CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

S T U D Y

SEPTEMBER 2010

Effects of Using 

Generic Drugs on 

Medicare’s 

Prescription Drug 

Spending

CBO
Pub. No. 4043
The Congress of the United States O Congressional Budget Office

A

STUDY

CBO

Effects of Using Generic Drugs on 

Medicare’s Prescription Drug Spending

September 2010

Preface

CBO

Medicare’s outpatient prescription drug benefit for senior citizens and people with 

disabilities, known as Part D, began in 2006. Part D uses private plans to provide coverage for 

prescription drugs to enrollees. The federal government does not mandate the amounts that 

plans pay for prescription drugs; instead, plans directly negotiate payment rates with pharmacies and rebates from drug manufacturers while competing with each other for enrollees. Such 

competition provides incentives for plans to control their costs. One important way in which 

plans seek to control costs is by encouraging the use of generic drugs. Plans can encourage 

enrollees to switch from brand-name drugs to their less expensive generic equivalents, a 

practice known as generic substitution. Plans can also encourage enrollees to switch from 

a brand-name drug to the generic form of a different drug that is in the same therapeutic class, 

one form of a practice known as therapeutic substitution. 

This Congressional Budget Office (CBO) study uses data on Medicare Part D prescription 

drug insurance claims from the Centers for Medicare and Medicaid Services (CMS) to assess 

how successful plans have been in encouraging the use of generic drugs and the potential for 

savings from the additional use of such drugs. The study was prepared at the request of the 

Chairman and Ranking Member of the House Budget Committee. In keeping with CBO’s 

mandate to provide objective, nonpartisan analysis, this study makes no recommendations.

The study was written by Julie Somers of CBO’s Microeconomic Studies Division under the 

supervision of Joseph Kile and David Moore. Anna Cook of CBO’s Health and Human 

Resources Division provided useful guidance throughout and thoughtful comments on drafts. 

Carol Frost and Susan Labovich (both formerly of CBO) assisted with data analysis. The analysis benefited from comments provided by David Austin, Elizabeth Bass, Sheila Campbell, 

Julia Christensen, Phil Ellis, Justin Falk, Holly Harvey, Tamara Hayford, Daniel Kao, 

Kate Massey (formerly of CBO), Andrea Noda, Allison Percy, Chayim Rosito, Ellen Werble, 

and Rebecca Yip.

Helpful comments also came from reviewers outside CBO: Jeffrey Kelman, at CMS; 

Darius Lakdawalla, at the University of Southern California; Fiona Scott-Morton, at Yale 

School of Management; and Rachel Schmidt and Shinobu Suzuki, at the Medicare Payment 

Advisory Commission. (The assistance of external reviewers implies no responsibility for the 

final product, which rests solely with CBO.)
CBO

PREFACE

Christine Bogusz edited the paper, and Kate Kelly proofread it. Jeanine Rees prepared the 

report for publication, and Maureen Costantino designed the cover. Monte Ruffin printed 

the initial copies, Linda Schimmel coordinated the print distribution, and Simone Thomas 

prepared the electronic version for CBO’s Web site (www.cbo.gov).

Douglas W. Elmendorf

Director

September 2010
Contents

CBO

Summary vii

Overview of the Medicare Prescription Drug Benefit Program 1

Design of the Medicare Prescription Drug Benefit 2

Distribution of Spending in Medicare Part D 3

The Role of Private Plans in Medicare Part D 5

Generic Drugs in Medicare Part D 7

Generic Substitution 7

Therapeutic Substitution 13

Comparing Potential Savings from Generic and Therapeutic Substitution 17

Implications of Future Developments 18

First-Time Generic Entry 18

New Brand-Name Drugs 20

Biologics 20

Appendix: Description of Data Used in This Analysis 23
VI EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

Tables

1. Cost Sharing and Manufacturers’ Discounts for Prescription Drugs in the 

Former Medicare Part D Coverage Gap 3

2. Share of Part D Prescriptions and Prescription Drug Costs, by 

Drug Type, 2007 12

3. Estimate of Realized Savings from Generic Substitution, 2007 13

4. Potential Additional Savings from Generic Substitution, 2007 14

5. Selected Classes of Drugs Analyzed for Possible Therapeutic Substitution 15

6. Percentage of Part D Prescriptions and Prescription Drug Costs, by 

Drug Type, in Seven Selected Classes and Subclasses, 2007 16

7. Potential Savings from Therapeutic Substitution for Seven Selected 

Drug Classes, 2007 17

Figures

1. Distribution of Payments to Plans and Pharmacies for Enrollees’ 

Prescription Drug Spending Under Medicare Part D, 2007 4

2. U.S. Retail Sales of Brand-Name Drugs Before First-Time Generic Entry 19

Boxes

1. Generic Drugs in the U.S. Pharmaceutical Marketplace 8

2. How Competition from Generic Drugs Affects Prices and Quantities of 

Prescription Drugs 10
CBO

Summary

In 2006, Medicare began offering outpatient prescription drug benefits to senior citizens and people with 

disabilities in a program called Part D. Unlike other 

Medicare benefits covered under the traditional fee-forservice program—in which providers are paid an administratively determined price for each covered service (or 

bundle of services) they provide—prices in Part D are not 

set by the government. Instead, private plans deliver the 

drug benefit and negotiate their own drug prices while 

competing with each other for enrollees. 

That framework was intended to provide those plans 

with incentives to make their drug benefits attractive to 

potential enrollees and to control their costs. One important way in which they do so is by negotiating with manufacturers of brand-name drugs for rebates. Another 

important mechanism is managing enrollees’ use of prescription drugs—and in particular, encouraging the use 

of generic drugs. Using differences in copayments and 

other methods, plans can encourage enrollees to switch 

from brand-name drugs to their less expensive generic 

equivalents—a practice known as generic substitution. 

Plans can also encourage enrollees to switch from a 

brand-name drug to the generic form of a different drug 

that is in the same therapeutic class, which is one form of 

a practice known as therapeutic substitution. (Therapeutic substitution can also include switching from a higher 

priced brand-name drug to a lower priced brand-name 

drug in the same class.) 

The Congressional Budget Office (CBO) used data from 

the Centers for Medicare and Medicaid Services on prescriptions filled in 2007 under Part D to assess how successful plans have been in encouraging the use of generic 

drugs and how much additional savings could arise from 

the wider use of such drugs. Developing policy tools to 

achieve additional savings from greater use of generic 

drugs is a further challenge not addressed in this study.

Potential Savings from 

Generic Substitution

In 2007, total payments to plans and pharmacies 

from the Part D program and its enrollees were about 

$60 billion. The total number of prescriptions filled 

under Part D was about 1 billion, of which 65 percent 

were filled with generic drugs, 5 percent were filled with 

multiple-source brand-name drugs (brand-name drugs 

that are also available in generic versions), and 30 percent 

were filled with single-source brand-name drugs (brandname drugs for which no chemically equivalent generic 

versions are available). Even though a majority of prescriptions were filled with generic drugs, their lower 

prices meant that those prescriptions accounted for only 

25 percent of total prescription drug costs.

Using the Part D data, CBO estimates that dispensing 

generic drugs rather than their brand-name counterparts 

reduced total prescription drug costs in 2007 by about 

$33 billion. Thus, total payments to plans and pharmacies from the Part D program and its enrollees would 

have been about $93 billion—or 55 percent higher—if 

no generics had been available. That analysis holds several 

factors constant and reflects CBO’s assessment (discussed 

below) that generic entry is unlikely to have a substantial 

effect on either the price of the brand-name drug or the 

total quantity (including brand-name and generic versions) of the drug sold.

The savings from using generic drugs accrued to Medicare and its enrollees. In 2007, Medicare made 72 percent 

of the total payments to plans and pharmacies under 

Part D, and enrollees paid for the remainder through 

premiums, deductibles, coinsurance, and copayments. 

A reasonable judgment is that those shares of payments 

would also apply to the savings from generic utilization—

which translates into savings of about $24 billion for the 

Part D program in 2007 and about $9 billion for its 

enrollees. The actual share of savings going to each group 
VIII EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

could have been somewhat higher or lower, however, 

depending on a number of factors, such as how the savings altered spending across the various coverage phases 

of the Part D program. 

CBO also analyzed the potential for additional savings 

from increased generic substitution and found that it is 

comparatively small. If all of the 45 million prescriptions 

filled with multiple-source brand-name drugs had instead 

been filled with their generic counterparts, an additional 

$900 million—representing less than 2 percent of total 

payments to plans and pharmacies from the Part D program and its enrollees in 2007—would have been saved. 

Using their shares of payments to plans and pharmacies 

to allocate those savings, the Part D program would have 

saved about $650 million, and its enrollees would have 

saved about $250 million.

Potential Savings from 

Therapeutic Substitution

Single-source brand-name drugs accounted for 68 percent of total prescription drug costs under Part D in 

2007, even though those drugs accounted for only about 

30 percent of prescriptions. Plans could have achieved 

some savings from that group of drugs by encouraging 

enrollees to switch to the generic form of a different drug 

in the same therapeutic class—that is, a drug designed to 

treat the same medical condition. 

The potential to reduce costs by promoting such therapeutic substitution depends on the number of singlesource prescriptions that it would be medically appropriate to switch. To assess the potential for such savings, 

CBO examined potential therapeutic substitution for 

seven therapeutic classes identified by the Medicare program as providing opportunities for such substitution. If 

all of the single-source brand-name prescriptions in those 

seven classes had been switched to generic drugs from the 

same class, prescription drug costs would have been 

reduced by $4 billion in 2007, or 7 percent of total payments to plans and pharmacies in that year. Again using 

their overall shares of payments to plans and pharmacies 

to allocate those savings, Medicare spending would have 

been reduced by $2.9 billion, and enrollees’ spending 

would have been reduced by $1.1 billion. As with generic 

substitution, the actual share of the savings going to 

either group could have been somewhat higher or lower. 

The potential savings from therapeutic substitution to 

generic drugs could have been higher or lower than those 

estimates, for two reasons. On the one hand, the reduction in costs in the seven therapeutic classes that feasibly 

could have been achieved would be less than $4 billion 

because in many cases it would have been medically inappropriate to switch a prescription from a single-source 

brand-name drug to the generic form of a therapeutically 

similar drug. Some drugs in a class either may be more 

effective than others for some of the population or may 

not be safe for people with other health conditions. Consequently, a pharmacist must obtain the consent of the 

prescribing physician before substituting a generic drug 

for a single-source drug that is in the same therapeutic 

class but is not chemically equivalent.

On the other hand, savings from therapeutic substitution 

to generic drugs could have been much higher than 

$4 billion to the extent that other classes of drugs also 

would have presented options for substitution. The seven 

classes that CBO evaluated represented only about onefifth of total prescription drug costs and 15 percent of the 

cost of single-source brand-name drugs under Part D. 

Even if the share of drugs that feasibly could have been 

switched in those other classes had been lower than in the 

classes that Medicare highlighted, those switches would 

generate additional savings. Compared with the potential 

for additional savings from generic substitution, the 

potential for additional savings from therapeutic substitution was greater both because the savings per prescription 

were greater (given the relative prices of the specific drugs 

involved) and because slightly more prescriptions had the 

potential to be switched. 

Policymakers would face several challenges in developing 

tools to achieve any additional savings from the expanded 

use of generic drugs—particularly in the case of therapeutic substitution. About half of Part D spending is on 

behalf of enrollees who have lower incomes and thus 

qualify for additional subsidies. Policies that used financial incentives to steer enrollees toward certain drugs 

might not be effective for that population because 

Medicare pays nearly all of their costs. In addition, plans 

must meet certain requirements intended to ensure that 

enrollees have access to the drugs that they need and to 

prevent the plans from discouraging beneficiaries with 

high drug costs from enrolling; those requirements limit 

plans’ ability to steer drug use. Finally, it could be difficult for policymakers to design policies so that switches 

from single-source brand-name drugs to generic drugs 

were made only when medically appropriate.
SUMMARY EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING IX

CBO

Implications of Future Developments

The estimates of actual savings from generic substitution 

in 2007 and potential savings that could have been realized from greater generic and therapeutic substitution 

during that year illustrate that using generic drugs in the 

future can reduce spending under Part D. However, the 

potential for such savings will vary from year to year 

depending on many factors, including the extent to 

which generic drugs and new brand-name drugs enter the 

market. 

