The Department of Veterans Affairs (VA) and the Department of Defense (DoD) comprise the largest health care system today in the United States. In fiscal year 1997, the DoD spent $15.5 billion on the Defense Health Program and the VA spent $17.7 billion on medical care expenditures. These systems offer tremendous opportunities to suppliers and manufacturers of medical, surgical, pharmaceutical, and other health care supplies and equipment. Moreover, although these systems offer financially rewarding opportunities, they are also difficult to navigate and require an understanding of the law as well as careful planning. This article highlights some of the opportunities and pitfalls awaiting health care contractors.
The Department of Veterans Affairs
A. Federal Supply Schedules
The VA, by a delegation of authority from the General Services Administration, purchases the majority of its health care supplies through the use of the Federal Supply Schedule (FSS). This program permits the VA to purchase health care supplies from multiple contractors. Each contract is individually negotiated between the VA National Acquisition Center and the contractor. Moreover, the VA has begun to develop an "open season" which permits the VA to enter into contracts on an ongoing basis rather than during a specific time period.
The VA administers the following schedules:
- Medical Supplies
- Dental Equipment and Supplies
- Pharmaceuticals
- Invitro Diagnostics and Reagents
- Medical Equipment
- Pacemakers
- Antibacterial Soap
- Wheelchairs
- Cost-per-test Laboratory
- Subsistence
- New Item Introductory Schedule
- X-ray Equipment and Supplies (Including Medical/Dental X-ray Film)
Entities in addition to the VA can purchase off of a FSS contract. These entities include: DoD, the Public Health System (PHS), the Bureau of Prisons, State Veterans Homes with sharing agreements with a VA facility and the Coast Guard.
B. Blanket Purchase Agreements
Contractors who enter into a FSS contract with the VA may also enter into a Blanket Purchase Agreement (BPA). A BPA is "a simplified method of filling anticipated repetitive needs for supplies or services by establishing 'charge accounts' with qualified sources of supply." The government may use a BPA when there is a need for a wide variety of items, but the exact items, quantities, and delivery requirements are not known in advance; when there is a need for commercial source of supply for offices that do not have purchase authority; or to reduce the administrative burden of writing numerous purchase orders. In a BPAs, the contractors may offer additional volume-based discounts. Moreover, the contractor can enter into a BPA with a VA hospital, one of the Veterans Integrated Service Networks (VISNs), or the entire system.
C. The National Formulary
During the past few years, the VA has begun to standardize the procurement of pharmaceutical and medical/surgical items in order to achieve concentrated buying power. Because the VA expends nearly $1 billion in the procurement of pharmaceuticals each year, "the VA seeks to accomplish its 'greater goals of quality care, access, customer service, and cost efficiency' by creating 'national formularies' for various drugs." The National Formulary program offers contractors the opportunity to be the sole supplier of one product to be used nationally. The VA contends that this standardization will reduce the costs of procurement.
The VA has awarded several national contracts, including contracts for H2 Antagonists, LHRH Antagonists, Proton Pump Inhibitors, HMG CoA Reductase Inhibitors, ACE Inhibitors, Alpha Blockers, Nifedipine, and Diltiazem. A national contract is typically for one-year with four one-year options.
A recent development may have lasting effects upon contractors. In May 1998, the DoD announced its Basic Core Formulary (BCF). The DoD stated its version of the National Formulary would involve collaborating with the VA. Indeed, the recent procurements for Diltiazem and Albuteron were a joint effort of the DoD and VA. It remains to be seem whether this is a continuing trend in government procurement.
D. Prime Vendor Program
Both the VA and DoD maintain Prime Vendor programs. A prime vendor is a contractor who acts as a distributor on behalf of the government, taking orders from and delivering products to customers within its region. There are different prime vendors for pharmaceuticals and medical/surgical items. Contractors who hold a FSS contract or Distribution and Pricing Agreement (DAPA) agree to permit the prime vendor to distribute their product and charge the prime vendor the agreed-upon price.
THE DEPARTMENT OF DEFENSE
A. Distribution and Pricing Agreements
Although the DoD can purchase equipment off of the FSS schedules administered by the VA, it also maintains its own procurement system through DAPAs. The Directorate of Medical Material (Medical Directorate) located at the Defense Supply Center-Philadelphia (DSCP) administers DAPAs. Contractors can submit a DAPA for approval on an ongoing basis and the Medical Directorate negotiates prices with the potential contractor like the VA does. The Medical Directorate examines proposed DAPAs for price reasonableness and seeks the most favored customer price under similar terms and conditions. Often, negotiations result in setting the DAPA price at the FSS contract price. The length of a DAPA is five years.
DAPAs offer more flexibility for contractors than FSS contracts do. First, DAPAs do not contain a price reduction clause and do not require the maintenance of a price or discount relationship during the contract. Under DAPAs, however, the government may request additional pricing information at any time to support the negotiations and reserves the right to terminate the agreement at any time. Second, DAPAs do not contain a price adjustment clause, which entitles the government to reduce a contract price for failure to provide accurate information. Last, DAPAs may be canceled by either party for any reason with 30 days' notice.
POTENTIAL AREAS OF VULNERABILITY
Although contracting with the government yields numerous financial benefits, it is also fraught with potential difficulties. Indeed, a complex series of regulations govern the creation and administration of government contracts. Some of the most common issues targeted by the VA and DoD Offices of Inspector General are discussed below.
A. Failure to Disclose Current, Accurate, and Complete Discount Information at the Time of Contracting
When a potential VA FSS contractor submits an offer to the government, it is required to submit a Commercial Sales Practice (CSP) sheet. This sheet requires, inter alia, that the potential contractor disclose any discounts which are equal to or better than the discount offered to the government. It is important to note that disclosing a discount does not mean the potential contractor must offer that discount to the government. Instead, the contractor negotiates a price with the government, with the government's negotiation objective being "most favored customer" status.
