Changes in Medicaid Reimbursement: Implications for Generic Manufacturers and Pharmacies

According to the most recent data, the Medicaid program pays for the prescription drugs of approximately 44 million Medicaid fee-for-service patients. By the second quarter of 2010, Medicaid had paid for more than 266 million prescriptions, with these prescription drug costs totaling about $20 billion dollars. Medicaid is expected to expand in 2014 as a result of the new health care reform law. About 16 million more people, primarily adults, are expected to be added to the program, significantly increasing the number of prescriptions paid for by Medicaid. This will have an impact on generic drug manufacturers as well as pharmacies. Thus, Medicaid pharmacy reimbursement policies are critical to pharmacies, wholesalers, and generic-drug manufacturers.

Generic Use Helps Medicaid Save Billions

The Medicaid program—at both the federal and the state level—can save billions of dollars by increasing the use of high-quality, low-cost generic medications. As the Congress and state lawmakers debate ways to improve the Medicaid program, lawmakers should consider policies to promote the use of cost-saving generic medications. 

  • About 69% of all Medicaid prescriptions are dispensed with generic medications, but those prescriptions represent only about 20% of total Medicaid drug-program spending. The remaining 31% dispensed with higher-cost brands make up 80% of Medicaid drug-program spending
  • The average brand prescription costs Medicaid about $200, which is 10 times more than the average generic prescription cost of $20 If generic medication use was increased by just 1%, Medicaid would save $682 million in one year. If generic use was increased by 5%, $3.4 billion would be saved
  • Many states have Medicaid generic dispensing rates that are less than the national average of 69%. If states increased these rates just to the national average, the states and the federal government would save hundreds of millions of dollars.

Reimbursement policies are a key driver in determining generic dispensing rates. Lower generic-drug reimbursement may reduce incentives for pharmacies to dispense generics.

Currently, most states still base reimbursement to pharmacies for brand-name drugs on the average wholesale price (AWP) or the wholesale acquisition cost (WAC), while generic reimbursement is based on federal upper limits (FULs), which are set by the Centers for Medicare and Medicaid Services (CMS) or state-based maximum allowable costs (MACs), which are usually lower than the FULs. States can apply their MACs to more drugs than just those with FULs. States also pay a dispensing fee for each prescription, although the fees are usually lower than pharmacies’ actual cost of dispensing, which remains in the range of about $11 per prescription. 

Some states, such as Alabama and Oregon, have moved to a reimbursement system based on actual acquisition cost (AAC) for drug product reimbursement. The AAC amounts are determined based on surveys of pharmacy purchasing invoices. The dispensing fees in these situations are usually higher than average, approximating the pharmacy’s cost of dispensing, because there is no “margin” for the pharmacy on acquisition cost–based reimbursement. For example, in Oregon the pharmacy dispensing fee is tiered but averages $10.65, while in Alabama it averages $10.64 per prescription. 

More changes are in store for Medicaid pharmacy reimbursement. The new Patient Protection and Affordable Care Act (PPACA) of 2010 included changes to Medicaid reimbursement policies that were originally enacted in the Deficit Reduction Act (DRA) of 2005. The 2005 law moved Medicaid pharmacy reimbursement—specifically the setting of the FULs—to an average manufacturer price (AMP)–based reimbursement system for generic medications. Previously, FULs were based on the AWP or WAC, which policy makers believed did not reflect pharmacies’ costs of purchasing these drugs. These 2005 changes were never implemented, however, because of a court injunction that has since been lifted, but it is likely that AMP-based reimbursement will be coming soon to Medicaid programs.

What Is AMP?

AMP was originally created in a federal law known as OBRA 90 (Omnibus Budget Reconciliation Act of 1990) as a benchmark for manufacturers to determine the basis of rebates that they would have to pay to states for drugs dispensed to Medicaid patients. The rebate program, still in effect today, is supposed to reduce the cost of drugs for Medicaid programs. Quarterly rebates are paid by brand and generic companies based on their utilization in the state Medicaid program, although brand drugs pay a higher amount than generic drugs. 

