Department of Health and Human Services
 

OFFICE OF 
 

INSPECTOR GENERAL 
 

DEFICIT REDUCTION ACT OF 

2005: IMPACT ON THE MEDICAID 

FEDERAL UPPER LIMIT 

PROGRAM 

Daniel R. Levinson
 

Inspector General 
 

June 2007 
 

OEI-03-06-00400
 
Office of Inspector General 
 http://oig.hhs.gov 

The mission of the Office of Inspector General (OIG), as mandated by Public Law 95-452, as 

amended, is to protect the integrity of the Department of Health and Human Services (HHS) 

programs, as well as the health and welfare of beneficiaries served by those programs. This 

statutory mission is carried out through a nationwide network of audits, investigations, and 

inspections conducted by the following operating components: 

Office of Audit Services 

The Office of Audit Services (OAS) provides all auditing services for HHS, either by conducting 

audits with its own audit resources or by overseeing audit work done by others. Audits 

examine the performance of HHS programs and/or its grantees and contractors in carrying out 

their respective responsibilities and are intended to provide independent assessments of HHS 

programs and operations. These assessments help reduce waste, abuse, and mismanagement 

and promote economy and efficiency throughout HHS. 

Office of Evaluation and Inspections 

The Office of Evaluation and Inspections (OEI) conducts national evaluations to provide HHS, 

Congress, and the public with timely, useful, and reliable information on significant issues. 

Specifically, these evaluations focus on preventing fraud, waste, or abuse and promoting 

economy, efficiency, and effectiveness in departmental programs. To promote impact, the reports 

also present practical recommendations for improving program operations. 

Office of Investigations 

The Office of Investigations (OI) conducts criminal, civil, and administrative investigations of 

allegations of wrongdoing in HHS programs or to HHS beneficiaries and of unjust enrichment 

by providers. The investigative efforts of OI lead to criminal convictions, administrative 

sanctions, or civil monetary penalties. 

Office of Counsel to the Inspector General 

The Office of Counsel to the Inspector General (OCIG) provides general legal services to OIG, 

rendering advice and opinions on HHS programs and operations and providing all legal support 

in OIG’s internal operations. OCIG imposes program exclusions and civil monetary penalties 

on health care providers and litigates those actions within HHS. OCIG also represents OIG in 

the global settlement of cases arising under the Civil False Claims Act, develops and monitors 

corporate integrity agreements, develops compliance program guidances, renders advisory 

opinions on OIG sanctions to the health care community, and issues fraud alerts and other 

industry guidance. 
ΔINTROD UCT ION

 EXECUTIVE SUMMAR Y 
 

OBJECTIVES 

1.	 To compare Federal upper limit amounts under the previous 

calculation method to estimated pharmacy acquisition costs for 

selected high-expenditure drugs. 

2.	 To estimate how previous Medicaid Federal upper limit amounts 

may change under the new calculation method requiring payment 

limits for a drug to be set at 250 percent of the lowest average 

manufacturer price (AMP). 

3.	 To compare Federal upper limit amounts under the new calculation 

method to estimated pharmacy acquisition costs for selected highexpenditure drugs. 

4.	 To compare the lowest AMP to other AMPs for Federal upper limit 

drugs. 

5.	 To determine whether the relationship between the lowest AMP and 

other AMPs for selected high-expenditure drugs could help identify 

instances in which pharmacy acquisition costs may exceed the new 

Federal upper limit amounts. 

BACKGROUND 

Previous Office of Inspector General (OIG) work consistently found that 

the published prices that were used to set Medicaid Federal upper limit 

amounts often greatly exceeded prices available in the marketplace. 

Based in part on this work, the Deficit Reduction Act of 2005 (DRA) 

required that, beginning January 1, 2007, Medicaid Federal upper 

limits be based on 250 percent of the lowest AMP rather than on 

150 percent of the lowest price published in the national compendia. 

The Congressional Budget Office estimates that this will reduce 

Medicaid expenditures for Federal upper limit drugs by $3.6 billion over 

5 years. 

In response to these changes, industry groups have expressed concerns 

that pharmacies will not be able to acquire drugs for prices at or below 

the new Federal upper limit amounts. In an effort to ensure that 

Medicaid providers are reimbursed appropriately and, in turn, that 

Medicaid beneficiaries continue to have access to needed drugs, this 

study provides a preliminary assessment of the expected impact of the 

DRA reductions. 

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We identified all drugs on the Federal upper limit list in the second 

quarter of 2006. To estimate Federal upper limit amounts for these 

521 drugs under the new methodology set forth in the DRA, we obtained 

AMP data from the second quarter of 2006. We then multiplied the 

lowest AMP for each drug by 250 percent and compared the result to the 

actual Federal upper limit amounts from the second quarter of 2006, 

which were based on 150 percent of the lowest published prices. 

To estimate pharmacy acquisition costs, we collected second-quarter 

2006 sales and pricing data from five distributors for the 25 selected 

drugs with the highest total Medicaid expenditures in 2005 included on 

the Federal upper limit list. We then compared our estimate of 

pharmacy acquisition costs to the previous and new Federal upper limit 

amounts for each of the 25 selected high-expenditure drugs. 

To determine whether the lowest AMPs used to set the new Federal 

upper limit amounts were representative of other AMPs for the same 

drugs, we determined whether the lowest AMP was more than 

60 percent below the second-lowest AMP and/or volume-weighted AMP 

(weighted by the number of units reimbursed by Medicaid in 2005). In a 

recently issued proposed regulation, the Centers for Medicare & 

Medicaid Services (CMS) announced plans to use a similar threshold 

(70 percent) involving the second-lowest AMP to identify potential 

issues. We chose to use 60 percent in our analysis because whenever 

the lowest AMP exceeds this threshold relative to the second-lowest 

AMP, then the second-lowest AMP (and all other AMPs) for a drug 

would be higher than the new Federal upper limit amount. 

For any of the 25 selected high-expenditure drugs for which the secondlowest AMP and/or volume-weighted AMP exceeded our 60-percent 

threshold, we determined whether the estimated average pharmacy 

acquisition cost exceeded the new Federal upper limit amount. We 

repeated this analysis for drugs that did not exceed the 60-percent 

threshold. This analysis enabled us to determine whether, for these 

25 drugs, exceeding the 60-percent threshold was linked to a drug’s 

average acquisition cost being higher than new Federal upper limit 

amount. 

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FINDINGS 

For 23 of the 25 drugs under review, Federal upper limit amounts 

set under the previous calculation method were more than double 

the average pharmacy acquisition costs. Pre-DRA Federal upper 

limit amounts substantially exceeded our estimate of average pharmacy 

acquisition costs for the 25 selected high-expenditure drugs in the 

second quarter of 2006. For 23 of these 25 drugs, Federal upper limit 

amounts based on 150 percent of the lowest published price were more 

than double the average pharmacy acquisition costs. For 13 drugs, the 

second-quarter 2006 Federal upper limit amounts were at least 5 times 

higher. 

As intended by the Deficit Reduction Act of 2005, Federal upper limit 

amounts are likely to decrease under the new calculation method. 

We estimate that Federal upper limit amounts will decrease by a 

median of 61 percent under the new calculation method set forth in the 

DRA. Based on AMP data from the second quarter of 2006, we 

determined that Federal upper limit amounts for 492 of the 521 drugs 

(94 percent) under review would be reduced under the new DRA 

requirements, with 334 (64 percent) decreasing by at least half. Federal 

upper limit amounts for 90 of the 521 drugs would be at least 90 percent 

below the second-quarter 2006 amounts. 

Six of twenty-five selected high-expenditure drugs had estimated 

average pharmacy acquisition costs that would be below the new 

Federal upper limit amounts. Based on pricing and sales data 

provided by distributors, we determined that, on average, pharmacies 

would have been able to purchase only 6 of 25 selected high-expenditure 

drugs for less than the new Federal upper limit amounts during the 

second quarter of 2006. For the remaining 19 drugs, the average 

pharmacy acquisition costs would have been higher than the new 

Federal upper limit amounts that quarter. We estimate that 12 of these 

19 drugs had average pharmacy acquisition costs that would have been 

more than double the new reimbursement limit. For 13 of the 

25 selected high-expenditure drugs, at least one individual drug product 

was available for a price at or below the new Federal upper limit 

amount. 

The average manufacturer price used to set a new Federal upper 

limit amount may be substantially lower than other average 

manufacturer prices associated with a drug. For 14 percent of the 

drugs on the Federal upper limit list, the lowest AMP was more than 

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60 percent below the second-lowest AMP. In addition, for 29 percent of 

reviewed drugs, the lowest AMP was more than 60 percent less than the 

volume-weighted AMP. 

