Department of Health and Human Services
 

OFFICE OF 
 

INSPECTOR GENERAL 
 

COMPARISON OF MEDICAID 
 

FEDERAL UPPER LIMIT 
 

AMOUNTS TO AVERAGE 
 

MANUFACTURER PRICES
 

Daniel R. Levinson
 

Inspector General 
 

June 2005 
 

OEI-03-05-00110
 
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 compliance program guidances, renders advisory opinions on OIG sanctions to 

the health care community, and issues fraud alerts and other industry guidance. 
Δ EXECUTIVE SUMMAR Y 
 

OBJECTIVE 

To (1) determine how prices for drugs set under the Medicaid Federal 

upper limit program compare to reported average manufacturer prices 

(AMP) and (2) estimate the savings that could be achieved if Federal 

upper limit amounts were based on reported AMPs. 

BACKGROUND 

The Federal upper limit program was put in place to ensure that the 

Federal Government acts as a prudent payer by taking advantage of 

current market prices for multiple-source drugs. Statutory and 

regulatory criteria generally require the Centers for Medicare & 

Medicaid Services (CMS) to include a drug on the Federal upper limit 

list if: (1) at least three versions of the drug are rated as therapeutically 

equivalent by the Food and Drug Administration (FDA), and (2) the 

drug has at least three suppliers listed in current editions of national 

compendia. The Federal upper limit amount for a drug is set at 

150 percent of the published price for the least costly, therapeutically 

equivalent product found in national compendia plus a reasonable 

dispensing fee. 

For the covered outpatient drugs of a manufacturer to be eligible for 

Federal matching funds under Medicaid, the manufacturer must enter 

into a rebate agreement with CMS and pay quarterly rebates to State 

Medicaid agencies. Under these rebate agreements and the law, 

manufacturers must provide CMS with the AMPs for each of their 

covered drugs on a quarterly basis. Pursuant to Federal statute, AMP 

is the average price paid to a manufacturer for a drug in the United 

States by wholesalers for drugs distributed to the retail pharmacy class 

of trade, net of customary prompt pay discounts. The Medicare 

Prescription Drug, Improvement, and Modernization Act of 2003 

recognizes AMP as a potential measure to be substituted in Medicare 

reimbursement calculations. 

We obtained the third-quarter 2004 version of the Federal upper limit 

list and third-quarter 2004 AMP data from CMS. For each drug on the 

Federal upper limit list, we determined the minimum AMP, average 

AMP, and maximum AMP. To follow current procedures prescribed by 

Federal regulation, we limited the calculation to products that (1) were 

rated therapeutically equivalent by FDA, and (2) were available in the 

most commonly listed package size. We also limited the analysis to 

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EXE CUTIVE S U MMAR Y 

products with Medicaid utilization in the third quarter of 2004. We 

calculated the percentage difference between the Federal upper limit 

amount and the minimum, average, and maximum AMPs. 

To determine the potential implications of using AMPs rather than 

published prices to set Federal upper limit amounts, we multiplied the 

minimum and average AMPs for the drugs by 150 percent. We then 

subtracted 150 percent of the minimum and average AMPs from the 

average Medicaid reimbursement amount in the third quarter of 2004. 

Finally, we multiplied the difference by the number of units of the drug 

product reimbursed during the time period. 

FINDINGS 

Federal upper limit amounts were five times higher than the average 

AMP. Overall, Federal upper limit amounts were five times higher than 

the average AMPs for generic drug products in the third quarter of 

2004. Among individual generic drug products, Federal upper limits 

exceeded average AMPs by as much as 19 times. During the same 

period, the Federal upper limit amount was, on average, 22 times 

higher than the lowest reported AMP, and usually exceeded even the 

highest reported AMP. 

Medicaid could save hundreds of millions of dollars per year by 

basing Federal upper limit amounts on reported AMPs. If Medicaid 

based Federal upper limit amounts on 150 percent of the average AMP, 

the financial implications would be substantial. In the third quarter of 

2004, the program could have saved an estimated $161 million (or 

almost $650 million in 1 year) had Medicaid used the average AMP 

instead of the lowest published price when calculating Federal upper 

limits. 

Furthermore, if Medicaid based Federal upper limit amounts on 

150 percent of the lowest reported AMP rather than 150 percent of the 

lowest published price, the program may have saved up to $300 million 

in just one quarter of 2004. This figure represents 75 percent of the 

$396 million spent on generic versions of Federal upper limit drugs 

during that period. Assuming spending in the following three quarters 

would be similar to the previous quarter, basing Federal upper limit 

amounts on 150 percent of the lowest reported AMP rather than 

150 percent of the lowest published price could save Medicaid up to 

$1.2 billion per year. 