Over the next several years, entities that pay for prescription drugs will benefit from a wave of brand-name drugs 

in high-priced therapeutic classes losing patent protection 

or other periods of exclusivity, which will allow generic 

drugs to enter those markets for the first time. Also, relatively few new brand-name drug products are expected to 

reach the market in the near term. If the current rate of 

generic substitution is maintained, first-time generic 

entry occurring through 2012 will generate about 

$14 billion in additional savings from generic substitution, in addition to the $33 billion in savings calculated 

above (where both figures apply to 2007 spending patterns). However, potential savings from therapeutic 

substitution for the classes that CBO considered would 

be reduced from $4 billion to about $2 billion (also based 

on 2007 spending). That reduction occurs because some 

of the prescriptions that would have been shifted to a 

different generic drug (when generating the estimate for 

therapeutic substitution in 2007) will have their own 

generic competitor by 2012; those savings are thus 

included in the $14 billion figure for additional savings 

from generic substitution. 

Two other important considerations stem from the provisions of the recently enacted legislation on health care 

(the Patient Protection and Affordable Care Act, as modified by the Health and Education Reconciliation Act of 

2010). First and foremost, the coverage gap in the Part D 

benefit—a range of spending in which many enrollees 

have to pay all of their drug costs—will gradually be 

closed. As a result, the total amount of drug spending 

under Part D, the mix of generic and brand-name drugs 

used, and the federal government’s share of drug spending will all change at least to some degree. In addition, 

the legislation created a regulatory pathway for approving 

drugs that are “biosimilar” to brand-name biologic 

products—drugs that are made from living organisms 

and that tend to be very expensive. How quickly those 

biosimilar drugs are developed and used, how they are 

priced, and whether they will be treated under regulation 

in the same manner as generic drugs for purposes of closing the coverage gap under Part D will all have important 

implications for future prescription drug spending. 

CBO

Effects of Using Generic Drugs on 

Medicare’s Prescription Drug Spending

In 2006, Medicare began offering outpatient prescription drug benefits to senior citizens and people with disabilities through the Medicare Prescription Drug Benefit 

Program (Part D). The program relies upon private plans 

to deliver those benefits to its enrollees. In contrast to the 

traditional fee-for-service programs employed to deliver 

other Medicare benefits—in which providers of health 

care are paid an administratively determined price for 

each covered service, or bundle of services, that enrollees 

receive—prices in Part D are negotiated by private plans 

that compete with one another for enrollees. That framework was intended to give plans incentives to make their 

drug benefits attractive to potential enrollees and to control costs. Toward that end, plans use various techniques 

to manage enrollees’ use of drugs and to negotiate price 

rebates from drug manufacturers and discounts from 

pharmacies.

Generic substitution, the practice of switching a prescription from a brand-name drug to a less expensive chemically equivalent generic drug, is one prominent approach 

to controlling costs.1

 This analysis uses data provided by 

the Centers for Medicare and Medicaid Services (CMS) 

on prescriptions filled under Part D in 2007 to assess the 

extent to which generic substitution reduced prescription 

drug spending in that year. The study also provides estimates of how much more spending could have been 

reduced in 2007 by additional generic substitution and 

by one form of another practice—known as therapeutic 

substitution—in which a prescription is switched from a 

brand-name drug to the generic form of a different drug 

that is in the same therapeutic class. In addition, the outlook for future savings from using generic drugs is briefly 

discussed. To explain who benefits from lower prescription drug spending and the incentives of enrollees and 

private plans to control such spending, the study begins 

by describing the design of the Part D benefit, the distribution of spending under Part D, and the role of private 

plans in the Part D program.

Overview of the Medicare Prescription 

Drug Benefit Program

Medicare Part D has about 28 million enrollees, and the 

Congressional Budget Office (CBO) estimates that net 

outlays will amount to $48 billion in fiscal year 2010.2

The program as it existed during its first five years is 

described below, with a particular focus on 2007 because 

this study uses detailed data from that year. The health 

care legislation enacted in March 2010 makes changes to 

Part D that will be phased in over a 10-year period.3

 The 

1. The term “chemically equivalent generic” is used throughout this 

study to refer to a generic drug that the Food and Drug Administration has determined is identical or bioequivalent to a brandname drug in dosage form, safety, strength, route of administration, quality, performance characteristics, and intended use.

2. Figures exclude enrollees in and payments to plans that receive the 

retiree drug subsidy (a subsidy that Medicare provides to certain 

prescription drug plans offered by employers and union groups to 

their retirees). For details, see enrollment data for 2010, available 

at www.cms.gov/PrescriptionDrugCovGenIn/. Net outlays are 

spending on payment benefits minus payments from the states 

and the portion of premiums paid by enrollees through withholdings from Social Security benefits. (When Part D coverage began, 

the responsibility for paying for drugs for individuals who are 

enrolled in both Medicaid and Medicare shifted from the Medicaid program to the Medicare Part D program. In recognition of 

that change, states are required to contribute to Part D a portion 

of their estimated avoided drug costs for that population.)

3. Patient Protection and Affordable Care Act (Public Law 111-148) 

and Health Care and Education Reconciliation Act of 2010 

(P.L. 111-152).
2 EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

changes expected in 2011 and beyond from that legislation are also described.

Design of the Medicare Prescription Drug Benefit

The Medicare prescription drug benefit is delivered by 

private plans. Private prescription drug plans—sometimes called “stand-alone” drug plans—offer only prescription drug coverage and are designed for enrollees 

who get their other Medicare benefits in the traditional 

fee-for-service program. In addition, private health plans, 

called Medicare Advantage plans, offer prescription drug 

coverage that is integrated with the health care coverage 

they provide to Medicare beneficiaries under Part C.4

Original Benefit Design. Before the recent enactment of 

health care legislation, the Part D standard prescription 

drug benefit included these phases of coverage:

B A deductible paid by the beneficiary ($265 in 2007);

B Coverage paid by the plan for 75 percent of drug costs 

between the deductible and the initial coverage limit 

($2,400 in 2007);

B A coverage gap beyond the initial coverage limit in 

which no further coverage is provided until an enrollee 

has incurred out-of-pocket drug costs for the year 

exceeding the catastrophic threshold ($3,850 in 2007, 

which corresponds to about $5,450 in total drug 

spending for someone who has no supplemental drug 

coverage); and

B Coverage of about 95 percent of drug costs beyond 

that threshold, with 15 percent of those costs paid by 

the plan and 80 percent paid by the Part D program. 

That coverage is not capped.

Over time, the dollar values that set those thresholds are 

indexed to growth in drug spending per enrollee, so that 

the benefit covers roughly the same share of drug costs 

from year to year. 

Plans may offer the standard benefit established in law, 

alternative prescription drug benefits that are actuarially 

equivalent to the standard prescription drug benefit, or 

benefits that are enhanced in some way. The standard 

benefit establishes the minimal level of coverage within 

Part D, but most people receive benefits that have different cost-sharing requirements—such as having a copayment that is a fixed dollar amount per prescription rather 

than a percentage of the prescription’s cost. To be actuarially equivalent, an alternative benefit design must cover 

the same share of enrollees’ drug costs, on average, as the 

standard benefit. Enhanced plans have a higher actuarial 

value.

For enrollees in stand-alone plans in 2007, about 20 percent were in standard benefit plans, 60 percent were in 

actuarially equivalent plans, and 20 percent were in 

enhanced benefit plans. By 2009, about 10 percent of 

enrollees in stand-alone plans were in standard benefit 

plans, 64 percent were in actuarially equivalent plans, and 

26 percent were in enhanced benefit plans. Enrollees in 

Medicare Advantage plans were predominantly in 

enhanced benefit plans (80 percent in 2007 and 94 percent in 2009). Only about 1 percent of enrollees in Medicare Advantage plans were in standard benefit plans over 

that time period.5

For each enrollee, Medicare provides plans with a subsidy 

of about 75 percent of the average cost of the standard 

prescription drug benefit. (A portion of that subsidy is 

provided by paying 80 percent of drug costs above the 

catastrophic threshold, and the rest is made as a perenrollee payment.) Most enrollees pay for the rest of the 

benefit and any enhanced benefits through premiums. 

Enrollees who have low income and few assets, however, 

may qualify for additional subsidies. For those enrollees, 

Medicare pays for nearly all of the premiums, deductibles, coinsurance, and copayments and for drug spending in the coverage gap.6

4. In addition to Part D, Medicare consists of Parts A, B, and C, 

which pay for other health care services for seniors and people 

with disabilities. Part A covers inpatient hospital stays, skilled 

nursing facilities, home health care, and hospice care. Part B covers outpatient hospital care, doctors’ services, and many other 

medical services not covered by Part A. The health care services 

offered under Parts A, B, and D (except hospice care) can be 

obtained through private health plans operating under Part C. For 

more information on Medicare, see Hinda Chaikind and others, 

Medicare Primer, CRS Report for Congress R40425 (Congressional Research Service, March 10, 2009).

5. Medicare Payment Advisory Commission, Report to the Congress: 

Medicare Payment Policy (March 2008), p. 290 and p. 292; and 

Report to the Congress: Medicare Payment Policy (March 2010), 

p. 287.

6. Enrollees qualifying for low-income subsidies are liable for additional costs if they choose plans with higher premiums than the 

limits set by the Centers for Medicare and Medicaid Services. 

Those limits ensure that enrollees will have at least one standalone drug plan available to them for which they do not have to 

pay a premium. See Patricia A. Davis, Medicare Part D Prescription 

Drug Benefit, CRS Report for Congress R40611 (Congressional 

Research Service, June 1, 2009), p. 12. 
EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING 3

CBO

Table 1.

Cost Sharing and Manufacturers’ Discounts for Prescription Drugs in the 

Former Medicare Part D Coverage Gap 

(Percentage of prescription drug spending)

Source: Congressional Budget Office based on the provisions of the Patient Protection and Affordable Care Act (Public Law 111-148) and the 

Health Care and Education Reconciliation Act of 2010 (Public Law 111-152).

Notes: Those provisions do not apply to the prescription drug spending of enrollees with low-income subsidies or enrollees who are in plans 

that receive the retiree drug subsidy.

n.a. = not applicable.

Medicare also subsidizes prescription drug plans provided 

by employers and unions for their retirees. To qualify for 

that subsidy (called the retiree drug subsidy), the plans 

must offer benefits that are at least actuarially equivalent 

to the standard prescription drug benefit under Part D. 

As long as they meet those requirements, the plan sponsors have complete flexibility over the design of the 

benefits they provide. 

Recently Enacted Changes. The recently enacted health 

care legislation makes several changes affecting the coverage gap in Part D. Beginning in 2011, manufacturers will 

be required to provide a 50 percent discount off the negotiated price of brand-name drugs included in a plan’s formulary—a list of drugs that the plan will pay for—to an 

enrollee when his or her prescription drug spending is in 

the coverage gap. Those manufacturers’ discounts will be 

counted toward enrollees’ out-of-pocket costs for determining whether they have reached the catastrophic 

threshold. Enrollees who receive low-income subsidies or 

are in plans receiving the retiree drug subsidy will not be 

eligible for the discount (presumably because they would 

not have faced the coverage gap under prior law).

