Medicaid is a federal-state entitlement program that pays for health care and related services on behalf of certain low-income individuals. All states participate in Medicaid, but participation is not required. If states participate, then under federal Medicaid law they are required to provide health service benefits to certain individuals—mandatory eligibility groups—but states have the option of covering other groups too. Similarly, states must cover certain services for mandatory eligibility groups, but they have the option to cover fewer services for other eligibility groups. In general, Medicaid health benefits are broad for mandatory eligibility groups, but more restricted for other eligibility groups. Prescription drugs are an optional Medicaid benefit, but all states cover outpatient drugs. States may create formularies, lists of preferred drugs, but federal rules tend to result in comprehensive coverage, even for beneficiaries enrolled in Medicaid managed care plans. Since 1990, pharmaceutical manufacturers who voluntarily agree to participate in Medicaid are required to rebate a portion of drug payments back to states. When a manufacturer participates in Medicaid, states must make most of their drugs available to Medicaid beneficiaries. States share the rebates they receive from drug manufacturers with the federal government. The drug rebates required under federal law help the state and federal Medicaid program receive manufacturers' lowest or best price . Beginning in 2010, drug manufacturers also were required to pay rebates on drugs provided to Medicaid beneficiaries enrolled in managed care. For the purpose of determining rebates, Medicaid distinguishes between two drug types: (1) single source drugs (generally, those still under patent) and innovator multiple source drugs (drugs originally marketed under a patent or original new drug application but for which there now are generic equivalents); and (2) all other, non-innovator, multiple source drugs. Rebates for the first category of drugs—drugs still under patent or those once covered by patents—have two components: a basic rebate and an additional rebate. Medicaid's basic rebate for single source and innovator multiple source drugs is the larger of either the difference between a drug's quarterly average manufacturer price (AMP) and the best price for the same period, or a flat percentage (23.1%) of the drug's quarterly AMP. Drug manufacturers owe an additional rebate when their unit prices for individual products increased faster than inflation. For all other drugs, the rebate is a flat percentage (13%) of a drug's quarterly AMP. States separately negotiate additional, supplemental, rebates with drug manufacturers in exchange for listing manufacturer products on the state's preferred drug list. State Medicaid agencies reimburse retail pharmacies for covered outpatient prescription drugs dispensed to Medicaid beneficiaries. Medicaid FFS payments to pharmacies for outpatient prescription drugs have two components: a payment to cover the cost of the pharmacy buying the drug (the ingredient cost) and a payment for the pharmacist's professional services in filling and dispensing the prescription (the dispensing fee). States, subject to the Centers for Medicare & Medicaid Services (CMS) approval, set reimbursement amounts for both ingredient costs and dispensing fees. Dispensing fees usually are a fixed amount, intended to cover the procuring and storing drugs, consultation, and dispensing drugs. The ingredient cost component of the pharmacy payment is an approximation of a drug's market price which is intended to reimburse the pharmacy for the cost of acquiring the drug. To encourage substitution of lower-cost generic equivalent drugs for more expensive sole source drugs, federal law requires CMS to set a maximum on what it will pay for certain multiple source drug ingredients. The maximum multiple drug ingredient payments are called federal upper limits (FULs). Based on state FY2013 Medicaid financial reports, Medicaid FFS outpatient prescription drug expenditures, net of federal and state rebates, were $16.2 billion, down from $30.7 billion in FY2005 ( Figure 1 ). However, decreases in Medicaid FFS drug expenditures do not represent an overall decrease in Medicaid prescription drug expenditures, because there have been prescription drug industry trends as well as a number of statutory changes that have shifted Medicaid drug expenditures to other spending accounts. For instance, beginning January 1, 2006, prescription drug coverage of disabled and elderly Medicaid beneficiaries—those covered by both Medicare and Medicaid (dual eligibles)—was moved from Medicaid to Medicare Part D. Dual eligibles accounted for a considerable portion of Medicaid drug expenditures, and as a result, when they were moved to Medicare Part D, Medicaid drug expenditures decreased. A maintenance of effort (MOE) provision in federal Medicare law required states to continue to pay the vast majority of dual eligible drug costs. Another factor that contributed to the decline in FFS drug expenditures is the recent escalation in the movement of Medicaid beneficiary drug coverage from FFS to managed care contracts that include drug coverage. One indicator of the movement to managed care coverage of drugs was the growth in managed care rebates, which were required beginning in FY2010. In FY2011, states collected $932 million (national and state