Drug Benefit Debate Will Shed Light on Medicare Mess

Published June 1, 2001

When Medicare was established in 1965, pharmaceutical drugs represented a small part of medical expenditures.

Thirty-six years later, pharmaceuticals have become a major therapeutic approach to disease, as well as a substitute for much surgery and hospitalization. But with few exceptions Medicare does not cover drugs. The 107th Congress will vigorously debate adding comprehensive drug coverage to the program.

A new drug benefit will be expensive. The Congressional Budget Office estimates Medicare beneficiaries will consume $1.5 trillion worth of pharmaceuticals over the next 10 years. A drug benefit covering half of this spending could cost $728 billion over that period. Even a catastrophic benefit covering pharmaceutical costs above $5,000 per beneficiary would cost $365 billion.

But the Medicare program is financially shaky, and the benefits it pays to enrollees are already eroding. If those responsible for the program can’t keep their old promises, how can they keep new ones?

Design Flaws Plague Medicare

Two design flaws have made a mess of Medicare.

First, the program’s cost-sharing requirements are counterproductive. Calculated by adding up enumerated co-payment and deductible amounts for Parts A and B, the potential cost-sharing liability faced by beneficiaries exceeds $34,000 per year.

Unlike most private insurance polices, Medicare puts no limit on the out-of-pocket cost beneficiaries can incur. The potential liability causes most beneficiaries (74 percent) to insure against it, either as recipients of a retiree supplemental medical benefit or through “medigap” policies they purchase themselves.

Fewer employers are providing supplemental coverage (down to 24 percent of large employers in 2000 from 40 percent in 1995), so more beneficiaries must purchase medigap themselves—at an average annual cost of $1,330 in 1999, and growing faster than the rate of Medicare per-capita spending. Overall, therefore, maintaining Medicare benefits is costing beneficiaries more and more out-of-pocket.

Supplemental coverage converts Medicare into first-dollar coverage for covered benefits. It boosts beneficiaries’ use of services and contributes to Medicare’s unsustainable rate of expenditure growth. Beneficiaries with supplemental coverage consume 28 percent more health care services than they would otherwise, according to government estimates.

The other Medicare design flaw is the elaborate system of price controls to which Parts A and B of Medicare are subject. Surveys conducted by the American Medical Association and Congress’s Medicare advisory commission have shown physicians are reducing the content of services they provide to beneficiaries in response to price controls.

For example, substantial proportions of physicians are delaying or canceling investments in new technology, reducing the time they spend with Medicare patients, referring more difficult patients out of their practices, and reducing or dropping such services as telephone consultations, screening and counseling, and in-office x-ray and blood testing.

While most physicians continue to see Medicare patients, many are being forced to adjust to inadequate Medicare payment by economizing drastically in the content of services they provide to beneficiaries.

Also, while Congress created Medicare+Choice in 1997 to encourage beneficiaries to shift to HMO plans once thought key to cost control, burdensome administrative requirements and price controls on HMO payments have caused many HMOs to drop Medicare. More than 1,000,000 beneficiaries have been forced to find alternative HMOs or reenter the traditional program. Analysts have warned beneficiaries not to join other Medicare HMOs because they will be dumped again sooner or later.

Three Easy Fixes

Three easy fixes could clean up this Medicare mess.

Cost-sharing. First, Medicare’s cost-sharing requirements should be collapsed into a single, modest deductible that would reduce beneficiaries’ perceived need to insure against it. Beneficiaries could be charged a premium for the extra coverage, but the actuarially fair premium would be less than the price of commercial medigap insurance.

Price competition. Second, Medicare prices should be decontrolled to stop the devaluation of the program’s promises. The solution to price control problems is price competition to make sure prices are not higher than necessary to give beneficiaries access to promised services.

Competition can work if consumers care about prices and seek low-price producers for their services, in turn motivating producers to make their prices apparent to consumers and to produce efficiently so their prices can be as low as their competitors’. Consumers should be rewarded for seeking lower prices, but such rewards are impossible when price controls prevent providers from competing through prices.

Price competition can easily be introduced into Part B by using the current relative value scale but allowing physicians to determine their own conversion factors (CFs), which convert the relative values into dollar charges. Physicians could be required to post their CFs so beneficiaries would know their charges and would be able to compare the charges of different physicians. In turn, Medicare could set a CF by which it would reimburse beneficiaries for services they received.

Medicare’s CF could be based on physicians’ CFs in each market, and could be determined to guarantee beneficiaries access to a certain proportion of the physicians in the market at no additional out-of-pocket cost. For example, if Medicare wanted to assure beneficiaries they could see one-half of the physicians in their area at no out-of-pocket cost beyond what Medicare pays, Medicare would choose the median CF for reimbursing beneficiaries.

Medicare+Choice. Finally, Medicare+Choice should be converted to a premium support program similar to that of the Federal Employee Health Benefit Plan (FEHBP), which sets its subsidy of employees’ choice of coverage based on the premiums of the most popular plans. In this way, beneficiaries’ out-of-pocket liability could be limited to specific levels while encouraging price competition among plans to hold down cost as the FEHBP approach has demonstrated can be done.

Jesse Hixson is principal economist for American Medical Association. His email address is [email protected].