In addition, and also starting in 2011, plans will provide 

an increasing amount of coverage under the standard prescription drug benefit for drugs purchased in the range of 

spending that would have constituted the coverage gap; 

plans that provide an actuarially equivalent benefit will 

have to increase their value correspondingly. For brandname drugs purchased in that spending range, plans will 

pay 2.5 percent of their cost in 2013, increasing to 

25 percent by 2020 and beyond. For generic drugs purchased in that spending range, plans will pay 7 percent of 

the cost in 2011; that coverage will increase each year to 

reach a total of 75 percent by 2020, where it will remain 

(see Table 1). As a result, by 2020, enrollees will pay 

25 percent of drug costs in the former coverage gap, just 

as they do in the initial phase of coverage. 

Distribution of Spending in Medicare Part D

Enrollees pay premiums to Part D plans and also pay 

deductibles, coinsurance, and copayments to pharmacies 

under the program. (Those premiums and cost-sharing 

requirements may be covered by third parties, such as 

charities or employers.) Medicare pays a premium subsidy to drug plans for all enrollees and additional subsidies for premiums and cost-sharing for low-income 

enrollees. All together, those payments to plans and 

2010 100.0 n.a. n.a. 100.0 n.a. n.a.

2011 50.0 n.a. 50.0 93.0 7.0 n.a.

2012 50.0 n.a. 50.0 86.0 14.0 n.a.

2013 47.5 2.5 50.0 79.0 21.0 n.a.

2014 47.5 2.5 50.0 72.0 28.0 n.a.

2015 45.0 5.0 50.0 65.0 35.0 n.a.

2016 45.0 5.0 50.0 58.0 42.0 n.a.

2017 40.0 10.0 50.0 51.0 49.0 n.a.

2018 35.0 15.0 50.0 44.0 56.0 n.a.

2019 30.0 20.0 50.0 37.0 63.0 n.a.

2020 and Beyond 25.0 25.0 50.0 25.0 75.0 n.a.

Manufacturers'

Discounts

Brand-Name Drugs Generic Drugs

Enrollees' Plans' Manufacturers'

Cost Sharing Cost Sharing Discounts

Enrollees'

Cost Sharing

Plans'

Cost Sharing
4 EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

Figure 1.

Distribution of Payments to Plans and Pharmacies for Enrollees’ 

Prescription Drug Spending Under Medicare Part D, 2007

Source: Congressional Budget Office based on Medicare Board of Trustees, 2010 Annual Report of the Boards of Trustees of the Federal 

Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds (August 5, 2010), p. 186, Table IV.B10, and p. 189, 

Table IV.B11; information from the Office of the Actuary at the Centers for Medicare and Medicaid Services; and claims data 

(Prescription Drug Event data) reported to the Centers for Medicare and Medicaid Services by plans.

Notes: In dollars, the total payments to plans and pharmacies ($59.8 billion) breaks down into the following categories: $5.5 billion for 

enrollees’ premiums, $11.4 billion for enrollees’ out-of-pocket spending, $16.8 billion for the Medicare Part D program benefit for 

low-income subsidies, $14.6 billion for the Medicare Part D program payment for the standard benefit for enrollees receiving those 

subsidies, and $11.5 billion for the Medicare Part D program payment for the standard benefit for other enrollees. 

Enrollees’ out-of-pocket spending includes spending by other organizations (such as charitable organizations) on an enrollee’s behalf.

Medicare Part D program payments for low-income subsidies include payments for premiums made by the Part D program to plans on 

behalf of enrollees receiving low-income subsidies.

Medicare Part D program payments exclude payments made under the retiree drug subsidy; those payments totaled about $4 billion 

in 2007. 

Enrollees'

Premiums

 (9%)

Enrollees'

Out-of-Pocket

Spending

 (19%)

Medicare Part D

Program Payment

for Low-Income

Subsidies

 (28%)

Medicare Part D

Program Payment for

Standard Benefit for 

Enrollees Receiving

Low-Income Subsidies

 (25%)

Medicare Part D

Program Payment for

Standard Benefit for

Enrollees Who

Do Not Receive

Low-Income Subsidies

 (19%)
EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING 5

CBO

pharmacies totaled $59.8 billion in 2007.7

 (That amount 

excludes prescription drug spending under plans that 

receive the retiree drug subsidy.) Enrollees paid 9 percent 

of that total amount in premiums to plans and 

19 percent in out-of-pocket payments to pharmacies (see 

Figure 1), for a total of 28 percent.8

 The Part D program 

paid 28 percent of the total for low-income subsidies 

beyond the standard benefit, 25 percent for the standard 

benefit of enrollees receiving low-income subsidies, and 

19 percent for the standard benefit of other enrollees.9

 In 

sum, the Part D program paid 72 percent of the total. (As 

a result of the recently enacted health care legislation, the 

share covered by Part D will increase gradually, reaching 

75 percent in 2019.)

The contribution from the Part D program differed 

greatly depending on whether an enrollee received a lowincome subsidy. In 2007, 24 million people were enrolled 

in Part D (excluding those enrolled in plans that received 

the retiree drug subsidy). Low-income subsidies were provided to 38 percent (or 9 million) of the enrollees.10 For 

those enrollees, the Part D program paid nearly all of the 

payments to plans and pharmacies. For enrollees who did 

not receive those subsidies, the Part D program paid 

about 40 percent of the payments to plans and 

pharmacies. 

The Role of Private Plans in Medicare Part D

The Part D program was designed to have private plans 

compete for enrollees on the basis of price, access to prescription drugs, quality, and performance. Each year, 

plans submit bids to CMS for the cost of offering the 

standard benefit to an average enrollee. CMS calculates a 

base premium using the nationwide average bid and 

determines its subsidy payments on that basis. (Steps that 

reduce the average bid thus reduce Medicare’s costs.) 

Enrollees must pay the base premium plus any difference 

between their plan’s bid and the nationwide average bid. 

Thus, enrollees in costlier plans face higher-than-average 

premiums for standard Part D benefits, and enrollees in 

less expensive plans pay lower-than-average premiums.

Plans try to reduce the cost of providing Part D benefits 

by managing enrollees’ use of prescription drugs, by 

negotiating rebates with manufacturers of brand-name 

drugs, and by negotiating payment rates with pharmacies. Plans can perform those functions within their 

organization, but often they contract them out to 

pharmacy benefit managers (PBMs)—similar to the way 

that private health plans, including health maintenance 

organizations and employers’ plans, often use PBMs to 

manage pharmacy benefits on their behalf.

Manage Enrollees’ Use of Prescription Drugs. Many 

plans use tiered copayments to give enrollees incentives to 

follow a plan’s formulary and to use less expensive drugs. 

A three-tier copayment structure is common: Enrollees 

pay a low copayment for generic drugs (the first tier), a 

7. Total payments to plans and pharmacies of $59.8 billion exceeded 

prescription drug costs net of rebates in 2007, which CBO estimated at $56.2 billion. The difference between the two amounts, 

in part, reflects administrative expenses and profits of plans. See 

the appendix for more details.

8. Enrollees’ premiums are the sum of premiums for the standard 

benefit and for enhanced benefits that have greater actuarial value. 

Premiums for the standard benefit (or a benefit of equal actuarial 

value to the standard benefit) are from Medicare Board of Trustees, 2010 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust 

Funds (August 5, 2010), p.189, Table IV.B11, the column labeled 

“Premiums.” For enrollees with enhanced benefits, that report 

includes only a portion of their premiums—the amount they 

would have paid if they had received a benefit of equal value to the 

standard benefit. Information on additional premium amounts 

for enrollees with enhanced benefits, which amounted to 

$1.5 billion in 2007, was provided by the Office of the Actuary at 

CMS. 

Enrollees’ out-of-pocket spending is based on data on prescription 

drug expenditures and includes spending in the categories “Patient 

Pay Amount” (amounts paid by enrollees), “Other True Out-ofPocket (TrOOP)” (for example, amounts paid by a qualified State 

Pharmacy Assistance Program), and “Patient Liability Reduction 

Due to Other Payer Amount” (for example, amounts paid by programs for workers’ compensation). “True Out-of-Pocket” refers to 

the requirement that enrollees must generally incur out-of-pocket 

costs themselves (and not be reimbursed by a third party) for those 

costs to count toward reaching the catastrophic threshold. 

9. Medicare Part D program payments to plans for the standard 

benefit are based on information provided by the Office of the 

Actuary at CMS. Part D program payments to plans for lowincome subsidies are from Medicare Board of Trustees, 2010 

Annual Report of the Boards of Trustees of the Federal Hospital 

Insurance and Federal Supplementary Medical Insurance Trust Funds

(August 5, 2010), p.186, Table IV.B10. They include payments 

for premiums, deductibles, coinsurance, and copayments made by 

the Part D program to plans on behalf of enrollees receiving lowincome subsidies. Part D program payments exclude those made 

under the retiree drug subsidy, which, according to the same 

report, totaled about $4 billion in 2007.

10. See Medicare Board of Trustees, 2010 Annual Report of the Boards 

of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, p. 183.
6 EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

higher one for preferred brand-name drugs (the second 

tier), and the highest copayment for nonpreferred brandname drugs (the third tier). In 2007, the median copayments for stand-alone prescription drug plans were $5 for 

generic drugs, $28 for preferred brand-name drugs, and 

$60 for nonpreferred brand-name drugs.11 (In the coverage gap, many enrollees must pay the full price for their 

drugs, so they may have even stronger financial incentives 

to use less costly drugs.) 

Plans may also combine formularies with other rules—

such as step therapy and prior authorization—to manage 

enrollees’ use of prescription drugs. Step therapy requires 

that enrollees try a cheaper generic drug or preferred 

brand-name drug before using a more expensive nonpreferred brand-name drug. The use of nonpreferred 

brand-name drugs may also require prior authorization 

from the plan, meaning that an enrollee’s physician may 

have to explain why a more costly nonpreferred drug is 

required over a lower-cost generic or preferred brand. 

About half of total prescription drug spending under 

Part D is on behalf of enrollees with low-income subsidies. Because those enrollees have very little cost sharing, 

a tiered copayment structure that relies on financial 

incentives may not be as effective in steering their drug 

use. Even so, rules such as step therapy and prior authorization could still be used to manage their drug use.

Negotiate Rebates with Manufacturers. Plans (or PBMs 

acting on their behalf) also use formularies to negotiate 

rebates with manufacturers of brand-name drugs. In 

developing its formulary, a plan determines which drugs 

are therapeutically similar. Then, for brand-name drugs 

with one or more close substitutes, the plan negotiates 

with manufacturers for rebates to be paid to the plan in 

return for placing manufacturers’ drugs on the plan’s preferred drug list.

In general, rebates are paid to plans for single-source 

brand-name drugs that are in classes containing similar 

drugs from which to choose. Rebates are typically not 

paid to plans (or are small) for multiple-source brandname drugs and generic drugs. Once a drug is available in 

a generic version, pharmacists can dispense either the 

generic or the brand. At that point, prescription drug 

plans are not in a position to promote either the 

multiple-source brand-name drug or the generic version, 

so they do not typically receive rebates on them. 

Restrictive formularies that list fewer drugs in each therapeutic class will generate higher rebates than less restrictive formularies that list several drugs in each therapeutic 

class, because plans with more restrictive formularies will 

be better able to steer enrollees to a particular manufacturer’s drug and away from the drug’s competitors. Plans 

with more restrictive formularies may be less attractive to 

enrollees, however.

Pharmaceutical manufacturers paid rebates to prescription drug plans under Part D that totaled about $6 billion in 2007. Costs of single-source brand-name drugs in 

that year totaled about $44 billion in the Part D program. 

If the $6 billion in rebates were paid primarily for singlesource brand-name drugs, then rebates constituted about 

14 percent of the cost of those drugs. (Unless otherwise 

indicated, figures for total prescription drug costs are net 

of those rebates.)

