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CIAO DATE: 12/03
What Congress Should Do about Prescription Drugs for Seniors
Joseph Antos and Grace-Marie Turner
On The Issues
September 2002
The leading proposals in Congress for a Medicare drug benefit would displace insurance coverage that many seniors already have, impose tremendous new costs on taxpayers, and threaten to retard the development of new drugs. A better approach would target the help where it is most needed and lay the foundation for Medicare's future.
After three years of rancorous debate, Congress remains deadlocked over a prescription drug benefit for senior citizens. But the September 30 sunset of some arcane budget rules dramatically increases the chance that Congress will enact a new Medicare drug benefit. That change also sharply increases the chance of passing a bloated and unworkable program.
Prescription drug coverage should be integrated into Medicare's benefits. There has been a revolution in our ability to treat illnesses through the development of effective pharmaceuticals—true wonder drugs that can extend and improve the lives of millions. Policymakers recognize the need to modernize Medicare's benefit structure, but they sharply disagree on how.
The battleground is in the Senate. In the last days before the August recess, the Senate tried four times to pass a prescription drug benefit for Medicare. Two bills—one from Democrats, one from Republicans—received a thin majority but failed to get the sixty votes needed for passage under current budget rules.
But after September 30, when the old budget restrictions no longer apply, the Senate needs only a simple majority. Under those circumstances in an election year, it will be difficult to stop an extravagant benefit expansion unless policymakers consider new options.
The End of Budget Limits?
Congressional procedures thus far have frustrated attempts by the Senate to pass a Medicare drug benefit. Last year, the Congress agreed that it would consider a drug benefit costing no more than $300 billion. Because Senators were unable to reach agreement on new budget targets this year that limit is still binding. Under the Budget Enforcement Act of 1990, such limits can be exceeded, but only if sixty Senators agree. Because the Senate is almost evenly split (fifty Democrats, forty-nine Republicans, and one Independent), it has been impossible to reach the necessary super majority.
Similar provisions apply to the House of Representatives, but the House has a more substantial majority (223 Republicans, 210 Democrats, one Independent) and procedural obstacles have not been an impediment to legislation. A Republican-backed Medicare drug benefit passed the House in late June on a largely party-line vote.
Congress does not seem to have the time or the will necessary to extend Budget Act provisions after they expire on September 30. Senate Majority Leader Tom Daschle (D-S.Dak.) is likely to bring a generous (and expensive) government-run drug benefit to the floor in early October. Such a bill could pass if it had strong backing from Democrats and gathered a few Republican votes.
Republicans could try to prevent a vote through a filibuster, since sixty votes are necessary to end debate in the Senate. But filibustering such a popular benefit could be political suicide, particularly if the polls in late September show continuing public anxiety over prescription drug costs. Under that circumstance, an alternative proposal from the Republicans is the more likely response.
A Second Chance for Failed Proposals
Left to their own devices, the two sides are likely to recycle the same ideas that deadlocked the debate in July. Let us look at what that might mean.
Graham-Miller-Kennedy.The proposal by Senators Bob Graham (D-Fla.), Zell Miller (D-Ga.), and Edward Kennedy (D-Mass.) gathered fifty-two votes—the highest vote count of the four proposals considered by the Senate. This benefit would be controlled by the federal government and administered by private contractors, just as other Medicare benefits are today. The Medicare Outpatient Prescription Drug Act of 2002 has a politically attractive premium, set at $25 per month. Beneficiaries would be required to pay part of the cost of each prescription—$10 for a generic drug and $40 for a brand drug on the formulary, which is a list of approved drugs. Beneficiaries would pay higher amounts for drugs that were not on the formulary.
The federal government would pay all costs once a beneficiary used $4,000 worth of drugs. However, it is not clear how much financial exposure a senior might have under this plan. The catastrophic spending limit would depend on the total cost of drugs purchased, not on the portion of the cost actually paid by the beneficiary. Someone who had other insurance coverage might reach the catastrophic limit after having paid a relatively modest amount himself. A beneficiary who needed very expensive drugs would spend less of his own money and reach the catastrophic limit more quickly than one who primarily used lower-cost generics.
