Prescription Drugs: Setting Fair Prices

Introduction | Evidence of Quality Improvements | Evidence of Savings | Key Considerations |Further Resources | State-by-State Ratings

The Policy

State Medicaid department adopts the Average Acquisition Cost (AAC) to calculate Medicaid drug reimbursement for pharmacies


States reimburse pharmacies for the drugs they purchase for Medicaid beneficiaries in a variety of different ways. At least forty states use a benchmark called Average Wholesale Price (AWP), combined with varying percentage-based discounts, to determine payments to pharmacies. The AWP benchmark is based on list prices set by manufacturers and does not reflect the actual payments made by pharmacies to manufacturers; this has meant that Medicaid overpays pharmacies. Due to court challenges, AWP will likely no longer be published as of September 2011, requiring most states to change their current formulas.

By reimbursing pharmacies based on Average Acquisition Cost (AAC), rather than AWP or another manufacturer-generated benchmark, states can reduce their prescription drug costs. AAC is based on the actual invoices drug manufacturers and wholesalers send to pharmacies, and thus reflects the actual cost of the drugs (also called ingredient costs) to the purchasing pharmacies. CMS has indicated its intention to promote AAC and has approved both the recent Alabama and Oregon plans to use this price benchmark.

Evidence of Quality Improvements

Changing the reimbursement formula does not affect prescription drug benefits provided to Medicaid beneficiaries. The president of the Medical Society of the State of Alabama and the director of the Oregon Health Authority affirmed that changing to AAC should not affect patients' access to care.

Evidence of Savings

Alabama, the first state to receive CMS approval for using AAC, has projected savings of $30.5 million in the first year, or 6.1 percent of its current fee-for-service drug expenditures of $500 million. The new method was announced September 22, 2010 and went into effect March 23, 2011.

Oregon expects to save $1.6 million, or 1 percent of its $160 million fee-for-service Medicaid drug expenditures. The Director of the Oregon Health Authority said Oregon's change to using AAC for reimbursement was not an effort to save money; rather Oregon's goal is to increase accuracy, since relying on the Average Wholesale Price set by the manufacturers is not seen as an accurate reimbursement tool.

Idaho, which is in the process of implementing AAC, expects to save $2 million in state general funds and $4.6 million in federal funds, for a total of $6.6 million.

Potential savings from using AAC will vary state by state, depending on the current formula being used.  Alabama and Oregon both publish online the data they collect on AAC reimbursement rates. Oregon updates its prices weekly, therefore any state program could compare its current reimbursement rates to Oregon's online data to determine whether the reimbursement model in a particular state is causing it to pay more than what Oregon pays using AAC.

Key Considerations

Effect of Medicaid Managed Care Organizations: The savings that a state can generate can be measured as a percentage of the money spent by the state on drugs for Medicaid fee-for-service beneficiaries. This is because, unless there is a prescription drug "carve-out," MCOs pay for their enrollees' drugs and generally contract with a Pharmacy Benefit Manager (PBM) to negotiate and manage reimbursements to pharmacies. MCOs wouldn't be affected by a change in the prescription payment formula used in Medicaid's fee-for-service benefits and thus could be paying higher rates. However, the state could change contracting rules to require MCOs (or their PBMs) to pay no more than the fee-for-service rate of AAC plus dispensing fee.

Increased Dispensing Fees: States typically pay a dispensing fee to the pharmacy to cover overhead. Dispensing fees may be different for brand-name vs. generic drugs, or other factors such as the size of the pharmacy (claims volume). Under the current AWP system in most states, pharmacies participating in state Medicaid programs make their money by collecting the dispensing fee and keeping the difference (the "spread") between what the pharmacy actually pays the manufacturer or wholesaler for the drugs and what Medicaid pays the pharmacy.

It may be that dispensing fees would have to be increased if pharmacies are reimbursed at cost, using AAC, because they could no longer make some of their income from the "spread" between the actual cost and an inflated reimbursement benchmark price. However, this would depend on the current dispensing fees, benchmarks and discounts.

In some past instances in which states have attempted to reduce reimbursement formulas, pharmacies have claimed that they could not operate with lower rates and have threatened to leave the Medicaid program. At the same time, pharmacies have refused to be transparent about actual drug costs so these complaints were impossible to evaluate. State advocates can expect such challenges, threats or appeals from pharmacies. Legitimate concerns can be addressed by increasing the dispensing fees, if appropriate. 

Determining AACOne of the barriers to implementation of AAC can be the work of collecting invoice data from pharmacies. To address this barrier, CMS has issued a request for proposals (RFP) for a project to collect actual cost data from pharmacies nationwide and publish it in databases that will allow state Medicaid programs to use this information to compare their own pricing methodologies and payments to those derived from this survey.

Further Resources

CMS keeps a state-by-state list of current prescription drug reimbursement formulas here.

Alabama and Oregon both publish their AAC reimbursement rates online, here and here.

State-by-State Ratings

Made the GradeMade the Grade Room to ImproveRoom to Improve (?) Made the GradeMiss the Mark

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