Negotiate Payment Rates with Pharmacies. Plans (or 

PBMs acting on their behalf) negotiate payment rates 

with pharmacies and seek discounts in exchange for 

including pharmacies in their networks. Drugs purchased 

at pharmacies outside a plan’s network may not be covered or may require a higher copayment or coinsurance 

rate. 

Pharmacies may be willing to accept lower payments per 

prescription in exchange for the greater volume of sales 

that can result from being part of a plan’s pharmacy network. The plan’s ability to achieve large discounts is 

greater the more restrictive the pharmacy network. 

However, like restrictive formularies, an overly restrictive 

pharmacy network may make a plan less attractive to 

enrollees.

Restrictions on Private Plans in Medicare Part D. Plans 

must meet certain requirements that limit their ability to 

reduce the costs of providing Part D benefits. Those 

requirements are intended to ensure that enrollees have 

access to the drugs that they need and to prevent plans 

from discouraging beneficiaries with high drug costs from 

enrolling. For example, some requirements concern how 

many drugs in a category or class of drugs must be 

covered; others involve having an adequate pharmacy 

network.

11. Patricia Neumana and Juliet Cubanski, “Medicare Part D 

Update—Lessons Learned and Unfinished Business,” New England Journal of Medicine, vol. 361, no. 4 (July 23, 2009), p. 408.
EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING 7

CBO

Classification systems for drugs are used by plans when 

developing their formularies. The classification systems 

group drugs into therapeutic categories and pharmacologic classes of drugs that work in a similar way or are 

used to treat the same condition.12 There are many different classification systems. “Model Guidelines” is one such 

system specifically developed for Medicare Part D.13 Plans 

may adopt the Model Guidelines or may use their own 

classification system. A plan’s formulary must include at 

least two drugs in each therapeutic category and class 

and must include all, or substantially all, of the drugs in 

the following six “protected” categories or classes: anticonvulsant, antidepressant, antineoplastic, antipsychotic, 

antiretroviral, and immunosuppressant.

Generic Drugs in Medicare Part D

CBO examined the use of generic drugs in Medicare 

Part D for calendar year 2007 using a sample of claims 

data containing about 10 million prescription records 

submitted by plans to the Centers for Medicare and 

Medicaid Services.14 (For a description of the claims data 

used in the analysis, see the appendix.) CBO analyzed 

how much was saved as a result of the use of generic 

drugs and the potential for savings from increasing the 

use of those drugs. The analysis examined savings from 

generic substitution—substituting a chemically equivalent generic drug for a brand-name drug. It also examined 

one form of therapeutic substitution—namely, substituting a generic drug for a brand-name drug when the 

generic is not chemically equivalent to the brand but is in 

the same therapeutic class. Therapeutic substitution can 

also include substituting a lower priced brand for a higher 

priced brand that is in the same therapeutic class, but 

that approach is beyond the scope of this report. (For 

information about the role of generic drugs in the U.S. 

pharmaceutical marketplace more generally, see Box 1.)

Generic Substitution

In 2007, about 65 percent of Part D prescriptions were 

filled with generic drugs, but those prescriptions 

accounted for about one-quarter of total prescription 

drug costs (see Table 2 on page 12).15 By contrast, 30 percent of Part D prescriptions were filled with single-source 

brand-name drugs, but those prescriptions accounted for 

68 percent of total prescription drug costs. Among Part 

D prescriptions written for multiple-source drugs (drugs 

that are available in brand-name and generic versions), 

more than 90 percent were filled with the generic option. 

That figure reflects the strong financial incentives for 

plans to encourage the use of generic drugs and for 

enrollees to use generics when available. 

Those estimates for Part D of the percentage of prescriptions filled with generic drugs (65 percent) and the percentage of prescriptions written for multiple-source drugs 

that were filled with the generic option (more than 

90 percent) are similar to estimates from other studies of 

the U.S. market as a whole and of Medicaid. One study 

found that 69 percent of prescriptions in the United 

States were filled with generic drugs at the end of 2008.16

Another study found that 89 percent of prescriptions 

written for multiple-source drugs were filled with the 

generic option under the Medicaid program in 2004.17

Other industry observers have reported that 90 percent or 

more of prescriptions written for multiple-source drugs 

were filled with the generic option under plans in the private sector by 2006.18

Savings from Generic Substitution in Medicare Part D.

CBO estimates that, in 2007, about $33 billion was saved 

because a generic drug was dispensed instead of its

12. For example, Lipitor, a top-selling drug that lowers cholesterol, is 

in the “cardiovascular agents” therapeutic category. That category 

is further subdivided into pharmacologic classes. Lipitor is in the 

pharmacologic class “dyslipidemics.”

13. For more about the development of the Model Guidelines, see 

The USP Model Guidelines Expert Committee and U.S. Pharmacopeia Staff, “Narrative Review: The U.S. Pharmacopeia and 

Model Guidelines for Medicare Part D Formularies,” Annals of 

Internal Medicine, vol. 145 (2006), pp. 448–453.

14. Claims data from calendar year 2007 were the most recent available for Medicare Part D when CBO’s analysis began.

15. Estimates of generic utilization can vary depending on which 

database of drug information is used. CBO used Thomson 

Micromedex’s Red Book database to classify prescription drugs as 

either brand-name or generic. Medi-Span and First DataBank also 

publish databases of drug information.

16. Generic Pharmaceutical Association, Generic Pharmaceuticals, 

1999–2008: $734 Billion in Health Care Savings (May 2009), 

p. 4.

17. Department of Health and Human Services, Office of Inspector 

General, Generic Drug Utilization in State Medicaid Programs,

OEI-05-05-00360 (July 2006), p. 7.

18. Statement of Mark Merrit, Pharmaceutical Care Management 

Association, before the United States Senate Special Committee 

on Aging, The Generic Drug Maze: Speeding Access to Affordable, 

Life Saving Drugs (July 20, 2006).
8 EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

Continued

brand-name counterpart. Thus, total payments to plans 

and pharmacies from the Part D program and its enrollees would have been about $93 billion—or 55 percent 

higher—if no generics had been available. The estimate is 

based on the number of prescriptions filled with a generic 

drug and the observed difference between prices for 

brand-name drugs and the generic alternatives. The 

analysis holds several factors constant and reflects CBO’s 

assessment that generic entry is not likely to have a substantial effect on either the price of the brand-name drug 

or the total quantity (including brand-name and generic 

versions) of the drug sold (see Box 2 on page 10).

Based on the data that CBO analyzed, about 600 million 

prescriptions were filled with a generic drug in 2007. 

For about 500 million of those, a multiple-source brandname drug was available. (A brand-name drug is not 

always available because the manufacturer may choose to 

exit the market after generic entry.) For those 500 million 

prescriptions, the average price (weighted by the number 

of generic prescriptions) of the multiple-source brandname drugs was $89 per prescription, whereas the average 

price of their generic counterparts was $23 per prescription. The savings per prescription equals $66—the difference between those two average prices. The savings per 

prescription multiplied by the 500 million prescriptions 

yields the estimate of about $33 billion in savings (see 

Table 3 on page 13).19

Box 1.

Generic Drugs in the U.S. Pharmaceutical Marketplace

Generic drugs are chemically equivalent versions of 

brand-name drugs that can be approved under an 

abbreviated regulatory process once the brand’s 

patent or other periods of exclusivity in the market 

expire (or the patent is successfully challenged). 

Manufacturers of generic drugs are not required to 

duplicate all of the costly clinical trials conducted by 

the manufacturer of the brand-name drug; instead, to 

gain approval from the Food and Drug Administration (FDA), they must demonstrate only that the 

generic version contains the same active ingredient as 

the brand-name version (inactive ingredients may 

vary) and provides very similar concentrations of the 

drug in the blood.1

 The FDA maintains that if blood 

concentrations are the same, the therapeutic effect 

will be the same, so there is no need to carry out studies for clinical effectiveness.2

 Even so, some groups 

of physicians have expressed concern that generic 

drugs may not work as well as their brand-name 

counterparts. For example, the American Academy 

of Neurology opposes the substitution of generic 

anticonvulsant drugs for the treatment of epilepsy 

without the attending physician’s approval.3

As a result of the abbreviated regulatory process, 

several manufacturers of generic drugs typically enter 

the market when the law allows them to do so. As the 

number of manufacturers grows, price competition 

among them increases, and the average price of the 

generic drug relative to that of the brand-name drug 

declines. On average, the retail price of a generic 

drug is 75 percent lower than the retail price of a

1. In addition, the generic drug must be identical to the brandname (or innovator) drug in strength, dosage form, and route 

of administration. It also must be indicated for the same uses; 

be bioequivalent; meet the same batch requirements for identity, strength, purity, and quality; and be manufactured under 

the same standards of the FDA’s good manufacturing practice 

regulations required for brand-name products. See the FDA’s 

Web site, www.fda.gov/Drugs/ResourcesForYou/Consumers/

BuyingUsingMedicineSafely/UnderstandingGenericDrugs/

ucm144456.htm.

2. See “Facts and Myths about Generic Drugs,” www.fda.gov/

Drugs/ResourcesForYou/Consumers/BuyingUsingMedicine 

Safely/UnderstandingGenericDrugs/ucm167991.htm.

3. See K. Liow and others, “Position statement on the coverage 

of anticonvulsant drugs for the treatment of epilepsy,” 

Neurology, vol. 68, no. 16 (April 17, 2007), pp. 1249–1250.

19. The estimate of savings from generic substitution does not include 

savings from the approximately 100 million prescriptions filled 

with a generic drug for which there is no alternative brand 

available because the brand’s manufacturer exited the market. 

Those prescriptions represent about 4 percent of total prescription 

drug spending.
EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING 9

CBO

The $33 billion in savings was shared by enrollees and 

the Part D program through a combination of lower 

copayments and lower premiums than would have been 

charged otherwise, but determining the precise share that 

accrued to each payer is difficult. A reasonable estimate is 

that the savings were shared in the same proportion as 

total payments by those groups to plans and pharmacies 

in 2007 (see Figure 1 on page 4). On that basis, enrollees 

saved about $9 billion (or 28 percent), and the Part D 

program saved about $24 billion (or 72 percent). 

The actual split of the savings between enrollees and the 

Part D program depends on several factors: how the savings from switching to generic drugs affects spending 

across the different phases of coverage, such as the coverage gap and the range of spending above the catastrophic 

threshold; the mix of prices and copayments for generic 

drugs and their brand-name counterparts; and whether 

the use of generic drugs is different for enrollees who 

receive low-income subsidies than for the rest of the 

Part D population. As a result, the shares of savings for 

enrollees and the Part D program could have been higher 

or lower. For example, the share of savings that accrued to 

enrollees could have been higher than 28 percent if the 

savings from switching to generic drugs reduced spending 

in the coverage gap disproportionately. Alternatively, the 

share of savings that accrued to enrollees could have been 

less than 28 percent if the savings from switching to 

generic drugs disproportionately reduced spending for 

catastrophic coverage, because that spending is borne 

mostly by the Part D program.

Box 1. Continued

Generic Drugs in the U.S. Pharmaceutical Marketplace

brand-name drug.4 Accordingly, generic substitution—substituting a generic drug, when one is available, for a brand-name drug—is a major strategy that 

health insurers use to reduce their spending on prescription drugs. 

Private health insurers can promote generic substitution by using a formulary (a list of covered drugs) 

combined with tiered copayments, charging the 

lowest copayment for generic drugs and a higher one 

for multiple-source brand-name drugs (brand-name 

drugs that have a generic form available). Some 

health insurers have formularies that exclude 

multiple-source brand-name drugs from coverage. 