The proposed program would exacerbate Medicare's managerial inefficiency and waste and drive the price of prescription drugs to new heights. The government would reimburse the contractors managing the benefit exactly what they paid for the drugs they purchased from pharmaceutical manufacturers for beneficiaries. Thus there would be little incentive for the contractors to drive a hard bargain. Drug prices would surely increase, because every dollar saved by the contractors would reduce their government reimbursement by a dollar without adding to their profits.
The Graham-Smith-Kennedy plan offers a one-size-fits-all drug benefit for a highly diverse population of Medicare beneficiaries with different health needs and financial circumstances. Premiums and benefits would be uniform nationally, and beneficiaries would not be able to select a less expensive drug plan. They would also have first-dollar coverage, which blunts the incentive for economizing in routine drug purchases. The proposal requires copayments for generics and drugs on the formulary that are modest compared to other proposals, and does not have a deductible. Thus the plan would pay a very high percentage of the routine and affordable pharmaceutical costs of Medicare beneficiaries.
Cost is a big issue for such a generous and inefficient proposal. This bill "solved" the budget problem by taking two actions. First, the drug benefit was scheduled to end in 2010, lopping off two expensive years of federal cost (budget rules require spending estimates on a ten-year basis). The budget savings from this sunset provision are illusory; Congress would never allow a benefit as important as this one to lapse.
The second action designed to produce budget savings is more pernicious and gives a clear warning of the dangers of over-regulation if a poorly designed drug benefit were to be enacted. The Graham-Miller-Kennedy bill states that no more than two brand name drugs per therapeutic class would be permitted on the formulary. Beneficiaries would be responsible only for the $40 copayment for those drugs. Beneficiaries could purchase other branded drugs, but they would pay as much as the full retail price which could run to thousands of dollars. There is no industry standard for the number of therapeutic drug classes, however. Regulators could limit the number of classes so that more branded drugs were off the Medicare formulary to try to save money for the program, but this could impose substantial costs on many seniors who need these drugs. Although the restriction would almost certainly be lifted by Congress, the fact that such a provision was advanced indicates the willingness of the bill's sponsors to regulate seniors' use of drugs on a national scale.
Even with the sunset provision and formulary restriction, the Graham-Miller-Kennedy bill is expensive. According to the Congressional Budget Office (CBO), the proposal would cost taxpayers $421 billion through 2010. The total cost would reach $594 billion over the next decade, making it the largest single benefit expansion in Medicare's history. If the formulary restriction was lifted, the cost of this proposal could reach $800 billion.
If history is a guide, Medicare's prescription drug costs under the Graham-Miller-Kennedy bill will spiral even higher than the official estimates indicate. The cost of Medicare drug benefits will begin to crowd out other popular federal programs. There are no good solutions. Cutting back benefits for seniors is politically dangerous. Tax increases are obviously unpopular. That leaves one other revenue source: the health care industry. Faced with rapidly growing costs, Congress is likely to clamp price controls on drugs and impose burdensome regulations on their use.
Congress has repeatedly turned to price controls in Medicare over the past twenty years, beginning with hospital payments in the early 1980s. Today, every major service paid for by Medicare is subject to a federal price schedule.
The problems of that approach to limiting Medicare spending are graphically illustrated by the ongoing furor over physician payments. The complicated fee schedule used to pay doctors sets prices for more than 7,000 individual physician services. Medicare also limits how much a physician can charge the patient. In implementing this system, the Medicare bureaucracy has issued thousands of pages of directives to doctors as a condition for reimbursement, regulating what they do and how they do it.
Unfortunately, the fee schedule and regulations have not succeeded in keeping Medicare spending on physician services below congressionally mandated levels. In an unprecedented action, doctors' fees were cut by 5.4 percent in 2002 to compensate for excess spending in earlier years. Those fees were reduced despite of the continuing increase in the cost of providing services to Medicare beneficiaries. Unless new legislation emerges, further sizeable reductions in fees are expected over the next several years.
With limits on their ability to recoup the lost revenue, physicians are beginning to limit the size of their Medicare practices. In some parts of the country, newly-retired seniors are having difficulty finding a doctor willing to see them.
