The 2025-26 Budget: Medi-Cal Pharmacy Spending

2025-26 BUDGET The 2025-26 Budget: Medi-Cal Pharmacy Spending GABRIEL PETEK | LEGISLATIVE ANALYST | APRIL 2025 SUMMARY Medi-Cal Pharmacy Spending Has Grown Over Time. Medi-Cal, California’s Medicaid program, covers the cost of prescription drugs (among other health care services) for low-income people. From 2018-19 through 2023-24, we estimate Medi-Cal pharmacy spending nearly doubled. Nearly half of this growth was associated with certain drugs treating diabetes, obesity, and inflammatory diseases. Accordingly, the Governor’s budget assumes continued growth in pharmacy spending through 2025-26, including a substantial upward revision in estimated spending in 2024-25. Medi-Cal Pharmacy Data Could Be More Transparent. On a total funds basis (both state and federal funds), the assumed overall growth in pharmacy spending under the Governor’s budget appears to be roughly in line with recent data highlighting growth in utilization and cost. However, given data constraints, assessing some of the administration’s underlying cost assumptions is difficult. For example, the administration assumes growth in drug utilization among undocumented beneficiaries. While this growth is plausible, historical data on pharmacy use for this population is limited. Also, limited data on drug price discounts and rebates makes assessing the transition to Medi-Cal Rx in 2022 difficult. In light of these limitations, we recommend the Legislature (1) direct the Department of Health Care Services (DHCS) to report specified data annually and (2) withhold action around Medi-Cal pharmacy spending in 2025-26 until May Revision, when updated data are available. State Could Better Prepare for Drug Spending Volatility. Though the full effects of Medi-Cal Rx are uncertain, it is likely the new system has increased budget volatility and uncertainty in the Medi-Cal program. This is because the state now pays for all drug costs directly under Medi-Cal Rx, which are highly variable year to year. (Prior to the creation of Medi-Cal Rx in 2022, the state indirectly paid for most prescription drugs, like most Medi-Cal benefits, through contracts with health plans that cover the cost of care for beneficiaries.) As a result, significant midyear revisions—much like the one in the current-year budget—may be more common moving forward. To help manage this volatility, the state in 2019-20 created a new fund account to reserve a portion of drug rebate funds. To date, however, reserve amounts have been inconsistent. To better prepare for budget volatility moving forward, we recommend the Legislature tighten the mission and rules around this fund account in state law. State Has Limited Control Over Pharmacy Spending. Given the state’s constrained fiscal situation, the Legislature may face pressure to limit General Fund spending growth, including in the Medi-Cal program. The state has limited ways of doing so with regard to Medi-Cal pharmacy spending specifically. For example, the Legislature could adjust coverage of optional drugs (such as anti-obesity drugs) or impose certain utilization controls (such as requiring copays). That said, there are limitations and trade-offs to consider. Most notably, federal rules limit how states can control pharmacy spending, and the federal government is contemplating whether to impose additional constraints. Also, caution is warranted when reacting to emerging trends, given the historical volatility of the drug market. To this end, we recommend the Legislature continue to monitor spending trends, particularly around optional drugs. To the extent the Legislature takes actions this year to limit spending, it will want to ensure such actions have measurable and likely impacts on long-term state costs. www.lao.ca.gov 1 2025-26 BUDGET INTRODUCTION Pharmacy Is Key Driver Behind fee-for-service system. The new system—known Higher-Than-Anticipated Medi-Cal Spending. as Medi-Cal Rx—was intended to result in lower State spending on Medi-Cal—California’s Medicaid drug costs and higher rebates. Initial projections program—is expected to be higher in 2024-25 than of savings, however, have not been validated originally anticipated. Specifically, the Governor’s by actual data. Moreover, since the transition to budget estimates General Fund spending for this the new system in 2022, newer, relatively costly program in 2024-25 to be $2.6 billion (7.5 percent) drugs have become a bigger portion of Medi-Cal higher than the level assumed at budget enactment pharmacy spending. last June. The administration estimates half of Brief Analyzes Pharmacy Spending Trends this growth to be from spending on prescription and Estimates. Given the above issues, this brief drugs, with the other half largely due to higher analyzes the recent pharmacy spending increases caseload levels. in the Governor’s budget. It begins with background Increase Raises Questions About Recent on prescription drugs and Medi-Cal’s pharmacy Delivery System Change. Over the years, the benefit. Next, it provides key historical spending state has undertaken efforts to control Medi-Cal trends and summarizes assumptions in the pharmacy spending. Most notably, the state Governor’s budget. It then provides our assessment consolidated the way it pays for drugs into one of these trends and associated recommendations. BACKGROUND In this section, we describe: (1) the prescription drugs into the market; and (3) pharmacies, entities drug market and (2) Medi-Cal’s pharmacy benefit. that purchase drugs and dispense them to patients. Moreover, many health care payors contract with Prescription Drugs third parties (known as pharmacy benefit managers) “Prescription Drugs” Generally Refers to to