e-Texas e-Texassmaller smarter faster governmentDecember, 2000
Carole Keeton Rylander
Texas Comptroller of Public Accounts

Recommendations of the Texas Comptroller

Chapter 8: Health and Human Services

Improve Texas’ Medicaid

Vendor Drug Program


Texas’ Vendor Drug Program for Medicaid recipients should consider contracting directly with a pharmacy benefit manager, and also expand its current list of drugs requiring a physician’s prior authorization to ensure that its pharmacy benefit is managed in a cost-effective manner that preserves quality of care.


Prescription drugs are a covered benefit of the Texas Medicaid program. In 1999, the state spent $945 million on prescription drugs for Medicaid recipients.[1] According to the Health Care Financing Administration (HCFA), the federal agency responsible for administering Medicaid, about 8 percent of all the funds spent by Texas Medicaid in 1997 went for prescription drugs.[2]

Prescription drug costs are one of the fastest-growing segments of health care spending nationwide. Since 1990, national spending for prescription drugs has tripled, and in the next eight years, spending is expected to increase from $112 billion in 2000 to $243 billion in 2008.[3] These costs are skyrocketing because physicians are prescribing more drugs; the prices of drugs in general are rising; and new drugs coming to market are significantly more expensive than their predecessors.[4] Texas’ Medicaid Vendor Drug Program, which provides prescription drugs to Medicaid recipients, reflects the national trend; its costs rose by 9 percent in 1998 and 15 percent in 1999.[5]

The Health and Human Services Commission (HHSC) is the official state Medicaid agency. The Texas Department of Health (TDH) administers the Vendor Drug Program, and the Department of Human Services (DHS) processes the Medicaid drug claims.

Medicaid Drug Rebate Program

In the federal Omnibus Reconciliation Act of 1990 (OBRA 90), Congress created a national Medicaid Drug Rebate Program to help control federal and state expenditures for Medicaid prescription drugs. The program, administered by the Medicaid Bureau of the federal Health Care Financing Authority (HCFA), requires drug manufacturers to enter into national rebate agreements as a condition of participation in Medicaid. HCFA calculates a unit rebate amount (URA) for each drug. For generic drug products, the URA is 11 percent of the average manufacturer’s price. For brand-name drugs, the URA is about 15 percent of the average manufacturer’s price or the difference between that price and the “best price” the drug sells for anywhere in the US, as determined by HCFA, whichever is lower.[6]

HCFA sends the states quarterly updates on the rebate to be collected per unit of each drug. In Texas, the Texas Department of Health’s (TDH) Vendor Drug Program tracks each prescription dispensed to Medicaid clients, calculates the rebate, and then bills drug manufacturers each quarter. Texas keeps about 39 percent of the drug rebates it collects and returns the rest to the federal government, in keeping with Medicaid’s federal matching-fund requirements. In fiscal 2000, Texas is expected to keep about $81 million in Medicaid drug rebates; this amount is expected to grow to $97 million in fiscal 2001.[7]

States are free to create a state Medicaid supplemental rebate program in addition to the federal rebate program. In addition, any state adopting a supplemental drug rebate program must report and share a percentage of the supplemental rebates (the same percentage as its Medicaid federal/state share) with the federal government. To date, California is the only state that has successfully implemented a comprehensive state supplemental drug rebate program.

Pharmacy Benefit Managers

Many states are seeking new ways to control sharply rising drug costs. One way is by using pharmacy benefit managers (PBM), companies that administer pharmaceutical benefits for health plans, HMOs, and employers by managing drug usage and obtaining discounts from both retail pharmacies and manufacturers.

PBMs are common in the private sector. In 1999, they managed an estimated 71 percent of all prescription drugs dispensed through retail pharmacies and covered by private third-party payers, such as private insurance companies and HMOs.[8] PBMs do not distribute drugs, instead, they encourage appropriate generic substitutions, negotiate for manufacturer rebates and lower retail pharmacy prices, and conduct chronic disease management programs. PBMs typically can negotiate discounts of 12 to 15 percent off the manufacturers’ average price to wholesalers.[9]

States are exploring this strategy as well. Georgia recently released a request for proposals for a PBM to cover 1.8 million persons, including both Medicaid recipients and state employees. Georgia estimates the program will save $40 million annually.[10] The governors of Vermont, New Hampshire, and Maine announced that they are accepting bids from PBMs to run a tri-state drug-buying pool.[11] In Texas, the State Employees Retirement System, the Teacher Retirement System, and several of the State University systems are already contracting with PBMs to provide pharmacy services for their employees.

