Department of Health and Human Services
 
OFFICE OF  

INSPECTOR GENERAL  

D R A
EFICIT  EDUCTION  CT OF 
2005:  I M
MPACT ON THE  EDICAID 
F U L
EDERAL  PPER  IMIT 
P
ROGRAM 
Daniel R. Levinson
 
Inspector General  

June 2007  

OEI-03-06-00400 
 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.  These assessments help reduce waste, abuse, and mismanagement 
and promote economy and efficiency throughout HHS. 
Office of Evaluation and Inspections 
The Office of Evaluation and Inspections (OEI) conducts national evaluations to provide HHS,  
Congress, and the public with timely, useful, and reliable information on significant issues.  
Specifically, these evaluations focus on preventing fraud, waste, or abuse and promoting 
economy, efficiency, and effectiveness in departmental programs.  To promote impact, the reports 
also present practical recommendations for improving program operations. 
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 OIGs 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.  I N T R O D U C T I O N
  E X E C U T I V E   S U M M A R Y   
  
OBJECTIVES 
1. 	 To compare Federal upper limit amounts under the previous 
calculation method to estimated pharmacy acquisition costs for 
selected high-expenditure drugs. 
2. 	 To estimate how previous Medicaid Federal upper limit amounts 
may change under the new calculation method requiring payment 
limits for a drug to be set at 250 percent of the lowest average 
manufacturer price (AMP). 
3. 	 To compare Federal upper limit amounts under the new calculation 
method to estimated pharmacy acquisition costs for selected high-
expenditure drugs. 
4. 	 To compare the lowest AMP to other AMPs for Federal upper limit 
drugs. 
5. 	 To determine whether the relationship between the lowest AMP and 
other AMPs for selected high-expenditure drugs could help identify 
instances in which pharmacy acquisition costs may exceed the new 
Federal upper limit amounts. 
BACKGROUND 
Previous Office of Inspector General (OIG) work consistently found that 
the published prices that were used to set Medicaid Federal upper limit 
amounts often greatly exceeded prices available in the marketplace.  
Based in part on this work, the Deficit Reduction Act of 2005 (DRA) 
required that, beginning January 1, 2007, Medicaid Federal upper 
limits be based on 250 percent of the lowest AMP rather than on 
150 percent of the lowest price published in the national compendia.  
The Congressional Budget Office estimates that this will reduce 
Medicaid expenditures for Federal upper limit drugs by $3.6 billion over 
5 years. 
In response to these changes, industry groups have expressed concerns 
that pharmacies will not be able to acquire drugs for prices at or below 
the new Federal upper limit amounts.  In an effort to ensure that 
Medicaid providers are reimbursed appropriately and, in turn, that 
Medicaid beneficiaries continue to have access to needed drugs, this 
study provides a preliminary assessment of the expected impact of the 
DRA reductions. 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  i  E X E C U T I V E   S U M M A R Y  
We identified all drugs on the Federal upper limit list in the second 
quarter of 2006.  To estimate Federal upper limit amounts for these   
521 drugs under the new methodology set forth in the DRA, we obtained 
AMP data from the second quarter of 2006.  We then multiplied the 
lowest AMP for each drug by 250 percent and compared the result to the 
actual Federal upper limit amounts from the second quarter of 2006, 
which were based on 150 percent of the lowest published prices.   
To estimate pharmacy acquisition costs, we collected second-quarter 
2006 sales and pricing data from five distributors for the 25 selected 
drugs with the highest total Medicaid expenditures in 2005 included on 
the Federal upper limit list.  We then compared our estimate of 
pharmacy acquisition costs to the previous and new Federal upper limit 
amounts for each of the 25 selected high-expenditure drugs. 
To determine whether the lowest AMPs used to set the new Federal 
upper limit amounts were representative of other AMPs for the same 
drugs, we determined whether the lowest AMP was more than    
60 percent below the second-lowest AMP and/or volume-weighted AMP 
(weighted by the number of units reimbursed by Medicaid in 2005).  In a 
recently issued proposed regulation, the Centers for Medicare & 
Medicaid Services (CMS) announced plans to use a similar threshold 
(70 percent) involving the second-lowest AMP to identify potential 
issues.  We chose to use 60 percent in our analysis because whenever 
the lowest AMP exceeds this threshold relative to the second-lowest 
AMP, then the second-lowest AMP (and all other AMPs) for a drug 
would be higher than the new Federal upper limit amount.  
For any of the 25 selected high-expenditure drugs for which the second-
lowest AMP and/or volume-weighted AMP exceeded our 60-percent 
threshold, we determined whether the estimated average pharmacy 
acquisition cost exceeded the new Federal upper limit amount.  We 
repeated this analysis for drugs that did not exceed the 60-percent 
threshold. This analysis enabled us to determine whether, for these 
25 drugs, exceeding the 60-percent threshold was linked to a drugs 
average acquisition cost being higher than new Federal upper limit 
amount. 
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FINDINGS 
For 23 of the 25 drugs under review, Federal upper limit amounts 
set under the previous calculation method were more than double 
the average pharmacy acquisition costs. Pre-DRA Federal upper 
limit amounts substantially exceeded our estimate of average pharmacy 
acquisition costs for the 25 selected high-expenditure drugs in the 
second quarter of 2006. For 23 of these 25 drugs, Federal upper limit 
amounts based on 150 percent of the lowest published price were more 
than double the average pharmacy acquisition costs. For 13 drugs, the 
second-quarter 2006 Federal upper limit amounts were at least 5 times 
higher. 
As intended by the Deficit Reduction Act of 2005, Federal upper limit 
amounts are likely to decrease under the new calculation method. 
We estimate that Federal upper limit amounts will decrease by a 
median of 61 percent under the new calculation method set forth in the 
DRA. Based on AMP data from the second quarter of 2006, we 
determined that Federal upper limit amounts for 492 of the 521 drugs 
(94 percent) under review would be reduced under the new DRA 
requirements, with 334 (64 percent) decreasing by at least half. Federal 
upper limit amounts for 90 of the 521 drugs would be at least 90 percent 
below the second-quarter 2006 amounts. 
Six of twenty-five selected high-expenditure drugs had estimated 
average pharmacy acquisition costs that would be below the new 
Federal upper limit amounts. Based on pricing and sales data 
provided by distributors, we determined that, on average, pharmacies 
would have been able to purchase only 6 of 25 selected high-expenditure 
drugs for less than the new Federal upper limit amounts during the 
second quarter of 2006. For the remaining 19 drugs, the average 
pharmacy acquisition costs would have been higher than the new 
Federal upper limit amounts that quarter. We estimate that 12 of these 
19 drugs had average pharmacy acquisition costs that would have been 
more than double the new reimbursement limit. For 13 of the 
25 selected high-expenditure drugs, at least one individual drug product 
was available for a price at or below the new Federal upper limit 
amount. 
The average manufacturer price used to set a new Federal upper 
limit amount may be substantially lower than other average 
manufacturer prices associated with a drug. For 14 percent of the 
drugs on the Federal upper limit list, the lowest AMP was more than 
OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  iii  E X E C U T I V E   S U M M A R Y  
60 percent below the second-lowest AMP.  In addition, for 29 percent of 
reviewed drugs, the lowest AMP was more than 60 percent less than the 
volume-weighted AMP.  
Among the 25 selected high-expenditure drugs, examining the 
volume-weighted AMPs helped identify instances in which 
pharmacy acquisition costs may exceed the new Federal upper 
limit amounts.  In the second quarter of 2006, the lowest AMP was 
more than 60 percent below the volume-weighted AMP for 20 of the 
25 selected high-expenditure drugs under review.  For all but one of 
these drugs, the estimated average pharmacy acquisition cost exceeded 
the new Federal upper limit amount. Likewise, for the five drugs for 
which the lowest AMP did not exceed the 60-percent threshold 
compared to the volume-weighted AMP, the average pharmacy 
acquisition costs were below the new Federal upper limit amount.  In 
other words, in all but one case, determining whether or not the lowest 
AMP for any of the 25 selected high-expenditure drugs exceeded the 
60-percent threshold compared to the volume-weighted AMP would 
have accurately determined whether or not its average acquisition cost 
was higher than the new Federal upper limit amount.  
Examining the second-lowest AMP, rather than the volume-weighted 
AMP, was not as effective in identifying instances in which pharmacy 
acquisition costs exceeded the new Federal upper limit amount for the 
25 selected high-expenditure drugs. 
RECOMMENDATIONS 
The findings of this report again illustrate why changes to the previous 
calculation method were needed, as this method (based on published 
prices) led to inflated Medicaid payments for many high-dollar generic 
drugs. However, we have concerns that, at least initially, the new 
formula mandated by the DRA (based on lowest AMPs) may result in 
some Federal upper limit amounts that are below pharmacy acquisition 
costs.  This could occur because for certain drugs the lowest AMPs may 
not reflect prices generally available in the marketplace. 
As part of the proposed Federal upper limit regulation, CMS announced 
plans to identify potential reimbursement issues by removing the lowest 
AMP if it appears to be an outlier. The proposed regulation defines an 
outlier as a lowest AMP that is more than 70 percent below the second-
lowest AMP. We support CMSs attempts to proactively resolve 
potential problems with the new formula.  However, our analysis 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  iv  E X E C U T I V E   S U M M A R Y  
(applying a more limited 60-percent threshold) indicates that using the 
second-lowest AMP may not alleviate all reimbursement issues. 
In addition to CMSs efforts, drug manufacturers and pharmacies also 
have important roles in helping to ensure that the new Federal upper 
limit amounts are appropriate. Manufacturers of generic drugs should 
make certain that the AMPs they are reporting to CMS are accurate.  In 
turn, pharmacies should inform CMS if the new Federal upper limit 
amounts are lower than the prices at which they can purchase certain 
drugs. 
We recognize that for various reasons (e.g., definitional changes in 
AMP, market forces, etc.), the relative relationship between the Federal 
upper limit amounts and other price points presented in this report may 
change once the new method of calculation is implemented. However, 
new Federal upper limit amounts should be monitored closely to help 
ensure that reimbursement changes do not lead to access problems for 
Medicaid beneficiaries. Specifically, we recommend that:   
CMS should take steps to identify when a new Federal upper limit amount 
may not be representative of a drugs acquisition cost to pharmacies.  
These steps could include: 
	  issuing a final regulation that would remove the lowest AMP 
from the Federal upper limit calculation when it is significantly 
lower than the volume-weighted AMP (rather than the second-
lowest AMP) for a drug, 
	  contacting manufacturers to verify reported data in situations 
for which the lowest AMP appears to be significantly lower than 
other AMPs for a drug, 
	  examining Medicaid utilization data to ensure that the product 
on which the Federal upper limit is based is actually utilized in 
the marketplace, and 
	  providing an opportunity for pharmacies to alert the States and 
CMS when they can demonstrate an inability to purchase a drug 
at prices at or below the new Federal upper limit amount. 
In situations where 250 percent of the lowest AMP may not be sufficient 
to cover pharmacy acquisition costs, CMS should determine the proper 
course of action (working with Congress, if necessary).  
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  v  E X E C U T I V E   S U M M A R Y 
   