AMP did not exist before 1990. It was created because it was generally recognized that the AWP was not really a transaction price, and that it would be unfair to base manufacturer rebates to states on a price that did not accurately reflect market transactions and the actual revenues received by manufacturers. 

AMP was supposed to reflect prices paid by retail community pharmacies for prescription drugs, because almost all Medicaid drugs are provided through such pharmacies. Thus, manufacturers would pay back a percentage of the revenues they actually received on sales of drugs to Medicaid through community retail pharmacies. 

Even though the law mandated changes in Medicaid pharmacy reimbursement in 2005, CMS never published a final regulatory definition of AMP until 2007. Under the 2005 law, reimbursement for a particular multiple-source drug, as reflected by the FULs, was to be changed from 150% of the lowest published price (WAC or AWP) to 250% of the lowest AMP.This change was expected to reduce pharmacy reimbursement by billions of dollars, creating concerns among the pharmacy community that many pharmacies with a significant number of Medicaid patients, such as small pharmacies in urban and rural areas, would be hardest hit by these reductions. 

In fact, various government reports after the 2005 law was enacted suggested that this new benchmark would not cover pharmacies costs of purchasing generic drugs. Making matters worse, states could even further reduce the FULs for reimbursement purposes. This fact exacerbated concerns among the pharmacy supply chain that generic-drug reimbursement would be squeezed down hard, with the result that generic-drug dispensing would be reduced. 

In fact, two Government Accountability Office (GAO) studies found that use of 250% of the lowest published AMP to set FULs would have underpaid pharmacies by 36%. The AMP-based reimbursements could have averaged about 78% below what pharmacies were getting paid. An economic analysis of this Medicaid FUL reimbursement policy found that 11,000 pharmacies would have closed had the policy been implemented. That means about 20% of all pharmacies could have closed. Such an outcome could have devastated the community pharmacy infrastructure that is relied on by millions of Medicaid, Medicare, and other patients every day to obtain their pharmacy services. 

Community pharmacy believed that the July 2007 CMS regulation implementing the 2005 changes had several flaws that did not follow the intent of Congress. The National Association of Chain Drug Stores (NACDS) and the National Community Pharmacists Association (NCPA) filed suit in federal court against CMS and won an injunction in December 2007, staying certain parts of the regulation relating to pharmacy reimbursement and the public posting of AMP data.

According to the retail pharmacies, the AMP definition finalized in 2007 did not reflect the statutory intent of Congress that the AMP should only include retail pharmacy prices. To their consternation, CMS required manufacturers to include in the AMP any price for a drug dispensed in an outpatient setting, including hospitals, mail order, pharmacy benefit managers (PBMs), physician offices, and others. 

Pharmacies believed that this would result in an AMP that would not reflect their costs of purchasing—especially for brands—and they won an injunction on the regulation. As of December 15, 2010, the NCPA and NACDS reached an agreement with CMS to dismiss the Medicaid AMP lawsuit. This was made possible by CMS’s withdrawal of the last remaining provisions of the AMP rule that had been blocked by a preliminary injunction following the litigation. This injunction has helped to avert billions of dollars in Medicaid generic-drug reimbursement reductions to community pharmacies.

How Did the Health Care Reform Law Change Medicaid Pharmacy Reimbursement?

The PPACA of 2010 made significant changes to the original Medicaid pharmacy reimbursement changes in the 2005 DRA law. These changes were made in response to concerns that the original DRA law excessively reduced Medicaid generic pharmacy reimbursement and that CMS did not correctly implement the law as originally intended by Congress. 