PBMs are paid in a variety of ways. Often, an HMO will subcontract with a PBM to provide pharmacy benefit management services. Payments can be made via a fee-per-patient (capitated) or a fee-for-service basis. However, federal law specifies that for a state to be eligible to receive the federal Medicaid drug rebate, payments must be made on a fee-for-service basis. In some states, such as Pennsylvania, the Medicaid program contracts with HMOs to provide health services and the HMOs in turn contract with PBMs to provide pharmacy benefits. States that contract with an HMO on a capitated basis to provide both health services and pharmacy benefits are not eligible for the federal drug rebate.

Because Texas has kept its Medicaid HMO services separate from its Vendor Drug Program, it can take advantage of a PBM’s extensive experience in negotiating lower drug prices and still be eligible for the federal drug rebate.

Prior Authorization

PBMs specialize in implementing prior authorization, an important tool used to reduce rising drug expenditures. A drug requiring prior authorization is not dispensed automatically, but must first be approved by the state’s Medicaid office. Drugs assigned prior authorization status are less likely to be prescribed because the physician must fill out and submit a request to the state Medicaid office. If a request is not approved, the doctor is notified and asked to provide additional documentation. Some doctors avoid prescribing drugs that require prior authorization due to the additional administrative burden they entail.

Before 1993, state Medicaid programs could not require prior authorization except for a few drugs. OBRA 93 changed this limitation and allowed states to implement prior authorization for any prescription product. To do so, however, states must follow federal criteria, including the requirement that requests for authorization be answered within 24 hours.[12] According to HCFA, the 24-hour turnaround time requirement constitutes an administrative burden that has prompted many states to require prior authorization for only a limited number of drugs.[13]

The Texas Medicaid Vendor Drug Program uses prior authorization, but in a limited way, requiring it only for a handful of drugs that are rarely prescribed. Only one of these drugs, Nutropin, which is used to treat chronic renal insufficiency, was among the program’s top 200 drugs, as ranked by total expenditures in fiscal 1999.

While extensive use of prior authorization increases administrative costs, it can reduce overall Medicaid drug costs. For example, a generic drug often is therapeutically equivalent to a brand-name drug, but considerably less expensive. As noted above, requiring physicians to submit prior authorization requests for a brand-name product gives them an incentive to avoid using it. In some cases, moreover, a less-expensive brand-name drug that treats the same condition may be available even when a generic is not.

In fiscal 1999, for instance, Texas Medicaid paid more than 222,000 claims for prescriptions of Claritin, a non-sedating antihistamine used to treat allergies. Zyrtec is in the same drug class as Claritin and can be used to treat the same condition, but costs $14 less per prescription than Claritin.[14] In 1990, Texas Medicaid received 50 percent fewer claims for Zyrtec than for Claritin. By requiring prior authorization for Claritin but not for Zyrtec, the state could give physicians an incentive to prescribe the less-expensive drug when clinically appropriate. In fiscal 1999, Texas Medicaid paid a combined $18 million for these two drugs. If 20 percent of Medicaid’s Claritin users switch to Zyrtec, Texas Medicaid would save about $630,000 per year. Furthermore, if a PBM could negotiate a 5 percent rebate with Zyrtec’s manufacturer, Pfizer, Texas Medicaid could save an additional $347,000 annually.

Other examples point to similar savings. For example, requiring prior authorization for the drug Procardia XL, which is used to treat hypertension, would save the state about $420,000 per year even if only 20 percent of Procardia XL users switch to Adalat CC, a less-expensive drug used to treat the same condition. If a PBM were to negotiate a 5 percent rebate with Adalat CC’s manufacturer, Bayer, the Texas Medicaid program could save an additional $200,000 annually.

In 1997, the US Veteran’s Administration (VA) implemented a prior-authorization requirement for a number of drugs. The VA identified six classes of drugs that account for a major portion of the VA’s spending. In each of the classes, one drug can be obtained without prior authorization; any other drug in the class requires prior authorization. A recent study estimated this program has saved an amount equal to about 3 percent of the VA’s total pharmacy expenditures.[15]

Prior authorization is an important negotiating tool in California’s successful state supplemental drug rebate program, because it gives the state bargaining power with the pharmaceutical manufacturers. In 1999, California estimated the savings from this program to be about $121 million and its administrative costs to be about $6 million, or 5 percent of the savings accrued.[16]


The Health and Human Services Commission should contract directly with a pharmacy benefit manager (PBM) to administer the Medicaid Vendor Drug Program and to implement a state supplemental rebate.

