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.