Department of Health and Human Services 
OFFICE OF 
INSPECTOR GENERAL 
S S C
TATE  TRATEGIES TO  ONTAIN 
M D C
EDICAID  RUG  OSTS 
Inspector General 
October 2003 
OEI-05-02-00680  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 OIG's 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 the department. 
Office of Evaluation and Inspections 
The OIG's Office of Evaluation and Inspections (OEI) conducts short-term management 
and program evaluations (called inspections) that focus on issues of concern to the 
department, the Congress, and the public. The findings and recommendations contained 
in the inspections reports generate rapid, accurate, and up-to-date information on the 
efficiency, vulnerability, and effectiveness of departmental programs. 
Office of Investigations 
The OIG's 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. The OI also oversees 
state Medicaid fraud control units, which investigate and prosecute fraud and patient 
abuse in the Medicaid program. 
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. The OCIG imposes program exclusions and 
civil monetary penalties on health care providers and litigates those actions within the 
department. The OCIG also represents OIG in the global settlement of cases arising 
under the Civil False Claims Act, develops and monitors corporate integrity agreements, 
develops model compliance plans, renders advisory opinions on OIG sanctions to the 
health care community, and issues fraud alerts and other industry guidance.  A B S T R A C T  
Escalating Medicaid drug expenditures, combined with strained 
State budgets, have led States to contain Medicaid drug costs. 
Federal Medicaid law and regulation prevent States from 
benefiting from some cost containment tools widely used by 
private purchasers. However, States do exercise flexibility 
within Federal Medicaid law and regulation to employ three 
main drug cost containment strategies. These key strategies 
contain costs by (1) limiting Medicaid reimbursement for drugs 
(reported by 32 States); (2) shifting use from higher to lower 
cost drugs (39 States); and (3) limiting the amount of 
prescription drugs a beneficiary can obtain within a given time 
period (25 States). Maximizing a States ability to contain drug 
costs can provide a significant fiscal benefit to both State and 
Federal Medicaid budgets. However, there are significant 
challenges to maximizing drug cost savings, including a lack of 
accurate drug price information and stakeholder opposition to 
cost containment efforts. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  i  E X E C U T IV E   S U M M A R Y

OBJECTIVE 
To describe States key strategies to contain their Medicaid 
outpatient prescription drug costs. 
BACKGROUND 
Medicaid prescription drug coverage is one of the most 
expensive and fastest growing health care expenditures.  In 
fiscal year (FY) 2001, Medicaid expenditures for prescription 
drugs totaled approximately $20 billion, or 9 percent of the 
Medicaid budget. From 1997 to 2001, Medicaid expenditures for 
prescription drugs grew at more than twice the rate of total 
Medicaid spending. 
Increasing Medicaid drug costs create concern for States. In FY 
2002, 40 States faced budget shortfalls that totaled nearly $40 
billion. In a recent survey, 36 States identified prescription 
drug costs as the top Medicaid cost driver in FY 2001, and 12 
additional States listed drugs as 1 of the top 3. 
Federal Medicaid law and regulation prevent States from 
benefiting from the array of cost containment tools available to 
private purchasers. However, States retain some flexibility to 
set Medicaid drug reimbursement levels and to implement a 
variety of cost saving measures. 
To assess States strategies to contain their Medicaid drug costs, 
we collected information from multiple sources, including a 
national survey of State Medicaid pharmacy directors, State 
Medicaid plans, State cost saving reports, and interviews with 
staff from the Centers for Medicare & Medicaid Services (CMS) 
and State Medicaid agencies. 
FINDINGS 
REDUCE PRICE:  Thirty-two States Reported Strategies Designed 
to Reduce the Price Medicaid Pays for Drugs as Key to Cost 
Containment.  Seventeen States contain drug costs by lowering 
the rate at which they reimburse pharmacies for drugs, and 10 
States reported annual savings up to $21.7 million from these 
changes.  However, States also face barriers to setting 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  ii  E X E C U T I V E   S U M M A R Y  
reimbursement rates reflective of actual pharmacy acquisition 
costs, including lack of accurate drug prices and pharmacy 
opposition to reimbursement reductions. 
When asked to identify top cost containment strategies, 24 
States reported State maximum allowable cost (MAC) programs, 
which establish maximum reimbursement amounts for groups of 
equivalent drugs (i.e., a brand name drug and its generic 
equivalents). Seventeen of these States reported cost savings 
from their MAC programs, ranging up to $45.8 million per year. 
SHIFT USE:  While Required to Cover Most Drugs, 39 States 
Encourage a Shift from Higher to Lower Cost Drugs.  Thirty-nine 
States report cost containment strategies aimed at shifting 
Medicaid prescription drug use toward lower cost drugs as 
central to their efforts to contain costs. These strategies include 
prior authorization programs (29 States), preferred drug lists 
(20), generic substitution requirements (15), and beneficiary cost 
sharing (10). 
Prior authorization programs, which require State-sanctioned 
approval before particular drugs can be dispensed, discourage 
physicians from prescribing these drugs unless medically 
necessary. Sixteen States identified savings, which ranged up to 
$89 million, through their prior authorization programs. 
States create preferred drug lists by identifying the most cost-
effective drugs in each therapeutic class. States encourage 
physicians to prescribe preferred drugs through outreach efforts 
and/or by creating disincentives for prescribing non-preferred 
drugs. States may achieve additional savings by obtaining 
supplemental rebates from drug manufacturers. Six States 
saved up to $127 million annually through preferred drug lists. 
However, industry opposition to preferred drug lists creates 
challenges. 
LIMIT QUANTITY:  While Required to Maintain Sufficient Amount, 
Duration, and Scope of Benefits, 25 States Limit the Quantity of 
Drugs Used as a Central Strategy to Contain Costs.  Eighteen 
States limit (1) the number of prescriptions filled in a specified 
time period, such as six prescriptions per month; (2) the amount 
of a drug, such as a maximum daily dosage; or (3) the frequency 
of dispensing a drug, such as limits on early refills as a central 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  iii  E X E C U T I V E   S U M M A R Y  
means to contain costs. Nine States estimated annual savings 
of up to $51 million through quantity limits. 
Fourteen States find prospective drug utilization reviews 
important to drug cost containment because they help to prevent 
duplicative, contraindicated, or medically unnecessary 
prescriptions from being dispensed. These preventive measures 
produce annual State savings ranging up to $27 million per 
State. 
CONCLUSION 
Maximizing States ability to contain drug costs can provide a 
significant fiscal benefit to both State and Federal Medicaid 
budgets. In 2002, CMS centralized its efforts to provide 
guidance regarding States Medicaid pharmacy programs 
through shifting responsibility for State plan amendment 
approval from CMS regional offices to its headquarters location. 
We support CMSs efforts to provide consistent, timely, and 
pertinent information to State Medicaid pharmacy 
representatives. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  iv  T A B L E   O F   C O N T E N T S

A B S T R A C T  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . .   i

E X E C U T I V E   S U M M A R Y  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . .   ii

I N T R O D U C T I O N . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . .   1

F I N D I N G S  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . .   7

32 States Reduce Price Paid for Drugs..............................................7

39 States Shift Use to Lower Cost Drugs ................ ................... 15

25 States Limit Drug Quantities ..................................................... 25

C O N C L U S I O N  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . .  30

A P P E N D I X  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . .  31

Additional State Savings Projections for Preferred Drug Lists. ..... 31

A C K N O W L E D G M E N T S  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . .  32

E N D   N O T E S  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . .  33

OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  v
 I N T R O D U C T I O N

OBJECTIVE 
To describe States key strategies to contain their Medicaid 
outpatient prescription drug costs. 
BACKGROUND 
Medicaid Drug Expenditures 
All State Medicaid programs have elected to include prescription 

drug coverage, which is one of the most expensive Medicaid 

benefits. In fiscal year (FY) 2001, Medicaid expenditures on 

prescription drugs totaled approximately $20 billion, 

representing 9 percent of the annual Medicaid budget.1 The 

Medicaid program is the largest payer of prescription drugs 

nationally, representing 14 percent of the drug market.2 The 

Federal Government contributes a matching percentage of State 

Medicaid outlays, ranging from 50 to 83 percent, depending on 

the States per capita income.3

Payment for prescription drugs is the fastest growing health 

care expenditure. Nationally, total spending for prescription 

drugs rose from $48.2 billion in 1992 to $141.8 billion in 2001.4

Likewise, Medicaid expenditures for prescription drugs grew at 

more than twice the rate of total Medicaid spending from FYs 

1997 to 2001.5  The Centers for Medicare & Medicaid Services 

(CMS) projects that Medicaid drug expenditures will continue to 

increase by an average rate of 12.7 percent per year through 

2011.6 In FY 2002, 40 States faced budget shortfalls that 

totaled nearly $40 billion. The gap between State revenue and 

total spending is expected to widen to $58 billion during FY 

2003.78 These expected increases are significant in light of State 

budget constraints. Further, in a recent survey, 36 States 

identified prescription drug costs as the top Medicaid cost driver 

in FY 2001, and 12 additional States listed drugs as 1 of the top 

3.9

Medicaid Pharmacy Reimbursement 

Drug Cost Reimbursement.  For Medicaid, CMS sets maximum 

drug reimbursement limits to ensure that the Federal 

Government acts as a prudent buyer.10 Within these Federal 

parameters, each State determines its own pharmacy 

reimbursement formula(s).

OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  1  I N T R O D U C T I O N  
For certain multiple source drugs with a sufficient number of 
equivalent products and at least three suppliers, CMS sets 
specific Federal upper limit (FUL) amounts. FUL equals 150 
percent of the lowest published priced version of the drug listed 
in national pricing compendia.11  FUL acts as a ceiling, and 
States may reimburse below this amount. 
For drugs without a FUL, the Medicaid drug reimbursement 
limit is the lower of (1) the pharmacists usual and customary 
charge; (2) the estimated [pharmacy] acquisition cost (EAC); or 
(3) the States maximum allowable cost (MAC), if applicable.12 
EAC is the State Medicaid agencys best estimate of the price 
generally paid by providers for a drug.13 CMS does not prescribe 
a method for calculating estimated acquisition cost; instead, 
each State establishes and specifies its own EAC formula in its 
State plan. Conceptually, State MAC programs resemble the 
FUL program in that they establish maximum reimbursement 
amounts for groups of equivalent drugs. 
Dispensing Fees.  In addition to reimbursing pharmacies for the 
cost of the drug (also known as the ingredient cost), States are 
required to determine reasonable dispensing fees.14 This fee 
represents the charge for the professional services provided by a 
pharmacist when dispensing a prescription. 
Medicaid Drug Rebate Program 
In addition to setting reimbursement limits, the Medicaid 
program limits expenditures by obtaining rebates from drug 
manufacturers. Federal statute mandates that in order for their 
drugs to be reimbursed by Medicaid, drug manufacturers must 
generally enter into rebate agreements and pay quarterly 
rebates to the State Medicaid agencies. 15 CMS calculates rebate 
amounts using a statutory formula based on the average 
manufacturer price at which manufacturers sell drugs to 
wholesalers. a 
States Flexibility to Contain Medicaid Drug Costs 
Federal law and regulations governing the Medicaid program 
include provisions, such as required coverage of almost all drugs 
and limited beneficiary cost sharing. These constraints prevent 
States from benefiting from certain cost saving tools available to 
a This summary is not meant to capture the full complexity of the Federal Medicaid rebate formula, 
which includes additional calculations using best price and an inflation factor. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  2  I N T R O D U C T I O N  
private purchasers. b States retain some flexibility, however, to 
set Medicaid drug reimbursement levels and to implement a 
variety of cost saving measures within Federal Medicaid 
parameters. Common strategies include: 
o	 Limits on Amount, Duration, and Scope.  States may limit 
any Medicaid benefit, including prescription drugs, as long 
as each benefit is sufficient in amount, duration, and scope 
to reasonably achieve its purpose.16 Within this guideline, 
States may set limits on utilization, such as the number of 
prescriptions per month for each beneficiary, the amount of 
medication per prescription, or the number of refills. 
o	 Prior Authorization.  A State may require providers to obtain 
prior authorization from the Medicaid agency before 
dispensing a particular drug or class of drugs. However, 
Medicaid agencies must respond to providers within 24 
hours, and pharmacies must dispense a 72-hour supply of 
the drug to the beneficiary in an emergency situation. 
o	 Preferred drug lists.  In general, States that offer the 
Medicaid prescription drug benefit must cover all FDA-
approved drugs produced by manufacturers with Medicaid 
rebate agreements. However, States can encourage the use 
of preferred drugs, so long as non-preferred drugs are 
available through an exception process like prior 
authorization.17 
o	 Supplemental Rebates.  States may negotiate with drug 
manufacturers to receive supplemental rebates in addition 
to Federally-mandated rebates.18 Drug manufacturers may 
agree to provide States with supplemental rebates in 
exchange for including their drugs on the States preferred 
drug list. 
o	 Generic Substitution.  States may require the use of an 
equivalent generic drug in place of a brand name drug, 
unless the physician either deems the brand name drug 
medically necessary or obtains prior authorization. 
o	 Cost sharing.  Federal law allows States to require nominal 
cost sharing or co-payments from beneficiaries. 19 Co
b Federal law allows State Medicaid programs to exclude only a limited list of specific drugs and drug 
classes from coverage. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  3  I N T R O D U C T I O N  
payments may not exceed $3 per prescription.20 Also, 
pharmacists may not withhold a drug from a beneficiary who 
cannot afford to pay the co-payment.21 
o	 Provider Education.  States provider education or counter-
detailing efforts seek to balance drug manufacturers direct 
marketing to physicians and consumers by providing 
information on generic alternatives and less expensive brand 
name drugs. 
o	 Drug Utilization Review.  Federal Medicaid law requires 
States to perform drug utilization review (DUR) to examine 
the appropriateness, quality, and medical necessity of drug 
use.22 In addition to improving quality of care, DUR can 
result in cost savings by reducing medically inappropriate 
drug use. 
Related Work by the Office of Inspector General 
The Office of Inspector General (OIG) has issued a significant 
body of work related to Medicaid drug pricing issues. Numerous 
OIG reports have concluded that Medicaid pays more than 
several other Federal and private purchasers for a wide variety 
of drugs. Also, a 2002 OIG report, Medicaid Pharmacy -
Additional Analyses of the Actual Acquisition Cost of 
Prescription Drug Products (A-06-02-00041) found that the 
data upon which States base pharmacy reimbursement 
overstates pharmacy acquisition costs. In these reports, OIG 
recommends that CMS review the current reimbursement 
methodology, work with States to find a method that more 
accurately estimates pharmacy acquisition cost, and initiate a 
review of Federal Medicaid rebates. 
SCOPE 
This report is limited to describing State Medicaid key 
strategies for containing costs of prescription drugs purchased 
through the fee-for-service component of Medicaid.  We do not 
include strategies negotiated by Medicaid managed care 
organizations. We did not examine the Federal rebate drug 
program; however, we did include States efforts to acquire 
supplemental drug rebates beyond the mandated Federal 
rebates. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  4  We did not evaluate the outcomes of individual States cost 
containment strategies. However, we reviewed State 
documentation of their measured or estimated cost savings, 
when available. 
METHODOLOGY 
To provide descriptive information on all States Medicaid drug 
cost containment efforts, we conducted a fax survey of State 
Medicaid directors and pharmacy directors. Forty-three States 
responded to our survey between November 2002 and February 
2003. This survey requested information on efforts that States 
considered to be their top drug cost containment strategies or 
wished to highlight. States responses included key efforts 
already in place and those that they planned to implement. 
Where multiple States adopted similar measures, we 
highlighted particular States based on characteristics, such as 
geography or size of the States Medicaid population. 
States were asked to submit relevant documentation of their 
efforts, including evaluations and supporting documentation of 
pharmacy cost savings, as applicable. State-submitted 
documents included outcome evaluations and analyses of drug 
cost data, reports to State legislatures, annual reports by the 
drug utilization review board, provider bulletins and 
instructions, and provider and beneficiary education materials. 
We did not ask States for a comprehensive list of their efforts as 
this data is available from other researchers. Health Strategies 
Consultancy (contracted by CMS) and George Washington 
University (contracted by the Kaiser Family Foundation) have 
shared such data with us, and we have incorporated it 
contextually, where appropriate. 
We interviewed staff from CMS central office and four regional 
offices. As needed, we collected additional information from 
State plan amendments, State Medicaid manuals, and other 
documents from several States. We interviewed selected State 
respondents, primarily from Oregon, Texas, Florida, Arkansas, 
Vermont, and Michigan. We interviewed respondents from 
these particular States because these States employ a variety of 
innovative or successful cost containment strategies and are 
recognized by CMS, States, and other experts as leaders in 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  5  I N T R O D U C T I O N  
particular areas of drug cost containment. In these States, we 
interviewed the Medicaid director, pharmacy director, and other 
Medicaid staff. We also interviewed experts, including 
representatives from State pharmacy benefit managers, drug 
utilization review boards, pharmacy and industry associations, 
consumer interest groups, and researchers. 
Our review was conducted in accordance with the Quality 
Standards for Inspections issued by the Presidents Council on 
Integrity and Efficiency. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  6  F I N D I N G S