AGENCY COMMENTS AND OFFICE OF INSPECTOR GENERAL 
RESPONSE 
CMS concurred with our recommendation that the new Federal upper 
limit amount should be monitored closely during initial implementation 
and agreed that manufacturers play an important role in this regard. 
However, CMS strongly disagreed with our findings concerning the 
effect of the DRA-related changes to the Federal upper limit calculation.  
CMS suggested that OIG should have waited until the final AMP 
regulation is promulgated before completing its study, stating it is only 
after a final definition of AMP has been issued that an accurate analysis 
of the impact of DRA can be conducted.  Once that occurs, CMS 
believes that an analysis based on actual AMPs would yield 
substantially different results. CMS stated that the analysis in OIGs 
report is deficient in numerous ways and such deficiencies lead to 
flawed results and misleading conclusions.  Therefore, CMS requested 
that we (1) revise our analysis to address these flaws and (2) delay 
issuing this report while considering earlier discussions and working 
collaboratively with the agency. 
OIG will continue to work collaboratively with CMS in an effort to 
address any potential issues with the new calculation method for 
Federal upper limits. However, issuing this report prior to CMSs 
publication of its final regulation provides the agency with the 
opportunity to consider our findings and incorporate our 
recommendations.  The data presented in this report are the best 
available for the timeframe, and any limitations have marginal impact 
and do not change the overall findings and conclusions.  We note that a 
similar report by the Government Accountability Office identified the 
same issues and reached similar conclusions. 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  vi    T A B L E   O F   C O N T E N T S   
  
EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i 
  
I N T RO DUC T IO N  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  1 
  
F I N D IN G S  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  9 
  
For 23of 25drugs, previous limit was double acquisition cost. . . .  9 
  
Federal upper limits are likely to decrease substantially . . . . . . .  10 
  
Acquisition costs are below new limit for 6of 25drugs. . . . . . . . .  11 
  
Lowest AMP may be substantially lower than other AMPs . . . . .  12 
  
Examining volume-weighted AMPsmay help identify issues. . . .  13 
  
R E C O MMEN D A T ION S  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  15 
  
Agency Comments andOffice of Inspector General Response . . .  16 
 
APPENDIXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  21 
  
A.  Detailed Methodology  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  21 
  
B.  Agency Comments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  25 
  
A C K NO WL E D G M E N T S  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  33 
     I N T R O D U C T I O N   
  
