Drug Spending Glossary

© iStockphoto

This glossary was expanded on November 30, 2017.

Drug spending is a complex issue that involves a range of products, policies, and stakeholders across the health care system. Understanding the many factors that affect drug spending is critical to grasping how pharmaceuticals are priced and purchased. These definitions provide a frame of reference when examining the drug spending debate.

340B Drug Pricing Program. A federal program that requires drug manufacturers to provide discounted prices on covered outpatient drugs—including prescription drugs and biologics other than vaccines—to certain health care providers and hospitals that provide health services to many low-income uninsured people, Medicaid enrollees, and other vulnerable populations.

Active ingredient. An ingredient in a drug that provides pharmacological activity or other direct effect in the diagnosis, cure, mitigation, treatment, or prevention of disease. Some medications contain more than one active ingredient.

Average manufacturer price (AMP). Used to calculate drug rebates for the Medicaid program and prices for the federal 340B program. There are two methods used to calculate the AMP: For most drugs, AMP is the average of the prices paid to manufacturers for drugs distributed or sold directly to retail community pharmacies. This method includes discounts and rebates to wholesalers and retail community pharmacies but not to any other entities, including insurers, pharmacy benefit managers, hospitals, governmental bodies, or outpatient clinics. For 5i drugs—medications that are inhaled, infused, instilled, implanted, or injected—an alternate AMP calculation (5i AMP) is used if at least 70 percent of units are not sold through retail community pharmacies. 5i AMP includes sales and associated discounts and rebates to many entities excluded from standard AMP—including physicians, pharmacy benefit managers, insurers, hospitals, outpatient clinics, and mail-order pharmacies. The AMP and 5i AMP are confidential prices, calculated monthly and quarterly.

Average sales price (ASP). Used to determine the publicly available price for drugs reimbursed by Medicare Part B. The ASP uses the Medicaid best price standard to determine which sales to include in the average. The ASP is the quarterly average of the manufacturer’s sales, net of rebates, discounts, and other price concessions of a drug to all purchasers included in best price, divided by the total number of units of the drug sold to those purchasers in that same quarter.

Average wholesale price (AWP). Described as the “sticker price,” the AWP is a benchmark used for the pricing and reimbursement of prescription drugs for public and private payers. The publicly available price does not include discounts or rebates and rarely reflects the actual price paid for a drug.

Biologic. A drug made up of proteins or other materials derived from living cells through a complex manufacturing process. There are no clinically meaningful differences between a biosimilar, or highly similar “follow-on” drug, and the reference biologic product in terms of safety, purity, and potency. Biologics are used to treat a wide range of health conditions, including cancer, rheumatoid arthritis, and multiple sclerosis.

Biologics Price Competition and Innovation Act. A component of the Affordable Care Act, it creates an abbreviated approval pathway for biosimilar and interchangeable biological products while providing biologics with 12 years of protection from biosimilar competition.

Biosimilar. A follow-on drug that is highly similar to an FDA-approved biologic. Like generic versions of conventional drugs, biosimilars are intended to reduce prices by creating competition in the marketplace.

Brand drug. A product originally discovered and developed by a pharmaceutical company, and marketed under a proprietary, trademark-protected name.

Centers for Medicare & Medicaid Services (CMS). A federal agency within the U.S. Department of Health and Human Services that administers the Medicare program and works in partnership with state governments to administer Medicaid, the Children’s Health Insurance Program (CHIP), and health insurance portability standards.

Children’s Health Insurance Program (CHIP). A public health program for uninsured children in families with incomes too high to qualify for Medicaid. States implement the program, with approval and joint funding from the federal government.

Clinically comparable. Term for two drugs for which there are no clinically meaningful differences in terms of safety and effectiveness.

Coinsurance. A percentage share of the cost that patients pay for prescriptions or services covered by their health insurance. For example, if an insurer charges 30 percent coinsurance for a $100 prescription drug, the patient’s out-of-pocket cost is $30.

