Over the past five years, the budgets of state Medicaid programs have been challenged by the introduction of new high-cost drugs into the marketplace. Many of these drugs have important clinical benefits, and some are even cures for debilitating diseases. But with price tags reaching tens of thousands or even hundreds of thousands of dollars per year, states are struggling to pay for these drugs. The percentage of Medicaid budgets dedicated to pharmaceuticals has been increasing, with annual Medicaid drug spending nationwide increasing by almost 50%—from $22.4 billion to $33.4 billion—from 2013 to 2016.

In administering the pharmacy benefit in Medicaid, states are obligated to comply with the requirements of Section 1927 of the Social Security Act, and some states have argued that Section 1927 limits their ability to control drug prices. Under Section 1927, states generally must include on their formularies all Food and Drug Administration (FDA)-approved drugs of a pharmaceutical manufacturer, so long as the manufacturer has entered into a rebate agreement under which the manufacturer offers rebates to Medicaid programs (rebates are subject to complicated formulas but typically must be at least 23.1% for brand-name drugs and 13% for generics). States can take certain steps to control costs within the parameters of Section 1927, such as by subjecting drugs to prior authorization and requesting that manufacturers provide supplemental rebates in exchange for their drugs being treated as “preferred.” But ultimately, states cannot label a drug as “non-covered” except under very limited circumstances, a prohibition that may impact states’ ability to demand discounts from manufacturers.

In the past six months, states and the federal government have begun to take steps to alter this framework and give Medicaid programs more leverage in negotiating drug prices. Massachusetts and Arizona have led these initiatives at the state level. More recently, President Trump’s budget has called for a five-state drug pricing demonstration program.

Proposed Massachusetts Waiver

In September 2017, Massachusetts filed with the Centers for Medicare & Medicaid Services (CMS) a proposed amendment to its Section 1115 waiver that, if approved, would substantially change how the state’s Medicaid program pays for drugs. Massachusetts proposed a “closed formulary”—that is, a formulary that does not include nearly every FDA-approved drug but is limited to certain drugs selected by the state. Massachusetts indicated that it would cover at least one drug per therapeutic class. The state also proposed that non-formulary drugs could still be accessed by Medicaid beneficiaries on a case-by-case basis if a beneficiary filed an appeal under what is known as an exceptions process.

The proposal could result in Massachusetts deciding not to cover many different types of drugs. The state specifically called out drugs coming to market through the FDA’s accelerated approval pathway as a source of concern. Massachusetts views these drugs as lacking sufficient clinical trial data to support their high price tags.

CMS has not yet reached a decision on the Massachusetts waiver amendment. The amendment appears to assume that manufacturers would continue to be required to pay rebates even with the loss of guaranteed coverage, and some have questioned whether CMS has the legal authority to waive the drug coverage mandate without also waiving the rebate mandate. If the amendment is approved by CMS, it would almost certainly become a model for other states.

Arizona Proposal

In November 2017, Arizona’s Medicaid director wrote to CMS asking for greater flexibility in administering its drug benefit. The state noted that per-member-per-year drug spending increased by 42%—from $747 to $1,061—from fiscal year 2014 to fiscal year 2016. In light of these costs, Arizona proposed a new model for drug coverage that mirrored the Massachusetts proposal in many respects.

Like Massachusetts, Arizona proposed that the state have the authority to exclude drugs from its formulary and said it was modeling its proposal on drug coverage under commercial plans. Arizona proposed covering at least two drugs per category or class, subject to limited exceptions. Arizona specifically stated that manufacturers should be required to continue to pay the rebates mandated under Section 1927. To date, CMS has not opined on Arizona’s proposal.

President’s Budget Demonstration

Echoing the Massachusetts and Arizona proposals, the president’s budget also proposed a revision to the federal requirement for states to cover nearly all FDA-approved drugs. The budget called for a five-state demonstration program under which states would be allowed to exclude drugs from their formularies as a means of negotiating more favorable drug prices from manufacturers. As with the Massachusetts proposal, beneficiaries would still be allowed to obtain non-formulary drugs through an exceptions process. The budget differed from the Massachusetts and Arizona proposals, however, in that it did not call for continuation of rebates by manufacturers in the states that are subject to the demonstration. The budget projected only $85 million in savings over ten years, or less than $2 million in savings per state per year.

The budget also differed from the state proposals in that it proposed an enactment through a legislative change. However, given the state proposals, it is likely that the administration is contemplating whether such a demonstration can be effected without a statutory change.


For more than 25 years, drug benefits under state Medicaid programs have been required to cover nearly every FDA-approved drug pursuant to Section 1927 of the Social Security Act. With mounting concern at the state and federal levels over drug prices, that might be on the cusp of changing. However, unless and until CMS takes action to approve a waiver request or launch a demonstration, the details of potential new drug coverage rules remain unclear.