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entitled 'Medicaid: States' Payments for Outpatient Prescription Drugs' 
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October 31, 2005: 

The Honorable Edward Whitfield: 
Subcommittee on Oversight and Investigations: 
Committee on Energy and Commerce: 
House of Representatives: 

Subject: Medicaid: States' Payments for Outpatient Prescription Drugs: 

Dear Mr. Chairman: 

Spending on outpatient prescription drug coverage for Medicaid 
beneficiaries has accounted for a substantial and growing share of 
Medicaid program expenditures.[Footnote 1] All states and the District 
of Columbia have elected to include outpatient prescription drug 
coverage as a benefit of their Medicaid programs. Total Medicaid 
expenditures on outpatient prescription drugs grew from $4.6 billion 
(nearly 7 percent of Medicaid's total medical care expenditures) in 
fiscal year 1990 to $33.8 billion (13 percent of Medicaid's total 
medical care expenditures) in fiscal year 2003. This represented more 
than twice the rate of increase in total Medicaid spending from fiscal 
year 1990 through fiscal year 2003. Amid concerns about increasing 
Medicaid drug spending, focus has been drawn to the ways states pay for 
prescription drugs. 

State Medicaid programs pay pharmacies for covered outpatient 
prescription drugs dispensed to Medicaid beneficiaries. The Centers for 
Medicare & Medicaid Services (CMS)--the agency of the Department of 
Health and Human Services (HHS) that oversees states' Medicaid 
programs--sets maximum payment limits for certain drugs--federal upper 
limits (FUL)[Footnote 2]--and provides guidelines regarding drug 
payment, as defined by regulation.[Footnote 3] Within these parameters, 
states may determine their own drug payment methodologies. States are 
to pay pharmacies the lower of the state's estimate of the drug's 
acquisition cost to the pharmacy, plus a dispensing fee, or the 
pharmacy's usual and customary charge to the general public; for 
certain drugs, the FUL or the state maximum allowable cost (MAC) may 
apply if lower.[Footnote 4] All states estimate the acquisition cost of 
drugs using published prices because they do not have access to actual 
sales price data, which are not publicly available. Most states choose 
to estimate drug acquisition cost by taking a percentage discount off 
of Average Wholesale Price (AWP).[Footnote 5] AWP is a list price that 
a manufacturer suggests wholesalers charge pharmacies. 

Based on concerns about escalating Medicaid drug expenditures, you 
asked us to review state Medicaid payments for covered outpatient 
prescription drugs. We reviewed how Medicaid payments for prescription 
drugs compared across selected states and how these states' Medicaid 
payments for prescription drugs compared to three market-based prices. 

We briefed your staff on the information contained in this report on 
September 16, 2005. As discussed with your staff at that time, we 
agreed to issue this report, which officially transmits the briefing 
slides (see enc. I) and expands on the information provided at the 

Scope and Methodology: 

To examine state Medicaid payments for outpatient drugs, we analyzed 
CMS data to develop a basket of 200 drugs that accounted for more than 
half of Medicaid's national spending on outpatient prescription drugs 
in 2003.[Footnote 6] We judgmentally selected five states for review-- 
Mississippi, Montana, Pennsylvania, South Carolina, and Utah; these 
states utilize a varying percentage discount off of AWP to estimate 
drug acquisition cost. We interviewed officials from the five states' 
Medicaid agencies to gather information on each state's pharmacy 
payment practices. We also obtained the five states' 2003 payment data 
for each of the 200 drugs in our basket. For every drug, we calculated 
each state's payment per unit.[Footnote 7] Using these calculations, we 
reviewed the variation in the percent difference between the lowest 
state payment and the highest state payment for each drug. We report 
our findings based on drug type (brand or generic) and drug therapeutic 
class based on data we obtained from First DataBank.[Footnote 8] 

To compare state Medicaid payments to selected market-based prices, we 
reviewed how states' average payments compared to three prices that are 
based on actual sales transactions--Average Manufacturer Price (AMP), 
Best Price, and Federal Supply Schedule (FSS) Price. We selected AMP 
and Best Price because they are currently used in the Medicaid program 
to calculate drug rebates;[Footnote 9] FSS Price was selected because 
it represents prices available to certain federal government 
purchasers. Table 1 provides descriptive characteristics of these 
prices. We obtained AMP and Best Price data from CMS and FSS Price data 
from the Department of Veterans Affairs (VA).[Footnote 10] We assessed 
the variation in the percent difference between each state's payment 
and the states' average payment, to each of the market-based prices. 

Table 1: Characteristics of Selected Market-Based Prices: 

[See PDF for image] 

Source: GAO analysis of CMS and VA data. 

