Department of Health and Human Services 

OFFICE OF 

INSPECTOR GENERAL 

Inspector General 

October 2003 

OEI-05-02-00680 

STATE STRATEGIES TO CONTAIN 

MEDICAID DRUG COSTS 
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. 
ABSTRACT 

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 State’s 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 C ONTAIN M EDICAID D RUG C OSTS i 
EXECUTI VE SUMMARY

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 C ONTAIN M EDICAID D RUG C OSTS ii 
EXECUTIVE SUMMARY 

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 costeffective 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 C ONTAIN M EDICAID D RUG C OSTS iii 
EXECUTIVE SUMMARY 

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 CMS’s efforts to provide consistent, timely, and 

pertinent information to State Medicaid pharmacy 

representatives. 

OEI - 05 - 02 - 00680 STATE STRATEGIES TO C ONTAIN M EDICAID D RUG C OSTS iv 
TABLE OF CONTENTS

ABSTRACT ................................ ....................... i

EXECUTIVE SUMMARY ................................ ......... ii

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

FINDINGS ................................ ....................... 7

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

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

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

CONCLUSION ................................ ................... 30

APPENDIX ................................ ....................... 31

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

ACKNOWLEDGMENTS ................................ .......... 32

END NOTES ................................ ..................... 33

OEI - 05 - 02 - 00680 STATE STRATEGIES TO C ONTAIN M EDICAID D RUG C OSTS v
INTRODUCTION

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 State’s 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 C ONTAIN M EDICAID D RUG C OSTS 1 
INTRODUCTION 

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 pharmacist’s usual and customary 

charge; (2) the estimated [pharmacy] acquisition cost (EAC); or 

(3) the State’s maximum allowable cost (MAC), if applicable.12 

EAC is the State Medicaid agency’s 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 C ONTAIN M EDICAID D RUG C OSTS 2 
INTRODUCTION 

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 FDAapproved 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 State’s 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 Cob 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 C ONTAIN M EDICAID D RUG C OSTS 3 
INTRODUCTION 

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 “counterdetailing” 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 C ONTAIN M EDICAID D RUG C OSTS 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 State’s 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 C ONTAIN M EDICAID D RUG C OSTS 5 
INTRODUCTION 

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 President’s Council on 

Integrity and Efficiency. 

OEI - 05 - 02 - 00680 STATE STRATEGIES TO C ONTAIN M EDICAID D RUG C OSTS 6 
FINDINGS

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 pharmacy’s 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 C ONTAIN M EDICAID D RUG C OSTS 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%, multisource generic drugs (without FULs) by 54.2 percent, and all drugs with FULs by 72.1%. 

OEI - 05 - 02 - 00680 STATE STRATEGIES TO C ONTAIN M EDICAID D RUG C OSTS 8 
Table 2. State EAC Changes Involving Tiered Formulas 

State Previous EAC Revised EAC 

AR AWP-10.5% Brand: -14% 

Generic: -20% 

CO AWP-12% Brand: -13.5% 

Generic: -35% 

IL Brand: 

Generic: 

Brand: -12% 

Generic: -25% 

KS AWP-10% Brand: -11% 

Generic: -27% 

AWP

AWP

AWP

AWP

WAC+8% 

WAC+12% 

AWP

AWP

AWP

AWP

WA AWP-11% Brand: AWP-14% 

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 C ONTAIN M EDICAID D RUG C OSTS 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. 

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. 

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. 

wholesaler, Texas applies its EAC formula. 

warehouse, Texas modifies its methodology to account for the volume discount 

associated with warehouse purchasing. 

the drug purchase is direct from the manufacturer. 

Rather than relying solely on the national compendia used by most 

Direct 

If the drug is purchased through a 

If a pharmacy obtains the drug through a 

Finally, Texas reimburses at the direct price if 

CMS’s primary role is to approve the State plan amendments 

required for a State’s pharmacy reimbursement change. To 

obtain approval, States must submit documentation showing 

that the new estimated acquisition cost formula represents the 

State’s “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 C ONTAIN M EDICAID D RUG C OSTS 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 C ONTAIN M EDICAID D RUG C OSTS 11 
Table 3. Savings from Reductions in EAC Reimbursement Formulas 

State 

Projected/Estimated 

Annual Savings 

(in millions) 

Savings as Percent 

of State’s FY 01 

Drug 

Expenditures 

NV $9.6* 21.3% 

AZ $0.5 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% 

(actual) 

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 C ONTAIN M EDICAID D RUG C OSTS 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 program’s first quarter of operation, 

measured savings of $143,603 for that quarter. These savings 

represent just over 2 percent of the State’s average quarterly drug 

costs. Tables 4 and 5 below provide reported savings by State. 

OEI - 05 - 02 - 00680 STATE STRATEGIES TO C ONTAIN M EDICAID D RUG C OSTS 13 
Table 4. Actual MAC Savings 

State 

Actual Annual 

Savings 

(in millions) 

Savings as Percent 

of State’s FY 01 

Drug Expenditures 

NE $22 15.7% 

MO $45.8 8.5% 

VT $4 4.9% 

WA $15.3 4.2% 

HI $1.5 2.5% 

GA $5.5 0.9% 

Total $94.1 -

Source: OIG National Survey, 2002 

Table 5. Estimated/Projected MAC Savings 

State 

Estimated 

Annual Savings 

(in millions) 

Savings as Percent 

of State’s FY 01 

Drug Expenditures 

OK $10 7.6% 

OR $12* 6.2% 

MN $7 3.3% 

NC $17.2 2.2% 

NM $1 2.2% 

WY $0.57# 2.2% 

CT $5 2.1% 

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. 

