Prescription Drug Coverage Under Medicaid

Prescription Drug Coverage Under Medicaid
Updated February 6, 2008
Jean Hearne
Specialist in Social Legislation
Domestic Social Policy Division

Prescription Drug Coverage Under Medicaid
Medicaid is a joint federal-state entitlement program that pays for services on
behalf of certain groups of low-income persons. One of its most important benefits
is prescription drug coverage. As of January 2006, many of Medicaid’s elderly and
disabled beneficiaries began receiving their drug coverage under Medicare.
Nonetheless, Medicaid continues to be an important source of funding in the nation’s
pharmaceutical markets, and Medicaid drug coverage an important source of drugs
for many low-income and disabled Medicaid beneficiaries.
Outpatient prescription drug coverage under Medicaid is an optional benefit.
If states choose to cover prescription drugs, they must be provided to Medicaid
enrollees who are categorically needy, that is, to individuals who qualify for
Medicaid on the basis of being in certain groups. In addition, states have the option
of choosing to provide prescription drug coverage to medically needy individuals,
persons who are not poor by cash welfare standards, but who require help with
medical expenses. Thirty-three states and the District of Columbia provide
prescription drug coverage to all Medicaid beneficiaries.
Prescription drug benefits under Medicaid are very broad. States can create
formularies, or lists of preferred benefits, but certain federal rules keep actual
coverage very comprehensive. Even in Medicaid managed care organizations, which
are not subject to those rules, current practice ensures a generous drug benefit. There
are 11 categories of prescription drugs that states are allowed to exclude from
Based on state financial reports for 2005, payments for Medicaid outpatient
prescription drugs, net of all rebates (federally required rebates plus state
supplemental rebates), were $30.7 billion, accounting for just over 10% of payments
for all Medicaid services. Since 1990, pharmaceutical manufacturers whose drugs are
covered by state Medicaid programs are required to rebate a portion of states’
payments for their products. States reported collecting a total of $11.1 billion in
federal rebates and an additional $1.3 billion in state supplemental rebates on
prescription drugs in 2005. On average, in 2005, per-person spending for Medicaid
drugs was just over $1,500.
The Deficit Reduction Act of 2005 made a number of changes to the program’s
rules, primarily relating to the financing of drugs, the definition of average
manufacturer’s price (AMP), and the cost sharing amounts that states are able to
require Medicaid beneficiaries to pay for these drugs. CMS regulations providing
instructions to states on implementing the new AMP, however, have been enjoined
from being implemented while awaiting the outcome of a lawsuit brought by
associations of pharmacists.

In troduction ......................................................1
Prescription Drug Benefits.......................................3
Fee-for-Service Coverage...................................4
Managed Care Coverage....................................5
Over-the-counter (OTC) Medications..........................5
Prescription Drugs: Pricing Policies and Rebates.........................6
Medicaid Drug Payments and Federal Upper Limits...................6
FULs for Multiple Source Drugs..............................7
Upper Limits for all Other Drugs..............................8
States’ Payment Formulas.......................................8
Dispensing Fees..............................................11
Medicaid Drug Rebates........................................11
Single Source and “Innovator” Multiple Source Drugs............12
“Non-Innovator” Multiple Source Drugs.......................13
Drug Pricing and Rebate Issues..................................15
Average Wholesale Prices..................................15
Circumventing the Best Price or Rebate Policies................15
Supplemental Rebates.....................................17
Policies to Control Drug Cost and Use............................17
Prior Authorization.......................................17
Prescribing/Dispensing Limitations...........................18
Drug Use Review.........................................20
Cost Sharing Requirements for Medicaid Prescription Drugs.......20
Other Cost Containment Strategies...........................23
Purchasing Pools.........................................23
Medicaid Spending for OutpatientPrescription Drugs.....................24
Spending by Eligibility Group...............................24
Number and Cost of Prescriptions Filled.......................26
Spending on Top Five Therapeutic Categories..................26
Current Issues....................................................26
Impact of DRA 2005..........................................26
Federal Upper Limits......................................26
Proposed regulation.......................................27
Cost sharing and Other Flexibility Enabled by DRA..............27
Impact of MMA 2003.........................................28
Drug Coverage...........................................28
Additional Administrative Responsibilities.....................28
Maintenance of Effort Payments.............................28
Glossary ........................................................30

Table 1. Medicaid Coverage of Outpatient Prescription Drugs, 2005.........3
Table 2. States’ Payment Formulas as of March 2007 (for acquisition costs)...9
Table 3. Medicaid Rebate Formulas..................................13
Table 4. Medicaid Total Drug Spending and Rebates by State, 2005........14
Table 5. Medicaid Drug Prescription or Dispensing Limits, 2005...........18
Table 6. Cost Sharing Requirements for Medicaid Pharmaceuticals as
of March 2007 ...............................................22
Table 7. Total Medicaid Spending and Medicaid Prescription Drug Spending
and Percentage Change in Spending for Selected Years...............24
Table 8. Average Medicaid Prescription Drug Spending Among
Medicaid Prescription Drug Users by Basis of Eligibility, FY2005......25

Prescription Drug Coverage Under Medicaid
Medicaid is a joint federal-state entitlement program that pays for medical
services on behalf of certain groups of low-income persons. It is the third largest
social program in the federal budget, exceeded only by Social Security and Medicare
and is typically the second largest spending item for states. The federal share of
Medicaid costs in FY2005 for benefits and administration is estimated to have been1
$180 billion; states are estimated to have spent an additional $136 billion, for a total
program cost of $316 billion.
Medicaid programs are administered and designed by the states under broad
federal guidelines. States must provide Medicaid to certain population groups and
have the option of covering others. Similarly, a state must cover certain basic
services and may cover additional services if it chooses. States set their own
payment rates for services, with some limitations. There is, thus, considerable
variation in Medicaid programs with some relatively limited and others very
generous in terms of eligible populations, covered benefits and payments for services.
Medicaid is a means-tested program. Enrollees’ income and other resources2
must be within program financial standards. These standards vary among states, and
among different population groups within a state. With some exceptions, Medicaid
is available only to persons with very low incomes — most Medicaid enrollees have
income that is below the poverty level.
With a number of exceptions, Medicaid is available only to children, adult
members of families with children, pregnant women, and to persons who are aged,
blind, or disabled. Persons not falling into those categories — such as single adults3
and childless couples — generally cannot qualify no matter how low their income is.
The various eligibility groups have traditionally been divided into two basic classes,
the “categorically needy” and the “medically needy.” The two terms once
distinguished between welfare-related (categorically needy) beneficiaries and those
qualifying only under special Medicaid rules which allow states to cover persons
whose income is too high to qualify for cash welfare support but who nevertheless
need help with medical bills (medically needy). However, non-welfare groups have

1 Preliminary FY2005 CMS Form 64 Financial Reports.
2 “Resources” include bank accounts and similar liquid assets, as well as real estate,
automobiles, and other personal property whose value exceeds specified limits and usually
exclude an individual’s primary residence.
3 Several states use special waivers of Medicaid’s eligibility rules to extend coverage to
other groups of individuals not traditionally eligible.

been added to the “categorically needy” list over the years. As a result, the terms are
no longer especially helpful in sorting out the various populations for whom
mandatory or optional Medicaid coverage has been made available. However, the
distinction remains important when considering certain benefits. Some benefits are
considered mandatory for categorically needy individuals; that is, states must cover
those benefits for the categorically needy but they are optional for medically needy
individuals. Other benefits, including prescription drugs, are optional for both groups
of beneficiaries. Some states provide those optional benefits only to categorically
needy individuals, some states provide those benefits to both groups, and some
provide those benefits to certain subcategories of medically needy as well as
categorically needy. (See Table 1.)
Several recent laws have had and will continue to have a major impact on
Medicaid prescription drug benefits. While specific provisions will be discussed in
detail below, a summary of those major changes that affect prescription drugs for
Medicaid beneficiaries are as follows.
The Deficit Reduction Act of 2005 (DRA 2005, P.L. 109-171)
!changed the federal upper limit applying to payments for most
generic drugs under the Medicaid program;
!required that manufacturer-reported average manufacturer
prices be publically available;
!included provisions intended to improve states’ ability to
collect drug rebates for physician-administered and authorized
generic drugs; and
!liberalized states’ ability to establish co-payments on
prescription drugs for Medicaid beneficiaries.
The Medicare Prescription Drug, Improvements, and Modernization Act of 2003
(MMA, P.L. 108-173)
!established the Part D Medicare benefit. Effective January 1,
2006, all beneficiaries who are eligible for both Medicaid
benefits and Medicare benefits will receive their drug
coverage under the new Medicare Part D; and
!established a formula to continue the states’ contribution for
the cost of prescription drugs provided to dually eligible
beneficiaries whose drug coverage moved from Medicaid to
Medicare upon implementation of Part D.
Other recent activity includes a provision passed in P.L. 110-28 (The U.S. Troop
Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability
Appropriations Act of 2007) that would require all paper Medicaid prescriptions to
be written on “tamper-resistant” pads. Subsequent legislation (P.L. 110-90, TMA,
Abstinence Education, and QI Programs Extension Act of 2007), however, delayed

its implementation through March 31, 2008. In addition, CMS rules4 intended to
define the way the AMP is to be calculated under DRA have been challenged,5 and
CMS has been enjoined from implementing the changed rules until the court’s
deliberation is complete.
Prescription Drug Benefits
Coverage of outpatient prescription drugs is optional for state Medicaid
programs. States choose whether or not to include coverage of outpatient drugs in
their Medicaid benefit package. In 2005, all states covered outpatient prescription
drugs for at least some Medicaid beneficiaries; well more than half of the states
reported covering outpatient drugs for all Medicaid beneficiaries. The remaining
states covered drugs for at least categorically needy individuals (Table 1) and
sometimes for other specified groups in addition to the categorically needy.
Prescription drug coverage is one of the few optional Medicaid services provided by
all states. This is in part due to the belief that coverage of prescription drug benefits
is a “good deal” — that the provision of this benefit can help to keep enrollees
healthier and potentially prevent more serious and/or costly medical interventions.
Table 1. Medicaid Coverage of
Outpatient Prescription Drugs, 2005
StateCategorically needyMedically needy
District of ColumbiaXX

4 Department of Health and Human Services, Centers for Medicare and Medicaid Services,
“Medicaid Program; Prescription Drugs,” 72 Federal Register 39142, July 17, 2007.
5 National Association of Chain Drug Stores v. HHS, D.D.C., No. 07-02017.

