- Section 1074g of title 10, United States Code, is amended—

(1) by redesignating subsections (f) and (g) as subsections (g) and (h), respectively; and

(2) by inserting after subsection (e) the following new subsection (f):

(f) Procurement of Pharmaceuticals by TRICARE Retail Pharmacy Program - With respect to any prescription filled on or after the date of the enactment of the National Defense Authorization Act for Fiscal Year 2008, the TRICARE retail pharmacy program shall be treated as an element of the Department of Defense for purposes of the procurement of drugs by Federal agencies under section 8126 of title 38 to the extent necessary to ensure that pharmaceuticals paid for by the Department of Defense that are provided by pharmacies under the program to eligible covered beneficiaries under this section are subject to the pricing standards in such section 8126.

(b) Regulations - The Secretary of Defense shall, after consultation with the other administering Secretaries under chapter 55 of title 10, United States Code, modify the regulations under subsection

(h) of section 1074g of title 10, United States Code (as redesignated by subsection (a)(1) of this section), to implement the requirements of subsection (f) of section 1074g of title 10, United States Code (as amended by subsection (a)(2) of this section). The Secretary shall so modify such regulations not later than December 31, 2007.

Under current law, 38 U.S.C. § 8126 (the Veterans Health Care Act of 1992 or VHCA), manufacturers offer deeply discounted pricing on procurements by VA, DoD, and certain other Federal agencies as a precondition to having Federal funding made available to pay for their drugs under Medicaid, Medicare Part B, and certain other programs. VHCA requirements are implemented vis-à-vis individual manufacturers through a Master Agreement, which is a contract between the manufacturer and the Department of Veterans Affairs (VA). The terms of the Master Agreement require the manufacturer to make its products available for procurement on VA Federal Supply Schedule (FSS) contracts at prices that are equal to or less than “Federal Ceiling Prices” (FCPs). The Master Agreement also provides that the manufacturer will charge no more than FCPs on any “depot” contracts that it enters with DoD and other covered Federal agencies. FCPs are calculated pursuant to a statutory formula that yields pricing that is at least 24% less than average commercial “wholesaler” pricing.

Beneficiaries of DoD’s Tricare health plan – including members of the U.S. armed forces, their dependents, and military retirees – can have prescriptions filled in three venues: (1) military treatment facilities (MTFs), (2) mail order pharmacy, and (3) retail pharmacies. Under the VHCA, DoD has been able to purchase drugs off of FSS contracts at prices that are equal to or lower than FCPs for its MTFs and mail order pharmacy program. However, thus far DoD has not been able to access FCPs for its retail pharmacy program. Unlike with MTFs and mail order, where DoD purchases the drugs and stocks its own pharmacies, in the retail sector, retail pharmacies buy the drugs through standard commercial channels. DoD then pays (reimburses) the pharmacies for drugs dispensed to its beneficiaries through its Pharmacy Benefit Management (PBM) contractor.

Through Section 703 of the DAA, DoD will seek to access FCPs for drugs and biologics dispensed in the retail pharmacy sector by obtaining rebates from manufacturers. DoD expects to realize savings of $1.8 billion over the next 5 years through application of this rebate program.1

By way of background, DoD’s attempts to access FCPs for its Tricare retail pharmacy program date back many years. Industry was notified about the most recent attempt through a VA “Dear Manufacturer Letter” in 2004. In that letter, VA announced that it considered DoD’s revamped Tricare retail pharmacy program (TRRx), involving payment of network retail pharmacies with Federal funds by a DoD PBM contractor, to be a “virtual depot” subject to the VHCA’s FCP-based price caps. Accordingly, the VA concluded that manufacturers would be required to provide quarterly rebates on Tricare retail utilization provided by DoD. The rebates would be calculated as the difference between an average wholesaler price and applicable FCPs.

In March 2005, a trade association filed a petition for review in the United States Court of Appeals for the Federal Circuit (Federal Circuit) seeking to invalidate the VA’s letter implementing the TRRx rebate program. On September 11, 2006, the court set aside the letter, holding that the VA did not follow proper procedural notice-and-comment rulemaking requirements when implementing the program. As a result of that decision, manufacturers were no longer required to pay rebates based on Tricare retail utilization, and DoD refunded rebates previously paid.

DoD then turned to Congress for assistance in accessing FCPs for its retail pharmacy network. By deeming the Tricare retail pharmacy program to be part of DoD for purposes of the VHCA, Section 703 is intended to apply VHCA price ceilings to the retail sector – presumably by way of a rebate program that would resemble the now-defunct TRRx program. As noted previously, under Section 703, DoD is required to modify its regulations to implement this program by December 31, 2007. Given that this date has already passed and that DoD is eager to obtain retail savings, it is expected that DoD will move quickly to issue the regulations.

It is possible that, as in 2004, VA will consider the Section 703 retail pharmacy program to be a “depot” contracting program that is covered by the VHCA FCP requirement and will require manufacturers to pay rebates on Tricare retail utilization under their current Master Agreements.2 It is not clear, however, whether implementation in this manner would withstand legal scrutiny. It is also possible that DoD’s regulations for the new program could contemplate implementation by way of separate agreements between manufacturers and DoD or some other means independent of the Master Agreements.