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89–405 2003

EXPANDING COVERAGE OF PRESCRIPTION DRUGS

IN MEDICARE

HEARING

BEFORE THE

COMMITTEE ON WAYS AND MEANS 

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

APRIL 9, 2003

Serial No. 108–7

Printed for the use of the Committee on Ways and Means

(

ii

COMMITTEE ON WAYS AND MEANS

BILL THOMAS, California, Chairman

PHILIP M. CRANE, Illinois 

E. CLAY SHAW, JR., Florida 

NANCY L. JOHNSON, Connecticut 

AMO HOUGHTON, New York 

WALLY HERGER, California 

JIM MCCRERY, Louisiana 

DAVE CAMP, Michigan 

JIM RAMSTAD, Minnesota 

JIM NUSSLE, Iowa 

SAM JOHNSON, Texas 

JENNIFER DUNN, Washington 

MAC COLLINS, Georgia 

ROB PORTMAN, Ohio 

PHIL ENGLISH, Pennsylvania 

J.D. HAYWORTH, Arizona 

JERRY WELLER, Illinois 

KENNY C. HULSHOF, Missouri 

SCOTT MCINNIS, Colorado 

RON LEWIS, Kentucky 

MARK FOLEY, Florida 

KEVIN BRADY, Texas 

PAUL RYAN, Wisconsin 

ERIC CANTOR, Virginia 

CHARLES B. RANGEL, New York 

FORTNEY PETE STARK, California 

ROBERT T. MATSUI, California 

SANDER M. LEVIN, Michigan 

BENJAMIN L. CARDIN, Maryland 

JIM MCDERMOTT, Washington 

GERALD D. KLECZKA, Wisconsin 

JOHN LEWIS, Georgia 

RICHARD E. NEAL, Massachusetts 

MICHAEL R. MCNULTY, New York 

WILLIAM J. JEFFERSON, Louisiana 

JOHN S. TANNER, Tennessee 

XAVIER BECERRA, California 

LLOYD DOGGETT, Texas 

EARL POMEROY, North Dakota 

MAX SANDLIN, Texas 

STEPHANIE TUBBS JONES, Ohio 

ALLISON H. GILES, Chief of Staff 

JANICE MAYS, Minority Chief Counsel

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records 

of the Committee on Ways and Means are also published in electronic form. The printed 

hearing record remains the official version. Because electronic submissions are used to 

prepare both printed and electronic versions of the hearing record, the process of converting 

between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process 

is further refined. 

iii

C O N T E N T S 

Page 

Advisories announcing the hearing ........................................................................ 2

WITNESSES 

Congressional Budget Office, Douglas Holtz-Eakin, Ph.D., Director .................. 9

U.S. General Accounting Office, Hon. David M. Walker, Comptroller General . 21

Pauly, Mark V., University of Pennsylvania ......................................................... 82

Reinhardt, Uwe E., Princeton University .............................................................. 88

Stuart, Bruce, University of Maryland School of Pharmacy ................................ 78

SUBMISSIONS FOR THE RECORD 

American Academy of Actuaries, Cori E. Uccello and John M. Bertko, statement ...................................................................................................................... 110

American Health Quality Association, David G. Shulke, statement ................... 115

Long Term Care Pharmacy Alliance, John F. Jonas, letter ................................. 118

National Association of Chain Drug Stores, Alexandria, VA, statement ............ 119

(1)

EXPANDING COVERAGE OF PRESCRIPTION 

DRUGS IN MEDICARE 

WEDNESDAY, APRIL 9, 2003

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON WAYS AND MEANS, 

Washington, DC.

The Committee met, pursuant to notice, at 11:10 a.m., in room 

1100 Longworth House Office Building, Hon. Bill Thomas (Chairman of the Committee) presiding. 

[The advisory and revised advisory announcing the hearing follow:]

2

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

FOR IMMEDIATE RELEASE CONTACT: (202) 225–1721

April 2, 2003

No. FC–7

Thomas Announces Hearing on Expanding

Coverage of Prescription Drugs in Medicare

Congressman Bill Thomas (R–CA), Chairman of the Committee on Ways and 

Means, today announced that the Committee will hold a hearing on modernizing 

Medicare and integrating prescription drugs into the program. The hearing will 

take place on Wednesday, April 9, 2003, in the main Committee hearing 

room, 1100 Longworth House Office Building, beginning at 10:30 a.m.

In view of the limited time available to hear witnesses, oral testimony at this 

hearing will be from invited witnesses only. Invited witnesses will include Dr. Douglas Holtz-Eakin, Director, Congressional Budget Office, and academics with extensive knowledge of prescription drugs and the Medicare program. Also, any individual or organization not scheduled for an oral appearance may submit a written 

statement for consideration by the Committee or for inclusion in the printed record 

of the hearing. 

BACKGROUND: 

When Medicare was enacted in 1965, most health insurers did not cover prescription drugs. Since that time, most private health plans have fully integrated prescription drug coverage yet Medicare still does not cover most outpatient prescription drugs. Prescription drugs are now as important to health care as hospitals and 

physician services were 38 years ago. 

Seniors are more likely to be faced with high out-of-pocket prescription drug costs 

than other individuals. While seniors comprise approximately 12 percent of the population, they consume nearly 40 percent of all prescription drugs. Yet nearly onethird of Medicare beneficiaries do not have some type of prescription drug coverage, 

and those without coverage often pay the highest prices for their medications. Further, many employers through their company retirement benefit plans are paring 

back or dropping prescription drug coverage as costs continue to dramatically escalate. Medigap plans with drug coverage are becoming increasingly unaffordable. Prescription drug costs are rising annually at double-digit rates. This causes seniors 

without coverage to often forgo necessary prescriptions, while jeopardizing current 

prescription drug coverage. 

At the same time, Medicare’s current costs are dramatically rising. For example, 

according to the Center for Medicare and Medicaid Services’ Office of the Actuary, 

hospital costs were up by 10 percent last year. Likewise, skilled nursing home expenditures rose by 9 percent, home health spending increased by 14 percent, durable medical equipment spending increased by 20 percent, and hospice expenditures 

rose by 24 percent. These increased expenditures are partially borne by beneficiaries, whose Part B premiums are projected to rise by 12.4 percent next year. 

Escalating Medicare spending in all areas means a new Medicare prescription 

benefit must be carefully designed to be affordable to both beneficiaries and taxpayers. In fact, all aspects of the program must be examined to discern where inefficiencies exist and changes need to be made. 

In the last Congress, the House passed a Medicare prescription drug bill (H.R. 

4954), but the Senate failed to act on the legislation. The President included $400 

billion over 10 years in the fiscal year 2004 budget. The House and Senate passed 

3

resolutions to include the same amount for prescription drugs, Medicare modernization, and appropriate adjustments to provider payments. 

In announcing the hearing, Chairman Thomas stated, ‘‘The House passed Medicare modernization and prescription drug legislation in the 106th and 107th Congresses. It is clear that this Congress must make law.’’

FOCUS OF THE HEARING: 

This hearing will focus on issues related to an outpatient prescription drug benefit 

for Medicare beneficiaries. 

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS: 

Please Note: Due to the change in House mail policy, any person or organization 

wishing to submit a written statement for the printed record of the hearing should 

send it electronically to hearingclerks.waysandmeans@mail.house.gov, along with a 

fax copy to (202) 225–2610, by the close of business, Wednesday, April 23, 2003. 

Those filing written statements that wish to have their statements distributed to 

the press and interested public at the hearing should deliver their 200 copies to the 

full Committee in room 1102 Longworth House Office Building, in an open and 

searchable package 48 hours before the hearing. The U.S. Capitol Police will refuse 

sealed-packaged deliveries to all House Office Buildings. 