StateCategorically needyMedically needy
New HampshireXX
New JerseyXX
New MexicoX
New YorkXX
North CarolinaXX
North DakotaXX
Rhode IslandXX
South CarolinaX
South DakotaX
TexasXFor children and adults infamilies
West Virginia XX
Source: Medicaid At-a-Glance, 2005; A Medicaid Information Source, Centers for Medicare and
Medicaid Services, Department of Health and Human Services, Publication No. CMS-11024-05.
Note: Arizona and Tennessee provide pharmaceutical coverage to all beneficiaries through programs
operated under Section 1115 demonstration waivers. These programs do not recognize the federal
distinction between categorically and medically needy.
Fee-for-Service Coverage. For Medicaid beneficiaries who are not enrolled
in Medicaid managed care plans, federal statute allows states to establish formularies.
“Formularies” are lists of preferred pharmaceuticals. When health care insurers or
providers cover only those drugs on the list and deny payment for others, the list is
referred to as a “closed formulary.” Medicaid formularies are seldom as restrictive
as the closed formularies found in the private market for insurance because of two
statutory requirements. The first requirement is that states must cover any non-
formulary drug (with the exception of drugs in 11 specific categories — see below)

that is specifically requested and approved through a prior authorization process.6
The second requires states to cover all drugs offered by manufacturers entering into
rebate agreements with the Secretary of Health and Human Services (HHS).
While ensuring that Medicaid formularies are not too restrictive, federal statute
does (Section 1927(d) of Medicaid law), on the other hand, clearly allow states to
exclude the following categories of drug products from Medicaid coverage: drugs
used (a) to treat anorexia, weight loss or weight gain; (b) to promote fertility; (c) for
cosmetic purposes or hair growth; (d) for the relief of coughs and colds; (e) for
smoking cessation; and (f) prescription vitamins and mineral products (except
prenatal vitamins and fluoride preparations; (g) non-prescription drugs; (h)
barbiturates; (i) benzodiazepines7; (j) drugs requiring tests or monitoring that can
only be provided by the drug manufacturer, and (k) for the treatment of sexual or
erectile dysfunction, unless such agents are used to treat a condition, other than
sexual or erectile dysfunction, for which the agents have been approved by the Food
and Drug Administration. Formularies may also exclude a drug for which there is
no significant therapeutic advantage over other drugs that are included in the
formularies as long as there is a written explanation of the reason for its exclusion
and the explanation is available to the public.
Managed Care Coverage. For Medicaid beneficiaries who are enrolled in
managed care plans, plans to which states pay a fixed monthly payment in exchange
for the provision all or some subset of covered services, Medicaid statute includes a
broad exception to the drug coverage rules described above.8 The law allows the
enrolling managed care organization to develop and administer its own formulary.
In practice, however, when prescription drugs are covered under the managed care
arrangement, states enforce limitations on the formularies of managed care entities
similar to those imposed on states by the federal government. This policy was
initiated in correspondence from the Secretary of Health and Human Services (HHS)
to State Medicaid Directors.9 This letter notified states that drugs covered under the
state plan must also be made available in Medicaid managed care formularies for
Medicaid managed care enrollees. States generally establish contract clauses in their
agreements with Medicaid health maintenance organizations (HMOs) and other
managed care organizations (MCOs) that allow such entities to establish formularies
but also require them to meet all of the fee-for-service coverage rules.
Over-the-counter (OTC) Medications. Many state Medicaid programs also
cover OTC medications — or those medications that can be purchased without a
prescription. A survey conducted by the National Pharmaceutical Council (NPC)
questions states about Medicaid coverage of eight categories of non-prescription
drugs: allergy, asthma, and sinus medications; analgesics; cough and cold medicines;

6 Prior authorization is a process whereby a patient’s provider requests approval for
coverage from the Medicaid agency or its contractor of a specific drug before dispensing
that drug.
7 Barbiturates and benzodiazepines are drugs generally used as sedatives and tranquilizers.
8 Section 1927(j) of the Social Security Act.
9 Coverage of Protease Inhibitors — June 19, 1996.

smoking deterrents; digestive products; H2 antagonists (drugs used to treat ulcers and
other stomach conditions); feminine products; and topical products. In 2005, all but
one state reported covering some OTC drugs, in most cases limited coverage or
coverage with restrictions.10 Thirty states reported covering at least some OTC drugs
in seven or more of the following categories: allergy, asthma, and sinus; analgesics;
cough and cold; smoking deterrents; digestive products; H2Antagonists; feminine
products; and topical products.11
In general, Medicaid pharmaceutical benefits are very broad, encompassing
most prescription drugs and many non-prescription drugs. Medicaid beneficiaries
receiving care in the fee-for-service sector are assured of broad pharmaceutical
coverage due to statutory requirements that prohibit states with closed formularies
from denying drugs requested and approved in the prior authorization process and
those offered by manufacturers that have rebate agreements in effect. The benefits
provided to Medicaid managed care enrollees tend to be similarly broad because of
administrative policies.
State Medicaid programs have undergone major changes in their drug coverage
policies over the past few years in response to the implementation of Medicare
prescription drug coverage (Part D). Under the provisions of the MMA 2003, and as
of January of 2006, Medicare Part D replaced Medicaid as the primary insurer for
most drugs for dual eligible beneficiaries. Medicaid programs are specifically
prohibited from continuing to cover drugs offered under the Medicare plans, but may,
however, cover those drugs not included in Part D coverage. State Medicaid
programs will continue to be required to contribute to the cost of drugs now covered
under Medicare Part D, however, based on a formula specified in MMA 2003. The
formula requires states to contribute an amount equal to 90%, declining to 75%, of
the per capita cost of states’ drug spending under Medicaid in 2003 multiplied by the
number of dual eligibles enrolling in the new Medicare benefit.12 In addition,
Medicaid administrations are required to conduct eligibility determinations for
individuals qualifying for assistance with co-pays under Part D.
Prescription Drugs: Pricing Policies and Rebates
Medicaid Drug Payments and Federal Upper Limits
Medicaid’s payments to pharmacies for outpatient prescription drugs have two
components: an amount to cover the cost of the ingredients (the acquisition cost) and
an amount to cover the pharmacist’s professional services in filling and dispensing

10 One state, Arizona, reports that managed care plans make such coverage decisions
11 Pharmaceutical Benefits Under State Medical Assistance Programs 2005/2006, National
Pharmaceutical Council at [
12 See CRS Report RL32902, Medicare Prescription Drug Benefit: Low-Income Provisions
by Jennifer O’Sullivan for more details.

the prescription (the dispensing fee). Medicaid law requires the Secretary to establish
upper limits on the federal share of payments for acquisition costs that are designed
to encourage the substitution of lower-cost generic equivalents for more costly brand-
name drugs. Those limits apply separately to multiple source drugs — defined to
include any drug for which there is at least one other drug sold and marketed during
the period that is rated as therapeutically equivalent and bioequivalent to it — and to
all other drugs.
FULs for Multiple Source Drugs. When applied to multiple source drugs,
the limits are referred to as the FULs — which stands for federal upper limits. The
FULs do not apply to individual claims for prescription drugs. Rather, the limits are
applied in the aggregate to each state’s spending for a particular drug. The DRA
2005, signed by the President on February 8, 2006, made several significant changes
to the FUL policy for multiple source drugs. The provision of law became effective
on January 1, 2007 — new FULs, however, have not yet been issued by CMS. As
a result, the FULs in effect today are based on formulas in prior law.
The FULs are calculated by the Centers for Medicare and Medicaid Services13
(CMS) and are periodically published in the state Medicaid Manual. Under the
Deficit Reduction Act of 2005, new FULs issued after January 1, 2007, are required
to be equal to 250% of the “average manufacturer price” (AMP) of the least costly
therapeutic equivalent computed without regard to prompt pay discounts.14 The
AMP is reported to CMS by manufacturers, and is defined in statute to be the average
price paid to the manufacturer by wholesalers for drugs distributed to the retail15
pharmacy class of trade.
Under the FUL policy, each state must assure the Secretary that its Medicaid
spending for multiple source drugs is in accordance with the upper limits plus
reasonable dispensing fees. The effect of this requirement is that, when a lower-cost
“generic” equivalent exists for a brand-name drug, a pharmacy will be paid at a price
tied to the least costly alternative even if the brand-name drug is actually furnished.
The Medicaid program, as well as the pharmacy supplying the drug, therefore, has
a financial incentive to see that lower-cost generic equivalents are substituted for
their brand-name counterparts.