Provisions in the health care reform law, which went into effect as of October 1, 2010, reversed some of the reductions in generic reimbursement by modifying the definition of AMP so that it includes only manufacturers’ sales to retail community pharmacies, increasing the AMP. When calculating AMP, manufacturers are required by law to exclude the following: 

  • Customary prompt pay discounts extended to wholesalers
  • Bona fide service fees paid by manufacturers to wholesalers or retail community pharmacies, including (but not limited to) distribution service fees, inventory management fees, product stocking allowances, and fees associated with administrative services agreements and patient care programs (such as medication compliance programs and patient education programs)
  • Reimbursement by manufacturers for recalled, damaged, expired, or otherwise unsalable returned goods
  • Payments received from, and rebates or discounts provided to, PBMs, managed care organizations, health maintenance organizations, insurers, hospitals, clinics, mail-order pharmacies, long-term care providers, manufacturers, or any other entity that does not conduct business as a wholesaler or a retail community pharmacy
  • Discounts provided by manufacturers under the Medicare coverage gap discount program.

When calculating AMP, manufacturers should include the following:

  • Notwithstanding the listed exclusions, any discounts, rebates, payments, or financial transactions that are received by, paid by, or passed through to, retail community pharmacies. 

Taken together, this list of inclusions and exclusions means that manufacturers should be calculating an AMP that more closely reflects pharmacy acquisition costs than would have occurred under the original regulation. 

The new law also directs CMS to set Medicaid FULs for reimbursement of generics at a rate of “no less than 175 percent of the utilization-weighted average of the most recently reported monthly AMPs for pharmaceutically and therapeutically equivalent multiple source drug products that are available for purchase by retail community pharmacies on a nationwide basis.” This replaced the 2005 DRA requirement that FULs be set at 250% of the lowest AMP for a multiple-source drug. These factors combined should help ameliorate some of the reduction that would have taken place had the original law gone into effect. In addition, the NCPA secured report language that encourages the CMS secretary to increase the reimbursement even higher for small independent community pharmacies. 

The lifting of the 2007 injunction clears the way for CMS to eventually release new FULs based on 175% of the weighted-average AMP. CMS has not released an update to the FUL list in almost 2 years. When the list is next updated, only AB-rated (bioequivalent) drugs that are available by three sources of supply will be included. However, this list could be released at any time, given that the new law allows CMS to implement the new FULs without final regulations. 

A December 2010 GAO report validates that the new PPACA FUL reimbursement policy is more reasonable. For example, the GAO found that for most of the drugs in their sample, using AMP and other data from 2008, FULs based on the new FUL formula were higher than the average retail pharmacy acquisition costs. In the aggregate, the sum of the FULs based on the PPACA’s formula for all the drugs in the sample was 35% higher than the sum total of the pharmacy acquisition costs for these drugs. 

Thus, for the market basket of generic drugs studied by GAO, pharmacies would not have to take a loss on average on the ingredient cost component of these Medicaid generic prescriptions. However, it does not mean that pharmacies are being overpaid. Studies based on percentages do not give a sense of how much dollar revenues pharmacies are making on these prescriptions. Generics tend to have a lower dollar cost basis, so even if the FULs are 35% percent on aggregate higher than acquisition costs, it does not mean that pharmacies are being over paid. It could mean pennies in terms of the actual difference between the AAC and the FUL. 

The 2010 law also changed which data CMS would publish on a public Web site. The original DRA law called for CMS to publish individual AMPs for brand and generic medications. The goal was to give the marketplace additional data in addition to the AWP and WAC that could be used to determine pharmacy reimbursement. However, concerns were raised about how such individual AMP data would be used and whether the publication of all these data could actually reduce competition and lead to an increase in prices for some purchasers. As a result, the 2010 law only requires that CMS publish weighted-average AMPs for multiple-source drugs. 

The Future of AMP and Other Key Issues

Pharmacies and generic-drug companies have expressed concerns to CMS that without a formal AMP regulation or guidance, there could be significant variance among manufacturers in the calculation of AMP, and that could affect pharmacy reimbursement under the new FUL for generics. Manufacturers have been reporting monthly AMPs to CMS since November 2010 (for the month of October), given that the changes to the AMP took effect October 1, 2010, even though a regulation has not been published to date.

While the new PPACA law does provide more direction to manufacturers on how to calculate AMP, many questions remain that can likely only be addressed through more detailed direction from the agency, including, for example, the definition of bona fide service fees. However, the proposed regulation also needs to address other important implementation issues for both generic manufacturers and pharmacies. 