However, those sorts of formularies are not very common. One 2004 survey found that about 20 percent 

of employees in the private sector with prescription 

drug benefits had no coverage for multiple-source 

brand-name drugs.5

Health insurers have help from pharmacists in promoting generic substitution. Generally, when a drug 

is available in both generic and brand-name forms, 

states’ laws allow pharmacists to fill the prescription 

with the generic even when the physician has written 

the prescription for the brand-name drug. Federal 

regulations implementing the drug benefit under 

Part D of Medicare also require pharmacists to notify 

patients if a generic substitute is available. In most 

states, however, the pharmacist must obtain the consent of the patient or at least must inform the patient 

when a generic drug is being substituted. The pharmacist cannot dispense the generic drug if the physician indicates in writing on the prescription “no substitution” or that the brand is “medically necessary.”6

4. That information is based on average prescription drug costs 

in 2007 from the National Association of Chain Drug Stores 

(www.nacds.org/wmspage.cfm?parm1=6536, accessed 

January 11, 2010).

5. The Kaiser Family Foundation and the Health Research and 

Educational Trust survey employers each year to examine 

trends in employment-based health coverage. The 2004 survey is the most recent one to include a question about mandatory use of generic drugs when available. See Kaiser Family 

Foundation and Health Research and Educational Trust, 

Employer Health Benefits: 2004 Annual Survey (Menlo Park, 

Calif., and Chicago, 2004).

6. Jack Hoadley, Cost Containment Strategies for Prescription 

Drugs: Assessing the Evidence in the Literature (report prepared 

for the Henry J. Kaiser Family Foundation, March 2005), 

p. 32.
10 EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

Continued

Box 2.

How Competition from Generic Drugs Affects Prices and Quantities of 

Prescription Drugs

Competition from generic drugs has varied and 

sometimes ambiguous effects on the quantity of a 

drug sold (including brand-name and generic 

versions) and the price of the brand-name version. 

Effects on Prices

Researchers have found that the average prices of 

generic drugs are much lower than the prices of 

brand-name drugs. As more manufacturers of generic 

drugs enter the market, the average price of the 

generic drugs relative to that of the brand-name drug 

declines, and the market share of the generic drugs 

increases.1

The effect of generic competition on the price of the 

brand-name drug is less clear-cut. Some studies conclude that the price of the brand-name drug increases 

because of competition from generics. One explanation for that effect is that some consumers are less 

price-sensitive than others, especially if they perceive 

the quality of the brand-name drug to be higher than 

that of its generic competitors. According to that 

logic, manufacturers of generic drugs compete among 

themselves for the price-sensitive consumers; the 

brand-name manufacturer retains the less pricesensitive consumers and chooses to charge them a 

higher price for the brand-name drug than the price 

before generic entry.2

Other studies conclude that competition from generics exerts a downward pressure on the price of the 

brand-name drug. In this story, although the price of 

a brand-name drug typically increases over time after 

generics enter the market, the competition from 

generic entry causes the price of the brand-name drug 

to increase by less than it would have in the absence 

of generic entry.3

Regardless of how generic entry affects the price of 

the brand-name drug, the overall effect of generic 

entry is to decrease the average price of the drug (for 

brand-name and generic versions) because the prices 

of the generic drugs are so far below the price of the 

brand-name drug and because generic competitors 

capture a large share of the market. 

Effects on Quantities

Typically, the total quantity of a drug sold might be 

expected to increase as a result of competition from 

generic versions because consumers typically buy 

more of a good when its price decreases. However, 

the total quantity of a drug sold may remain 

unchanged or may decline somewhat after generic 

competitors enter the market, for many reasons.4

In response to anticipated generic entry, for example, 

manufacturers of the brand-name drug sometimes are 

able to modify it (by creating an extended-release version, for instance) and switch consumers to the modified and newly patented version before generic entry 

begins. Such a switch would reduce demand for the 

original drug.

1. See F.M. Scherer, “Pricing, Profits, and Technological 

Progress in the Pharmaceutical Industry,” Journal of Economic 

Perspectives, vol. 7, no. 3 (Summer 1993), pp. 97–115.

2. See, for example, Henry Grabowski and John Vernon, 

“Brand Loyalty, Entry, and Price Competition in Pharmaceuticals After the 1984 Drug Act,” Journal of Law and Economics, vol. 35 (October 1992), pp. 331–350; and Richard Frank 

and David Salkever, “Generic Entry and the Pricing of 

Pharmaceuticals,” Journal of Economics and Management 

Strategy, vol. 6, no. 1 (Spring 1997), pp. 75–90.

3. See, for example, Richard Caves, Michael Whinston, and 

Mark Hurwitz, “Patent Expiration, Entry, and Competition 

in the U.S. Pharmaceutical Industry,” Brookings Papers on 

Economic Activity: Microeconomics (1991), pp. 1–66; Jayanta 

Bhattacharya and William Vogt, “A Simple Model of Pharmaceutical Price Dynamics,” Journal of Law and Economics,

vol. 46 (October 2003); and Sara Fisher Ellison and others, 

“Characteristics of Demand for Pharmaceutical Products: 

An Examination of Four Cephalosporins,” RAND Journal of 

Economics, vol. 28, no. 3 (Autumn 1997), pp. 426–446.

4. See Caves, Whinston, and Hurwitz, “Patent Expiration, 

Entry, and Competition in the U.S. Pharmaceutical 

Industry.”
EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING 11

CBO

Box 2. Continued

How Competition from Generic Drugs Affects Prices and Quantities of 

Prescription Drugs

A decline in sales could also result if the brand-name 

manufacturer decreases advertising for the drug. That 

often occurs when generic competitors enter the market because the brand-name manufacturer is no longer able to capture all the benefits of that advertising.5

Consumers may switch to a competing brand-name 

drug that is still advertised, or consumers with the 

condition may no longer use any drug therapy. A 

decline in quantity also could be caused by newer 

brands coming on the market and replacing the older 

drug therapy (in which case the decline is unrelated 

to generic entry). 

Researchers have found that the overall effect of 

generic entry is to lower total spending on the drug 

(for brand-name and generic versions) because the 

average price is much lower.6

Effects on Estimates of Savings

Based on research about the effects of generic entry, 

the Congressional Budget Office (CBO) concluded 

that generic entry is not likely to have a substantial 

effect on either the price of the brand-name drug or 

the total quantity (including brand-name and generic 

versions) of the drug sold. CBO’s estimates of 

savings under Part D of Medicare from generic 

substitution—substituting a chemically equivalent 

generic drug for a brand-name drug—reflect that 

assessment. If, instead, competition from generic 

drugs caused brand-name manufacturers to raise their 

prices, then CBO’s estimates of savings might be too 

high. Conversely, if competition from generics caused 

brand-name manufacturers to lower their prices, 

then CBO’s estimates of savings might be too low. 

The estimates would also change if generic entry led 

to changes in the quantity of a drug sold in a specific 

market. If the availability of cheaper generic drugs 

caused the total quantity of drugs sold to increase, 

then the estimates of savings might be too high. If the 

total quantity of drugs sold declined because consumers switched to modified and newly patented versions 

of the brand-name drug, then spending on those new 

versions would offset the estimated savings from 

generic substitution. 

In addition, changes in the marketing strategy of 

pharmaceutical firms producing brand-name drugs 

and consumers’ response to those changes could 

affect CBO’s estimates. If competition from equivalent generic drugs reduced the incentive of the manufacturer of the brand-name drug to advertise and 

consumers therefore switched to competing brandname drugs, then the estimates of savings might be 

too high (if the competing brand drugs have a higher 

price than the brand with generic equivalents). Or, 

the estimates of savings might be too low, if the price 

of the competing brand drugs was lower than the 

price of the brand with generic equivalents. Finally, 

if consumers discontinued drug therapy in response 

to lower levels of advertising, then the estimates of 

savings might be too low. 

More broadly, if entry by generic drugs had been prohibited—that is, if patents for drugs were essentially 

permanent—the market for drugs could have evolved 

in different ways that are very hard to predict. The 

types of drugs available, their prices, and their utilization rates could differ from the observed experience 

in ways that are not captured by studies of generic 

entry. Because of the uncertainties involved in predicting what would happen in that counterfactual 

case, CBO has not factored those possibilities into its 

estimate of the savings that have been achieved from 

generic substitution.

5. Ibid.; and Bhattacharya and Vogt, “A Simple Model of 

Pharmaceutical Price Dynamics.”

6. See Caves, Whinston, and Hurwitz, “Patent Expiration, 

Entry, and Competition in the U.S. Pharmaceutical 

Industry.”
12 EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

Table 2.

Share of Part D Prescriptions and 

Prescription Drug Costs, by Drug Type, 

2007

Source: Congressional Budget Office based on Medicare Part D 

Prescription Drug Event claims data for 2007 provided by 

the Centers for Medicare and Medicaid Services and 

rebate data from the Medicare Board of Trustees, 2010 

Annual Report of the Boards of Trustees of the Federal 

Hospital Insurance and Federal Supplementary Medical 

Insurance Trust Funds (August 5, 2010), p. 185.

Note: Multiple-source brand refers to a drug that is sold under a 

brand name but is also available in generic versions from 

other manufacturers. Single-source brand refers to a drug 

that is sold under a brand name and is under patent protection—and thus is available from only one manufacturer (or 

occasionally from other manufacturers under license from 

the patent holder) and for which no chemically equivalent 

generic version is available.

Another complication in the analysis stems from the fact 

that plans were also encouraging therapeutic substitution 

to varying degrees (if only by using tiered copayments). 

Consequently, some of the $33 billion in savings attributed to generic substitution was instead a result of therapeutic substitution. However, the amount of savings 

attributable to each form of substitution cannot be 

calculated from the available data. Because not enough is 

known about enrollees’ medical histories or the brandname drugs they might have been prescribed initially, it is 

difficult to determine when therapeutic substitutions 

might have occurred.

Potential Additional Savings from Generic Substitution 

in Medicare Part D. Generic substitution has produced 

substantial savings for Part D prescription drug spending, 

but the potential for additional savings from increased 

generic substitution is comparatively small. If all prescriptions for multiple-source brand-name drugs had instead 

been filled using generic drugs, about $900 million—or 

less than 2 percent of total payments to plans and pharmacies from the Part D program and its enrollees—

would have been saved in 2007, CBO estimates. 

That estimate was derived as follows. About 45 million 

prescriptions (or 5 percent) were filled with multiplesource brand-name drugs in 2007. Those drugs were 

most often dispensed when the difference between the 

price of the brand-name and generic drugs was relatively 

small. Specifically, the average price of multiple-source 

brand-name drugs was $89 per prescription, whereas the 

average price of their generic counterparts (weighted by 

the number of multiple-source brand-name prescriptions) was $69 per prescription. The savings per prescription equals the difference of about $20 in the average 

prices. The savings per prescription multiplied by the 

45 million prescriptions results in about $900 million 

in potential additional savings from generic substitution 

(see Table 4 on page 14). Again, the analysis holds several 

factors constant and reflects CBO’s assessment that 

generic entry is not likely to have a substantial effect 

on either the price of the brand-name drug or the total 

quantity (including brand-name and generic versions) of 

the drug sold.

The potential additional savings would have been shared 

by enrollees and the Part D program, but the amounts 

that would have accrued to each party are not known. 

Again, using the average shares of payments by enrollees 

and the Part D program to allocate those savings, about 

$250 million (or 28 percent) would have accrued to 

enrollees, and about $650 million (or 72 percent) would 

have accrued to the Part D program. Because the additional savings would have come from drugs for which the 

generic alternative was more expensive than average, 

however, the savings to the Part D program could have 

been less than 72 percent if the switch to a generic drug 

reduced enrollees’ spending by a proportionately larger 

amount. For example, on the basis of the difference 

between the median copayments in 2007 for a preferred 

brand-name drug ($28) and for a generic drug ($5) and 

with other factors held constant, the switch from a 

multiple-source brand-name drug to a generic drug 

would have saved the enrollee $23, but the plan would 

Drug Type

Generic 65 25

Multiple-Source Brand 5 7 

Single-Source Brand 30 68 ____ ____

Total 100 100 

Percentage of 

Prescription

Drug Costs

Percentage of

Prescriptions
EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING 13

CBO

Table 3.