13 42 CFR 447.331-447.332
14 The FULs in effect today, as calculated under prior law, are equal to 150% of the
published price for the least costly therapeutic equivalent. CMS uses average wholesale
prices (AWPs) as the basis for the formula. Those figures are published annually in
compendia by the pharmaceutical industry.
15 New FULs taking into account changes passed in DRA are not likely to be issued soon.
This is because regulations issued in July of 2007 describing the methodology for
calculating AMP, an important component of the FULs as required by DRA, have been
enjoined from being implemented pending a legal challenge brought by the National
Association of Chain Drug Stores and the National Community Pharmacists Association.
They contend that the regulation goes beyond congressional intent and would cause harm
if implemented.

The upper limit for multiple source drugs does not apply if a physician provides
handwritten certification on the prescription that a specific brand is medically
necessary for a particular recipient. The brand name would then be dispensed subject
to the limits applicable to “other” drugs.
Upper Limits for all Other Drugs. All “other” drugs include single source
or brand-name drugs and multiple source drugs for which a specific FUL limit has
not yet been established. The upper limit that applies to “other” drugs is the lower of
the estimated acquisition cost (EAC) plus a reasonable dispensing fee or the
provider’s usual and customary charge to the general public. The EAC is the state
Medicaid agency’s best estimate of the price generally paid by pharmacies and other
providers to acquire the drug. States may use any payment method as long as, in the
aggregate, a state’s payments for “other” drugs are below the payment levels
determined by applying the upper limit for other drugs.
States’ Payment Formulas
While states must ensure that federal matching funds do not pay for drug prices
that exceed the upper limits described above, there are no other rules on how states
set their payment formulas for drugs. For most Medicaid drugs, many states use
payment formulas that are based on published retail prices — known as “average16
wholesale prices” (AWPs) — less some percentage (Table 2), although this may
change following the full implementation of DRA 2005. The formulas below
represent states’ attempt to estimate the true acquisition costs that retailers pay to
wholesalers to obtain the pharmaceuticals they sell. While AWPs are used by the
states to estimate those acquisition costs, it is believed that the published AWPs are
more like manufacturers’ suggested wholesale prices rather than a true measure of
the average costs to pharmacies of obtaining pharmaceuticals. In reality, many drug
wholesalers compete with each other by offering pharmacies different discounts from
AWP, and some pharmacies purchase their drugs directly from the manufacturers,
skipping wholesalers entirely.17

16 AWPs are intended to represent the average price at which wholesalers sell a drug product
to retail pharmacies. They are compiled annually in industry compendia including First
DataBank’s Annual Directory of Pharmaceuticals (Blue Book) and National Drug Data
Files, Medi-Spans’ Price Alert and Master Drug Data Base, and Thomson PDR’s 2006
Redbook: Pharmacy’s Fundamental Reference.
17 E.K. Adams, D.H. Kreling, and K. Gondek, State Medicaid Pharmacy Payments and Their
Relation to Estimated Costs, Health Care Financing Review, vol. 15, no. 3, spring 1994, p.


Table 2. States’ Payment Formulas as of March 2007
(for acquisition costs)
StateAmount for each prescription
AlabamaWAC+9.2%; AWP-10%
AlaskaAWP - 5%
ArizonaAWP - 15%
ArkansasAWP - 20% (generic); AWP-14% (brand)
CaliforniaAWP - 17%
ColoradoAWP - 35% (generic) or AWP - 13.5%
ConnecticutAWP - 40% (generic);
AWP - 14% (brand)
DelawareAWP - 14% (retail);
AWP - 16% (LTC and specialty
District of ColumbiaAWP - 10%
FloridaLowest of AWP - 15.45% or WAC +
5.75%; FUL or SMAC
GeorgiaAWP - 11%
HawaiiAWP - 10.5%
IdahoAWP - 12%
IllinoisAWP - 25%, (generic);
AWP - 12% (brand)
IndianaAWP - 20% (generic);
AWP - 16% (brand)
IowaAWP - 12%
KansasAWP - 27% (generic);
AWP - 13% (single source, brand)
KentuckyAWP - 12%
LouisianaAWP - 13.5%;
AWP - 15% for chains
MaineAWP - 15%; AWP - 17% or usual and
customary plus professional fee or
FUL/MAC plus professional fee for direct
supply drug list; Lower of AWP-20% plus
professional fee, usual and customary, or
FUL or MAC plus professional fee for mail
MarylandLower of AWP - 12% or WAC+8%, direct
price+8% or distributor price when
MassachusettsWAC + 5%
MichiganAWP - 13.5% (1-4 stores); or AWP - 15.1%
(5+ stores)
MinnesotaAWP - 11.5%
MississippiLower of FUL, AWP-12%, and WAC+9%
(brand); lower of FUL, and AWP-25%
MissouriLower of AWP - 10.43% or WAC + 10%
MontanaAWP - 15%
NebraskaAWP - 11%

StateAmount for each prescription
NevadaAWP - 15%
New HampshireAWP - 16%
New JerseyAWP - 12.5%
New MexicoAWP - 14%
New YorkAWP - 13.5% (brand); lower of AWP-
20% and MAC (generic); AWP-12%for
specialized HIV pharmacies.
North CarolinaAWP - 10%, ASP +6%
North DakotaLower of WAC + 12.5% or AWP - 10%
OhioWAC+7% or its equivalent, AWP-14.4%
OklahomaAWP - 12%
OregonAWP - 11% (institutional), or AWP - 15%
PennsylvaniaLower of WAC +6%, AWP - 15%
Rhode IslandWAC
South CarolinaAWP - 10%
South DakotaAWP - 10.5%
TennesseeAWP - 13%
TexasLower of AWP - 15% or WAC + 12%
UtahAWP - 15%
VermontAWP - 11.9%
VirginiaAWP - 10.25%
WashingtonAWP - 14% [single source and multiple
source (1-4 manuf.)], AWP - 50% (multiple
source, 5+), AWP - 19% (brand-mail order),
AWP - 15% (generic-mail order)
West Virginia AWP - 15% (brand), AWP-30% (generic)
WisconsinAWP - 11.25%
WyomingAWP - 11%
Source: [
Notes: * For other exceptions see state plan.
ASP: Average sales price
AWP: Average wholesale price
WAC: Wholesaler acquisition cost
SMAC: State maximum allowable cost
Another provision in DRA 2005 requires the Secretary of HHS to make
manufacturers’ reported AMP data available on a monthly basis to states and to post
those amounts, with at least quarterly updates, on a website accessible to the public.
The availability of such data, which CMS plans to make available in the spring of
2007, may encourage states to make changes to their drug reimbursement formulas
based on AMPs instead of AWPs. There are a few reasons why states may want to
make this change. First, basing reimbursements on the same measure of price that
the FULs are based on could help to ensure that the ceilings are not exceeded.
Second, the AMPs, unlike the AWPs, will presumably be calculated in a consistent

fashion once proposed regulations defining those calculation become finalized.18 In
addition, AMPs are subject to the oversight and review of the Secretary of HHS.
Dispensing Fees
Dispensing fees, the amounts paid to pharmacies to cover the cost of dispensing
the prescription medication are only limited insofar as they must be “reasonable.”
Most such fees generally range from around $3.50 per prescription to $5.00 per
prescription, although fees may be higher in states that do not use a flat fee. Until
only recently, few states varied professional dispensing fees. Today dispensing fees
in many states vary, most often with higher fees paid for generics than for single
source drugs. In a few states, the fees vary by urban/rural location or based on the
pharmacy’s historical operating cost and volume.
Medicaid Drug Rebates
An important feature of Medicaid’s “best price” drug payment policy was
created in the Omnibus Budget Reconciliation Act of 1990. That law requires drug
manufacturers that wish to have their drugs available for Medicaid enrollees to enter
into rebate agreements with the Secretary of HHS, on behalf of the states. Under the
agreements, pharmaceutical manufacturers must provide state Medicaid programs
with rebates on drugs paid for Medicaid beneficiaries. The formulas used to compute
the rebates are intended to ensure that Medicaid pays the lowest price that the
manufacturers offer for the drugs. In return for entering into agreements with the
Secretary, state Medicaid programs are required to cover all of the drugs marketed
by those manufacturers (with possible exceptions for the 11 categories of drugs that
states are allowed to exclude from coverage). In 2003 there were reported to have
been more than 550 manufacturers participating in the Medicaid drug rebate
Rebate requirements do not apply to drugs dispensed by Medicaid managed care
organizations when the drugs are paid as part of the MCOs capitation rate, and to
drugs provided in hospitals, and sometimes in physicians’, or dentists’ offices, or20
similar settings. Rebate requirements, on the other hand, do apply to prescription
drugs provided on a fee-for-service basis as well as to nonprescription items, such as
aspirin, when they are prescribed for a Medicaid beneficiary and covered under the
state’s Medicaid plan.
The rebates are computed and remitted by pharmaceutical manufacturers each
quarter based on utilization information supplied by the state programs. States