FORMATTING REQUIREMENTS: 

Each statement presented for printing to the Committee by a witness, any written statement 

or exhibit submitted for the printed record or any written comments in response to a request 

for written comments must conform to the guidelines listed below. Any statement or exhibit not 

in compliance with these guidelines will not be printed, but will be maintained in the Committee 

files for review and use by the Committee. 

1. Due to the change in House mail policy, all statements and any accompanying exhibits for 

printing must be submitted electronically to hearingclerks.waysandmeans@mail.house.gov, along 

with a fax copy to (202) 225–2610, in Word Perfect or MS Word format and MUST NOT exceed 

a total of 10 pages including attachments. Witnesses are advised that the Committee will rely 

on electronic submissions for printing the official hearing record. 

2. Copies of whole documents submitted as exhibit material will not be accepted for printing. 

Instead, exhibit material should be referenced and quoted or paraphrased. All exhibit material 

not meeting these specifications will be maintained in the Committee files for review and use 

by the Committee. 

3. Any statements must include a list of all clients, persons, or organizations on whose behalf 

the witness appears. A supplemental sheet must accompany each statement listing the name, 

company, address, telephone and fax numbers of each witness. 

Note: All Committee advisories and news releases are available on the World 

Wide Web at http://waysandmeans.house.gov. 

The Committee seeks to make its facilities accessible to persons with disabilities. 

If you are in need of special accommodations, please call 202–225–1721 or 202–226–

3411 TTD/TTY in advance of the event (four business days notice is requested). 

Questions with regard to special accommodation needs in general (including availability of Committee materials in alternative formats) may be directed to the Committee as noted above.

f

4

* * * NOTICE—CHANGE IN TIME * * *

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

FOR IMMEDIATE RELEASE CONTACT: (202) 225–3943

April 4, 2003

No. FC–7–REV

Change in Time for Hearing on Expanding

Coverage of Prescription Drugs in Medicare

Congressman Bill Thomas (R–CA), Chairman, Committee on Ways and Means, 

today announced that the Committee hearing on modernizing Medicare and integrating prescription drugs into the program scheduled for Wednesday, April 9, 2003, 

at 10:30 a.m., in the main Committee hearing room, 1100 Longworth House Office 

Building, will now be held at 11:00 a.m.

All other details for the hearing remain the same. (See full Committee Advisory

No.

important hearings the full Committee will have as we consider 

Chairman THOMAS. The Chair considers this one of the more 

FC–7 dated April 2, 2003.)

f how to modernize Medicare and, obviously, the importance of Medicare and the improvements it has made in millions of seniors’ lives, 

especially as we notice that seniors are living longer and actually 

healthier lives than any generation in history. Although one of the 

reasons we are holding the hearing is because we think Medicare 

can do better. It really isn’t 21st century-ready; it isn’t even the 

last quarter of the 20th century-ready, because it doesn’t provide 

a meaningful prescription drug coverage to seniors, who, coincidentally, are the largest group of consumers of the pharmaceuticals. In 

modern health care, prescription drugs are often the health care solution of choice. They prevent, treat, or manage diseases more effectively and less invasively than hospitals. 

However, as we all know, Medicare provides extremely limited 

coverage for what are today vital medicines. That means the typical senior will spend about $1,450 out of pocket on prescription 

drugs this year. Unfortunately, notwithstanding that amount, seniors often pay the highest price because about a third of the seniors 

have no prescription drug coverage. However, as we all know, 

Medicare provides extremely limited coverage for what are today 

vital medicines. That means the typical senior will spend about 

$1,450 out of pocket on prescription drugs this year. Unfortunately, 

notwithstanding that amount, seniors often pay the highest price 

because about a third of the seniors have no prescription drug coverage. 

Clearly something has to be done. Change cannot occur in a vacuum. You have to consider the context. This March, the Medicare 

trustees issued their annual report, which said that Medicare will 

start running deficits in about 10 years, and will go broke in 2026. 

This is complicated by the Congressional Budget Office’s (CBO) 

5

projection that annual spending on Medicare will more than double 

over the next 10 years, while spending on prescription drugs will 

triple. 

Analysis by the Centers for Medicare & Medicaid Services (CMS) 

Actuary also shows that Medicare spending last year spiked. Hospital spending was up 10 percent; home health up 14 percent; 

skilled nursing facilities up 9 percent; durable medical equipment 

up 20 percent. All of these increases occurred with the backdrop of 

inflation at about 2.4 percent. 

Integrating a prescription drug benefit to Medicare will clearly 

improve seniors’ health and is long overdue. Hopefully, it can also 

reduce what would otherwise be Medicare’s cost over time because 

we can substitute drugs as a more effective and less expensive alternative than some other treatment options. Also hopefully, we 

can integrate drugs around a disease management program that 

would provide a more comprehensive package for seniors when 

they are on multiple drugs, which is becoming more the pattern 

than not. 

Steps must be taken when crafting the prescription drug benefit 

into other changes to ensure the sustainability of Medicare over the 

long haul. To simply take current Medicare and add prescription 

drugs is not the solution. The Medicare Payment Advisory Commission (MEDPAC), the non-partisan panel of experts that advise this 

Congress, has made a number of recommendations which would 

slow the growth of Medicare and which this Committee will examine very carefully. 

History, and especially recent history, shows that we can deliver. 

In the last two Congresses, this Committee has produced, and the 

House has approved, legislation to modernize Medicare. As we 

know, those bills did not become law. They did not become law 

with a Democratic Senate and they did not become law with a Republican Senate. This year, the President has indicated he is willing to provide an additional $400 billion over 10 years to improve 

Medicare. The House and the Senate has passed a budget agreeing 

that that money would be utilized for Medicare. 

We should not squander this opportunity to deliver prescription 

drugs for seniors while improving and strengthening Medicare for 

future generations. Shortly we will hear from the Director of the 

Congressional Budget Office, Dr. Douglas Holtz-Eakin, who I believe is in his first appearance in front of the Committee on Ways 

and Means, and David Walter, the Comptroller General of the General Accounting Office, who has been before us previously and who 

plays a significant role both in producing documents that assist us 

in making decisions and in making sure that those institutions 

which advise us are professionally structured and maintained. 

Prior to doing that, I will recognize the Ranking Member from 

New York, Mr. Rangel, for any comments he would like to make. 

[The opening statement of Chairman Thomas follows:]

Opening Statement of The Honorable Bill Thomas, Chairman, and a 

Representative in Congress from the State of California 

As the Committee considers how to modernize Medicare, it’s worth noting that 

since its inception Medicare has improved the lives of millions of our nation’s seniors. Today, our seniors are living longer and healthier lives than any generation 

in history. 

6

But we can do better. Medicare is not 21st century-ready. It does not provide prescription drug coverage to seniors—the largest consumers of pharmaceuticals. 

In modern health care, prescription drugs are often the health care solution of 

choice. They prevent, treat or manage diseases more effectively and less invasively 

than hospitals. 

However, Medicare provides extremely limited coverage for what are today vital medicines. That means the typical senior will spend about $1,450 out of pocket on 

prescription drugs this year. And unfortunately seniors often pay the highest prices 

because more than one-third of seniors have no prescription drug coverage. 

But change can’t occur in a vacuum; we must first consider the context. This 

March, the Medicare Trustees issued their annual report which said that Medicare 

will start running deficits in about ten years and will go broke in 2026. This is complicated by the Congressional Budget Office’s projection that annual spending on 

Medicare will more than double over the next ten years, while spending on prescription drugs will triple. 

