Number range CHAPTER

**A Medicare Prescription Drug Safety Net:**

# Creating a Targeted Benefit for Low-Income Seniors

**Joseph R. Antos, Ph.D.**

**Wilson H. Taylor Scholar**

**in Health Care and Retirement Policy**

**The American Enterprise Institute**

**Testimony Before**

**Subcommittee on Human Rights and Wellness**

**Committee on Government Reform**

**U.S. House of Representatives**

**September 18, 2003**

Mr. Chairman and Members of the Committee: Thank you for inviting me to
appear before you. I am Joseph Antos, the Wilson H. Taylor Scholar in
Health Care and Retirement Policy at the American Enterprise Institute.
I am also adjunct professor in the School of Public Health at the
University of North Carolina at Chapel Hill. I have previously served as
the assistant director for health and human resources at the
Congressional Budget Office (CBO), and earlier held several research and
management positions in the Health Care Financing Administration, the
precursor to the Centers for Medicare and Medicaid Services (CMS). The
views I present today are my own and do not represent the position of
the institutions with which I am associated.

The chances of hammering out an agreement on reforming Medicare and
providing a prescription drug benefit to 40 million seniors and disabled
people seem to diminish every day. Democrats maintain that the
prescription drug benefit is just not good enough, while Republicans
raise the specter of program meltdown if we spend too much. Republicans
see the promise of lower cost and better performance through competing
health plans, while Democrats fear that competition will jeopardize the
traditional Medicare program and harm millions of beneficiaries.

There has been growing speculation in the press that the Medicare
conference will not be able to reach a compromise and will need an exit
strategy. That strategy could focus on the needs of low-income
beneficiaries---those with no prescription drug coverage, some of whom
have very high drug costs. A carefully designed drug benefit targeted on
those most in need could be a very good investment of taxpayer dollars.
But such a program could be as controversial as the bills that are
currently under consideration.

Chairman Burton has developed the Medicare Safety Net Prescription Drug
Act, which provides a drug benefit to low-income beneficiaries. In broad
terms, the proposal is similar to other targeted benefit approaches.
Beneficiaries would have access to discounted drug prices, their
purchases would be subsidized through a personal account accessible by a
debit card, and catastrophic insurance would be provided. The benefit
would not be open to all Medicare beneficiaries, and federal outlays
would be capped. The proposal is limited to a drug benefit, and does not
include broader reform measures.

The Chairman's proposal has several desirable features but also
significant flaws that are shared by other similar proposals. My
testimony will address those design aspects and suggest other approaches
that could be more effective in reaching policy goals.

Two key points emerge. First, full consumer choice and strong
competition among health plans are necessary to assure that
beneficiaries receive the best value from a Medicare prescription drug
benefit. Second, a targeted drug benefit is likely to mushroom into an
expensive entitlement within a few years through future legislative
expansions. To ensure that the Medicare program will be able to
accommodate future fiscal shocks, any prescription drug proposal should
include elements that can form the basis for future reforms.

Designing a Low-Income Drug Benefit

The first principle in designing a Medicare prescription drug benefit is
that someone will be unhappy, no matter what you do. The plethora of
competing, and often contradictory, policy objectives cannot all be
satisfied. For example, the House and Senate bills carve a "doughnut
hole" out of the middle of the drug benefit, not because that is good
policy but to keep the CBO cost estimate down to \$400 billion. This
budgetary legerdemain results in a peculiar kind of drug benefit that
some have labeled unfair to the poor. However, everyone eligible for
Medicare would participate. The bills' sponsors struck a balance between
benefit generosity, budget cost, and beneficiary participation that
others would dispute. A narrower proposal like the Burton bill shifts
that balance---creating new winners and losers among beneficiaries,
gaining some votes and losing others in Congress.

I will focus on five major design features of the Burton proposal:
eligibility, benefit structure, benefit administration and competition,
the budget cap, and prescription drug reimportation. Although the
proposal contains some innovative elements, it does not stray far from
the regulatory model of traditional Medicare. Other proposals, including
variants of the bill proposed earlier this year by Congressman Cal
Dooley (D-Cal.), are more promising but also fall short of the mark.

## Eligibility

More than three-quarters of Medicare beneficiaries have some
prescription drug coverage (see Table 1). Perhaps surprisingly, that is
true at all income levels. Lower-income people are more likely to have
coverage through Medicaid, while higher-income people primarily have
private coverage (see Table 2).