18 Proposed rules were published on Friday, December 22, 2006: 42 CFR 447; Medicaid
Program; Prescription Drugs.
19 Testimony of Dennis Smith, Director, Center for Medicaid and State Operations, Centers
for Medicare and Medicaid Services, before the Energy and Commerce Committee,
Subcommittee on Oversight and Investigations, December 7, 2004.
20 The general rule here is that rebates apply to drugs when they are billed separately, and
not when their costs are embedded in a claim for another service.

collect the rebates from the manufacturers. The federal share of the rebates are
subtracted from states’ claims for their federal share of program costs.
In setting the amount of required rebates, the law distinguishes between two
classes of drugs. The first includes single source drugs (generally, those still under
patent) and “innovator” multiple source drugs (drugs originally marketed under a
patent or original new drug application (NDA) but for which generic competition
now exists). The second class includes all other, “non-innovator” multiple source
drugs (generics). Table 3 shows the requirements applicable to the two different
classes of drugs. These are discussed in further detail below.
Single Source and “Innovator” Multiple Source Drugs. Manufacturers
are required to pay state Medicaid programs a basic rebate for single source and
innovator multiple source drugs. Basic rebate amounts are determined by comparing
the AMP for a drug to the “best price,” which is the lowest price offered by the
manufacturer in the same period to any wholesaler, retailer, nonprofit, or public
entity.21 The basic rebate is the greater of 15.1% of the AMP or the difference
between the AMP and the best price.
Additional rebates are required if the weighted average prices for all of a given
manufacturer’s single source and innovator multiple source drugs rise faster than
inflation as measured by the consumer price index for all urban consumers. Prices
in effect on October 1, 1990 are used as a base and are compared with prices in the
month before the start of the period for which the rebate is to be issued to determine
if current prices have risen faster than inflation.22
Since 1990 there have been a few changes to the Medicaid drug rebate policy.
Before 1992 “best price” was defined to exclude drugs sold to federal agencies at
depot prices23 and single award contract prices. Under the Veterans Health Care Act
of 1992 (P.L. 102-585) prices charged by manufacturers to certain federal agencies
were also excluded from the determination of “best price.” These agencies include
the Department of Veteran’s Affairs (DVA), the Department of Defense (DOD), the
Public Health Service (PHS) and various PHS-funded health programs, and state
(non-Medicaid) pharmaceutical assistance programs. The exclusion of those prices
from the “best price” potentially reduced Medicaid savings from the rebate program,
so Congress responded with an offset. Rebate percentages were increased to those

21 For the purposes of determining Medicaid rebates, prices paid by a number of federal and
state entities are excluded from the definition of the “best price.” These are discussed in
further detail below.
22 U.S. Department of Health and Human Services, Office of the Inspector General,
Medicaid Drug Price Comparisons: Average Manufacturer Price to Published Prices, OEI-

05-05-00240, June 2005. Other comparative pricing analyses can be found in U.S.

Government Accountability Office (GAO), States’ Medicaid Payments for Prescription
Drugs, GAO-06-69R, October 2005, and U.S. Congressional Budget Office, How the
Medicaid Rebate on Prescription Drugs Affects Pricing in the Pharmaceutical Industry,
January 1996.
23 Depot prices are the prices paid for drugs procured through federal distribution systems
and warehoused at federal facilities (depots).

amounts shown in Table 3. MMA 2003 further excludes the prices of drugs
provided under Medicare Part D from best price. That legislation, however, did not
include an offsetting rebate adjustment.
The Veteran’s Health Care Act also provides, as a condition of Medicaid
reimbursement for a manufacturer’s drugs, that the manufacturer enter into a separate
agreement with the Secretary to provide discounts and rebates to certain PHS-funded
entities with public disproportionate share hospitals, as well as a new discount24
agreement with DVA.
“Non-Innovator” Multiple Source Drugs. For non-innovator multiple
source drugs, basic rebates are equal to 11% of the AMP. Prices offered to other
payers are not considered, nor is there any additional rebate for excess price
Table 3. Medicaid Rebate Formulas
Single source and
“innovator” multiple“Non-innovator”
source drugsmultiple source drugs
The greater of:
15.1% of the AMP or AMP
Basic rebateminus best price11% of the AMP
Required if the drug
product price rises faster
than inflation as measured
Additional rebateby the CPI-UN/A
Source: 42 USC Sec. 1396r-8.
In 2005, the total amount of federally required drug rebates was reported by
states to be $11.1 billion. (States also reported collecting more than $1.3 billion in
supplemental rebates not required by the federal government, although there is reason
to believe that reported amounts for state supplemental rebates are too low. See the
discussion on page 16.) On average, federal rebates represented about 26% of
Medicaid spending on outpatient prescription drugs. Rebates for 2005 by state are
reflected in Table 4.

24 Even before the Veterans Health Care Act of 1992, the DVA had been negotiating
discounted prices with manufacturers for drugs provided at DVA and other military

Table 4. Medicaid Total Drug Spending and Rebates
by State, 2005
(in millions of dollars, includes state and federal shares)
TotalRebates as a
Spending onAll RebatesSpending NetPercentage of
PrescriptionCollectedRebatesDrug Spending
Alabama 606.6 145.2 461.3 24%
Alaska 127.3 27.5 99.8 22%
Arka nsas 419.4 93.6 325.7 22%
California 5,187.3 2,056.5 3,130.8 40%
Colorado 285.4 74.6 210.7 26%
Connecticut 496.7 109.4 387.3 22%
Delaware 122.0 35.4 86.6 29%
District of Columbia105.924.781.223%
Florida 2,503.2 728.6 1,774.6 29%
Georgi a 1,184.9 336.3 848.6 28%
Hawaii 119.9 25.1 94.7 21%
Idaho 168.8 48.5 120.3 29%
Illinois 1,716.4 575.5 1,140.9 34%
Indiana 751.5 204.4 547.2 27%
Io wa 412.3 90.1 322.2 22%
K a nsas 296.3 93.1 203.2 31%
K e ntucky 794.5 217.3 577.2 27%
Louisiana 1,082.6 278.8 803.8 26%
Maine 282.0 99.8 182.2 35%
Maryland 578.2 154.1 424.2 27%
Massachusetts 1,067.4 281.5 785.9 26%
Michigan 965.4 325.1 640.2 34%
Minnesota 441.9 118.0 323.9 27%
Mississippi 665.5 180.1 485.4 27%
Missouri 1,246.1 300.3 945.9 24%
Montana 105.2 25.2 80.0 24%
Nebraska 228.6 68.4 160.1 30%
Neva da 134.6 34.1 100.5 25%
New Hampshire133.337.695.728%
New Jersey1,158.6261.6897.023%
New Mexico116.325.490.822%
New York5,253.71,300.13,953.525%
North Carolina1,790.4452.71,337.725%
North Dakota64.215.348.824%
Ohio 1,981.2 591.9 1,389.3 30%
Oklahoma 500.4 103.4 397.0 21%
Oregon 261.4 60.5 200.9 23%
Pennsyl va nia 1,009.8 253.7 756.1 25%
Rhode Island173.944.7129.226%
South Carolina716.7217.0499.730%
South Dakota89.022.166.925%
T e nnessee 2,344.4 768.9 1,575.5 33%

TotalRebates as a
Spending onAll RebatesSpending NetPercentage of
PrescriptionCollectedRebatesDrug Spending
T e xas 2,416.9 736.8 1,680.1 30%
Utah 221.9 39.9 182.0 18%
V e rmont 184.7 45.1 139.7 24%
V i rginia 634.7 174.0 460.7 27%
Washington 682.6 176.8 505.8 26%
Wisconsin 759.7 202.8 556.9 27%
West Virginia431.6114.3317.326%
Wyoming 51.2 13.7 37.6 27%
National Total43,084.311,102.230,662.526%
Source: Table prepared by Congressional Research Service (CRS) based on tabulations of 2005 CMS
Financial Management Reports.
* Arizona has a statewide managed care waiver in place. Under the waiver, all Medicaid services are
provided through capitated arrangements. Since drugs are included in the capitation payment to
MCOs, rebates do not apply.
Drug Pricing and Rebate Issues
Average Wholesale Prices. The DRA 2005 addressed concerns that had
been raised repeatedly in the last several years regarding the AWPs and the states’
and HHS’s reliance on those prices for setting pharmaceutical payment levels and
FULs. Today, FULs are calculated based on the published AWPs. However,
Congressional hearings and investigations by the General Accounting Office, and the
office of the Inspector General (IG) of Health and Human Services (HHS) found that
the AWPs do not reflect the intended wholesale prices, and that some manufacturers
manipulated the published AWPs to offer discounts to certain purchasers without
offering those prices to Medicaid.25 By replacing the FUL computation with a
formula based on AMPs, the use of AWPs for setting Medicaid drug prices may
become a thing of the past. In addition, DRA 2005 allows the Secretary to gather
data on retail drug prices. Once implemented, DRAs data reporting provisions may
prove to be useful for determining whether the upper limits on drug prices are too
high, too low, or adequate.
Circumventing the Best Price or Rebate Policies. A second area that
has raised concerns relates to the best prices that are reported by manufacturers to
CMS and are used by CMS to calculate rebates. There have been cases in which
manufacturers sell drugs or report drug prices in ways that circumvent Medicaid’s
rebate requirement or minimize rebates to be paid. For example, manufacturers
could skirt the best price requirement by selling finished drugs to certain favored
HMOs at large discounts and claiming that they have been sold to “repackagers” or
“redistributors.” Since drugs sold by repackagers or redistributors are not subject to

25 U.S. Congress, House Committee on Government Reform, Correspondence to
Representative Henry A. Waxman, Ranking Minority member, from June Gibbs Brown,
Inspector General, Dept. of Health and Human Services, November 22, 1999.