OBJECTIVES 
1. 	 To compare Federal upper limit amounts under the previous 
calculation method to estimated pharmacy acquisition costs for 
selected high-expenditure drugs. 
2. 	 To estimate how previous Medicaid Federal upper limit amounts 
may change under the new calculation method requiring payment 
limits for a drug to be set at 250 percent of the lowest average 
manufacturer price (AMP). 
3. 	 To compare Federal upper limit amounts under the new calculation 
method to estimated pharmacy acquisition costs for selected high-
expenditure drugs. 
4. 	 To compare the lowest AMP to other AMPs for Federal upper limit 
drugs. 
5. 	 To determine whether the relationship between the lowest AMP and 
other AMPs for selected high-expenditure drugs could help identify 
instances in which pharmacy acquisition costs may exceed the new 
Federal upper limit amounts. 
BACKGROUND 
Previous Office of Inspector General (OIG) work consistently found that 
the published prices that were used to set Medicaid Federal upper limit 
amounts often greatly exceeded prices available in the marketplace.  
Based in part on this work, the Deficit Reduction Act of 2005 (DRA), 
Public Law 109-171, made substantial changes to the way Federal 
upper limit amounts are to be calculated.  Beginning January 1, 2007, 
Federal upper limits are to be based on 250 percent of the lowest 
reported AMP for each drug rather than 150 percent of the lowest price 
published in the national compendia.  The Congressional Budget Office 
estimates that this new methodology will reduce Medicaid expenditures 
for Federal upper limit drugs by $3.6 billion over 5 years.   
In response to these changes, industry groups have expressed concerns 
that pharmacies will not be able to acquire drugs for prices at or below 
the new Federal upper limit amounts.1  In an effort to ensure that 
1 An example includes Implications of Federal Medicaid Generic Drug Payment 
Reduction for State Policymakers.  National Association of Chain Drug Stores, February 
2006. 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  1  III NNN TTT RRR OOO DDD UUU CCC TTT III OOO NNN
Medicaid providers are reimbursed appropriately and, in turn, that 
Medicaid beneficiaries continue to have access to needed drugs, this 
study provides a preliminary assessment of the expected impact of the 
DRA reductions. 
Medicaid Reimbursement for Prescription Drugs 
Currently, all 50 States and the District of Columbia offer prescription 
drug coverage under Medicaid. Medicaid beneficiaries typically obtain 
covered drugs from pharmacies. Pharmacies bill State Medicaid 
agencies using national drug codes (NDC), which are 11-digit identifiers 
that indicate a drugs manufacturer, product dosage form, and package 
size. Pharmacies are then reimbursed for these drugs by State 
Medicaid agencies. In calendar year (CY) 2005, Medicaid payments for 
prescription drugs totaled over $41 billion.2 
Federal regulations require, with certain exceptions, that each State 
Medicaid agencys reimbursement for covered outpatient drugs not 
exceed (in the aggregate) the lower of their estimated acquisition cost 
plus a reasonable dispensing fee or the providers usual and customary 
charge to the public for the drugs.3 The Centers for Medicare & 
Medicaid Services (CMS) allows States the flexibility to define 
estimated acquisition cost, with most States basing their calculation on 
list prices published in the national compendia. For certain drugs, 
States also use the Federal upper limit and/or State maximum 
allowable cost programs in setting reimbursement amounts.4 
Medicaid Federal Upper Limit Requirements Prior to January 1, 2007 
According to CMSs Web site, the Federal upper limit program was 
created to ensure that the Federal Government acts as a prudent buyer 
by taking advantage of current market prices for multiple-source drugs.5 
2 Calculated using national summary data for 2005. This amount includes both Federal 
and State payments. Rebates collected by States under the Medicaid drug rebate program 
(section 1927 of the Social Security Act) were not subtracted from this figure. Available 
online at http://www.cms.hhs.gov/MedicaidDrugRebateProgram/SDUD/list.asp. Accessed 
on October 30, 2006. 
3 42 CFR  447.331(b). On December 22, 2006, CMS issued a proposed regulation that 
would remove 42 CFR  447.331 but include the unchanged substance of this section in a 
new section, 42 CFR  447.512. 
4 Many States have implemented maximum allowable cost programs 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. 
5 Available online at http://www.cms.hhs.gov/FederalUpperLimits. Accessed on 
September 8, 2006. 
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For purposes of the time covered by our review, pursuant to section 
1927(e)(4) of the Social Security Act and 42 CFR  447.332, CMS is 
generally to establish a Federal upper limit amount for a drug when 
three or more formulations of a drug have been rated as therapeutically 
equivalent by the Food and Drug Administration and 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 (e.g., Micromedex RedBook). 
Prior to January 1, 2007, Federal regulations (42 CFR  447.332) set the 
Federal upper limit amount at 150 percent of the lowest price published 
in the national compendia for therapeutically equivalent products that 
can be purchased by pharmacists in quantities of 100 tablets or 
capsules, plus a reasonable dispensing fee.6 If the drug is not typically 
available in quantities of 100 or if the drug is a liquid, then the Federal 
upper limit amount is based on the price for a commonly listed size of 
the product. 
CMS publishes the Federal upper limit list in the State Medicaid 
Manual and on its Web site. Revisions to the list are typically noted on 
the Web site. CMS establishes a Federal upper limit for specific forms 
and strengths for each multiple-source drug on the list. As of June 30, 
2006, CMS had set Federal upper limit amounts for 530 drugs. 
According to CMS data, generic drugs included on the Federal upper 
limit list account for approximately 8 percent of total Medicaid 
expenditures for all prescription drugs. 
New Federal Upper Limit Requirements in Effect January 1, 2007 
Section 6001(a) of the DRA makes significant changes to the Federal 
upper limit program. As of January 1, 2007, a drug needs only two 
therapeutically equivalent versions to be included on the Federal upper 
limit list.7 Beginning that same date, Federal upper limit amounts are 
to be based on 250 percent of the lowest reported AMP for each drug 
rather than 150 percent of the lowest price published in the national 
compendia.8 
6 States are required to meet Federal upper limit requirements only in the aggregate, 
i.e., a State can pay more than the Federal upper limit amount for certain products as long 
as these payments are balanced out by lower payments for other products. 
7 Section 6001(a)(1)(B) of the DRA. 
8 Section 6001(a)(2) of the DRA. 
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For the period of time covered by this review, section 1927(k)(1) of the 
Social Security Act defines the AMP as the average price paid to the 
manufacturer for the drug in the United States by wholesalers for drugs 
distributed to the retail pharmacy class of trade after deducting 
customary prompt pay discounts. Pursuant to sections 6001(c)(1) and 
6001(c)(2) of the DRA, as of January 1, 2007, the AMP is required to be 
determined without regard to customary prompt pay discounts extended 
to wholesalers, and such discounts shall be reported separately to CMS. 
On December 22, 2006, CMS issued a proposed regulation to implement 
certain provisions of the DRA.9 For example, 42 CFR  447.504 of the 
proposed regulation outlines the manner in which the AMP is to be 
determined, and 42 CFR  447.514 addresses the new criteria for the 
establishment of Federal upper limit amounts.  The latter section 
(447.514(b)) implements the use of 250 percent of the AMP for the least 
costly therapeutically equivalent drug as the basis for Federal upper 
limit amounts. Section 447.514(c) of the proposed regulation establishes 
an alternative methodology to be used in setting Federal upper limit 
amounts if the lowest AMP is significantly below the next highest AMP 
for a drug. As further explained in the background to the proposed 
regulation, CMS will use the AMP of the lowest-priced therapeutically 
equivalent drug except in cases where this AMP is more than 70 
percent below the second lowest AMP.10 CMS is currently soliciting 
public comment on the proposed regulation.  Section 6001(c) of the DRA 
requires CMS to publish a final regulation by July 1, 2007. 
In addition, prior to the enactment of the DRA, section 1927(b)(3)(D) of 
the Social Security Act prohibited the disclosure of AMP data except in 
certain narrow circumstances.  At that time, AMP data were used 
primarily by CMS for purposes of the Medicaid drug rebate program. 
However, pursuant to sections 6001(a) and 6001(b) of the DRA, AMP 
data will also be used to calculate Federal upper limit amounts and will 
be made available to State Medicaid agencies and the public.  These 
changes allow States to use AMP data in their determination of 
estimated acquisition costs for drugs covered under Medicaid.11 
9 Proposed Rule, Medicaid Program; Prescription Drugs, 71 Federal Register 77174. 
 
