DEPARTMENT OF HEALTH & HUMAN SERVICES 
Centers for Medicare & Medicaid Services 
7500 Security Boulevard, Mail Stop C5-21-17 
Baltimore, Maryland 21244-1850 
 
Center for Medicaid and State Operations 
 
                  SMDL #04-006 
 
              September 9, 2004 
 
Dear State Medicaid Director: 
 
The Centers for Medicare & Medicaid Services (CMS) recently approved State Plan 
Amendments (SPAs) for five states in order to allow them to pool their purchasing 
power to acquire prescription drugs for their Medicaid populations.  The purpose of this 
letter is to clarify issues related to multi-state pooling arrangements in the event that 
other states decide to implement similar purchasing pools.  In addition, this letter 
provides some points of consideration for states that have implemented Preferred Drug 
Lists (PDLs) and prior authorization requirements as part of their Medicaid 
supplemental rebate programs, including both state-specific supplemental rebate 
programs and multi-state supplemental rebate programs. In particular, to the extent that 
states wish to take any of these steps, we believe that it is important for CMS to provide 
guidance on how states can implement these programs to achieve cost savings while at 
the same time protecting the interests of Medicaid beneficiaries and promoting 
competition.   
 
Under Sections 1927(a)(1) and 1927(a)(4) of the Social Security Act (the Act) and as 
previously specified in the September 18, 2002, State Medicaid Director letter, the 
Secretary may authorize a state to enter directly into separate or supplemental rebate 
agreements with manufacturers.  Any drug rebate agreement between a state and a drug 
manufacturer may constitute a rebate agreement in compliance with the statute if CMS 
determines that the agreement provides for rebates that are at least as large as the 
rebates set forth in the Secretarys national rebate agreement with drug manufacturers, 
which is published at 56 Fed. Reg. 7049 (Feb. 21, 1991).  In an effort to gain additional 
rebates, a state can submit to CMS for its approval a SPA to allow the state to 
implement a prior authorization program to negotiate drug discounts for Medicaid 
populations or, consistent with previous guidance, to use a Medicaid prior authorization 
program to secure drug benefits, rebates, or discounts for non-Medicaid beneficiaries. 
 
Under Section 1927(d)(5), States may also submit a SPA to CMS for approval in order 
to implement prior authorization programs to require authorization prior to dispensing 
covered outpatient drugs to Medicaid beneficiaries.  States may establish a PDL of 
covered outpatient drugs that will not be subject to prior authorization and may, with 
CMS authorization, require manufacturers to enter into supplemental rebate agreements 
as a condition of including the manufacturers covered outpatient drugs on the states 
PDL.  Many states have implemented these measures to address concerns with 
escalating Medicaid budgets. 
    
 
Page 2 - State Medicaid Director 
 
Before a state decides whether to implement a PDL and pursue supplemental rebates, 
either on its own or as part of a multi-state pool, it must consider, and demonstrate to us 
that it has considered, numerous factors.  These factors will ensure that any such 
program complies with section 1902(a)(19) of the Act, which requires that care and 
services under a Medicaid state plan be provided in a manner consistent with simplicity 
of administration and the best interests of beneficiaries.  To that end, we would expect 
that any program will continue to ensure that appropriate medically necessary drugs will 
be available to Medicaid-eligible individuals.  We intend to evaluate any SPA seeking 
to implement a prior authorization program and PDL, establish a state-specific 
supplemental rebate program, or join a multi-state pooling arrangement, to ensure that 
the states program furthers Medicaid goals and objectives.  In particular, before 
approving any SPA seeking to implement these initiatives, we will seek assurance from 
the state that its PDL is designed in a manner that balances the interests of beneficiaries 
in receiving medically necessary drugs with the states interest in ensuring that 
Medicaid pays for prescription drugs in an efficient and economical manner.  For 
example, we would expect a states PDL to be based on several factors, including the 
needs of the states Medicaid beneficiaries.  We further would expect a states PDL to 
address the needs of beneficiaries with special and complex medical conditions.  We 
especially urge states to consider including in their PDLs drugs that are needed by some 
of Medicaids most vulnerable populations, such as individuals with HIV/AIDS, mental 
health conditions, cancer, and other conditions for which clinical effectiveness or 
individual tolerance and responsiveness to drugs frequently vary.  
 