Among the 25 selected high-expenditure drugs, examining the 

volume-weighted AMPs helped identify instances in which 

pharmacy acquisition costs may exceed the new Federal upper 

limit amounts. In the second quarter of 2006, the lowest AMP was 

more than 60 percent below the volume-weighted AMP for 20 of the 

25 selected high-expenditure drugs under review. For all but one of 

these drugs, the estimated average pharmacy acquisition cost exceeded 

the new Federal upper limit amount. Likewise, for the five drugs for 

which the lowest AMP did not exceed the 60-percent threshold 

compared to the volume-weighted AMP, the average pharmacy 

acquisition costs were below the new Federal upper limit amount. In 

other words, in all but one case, determining whether or not the lowest 

AMP for any of the 25 selected high-expenditure drugs exceeded the 

60-percent threshold compared to the volume-weighted AMP would 

have accurately determined whether or not its average acquisition cost 

was higher than the new Federal upper limit amount. 

Examining the second-lowest AMP, rather than the volume-weighted 

AMP, was not as effective in identifying instances in which pharmacy 

acquisition costs exceeded the new Federal upper limit amount for the 

25 selected high-expenditure drugs. 

RECOMMENDATIONS 

The findings of this report again illustrate why changes to the previous 

calculation method were needed, as this method (based on published 

prices) led to inflated Medicaid payments for many high-dollar generic 

drugs. However, we have concerns that, at least initially, the new 

formula mandated by the DRA (based on lowest AMPs) may result in 

some Federal upper limit amounts that are below pharmacy acquisition 

costs. This could occur because for certain drugs the lowest AMPs may 

not reflect prices generally available in the marketplace. 

As part of the proposed Federal upper limit regulation, CMS announced 

plans to identify potential reimbursement issues by removing the lowest 

AMP if it appears to be an outlier. The proposed regulation defines an 

outlier as a lowest AMP that is more than 70 percent below the secondlowest AMP. We support CMS’s attempts to proactively resolve 

potential problems with the new formula. However, our analysis 

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(applying a more limited 60-percent threshold) indicates that using the 

second-lowest AMP may not alleviate all reimbursement issues. 

In addition to CMS’s efforts, drug manufacturers and pharmacies also 

have important roles in helping to ensure that the new Federal upper 

limit amounts are appropriate. Manufacturers of generic drugs should 

make certain that the AMPs they are reporting to CMS are accurate. In 

turn, pharmacies should inform CMS if the new Federal upper limit 

amounts are lower than the prices at which they can purchase certain 

drugs. 

We recognize that for various reasons (e.g., definitional changes in 

AMP, market forces, etc.), the relative relationship between the Federal 

upper limit amounts and other price points presented in this report may 

change once the new method of calculation is implemented. However, 

new Federal upper limit amounts should be monitored closely to help 

ensure that reimbursement changes do not lead to access problems for 

Medicaid beneficiaries. Specifically, we recommend that: 

CMS should take steps to identify when a new Federal upper limit amount 

may not be representative of a drug’s acquisition cost to pharmacies. 

These steps could include: 

•	 issuing a final regulation that would remove the lowest AMP 

from the Federal upper limit calculation when it is significantly 

lower than the volume-weighted AMP (rather than the secondlowest AMP) for a drug, 

•	 contacting manufacturers to verify reported data in situations 

for which the lowest AMP appears to be significantly lower than 

other AMPs for a drug, 

•	 examining Medicaid utilization data to ensure that the product 

on which the Federal upper limit is based is actually utilized in 

the marketplace, and 

•	 providing an opportunity for pharmacies to alert the States and 

CMS when they can demonstrate an inability to purchase a drug 

at prices at or below the new Federal upper limit amount. 

In situations where 250 percent of the lowest AMP may not be sufficient 

to cover pharmacy acquisition costs, CMS should determine the proper 

course of action (working with Congress, if necessary). 

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AGENCY COMMENTS AND OFFICE OF INSPECTOR GENERAL 

RESPONSE 

CMS concurred with our recommendation that the new Federal upper 

limit amount should be monitored closely during initial implementation 

and agreed that manufacturers play an important role in this regard. 

However, CMS strongly disagreed with our findings concerning the 

effect of the DRA-related changes to the Federal upper limit calculation. 

CMS suggested that OIG should have waited until the final AMP 

regulation is promulgated before completing its study, stating “it is only 

after a final definition of AMP has been issued that an accurate analysis 

of the impact of DRA can be conducted.” Once that occurs, CMS 

believes that an analysis based on actual AMPs would yield 

substantially different results. CMS stated that the analysis in OIG’s 

report is deficient in numerous ways and such deficiencies lead to 

flawed results and misleading conclusions. Therefore, CMS requested 

that we (1) revise our analysis to address these flaws and (2) delay 

issuing this report while considering earlier discussions and working 

collaboratively with the agency. 

OIG will continue to work collaboratively with CMS in an effort to 

address any potential issues with the new calculation method for 

Federal upper limits. However, issuing this report prior to CMS’s 

publication of its final regulation provides the agency with the 

opportunity to consider our findings and incorporate our 

recommendations. The data presented in this report are the best 

available for the timeframe, and any limitations have marginal impact 

and do not change the overall findings and conclusions. We note that a 

similar report by the Government Accountability Office identified the 

same issues and reached similar conclusions. 

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Δ T ABLE OF CONTENTS 
 

EXECUTIVE SUMMARY ..................................... i 
 

INTR O D U C T I ON ........................................... 1 
 

FINDI NGS ................................................. 9 
 

For 23 of 25 drugs, previous limit was double acquisition cost.... 9 
 

Federal upper limits are likely to decrease substantially ....... 10 
 

Acquisition costs are below new limit for 6 of 25 drugs......... 11 
 

Lowest AMP may be substantially lower than other AMPs ..... 12 
 

Examining volume-weighted AMPs may help identify issues.... 13 
 

RECOM M E NDATI O NS ..................................... 15 
 

Agency Comments and Office of Inspector General Response . . . 16 
 

APPENDIXES ............................................. 21 
 

A. Detailed Methodology ............................... 21 
 

B. Agency Comments................................... 25 
 

ACKN O W LEDGMENTS .................................... 33 
 
Δ INTRODU C TION 
 

OBJECTIVES 

1.	 To compare Federal upper limit amounts under the previous 

calculation method to estimated pharmacy acquisition costs for 

selected high-expenditure drugs. 

2.	 To estimate how previous Medicaid Federal upper limit amounts 

may change under the new calculation method requiring payment 

limits for a drug to be set at 250 percent of the lowest average 

manufacturer price (AMP). 

3.	 To compare Federal upper limit amounts under the new calculation 

method to estimated pharmacy acquisition costs for selected highexpenditure drugs. 

4.	 To compare the lowest AMP to other AMPs for Federal upper limit 

drugs. 

5.	 To determine whether the relationship between the lowest AMP and 

other AMPs for selected high-expenditure drugs could help identify 

instances in which pharmacy acquisition costs may exceed the new 

Federal upper limit amounts. 

BACKGROUND 

Previous Office of Inspector General (OIG) work consistently found that 

the published prices that were used to set Medicaid Federal upper limit 

amounts often greatly exceeded prices available in the marketplace. 

Based in part on this work, the Deficit Reduction Act of 2005 (DRA), 

Public Law 109-171, made substantial changes to the way Federal 

upper limit amounts are to be calculated. Beginning January 1, 2007, 

Federal upper limits are to be based on 250 percent of the lowest 

reported AMP for each drug rather than 150 percent of the lowest price 

published in the national compendia. The Congressional Budget Office 

estimates that this new methodology will reduce Medicaid expenditures 

for Federal upper limit drugs by $3.6 billion over 5 years. 

In response to these changes, industry groups have expressed concerns 

that pharmacies will not be able to acquire drugs for prices at or below 

the new Federal upper limit amounts.1 In an effort to ensure that 

1 An example includes “Implications of Federal Medicaid Generic Drug Payment 

Reduction for State Policymakers.” National Association of Chain Drug Stores, February 

2006. 

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INTROD UCT ION

Medicaid providers are reimbursed appropriately and, in turn, that 

Medicaid beneficiaries continue to have access to needed drugs, this 

study provides a preliminary assessment of the expected impact of the 

DRA reductions. 