Using this failed model of open-ended benefits leading inexorably to price controls would be a terrible mistake. Government price setting could distort market incentives, leading to shortages of particular drugs. Costs inevitably would rise, and access to the newest drugs might be restricted as a cost containment measure. Restrictions on the senior drug market, which accounts for about 40 percent of all pharmaceutical spending, would reduce the chances that a new drug would be able to cover its high cost of development. That would discourage research—particularly research on diseases of the elderly, such as cancer and Alzheimer's disease—that could lead to more effective treatments or cures.
The Tripartisan Proposal.The Tripartisan proposal—the 21st Century Medicare Act, sponsored by Senators Charles Grassley (R-Iowa), John Breaux (D-La.), and James Jeffords (I-Vt.)—received forty-eight votes in the Senate. The bill has been criticized for the complexity of its benefit structure. The proposal would require that beneficiaries pay a significant share of their prescription drug expenses, including a $250 deductible and half of the cost of their prescription drugs between $250 and $3,450. Beneficiaries would be responsible for all costs between $3,450 and $5,425—a "hole" in benefits that would keep federal costs down. Above that level, the federal government would pay all costs. Adding the deductible, cost-sharing, and spending in the benefit "hole," beneficiaries would have to pay out-of-pocket no more than $3,700 a year under this proposal.
The Tripartisan proposal adopts many of the market principles of the Medicare drug benefit recently enacted by the House. In contrast to the Democrats' proposal, the benefit would be offered by competing drug plans. Such plans currently manage the pharmacy benefits for employer-sponsored health benefit programs, but they typically do not operate as insurers and are not exposed to financial risk. As an inducement to private drug plans the proposal would provide federal payments to reinsure plans that enrolled beneficiaries with drug spending exceeding $2,000. Consequently, although the plans would be exposed to financial risk for their management of the benefit, that risk would be greatly attenuated.
The competing plans would have an incentive to manage costs and negotiate favorable prices with pharmaceutical manufacturers. Plans would be permitted to pass on the savings to beneficiaries through lower premiums. The government would also provide a sizeable premium subsidy through reinsurance payments. As a result, premiums are expected to average about $30 a month in 2005.
The Tripartisan proposal also would make significant changes to the larger Medicare program, establishing a new fee-for-service option that would give seniors both greater financial protection against high medical expenses and additional preventive care benefits. That new option would limit the total out-of-pocket costs paid by beneficiaries for all Medicare services to $6,000 a year. It would eliminate separate deductibles for hospital and physician services, replacing them with a combined deductible of $300, and adjusts other cost-sharing requirements. Preventive services would be made available without any cost-sharing requirements. Such changes would improve the financial protection afforded to enrollees in the enhanced program.
Another provision would provide some relief to Medicare's beleaguered HMO program, Medicare+Choice. Attempting to stem the exodus of HMOs out of Medicare, the bill would give the plans added administrative flexibility. It would also improve the way HMO payments are determined to better reflect the plans' actual cost of providing care.
According to CBO, the proposed drug benefit would increase federal spending by about $340 billion over the next decade. Other enhancements to Medicare's benefits would require an additional $30 billion in federal spending.
A troublesome feature of the Tripartisan proposal is the creation of a new federal reinsurance program rather than relying on the private market to develop its own mechanisms for handling business risk. Such mechanisms, which include private reinsurance, are commonplace in the insurance industry, and could be expected to develop in a new market if permitted to do so. Federal reinsurance would impose higher total costs on the economy than private approaches. If a substantial part of the financial risk was federalized, drug plans would face fewer consequences for inefficient management, resulting in a more rapid escalation of Medicare costs.
The Tripartisan proposal would introduce some new elements of competition into Medicare and provide additional incentives for more efficient use of health care resources, but it does not go far enough toward Medicare modernization. Although it is less expansive and more economically efficient than the Graham-Miller-Kennedy proposal, the bill still imposes substantial new costs on an already over-burdened program. That level of spending would compromise Medicare's long-term solvency without the aggressive new efforts needed to reform the program.
