Medicare Reform and Prescription Drugs: Ten Principles

Studies | Health

No. 256
Wednesday, October 09, 2002
by John C. Goodman, Robert Goldberg, and Greg Scandlen


Executive Summary

In an election-year rush to satisfy impatient voters, politicians of both parties are endorsing ill-considered schemes to add a prescription drug benefit to Medicare. While the problems with the program are bad, most of the proposed solutions are worse. Medicare deserves thoughtful reform - reform that can greatly reduce seniors' exposure to catastrophic prescription drug costs, improve overall health care quality and control taxpayer costs. What follows are 10 principles to guide that reform.

Principle No. 1: Medicare Needs Fundamental Reform. Despite its popularity, Medicare violates almost all principles of sound insurance. It pays too many small bills the elderly could easily afford on their own while exposing them to thousands of dollars of potential out-of-pocket expenses, including the cost of most of their drugs.

Seniors are the only people in our society who have to buy a second health plan to fill the gaps in the first. But even with Medicare and medigap insurance, most do not have the same drug coverage nonseniors have. Some proposals would keep the basic structure of Medicare intact but add a new drug benefit. This approach would be wasteful and inefficient and would create enormous taxpayer burdens in future years.

Principle No. 2: The Failure to Cover Prescription Drugs Creates Incentives to Substitute More Costly Therapies. Dollar for dollar, drugs offer a better return on health care spending than do other major therapies. Yet Medicare's practice of covering very few prescription drugs encourages doctors and their elderly patients to choose physician and hospital services over less costly, more appropriate drug therapies.

Principle No. 3: The Plan that Administers Drug Benefits Should Be the Same Plan that Administers Other Benefits. When two health plans administer two different sets of benefits, the decision makers can avoid the full costs of their bad decisions and cannot reap the full benefits of their good decisions. Suppose one plan controls hospital benefits and another controls drug benefits. Given a fixed premium for each, the incentive of the first plan is to reduce hospital costs. The incentive of the second is to reduce drug costs. Neither plan has an incentive to consider the overall picture and maximize the health benefits of a given money outlay. The solution is to have a single health plan making all treatment decisions.

Principle No. 4: Paying One Premium to One Plan Is Much More Efficient than Paying Several Premiums to Several Plans. When seniors purchase medigap insurance to reduce their exposure under Medicare, the federal government requires that insurance to cover the Part A and Part B deductibles and copayments. Thus seniors with medigap insurance have first dollar coverage for many medical services, even though they may lack drug coverage. The result is a great deal of waste. Health economists estimate that seniors with both Medicare and medigap insurance spend about 30 percent more on health care than those with Medicare alone.

Some propose creating a third plan with a separate premium to cover drugs. For most seniors, this would mean three premiums for three plans. But this approach would compound the problems of the current system. What is needed is not three premiums for three plans, but one premium for one plan - a plan similar to the health coverage most nonseniors have.

Principle No. 5: Adding a Drug Benefit to Medicare as Currently Structured Would Create an Unbearable Burden for Future Generations. Medicare currently pays only about 5 percent of the cost of the prescription drugs Medicare beneficiaries use. Proposals to add a comprehensive prescription drug benefit to the program could shift as much as two-thirds of senior drug costs to Medicare. Such a benefit would increase the already substantial burden Medicare will create for future taxpayers:

  • Even without reform, 48 percent of federal income tax revenues will be needed to meet the annual deficits in Social Security and Medicare by the year 2050 - in addition to the 15.3 percent payroll tax.
  • Under the House Republican proposal, 55 percent of income tax revenues will be needed just to pay seniors' benefits by the time today's teenagers reach retirement age.
  • Under the House Democrats' proposal, more than two-thirds of income tax revenues will be needed just to pay seniors' benefits by mid-century.

Principle No. 6: A Reformed Medicare Could Cover Prescription Drugs without Any Increase in Taxpayer Subsidies. Add the amount that Medicare spends on the average beneficiary each year to the amount seniors are already paying for the most popular medigap policy and the combined sum should be enough to buy the same kinds of health insurance coverage the nonelderly now have, including prescription drug coverage (assuming the private plans can pay Medicare rates). That is the conclusion of an NCPA study by Milliman & Robertson, Inc., the nation's leading actuarial firm on health benefits.

Principle No. 7: A Reformed Medicare Should Have Different Levels of Cost Sharing for Different Drugs. Almost all proposals to add a prescription drug benefit to Medicare establish a uniform level of cost sharing for all drugs - regardless of the drug and regardless of the condition it is supposed to treat. Yet an insurance plan with this feature makes little economic sense. Just as some general health care services are more discretionary than others, some drugs are more discretionary than others. And when patients exercise greater discretion, less waste and better outcomes will result if patients bear a larger share of the bill.

Principle No. 8: By Using Medical Savings Accounts, Seniors Could Control Drug Costs as Well as or Better than under Managed Care. Managed health care plans in general have attempted to hold down their drug cost increases by using pharmacy benefit managers (PBMs) to negotiate discounts with pharmacy chains, to limit coverage to lower-price generic drugs instead of patented, brand-name drugs, and to encourage the use of prescription drug therapies only if the benefits to the patient's health appear to justify the added cost. Yet one study found that restricting seniors' access to pharmaceuticals was associated with more emergency room admissions, hospital stays and doctor visits for such illnesses as depression, heart disease, ulcers and diabetes. The elderly were twice as likely to be harmed by these restrictions as were people under age 65.

An alternative approach has been taken in South Africa, where patients with Medical Savings Accounts (MSAs) are controlling drug costs as well as managed care, but without the cost of managed care. In one plan, per-member-per-month costs for drugs were 27.6 percent higher when patients were spending insurance company money than when they were spending their own money from MSA accounts.

Principle No. 9: Under a Reformed Medicare, Seniors Should Have Access to the Same Health Plans as Nonseniors. Virtually all of Medicare's shortcomings stem from the fact that Medicare's features have been determined by politicians and not by firms that have to compete for business by pleasing their customers. Dollar for dollar, health plans designed in the marketplace will almost always be superior to health plans designed by politicians. Like for-profit firms, politicians must compete to survive. But the nature of that competition forces them to weigh political costs against political benefits - where "costs" and "benefits" are measured in terms of impact on the next election. Private firms competing in a marketplace, by contrast, must compare economic costs with economic benefits. Our ultimate goal should be to enroll seniors in the same plans to which nonseniors have access.

Principle No. 10: Under a Reformed Medicare, Health Plans Should Not Have Incentives to Overprovide or Underprovide Care. In designing a reformed Medicare, we must be careful not to give health plans incentives to underprovide to the sick and overprovide to the healthy. An ideal structure is for seniors to have long-term enrollment in a health plan so they can establish long-term relationships with physicians and health care facilities. During the contract period, enrollees could switch health plans at any time. However, a switch of plans would require the consent of both the acquiring and the departed plan and this would almost always necessitate a lump sum payment from one plan to the other. In such a system, health plans would have an incentive to compete for the sick rather than to avoid them. Plans would also have an incentive to specialize in certain kinds of care, e.g., cancer care or treatment of heart disease.

Following these principles would not solve every problem under the Medicare program. But adhering to them would keep policy makers from creating problems that are even worse than the problems they are trying to solve.


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