Medicaid Reimbursement for Prescription Drugs 

Currently, all 50 States and the District of Columbia offer prescription 

drug coverage under Medicaid. Medicaid beneficiaries typically obtain 

covered drugs from pharmacies. Pharmacies bill State Medicaid 

agencies using national drug codes (NDC), which are 11-digit identifiers 

that indicate a drug’s manufacturer, product dosage form, and package 

size. Pharmacies are then reimbursed for these drugs by State 

Medicaid agencies. In calendar year (CY) 2005, Medicaid payments for 

prescription drugs totaled over $41 billion.2 

Federal regulations require, with certain exceptions, that each State 

Medicaid agency’s reimbursement for covered outpatient drugs not 

exceed (in the aggregate) the lower of their estimated acquisition cost 

plus a reasonable dispensing fee or the provider’s usual and customary 

charge to the public for the drugs.3 The Centers for Medicare & 

Medicaid Services (CMS) allows States the flexibility to define 

estimated acquisition cost, with most States basing their calculation on 

list prices published in the national compendia. For certain drugs, 

States also use the Federal upper limit and/or State maximum 

allowable cost programs in setting reimbursement amounts.4 

Medicaid Federal Upper Limit Requirements Prior to January 1, 2007 

According to CMS’s Web site, the Federal upper limit program was 

created to ensure that the Federal Government acts as a prudent buyer 

by taking advantage of current market prices for multiple-source drugs.5 

2 Calculated using national summary data for 2005. This amount includes both Federal 

and State payments. Rebates collected by States under the Medicaid drug rebate program 

(section 1927 of the Social Security Act) were not subtracted from this figure. Available 

online at http://www.cms.hhs.gov/MedicaidDrugRebateProgram/SDUD/list.asp. Accessed 

on October 30, 2006. 

3 42 CFR § 447.331(b). On December 22, 2006, CMS issued a proposed regulation that 

would remove 42 CFR § 447.331 but include the unchanged substance of this section in a 

new section, 42 CFR § 447.512. 

4 Many States have implemented maximum allowable cost programs to limit 

reimbursement amounts for certain drugs. Individual States determine the types of drugs 

that are included in their maximum allowable cost programs and the methods by which the 

maximum allowable cost for a drug is calculated. 

5 Available online at http://www.cms.hhs.gov/FederalUpperLimits. Accessed on 

September 8, 2006. 

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For purposes of the time covered by our review, pursuant to section 

1927(e)(4) of the Social Security Act and 42 CFR § 447.332, CMS is 

generally to establish a Federal upper limit amount for a drug when 

three or more formulations of a drug have been rated as therapeutically 

equivalent by the Food and Drug Administration and at least three 

suppliers of the drug are listed in current editions (or updates) of the 

published compendia of cost information for drugs available for sale 

nationally (e.g., Micromedex “RedBook”). 

Prior to January 1, 2007, Federal regulations (42 CFR § 447.332) set the 

Federal upper limit amount at 150 percent of the lowest price published 

in the national compendia for therapeutically equivalent products that 

can be purchased by pharmacists in quantities of 100 tablets or 

capsules, plus a reasonable dispensing fee.

6 If the drug is not typically 

available in quantities of 100 or if the drug is a liquid, then the Federal 

upper limit amount is based on the price for a commonly listed size of 

the product. 

CMS publishes the Federal upper limit list in the “State Medicaid 

Manual” and on its Web site. Revisions to the list are typically noted on 

the Web site. CMS establishes a Federal upper limit for specific forms 

and strengths for each multiple-source drug on the list. As of June 30, 

2006, CMS had set Federal upper limit amounts for 530 drugs. 

According to CMS data, generic drugs included on the Federal upper 

limit list account for approximately 8 percent of total Medicaid 

expenditures for all prescription drugs. 

New Federal Upper Limit Requirements in Effect January 1, 2007 

Section 6001(a) of the DRA makes significant changes to the Federal 

upper limit program. As of January 1, 2007, a drug needs only two 

therapeutically equivalent versions to be included on the Federal upper 

limit list.7 Beginning that same date, Federal upper limit amounts are 

to be based on 250 percent of the lowest reported AMP for each drug 

rather than 150 percent of the lowest price published in the national 

compendia.8 

6 States are required to meet Federal upper limit requirements only in the aggregate, 

i.e., a State can pay more than the Federal upper limit amount for certain products as long 

as these payments are balanced out by lower payments for other products. 

7 Section 6001(a)(1)(B) of the DRA. 

8 Section 6001(a)(2) of the DRA. 

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For the period of time covered by this review, section 1927(k)(1) of the 

Social Security Act defines the AMP as the average price paid to the 

manufacturer for the drug in the United States by wholesalers for drugs 

distributed to the retail pharmacy class of trade after deducting 

customary prompt pay discounts. Pursuant to sections 6001(c)(1) and 

6001(c)(2) of the DRA, as of January 1, 2007, the AMP is required to be 

determined without regard to customary prompt pay discounts extended 

to wholesalers, and such discounts shall be reported separately to CMS. 

On December 22, 2006, CMS issued a proposed regulation to implement 

certain provisions of the DRA.

9 For example, 42 CFR § 447.504 of the 

proposed regulation outlines the manner in which the AMP is to be 

determined, and 42 CFR § 447.514 addresses the new criteria for the 

establishment of Federal upper limit amounts. The latter section 

(447.514(b)) implements the use of 250 percent of the AMP for the least 

costly therapeutically equivalent drug as the basis for Federal upper 

limit amounts. Section 447.514(c) of the proposed regulation establishes 

an alternative methodology to be used in setting Federal upper limit 

amounts if the lowest AMP is significantly below the next highest AMP 

for a drug. As further explained in the background to the proposed 

regulation, CMS will use the AMP of the lowest-priced therapeutically 

equivalent drug “except in cases where this AMP is more than 70 

percent below the second lowest AMP.”10 CMS is currently soliciting 

public comment on the proposed regulation. Section 6001(c) of the DRA 

requires CMS to publish a final regulation by July 1, 2007. 

In addition, prior to the enactment of the DRA, section 1927(b)(3)(D) of 

the Social Security Act prohibited the disclosure of AMP data except in 

certain narrow circumstances. At that time, AMP data were used 

primarily by CMS for purposes of the Medicaid drug rebate program. 

However, pursuant to sections 6001(a) and 6001(b) of the DRA, AMP 

data will also be used to calculate Federal upper limit amounts and will 

be made available to State Medicaid agencies and the public. These 

changes allow States to use AMP data in their determination of 

estimated acquisition costs for drugs covered under Medicaid.11 

9 Proposed Rule, “Medicaid Program; Prescription Drugs,” 71 Federal Register 77174. 
 

10 Ibid at 77188. 
 

11 OIG examines AMP-based reimbursement issues in “States’ Use of New Drug Pricing
 

Data To Establish Medicaid Reimbursement for Prescription Drugs” (OEI-03-06-00490) and 

“Examining Fluctuations in Average Manufacturer Prices” (OEI-03-06-00350). 

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Previous OIG Work Regarding the Federal Upper Limit Program 

In the past 3 years, OIG has issued four reports detailing potential 

problems with the Federal upper limit program.12 These reports focused 

on two main concerns: (1) qualified drugs were not being included on 

the Federal upper limit list in a timely manner and (2) Federal upper 

limit amounts often greatly exceeded pharmacy acquisition costs. For 

example, we found that Federal upper limit amounts were five times 

higher than average AMPs (a figure that we used as an estimate of 

pharmacy acquisition costs) in the third quarter of 2004. At that time, 

we recommended that CMS work with Congress to set Federal upper 

limit amounts that more closely approximate pharmacy acquisition 

costs. 

The findings and recommendations from all four reports were presented 

at several congressional hearings, with the most recent testimony 

delivered before the Senate Finance Committee in June 2005.13 

METHODOLOGY 

Please see Appendix A for a detailed methodology. 

Data Sources 

Using Federal upper limit data from CMS’s Web site and the national 

drug compendium “Redbook,” we identified the 530 drugs included on 

the Federal upper limit list in the second quarter of 2006. 14 We 

obtained Medicaid drug reimbursement and utilization data from CMS’s 

Web site and then identified the 25 drugs on the Federal upper limit list 

with the highest total Medicaid expenditures in CY 2005. 

For the 25 selected drugs with the highest total Medicaid expenditures 

in 2005, we collected second-quarter 2006 pricing and sales data from 

the three largest national distributors and two smaller regional 

12 “Omission of Drugs From the Federal Upper Limit List in 2001” (OEI-03-02-00670, 

February 2004); “Addition of Qualified Drugs to the Federal Upper Limit List” (OEI-03-04-

00320, December 2004); “Comparison of Medicaid Federal Upper Limit Amounts to Average 

Manufacturer Prices” (OEI-03-05-00110, June 2005); and “How Inflated Published Prices 

Affect Drugs Considered for the Federal Upper Limit List” (OEI-03-05-00350, September 

2005). 