Proposals for unrestricted eligibility for a Medicare drug benefit, such
as the House bill, would displace much of the existing coverage and
substitute federal taxpayer dollars for other funds that are now being
spent. The Senate bill excludes people (the "full duals") who are
eligible for both Medicare and full Medicaid benefits from the Medicare
benefit. That reduces federal outlays (which the Senate bill spends
elsewhere), but leaves states with a growing liability.

A targeted benefit gives larger subsidies to low-income beneficiaries,
rather than distributing that money to everyone. The Burton proposal
goes further, limiting the benefit to those who are not
[eligible]{.underline} for any other prescription drug coverage. If it
could be implemented, that would be a stronger restriction than
excluding those who are enrolled in some other drug benefit.

It is possible to verify the incomes of most beneficiaries through
income tax forms. But it is extremely difficult to determine if someone
does [not]{.underline} have prescription drug coverage and is
[not]{.underline} eligible for such coverage from some source. The
absence of insurance does not leave a paper trail.

Table 1. Prescription Drug Coverage of Medicare Beneficiaries by Poverty
Level, 2000

[% Of Federal Poverty Level]{.underline} [% of Medicare
Beneficiaries]{.underline} [% With Rx Coverage]{.underline}

Less than 100% 24% 77%

100% to 199% 31% 75%

200% to 299% 19% 82%

300% or higher 26% 81%

All income levels 100% 79%

**Note:** Includes only Medicare beneficiaries living in the community.

**Source:** Tabulations of the Medicare Current Beneficiary Survey from
Becky Briesacher, University of Maryland.

Table 2. Sources of Prescription Drug Coverage for Medicare
Beneficiaries by Poverty Level, 2000

\% Of Federal Employer- Other

## Poverty Level Sponsored Medigap Medicare HMO Medicaid Public

Less than 100% 12% 7% 13% 42% 10%

100% to 199% 28% 12% 19% 9% 8%

200% to 299% 45% 14% 20% 2% 4%

300% or higher 49% 15% 14% 1% 4%

**Note:** Beneficiaries may have more than one source of coverage.
Includes only Medicare beneficiaries living in the community.

**Source:** Tabulations of the Medicare Current Beneficiary Survey from
Becky Briesacher, University of Maryland.

Even if we could enforce such eligibility restrictions, we might not
want to. Some people may be eligible for private coverage but cannot
afford to participate. Others may have limited coverage that provides no
catastrophic protection. Some people with incomes too high to qualify
for the Burton program might have high prescription drug expenses and no
coverage. Future Congresses would be tempted to loosen the eligibility
limits to accommodate many of those people, just as they would be
tempted to expand benefits and fill the doughnut hole under the Senate
and House proposals.

## Benefit Structure

The House and Senate bills offer traditional first-dollar coverage for
prescription drugs. After a modest deductible (\$250 in H.R. 1 and \$275
in S. 1), beneficiaries would have a significant fraction (80 percent in
H.R. 1 and 50 percent in S. 1) of their prescription drug costs paid by
the government. This is a use-it-or-lose-it benefit, and enrollees will
have a powerful incentive to use it after they've paid \$420 or more in
annual premiums.

The Burton proposal changes that incentive. Instead of first-dollar
insurance coverage, beneficiaries would be required to pay a high
deductible (perhaps \$3,000) before catastrophic insurance covers their
prescription drug expenses. To help them pay the deductible,
beneficiaries would be given a cash subsidy paid into individual
accounts and accessible using a debit card. Under this approach,
beneficiaries would be sensitive to prescription drug costs and still be
protected financially. Beneficiaries would use their own money (from
their accounts and out-of-pocket payments) to pay for drugs until they
met the deductible. Any amount left in their accounts would roll over
for use in the next year.

The drug account would not become a permanent asset for beneficiaries,
however. If an enrollee lost eligibility for the benefit or passed away,
his cash balance would revert to the Treasury. Although that may seem
fiscally prudent, it undercuts the beneficiary's incentive to limit
unnecessary spending. Beneficiaries might not be as diligent in
selecting lower-cost pharmaceuticals if they felt that the account
balance could be taken away at any time.

## Benefit Administration and Competition

The prescription drug benefit under the Burton proposal would operate
much like a Part B benefit. That is, a division of the U.S. Department
of Health and Human Services (HHS) would determine what drugs would be
covered, set their prices, certify participating pharmacies, determine
the eligibility and level of subsidy available to beneficiaries,
establish the personal drug accounts, and issue the debit card. Private
entities would be contracted to handle administrative functions and pay
the bills, just as large insurance companies acting as Part B carriers
do today.