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EXE CUTIVE S U MMAR Y 
 

RECOMMENDATION 

The Centers for Medicare & Medicaid Services should work with 

Congress to set Federal upper limit amounts that more closely 

approximate acquisition costs. In the past several months, the 

President, Congress, and individual Medicaid State agencies have 

expressed renewed interest in reducing excessive Medicaid 

reimbursement for prescription drugs. The original purpose of the 

Federal upper limit program was to do just that by allowing Medicaid to 

take advantage of current market prices for generic drugs. However, 

the applicable regulation requires Federal upper limit amounts to be 

based on prices published in the national drug compendia. As studies 

by the Office of Inspection General and numerous other entities have 

shown, published prices for many products bear little or no resemblance 

to the actual prices paid by providers. Because the already inflated 

published prices are multiplied by 150 percent when calculating Federal 

upper limit amounts, Medicaid reimbursement for qualified products 

has the potential to greatly exceed acquisition costs. The findings of 

this report further illustrate this point. 

We understand that pharmacies need to make some profit from the 

drugs they supply. In addition, we realize that reimbursement 

amounts should be sufficient to provide pharmacies with incentives to 

dispense lower-cost generic drugs rather than the more expensive 

brand name versions. However, that Federal upper limit amounts are 

typically 5 times higher (and as much as 19 times higher) than the 

average AMP seems excessive. 

Therefore, we recommend that CMS work with Congress to set Federal 

upper limit amounts that more closely approximate acquisition costs. 

At a time when States are trying to most effectively allocate resources 

due to shrinking Medicaid budgets, revised Federal upper limit laws 

and regulations would allow States and the Federal Government to 

share in the cost savings that should be associated with lower-priced 

generic drugs. Subsequently, these cost savings should help States to 

continue providing needed care to Medicaid beneficiaries. 

Agency Comments 

CMS concurred with our recommendation, stating that Congress should 

take action to ensure that Medicaid reimbursement amounts more 

closely relate to actual transaction prices. 

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Δ T ABLE OF CONTENTS 
 

EXECUTI VE SUMMARY ......................................... i 
 

INTRODUCTI ON ................................................ 1 
 

FINDI NGS 
 

Federal upper limits five times higher than the average AMP .... 8 
 

Savings from using AMPs could exceed $1 billion per year ...... 9 
 

RECOM M E NDATI O N ........................................... 11 
 

APPENDI CES 

A: Methodology ............................................ 13 
 

B: Centers for Medicare & Medicaid Services Comments ....... 16
 

ACKN O W LEDGMENTS ......................................... 19 
 
Δ INTRODU C TION 
 

OBJECTIVE 

To (1) determine how prices for drugs set under the Medicaid Federal 

upper limit program compare to reported average manufacturer prices 

(AMP) and (2) estimate the savings that could be achieved if Federal 

upper limit amounts were based on reported AMPs. 

BACKGROUND 

Medicaid Program. 

Medicaid is a jointly funded, Federal and State health insurance 

program for certain low-income and medically needy people. Individual 

States establish eligibility requirements, benefits packages, and 

payment rates for their Medicaid programs under broad Federal 

standards administered by the Centers for Medicare & Medicaid 

Services (CMS). Medicaid requirements mandate that States provide 

basic services to beneficiaries to receive Federal matching funds. States 

may also receive Federal funding if they provide other optional services. 

One universally offered optional service is prescription drug coverage. 

All 50 States and the District of Columbia currently offer prescription 

drug coverage under the Medicaid program. In calendar year 2003, 

CMS estimates that Medicaid payments for prescription drugs totaled 

over $34 billion.1 

Medicaid Drug Reimbursement Methodology. 

Each State is required to submit a Medicaid State plan to CMS 

describing its payment methodology for covered drugs. Federal 

regulations require, with certain exceptions, that each State’s 

reimbursement for a drug not exceed the lower of its estimated 

acquisition cost plus a reasonable dispensing fee or the provider’s usual 

and customary charge to the public for the drug. 

CMS allows States flexibility to define estimated acquisition cost. Most 

States base their calculation of estimated acquisition cost on a drug’s 

average wholesale price (AWP) discounted by a certain percentage. As 

of the first quarter of 2005, this discount ranged from 5 to 50 percent of 

AWP. A small number of States use wholesale acquisition costs plus a 

percentage markup rather than, or in addition to, discounted AWPs 

when determining estimated acquisition cost. 

1 This amount includes both the Federal and State shares of payments. Rebates collected 

under the Medicaid Drug Rebate program have not been subtracted from the total. 

