Pharmaceuticals Follow-Up
State Departments That Purchase Prescription Drugs
Have Not Yet Fully Implemented Recommendations
to Further Refine Their Cost Savings Strategies
June 2007 Letter Report 2007-501

CALIFORNIA
S TAT E A U D I T O R

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CALIFORNIA STATE AUDITOR

Elaine M. Howle
State Auditor

Bureau of State Audits

Doug Cordiner
Chief Deputy
555 Capitol Mall, Suite 300

S a c r a m e n t o, C A 9 5 8 1 4

June 12, 2007

916.445.0255

916.327.0019 fax

w w w. b s a . c a . g o v

2007-501

The Governor of California
President pro Tempore of the Senate
Speaker of the Assembly
State Capitol
Sacramento, California 95814
Dear Governor and Legislative Leaders:
This letter report presents the results of a follow-up review the Bureau of State Audits (bureau)
conducted concerning the California Public Employees’ Retirement System (CalPERS), Department
of General Services’ (General Services), and the Department of Health Services’ (Health Services)
efforts to implement selected recommendations from a report the bureau issued in May 2005 titled
Pharmaceuticals: State Departments That Purchase Prescription Drugs Can Further Refine Their Cost
Saving Strategies (2004-033). During the follow-up review we focused on eight key findings related
to cost saving strategies used by CalPERS, General Services, and Health Services when purchasing
prescription drugs. We found that although some progress has been made, both General Services and
Health Services need to do more to fully address the recommendations from our May 2005 report as
well as the following earlier reports:
•	 Department of Health Services: Its Efforts to Further Reduce Prescription Drug Costs Have Been
Hindered by Its Inability to Hire More Pharmacists and Its Lack of Aggressiveness in Pursuing
Available Cost-Saving Measures (issued April 2003, 2002-118)
•	 State of California: Its Containment of Drug Costs and Management of Medications for Adult Inmates
Continue to Require Significant Improvements (issued January 2002, 2001-012)
During this follow-up review, we found that General Services expects to generate savings from two
new contracts it negotiated for pharmaceutical services; however, it has yet to analyze other saving
options. Specifically, General Services has been slow to fully analyze measures to improve its
procurement process, such as joining various group purchasing organizations and alliances.
Additionally, General Services and the Common Drug Formulary Committee (committee) have not yet
reviewed the statewide formulary for patient safety, efficacy, high quality, and best value drugs. We also
found that although Health Services has made some progress in reducing its backlog of older disputed
rebates, its current backlog has increased significantly. Finally, Health Services has yet to recoup at least
$2.5 million resulting from erroneous payments it made to pharmacies we identified in our 2005 audit.
Background
Chapter 938, Statutes of 2004, required the bureau to report to the Legislature on the State’s
procurement and reimbursement practices as they relate to the purchase of drugs for or by state
departments, including, but not limited to, the departments of Mental Health, Corrections and
Rehabilitation (Corrections), the Youth Authority, Developmental Services, Health Services, and
CalPERS. Specifically, the statutes required the bureau to review a representative sample of the State’s
procurement and reimbursement of drugs to determine whether it is receiving the best value for the
drugs it purchases. The statutes also required the bureau to compare, to the extent possible, the State’s