The Hagel-Ensign Proposal.Senators Hagel (R-Nebr.), Ensign (R-Nev.), and others, proposed a drug benefit that combines a prescription drug discount card with catastrophic coverage. Unlike the other proposals that have been considered in the Senate, the Medicare Rx Drug Discount and Security Act of 2002 requires all beneficiaries to meet a large deductible before insurance coverage would be provided, but imposes only a $25 annual membership fee (rather than a monthly premium) to encourage participation. The cost is $160 billion over the next ten years, according to CBO. In a surprising turn of events, the proposal received fifty-one votes, which precipitated a major shift in legislative strategy by the Democrats.
The Hagel-Ensign bill offers assistance that is narrowly targeted to people who are most in need. Catastrophic coverage would be triggered by a beneficiary's drug expenditures and income, with lower-income beneficiaries spending less on drugs to reach the catastrophic spending limit. The government would pay all drug costs for beneficiaries with incomes below 200 percent of the poverty line (equivalent in 2002 to $17,720 for an individual or $23,880 for couples) once they had out-of-pocket payments of $1,500. As income increases, so does the catastrophic limit, rising to $5,500 for those between 400 percent and 600 percent of the poverty line, for example. Although the catastrophic coverage provisions are complex, they would be effective in limiting the amount of taxpayer subsidy going to higher-income seniors who have more ability to pay for their own prescription drugs.
Every Medicare beneficiary would also be given a prescription drug discount card that would reduce the cost of prescription drugs before the catastrophic limit was reached. Major pharmaceutical companies and retail pharmacies offer such discount cards today. The size of the discount varies depending on the card, with some pharmaceutical manufacturers offering very large savings for low- and moderate-income seniors. With Pfizer's Share Card, for example, a qualifying senior can get a thirty-day supply of any Pfizer drug for $15. That could mean a savings of 50 percent or more for a number of commonly prescribed drugs. The Hagel-Ensign approach is similar to President Bush's discount card program, which would make discount cards available to all Medicare beneficiaries regardless of income.
The Achilles' heel of this proposal is having the federal government bear the full financial risk for catastrophic drug coverage. That is, drug plans would be fully reimbursed for their costs, regardless of how well they managed the benefit. Similar to the Graham-Miller-Kennedy proposal, the plans would have little reason to restrain costs or bargain for drug discounts since they could not profit from that effort. Government regulation, rather than private market initiative, eventually would be required to limit program costs.
A catastrophic-only drug benefit does not have to operate that way. Such a benefit could be managed to maintain the quality of patient care while keeping costs down, but only if the plans have an economic incentive to do so.
The Hagel-Ensign bill avoids the inefficiencies of first-dollar coverage and takes advantage of the discounts that are already available in the market. But it fails to make private health plans active partners in managing the program, and it does not move us toward Medicare reform.
The Graham-Smith Proposal.In response to the unexpected support for the Hagel-Ensign proposal, the Democrats developed a new compromise proposal sponsored by Senators Graham (D-Fla.), Gordon Smith (R-Ore.), and others. The Medicare Prescription Drug Costs Protection Act combines first-dollar coverage for the prescription drug costs of low-income beneficiaries with catastrophic protection for all. This hybrid bill gathered forty-nine votes.
Under this proposal, Medicare beneficiaries with incomes up to 200 percent of the poverty line would be responsible only for nominal copayments for their prescription drugs. Beneficiaries with incomes over 200 percent of the poverty line would be eligible for any discounts that may be offered on their drugs, although they are promised at least a 5 percent discount. The catastrophic drug coverage provisions are simpler than under Hagel-Ensign, offering full coverage for everyone once they had incurred $3,300 in drug expenses. To ensure full participation, the bill would charge an annual $25 membership fee. CBO estimates that the taxpayer cost of this proposal is $390 billion over the next decade.
The Graham-Smith proposal shares the inefficiencies and limitations of other proposals that guarantee full government payment for drug plan costs, regardless of how well they manage the benefit. Spending under this bill would quickly spiral out of control, inevitably leading to harsh regulatory measures that would limit drug availability and retard the development of new drugs.
Despite its clear defects, the Graham-Smith proposal represents an important ideological shift among Democrats. For the first time, they have accepted something other than a universal benefit in Medicare. By endorsing income-related benefits, Senate Democrats have moved toward agreement with Republicans on an important policy objective. Both sides have now said that scarce taxpayer dollars should first be used for seniors who really need the help.