Medicaid’s rebate requirements, rebates are avoided. In 1999, the Inspector General
estimated the lost rebate for one repackaged drug at over $25 million in one year.26
In addition, recently, Schering Plough Corporation agreed to pay $293 million to
resolve its liabilities in connection with fraudulent pricing of its allergy drug Claritin
under the Medicaid drug rebate program. Schering Plough allegedly failed to include
the value of certain incentives offered to two managed care organizations in the best
price reported for purposes of the Medicaid drug rebate program. The resulting
charge was that Medicaid rebates were underpaid, and other entities (such as
community health centers) that purchase drugs at ceiling prices that are based on
Medicaid drug rebate prices were overcharged.27
DRA 2005 intervened to address another concern related to the collection of
rebates on certain drugs. The IG and CMS have both raised the concern that some
rebates have gone unpaid for certain drugs administered by physicians in their offices
(or in another outpatient setting), such as chemotherapy, simply due to operational
gaps. This is because providers use Healthcare Common Procedure Coding System
(HCPCS) J-codes to bill the Medicaid program for injectible prescription drugs,
including cancer drugs. The HCPCS J-codes do not, however, provide states with
the specific manufacturer information necessary to enable them to seek rebates. In
a letter to state Medicaid directors, CMS requested that states identify Medicaid
drugs, specifically those using HCPCS J-codes, by their NDC codes so that rebates
can be collected for these drugs (SMDL #03-002, dated March 14, 2003).
Nonetheless, DRA 2005 stepped in to require, as a condition of receiving Medicaid
payments, that states submit to the Secretary of HHS utilization data and coding
information for certain physician-administered outpatient drugs. Such data would be
required initially for all single source drugs administered by physicians. Later, the
same data would be required for the 20 physician-administered multiple source drugs
with the highest dollar volume as determined by the Secretary.
Finally, the DRA included a provision intended to improve best price reporting
for authorized generic drugs. Sometimes manufacturers produce both a brand-name
version of a prescription drug and also sell or license a second manufacturer (or a
subsidiary) to produce some of the same product to be sold or re-labeled as a generic.
Concerns have been raised by two Senators, both in a letter to the Chairman of the
Federal Trade Commission28 and at a hearing on Medicaid fraud29 that there may be
problems collecting rebates on these generic products, referred to as “authorized
generics.” One potential problem is that the reported best prices for the brand-name

26 Correspondence from the Office of the Inspector General, November 1999.
27 Testimony of George M. Reeb, Assistant Inspector General for the Centers for Medicare
and Medicaid Audits, Office of Inspector General, U.S. Department of Health and Human
Services before the Energy and Commerce Committee, Subcommittee on Oversight and
Investigations, December 7, 2004.
28 Letter dated May 9, 2005 from Senators Grassley and Rockefeller to Federal Trade
Commission Chairman Deborah Platt Majoras posted at [http://www.Grassley.Senate.Gov].
29 U.S. Congress, House Committee on the Energy and Commerce, Subcommittee on
Oversight and Investigations, Medicaid Prescription Drug Reimbursement: Why thethnd
Government Pays Too Much, hearings, 108 Cong., 2 sess., December 7, 2004, H.Rept.

108-126 (Washington: GPO, 2004).

product do not properly account for prices at which the authorized generics are sold.
A second potential problem is that the rebates for the authorized generics are
calculated using the wrong rebate formula. DRA 2005 modified the existing drug
price reporting requirements to ensure, effective January 1, 2007, that the
manufacturer-reported prices, including both the average manufacturer’s price and
the manufacturer’s best price, include the price of the authorized generic.30
Supplemental Rebates. In addition to the rebates required under federal
law, a number of states charge certain pharmaceutical manufacturers additional
rebates. In 2005, 22 states reported collecting a total of $1.3 billion in supplemental31
rebates (federal share of $719 million). California collected 50% of the reported
amounts. But reported collections are likely to be too low. In information provided
by CMS to the Committee on Energy and Commerce in 2004, 33 states were noted
to have supplemental rebates in effect. If those programs remained in effect in 2005,
supplemental rebate collections may well exceed the amounts reported in the 2005
CMS Financial Management Reports.32
Policies to Control Drug Cost and Use
Prior Authorization. States use a number of techniques to control cost and/or
use of pharmaceuticals. One of those techniques is prior authorization. Under a prior
authorization requirement, only those pharmaceutical products that have been
approved in advance by a designated individual or entity are covered. States may
establish prior authorization programs under Medicaid for all drugs or for certain
classes of drugs, as long as these programs meet two criteria: (1) they must respond
within 24 hours to a request for approval, and (2) they must dispense at least a 72-
hour supply of a covered drug in emergency situations. In 2005, all (including the
District of Columbia) but one state reports having a prior authorization procedure for
at least some covered drugs, but little information is available describing the number33
or types of drugs those states require to undergo such review.
Some pharmaceutical industry representatives and consumer advocates have
voiced opposition to states’ use of prior authorization programs. They claim such
programs are burdensome, are not cost effective, and are becoming increasingly

30 The bill language doesn’t use the term “authorized generic.” Instead it requires the
reported prices to include the price of any drug sold under a new drug application approved
(under Section 505c of the Federal Food, Drug and Cosmetic Act, FFDCA) by FDA.
31 Supplemental rebates are required to be shared by states and the federal government in the
same way that federally required rebates are shared.
32 Prepared Statement of Dennis Smith, Director of Center for Medicaid and State
Operations of CMS, submitted for the record in U.S. Congress, House Committee on Energy
and Commerce; Subcommittee on Oversight and Investigations, Medicaid Prescription Drugthnd
Reimbursement: Why the Government Pays Too Much, 108 Cong., 2 sess., December 7,

2004, 2004, 108-126 (Washington: GPO, 2004)

33 National Pharmaceutical Council, 2005/2006. South Dakota reports having no prior
authorization procedure. Arizona reports that such policies are left to individual managed
care organizations.

restrictive. In addition, there are concerns that states are adding more and more drugs
to lists of those that require prior authorization and that such requirements are
particularly problematic for individuals who need newly developed drugs, possibly
because reviewers are less familiar with those drugs. Prior authorization is reportedly
particularly problematic for persons needing psychotherapeutics, a population for
whom compliance with drug therapies is often challenging to achieve even without
additional administrative barriers.
Prescribing/Dispensing Limitations. States may also restrict the quantity
of prescription drugs available to beneficiaries. Such prescribing and dispensing
limits are ubiquitous. All but three states surveyed for the National Pharmaceutical
Council (NPC) indicated the use of prescribing or dispensing limits (Table 5). The
most common type of constraint is on the quantity of drug that may be made
available for each prescription. Almost all of the states routinely limit the amount
of certain drugs dispensed to a 30- to 34-day supply.
Table 5. Medicaid Drug Prescription or Dispensing Limits, 2005
StateLimits on number, quantity, and refills of prescriptions
Alabama34-day supply per Rx, 5 refills per Rx, 4 brand limit per month
Alaska30-day supply per Rx, other ceilings on certain classes of drugs
Arkansas31-day supply per Rx, 3 Rx per month (extension to 6), five refills
per Rx within 6 months
California6 Rx per month, maximum 100 day supply for most meds, 3
claims per drug w/in 75 days.
Colorado30-day supply per Rx, 100 days for maintenance medication, other
limits may apply
Connecticut240 units or 30-day supply, 5 refills except for oral contraceptives
Delaware34-day supply or 100 unit doses per Rx (whichever is greater)
District of30-day supply per Rx, 3 refills per Rx within 4 months, other
Columbialimits specific to certain medications
FloridaVary according to drug
Georgia34-day supply per Rx, 5 Rx per month (adult), 6 Rx per month
(child); $2999.99/Rx limit (potential override)
Hawaii30-day supply or 100 unit doses per Rx, maximum quantities for
some drugs.
Idaho34-day supply (with exceptions), 3 cycles birth control, limits on
IllinoisMedically appropriate monthly quantity, 3 brand Rxs per month,
11 refills per Rx
Indiana —
IowaMaximum 30-day supply except oral contraceptives (90 days)
Kansas31 day supply per Rx, 5 Rx per month, other limitations specific
to certain medications
Kentucky32 day supply, Maximum 5 refills in 6 months, 92 days/100 units
per month for maintenance medication, 4 Rxs per month.