Analysis by the Centers for Medicare and Medicaid Services Actuary also shows 

that Medicare spending last year spiked: hospital spending was up ten percent, 

home health up 14 percent, skilled nursing facilities up nine percent and durable 

medical equipment up 20 percent. And all of these increases occurred with a backdrop of inflation around 2.4 percent. 

Integrating a prescription drug benefit to Medicare will clearly improve seniors’ 

health and is long overdue. Hopefully it can also help reduce Medicare’s costs over 

time because we can substitute drugs as a more effective and less expensive alternative to other treatment options. Integrating prescription drugs around disease 

management is important for seniors when they take multiple prescription drugs, 

which is happening more and more. 

Steps must be taken when crafting the prescription benefit and other changes to 

ensure the sustainability of Medicare over the long haul. To take the current Medicare system and simply add on prescription drugs is not a solution. The Medicare 

Payment Advisory Commission, the non-partisan panel of experts that advises Congress, has made a number of recommendations to slow the growth of Medicare, 

which this Committee will examine very carefully. 

History shows we can deliver. In the last two Congresses, this Committee has produced and the House has approved legislation to modernize Medicare. As we know, 

those bills did not become law. This year, the President recommended an additional 

$400 billion over ten years to improve Medicare. The House and Senate have passed 

budget resolutions providing for these resources. We should not squander this opportunity to deliver prescription drugs for seniors while improving and strengthening Medicare for future generations.

bringing the Committee together on this most important subject 

Mr. RANGEL. Thank you, Mr. Chairman, and thank you for 

f matter. It has been almost a year since when we last visited it. I 

agree with you that this serious national issue demands and 

screams for some type of relief and solution, and everybody who 

campaigned, campaigned that they would do that. I do hope that 

you would agree, however, that this matter, there is no Democrat 

or Republican or presidential solution, that we should be working 

together. I understand that we have not been doing that. We have 

no bill, we have no direction. 

We welcome a hearing from the witnesses, and I would like to 

yield to the Ranking Member on the Subcommittee on Health so 

that he can share with us what progress has been made by the 

Committee on this important subject. Mr. Stark. 

Mr. STARK. Well, thank you, Mr. Rangel. 

Mr. Chairman, thank you for holding this hearing. I notice from 

the comments today in the Congress Daily, that this hearing is to 

be the launch pad for getting started on a Medicare prescription 

drug benefit, that your approach will be comprehensive, dealing 

with Medicare as a whole and not just as a prescription drug benefit. I am hopeful that this morning we will hear more about what 

7

you really mean. The answer to that question outlines, I think, the 

entire debate. 

Are we going to move ahead to add a prescription drug benefit 

in Medicare in order to improve the Medicare program for seniors 

and people with disabilities, or will we use the allure of a prescription drug benefit as a tool to achieve fundamental restructuring—

I would call it dismantling—of the Medicare program? Will the addition of long-overdue drug benefits come at the cost of ending 

Medicare as we know it, as an entitlement program that guarantees all seniors and people with disabilities access to the same set 

of benefits for the same costs? These are the questions that need 

to be answered. 

I note that this hearing has no witness from the Administration. 

I would comment that the Energy and Commerce hearing yesterday, another hearing today, and a Joint Economic Committee hearing scheduled for tomorrow—no Administration witnesses. Now, I 

don’t know if that is because they have refused to come, or they 

have not been invited. It leaves us all wondering what direction 

you plan to go, Mr. Chairman, with the Medicare prescription drug 

benefit. Are you going to proceed with a plan that is similar to that 

passed last year in the House, or will you take into account the policy the President has put forth? I think the American public, and 

especially America’s seniors, would like to see that answered. Certainly, we on our side of the aisle would be better able to proceed 

in a bipartisan manner if we had some indication of what you had 

in mind. 

Finally, I hope this is not the only hearing that we have prior 

to moving a Medicare bill through our Committee onto the House 

floor. Having a bill completed, as I know you want to, by the end 

of May is an ambitious agenda when the American public has 

never seen or been able to have any input in what you may plan 

to do. This is a program that covers 40 million lives and will cover 

many more than that before long. Change to this needs to be made 

in the open, and the seniors need to know what your plan will really mean for them. 

So, once your plan is announced, I hope we will have more hearings that will allow representatives of the seniors organizations 

and others affected by the changes to come before our Committee 

and provide their counsel to this major change. 

I look forward to hearing from the witnesses today and want to 

especially welcome Professor Uwe Reinhardt, who has come to 

share with us a bit of wisdom with regard to the Medicare reform. 

I thank the Chair again. 

Chairman THOMAS. Thank the gentlemen. The Ranking Member of the Subcommittee on Health posed a number of questions, 

and to make sure that people don’t think they were rhetorical, the 

Chair will respond briefly prior to recognizing the first panel. 

The Ranking Member from New York indicated that all Members 

had taken a position on this issue during campaigns—therefore setting a clear political tone—but then indicated there were Democrat 

or Republican solutions. The Chair finds it interesting, then, that 

the Ranking Member of the Subcommittee, from California, indicated that before they could proceed in a bipartisan manner, they 

8

needed the majority to commit to a partisan position so they could 

therefore react in a bipartisan way. 

I tell the gentlemen that, just as in the last two Congresses, the 

plan that passes this Committee and will pass the House will be 

a Medicare plan under Medicare. The attempt to characterize the 

plans that have been passed as not under Medicare may in fact revert back to that campaign position that the gentleman from New 

York referred to. No plan has been offered and no plan has passed 

that does not come under Medicare. It is not outside of Medicare, 

it isn’t a privatization; it is a Medicare program. 

The reason we are holding a hearing is to try to ask basic questions, not to flak for any particular plan on either side of this dais. 

It is to inquire about the best estimate of cost of proposals that 

have been presented in the past, as a guide to helping us make decisions in the future. I think the panel will provide us with some 

basic understandings, so that as we begin to examine bills we have 

more of a common knowledge base in which to address the options 

that might be presented to us. The Chair believes that is the best 

way to pursue a program that has the best chance of not bankrupting Medicare, but providing prescription drugs for seniors. 

With that, the Chair is once again pleased to recognize Dr. HoltzEakin, who is the new head of Congressional Budget Office, been 

in place for just a few months. I am sure that you have already 

fully appreciated the stress and cross-purposes for which that position was delightfully created. I am always amazed that people with 

brilliant academic backgrounds and successful work experience say 

yes to putting themselves in the kind of position that the Director 

of the Congressional Budget Office finds himself shortly after saying yes. 

Also, to David Walker, who has a very difficult job in which 

Members ask the General Accounting Office to produce any number of documents, which are done in a timely fashion and in a 

scholarly way. If they don’t conform to preconceived notions of what 

the report should have been, they aren’t given the credence they 

should be. I have been pleased to say that, notwithstanding where 

the outcome of the research might fall, that the research itself has 

been impeccable. For that, I do want to compliment Mr. Walker. 

He, for this Committee, performs another service, and that is tends 

to oversee, as the landlord, the MEDPAC Commission, which is 

critical to assisting us in evaluating what is going on in the medical world so that we can make very difficult decisions across the 

broad spectrum of providers. 

With that——

Mr. RANGEL. Mr. Chairman, would you yield——

Chairman THOMAS. Certainly. 

Mr. RANGEL. For purposes of allowing me to join in welcoming 

our new Director. He brings a lot of credibility and prestige to this 

most important job. We look forward to working with you in a bipartisan way. Of course, I have always been a great supporter of 

U.S. General Accounting Office (GAO) and the great work that you 

do for the Congress and the country. We look forward to working 

with you. Thank you, Mr. Chairman. 

Chairman THOMAS. Thank the gentleman very much for his 

comments. 