The proposal asserts that the Secretary of HHS would negotiate
pharmaceutical prices, but those negotiations would quickly become rate
setting exercises similar to the way physician fees are set. It is clear
that any negotiations that did occur would be the exception rather than
the rule. Since Medicare beneficiaries use every available
pharmaceutical, that means negotiating tens of thousands of prices for
products in every dosage form, strength, and packaging. Prices for drugs
would be set in an unspecified manner the first year. Almost certainly,
HHS would establish an inflation factor that would ratchet up the entire
price structure in subsequent years.

Negotiations would be necessary whenever a new drug appeared on the
market. The Secretary would be able to withhold access to any new
pharmaceutical, a powerful threat that could lead to low prices for new
drugs under Medicare. However, there are bad side effects with this
policy prescription:

-   Competition from generics and therapeutically similar drugs would no
    longer force down prices of branded drugs under a rigid federal
    price structure.

-   Delaying the entry of a new drug onto the federal formulary would be
    politically difficult and could hurt some patients.

-   If Medicare set prescription prices at very low levels,
    manufacturers are likely to raise prices to private purchasers,
    including most people under age 65. The proposal includes a
    reimportation provision, discussed below, to limit that possibility.

-   The threat of a low launch price would deter the research and
    development of potentially valuable or life-saving drugs,
    particularly those that treat illnesses associated with older age
    groups.

The budget savings from top-down regulation are immediate and seductive.
But the consequences of such an approach are long-term and serious,
discouraging the research and development that could lead to more
effective and potentially cost-saving drug therapies. Even in the near
term, lower prices for Medicare could mean higher prices for everyone
else.

A competitive approach can strike a better balance between lowering
prices and promoting innovation. This is the conceptual basis of the
House prescription drug provisions, and it relies on the proven ability
of competing private plans to negotiate substantial discounts and manage
the cost of the benefit.

If private drug plans are placed at risk for the cost of providing
prescription drugs to their Medicare enrollees, they have a strong
incentive to limit cost growth. The plans can act on that incentive if
they are given the flexibility to manage the benefit aggressively. With
a wide choice of plans, beneficiaries will be able to select a plan that
meets their needs---and change plans if they are dissatisfied.

A number of proposals, including the Medicare Rx Now Act proposed this
year by Congressman Dooley and the Medicare Rx Drug Discount and
Security Act proposed last year by Senator Chuck Hagel (R-Neb.), rely on
private plans to deliver a benefit structured like that of Chairman
Burton's bill. The earlier proposals would make drug benefits available
to all Medicare beneficiaries, rather than targeting those with low
incomes. They merit discussion because they use a modified form of plan
competition.

The Dooley and Hagel bills would offer the new benefit through many
competing plans, but those plans would not be liable for excess costs
for beneficiaries who exceed the catastrophic spending limit. Instead,
the federal government would pay all costs of catastrophic coverage on a
fee-for-service basis.

Although that might seem to be a reasonable split of private and federal
responsibilities, such an approach is a short step from the situation
posed by the Burton bill. The federal government could pay whatever each
plan asked, but then some plans would be paid more than others for the
same prescription drug purchases. To prevent unfairness and potential
fraud, HHS would probably establish a federal price list for all
pharmaceuticals. Reimbursement based on federal, rather than actual,
prices would potentially ignore real cost differences faced by the
private plans. The likely result would be an increasingly complex
pricing system, as the price schedule is modified to take account of
special circumstances. If federal prices lagged behind actual prices
(likely if Congress faces budget pressures and holds down Medicare
reimbursements), private plans would drop out of the program and the
demand for a fully federalized system might be irresistible to
policymakers.

An alternative approach would solve many of the problems posed by
proposals like the Dooley bill. First, the restrictions on how private
plans could manage their drug benefit should be relaxed. The Dooley bill
assumes that many kinds of plans would participate, including
employer-sponsored retiree plans. However, the regulatory requirements
imposed on such plans would force such plans to revamp their benefits
and methods of operation, making participation in Medicare impractical
at best. Second, plans should be placed at financial risk for the
catastrophic insurance benefit. To assure a stable system and encourage
plan participation, a national reinsurance pool run by the participating
plans could be organized for all Medicare drug plans. Such a pool would
spread excess costs among all beneficiaries, eliminating the incentive
to avoid enrolling sicker seniors. Premiums would include the cost of
those high expenses averaged over all Medicare beneficiaries. That would
protect private plans from the problems of adverse selection and provide
greater incentive for plans to participate in the program. This
arrangement would offer the advantages of a national risk pool without
the threat of price controls and limits on beneficiary choice posed by
fully federalized benefits.

