Department of Health and Human Services

OFFICE OF 

INSPECTOR GENERAL 

H I P
OW  NFLATED  UBLISHED 

P A D
RICES  FFECT  RUGS 

C
ONSIDERED FOR THE

F U L L
EDERAL  PPER  IMIT  IST

Daniel R. Levinson

Inspector General 

September 2005

OEI-03-05-00350
 Office of Inspector General 

http://oig.hhs.gov 
The mission of the Office of Inspector General (OIG), as mandated by Public Law 95-452, 
as amended, is to protect the integrity of the Department of Health and Human Services 
(HHS) programs, as well as the health and welfare of beneficiaries served by those 
programs. This statutory mission is carried out through a nationwide network of audits, 
investigations, and inspections conducted by the following operating components: 
Office of Audit Services 
The Office of Audit Services (OAS) provides all auditing services for HHS, either by 
conducting audits with its own audit resources or by overseeing audit work done by others. 
Audits examine the performance of HHS programs and/or its grantees and contractors 
in carrying out their respective responsibilities and are intended to provide independent 
assessments of HHS programs and operations in order to reduce waste, abuse, and 
mismanagement and to promote economy and efficiency throughout HHS. 
Office of Evaluation and Inspections 
The Office of Evaluation and Inspections (OEI) conducts management and program 
evaluations (called inspections) that focus on issues of concern to the HHS, Congress, 
and the public. The findings and recommendations contained in the inspections generate 
rapid, accurate, and up-to-date information on the efficiency, vulnerability, and 
effectiveness of departmental programs.  OEI also oversees State Medicaid Fraud 
Control Units which investigate and prosecute fraud and patient abuse in the Medicaid 
program. 
Office of Investigations 
The Office of Investigations (OI) conducts criminal, civil, and administrative 
investigations of allegations of wrongdoing in HHS programs or to HHS beneficiaries 
and of unjust enrichment by providers. The investigative efforts of OI lead to criminal 
convictions, administrative sanctions, or civil monetary penalties. 
Office of Counsel to the Inspector General 
The Office of Counsel to the Inspector General (OCIG) provides general legal services to 
OIG, rendering advice and opinions on HHS programs and operations and providing all 
legal support in OIG's internal operations. OCIG imposes program exclusions and civil 
monetary penalties on health care providers and litigates those actions within HHS. 
OCIG also represents OIG in the global settlement of cases arising under the Civil False 
Claims Act, develops and monitors corporate integrity agreements, develops compliance 
program guidances, renders advisory opinions on OIG sanctions to the health care 
community, and issues fraud alerts and other industry guidance.    E X E C U T I V E   S U M M A R Y  