9

Any written presentation you may have, gentlemen, will be made 

a part of the record, and you can address us in any way that you 

see fit in the time that you have available to you. These microphones are fifties era. The Chair hopes we will remodel this room 

soon. It has great ambiance, but we also need decent acoustics. So, 

if you will address directly into the mike, Members and the audience will have a chance to hear you. Dr. Holtz-Eakin. 

[The opening statement of Mr. Ramstad follows:]

Opening Statement of The Honorable Jim Ramstad, a Representative in 

Congress from the State of Minnesota 

Mr. Chairman, thank you for calling this important hearing on the critical issue 

of providing America’s seniors with prescription drug coverage and Medicare’s fiscal 

challenges. 

As founder and co-chair of the House Medical Technology Caucus, I appreciate the 

incredible advances that medical technology and pharmaceuticals have made in recent years to treat and cure debilitating conditions. These advances are truly 

breathtaking and will become more and more prevalent as medical science continues 

to advance. 

Unfortunately, the Medicare system penalizes seniors by incorporating these advances too late, if at all. 

Congress needs to comprehensively reform Medicare to modernize the program 

and expand access to critical new technologies and drugs. By acting this year, we 

can improve health, save lives and save the system money. 

The question is how to maintain the standard of care enjoyed by America’s seniors, improve the system and meet the incredible demographic challenges facing us. 

This is not a simple task, and a prescription drug benefit will place new pressure 

on Medicare as our nation’s senior population grows. With the President and Congress committing to invest $400 billion over the next 

ten years on Medicare reform and a prescription drug benefit, the time to act is 

now. Our seniors have waited too long. 

At the same time, we must ensure the long-term stability of the Medicare system 

so that it is vibrant for both current and future beneficiaries. To that end, we must 

examine the fiscal implications of our actions, and examine ways to prevent wasteful spending while ensuring the highest quality of care for our seniors. 

Thank you again, Mr. Chairman, for holding this important hearing.

STATEMENT OF DOUGLAS HOLTZ-EAKIN, PH.D., DIRECTOR, 

CONGRESSIONAL BUDGET OFFICE 

f Dr. HOLTZ-EAKIN. Well, thank you, Mr. Chairman, thank you, 

Mr. Rangel, both, for the chance to be here and for the gracious 

welcome. I really do appreciate it and look forward to working with 

you. 

You have my written testimony. Let me take my time and pull 

out what I think are key facts that may be of some use to the Committee in thinking about the issues that face us today. 

One message that I hope comes through clearly is that the entitlement programs of Medicare, Medicaid, and Social Security, as 

currently structured, are on a trajectory to overwhelm the Federal 

budget. Currently, these three programs constitute 8 percent of 

gross domestic product (GDP). By the year 2030, they will rise to 

14 percent of GDP—a bit under the size of the Federal budget at 

the moment; and by the year 2075, they will rise to fully 21 percent 

of GDP, a share larger than that of the Federal budget. 

Medicare is the largest part of that rise. The chart that we have 

pulled out of the testimony to display shows this rapid rise in 

Medicare as a fraction of GDP from 2.4 percent today to about 9.2 

percent in 2075. As you can see on the chart, that rise comes in 

10

two different components. The first is a component that just is due 

to the aging-of-the-population phenomenon, with which you are 

quite familiar. That is a smaller component, about 30 percent of 

the overall increase. The larger component comes from the rapid 

rise in health care costs above the growth in GDP. That excess cost 

growth is not unique to Medicare, but is at the source of the large 

run-up in this entitlement program as a fraction of GDP. 

Now, if we turn to cost growth in Medicare per se, CBO projects 

that over the next 10 years in the budget window, Medicare will 

continue to grow faster than GDP, at about 6.8 percent per year. 

As we detailed in the testimony, there are limited direct tools at 

the Congress’ disposal to control that growth. It is a phenomenon 

that exists not only in Medicare, but in the health care area as a 

whole. 

Now, for the purpose of this hearing, an interesting piece of information is the growth in prescription drug spending. On that 

front, there is both good news and bad news. CBO’s baseline projections for prescription drug spending by the Medicare population indicate that the good news is that spending in the baseline is up by 

only 4 percent from last year. Typically, one might expect a larger 

increase in baseline spending. The 4-percent increase comes from 

the net effect of dropping a relatively inexpensive year at the beginning of the budget window and adding a relatively expensive 

year at the end of the budget window—that is the typical story. 

This year, we also learned, after looking into the research, that we 

had less underreporting of prescription drug spending than had 

previously been thought and slower growth in prescription drug 

prices than had been anticipated. 

The net effect of that is a modest increase in our baseline estimates of prescription drug spending by this population, making it 

easier to compare cost proposals. Although they won’t all be 4 percent higher—it depends on the details of the proposals—it does 

make year-to-year comparisons a bit easier, perhaps, than in the 

past. 

Now, the bad news is that prescription drug spending continues 

to rise faster even than overall Medicare spending itself. We project 

that over the 10-year budget horizon, it will rise by 9 percent per 

year, for a total of $1.8 trillion. 

The final piece that I would like to pull out of the testimony is 

the composition of some of that prescription drug spending. For 

purposes of this hearing, we put together three charts, the first of 

which shows who is covered by drug coverage at the moment and 

who is not. If you look at the chart, what the bars show you are 

the coverage for different income levels, each measured as a fraction of the poverty level, so the first bar is from 0 to 100 percent 

of the Federal poverty level and the others rise to 400 percent of 

the poverty level or more. Shown in the chart are lighter gray 

areas, which are the fraction of beneficiaries in each income area 

who do not have drug coverage, and darker gray shading, for those 

who do have drug coverage. Roughly speaking, the population as a 

whole has about a 25 percent share, in our estimate, that does not 

have prescription drug coverage, and the share does not vary much 

by income class—from 22 percent to 32 percent. 

11

If we turn from who has coverage to how much individuals are 

spending, we get roughly the same story. The second chart looks 

at average prescription drug spending by Medicare beneficiaries. 

The bottom lighter gray area shows how much is paid out of pocket—about three-eighths is paid out of pocket—and that share does 

not vary much by income. The top darker gray part shows the 

share paid by third parties, including other Federal programs. The 

average spending is about $1,500. 

If you put those two pieces together, coverage and average spending by individuals, we can show the total spending, in the final 

chart, for the Medicare population. Here, again, we can find total 

drug spending by income class, with the lighter gray area showing 

the fraction that is actually paid out of pocket—and that turns out 

to be roughly the three-eighths I mentioned before—and the darker 

gray area, which has been covered by third parties already. The 

basic message, again, in this chart is that there is not much difference across income levels in the degree to which these costs 

come from out of pocket. 

So, I close with these pieces of information, which we think will 

be useful in framing the important issues that this Committee will 

face. I look forward to answering your questions. 

[The prepared statement of Dr. Holtz-Eakin follows:]

Statement of Douglas Holtz-Eakin, Ph.D., Director,

Congressional Budget Office 

Chairman Thomas, Congressman Rangel, and Members of the Committee, I am 

pleased to be here with you today. I understand that the focus of this hearing is 

on expanding Medicare’s coverage of prescription drugs, and I am prepared to discuss that topic in some detail. But I would first like to frame that discussion by 

looking at Medicare’s overall financial picture, both in the near term and the long 

run. As this Committee well knows, Medicare is projected to consume an ever-larger 

piece of our national income just in delivering its current set of benefits. In determining whether and how to add prescription drug coverage to its benefit package—

and the desirability of adopting other reforms to the program at the same time—

lawmakers will face the challenge of balancing the needs of beneficiaries against the 

resulting pressures on the economy. To assist in that effort, I will describe the Congressional Budget Office’s (CBO’s) latest projections of prescription drug coverage 

and of drug spending for the Medicare population. I will then conclude my testimony 

by outlining some of the key issues that arise in designing a prescription drug benefit for Medicare. 