REDUCE PRICE:  Thirty-two States Reported 
Strategies Designed to Reduce the Price Medicaid 
Within Federal guidelines that 
Pays for Drugs as Key to Cost Containment 
seek to ensure that the Federal 
Government acts as a prudent purchaser, each State determines 
its own pharmacy reimbursement methodology.23 State 
strategies to reduce drug reimbursement prices include lowering 
their standard pharmacy reimbursement formulas in order to 
pay less for Medicaid drugs, in general, and setting State 
maximum allowable costs (MACs) for specific drugs with generic 
equivalents. Table 1 displays the number of States that 
reported reduction to reimbursement formulas, MAC programs, 
or both strategies in their survey responses as key methods used 
to contain Medicaid drug costs. 
Table 1. Key State strategies to reduce drug reimbursement prices 
States that reduced reimbursement formula and set MACs  9 
States that reduced reimbursement formula only  8 
States that set MACs only  15 
Total  32 
Source: OIG National Survey, 2002 
Rising drug prices contribute to States increasing Medicaid 
pharmacy expenditures and, in turn, to their mounting budget 
deficits. In 2001, the average brand name prescription drug 
price climbed to $71.18, a nine percent increase from 2000. 
During this same time, the average generic drug price rose 
14 percent, to $21.96.24 
Seventeen States Lowered their Estimates of Pharmacy Acquisition 
Cost. 
When asked to identify top cost containment strategies, 17 
States report changes to their estimated acquisition cost (EAC) 
formula, which, along with pharmacys usual and customary 
charge, is the basis of reimbursement for drugs without a 
designated upper payment limit. These States lowered their 
EAC formulas to reduce reimbursement and more accurately 
reflect pharmacies actual acquisition costs. Previous OIG work 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  7  found evidence that States overestimate actual pharmacy 
acquisition costs. 25 
Nationally, 43 States base their formulas exclusively on average 
wholesale price (AWP) minus a percentage-based discount, and 
6 States use wholesale acquisition cost (WAC) plus some 
percentage-based mark-up. AWP and WAC are published 
reference prices. Typically, States reimbursement changes 
increase the discount off AWP. For example, Nevada revised its 
estimated acquisition cost formula from AWP minus 10 percent 
to AWP minus 15 percent, while Oregon increased its discount 
off AWP from 11 to 14 percent. 
Of the 17 States reporting reimbursement rate changes as key 
to cost containment, 5 have refined their estimated acquisition 
cost formulas to better reflect the complexity of the 
pharmaceutical marketplace. Instead of using a single EAC 
formula for all drugs, these States adopted a tiered formula to 
account for differences in pharmacy acquisition costs between 
brand name and generic drugs. Table 2 lists these formulas. 
The tiered reimbursement formulas incorporate larger discounts 
for generic drugs, which is consistent with previous OIG 
findings that AWP overstates generic drugs to a greater degree 
than brand name drugs. Specifically, OIG found that, on 
average, AWP overstated pharmacy acquisition costs for brand 
name drugs by 22 percent and overstated acquisition costs for 
generic drugs by 66 percent.c 
c The OIG report (A-06-02-00041) provided a further break down of variation within the brand and 
generic categories. More specifically, AWP overstated acquisition costs of single source brand name 
drugs by 17.2%, multi-source brand name drugs (without Federal upper limits (FULs)) by 24.4%, multi-
source generic drugs (without FULs) by 54.2 percent, and all drugs with FULs by 72.1%. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  8  Table 2. State EAC Changes Involving Tiered Formulas 
State  Previous EAC  Revised EAC 
Brand:  AWP-14% 
AR  AWP-10.5% 
Generic: AWP-20% 
Brand:  AWP-13.5% 
CO  AWP-12% 
Generic: AWP-35% 
Brand: WAC+8%  Brand:  AWP-12% 
IL 
Generic: WAC+12%  Generic: AWP-25% 
Brand:  AWP-11% 
KS  AWP-10% 
Generic: AWP-27% 
Brand:  AWP-14% 
WA  AWP-11% 
Generic: AWP-50% 
Sources: OIG National Survey, State Plan Amendments, and State websites 
Lack of Accurate Information on Drug Prices.  As reported by 12 
States, the lack of accurate drug pricing information constitutes a 
significant barrier to containing Medicaid drug costs. Most States 
rely on AWP and/or WAC cost to determine pharmacy 
reimbursement. These are reference prices that States obtain 
from First Databank, a private company which issues a national 
drug pricing compendium. Reports by the OIG and other 
researchers have found AWP to substantially overstate 
pharmacies actual acquisition costs and have discredited its 
validity. OIG audits have also suggested that WAC is unreliable. 
Despite the widely recognized unreliability of AWP and WAC as 
a measure of pharmacy acquisition cost, States have few 
alternative sources for drug prices. Actual sales data are 
proprietary, and only three States indicated that they regularly 
obtain additional price information from drug manufacturers, 
pharmacies, or other sources. One State criticized the 
obfuscation of price by drug manufacturers. Several States 
suggested that CMS share average manufacturer price (AMP) 
data with States. CMS collects AMP from manufacturers as 
part of the Federal drug rebate program, but the agency does 
not share these prices with States. OIG has recommended that 
CMS provide States with AMP. However, CMS has not 
implemented this recommendation due to legal issues. 26 
One advantage of using AMP to more accurately estimate 
pharmacy acquisition cost is that AMP is a statutorily-defined 
price calculated from actual sales and subject to audit by the 
Department. Texas recently passed legislation requiring 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  9  manufacturers to provide AMP to the State Medicaid agency; 
however, many manufacturers have not yet complied. 
Profile of Pharmacy Reimbursement by Texas Medicaid 
Texas stands out among Medicaid programs in its aggressive pursuit of accurate drug 
pricing information and its efforts to reflect the complexity of the pharmaceutical 
marketplace. Rather than relying solely on the national compendia used by most 
States to obtain AWP and WAC, Texas requires drug manufacturers to submit cost to 
wholesaler and direct prices to the Medicaid agency, as well as AMP data. Direct 
prices represent sales directly from manufacturers to pharmacies, rather than through 
wholesalers. Cost to wholesaler is conceptually equivalent to WAC, but drug 
manufacturers must certify these prices, which may increase their accuracy. 
Texas also uses a complex system for estimating pharmacy acquisition cost that takes 
into account how the pharmacy purchased the drug. If the drug is purchased through a 
wholesaler, Texas applies its EAC formula. If a pharmacy obtains the drug through a 
warehouse, Texas modifies its methodology to account for the volume discount 
associated with warehouse purchasing. Finally, Texas reimburses at the direct price if 
the drug purchase is direct from the manufacturer. 
CMSs primary role is to approve the State plan amendments 
required for a States pharmacy reimbursement change. To 
obtain approval, States must submit documentation showing 
that the new estimated acquisition cost formula represents the 
States best estimate of the price generally, and currently, paid 
by providers for the drug.27 According to CMS staff, acceptable 
evidence includes audits of pharmacy acquisition costs, and 
reviews of pharmacy reimbursement by other payers, or by 
surrounding States Medicaid agencies. 
CMS considers the establishment of pharmacy reimbursement 
rates to be a State prerogative.28 However, 10 States report 
wanting to receive additional reimbursement guidance, 
including more accurate drug price information, from CMS. In 
addition to specific requests for AMP, States also look for 
guidance from CMS in setting accurate drug reimbursement 
estimates and for support in overcoming stakeholder opposition 
to reimbursement changes. 
Pharmacy Opposition to Reimbursement Reductions.  States 
often face resistance to changing their estimated pharmacy 
acquisition cost formulas because reduced Medicaid drug 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  10  reimbursement decreases pharmacies revenue. Of the 17 States 
that reported reductions to their EAC formula as an important 
cost containment strategy, all except 2 reported pharmacy 
opposition as a barrier to such efforts. Twelve additional States 
also reported pharmacy opposition as a barrier to reducing 
pharmacy reimbursement. 
It is important to distinguish between two types of costs for 
which Medicaid reimburses pharmacies: (1) the cost of the drug 
itself (ingredient cost) and (2) the cost associated with 
dispensing the drug. States estimated acquisition cost formulas 
represent the ingredient cost the provider paid for the drug, 
while dispensing fees cover the other professional costs of 
dispensing the drug.29 The reductions to EAC discussed in this 
section address only this ingredient cost, not the additional 
dispensing fee. 
States face competing demands as they reconcile the need to 
reduce drug prices with the need to maintain adequate 
pharmacy participation in Medicaid. Concerns about 
beneficiary access influence attempts to reduce drug 
reimbursement. In 2002, Massachusetts substantially scaled 
back proposed drug reimbursement reductions after 3 major 
pharmacy chains threatened to stop serving Medicaid 
beneficiaries. 30 In 2002, Washington successfully reduced 
pharmacy reimbursement while acting to protect beneficiary 
access to drugs through implementing a pharmacy mail order 
service and offering transportation services to beneficiaries in 
rural areas with limited pharmacy participation.31 
Savings Attributed to Changing States Reimbursement Formulas. 
Two States, Arizona and Washington, measured cost savings 
achieved through reductions in reimbursement, and eight 
additional States provided estimates or projections of cost 
savings attributed to their EAC changes. States annual savings 
ranged from $500,000 to $21.7 million, as shown in Table 3. 
States savings represent a proportion of their total FY 2001 
drug expenditures that ranged from less than 1 percent to more 
than 21 percent. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  11  Table 3. Savings from Reductions in EAC Reimbursement Formulas 
Savings as Percent 
Projected/Estimated 
of States FY 01 
State  Annual Savings 
Drug 
(in millions) 
Expenditures 
NV  $9.6*  21.3% 
AZ  $0.5 (actual)  19.3% 
WA  $21.7 (actual)  5.9% 
KY  $11.4  2.3% 
TX  $20.3  1.9% 
OH  $16  1.8% 
OR  $3  1.6% 
CO  $1.4  1.1% 
KS  $1.5  1.0% 
NE  $1.2  0.9% 
Source: OIG National Survey, 2002 
*Nevada projected $2.4 million/quarter. We used this rate to estimate 
annual savings. 
Twenty-Four States Reported State Maximum Allowable Cost Programs 
to Rein in Drug Costs as Central to Cost Containment. 
Beyond the national Federal upper limits (FULs), States can 
achieve additional savings by setting State maximum allowable 
costs (MACs). Twenty-four States identified their MAC program 