We also believe that the level of supplemental rebates received by states will benefit 
from a competitive environment.  For this reason, we believe that states should not limit 
their choice of vendors to develop and operate a supplemental rebate program to those 
vendors that have current contracts with other states solely on the basis that those 
vendors programs have already received CMS approval through a SPA approval.  In 
fact, we believe that states should consider other vendors, and not necessarily seek 
approval to join other state purchasing pools merely because those pools already exist. 
There are a number of contractors in the marketplace that have the knowledge and 
experience to provide these services.  Some of these vendors have more experience in 
the broader market of health insurers and payers than in Medicaid, but may provide the 
best value to Medicaid programs.  Therefore, you should not limit your choice to 
vendors that have current contracts with other states, nor should you limit your attempt 
to join a multi-state pooling arrangement to those arrangements already approved by 
CMS through the SPA process.  In fact, in considering any SPA request to implement a 
prior authorization program and PDL, establish a state-specific supplemental rebate 
program, or join a multi-state pooling arrangement, CMS will consider the extent to 
which the state considered these competitive factors and will look favorably upon a 
state that uses other vendors or develops multi-state pooling arrangements other than 
those already approved.  Through these competitive efforts, states can ensure that they 
and the Federal Government receive high quality services at the most competitive price.  
    
 
Page 3 - State Medicaid Director 
 
The document enclosed provides additional technical guidance for states. We look 
forward to working with you on additional pharmacy cost savings measures in the 
Medicaid program.  If you have questions or need additional information, you may 
contact Larry Reed at (410) 786-3325 or Deirdre Duzor at (410) 786-4626.    
 
 
Sincerely,  
 
            /s/ 
 
            Dennis G. Smith 
            Director 
 
Enclosures 
 
cc: 
CMS Regional Administrators 
 
CMS Associate Regional Administrators 
    for Medicaid and State Operations 
 
Kathryn Kotula 
Director, Health Policy Unit 
American Public Human Services Association 
 
Joy Wilson 
Director, Health Committee 
National Conference of State Legislatures 
 
Matt Salo 
Director of Health Legislation 
National Governors Association 
 
Brent Ewig 
Senior Director, Access Policy 
Association of State and Territorial Health Officials 
 
Jim Frogue 
Director, Health and Human Services Task Force 
American Legislative Exchange Council 
 
Trudi Matthews 
Senior Health Policy Analyst 
Council of State Governments 
    
                    Enclosure 
 
Guidelines for Multi-State Pooling Agreements 
 
As discussed below, states may use vendors, such as pharmacy benefit administrators 
(PBAs), to negotiate supplemental or multi-state pooling rebate agreements with 
manufacturers.  Participation in any multi-state pool requires that the services of the 
vendor, if any, be procured by each participating state in a manner consistent with 
Federal and state procurement standards.  While the five states participating in the new 
multi-state pool have contracts with the same vendor, we do not expect that all 50 states 
will participate in this arrangement.  In fact, we believe that states should not limit their 
choice of vendors to develop and operate a supplemental rebate program to those 
vendors that have current contracts with other states solely on the basis that those 
vendors programs have already received CMS approval.  Moreover, we believe that 
states should consider other vendors, and not necessarily seek approval to join other 
state purchasing pools merely because those pools already exist. 
 
We will review any SPA involving multi-state pools for compliance with section 
1902(a)(19) of the Act.  In accordance with these provisions, we will monitor the 
impact of one vendor on beneficiary access.  States may form pools that use a different 
vendor or join together to negotiate supplemental rebates without using a vendor.  Any 
Request for Proposal (RFP) for vendor contracts, whether issued jointly by all the states 
or separately by each participating state, should identify the populations for which the 
supplemental rebates would apply and should specify all of the states involved to 
clearly indicate from the outset which states are participating in the new pool. 
 
In addition to the procurement requirements described above, each state participating in 
a new pool should submit a SPA package that includes the following elements: 
 
1.  Standard multi-state pooling language incorporated into the supplemental 
rebate agreement portion of the state plan.  Specifically, this language should 
read as follows: 
 
CMS has authorized the state of [insert state name] to enter into the [insert the 
name of the multi-state pooling agreement].  This Supplemental Drug Rebate 
Agreement was submitted to CMS on [insert submittal date] and has been 
authorized by CMS. 
 
2.  A supplemental rebate agreement template.  Consistent with section 
1902(a)(19) of the Act, we expect that the SPA would include a standard 
template, to ensure uniformity of the pools supplemental rebate agreements for 
ease of administration.  The template should be the same for each participating 
state and should not include an effective date that is earlier than the first day of 
the quarter in which the SPA was submitted.  In addition, as a template, the 
model agreement should not contain any manufacturer-specific information. 
 