OBJECTIVE 
To determine (1) the extent to which the mandated method for 
calculating Medicaid Federal upper limit amounts causes qualified 
products to be excluded from the Federal upper limit list and (2) the 
potential financial implications of these exclusions to Medicaid. 
BACKGROUND 
The Federal upper limit program was put in place to ensure that the 
Federal Government acts as a prudent payer by taking advantage of 
current market prices for multiple-source drugs.  Statutory and 
regulatory criteria generally require the Centers for Medicare & 
Medicaid Services (CMS) to include a drug on the Federal upper limit 
list if: (1) at least three versions of the drug are rated as therapeutically 
equivalent by the Food and Drug Administration (FDA), and (2) the 
drug has at least three suppliers listed in current editions of national 
compendia. The Federal upper limit amount for a drug is set at    
150 percent of the published price for the least costly, therapeutically 
equivalent product found in national compendia plus a reasonable 
dispensing fee. 
CMS applies an additional standard in determining which drugs should 
be subject to Federal upper limits. According to CMS staff, only drugs 
for which a Federal upper limit could potentially lead to savings should 
be included on the Federal upper limit list.  Therefore, if a drug does not 
have a published price that, when multiplied by 150 percent, is lower 
than the average wholesale price (AWP) (upon which reimbursement is 
typically based), CMS does not include the product.  
For the covered outpatient drugs of a manufacturer to be eligible for 
Federal matching funds under Medicaid, section 1927(a)(1) of the Social 
Security Act mandates that the manufacturer must enter into a rebate 
agreement with CMS and pay quarterly rebates to State Medicaid 
agencies. Under these rebate agreements and the law, manufacturers 
must provide CMS with the average manufacturer prices (AMP) for 
each of their covered drugs on a quarterly basis.  Pursuant to Federal 
statute, the AMP is the average price paid to a manufacturer for a drug 
in the United States by wholesalers for drugs distributed to the retail 
pharmacy class of trade, net of customary prompt pay discounts.  The 
Medicare Prescription Drug, Improvement, and Modernization Act of 
  OEI-03-05-00350  HOW INFLATED PUBLISHED PRICES AFFECT DRUGS CONSIDERED FOR THE FEDERAL UPPER LIMIT LIST  i  E X E C U T I V E   S U M M A R Y  
2003 recognizes the AMP as a potential measure to be substituted in 
Medicare reimbursement calculations. 
For each drug product approved between 2001 and 2003 that met all 
statutory and regulatory criteria for inclusion on the Federal upper 
limit list but did not meet CMSs additional criterion, we calculated the 
minimum AMP, average AMP, and maximum AMP in the first and 
second quarters of 2004.  To follow current procedures prescribed by 
Federal regulation, we limited the calculation to products that (1) were 
rated therapeutically equivalent by FDA and (2) were available in the 
most commonly listed package size. We also limited the analysis to 
products with Medicaid utilization in the first two quarters of 2004.   
To determine the potential implications if CMS were able to use AMPs 
rather than published prices to set Federal upper limit amounts, we:  
(1) multiplied the minimum, average, and maximum AMPs for the 
reviewed drugs by 150 percent (the percentage stated in current 
regulation); (2) subtracted 150 percent of the minimum, average, and 
maximum AMPs from the average Medicaid reimbursement amount 
(less the dispensing fee) in each of the first two quarters of 2004; and  
(3) multiplied the difference calculated in step two by the number of 
units of the drug product reimbursed during these quarters.  This figure 
provided us with the savings that could have resulted in just two 
quarters for drugs that were not included on the Federal upper limit list 
due to issues with their published prices. 
FINDINGS 
In the first two quarters of 2004, 58 drug products that met all 
statutory and regulatory requirements were not added to the Federal 
upper limit list due to inflated published prices.  Of the 252 first-time 
generic drug products approved between 2001 and 2003, 58 met all 
statutory and regulatory requirements as of June 30, 2004, but were not 
included on the Federal upper limit list because their addition would 
not have lead to savings.  Each of these 58 products had at least    
3 A-rated versions and 3 suppliers, but did not have a published price 
that when multiplied by 150 percent was less than the AWP.   
Overall, average AWPs were more than three times higher than the 
