The deal, which will replace the current pricing scheme for branded medicines, will limit growth in the NHS drug bill to 0% for two years, followed by increases of under 2% for the following three years.
The pharmaceutical industry will 'absorb' any additional cost beyond this limit, the DH said.
But plans to reform the way NICE appraises new medicines have been delayed by several months.
The NHS spent £12bn on branded medicines in 2011/12, and spending has risen 5% per year on average over previous years, according to the DH. It said the deal would lead to 'significant savings'.
Health secretary Jeremy Hunt said: 'This agreement ensures NHS patients will receive the best and most advanced medicines in the world while managing the cost.
'UK pharmaceutical companies have responded to the challenges we face as a country, both in terms of the increased demand for medicines and pressure on public spending. I hope in return we have given them the certainty and backing they need to flourish as a sector both here and in the global market.'
The deal follows negotiations between the DH and the Association of the British Pharmaceutical Industry (ABPI). It will apply across the whole of the UK.
The programme remains voluntary, but the DH has said the statutory scheme for companies that do not take part will ensure a 15% price cut for the NHS.
ABPI president Deepak Khanna said: 'This has been a very challenging and long negotiation and it should not be underestimated how tough this deal is for the industry. However, we have agreed to play our part in recognising the financial challenges facing the NHS whilst focusing on the key issue of ensuring that patients in the UK get access to the medicines they need.'
However, a new scheme to replace NICE's current system of drug appraisal has been delayed until autumn 2014.
Value-based pricing was due to begin in January, but has been hit by delays and will now begin in the autumn after a public consultation.
Under the scheme, NICE was due to appraise new drugs based on the wider value to the NHS, with the DH set to negotiate prices with the pharmaceutical industry. However, details on how this would operate have been scarce.
In January 2013, a House of Commons health select committee report said it was 'unacceptable' that proposed value-based pricing changes were still not explained despite government plans to implement the measures in less than 12 months.
GP leaders criticised the plans as 'smoke and mirrors'.