Estimate of Realized Savings from Generic Substitution, 2007

(Dollars)

Source: Congressional Budget Office based on Medicare Part D Prescription Drug Event claims data for 2007 provided by the Centers for 

Medicare and Medicaid Services.

Note: Multiple-source brand refers to a drug that is sold under a brand name but is also available in generic versions from other 

manufacturers.

have paid an additional $3. If the multiple-source brandname drug was nonpreferred, an enrollee’s savings from 

switching to a generic version would have been even 

higher. 

Two considerations, however, limit the applicability of 

those examples. First, they apply only to prescription 

drug spending between the deductible and the initial 

coverage limit on behalf of enrollees without low-income 

subsidies. Nearly all of the potential additional savings on 

behalf of enrollees with low-income subsidies would have 

accrued to the Part D program because that program pays 

nearly all of their costs. Second, if many enrollees had 

made such switches, then the average share of drug costs 

paid by enrollees would have been reduced; although 

enrollees might have initially captured most of the resulting savings, the calculated actuarial value of the plan 

could have been increased as a result. In that case, CMS 

probably would have required plans to rebalance their 

copayment structures to maintain the same actuarial 

value as provided by the standard benefit design, which 

would have shifted some savings from enrollees to Medicare. Therefore, using the current shares of spending on 

Part D to allocate the savings represents a reasonable 

approximation of the likely outcome, at least on average. 

Therapeutic Substitution

Single-source brand-name drugs under Part D in 2007 

cost about $38 billion. Some savings could have been 

achieved from that group of drugs by switching enrollees 

from a higher priced brand-name drug to a lower priced 

brand-name or generic drug that is not chemically equivalent but is in the same therapeutic class, a practice 

known as therapeutic substitution.

Using a tool called the “Medicare Prescription Drug Plan 

Finder,” CBO analyzed one form of therapeutic substitution—switching an enrollee from a single-source brandname drug to the generic form of a different drug that is 

in the same therapeutic class. The main purpose of the 

Medicare Prescription Drug Plan Finder is to help Medicare beneficiaries compare the total prices of plans on the 

basis of the drugs they take—counting not only the premium they would have to pay but also each plan’s costsharing requirements for those specific drugs. The tool 

also indicates when generic versions of drugs are available 

and provides information to beneficiaries on lower priced 

drugs that could be substituted for higher priced drugs in 

15 classes and subclasses. The majority of those classes 

and subclasses are for drugs that treat cardiovascular diseases (for example, high cholesterol and high blood pressure). Also included in the list are classes and subclasses of 

drugs that treat gastrointestinal diseases and allergies.

CBO calculated potential savings from therapeutic substitution for 7 of the 15 therapeutic classes identified by 

the drug finder as offering opportunities for such substitution (see Table 5 on page 15). Those seven classes were 

chosen because they contained at least one single-source 

brand-name drug and one therapeutically similar drug 

that was also available in a generic form. There were 

about 180 million prescriptions written for drugs in the 

seven classes and subclasses in 2007, totaling about 

Average Price of Multiple-Source Brand-Name Drugs Weighted by the Number of Generic Prescriptions 89

Minus: Average Price of Generic Prescriptions 23

Equals: Average Savings per Prescription 66

Average Savings per Prescription 66

Multiplied by: Number of Generic Prescriptions Filled When a Multiple-Source Brand-Name Drug Was Available (Millions) 500

Equals: Total Savings (Millions of dollars) 33,000

Savings per Prescription

Total Savings
14 EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

Table 4.

Potential Additional Savings from Generic Substitution, 2007

(Dollars)

Source: Congressional Budget Office based on Medicare Part D Prescription Drug Event claims data for 2007 provided by the Centers for 

Medicare and Medicaid Services.

Note: Multiple-source brand refers to a drug that is sold under a brand name but is also available in generic versions from other 

manufacturers.

$10 billion in prescription drug costs. That amount represents about 17 percent of total payments to plans and 

pharmacies from the Part D program and its enrollees. 

About 66 percent of the prescriptions in the seven classes 

were dispensed with generic drugs, accounting for 36 percent of prescription drug costs in those classes. About 

30 percent of the prescriptions were filled with singlesource brand-name drugs, which were 59 percent of prescription drug costs in those classes (see Table 6 on 

page 16). For prescriptions written for multiple-source 

drugs, 95 percent were filled with the generic option.

Focusing on those seven therapeutic classes, CBO 

determined that switching a prescription in 2007 from a 

single-source brand-name drug to a generic drug in the 

same class would have reduced the cost of each prescription by about 70 percent, on average. On the one hand, 

the potential to increase savings through therapeutic 

substitution would have been limited by the number of 

single-source prescriptions that it would have been medically appropriate to switch. On the other hand, savings 

might also have been feasible in other classes of drugs, but 

the difference in prices and the extent of the opportunities for therapeutic substitution would have differed in 

those classes. 

Potential Savings from Therapeutic Substitution in 

Certain Drug Classes. Prescription drug spending for 

single-source drugs totaled about $5.8 billion (net of 

rebates) in 2007 in the seven classes that CBO considered. In the claims data that CBO analyzed, the price of a 

single-source brand-name drug was $128 per prescription, on average. Because plans received rebates from 

manufacturers that averaged about 14 percent of singlesource prescription drug spending, the average price of a 

single-source brand-name prescription minus rebates was 

about $110. The average price of generic drugs in those 

seven classes (weighted by the number of single-source 

prescriptions in each class) was $34 per prescription, 

or about 70 percent lower than the average price of the 

single-source brand-name drugs. Thus, the average 

savings per prescription from switching equals $76. 

There were 53 million single-source brand-name prescriptions in those classes. If all had been switched to 

generics from the same class, then multiplying by the savings per prescription would yield a potential reduction in 

prescription drug spending of about $4 billion (see Table 

7 on page 17).20 That reduction would have been about 

Average Price of Multiple-Source Brand-Name Drugs 89

Minus: Average Price of Generic Drugs Weighted by the Number of Multiple-Source Brand Prescriptions 69

Equals: Average Savings per Prescription 20

Average Savings per Prescription 20

Multiplied by: Number of Multiple-Source Brand Prescriptions Filled When a Generic Drug Was Available (Millions) 45

Equals: Total Potential Additional Savings (Millions of dollars) 900

Savings per Prescription

Total Potential Savings

20. The potential additional savings from therapeutic substitution are 

based on the difference between the price per prescription for the 

single-source brand-name drug and the average price per prescription for all generic drugs in the same therapeutic class. CBO also 

estimated savings for each class and subclass using other measures: 

the average price for a 30-day supply of generic drugs, the lowest 

price for a generic prescription, the lowest price for a 30-day supply of generic drugs, the price of the most frequently used generic 

prescription, and the price of the most frequently used generic 

drug based on the number of days supplied. The estimates of savings varied little between methodologies.
EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING 15

CBO

Table 5.

Selected Classes of Drugs Analyzed for 

Possible Therapeutic Substitution

Source: Congressional Budget Office based on information provided by the Centers for Medicare and Medicaid Services.

Notes: The Congressional Budget Office selected these seven 

classes and subclasses because they contained at least one 

single-source brand drug and a therapeutically similar drug 

that is also available in a generic form in 2007. Single-source 

brand refers to a drug that is sold under a brand name and is 

under patent protection––and thus is available from only 

one manufacturer (or occasionally from other manufacturers 

under license from the patent holder) and for which no 

chemically equivalent generic version is available.

This analysis excludes combination drugs and drugs that 

have alpha receptor activity or intrinsic sympathomimetic 

activity. 

7 percent of total payments to plans and pharmacies from 

the Part D program and its enrollees in 2007. The analysis holds several factors constant and reflects CBO’s 

assessment that generic entry is not likely to have a substantial effect either on the price of the brand-name drug 

or on the total quantity (including brand-name and 

generic versions) of the drug sold.

The potential reduction of $4 billion in prescription drug 

spending would have been shared by enrollees and the 

Part D program. Again applying the shares of payments 

by those groups to plans and pharmacies in 2007 (see Figure 1 on page 4), enrollees’ spending would have been 

reduced by $1.1 billion (or 28 percent), and the Part D 

program’s spending would have been reduced by $2.9 billion (or 72 percent). The shares of those savings that 

would have accrued to both parties could have been 

higher or lower in actuality, however. In particular, shares 

of savings for any subset of therapeutic classes could have 

differed from average shares calculated for all classes.

Medical Appropriateness of Therapeutic Substitution.

The savings that feasibly could have been achieved from 

therapeutic substitution in those classes of drugs would 

have been smaller than $4 billion because it would have 

been medically inappropriate, in many cases, to make 

such switches. Within a therapeutic class, drugs may be 

approved by the Food and Drug Administration (FDA) 

to treat different symptoms and diseases. For example, 

within the class of drugs known as “nonselective betaadrenergic blocking agents” (used for treating high blood 

pressure) is a subset of drugs that is also approved for 

treating migraines. The physician of a patient with 

migraines may not be willing to write a new prescription 

for a generic drug in that class of blocking agents if the 

drug has not been approved by the FDA to treat 

migraines. 

Even among drugs approved to treat the same condition, 

important differences can exist. Some drugs in a class 

may be more effective than others, at least for some 

members of the population. Certain subpopulations—for 

example, people with liver or kidney disease—may need a 

specific brand-name drug in a class. In addition, some 

drugs in a class may have harmful side effects for different 

patients. Depending on the drug, side effects can range 

from relatively mild (such as dry mouth and drowsiness) 

to more severe (such as nausea and headaches) to life 

threatening (such as seizures, difficulty breathing, and 

liver damage). Moreover, drugs may have different dosing 

regimens, and physicians may be concerned about a 

reduction in patient compliance if they switched to drugs 

that must be taken more frequently. Also, physicians and 

their patients may be reluctant to switch to a therapeutic 

alternative once a condition has been stabilized using a 

brand-name drug. Finally, physicians’ clinical experience 

with their patients may lead them to conclude that certain patients respond better to a particular drug from a 

given class.

Reflecting those considerations, a pharmacist must obtain 

the consent of the prescribing physician before substituting a generic drug for a single-source drug that is not 

chemically equivalent but is in the same therapeutic class. 

In contrast, a pharmacist can generally substitute a chemically equivalent generic drug for its brand-name counterpart without contacting the physician.

The claims data that CBO used do not contain enough 

information to determine the percentage of prescriptions 

for which therapeutic substitution would have been 

Cardiovascular Agents

HMG CoA reductase inhibitors (statins)

Angiotensin-converting enzyme (ACE) inhibitors

Calcium channel blocking agents, dihydropyridines

Calcium channel blocking agents, nondihydropyridines

Nonselective beta-adrenergic blocking agents

Gastrointestinal Agents

Proton pump inhibitors

Respiratory Tract Agents

Mildly/nonsedating histamine1 (H1) blocking agents
16 EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

Table 6.

Percentage of Part D Prescriptions and 

Prescription Drug Costs, by Drug Type, 

in Seven Selected Classes and 

Subclasses, 2007

Source: Congressional Budget Office based on Medicare Part D 

Prescription Drug Event claims data for 2007 provided by 

the Centers for Medicare and Medicaid Services and 

rebate data from the Medicare Board of Trustees, 2010 

Annual Report of the Boards of Trustees of the Federal 

Hospital Insurance and Federal Supplementary Medical 

Insurance Trust Funds (August 5, 2010), p. 185.