average AMPs for the reviewed drug products.  Even the minimum 
published prices for these drugs were substantially higher than the 
  OEI-03-05-00350  HOW INFLATED PUBLISHED PRICES AFFECT DRUGS CONSIDERED FOR THE FEDERAL UPPER LIMIT LIST  ii  E X E C U T I V E   S U M M A R Y  
average AMP.  Given that Federal law requires that these minimum 
published prices be multiplied by 150 percent, the difference between 
Federal upper limit amounts and AMPs would grow even wider. 
Basing Federal upper limit amounts on AMPs could save Medicaid 
over $100 million per year by allowing otherwise qualified products 
to be included on the Federal upper limit list.   As the previous finding 
shows, inflated published prices are causing CMS to exclude otherwise 
qualified drug products from the Federal upper limit list because their 
Federal upper limit amount would exceed the reimbursement amount 
set under the usual methods.  However, if Medicaid based Federal upper 
limit amounts on 150 percent of the average reported AMP rather than 
150 percent of the lowest published price, the program may have saved 
$75 million in just two quarters of 2004 due to these excluded drugs 
being added to the Federal upper limit list.  Furthermore, if Medicaid 
could have used the lowest reported AMP multiplied by 150 percent 
when calculating Federal upper limit amounts, the program would have 
saved an estimated $111 million in the first and second quarters of 2004 
for these drugs.  Even if Federal upper limit calculations were based on 
150 percent of the highest reported AMP, the program would have saved 
almost $39 million. 
CONCLUSION 
In the past several months, the President, Congress, and individual 
State Medicaid programs have expressed heightened interest in 
ensuring that Medicaid drug reimbursement amounts more closely 
resemble actual acquisition costs. In addition, the Office of Inspector 
General (OIG) has recently released a number of reports that once again 
showed that the published prices used as the basis for Medicaid 
reimbursement bear little or no resemblance to prices based on actual 
sales, especially for generic drugs.  The Federal upper limit program is 
particularly affected by this disconnect between published prices and 
acquisition costs among generic drugs.   
Congress created the Federal upper limit program to help Medicaid take 
advantage of current market prices for lower-cost generic drugs.  
However, Federal regulation requires that Federal upper limit amounts 
be based on 150 percent of the prices published in national compendia.  
Not only does the pricing methodology prescribed by Federal law cause 
artificially high Federal upper limit amounts for those products on the 
  OEI-03-05-00350  HOW INFLATED PUBLISHED PRICES AFFECT DRUGS CONSIDERED FOR THE FEDERAL UPPER LIMIT LIST  iii  E X E C U T I V E   S U M M A R Y  
Federal upper limit list, it also causes other qualified drugs to never be 
included on the list in the first place.  This secondary effect is costing 
Medicaid millions of dollars per year, in addition to the considerable 
losses the program faces due to the inflated prices of drugs already on 
the Federal upper limit list. 
Based on years of work by OIG, the Government Accountability Office, 
and others revealing the inflated nature of AWPs and other published 
prices, the Medicare program eliminated the use of AWP in its pricing 
methodology for Part B covered drugs.  The fact that Medicaid still uses 
these published prices to determine Federal upper limit amounts makes 
little sense.  We believe that reimbursement in general and Federal 
upper limit amounts in particular should reliably reflect the actual costs 
of drugs to pharmacies. Consequently, there is an urgent need for the 
Medicaid policymaking community to revise Federal upper limit 
policies, thereby ensuring that reimbursement amounts for generic 
drugs accurately reflect market prices, and that the Federal upper limit 
program better meets its original intent. 
Agency Comments 
CMS concurred with our findings, stating that the use of published 
prices as the basis for Federal upper limit amounts precludes the 
addition of some drugs to the Federal upper limit list.  CMS also noted 
the recent changes to the basis of reimbursement for Medicare drugs 
made by the Medicare Prescription Drug, Improvement, and 
Modernization Act of 2003, and indicated that the same types of 
measures should be enacted for Medicaid.   The full text of CMSs 
comments is presented in Appendix A. 
  OEI-03-05-00350  HOW INFLATED PUBLISHED PRICES AFFECT DRUGS CONSIDERED FOR THE FEDERAL UPPER LIMIT LIST  iv    T A B L E   O F   C O N T E N T S  