+ Texas’s $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 C ONTAIN M EDICAID D RUG C OSTS 14 
SHIFT USE: While Required to Cover Most 

Drugs, 39 States Encourage a Shift from Higher 

to Lower Cost Drugs 

States implement a variety of 

cost containment strategies 

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: 

substitution, beneficiary copayments, physician education 

24 

Total 39 

prior authorization, preferred drug list, generic 

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 State’s 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 State’s 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 C ONTAIN M EDICAID D RUG C OSTS 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 beneficiary’s 

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 State’s call center. The 

physician must provide specified information about the 

beneficiary’s 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 C ONTAIN M EDICAID D RUG C OSTS 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 C ONTAIN M EDICAID D RUG C OSTS 17 
Table 7. Actual/Projected Savings from Prior Authorization 

State 

Actual/Projected 

Annual Savings 

(in millions) 

Savings as Percent 

of State’s FY 01 

Drug Expenditures 

Specific Drugs or Drug Classes 

(as applicable) 

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 

State 

Estimated 

Annual Savings 

(in millions) 

Savings as Percent 

of State’s FY 01 

Drug Expenditures 

Specific Drugs or Drug Classes 

(as applicable) 

ID $10.5 12.5% 4 classes: -2 inhibitors, 

non-steroidal anti-inflammatory drugs, and nonsedating 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: -2 inhibitors 

NC $4.7 0.6% N/A 

Total $76.7 - -

proton pump inhibitors, COX

COX

Source: OIG National Survey, 2002 

OEI - 05 - 02 - 00680 STATE STRATEGIES TO C ONTAIN M EDICAID D RUG C OSTS 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, H2 receptor antagonists, increased 

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 State’s 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 Florida’s, Oregon’s, Vermont’s, and 

Michigan’s 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 H2 receptor antagonists are both classes of drugs used to treat 

gastrointestinal problems, including ulcers and acid reflux disease. COX-2 inhibitors are a type of nonsteriodal, anti-inflammatory drug (NSAID) used to treat pain and inflammation. 

OEI - 05 - 02 - 00680 STATE STRATEGIES TO C ONTAIN M EDICAID D RUG C OSTS 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 Oregon’s 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. Oregon’s 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 Vermont’s 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. Vermont’s contracted 

pharmacy benefits manager reviewed the clinical and financial 

merits for each drug and developed an initial list of drugs. The 

State’s Drug Utilization Review board used this list and public 

comments to determine the State’s final PDL. 

Because most drugs are considered clinically effective, cost 

ultimately determines which drugs are included on Vermont’s 

preferred list. However, the State’s 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 C ONTAIN M EDICAID D RUG C OSTS 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. 

Florida’s 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 nong Manufacturers’ bids include both the Federal and supplemental rebate. 

OEI - 05 - 02 - 00680 STATE STRATEGIES TO C ONTAIN M EDICAID D RUG C OSTS 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 Vermont’s PDL, which 

State respondents attributed to insufficiently planning the 

implementation of the PDL. In response, Vermont’s 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 CMS’s State 

OEI - 05 - 02 - 00680 STATE STRATEGIES TO C ONTAIN M EDICAID D RUG C OSTS 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 State’s 

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 director’s 

letter clarifying a State’s 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, Oregon’s State policy mandating 

information sharing and a completely open process for PDL 

decisions may prevent the State from adopting Florida’s 

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 C ONTAIN M EDICAID D RUG C OSTS 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. Michigan’s 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 

State Estimated 

Market Shift Savings in First Year 

Savings as 

Percent of State’s 

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 

only) 

7.1% 

Oregon 30 to 40% $6 to 8 million 

(projected) 

3.1 to 4.1% 

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 C ONTAIN M EDICAID D RUG C OSTS 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 

Sufficient “Amount, Duration, and Scope” of 

Benefits, 25 States Limit the Quantity of Drugs 

Used as a Central Strategy to Contain Costs 

State Medicaid agencies may 

limit prescription drug utilization 

as long as these restrictions 

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 C ONTAIN M EDICAID D RUG C OSTS 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: 

utilization review, pharmacy lock in 

11 

Total 25 

quantity limits, prospective drug 

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 C ONTAIN M EDICAID D RUG C OSTS 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 

State Type of Limit Annual Savings 

(in millions) 

Savings as Percent 

of State’s FY 01 

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 C ONTAIN M EDICAID D RUG C OSTS 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 

State Annual Savings 

(in millions) 

Savings as Percent 

of State’s FY 01 

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 C ONTAIN M EDICAID D RUG C OSTS 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 C ONTAIN M EDICAID D RUG C OSTS 29 
CONCLUSION

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 CMS’s efforts to provide 

consistent, timely, and pertinent information to State Medicaid 

pharmacy representatives. 

OEI - 05 - 02 - 00680 STATE STRATEGIES TO C ONTAIN M EDICAID D RUG C OSTS 30 
APPENDIX~A APPENDIX

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 

State 

Projected Annual 

Savings from PDL 

Savings as Percent 

of State’s FY 01 

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 C ONTAIN M EDICAID D RUG C OSTS 31 
ACKNOWLEDGMENTS

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 C ONTAIN M EDICAID D RUG C OSTS 32 
END NOTES

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 C ONTAIN M EDICAID D RUG C OSTS 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 C ONTAIN M EDICAID D RUG C OSTS 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 

State’s 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 Legislature’s Pharmaceutical Snapshot, 

March 3, 2003. Available at www.nscl.org 

42. 42 CFR § 447.54 

OEI - 05 - 02 - 00680 STATE STRATEGIES TO C ONTAIN M EDICAID D RUG C OSTS 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 Legislature’s 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 C ONTAIN M EDICAID D RUG C OSTS 36