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INTROD UCT ION 

For certain drugs, States also use the Federal upper limit and/or State 

maximum allowable cost programs in determining reimbursement 

amounts. CMS has established Federal upper limit amounts for more 

than 400 drugs. In addition, numerous States have implemented a 

maximum allowable cost program to limit reimbursement amounts for 

certain drugs. Individual States determine the types of drugs that are 

included in their maximum allowable cost programs and the methods by 

which the maximum allowable cost for a drug is calculated. 

In summary, States use a variety of mechanisms when setting drug 

reimbursement amounts. In most cases, States reimburse for a drug at 

the lower of the estimated acquisition cost, the Federal upper limit 

amount, or the State maximum allowable cost, plus a reasonable 

dispensing fee. 

Federal Upper Limit Program. 

According to CMS’s “State Medicaid Manual,” the Federal upper limit 

program was created to ensure that the Federal Government acts as a 

prudent payer by taking advantage of current market prices for 

multiple-source drugs. Under 42 CFR § 447.332, CMS is to establish a 

Federal upper limit amount for a drug when: (1) all formulations of a 

drug have been rated as therapeutically equivalent by the Food and 

Drug Administration (FDA), and (2) at least three suppliers of the drug 

are listed in current editions (or updates) of published compendia of cost 

information for drugs available for sale nationally. The Omnibus 

Budget Reconciliation Act of 1990 (OBRA ’90) established new criteria 

requiring a drug to be included on the Federal upper limit list when 

three or more versions of a drug had been rated therapeutically and 

pharmaceutically equivalent by FDA, regardless of the ratings of other 

versions.

2 FDA designates drugs that are therapeutically equivalent as 

“A-rated.” 

Federal regulation (42 CFR § 447.332) sets the Federal upper limit 

amount at 150 percent of the published price for the least costly, 

therapeutically equivalent product that can be purchased by 

pharmacists in quantities of 100 tablets or capsules plus a reasonable 

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2 According to the “State Medicaid Manual,” the language of OBRA ’90 “augments” the 

upper limits established by the regulation and creates “new criteria” for adding drugs to 

the Federal upper limit list. CMS has not modified the language of the regulation since it 

was promulgated in 1987, nor has the regulation been withdrawn. In practice, CMS relies 

on the language of the regulation and the OBRA ’90 provisions in establishing Federal 

upper limits. 

C O M PARI S O N O F F EDERAL UP PER L I M IT A M O UNTS T O AVERAGE MANUFA C TURER P R I C E S 2 
INTROD UCT ION

dispensing fee. If the drug is not typically available in quantities of 

100 or if the drug is a liquid, the Federal upper limit amount is based on 

a commonly listed size. 

CMS applies an additional standard in determining which drugs should 

be subject to Federal upper limits. According to CMS staff, only drugs 

for which a Federal upper limit could potentially lead to savings should 

be included on the Federal upper limit list. Therefore, if a drug does not 

have a published price that, when multiplied by 150 percent, is lower 

than the AWP, CMS does not include the product. 

CMS publishes the Federal upper limit list on its Web site at 

www.cms.hhs.gov/medicaid/drugs/drug10.asp and in the “State 

Medicaid Manual.” Any revisions to the Federal upper limit list are 

typically noted on the Web site as well. CMS establishes an upper limit 

for specific forms and strengths for each multiple-source drug on the 

list. The Federal upper limit list also provides the source of the pricing 

information used to calculate the upper limit amount for each drug. 

The Medicaid Drug Rebate Program and Average Manufacturer Price. 

For the covered outpatient drugs of a manufacturer to be eligible for 

Federal matching funds under Medicaid, section 1927(a)(1) of the Social 

Security Act mandates that drug manufacturers enter into rebate 

agreements with CMS and pay quarterly rebates to States. Under these 

rebate agreements and the law, manufacturers must provide CMS with 

the AMP for each of their covered drugs on a quarterly basis. Pursuant 

to section 1927(k)(1) of the Social Security Act, AMP is defined as the 

average price paid to a manufacturer for a drug in the United States by 

wholesalers for drugs distributed to the retail pharmacy class of trade, 

net of customary prompt pay discounts. The AMP is calculated as a 

weighted average of prices for all of a manufacturer’s package sizes of a 

drug sold during a given quarter. Section 1927(b)(3)(D) of the Social 

Security Act requires that, subject to certain exceptions, AMPs reported 

to CMS not be publicly disclosed. 