EXECUTIVE SUMMARY ........................................  i

INTRODUCTION ................................................ 1 

F I N D IN G S

Fifty-eight drugs were not added to list due to inflated prices .... 9 

Current calculation method could be costing Medicaid millions ... 9 

CONCLUSION .................................................. 11 

APPENDIX 
A : Centers for Medicare & Medicaid Services Comments.......  13

ACKNOWLEDGMENTS ......................................... 15 

  OEI-03-05-00350  HOW INFLATED PUBLISHED PRICES AFFECT DRUGS CONSIDERED FOR THE FEDERAL UPPER LIMIT LIST  v    I N T R O D U C T I O N  

OBJECTIVE 
To determine (1) the extent to which the mandated method for 
calculating Medicaid Federal upper limit amounts causes qualified 
products to be excluded from the Federal upper limit list and (2) the 
potential financial implications of these exclusions to Medicaid. 
BACKGROUND 
Medicaid Program 
Medicaid is a jointly funded Federal and State health insurance 
program for certain low income and medically needy people.  Individual 
States establish eligibility requirements, benefits packages, and 
payment rates for their Medicaid programs under broad Federal 
standards administered by the Centers for Medicare & Medicaid 
Services (CMS).  Medicaid requirements mandate that States provide 
basic services to beneficiaries to receive Federal matching funds.  States 
may also receive Federal funding if they provide other optional services. 
One universally offered optional service is prescription drug coverage.  
All 50 States and the District of Columbia currently offer prescription 
drug coverage under the Medicaid program.  In calendar year 2003, 
CMS estimates that Medicaid payments for prescription drugs totaled 
over $34 billion.1 
Medicaid Drug Reimbursement Methodology 
Each State is required to submit a Medicaid State plan to CMS 
describing its payment methodology for covered drugs.  Federal 
regulations require, with certain exceptions, that each States 
reimbursement for a drug not exceed the lower of its estimated 
acquisition cost plus a reasonable dispensing fee or the providers usual 
and customary charge to the public for the drug.   
CMS allows States flexibility to define estimated acquisition cost. Most 
States base their calculation of estimated acquisition cost on a drugs 
average wholesale price (AWP) discounted by a certain percentage.  As 
of the first quarter of 2005, this discount ranged from 5 to 50 percent of 
the AWP.  A small number of States use wholesale acquisition costs plus 
a percentage markup rather than, or in addition to, discounted AWPs 
when determining estimated acquisition cost. 
1 This amount includes both the Federal and State shares of payments.  Rebates collected 
under the Medicaid Drug Rebate program have not been subtracted from the total. 
  OEI-03-05-00350  HOW INFLATED PUBLISHED PRICES AFFECT DRUGS CONSIDERED FOR THE FEDERAL UPPER LIMIT LIST  1  I N T R O D U C T I O N  
For certain drugs, States also use the Federal upper limit and/or State 
maximum allowable cost programs in determining reimbursement 
amounts.  CMS has established Federal upper limit amounts for more 
than 400 drugs.  In addition, numerous States have implemented a 
maximum allowable cost program to limit reimbursement amounts for 
certain drugs.  Individual States determine the types of drugs that are 
included in their maximum allowable cost programs and the methods by 
which the maximum allowable cost for a drug is calculated. 
In summary, States use a variety of mechanisms when setting drug 
reimbursement amounts.  In most cases, States reimburse for a drug at 
the lower of the estimated acquisition cost, the Federal upper limit 
amount, or the State maximum allowable cost, plus a reasonable 
dispensing fee. 
Federal Upper Limit Program 
According to CMSs State Medicaid Manual, the Federal upper limit 
program was created to ensure that the Federal Government acts as a 
prudent payer by taking advantage of current market prices for 
multiple-source drugs. Under 42 CFR  447.332, CMS is to establish a 
Federal upper limit amount for a drug when:  (1) all formulations of a 
drug have been rated as therapeutically equivalent by the Food and 
Drug Administration (FDA), and (2) at least three suppliers of the drug 
are listed in current editions (or updates) of the published compendia of 
cost information for drugs available for sale nationally.  Section 4401 of 
the Omnibus Budget Reconciliation Act of 1990 (OBRA 90) established 
new criteria requiring a drug to be included on the Federal upper limit 
list when three or more versions of a drug had been rated 
therapeutically and pharmaceutically equivalent by FDA, regardless of 
the ratings of other versions.2 FDA designates drugs that are 
therapeutically equivalent as A-rated.   
Federal regulation (42 CFR  447.332) sets the Federal upper limit 
amount at 150 percent of the published price for the least costly, 
therapeutically equivalent product that can be purchased by 
pharmacists in quantities of 100 tablets or capsules plus a reasonable 
2 According to the State Medicaid Manual, the language of OBRA 90 augments the 
upper limits established by the regulation and creates new criteria for adding drugs to 
the Federal upper limit list.  CMS has not modified the language of the regulation since it 
was promulgated in 1987, nor has the regulation been withdrawn.  In practice, CMS relies 
on the language of the regulation and the OBRA 90 provisions in establishing Federal 
upper limits. 
  OEI-03-05-00350  HOW INFLATED PUBLISHED PRICES AFFECT DRUGS CONSIDERED FOR THE FEDERAL UPPER LIMIT LIST  2  II NN TT RR OO DD UU CC TT II OO NN
dispensing fee. If the drug is not typically available in quantities of 
100 or if the drug is a liquid, the Federal upper limit amount is based on 
a commonly listed size. 