10 Ibid at 77188. 
 
11 OIG examines AMP-based reimbursement issues in States Use of New Drug Pricing
 
Data To Establish Medicaid Reimbursement for Prescription Drugs (OEI-03-06-00490) and 
Examining Fluctuations in Average Manufacturer Prices (OEI-03-06-00350). 
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Previous OIG Work Regarding the Federal Upper Limit Program 
In the past 3 years, OIG has issued four reports detailing potential 
problems with the Federal upper limit program.12  These reports focused 
on two main concerns:  (1) qualified drugs were not being included on 
the Federal upper limit list in a timely manner and (2) Federal upper 
limit amounts often greatly exceeded pharmacy acquisition costs.  For 
example, we found that Federal upper limit amounts were five times 
higher than average AMPs (a figure that we used as an estimate of 
pharmacy acquisition costs) in the third quarter of 2004.  At that time, 
we recommended that CMS work with Congress to set Federal upper 
limit amounts that more closely approximate pharmacy acquisition 
costs. 
The findings and recommendations from all four reports were presented 
at several congressional hearings, with the most recent testimony 
delivered before the Senate Finance Committee in June 2005.13 
METHODOLOGY 
Please see Appendix A for a detailed methodology. 
Data Sources 
Using Federal upper limit data from CMSs Web site and the national 
drug compendium Redbook, we identified the 530 drugs included on 
the Federal upper limit list in the second quarter of 2006. 14  We 
obtained Medicaid drug reimbursement and utilization data from CMSs 
Web site and then identified the 25 drugs on the Federal upper limit list 
with the highest total Medicaid expenditures in CY 2005. 
For the 25 selected drugs with the highest total Medicaid expenditures 
in 2005, we collected second-quarter 2006 pricing and sales data from 
the three largest national distributors and two smaller regional 
12 Omission of Drugs From the Federal Upper Limit List in 2001 (OEI-03-02-00670, 
February 2004); Addition of Qualified Drugs to the Federal Upper Limit List (OEI-03-04-
00320, December 2004); Comparison of Medicaid Federal Upper Limit Amounts to Average 
Manufacturer Prices (OEI-03-05-00110, June 2005); and How Inflated Published Prices 
Affect Drugs Considered for the Federal Upper Limit List (OEI-03-05-00350, September 
2005). 
13 Available online at http://www.oig.hhs.gov/testimony/docs/2005/50629-vito-fin.pdf. 
Accessed on September 8, 2006. 
14 In this report, drug refers to the specific drug name/dosage size/product form 
combination that is used as the basis for setting Federal upper limit amounts (e.g., 
Gabapentin 400 mg tablets).   
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  5  I N T R O D U C T I O N  
distributors. According to industry sales reports, these three national 
companies account for the vast majority of market share among drug 
distributors. We obtained second-quarter 2006 AMP data from CMS. 
Data Analysis 
Estimating Pharmacy Acquisition Costs for Selected Drugs.  To estimate 
average pharmacy acquisition costs for each of the 25 selected high-
expenditure drugs, we totaled the dollar amount sold (net of any 
discounts or rebates, when provided) by the five distributors and divided 
this amount by the total number of units sold.  For the purpose of this 
report, these estimates will hereinafter be referred to as average 
pharmacy acquisition costs. We also determined the lowest price 
reported to OIG by the distributors for any NDC associated with the 
25 drugs. 
Estimating Federal Upper Limit Amounts Under New Calculation Method.  We 
determined the lowest AMP reported by manufacturers for each of the 
530 drugs on the Federal upper limit list in the second quarter of 2006.  
Of the 530 drugs on the list that quarter, 9 did not have AMP data for 
any nonterminated, therapeutically equivalent NDCs of a commonly 
listed size.  Therefore, we did not include these nine drugs in our 
analysis. For the remaining 521 drugs, we multiplied the lowest AMP 
by 250 percent to estimate the new Federal upper limit amounts under 
the methodology mandated by the DRA.  For the purpose of this report, 
these estimates will hereinafter be referred to as new Federal upper 
limit amounts.  We calculated the difference between the new Federal 
upper limit amounts and the second-quarter 2006 Federal upper limit 
amounts for each of the 521 drugs. 
Comparing Pharmacy Acquisition Costs to Federal Upper Limit Amounts. We 
calculated the percentage difference between the second-quarter 2006 
Federal upper limit amounts and the average pharmacy acquisition 
costs for each of the 25 selected high expenditure drugs.  We then 
calculated the difference between the new Federal upper limit amounts 
and the average pharmacy acquisition costs. We also compared the 
lowest price reported to OIG by the distributors for each drug with the 
new Federal upper limit amounts. 
Comparing the Lowest AMP to Other AMPs.  To determine whether the 
lowest AMPs used to set the new Federal upper limit amounts were 
representative of other AMPs, we determined the second-lowest and 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  6  I N T R O D U C T I O N  
volume-weighted AMPs for each of the 521 drugs under review.15  We 
then compared the lowest AMP to both the second-lowest and volume-
weighted AMPs for each of the 521 drugs and identified instances when 
the lowest AMP was more than 60 percent below either of these two 
figures.16  We subset out the results for the 25 selected high-expenditure 
drugs for further analysis.    
Determining Whether Other AMPs Could Help Identify Potential Issues. 
Among the 25 selected high-expenditure drugs, we identified any 
instances in which the lowest AMP was more than 60 percent below the 
second-lowest and/or volume-weighted AMP.  For any of the 25 drugs 
that met this threshold, we determined whether the average pharmacy 
acquisition cost exceeded the new Federal upper limit amount.  We 
repeated this analysis for any of the 25 drugs that did not meet the 
60-percent threshold.  This enabled us to determine whether, for these 
25 drugs, exceeding the 60-percent threshold (compared to either the 
second-lowest or volume-weighted AMP) was linked to a drugs average 
acquisition cost being higher than the new Federal upper limit amount. 
Limitations 
This study uses AMP data from the second quarter of 2006 to estimate 
Federal upper limit amounts under the new methodology mandated by 
the DRA. For some drugs, the lowest AMP may have increased or 
decreased by the time the changes took effect in January 2007. 
Furthermore, although sections 6001(a) and 6001(c)(1) of the DRA 
provide that new Federal upper limit amounts will be based on AMPs as 
computed without regard to customary prompt pay discounts, AMPs 
used in this study did reflect the customary prompt pay discounts 
offered by manufacturers, because this is how AMPs were reported at 
the time of our analysis.  After January 1, 2007, AMPs that are used to 
15 We calculated the volume-weighted AMP among all NDCs for the drug by weighting 
the AMP for each individual NDC by the number of units of the NDC reimbursed by 
Medicaid in the second quarter of 2006. 
16 In its proposed regulation, CMS uses a 70-percent rather than a 60-percent threshold 
in comparing the lowest AMP to the second-lowest AMP.  We chose to use 60 percent in our 
analysis because whenever the lowest AMP exceeds this threshold relative to the second-
lowest AMP, then the second-lowest AMP (and all other AMPs) for a drug would be higher 
than the new Federal upper limit amount.  For example, a drug with a lowest AMP of $0.40 
would have a new Federal upper limit amount of $1.00 ($0.40 times 250 percent).  If the 
second-lowest AMP is higher than this new Federal upper limit amount (e.g., $1.01), then 
the lowest AMP would be at least 60 percent below the second-lowest AMP ($0.40 is 60.4 
percent below $1.01). 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  7  I N T R O D U C T I O N  
calculate Federal upper limit amounts may be higher than earlier AMPs 
because customary prompt pay discounts should no longer be included.   
As mentioned previously, we asked distributors for the amount of 
discounts and rebates provided to purchasers. Two of the five 
distributors provided these data, which were then used in our 
acquisition cost calculations.  However, the three remaining distributors 
did not provide discount and rebate data.  Therefore, pharmacies 
bottom-line costs for some drugs may be lower than our estimates in 
instances for which discounts and rebates were not captured in our data 
collection.  Two of the distributors that did not provide this information 
stated that discounts and rebates are not captured on a quarterly basis 
and are negotiated on a customer-by-customer basis, making it 
extremely difficult to supply these data.  One distributor did not provide 
an explanation for the lack of discount and rebate data.  In addition, we 
did not determine whether the prices reported by the distributors were 
nationally available to all pharmacies. 
Because many States use maximum allowable cost programs to further 
reduce drug expenditures, States may actually be reimbursing less than 
the Federal upper limit amount for certain drugs.  Therefore, the 
differences between the pre-DRA Federal upper limit amount and the 
new Federal upper limit amount may overstate the actual changes to 
pharmacy reimbursement in these cases. 
This study examines only drugs that were on the Federal upper limit 
list as of the second quarter of 2006. Our review did not include any 
drugs that may be added to the list based on the expanded criteria set 
forth in the DRA (i.e., the establishment of Federal upper limits based 
on two rather than three therapeutically equivalent products). 
Finally, this study addresses Federal upper limit amounts and not 
dispensing fees paid to pharmacies for providing drugs to Medicaid 
beneficiaries. Both components of reimbursement are important to 
ensure that Medicaid reimburses pharmacies appropriately for 
prescription drugs.   
Standards 
This study was conducted in accordance with the Quality Standards for 
Inspections issued by the Presidents Council on Integrity and 
Efficiency and the Executive Council on Integrity and Efficiency. 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  8    F I N D I N G S 
   
As in previous studies that found 
For 23 of the 25 drugs under review, Federal 
Federal upper limit amounts to be 
upper limit amounts set under the previous 
excessive, we estimate that 
calculation method were more than double the 
Federal upper limit amounts 
average pharmacy acquisition costs  
under the pre-DRA methodology 
exceeded average pharmacy 
acquisition costs for each of the 25 selected high-expenditure drugs in 
the second quarter of 2006.  For 23 of these 25 drugs, second-quarter 
2006 Federal upper limit amounts (based on 150 percent of the lowest 
published price) were more than two times higher than the average 
pharmacy acquisition costs. In 13 cases, second-quarter 2006 Federal 
upper limit amounts were at least five times higher.  Table 1 illustrates 
the percentage difference between the actual Federal upper limit 
amounts and the pharmacy acquisition costs for the 25 selected drugs in 
the second quarter of 2006. 
Table 1: Comparison of Estimated Pharmacy Acquisition Costs to Previous Federal Upper Limit Amounts 
Second-Quarter 
2006 Federal 
Average Pharmacy  Upper Limit 
Drug  Acquisition Cost  Amount  Difference 
Lorazepam, 1MG, Tablet  $0.040  $0.572  -93.0% 
Ranitidine Hydrochloride, 150MG, Tablet  $0.030  $0.341  -91.2% 
Gabapentin, 300MG, Capsule  $0.157  $1.308  -88.0% 
Gabapentin, 400MG, Capsule  $0.203  $1.570  -87.1% 
Glyburide/Meformin Hydrochloride, 5MG-500MG, Tablet  $0.142  $1.003  -85.8% 
Metformin Hydrochloride, 500MG, Tablet  $0.055  $0.356  -84.5% 
Omeprazole, 20MG, Enteric Coated Tablet  $0.638  $3.979  -84.0% 
Tramadol Hydrochloride, 50MG, Tablet  $0.049  $0.307  -84.0% 
Paroxetine Hydrochloride, 20MG, Tablet  $0.445  $2.520  -82.3% 
Gabapentin, 600MG, Tablet  $0.447  $2.470  -81.9% 
Paroxetine Hydrochloride, 40MG, Tablet  $0.517  $2.700  -80.9% 
Gabapentin, 800MG, Tablet  $0.573  $2.959  -80.6% 
Metformin Hydrochloride, 1000MG, Tablet  $0.091  $0.460  -80.2% 
Glimepiride, 4MG, Tablet  $0.084  $0.410  -79.5% 
Glyburide, 5MG, Tablet  $0.069  $0.283  -75.6% 
Potassium Chloride, 20MEQ, Tablet Extended Release  $0.121  $0.463  -73.8% 
Acetaminophen/Propoxyphene Napsylate, 650MG-100MG, Tablet  $0.049  $0.180  -72.8% 
Ribavirin, 200MG, Capsule  $2.304  $7.576  -69.6% 
Albuterol Sulfate, 0.83%, Solution  $0.041  $0.115  -64.3% 
Acetaminophen/Hydrocodone Bitartrate, 500MG-5MG, Tablet  $0.032  $0.083  -61.6% 
Oxycodone Hydrochloride, 80MG, Tablet Extended Release  $2.633  $6.118  -57.0% 
Oxycodone Hydrochloride, 40MG, Tablet Extended Release  $1.445  $3.260  -55.7% 
Oxycodone Hydrochloride, 20MG, Tablet Extended Release  $0.875  $1.837  -52.4% 
Zonisamide, 100MG, Capsule  $0.657  $1.174  -44.0% 
Albuterol, 0.09MG/Actuation, Aerosol Solid (Inhaler)  $0.335  $0.437  -23.3% 
Source: OIG analysis of second-quarter 2006 Federal upper limit amounts and drug distributor data, 2006. 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  9  F I N D I N G S   
  
