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Tampering with Part D will not solve our debt crisis.


It was clear from the outset that spending reductions in Medicare would be on the table in negotiations over raising the legal limit on U.S. government borrowing. As the first meetings of Vice-President Biden's negotiation committee were being organized, Senate Minority Leader Mitch McConnell (R-Ky.) pointed out that significant changes in Medicare would be needed as part of a "grand bargain" if a debt limit increase was to have a realistic chance of passage through a reluctant Congress. (i)

Following the President's lead, some Democrats--notably Rep. Henry Waxman (D-Calif.) and Senator Jay Rockefeller (D-W.Va.)--have responded with a proposal to save $112 billion over the next decade by requiring pharmaceutical manufacturers to pay a rebate on prescription drugs purchased by low-income enrollees under Medicare's drug benefit, known as Medicare Part D. According to Rep. Waxman, the Medicare Drug Savings Act of 2011 would "[eliminate] drug manufacturer windfalls instead of hurting seniors." (ii)

This proposal does nothing to ease our immediate debt crisis. According to the Congressional Budget Office (CBO), the rebate would generate no savings in 2012 and only $4 billion in 2013. (iii) If we want to keep the federal government operating without any significant change in outlays or revenue until after the next election, the debt limit must increase by $2.5 trillion. (iv) The Part D rebate proposal would do little to satisfy Republican demands that any increase in the debt limit be accompanied by an equal decrease in federal spending. (v)

Although fiscal arithmetic is important, the greater concern is the persistent belief among many policymakers that they can get something for (almost) nothing. Sen. Rockefeller and Rep. Waxman are wrong to claim that mandated rebates offer savings to the federal government with no consequences for Medicare beneficiaries, and by implication, anyone other than drug company stockholders.

This view fails to recognize an important fact: changing the operation of a successful program is asking for trouble. Part D created a competitive market for Medicare prescription drug plans with strong incentives to keep costs low while offering coverage that meets the needs of an older population. A poorly-designed program would have failed if the drug plans had focused on avoiding high-risk enrollees needing more expensive prescriptions.

Instead, Part D has provided a substantial benefit to all of its enrollees at a cost well below what CBO originally estimated. That includes enrollees who qualify for a low-income subsidy (LIS)--a group that is high risk, spending about twice as much as other Part D beneficiaries. (vi) Upsetting the balance that has been achieved in Part D could result in poorer program performance and disruption for enrollees who have the lowest incomes and the poorest health.

Legislating a rebate in Part D may change who pays what amount for the drugs, but it does not lower the cost of the products. As a consequence, Part D plans may not be able to negotiate prices as low as they were before the rebate policy, necessitating increases in premiums or changes in the benefit offered by plans (for example, through more restrictive formularies or higher copayments). Higher-income enrollees could see their costs rise or benefits deteriorate as a consequence of the rebate policy. Medicare might also face higher costs because of the poorer deals negotiated by Part D plans, undercutting net savings to the government after factoring in the rebate revenue.

Part D's Surprising Success

The Part D prescription drug program is a major departure from Medicare's traditional method of operation. The drug benefit is voluntary, delivered through stand-alone prescription drug plans (PDPs) and drug plans sponsored by Medicare Advantage plans (MA-PDs) that compete head to head in each geographic region. There is no government-managed plan to serve as a benchmark, and there are no government price-setting mechanisms to influence either the prices that drug plans pay manufacturers for pharmaceuticals or the premiums that drug plans may charge enrollees. Every Part D plan participates in the annual bidding process that determines the federal subsidy to enrollees, which averages 74.5 percent of the cost of a standard benefit. (vii)

The novelty of a drug-only benefit offered separately from medical coverage and the absence of active government participation in the price-setting process led many observers to doubt the wisdom of Part D's design. (viii) The Congressional Budget Office estimated that the prescription drug program would cost $551 billion between 2004 and 2013, offset by $142 billion in lower federal payments to state Medicaid programs. (ix) Medicare's cost experience has been far better.