PBM’s have considerable expertise in managing drug usage and obtaining rebates on drug prices from both pharmaceutical manufacturers and retail pharmacies. In addition, PBMs have experience with prior authorization, drug utilization review, generic substitution, and chronic disease management programs that reduce drug expenditures. Furthermore, PBMs have up-to-date, flexible computer and support systems that allow them to adjust rapidly to developments in the pharmaceutical drug industry.

Texas should pay the PBM on a fee-for-service basis. This would allow the state to retain its current federal drug rebates and to partner with the PBM in implementing supplemental state rebates. Because PBMs have experience negotiating with drug manufacturers for rebates, they can be helpful in the negotiation process. In addition, PBMs could play a role in containing the cost of the Medicaid drug benefit by steering utilization toward more cost-effective drugs.

Fiscal Impact

If Texas implements the recommendation listed above, savings would accrue to both the General Revenue Fund and the federal government. Pharmacy costs are expected to continue to rise at rates significantly above the overall rate of inflation, so the savings would likely rise over time as well.

Contracting with a PBM for Medicaid pharmacy services should provide savings; however, the use of a PBM also would drive up administrative costs. Even so, net savings to the General Revenue Fund are estimated to be $46.2 million by fiscal 2006.

Estimated savings below are based on TDH’s Legislative Appropriation Request. According to TDH, to maintain the current level of service in the Medicaid Vendor Drug Program, it must allocate an additional $185.6 million in fiscal 2002 and $345.1 million in fiscal 2003. As such, the fiscal impact estimates listed below should be considered conservative and may underestimate the savings that could be generated. Because of an administrative lag before the new program begins operating, these benefits would accrue beginning in the last quarter of fiscal 2002.

Fiscal Year
Savings to the General Revenue Fund
Savings to Federal Funds
Cost to theGeneral Revenue Fund
Cost to Federal Funds

Net Savings to the General Revenue Fund
Net Savings to Federal Funds
Net Savings

Note: Figures may not add to totals due to rounding.

[1] Texas Department of Health, Medicaid Vendor Drug Program (March 28, 2000), p. 4.

[2] US Health Care Financing Administration, “Financial Management Report for Fiscal Year 1997,” April 18, 2000 (http://www.hcfa.gov/medicaid/ofs-64.htm). (Internet document.)

[3] Henry J. Kaiser Family Foundation, “Medicare and Prescription Drugs,” Menlo Park, California, March 2000. (Fact sheet.)

[4] “New Questions on Drug Plans As Costs Soar,” The New York Times (May 7, 2000), p. 1.

[5] Texas Department of Health, Medicaid Vendor Drug Program, p. 7.

[6] US Health Care Financing Administration, “Medicaid Drug Rebate Program,” Washington, DC, September 29, 1999 (http://www.hcfa.gov./medicaid/drughmpg.htm). (Internet document.)

[7] Texas Department of Health, Medicaid Vendor Drug Program, p. 7.

[8] Henry J. Kaiser Family Foundation, Role of PBMs in Managing Drug Costs: Implications for a Medicare Prescription Drug Benefit (January 2000), p ix.

[9] “New Questions on Drug Plans As Costs Soar.”

[10] Andy Miller, “State Seeking Drug Cost Limits,” Atlanta Journal and Constitution (March 18, 2000), p. 1E.

[11] Reuters Medical News, “States Seek Bids to Manage Drug-Buying Pool,” October 27, 2000 (http://managedcare.medscape.com/reuters/prof/2000/10/10.27/20001026plt1001.htm). (Internet document.)

[12] The Social Security Act of 1935 as amended, §1927(d)(5)(A) & (B) codified at 42 U.S.C. §1396r-8 (a).

[13] Letter from Cindy Pelter, Health Care Financing Administration, US Department of Health and Human Services, May 23, 2000.

[14] Texas Department of Health, Medicaid Vendor Drug Program, p 22.

[15] Institute of Medicine, Description and Analysis of the VA National Formulary (Washington, DC, October 2000), p. 90.

[16] Letter from Cathy Greenhouse, MediCal Drug Rebate Program, contract analyst, California Department of Health Services, June 15, 2000.

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