supplemental rebates) in managed care rebates, which increased to $4.7 billion in FY2013 ( Table 5 ). Another indicator of the migration to managed care is the change in the number of FFS drug claims, which declined by almost 25% between FY2011-FY2012 ( Table C-1 ). Decreased drug claims for five states accounted for over 90% of the decrease. The statutory changes helped to increase overall rebate collections, which had the effect of reducing net drug expenditures. States reported collecting a total of $11.7 billion in federally required FFS rebates and an additional $726 million in state FFS supplemental drug rebates, and $4.7 billion in managed care rebates for a total of $17.2 billion in FY2013 ( Table 7 and Table 6 ). Other factors that contributed to the decline in FFS drug expenditures were drug industry trends and changes in Medicaid laws applicable to prescription drugs. The drug industry patent cliff, where a number of blockbuster drugs came off patent over a few years, reduced Medicaid FFS drug costs as these drugs became available as cheaper generic products. Selected other Medicaid FFS prescription drug data show that average FY2013 per-person Medicaid prescription drug expenditures were just over $926 ( Table 11 ), down from $1,509 in FY2005. In FY2012, Medicaid on average paid approximately $282 for single source prescription drug claims, $149 for innovator multiple source claims, and $18 for non-innovator multiple source drug claims ( Table 12 ). Medicaid's generic prescribing rate for all states varies; the national average in FY2012 was 76% ( Table D-1 ). The Patient Protection and Affordable Care Act (ACA, P.L. 111-148 ) made a number of modifications to federal Medicaid law. The CMS published a proposed rule that provided guidance on implementation of the ACA changes in February 2012. A final rule that would codify many of the new Medicaid drug requirements is pending as of the date of this report. In December 2013, Sovaldi ® a new brand name drug was approved by the Food and Drug Administration for treatment of hepatitis virus C (HVC) infections. Sovaldi was estimated to cost $1,000 per pill and total treatment cost estimates can range from $84,000 to more than $168,000. Through federal health programs, including Medicaid's prescription drug benefit, federal and state governments may pay the majority of HVC treatment costs. Sovaldi has raised an issue because of its high price and that many individuals with HCV infections are covered by Medicaid. For Medicaid, states and the federal government will receive rebates for Sovaldi that will help reduce the drug's cost, but until other equivalent drugs are available to increase competition, states may have limited leverage to negotiate additional manufacturer price concessions. Medicaid rebates, while buffering the cost of prescription drugs somewhat, might also contribute to drug manufacturers setting increasingly higher launch prices. Medicaid's drug pricing and policy have been effective in helping to control Medicaid FFS drug expenditures. Outpatient drug expenditures have decreased and Medicaid is able to buy drugs for lower prices than Medicare Part D plans, the other major federal outpatient prescription drug purchaser. Congress has been instrumental in establishing state and federal authority to ensure Medicaid receives manufacturers' lowest prescription drug prices. Congress authorized creation of Medicaid program infrastructure to manage, monitor, and enforce prescription drug pricing. However, if the pace in the movement of Medicaid enrollees to managed care that includes prescription drug benefits continues, then prescription drug oversight may be more difficult. The current Medicaid drug pricing and policy infrastructure was designed for FFS, and may not work as well with significant managed care enrollment. States have authority to collect rebates under managed care arrangements, although how state supplemental rebates will align with managed care plan drug discount negotiations is unclear. Under managed care contracts, states generally delegate some or all of drug utilization review and individual drug claim oversight to plans, including program integrity. When managed care and PBMs are responsible for these activities, states have responsibility for ensuring plans uphold their contract obligations. States' prescription drug monitoring is tailored to FFS drug claims, and it is unclear how much oversight of managed care claims states will be able to provide. If states and the federal government currently procure drugs for Medicaid beneficiaries at some of the lowest prices, will it be possible for managed care plans and PBMs to further reduce costs without imposing barriers to Medicaid beneficiaries in obtain covered drugs? Medicaid drug pricing and policy is complex, in part because prescription drug markets are dynamic. Drug manufacturers and wholesalers adapt to policy and statutory changes by creating new products and new marketing approaches that sometimes circumvent Medicaid pricing rules. Drug companies and health insurers operate in private markets in which they are seeking private advantages to earn revenue and profits. Medicaid pricing policies are, in part, based on competitive market transactions. Even though Medicaid buys drugs through the same markets as other payers, federal law requires drug companies, operating through wholesalers and distributors, to sell drugs to Medicaid at discounted prices.