manage their enrollees’ drug benefits and Drugs Purchased at a Pharmacy. Generally, claims. Different kinds of financial transactions prescription drugs are drugs prescribed by a occur between these entities—many of which are doctor and purchased at a pharmacy. Coverage confidential. As a result of this complex and opaque of prescription drugs often is referred to as a system, it can be difficult to track drug prices and pharmacy benefit. (Drugs provided during inpatient costs over time. settings, such as at the hospital, are considered to Drug Market Is Constantly Evolving. The drug be part of the inpatient service.) Prescription drugs market has been a major source of innovation within represent around 10 percent of personal health the health care sector. This is because drug makers care spending in the United States and in California. continue to research and develop new drugs for Drug Market Is Complex and Opaque. Many patients. This evolving market can have different health care services involve transactions between effects on costs. For example, new brand name providers, patients, and payors (such as private drugs that enter the market can be quite expensive, health insurance and government programs) that driving up costs. On the other hand, drugs makers reimburse providers for services. For prescription lose their exclusive rights to sell the brand drugs drugs, however, there are additional entities over time, allowing competitors to sell generic involved. These entities include (1) the drug versions and drive down costs. makers, generally large manufacturing companies; (2) wholesalers, large companies that help distribute 2 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET Medi-Cal’s Pharmacy Benefit monthly prescriptions and requiring copays. Historically, Medi-Cal included some of these Medi-Cal Covers Health Care Services for tools (such as by charging $1 copays). As Low-Income People. Medi-Cal is California’s part of the 2020-21 budget, however, the combined Medicaid and Children’s Health Legislature eliminated these tools, with the Insurance Program (CHIP). Both Medicaid and CHIP aim of simplifying pharmacy benefits and are joint federal-state programs that cover health increasing access. care services to low-income people. In California, the Medi-Cal program is a particularly large part State Recently Created New “Medi-Cal of the health care sector, currently enrolling nearly Rx” System to Pay for Drugs. Most Medi-Cal 15 million people (more than one-third of the beneficiaries are enrolled in the program’s managed state’s population). care system, in which the state pays health plans Medi-Cal Coverage Includes Pharmacy each month to cover services for beneficiaries. Benefits. Under federal law, state programs must A small share of people (less than 10 percent) are cover a minimum set of health care services (such not enrolled in a health plan, and instead have their as doctor’s visits and hospital stays). Services services paid for directly by the Medi-Cal program beyond this minimum are optional. Pharmacy is one on a fee-for-service basis. Historically, the state also key benefit that is optional—meaning that states are took this bifurcated approach to pay for prescription not required to cover the cost of prescription drugs drugs. Beginning in 2022, however, the state to operate their Medicaid programs. Nonetheless, consolidated pharmacy benefits under one system all states—including California—cover pharmacy called Medi-Cal Rx. Under this approach, the state benefits in their Medicaid programs. pays for all drug claims on a fee-for-service basis— California Has Little Control Over Pharmacy including for people in the managed care system. Benefits, With Some Exceptions. Once choosing The new Medi-Cal Rx system was intended to lower to cover pharmacy benefits in their Medicaid costs and increase savings on drugs. The state programs, states must cover most drugs available contracts with a third party (Magellan Medicaid to patients. Specifically, states must cover nearly Administration) to help manage the Medi-Cal Rx all drugs from drug makers that participate in the system. Though initially enacted via executive federal Medicaid Drug Rebate Program (described order, Medi-Cal Rx later became permanent in state further a little later). With this restriction in place, law when voters enacted Proposition 34 (2024). states have limited ability to adjust pharmacy Net Spending on Drugs Driven by Two Key spending levels over time. That said, there are two Components. Medi-Cal pharmacy spending key flexibilities that offer states limited control: generally consists of two key components: • Optional Drugs. Under federal law, certain Figure 1 kinds of drugs, such as weight loss drugs, are optional for states to cover. As Figure 1 Medi-Cal Covers Some Kinds of shows, California has chosen to cover many, Optional Drugs but not all, of these optional drugs. Optional Drug Medi-Cal Coverage? • Utilization Controls. Federal law also Anorexia/weight loss or gain Yes allows states to implement policies that help Cosmetic/hair growth No limit utilization of drugs. For example, most Cough/cold relief Yes states (including California) maintain lists of Fertility No Nonprescription drugs Yes preferred drugs. Drugs that are not on these Vitamins and minerals Yesa lists (known as the “contract drugs list” in a Only certain products, subject to prior authorization or other Medi-Cal) are subject to certain constraints, restrictions. such as having to get special approval to prescribe to patients. States also can enact other tools, such as by limiting the number of www.lao.ca.gov 3 2025-26 BUDGET • Gross Payment for Drugs and Pharmacy State and Federal