A Responsible Alternative
Can Medicare survive an expensive new drug benefit? The program already requires increasing amounts of taxpayer dollars to meet its obligations. Adding a costly entitlement would put more strain on a program that millions of baby boomers are counting on when they retire.
A new drug benefit must include elements of broader program reform or it will seriously endanger the financial stability of Medicare. We have developed a proposal called the Prescription Drug Security (PDS) plan, which offers significant drug coverage to seniors most in need while promoting efficiency, innovation, and consumer choice. It also provides a way of testing market-based reforms that are key to Medicare's long-term survival.
The PDS proposal combines the key elements of earlier proposals: a low-income subsidy, a discount card, and catastrophic insurance protection. It would provide immediate financial assistance to low-income seniors to assist them in purchasing routine medications, while providing private catastrophic coverage for large drug expenses. But there are important differences from other proposals:
Low- and Moderate-Income Beneficiaries.The PDS program would be very attractive to low- and moderate-income beneficiaries who did not already have comprehensive drug coverage from Medicaid or an employer. Those with incomes up to 200 percent of the poverty line would pay nothing to participate in the PDS benefit. According to estimates by PricewaterhouseCoopers, nearly all of the people in this low-income group who did not otherwise have drug coverage would enroll in the PDS program. 1
PDS card subsidies and premium subsidies would be gradually reduced for those with higher incomes. Beneficiaries with incomes as high as 350 percent of the poverty line (equivalent to $31,010 for an individual or $41,790 for couples) would receive some cash subsidy. Beneficiaries with incomes between 200 percent and 300 percent of poverty would pay a subsidized premium averaging $28 per month. Those with incomes greater than 350 percent of poverty would pay an unsubsidized premium, expected to average $111 per month.
Medicare beneficiaries who did not qualify for a full subsidy would get a tax deduction for their insurance premiums and any deposit they made to their PDS card. Total contributions to a PDS account (including any federal contribution) would be limited to $600 per year. Unspent balances in the PDS account would be rolled over to the next year.
The combination of some direct subsidy, the tax deduction, and the ability to accumulate PDS balances from year to year would make the PDS program affordable for most middle-income people. Those with incomes up to 300 percent of poverty would almost certainly come out ahead with the PDS program. About 70 percent of individuals without drug coverage in this income group would enroll in the PDS program.
High-Income Beneficiaries.The effective premium paid by high-income beneficiaries who participate in the PDS program would be reduced by tax breaks on their payments for premiums and contributions to the PDS account. For those making the maximum PDS contribution, premiums net of taxes would drop to about $70 per month. In addition, the saving mechanism offered by PDS would be attractive for those who did not expect to have high drug costs in the short run. Although the net premium is substantial, the PDS program would enroll several million beneficiaries who would not qualify for a federal subsidy. About 10 percent of high-income people without drug coverage would join the PDS program in the first year of operation. But that understates the program's impact. A significant fraction of those with other drug coverage would also enroll in the PDS plan.
Most high-income beneficiaries have drug coverage through employer-sponsored retiree plans or private Medigap insurance. In some cases, beneficiaries would enroll in PDS because of changes in their employer-sponsored coverage. Many employers would take advantage of a new Medicare benefit by adjusting the private benefits to fill in some or all of the gaps in the Medicare coverage. This "wrap around" approach allows the employer to reduce its costs without reducing the benefits for its Medicare-eligible retirees. Some employers might also help their Medicare-eligible retirees buy into the PDS program by subsidizing their premiums directly. About a quarter of beneficiaries with employer-sponsored coverage would participate in the PDS program. Most of those people would also retain their employer drug coverage.
Beneficiaries who purchase Medigap policies to obtain drug coverage are constrained by regulatory requirements imposed by Congress, which permit only ten types of policies to be sold. Only three of those policies offer any prescription drug coverage, and none protect against catastrophic drug expenses. Because those plans are required to include generous coverage for Medicare copayments and deductibles, their premiums can exceed $3,000 a year. The PDS program provides insurance coverage for high drug costs that is not available in the private Medigap market. About 20 percent of high-income beneficiaries with Medigap drug coverage would participate in the PDS program. The strange anomaly of the government's banning seniors from purchasing insurance for catastrophic drug expenses, and requiring that insurance for lesser drug expenses be provided in a highly inefficient form, would be effectively eliminated.