StateLimits on number, quantity, and refills of prescriptions
LouisianaGreater of 30-day supply per Rx or 100 unit doses, 5 refills per Rx
within 6 months, max 8 Rx per recipient per month
Maine34-day supply (brand), 90-day supply (generic), maximum 11
refills per Rx, 5 brand Rx per month
Maryland34-day supply per Rx, 11 refills per Rx, refills cannot exceed 360-
day supply
Massachusetts30-day supply, 5 refills per Rx, per month limits on some drugs
Michigan100-day supply, quantity limits for certain drugs
Minnesota34-day supply, quantity limits for selected drugs
MississippiGreater of 31-day supply or 100 unit doses per Rx, 5 Rx per
month, 11 refills maximum
Missouri —
Montana34-day supply
NebraskaGreater of 90-day supply or 100 dosage units per Rx, 5 refills per
Rx, 6 mo. for controlled substances, 31 days for injectibles
Nevada34-day supply per Rx, 100 day supply for maintenance
medications, 5 refills within 6 months
New Hampshire34-day supply, 90-day supply on maintenance medications
New Jersey34-day supply or 100-unit dosage per Rx, 5 refills within 6 months
New Mexico34-day supply except contraceptives (100 days) and maintenance
drugs (90 days)
New York5 refills per Rx, annual limits on number of Rx and OTC drugs
available (with exceptions)
North Carolina34-day supply per Rx, with exceptions, 8 Rx per month
North Dakota34-day supply per Rx
Ohio34-day supply; 102 day supply for maintenance, 5 refills per Rx
Oklahoma34-day supply or 100 unit doses per Rx, 6 Rx per month (age 21
and over, under 21 unlimited)
Oregon34-day supply, 100 days for mail order and maintenance drugs
PennsylvaniaGreater of 34-day supply or 100 unit, 5 refills within 6 months, 6
Rx per month
Rhode Island30-day supply per Rx (non-maintenance), 5 refills per Rx
South Carolina34-day supply w/ unlimited Rx (children), 4 Rx per month (adult)
with exceptions, other limits may apply
South DakotaVaries by drug
TennesseeVaries by basis of eligibility
Texas3 Rx per month, unlimited Rxs for nursing home residents and
children, max 5 refills or 6 months per Rx
Utah31-day supply per Rx, max 5 refills per Rx, other limits on
specific drugs
Vermont34-day supply per Rx, 102-day supply for maintenance
medications, 5 refills per Rx
Virginia34-day supply per Rx
Washington34-day supply per Rx, 2 scripts per month except for antibiotics or
scheduled drugs, 4 brand cap

StateLimits on number, quantity, and refills of prescriptions
West Virginia 34-day supply except antibiotics (14 days and 1 refill)
Wisconsin34-day supply per Rx with exceptions, maximum 11 refills during

12-month period for non-schedule drugs, 5 refills for Schedule III,

IV, V drugs
WyomingQuantity limits on some medications as deemed clinically
Source: National Pharmaceutical Council, Pharmaceutical Benefits Under State Medical Assistance
Programs 2005/2006.
Notes: Rx: Prescription.
** Individual managed care and pharmacy benefit management organizations make formulary/drug
d e c i sio ns.
Drug Use Review. All states use policies to control the use of outpatient
prescription drugs and all have programs in place to assess the quality of their
pharmaceutical programs. The Omnibus Budget Reconciliation Act of 1990 included
a requirement that all states implement drug use review (DUR) programs, and
provided for enhanced federal matching payment to cover the costs of conducting
those DUR activities. DUR programs are aimed at both improving the quality of
pharmaceutical care and assisting in containing costs. The major features of DUR
programs are: enhanced communication between pharmacists and beneficiaries upon
dispensing prescriptions; ongoing retrospective review of prescribing practices;
educational outreach for pharmacists, physicians, and beneficiaries; and pharmacy
Cost Sharing Requirements for Medicaid Prescription Drugs. In
addition to prior authorization and utilization review, many Medicaid programs
impose cost sharing requirements on enrollees to control drug use and spending.
Cost sharing is another area that DRA 2005 made significant changes to that could
impact prescription drug benefits for Medicaid beneficiaries. Pre-DRA 2005 cost
sharing limitations prohibited states from requiring copayments on services provided
to children under age 18, pregnant women for any services that relate to the
pregnancy or to any medical condition that may complicate pregnancy; and people
who are hospitalized or residing in a long-term care facility. In addition, copayments
could not be charged for people receiving hospice, emergency34 and family planning
services. Any copayments charged for other beneficiaries or benefits were limited
to “nominal” amounts.35

34 States may obtain a waiver of this rule to impose up to twice the nominal amount
established for outpatient services for services received at a hospital emergency room, if the
services are not emergency services, as long as they have established to the satisfaction of
the Secretary that beneficiaries have alternative sources of non-emergency, outpatient
services that are available and accessible.
35 Nominal amounts are defined in 42 CFR 447.52 - .54. DRA 2005 changed the definition
of “nominal” amounts so that beginning with FY2006, those amounts will be indexed by
inflation (as estimated using the medical care component of the consumer price index).

DRA 2005 created two optional cost sharing plans that states could choose to
implement as alternatives to the cost sharing limitations described above. Under the
new cost sharing options, both of which became effective on March 31, 2006, states
are prohibited from requiring cost sharing for certain Medicaid beneficiaries. The list
of those that must remain exempt from cost sharing is slightly different from the list
of those exempt under prior law. States will be prohibited from imposing cost
sharing for (1) services provided to mandatory children who are under age 18 or are
in foster care under Part B of Title IV, or are receiving adoption or foster care
assistance under Title IV-E regardless of age; (2) preventive services provided to
children under 18 regardless of family income; (3) services provided to pregnant
women that relate to pregnancy or to other medical conditions that may complicate
pregnancy; (4) services provided to terminally ill individuals receiving Medicaid
hospice; (5) services provided to individuals in medical institutions who are required
to spend their income down to qualify for Medicaid; (6) emergency services; (7)
family planning services and supplies; and (8) services provided to women qualifying
for Medicaid under the breast and cervical cancer eligibility group.
The first new cost sharing option under DRA 2005 allows states to establish cost
sharing amounts that exceed nominal amounts and to vary those amounts among
classes or groups of individuals or by types of services. The second option, which
applies specifically to outpatient prescription drugs, allows states to establish a cost
sharing plan under which beneficiaries are charged higher cost sharing amounts for
state-identified non-preferred drugs, and no or reduced cost sharing amounts for
preferred drugs.
The two new options come with additional limitations. Besides the groups that
are specifically exempted, as described above, the DRA 2005 cost sharing amounts
cannot exceed 10% of the cost of the item or service for individuals with income
between 100% and 150% of poverty, and 20% of the cost of the item or service for
individuals with an income over 150% of poverty. In addition, an aggregation of all
cost sharing amounts cannot exceed 5% of family income.
Table 6 shows co-payment requirements as of March of 2007. These amounts
are not likely to reflect the full impact of the DRA flexibilities, since those provisions
became effective at the end of that month. States that require copayments for covered
outpatient drugs generally charge between $.50 and $3.00 per prescription — most
falling at about $1.00 per prescription.

Table 6. Cost Sharing Requirements for Medicaid
Pharmaceuticals as of March 2007
StateAmount for each prescription
Alabama$.50 to $3.00
Alaska $2.00a
Arizona —
Arkansas$.50 to $3.00
Colorado$.75 (generic); $3.00 (brand)
Connecticut $1.00
District of Columbia$1.00
Florida2.5% of payment up to $300
Georgia$.50 (generic and preferred brand); $.50 to$3.00 (brand)
Illinoisnone for generic; $3.00 (brand)
$1.00 (non-preferred brand up to $25); $2.00
Iowa(non-preferred brand between $25 and $50),
$3.00 (non-preferred brand, $50 and more)
Louisiana$.50 to $3.00
$2.50 (generic and brand); $3.00 per day in
Mainerural health clinics-All subject to ceilings;
Mail order not subject to copay
Maryland$1.00 (generic, preferred brand), $3.00 (non-preferred brand)
Massachusetts$1.00 (multi-source &non-legend OTC) -$3.00
Michigan$1.00 (generic); $3.00 (brand)
Minnesota$1.00 (generic); $3.00 (brand)
Mississippi $3.00
Missouri$.50 to $2.00
Nevada$1.00 (generic); $2.00 (brand)
New Hampshire$1.00 (generic); $2.00 (brand & compound)
New Jersey$2.00
New MexicoNone
New York$1.00 (generic); $3.00 (brand); $.50 (OTC)
North Carolina$1.00 (generic); $3.00 (brand)
North Dakota$3.00 (brand)
Ohio$3.00 (non-preferred), $2.00 (preferred brand)
Oklahoma$1.00 to $2.00
Oregon$2.00 (generic); $3.00 (brand)
Pennsyl va nia $1.00
Rhode IslandNone
South Carolina$3.00

StateAmount for each prescription
South Dakota$2.00a
Tennessee —
Vermont$1.00 to $3.00
West Virginia $.50-$3.00
Wisconsin$.50 (over the counter); $1.00 (generic) $3.00(brand)
Source: [
a. Within federal and state guidelines, individual managed care and pharmacy benefit management
organizations make formulary/drug decisions.
Other Cost Containment Strategies. Some states are attempting to
manage drug costs through the use of pharmaceutical benefits managers (PBMs).
Many private insurers, including those that provide coverage to federal employees
under the Federal Employees Health Benefits Program (FEHBP), contract with
PBMs for drug benefits management and claims payment. PBMs enable insurers to
obtain discounts for pharmaceuticals that would not otherwise be available to single
insurers because the PBMs administer multiple insurers’ covered populations. In
addition, PBMs provide a variety of administrative services intended to improve
quality and control costs, such as retail pharmacy network development, mail order
pharmacy operation, formulary development, manufacturer rebate negotiation and
prescription checks for adverse drug interactions.36 While PBMs have begun to
administer a significant portion of the market for private prescription drug benefits,
they are not broadly used by states in administering Medicaid drug benefits.
Purchasing Pools. Seventeen states participate in multi-state bulk
purchasing pools for outpatient prescription drugs. Those states partner together to
negotiate on prices and rebates for drugs required by the multiple Medicaid
programs. Three states have established intra-state pools that negotiate on prices for
Medicaid drugs combined with those needed for other in-state agencies such as state
employees’ plans and local governments. Nine of those states have reported modest
savings from those activities.37

36 GAO/HEHS-97-47; Pharmacy Benefit Managers; FEHBP Plans Satisfied With Savings
and Services, but Retail Pharmacies Have Concerns, February 1997.
37 National Association of State Medicaid Directors and Avalere Health LLC, State
Perspectives on Emerging Medicaid Pharmacy Policies and Practices, November 2006.