3.  A document referenced in the supplemental rebate agreement template that 
indicates the states participation in the purchasing pool.  This document 
    
will serve as the mechanism by which other states will be added to the multi-
state pooling agreement and should be filled in with any necessary state-specific 
information.  This document will also serve as a template; therefore, it should be 
the same for each participating state and should not contain any manufacturer-
specific information. 
 
4.  A document that indicates if a state joining the pool intends to include its 
non-Medicaid program in the supplemental rebate program that has been 
approved by CMS, if applicable.  States that intend to include non-Medicaid 
programs must receive approval from CMS prior to joining the pool under the 
procedures outlined in the letter from Dennis Smith, Director, Center for 
Medicaid and State Operations, to all State Medicaid Directors (Sept. 18, 2002). 
In addition, each state should provide specific evidence to demonstrate that its 
prior authorization requirement furthers Medicaid goals and objectives and is 
designed to increase the efficiency and economy of the Medicaid program. 
 
Guidance for States on Preferred Drug Lists (PDLs) and Prior Authorization  
 
A state that seeks for the first time to use its prior authorization authority to create a 
PDL and to negotiate supplemental rebates (regardless of whether it seeks to join or 
create a multi-state pooling arrangement) must amend its state plan to refer to the 
supplemental rebate agreement and submit its proposed rebate agreement for CMS 
authorization.  Along with the implementation of a supplemental rebate program, most 
states have also implemented a PDL in conjunction with their prior authorization 
program.  Because non-preferred drugs remain available to beneficiaries through prior 
authorization, a PDL allows states to ensure appropriate patient access to needed 
medications and maintain continuity of patient therapy.   
 
1.  Patient Access to Needed Medications - Upon implementation of a PDL, states should 
ensure that patients continue to have appropriate access to needed medications.  A prior 
authorization program is intended to balance the interests of beneficiaries in receiving 
medically necessary drugs and the interests of states in ensuring that Medicaid pays for 
prescription drugs in an efficient and economical manner.  Therefore, we will seek 
assurance from states that all covered outpatient drugs that are not included on a PDL 
remain available pursuant to prior authorization, consistent with section 1927(d)(5) of the 
Act.  
 
2.  Autonomy of the State PDL - Because we are concerned about beneficiary access to 
medications, we would expect states to ensure that a PDL is consistent with Medicaid 
goals and objectives and section 1902(a)(19) of the Act.   
 
3.  Continuity of Care - When implementing PDLs, we urge states to be mindful of patients 
who are stabilized on previously prescribed, non-preferred medications.  Consistent with 
our concerns for balancing the needs of patients with the efficiency and economy of the 
Medicaid program, we further urge states to consider the impact on beneficiaries of 
sudden changes in therapy as a result of a states implementation of a PDL.  Such a 
sudden change could, in some instances, result in higher costs due to a patients failure of 
therapy on PDL drugs. 
    
 
4.  Vendor Contracting   In contracting with a pharmacy benefit manager or other vendor 
for purposes of negotiating state-specific or multi-state supplemental rebates, states 
should make sure that the selected contractor discloses all types of remuneration and the 
methodology for calculating any such remuneration, all rebate offers being made by 
manufacturers, and any other pertinent information including vendor administrative costs 
and incentives related to vendor supplemental rebate negotiation, and PDL development.  
We suggest that such information include descriptions of any and all payment from 
manufacturers or other entities involved in the manufacture, distribution, sale, or payment 
of pharmaceuticals.   
 
5.  State-Specific Supplemental Rebate Agreements  In order to realize additional cost 
savings, states are encouraged to continue negotiating state-specific supplemental rebate 
agreements, either in addition to, or in lieu of, multi-state pooling agreements.   
 
6.  Annual Evaluations  If states choose to participate in a multi-state pooling agreement, 
we recommend that those states annually evaluate and issue a public report on the 
aggregate cost savings associated with their participation to determine whether 
expenditures in other Medicaid areas, such as hospitalizations or physician services, have 
increased as a result of the implementation of the multi-state pooling agreement.  Even if 
a state chooses not to participate in a pool, we encourage such an evaluation in 
connection with the states PDL, prior authorization program, and state-specific 
supplemental rebate agreement, if applicable. 
 
7.  Non-Medicaid Programs - As we stated in our September 18, 2002, SMD, in submitting 
a SPA to link a Medicaid prior authorization program to rebates or discounts for non-
Medicaid drug purchases, states should be prepared to demonstrate through appropriate 
evidence that the prior authorization program will further the goals and objectives of the 
Medicaid program.