The Medicare trustees report that federal outlays for Part D, netting out premiums paid by enrollees and payments made by states to "claw back" some Medicaid savings, totaled $214 billion through 2010. By 2013, we will have spent $375 billion--32 percent less than the original CBO estimate. (x)

Those savings are due in large measure because of Part D's competitive design. Over 1,100 plans are available nationwide this year, the smallest number since the start of the benefit in 2006.

Notably, there are 332 "benchmark" PDPs nationally that are available for no monthly premium to LIS enrollees. (xi) (A benchmark plan offers the basic benefit for a premium that is no higher than the federal subsidy offered to low-income enrollees. (xii))

There is an important advantage in becoming a benchmark plan which provides an incentive for lower premium bids. The Centers for Medicare and Medicaid Services (CMS) uses an automatic enrollment process that randomly assigns LIS beneficiaries who are eligible for full benefits under Medicare and Medicaid to PDPs when they first qualify. Those plans must offer the basic benefit to LIS enrollees for no additional premium. In addition LIS beneficiaries who are enrolled in a plan that does not qualify as a benchmark plan for the next year are either automatically reassigned by CMS to a new plan or may select a plan on their own if they want to avoid paying premiums. (xiii) This auto-enrollment process reduces the drug plan's administrative costs associated with attracting new members. Since LIS beneficiaries account for about 40 percent of Part D enrollees and about 56 percent of Part D spending, that can be a significant advantage. (xiv)

The extent of competition in this market undoubtedly came as a surprise to many. Then-Medicare administrator Tom Scully asserted that stand-alone drug plans "do not exist in nature," and CBO assumed that there would be a need for a government back-up plan in areas where there would not be at least two plan choices. (xv)

Critics dismiss these results as the consequence of circumstances unrelated to the competitive design of Part D. (xvi) Actual enrollment was lower than CBO initially estimated, reducing the program's cost below the CBO score. True, but that explains no more than 17 percent of the difference between the estimate and actual experience. (xvii) Drug spending was lower economy-wide, a result of many brand drugs going off patent and fewer new drugs in the pipeline. True, but Part D spending per enrollee grew significantly more slowly than drug spending for the country (1.8 percent a year between 2006 and 2009 compared with 2.8 percent a year). (xviii)

Much of Part D's superior cost experience is the result of drug formularies and cost-sharing arrangements that steered seniors toward the greater use of generics and lower-cost brand drugs. Aggressive cost containment efforts in Part D may even be partly responsible for the slower cost growth seen in the entire prescription drug market. The shift toward generics among the elderly may have caused physicians to change prescribing behaviors for all their patients. (xix)

It is difficult to explain away the cost experience we have seen thus far in Part D. Even though the average person's health costs typically rise every year, federal Part D payments per enrollee declined from 2006 through 2008 and increased by only $80 through 2010. (xx)

One might think that the drug plans over-priced their offerings in the first year or two out of lack of familiarity with an entirely new market and new insurance product. That could account for reductions in federal payments (and correspondingly, beneficiary payments) in 2007 and perhaps even 2008, but a good insurance actuary could surely determine the correct pricing after a couple years of experience.

Alternatively, perhaps the reduced payments per enrollee in 2007 and 2008 represent a calculated strategy by plans to attract enrollment by offering "loss leader" pricing. In that case, we would expect payments to rise sharply once the plans had pulled in their shares of enrollment, and in fact we saw those per-enrollee payments rise in 2009. But they fell again in 2010, casting doubt that the entire industry was simply playing marketing games in Part D.

Something real is holding down Part D's cost growth, and a similar degree of restraint has not been obtained in the rest of the market. At the same time, high-cost individuals have ready access to prescription drug coverage rather than being turned away, and consumer satisfaction with Part D is high. (xxi) This is a record of performance that many considered impossible when the program was enacted.

Minimum Rebate Proposal

Although Part D has exceeded expectations, there is always a temptation to demand more. Sen. Rockefeller and Rep. Waxman's proposal to require rebates from drug manufacturers might even seem reasonable at first glance since it would restore a similar requirement that previously existed for some Part D beneficiaries.

Prior to Part D, low-income Medicare beneficiaries who were also eligible for Medicaid (and thus known as "dual eligibles") received their prescription drug coverage from state Medicaid programs. Congress required manufacturers to rebate part of the cost of their drugs back to the states. Dual eligibles were shifted into Part D plans at the start of the program, and the rebate requirement was dropped.