CMS applies an additional standard in determining which drugs should 
be subject to Federal upper limits. According to CMS staff, only drugs 
for which a Federal upper limit could potentially lead to savings should 
be included on the Federal upper limit list. Therefore, if a drug does not 
have a published price that, when multiplied by 150 percent, is lower 
than the AWP, CMS does not include the product. 
CMS publishes the Federal upper limit list in the State Medicaid 
Manual and on its Web site.3  Any revisions to the Federal upper limit 
list are typically noted on the Web site as well. CMS establishes an 
upper limit for specific forms and strengths for each multiple-source 
drug on the list. The Federal upper limit list also provides the source of 
the pricing information used to calculate the upper limit amount for 
each drug. 
The Medicaid Drug Rebate Program and Average Manufacturer Price 
For the covered outpatient drugs of a manufacturer to be eligible for 
Federal matching funds under Medicaid, section 1927(a)(1) of the Social 
Security Act (the Act) mandates that the manufacturer must enter into 
a rebate agreement with CMS and pay quarterly rebates to States. 
Under these rebate agreements and the law, manufacturers must 
provide CMS with the average manufacturer price (AMP) for each of 
their covered drugs on a quarterly basis. Pursuant to section 1927(k)(1) 
of the Act, the AMP is defined as the average price paid to a 
manufacturer for a drug in the United States by wholesalers for drugs 
distributed to the retail pharmacy class of trade, net of customary 
prompt pay discounts. The AMP is calculated as a weighted average of 
prices for all of a manufacturers package sizes of a drug sold during a 
given quarter. Section 1927(b)(3)(D) of the Act requires that, subject to 
certain exceptions, AMPs reported to CMS should not be publicly 
disclosed. 
In a December 2004 report, the Congressional Budget Office used the 
AMP to estimate what pharmacies pay to acquire drugs. While the 
acquisition costs for pharmacies that buy through wholesalers rather 
than directly from manufacturers may exceed the AMP, the wholesaler 
3 www.cms.hhs.gov/medicaid/drugs/drug10.asp 
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markup is estimated to be a small proportion (approximately 3 percent) 
of the actual price.4  The Medicare Prescription Drug, Improvement, 
and Modernization Act of 2003 (MMA) also recognizes the AMP as a 
potential measure to be substituted in Medicare reimbursement 
calculations.5 
Related Work by the Office of Inspector General 
In June 2005, the Office of Inspector General (OIG) issued Comparison 
of Medicaid Federal Upper Limit Amounts to Average Manufacturer 
Prices (OEI-03-05-00110).  OIG found that, overall, Federal upper 
limits were five times higher than the average AMPs for generic drug 
products in the third quarter of 2004.  During the same period, the 
Federal upper limit amount was, on average, 22 times higher than the 
lowest reported AMP and usually exceeded even the highest reported 
AMP. Medicaid could save hundreds of millions of dollars a year by 
basing Federal upper limit amounts on reported AMPs.  We 
recommended that CMS work with Congress in an effort to lower 
Federal upper limit amounts.   
In December 2004, OIG issued Addition of Qualified Drugs to the 
Medicaid Federal Upper Limit List (OEI-03-04-00320). OIG found that 
CMS does not add qualified drugs to the Federal upper limit list in a 
timely manner. Of the 252 first-time generic drugs approved between 
January 2001 and December 2003, 109 drugs met the criteria for 
inclusion on the Federal upper limit list; however, only 25 of these drugs 
were actually added. For the 25 that were added, CMS took an average 
of 36 weeks to place the products on the Federal upper limit list once 
the drugs were qualified for inclusion.  Qualified drugs not being added 
to the list in a timely manner cost the Medicaid program an estimated 
$167 million between 2001 and 2003.  We recommended that CMS 
establish an administrative procedure and schedule to govern the 
determination and publication of Federal upper limits. 
In February 2004, OIG issued Omission of Drugs from the Federal 
Upper Limit List in 2001 (OEI-03-02-00670).  OIG found that 90 drug 
products were not included on the Federal upper limit list in 
4 As reported by the National Association of Chain Drug Stores in the Congressional Budget 
Office report, Medicaids Reimbursement to Pharmacies for Prescription Drugs. 
5 Medicare typically uses the manufacturer reported average sales price (ASP) plus 6 
percent as the basis for drug reimbursement.  However, if the ASP for a drug exceeds the 
AMP by a threshold percentage, section 303 of the MMA allows the program to base 
reimbursement on 103 percent of the AMP instead.  In 2005, this threshold is 5 percent. 
  OEI-03-05-00350  HOW INFLATED PUBLISHED PRICES AFFECT DRUGS CONSIDERED FOR THE FEDERAL UPPER LIMIT LIST  4  I N T R O D U C T I O N  
2001 despite meeting the criteria established by Federal laws and 
regulations.  Medicaid could have saved $123 million in 2001 by adding 
55 of the 90 drug products to the Federal upper limit list.  OIG 
recommended that CMS take steps to ensure that all drugs meeting the 
criteria set by Federal laws and regulations are included on the Federal 
upper limit list. 
In October 2003, OIG issued State Strategies to Contain Medicaid Drug 
Costs (OEI-05-02-00680).  OIG found that States employ three main 
drug cost containment strategies:  (1) limiting Medicaid reimbursement 
for drugs; (2) shifting use from higher to lower cost drugs; and     
(3) limiting the amount of prescription drugs a beneficiary can obtain.  
States reported facing challenges in their attempts to maximize drug 
cost savings, including a lack of accurate drug price information and 
