Policy Documents

A Decade of Success: How Competition Drives Savings in Medicare Part D

Paul Howard, Yevgeniy Feyman –
December 16, 2013

Executive Summary

On December 8, 2003, then-president George W. Bush signed into law the Medicare Modernization Act (MMA). Without a doubt, the law created the most significant overhaul of Medicare in the program’s history. As part of the MMA, a new, voluntary prescription drug program called “Medicare Part D” was enacted. Beginning in 2006, Medicare enrollees would also be able to sign up for outpatient prescription drug coverage through private insurance companies, with premiums subsidized by Medicare. To date, seniors have expressed high levels of satisfaction with the program, and Part D expenditures have been more than 40 percent lower than initial government estimates—a rarity for a government health-care program.

However, the program was controversial at the time of its launch in 2006 (and at the time of its passage). Indeed, soon after the bill became law, a plurality of seniors—some 47 percent—disapproved of the law.[1] Nevertheless, Part D is now often touted as a rare entitlement success story, with praise from both sides of the political aisle. In 2011, then–CMS administrator Donald Berwick said that Part D was a “competitive market and we’re seeing effects of good competition among Part D plans,” as he explained to reporters why Part D premiums had actually declined that year.[2] Former Senate majority leader Bill Frist pointed out that “[s]eniors, taxpayers and private industry all found a way to make [Part D] work,”[3] and Karen Ignagni, CEO of America’s Health Insurance Plans, noted that Part D is one of the few successful public-private partnerships operating at a national level.[4]On December 8, 2003, then-president George W. Bush signed into law the Medicare Modernization Act (MMA). Without a doubt, the law created the most significant overhaul of Medicare in the program’s history. As part of the MMA, a new, voluntary prescription drug program called “Medicare Part D” was enacted. Beginning in 2006, Medicare enrollees would also be able to sign up for outpatient prescription drug coverage through private insurance companies, with premiums subsidized by Medicare. To date, seniors have expressed high levels of satisfaction with the program, and Part D expenditures have been more than 40 percent lower than initial government estimates—a rarity for a government health-care program.

The root cause of Part D’s success remains hotly disputed. Part D proponents attribute the law’s success to competition driven by the use of private plans, competition, and private-sector cost-saving innovations.

Critics attribute Part D’s lower-than-expected costs to external factors unrelated to the program’s design. They argue that lower-than-predicted overall costs are a result of lower-than-predicted enrollment as well as a general slowdown in national drug spending, primarily due to a wave of patent expirations and other national trends unrelated to plan designs.

In this report, we review data from the Centers for Medicare and Medicaid Services, the Congressional Budget Office, and other sources, to examine which factors—market competition, patent expirations, or other national trends (including private-sector innovations such as tiered formularies and preferred networks)—explain overestimates for Part D costs.

In our analysis, we find strong evidence that:

National trends are not a sufficient explanation for Part D’s success. While patent expirations are part of the story—national drug spending as a whole slowed during the period we examine—they are far from the full explanation for large overestimates in Part D spending (indeed, patent expirations were likely captured in the original projections). Instead, the available evidence indicates that private-sector firm-level innovations, including preferred pharmacy networks and aggressive negotiations with drug manufacturers, have played a significant role in keeping the program’s costs below projections. We find that broader market trends (e.g., patent expirations and other changes) account for only about half (56 percent) of the program’s performance. The remainder—44 percent—of Part D’s lower-than-estimated cost savings is attributable to factors not captured in national prescription drug trends, which should include competition between Prescription Drug Plans (PDPs). This is strong evidence indicating that consumer-driven competition in Part D has been critical to the program’s financial success.

Consumer-driven competition is a relatively new tool in the government’s effort to control health-care costs. In hindsight, government overestimates of Part D’s cost are not surprising, since the program utilizes a model of consumer choice (robust competition among dozens of regional drug plans and Medicare Advantage plans) that has no perfect analogue in other government health plans, such as Medicaid.

Part D is an excellent model for future health-care and entitlement reforms. Arguably, Part D and Medicare Advantage plans represent the first national health-care exchange (the Federal Employees’ Health Benefits Program [FEHBP] is a close cousin). While the Affordable Care Act (ACA) operates a similar exchange concept, there are important differences. First, Part D plans compete in large regional areas, not states (this creates much bigger risk pools because even large states are incorporated into larger regions), as the ACA exchanges do. Even the federal exchange is layered on top of a state-regulated insurance market. This potentially limits the ability of plans to create economies of scale to bargain with providers and to utilize innovative tools to arbitrage cost and quality differences across state markets (preferred pharmacy and mail-order networks in Part D; telemedicine and medical tourism to “centers of excellence” for health-insurance plans). Notably, while Part D includes higher subsidies for sicker seniors (typically, the low-income subsidy population), it does not penalize healthier seniors through higher premiums, as the ACA’s community rating provisions do. Arguably, a better approach would be to rely more on backdoor (non-cross-subsidized) risk adjustment of plans and larger subsidies for sicker or older patients, while allowing plans to charge actuarially fair premiums to younger enrollees. The cross-subsidies in the Part D approach are more transparent in that sense, since they come from tax revenues rather than from private premiums.

Finally, we also suggest additional reforms for Part D, including a “shared savings” program for participating plans that would encourage them to focus on chronic disease management and prevention, reducing Medicare spending in other parts of the program.