Note: Multiple-source brand refers to a drug that is sold under a 

brand name but is also available in generic versions from 

other manufacturers. Single-source brand refers to a drug 

that is sold under a brand name and is under patent protection—and thus is available from only one manufacturer (or 

occasionally from other manufacturers under license from 

the patent holder) and for which no chemically equivalent 

generic version is available.

medically appropriate. That analysis would require 

detailed information about the incidence of diseases and 

other conditions in the Part D population and a thorough review of disease-treatment guidelines. However, 

examining potential savings by class provides some 

additional insight. Almost all of the potential savings 

from therapeutic substitution were concentrated in two 

of the seven classes that CBO examined: Proton pump 

inhibitors accounted for about 50 percent of the potential 

savings, and statins accounted for 44 percent. That concentration of savings resulted from the high percentages 

of prescriptions filled with single-source brand-name 

drugs in the two classes relative to the others—as well as 

the large number of prescriptions written for those widely 

used drugs.

Proton pump inhibitors are used to treat chronic symptoms of heartburn or acid regurgitation (known as gastroesophageal reflux disease) and to treat and prevent 

ulcers.21 Research indicates that drugs in that class are 

similar in safety and effectiveness when compared at 

equivalent doses.22 That finding would indicate that a 

large share of single-source prescriptions could be 

switched to generic proton pump inhibitors.

Statins are used to lower cholesterol. High cholesterol can 

increase the risk of a heart attack and death from heart 

disease or stroke. Statins differ by how much of a reduction in cholesterol they provide. Enrollees who require 

large reductions to achieve desired blood concentrations 

would probably require a brand-name statin.23 Although 

one health plan reported that more than 75 percent of 

patients taking a statin could achieve their cholesterollowering goals using a generic statin, specific information 

on the population of Medicare enrollees taking singlesource brand-name statins would be needed to determine 

if the use of generic drugs could be increased among that 

population.24

Application to Other Drug Classes. For other reasons, 

potential savings from therapeutic substitution could 

have been higher than $4 billion. The seven classes 

that CBO examined accounted for only 17 percent of 

total prescription drug costs in 2007 and only about 

15 percent of the costs of single-source brand-name drugs 

under Part D. To the extent that other classes also present 

opportunities for therapeutic substitution, potential savings would increase. Additionally, this analysis considered 

just one form of therapeutic substitution. If potential 

savings from substituting lower priced brands for higher 

priced brands in the same therapeutic class were also 

considered, then those savings would increase.

Drug Type

Generic 66 36

Multiple-Source Brand 4 5

Single-Source Brand 30 59 ____ ____

Total 100 100

Percentage of

Percentage of

Prescriptions

Prescription

Drug Costs

21. Proton pump inhibitors are also available in low doses over the 

counter. Those versions are approved by the FDA only to treat 

infrequent symptoms of heartburn.

22. Kenneth DeVault and Donald Castell, “Updated Guidelines for 

the Diagnosis and Treatment of Gastresophageal Reflux Disease,” 

American Journal of Gastroenterology, vol. 100 (2005), pp. 190–

200.

23. Drug Effectiveness Review Project, Drug Class Review, HMGCoA Reductase Inhibitors (Statins) and Fixed-Dose Combination 

Products Containing a Statin, Final Report Update 5, Oregon 

Health and Science University (November 2009).

24. Emily Cox, Andy Behm, and Doug Mager, 2005 Generic Drug 

Trend Usage Report (St. Louis, Mo.: Express Scripts).
EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING 17

CBO

Table 7.

Potential Savings from Therapeutic Substitution for Seven Selected 

Drug Classes, 2007

(Dollars)

Source: Congressional Budget Office based on Medicare Part D Prescription Drug Event claims data for 2007 provided by the Centers for 

Medicare and Medicaid Services and rebate data from the Medicare Board of Trustees, 2010 Annual Report of the Boards of Trustees 

of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds (August 5, 2010), p. 185.

Note: Single-source brand refers to a drug that is under patent protection and is sold under a brand name––and thus is available from only 

one manufacturer (or occasionally from other manufacturers under license from the patent holder). No chemically equivalent generic 

version is available.

a. Plans received rebates from manufacturers that averaged about 14 percent of single-source prescription drug costs in 2007.

b. Potential savings are higher than the actual amount would be; in many cases, it would be medically inappropriate to switch a patient’s 

prescription from a single-source brand in one of the seven classes to a generic in the same class.

The range of rates for the utilization of generic drugs 

across plans in Part D may provide some insight into the 

potential for switching prescriptions from single-source 

brands to generic alternatives across all therapeutic 

classes. Although the overall share of prescriptions filled 

with generic drugs was about 65 percent under Part D in 

2007, it generally ranged from about 55 percent to about 

70 percent among stand-alone drugs plans, and it reached 

somewhat higher rates in some integrated health plans—

indicating that the degree to which plans are promoting 

the use of generics over brands varies widely, so there may 

be room for plans with low rates of generic utilization to 

increase them.25 (However, the differences in rates of 

generic utilization could also stem from differences in the 

population of enrollees in each plan.)

Comparing Potential Savings from Generic and 

Therapeutic Substitution

CBO’s analysis of claims data from 2007 indicates that 

the potential for additional reductions in prescription 

drug spending is greater with therapeutic substitution 

than with the more straightforward generic substitution—although as noted above, the challenges in achieving those savings may also be greater for therapeutic 

substitution. In that analysis, therapeutic substitution 

resulted in higher savings primarily because the cost of a 

generic prescription was about 70 percent lower than that 

of a single-source brand-name prescription in the same 

therapeutic class (for the classes examined), whereas the 

cost of a generic prescription was only about 20 percent 

lower than the cost of a multiple-source brand-name 

prescription, on average. 

Several factors explain that difference in potential savings. 

First, single-source brand-name drugs are generally newer 

and often represent improvements (real or perceived) over 

multiple-source brand-name drugs that treat the same 

condition, and their patent protection thus allows their 

manufacturers to charge prices that are typically higher 

than those charged for older drugs; that increases the 

potential savings from therapeutic substitution. Furthermore, when multiple-source brand-name drugs were 

dispensed, the prices of their generic counterparts were 

higher than the average price of all generic drugs that had 

Average Price of Single-Source Brand-Name Drugs, Net of Rebatesa 110

Minus: Average Price of Generic Drugs Weighted by the Number of Single-Source Brand Prescriptions 34

Equals: Potential Additional Savings per Prescription 76

Potential Additional Savings per Prescription 76

Multiplied by: Number of Single-Source Brand Prescriptions Filled When a Generic Drug Was Available (Millions) 53

Equals: Total Potential Savingsb (Millions of dollars) 4,028

Savings per Prescription

Total Potential Savingsb

25. Rates of utilization of generic drugs by plan are based on data 

from CMS (see www.cms.hhs.gov/PrescriptionDrugCovGenIn/

06_PerformanceData.asp#TopOfPage).
18 EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

been dispensed, which limits the potential additional 

savings from generic substitution. Moreover, the number 

of prescriptions under Part D that could be switched to a 

generic drug through therapeutic substitution was 

slightly greater than the number that could be switched 

through generic substitution—largely reflecting the 

extensive use of generic substitution that has already 

occurred. An offsetting consideration is that it would be 

medically inappropriate to practice therapeutic substitution in many cases, which is one factor that would reduce 

the actual savings that could be obtained from that 

approach.

Policymakers would face several challenges in developing 

tools to achieve any additional savings from the expanded 

use of generic drugs—particularly in the case of therapeutic substitution. About half of Part D spending is on 

behalf of enrollees who have lower income and thus qualify for additional subsidies. Policies that used financial 

incentives to steer enrollees toward certain drugs might 

not be effective on that population because Medicare 

pays nearly all of their costs. In addition, plans must meet 

certain requirements intended to ensure that enrollees 

have access to the drugs that they need and to prevent the 

plans from discouraging beneficiaries with high drug 

costs from enrolling; those requirements limit plans’ 

ability to steer drug use. Finally, it could be difficult for 

policymakers to design policies so that switches from 

single-source brand-name drugs to generic drugs were 

made only when medically appropriate.

Implications of Future Developments

The estimates of actual savings from generic substitution 

and potential savings from additional generic and 

therapeutic substitution in 2007 provide some insight 

into how much savings could be obtained in the future 

through the increased use of generic drugs. However, 

some changes in the pharmaceutical marketplace have 

already occurred—and many others could occur—that 

might affect actual and potential savings from the 

increased use of generic drugs. In addition, changes 

introduced by the recently enacted health care legislation 

will direct a larger share of any savings that are achieved 

to the Medicare Part D program because the program will 

cover an increasing share of prescription drug spending as 

the coverage gap closes.

Two factors may hold down prescription drug spending 

in the near term. First, payers will benefit from a wave of 

brand-name drugs in high-priced therapeutic classes 

losing patent protection or other periods of exclusivity, 

allowing first-time generic entry. Second, relatively few 

new brand-name drug products are expected to reach the 

market over the next few years. 

A countervailing factor is that analysts expect to see a 

rapid increase in spending under Part D for a particular 

category of drugs called biologics. Those drugs, which are 

derived from living organisms, can be particularly 

expensive. The recently enacted health care legislation 

created a regulatory pathway for approving less expensive 

alternatives to those drugs, but in certain circumstances 

enrollees in Part D may have limited incentives to use 

them and drug plans may have limited incentives to 

encourage their use.

First-Time Generic Entry 

Over the past several years, more brand-name drugs have 

become available in generic form, and the dollar value of 

sales of brand-name drugs that face generic competition 

has increased accordingly. Brand-name drugs with U.S. 

retail sales totaling roughly $21 billion in 2007, representing 11 percent of the U.S. retail market in that year, 

experienced first-time generic entry in 2008 and 2009 

(see Figure 2). Drugs accounting for another $43 billion 

in U.S. retail sales, representing a further 21 percent of 

the U.S. retail market in 2007, will be subject to firsttime generic entry during 2010 through 2012. Within 

Part D, the cost of those drugs was about $20 billion—

equal to 33 percent of total payments to plans and 

pharmacies from the Part D program and its enrollees in 

2007. 

The introduction of more generic drugs increases the 

amount of savings that could be derived under Part D 

from their use. If the patterns of generic use and price differentials observed in 2007 were to continue, then 

93 percent of those brand-name prescriptions would be 

switched to the generic version at a price 74 percent less 

than that of the brand-name versions. Applying those 

percentages to the 2007 data on drug spending yields an 

estimate of about $14 billion in additional savings under 

Part D. That amount represents a 42 percent increase in 

the $33 billion in savings estimated from generic substitution in 2007. 

Because those calculations use 2007 data, they represent 

an estimate of the additional savings that could have
EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING 19

CBO

Figure 2.

U.S. Retail Sales of Brand-Name Drugs Before First-Time Generic Entry

(Billions of dollars)

Source: Congressional Budget Office based on Medco’s Drug Trend Reports from 2002 through 2010. 

Note: For the years from 2002 through 2008, retail sales are reported for the year before generic entry. For the years from 2009 through 

2012, retail sales are reported for 2007.

accrued in 2007 if single-source drugs that will lose 

patent protection by 2012 had been available in generic 

form in 2007. Both of those savings estimates—the 

$14 billion and the $33 billion—would be higher if calculated for future years because of inflation in drug prices 

and the likely growth in the number of Part D enrollees 

and prescriptions filled. Because the price of generic 

drugs relative to the price of brand-name drugs declines 

as more manufacturers of generic drugs enter the market, 

the additional savings from new generic entry would also 

be achieved over time rather than realized immediately.

Those trends in generic drug entry also affect the estimates of how much in additional savings could be 

achieved either through more generic substitution or 

from therapeutic substitution. The calculations above 

assumed that 7 percent of prescriptions would have been 

filled with multiple-source brand-name drugs, even 

though generics were newly available at a price 22 percent 

less than the price of the brand-name drug. If all of those 

prescriptions were instead filled with generic drugs, about 

$300 million in additional savings would be generated 

from generic substitution. That amount (which was also 

calculated using 2007 claims data and relative drug 

prices) represents a 33 percent increase in the $900 million in potential savings from additional generic substitution in 2007. 