Government Share Services. First, the state pays pharmacies Pharmacy Costs and Rebate Savings. As a joint for delivering drugs to patients. For each federal-state program, Medi-Cal’s costs are shared prescription, there are two payments: (1) the between federal and state funds. The federal share cost of the drug, generally based on the cost of cost in each state generally is determined by a to the pharmacy of purchasing the drug; and formula, with the share in California at 50 percent. (2) a set rate to pharmacies (either $10 or $13, Each state’s specific federal share (in California’s depending on the size of the pharmacy) for the case, 50 percent) also applies to gross pharmacy cost of dispensing the drug. costs and drug rebate savings, with some • Savings From Negotiated Rebates. After exceptions. For example, drugs associated with paying pharmacies for the drugs, Medi-Cal childless, nondisabled adults (as well as most other submits claims to drug makers for negotiated services for this population) come with a 90 percent rebates. These rebates provide money back federal share. On the other hand, the state generally to the Medi-Cal program, effectively helping pays for the full cost of drugs for undocumented to offset some of the cost of the drugs. Most beneficiaries (as is the case for many other services of the savings come from federally negotiated to this population). Drugs to undocumented rebates. In addition, the state also negotiates beneficiaries also generally are not eligible for supplemental rebates. The nearby box rebates. The state’s General Fund covers the state provides more information on how rebates share of cost and savings for drugs. work in the Medi-Cal program. How Do Drug Rebates Work in Medi-Cal? Federal Rebates Are Mandatory and Determined by Formula. Created in 1990 and revised over time, the federal Medicaid Drug Rebate Program determines federal rebates for drugs in the Medicaid program. Drug makers must agree to participate in this program as a condition of having their drugs covered by state Medicaid programs. Rebates for specific drugs, which are considered confidential, are set by formulas. Under these formulas, a drug’s initial rebate is between 13 percent and 23 percent of its price, depending on the type of drug. Over time, the initial rebate increases if the drug’s price rises faster than inflation. Consequently, older drugs (which have tended to have price increases over time in excess of inflation) can come with much higher rebates. Drug makers pay their rebates to states, which then submit the federal share of savings to the federal government. State-Negotiated Supplemental Rebates Are Voluntary. In addition to the mandatory federal rebates, the state (through the Department of Health Care Services) negotiates additional rebates with manufacturers. Unlike for federal rebates, drug makers are not required to provide state-negotiated supplemental rebates. To induce participation, California leverages its negotiating power by including drugs with supplemental rebates in its preferred drug list. State supplemental rebates historically have comprised just a fraction of the overall savings from Medi-Cal rebates. 4 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET KEY TRENDS In this section, we summarize key historical and Below, we summarize trends on overall pharmacy projected trends in Medi-Cal pharmacy spending. spending and spending by type of drug. As the nearby box explains, we analyzed trends Overall Spending by combining data from federal and state sources. Because we combined data from different sources, Pharmacy Spending Has Grown in Recent Years, some of which use different methodologies, our in Line With Medi-Cal Program. Over the years, findings have some limitations. As such, the below Medi-Cal pharmacy spending has continued to grow, trends should be treated as rough estimates. both on a gross basis and after netting out rebates. How Did We Compile Estimates in This Brief? For Overall Spending, Two Key Sources. To measure overall Medi-Cal pharmacy spending trends over the last few years, we used two key sources of data. (Our methodology largely follows the approach taken by other health policy organizations, such as the Kaiser Family Foundation.) • Gross Spending—State Drug Utilization Data. Under federal law, states must report to the federal government quarterly drug utilization information in their Medicaid programs. These data include the number of prescriptions and gross Medicaid spending for each drug. The data are publicly available. Accordingly, we downloaded California’s drug utilization data from the first quarter of 2018 through the second quarter of 2024 (the latest quarter available at the time of our analysis). • Rebates—Federal Financial Management Reports. Federal law also requires states to submit annual financial information on their Medicaid programs. These financial reports, which also are available to the public, include line-item information on federal and state supplemental drug rebate savings. Accordingly, we downloaded available financial reports through federal fiscal year 2023 (the last year available at the time). For Drug-Level Spending, Federal Drug Classifications. We also used drug utilization data to track which drugs have driven changes in pharmacy spending. However, the data on their own are not conducive to effective trend analysis. This is because each quarter of data contains around 40,000 line items, and some drugs are spread across multiple lines. To better simplify these data, we used each drug’s classification as identified under the Food and Drug Administration’s National Drug Code Directory. These classifications generally categorize drugs based on how they