As intended by the Deficit Reduction Act of  In an effort to lower inflated 
2005, Federal upper limit amounts are likely to  Federal upper limit amounts 
and bring Medicaid 
decrease under the new calculation method  
reimbursement for generic 
drugs more in line with actual costs, the DRA established a new method 
for determining Federal upper limit amounts. Using data from the 
second quarter of 2006 to assess the impact of the DRA changes, we 
estimate that Federal upper limit amounts will decrease by a median of 
61 percent under the new calculation method. Overall, based on second-
quarter 2006 data, we determined that Federal upper limit amounts for 
492 of the 521 (94 percent) drugs under review would be reduced under 
the new DRA requirements, with 334 (64 percent) expected to decrease 
by at least half. Federal upper limit amounts for 90 of the 521 drugs 
would be at least 90 percent below the second-quarter 2006 amounts. 
Although our analysis indicates Federal upper limit amounts for the 
vast majority of included drugs may be substantially reduced as a result 
of the new law, we estimate that Federal upper limits for 29 drugs   
(6 percent) would increase.  Table 2 describes the estimated changes to 
the 521 Federal upper limit drugs that were included in this part of our 
review. As mentioned previously, it is important to note that because of 
State maximum allowable cost programs, these percentage differences 
may not reflect the actual changes to pharmacy reimbursement for all 
drugs on the Federal upper limit list. 
Table 2:  Estimated Changes to Federal Upper Limit 
                   Amounts Under the DRA      
Difference Between  
New and Second Quarter 2006  Number of  Percentage of 
Federal Upper Limit Amount  Drugs  Drugs 
-99.9% to -90%  90  17.3 
-89.9% to -80%  59  11.3 
-79.9% to -50%  185  35.5 
-49.9% to -20%  129  24.8 
-19.9% to 0%  29  5.6 
0.1% to 19.9%  16  3.1 
20% to 49.9%  4  0.8 
50% to 79.9%  4  0.8 
80% and above  5  1.0 
    Total  521  100 * 
Source:  OIG analysis of second-quarter 2006 AMP data, 2006. 
*Note: Percentages do not add to 100 because of rounding. 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  10  F I N D I N G S   
  
Six of twenty-five selected high-expenditure  Based on pricing and sales data 
drugs had estimated average pharmacy  provided by distributors, we 
determined that, on average, 
acquisition costs that would be below the new 
pharmacies would have been able 
Federal upper limit amounts 
to purchase 6 of the 25 selected 
high-expenditure drugs for less than the new Federal upper limit 
amount in the second quarter of 2006.  For the remaining 19 drugs, 
average pharmacy acquisition costs would have been higher than the 
new Federal upper limit amounts.  Twelve of these nineteen drugs had 
average pharmacy acquisition costs that would have been more than 
double the new limits.  For one drug, the average acquisition cost would 
have been 18 times higher than the new Federal upper limit amount. 
Table 3 illustrates the percentage difference between the new Federal 
upper limit amounts and the pharmacy acquisition costs for the  
25 selected drugs in the second quarter of 2006. 
Table 3: Comparison of Estimated Pharmacy Acquisition Costs to New Federal Upper Limit Amounts 
Average Pharmacy  New Federal Upper 
Drug  Acquisition Cost  Limit Amount  Difference 
Albuterol, 0.09MG/Actuation, Aerosol Solid (Inhaler)  $0.335  $0.767  -56% 
Ranitidine Hydrochloride, 150MG, Tablet  $0.030  $0.042  -29% 
Acetaminophen/Hydrocodone Bitartrate, 500MG-5MG, Tablet  $0.032  $0.039  -18% 
Gabapentin, 800MG, Tablet  $0.573  $0.669  -14% 
Gabapentin, 600MG, Tablet  $0.447  $0.476  -6% 
Oxycodone Hydrochloride, 80MG, Tablet Extended Release  $2.633  $2.719  -3% 
Glimepiride, 4MG, Tablet  $0.084  $0.077  9% 
Lorazepam, 1MG, Tablet  $0.040  $0.033  21% 
Glyburide/Meformin Hydrochloride, 5MG-500MG, Tablet  $0.142  $0.105  35% 
Potassium Chloride, 20MEQ, Tablet Extended Release  $0.121  $0.086  41% 
Gabapentin, 300MG, Capsule  $0.157  $0.108  45% 
Zonisamide, 100MG, Capsule  $0.657  $0.405  62% 
Tramadol Hydrochloride, 50MG, Tablet  $0.049  $0.027  82% 
Acetaminophen/Propoxyphene Napsylate, 650MG-100MG, Tablet  $0.049  $0.024  104% 
Metformin Hydrochloride, 500MG, Tablet  $0.055  $0.026  112% 
Omeprazole, 20MG, Enteric Coated Tablet  $0.638  $0.299  113% 
Glyburide, 5MG, Tablet  $0.069  $0.031  123% 
Paroxetine Hydrochloride, 40MG, Tablet  $0.517  $0.158  227% 
Albuterol Sulfate, 0.83%, Solution  $0.041  $0.011  273% 
Ribavirin, 200MG, Capsule  $2.304  $0.400  476% 
Gabapentin, 400MG, Capsule  $0.203  $0.030  577% 
Oxycodone Hydrochloride, 40MG, Tablet Extended Release  $1.445  $0.191  657% 
Oxycodone Hydrochloride, 20MG, Tablet Extended Release  $0.875  $0.080  994% 
Paroxetine Hydrochloride, 20MG, Tablet  $0.445  $0.025  1,680% 
Metformin Hydrochloride, 1000MG, Tablet  $0.091  $0.005  1,720% 
Source: OIG analysis of second-quarter 2006 AMP data and drug distributor data, 2006. 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  11  F I N D I N G S  
For 13 of the 25 selected high-expenditure drugs, at least one individual 
drug product was available for a price at or below the new Federal upper 
limit amount.  In the second quarter of 2006, 13 of the 25 selected high-
expenditure drugs had at least one associated NDC with an average 
price from a distributor that would have been at or below the new 
Federal upper limit amount.  Of the remaining 12, there were 6 drugs 
for which even the lowest price would be at least double the new Federal 
upper limit amount.  We did not determine whether the lowest-priced 
NDCs were nationally available to all pharmacies. 
In the second quarter of 2006, 
The average manufacturer price used to set a new 
the lowest AMP was more 
Federal upper limit amount may be substantially 
than 60 percent below the 
lower than other average manufacturer prices 
second-lowest AMP (among 
associated with a drug 
therapeutically equivalent 
products in a commonly-listed size) for 72 of the 521 listed drugs   
(14 percent).  In other words, the second-lowest AMPs (and all other 
AMPs associated with the drug) for these drugs would be higher than 
the new Federal upper limit amount.17  That same quarter, the lowest 
AMP for 149 of the 521 listed drugs (29 percent) was more than  
60 percent below the volume-weighted AMP.18 
Volume-weighted AMPs sometimes differed from the lowest AMPs by a 
large margin because NDCs associated with the lowest AMPs often 
accounted for a small portion of Medicaid utilization. For 109 of the 
521 drugs (21 percent) on the Federal upper limit list, the NDC with the 
lowest AMP was responsible for less than 2 percent of all units of the 
drug reimbursed by Medicaid in the second quarter of 2006.  For 23 of 
these drugs, NDCs whose AMPs would be used to set the Federal upper 
limit accounted for less than 0.01 percent of the utilization, with  
14 having no utilization at all in the second quarter of 2006. 
17  For example, a drug with a lowest AMP of $0.40 would have a new Federal upper 
limit amount of $1.00 ($0.40 times 250 percent).  If the second-lowest AMP is higher than 
this new Federal upper limit amount (e.g., $1.01), then the lowest AMP would be at least  
60 percent below the second-lowest AMP ($0.40 is 60.4 percent below $1.01).  In its proposed 
regulation, CMS uses a 70-percent rather than 60-percent threshold in comparing the 
lowest AMP to the second-lowest AMP. 
18 We calculated the volume-weighted AMP among all NDCs for the drug by weighting 
the AMP for each individual NDC by the number of units of the NDC reimbursed by 
Medicaid in the second quarter of 2006. 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  12  FF II NN DD II NN GG SS  
  