A further complication is that some of the brand-name 

drugs experiencing first-time generic entry are in one of 

the seven classes for which CBO calculated savings from 

therapeutic substitution. The single-source drugs that 

will face new generic entry accounted for about $2.5 billion of the $4 billion in potential savings from such substitution estimated for 2007. After that generic entry 

occurs, savings from those drugs would be included in 

CBO’s estimate of savings and potential additional savings from generic substitution, so potential savings from 

therapeutic substitution would be reduced by their contribution. In other words, the $2.5 billion in lost savings 

from therapeutic substitution arises from part of the 

$14 billion in additional savings that CBO estimated to 

stem from new generic substitution. 

Then again, some of the generic entry that is expected 

through 2012 will create new opportunities for substitution in three additional therapeutic classes.26 Although 

the Medicare Prescription Drug Plan Finder identifies 

opportunities for possible therapeutic substitutions in 

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

0

5

10

15

20

25

30

13

6

11

9

17

14

9

12

7

11

25

Actual Projected

Year of Generic Entry

26. Those additional classes are angiotensin II receptor antagonists 

and angiotensin II receptor antagonists/diuretic combinations 

(drugs in those classes treat cardiovascular diseases) and mildly/

nonsedating histamine1 (H1) blocking agents/decongestants 

(drugs in that class treat allergies).
20 EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

those three classes, they were not included in CBO’s calculation of potential savings from therapeutic substitution in 2007 because they currently contain only singlesource drugs. In other words, the generic drugs in those 

classes would be first-in-class generics and create opportunities for the type of therapeutic substitution that CBO 

examined. 

However, the potential savings from therapeutic substitution in those three classes would be small. The potential 

savings associated with entry of those generic drugs was 

estimated as follows. Single-source brand-name drugs 

totaling about $0.3 billion in prescription drug spending 

in 2007 would be candidates for therapeutic substitution. 

If enrollees’ prescriptions for all of those single-source 

brand-name drugs were switched to the new generic 

drugs in their classes at a price about 70 percent less than 

the price of the brand-name drugs, then an additional 

$0.2 billion would be saved through therapeutic substitution. On net, potential savings from therapeutic substitution in 10 therapeutic classes would decline from the 

$4 billion calculated for 2007 to $1.7 billion, or by 

60 percent. Moreover, in many cases, it would be medically inappropriate to practice therapeutic substitution, 

which is one factor that would reduce the actual savings 

that could be obtained.

New Brand-Name Drugs

The rate of introduction of new brand-name drugs is 

another major factor that will affect potential savings 

from generic drugs in the future. The introduction of 

new brand-name drugs can increase the utilization of 

single-source brand-name drugs and decrease savings 

from generic drugs, although the precise effect will 

depend on how big a share of the Part D market the 

new drugs can capture—and whether they shift drug 

utilization from existing therapies or largely establish new 

categories of spending. New drugs that are first in class 

(or breakthrough drugs) and treat a high-prevalence 

condition among Part D enrollees could gain a significant 

share of the Part D market. If enrollees switch from 

generic drugs to those new drugs, the opportunities for 

generic substitution would decline—at least until the 

new single-source drug loses patent protection. Moreover, 

if the new drug is truly superior, then opportunities for 

therapeutic substitution would not arise. Conversely, new 

drugs that enter into a crowded therapeutic class and that 

have little benefit over existing therapies for most people 

or that treat a low-prevalence condition among Part D 

enrollees may not gain much of a share of the Part D 

market and thus may have only a limited impact on projected savings from using generic drugs.

In the near term, first-time generic entry is expected to 

have a bigger impact on potential savings than the introduction of new brand-name drugs because the sales of 

new brand-name drugs are expected to be smaller than 

the sales of existing brands experiencing first-time generic 

entry.

Biologics

Spending under Part D on the category of drugs called 

biologics is expected to increase rapidly in the future. 

Those drugs can be particularly expensive, with prices 

reaching tens of thousands of dollars per patient each 

year. Because most biologics are injected or infused 

directly into the patient, they are more likely to be covered under Part B of Medicare. Consequently, biologics 

accounted for only about 6 percent of total prescription 

drug costs under Part D in 2007.27 Between 2006 and 

2007, however, spending on biologics under Part D grew 

by about 36 percent, whereas total Part D spending grew 

by 22 percent, according to the Medicare Payment Advisory Commission.28 A higher rate of growth for Part D 

spending on biologics is expected to persist because of the 

continuing rapid increase in the price of biologics (compared with the prices of traditional drugs), greater use of 

existing biologics, and the large number of biologics 

under development.29

Provisions of the recently enacted health care legislation 

will partially mitigate that spending increase by creating a 

regulatory pathway for licensing products that are 

“biosimilar” to brand-name biologics. Unlike generic 

drugs, which contain the same active chemical ingredient 

as the original patented drug contains, biosimilars are 

similar to—but not exact copies of—much more complex molecules.

Potential savings in Part D from biosimilar drugs may be 

limited, however, for several reasons. In certain circum27. Medicare Payment Advisory Commission, Report to the Congress: 

Improving Incentives in the Medicare Program (June 2009), 

pp. 120–124.

28. Ibid., p. 120.

29. Congressional Research Service, Follow-On Biologics: Intellectual 

Property and Innovation Issues, CRS Report for Congress RL33901 

(January 6, 2010).
EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING 21

CBO

stances, enrollees and plans in Part D may have reduced 

incentives to use biosimilars. The process of designing 

and manufacturing biosimilars is complex and more 

costly than it is for traditional generic drugs, so the price 

discounts for biosimilars will not be as high in percentage 

terms as those for traditional generic drugs.30 Specifically, 

CBO estimated that prices for biosimilars would ultimately be about 40 percent lower than prices of the 

original drugs—although the higher average prices for 

biologic products mean that the dollar differences in 

prices could still be quite large. The ability of plans to 

steer utilization toward biosimilars will also play an 

important role in determining the extent to which savings are realized under Part D. One potential constraint 

to that ability is that enrollees with low-income subsidies 

make up a disproportionately large share of the market 

for biologics under Part D. Because that group has nominal cost sharing, plans would probably need to use tools 

other than cost sharing (such as step therapy and prior 

authorization) to steer use toward biosimilars.

Another important issue is whether biosimilars will be 

treated in the same manner as generic drugs under Part D 

as the coverage gap is filled in. In particular, CMS has not 

yet issued guidance on how biosimilars will be classified 

for purposes of coverage determination in the range of 

spending that (under prior law) represented the coverage 

gap. If biosimilars are classified in the same category as 

generic drugs, enrollees without low-income subsidies 

and their plans may have incentives to purchase brandname biologics over biosimilars. Because plans would pay 

a higher share of the cost of biosimilars than of brandname biologics in that range of spending on behalf of 

enrollees without low-income subsidies (see Table 1), 

plans would probably pay more for biosimilars than for 

brand-name biologics. The discount provided by manufacturers of brand-name biologics will not only reduce 

costs to plans and enrollees but will also be counted 

toward the amount of spending required to reach the catastrophic threshold (at which point coverage is borne 

mostly by the Part D program), whereas no discount 

would be required of the manufacturer of the biosimilar. 

Only about 2 percent of enrollees without low-income 

subsidies reached that threshold in 2007, however, so that 

incentive will probably have a limited impact on total 

prescription drug spending under Part D.31

30. Congressional Budget Office, Budget Options, Volume I: Health 

Care (December 2008), pp. 126–128; and cost estimate for 

S. 1695, Biologics Price Competition and Innovation Act of 2007

(June 25, 2008).

31. For the percentage of enrollees with spending that reached the 

coverage gap, see Medicare Payment Advisory Commission, 

Report to the Congress: Medicare Payment Policy (March 2010), 

p. 289.

CBO

Appendix: 

Description of 

Data Used in This Analysis

This Congressional Budget Office (CBO) analysis of 

prescription drug spending is based on Medicare Part D 

Prescription Drug Event claims data for calendar year 

2007.1

 Plans submit the claims data to the Centers for 

Medicare and Medicaid Services (CMS), which uses it to 

calculate a portion of Medicare’s payments to plans. Each 

record in the data indicates a filled prescription and 

includes information about the enrollee, plan, pharmacy, 

and drug product dispensed. For this analysis, the main 

elements of interest are the product dispensed (identified 

by its national drug code number), days supplied, prices 

of the ingredients, dispensing fee paid to the pharmacy, 

and sales tax. 

The claims data for 2007 include about 1 billion records, 

or prescriptions filled. The total cost for those prescriptions was $62.2 billion (including the prices for the ingredients, the dispensing fee, and the sales tax). For this 

analysis, CBO used a 1 percent sample of the claims data. 

The sample was constructed by first selecting a random 

sample of 1 percent of Part D enrollees and then selecting 

all the records on filled prescriptions for 2007 for those 

enrollees. CBO matched brand-name drugs with their 

chemically equivalent generic drugs in the sample using 

Thomson Micromedex’s Red Book database. That database contains a code to identify drugs with common 

active ingredients, master dosage form, strength, and 

route of administration. It also contains information on 

list prices and other descriptive details on prescription 

and over-the-counter drugs. Using the additional information from the Red Book database, CBO was able to 

categorize the drugs as generic, multiple-source brand 

(brands with generic versions available), or single-source 

brand (brands without generic versions available).

The data do not include information on rebates from 

drug manufacturers. But according to the 2010 report of 

the Board of Trustees for the Medicare program, rebates 

for 2007 were approximately 9.6 percent of total prescription drug costs.2

 Applying that factor to total 

recorded cost produces an estimate of $56.2 billion for 

the total prescription drug cost net of rebates in 2007.

Total payments to plans and pharmacies by the Part D 

program and its enrollees ($59.8 billion) exceeded the 

total prescription drug cost net of rebates ($56.2 billion) 

by $3.6 billion in 2007. That difference in part reflects 

administrative expenses and profits of plans (including 

the costs of managing the drug benefit, which plans may 

do themselves or contract out to pharmacy benefit managers). However, that difference also reflects losses that 

plans incur on supplemental benefits that are offset by 

payments under other Medicare accounts.3

 The Medicare 

Board of Trustees estimates that actual administrative 

expenses and profits were about $4.3 billion in 2007 or 

roughly 13.5 percent of plans’ benefit payments, which 

1. The claims data do not include prescription drug spending under 

plans that receive drug subsidies for retirees. In 2007, those subsidies totaled about $4 billion.

2. Medicare Board of Trustees, 2010 Annual Report of the Boards of 

Trustees of the Federal Hospital Insurance and Federal Supplementary 

Medical Insurance Trust Funds (August 5, 2010), p. 185.

3. Some private plans provide Medicare Part D benefits that are integrated with other health care benefits (such as inpatient hospital 

stays and doctors’ visits) traditionally provided under Parts A and 

B of Medicare. Those plans, called Medicare Advantage plans, are 

permitted to reduce premiums for prescription drug benefits and 

offer supplemental benefits using savings on Medicare payments 

for providing services under Parts A and B.
24 EFFECTS OF USING GENERIC DRUGS ON MEDICARE’S PRESCRIPTION DRUG SPENDING

CBO

totaled about $32.4 billion.4

 Profits and administrative 

expenses as a percentage of plans’ benefit payments are 

expected to decline slowly through 2019 because 

increases in prescription drug spending under Part D are 

estimated to be larger than increases in employee wages 

and the other input costs that affect plans’ administrative 

expenses.5 4. Plans’ benefit payments are for the standard benefit only. They 

include the Medicare Part D Program Payment for the standard 

benefit ($26.1 billion), enrollees’ premiums for the standard 

benefit ($4.0 billion), and low-income subsidies for premiums 

($2.3 billion). They do not include payments for supplemental 

benefits and low-income subsidies for cost sharing (deductibles, 

coinsurance, and copayments).

5. See Medicare Board of Trustees, 2010 Annual Report, p. 185, for 

projections of plans’ administrative expenses and profits.