as a successful drug cost containment effort. Conceptually, 
State maximum allowable cost programs resemble the Federal 
upper limit program in that they establish maximum 
reimbursement amounts for groups of equivalent drugs, i.e., a 
brand name drug and its generic equivalents. 
States with MAC programs achieve additional cost savings by 
(1) setting reimbursement limits for multisource drugs not covered 
by the FUL program, and (2) setting MACs at lower amounts than 
existing FULs. While the current FUL list includes less than 200 
drug entities out of thousands of multisource drugs, Texas has 
established MACs for 837 drug entities. d32 South Carolina 
reimburses at 10 percent below the FUL. 
d A drug entity includes the multiple strengths and forms in which a particular drug is available. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  12  To set MACs, States commonly employ multiple methodologies and 
sources of drug price information. Eleven States report conducting 
pharmacy surveys or invoice reviews. Minnesota surveys the prices 
paid by private payers with State contracts, obtains actual 
acquisition costs from some pharmacies, and consults the MACs set 
by other State Medicaid agencies. Idaho and Michigan also consult 
other States MAC lists; Michigan additionally reviews 
reimbursements by third party insurers. Six States rely on 
contracted vendors to set their MACs. 
Seventeen of the 24 States provided actual or projected cost savings 
associated with their MAC program. Annual savings ranged from 
$575,000 to $45.8 million. Wyoming, which included only 3 drug 
entities during its MAC programs first quarter of operation, 
measured savings of $143,603 for that quarter. These savings 
represent just over 2 percent of the States average quarterly drug 
costs. Tables 4 and 5 below provide reported savings by State. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  13  Table 4. Actual MAC Savings  Table 5. Estimated/Projected MAC Savings 
Actual Annual  Savings as Percent  Estimated  Savings as Percent 
State  Savings  of States FY 01  State  Annual Savings  of States FY 01 
(in millions)  Drug Expenditures  (in millions)  Drug Expenditures 
NE  $22  15.7%  OK  $10  7.6% 
MO  $45.8  8.5%  OR  $12*  6.2% 
VT  $4  4.9%  MN  $7  3.3% 
WA  $15.3  4.2%  NC  $17.2  2.2% 
HI  $1.5  2.5%  NM  $1  2.2% 
GA  $5.5  0.9%  WY  $0.57#  2.2% 
Total  $94.1  - CT  $5  2.1% 
Source: OIG National Survey, 2002  TX  $16.4 +  1.6% 
IA  $0.58  1.2% 
MA  $7  1.1% 
NH  $0.7  0.9% 
Total  $77.5  -
Source: OIG National Survey, 2002 
* Oregon saved $1million/month from March to November, 2002; we used this rate to calculate annual savings. 
# Wyoming saved $143,603 in the 1st quarter of its MAC program. We used this rate to calculate annual savings. This calculation is 
conservative. Wyoming will add at least three additional drugs as during the first year. 
+ Texass $16.4 million in projected savings refers only to savings from the new drugs that Texas will add to its MAC in FY 2003. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  14  SHIFT USE:  While Required to Cover Most 
States implement a variety of 
Drugs, 39 States Encourage a Shift from Higher 
cost containment strategies 
to Lower Cost Drugs 
aimed at shifting Medicaid 
prescription drug use toward lower cost drugs. Thirty-nine 
States in our survey identified shifting utilization toward less 
expensive drugs as key to Medicaid pharmacy cost containment. 
Top strategies identified by States to stimulate this shift include 
prior authorization programs (29 States), preferred drug lists 
(20), generic substitution requirements (15), beneficiary cost 
sharing (10), and physician education (5). As Table 6 shows, 
many States use a combination of these strategies. 
Table 6. Key State strategies to encourage use of lower cost drugs 
Prior authorization only  8 
Preferred drug list only  5 
Beneficiary copayments only  2 
At least two of the following: prior authorization, preferred drug list, generic  24 
substitution, beneficiary copayments, physician education 
Total  39 
Source: OIG National Survey, 2002 
Prior Authorization is Key to Containing Costs in 29 States. 
Twenty-nine States cited prior authorization as a central cost 
containment measure. Federal statute allows States to require 
approval of a prescription before its dispensed.33 According to 
CMS, the statute affords States broad authority and flexibility 
to implement a prior authorization program in order to secure 
cost savings for the Medicaid program.34 
In general, a States prior authorization process requires that a 
prescribing physician provide supplemental information before 
the pharmacist can dispense certain drugs. This information is 
provided to either the dispensing pharmacist or a pharmacist at 
the States designated call center. In practice, States report that 
call centers rarely deny provider requests. In the case of a 
denial, an appeals process is required to resolve the dispute. 
Prior authorization processes contain prescription drug 
expenditures in three primary ways. First, the required call-in 
process may deter physicians from prescribing drugs subject to 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  15  prior authorization. According to State respondents, physicians 
tend to prescribe drugs subject to prior authorization only when 
medically necessary because they dislike the requirement to 
consult a second party. Second, the call between the pharmacist 
and the prescribing physician provides the opportunity to 
educate physicians about more cost-effective drug therapies and 
options. Third, prior authorization may prevent the 
inappropriate dispensing of a drug when the beneficiarys 
medical and drug histories do not meet clinical criteria for 
approving the prior authorization request. States can use prior 
authorization as a cost containment strategy itself, or to enforce 
other cost containment measures, such as preferred drug lists, 
generic substitution requirements, or script limits. 
States use of administrative disincentives to prescribing drugs 
subject to prior authorization include telephone and written 
authorization processes. Six States report requiring the 
pharmacy to contact the prescribing physician, who must then 
contact a clinical pharmacist at the States call center. The 
physician must provide specified information about the 
beneficiarys medical history, diagnosis, or other information to 
make the case that an alternative drug is unacceptable. Two 
States require the prescribing physician to provide written 
authorization before the pharmacy will dispense the drug. 
Barriers to Prior Authorization.  Though prior authorization is a 
common cost containment measure, 18 States report facing provider 
and/or pharmacist opposition to its implementation. Twenty-one 
States report that providers and pharmacists oppose the 
administrative burdens required under prior authorization. 
However, five States indicated that physicians have expressed 
appreciation of the States efforts to monitor beneficiaries use of 
prior authorization-targeted drugs. Eight States respond to provider 
concerns about prior authorization by conducting outreach to 
physicians and pharmacists. These States attempt to include 
provider input into their decisions regarding the prior authorization 
process and the selection of drugs to be subject to prior authorization. 
For example, New York posts online forms for providers to use to 
request that a drug be exempt from prior authorization 
consideration. Four States also report extensive efforts to educate 
providers on the prior authorization process and appeal procedures. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  16  Seventeen States indicated that opposition from pharmaceutical 
manufacturers acts as a barrier to implementing prior 
authorization. These States report that, in general, 
manufacturers oppose any State-imposed restrictions on 
prescribing. In one State, pharmaceutical manufacturers 
successfully lobbied to require that manufacturers be notified in 
advance when one of their drugs is considered for inclusion on 
the prior authorization list. 
Fifteen States also reported opposition to prior authorization 
from consumer interest groups. Medicaid regulations require a 
response to a prior authorization request within 24 hours and 
require pharmacists to dispense a 72-hour supply of the drug in 
emergency situations. Nonetheless, interest groups report 
concern about the potential for delays in beneficiary access due 
to perceived difficulty navigating the prior authorization 
process. 
Cost Savings Attributed to Prior Authorization.  States conveyed 
difficulty measuring cost savings attributable to prior 
authorization. The effects caused by prior authorization on 
prescription drug use patterns and expenditures are difficult to 
distinguish from the effects of other factors. In our survey, five 
States reported actual cost savings that they attributed to prior 
authorization. Some States measured savings attributed to 
prior authorization in general, while other States specified 
savings associated with prior authorization for specific drugs or 
classes of drugs. Table 7 breaks out the cost savings measured 
by these five States. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  17  Table 7. Actual/Projected Savings from Prior Authorization 
Actual/Projected  Savings as Percent 
Specific Drugs or Drug Classes 
State  Annual Savings  of States FY 01 
(as applicable) 
(in millions)  Drug Expenditures 
FL  $89  7.6%  N/A 
WV  $13.9  6.8%  N/A 
WY  $1.1*  4.2%  2 classes: proton pump inhibitors and COX-2 
inhibitors 
AK  $1.7#  3.7%  3 drugs in opioid class (pain medication) 
WA  $2.5  0.7%  One class: non-steriodal anti-inflammatory drugs 
Total  $108.2  - -
Source: OIG National Survey, 2002 
* Wyoming measured $180,000 in savings over 2 months. 	We used this rate to estimate annual savings. 
# Alaska measured $800,000 in savings over 5.5 months. We used this rate to estimate annual savings. 
Eleven additional States reported estimated cost savings from 
prior authorization. States estimated prior authorization cost 
savings ranging from $1 million to $18 million per year, as 
shown in Table 8. In some cases, estimated savings reflect the 
implementation of prior authorization for specific drugs or 
classes of drugs. 
Table 8. Estimated Savings from Prior Authorization 
Estimated  Savings as Percent 
Specific Drugs or Drug Classes 
State  Annual Savings  of States FY 01 
(as applicable) 
(in millions)  Drug Expenditures 
ID  $10.5  12.5%  4 classes: proton pump inhibitors, COX-2 inhibitors, 
non-steroidal anti-inflammatory drugs, and non-
sedating antihistamines 
OK  $11  8.4%  N/A 
NE  $9.8  7.0%  N/A 
MN  $7.1  3.4%  N/A 
MO  $18  3.3%  One class: anti-ulcer drugs 
NH  $2.1  2.7%  N/A 
PA  $11  2.0%  One drug: Oxycontin 
HI  $1  1.7%  One drug: Oxycontin 
KS  $1.5  1.0%  One class: COX-2 inhibitors 
NC  $4.7  0.6%  N/A 
Total  $76.7  - -
Source: OIG National Survey, 2002 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  18  Finally, two States reported measuring the impact of prior 
authorization on the use of selected drugs. Nevada estimates a 
75 to 80 percent decrease in utilization and a 74 to 78 percent 