Factors Driving Medicare Spending

Under current law, Medicare spending—measured as a share of the economy—is 

projected to nearly quadruple by 2075, growing to more than 9 percent of gross domestic product (GDP) from its current level of 2.5 percent. As a consequence, Medicare will necessarily compete with other spending priorities for a much greater 

share of the Federal budget or with private-sector spending for a bigger share of 

the national economy—or with both. In thinking about how to address the substantial challenges that the Medicare program faces, however, it is important to recognize that they are not unique to Medicare; rather, they reflect the broader forces 

of an aging society, the rising costs of health care generally, and the looming longrange financial strains that will affect the Federal Government and the economy as 

a whole. 

Clearly, part of the challenge facing Medicare stems from the demographic trends 

that are making the country as a whole older. From 1970 to 2010, the number of 

Americans ages 20 to 64 is projected to increase by nearly 80 million; the elderly 

population by 2010 will have grown by about 20 million, or roughly one-fourth as 

much. In contrast, for the period 2010 to 2030—when the baby-boom generation will 

retire—the number of working-age individuals is projected to grow by about 10 million, whereas the population ages 65 and older will increase by 30 million, or three 

times as much. The consequence of those diverging patterns is that the ratio of the 

elderly population to the population in its prime working years—which stood at 19 

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percent in 1970—is projected to grow from 21 percent today to 35 percent by 2030. 

The ratio is then expected to continue to climb (albeit at a slower rate) and could 

reach 42 percent in 2075. In other words, the shift to an older society will accelerate 

as the baby-boom generation retires, and it will persist afterwards, making the 

changes that the nation faces—and their implications for the spectrum of Federal 

tax and spending policies—more than just temporary. 

Compounding those demographic pressures are the seemingly inexorable increases 

in health costs per person—but that issue, too, is not limited to Medicare. Nationally, health care expenditures as a percentage of GDP have more than doubled over 

the past several decades, growing from 7.0 percent in 1970 to 14.8 percent in 2002. 

On a per capita basis, national spending for health care (in 2002 dollars) increased 

from $1,321 in 1970 to $5,366 in 2002, or at an average rate of about 4.5 percent 

per year—which is about 2.4 percentage points faster than the growth of the underlying economy. The factors contributing to the trend in real (inflation-adjusted) per 

capita health care spending include expansions in insurance coverage, rising income, 

medical price inflation in excess of general inflation, and the aging of the population—but the major impetus has been the development and diffusion of new medical technology. At the same time, it should be noted that improvements in that 

technology—while costly—have increased the health care system’s potential to deliver high-quality care. If the adoption of new technology is driven by the needs of 

patients, the value of those improvements may well exceed their cost. 

Over the 1970–2002 period, Medicare spending has risen even more rapidly than 

national health expenditures, growing eightfold even after adjusting for inflation. As 

a share of GDP, Medicare costs rose from 0.7 percent in 1970 to their current level 

of 2.5 percent. Although cost growth on a per-enrollee basis has been volatile, it has 

also tended to rise at a much faster pace than the economy has grown. Over the 

period, real costs per enrollee grew more than twice as fast as the economy—specifically, at the rate of per capita GDP plus 2.8 percentage points. One reason that total 

Medicare costs have grown more quickly than overall health costs is that the number of beneficiaries has grown more quickly than the U.S. population as a whole, 

owing both to program expansions and to the increase in the share of Americans 

who are elderly. In terms of costs per beneficiary, the growth of Medicare spending 

is due in part to the same factors that have driven increases in health care spending 

nationally, but it also reflects legislative and administrative expansions of the program’s benefit package. 

In general, precisely determining each factor’s effect on overall program spending 

is difficult. As an illustration, however, consider spending for services provided to 

fee-for-service program enrollees during acute care hospital stays (which now account for about one-third of Medicare’s total costs). The program’s total spending for 

those services grew by 261 percent between 1972 and 1998, after adjusting for general inflation (see Table 1). That growth in total spending is the product of three 

factors: increases in the number of Medicare beneficiaries; increases in the number 

of hospital admissions per beneficiary; and—the most important factor—increases in 

the real cost per admission. That cost nearly doubled over the period in real terms 

and accounted for 57.4 percent of the overall growth. Over the same period, the 

number of enrollees in the fee-for-service program increased by about 50 percent, 

contributing 30.3 percent of the rise in spending. The number of hospital admissions 

per beneficiary grew more slowly and accounted for only 12.3 percent of the increase 

in total costs.

Table 1.—Sources of Fee-for-Service Medicare Cost Growth for Acute Care Hospital Services 

1972 1998

Percentage

Increase,

1972–1998

Percentage

Share of

Total

Increase 

Total Costs (Millions of dollars) 21,744 78,522 261.1 100.0

Number of Beneficiaries (Millions) 21.1 32.0 51.3 30.3

Admissions per Beneficiary 0.302 0.365 20.9 12.3

Cost per Admission (Dollars) 3,408 6,724 97.3 57.4

Source: Congressional Budget Office based on Department of Health and Human Services, Health Care Financing Administration, Health Care Financing Review: Medicare and Medicaid Statistical Supplement, 2000. 

Note: The costs noted in the table (which are in 1998 dollars) reflect inpatient costs for fee-for-service enrollees at acute care hospitals. 

13

One valuable feature of such a breakdown is that it highlights the factors driving 

Medicare spending that lawmakers can influence and those that they cannot. In this 

case, costs per admission reflect the mix of, and prices for, therapies or services provided in an average admission. Today, policymakers can directly control only one 

of those two components: the price paid for a given service, which is updated annually as specified by statute. Thus, for example, lawmakers can seek to change the 

increase in payments for procedures such as a coronary artery bypass graft, but 

they do not control the share of total admissions accounted for by each procedure—

which results from decisions made by doctors and their patients. The payment systems that are established in law do influence how doctors and other health care providers make treatment decisions. Similarly, features such as the cost sharing for 

those services can affect what beneficiaries choose to do. But the impact of changes 

in policy on those individual decisions is complicated and far from direct. 

CBO’s Projections of Medicare Spending Under Current Law 

With that historical view in mind, let me turn now to CBO’s projections of Medicare spending for the next 10 years, which were updated in March. CBO projects 

that gross outlays for Medicare benefits will total $271 billion in 2003 and $3.9 trillion over the 2004–2013 period (see Table 2). As a share of the economy, those Medicare outlays are projected to rise from 2.5 percent in 2003 to 2.9 percent in 2013, 

on average constituting 2.7 percent of GDP over the 2004–2013 period. After deducting projected premium payments by beneficiaries—which amount to $28 billion in 

2003 and $461 billion over the 10-year period—CBO estimates that net spending for 

Medicare benefits will total $243 billion in 2003 and $3.4 trillion from 2004 through 

2013. All of CBO’s projections reflect the assumption that current law remains unchanged, thereby establishing the ‘‘baseline’’ for legislative proposals. 

Focusing on the program’s growth rates, CBO projects that net spending for Medicare benefits will increase by 5.9 percent in 2003 and will grow at an average annual rate of 6.8 percent over the 2004–2013 period. In recent years, the annual rate 

of growth of Medicare spending has varied considerably. Growth averaged 1.2 percent annually during the 1997–2000 period but has averaged more than 8 percent 

since then. Spending for benefits provided under Part B of Medicare (Supplementary 

Medical Insurance) grew particularly rapidly in 2002, driven by a significant rise 

in the volume and intensity of physician services and by increases of about 20 percent in spending for durable medical equipment and physician-administered pharmaceuticals. Costs for Part A of Medicare (Hospital Insurance) also rose sharply, including a 10 percent increase in spending for inpatient hospital services.