The current proposal would mandate rebates for dual eligibles in Part D, increase the amount of the rebate, and extend it to over four million additional low income beneficiaries. (xxii) Pharmaceutical manufacturers would be required to pay the difference between the average rebates they are paying to Part D plans and 23.1 percent of the Average Manufacturer's Price (AMP)--up from 15.1 percent for dual eligibles prior to Part D. (xxiii) Additional rebates would also be required if drug prices increased faster than general inflation. The rebates would apply only to the drugs used by LIS enrollees and paid to the federal government rather than to Part D plans. In effect, the rebates reduce the government's cost of Part D drugs to the same level as that obtained in Medicaid. Failure to pay the rebates would disqualify the manufacturer from selling any of its products to any Part D plan.

Sen. Rockefeller and Rep. Waxman focus solely on rebates when, in fact, rebates alone are not an accurate measure of program cost savings. They neglect to consider another way in which Part D drug plans save money--shifting drug utilization from brand name drugs to generic substitutes. As the generic prescribing rate increases, aggregate costs are reduced. However, the average rebate falls at the same time because generic manufacturers do not pay rebates to Part D plans. (xxiv) Thus, Part D would be expected to have lower overall rebates compared to Medicaid.

Focusing on rebates specific to the LIS population ignores the fact that Part D plans negotiate rebates and price discounts for drugs on behalf of their entire covered populations. Policy choices made in the Medicaid program do not transfer simply to the Part D program, which serves a broader population. Contrary to claims made by proponents, the legislation would not restore a similar requirement that previously existed for dual eligibles, and the wider application could disrupt a program that is working well.

Perversely, the minimum rebate proposal could discourage Part D plans from seeking to enroll LIS individuals. In the current Part D market, manufacturers have complete flexibility to negotiate discounts with the plans. Plans with larger enrollments and those that are willing to set formulary and cost-sharing policies to favor a manufacturer's products are rewarded with higher rebates--effectively, lower prices for the pharmaceuticals used by the plan's enrollees.

With a required rebate, manufacturers would be locked into a minimum 23.1 percent discount from AMP for a significant portion of Part D enrollees regardless of the market clout of individual Part D plans. From the manufacturers' viewpoint, smaller plans that are not among their best customers would receive higher discounts than they did without a new federal regulation. However, because the plans would not benefit from the extra discount, they would not be able to pass the savings to their enrollees and would gain no advantage in marketing to Medicare beneficiaries.

The incentive to offer rebates to drug plans that promoted sales of the manufacturer's products would be smaller than under current law because the federal rebate would make additional sales less profitable than before. (xxv) With the government taking higher rebates manufacturers would be less able to provide deep discounts, particularly on drugs that are most often prescribed to LIS enrollees.

By essentially standardizing the manufacturers' discounts, we are likely to see less price competition among Part D plans. Lower discounts to the plans would increase their operating costs. That would drive up both the average premiums paid by enrollees and federal outlays for the benefit relative to where they would have been without the required discount. But since a portion of the minimum rebate would be paid to the federal government, the new revenue would be treated as an offset to the government's outlays--that is, as budget savings.

Plans with the highest concentration of dual eligibles would suffer the greatest loss of flexibility to negotiate discounts. Those plans would lose their competitive advantage to plans with low concentrations of LIS enrollees.

Faced with the prospect of higher operating costs directly associated with LIS enrollment, plans would have a financial incentive to discourage LIS individuals from remaining members. Subtle changes in formularies, access to retail pharmacies, and the like can have a dramatic impact on who is likely to enroll in a drug plan. Over a few years, Part D plans that currently target the LIS population could shift to a primarily non-LIS consumer base.

Medicare's most vulnerable population could find themselves having to change drug plans, and their choices could be sharply limited. A growing number of LIS individuals currently enroll in drug plans that are not benchmark plans, requiring that they pay a premium to bridge the gap between the federal subsidy and the plan's full cost. (xxvi) That trend could accelerate under the Rockefeller/Waxman proposal.