work, how they are used, and other factors. There are over 1,000 such classifications in the federal directory. Analysis Likely Omits Some Key Kinds of Drug Claims. Generally, states are required to report Medicaid drug utilization data connected to federal drug rebates. Federal guidance directs states to exclude reporting certain drug claims outside of the rebate system. For example, states are to exclude drugs that come with federal price discounts (known as 340B discounts). These drugs do not come with rebates, because federally required price reductions already occurred at the front end when the pharmacy purchased the drugs. Federal guidance also directs states to exclude claims that do not come with a federal share of cost. For example, drugs for undocumented immigrants do not qualify for federal cost sharing or rebates. As such, these kinds of drugs likely are excluded from our trend analyses. www.lao.ca.gov 5 2025-26 BUDGET As Figure 2 shows, we estimate Figure 2 (based on historical federal data) Medi-Cal Pharmacy Spending Has Grown Over Time that Medi-Cal pharmacy spending Total Funds (In Billions) in 2023-24 was nearly double the level in 2018-19. Pharmacy $16 spending continued growing even State Supplemental Rebates after the roll out of Medi-Cal Rx in 14 Federal Rebates Managed Care 2022. While this growth seems fast 12 Fee-for-Service in isolation, it is roughly in line with 10 overall Medi-Cal spending over the 8 same time period. 6 Rebates Average Drug Costs Have 4 Been Key Driver of Spending Increase. Spending on Medi-Cal 2 Net Spending services is driven by caseload, 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 service utilization, and service costs. Based on historical trends, the growth in pharmacy spending specifically appears to be driven by Figure 3 higher drug costs. As Figure 3 shows, we estimate the average cost per drug nearly doubled over the The Cost of Drugs Has Steadily Risen period, with the growth somewhat lower on a net Average Spending Per Prescription spending basis. While overall Medi-Cal caseload also increased over the same period, the increase $200 was much slower (17.6 percent). 150 Federal Rebates Appear to Have Ebbed and Gross Spending Flowed Over Time. Based on limited data, the level 100 of federal rebates also appears to have grown over time. As a percent of gross spending, however, the 50 Net Spending trend appears to be somewhat variable, fluctuating between 40 percent to 50 percent over the period. 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 These estimates are imprecise, however. Several factors can drive changes in federal rebates. For example, increasing use of generic drugs, Spending by Drug Type which come with lower costs and lower rebates Several Kinds of Drugs Represented Bulk of than brand name drugs, can drive down rebates. Spending. Spending on drugs is fairly lopsided, State Supplemental Rebates Appear to Be with certain kinds of drugs representing much of Increasing. Our imprecise estimates also suggest the spending. To gauge this effect, we looked at that state supplemental rebates have ebbed and the kinds of drugs that represented the most gross flowed somewhat over time, but generally in the spending in the Medi-Cal program. As Figure 4 upward direction. In 2023-24, we estimate these shows, the top 30 drugs in terms of spending (out rebates comprised 3 percent of gross spending, of about 950 drug categories) represented less up from as low as 1 percent in some years. This than 20 percent of all prescriptions (left column) increase was expected following the switch to the but more than 50 percent of gross spending Medi-Cal Rx system in 2022. This is because the (right column). Within these 30 kinds of drugs, the state did not receive state supplemental rebates on majority treat diabetes (or other related issues, drug claims in the managed care system. described further below), certain other autoimmune or inflammatory diseases (such as arthritis or psoriasis), and mental illness. 6 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET Figure 4 Certain Kinds of Drugs Comprise Majority of Drug Spending Second Quarter of 2024 Remaining Around 900 Kinds of Drugs Top 30 Kinds of Drugs by Spending 100% 90 80 Other 70 60 50 Mental Diabetes-Relatedª Health-Related 40 30 20 Certain Other 10 Autoimmune/ Inflammation-Relatedb Number of Gross Spending Prescriptions a Includes some drugs that treat other diseases, such as obesity. b Reflects variety of diseases, such as arthritis, psoriasis, and asthma. Three Kinds of Drugs Comprised Bulk of versions of these drugs (known as “atypical Spending Increases. When looking at the start antipsychotics”) entered the market. Over time, of the period and the end of the period, different the initial brand drugs have lost their patent kinds of drugs represented the most gross exclusivity and generic competitors have entered spending. As Figure 5 on the next page shows, the market. As Figure 6 on the next page shows, at the start of 2018, antipsychotics (drugs that generic versions have become a growing share of treat certain mental health conditions) and insulin antipsychotic prescriptions. Because these generic (drugs that help regulate blood sugar for diabetics) drugs are notably less expensive than their brand represented around one-quarter of gross spending. counterparts, their increasing use has helped By 2024, however, these drugs represented a limit spending on antipsychotics, driving down smaller percentage. In their place, newer specialty their share of overall gross pharmacy spending anti-inflammatory and diabetes-related drugs in Medi-Cal. represented around one-third of gross spending. Spending on Insulin Is Down… Historically, In