What Will the Federal Prescription Drug Program Cost?

Published March 1, 2005

“There has been no significant change in the cost of the prescription drug benefit.” Mark McClellan, director
Centers for Medicare and Medicaid Services

News reports recently seized on the Bush administration’s February 9 announcement that the projected cost of the Medicare prescription drug benefit, initially estimated to be about $400 billion, is now estimated at $720 billion.

The $320 billion increase does not reflect an increase in the program’s costs, however, but rather a change in the time period over which the costs are being estimated. No secret was made in the debate over the program that it would be less expensive in its early years and more expensive later.

The administration’s new estimate begins tracking costs in 2006, when the drug benefit goes into effect, and projects out to 2015, at an estimated cost of $724 billion.

The original estimate began tracking costs in 2004, before the drug benefit was to be made available, and projected out to 2013, at a cost of about $511 billion.

Competing Estimates

Making things even more complicated, when Congress debated the legislation in 2003 a Congressional Budget Office (CBO) estimate put the cost at $395 billion. In a December 2003 speech at The Heritage Foundation, the head of the CBO, Douglas Holtz-Eakin, said, “I hope everyone in this room has memorized a single number: $395 billion, the CBO’s estimate of the 10-year cost of this bill.

“This cost represents not really a 10-year cost, but because the benefit doesn’t begin until 2006 and ramps up from about $26 billion then to about $75 billion by the end, it’s closer to an 8-year budget cost,” Holtz-Eakin said.

The Centers for Medicare and Medicaid Services (CMS), in a report from the director of Medicare Outreach, projects the cost of the Medicare prescription drug benefit to reach $109 billion per year by 2015. Moreover, according to a recent report co-authored by National Center for Policy Analysis (NCPA) Senior Fellow Thomas R. Saving, public trustee of Social Security and Medicare, the unfunded liability of the Medicare prescription drug benefit amounts to $17 trillion.

Making accurate estimates even more difficult to come by, participating seniors will pay premiums estimated at $35 per month starting in 2006. They will then be responsible for the first $250 in drug spending. This means seniors will have to spend $670 per year (a $250 deductible and $35 per month in premiums) before receiving any benefit.

For the next $2,000 in drug spending–that is, all drug spending more than the $250 deductible and less than $2,250–Medicare Part D will pay 75 percent; the seniors will pay 25 percent. After that, Medicare Part D will pay nothing for prescription drugs until the tab reaches $5,100. Once the $5,100 threshold is reached, Medicare will pay 95 percent.

And to make things even more complicated, these deductibles and thresholds will be adjusted yearly.

Enrollment Numbers Are Key

The big question is, will seniors actually participate in the new drug benefit? If healthy seniors do not enroll in large numbers, overall costs are likely to rise, because there will be fewer seniors paying the premiums that are necessary to keep government spending on the program low.

The problem is, nearly half of all U.S. seniors will not benefit to any extent if they sign up. According to the Kaiser Family Foundation, about 10 percent of seniors have no annual drug expense, and an estimated 10 percent more spend less than the $250 deductible.

Participating seniors would not be better off under the Medicare prescription drug program unless their yearly drug bill exceeds $810. It is at this point where the benefits received under the program pay back the yearly cost of premiums. About one-third of the nation’s seniors don’t spend that much. And more than two-thirds of seniors today already have drug coverage. So participation by healthy seniors is by no means assured.

One way Medicare hopes to get around this is by imposing a penalty for late enrollment in the program. For every month an eligible senior delays signing up, future premiums will increase by 1 percent per month when they do sign up. And once the drug benefit begins in 2006, new private-sector Medigap policies will be prohibited from containing prescription drug coverage, a policy also meant to encourage enrollment in the Medicare drug benefit program.

Big Spenders Will Enroll

Those less likely to benefit from prescription drug coverage–persons with annual drug spending less than $1,000, about 41 percent of all seniors–may rationally decide not to enroll. These individuals account for only 6 percent of all seniors’ prescription drug costs.

The problem for Medicare is that the remaining 59 percent of seniors account for about 94 percent of seniors’ drug costs.

One-quarter of U.S. seniors (10.8 million) account for more than two-thirds of all drug spending by seniors. Thirty-nine percent (15.6 million people) account for nearly 82 percent of seniors’ drug spending. These are the persons most likely to sign up for the Medicare drug program, and they are the ones who will cost the most to cover.

The Bush administration’s announcement “will throw fuel on the flames of those who want to do the wrong thing–impose price controls on the industry,” warned Merrill Matthews Jr., director of the Council for Affordable Health Insurance.

“Medicare is already replete with price controls,” said Matthews, “and if Washington hasn’t noticed, it hasn’t stopped the growth of Medicare spending. If Congress has to do something, the better solution would be to cut back on those eligible for the prescription benefit so that only low-income seniors without drug coverage and those with the highest costs would be covered.”

Devon M. Herrick, Ph.D. ([email protected]) is a senior fellow with the National Center for Policy Analysis.

For more information …

The December 15, 2003 Heritage lecture by Douglas Holtz-Eakin, “The Cost of Medicare: What the Future Holds,” is available online at http://www.heritage.org/Research/HealthCare/HL815.cfm.

The June 4, 2004 NCPA Policy Study by Andrew J. Rettenmaier and Thomas R. Saving, “The 2004 Medicare and Social Security Trustees Reports,” is available online at http://www.ncpa.org/pub/st/st266/.