stakeholder opposition to cost containment efforts. 
In September 2002, OIG issued Medicaid Pharmacy - Additional 
Analyses of the Actual Acquisition Cost of Prescription Drug Products 
(A-06-02-00041).  The audit found that there was a wide range of 
discounts from the AWP for pharmacy purchases depending on the 
category of drug that is being purchased.  For multiple-source drugs 
included on the Federal upper limit list, OIG estimated that pharmacy 
acquisition costs were 72.1 percent below the AWP. 
Recent Interest in Medicaid Drug Pricing Issues 
In June 2005, the U.S. Senate Committee on Finance held a hearing 
entitled Medicaid Fraud, Waste, and Abuse:  Threatening the Health 
Care Safety Net.  Excessive payments for Medicaid-covered drugs was 
a major focus area.  Representatives from OIG, CMS, the Department of 
Justice, State Medicaid agencies, and the drug industry provided 
testimony. 
In December 2004, the U.S. House Committee on Energy and Commerce 
Subcommittee on Oversight and Investigations held a hearing entitled 
Medicaid Prescription Drug Reimbursement:  Why the Government 
Pays Too Much.  Representatives from OIG, CMS, several State 
Medicaid agencies, and the drug industry testified at this hearing.  The 
role that Federal upper limits play in reducing costs for prescription 
drugs was a key area of interest to the subcommittee. 
The Presidents 2006 budget proposes changes that would cause 
Medicaid reimbursement amounts to more closely approximate 
pharmacy acquisition costs. Specifically, the budget recommends that 
  OEI-03-05-00350  HOW INFLATED PUBLISHED PRICES AFFECT DRUGS CONSIDERED FOR THE FEDERAL UPPER LIMIT LIST  5  I N T R O D U C T I O N  
Medicaid reimbursement for prescription drugs be at 106 percent of a 
drugs ASP. 
Prior to 2005, Medicare, like Medicaid, based drug reimbursement on 
published AWPs.  However, due in part to numerous reports by OIG 
and the Government Accountability Office (GAO) that found that AWPs 
were significantly inflated, Congress required that Medicare begin 
basing reimbursement amounts on 106 percent of the ASP instead. 
Section 303 of the MMA defines the ASP as the manufacturers sales to 
all purchasers (with certain exemptions) divided by the number of units 
sold. The ASP is to be net of chargebacks, discounts, rebates, and other 
price concessions.  ASPs are reported to CMS by drug manufacturers. 
METHODOLOGY 
Identifying Drugs Not Included Due to Pricing Issues 
In our December 2004 report, Addition of Qualified Drugs to the 
Medicaid Federal Upper Limit List (OEI-03-04-00320), we identified all 
first-time generic drug products approved between 2001 and 2003 that 
met the statutory and regulatory criteria for being included on the 
Federal upper limit list.   During our analysis, we determined that a 
number of these drugs did not meet CMSs additional pricing criterion.  
Each of these products had at least three A-rated versions and three 
suppliers, but did not have any published prices that when multiplied 
by 150 percent were less than the AWP. None of these drugs had been 
included on the Federal upper limit list as of June 30, 2004. 
Using data obtained from a national drug compendium, we compiled a 
list of all the national drug codes (NDC)6 associated with generic 
versions of each drug product not included on the Federal upper limit 
list during the first and second quarters of 2004 due to a failure to meet 
CMSs additional pricing criterion. For each of these drug products, we 
calculated the average AWP among all therapeutically equivalent NDCs 
in the proper package size listed in the compendium.  We also calculated 
the Federal upper limit amount that would have been set for each drug 
product under the required formula by multiplying the lowest published 
price among all relevant NDCs by 150 percent. 
6 Each individual drug product manufactured or distributed in the United States has a 
unique NDC.  An NDC identifies the manufacturer of the drug product, the product 
dosage form, and the package size. 
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Obtaining Medicaid Utilization Data 
We downloaded 50 State Medicaid payment and utilization files for 
2004 from CMSs Web site.7 We limited our analysis to utilization 
occurring in the first or second quarters of 2004.8 
The total State reimbursement amount listed in the State utilization 
files included both the payments made for the NDC and the dispensing 
fees paid to the pharmacy. To determine a States reimbursement for 
the drug product only, we removed the amount paid in dispensing fees 
for each corresponding NDC. We then calculated the average Medicaid 
reimbursement amount per quarter for each of the drugs under review 
by dividing the total reimbursement for the product (without the 
dispensing fee) by the total number of units reimbursed. 
Determining AMPs for Drugs Under Review 
We obtained AMP data for the first and second quarters of 2004 from 
CMS. We matched those data against the Medicaid utilization data to 
verify that all products upon which the comparisons would be made had 
actually been reimbursed by Medicaid. 
Federal regulations require that the prices on which Federal upper limit 
amounts are based be for therapeutically equivalent (A-rated) products 
in common package sizes. Therefore, we removed from the analysis any 
NDCs that represented drug products that were not A-rated. We also 
determined the most common package size listed in the compendium, 
and removed any NDCs that did not match this package size. We then 
calculated the minimum, average, and maximum AMPs among the 
remaining NDCs in each quarter for the drug products not included on 
the Federal upper limit list due to inflated published prices.9 
Calculating Potential Savings 
To determine the potential savings if CMS were able to use AMPs 