Medicaid Spending for Outpatient
Prescription Drugs
Total Medicaid payments for outpatient prescription drugs represent a growing
portion of Medicaid spending. In 1990, states reported total payments for outpatient
prescription drugs of about $4.6 billion, or just over 6% of total program spending.
In 2005, total payments for Medicaid outpatient prescription drugs, net of all rebates
— federal and state — was $30.7 billion, accounting for about 10.2% of payments
for all Medicaid services.38 The average annual growth in drug spending under
Medicaid over the 15- year period from 1990 to 2005 was about 13.1% per year.
Despite the large and growing share of Medicaid spending on drugs, those
numbers represent only a portion of true Medicaid drug spending. States do not
include the cost of outpatient prescription drugs provided through capitated
arrangements in their reports. In 1990, this probably did not present a major gap in
the available information about Medicaid drug spending since only about 10% of
Medicaid enrollees received coverage through capitated managed care arrangements.
Today, however, well over one-half of Medicaid’s enrollees receive some or all of
their benefits through Medicaid managed care organizations or prepaid health plans.
In addition, other prescription drug payments for products purchased directly from
physicians or included in claims for other services, such as institutional and home
health care, are not reported as outpatient drug spending.
Table 7. Total Medicaid Spending and Medicaid Prescription
Drug Spending and Percentage Change in Spending
for Selected Years
(in billions of dollars)
Total MedicaidAverage annualMedicaidAverage annual
benefitsa percentageprescriptionbpercentage
Yearspending changedrug spendingchange

1990$ 72.5 — $ 4.6 —

1995$ 151.815.9%$ 8.412.7%

2000 $195.5 5.2% $16.6 14.7%

2005 $300.7 9.0% $30.7 13.1%

Source: Table prepared by Congressional Research Service (CRS) based on tabulations from HCFA
Form 64/ CMS Form 64 data and Financial Management Reports.
a. Does not include administrative costs.
b. Does not include prescription drugs paid through capitated arrangements, obtained directly from
physicians or bundled in claims for other services, and federal and state rebates have been
subtracted from totals.
Spending by Eligibility Group. The Medicaid Statistical Information
System (MSIS) identifies Medicaid spending for prescription drugs by eligibility
group and, to date, includes data from 49 states plus the District of Columbia. (Data
for Maine are not yet included). Based on this data, of total Medicaid spending for

38 CRS tabulation of 2005 Medicaid Financial Management Reports.

prescription drugs, about 81% is for individuals qualifying for Medicaid on the basis
of being elderly, blind, or having a disability (about 56% for blind and disabled
individuals and 25% for elderly beneficiaries). About 10% of drug spending is for
non-disabled and foster care children, and an additional 9% is for adults in families
with dependent children and women with breast or cervical cancer.39
Table 8 shows average Medicaid prescription drug spending among Medicaid
prescription drug users by eligibility group. The data do not reflect spending for
those who receive prescription drugs through managed care only, but they do provide
a general idea of the relative spending among different groups of beneficiaries.40
Among all Medicaid prescription drug users in FY2005, the average Medicaid
prescription drug spending amount was $1,510. Children had the lowest average
spending, while blind and disabled enrollees had the highest. Among blind and
disabled enrollees with prescription drug spending, the average amount was almost
$3,795. Among children with prescription drug spending, the average amount was
about $357.
Table 8. Average Medicaid Prescription Drug Spending Among
Medicaid Prescription Drug Users by Basis of Eligibility, FY2005
Percentage of Medicaid enrolleesAverage Medicaid drug spending per
with prescription drug SpendingMedicaid prescription drug user
Aged 68% $2,944
Blind/Disabled 71% $3,795a
Child 40% $357
Adult 38% $622
BCCA women70%$2,124b
To t a l 48% $1,510
Source: Congressional Research Service (CRS) tabulations of data from CMS MSIS State Summary
Datama rt.
Notes: Does not include data for Maine. Also does not include drug rebates or payments for drugs
purchased directly from physicians or included in claims for other services such as institutional care.
Since it is generally included in the capitation payment for managed care (not broken out separately),
figures on prescription drug users and spending do not include those who receive prescription drugs
through managed care only.
a. Includes foster care children.
b. Includes enrollees for whom basis of eligibility was unknown.

39 Expenditures in this paragraph are those reported by states through the Medicaid
Statistical Information System (MSIS) for FY2005. MSIS expenditures are different from
expenditures reported in Tables 4 and 8 (based on CMS-64 reports) because data reported
on form CMS 64 are for slightly different time periods and for different purposes.
40 If per-person drug spending under managed care (which is not shown separately in MSIS
data) differs significantly from per-person drug spending under FFS (which is shown
separately in MSIS data), the estimates provided here could be somewhat distorted. Since
Medicaid HMOs enroll many more children and adults than aged or disabled individuals,
the exclusion of managed care drug payments might have a greater relative impact on
estimates of average spending among children and adults.

Number and Cost of Prescriptions Filled. In 2005, Medicaid agencies
reported processing more than 595 million prescriptions. The average cost of a41
prescription for the same year was about $66.84.
Some studies have found large variations in drug use patterns among states.
Among the many reasons for such variation differences in health care needs and the
composition of Medicaid enrollment, drug policies in effect in the state, and/or
different physician prescribing behaviors.42
Spending on Top Five Therapeutic Categories. The National
Pharmaceutical Council (NPC) reported that, in 2005, over 65% of Medicaid drug
spending was for drugs in five categories: central nervous system drugs;
cardiovascular drugs; psychotherapeutic agents; hormones; and anti-infective
agents.43 While state-by-state variation is large, spending on psychotherapeutic drugs
is by far the largest category for which Medicaid drug spending occurs. On average,
spending for this class of drugs comprises about 24% of states’ total drug spending.
Current Issues
Impact of DRA 2005
Federal Upper Limits. The DRA provision instructing CMS to use the
AMP for the purpose of calculating FULs instead of the AWP was intended to
eliminate some of the opportunities for drug manufacturers to inflate Medicaid
reimbursements as well as to simply reduce spending for Medicaid’s generic
prescription drugs. Indeed, the CBO estimated federal budgetary savings for this
provision to be substantial; totaling $3.6 billion for 2006 through 2010 and almost
$12 billion over 10 years. The AMPs, as submitted by the manufacturers to CMS,
are generally lower than any of the published AWPs and as yet, remain confidential.
Until the passage of DRA, CMS was prohibited from making those prices publically
available and could only share them with the U.S. General Accounting Office and the
Congressional Budget Office. Upon full implementation of the DRA provisions,
AMPs are to become publically available.
Retail pharmacies have responded to DRA’s FUL formula change with concerns
that the lower FULs will push Medicaid reimbursements for multiple source drugs
to amounts below pharmacies’ acquisition costs. Small community pharmacies that
buy smaller quantities of drugs than the big chain pharmacies are particularly
concerned, since they have less price negotiating power and almost always purchase
through third-party wholesalers.

41 Pharmaceutical Benefits Under State Medical Assistance Programs 2005/2006.
42 B. Stuart, B.A. Briesacher, F. Ahern, D. Kidder, C. Zacker, G. Erwin, D. Gilden, and C.
Fahlman “Drug Use and Prescribing Problems in Four State Medicaid Programs,” Health
Care Financing Review, vol. 20, no. 3, spring 1999.
43 A large classification of drugs that includes psychotherapeutics, treatments for seizure
disorders and Parkinson’s, and drugs for pain, among others.