13 Available online at http://www.oig.hhs.gov/testimony/docs/2005/50629-vito-fin.pdf. 

Accessed on September 8, 2006. 

14 In this report, “drug” refers to the specific drug name/dosage size/product form 

combination that is used as the basis for setting Federal upper limit amounts (e.g., 

Gabapentin 400 mg tablets). 

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distributors. According to industry sales reports, these three national 

companies account for the vast majority of market share among drug 

distributors. We obtained second-quarter 2006 AMP data from CMS. 

Data Analysis 

Estimating Pharmacy Acquisition Costs for Selected Drugs. To estimate 

average pharmacy acquisition costs for each of the 25 selected highexpenditure drugs, we totaled the dollar amount sold (net of any 

discounts or rebates, when provided) by the five distributors and divided 

this amount by the total number of units sold. For the purpose of this 

report, these estimates will hereinafter be referred to as “average 

pharmacy acquisition costs.” We also determined the lowest price 

reported to OIG by the distributors for any NDC associated with the 

25 drugs. 

Estimating Federal Upper Limit Amounts Under New Calculation Method. We 

determined the lowest AMP reported by manufacturers for each of the 

530 drugs on the Federal upper limit list in the second quarter of 2006. 

Of the 530 drugs on the list that quarter, 9 did not have AMP data for 

any nonterminated, therapeutically equivalent NDCs of a commonly 

listed size. Therefore, we did not include these nine drugs in our 

analysis. For the remaining 521 drugs, we multiplied the lowest AMP 

by 250 percent to estimate the new Federal upper limit amounts under 

the methodology mandated by the DRA. For the purpose of this report, 

these estimates will hereinafter be referred to as “new Federal upper 

limit amounts.” We calculated the difference between the new Federal 

upper limit amounts and the second-quarter 2006 Federal upper limit 

amounts for each of the 521 drugs. 

Comparing Pharmacy Acquisition Costs to Federal Upper Limit Amounts. We 

calculated the percentage difference between the second-quarter 2006 

Federal upper limit amounts and the average pharmacy acquisition 

costs for each of the 25 selected high expenditure drugs. We then 

calculated the difference between the new Federal upper limit amounts 

and the average pharmacy acquisition costs. We also compared the 

lowest price reported to OIG by the distributors for each drug with the 

new Federal upper limit amounts. 

Comparing the Lowest AMP to Other AMPs. To determine whether the 

lowest AMPs used to set the new Federal upper limit amounts were 

representative of other AMPs, we determined the second-lowest and 

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volume-weighted AMPs for each of the 521 drugs under review.15 We 

then compared the lowest AMP to both the second-lowest and volumeweighted AMPs for each of the 521 drugs and identified instances when 

the lowest AMP was more than 60 percent below either of these two 

figures.16 We subset out the results for the 25 selected high-expenditure 

drugs for further analysis. 

Determining Whether Other AMPs Could Help Identify Potential Issues. 

Among the 25 selected high-expenditure drugs, we identified any 

instances in which the lowest AMP was more than 60 percent below the 

second-lowest and/or volume-weighted AMP. For any of the 25 drugs 

that met this threshold, we determined whether the average pharmacy 

acquisition cost exceeded the new Federal upper limit amount. We 

repeated this analysis for any of the 25 drugs that did not meet the 

60-percent threshold. This enabled us to determine whether, for these 

25 drugs, exceeding the 60-percent threshold (compared to either the 

second-lowest or volume-weighted AMP) was linked to a drug’s average 

acquisition cost being higher than the new Federal upper limit amount. 

Limitations 

This study uses AMP data from the second quarter of 2006 to estimate 

Federal upper limit amounts under the new methodology mandated by 

the DRA. For some drugs, the lowest AMP may have increased or 

decreased by the time the changes took effect in January 2007. 

Furthermore, although sections 6001(a) and 6001(c)(1) of the DRA 

provide that new Federal upper limit amounts will be based on AMPs as 

computed without regard to customary prompt pay discounts, AMPs 

used in this study did reflect the customary prompt pay discounts 

offered by manufacturers, because this is how AMPs were reported at 

the time of our analysis. After January 1, 2007, AMPs that are used to 

15 We calculated the volume-weighted AMP among all NDCs for the drug by weighting 

the AMP for each individual NDC by the number of units of the NDC reimbursed by 

Medicaid in the second quarter of 2006. 

16 In its proposed regulation, CMS uses a 70-percent rather than a 60-percent threshold 

in comparing the lowest AMP to the second-lowest AMP. We chose to use 60 percent in our 

analysis because whenever the lowest AMP exceeds this threshold relative to the secondlowest AMP, then the second-lowest AMP (and all other AMPs) for a drug would be higher 

than the new Federal upper limit amount. For example, a drug with a lowest AMP of $0.40 

would have a new Federal upper limit amount of $1.00 ($0.40 times 250 percent). If the 

second-lowest AMP is higher than this new Federal upper limit amount (e.g., $1.01), then 

the lowest AMP would be at least 60 percent below the second-lowest AMP ($0.40 is 60.4 

percent below $1.01). 

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INTROD UCT ION 

calculate Federal upper limit amounts may be higher than earlier AMPs 

because customary prompt pay discounts should no longer be included. 

As mentioned previously, we asked distributors for the amount of 

discounts and rebates provided to purchasers. Two of the five 

distributors provided these data, which were then used in our 

acquisition cost calculations. However, the three remaining distributors 

did not provide discount and rebate data. Therefore, pharmacies’ 

bottom-line costs for some drugs may be lower than our estimates in 

instances for which discounts and rebates were not captured in our data 

collection. Two of the distributors that did not provide this information 

stated that discounts and rebates are not captured on a quarterly basis 

and are negotiated on a customer-by-customer basis, making it 

extremely difficult to supply these data. One distributor did not provide 

an explanation for the lack of discount and rebate data. In addition, we 

did not determine whether the prices reported by the distributors were 

nationally available to all pharmacies. 

Because many States use maximum allowable cost programs to further 

reduce drug expenditures, States may actually be reimbursing less than 

the Federal upper limit amount for certain drugs. Therefore, the 

differences between the pre-DRA Federal upper limit amount and the 

new Federal upper limit amount may overstate the actual changes to 

pharmacy reimbursement in these cases. 

This study examines only drugs that were on the Federal upper limit 

list as of the second quarter of 2006. Our review did not include any 

drugs that may be added to the list based on the expanded criteria set 

forth in the DRA (i.e., the establishment of Federal upper limits based 

on two rather than three therapeutically equivalent products). 

Finally, this study addresses Federal upper limit amounts and not 

dispensing fees paid to pharmacies for providing drugs to Medicaid 

beneficiaries. Both components of reimbursement are important to 

ensure that Medicaid reimburses pharmacies appropriately for 

prescription drugs. 

Standards 

This study was conducted in accordance with the “Quality Standards for 

Inspections” issued by the President’s Council on Integrity and 

Efficiency and the Executive Council on Integrity and Efficiency. 

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Δ FINDINGS 
 

For 23 of the 25 drugs under review, Federal 

upper limit amounts set under the previous 

calculation method were more than double the 

average pharmacy acquisition costs 

As in previous studies that found 

Federal upper limit amounts to be 

excessive, we estimate that 

Federal upper limit amounts 

under the pre-DRA methodology 

exceeded average pharmacy 

acquisition costs for each of the 25 selected high-expenditure drugs in 

the second quarter of 2006. For 23 of these 25 drugs, second-quarter 

2006 Federal upper limit amounts (based on 150 percent of the lowest 

published price) were more than two times higher than the average 

pharmacy acquisition costs. In 13 cases, second-quarter 2006 Federal 

upper limit amounts were at least five times higher. Table 1 illustrates 

the percentage difference between the actual Federal upper limit 

amounts and the pharmacy acquisition costs for the 25 selected drugs in 

the second quarter of 2006. 