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June 2007 

cost (price per unit) to those of other appropriate entities such
as the federal government, Canadian government, and private
payers. Finally, the bureau was required to determine whether
the State’s procurement and reimbursement practices resulted
in savings from strategies such as negotiated discounts, rebates,
and contracts with multistate purchasing organizations, and
whether the State’s strategies resulted in the lowest possible
costs. The bureau examined the purchasing strategies of the
three primary departments that contract for prescription drugs—
General Services, Health Services, and CalPERS.
Pursuant to the authority granted to the bureau, including the audit
standards the bureau operates under, it has been a long-standing
administrative practice to require each agency or department
we have audited to report to the bureau on its progress in
implementing our recommendations at three intervals—60 days,
six months, and one year (California Government Code, Title 2,
Section 8543, and Government Auditing Standards, paragraph 1.27).
Under that same authority, it has also been a long-standing
administrative practice of the bureau to conduct follow-up reviews
of audits when resources are available and the bureau determines it
is prudent to do so.
CalPERS Has Greater Access to Rebate Information for One of
Its Contracts
CalPERS entered into a new pharmacy benefit management
agreement on July 1, 2006, that allows it to audit the entity’s records
pertaining to rebates under the agreement. As reported in our 2005
audit report, the previous agreement prohibited CalPERS from
having access to the entity’s rebate contracts with pharmaceutical
manufacturers or distributors. We recommended that CalPERS
explore various contract negotiation methods that would allow it
to achieve greater disclosure requirements. During our follow-up,
we reviewed the current contract and verified that it contains the
language that will enable CalPERS to verify that it is receiving all of
the rebates related to this contract to which it is entitled. CalPERS
has indicated that it anticipates performing an audit of its current
pharmacy benefit manager during fiscal year 2007–08.
General Services Has Negotiated Two New Contracts for
Pharmaceutical Services From Which It Expects to Generate Savings
In a January 2002 report, State of California: Its Containment of
Drug Costs and Management of Medications for Adult Inmates
Continue to Require Significant Improvements, the bureau
recommended that General Services increase its efforts to

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June 2007

solicit bids from drug manufacturers to obtain more drug prices
on contract. General Services negotiates contracts with drug
manufacturers so that state agencies can purchase drugs at
less‑than-wholesale acquisition cost (contract drugs), defined as the
standard price a wholesaler pays a manufacturer for drug products
not including special deals, such as rebates or discounts. During
2002 General Services had about 850 drugs on contract, but
during most of fiscal year 2003–04 had only 665 drugs on contract.
General Services stated that because of limited resources, it was
focusing on negotiating contracts with manufacturers of high‑cost
(price per unit) drugs. However, opportunities still existed for
General Services to increase the amount of purchases made
under contract with drug companies. We recommended that
General Services continue its efforts to obtain more drug prices
on contract by working with its strategic sourcing contractor to
negotiate new and renegotiate existing contracts with certain
manufacturers. General Services hired this strategic sourcing
contractor to analyze state spending and identify opportunities to
generate savings. In May 2005 General Services reported that its
strategic sourcing contractor and the contractor’s partners were
providing support to General Services in its efforts to negotiate and
renegotiate contracts with drug manufacturers.
According to General Services, its strategic sourcing contractor
assisted it in negotiating two new pharmaceutical contracts for the
period of November 2005 to November 2007 that General Services
believed would result in significant savings to the State. The first
of these two-year contracts is with a pharmacy benefits manager
(benefits manager) to provide prescription drugs to parolees
for Corrections. The second contract is with a pharmaceuticals
prime vendor (prime vendor) to distribute drugs purchased
under the State’s bulk purchasing program. Our follow‑up review
of reports summarizing pharmaceutical purchases provided by
General Services indicates that the State appears to have achieved
savings of $7.8 million during the first 10 months of these two new
contracts. Although General Services has yet to verify the accuracy
of its savings estimates, the methodology it used to calculate its
savings estimates appears reasonable.
When we compared the discounts of the earlier contracts with the
two new pharmaceutical contracts, we found that the State should
achieve savings in three ways. First, although the benefits manager
sells its prescription drugs to the State at the same price, the new
contract guarantees discounts greater than the former contracts.
Second, the previous and new prime vendor also sell their
prescriptions at the same price, but the new contract guarantees
discounts off certain prices that were not formerly discounted.
Third, unlike the previous prime vendor contract, the new contract
does not require General Services to pay administrative fees

Although General Services has yet
to verify the accuracy of its savings
estimates, the methodology it used
to calculate its savings estimates
appears reasonable.





California State Auditor Letter Report 2007-501

June 2007 

and offers volume discounts. Based on the discounts in the new
contracts, it is logical to assume that the State will achieve savings
from greater discounts and fewer fees.

Based on reports from the strategic
sourcing contractor, it appears that
the State generated $3.7 million in
savings by contracting with the new
benefits manager and an additional
$4.1 million in savings from its prime
vendor contract.