In a December 2004 report, the Congressional Budget Office used AMP 

to estimate what pharmacies pay to acquire drugs. While the 

acquisition costs for pharmacies that buy through wholesalers rather 

than directly from manufacturers may exceed AMP, the wholesaler 

markup is estimated to be a small proportion (approximately 3 percent) 

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INTROD UCT ION 

of the actual price.3 The Medicare Prescription Drug, Improvement, 

and Modernization Act of 2003 (MMA) also recognizes AMP as a 

potential measure to be substituted in Medicare reimbursement 

calculations.4 

Related Work by the Office of Inspector General. 

In December 2004, the Office of Inspector General (OIG) issued 

“Addition of Qualified Drugs to the Medicaid Federal Upper Limit List” 

(OEI-03-04-00320) as requested by a Congressional subcommittee. OIG 

found that CMS does not add qualified drugs to the Federal upper limit 

list in a timely manner. Of the 252 first-time generic drugs approved 

between January 2001 and December 2003, 109 drugs met the criteria 

for inclusion on the Federal upper limit list; however, only 25 of these 

drugs were actually added. For the 25 that were added, CMS took an 

average of 36 weeks to place the products on the Federal upper limit list 

once they were qualified for inclusion. CMS’s not adding qualified drugs 

in a timely manner cost the Medicaid program an estimated 

$167 million between 2001 and 2003. We recommended that CMS 

establish an administrative procedure and schedule to govern the 

determination and publication of Federal upper limits. 

In February 2004, OIG issued “Omission of Drugs from the Federal 

Upper Limit List in 2001” (OEI-03-02-00670). OIG found that 90 drug 

products were not included on the Federal upper limit list in 2001 

despite meeting the criteria established by Federal law and regulation. 

Medicaid could have saved $123 million in 2001 by adding 55 of the 

90 drug products to the Federal upper limit list. OIG recommended 

that CMS take steps to ensure that all drugs meeting the criteria are 

included on the Federal upper limit list. 

In October 2003, OIG issued “State Strategies to Contain Medicaid Drug 

Costs” (OEI-05-02-00680). OIG found that States employ three main 

drug cost containment strategies: (1) limiting Medicaid reimbursement 

for drugs, (2) shifting use from higher to lower cost drugs, and 

(3) limiting the amount of prescription drugs a beneficiary can obtain. 

States reported facing challenges in their attempts to maximize drug 

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3 As reported by the National Association of Chain Drug Stores in the Congressional Budget 

Office report, “Medicaid’s Reimbursement to Pharmacies for Prescription Drugs.” 

4 Medicare typically uses manufacturer-reported average sales price (ASP) plus 6 percent as 

the basis for drug reimbursement. However, if the ASP for a drug exceeds the AMP by a 

threshold percentage, section 303 of MMA allows the program to base reimbursement on 

103 percent of AMP instead. In 2005, this threshold percentage is 5 percent. 

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INTROD UCT ION 

cost savings, including a lack of accurate drug price information and 

stakeholder opposition to cost containment efforts. 

Recent Interest in Medicaid Drug Pricing Issues. 

In December 2004, the United States House Committee on Energy and 

Commerce Subcommittee on Oversight and Investigations held a 

hearing entitled “Medicaid Prescription Drug Reimbursement: Why 

the Government Pays Too Much.” Representatives from OIG, CMS, 

several State Medicaid agencies, and the drug industry testified at this 

hearing. The role that Federal upper limits play in reducing costs for 

prescription drugs was a key area of interest to the subcommittee. 

In addition, the President’s 2006 budget proposes changes that would 

cause Medicaid reimbursement amounts to more closely approximate 

pharmacy acquisition costs. Specifically, the budget recommends that 

Medicaid reimbursement for prescription drugs be at 106 percent of a 

drug’s ASP. 

Prior to 2005, Medicare, like Medicaid, based drug reimbursement on 

published AWPs. However, due in part to numerous reports by OIG 

and the Government Accountability Office that found that AWPs were 

significantly inflated, Congress required that Medicare begin basing 

reimbursement amounts on 106 percent of ASP instead. Section 303 of 

MMA defines ASP as the manufacturer’s sales to all purchasers (with 

certain exemptions) divided by the number of units sold. The ASP is to 

be net of chargebacks, discounts, rebates, and other price concessions. 

The ASPs are reported to CMS by drug manufacturers. 

METHODOLOGY 

Identifying Drugs on the Federal Upper Limit List. 

We obtained a list of drugs subject to Federal upper limits as of the 

third quarter of 2004 from the CMS Web site. Using data obtained from 

the publisher of a national drug compendium, we compiled a list of all 

the national drug codes (NDC) associated with generic versions of each 

drug product. 

Obtaining Medicaid Utilization Data. 