## Budget Cap

The prescription drug benefits proposed in the House and Senate bills
are open-ended entitlements and are likely to cost far more than \$400
billion by 2013. CBO has produced its best estimate of federal outlays,
but the likelihood of higher spending is greater than the reverse.
Moreover, political pressure to fill the doughnut hole in the benefit is
likely to be irresistible, and future benefit expansions could easily
double the level of actual outlays.

The Burton proposal includes a hard cap on spending in the hope of
preventing higher outlays resulting from either estimating errors or
legislative action. If spending was projected to exceed the cap, the
Secretary would increase the catastrophic coverage threshold or reduce
the federal subsidies provided through the prescription drug accounts.

Spending caps do not work. Nothing can prevent a future Congress from
changing the law and wiping out the cap. If the cap was binding, that
would reduce the value of the drug benefit to low-income people---a
difficult situation to sustain politically, particularly if further
reductions would be necessary year after year.

Medicare currently has a spending cap on physician payments called the
sustainable growth rate. If physician spending rises above that growth
rate, fees are to be reduced.

In 2002, Medicare reduced physician fees by 5.4 percent across the
board. That caused a reduction in access to physician services in some
parts of the country and complaints from doctors everywhere. A further
reduction was scheduled for 2003. In February, Congress modified the
payment formula to give physicians an increase, and there is substantial
sentiment for additional relief in future years.

This is a clear case in point. The sustainable growth rate was popular
only when it was not acted upon. We can expect no more from a spending
cap on prescription drugs. Rather than trying to control spending with
caps, we should design a program that gives beneficiaries more
control---and more personal responsibility---over their health care.
Personal accounts and high deductible insurance provide some incentive
for prudent purchasing, but other restrictions in the Burton bill limit
their impact. More plan options and effective competition are needed if
we expect to limit spending without limiting the value of the benefit.

## Reimportation

The Burton bill would apply additional pressure on the pharmaceutical
industry by authorizing the importing of drugs (often called
reimportation). Importers who resell the drugs would be responsible for
ensuring that the imported products are genuine and safe. This provision
is intended to lower prices of drugs in the market generally, not just
those dispensed under Medicare.

Supporters of a reimportation provision point out that U.S. residents
pay the highest drug prices in the world, exceeding the prices found in
Germany, France, and other developed countries. Those countries threaten
to produce their own versions of branded drugs ("compulsory licensing")
unless pharmaceutical manufacturers agree to sell products at very low
prices. Since the cost of developing a drug is very high (perhaps as
high as \$800 million) and the cost of manufacturing it is usually
fairly low, manufacturers are ahead in the short term as long as their
costs of production are covered. Such prices would not compensate for
the huge costs of research and development required to get a new drug to
market, thus discouraging future research.

The U.S. government also negotiates low prices for prescription drugs,
but those prices apply only to federal programs such as the Veterans
Affairs health program. Reimportation is an indirect way of establishing
price controls in the U.S. for all pharmaceuticals sold in all markets.

The problems with price controls were discussed above, and those
comments apply in full to reimportation. The likely impact of
reimportation may be disappointingly small, however. Middlemen are
likely to absorb most of the price reduction that might be possible by
importing drugs at a lower price. People with employer-sponsored health
plans are unlikely to see reductions in their drug costs because such
plans typically have multi-tiered copayment systems, and savings that
might occur are likely to be retained by the employer. People without
drug coverage stand to benefit more, but even in this case we should
expect to see an uneven pattern of discounts rather than
across-the-board reductions of any significant magnitude.

Conclusion

A targeted low-income benefit could be a feasible alternative if the
Medicare conference stalls. Such a benefit would avoid displacing the
good coverage that many beneficiaries now have and are fearful of
losing. It could provide important financial support for people who need
help the most---those with a limited ability to pay for their
prescription drugs, those with high drug costs, those without insurance
coverage. Combining a discount card, a cash subsidy in a personal
account, and catastrophic insurance would provide some of the elements
for a sensible benefit for millions of seniors.

It would be a mistake to create even a limited Medicare drug benefit
that repeats the mistakes of the past. Attempts to limit federal cost by
overall spending caps, price controls, and restrictions on beneficiaries
and providers lead to worse health outcomes, and at best have only a
temporary ability to hold down spending. Competition among drug plans,
with flexibility to design their benefits and negotiate their best
prices, will lead to more effective cost control. Proposals that give
beneficiaries more purchasing power and more choice will result in
better value and provide the basis for future improvements in the
Medicare program.