Note: Retail pharmacies that dispense prescription drugs to Medicaid 
beneficiaries may be unable to purchase drugs at AMP, Best Price, or 
FSS Price. 

[A] See 42 U.S.C.  1396r-8(k)(1). According to CMS, transactions used 
to calculate AMP are to reflect cash discounts and any adjustments that 
affect the price realized, but are not to include prices to direct 
federal purchasers based on the Federal Supply Schedule (FSS), prices 
from direct sales to hospitals or health maintenance organizations, or 
prices to wholesalers when they relabel drugs they purchase under their 
own label. There is no definition in the statute for "retail pharmacy 
class of trade." 

[B] The Omnibus Reconciliation Act of 1990 created AMP and Best Price 
for use in the Medicaid program to calculate drug rebates. As we noted 
in our February 2005 report, we found considerable variation in the 
methods manufacturers used to determine AMP and Best Price. See GAO, 
Medicaid Drug Rebate Program: Inadequate Oversight Raises Concerns 
about Rebates Paid to States, GAO-05-102 (Washington, D.C.: Feb. 4, 

[C] See 42 U.S.C.  1396r-8(c)(1)(C). CMS has further defined Best 
Price as the lowest price at which the manufacturer sells the drug to 
any purchaser in any pricing structure, including capitated payments, 
with some exceptions. Best Price is required to be reduced to account 
for price adjustments such as discounts and rebates, but is not to 
include prices charged to certain federal purchasers (including prices 
to direct federal purchasers based on the FSS) and other select 

[D] See Pub. L. No. 102-585,  603, 106 Stat. 4943, 4971-75. The 
Veterans Health Care Act of 1992 required that drug manufacturers list 
their brand-name drugs on the FSS in order for purchases of such drugs 
to be eligible for Medicaid payment. During a multiyear contract 
period, FSS Prices may not increase faster than inflation. 

[End of table] 

While we generally relied on and did not independently verify the data 
provided to us by the states, we reviewed the data for reasonableness 
and to identify unusual patterns, including outliers. To ensure that 
state payments and market-based prices were based on the same number of 
units, we compared the units used to calculate both. Where necessary, 
we recalculated unit payments to ensure valid per-unit comparisons. We 
also reviewed the reasonableness of states' payments in comparison to 
their formulas for estimating acquisition cost. Additionally, we 
discussed unusual patterns and outliers with state Medicaid officials 
and as a result of unresolved data reliability concerns, eliminated six 
drugs from our basket.[Footnote 11] Our final basket contained 194 
drugs, which consisted of 189 brand-name drugs--187 single-source and 2 
multiple-source drugs--and 5 generic drugs.[Footnote 12] 

Our results cannot be generalized to states or drugs not included in 
our analysis. Our work also did not consider other mechanisms state 
Medicaid programs may use to control the costs of prescription drugs, 
such as the collection of rebates through federal and state programs 
and policies on the mandatory use of generic drugs. Furthermore, our 
analysis did not examine the utilization of drugs and therefore does 
not estimate cost savings for the Medicaid program. We performed our 
work from February 2004 through October 2005 in accordance with 
generally accepted government auditing standards. 

Results in Brief: 

Overall, minimal variation existed among the five states' payments for 
most drugs. Specifically, the five states' payments for 189 brand-name 
drugs varied less than 7 percent on average; the five states' payments 
for the 5 generic drugs we reviewed varied 30 percent on average. 
States' payment levels aligned with their respective formulas for 
estimating drug acquisition cost. In particular, states that based 
their estimates of drug acquisition cost on larger discounts off of AWP 
often paid the lowest amount for drugs; similarly, states that based 
their estimates of drug acquisition cost on smaller discounts off of 
AWP often paid the highest amount for drugs. 

The five states' payments exceeded the three market-based prices we 
reviewed--AMP, Best Price, and FSS Price. Each state's payments 
exceeded these market-based prices for nearly all of the brand-name 
drugs we reviewed. On average, each state's payments for brand-name 
drugs exceeded each market-based price by 10 percent or more. 
Additionally, states' average payments for brand-name drugs were 12 
percent higher than AMP, 36 percent higher than Best Price, and 73 
percent higher than FSS Price, on average. Our results highlight the 
differences between states' payments (based on the lower of states' 
estimates of drug acquisition cost or the pharmacy's usual and 
customary charge; for certain drugs, the FUL or the state MAC may apply 
if lower) and market- based prices (based on actual sales transaction 

Agency and State Comments: 

We provided a draft of this report for comment to the Administrator of 
CMS and Medicaid directors in Mississippi, Montana, Pennsylvania, South 
Carolina, and Utah. CMS comments are included in enclosure II. We 
received technical comments from some states, which we incorporated as 