We downloaded 50 State Medicaid payment and utilization files for 2004 

from CMS’s Web site. We limited our analysis to utilization occurring in 

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INTROD UCT ION 

the third quarter of 2004.5 We calculated the average Medicaid 

reimbursement amount for each of the 415 drugs on the Federal upper 

limit list by dividing the total reimbursement for the product (net of 

dispensing fees) by the total number of units reimbursed.

6 

Determining AMPs for Drugs Subject to Federal Upper Limits. 

We obtained third-quarter 2004 AMP data from CMS. We matched the 

AMP data with the Medicaid utilization data to verify that all products 

on which the comparisons would be made had actually been reimbursed 

by Medicaid. Consistent with Federal regulations, we removed any 

NDCs that represented drug products that were not A-rated, and also 

removed any NDCs that did not match the most commonly listed 

package size. We then determined the minimum, average, and 

maximum AMPs among the remaining NDCs for each of the drug 

products. We did not verify that the AMPs reported to CMS were 

correct. 

Comparing Federal Upper Limit Amounts to AMPs. 

We compared the third-quarter 2004 Federal upper limit amounts to the 

third-quarter 2004 AMPs. We calculated the percentage difference 

between the Federal upper limit amount and the minimum, average, 

and maximum AMPs for each of the 415 drug products under review. 

We then calculated an overall percentage difference weighted by 

Medicaid reimbursement. We will not be reporting the actual dollar 

differences between the Federal upper limit amounts and AMPs for 

individual drug products due to confidentiality issues. 

Estimating Potential Savings. 

To determine the potential impact of using AMPs rather than published 

prices to set Federal upper limit amounts, we: 

(1) multiplied the minimum and average AMPs for the drugs on the 

Federal upper limit list by 150 percent (consistent with current 

regulation), 

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5 Third-quarter data for seven States were not yet available, and an additional State had no 

data in the system because its drug benefit is provided completely through managed care 

organizations. Therefore, our analysis is limited to information from 42 States and the 

District of Columbia. 

6 As of the third quarter of 2004, there were 419 drug products on the Federal upper limit 

list. Four of these drug products were removed from the analysis for reasons detailed in 

Appendix A, leaving 415 drugs in our review. 

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INTROD UCT ION 

(2) subtracted 150 percent of the minimum and average AMPs from the 

average Medicaid reimbursement amount in the third quarter of 

2004, and7 

(3) multiplied the difference calculated in step two by the number of 

units of the drug product reimbursed during the time period. 

A complete discussion of our methodology is presented in Appendix A. 

This evaluation was conducted in accordance with the “Quality 

Standards for Inspections” issued by the President’s Council for 

Integrity and Efficiency and the Executive Council for Integrity and 

Efficiency. 

 OE I-03-05-00 11 0 

7 In calculating potential savings, we used average Medicaid reimbursement amounts 

rather than Federal upper limit amounts. Because of State maximum allowable cost 

programs, some States may reimburse substantially less than the Federal upper limit 

amount for certain drugs. Therefore, using Federal upper limit amounts in our 

calculations would tend to exaggerate potential savings. Using average Medicaid 

reimbursement amounts provides a much more accurate estimate of the potential savings. 

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Δ FINDINGS 
 

Overall, Federal upper limit Federal upper limit amounts were five times amounts were five times higher higher than the average AMP than the average AMPs for 

generic drug products in the third 

quarter of 2004. Among individual generic drug products, Federal 

upper limits exceeded average AMPs by as much as 19 times ($1.20 per 

tablet compared to $0.063 per tablet). For 327 of the 415 drug products 

reviewed, the Federal upper limit amount was at least double the 

average generic AMP, with Federal upper limits being more than 

4 times higher in 131 cases. The Federal upper limit amount was below 

the average AMP for just 13 of the 415 drug products during the third 

quarter of 2004. 

Among the 20 reviewed drug products with the highest total Medicaid 

reimbursement, the Federal upper limit amount was between 2 and 

14 times higher than the average generic AMP during the third quarter 

of 2004.8 Ten of the top twenty drug products had a Federal upper limit 

amount that was at least 5 times more than the average generic AMP. 

On average, Federal upper limit amounts were more than 20 times higher 

than the lowest reported AMPs. 

During the third quarter of 2004, the Federal upper limit amount for 

415 drug products was, on average, 22 times higher than the minimum 

generic AMP reported by drug manufacturers. For 29 drug products, 

the Federal upper limit amount exceeded the minimum reported AMP 

for generic versions by at least 40 times. All but 12 of the 415 drug 

products had Federal upper limit amounts that were at least double the 

minimum generic AMP. 

For the 20 drug products with the highest total Medicaid 

reimbursement, Federal upper limit amounts ranged from 4 times more 

than the minimum AMP up to 61 times more than the minimum AMP. 