Moreover, General Services provided us with monthly
savings reports from March to December 2006 related to the
pharmaceutical purchases made under these two contracts.
According to General Services, it obtains these reports from the
strategic sourcing contractor it used to assist it in negotiating these
two contracts. The contractor compiles the reports from data
provided to General Services by the two new contractors. These
reports are lists of all purchases made by state agencies under the
two new contracts and include information such as drug names,
drug prices, purchased quantities, and accrued savings. The accrued
savings included in these reports are calculated by subtracting
the costs of goods purchased under the new contract from what the
costs of these exact same goods would be, were they purchased
under the former contracts. Based on reports from the
strategic sourcing contractor, it appears that the State generated
$3.7 million in savings by contracting with the new benefits
manager and an additional $4.1 million in savings from its prime
vendor contract.
We reviewed the methodology for calculating the accrued savings
and believe it is appropriate. However, General Services has
not verified the accuracy of the accrued savings. According to
General Services it is currently relying on pricing for individual
drugs provided by the new benefits manager and prime vendor to
calculate savings because it does not have access to First DataBank
Inc., a pricing database that could allow it to verify drug prices
used in the reports. However, by not performing some type of
procedures to verify the accuracy of the information included in
these reports, General Services cannot state with assurance that
the calculated savings are accurate. Further, because the fees it pays
its strategic sourcing contractor that assisted it in negotiating the
two pharmaceutical contracts are based on the amount of savings
generated under the contracts, by not verifying the accuracy of
the reports, General Services cannot be certain that it paid its
contractor the appropriate fee. According to General Services,
it may seek to obtain access to First DataBank Inc. as part of a
larger effort to verify the data included in these reports, but it had
not completed the feasibility study report for this project as of
April 2007 and it does not know when it will complete the study.

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June 2007

General Services Has Not Yet Analyzed Options for Improving Its
Procurement Process
In our January 2002 report, we also recommended that
General Services fully analyze measures to improve its procurement
process, such as joining various group purchasing organizations
and alliances. These organizations negotiate volume discounts
with manufacturers and suppliers on behalf of their members,
providing members with favorable prices, terms, and conditions.
General Services contracted with the Massachusetts Alliance for
State Pharmaceutical Buying (alliance) in October 2001 without
performing a thorough analysis to determine whether the alliance
would be the most effective option for reducing the State’s
drug costs. In its January 2003 follow-up response to our audit,
General Services stated it was conducting a detailed review of
the effectiveness of using the alliance. However, as we reported
in our May 2005 report, General Services was unable to provide
us with the results of its effectiveness review. Additionally, in our
2005 report General Services stated that as resources become
available, it intended to solicit bids to contract directly with a
group‑purchasing organization.
In its one-year response to our 2005 audit, General Services
informed us that it planned to send a request for information to
large- and medium-size group-purchasing organizations by early
January 2007 to gather information to assist it in evaluating the
pricing and services available through its current alliance contract.
We found that General Services sent a request for information to
13 group-purchasing organizations, and received seven responses
by the February 9, 2007, deadline. General Services indicated that
it has not yet evaluated the responses; however, it hopes to perform
its analysis by the end of June 2007. According to General Services,
if its analysis of the responses indicates it may be able to benefit
from a different group purchasing relationship, it will release a
request for proposal.
General Services and the Committee Have Not Yet Reviewed the
Formulary Based on Safe, Effective, High Quality, and Best Value Drugs
In our January 2002 report, we recommended that General Services
fully consider and try to mitigate all obstacles that could prevent
the successful development of a statewide formulary, such as
departments not strictly enforcing such a formulary. A drug
formulary is a list of drugs and other information representing the
clinical judgment of physicians, pharmacists, and other experts in
the diagnosis and treatment of specific conditions. A main purpose
of a formulary is to create competition among manufacturers of
similar drugs when the clinical uses are roughly equal. However,





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June 2007 

the success of a statewide formulary and the State’s ability to
create enough competition to negotiate lower drug prices
for certain products depends on how well state departments
adhere to the formulary when they prescribe drugs. Although
General Services had developed a statewide formulary, it had not
identified the obstacles to enforcing it. General Services had not
required departments to adopt a policy requiring strict adherence
to the statewide formulary and it was not monitoring departments’
adherence to the formulary.
In our 2005 report, we recommended that General Services
facilitate the committee and the Pharmacy Advisory Board’s
development of guidelines, policies, and procedures relating to
departments’ adherence to the statewide formulary and ensure that
departments formalize their plans for compliance. In its one‑year
response to our report, General Services indicated that at the
committee’s October 2005 meeting, and the Pharmacy Advisory
Board’s January 2006 meeting, the formulary was approved.
It also stated that now that the statewide formulary has been
implemented, General Services and the committee would begin to
focus additional resources on the administrative and enforcement
concerns raised in our report.