all, we estimate these newer specialty drugs insulin also has comprised a substantial share of accounted for around half of the growth in overall gross spending on drugs. Over time, however, we gross pharmacy spending over the period. estimate that this share has fallen. A few factors Increasing Use of Generic Drugs Helped Limit seem to be behind this trend. Most importantly, Spending on Antipsychotics. Antipsychotics utilization appears to have declined somewhat. historically have represented a large portion of More recently, some of the largest makers of insulin pharmacy spending in Medi-Cal and in other state notably reduced prices, yielding declines in average Medicaid programs. This is in part because of cost. The notable reduction has been attributed their relative cost. In particular, a few decades to recent federal policy changes around Medicaid ago, relatively expensive second-generation drug rebates. www.lao.ca.gov 7 2025-26 BUDGET Figure 5 Spending Has Fallen for Some Key Drugs, Risen for Others Percent of Gross Spending Major Drugs With Declining Spending Major Drugs With Increasing Spending 18% 16 14 12 Antipsychotics Certain Anti-Inflammatory Drugs (TNF Blockers and Interleukin Inhibitors) 10 8 Diabetes, Heart, Insulin and Kidney 6 Disease Drugs Diabetes/Weight Loss Drugs (SGLT2 Inhibitors) (GLP-1 Agonists) 4 2 2018 2019 2020 2021 2022 2023 2024 2018 2019 2020 2021 2022 2023 2024 TNF = tumor necrosis factor; GLP-1 = glucagon-like peptide-1; and SGLT2 = sodium-glucose cotransporter 2. As the nearby box explains, these Figure 6 drugs stimulate insulin production Medi-Cal Has Increasingly Used Generic Antipsychotics and lower appetite. As a result, some of these drugs also are Share of Quarterly Antipsychotic Prescriptions approved for obesity treatment, 100% even for patients without diabetes. Somewhat less notably, spending 80 also has increased for drugs 60 Generic that help control blood sugar, kidney disease, and heart disease 40 among diabetics (known as 20 Brand Sodium-Glucose Cotransporter 2, or SGLT2, inhibitors). For both 2018 2019 2020 2021 2022 2023 2024 kinds of drugs, rapid growth in utilization has driven the higher spending levels. Certain Kinds of …While Newer Blood Sugar-Regulating Drugs Anti-Inflammatory Drugs Also Drove Up Have Increased Spending. Though the share Spending. Some of the most-used drugs in of spending on insulin appears to have declined, Medi-Cal address inflammatory diseases and spending on certain other diabetes-related conditions. Many of these drugs are not particularly drugs increased considerably. The most notable expensive and therefore comprise relatively increase (alone comprising 25 percent of the smaller shares of overall spending. In recent years, growth in overall spending over the period) was for however, we estimate certain kinds of relatively specialty diabetes and weight loss drugs (known costly anti-inflammatory drugs (including tumor as Glucagon-Like Peptide-1, or GLP-1, agonists). 8 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET What Are Glucagon-Like Peptide-1 (GLP-1) Agonists? GLP-1 agonists are a type of drug that help regulate blood sugar, generally by stimulating the release of insulin in the body. Use of these drugs also can result in weight loss among patients. Accordingly, in recent years, newer brands of drugs specifically focused on treating obesity have entered the market. As the nearby figure shows, there are three key GLP-1 agonists, each with different brand names for treating diabetes and obesity. Within the Medi-Cal program, semaglutide has comprised most of the utilization of Different Brands Treat Obesity and Diabetes GLP-1 agonists, mostly for Glucon-Like Peptide-1 (GLP-1) Agonists Ozempic (which primarily treats diabetes). That said, Brand utilization could increase Drug Maker Obesity Diabetes for other GLP-1 agonists Semaglutide Novo Nordisk Wegovya Ozempic, Rybelsus over time. This is because Tirzepatide Eli Lily Zepbound Mounjaro tirzepatide and its associated Liraglutide Novo Nordisk Saxenda Victoza brands entered the market a Also approved for cardiovascular disease. only a few years ago. necrosis factor, or TNF, blockers, and interleukin reflect gross pharmacy spending, before rebates. inhibitors) helped drive up spending over time. Because drug-level rebate information is not Over the period, utilization increased (particularly publicly available, it is not certain how drug-level for interleukin inhibitors) and costs rose. Recent spending trends differ on a net spending basis. entry of newer brand drugs partly has contributed Limited evidence, however, suggests that some to these trends. the above trends hold even after factoring rebates. Drug-Level Net Spending Trends Are For example, research suggests that Medicaid Uncertain. All of the above spending trends rebates have been growing as a share of gross spending for major insulin brands. GOVERNOR’S BUDGET Assumes Increase in Gross Drug Spending. Increase Driven Both by Higher Caseload Under the Governor’s budget, gross pharmacy and Costs. Generally, the uptick in spending in the spending in Medi-Cal in 2024-25 is estimated Governor’s budget is from higher caseload and the to be $19.4 billion total funds, a $1.6 billion higher cost of drugs. Specifically, in the last two (9 percent) increase over the level assumed at quarters of 2023, the number of enrollees using budget enactment last year. This revision is the drugs and average monthly cost of drugs came in result of having six additional months of data in higher than initial predictions. This uptick in actual 2024 to estimate spending. From this revised level, data, in addition to DHCS assumptions around gross spending rises by $1.2 billion (6 percent) Medi-Cal caseload, shifted the department’s to $20.6 billion in 2025-26. The administration’s pharmacy projection model. According to the back up does not readily provide the portion of this administration, a sizable portion of the increase spending attributable to General Fund. However, we in caseload is attributable to undocumented understand based on limited information from the beneficiaries, though drug utilization patterns administration that the 2024-25 revision reflects an among this population is not publicly available. increase of $1.3 billion General Fund. The department attributes the uptick in average drug costs to increasing use of specialty diabetes/obesity drugs. www.lao.ca.gov 9 2025-26 BUDGET Assumes Higher Rebates, but Lower State a total funds basis, the state’s share of savings is Savings. Similar to the increase in gross drug expected to be lower in 2024-25 (by 13 percent) and spending, the Governor’s budget assumes a rise then to further decline (by 0.8 percent) in 2025-26. in drug rebate savings. Specifically, drug rebates Federal savings, in turn, are projected to be higher are estimated to be $6.8 billion in 2024-25, a over the period. The department attributes the $145 million (2.2 percent) increase over the lower state savings to a larger share of rebates assumed level at budget enactment. Rebates coming from claims associated with childless further increase in 2025-26. The increases largely adults. (For this population, 90 percent of rebate are attributable to assumed higher savings from savings go to the federal government, instead of state supplemental rebates. Despite increasing on 50 percent for most other populations.) ASSESSMENT AND RECOMMENDATIONS In this section, we provide our assessment and In Other Ways, However, Pharmacy Data Are associated recommendations of the Governor’s Limited. Despite having relatively rich data on drug budget pharmacy estimate and recent spending utilization, California lacks complete data in some trends. As Figure 7 shows, we raise three key areas related to pharmacy spending. Most notably, points. Below, we describe each issue. actual data on federal and state rebates are notably limited. This in part reflects the fact that drug-level Figure 7 rebate information is confidential, though even actual data on aggregate rebates—which are not We Raise Three Key Issues Around confidential—are limited. These limitations make Medi-Cal Pharmacy Spending Trends it difficult to comprehensively assess Medi-Cal LAO Assessment pharmacy spending over time. Data Limitations Hinder Full Assessment • Medi-Cal Pharmacy Data Could Be More Transparent of Governor’s Budget Estimates… Operating • State Could Better Prepare for Drug Spending Volatility • State Has Limited Control Over Pharmacy Spending within these data limitations, the Governor’s budget assumptions around Medi-Cal pharmacy spending generally appear reasonable on a total fund basis. Medi-Cal Pharmacy Data Could Be The administration’s modelling generally reflects updated data around utilization and costs. That More Transparent said, some parts of the administration’s projections In Some Ways, Pharmacy Data Is More are difficult to assess. For example, though the Robust Than for Medi-Cal Services. Generally, administration historically has reported overall data on utilization and cost are fairly limited for fee-for-service utilization and spending trends by most Medi-Cal services. This is because Medi-Cal major Medi-Cal population, these data have not primarily relies on the managed care system to included breakouts for undocumented populations. deliver services, in which contracted health plans For this reason, while growth in drug utilization and manage provider claims and payments. In this cost is plausible for this population, it is difficult regard, the state has relatively richer data on to fully assess how changes in undocumented Medi-Cal pharmacy spending, which is entirely now enrollment are driving General Fund spending fee-for-service. Also, longstanding federal rules on pharmacy benefits. Also, the lack of complete require states to report on drug utilization, including actual data on drug rebates complicates assessing in their managed care systems. Given these DHCS’s assumptions around federal and state richer data, the Legislature has relatively robust rebates in the current year and budget year. information to track and assess pharmacy spending trends over time. 10 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET …and Savings From Change to Medi-Cal Rx. Moreover, we recommend the Legislature Data limitations also hinder more comprehensive direct DHCS to report on the estimated savings assessment of the savings from the switch to the resulting from the implementation of Medi-Cal Medi-Cal Rx delivery system in 2022. Though a Rx, with a potential due date in spring 2026. topic of interest to the Legislature, the assumed While such reporting could come with heightened savings from the adoption of Medi-Cal Rx have administrative costs at DHCS, it also would better not been validated with actual data. As Figure 8 inform legislative discussions and decisions in shows, Medi-Cal Rx was intended to save the future budgets. state money in a few different ways. Most of these Recommend Withholding Action on effects remain uncertain, even with a few years of Budget-Year Spending. Given the uncertainty implementation underway. around projecting pharmacy spending, we Given Limitations, Recommend Stronger recommend the Legislature withhold final action Transparency Around Medi-Cal Pharmacy on Medi-Cal spending (including pharmacy Spending. Given the above issues, we recommend spending) in 2025-26 until after the release of the