decrease in expenditures on each of two classes of drugs, protein 
pump inhibitors and COX-2 inhibitors, subject to prior 
authorization. Washington reports that generic Ranitidine use 
within its therapeutic class, H  receptor antagonists, increased 
2
from 69 to 97 percent the month following implementation of 
prior authorization for brand name drugs in that class.e 
Twenty States Report that Preferred Drug Lists are Central to Cost 
Containment. 
When asked to identify their top cost containment strategies, 20 
States reported that a preferred drug list (PDL) is central to 
their States efforts to contain Medicaid prescription drug 
expenditures. Though private health insurers routinely restrict 
access to high-priced drugs through the use of closed 
formularies, the Federal Medicaid statute prohibits States from 
implementing a formulary without means of accessing excluded 
drugs.35 As an alternative, PDLs enable States to contain 
prescription drug costs and promote clinical effectiveness by 
encouraging physicians to prescribe less costly, therapeutically 
appropriate drugs. At the same time, States must permit access 
to non-preferred drugs through an exception process. States 
strongly encourage physicians to prescribe preferred drugs 
through outreach and education efforts or by creating 
administrative disincentives to prescribing non-preferred drugs. 
In this section we highlight Floridas, Oregons, Vermonts, and 
Michigans use of preferred drug lists to contain costs. 
Nationally, these States have the most experience with PDLs 
and emphasize that PDLs are their central strategy to 
containing Medicaid pharmacy costs. They are also recognized 
as leaders in this area by other States and Medicaid pharmacy 
experts. Finally, these four States exemplify a range of 
approaches to creating PDLs and to using PDLs to stimulate a 
shift toward lower cost-alternative drugs. 
e Proton pump inhibitors and H receptor antagonists are both classes of drugs used to treat 
2
gastrointestinal problems, including ulcers and acid reflux disease. COX-2 inhibitors are a type of non
steriodal, anti-inflammatory drug (NSAID) used to treat pain and inflammation. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  19  Preferred Drug Selection.  While PDLs are created using both 
cost and clinical criteria, States use different types of 
information and development processes to determine which 
drugs to include on their preferred lists. These differences affect 
what type of clinical and cost data are considered, as well as 
which decision makers are involved in the preferred drug list 
development process. 
By State law, Oregon incorporates both clinical evidence-based 
research on drug efficacy and public input into the preferred 
drug selection process. 36 Oregons evidence-based research 
provides comparative effectiveness and safety information for 
each drug in a class. Through a series of State-wide public 
meetings, a commission identifies effective drugs that are 
available at the lowest AWP. Oregons Medicaid agency uses 
these recommendations and public input to identify a 
benchmark drug they determine to be the most effective 
available for the best possible price.37 PDL includes this 
benchmark drug and the other less expensive drugs in that 
class. f 
Unlike Oregon, which compares drugs relative merits to each 
other, Vermont uses clinical drug data, which compares 
individual drugs to a placebo to determine their effectiveness 
and suitability for inclusion on a PDL.38 Vermonts Medicaid 
agency prioritized which drug classes to place on their PDL, 
based on the (1) existence of generic alternatives, and 
(2) amount spent on each drug class. Vermonts contracted 
pharmacy benefits manager reviewed the clinical and financial 
merits for each drug and developed an initial list of drugs. The 
States Drug Utilization Review board used this list and public 
comments to determine the States final PDL. 
Because most drugs are considered clinically effective, cost 
ultimately determines which drugs are included on Vermonts 
preferred list. However, the States Drug Utilization Review 
board retains the right to include a more expensive drug on the 
PDL for clinical reasons. 
Linking Supplemental Rebates to Preferred Drug Lists.  Florida, 
Michigan, and Vermont aim to achieve lower net prices and 
f All drugs deemed effective with AWP under 105 percent of benchmark are on the Oregon PDL. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  20  greater cost savings with their PDLs through State-negotiated 
supplemental rebates. 
Like Oregon and Vermont, Florida combines clinical and 
financial information to determine its PDL. In Florida, a 
contracted vendor researches clinical data and ranks the 
effectiveness of each drug in a class. In addition, manufacturers 
submit price bids for each drug. The vendor combines clinical 
and cost data and recommends drugs that are effective, yet 
relatively inexpensive. A committee of physicians and 
pharmacists hold public meetings and then make the final PDL 
designations. 
Floridas process of soliciting manufacturers bids affords the 
State the opportunity to reap enhanced cost savings as 
manufacturers compete to offer the lowest priced drug in each 
class. State law requires that manufacturers bids offer a total 
rebate of at least 25.1 percent of the average manufacturer 
prices. 39 g  Through competition, Florida has received 
substantially greater rebates than this minimum. 
Vermont and Michigan offer manufacturers of non-preferred 
drugs the opportunity to bring their drug costs in line with 
clinically-preferred drugs through supplemental rebates. 
Michigan identifies a reference-price drug for each class, and 
manufacturers of all drugs above that price must provide a 
supplemental rebate to be included on the preferred list. In 
addition, Michigan, Vermont, South Carolina, and Wisconsin 
are partnering to negotiate supplemental rebates from 
pharmaceutical manufacturers. It is the first time that States 
are partnering to negotiate prices for the Medicaid program. 
State officials estimate that States are likely to see savings of 10 
to 15 percent from enhanced rebates and better pharmacy 
benefits management.40 
Stimulating the Use of Preferred Drugs.  States ability to contain 
costs through PDLs depends upon the extent to which 
physicians prescribe preferred versus non-preferred drugs. One 
way States promote preferred drugs is by creating 
administrative disincentives to prescribing non-preferred drugs. 
Florida and Michigan require prior authorization for non-
g Manufacturers bids include both the Federal and supplemental rebate. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  21  preferred drugs. Though prior authorization requests are 
generally granted, the process itself deters physicians from 
making prior authorization requests, unless the non-preferred 
drug is medically necessary. 
States also conduct provider outreach and education to facilitate 
and encourage the use of preferred drugs. Oregon and Vermont 
allow physicians to prescribe non-preferred drugs through a 
prescription-based notation, which presents a lesser 
administrative burden to obtaining these drugs. Oregon allows 
reimbursement of non-preferred drugs if doctors indicate no 
substitution, dispense as written, or brand medically 
necessary. Vermont physicians must indicate a clinical reason 
why a non-preferred drug is needed. 
Both Oregon and Vermont emphasize collaboration with 
physicians and beneficiaries to further encourage use of the 
PDL. These States impress upon physicians and beneficiaries 
the importance of containing drug costs to maintain existing 
Medicaid coverage and services. Additional information is 
provided to physicians on generic and low-cost brand name 
drugs to counter balance pharmaceutical representatives efforts 
to promote their more costly brand drugs. Oregon, in particular, 
credits its open process with lending needed credibility to a 
system which relies on the voluntary compliance of physicians. 
Initially, Medicaid providers opposed Vermonts PDL, which 
State respondents attributed to insufficiently planning the 
implementation of the PDL. In response, Vermonts Medicaid 
agency collaborated successfully with the Vermont Medical 
Association to implement a physician education and outreach 
program to explain PDL procedures and emphasize the 
necessity of this strategy to maintain Medicaid services. 
Vermont continues to assess prescribing of non-preferred drugs 
to determine if further intervention is necessary. 
Barriers to PDLs.  Nationally, 18 States cited barriers related to 
the use of PDLs. The most common barriers related to 
opposition from pharmaceutical manufacturers (17 States), 
consumers (13 States), physicians (7 States) and pharmacy 
representatives (3 States). In addition, some States raised 
concerns about approval delays associated with CMSs State 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  22  plan amendment process, which, in turn, delayed 
implementation of their preferred drug list. 
As a response to stakeholder concern, States may exempt 
certain drug classes, specific drugs, or beneficiaries with certain 
illnesses from their PDL. This compromise limits States ability 
to contain costs. In Oregon, mental illness, HIV/AIDS and 
cancer drugs, which represent over 60 percent of the States 
Medicaid drug expenditures, are exempted from the PDL. That 
is, all FDA-approved drugs in these classes are available to 
Medicaid beneficiaries. Florida also exempts mental health and 
HIV/AIDS drugs from its PDL requirements. Vermont 
designated preferred drugs within the psychotropic drug class, 
but allows individuals with serious mental illness to access any 
prescribed psychotropic drug. 
In September 2002, CMS issued a State Medicaid directors 
letter clarifying a States ability to create PDLs and 
supplemental rebate agreements with drug manufacturers. 
Eleven States in our survey commended CMS for this particular 
guidance and found it a useful support against pharmaceutical 
industry opposition. 
Some Oregon respondents report that the Federal law 
preventing States from disclosing Federal Medicaid rebate 
information is a significant barrier. These respondents believe 
that the law hinders a true cost analysis because the State 
cannot publicly disclose Federal rebate pricing information 
when deciding which drugs to include on the PDL. Florida, on 
the other hand, overcomes this potential barrier by temporarily 
closing its public meetings when discussing proprietary pricing 
information. However, Oregons State policy mandating 
information sharing and a completely open process for PDL 
decisions may prevent the State from adopting Floridas 
strategy. 
Cost Savings Attributed to PDLs.  Through their PDLs, States 
seek to shift beneficiaries drug use toward less-costly preferred 
drugs. Restrictive formularies in the private sector typically 
stimulate an 80 to 90 percent market shift.  State Medicaid 
programs generally expect to achieve a lesser shift due to 
required formulary exception procedures.  However, Michigan 
and Florida estimate an 80 to 90 percent market shift toward 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  23  preferred drugs in particular classes. Oregon achieved a 30 to 