Table 1: Comparison of Estimated Pharmacy Acquisition Costs to Previous Federal Upper Limit Amounts 

Drug 

Average Pharmacy 

Acquisition Cost 

Second-Quarter 

2006 Federal 

Upper Limit 

Amount Difference 

Lorazepam, 1MG, Tablet $0.040 $0.572 -93.0% 

Ranitidine Hydrochloride, 150MG, Tablet $0.030 $0.341 -91.2% 

Gabapentin, 300MG, Capsule $0.157 $1.308 -88.0% 

Gabapentin, 400MG, Capsule $0.203 $1.570 -87.1% 

Glyburide/Meformin Hydrochloride, 5MG-500MG, Tablet $0.142 $1.003 -85.8% 

Metformin Hydrochloride, 500MG, Tablet $0.055 $0.356 -84.5% 

Omeprazole, 20MG, Enteric Coated Tablet $0.638 $3.979 -84.0% 

Tramadol Hydrochloride, 50MG, Tablet $0.049 $0.307 -84.0% 

Paroxetine Hydrochloride, 20MG, Tablet $0.445 $2.520 -82.3% 

Gabapentin, 600MG, Tablet $0.447 $2.470 -81.9% 

Paroxetine Hydrochloride, 40MG, Tablet $0.517 $2.700 -80.9% 

Gabapentin, 800MG, Tablet $0.573 $2.959 -80.6% 

Metformin Hydrochloride, 1000MG, Tablet $0.091 $0.460 -80.2% 

Glimepiride, 4MG, Tablet $0.084 $0.410 -79.5% 

Glyburide, 5MG, Tablet $0.069 $0.283 -75.6% 

Potassium Chloride, 20MEQ, Tablet Extended Release $0.121 $0.463 -73.8% 

Acetaminophen/Propoxyphene Napsylate, 650MG-100MG, Tablet $0.049 $0.180 -72.8% 

Ribavirin, 200MG, Capsule $2.304 $7.576 -69.6% 

Albuterol Sulfate, 0.83%, Solution $0.041 $0.115 -64.3% 

Acetaminophen/Hydrocodone Bitartrate, 500MG-5MG, Tablet $0.032 $0.083 -61.6% 

Oxycodone Hydrochloride, 80MG, Tablet Extended Release $2.633 $6.118 -57.0% 

Oxycodone Hydrochloride, 40MG, Tablet Extended Release $1.445 $3.260 -55.7% 

Oxycodone Hydrochloride, 20MG, Tablet Extended Release $0.875 $1.837 -52.4% 

Zonisamide, 100MG, Capsule $0.657 $1.174 -44.0% 

Albuterol, 0.09MG/Actuation, Aerosol Solid (Inhaler) $0.335 $0.437 -23.3% 

Source: OIG analysis of second-quarter 2006 Federal upper limit amounts and drug distributor data, 2006. 

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F I NDING S 
 

As intended by the Deficit Reduction Act of 

2005, Federal upper limit amounts are likely to 

decrease under the new calculation method 

In an effort to lower inflated 

Federal upper limit amounts 

and bring Medicaid 

reimbursement for generic 

drugs more in line with actual costs, the DRA established a new method 

for determining Federal upper limit amounts. Using data from the 

second quarter of 2006 to assess the impact of the DRA changes, we 

estimate that Federal upper limit amounts will decrease by a median of 

61 percent under the new calculation method. Overall, based on secondquarter 2006 data, we determined that Federal upper limit amounts for 

492 of the 521 (94 percent) drugs under review would be reduced under 

the new DRA requirements, with 334 (64 percent) expected to decrease 

by at least half. Federal upper limit amounts for 90 of the 521 drugs 

would be at least 90 percent below the second-quarter 2006 amounts. 

Although our analysis indicates Federal upper limit amounts for the 

vast majority of included drugs may be substantially reduced as a result 

of the new law, we estimate that Federal upper limits for 29 drugs 

(6 percent) would increase. Table 2 describes the estimated changes to 

the 521 Federal upper limit drugs that were included in this part of our 

review. As mentioned previously, it is important to note that because of 

State maximum allowable cost programs, these percentage differences 

may not reflect the actual changes to pharmacy reimbursement for all 

drugs on the Federal upper limit list. 

Table 2: Estimated Changes to Federal Upper Limit 

 Amounts Under the DRA 

Difference Between 

New and Second Quarter 2006 

Federal Upper Limit Amount 

Number of 

Drugs 

Percentage of 

Drugs 

-99.9% to -90% 90 17.3 

-89.9% to -80% 59 11.3 

-79.9% to -50% 185 35.5 

-49.9% to -20% 129 24.8 

-19.9% to 0% 29 5.6 

0.1% to 19.9% 16 3.1 

20% to 49.9% 4 0.8 

50% to 79.9% 4 0.8 

80% and above 5 1.0 

 Total 521 100 * 

Source: OIG analysis of second-quarter 2006 AMP data, 2006. 

*Note: Percentages do not add to 100 because of rounding. 

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F I NDING S 
 

Six of twenty-five selected high-expenditure 

drugs had estimated average pharmacy 

acquisition costs that would be below the new 

Federal upper limit amounts 

Based on pricing and sales data 

provided by distributors, we 

determined that, on average, 

pharmacies would have been able 

to purchase 6 of the 25 selected 

high-expenditure drugs for less than the new Federal upper limit 

amount in the second quarter of 2006. For the remaining 19 drugs, 

average pharmacy acquisition costs would have been higher than the 

new Federal upper limit amounts. Twelve of these nineteen drugs had 

average pharmacy acquisition costs that would have been more than 

double the new limits. For one drug, the average acquisition cost would 

have been 18 times higher than the new Federal upper limit amount. 

Table 3 illustrates the percentage difference between the new Federal 

upper limit amounts and the pharmacy acquisition costs for the 

25 selected drugs in the second quarter of 2006. 

Table 3: Comparison of Estimated Pharmacy Acquisition Costs to New Federal Upper Limit Amounts 

Drug 

Average Pharmacy 

Acquisition Cost 

New Federal Upper 

Limit Amount Difference 

Albuterol, 0.09MG/Actuation, Aerosol Solid (Inhaler) $0.335 $0.767 -56% 

Ranitidine Hydrochloride, 150MG, Tablet $0.030 $0.042 -29% 

Acetaminophen/Hydrocodone Bitartrate, 500MG-5MG, Tablet $0.032 $0.039 -18% 

Gabapentin, 800MG, Tablet $0.573 $0.669 -14% 

Gabapentin, 600MG, Tablet $0.447 $0.476 -6% 

Oxycodone Hydrochloride, 80MG, Tablet Extended Release $2.633 $2.719 -3% 

Glimepiride, 4MG, Tablet $0.084 $0.077 9% 

Lorazepam, 1MG, Tablet $0.040 $0.033 21% 

Glyburide/Meformin Hydrochloride, 5MG-500MG, Tablet $0.142 $0.105 35% 

Potassium Chloride, 20MEQ, Tablet Extended Release $0.121 $0.086 41% 

Gabapentin, 300MG, Capsule $0.157 $0.108 45% 

Zonisamide, 100MG, Capsule $0.657 $0.405 62% 

Tramadol Hydrochloride, 50MG, Tablet $0.049 $0.027 82% 

Acetaminophen/Propoxyphene Napsylate, 650MG-100MG, Tablet $0.049 $0.024 104% 

Metformin Hydrochloride, 500MG, Tablet $0.055 $0.026 112% 

Omeprazole, 20MG, Enteric Coated Tablet $0.638 $0.299 113% 

Glyburide, 5MG, Tablet $0.069 $0.031 123% 

Paroxetine Hydrochloride, 40MG, Tablet $0.517 $0.158 227% 

Albuterol Sulfate, 0.83%, Solution $0.041 $0.011 273% 

Ribavirin, 200MG, Capsule $2.304 $0.400 476% 

Gabapentin, 400MG, Capsule $0.203 $0.030 577% 

Oxycodone Hydrochloride, 40MG, Tablet Extended Release $1.445 $0.191 657% 

Oxycodone Hydrochloride, 20MG, Tablet Extended Release $0.875 $0.080 994% 

Paroxetine Hydrochloride, 20MG, Tablet $0.445 $0.025 1,680% 

Metformin Hydrochloride, 1000MG, Tablet $0.091 $0.005 1,720% 

Source: OIG analysis of second-quarter 2006 AMP data and drug distributor data, 2006. 

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F I NDING S 

For 13 of the 25 selected high-expenditure drugs, at least one individual 

drug product was available for a price at or below the new Federal upper 

limit amount. In the second quarter of 2006, 13 of the 25 selected highexpenditure drugs had at least one associated NDC with an average 

price from a distributor that would have been at or below the new 

Federal upper limit amount. Of the remaining 12, there were 6 drugs 

for which even the lowest price would be at least double the new Federal 

upper limit amount. We did not determine whether the lowest-priced 

NDCs were nationally available to all pharmacies. 