the Legislature take actions to further enhance May Revision. At that point, more updated data transparency around pharmacy spending in on pharmacy spending trends will be available to Medi-Cal. Specifically, we recommend the better inform decisions. Legislature direct DHCS to annually report State Could Better on the following information: (1) complete drug utilization data in the Medi-Cal program, Prepare for Drug Cost Volatility including for claims excluded in the federal data; Managed Care System Is Intended to Reduce (2) data on fee-for-service average monthly Volatility. Originally, Medi-Cal paid for most prescription drug users, claims, and costs by services on a fee-for-service basis. Over time, major Medi-Cal population, including breakouts for however, the state has shifted most enrollees undocumented beneficiaries; and (3) actual annual and services into the managed care system. aggregate federal and state drug rebate trends. The managed care system is intended to bring several advantages to the state and to Medi-Cal beneficiaries. Figure 8 From a fiscal perspective, the Most Intended Effects of Medi-Cal Rx Remain chief intended advantage is to Uncertain limit the state’s exposure to the Key Areas of Intended Savings Under Medi-Cal Rx financial risk from swings in service utilization and costs. Instead, the Intended Fiscal Effect Area of Pharmacy managed care system enables the Spending Description Has It Happened? state to shift some of this risk onto State savings from Increase. Savings accrue Yes, but Effect Limited. State health plans. That is, the managed federal price to state (rather than likely earned savings from care system, in concept, helps discounts to providers under price discounts, though total managed care system). savings unknown. Portion reduce budget volatility in the of savings was redirected Medi-Cal program. back to nonhospital providers as supplemental Medi-Cal Shifting Pharmacy to payment. Fee-for-Service Likely Increased Supplemental Increase. Increased state Uncertain. State rebates Volatility and Uncertainty. While rebates supplemental rebates appear to have increased, but the overall fiscal effects of Medi-Cal (which state could not managed care plan-negotiated claim in managed care supplemental rebates have Rx remain uncertain, it is likely the system), resulting in ended. Net effect of these two transition to the fee-for-service more savings. factors is unknown. approach in 2022 increased Administrative Increase. Reduced costs Uncertain. Net savings to plans budget volatility in Medi-Cal. costs savings for managed care plans. have not been documented. www.lao.ca.gov 11 2025-26 BUDGET This is because the state now bears the full risk …Effect of Fund Has Been Limited. Though of swings in pharmacy spending. As Figure 9 apparently agreed to in concept by the Legislature shows, as measured by the consumer price index, and administration, the rebate fund’s mission is prescription drug prices tend to rise and fall much not specified in the existing authorizing statute. more substantially than for medical services. These Moreover, the statute does not specify target swings in part are driven by the relatively dynamic reserve levels for the fund. Accordingly, reserve drug market, with new entrant brand drugs and levels have been determined each year as part of generic competitors pushing up and pulling down the annual budget process. These levels have been costs. As such, significant upward and downward somewhat inconsistent in the six years since the revisions in pharmacy spending—much like the one fund’s creation, ranging from 0 percent to around in the current-year budget—may be more common 25 percent of state drug rebate savings each year. moving forward. This inconsistency stems in part from the state While Fund Exists to Managed Drug Spending using the reserves to address broader budgetary Volatility and Uncertainty… In recent years, the problems. In fact, the state has swept the fund’s administration and the Legislature have sought planned reserve three times (in 2020-21, 2023-24, to develop tools to mitigate spending volatility and 2024-25) as a budget solution. As a result, the in Medi-Cal. In the case of pharmacy spending, fund had a relatively small reserve at the end of volatility is managed in part through a special fund 2023-24 ($127 million) available to help manage the called the Medi-Cal Drug Rebate Fund, created in significant upward revision in pharmacy spending 2019-20 trailer bill legislation. The state share of in 2024-25. drug rebate savings is deposited into the special Recommend Tightening Rules Around Drug fund. (Previously, these savings would directly offset Rebate Fund. To better prepare for pharmacy General Fund spending, without being deposited spending volatility and uncertainty moving forward, in a special account.) According to analyses at the we recommend the Legislature enact tighter rules time, the purpose of the fund was to hold some of around the Medi-Cal Drug Rebate Fund’s reserve the monies in reserve during years of relatively high levels. Specifically, we recommend the Legislature rebate savings. The state could then draw from this codify the fund’s mission to better manage reserve during years of relatively lower rebates. pharmacy spending volatility and uncertainty. Moreover, we recommend the Legislature set forth target reserve Figure 9 levels and guidelines around Prices for Prescription Drugs when to draw down money from Are More Volatile Than for Medical Services the reserve. Annual Change in Consumer Price Index State Has Limited Control Over Pharmacy Spending 6% Rising Pharmacy Spending 5 Medical Care Services Comes at Time of State Fiscal 4 Constraints. As we have noted in 3 Prescription Drugs other publications, the Legislature 2 faces a constrained General Fund 1 budget with limited capacity for new ongoing spending. -1 This is because, while roughly -2 balanced in the short run, the -3 Governor’s budget assumes a 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 structural deficit in the out-years. The upward revision in Medi-Cal spending could further exacerbate these constraints. 