Table 2.—Summary of CBO’s March 2003 Baseline Projections of Medicare Benefit Outlays 

(By fiscal year) 

Billions of Dollars 

Average Annual

Rate of Growth,

2004–2013

2003 2004–2013 (Percent) 

Gross Benefit Outlays 271 3,880 6.9

Premiums −28 −461 8.2

Net Benefit Outlays 243 3,419 6.8

Source: Congressional Budget Office. 

a. Outlays exclude spending by Medicare for quality improvement organizations, health care fraud and abuse control, and other administrative costs. Total spending on those activities is projected to be $5.4 billion 

in 2003. Of that amount, $3.8 billion is subject to appropriation. 

The projected growth rates of Medicare’s payments vary by service type. Total 

payments to hospitals for inpatient services and payments to physicians, which together account for two-thirds of the program’s outlays, are the slowest-growing components of spending for fee-for-service enrollees, respectively averaging 6.4 percent 

and 5.9 percent annually in CBO’s baseline projections through 2013. By contrast, 

rates of growth for the costs of other services—for example, those provided by home 

health agencies and non-physician professionals—are projected to average 10 percent to 13 percent annually (but will still constitute a relatively small share of total 

Medicare spending). 

Over the next decade, CBO expects several factors to play a major role in the program’s cost growth. Those factors include rising levels of enrollment in Medicare 

and automatic increases in payment rates for many services in the fee-for-service 

program (to adjust rates for rising input costs). CBO also projects changes in the 

14

use of Medicare’s services, reflecting an increase in the number of services furnished 

per enrollee as well as a shift in the mix of services toward those that are higher 

priced and (often) more technologically advanced. In part offsetting the effects of 

those spending components on total costs will be small or negative updates (adjustments) to payment rates for physician services and smaller updates (relative to cost 

increases in the fee-for-service program) to the rates paid to Medicare+Choice plans. 

Specifically, increases in payment rates account for about 45 percent of the projected rise in Medicare spending over the next decade; the other 55 percent is equally divided between increases in enrollment and changes in the quantity and mix of 

services delivered per beneficiary. As noted above, payment rates are the easiest factor for policymakers to control. Rates for many services are automatically adjusted 

for rising input costs. In the past, legislation has frequently limited those increases 

to less than the full change estimated for those costs. Since 1990, for example, updates to payment rates for hospital admissions have averaged about 1 percentage 

point less than the increase in the market-basket index used to measure increases 

in the cost of hospital inputs. Under current law, however, payment rates for services furnished by hospitals and many other providers will automatically rise by the 

full amount of the increase in estimated input costs, as a result of the expiration 

of many of the provisions contained in the 1997 Balanced Budget Act. 

Medicare’s payment rates for physician services are subject to a very different update formula. Most recently, the Balanced Budget Act established an ongoing target 

for cumulative spending for physician services (and services that accompany physician visits). By statute, that target is automatically adjusted each year for changes 

in physicians’ input costs and in the program’s enrollment—plus the change in GDP 

per capita. (Future effects of enacted legislation and of regulation are also taken 

into account.) In the absence of per capita GDP growth, the real (inflation-adjusted) 

target for spending per enrollee remains unchanged. Increases in GDP per capita 

thus act as an allowance to cover increases in the number and average cost of services being furnished per enrollee as technology and medical practices evolve over 

time. If total spending for physicians deviates from that allowance—in either direction—then the annual updates to payment rates are adjusted over a period of several years to bring cumulative spending back in line with the target. 

By the time payment rates were set for 2002, expenditures for physician services 

had exceeded the cumulative target, so rates for those services were reduced by 

about 5 percent, and a further reduction of 4.4 percent was originally scheduled for 

2003. However, the Department of Health and Human Services invoked a provision 

of the 2003 Consolidated Appropriations Resolution to increase the cumulative target for 2002. As a result, payment rates for physician services in 2003 were increased by 1.6 percent. 

Nevertheless, CBO projects that spending for physician services will again exceed 

the target in 2003 and remain above it on a cumulative basis through 2013. Therefore, in the absence of further legislative action, payment rates for those services 

are likely to decline (in absolute terms) for the next several years. (For example, 

last month the Centers for Medicare and Medicaid Services released a very preliminary estimate of the physician fee schedule update for calendar year 2004 indicating 

that payment rates could be cut by 4.2 percent.) At the same time, the total volume 

of services provided will continue to rise as the number of beneficiaries increases 

and the number of services provided per beneficiary grows. As a result, CBO 

projects that total Medicare spending for physician services—which is the product 

of the prices paid and quantities used for the mix of services provided—will rise 

each year through 2013, on both an aggregate and a per capita basis. I should reiterate here that those projections reflect CBO’s best estimate of what will occur 

under the assumption that no changes are made in current law; in the past, lawmakers have often acted to modify those payments, whether to correct discrepancies 

between payment rates and the costs providers incur or for other purposes. 

Medicare’s Long-Term Financing Challenges 

Although the 10-year budget window for Medicare now includes enrollment of the 

first wave of the baby-boom generation—those individuals born between 1946 and 

1948, who will turn 65 by 2013—a complete picture of the program’s fiscal outlook 

requires an even longer view. Toward that end, CBO projected the cost of Medicare 

as a share of GDP out to 2075 to show how much of the country’s production of 

goods and services would be needed to pay for the program as it is currently structured. Although we are continuing to refine our projection models, CBO currently 

estimates that Medicare’s costs as a percentage of GDP will rise from 2.5 percent 

in 2003 to 9.2 percent in 2075. Approximately 30 percent of that growth is due to 

society’s aging and the resulting increase in the number of Medicare beneficiaries; 

15

the remaining 70 percent is attributable to the growth of health care costs per enrollee in excess of the rate of growth of GDP per capita (see Figure 1). 

For a sense of the magnitudes involved, if the Medicare program’s costs accounted 

for 9.2 percent of GDP today, they would equal half of what is now spent by the 

entire Federal Government. If the program’s higher costs were simply added to current Federal spending, total Federal receipts (which currently absorb about 18 percent of GDP) would have to be one-third larger to balance the budget. And if those 

increased costs were paid for entirely through a payroll-based tax, the rate for Social 

Security and Medicare, now set at 15.3 percent on the earnings of most workers, 

would have to more than double—a rise equal to roughly $6,000 per worker (that 

is, $3,000 each for the worker and his or her employer). 

Figure 1.—Projected Long-Term Growth of Medicare Spending

(Percentage of GDP)

Source: Congressional Budget Office.

Of course, the fiscal challenges facing Medicare will occur in parallel with those 

for Social Security and Medicaid. Those three programs now absorb 8 percent of 

GDP, but if CBO’s projections hold, that figure will rise to 14 percent by 2030. Beyond that point, spending pressures will only intensify, with life expectancy continuing to increase and health costs continuing to grow. CBO projects that by 2075, 

the cost of the three programs could climb to 21 percent of GDP, the largest portion 

of which would be attributable to Medicare. To accommodate the increase in spending, either taxes would need to be raised dramatically or spending on other Federal 

programs would have to be curtailed severely—or Federal borrowing would soar. 