CMS stated that this report makes it clear that the current payment 
rules result in overpayments for drugs and emphasizes the need for 
reform. CMS commented that payments should be determined using accurate 
acquisition cost data, which it said requires congressional action. Our 
review focused on describing how payments for prescription drugs 
compared across selected states and how these states' payments compared 
to three market-based prices. As such, the scope of our work did not 
include an evaluation of the need to reform the current payment system. 
CMS also commented that it has encouraged states to review their 
estimates of drug acquisition cost and that states have submitted to 
the agency an increased number of amendments to their state Medicaid 
plans that would lower these estimates. Finally, CMS commented that the 
report focused solely on states' payment rates for drugs and did not 
consider a variety of other approaches that states have adopted to 
control their drug spending. As we noted in our draft report, such 
consideration was beyond the scope of our work. 

One state--Utah--raised concerns that states do not have access to the 
market-based pricing data we used in our analysis, which makes it 
difficult for them to accurately estimate the acquisition cost of 
drugs. Our draft report noted that states do not have access to actual 
sales price data and that states therefore use published prices, such 
as AWP, to estimate the acquisition cost of drugs. 

As agreed with your office, unless you publicly announce the contents 
of this report earlier, we plan no further distribution of it until 30 
days from the date of this report. At that time, we will send copies to 
the Administrator of CMS and interested congressional committees. The 
report will also be available on GAO's home page at 

If you or your staff have any questions about this report, please 
contact me at (202) 512-7119 or Contact points for our 
Offices of Congressional Relations and Public Affairs may be found on 
the last page of this report. GAO staff who made major contributions to 
this report are listed in enclosure III. 

Sincerely yours, 

Signed by: 

Kathleen M. King: 

Director, Health Care: 

Enclosures - 3: 

Enclosure I: 

[See PDF for images] 

[End of slide presentation] 

[End of section] 

Enclosure II: Comments from the Centers for Medicare & Medicaid 

Centers for Medicare & Medicaid Services: 
Washington, DC 20201: 

DATE: OCT 19 2005: 

TO: Kathleen M. King: 
Director, Health Care: 
U.S. Government Accountability Office: 

FROM: Mark B. McClellan, M.D., Ph.D.: 
Centers for Medicare & Medicaid Services: 

SUBJECT: Government Accountability Office's (GAO) Draft Report: 
Medicaid: States' Payments for Outpatient Prescription Drugs (GAO-06- 

Thank you for the opportunity to comment on the above-referenced draft 
report. The report reviews State Medicaid payments for covered 
outpatient prescription drugs under the Medicaid drug rebate program. 
Specifically, the report examines (1) how Medicaid payments for 
outpatient prescription drugs compare across selected States and (2) 
how selected States' Medicaid payments compare to market-based prices. 

As for every major payer in this country, prescription drug costs in 
Medicaid have increased substantially and account for a growing share 
of Medicaid program expenditures. The Centers for Medicare & Medicaid 
Services (CMS) shares the GAO's concerns regarding the increase in 
Medicaid spending for prescription drugs and the high reimbursement 
levels paid by States. 

Federal regulations at 42 CFR 447.331 require States to pay for 
prescription drugs at the lower of estimated acquisition cost or usual 
and customary charges. Absent a more accurate source of price data, 
States rely on prices published by drug compendia to estimate 
acquisition costs. The regulations at 42 CFR 447.332 also require CMS 
to set upper limits for certain multiple source drugs. 

The GAO report makes clear that the current payment rules result in 
overpayments for drugs and emphasizes the need for reform. The 
President's fiscal year (FY) 2006 budget proposes to solve this problem 
by basing Medicaid drug payment on average sales prices (ASP). The FY 
2006 budget proposal would require drug manufacturers to report the ASP 
for each drug and would cap Federal payment, in the aggregate, at ASP 
plus 6 percent. As long as States must rely on prices that are not 
based on market prices paid to manufacturers, they lack sufficient 
information to set appropriate payment amounts. Current wholesale 
acquisition cost (WAC) and average wholesale prices (AWP) are greatly 
inflated, in part because higher list prices from manufacturers result 
in greater profits to pharmacies when payment is set in relation to the 
artificial prices. Requiring manufacturers to report true market based 
prices and limiting Medicaid payment to a reasonable amount above these 
prices will eliminate the opportunity for manufacturers and pharmacies 
to gain through reporting inflated prices, yield substantial State and 
Federal government savings, and retain flexibility for States to set 
prices for individual drugs as they find appropriate within the overall 

The GAO report finds that Medicaid payments exceed market based prices, 
but it provides no new or additional information regarding the true 
acquisition cost of drugs. CMS continues to believe that an accurate 
acquisition cost should be used to determine payments. This requires 
Congressional action to define acquisition cost in statute, require 
manufacturers to report this cost to the Federal government, and set a 
cap on Federal reimbursement to States based on this cost. As long as 
States must rely on data submitted by manufacturers which is inflated, 
States will continue to pay at rates not reflective of market prices. 