In the second quarter of 2006, the 
Among the 25 selected high-expenditure drugs, 
lowest AMP was more than 
examining the volume-weighted AMPs helped 
60 percent below the volume-
identify instances in which pharmacy acquisition 
weighted AMP for 20 of the 
costs may exceed the new Federal upper limit 
25 selected high-expenditure 
amounts  drugs under review. In all but one 
of these cases, the average pharmacy acquisition costs exceeded the new 
Federal upper limit amount. Likewise, for the five drugs for which the 
lowest AMP did not exceed the 60-percent threshold compared to the 
volume-weighted AMP, the average pharmacy acquisition costs were 
below the new Federal upper limit amount. In other words, in all but 
one case, determining whether or not the lowest AMP for any of the 
25 selected high-expenditure drugs exceeded the 60-percent threshold 
compared to the volume-weighted AMP would have accurately 
determined whether or not its average acquisition cost was higher than 
the new Federal upper limit amount. 
Examining the second-lowest AMP was not as effective in identifying 
instances in which pharmacy acquisition costs may exceed the new 
Federal upper limit amounts. In the second quarter of 2006, the lowest 
AMP was more than 60 percent below the second-lowest AMP for 5 of 
the 25 selected high-expenditure drugs under review. In each of these 
cases, the average pharmacy acquisition cost was at least double the 
new Federal upper limit amount. 
However, 14 of the 20 high-expenditure drugs for which the lowest AMP 
did not exceed the 60-percent threshold compared to the second-lowest 
AMP also had pharmacy acquisition costs that were higher than the 
new Federal upper limit amount. In fact, for 6 of these 14 drugs, the 
lowest AMP was no more than 10 percent below the second-lowest AMP. 
Therefore, potential reimbursement issues for these 14 drugs would not 
have been identified by using the second-lowest AMP as a point of 
comparison during the second quarter of 2006. 
Table 4 on the following page illustrates the relationship between the 
new Federal upper limit amounts, average acquisition costs, second-
lowest AMPs, and volume-weighted AMPs for the 25 selected high-
expenditure drugs. 
OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  13  F I N D I N G S   
  
Table 4: Relationship Between New Federal Upper Limit Amounts, Estimated Acquisition Costs, and Other AMPs 
Average  Lowest AMP  Lowest AMP 
Acquisition  More Than   More Than  
Cost Exceeds  60 Percent  60 Percent 
New Federal  Below Second  Below Volume-
Drug  Upper Limit  Lowest AMP  Weighted AMP 
Albuterol, 0.09MG/Actuation, Aerosol Solid (Inhaler) 
Ranitidine Hydrochloride, 150MG, Tablet 
Acetaminophen/Hydrocodone Bitartrate, 500MG-5MG, Tablet 
Gabapentin, 800MG, Tablet 
Gabapentin, 600MG, Tablet 
Oxycodone Hydrochloride, 80MG, Tablet Extended Release  X 
Glimepiride, 4MG, Tablet  X  X 
Lorazepam, 1MG, Tablet  X  X 
Glyburide/Meformin Hydrochloride, 5MG-500MG, Tablet  X  X 
Potassium Chloride, 20MEQ, Tablet Extended Release  X  X 
Gabapentin, 300MG, Capsule  X  X 
Zonisamide, 100MG, Capsule  X  X 
Tramadol Hydrochloride, 50MG, Tablet  X  X 
Acetaminophen/Propoxyphene Napsylate, 650MG-100MG, Tablet  X  X 
Metformin Hydrochloride, 500MG, Tablet  X  X 
Omeprazole, 20MG, Enteric Coated Tablet  X  X 
Glyburide, 5MG, Tablet  X  X  X 
Paroxetine Hydrochloride, 40MG, Tablet  X  X  X 
Albuterol Sulfate, 0.83%, Solution  X  X 
Ribavirin, 200MG, Capsule  X  X 
Gabapentin, 400MG, Capsule  X  X 
Oxycodone Hydrochloride, 40MG, Tablet Extended Release  X  X  X 
Oxycodone Hydrochloride, 20MG, Tablet Extended Release  X  X  X 
Paroxetine Hydrochloride, 20MG, Tablet  X  X 
Metformin Hydrochloride, 1000MG, Tablet  X  X  X 
Source: OIG analysis of second-quarter 2006 AMP data and drug distributor data, 2006. 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  14  
   R E C O M M E N D A T I O N S   
  