rather than published prices to set Federal upper limit amounts, we: 
7 The 50 files represent 49 States and the District of Columbia. Arizonas data were not 
available for download because the States drug benefit is administered completely 
through managed care organizations and not the traditional fee-for-service system. 
8 Both first- and second-quarter utilization data for Delaware and Rhode Island were 
missing from CMSs files. Second-quarter utilization data were missing for Colorado and 
Vermont. 
9 Two drug products under review did not have any AMPs listed on CMSs first quarter 
AMP file. One of the two products also did not have AMPs listed on the second quarter 
file. These products were excluded from any calculations in the respective quarter(s). 
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(1) multiplied the minimum, average, and maximum AMPs for the 
reviewed drugs by 150 percent (the percentage stated in current 
regulation); 
(2) subtracted 150 percent of the minimum, average, and maximum 
AMPs from the average Medicaid reimbursement amount (net of 
dispensing fees) in each of the first two quarters of 2004; and 
(3) multiplied the difference calculated in step 2 by the number of units 
of the drug product reimbursed during these two quarters. 
This figure provided us with the savings that could have resulted in just 
two quarters for drugs that were not included on the Federal upper 
limit list due to not meeting CMSs additional criterion.10 
This evaluation was conducted in accordance with the Quality 
Standards for Inspections issued by the Presidents Council for 
Integrity and Efficiency and the Executive Council for Integrity and 
Efficiency. 
10 Nine of the drug products did not become eligible for the Federal upper limit list until 
April 1, 2004.  Therefore, these drugs were only included in the savings calculations for 
the second quarter of that year. 
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In the first two quarters of 2004, 58 drug products  Of the 252 first-time generic 
that met all statutory and regulatory requirements  drug products approved between 
2001 and 2003, 58 met all 
were not added to the Federal upper limit list due to 
statutory and regulatory 
inflated published prices 
requirements as of June 30, 
2004, but were not included on the Federal upper limit list because their 
addition would not have lead to savings.  Each of these 58 products had 
at least 3 A-rated versions and 3 suppliers, but did not have a published 
price that, when multiplied by 150 percent, was less than the AWP.11 
Overall, average AWPs were more than three times higher than the 
average AMPs for the reviewed drug products in the second quarter of 
2004. Among the 58 individual drug products, the average AWP 
exceeded the average AMP by as much as 10 times.  Even the minimum 
published prices for these drugs were substantially higher than AMPs.  
On average, the lowest manufacturer-reported AWP or wholesale 
acquisition cost was almost two-and-a-half times the average AMP.  
Given that Federal regulation requires that these minimum published 
prices be multiplied by 150 percent, the difference between Federal 
upper limit amounts and AMPs would grow even wider. 
Basing Federal upper limit amounts on AMPs  As the previous finding shows, 
could save Medicaid over $100 million per year  inflated published prices are 
causing CMS to exclude otherwise 
by allowing otherwise qualified products to be 
qualified drug products from the 
included on the Federal upper limit list 
Federal upper limit list because 
their Federal upper limit amount would exceed the reimbursement 
amount set under the usual methods. However, if Medicaid based 
Federal upper limit amounts on 150 percent of the average reported 
AMP rather than 150 percent of the lowest published price, the program 
may have saved $75 million in just two quarters of 2004 due to these 
excluded drugs being added to the Federal upper limit list. Ten versions 
of two drugs were responsible for more than half of the $75 million in 
11 For 50 of the 58 drug products, both wholesale acquisition costs and AWPs were 
published in the compendium.  Although wholesale acquisition costs are generally lower 
than the AWP, none of the published wholesale acquisition costs for these 58 drugs was 
low enough to result in a Federal upper limit amount that could potentially lead to 
savings; i.e., 150 percent of the lowest wholesale acquisition cost was not less than the 
AWP. 
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potential savings. Adding six versions of amoxicillin/potassium 
clavulanate at 150 percent of their average AMP would have saved 
almost $21 million in the first and second quarters of 2004.  Adding four 
versions of paroxetine would have saved nearly $19 million in just the 
one quarter that it was qualified.12 
Furthermore, if Medicaid used the lowest reported AMP multiplied by 
150 percent when calculating Federal upper limit amounts, the program 
could have saved an estimated $111 million in just two quarters of 2004.  
Even if Federal upper limit calculations were based on 150 percent of 
the highest reported AMP, the program could have saved almost  
$39 million. 
12 According to our analysis, paroxetine (brand name Paxil) first qualified for the Federal 
upper limit list on April 1, 2004.  Four versions of paroxetine were added to the Federal 
upper list on February 14, 2005.  While the Federal upper limit amounts for the four 
versions were slightly below their average AWP, the amounts were at least 20 percent 
higher than average Medicaid reimbursement for the products in the second quarter of 
2004. Therefore, adding paroxetine at 150 percent of its lowest published price (the 
current method) is unlikely to save Medicaid a significant amount. 
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  C O N C L U S I O N  

