Executive Summary

This study explores how more efficient pharmacy benefits management—apart from drug manufacturer rebates—could save Medicaid an additional $74.4 billion over the next decade. These savings opportunities are compelling as the federal government and states strive to protect benefits and prepare for the Medicaid expansion authorized by the Affordable Care Act starting in 2014.

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Today, Medicaid remains an outlier among the nation’s large pharmacy benefits programs. In most states, Medicaid pharmacy payments are set by statute, not negotiated with pharmacies.

This report estimates the savings available if each state Medicaid program—both fee-for-service (FFS) and managed care—applied pharmacy best practices. Some states may contract with a pharmacy benefit manager (PBM) or Medicaid Managed Care Organization (MCO), but may impose restrictions on how they design formularies or negotiate with pharmacies. Likewise, some states may use a FFS approach that is more efficient than other approaches.

Regardless, states tend to save more when pharmacy reimbursements and dispensing fees are negotiated by PBMs or MCOs rather than set by state governments. States also save more when they resist a “one-size-fits-all” approach to formularies and instead allow them to be flexible and actively managed.

Experience in many states indicates that Medicaid pharmacy benefits can be more actively managed without compromising quality or access to medications for the unique and vulnerable populations that Medicaid serves. Likewise, widely varying payment levels—and per member per month (PMPM) costs—among state Medicaid FFS programs suggest that there is substantial room for improvement.

Key Savings Opportunities

Optimizing pharmacy benefit management tools and strategies in state Medicaid programs nationwide could save a total of $74.4 billion across the 10-year period 2014–2023, including $43 billion in federal savings and $31.4 billion in state savings. Components of these potential savings include:

  • $23.5 billion saved by increasing the use of generic drugs: State-administered Medicaid programs that do not already manage formularies are less effective at encouraging the use of generic medications. The average generic dispensing rate in the Medicaid FFS setting is 73%, compared to an average generic dispensing rate exceeding 80% in the Medicaid MCO setting.
  • $12.5 billion saved by negotiating market-based pharmacy dispensing fees: Medicare Part D and commercial sector plans negotiate market-based pharmacy dispensing fees that average less than half those set by officials in most state Medicaid programs.
  • $33.4 billion saved by using limited pharmacy networks: In most state Medicaid programs, every drugstore in the state is entitled to participate. State Medicaid programs could achieve greater savings by using a competitive process and negotiating better discounts from select drugstores that wish to participate in a limited pharmacy network.
  • $2.7 billion saved by encouraging the use of more affordable, preferred brands: Unlike PBMs, state Medicaid FFS programs generally do not aggressively encourage the use of more affordable, preferred brands through active formulary management.
  • $2.3 billion saved by reducing drug diversion, polypharmacy, fraud, and waste: Medicaid plans that are more actively managed detect patterns of fraud through use of tools like step therapy, audits, and pharmacy lock-in programs to help detect and avoid inappropriate utilization.

Rebates from Brand Drug Manufacturers Are Unrelated to Medicaid Pharmacy Payments

The statutory and supplemental rebates paid to Medicaid by brand-name manufacturers are determined separately from pharmacy dispensing fees and ingredient cost reimbursements. Increasing generic drug utilization will reduce drug manufacturer rebates, but will still generate net savings of $23.5 billion.

Although an increase in the use of generics reduces the use of brand drugs and the related rebate income they generate for states, the net savings to Medicaid FFS programs are nonetheless enormous, as reflected in our savings estimate.