Based in part on OIG work that consistently found that the published 
prices used to set Federal upper limit amounts often greatly exceed 
prices available in the marketplace, the DRA has substantially changed 
the way Medicaid Federal upper limit amounts are calculated.  As of 
January 1, 2007, Federal upper limits are based on 250 percent of the 
lowest reported AMP rather than 150 percent of the lowest price 
published in the national compendia.   
The findings of this report again illustrate why changes to the previous 
calculation method were needed, as this method led to inflated Medicaid 
payments for many high-dollar generic drugs.  Furthermore, using 
actual sales data (such as AMP) rather than published prices to 
calculate Federal upper limit amounts present several additional 
advantages, i.e., they are defined by statute, are based on real-world 
transactions, and can be audited.  However, we have concerns that, at 
least initially, the new formula may result in some Federal upper limit 
amounts that are below pharmacy acquisition costs.  This could occur 
because for certain drugs the lowest AMPs may not reflect prices 
generally available in the marketplace. 
As part of the proposed Federal upper limit regulation, CMS announced 
plans to identify potential reimbursement issues by removing the lowest 
AMP if it appears to be an outlier. The proposed regulation defines an 
outlier as a lowest AMP that is more than 70 percent below the second-
lowest AMP. We support CMSs attempts to proactively resolve 
potential problems with the new formula.  However, our analysis 
(applying a more limited 60-percent threshold) indicates that using the 
second-lowest AMP may not alleviate all reimbursement issues. 
In addition to CMSs efforts, drug manufacturers and pharmacies also 
have important roles in helping to ensure that the new Federal upper 
limit amounts are appropriate. Manufacturers of generic drugs should 
make certain that the AMPs they are reporting to CMS are accurate.  In 
turn, pharmacies should inform CMS if the new Federal upper limit 
amounts are lower than the prices at which they can purchase certain 
drugs. 
We recognize that for various reasons (e.g., definitional changes in 
AMP, market forces, etc.) the relative relationship between the Federal 
upper limit amounts and other price points presented in this report may 
change once the new method of calculation is implemented. However, 
new Federal upper limit amounts should be monitored closely to help 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  15  R 	E C O M M E N D A T I O N S  
ensure that reimbursement changes do not lead to access problems for 
Medicaid beneficiaries. Specifically, we recommend that: 
CMS should take steps to identify when a new Federal upper limit amount 
may not be representative of a drugs acquisition cost to pharmacies.  
These steps could include: 
	  issuing a final regulation that would remove the lowest AMP 
from the Federal upper limit calculation when it is significantly 
lower than the volume-weighted AMP (rather than the second-
lowest AMP) for a drug, 
	  contacting manufacturers to verify reported data in situations 
for which the lowest AMP appears to be significantly lower than 
other AMPs for a drug, 
	  examining Medicaid utilization data to ensure that the product 
on which the Federal upper limit is based is actually utilized in 
the marketplace, and 
	  providing an opportunity for pharmacies to alert the States and 
CMS when they can demonstrate an inability to purchase a drug 
at prices at or below the new Federal upper limit amount. 
In situations where 250 percent of the lowest AMP may not be sufficient 
to cover pharmacy acquisition costs, CMS should determine the proper 
course of action (working with Congress, if necessary).  
AGENCY COMMENTS AND OFFICE OF INSPECTOR GENERAL 
RESPONSE 
CMS concurred with our recommendation that the new Federal upper 
limit amount should be monitored closely during initial implementation 
and agreed that manufacturers play an important role in this regard. 
However, CMS strongly disagreed with our findings concerning the 
effect of the DRA-related changes to the Federal upper limit calculation.  
CMS suggested that OIG should have waited until the final AMP 
regulation is promulgated before completing its study, stating it is only 
after a final definition of AMP has been issued that an accurate analysis 
of the impact of DRA can be conducted.  Once that occurs, CMS 
believes that that an analysis based on actual AMPs would yield 
substantially different results. CMS stated that the analysis in the OIG 
report is deficient in numerous ways and such deficiencies lead to 
flawed results and misleading conclusions.  Therefore, CMS requested 
that we (1) revise our analysis to address these flaws and (2) delay 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  16  R E C O M M E N D A T I O N S  
issuing this report while considering earlier discussions and working 
collaboratively with the agency. 
OIG will continue to work collaboratively with CMS in an effort to 
address any potential issues with the new calculation method for 
Federal upper limits. However, issuing this report prior to CMSs 
publication of its final regulation provides the agency with the 
opportunity to consider our findings and incorporate our 
recommendations.  The data presented in this report are the best 
available for the timeframe, and any limitations have marginal impact 
and do not change the overall findings and conclusions.  We note that a 
similar report by the Government Accountability Office (GAO) identified 
the same issues and reached similar conclusions.19 
A detailed discussion of CMSs specific comments is presented below.  
The full text of CMSs comments is presented in Appendix B. 
Detailed Discussion of CMS Comments 
AMP-related issues: CMS stated that AMPs used in OIGs analysis are 
lower than appropriate, noting that we did not account for the exclusion 
of prompt pay discounts from AMP starting in 2007 or other changes to 
AMP that may occur under the new AMP regulation.  Therefore, OIG 
should have waited until this regulation takes effect before conducting 
this study. CMS also stated that it will not calculate Federal upper 
limit amounts based on AMPs for terminated products and that our 
analysis does not address this.  Furthermore, CMS disagreed with our 
use of volume-weighted average AMPs in part of our analysis.  The 
agency stated that current market volume is not indicative of a drug 
products national availability because of the incentives in the previous 
system that may have lead pharmacies to purchase drugs with the most 
inflated price. 
OIG addresses several of these issues in the report.  While OIG does 
plan to undertake similar work once the new regulation goes into effect, 
it was also important to conduct a pre-implementation study to identify 
any potential issues with the new calculation method so that CMS could 
consider them in the development of its final regulation. 
19 Medicaid Outpatient Prescription Drugs:  Estimated 2007 Federal Upper Limits for 
Reimbursement Compared with Retail Pharmacy Acquisition Costs, (GAO-07-239R, 
December 2006).  Available online at http://www.gao.gov/new.items/d07239r.pdf.  Accessed 
January 22, 2007. 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  17  R E C O M M E N D A T I O N S  
We agree with CMS that the AMPs we used may have increased since 
the time of our analysis, as prompt-pay discounts are no longer included 
in manufacturers calculations.  However, in previous studies, we found 
that prompt-pay discounts typically range from 1 percent to 3 percent 
not a substantial enough margin to change the overall impact of the 
data presented in this report.  In regard to terminated products, AMPs 
for terminated NDCs were excluded from our analysis and therefore 
were not a factor in our calculations.  Finally, the lowest AMP, second-
lowest AMP, and volume-weighted AMP were all important comparison 
points we used in our analysis.  The advantages of using volume-
weighted AMP are that (1) it reflects the products actually used in the 
marketplace; (2) it is very similar to the average sales prices used as the 
basis for Medicare drug reimbursement; and (3) based on our analysis of 
25 drugs, it was a more accurate predictor of drugs for which acquisition 
costs may exceed the Federal upper limit amount than was the second-
lowest AMP. 
Acquisition cost-related issues. CMS stated that the acquisition costs 
presented in our report are higher than appropriate because (1) our 
analysis does not fully account for discounts and rebates, and (2) our 
analysis should have focused on the lowest acquisition costs available to 
pharmacies rather than the average acquisition costs. 
Overall, the data provided in this report are the best available for the 
timeframe. We note that CMS has also used these data to perform its 
own analysis. In this report, OIG states that we asked distributors to 
provide information on discounts and rebates, but only two of the five 
respondents did so.  The other three distributors described the difficulty 
in capturing these data on a drug-by-drug basis. However, given the 
magnitude of the difference between the new Federal upper limit 
amount and pharmacy acquisition cost for a number of drugs, this 
limitation does not negate our underlying concerns.   
With respect to the lowest acquisition costs, numerous pricing points 
could have been used in our analysis.  The lowest price reported by 
distributors is one important pricing point, and the report includes a 
subfinding that addresses how the new Federal upper limit amounts 
compare to these figures.  Even when using the lowest price reported by 
distributors, potential reimbursement issues would still exist, as we 
found that the lowest acquisition costs for half of the drugs exceeded the 
new Federal upper limit amount.  We chose the volume-weighted 
average acquisition cost for the primary analysis because it reflects the 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  18  R E C O M M E N D A T I O N S  
prices of the drugs that pharmacies actually purchased and because we 
could not determine whether the lowest prices reported by distributors 
were readily available to most purchasers. 
Aggregate cost-related issues. Under current law, Federal upper limits 
apply in the aggregate.  In other words, States may set reimbursement 
for some drugs at amounts above the Federal upper limit if other drugs 
are reimbursed at amounts that are below (as long as a States overall 
spending is below the aggregate spending that would occur at the  
CMS-determined Federal upper limit amounts).  CMS stated that our 
analysis does not address the mitigating effects of applying Federal 
upper limits in the aggregate. 
OIG recognizes the importance of the aggregate concept and agrees with 
CMS that States should continue to use this flexibility when 
appropriate.  However, balancing reimbursements above and below the 
Federal upper limit amounts while meeting the aggregate spending 
limit was easier when Federal upper limit amounts were highly 
inflated. Before the DRA-related changes, Federal upper limit amounts 
for most drugs exceeded acquisition costs (often by a large margin), 
meaning that few drugs would warrant an increase in their 
reimbursement amounts.  Furthermore, the many drugs with Federal 
upper limit amounts above acquisition costs provided States with 