In the past several months, the President, Congress, and individual 
State Medicaid programs have expressed heightened interest in 
ensuring that Medicaid drug reimbursement amounts more closely 
resemble actual acquisition costs.  In addition, the OIG has recently 
released a number of reports that once again showed that the published 
prices used as the basis for Medicaid reimbursement bear little or no 
resemblance to prices based on actual sales, especially for generic drugs. 
The Federal upper limit program is particularly affected by this 
disconnect between published prices and acquisition costs among 
generic drugs.   
Congress created the Federal upper limit program to help Medicaid take 
advantage of current market prices for lower-cost generic drugs.  
However, Federal regulation requires that Federal upper limit amounts 
be based on 150 percent of the prices published in national compendia.  
Not only does the pricing methodology prescribed by Federal law cause 
artificially high Federal upper limit amounts for those products on the 
Federal upper limit list, it also causes other qualified drugs to never be 
included on the list in the first place.  This secondary effect is costing 
Medicaid millions of dollars per year, in addition to the considerable 
losses the program faces due to the inflated prices of drugs already on 
the Federal upper limit list. 
Based on years of work by OIG, GAO, and others revealing the inflated 
nature of AWPs and other published prices, the Medicare program 
eliminated the use of AWP in its pricing methodology for Part B covered 
drugs. The fact that Medicaid still uses these published prices to 
determine Federal upper limit amounts makes little sense. We believe 
that reimbursement in general and Federal upper limit amounts in 
particular should reliably reflect the actual costs of drugs to 
pharmacies.  Consequently, there is an urgent need for the Medicaid 
policymaking community to revise Federal upper limit policies, thereby 
ensuring that reimbursement amounts for generic drugs accurately 
reflect market prices, and that the Federal upper limit program better 
meets its original intent. 
Agency Comments 
CMS concurred with our findings, stating that the use of published 
prices as the basis for Federal upper limit amounts precludes the 
addition of some drugs to the Federal upper limit list.  CMS also 
noted the recent changes to the basis of reimbursement for Medicare 
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drugs made by the MMA, and indicated that the same types of 
measures should be enacted for Medicaid.  The full text of CMSs 
comments is presented in Appendix A. 
OIG Response 
OIG appreciates CMSs comments on this report, and looks forward to 
assisting CMS and Congress in their efforts to reform Medicaids 
current reimbursement methodology. 
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  Comments from the Centers for Medicare & Medicaid Services 
 
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This report was prepared under the direction of Robert A. Vito, Regional Inspector 
General for Evaluation and Inspections in the Philadelphia regional office, and Linda 
M. Ragone, Deputy Regional Inspector General.  Other principal Office of Evaluation 
and Inspections staff who contributed include: 
David Tawes, Team Leader 
Linda Boone Abbott, Program Specialist 
Tricia Davis, Director, Medicare and Medicaid Branch 
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