GAO was asked to examine the estimated FULs using AMP and compare those
amounts to pharmacy acquisition prices. In a memorandum dated December 22,
2006 addressed to Representative Joe Barton, the GAO compared 250% of the lowest
AMP with acquisition costs for a sample of frequently used and high expenditure
Medicaid drugs. GAO found that the estimated FULs were below average retail
pharmacy acquisition costs for 59 of the 77 drugs examined.44 These findings
potentially provide support for the concerns raised by the retail pharmacies and may
raise other concerns as well. For example, if the FULs, when finally implemented,
turn out to be below acquisition costs, Medicaid beneficiaries could suffer reduced
access to such products since pharmacies might be disinclined to do business with
Medicaid programs.
Proposed regulation. In December 2006, CMS issued a proposed rule to
implement the DRA provisions pertaining to prescription drugs under Medicaid. The
rule, which was issued in final form in July of 2007 (72 Federal Register 39142),
defines a number of important terms related to drug pricing under Medicaid,
including definitions impacted by DRA provisions such as AMP, multiple source
drugs, and nominal prices.
The rule has elevated the concerns of pharmacy groups. Some of those concerns
were expressed in letters from members of the U.S. House of Representatives and the
Senate to the acting CMS administrator in February and March of 2007. One of the45
issues identified in the letters was about CMS’s inclusion of prices that are not
available to retailers in calculating AMP. According to the pharmacy groups, by
including those prices in AMP — prices and rebates that community pharmacists do
not have access to — the FULs would be lowered, as would Medicaid46
reimbursements, potentially making their Medicaid business unsustainable. This
has prompted a pending lawsuit brought by the National Association of Chain Drug
Stores and the National Community Pharmacists Association to halt the
implementation of this rule. At this time, the rule has been prohibited from being
implemented while the court case proceeds.
Cost sharing and Other Flexibility Enabled by DRA. As summarized
above, the DRA gave states several new cost sharing options, although the outcome
of these new options on beneficiaries’ copayments is not yet clear. A survey of state
Medicaid Directors conducted during the summer of 2006 suggests that only a
handful of states consider it likely or were certain to make changes based on the DRA
options. Thirty states, however responded that they didn’t know or had not yet
determined whether such changes would be forthcoming.47

44 Letter from John E. Dicken, Director of Health Care at U.S. Government Accountability
Office to Representative Joe Barton, December 22, 2006, GAO-07-239R.
45 Letters from Senators and Representatives and statement of the National Community
Pharmacists Association at [].
46 See complaint for National Association of Chain Drug Stores v. HHS, D.D.C. No. 07-


47 National Association of State Medicaid Directors and Avalere Health LLC, State
Perspectives on Emerging Medicaid Pharmacy Policies and Practices, November 2006.

In addition to cost sharing flexibility, Section 6081 of the Deficit Reduction Act
(DRA) authorized “transformation grants” to States for the adoption of innovative
methods to improve effectiveness and efficiency in providing medical assistance
under Medicaid. A number of activities were named as potential projects that would
qualify for such funds, including increasing the utilization of generic drugs through
education programs and other incentives and implementing a medication risk
management program as part of a drug use review program. During the first round
of grants, three states; Florida, New Mexico, and North Dakota were provided funds
to implement electronic prescribing programs.
Impact of MMA 2003
Drug Coverage. State Medicaid programs are undergoing major changes in
response to the implementation of the provisions of the Medicare Prescription Drug,
Improvements and Modernization Act of 2003 (MMA 2003, P.L. 108-173) signed
in December of 2003. As of the start of 2006, Medicaid eligibles who also qualify
for Medicare receive their outpatient prescription drugs under Medicare Part D
instead of under Medicaid. While this law doesn’t affect eligibility for Medicaid
programs, it does, however, affect the benefits that Medicaid programs will cover.
Under MMA 2003, state Medicaid programs are prohibited from covering drugs that
are to be provided under Part D, and cannot pay cost sharing amounts for those drugs.
Additional Administrative Responsibilities. States have both new
administrative and financial obligations under MMA 2003. States are required to
conduct eligibility determinations for the low-income subsidies and cost sharing
assistance for the Medicare program. This is because the assistance for low-income
Medicare Part D beneficiaries is based on the statutory description for a Medicaid
coverage group — Qualified Medicare Beneficiaries (QMBs). QMBs are a group of
dual eligible enrollees for whom Medicaid pays Medicare’s cost sharing
requirements. The group of individuals who qualify for low-income subsidies under
Medicare Part D is similar to the QMB eligibility group, except that the Part D group
allows for somewhat higher income financial standards.
Maintenance of Effort Payments. Finally, MMA requires states to continue
to pay part of the cost of the Medicare Part D drug benefit based on a formula that
projects what they would have paid for pharmacy benefits for the dual eligible
population in the absence of Medicare Part D. Beginning in 2006, each state must
make a monthly payment to the Secretary of HHS equal to the product of the state’s
share of 2003 Medicaid per capita spending for drugs for all full-benefit dual
eligibles48 trended forward to the current year, multiplied by the total number of such
dual eligibles in the state for the month, and multiplied again by the “factor” for the
year. The “factor” was 90% in 2006, and will phase down to 75% over 10 years.
This provision has proven to be controversial. Some states claim that the
payments for Part D exceed what they would have had to pay under Medicaid
because the formula doesn’t account for cost cutting activities that would have
occurred under Medicaid. Five states were party to an action, filed directly with the
Supreme Court challenging the constitutionality of the so-called “clawback”

48 Including the estimated actuarial value of prescription drug benefits provided under
Medicaid HMOs.

payments. Ten other states signed on as amici curiae, literally ‘friends of the court,’
in support of the five states.49 The Supreme Court, however, declined to hear the
action and also declined a separate request to block CMS from collecting the
payments. States would need to take the actions to federal district courts, which may
yet happen, but to date, have not.

49 Texas v. Leavitt, U.S., Original Action 135, filed March 3, 2006. The action was brought
by Texas, Kentucky, Maine, Missouri, and New Jersey. Ten states signing as amici curiae
were Alaska, Arizona, Connecticut, Kansas, Mississippi, New Hampshire, Ohio, Oklahoma,
South Carolina, and Vermont.

Actual Acquisition Cost (AAC) — Pharmacist’s or provider’s payments made
to purchase a drug from any source (e.g., manufacturer, wholesaler) net of discounts,
rebates, etc.
Average wholesale price (AWP) — Intended to reflect the average price at
which pharmaceutical products are purchased from wholesalers. In reality, it is more
like a manufacturer’s suggested wholesale price to the retailer, listed in any of the
published compendia of cost. In 2003 the compendia include the American Druggist
First DataBank Annual Directory of Pharmaceuticals (Blue Book), and Medi-Span’s
Pricing Guide, and Medical Economic’s Drug Topics Redbook.
Average manufacturers price (AMP) — the average price paid to a
manufacturer by wholesalers for a drug. AMP was created as a benchmark for the
purpose of calculating Medicaid rebates (OBRA 1990). A proposed definition has
been promulgated and is to be finalized by July 1, 2007. In addition, reported AMP
are to become publically available some time during 2007.
Average Sales Price (ASP) — A new system created by federal and state
prosecutors in settlements with pharmaceutical manufacturers TAP and Bayer to
ensure more accurate price reporting and more recently applied to Medicare products
paid under Part B of the program. ASP is the weighted average of all non-federal
sales to wholesalers and is net of chargebacks, discounts, rebates, and other benefits
tied to the purchase of the drug product, whether it is paid to the wholesaler or the
“Best price” — with respect to single source and innovator multiple source
drugs, the lowest price at which the manufacturer sells the covered outpatient drug
to any purchaser (excluding depot prices and single award contract prices of any
federal agency, prices charged by manufacturers to DVA, DOD, PHS and various
PHS-funded health programs, and state (non-Medicaid) pharmaceutical assistance
programs) in the United States. Used to calculate rebates due for those drugs.
Dispensing fee — a payment to cover the cost of the pharmacist’s professional
services in filling and dispensing a prescription.
Estimated acquisition cost (EAC) — the Medicaid agency’s best estimate of
the price paid by pharmacists or providers.
Formulary — a list of drug products that may be dispensed or reimbursed.
Insurers or states may create a “closed” (or “restricted”) formulary where only those
drug products listed will be reimbursed by that plan or program. Other formularies
may have no restrictions (“open” formularies) or may have certain restrictions such
as higher patient cost sharing requirements for off-formulary drugs.
Maximum allowable cost (MAC) — A maximum dollar amount the
pharmacist is paid for selected products.
Multiple source drug — a covered outpatient drug for which there is at least
one other drug product rated as therapeutically equivalent (under the FDA’s most
recent publication of “Approved Drug Products with Therapeutic Equivalence

Evaluations”) and is pharmaceutically equivalent and bioequivalent, as determined
by the FDA, and is sold or marketed in the State during the period. Innovator
multiple source drugs are those that are marketed under an original new drug
application (NDA) approved by the FDA. Non-innovator multiple source drugs are
all other multiple source drugs.
Original new drug application — an FDA-approved drug or biological
application that received one or more forms of patent protection, patent extension or
marketing exclusivity rights granted by the FDA.
Pharmaceutical benefit managers (PBMs) — Entities that contract with
health insurers to manage pharmaceutical benefits. Activities provided by PBMs
could include claims payment; administrative services, such as retail pharmacy
network development; mail order pharmacy operation; formulary development;
manufacturer rebate negotiation and prescription checks for adverse drug
interactions; and negotiating discounts on pharmaceuticals products.
Single source drug — A covered outpatient drug that is produced or distributed
under an original NDA approved by the FDA, including a drug product marketed by
any cross-licensed producers or distributors operating under the NDA.
Stop-loss — A specified annual threshold for medical services to be paid by an
insured person. Once the threshold is reached, the insurance coverage commences.
Wholesale acquisition cost (WAC) — The wholesaler’s net payment made to
purchase a drug product from the manufacturer, net of purchasing allowances and
Sources: E.K. Adams, Emory University School of Public Health, Atlanta, GA and
K. Gondek, HCFA as published in the Health Care Financing Review, vol. 15, no.

3, spring 1994, p. 26; State Medicaid Manual, Part Six, Transmittal 36, April 2000;

Federal Regulations.