Minimal Risk of Adverse Selection.The PDS program is designed to encourage healthy as well as sicker beneficiaries to enroll. The generous up-front subsidies would result in high enrollment rates among low- and middle-income people. Since unspent balances on the PDS card would roll over to the next year, healthy as well as sicker beneficiaries would have an incentive to participate. Broader participation would make the catastrophic insurance coverage more affordable for everyone.
Although higher income people would not receive a direct subsidy, the adverse selection of sicker beneficiaries into the program is not likely to be a significant problem. To reduce the possibility that drug plans would avoid enrolling high cost beneficiaries, projected costs would be risk-adjusted based on readily obtained information on enrollee health status. Prescription drug spending can be predicted with considerable accuracy if one knows a patient's chronic diseases and recent history of prescription drug use, which would be available to the drug plans and to the government agency responsible for the program. Such information would also be useful for assessing how well the plans met the needs of the Medicare population.
Basis for Reform.The PDS program would lay the foundation for reforms needed to ensure the long-term viability of Medicare. The benefit would be managed through private, competing prescription drug plans. Each drug plan would be responsible for its own drug formulary, track the balances on each enrollee's debit card, negotiate discounts on behalf of its beneficiaries, organize the catastrophic coverage, and provide other services to improve patient safety.
Under the PDS program, and in contrast to all of the proposals considered by the Senate thus far, each drug plan would be fully at risk for its management of the benefit. Premiums would be established through negotiation, and plans would have a strong financial incentive to operate efficiently. Plans would be responsible for making their own provisions to handle financial risk, and it is likely that pharmacy benefits managers would partner with insurers to create new types of business organizations for that purpose.
The PDS program would be run by a new agency that would have a genuine customer focus and the flexibility to manage the benefit effectively. The new agency would be modeled after the Office of Personnel Management, which runs the widely lauded Federal Employees Health Benefits Program for members of Congress, federal employees and retirees, and their families.
The agency would ensure that individual drug plans were providing appropriate benefits and consumer safeguards. Rather than waiting for an act of Congress to correct problems, the agency would have the power to take action. Price controls and over-regulation would be replaced with flexibility and a consumer focus.
The bottom-line cost of the PDS plan is $302 billion over ten years, according to an estimate from PricewaterhouseCoopers. The proposal would allow Congress to focus on seniors who lack drug coverage and not disrupt the good coverage that millions of others have now. It would allow seniors and their doctors to decide what drugs were best for them, and would actually put in place a foundation for changes that could save Medicare in the long run.
The Senate's Next Move
The political strategy in the Senate will change once the restrictions in the Budget Act expire. Instead of seeking a compromise that can be supported by most Democrats and perhaps a dozen Republicans to reach sixty votes, Senator Daschle will be able to focus on a more traditional proposal that needs only fifty-one votes for passage. Could a proposal similar to Graham-Miller-Kennedy form the eventual basis for a compromise in conference with the House? That might seem unlikely, but the pressure of the election could yield an unaffordable and flawed plan that the President would be hard pressed to veto.
Although that might be good politics, it would be very bad public policy. We should ensure that all seniors have access to prescription drug coverage. But most senior citizens today have coverage, through their former employers, private supplemental insurance, or Medicaid. A badly designed Medicare drug benefit would shift seniors out of the coverage they do have into a government program that will be plagued by explosive costs and constrained by regulatory restrictions on the availability of the most innovative drugs.
Congress should act responsibly for both senior citizens and young working families who pay the bulk of Medicare costs. The Prescription Drug Security plan could provide meaningful help for low-income seniors who do not have access to drug coverage. Those seniors should be the priority for Washington policymakers, who can—and should—provide this help while creating a structure for a market-based Medicare necessary to control costs in the future.
Endnotes
Note 1: All participation and financial projections have been made by PricewaterhouseCoopers. Back
Joseph Antos is a resident scholar at AEI. Grace-Marie Turner is president of the Galen Institute, a not-for-profit public policy research organization in Alexandria, Va.
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