Medicare’s prescription drug benefit is known as the one federal entitlement program that routinely comes in under budget. Now, a new push is on in Congress to make changes to the program that could increase costs.
Medicare’s unique drug benefit
Medicare, originally enacted in 1965, has many outdated design flaws. One of those was that the original law only covered prescription drugs if they were administered by a hospital (Medicare Part A) or in a physician’s office (Part B). Drugs that we obtain from retail pharmacies, like CVS or Walgreens, were not covered.
In 2003, under George W. Bush, Congress changed that by adding Medicare’s prescription drug benefit, also known as Part D, in a bill known as the Medicare Modernization Act of 2003. Under Part D, seniors choose among dozens of private plans, who compete for seniors’ business by negotiating drug prices effectively enough to offer retirees the lowest possible premium. Roughly three quarters of the cost of Part D are paid by taxpayers; the rest by seniors through their premiums and out-of-pocket costs.
This structure—insurers competing for market share through lower prices, with seniors incentivized to choose low-cost drugs—has worked remarkably well, so much so that in 2011 I described Part D as “the most successful cost-control experiment in Medicare.”
Indeed, during the 12 years from 2006 to 2018, per-enrollee spending in Medicare Part D actually declined in seven of them. The notable exception came in the period from 2013 to 2016, when the launch of new treatments for hepatitis C substantially increased Medicare drug spending.
Pretty good, right? You’d think so.
Seniors unhappy with out-of-pocket exposure
Even though three fourths of the Medicare drug benefit is funded by other taxpayers, seniors are still unhappy with the costs they pay for prescription drugs. As prices for branded pharmaceuticals continue to skyrocket, seniors’ out-of-pocket spending is increasing.
When Democrats passed Obamacare in 2010, they funded their subsidies for the uninsured in large part by significantly cutting Medicare spending. Democrats tried to make this medicine go down more easily by pairing the Medicare cuts with more subsidies for Medicare Part D’s “donut hole” deductible. In total, over the law’s first decade, Obamacare paired $768 billion in Medicare cuts with $48 billion in prescription drug subsidies and $4 billion for preventive care.
Drug companies loved this, because less out-of-pocket spending for seniors would translate into less price-sensitive consumers. That, in turn, would increase the ability of manufacturers to raise prices.
Sure enough, the government’s share of Medicare D spending has risen sharply in recent years, as more and more enrollees reach the “catastrophic” portion of their coverage.
(The Medicare Part D benefit goes through four stages. In stage 1—the deductible—the senior pays 100% of his drug costs. In stage 2, the “initial coverage phase,” the enrollee pays 25%, and the insurer pays 75%. In stage 3, the “donut hole” or “coverage gap” phase, the enrollee pays the same 25%, but the remainder is split between the insurer (5%) and a rebate funded by drug manufacturers (70%). In stage 4—the “catastophic” phase—80% of the costs are paid by Medicare, 15% by the insurer, and only 5% by the enrollee directly.)
Concerns about Part D’s current structure
Some Part D wonks are concerned that insurers don’t have a strong incentive to worry about drug costs once an enrollee reaches the catastrophic threshold because, as noted above, most of the costs are paid by the government, not the insurer.
Earlier this year, the Center for Medicare & Medicaid Innovation, led by Adam Boehler, set up a pilot program under which, beginning in 2020, insurers can volunteer to take on Medicare’s 80% responsibility in the catastrophic phase. Insurers would be on the hook if drug spending exceeded Medicare’s standard spending, but insurers could keep the change if they found a way to save more than Medicare.
In May 2018, Andrea Sheldon of the actuarial firm Milliman, at the request of Aetna, modeled a proposal to cap seniors’ out-of-pocket costs at $2,500, eliminating their cost-sharing responsibilities in the catastrophic phase. Instead, Medicare would pay 20% of catastrophic costs, with insurers paying 70-72% and drug manufacturers 8%-10% (their role in funding the “donut hole” would be eliminated).
Like the CMMI pilot, this approach would give insurers a stronger incentive to manage seniors’ drug costs, because if they fail at doing so, they will have to charge higher premiums and risk losing market share to more efficient competitors.
On the flip side, manufacturers are likely to react to the 9 percent Part D rebate by raising their prices by that amount. And with seniors’ out-of-pocket costs capped, a significant amount of the political pressure to reduce drug spending will vanish, giving manufacturers an incentive to raise prices even more.
Faulty reform assumptions
As you can imagine, the idea of capping seniors’ out-of-pocket costs is popular with seniors, and therefore popular with politicians. But it would likely lead manufacturers to take even higher price increases than they usually do, because if insurers refuse to pay up, patients will likely blame insurers instead of drug companies.