40 percent shift in the first quarter of PDL implementation. 
Oregon officials expect to save less money with their PDL than 
those States with stricter exception processes. 
A PDL can contain costs through a combination of (1) initial 
savings, as beneficiaries switch to lower cost drugs; (2) cost 
avoidance, as beneficiaries remain on lower cost drugs; and 
(3) supplemental rebates, if applicable.  After implementation 
and initial savings are realized, a PDL becomes a long term cost 
avoidance strategy that States may use to stabilize their 
Medicaid pharmacy budgets. 
PDLs have the potential to significantly reduce State Medicaid 
pharmacy costs. Table 9 lists the savings attributed to PDLs by 
these four States. Florida saved $127 million in FY 2001 
through its PDL and supplemental rebate provision. Michigan 
estimates saving $850,000 per week. Michigans overall annual 
savings measurement of $45 million exceeds their initial savings 
projections.41 While Oregon and Vermont have implemented 
their PDLs more recently, they have also realized cost savings. 
Oregon estimates that its PDL will save $6 to $8 million in its 
first year of implementation. In the first 6 months of 
implementation, Vermont estimates a $2.8 million comparative 
savings of the three most costly classes of drugs on the PDL. 
Table 9. Reported Market Shift and Cost Savings from PDLs 
Savings as 
Estimated  Percent of States 
State  Savings in First Year 
Market Shift  FY 01 Drug 
Expenditures 
Florida  90%  $127 million  10.8 % 
Michigan  80 to 90%  $45 million  9.5% 
Vermont  Not available  $2.9 million (6 months  7.1% 
only) 
Oregon  30 to 40%  $6 to 8 million  3.1 to 4.1% 
(projected) 
Sources: OIG National Survey and Interviews with State Medicaid Staff, 2002 
Two additional States measured savings from PDLs. Kentucky 
saved $8.5 million from April to June 2002 from establishing a 
preferred drug in one therapeutic class, proton pump inhibitors. 
Massachusetts reported $4 million in savings accrued from 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  24  August through November 2002. Six other States provided 
projections of savings they expect from PDLs. See Appendix A 
for information on these projections. 
Fifteen States Seek to Increase Generic Substitution. 
Fifteen States report either encouraging or requiring generic 
substitution to shift utilization towards generic drugs as central 
to their cost containment effort. On average, brand name drugs 
cost about three times more than their generic equivalents, so 
an increase in generic substitution can have a substantial fiscal 
impact. For example, Massachusetts Medicaid staff report that 
a State initiative requiring prior authorization for brand name 
drugs with available generic equivalents saved the State $29 
million from December 2001 to August 2002. 
To contain costs through the use of generics, Florida limits 
beneficiaries to four brand name prescriptions per month, while 
placing no restrictions on generic prescriptions. However, 
beneficiaries may obtain additional brand name drugs through 
prior authorization. State Medicaid officials found that their 4 
brand limit saves $100 million annually, which represents over 
8 percent of their Medicaid pharmacy expenditures in FY 2001. 
Florida Medicaid budget analysts determined that the policy has 
resulted in a shift to the use of generic drugs rather than a 
decline in overall utilization. 
LIMIT QUANTITY:  While Required to Maintain 
State Medicaid agencies may 
Sufficient Amount, Duration, and Scope of 
limit prescription drug utilization 
Benefits, 25 States Limit the Quantity of Drugs 
as long as these restrictions 
Used as a Central Strategy to Contain Costs 
maintain sufficient amount, 
duration and scope, as required 
under Federal Medicaid regulations. That is, any State-imposed 
benefit limit must maintain a sufficient level of the benefit to 
reasonably achieve its intended purpose. To contain drug 
expenditures, States frequently limit utilization through drug 
quantity limits, targeted drug utilization review programs, and 
pharmacy lock-in programs.  Currently, based on national data, 
44 States limit prescription drug utilization in 1 or more of these 
ways, and 25 States chose to report these limits as top cost 
containment strategies in our survey.44 These limits include 
restrictions on drug quantities, restrictions through prospective 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  25  drug utilization review, and restrictions through pharmacy lock 
in. Several States use a combination of these strategies, shown 
in Table 10. 
Table 10. Key State strategies that limit drug use 
Quantity limits only  8 
Prospective drug utilization review only  6 
At least two of the following: quantity limits, prospective drug  11 
utilization review, pharmacy lock in 
Total  25 
Source: OIG National Survey, 2002 
Quantity Limits are Important in 18 States. 
Eighteen States report quantity limits as important to cost 
containment. Typically, States limit the (1) number of 
prescriptions filled in a specified time period, such as six 
prescriptions per month; (2) amount of a drug, such as a 
maximum daily dosage; or (3) frequency of dispensing a drug, 
such as limits on early refills. States often allow exemptions 
from these limits for specific therapeutic drug categories, 
beneficiaries with certain illnesses, and particular subsets of the 
population, such as children and pregnant women. 
Six States specified limits on the number of prescriptions per 
month as a key cost saving strategy. These prescription limits 
ranged from 3 to 10 drugs allowed per month. Four of these six 
States allow beneficiaries to obtain additional prescriptions 
through prior authorization.  Texas prohibits dispensing more 
than three prescriptions per month. However, beneficiaries may 
obtain a 180-day drug supply with each prescription and stagger 
the filling of each prescription which, in effect, allows up to 9 
prescriptions per month. Arkansas limits beneficiaries to six 
prescriptions per month, and State Medicaid officials assert that 
this limits fraud and abuse. 
Ten States reported restrictions on drug amounts, daily dosages, 
or number of refills dispensed in an effort to decrease drug 
waste and to prevent over-utilization. Eight of these States 
specified restrictions on the amount of drug dispensed, such as a 
34-day supply, as an effective cost containing strategy. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  26  Additionally, early refill restrictions are an important means to 
contain costs in seven States.  Early refill limits require that a 
certain percentage, commonly 75 percent, of a medication be 
used before obtaining a refill. This helps to reduce waste by 
ensuring that refills are filled only when necessary. 
Cost Savings Attributed to Quantity Limits.  Two States reported 
cost savings associated with limits on the number of 
prescriptions per month. Mississippi projects $5.4 million in 
savings from reducing the number of prescriptions allowed from 
10 to 7 per month. Maryland projects savings of $1.2 million per 
year to result from its pending limit of 10 prescriptions per 
month. 
Four States identified cost savings from early refill limits. 
Wyoming only allows refills after 80 percent of the previously 
dispensed supply is used and reported, saving nearly $900,000 
per year, or 3.5 percent of their Medicaid drug budget. 
Additional cost savings information is summarized in Table 11. 
Table 11. Actual and Projected Cost Savings from Quantity Limits 
Savings as Percent 
Annual Savings 
State  Type of Limit  of States FY 01 
(in millions) 
Drug Expenditures 
MO  Early Refill  $51 (projected)  9.4% 
WY  Early Refill  $0.9*  3.5% 
ID  Early Refill  $2.3 (projected)  2.7% 
NJ  Days Supply  $12  2.3% 
MA  Early Refill  $13.3 million#  2.2% 
MS  7 prescriptions/month+  $5.4 (projected)  1.3% 
UT  Days Supply  $1.1  1.2% 
KS  Days Supply  $1.5 (projected)  1.0% 
MD  10 prescriptions/month  $1.2 (projected)  0.6% 
Source: OIG National Survey, 2002 
* Wyoming saved $224,000 in 3 months; we used this rate to estimate annual savings. 
# Massachusetts saved $10 million in 9 months; we used this rate to estimate annual savings. 
+ Mississippi reduced its limit from 10 prescriptions per month to 7 prescriptions per month. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  27  Prospective Drug Utilization Review is a Cost Containment Strategy in 
14 States. 
In addition to preventing adverse health outcomes, 14 States 
consider prospective drug utilization review (DUR), in which 
patient drug history is reviewed to detect therapeutic 
duplication, contraindications, drug interactions, and other 
inappropriate use, to be a top cost containment measure.  All 
States are required to conduct prospective DUR prior to 
dispensing a drug.45 Prospective DUR can contain pharmacy 
costs by preventing duplicative, medically unnecessary, or 
contraindicated prescriptions from being dispensed. Missouri is 
one of several States enhancing their prospective DUR program 
to link patients drug history with their medical history to 
further ensure patient safety and medically-appropriate drug 
use. 
Seven States reported yearly cost savings resulting from 
prospective DUR, ranging from $300,000 in Iowa to $27 million 
in Louisiana.  Additional cost savings are listed in Table 12. 
Table 12. Cost Savings from Prospective DUR 
Savings as Percent 
Annual Savings 
State  of States FY 01 
(in millions) 
Drug Expenditures 
OR  $20  10.4% 
AK  $4.8  10.1% 
LA  $27  5.7% 
CT  $2.8  1.1% 
TX  $5.3 (projected)  0.5% 
NJ  $1.6  0.3% 
IA  $0.3 (projected)  0.2% 
Source: OIG National Survey, 2002 
Pharmacy Lock-in Programs Limit Drug Costs in Six States. 
Six States identified pharmacy lock-in programs as a key cost 
containment strategy. Pharmacy lock-in programs require that 
beneficiaries fill their Medicaid prescriptions in one pharmacy or 
pharmacy chain. Typically, States use retrospective DUR data 
to identify beneficiaries whose drug utilization patterns may 
justify being locked in to a particular pharmacy. State criteria 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  28  for lock in ranges from evidence of abuse, resale of drugs, or 
misuse of Medicaid cards to general use patterns that indicate a 
high risk for abuse or misuse. Oregon is the only State 
implementing lock-in programs for all Medicaid beneficiaries. 
Last year, Wyoming locked in only 70 beneficiaries, all of whom 
filled prescriptions for pain medications from two or more 
physicians in two or more pharmacies. Wyoming projected a 
potential range of annual savings from their lock-in program of 
$39,000 to $98,000. 
Arkansas estimated $10,000 in savings in the first month of 
lock-in implementation, but expects savings to grow to $123,000 
per month when the program is fully operational. In Arkansas, 
beneficiaries have two chances to respond to warning letters 
citing concern about their pharmacy use before Arkansas 
imposes a lock in. As a result, less than half of those 
beneficiaries initially targeted, are ultimately locked in. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  29  C O N C L U S I O N