Numerous reports and studies on acquisition costs for brand name and 
generic drugs reimbursed under Medicaid have recommended that CMS 
require States to bring drug reimbursement more in line with the actual 
acquisition cost. Absent a change in the law, CMS has encouraged States 
to review their estimates of acquisition costs in light of those 
findings. Additionally, CMS continuously monitors States' estimated 
acquisition costs and provides a quarterly update on the CMS website. 
These actions have resulted in States submitting an increased number of 
State plan amendments to lower their estimates of acquisition costs. 

This report focused solely on payment rates to compare States drug 
spending. We note that States have adopted a variety of approaches to 
reduce prescription drug spending. These include establishing preferred 
drug lists, negotiating supplemental rebates (either individually or 
with other States), and expanding prior authorization requirements. The 
findings did not consider these other mechanisms State Medicaid 
agencies use to control the costs of prescription drugs. 

Thank you again for the opportunity to respond to the report. 

[End of section] 

Enclosure III: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Kathleen M. King, (202) 512-7119 or 


In addition to the contact named above, Debra Draper, Assistant 
Director; Jennie Apter; Robin Burke; Jessica Cobert; Martha R. W. 
Kelly; Kevin Milne; Daniel S. Ries; and Patricia Roy made key 
contributions to this report. 



[1] Medicaid is a joint federal-state program that finances health 
insurance for certain low-income adults and children. 

[2] See 42 C.F.R.  447.332 (2004). Federal regulations require CMS to 
set specific FUL amounts for certain multiple-source drugs that are 
provided by at least three suppliers. A multiple-source drug is a drug 
that is either marketed or sold by two or more manufacturers or 
labelers, or marketed or sold by the same manufacturer or labeler under 
two or more different proprietary names or both under a proprietary 
name and without such a name. Payments for these drugs must not exceed, 
in the aggregate, a reasonable dispensing fee plus an amount that 
equals 150 percent of the lowest published price of the drug listed in 
national pricing compendia. 

[3] See 42 C.F.R.  447.331 (2004). 

[4] As of December 2003, 38 states had established maximum allowable 
costs for multiple-source drugs at a rate below an established FUL or 
for drugs for which CMS had not set an FUL. 

[5] States may obtain AWP from one or more national pricing compendia; 
although multiple sources publish price lists, the prices listed by one 
source do not necessarily equal the prices listed by other sources. 

[6] For the purpose of this report, the term drug refers to a distinct 
national drug code (NDC). NDCs identify unique formulations of each 
drug, including the manufacturer, strength, and package size. A single 
drug may have multiple NDCs. Because our analysis was performed at the 
NDC level, multiple versions of the same drug are included in our 

[7] State's payment per unit was the state's payment to pharmacies as 
determined by the lowest of: the state's estimate of drug acquisition 
cost, the pharmacy's usual and customary charge, the FUL, if available, 
or the state MAC, if available, divided by the number of units 
dispensed. Our report summarizes results from our analysis of states' 
payments per unit as calculated without dispensing fees. 

[8] Drugs that possess similar chemical structures and similar 
therapeutic effects are grouped into therapeutic classes. Most drugs 
within a class produce similar benefits, side effects, adverse 
reactions, and interactions with other drugs and substances. 

[9] The Omnibus Budget Reconciliation Act of 1990, Pub. L. No. 101-508 
 4401, 104 Stat. 1388-143-1388-161, established the Medicaid drug 
rebate program to help control Medicaid drug spending. Under the rebate 
program, a pharmaceutical manufacturer pays rebates to states in order 
for federal payments to be available under Medicaid for the 
manufacturer's outpatient drugs. 

[10] AMP and Best Price data are reported quarterly; we obtained data 
on both prices for all four quarters of 2003 and calculated the average 
2003 AMP and Best Price. FSS Price is reported based on a contract 
period; if more than one contract was in place during calendar year 
2003, we averaged the available 2003 FSS Prices for the purposes of our 

[11] Five of the six excluded drugs were antihemophiliac factor drugs; 
the sixth drug was an injectable drug used to treat multiple sclerosis. 
As a result of data reliability concerns, we also excluded data on five 
drugs from one state, and data on one drug each from two states. 

[12] For the purposes of this report, we refer to single-source and 
multiple-source drugs that are marketed under a registered trade name 
as brand-name drugs. Single-source drugs are brand-name drugs that have 
no generic equivalent on the market and are generally available from 
only one manufacturer.