How to Calculate AMP for the Five “I” Drugs:Manufacturers that sell infusion, injection, inhalation, implantable, and instilled drugs (the five “I” drugs) can include nonretail pharmacy sales in their AMPs for these drugs if they are not generally dispensed through retail pharmacies. However, CMS has not indicated how it will interpret this phrase. Manufacturers may be making different assumptions about the cases in which a product is “not generally dispensed through a retail community pharmacy.” This is also important to pharmacies, as the AMPs for these drugs will likely be lower, meaning that reimbursement even at 175% of the weighted-average AMP could be lower than the acquisition costs. 

Reimbursement at Greater than 175%: How will CMS interpret Congressional intent to set FULs “at least 175% of the weighted-average AMP” for a particular multiple-source drug? Even if CMS sets FULs higher than 175%, nothing stops states from lowering them even further. Will CMS apply a higher multiplier to particular drugs or particular pharmacies, such as small rural pharmacies? The law also requires that only “nationally available” multiple-source drugs be used to set FULs. How will CMS determine if a particular drug meets this definition? 

Posting of Weighted-Average AMP Data: CMS will be publicly posting FUL data for 600 to 700 multiple-source drugs at 175% of the weighted-average AMP. Thus, it will be relatively easy to determine the weighted-average AMP for a particular multiple source drug. Individual AMPs will not be posted. But one issue relating to posting remains: How will the market react to the posting of weighted-average AMPs? Purchasers above the weighted average will obviously want to get a better price, while those below the weighted average will want to protect their “lower than average” price from price compression or equalization. How will third-party payers use the weighted-average AMPs? They might use them to set their own MACs once they have a better sense of this price point in the marketplace. 

Publication of AAC Data Based on Pharmacy Survey: CMS has indicated that it intends to publish a file that will include pharmacy acquisition cost data for Medicaid-reimbursed drugs.The data would be obtained from surveys of retail pharmacies. It is not clear whether the survey will include weighted-average or individual AACs. Moreover, it is not clear whether CMS has the authority to collect and publish such a file. CMS has said it would not allow states to use AAC-based reimbursement unless they increased the pharmacy dispensing fee. 

Updated on March of 2012: The CMS has contracted Myers & Stauffers to survey the retail pharmacy market for the National Average Drug Price and publish this file for viewing by the public at large as well as by the payor market. The OIG is convinced this data will go far in their efforts to create transparency in the marketplace and eliminate PBM spreads. Cash pricing will also be included in this survey which commenced as of December 2011. It is obvious that the CMS is attempting to establish a ceiling on pricing for all retail pharmacy sales and reimbursements.

State Initiatives to Determine Reimbursement:Regardless of CMS action, states are already acting to change their reimbursement to an AAC-based system. Both Oregon and Alabama have approved State Plan Amendments that move to AAC for product reimbursement plus a more accurate dispensing fee.

These changes could affect generic-drug dispensing if some of the economic incentives to dispense generics (such as a reduction in margin) are removed from the pharmacy’s reimbursement. CMS appears to be adopting a policy that only allows states to move to the AAC if they also increase the dispensing fee to more accurately reflect the pharmacies’ costs of dispensing prescriptions. 


Adequate Medicaid pharmacy reimbursement for generic drugs is critical to assuring that Medicaid maintains—and eventually increases—its generic dispensing rate. Lower cost generics create a win-win situation for pharmacies, generic manufacturers, and the federal and state Medicaid programs. The implementation of AMP-based reimbursement at 175% of the weighted-average AMP and the posting of weighted-average AMPs as modified in the PPACA of 2010, while an improvement over the DRA of 2005, could still have a dramatic impact on pharmacies and generic manufacturers. States also need to remember that pharmacies are the Medicaid program’s best partners in both promoting the use of generics and helping Medicaid patients manage their often complex drug therapies.

REFERENCE 1. Data provided by the Office of Inspector General