For Medicare, the most significant factor affecting those projections is that annual 

growth of spending per beneficiary is expected to increase faster than per capita 

GDP growth—but much less quickly than in the past. CBO’s current projection assumes that per capita Medicare spending will eventually grow 1 percentage point 

faster than per capita GDP, a rate that is substantially slower than the 2.8 percentage-point ‘‘excess cost’’ rate that the program has experienced over the past 32 years 

(part of which has been due to program expansions). CBO’s assumption of an eventual deceleration in the relative rise of health care costs is consistent with that of 

the Medicare trustees (as well as others) and reflects the view that forces within 

the health care sector will operate to slow the rate of growth somewhat. 

But that assumption might be too optimistic, and even seemingly small deviations 

from it could have significant economic implications when costs are projected over 

long periods. For example, if the growth of per capita Medicare costs slowed only 

to the rate of per capita GDP growth plus 1.5 percentage points, then program outlays would equal 5.4 percent of GDP in 2030 and 13.2 percent in 2075 (and if the 

health sector as a whole grew at that rate, it would account for more than half of 

the economy’s output by 2075). Adding to the uncertainty is the potential for program expansions, because enacting a new prescription drug benefit or easing existing limits on payments to providers could exacerbate the rising long-term spending 

trajectory. 

Prescription Drug Coverage and Spending 

I would now like to describe CBO’s latest projections of prescription drug coverage 

and spending for the Medicare population under current law. I offer them not just 

because they serve as the basis for our estimates of legislative proposals to add a 


Insert 89405A.001
16

drug benefit to Medicare but also because they may provide useful insights for the 

design of such proposals. 

Most Medicare beneficiaries now have coverage for prescription drugs at some 

point in the year, but the extent of that coverage varies widely. CBO’s analysis of 

the Medicare Current Beneficiary Survey indicates that in 2000 (the most recent 

year for which data are available), 75 percent of the Medicare population—or roughly 30 million individuals—had some form of insurance coverage for the costs of prescription drugs for at least part of the year; 25 percent—or roughly 10 million beneficiaries—had no drug coverage. Beneficiaries who have coverage for their drug costs 

obtain it from a variety of sources. For example, nearly 30 percent of Medicare beneficiaries obtained coverage through employer-sponsored retiree benefits, and another 

16 percent had coverage through the Medicaid program. About 12 percent of beneficiaries are estimated to have had drug coverage through individually purchased 

Medigap policies, while the remainder obtained coverage through a 

Medicare+Choice plan or from another State or Federal program. 

CBO’s estimates of the total number of Medicare beneficiaries grouped by income 

and the share of them who lacked drug coverage throughout 2000 appear in Figure 

2. Although the fraction of beneficiaries without coverage varied from 32 percent (for 

those with income between 100 percent and 150 percent of the Federal poverty 

level) to 22 percent (for those with income exceeding 400 percent of poverty), CBO’s 

main finding is that the differences across the income spectrum are not dramatic. 

The varying degrees of coverage are likely to reflect both difficulties in obtaining 

private drug coverage as well as rational ‘‘nonpurchase’’ of such coverage by beneficiaries with low levels of drug spending. 

Clearly, the extent of the drug coverage that Medicare beneficiaries have today—

and whether and how that coverage should be added to Medicare—is of central interest to policymakers, for two reasons: the elderly and disabled as a group use substantial amounts of prescription drugs, and their spending for such drugs has been 

rising rapidly in recent years. CBO’s analysis indicates that Medicare beneficiaries 

bought about $1,500 worth of drugs, on average, in 2000 and that more than 90 percent of beneficiaries filled at least one prescription that year. Overall, about threeeighths of those costs were paid out of pocket, a figure that combines the payments 

of those without coverage (who pay the full cost of their drugs) and those with coverage (who incur copayments and deductibles). When average drug spending and 

out-of-pocket costs for Medicare beneficiaries are broken down by beneficiaries’ level 

of income, again, the main finding is that average spending—both total and out-ofpocket—is remarkably similar for all income groups (see Figure 3). 

Figure 2.—Medicare Beneficiaries in 2000, by Income Level and Drug 

Coverage

(Millions of beneficiaries)

Source: Congressional Budget Office.

As Figure 4 indicates (see page 12), an important consideration in designing any 

Medicare drug benefit is how it will affect the out-of-pocket costs of enrollees as well 

as the large amount of payments currently made by third parties (including other 

Federal programs). For example, in 2000, the 8.5 million Medicare beneficiaries 

with income between 200 percent and 300 percent of the poverty level used about 


Insert 89405A.002
17

$13 billion worth of drugs. Beneficiaries paid about $5 billion of that cost directly, 

and $8 billion was paid on their behalf. (Beneficiaries ultimately pay part of those 

covered costs if they pay a premium for their coverage.) 

Figure 3.—Average Prescription Drug Spending in 2000 by and for 

Medicare Beneficiaries

(Dollars)

Source: Congressional Budget Office.

CBO’s Projections of Future Drug Spending

As the above data illustrate, elderly and disabled Medicare beneficiaries now consume substantial amounts of drugs. In addition, their spending is projected to continue growing at a rapid pace (as is drug spending for the country as a whole). For 

the period 2004 through 2013, CBO estimates that spending for prescription drugs 

by and on behalf of the Medicare population will total roughly $1.8 trillion, or nearly 

50 percent of the projected $3.9 trillion in Medicare outlays over that same period. 

Over that period, CBO expects Medicare beneficiaries’ average spending for prescription drugs to climb quickly—at an average annual rate of about 9 percent—

even in the absence of a Medicare drug benefit. 

CBO’s current estimate of total drug spending is about 4 percent higher than its 

projection last year for the 2003–2012 period. Typically, shifting the projection period forward by one year adds a relatively expensive year and drops a relatively inexpensive one, leading to a larger increase. This year’s estimate, however, reflects 

two offsetting factors: new information about the degree to which drug spending is 

underreported in current surveys (which slightly lowered the starting point for the 

projections); and somewhat lower projections of the rate of growth of drug spending 

(the result, in part, of slower-than-expected economic growth in the near term). 


Insert 89405A.003
18

Figure 4.—Total Prescription Drug Spending in 2000 by and for Medicare 

Beneficiaries

(Billions of dollars)

Source: Congressional Budget Office.

Issues in Designing a Drug Benefit

The financial challenges already facing the Medicare program and the significant 

sums that projections indicate its beneficiaries will spend on drugs combine to make 

designing a drug benefit for that program a formidable task. In considering how to 

design such a benefit, it is useful to begin with some key principles of insurance 

design that—as an economist—help me think through the complex issues involved 

and are related to some of the options with which the Congress is now grappling. 

The first and foremost issue to confront is the structure of the benefit that is provided—that is, the deductible and cost sharing it will require. In general, well-designed insurance should reduce the risk of catastrophic financial losses yet leave individuals to cover their routine, expected expenditures with their own resources. 

Such a design would also reflect concern about the phenomenon known as ‘‘moral 

hazard’’—in which further coverage would induce additional and perhaps excessive 

demand for services. 

Applying that principle would suggest that Medicare’s drug benefit should focus 

on protecting beneficiaries against very high drug costs. If Medicare adopted some 

kind of catastrophic approach, most enrollees would receive no payments in any 

given year, but they would nonetheless benefit from being protected against the possibility of catastrophic expenses. Several factors related to the nature of drug spending, however, complicate the application of a ‘‘pure insurance’’ approach. The two 

most important factors are the degree to which the distribution of drug spending 

is skewed and the degree to which it is persistent. 

Concentration and Persistence of Drug Spending

Although most Medicare enrollees use some prescription drugs, the bulk of such 

spending is concentrated among a much smaller group. In 2000, about 26 percent 

of enrollees had expenditures of $2,000 or more, and together they accounted for 65 

percent of total drug spending by the Medicare population. At the same time, 32 

percent of beneficiaries had expenditures of $500 or less, making up about 4 percent 

of total spending. 