Who Pays for the Rebate

One of Washington's great political canards is that a tax on business really does not affect anyone other than the companies on which the tax is levied. Usually such a foolish statement is left implicit, but unfortunately that seems to work for most people. The public often seems to have the visceral belief that the initial incidence of a tax is also its final incidence.

Like a tax, the requirement that pharmaceutical manufacturers pay a minimum rebate has its initial impact on the manufacturers but the final incidence would be borne primarily by patients, who are the end-users of the prescription drugs. Economic theory predicts that manufacturers would respond to the imposition of new government rebates by cutting their expenses, including investments in research and development of new products. Launch prices of new drugs are likely to be somewhat higher, and any reduction in discounts received by Part D plans or non-Medicare drug plans could result in higher copayments or narrower formularies for their enrollees.

Both seniors and younger patients would face higher costs, with the likely greatest impact on Part D enrollees who are not eligible for a low-income subsidy (and thus not protected from increased premiums and cost sharing). CBO argues that employment-based health plans would probably negotiate larger rebates to offset the higher prices, but that state Medicaid programs would pay the higher prices for new pharmaceuticals used by enrollees who were not also on Medicare. (xxvii) Although it is difficult to ascertain who will bear how much of the cost, it is clear that the federal savings generated by the minimum rebate policy represents a net transfer of resources from the private sector.


Congress will be able to pass a debt limit increase only if they couple it with bold action to slow the rapid growth of federal spending. Although the proposal to impose a minimum rebate on pharmaceutical manufacturers would provide very little immediate budget savings, its $112 billion CBO score makes it an attractive option to policymakers hoping for seemingly painless Medicare savings. Much like the new taxes imposed by the Affordable Care Act on insurers, pharmaceuticals, and medical equipment, the minimum rebate could be sold as reducing the profits of overpaid businesses rather than affecting patients or voters.

If this policy is adopted, patients will bear the cost. The immediate impact would be felt by higher-income seniors who are not eligible for Medicaid or other Part D subsidies. As drug plans respond to the new financial and regulatory incentives, enrollees who qualify for Medicaid or other low-income subsidies also could find fewer attractive options. The plans that continue to offer coverage to LIS enrollees without an additional premium are likely to have tighter formularies and less access to newer or more expensive drugs.

Mandated rebates are federal price controls one step removed. Congress would not set the price per se but would use its political power to extract a discount. This approach has the same problems as any other price-fixing scheme. The "right" discount that extracts just enough money from drug manufacturers without undue harm to patients cannot be determined, but budget constraints on policymakers' desire to expand federal spending in some other program will inevitably raise the ante. The Affordable Care Act increased the required discount for Medicaid prescriptions, and the same bracket creep is likely in Medicare--although the creep is more likely to become a leap.

Washington control over rebates virtually ensures that the relative prices of pharmaceuticals will be distorted. Some prices would be too low (causing spot shortages) and some too high. Some Part D plans could face losses or gains as a result because the political process does not respond with any precision to changes in market conditions. Since there is no effective feedback from the market to signal when relative prices are wrong, this mispricing will persist, introducing economic inefficiency in a program that has had proven success.

We need to slow Medicare spending as part of the effort to control the national debt. Even as a short-run expedient, tinkering with the Medicare Part D program is likely to do more harm than good.

(i) Lori Montgomery, "McConnell demands spending cuts, Medicare overhaul for deal on debt limit," Washington Post, May 12, 2011; business/economy/mcconnell-demands-spending-cuts-medicare-reform-for- deal-on-debt-limit/2011/05/12/AFTvBh0G_story.html.

(ii) Sam Baker, "Dems look to drug industry for Medicare savings," The Hill, June 16, 2011; -and-prescription-drug-policy-/166851-dems-look-to-drug-industry- for-medicare-savings.

(iii) CBO, Reducing the Deficit: Spending and Revenue Options, March 2011; See Option 25.

(iv) Martin Crutsinger, "Bernanke urges GOP to support raising debt ceiling," Salt Lake Tribune, June 14, 2011; debt-bernanke-government-limit.html.csp.

(v) Naftali Bendavid and Matt Phillips, "Boehner Wants Cuts With Debt Increase," Wall Street Journal, May 10, 2011; 4576313543440663916.html.