Copayment. A flat dollar amount that patients pay for prescriptions or services covered by their health insurance.

Cost-effectiveness analysis. A form of economic analysis that compares the relative costs and outcomes of different treatments.

Coupon. A voucher intended to help consumers save money on prescription drugs. They are offered by drug companies or distributed to consumers via doctors and pharmacists, and many can also be obtained online. Drug coupons are commonly offered for new products to stimulate demand by reducing copays for new drugs. They can also help incentivize use of a drug that is not covered by insurance.

Deductible. A fixed amount, usually expressed in dollars in the form of an annual fee, that the beneficiary must pay for health services or products before a health insurance plan begins to provide coverage.

Drug class. A set of medications grouped together based on a common active ingredient (or ingredients) or by pharmacologic or therapeutic class. (See definitions below.)

Drug Price Competition and Patent Term Restoration Act. Informally known as the Hatch-Waxman Act, this 1984 federal law created a streamlined generic drug approval process to facilitate access to lower-cost therapies while providing manufacturers of new drugs a period of protection from generic competition.   

Effective price. The per-unit cost of a drug after accounting for rebates, discounts, and other price concessions negotiated between drug companies and payers such as insurance companies or health plan sponsors. The effective price, also known as a net price, the effective price is not publicly available.

Employer-sponsored coverage. Health insurance provided through an employer, which may cover employees, their families, and retirees.

Exclusivity. The period during which the manufacturer of a new FDA-approved drug has exclusive marketing rights and no competing generic or biosimilar versions of the product may be approved. The typical exclusivity period is 12 years for biologics and five years for traditional drugs.

Federal Trade Commission. An independent agency of the United States government tasked with promoting consumer protection and the elimination and prevention of anticompetitive business practices.

Food and Drug Administration. A federal agency of the U.S. Department of Health and Human Services tasked with protecting and promoting public health through the control and supervision of food safety, tobacco products, dietary supplements, prescription and over-the-counter pharmaceutical drugs, vaccines, biopharmaceuticals, medical devices, and other consumer products. 

Formulary. A list of brand-name and generic drugs that payers cover, typically organized in tiers. Patients are required to pay different out-of-pocket costs for drugs in different tiers.

Generic drug. A drug that is identical to a traditional brand-name drug in dosage, safety, strength, route of administration, quality, performance characteristics, and intended use.

Indication. A particular use for a diagnostic, treatment, or drug. For example, insulin is indicated—or prescribed—to treat diabetes. FDA approves each drug for one or more indications.

Interchangeable biosimilar. A biological product is deemed interchangeable by FDA if it produces the same result as a reference biologic in any given patient, and if there is no safety risk or diminished efficacy in switching. In many states, an interchangeable biosimilar may be substituted for the reference biological product by a pharmacist without requiring the intervention of the health care provider who prescribed the reference product. Laws that govern automatic substitution at the pharmacy level vary by state.

List price. Often referred to as the “sticker price,” a drug’s list price is the wholesale acquisition cost or the amount at which a manufacturer publicly prices a drug. This price is rarely reflective of the actual costs paid and serves as a starting point for negotiations between manufacturers and payers.

Mechanism of action. The specific process through which a drug produces its pharmacological effect.

Medicaid. A public health program jointly administered by the federal government and states that primarily serves low-income people (children, parents, and, in some states, other adults) and some medically needy patients.

Medicaid Best Price. A provision under the Medicaid Drug Rebate Program that is triggered when a manufacturer offers a larger discount to an eligible customer than the standard Medicaid rebate amount (23.1 percent for most brand-name drugs). Manufacturers must identify the “best price” (the lowest price) of all discounts greater than the standard Medicaid rebate amount; this price will replace the 23.1 percent basis for calculating the total Medicaid rebate. Sales only to wholesalers, retailers, providers, HMOs, and certain nonprofits, and government agencies can establish best price, with rebates or discounts to pharmacy benefit managers not included, among other exceptions. Best price is not publicly available.