The drug with highest total reimbursement during the third quarter of 

2004, albuterol inhalation aerosol, had a Federal upper limit amount 

that was 36 times higher than the lowest reported generic AMP. 

8 These 20 drugs accounted for 36 percent of total Medicaid reimbursement for generic 

versions of Federal upper limit drugs during the third quarter of 2004. A list of these 

drugs is presented in Table 1 on page 10. 

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F I NDING S 

Federal upper limit amounts were usually greater than even the highest 

reported AMPs. 

On average, Federal upper limit amounts were more than double the 

highest reported generic AMPs during the third quarter of 2004. Only 

75 of the 415 drugs under review had a Federal upper limit amount that 

was less than the maximum AMP. In the case of the drug product with 

the highest total Medicaid reimbursement, albuterol inhalation aerosol, 

the Federal upper limit amount was approximately five times more 

than the maximum reported AMP among generic versions of the 

product. 

Medicaid could save hundreds of millions of 

dollars per year by basing Federal upper limit 

amounts on reported AMPs 

If Medicaid based Federal upper 

limit amounts on 150 percent of 

the average AMP, the program 

could have saved an estimated 

$161 million in the third quarter of 2004.9 Assuming spending in the 

following three quarters would be similar to the previous quarter, 

basing Federal upper limit amounts on 150 percent of the average AMP 

rather than 150 percent of the lowest published price could save 

Medicaid almost $650 million per year.10 Table 1 (see page 10) shows 

the potential savings for the 20 drugs with the highest total Medicaid 

reimbursement in the third quarter of 2004. The potential savings for 

these 20 drugs alone exceeded $75 million for the quarter. 

If Medicaid based Federal upper limit amounts on 150 percent of the 

lowest reported AMP rather than 150 percent of the lowest published 

price, the program may have saved up to $300 million in just a single 

quarter. This figure represents 75 percent of the $396 million spent on 

generic versions of Federal upper limit drugs during the third quarter of 

2004. Assuming spending in the following three quarters would be 

similar to the previous quarter, basing Federal upper limit amounts on 

150 percent of the lowest reported AMP rather than 150 percent of the 

lowest published price could save Medicaid up to $1.2 billion per year. 

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9 All savings in this report represent estimates for 42 States and the District of Columbia 

only. We did not perform calculations for eight states without third-quarter data. 

10 The President’s 2006 budget recommends using 106 percent of ASP as the basis for 

Medicaid drug reimbursement, an identical method to Medicare Part B. The ASP for 

most of the drugs included in this review are not provided to CMS since they are not 

covered under Medicare Part B. 

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F I NDING S 

Table 1: Potential Savings Based on Average AMP for 20 Drugs With Highest Reimbursement 

Generic Name 

Medicaid Reimbursement 

7/1/2004 - 9/30/2004 

Savings at 150% of 

Average AMP 

Albuterol aerosol 90 mcg/act $16,391,640 $12,105,942 

Metformin HCl tab 500 mg $13,430,697 $6,354,068 

Fluoxetine HCl cap 40 mg $9,292,817 $6,711,161 

Tramadol HCl tab 50 mg $8,921,358 $5,141,661 

Tizanidine HCl tab 4 mg $7,785,526 $4,286,990 

Ranitidine HCl tab 150 mg $7,570,846 $5,954,356 

Albuterol sulfate solution 0.083% $7,180,644 $3,553,728 

Lorazepam tab 1 mg $6,409,259 $4,204,818 

Lisinopril tab 20 mg $6,358,915 $3,590,489 

Hydrocodone-acetaminophen tab 10-500 mg $5,873,425 $3,099,228 

Hydroxyzine HCl tab 25 mg $5,737,177 -$555,585 

Amiodarone HCl tab 200 mg $5,550,813 $3,759,315 

Propoxyphene-N w/APAP tab 100-650 mg $5,464,571 $109,935 

Famotidine tab 20 mg $5,428,734 $4,474,399 

Lisinopril tab 10 mg $5,373,003 $2,752,882 

Lisinopril tab 40 mg $5,164,975 $2,527,996 

Baclofen tab 10 mg $5,116,346 $2,347,817 

Lovastatin tab 40 mg $5,007,263 $2,808,319 

Lorazepam tab 0.5 mg $4,934,603 $2,601,946 

Cephalexin cap 500 mg $4,670,980 $2,492,166 

Total $141,663,592 $78,321,631 

Source: Third-Quarter 2004 CMS Federal Upper Limit and AMP Data; OIG Analysis, April 2005. 

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The Centers for Medicare & Medicaid Services should work with 

Congress to set Federal upper limit amounts that more closely 

approximate acquisition costs. 