The regulations state that the information provided on the CSP sheet to the VA must be current, accurate and complete. If the government learns during the course of the contract (usually through an audit by the Inspector General) that the negotiated price was significantly increased because the contractor failed to provide required information, failed to submit accurate, current, and complete information, or failed to disclose changes which occurred after the original submission and before the completion of negotiations, the government may reduce the negotiated price. The contractor is therefore charged with "defective pricing" and must repay the VA the amount of the overpayment and simple interest. For purposes of this clause, information provided by the contractor is satisfactory so long as it is current, accurate, and complete fourteen days before the conclusion of negotiations. The contractor must therefore periodically update the information provided on the CSP sheet during the course of negotiations.
B. Failure to Offer Discounts to the Government During the Contract
The VA FSS contracts include the price reduction clause which obligates the contractor to ensure that, throughout the duration of the contract, the government continues to receive the price/discount advantage that it originally negotiated relative to the Customer(s) of Comparability (CoC) upon which the award was predicated. If a contractor reduces its price to the CoC at any time during the contract, the government must be notified of the reduction and the contractor must offer the same reduction to the government. The contractor must notify the government within fifteen days of the reduction's effective date.
Several different types of events can trigger the price reduction clause. Generally, any program that may result in a discount to the CoC should be offered to the government even if it is unclear that the government is eligible or the CoC will earn the discount. More specific examples include:
- reduction of the prices contained in the commercial catalog, price list, or schedule used to establish contract prices;
- granting a price reduction to the CoC which disturbs the price/discount relationship;
- granting the CoC more favorable terms and conditions;
- an FSS price increase approved by the Contracting Officer under the Economic Price Adjustment Clause if the price/discount relationship is disturbed; and
- granting temporary promotional discounts to the CoC which disturbs the price/discount relationship.
Failure to disclose a price reduction can result in the government taking the price reduction, even if the government would not be entitled to receive the price reduction otherwise. It may also result in termination of the contract for default and a potential civil or criminal action under the False Claims Act. Failure to report in a timely manner is unlikely to result in these penalties unless the VA has reason to believe fraud has been committed.
C. Failure to Comply with the Veterans Health Care Act
The Veterans Health Care Act (VHCA) requires pharmaceutical companies to list their covered drugs on the FSS, as a condition of continued participation in the Medicaid program. Moreover, the VHCA requires that the contractor enter into a Master Agreement with the VA. This agreement requires companies to list covered drugs on the FSS at or below a calculated Federal Ceiling Price (FCP). Further, for each covered drug listed on the FSS, the manufacturer must enter into a Pharmaceutical Pricing Agreement (PPA) with the VA that restricts prices to the calculated FCP for the VA, DoD, PHS, Indian Health Service, and Coast Guard.
Contractors are most likely to run afoul of the VHCA by miscalculating the FCP. The FCP is equal to 76 percent of the Non-Federal Average Manufacturers Price (Non-FAMP) minus an additional discount. The Non-FAMP is the weighted average price paid by wholesalers, taking into account any cash discounts or similar price reductions, but not taking into account prices paid by the government, nominal prices, and returned goods. It is essential that the contractor be able to calculate the Non-FAMP and FCP accurately. A failure to calculate the FCP correctly can result in a government claim for any increased costs.
Some of the issues that can pose difficulties for contractors include:
- Nominal prices may be excluded from the Non-FAMP calculation.
- Nominal prices are no more than ten percent of the previous quarter's. • Non-FAMPs are usually below cost, designed to benefit the public by financially aiding disadvantaged, not-for-profit covered drug dispensaries, or researchers using a drug for an experimental purpose.
- Sales to Section 602 entities do not have to be included in Non-FAMP calculations.
- The VA may permit companies use smoothing or accrual processes that eliminate sales fluctuations from quarter to quarter.
- The prompt payment discount is applied to gross wholesale sales.
- Rebates paid to wholesalers must be included in the Non-FAMP calculations.
- Returns can be excluded from the Non-FAMP calculation if records are available for verification.
- Drug samples allowed by 21 U.S.C. 353 do not need to be included in Non-FAMP calculations.
- Free goods contingent upon any written or verbal commercial agreement are not considered exempt from inclusion in the Non-FAMP calculations.
D. The Government's Audit Authority
The VA FSS contract also contains a clause which permits the VA to examine any books, documents, papers, computer tapes, and any other directly pertinent records related to the contract for over billings, billing errors, compliance with the price reduction clause, and compliance with the Industrial Funding Fee. The VA may conduct post-award audits for these reasons until three years after final payment.
The VA may also modify the examination of records clause in certain situations to include two year post-award audit rights to investigate suspected price adjustment clause violations. After modifying the clause, the VA can verify whether the pre-award/modification pricing that formed the basis of the award was accurate, complete, and current at the time of award.
DEVELOPING A COMPLIANCE PROGRAM
Many of the potential problems discussed above can be averted by developing a corporate compliance program. Moreover, government auditors, routinely review compliance programs in place during an audit. Indeed, if a contractor runs afoul of the law, a compliance program is often a mitigating factor when the government determines what type of punishment is appropriate.
A compliance program should include both a statement of policies and procedures. The statement of policies should set forth the principles to which the contractor adheres when it enters into a contract with the government. Appropriate sections for this section include: a statement banning gifts to the government, the importance of providing accurate data to the government, and training provided to applicable personnel. The statement of procedures, by contrast, should contain a detailed, step-by-step analysis of a CSP sheet, the FCP, and other reports that the government requires. A well-developed compliance program will help avert many of the potential liabilities a contractor faces when it does business with the government.