A Third--and Better--Way for Prescription-Drug Coverage

Health care has emerged as one of the top issues in this year’s election, and, not surprisingly, the rhetoric has reached a fevered pitch. Calls for reform have focused on adding a prescription-drug benefit to Medicare, an obvious gap in coverage since drugs are the fastest-growing component of health-care spending. Polls show a majority of Americans want generous prescription-drug coverage, and politicians, including Vice President Al Gore and Gov. George W. Bush, are dutifully competing to add comprehensive benefits.

Lost in the political cacophony is the concern expressed by many voters about Medicare solvency. The Medicare population is expected to increase by 15 million to 18 million in the next 20 years, and health-care costs are growing at rates far exceeding total economic growth. This will put enormous strain on the Medicare program. What is needed is a drug benefit that fills the gaps in existing coverage but does not imperil the Medicare trust fund. Such a plan is easily within reach.

First, any reform proposal should recognize that lack of drug coverage is not a universal problem. More than 60% of Medicare beneficiaries already have supplemental insurance that covers prescription drugs. Most of this comes from private sources such as former employers, individually purchased Medigap plans or Medicare health maintenance organizations. Furthermore, state Medicaid programs, all of which cover prescription drugs, provide a safety net for those with low incomes.

So what is the problem? About 40% of Medicare beneficiaries do not have prescription-drug coverage, and some supplemental policies may be inadequate. As a consequence, 7.7 million Medicare beneficiaries will spend, on average, more than $1,000 out-of-pocket next year for prescription drugs alone. With drug prices rising 13% annually and many new drug therapies on their way to market, this burden will increase rapidly over the next 10 years. Most of these drug expenses go toward treating chronic illness, leaving some elderly people facing catastrophic drug costs.

Both Gore and Bush are proposing to cover prescription drugs in Medicare. Under the Gore proposal, drug coverage would be added to the existing set of Medicare benefits. Bush’s plan would subsidize the purchase of private drug coverage, akin to the way one buys Medigap insurance. But before responding too quickly with comprehensive plans, policymakers would do well to remember that forecasting Medicare expenses is tricky business.

Still, there is a fiscally prudent solution to the drug-coverage issue. First, provide a comprehensive drug benefit for people whose incomes are low but too high for Medicaid. Second, for middle- and upper-income beneficiaries without supplemental coverage, place a cap on out-of-pocket drug expenditures of $2,000 a year. Third, administer the plan through a private pharmaceutical benefits manager to reduce costs; aggressive benefits management has been shown to reduce drug expenditures by 15% or more.

Such a plan would cost $15 billion in 2003. If Congress decided to charge beneficiaries a premium for this drug coverage, the net costs would be even less and would ensure that beneficiaries paid part of the costs if the program got too expensive.

This plan costs a lot less than competing alternatives. The Kaiser Family Foundation estimates the Gore prescription drug plan would cost $35 billion in 2003, despite an annual cap on out-of-pocket expenses of $4,000 and a monthly premium of $25. Why is the Gore plan more expensive if it has a higher cap? Mainly because it also pays half the costs of drug expenses below $2,000 annually. By providing generous coverage without any deductible, the Gore plan removes incentives to economize on drug expenditures. Of course, it does have the politically appealing feature that beneficiaries see a benefit almost every time they go to the pharmacy, but this is good politics, not good health policy.

A catastrophic plan also draws upon the best features of Bush’s proposal, without the uncertainties. His plan would create an out-of-pocket spending cap for all Medicare benefits, not just prescription drugs. This addresses a fundamental paradox in Medicare: It is supposed to provide insurance, and yet the federal government places limits on the amount it will pay if a beneficiary incurs extraordinary expenses. A cap on out-of-pocket expenses transfers this catastrophic risk from the beneficiary to the entity most able to afford it: the federal government. Congress should consider extending a catastrophic cap on drug expenses to all Medicare services, but only after the costs of a new drug benefit become clearer.

The problem with Bush’s proposal--in addition to its vagueness--is that it relies on the private sector to offer a prescription-drug benefit. Such a market is unlikely to develop. Insurance plans would bear the full risk of the benefit under his plan, making them reluctant to be among the first to offer a product. In addition, enrollees would be allowed to switch plans with few constraints. Presumably, this fosters competition and increases choice. More likely, it would exacerbate the role of adverse selection, by which enrollees with high drug expenditures switch to more generous plans, thereby raising premiums and driving out healthy beneficiaries. The result is very expensive plans with a few very sick enrollees.

Prescription-drug expenses have been growing rapidly over the past decade, and the Medicare population is increasing as well. Under such scenarios, any prescription-drug benefit would become quite costly. Implementing a modest catastrophic benefit with low-income subsidies would provide valuable insurance to the Medicare population. It also would provide a fiscally prudent alternative, allowing policymakers to better gauge future program costs and beneficiary behavior before committing to more comprehensive coverage. This seems a much wiser course than spending future budget surpluses that may prove ephemeral.