Medicare. A public health program administered by the federal government for people over the age of 65 or with permanent disabilities. Medicare has four “parts” that provide health services for beneficiaries. (See Medicare Part A, Medicare Advantage, Medicare Part B, and Medicare Part D.)

Medicare Part A. Also known as the hospital insurance program, Part A of the Medicare program covers inpatient hospital care, skilled nursing care for up to 100 days after a hospitalization, home health care, and hospice care. Part A is primarily funded by a payroll tax on earnings.

Medicare Advantage. A part of Medicare designed to offer beneficiaries a choice of managed care and other private plan options. Also called Part C of Medicare, Medicare Advantage encompasses health maintenance organizations (HMOs), preferred provider organizations (PPOs), Medicare health savings accounts (HSAs), regional PPOs, and other options. Medicare Advantage plans can combine prescription drug benefits (Part D) with coverage of other items and services typically included in Medicare Part A and Part B. Not all options are available in all areas. Part C is not financed separately and combines funding from Part A, Part B, and, when applicable, Part D. 

Medicare Part B. Also known as supplementary medical insurance, Part B of Medicare covers physician services, outpatient care, and home health care after 100 visits. It is funded partly by premiums paid by beneficiaries. The rest comes from the federal government’s general revenue. Part B covers drugs provided in a doctor’s office and an outpatient hospital setting, including physician-administered medicines.

Medicare Part D. An outpatient prescription drug benefit available to Medicare beneficiaries. For those who enroll, this benefit helps pay for drug costs and offers additional financial assistance through the low-income subsidy (LIS) program for beneficiaries with low incomes and modest assets. Part D plans are administered through private insurance companies, and patients can choose which plan best suits their needs. Part D is financed by general revenues, premiums, and state payments for people dually eligible for both Medicare and Medicaid.

National average drug acquisition cost (NADAC). The average price pharmacies pay to acquire a drug from a wholesaler or manufacturer. The NADAC is calculated from CMS’ monthly surveys of retail pharmacies. NADAC includes only the discounts received by pharmacies at a drug’s acquisition; it does not include subsequent discounts or rebates from manufacturers to wholesalers or pharmacies.

Off-label use. The use of a drug for indications that have not been approved by the relevant regulatory authority, such as FDA. Off-label prescribing is legal and can be used in scenarios when patients have few approved treatment options, such as for some cancers or rare diseases.

Orphan drug. A drug intended to treat a condition affecting fewer than 200,000 people in the U.S. or affecting more than 200,000, provided that the drug is not expected to recover the costs of developing and marketing. The Food and Drug Administration Orphan Drug Designation program confers orphan status to drugs and biologics intended for treatment, diagnosis, or prevention of rare diseases or conditions meeting these criteria. Designated orphan drugs receive numerous federal benefits, including tax credits for research, exclusion from required 340B discounts, and seven-year marketing exclusivity upon approval.

Out-of-pocket costs. Expenses for medical care, including prescription drugs, that aren’t reimbursed by insurance—including deductibles, coinsurance, and copayments for covered services, plus all costs for services that aren’t covered.

Out-of-pocket maximum. An annual limit on how much an individual has to pay for health services and products in a year, after which the health plan pays 100 percent of benefits. This includes deductibles, coinsurance, and copayments but excludes the premium.

Patent term.

• For applications filed on or after June 8, 1995, the patent term is 20 years from the filing date of the earliest U.S. or international application to which priority is claimed (excluding provisional applications).
• For applications filed before June 8, 1995, and for patents that were still in force on June 8, 1995, the patent term is either 17 years from the issue date or 20 years from the filing date of the earliest U.S. or international application to which priority is claimed (excluding provisional applications), the longer term applying.