Escalating Medicaid drug expenditures combined with strained State 
budgets have led States increasingly to seek strategies to contain 
Medicaid drug costs. Federal Medicaid law and regulation prevent 
States from benefiting from some cost containment tools widely used 
by private purchasers.  However, States exercise their flexibility 
within Federal Medicaid parameters to employ three main pharmacy 
cost containment strategies. These strategies include drug 
reimbursement limits, tools to shift utilization toward lower cost 
drugs, and drug utilization limits. 
Maximizing States ability to contain drug costs can provide a 
significant fiscal benefit to both State and Federal Medicaid budgets. 
Thirty-seven States provided information on drug cost savings 
ranging up to $127 million in annual savings attributed to various 
drug cost containment measures within those States. 
However, States face significant challenges to maximizing drug cost 
savings. States report that they lack accurate drug pricing 
information upon which to set drug reimbursement limits.  States also 
identified two primary constraints to shifting utilization toward lower 
cost drugs. First, Federal law, such as the prohibition on closed 
formularies and limits on beneficiary cost sharing, restrict States 
ability to influence drug utilization patterns. Second, States efforts 
to shift utilization have met with resistance from stakeholders, such 
as pharmaceutical manufacturer representatives and some patient 
advocacy groups. 
In 2002, CMS issued a letter to State Medicaid directors offering 
support and guidance on how to implement a preferred drug list 
within Federal law. States found this CMS document beneficial in 
their efforts to garner needed support to implement a preferred drug 
list. 
In FY 2002, CMS centralized its efforts to provide guidance regarding 
States Medicaid pharmacy programs through shifting responsibility 
for State plan amendment approval from CMS regional offices to its 
headquarters location. We support CMSs efforts to provide 
consistent, timely, and pertinent information to State Medicaid 
pharmacy representatives. 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  30  AA PP PP EE NN DD II XX
 ~ A
Additional State Savings Projections for Preferred Drug Lists (PDLs) 
In addition to the savings reported by Florida, Michigan, Oregon, 
and Vermont, two additional States reported preliminary cost 
savings from newly implemented PDLs. Kentucky saved $8.5 
million from April to June 2002 by establishing a preferred drug in 
a single therapeutic class, proton pump inhibitors. Massachusetts 
reported $4 million in savings accrued from August through 
November 2002. Six other States, listed in Table 13 below, 
provided projections of savings they expect from PDLs. 
Table 13. PDL Savings Projections from Additional States 
Savings as Percent 
Projected Annual  of States FY 01 
State  Savings from PDL  Drug 
Expenditures 
Idaho  $9 million  10.7% 
New Mexico  $4 million  8.7% 
Wyoming  $2.05 million  8.0% 
Alaska  $3.6 million  7.6% 
Maryland  $8 million  4.1% 
Kansas  $4.8 million  3.2% 
Source: OIG National Survey, 2002 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  31  A C K N O W L E D G M E N T S