(vi) Author's calculation based on Chart 11-17, Medicare Payment Advisory Commission, Healthcare Spending and the Medicare Program: A Data Book, June 2010;

(vii) Medicare Payment Advisory Commission, "Payment Basics: Part D Payment System," October 2010;

(viii) The following discussion draws from Joseph Antos, "What Does Medicare Part D Say About the Ryan Plan?" RealClearMarkets, June 15, 2011; does medicare part d say about the ryan plan 99074.html.

(ix) Douglas Holtz-Eakin, Estimating the Cost of the Medicare Modernization Act, testimony before the House Committee on Ways and Means, March 24, 2004;

(x) Boards of Trustees, Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, 2011 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds; downloads/tr2011.pdf.

(xi) Jack Hoadley, Juliette Cubanski, et al., "Medicare Part D Spotlight: Part D Plan Availability in 2011 and Key Changes Since 2006," Kaiser Family Foundation, October 2010;

(xii) Centers for Medicare and Medicaid Services, "'Benchmark' Part D Plans and the Low Income Subsidy," Part D Information for State Policymakers, November 25, 2009;

(xiii) Laura Summer, Jack Hoadley, and Elizabeth Hargrave, "The Medicare Part D Low-Income Subsidy Program: Experience to Date and Policy Issues for Consideration," Kaiser Family Foundation, September 2010;

(xiv) CBO, Reducing the Deficit, March 2011.

(xv) Robert Pear and Walt Bogdanich, "Some Successful Models Ignored As Congress Works on Drug Bill," New York Times, September 4, 2003; business/some-successful-models-ignored-ascongress-works- on-drug-bill.html.

(xvi) Edwin Park, "Lower-Than-Expected Medicare Drug Costs Reflect Decline in Overall Drug Spending and Lower Enrollment, Not Private Plans," Center for Budget and Policy Priorities, May 6, 2011;; and Ezra Klein, "Does Medicare Part D make the case for Paul Ryan's plan?" Washington Post, June 8, 2011; part-d-make-the-case-for-paul-ryans-plan/2011/05/19/AGfPbyLH blog.html.

(xvii) Author's calculations based on the CBO cost estimate and the Medicare Trustees' report of actual experience.

(xviii) Author's calculations based on the Medicare Trustees' report and data from the National Health Accounts.

(xix) James C. Capretta, "Klein's F on Part D," National Review Online, June 21, 2011; -d-james-c-capretta.

(xx) See Table V.B1 in the 2011 Medicare Trustees report. These figures include the costs of PDPs and MA-PDs, and are more comprehensive than estimates (such as the Hoadley-Cubanski study noted previously) that are based solely on PDP premiums.

(xxi) A recent survey shows that 84 percent of enrollees are satisfied with their Part D plan. See Peter Pitts, "Part D gets an A while Chuck Schumer gets a D,", June 13, 2011; post/show/7819; and KRC Research, "Seniors' Opinions About Medicare Rx: Fifth Year Update," September 2010; MedicareTodaySurveyofSeniorsMedicareRx.pdf.

(xxii) The legislative language for the Medicare Drug Savings Act of 2011 (HR 2190) is available at documents/HR2190_LegText.pdf.

(xxiii) House Committee on Energy and Commerce--Democrats, "House Democratic Leaders Introduce Legislation to Save More Than $100 Billion in Medicare Drug Costs," press release, June 16, 2011; house-democratic-leaders-introduce-legislation-to-save-more- than-100-billion-in-medicare-drug-c

(xxiv) Boards of Trustees, Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, 2011 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, p. 183.

(xxv) CBO, Reducing the Deficit, March 2011.

(xxvi) Summer, Hoadley, and Hargrave, "The Medicare Part D Low-Income Subsidy Program," September 2010.

(xxvii) CBO, Reducing the Deficit, March 2011.

Joseph Antos

American Enterprise Institute

Guy King, F.S.A., M.A.A.A.

Independent actuary and former chief actuary for Medicare and Medicaid
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Author:Antos, Joseph; King, Guy
Publication:AEI Paper & Studies
Article Type:Report
Geographic Code:1USA
Date:Jun 29, 2011
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