In the past several months, the President, Congress, and individual 

Medicaid State agencies have expressed renewed interest in reducing 

excessive Medicaid reimbursement for prescription drugs. The original 

purpose of the Federal upper limit program was to do just that by 

allowing Medicaid to take advantage of current market prices for 

generic drugs. However, the applicable regulation requires Federal 

upper limit amounts to be based on prices published in the national 

drug compendia. As studies by the Offce of Inspector General and 

numerous other entities have shown, published prices for many 

products bear little or no resemblance to the actual prices paid by 

providers. Because the already inflated published prices are multiplied 

by 150 percent when calculating Federal upper limit amounts, Medicaid 

reimbursement for qualified products has the potential to greatly exceed 

acquisition costs. The findings of this report further ilustrate this 

point. 

We understand that pharmacies need to make some profit from the 

drugs they supply. In addition, we realize that reimbursement 

amounts should be suffcient to provide pharmacies with incentives to 

dispense lower cost generic drugs rather than the more expensive 

brand name versions. However, that Federal upper limit amounts are 

typically 5 times higher (and as much as 19 times higher) than the 

average AMP seems excessive. 

Therefore, we recommend that CMS work with Congress to set 

Federal upper limit amounts that more closely approximate 

acquisition costs. At a time when States are trying to more effectively 

allocate resources due to shrinking Medicaid budgets, revised Federal 

upper limit laws and regulations would allow States and the Federal 

Government to share in the cost savings that should be associated 

with lower priced generic drugs. Subsequently, these cost savings 

should help States to continue providing needed care to Medicaid 

beneficiaries. 

Agency Comments 

CMS concurred with our recommendation, stating that Congress 

should take action to ensure that Medicaid reimbursement amounts 

more closely relate to actual transaction prices. CMS notes that 

OEI- 03. 05. 00110 COMPARISON OF FEDERAL UPPER LIMIT AMOUNTS TO AVERAGE MANUFACTURER PRICES 
R E C O MMENDA T I ON 

Congress recently acted to reform Medicare’s payment methodology 

for prescription drugs based on similar pricing issues, and goes on to 

state, “Congress should now enact similar legislation to ensure that 

Medicaid payment for drugs is related to actual prices paid by 

pharmacies.” The full text of CMS’s comments is presented in 

Appendix B. 

OIG Response 

OIG appreciates CMS’s comments on this report, and looks forward to 

assisting CMS and Congress in their efforts reform Medicaid’s current 

reimbursement methodology. 

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Δ APPENDIX ~ A 
 

METHODOLOGY 

Identifying Drugs on the Federal Upper Limit List. 

We obtained a list of drugs subject to Federal upper limits as of the 

third quarter of 2004 from the CMS Web site. At that time, 419 drug 

products (i.e., individual dosage forms and sizes of a generic drug 

ingredient) were included on the Federal upper limit list. 

Using data obtained from the publisher of a national drug compendium, 

we compiled a list of all the national drug codes (NDC) associated with 

generic versions of each of the 419 drug products. Each individual drug 

product manufactured or distributed in the United States has a unique 

NDC. An NDC identifies the manufacturer or labeler of the drug 

product, the product dosage form, and the package size. For each NDC, 

compendia provide published prices (usually average wholesale prices 

and wholesale acquisition costs), manufacturer information, and FDA 

therapeutic equivalency data. The compendia also identify whether the 

individual drug product is a brand name or generic version. According 

to the compendium used in our analysis, 2 of the 419 drug products on 

the Federal upper limit list did not have any matching generic NDCs. 

The remaining 417 drug products were represented by 17,945 generic 

NDCs. 

Obtaining Medicaid Utilization Data. 

To ensure that the comparisons between Federal upper limit amounts 

and AMPs were meaningful, we verified that all products upon which 

the comparisons were based had actually been reimbursed by Medicaid. 

We downloaded 50 State Medicaid payment and utilization files for 

2004 from CMS’s Web site.11 Each file contained variables representing 

total State reimbursement, number of units reimbursed, and number of 

prescriptions written for every NDC by calendar quarter. 

We limited our analysis to utilization occurring in the third quarter of 

2004. CMS had third-quarter utilization figures available for 42 States 

and the District of Columbia.12 Of the 17,945 NDCs subject to 

11 Arizona’s data were not available for download because the State’s drug benefit is 

administered completely through managed care organizations and not the traditional 

fee-for-service system. 

12 The seven States without third-quarter data on CMS’s Web site were Colorado, Georgia, 

Kansas, Louisiana, Ohio, Vermont, and Washington. 