This report was prepared under the direction of William Moran, 

Regional Inspector General for Evaluation and Inspections in the 

Chicago Regional Office and Natalie Coen, Deputy Regional 

Inspector General for Evaluation and Inspections. Other principal 

Office of Evaluation and Inspections staff who contributed include:

Emily Melnick, Team Leader

Erin Lemire, Program Analyst

Jennifer Gera, Intern

Linda Frisch, Program Specialist 

Tricia Davis, Director, Medicare and Medicaid Services Branch

Technical Assistance 

Barbara Tedesco, Mathematical Statistician 

OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  32  E N D   N O T E S

1.  This figure is based on data from Centers for Medicare & Medicaid 
Services, Center for Medicaid and State Operations, Financial 
Management Reports, Fiscal Year 2001. Available at 
http://www.cms.gov/medicaid/mbes/ofs-64.asp 
2.  Bruen, Brian. States Strive to Limit Medicaid Expenditures for 
Prescribed Drugs. Prepared for the Kaiser Commission on Medicaid 
and the Uninsured. Washington, DC; February 2002 
3.  65 FR 69560, November 17, 2000. From the Federal Register Online via 
Government Printing Office Access; http://wais.access.gpo.gov 
4.  Kreling, David H., David A. Mott, Joseph B. Wiederholt, Janet Lundy, 
Larry Levitt. Prescription Drug Trends: A Chartbook Update.  Kaiser 
Family Foundation. Washington, DC; November 2001 
5.  This figure is based on data from Centers for Medicare & Medicaid 
Services, Center for Medicaid and State Operations, Financial 
Management Reports, Fiscal Year (FY) 2001 and FY 1997. Total 
Medicaid expenditures (minus drug expenditures) increased 31 percent 
from FYs 1997 to 2001; total Medicaid drug expenditures increased 94 
percent during the same time period. Data available at 
http://www.cms.gov/medicaid/mbes/ofs-64.asp 
6.  National Association of State Budget Officers, http://www.nasbo.org 
7.  Associated Press. In Budget Crises, State Leaders Call for US Aid. 
New York Times, Final, Section A, Page 15, Column 1; July 25, 2002 
8.  National Association of State Budget Officers, http://www.nasbo.org 
9.  Bruen, Brian. States Strive to Limit Medicaid Expenditures for 
Prescribed Drugs. Prepared for the Kaiser Commission on Medicaid 
and the Uninsured. Washington, DC; February 2002 
10.  52 FR 28648, July 31,1987 
11. 42 CFR  447.332 
12. 42 CFR  447.331 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  33  13. 42 CFR  447.301

14. 52 FR 28648, July 31, 1987

15. 42 U.S.C.  1396r-8(a)

16. 42 CFR  440.230

17. 42 U.S.C.  1396r-8(d)(4)

18. State Medicaid Director Letter #02-014, Center for Medicaid and State 

Operations, Centers for Medicare & Medicaid Services, September 18, 

2002

19. 42 U.S.C.  1396o(a)(3)

20. 42 CFR  447.54

21. 42 U.S.C.  1396o(e)

22. 42 U.S.C.  1396r-8

23. CMS Notice of Final Rule, 52 FR 28648, (July 31, 1987), which sets 

Medicaid pharmacy reimbursement limits

24. National Association of Chain Drug Stores, Industry Facts-at-a-Glance, 

www.nacds.org, accessed February 26, 2003

25. Several OIG audits have found evidence that States estimated 

acquisition cost formulas overestimate pharmacies actual acquisition 

costs. These include Medicaid Pharmacy: Additional Analyses of the 

Actual Acquisition Cost of Prescription Drug Products (A-06-02-00041), 

Medicaid Pharmacy: Actual Acquisition Cost of Generic Prescription 

Drug Products (A-06-97-00011), and Medicaid Pharmacy: Actual 

Acquisition Cost of Prescription Drug Products for Brand Name Drugs 

(A-06-96-00030).

26.  Office of Inspector General report Cost Containment of Medicaid 

HIV/AIDS Drug Expenditures. OEI-05-99-00611. July, 2001

27. State Medicaid Manual, Part 6, Section 6305.1

OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  34  28. Office of Inspector General report Cost Containment of Medicaid 
HIV/AIDS Drug Expenditures.  OEI-05-99-00611. July 2001 
29. State Medicaid Manual, Part 6, Section 6305.1 
30. Mohl, Bruce and Chris Reidy. State Eases its Rate Curb on Druggists, 
Boston Globe. October 4, 2002 
31. Childs, Siri. Washington Medicaid Pharmacy Manager. Washington 
States Experience with AWP Discounts. August 2002 
32. Overview of Select State Maximum Allowable Cost (MAC) Programs. 
The Health Strategies Consultancy LLC. DRAFT report to CMS. 
December 2002 
33. 42 U.S.C.  1396r-8(d)(5) 
34. State Medicaid Director Letter #02-014, Center for Medicaid and State 
Operations, Centers for Medicare & Medicaid Services, September 18, 
2002 
35. A State may establish a formulary if the State plan permits coverage of a 
drug excluded from the formulary. 42 U.S.C.  1396r-8(4) 
36. Oregon Senate Bill 819, which became law on August 2, 2001 
37. Oregon Department of Human Services, Pharmaceutical Services Billing 
Guide -Rev.#3 --July 1, 2002 
38. Personal interview with Ann Rugg, Vermont State Medicaid Agency, 
Novem ber 2002 
39. Florida Statute 409.912 
40. National Governors Association. States Partner for Greater Discounts 
on Medicaid Drugs. March 6, 2003. Available at www.nga.org 
41. National Conference of State Legislatures Pharmaceutical Snapshot, 
March 3, 2003. Available at www.nscl.org 
42. 42 CFR  447.54 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  35  43. 	Rosenthal, Meredith B. Promotion of Prescription Drugs to Consumers: 
A Look at the Numbers. The New England Journal of Medicine. 
February 2002 
44. 	National Conference of State Legislatures Pharmaceutical Snapshot, 
February 17, 2003. Available at www.ncsl.org 
45. 42 U.S.C.  1396r-8(g) 
OEI-05-02-00680  STATE STRATEGIES TO CONTAIN MEDICAID DRUG COSTS  36