Until General Services and the
committee reviews each therapeutic
category based on the four criteria
and can determine whether
departments are purchasing drugs
that are not on the formulary, it
cannot fully utilize the formulary
process to achieve greater savings.

General Services stated that the committee plans to conduct
reviews of each therapeutic category to develop a formulary based
on four criteria: patient safety, efficacy, high quality, and best value.
The committee approved a process for the therapeutic category
review at its July 19, 2006, meeting. According to General Services,
it is continuing to work with the committee to develop policies
and procedures governing the administration and enforcement of
the formulary. However, these policies are not yet in place for the
major therapeutic categories. General Services stated that it plans
to have these policies and procedures in place within the next year.
Until General Services and the committee reviews each therapeutic
category based on the four criteria and can determine whether
departments are purchasing drugs that are not on the formulary, it
cannot fully utilize the formulary process to achieve greater savings.
Moreover, there may be some uncertainty as to whether
Corrections will continue to participate in the State’s bulk
purchasing program, which includes all of the drugs on the
State’s formulary. If Corrections discontinued its participation,
it could affect the committee’s ability to effectively review the
current therapeutic categories and revise the formulary. As the
result of a 2001 class action suit brought against the state of
California challenging the quality of medical care in the State’s
prison system, a federal court order placed the oversight of health
care delivery in the prison system under the federal court’s control.

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June 2007

On February 14, 2006, the federal court established a receivership
and appointed a federal receiver to direct the management of health
care delivery in the prisons. The receiver contracted with Maxor
National Pharmacy Services Corporation (Maxor) to provide
pharmacy management consulting services to implement the
receiver’s plan to develop a constitutionally adequate pharmacy
services delivery system. According to Maxor’s monthly progress
report for February 2007, it reviewed the State’s formulary and
identified redundant medications and patient safety risks. From
this review, it proposed a new formulary for Corrections, which
it presented to a reconstituted Pharmacy and Therapeutics
Committee for review and approval.
According to the receiver’s March 20, 2007, bi-monthly report
to the court, Maxor believes that the formulary committee
sometimes made decisions that failed to achieve the maximum
fiscal savings Corrections could have realized if it had negotiated
separate contracts based on its own clinical pharmaceutical needs.
Moreover, according to Maxor, several contracts negotiated by
General Services contain unacceptable terms, which assure free
access to the formulary with no restrictions on practitioners,
despite documented problems with medication management
within Corrections. In its report Maxor requested that it be
allowed to become the contract negotiator under the purview of
the receiver’s contracting office for Corrections’ pharmaceutical
procurements. Accordingly, the federal receiver has recommended
to the court that Maxor assume effective control over all
Corrections’ pharmaceutical purchases.
It is possible the receiver could decide that Corrections will no
longer participate in the formulary committee. Further, should
the receiver request a waiver of state law, the court could allow the
receiver to remove Corrections from the State’s bulk purchasing
program. Based on the prime vendor savings reports given to us
by General Services, during the period between March 2006 and
December 2006, Corrections’ purchases through the prime vendor
represented 73 percent of all purchases made by departments
participating in the bulk purchasing program. Should Corrections
no longer participate in the State’s bulk purchasing program,
the committee may have to change its current approach to review
the formulary because Corrections represents the majority of
purchases. More specifically, if Corrections is removed from
the State’s bulk purchasing program, the formulary committee
may need to re-establish the State’s pharmaceutical needs based
on the smaller volumes required by the remaining departments.
If that were to happen, it may become beneficial for the State to
use Corrections’ pharmaceutical purchaser to maintain the same
volume of purchases that might allow for greater discounts.