The average manufacturer price used to set a new 

Federal upper limit amount may be substantially 

lower than other average manufacturer prices 

associated with a drug 

In the second quarter of 2006, 

the lowest AMP was more 

than 60 percent below the 

second-lowest AMP (among 

therapeutically equivalent 

products in a commonly-listed size) for 72 of the 521 listed drugs 

(14 percent). In other words, the second-lowest AMPs (and all other 

AMPs associated with the drug) for these drugs would be higher than 

the new Federal upper limit amount.

17 That same quarter, the lowest 

AMP for 149 of the 521 listed drugs (29 percent) was more than 

60 percent below the volume-weighted AMP.18 

Volume-weighted AMPs sometimes differed from the lowest AMPs by a 

large margin because NDCs associated with the lowest AMPs often 

accounted for a small portion of Medicaid utilization. For 109 of the 

521 drugs (21 percent) on the Federal upper limit list, the NDC with the 

lowest AMP was responsible for less than 2 percent of all units of the 

drug reimbursed by Medicaid in the second quarter of 2006. For 23 of 

these drugs, NDCs whose AMPs would be used to set the Federal upper 

limit accounted for less than 0.01 percent of the utilization, with 

14 having no utilization at all in the second quarter of 2006. 

17 For example, a drug with a lowest AMP of $0.40 would have a new Federal upper 

limit amount of $1.00 ($0.40 times 250 percent). If the second-lowest AMP is higher than 

this new Federal upper limit amount (e.g., $1.01), then the lowest AMP would be at least 

60 percent below the second-lowest AMP ($0.40 is 60.4 percent below $1.01). In its proposed 

regulation, CMS uses a 70-percent rather than 60-percent threshold in comparing the 

lowest AMP to the second-lowest AMP. 

18 We calculated the volume-weighted AMP among all NDCs for the drug by weighting 

the AMP for each individual NDC by the number of units of the NDC reimbursed by 

Medicaid in the second quarter of 2006. 

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F I NDING S 
 

Among the 25 selected high-expenditure drugs, 

examining the volume-weighted AMPs helped 

identify instances in which pharmacy acquisition 

costs may exceed the new Federal upper limit 

amounts 

In the second quarter of 2006, the 

lowest AMP was more than 

60 percent below the volumeweighted AMP for 20 of the 

25 selected high-expenditure 

drugs under review. In all but one 

of these cases, the average pharmacy acquisition costs exceeded the new 

Federal upper limit amount. Likewise, for the five drugs for which the 

lowest AMP did not exceed the 60-percent threshold compared to the 

volume-weighted AMP, the average pharmacy acquisition costs were 

below the new Federal upper limit amount. In other words, in all but 

one case, determining whether or not the lowest AMP for any of the 

25 selected high-expenditure drugs exceeded the 60-percent threshold 

compared to the volume-weighted AMP would have accurately 

determined whether or not its average acquisition cost was higher than 

the new Federal upper limit amount. 

Examining the second-lowest AMP was not as effective in identifying 

instances in which pharmacy acquisition costs may exceed the new 

Federal upper limit amounts. In the second quarter of 2006, the lowest 

AMP was more than 60 percent below the second-lowest AMP for 5 of 

the 25 selected high-expenditure drugs under review. In each of these 

cases, the average pharmacy acquisition cost was at least double the 

new Federal upper limit amount. 

However, 14 of the 20 high-expenditure drugs for which the lowest AMP 

did not exceed the 60-percent threshold compared to the second-lowest 

AMP also had pharmacy acquisition costs that were higher than the 

new Federal upper limit amount. In fact, for 6 of these 14 drugs, the 

lowest AMP was no more than 10 percent below the second-lowest AMP. 

Therefore, potential reimbursement issues for these 14 drugs would not 

have been identified by using the second-lowest AMP as a point of 

comparison during the second quarter of 2006. 

Table 4 on the following page illustrates the relationship between the 

new Federal upper limit amounts, average acquisition costs, secondlowest AMPs, and volume-weighted AMPs for the 25 selected highexpenditure drugs. 

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F I NDING S 
 

Table 4: Relationship Between New Federal Upper Limit Amounts, Estimated Acquisition Costs, and Other AMPs 

Drug 

Average 

Acquisition 

Cost Exceeds 

New Federal 

Upper Limit 

Lowest AMP 

More Than 

60 Percent 

Below Second 

Lowest AMP 

Lowest AMP 

More Than 

60 Percent 

Below VolumeWeighted AMP 

Albuterol, 0.09MG/Actuation, Aerosol Solid (Inhaler) 

Ranitidine Hydrochloride, 150MG, Tablet 

Acetaminophen/Hydrocodone Bitartrate, 500MG-5MG, Tablet 

Gabapentin, 800MG, Tablet 

Gabapentin, 600MG, Tablet 

Oxycodone Hydrochloride, 80MG, Tablet Extended Release X 

Glimepiride, 4MG, Tablet X X 

Lorazepam, 1MG, Tablet X X 

Glyburide/Meformin Hydrochloride, 5MG-500MG, Tablet X X 

Potassium Chloride, 20MEQ, Tablet Extended Release X X 

Gabapentin, 300MG, Capsule X X 

Zonisamide, 100MG, Capsule X X 

Tramadol Hydrochloride, 50MG, Tablet X X 

Acetaminophen/Propoxyphene Napsylate, 650MG-100MG, Tablet X X 

Metformin Hydrochloride, 500MG, Tablet X X 

Omeprazole, 20MG, Enteric Coated Tablet X X 

Glyburide, 5MG, Tablet X X X 

Paroxetine Hydrochloride, 40MG, Tablet X X X 

Albuterol Sulfate, 0.83%, Solution X X 

Ribavirin, 200MG, Capsule X X 

Gabapentin, 400MG, Capsule X X 

Oxycodone Hydrochloride, 40MG, Tablet Extended Release X X X 

Oxycodone Hydrochloride, 20MG, Tablet Extended Release X X X 

Paroxetine Hydrochloride, 20MG, Tablet X X 

Metformin Hydrochloride, 1000MG, Tablet X X X 

Source: OIG analysis of second-quarter 2006 AMP data and drug distributor data, 2006. 

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Δ RECOMME NDA TIONS 
 

Based in part on OIG work that consistently found that the published 

prices used to set Federal upper limit amounts often greatly exceed 

prices available in the marketplace, the DRA has substantially changed 

the way Medicaid Federal upper limit amounts are calculated. As of 

January 1, 2007, Federal upper limits are based on 250 percent of the 

lowest reported AMP rather than 150 percent of the lowest price 

published in the national compendia. 

The findings of this report again illustrate why changes to the previous 

calculation method were needed, as this method led to inflated Medicaid 

payments for many high-dollar generic drugs. Furthermore, using 

actual sales data (such as AMP) rather than published prices to 

calculate Federal upper limit amounts present several additional 

advantages, i.e., they are defined by statute, are based on real-world 

transactions, and can be audited. However, we have concerns that, at 

least initially, the new formula may result in some Federal upper limit 

amounts that are below pharmacy acquisition costs. This could occur 

because for certain drugs the lowest AMPs may not reflect prices 

generally available in the marketplace. 

As part of the proposed Federal upper limit regulation, CMS announced 

plans to identify potential reimbursement issues by removing the lowest 

AMP if it appears to be an outlier. The proposed regulation defines an 

outlier as a lowest AMP that is more than 70 percent below the secondlowest AMP. We support CMS’s attempts to proactively resolve 

potential problems with the new formula. However, our analysis 

(applying a more limited 60-percent threshold) indicates that using the 

second-lowest AMP may not alleviate all reimbursement issues. 

In addition to CMS’s efforts, drug manufacturers and pharmacies also 

have important roles in helping to ensure that the new Federal upper 

limit amounts are appropriate. Manufacturers of generic drugs should 

make certain that the AMPs they are reporting to CMS are accurate. In 

turn, pharmacies should inform CMS if the new Federal upper limit 

amounts are lower than the prices at which they can purchase certain 

drugs. 

We recognize that for various reasons (e.g., definitional changes in 

AMP, market forces, etc.) the relative relationship between the Federal 

upper limit amounts and other price points presented in this report may 

change once the new method of calculation is implemented. However, 

new Federal upper limit amounts should be monitored closely to help 

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R E C O MMENDA T I O N S 

ensure that reimbursement changes do not lead to access problems for 

Medicaid beneficiaries. Specifically, we recommend that: 

CMS should take steps to identify when a new Federal upper limit amount 

may not be representative of a drug’s acquisition cost to pharmacies. 