12 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET Some Cost Pressure Appears to Be From Anti-Obesity Drugs May Become Mandatory, Optional Drugs. The Legislature appears to have Limiting the Availability of a Savings Option. some—though limited—control over the growth When assessing the trade-offs of covering in Medi-Cal pharmacy spending. In particular, anti-obesity drugs, it is important to consider that some of the growth appears to be driven by the federal rules may change soon. In particular, optional anti-obesity drugs. To date, these drugs in late 2024 the federal administrators proposed have been a small share of pharmacy spending. new rules to reinterpret federal statute around In 2023-24, we estimate the state spent in the anti-obesity drugs. The new interpretation would no low-to-mid hundreds of millions of dollars in total longer exclude covering these drugs in Medicare. funds on Wegovy, the main anti-obesity drug. The In addition, it would require coverage in Medicaid— state cost was likely less than half of this amount, effectively no longer making these kinds of drugs particularly after netting out rebates. However, optional. To date, the federal government has not pharmacy spending has grown rapidly due to finalized these proposed rules. Adoption of these growing utilization. Moreover, newer high-cost, rules is particularly uncertain given that a new anti-obesity brands have entered the market. Entry federal administration began its term in early 2025. of new brands tends to drive up spending. As a State Also Can Consider Other Tools to result, spending on these drugs could be quite a Control Drug Utilization. Beyond weighing the bit higher in the future. California also covers some trade-offs of covering optional drugs, California other kinds of optional drugs, though we are not likely has other tools at its disposal to control drug aware of more comprehensive spending estimates utilization. This is because federal law allows for for these drugs. some limited tools, such as by charging copays. Covering Anti-Obesity Drugs Comes With However, the potential effects of these tools are Trade-Offs. In considering whether to turn to the uncertain, and some tools may only have limited state’s current coverage of anti-obesity drugs to effect. For example, federal rules cap copays for limit growth in pharmacy spending, the potential preferred drugs to a small amount relative to the savings from eliminating coverage would need to cost of many high-cost drugs. be weighed against its policy benefits. The fact that Recommend Legislature Continue to Medi-Cal’s coverage of anti-obesity drugs appears Monitor Trends Related to Optional Drug to be much more extensive than other payors Coverage… Given the trade-offs at hand suggests that this might be a reasonable place to and inherent uncertainty with predicting drug turn for savings. Historically, the Medicare program spending, we recommend the Legislature has not covered the cost of weight loss drugs, and focus on monitoring trends in the short term. a recent University of California analysis found most private Figure 10 health plan enrollees similarly lack comprehensive coverage. Medi-Cal Enrollees Are More Likely to Be Obese California also appears to stand Percent of People Who Are Obese out from most other states, with just 12 other state Medicaid 40% programs covering these drugs 35 Medi-Cal 30 Commercial as of August 2024. On the other 25 hand, California’s policy reflects the 20 Medicare recognition of obesity as a disease. 15 Also, as Figure 10 shows, nearly 10 40 percent of adults in Medi-Cal 5 report being obese, a higher rate 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 than for Californians with private insurance or Medicare. www.lao.ca.gov 13 2025-26 BUDGET Specifically, we recommend the Legislature require spending, such as by scaling back coverage DHCS to annually report on utilization and spending (where allowed) or imposing new utilization on optional drugs, including anti-obesity drugs, controls. While taking some actions now could be to track their fiscal impacts. (This information reasonable, we also urge caution when reacting could be included as part of DHCS’s annual data to emerging pharmacy spending trends. This is transparency reporting we recommend earlier.) because the drug market is dynamic and tends With more consistent information at hand, the to change significantly over time. As our own Legislature could better weigh the trade-offs of analysis suggests, many of the recent cost-driving choosing to cover these drugs over time. drugs comprised relatively minimal portions of …And Exercise Caution When Reacting to gross spending several years ago. To this end, the Emerging Trends. Given the state’s current fiscal Legislature will want to ensure that any actions constraints, the Legislature may face pressure taken this year have measurable and likely impacts to take actions to control Medi-Cal pharmacy on long-term state costs. 14 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET www.lao.ca.gov 15 2025-26 BUDGET LAO PUBLICATIONS This report was prepared by Jason Constantouros, and reviewed by Mark C. Newton and Carolyn Chu. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, California 95814. 16 LEGISLATIVE ANALYST’S OFFICE