The federal receiver has
recommended to the court that
Maxor assume effective control over
all Corrections’ pharmaceutical
purchases.





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June 2007 

General Services Has Yet to Evaluate Whether Other Departments Are
Purchasing Pharmaceuticals Outside of the Bulk Purchasing Program
Although state law requires specific state departments to
purchase drugs through General Services, our 2005 audit
reported that a survey of various departments indicated they
were not always following the law in doing so. Specifically,
the California Government Code requires the departments of
Corrections, Developmental Services, and Mental Health to
participate in General Services’ bulk purchasing program. In
addition, the California Public Contract Code requires that all
state departments purchasing drugs totaling more than $100
must purchase them through General Services. We reported in
2005 that although departments generally purchase most drugs
through General Services’ contract with its prime vendor, they
also purchase drugs through other vendors. We recommended
that General Services ask the departments participating in the
State’s bulk purchasing program to notify General Services of
the volume, type, and price of prescription drugs they purchase
outside of the program.

Although most departments
required to submit quarterly reports
to General Services that identify
the purchases they are making
outside the State’s bulk purchasing
program do so, General Services
has not developed a formal process
to analyze and use the information
included in these reports.

In September 2005 General Services modified the Purchasing
Authority Manual (PAM) to include a requirement that
departments participating in the bulk purchasing program are also
required to report information on prescription drugs purchased
outside of the State’s program. During our follow-up review
we found that, although most departments required to submit
quarterly reports to General Services that identify the purchases
they are making outside the State’s bulk purchasing program do
so, General Services has not developed a formal process to analyze
and use the information included in these reports. In fact, our high
level review of these reports identified that not all departments
are consistent as to which types of purchases they include on
these reports and, at least one department—Corrections—failed
to include this information related to its divisions. Some of this
variability in reporting may be occurring because the quarterly
report template available on General Services’ Web site does
not include instructions to assist the departments in making
decisions as to which items should be reported. According to
General Services, it is currently working on creating a database to
assist it in analyzing the data included in the quarterly reports and
to deal with these inconsistencies.
However, as previously discussed, the court appointed receiver has
recommended to the federal court that Maxor assume effective
control of Corrections’ pharmaceutical purchases. Therefore, even
though the law requires Corrections to participate in the State’s bulk
purchasing program, depending on the actions of the receivership,

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June 2007

if Corrections is no longer purchasing drugs through the State’s
program it would no longer submit the quarterly reports. However,
until this occurs, General Services indicated that it will follow up
with Corrections to ensure that, in the future, it submits quarterly
reports that contain all of Correction’s non-state procurement
program purchases. Regardless, until General Services addresses
the accuracy and completeness problems we observed and
develops a process to analyze and use the information it receives
in these quarterly reports, it cannot make informed decisions
concerning the operation of the bulk purchasing program, nor can
it expand the program to include those prescription drugs that
best serve the needs of the State’s departments.
Health Services Has Not Yet Reconciled All Its Older Rebate Disputes
and Its Backlog of Current Disputes Is Growing
In addition to receiving federal rebates, Health Services is required
by state law to contract with all drug manufacturers to obtain
high-volume discount prices. Each quarter, Health Services sends
invoices to drug manufacturers for federal and applicable state
supplemental rebates. A manufacturer that does not agree with
an invoice can dispute the amount of the rebate due. However,
state law requires Health Services and manufacturers to cooperate
and make every effort to resolve rebate disputes within 90 days
of the manufacturers notifying Health Services of a dispute in the
calculation of rebate payments. In our 2003 report, Department
of Health Services: Its Efforts to Further Reduce Prescription Drug
Costs Have Been Hindered by Its Inability to Hire More Pharmacists
and Its Lack of Aggressiveness in Pursuing Available Cost-Saving
Measures, we found that Health Services’ records reflected that
it received approximately $216 million less in rebates than the
$3.4 billion it actually invoiced manufacturers from January 1991
to September 2001, and that it was just beginning to work with
manufacturers to reconcile the 10-year accumulated difference.
As of our 2007 follow-up, Health Services indicates that it had
reduced the amount of the disputed rebates from January 1991 to
December 2001 to $153 million. However, Health Services states
that the total amount of current rebate disputes, those arising
from January 2002 to December 2006, stood at approximately
$270 million as of January 2007. Health Services explains that it is
still unable to resolve new disputes within the mandatory 90‑day
period, and that, although it has reduced the older backlog of
disputed rebates, its current backlog has increased significantly. It
believes that this situation stems from problems in retaining the
personnel working on resolving those disputed rebates.