These steps could include: 

•	 issuing a final regulation that would remove the lowest AMP 

from the Federal upper limit calculation when it is significantly 

lower than the volume-weighted AMP (rather than the secondlowest AMP) for a drug, 

•	 contacting manufacturers to verify reported data in situations 

for which the lowest AMP appears to be significantly lower than 

other AMPs for a drug, 

•	 examining Medicaid utilization data to ensure that the product 

on which the Federal upper limit is based is actually utilized in 

the marketplace, and 

•	 providing an opportunity for pharmacies to alert the States and 

CMS when they can demonstrate an inability to purchase a drug 

at prices at or below the new Federal upper limit amount. 

In situations where 250 percent of the lowest AMP may not be sufficient 

to cover pharmacy acquisition costs, CMS should determine the proper 

course of action (working with Congress, if necessary). 

AGENCY COMMENTS AND OFFICE OF INSPECTOR GENERAL 

RESPONSE 

CMS concurred with our recommendation that the new Federal upper 

limit amount should be monitored closely during initial implementation 

and agreed that manufacturers play an important role in this regard. 

However, CMS strongly disagreed with our findings concerning the 

effect of the DRA-related changes to the Federal upper limit calculation. 

CMS suggested that OIG should have waited until the final AMP 

regulation is promulgated before completing its study, stating “it is only 

after a final definition of AMP has been issued that an accurate analysis 

of the impact of DRA can be conducted.” Once that occurs, CMS 

believes that that an analysis based on actual AMPs would yield 

substantially different results. CMS stated that the analysis in the OIG 

report is deficient in numerous ways and such deficiencies lead to 

flawed results and misleading conclusions. Therefore, CMS requested 

that we (1) revise our analysis to address these flaws and (2) delay 

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R E C O MMENDA T I O N S 

issuing this report while considering earlier discussions and working 

collaboratively with the agency. 

OIG will continue to work collaboratively with CMS in an effort to 

address any potential issues with the new calculation method for 

Federal upper limits. However, issuing this report prior to CMS’s 

publication of its final regulation provides the agency with the 

opportunity to consider our findings and incorporate our 

recommendations. The data presented in this report are the best 

available for the timeframe, and any limitations have marginal impact 

and do not change the overall findings and conclusions. We note that a 

similar report by the Government Accountability Office (GAO) identified 

the same issues and reached similar conclusions.19 

A detailed discussion of CMS’s specific comments is presented below. 

The full text of CMS’s comments is presented in Appendix B. 

Detailed Discussion of CMS Comments 

AMP-related issues: CMS stated that AMPs used in OIG’s analysis are 

lower than appropriate, noting that we did not account for the exclusion 

of prompt pay discounts from AMP starting in 2007 or other changes to 

AMP that may occur under the new AMP regulation. Therefore, OIG 

should have waited until this regulation takes effect before conducting 

this study. CMS also stated that it will not calculate Federal upper 

limit amounts based on AMPs for terminated products and that our 

analysis does not address this. Furthermore, CMS disagreed with our 

use of volume-weighted average AMPs in part of our analysis. The 

agency stated that current market volume is not indicative of a drug 

product’s national availability because of the incentives in the previous 

system that may have lead pharmacies to purchase drugs with the most 

inflated price. 

OIG addresses several of these issues in the report. While OIG does 

plan to undertake similar work once the new regulation goes into effect, 

it was also important to conduct a pre-implementation study to identify 

any potential issues with the new calculation method so that CMS could 

consider them in the development of its final regulation. 

19 “Medicaid Outpatient Prescription Drugs: Estimated 2007 Federal Upper Limits for 

Reimbursement Compared with Retail Pharmacy Acquisition Costs,” (GAO-07-239R, 

December 2006). Available online at http://www.gao.gov/new.items/d07239r.pdf. Accessed 

January 22, 2007. 

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R E C O MMENDA T I O N S 

We agree with CMS that the AMPs we used may have increased since 

the time of our analysis, as prompt-pay discounts are no longer included 

in manufacturers’ calculations. However, in previous studies, we found 

that prompt-pay discounts typically range from 1 percent to 3 percent— 

not a substantial enough margin to change the overall impact of the 

data presented in this report. In regard to terminated products, AMPs 

for terminated NDCs were excluded from our analysis and therefore 

were not a factor in our calculations. Finally, the lowest AMP, secondlowest AMP, and volume-weighted AMP were all important comparison 

points we used in our analysis. The advantages of using volumeweighted AMP are that (1) it reflects the products actually used in the 

marketplace; (2) it is very similar to the average sales prices used as the 

basis for Medicare drug reimbursement; and (3) based on our analysis of 

25 drugs, it was a more accurate predictor of drugs for which acquisition 

costs may exceed the Federal upper limit amount than was the secondlowest AMP. 

Acquisition cost-related issues. CMS stated that the acquisition costs 

presented in our report are higher than appropriate because (1) our 

analysis does not fully account for discounts and rebates, and (2) our 

analysis should have focused on the lowest acquisition costs available to 

pharmacies rather than the average acquisition costs. 

Overall, the data provided in this report are the best available for the 

timeframe. We note that CMS has also used these data to perform its 

own analysis. In this report, OIG states that we asked distributors to 

provide information on discounts and rebates, but only two of the five 

respondents did so. The other three distributors described the difficulty 

in capturing these data on a drug-by-drug basis. However, given the 

magnitude of the difference between the new Federal upper limit 

amount and pharmacy acquisition cost for a number of drugs, this 

limitation does not negate our underlying concerns. 

With respect to the lowest acquisition costs, numerous pricing points 

could have been used in our analysis. The lowest price reported by 

distributors is one important pricing point, and the report includes a 

subfinding that addresses how the new Federal upper limit amounts 

compare to these figures. Even when using the lowest price reported by 

distributors, potential reimbursement issues would still exist, as we 

found that the lowest acquisition costs for half of the drugs exceeded the 

new Federal upper limit amount. We chose the volume-weighted 

average acquisition cost for the primary analysis because it reflects the 

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R E C O MMENDA T I O N S 

prices of the drugs that pharmacies actually purchased and because we 

could not determine whether the lowest prices reported by distributors 

were readily available to most purchasers. 

Aggregate cost-related issues. Under current law, Federal upper limits 

apply in the aggregate. In other words, States may set reimbursement 

for some drugs at amounts above the Federal upper limit if other drugs 

are reimbursed at amounts that are below (as long as a State’s overall 

spending is below the aggregate spending that would occur at the 

CMS-determined Federal upper limit amounts). CMS stated that our 

analysis does not address the mitigating effects of applying Federal 

upper limits in the aggregate. 

OIG recognizes the importance of the aggregate concept and agrees with 

CMS that States should continue to use this flexibility when 

appropriate. However, balancing reimbursements above and below the 

Federal upper limit amounts while meeting the aggregate spending 

limit was easier when Federal upper limit amounts were highly 

inflated. Before the DRA-related changes, Federal upper limit amounts 

for most drugs exceeded acquisition costs (often by a large margin), 

meaning that few drugs would warrant an increase in their 

reimbursement amounts. Furthermore, the many drugs with Federal 

upper limit amounts above acquisition costs provided States with 

numerous choices for balancing out these price increases. 

With the move to AMPs as the basis for calculating Federal upper limit 

amounts, OIG anticipates that it will be more difficult to apply the 

flexibility afforded by an aggregate limit. Using our findings in this 

report as an example, reimbursement amounts for the 6 drugs with 

average acquisition costs below the Federal upper limit amount would 

need to be decreased sufficiently to balance out an increase in the 

reimbursement amounts for the 19 drugs with average acquisition costs 

above the new Federal upper limit amount. 

State maximum allowable cost programs. CMS stated that the comparison 

between pre- and post-DRA Federal upper limit amounts is improper 

because it does not account for the impact of State maximum allowable 

cost programs (i.e., States often pay less than the Federal upper limit 

amount for many drugs). 

OIG discusses the relevance of State maximum allowable cost to our 

findings in this report. The objective of this report was to determine 

how Federal upper limits were impacted under the DRA methodology, 

and we focused our analysis on that objective. 

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Attached chart containing CMS analysis. CMS attached a chart with its 

comments showing that, based on (1) February 2007 AMPs, 

(2) application of an outlier policy, and (3) the lowest reported 

acquisition costs, 20 of 25 drugs would be available at or below the new 

Federal upper limit amount. CMS also used the chart to conclude that, 

in the aggregate, pharmacies would not have been underreimbursed in 

the second quarter of 2006 if they all purchased drugs at the lowest 

price reported by distributors (but not at the average price). 