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APP E N D I X ~A 

Federal upper limits, 4,699 had Medicaid utilization in the third quarter 

of 2004. 

The total State reimbursement amount listed in the State utilization 

files included both the payments made for the NDC and the dispensing 

fees paid to the pharmacy. To determine a State’s reimbursement for 

only the drug product during the third quarter of 2004, we: 

(1) 	 calculated the total amount paid in dispensing fees for the NDC by 

multiplying the State’s dispensing fee by the number of 

prescriptions written for the NDC in each State, 

(2) 	 subtracted total dispensing fees from the total reimbursement for 

the NDC in each State, 

(3) 	 aggregated reimbursement (net of dispensing fees) and the 

number of units reimbursed for each NDC for all States, and 

(4) 	 summarized the data from step 3 to obtain reimbursement and 

utilization totals for each of the 417 drug products. 

We then calculated the average Medicaid reimbursement amount for 

each of the drugs by dividing the total reimbursement for the product 

(without the dispensing fee) by the total number of units reimbursed. 

Determining AMPs for Drugs Subject to Federal Upper Limits. 

We obtained third-quarter 2004 AMP data from CMS. We matched the 

AMP data with the Medicaid utilization data to verify that all products 

on which the comparisons would be made had actually been reimbursed 

by Medicaid. We determined that 4,526 NDCs that were subject to 

Federal upper limits appeared on both the AMP file and Medicaid 

utilization files that quarter. 

Federal regulations require that the prices on which Federal upper limit 

amounts are based be for therapeutically equivalent (A-rated) products 

in common package sizes. Therefore, we removed from the analysis any 

NDCs that represented drug products that were not A-rated. At this 

point, we removed another drug from the analysis because the drug did 

not have any A-rated versions with third-quarter 2004 utilization. For 

the 416 remaining drug products, we determined the most common 

package size listed in the compendia. We removed from our analysis 

any NDCs that did not match this package size. We then determined 

the minimum, average, and maximum AMPs for the remaining NDCs 

for each of the 416 drug products. We did not verify that the AMPs 

reported to CMS were correct. 

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APP E N D I X ~A 

Comparing Federal Upper Limit Amounts to AMPs. 

We compared third-quarter 2004 Federal upper limit amounts to the 

third-quarter 2004 AMPs. We first ensured that the unit (i.e., tablet, 

gram, etc.) upon which the Federal upper limit was based equaled the 

unit amount upon which AMP was based. For one product, the unit 

differed significantly and we could not readily determine an appropriate 

conversion factor. This drug product was removed from the analysis, 

leaving 415 products in our review. 

We calculated the percentage difference between the Federal upper 

limit amount and the minimum, average, and maximum AMP for each 

of the 415 drug products. We then calculated an overall percentage 

difference weighted by Medicaid reimbursement. We will not report the 

actual dollar differences between the Federal upper limit amounts and 

AMPs for individual drug products due to confidentiality issues. 

Estimating Potential Savings. 

To determine the potential savings of using AMPs rather than 

published prices to set Federal upper limit amounts, we: 

(1)	 multiplied the minimum and average AMPs for the 415 drugs on 

the Federal upper limit list by 150 percent (consistent with 

current regulation), 

(2)	 subtracted 150 percent of the minimum and average AMPs from 

the average Medicaid reimbursement amount in the third quarter 

of 2004, and 13 

(3) 	 multiplied the difference calculated in step 2 by the number of 

units of the drug product reimbursed during the time period. 

This evaluation was conducted in accordance with the “Quality 

Standards for Inspections” issued by the President’s Council for 

Integrity and Efficiency and the Executive Council for Integrity and 

Efficiency. 

 OE I-03-05-00 11 0 

13 In calculating potential savings, we used average Medicaid reimbursement amounts 

rather than Federal upper limit amounts. Because of State maximum allowable cost 

programs, some States may reimburse substantially less than the Federal upper limit 

amount for certain drugs. Therefore, using Federal upper limit amounts in our 

calculations would tend to exaggerate potential savings. Using average Medicaid 

reimbursement amounts provides a much more accurate estimate of the potential 

savings. 

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Δ APPENDIX ~ B 
 

Comments from the Centers for Medicare & Medicaid Services 

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APP E N D I X ~B 

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APP E N D I X ~B 

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Δ ACKNOWLEDGMENTS 
 

This report was prepared under the direction of Robert A. Vito, Regional 

Inspector General for Evaluation and Inspections in the Philadelphia 

regional office, and Linda M. Ragone, Deputy Regional Inspector 

General. Other principal Office of Evaluation and Inspections staff who 

contributed include: 

David Tawes, Team Leader 

Linda Boone Abbott, Program Specialist 

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