Health Services indicates that it
had reduced the amount of the
disputed rebates from January 1991
to December 2001 to $153 million.
However, Health Services states
that the total amount of current
rebate disputes, those arising from
January 2002 to December 2006,
stood at approximately
$270 million as of January 2007.



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For fiscal year 2003–04 Health Services requested and was
granted 11 new positions to assist in resolving drug rebate disputes.
However, according to Health Services, these 11 positions were for
a limited three-year term. Health Services explained that resolving
disputed rebates is a complex process that requires at least a six- to
12-month training period, and it indicated that it lost more than
half of its limited-term staff to other permanent positions. Thus,
for many of these 11 positions, Health Services spent the time to
train the staff, but lost them just at the point where they would
have become productive. As a result, Health Services requested
that these 11 positions be extended through fiscal year 2006–07,
which was approved. In addition, in its budget change proposal
for fiscal year 2007–08, Health Services is asking to convert half of
these limited-term positions to permanent positions to improve
its chances of retaining staff. It is also requesting an extension of
one more year for the remaining temporary positions as part of its
budget for fiscal year 2007–08.
Changes in Federal Regulations May Assist Health Services to Achieve
Lower Costs on Generic Drug Purchases
In our 2003 report we recommended that Health Services negotiate
state supplemental rebate contracts with manufacturers of generic
drugs as the Legislature had directed it to do. According to
Health Services’ May 2005 response to our recommendation,
generic drug manufacturers were not interested in entering into
supplemental rebate agreements because the margins of profit are
small and they have received negative feedback from the retail
community. Instead, Health Services decided to shift from
attempting to contract for generic drugs to implementing a new
maximum allowable ingredient cost (MAIC), which we describe
in the text box. Health Services expected that implementing the
new MAIC would result in savings for generic drugs beyond those
potential savings that might be achieved through its negotiations
with manufacturers of generic drugs.

Health Services plans to use certain
pricing information that was
unavailable to it in the past, which
the federal government plans to
publish during late spring 2007.

During our follow-up review, Health Services indicated that it plans
to change the way it calculates MAIC for generic drugs by using the
average manufacturer price (AMP). However, the change cannot
be implemented until certain issues are resolved at the federal level,
which Health Services believes most likely will affect the amount
it will establish as its MAIC. Health Services plans to use certain
pricing information that was unavailable to it in the past, which
the federal government plans to publish during late spring 2007.
Specifically, the federal Deficit Reduction Act of 2005 (act) requires
the federal Centers for Medicare and Medicaid Services (CMS) to
publish the AMP. In the past, Health Services did not have access

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June 2007

to the AMP because it was considered proprietary
information and therefore could not be released to the
public. According to Health Services, it believes that
using the AMP as a basis for calculating the MAIC
should result in even greater savings in some cases than
if it were to use the average wholesale price (AWP)
as it originally intended to do. However, the federal
Department of Health and Human Services has yet to
finalize the federal regulations related to the changes
contained in the act, and therefore has not yet published
the AMP information. Until the federal government
finalizes the regulations and releases the new pricing
information, Health Services indicated it cannot
perform a formal analysis to determine whether or not
they can achieve additional savings by using the AMP as
a basis for the MAIC.
Health Services Has Yet to Recoup Funds Resulting
From Overpayments to Pharmacies

Maximum allowable ingredient cost
(MAIC)—the price established
by Health Services for a generic drug
type. Health Services bases the MAIC on
the average wholesale price (AWP), which
is the mean price paid by a pharmacy to
a wholesale drug distributor, including
discounts and rebates. AWP is obtained from
Health Services’ primary price reference
source First DataBank Inc., or Redbook or
the principal labeler’s catalog.
Average manufacturer price (AMP)—
the average price paid for such drugs
by wholesalers for drugs distributed to
the retail pharmacy class of trade. AMP
will be published by the federal Centers
for Medicare and Medicaid Services on a
monthly basis.