Even if OIG accepts CMS’s assumptions regarding the data presented in 

its chart (including the assumption that all pharmacies could have 

purchased the drug for the lowest report acquisition cost, discussed on 

pages 18 and 19), we continue to have concerns about the potential 

impact of the new Federal upper limit amounts for certain drugs. 

According to CMS’s aggregate calculations, pharmacies would have 

made up for a $3 million total quarterly loss on 24 of the 25 drugs in the 

second quarter of 2006 by receiving $11 million in excessive 

reimbursement for one drug, albuterol aerosol (a drug for which the new 

Federal upper limit amount was well above acquisition cost). In other 

words, pharmacies could make up (in the aggregate) for losses on most 

other drugs by filling albuterol prescriptions. However, pharmacies 

that do not sell a large volume of albuterol would find it difficult to 

receive adequate reimbursement for the entire group of drugs. 

Therefore, while OIG acknowledges the aggregate application of the 

Federal upper limit program, we also see important advantages to 

striving to set reimbursement for all drugs at appropriate levels, with 

cross-subsidies being limited whenever possible. 

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Δ APPENDIX~A 
 

DETAILED METHODOLOGY 

Data Sources 

Identifying Drugs for Review. Using data from CMS’s Web site and the 

national drug compendium “Redbook,” we identified all drugs included 

on the Federal upper limit list in the second quarter of 2006. Federal 

upper limit amounts for these drugs were based on 150 percent of the 

lowest price published in the national compendia. During that quarter, 

CMS had established Federal upper limits for 530 drugs. 

We then obtained calendar year (CY) 2005 Medicaid drug 

reimbursement and utilization data from CMS’s Web site and identified 

the 25 drugs (of the 530) on the Federal upper limit list with the highest 

total Medicaid expenditures that year.20 

Acquisition Cost Data. For the 25 listed drugs with the highest total 

Medicaid expenditures in 2005, we collected second-quarter 2006 pricing 

and sales data from the three largest national distributors 

(AmerisourceBergen, McKesson, and Cardinal Health)21 and two 

smaller regional distributors (Mutual Drug Company and Burlington 

Drug Company). Each distributor was asked to provide the total dollar 

amount sold, the amount of discounts and rebates paid to purchasers, 

the net dollar amount sold, the total number of units sold, and the 

average selling price during the second quarter of 2006 for all NDCs 

associated with the top 25 Federal upper limit drugs. 

AMP Data. We obtained AMP data for the second quarter of 2006 from 

CMS. 

Data Analysis 

Estimating Pharmacy Acquisition Costs for Selected Drugs. Among the 

five distributors, we totaled the dollar amount sold (net of reported 

discounts and rebates, when possible) for all NDCs associated with each 

of the 25 selected high-expenditure drugs, and divided this amount by 

the total number of units of each NDC sold. We also determined the 

20 CY 2005 reimbursement and utilization data were the most current available at the 

time of our sample selection. 

21 According to industry sales reports, these three national companies account for the 

vast majority of market share among drug distributors. 

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lowest price reported to OIG by the distributors for any NDC associated 

with the 25 drugs. 22 

Estimating Federal Upper Limit Amounts Under New Calculation Method. To 

estimate what Federal upper limit amounts would be under the new 

methodology set forth in section 6001(a) of the DRA, we determined the 

lowest AMP reported by manufacturers among NDCs associated with 

the 530 drugs on the Federal upper limit list in that quarter. 

Under 42 CFR 447.332 (in effect during the time of our review), a 

Federal upper limit amount should be based on the least costly 

therapeutically equivalent drug that can be purchased by pharmacists 

in quantities of 100 (or if the drug is not commonly available in 

quantities of 100, a commonly listed package size). In determining the 

lowest AMP for any given Federal upper limit drug, we examined only 

NDCs in a commonly listed size that were identified as therapeutically 

equivalent in either CMS’s drug product file23 or the national drug 

compendium “Redbook.” For the purpose of this study, AMPs for 

terminated NDCs were not used to estimate new Federal upper limit 

amounts.24 

Of the 530 drugs included on the Federal upper limit list in the second 

quarter of 2006, 9 did not have AMP data for any nonterminated, 

therapeutically equivalent NDCs of a commonly listed size. Therefore, 

we did not include these drugs in our analysis. For the remaining 

521 drugs, we multiplied the lowest AMP by 250 percent to estimate the 

new Federal upper limit amounts under the methodology mandated by 

the DRA. 

Comparing New and Second-Quarter 2006 Federal Upper Limit Amounts. For 

each of the 521 drugs included in our review, we calculated the 

percentage difference between the new Federal upper limit amounts 

(based on 250 percent of AMP) and the second-quarter 2006 Federal 

upper limit amounts (based on 150 percent of the lowest published 

22 One of the five distributors did not provide sales and utilization data broken down by 

the NDC. Therefore, this distributor’s data were not included in the determination of the 

lowest price for a drug. 

23 Available online at 

http://www.cms.hhs.gov/MedicaidDrugRebateProgram/09_DrugProdData.asp. Accessed on 

September 8, 2006. 

24 As reported in the national drug compendium “RedBook,” a terminated NDC is one 

assigned to a product that has been deactivated by a manufacturer. 

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APP E N D I X ~A 

price). We categorized the drugs into ranges based on the percentage 

increases or decreases in their Federal upper limit amounts. 

Comparing Federal Upper Limit Amounts to Pharmacy Acquisition Costs. 

We calculated the percentage difference between the second-quarter 

2006 Federal upper limit amounts and the average pharmacy 

acquisition costs for each of the 25 selected high-expenditure drugs. We 

then calculated the difference between the new Federal upper limit 

amounts (based on 250 percent of the lowest AMP) and the average 

pharmacy acquisition costs. For each of the 25 drugs, we also compared 

the lowest price reported by any of the distributors for any associated 

NDC to the new Federal upper limit amount. 

Comparing the Lowest AMP to the Other AMPs. To assess whether the 

lowest AMPs used to set the new Federal upper limit amounts were 

representative of other AMPs for the same drug, we determined the 

second-lowest and volume-weighted AMPs for each of the 521 drugs 

under review. In identifying the second-lowest AMPs, we limited our 

analysis to nonterminated, therapeutically equivalent NDCs of a 

commonly listed size. We calculated the volume-weighted AMP among 

all NDCs for the drug by weighting the AMP for each individual NDC by 

the number of units of the NDC reimbursed by Medicaid in the second 

quarter of 2006. We then compared the lowest AMP to the secondlowest and volume-weighted AMPs for each of the 521 drugs and 

identified instances in which the lowest AMP was more than 60 percent 

below either of these other two figures. 25 We subset out the results for 

the 25 selected high-expenditure drugs for further analysis. 

Determining if Other AMPs Could Help Identify Potential Issues. Among the 

25 selected high-expenditure drugs, we identified any instances in 

which the lowest AMP was more than 60 percent below the secondlowest and/or volume-weighted AMP. For any drugs that exceeded this 

threshold, we determined whether the average pharmacy acquisition 

costs exceeded the new Federal upper limit amount. We repeated this 

25 In its proposed regulation, CMS uses a 70 percent rather than a 60-percent threshold 

in comparing the lowest AMP to the second-lowest AMP. We chose to use 60 percent in our 

analysis because whenever the lowest AMP exceeds this threshold relative to the secondlowest AMP, then the second-lowest AMP (and all other AMPs) for a drug would be higher 

than the new Federal upper limit amount. For example, a drug with a lowest AMP of $0.40 

would have a new Federal upper limit amount of $1.00 ($0.40 times 250 percent). If the 

second-lowest AMP is higher than this new Federal upper limit amount (e.g., $1.01), then 

the lowest AMP would be at least 60 percent below the second-lowest AMP ($0.40 is 

60.4 percent below $1.01). 

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APP E N D I X ~A 

analysis for drugs that did not meet the 60-percent threshold. This 

analysis allowed us to determine whether exceeding the 60-percent 

threshold (compared to either the second-lowest or volume-weighted 

AMP) was linked to a drug’s average acquisition cost being higher than 

the new Federal upper limit amount for these 25 drugs. 

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Agency Comments 

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APPENDIX ~ B 
ΔAPP E N D I X ~A 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 David E. Tawes, Director of the Medicare and 

Medicaid Prescription Drug Unit. 

Other principal Office of Evaluation and Inspections staff from the 

Philadelphia regional office who contributed include Lauren McNulty 

and Jessica Demko. Central office staff who contributed include Sarah 

Craren, Cynthia Thomas, and Gina Maree. 

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