Payers. Entities other than patients responsible for paying for health care costs. In the United States, payers generally include insurance companies, health plan sponsors—such as employers or unions—and pharmacy benefit managers. The nation’s largest payer is Medicare.

Pharmacologic class. A group of active moieties (i.e., parts of molecules) that share scientifically documented properties and are defined on the basis of any combination of three attributes: 1) mechanism of action, 2) physiologic effect, and 3) chemical structure.

Pharmacy benefit manager (PBM). A third-party administrator of prescription drug programs for insurance companies. PBMs often process pharmacy benefit claims, develop and maintain formularies, and negotiate prescription drug prices with drug manufacturers. In the United States, PBMs manage prescription drug programs for commercial health plans, self-insured employer plans, Medicare Part D plans, the Federal Employees Health Benefits Program, and state government employee plans.

Preferred drug list. A medication list developed by a prescription drug plan indicating certain drugs as “preferred,” given their clinical significance and overall efficiencies.

Preferred pharmacy network. A group of pharmacies that provide prescription drug plans with a larger discount than other network pharmacies in exchange for a greater share of the drug plan’s business. Prescription drug plans provide consumers lower copays or coinsurance as an incentive to use preferred pharmacies.

Premium. The amount a health plan enrollee or sponsor—such as an employer—pays to an insurer for health coverage, including drugs.

Rebate. A reduction of a drug’s price that is intended to increase sales. While the method used to calculate the rebate is specified at the time of purchase, the actual rebate is received in the future, as rebates are based on product sales.

Sole-source drug. Drugs eligible for generic competition but for which there is only one FDA-approved manufacturer marketing the product, either brand or generic. 

Specialty drug. No agreed-upon definition exists for a specialty drug. Therefore, Pew classifies specialty drugs as medications with high costs for a course of treatment or a year of therapy.

Substitution. The practice of replacing one prescribed drug with another that is expected to have the same clinical or psychological effect. Depending on state laws, generics can be automatically substituted for brands at the pharmacy. In some cases, pharmacists can also substitute a therapeutic alternative for a physician-prescribed drug without consulting the physician.

Therapeutic alternative (also referred to as a therapeutic equivalent). A drug that is either not chemically identical to another drug or in the same pharmacologic class, but has similar effects when given in therapeutically equivalent doses.

Therapeutic class. A group of drugs used to treat the same disease or condition.

United States Patent and Trademark Office. An agency in the U.S. Department of Commerce that issues patents to inventors and businesses for their inventions, including drugs, and trademark registrations for products and intellectual property identification.

User fee. A payment charged to fund aspects of the FDA review process. FDA has several user fee programs, in which the agency collects payments from companies developing brand pharmaceuticals, generic drugs, medical devices, and other products in order to review, inspect, and approve product applications for marketing. Congress regularly reauthorizes user fee legislation—including the Prescription Drug User Fee Act (PDUFA), the Generic Drug User Fee Act (GDUFA), and the Biosimilar User Fee Act (BsUFA)—to authorize FDA to collect fees from manufacturers. 

Utilization. A measure of the amount of use of health care items and services, including drugs.

Veterans Health Administration (VA). A part of the U.S. Department of Veterans Affairs that administers a public medical assistance program serving veterans. The VA manages its drug benefit through a restricted formulary that is developed, in part, through mandated discounts. The VA administers drug-purchasing programs for other government purchasers, including a series of mandated discounts available to the VA, Department of Defense, Indian Health Service, and Coast Guard (the “Big 4”), and a separate negotiated pricing structure for other federal purchasers (the Federal Supply Schedule.

Wholesale acquisition cost.​ A publicly available list price posted by manufacturers. The price does not include discounts or rebates from manufacturers to wholesalers or pharmacies.

Wholesaler. An entity engaged in wide distribution of prescription drugs from manufacturers, usually to retail community pharmacies, distributors, and others responsible for distributing pharmaceuticals.