In our 2005 audit report we identified several instances
where Health Services’ payments to pharmacies were based
on outdated or incorrect pricing information. For example, we
found that Health Services did not update its prices to reflect the
elimination of the direct pricing method, which was the price
listed by Health Services’ primary or secondary reference source
or the principal labeler’s catalog for 11 specified pharmaceutical
companies. Health Services also incorrectly calculated drug prices,
because it did not apply the appropriate discount to the AWP.
Despite state law eliminating the direct pricing method as of
December 1, 2002, Health Services continued to use it during fiscal
year 2003–04 to reimburse pharmacies. As a result of our findings,
we recommended that Health Services do the following:
•	 Identify prescription drug claims paid using the direct pricing
method, determine the appropriate price for these claims, and
make the necessary corrections.
•	 Ensure that the fiscal intermediary’s Integrated Testing Unit
removes future outdated pricing methods promptly.
•	 Ensure that its fiscal intermediary’s Integrated Testing
Unit verifies that, in the future, drug prices in the pricing
file are calculated correctly before authorizing their use for
processing claims.

11

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June 2007 

In its one-year response to our audit, Health Services indicated
that it is working with its fiscal intermediary to complete the
corrections. During our follow-up review Health Services
provided a correction notice dated February 2007 from its fiscal
intermediary—Electronic Data Systems (EDS)—indicating EDS
corrected the pricing of the 2,113 drugs that were incorrectly priced
as a result of the error. We reviewed 20 of these drugs during
our follow-up and found that all had been updated to reflect the
appropriate price.
In its one-year response to our 2005
audit, Health Services indicated
its total net recoupment will be
$2.5 million as a result of a pricing
error we identified. However, it has
not yet begun the process to recoup
the overpayments.

Additionally, in its one-year response to our 2005 audit,
Health Services indicated its total net recoupment will be
$2.5 million as a result of the pricing error. However, it has not
yet begun the process to recoup the overpayments. According
to Health Services, EDS identified four additional pricing errors
in addition to the errors we identified in our report that require
payment correction including rounding errors, delays in updating
its formulary files, and data conversion errors. Health Services
indicated that it intends to begin the process to concurrently
recoup any overpayments related to these errors and the ones we
identified. When we asked during our follow-up why it had not
yet started the process of identifying overpayments for these new
errors through EDS, Health Services stated that the payment of
current claims and current pricing corrections and changes receive
priority for system processing time. Health Services also stated that
this approach ensures that patient access to care is not hindered
and that payment errors on current claims do not occur. Therefore,
the pricing errors on previously paid claims are given lower
priority based on availability of system resources. Health Services
plans to determine the dollar impact of the additional pricing
errors EDS identified when it runs the programs to identify the
overpayments. Although Health Services plans to start the process
of identifying overpayments related to these additional errors
before July 2007, because other changes to the system could take
priority, Health Services was unable to provide us with an expected
completion date for recouping these erroneous payments.
Health Services also reported in its one-year response that to
ensure that future program errors do not occur, EDS’ testing unit
developed a testing environment that ensures all changes process
successfully by first processing all changes on a test copy of the
system prior to their implementation. In this way Health Services
expects to limit the types of errors we identified in our 2005 audit.

California State Auditor Letter Report 2007-501

June 2007

We conducted this review under the authority vested in the California State Auditor by
Section 8543 et seq. of the California Government Code and according to generally accepted
government auditing standards. We limited our review to those areas specified in the letter
report.
Respectfully submitted,

ELAINE M. HOWLE
State Auditor
Staff:	 Denise L. Vose, CPA, Audit Principal
Heather Kopeck, MPP
Kim Buchanan
Simon Jaud, Ph.D.

13

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California State Auditor Letter Report 2007-501

June 2007

cc:	
	
	
	
	
	
	
	
	
	
	
	

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Capitol Press