Critically, Aetna asked Milliman to assume that manufacturers would not increase prices in response to the cap on out-of-pocket costs. In one scenario, “we assumed the benefit structure changes have no impact including no changes to plan formularies, drug pricing, or beneficiary behavior.” In the other scenario, “Aetna asked that we demonstrate the impact of a 5% reduction in non-specialty brand drug spending as a result of drug pricing changes and plan management of high cost drugs.”
In other words, Aetna asked Milliman to assume that drug prices would go down, not up, with the new structure. In that second scenario, Milliman estimated that federal spending on Part D would decline by $23 billion from 2020 to 2029. (In the first scenario, with no behavioral changes or savings, the federal government would save $1.6 billion, but beneficiaries would spend $1.6 billion more.)
But what if prices went up? For example, manufacturers would almost certainly raise prices to make up for the 8% to 10% “rebate” imposed by the new Part D structure. In addition, capping seniors’ out-of-pocket costs would significantly reduce political pressure among retirees to rein in costs, giving manufacturers more ability to get away with higher price increases. At the very least, one could envision federal spending on Part D increasing by $23 billion over the next decade, if not more.
According to multiple sources, however, Congress is not considering these reasonable negative scenarios, let alone worst-case scenarios in which costs explode. Instead, key policymakers are taking the Milliman analysis and running with it, ignoring the caveats and the important scenarios that Milliman did not model out.
Reforming the reform
The positive incentives in the Aetna proposal—giving more incentives to insurers to rein in costs—would work better if it contained more ways to control costs.
For example, Congress could eliminate the Part D “protected classes” rule which forces insurers to pay for any drugs in six arbitrary categories, regardless of their price or value. (The Trump administration had proposed just such a reform, but withdrew it in a sop to the drug lobby.)
More substantially, Congress should require that drug companies selling drugs into Part D rebate any price increases above consumer inflation to Medicare, to offset the program’s taxpayer-funded subsidies.
Without reforms of this type, it’s highly likely that restructuring Part D would drive costs upward.
At a time when what we really need is entitlement reform, such a change would be more like entitlement deform: taking a reasonably well-performing public program and undermining its ability to be sustainable in the future.
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UPDATE 3: On July 19, I posted a follow-up article, discussing the decision by the Senate Finance Committee to include an inflation rebate essentially identical to what I described above. On July 23, the Senate Finance Committee released a summary of the draft legislation, to be marked up by the Committee on July 25. According to the Committee, the Congressional Budget Office estimates that the bill would, over the next decade, reduce federal spending by $100 billion—$85 billion in Medicare and $15 billion in Medicaid—while reducing seniors’ out-of-pocket costs by $27 billion, and Part D premiums by $5 billion. I posted some quick thoughts on the bill on Twitter:
THREAD: Some quick thoughts on the bipartisan Medicare drug reform bill whose draft summary has now been published. Overall, it’s a great bill that would reduce federal spending by $100B in total over the next decade, while also reducing out-of-pocket drug costs for seniors. https://t.co/DnRrPAa6Kj
— Avik Roy (@Avik) July 23, 2019
UPDATE 2: Actuarial firm Oliver Wyman, in analysis sponsored by America’s Health Insurance Plans (AHIP), estimates that capping seniors’ out-of-pocket costs, as a standalone policy, would increase federal spending on Medicare Part D by $87 billion over ten years.
UPDATE 1: Tara O’Neill Hayes of the American Action Forum has published a new analysis of the Part D out-of-pocket reform proposal. In it, she notes that, according to estimates by the Medicare Payment Advisory Commission (MedPAC), one advantage of moving the drugmakers’ rebates into the catastrophic portion of the Part D benefit is that it will be levied on those who charge the highest prices:
This change will target the rebate toward costlier drugs. MedPAC found that under the current CGDP, diabetic therapies are responsible for 31 percent of rebates paid; asthma and chronic obstructive pulmonary disease (COPD) drugs are responsible for 12 percent, and 11 percent are paid for anti-coagulants. The average price of these medicines is $480-$580 per claim. Alternatively, if the rebates were collected in the catastrophic phase, MedPAC estimates that antineoplastics (chemotherapy) would account for 20 percent of the rebates; antivirals would be responsible for 15 percent; diabetic therapies, 11 percent; analgesics and anti-inflammatory drugs would account for 9 percent; central nervous system agents another 9 percent; and Multiple Sclerosis drugs would account for 8 percent. The price of these drugs ranges from a few thousand to more than $30,000.
Nonetheless, the problem remains that drugmakers are likely to respond to out-of-pocket caps by raising their prices, as MedPAC suggests in its review:
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