numerous choices for balancing out these price increases.   
With the move to AMPs as the basis for calculating Federal upper limit 
amounts, OIG anticipates that it will be more difficult to apply the 
flexibility afforded by an aggregate limit.  Using our findings in this 
report as an example, reimbursement amounts for the 6 drugs with 
average acquisition costs below the Federal upper limit amount would 
need to be decreased sufficiently to balance out an increase in the 
reimbursement amounts for the 19 drugs with average acquisition costs 
above the new Federal upper limit amount.   
State maximum allowable cost programs. CMS stated that the comparison 
between pre- and post-DRA Federal upper limit amounts is improper 
because it does not account for the impact of State maximum allowable 
cost programs (i.e., States often pay less than the Federal upper limit 
amount for many drugs).  
OIG discusses the relevance of State maximum allowable cost to our 
findings in this report. The objective of this report was to determine 
how Federal upper limits were impacted under the DRA methodology, 
and we focused our analysis on that objective. 
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Attached chart containing CMS analysis. CMS attached a chart with its 
comments showing that, based on (1) February 2007 AMPs,     
(2) application of an outlier policy, and (3) the lowest reported 
acquisition costs, 20 of 25 drugs would be available at or below the new 
Federal upper limit amount.  CMS also used the chart to conclude that, 
in the aggregate, pharmacies would not have been underreimbursed in 
the second quarter of 2006 if they all purchased drugs at the lowest 
price reported by distributors (but not at the average price). 
Even if OIG accepts CMSs assumptions regarding the data presented in 
its chart (including the assumption that all pharmacies could have 
purchased the drug for the lowest report acquisition cost, discussed on 
pages 18 and 19), we continue to have concerns about the potential 
impact of the new Federal upper limit amounts for certain drugs.  
According to CMSs aggregate calculations, pharmacies would have 
made up for a $3 million total quarterly loss on 24 of the 25 drugs in the 
second quarter of 2006 by receiving $11 million in excessive 
reimbursement for one drug, albuterol aerosol (a drug for which the new 
Federal upper limit amount was well above acquisition cost).  In other 
words, pharmacies could make up (in the aggregate) for losses on most 
other drugs by filling albuterol prescriptions.  However, pharmacies 
that do not sell a large volume of albuterol would find it difficult to 
receive adequate reimbursement for the entire group of drugs. 
Therefore, while OIG acknowledges the aggregate application of the 
Federal upper limit program, we also see important advantages to 
striving to set reimbursement for all drugs at appropriate levels, with 
cross-subsidies being limited whenever possible. 
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DETAILED METHODOLOGY 
Data Sources 
Identifying Drugs for Review.  Using data from CMSs Web site and the 
national drug compendium Redbook, we identified all drugs included 
on the Federal upper limit list in the second quarter of 2006.  Federal 
upper limit amounts for these drugs were based on 150 percent of the 
lowest price published in the national compendia.  During that quarter, 
CMS had established Federal upper limits for 530 drugs.  
We then obtained calendar year (CY) 2005 Medicaid drug 
reimbursement and utilization data from CMSs Web site and identified 
the 25 drugs (of the 530) on the Federal upper limit list with the highest 
total Medicaid expenditures that year.20 
Acquisition Cost Data. For the 25 listed drugs with the highest total 
Medicaid expenditures in 2005, we collected second-quarter 2006 pricing 
and sales data from the three largest national distributors 
(AmerisourceBergen, McKesson, and Cardinal Health)21 and two 
smaller regional distributors (Mutual Drug Company and Burlington 
Drug Company).  Each distributor was asked to provide the total dollar 
amount sold, the amount of discounts and rebates paid to purchasers, 
the net dollar amount sold, the total number of units sold, and the 
average selling price during the second quarter of 2006 for all NDCs 
associated with the top 25 Federal upper limit drugs. 
AMP Data.  We obtained AMP data for the second quarter of 2006 from 
CMS. 
Data Analysis 
Estimating Pharmacy Acquisition Costs for Selected Drugs. Among the 
five distributors, we totaled the dollar amount sold (net of reported 
discounts and rebates, when possible) for all NDCs associated with each 
of the 25 selected high-expenditure drugs, and divided this amount by 
the total number of units of each NDC sold.  We also determined the 
20 CY 2005 reimbursement and utilization data were the most current available at the 
time of our sample selection. 
21 According to industry sales reports, these three national companies account for the 
vast majority of market share among drug distributors. 
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lowest price reported to OIG by the distributors for any NDC associated 
with the 25 drugs. 22 
Estimating Federal Upper Limit Amounts Under New Calculation Method.  To 
estimate what Federal upper limit amounts would be under the new 
methodology set forth in section 6001(a) of the DRA, we determined the 
lowest AMP reported by manufacturers among NDCs associated with 
the 530 drugs on the Federal upper limit list in that quarter.  
Under 42 CFR 447.332 (in effect during the time of our review), a 
Federal upper limit amount should be based on the least costly 
therapeutically equivalent drug that can be purchased by pharmacists 
in quantities of 100 (or if the drug is not commonly available in 
quantities of 100, a commonly listed package size).  In determining the 
lowest AMP for any given Federal upper limit drug, we examined only 
NDCs in a commonly listed size that were identified as therapeutically 
equivalent in either CMSs drug product file23 or the national drug 
compendium Redbook.  For the purpose of this study, AMPs for 
terminated NDCs were not used to estimate new Federal upper limit 
amounts.24 
Of the 530 drugs included on the Federal upper limit list in the second 
quarter of 2006, 9 did not have AMP data for any nonterminated, 
therapeutically equivalent NDCs of a commonly listed size. Therefore, 
we did not include these drugs in our analysis.  For the remaining    
521 drugs, we multiplied the lowest AMP by 250 percent to estimate the 
new Federal upper limit amounts under the methodology mandated by 
the DRA.  
Comparing New and Second-Quarter 2006 Federal Upper Limit Amounts.  For 
each of the 521 drugs included in our review, we calculated the 
percentage difference between the new Federal upper limit amounts 
(based on 250 percent of AMP) and the second-quarter 2006 Federal 
upper limit amounts (based on 150 percent of the lowest published 
22 One of the five distributors did not provide sales and utilization data broken down by 
the NDC.  Therefore, this distributors data were not included in the determination of the 
lowest price for a drug. 
23  Available online at 
http://www.cms.hhs.gov/MedicaidDrugRebateProgram/09_DrugProdData.asp. Accessed on 
September 8, 2006. 
24 As reported in the national drug compendium RedBook, a terminated NDC is one 
assigned to a product that has been deactivated by a manufacturer. 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  22  A P P E N D I X ~ A  
price).  We categorized the drugs into ranges based on the percentage 
increases or decreases in their Federal upper limit amounts.  
Comparing Federal Upper Limit Amounts to Pharmacy Acquisition Costs. 
We calculated the percentage difference between the second-quarter 
2006 Federal upper limit amounts and the average pharmacy 
acquisition costs for each of the 25 selected high-expenditure drugs.  We 
then calculated the difference between the new Federal upper limit 
amounts (based on 250 percent of the lowest AMP) and the average 
pharmacy acquisition costs. For each of the 25 drugs, we also compared 
the lowest price reported by any of the distributors for any associated 
NDC to the new Federal upper limit amount. 
Comparing the Lowest AMP to the Other AMPs.  To assess whether the 
lowest AMPs used to set the new Federal upper limit amounts were 
representative of other AMPs for the same drug, we determined the 
second-lowest and volume-weighted AMPs for each of the 521 drugs 
under review.  In identifying the second-lowest AMPs, we limited our 
analysis to nonterminated, therapeutically equivalent NDCs of a 
commonly listed size.  We calculated the volume-weighted AMP among 
all NDCs for the drug by weighting the AMP for each individual NDC by 
the number of units of the NDC reimbursed by Medicaid in the second 
quarter of 2006.  We then compared the lowest AMP to the second-
lowest and volume-weighted AMPs for each of the 521 drugs and 
identified instances in which the lowest AMP was more than 60 percent 
below either of these other two figures. 25  We subset out the results for 
the 25 selected high-expenditure drugs for further analysis. 
Determining if Other AMPs Could Help Identify Potential Issues. Among the 
25 selected high-expenditure drugs, we identified any instances in 
which the lowest AMP was more than 60 percent below the second-
lowest and/or volume-weighted AMP.  For any drugs that exceeded this 
threshold, we determined whether the average pharmacy acquisition 
costs exceeded the new Federal upper limit amount.  We repeated this 
25 In its proposed regulation, CMS uses a 70 percent rather than a 60-percent threshold 
in comparing the lowest AMP to the second-lowest AMP.  We chose to use 60 percent in our 
analysis because whenever the lowest AMP exceeds this threshold relative to the second-
lowest AMP, then the second-lowest AMP (and all other AMPs) for a drug would be higher 
than the new Federal upper limit amount.  For example, a drug with a lowest AMP of $0.40 
would have a new Federal upper limit amount of $1.00 ($0.40 times 250 percent).  If the 
second-lowest AMP is higher than this new Federal upper limit amount (e.g., $1.01), then 
the lowest AMP would be at least 60 percent below the second-lowest AMP ($0.40 is         
60.4 percent below $1.01). 
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analysis for drugs that did not meet the 60-percent threshold.  This 
analysis allowed us to determine whether exceeding the 60-percent 
threshold (compared to either the second-lowest or volume-weighted 
AMP) was linked to a drugs average acquisition cost being higher than 
the new Federal upper limit amount for these 25 drugs. 
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 A P P E N D I X ~ B  
 
Agency Comments 
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A P P E N D I X ~ A  
This report was prepared under the direction of Robert A. Vito, Regional 
Inspector General for Evaluation and Inspections in the Philadelphia 
regional office, and David E. Tawes, Director of the Medicare and 
Medicaid Prescription Drug Unit.   
Other principal Office of Evaluation and Inspections staff from the 
Philadelphia regional office who contributed include Lauren McNulty 
and Jessica Demko.  Central office staff who contributed include Sarah 
Craren, Cynthia Thomas, and Gina Maree. 
  OEI-03-06-00400  DEFICIT REDUCTION ACT OF 2005: IMPACT ON THE MEDICAID FEDERAL UPPER LIMIT PROGRAM  33