Of course, skewed annual expenses by themselves are actually typical of insurance markets, since insurance is usually purchased to protect against a small but 

relatively random risk of a large loss. What makes insurance for drug coverage difficult to provide is that prescription drug costs persist over time for the same enrollees. In particular, a large share of drug spending is associated with treatment of 

chronic conditions—such as hypertension, cardiovascular disease, and diabetes—

which are often evident by the time individuals become eligible for Medicare. The 

result is that potential enrollees have important ‘‘private information’’ about their 

future drug costs. That fact makes stand-alone drug coverage particularly susceptible to adverse selection, in which enrollment is concentrated among those who expect to receive the most in benefits. 

Indeed, those same facts help explain why beneficiaries may find it difficult today 

to purchase private coverage for prescription drugs—or why catastrophic protection 


Insert 89405A.004
19

is virtually unavailable except through subsidized retiree coverage or Medicaid. If 

beneficiaries were given a choice about whether and when to purchase individual 

prescription drug coverage, people with high drug costs would be most likely to participate. That would drive premiums up, which in turn would reduce enrollment as 

enrollees with below-average drug costs dropped out. In the extreme, that spiral 

could lead to a market failure in which no insurance was sold, even if most people 

would be willing to pay more than the average cost of a policy that had broad enrollment. Those theoretical pressures are well illustrated in practice by today’s market 

for new Medigap policies that include a drug benefit (which cover as much as half 

of an enrollee’s drug costs but cap the benefit at $1,250 or $3,000 per year). Insurers 

that offer such policies often charge a premium that represents a very large share 

of the maximum potential drug benefit—to reflect the average cost of their enrollees. 

Similarly, the drug coverage available through Medicare+Choice plans is generally 

subject to caps. 

Most proposals for a Medicare drug benefit have sought to correct for such market 

failures by including coverage for catastrophic drug costs but, accordingly, must also 

include measures designed to avoid an adverse selection spiral. One potential approach would be to make enrollment mandatory. A related option would integrate 

drug coverage into the benefit package for Part B of Medicare (and charge a correspondingly higher premium), so that beneficiaries could not separate their choice 

of whether to obtain drug coverage from their decision to purchase coverage for less 

predictable health costs. 

But most of the drug benefit proposals developed in recent years have sought to 

keep enrollment in the benefit as a separate option for the elderly and disabled. To 

mitigate the potential for adverse selection, they would use some or all of the following three methods:

• Restrict Participation. Most proposals have either given enrollees only one 

opportunity to choose the drug benefit—at the time they first become eligible 

for it—or imposed a substantial premium surcharge on those who delay enrollment. (Otherwise, beneficiaries with low drug costs would simply wait 

until they needed coverage to enroll.) • Provide Up-Front Coverage. Many proposals have sought to make enrollment more attractive for beneficiaries with low drug costs by providing some 

coverage for their initial drug expenditures—for example, covering a substantial share of costs after beneficiaries meet a deductible that can be as low as 

$100. • Offer High Premium Subsidy Rates. The extent of Federal subsidization 

of premiums for a drug benefit is a key determinant of total Federal costs for 

such a program both because of the direct costs and because the availability 

of subsidies would lead employers and State Medicaid programs to encourage 

or require full participation. However, such subsidies would also serve to encourage other beneficiaries with relatively low drug costs to enroll in the benefit. Most recent proposals have contained relatively high subsidy rates—67 

percent or higher—which mean that enrollees would pay one-third or less of 

the average covered costs through their monthly premiums. 

The Administration of a Medicare Drug Benefit

The way in which a drug benefit is administered also affects its costs, and the 

options for administration involve many of the same trade-offs between insurance 

and incentives that arise in designing the benefit itself. Most recent proposals have 

envisioned adopting the common private-sector approach of using pharmacy benefit 

managers (PBMs) to process drug claims. Those proposals would also give beneficiaries a range of drug plans from which to choose, either in conjunction with their 

choice of medical coverage or as a stand-alone benefit. The extent to which the organizations that administered a Medicare drug benefit could effectively constrain its 

costs would depend on the organizations’ having both the authority and the incentive to use the various cost-control mechanisms at their disposal. Proposals have differed, however, in the nature and extent of the risk that the entities responsible for 

administering the benefit would assume, the kind of restrictions that would be 

placed on them in managing drug costs, and the structure of the competition among 

those entities to enroll and serve beneficiaries. 

Private health plans use PBMs to process claims and negotiate price discounts 

with drug manufacturers and dispensing pharmacies. PBMs also try to encourage 

the use of certain drugs, such as generic, preferred-formulary, or mail-order pharmaceuticals—in part so that they can obtain lower prices for those preferred drugs 

that have competitors. In addition, because of their centralized records for each enrollee’s prescriptions, they may help prevent adverse drug interactions and take 

other steps to help beneficiaries manage their own drug use. 

20

In the private sector, PBMs often have considerable leeway in the tools they can 

use, but they do not assume any insurance risk for the drug benefit (although they 

may be guided or selected by an employer or insurer who does bear the residual 

risk). At most, they may be subject to a bonus or a penalty added to their administrative fee, which is based on how well they meet prespecified goals for their performance. Some proposals have envisioned having PBMs or similar entities administer a Medicare drug benefit in that way—accepting ‘‘performance risk’’ but not ‘‘insurance risk.’’ In such models, all costs for benefit claims would be paid by the Federal Government as they were incurred. 

Other proposals have adopted a different model, more akin to the risk-based competitive model characteristic of Medicare+Choice plans. Those proposals envision 

multiple risk-bearing entities (such as partnerships between PBMs and insurers) 

that would compete to serve enrollees. Enrollees would have some choice among providers, so that beneficiaries who were willing to accept more-restrictive rules (such 

as a closed formulary) in return for lower premium costs could do so, whereas others 

could select a more expensive provider with fewer restrictions. If the entities bore 

all of the insurance risk for the drug benefit—that is, if they received a fixed per 

capita payment for each enrollee—they would have strong incentives to use whatever cost-control tools were permitted. However, such tools might be unattractive to 

many beneficiaries, and the plans’ administrators would also have strong incentives 

to try to achieve favorable selection by avoiding enrollees with the highest spending. 

An additional concern about this model has been that entities might be unwilling 

to participate if they had to assume the full insurance risk for a stand-alone drug 

benefit. To mitigate that concern, proposals have included federally provided reinsurance for high-cost enrollees as well as so-called risk-adjustment mechanisms that 

would vary the per capita payments on the basis of enrollees’ characteristics, such 

as their age or previous disease diagnoses. (Reinsurance means that the Federal 

Government shares part or all of the claims costs of high-cost enrollees.) Although 

reinsurance would reduce the incentives to avoid the highest-cost enrollees that 

risk-bearing plans face, it would also tend to weaken the plans’ incentives to control 

costs commensurately. 

Complicating matters further, the incentives to control drug costs faced by entities 

administering a Medicare drug benefit would not depend solely on how they were 

paid; the financial incentives that beneficiaries faced would also be a key consideration. Such incentives might include lower beneficiary premiums for joining plans 

that could deliver the required benefits for a lower overall cost, as well as smaller 

out-of-pocket payments in plans that were able to negotiate lower prices for the 

drugs they covered. If plans competed primarily on the basis of the comprehensiveness of the coverage they provided, however, Federal expenditures would probably 

be higher than if plans competed on cost factors. Moreover, to devise a proposal that 

would require plans to bear insurance risk but not allow beneficiaries’ premiums to 

vary with their choice of plan appears to be difficult. 

Although much depends on a proposal’s specific design and details, a drug benefit 

could be structured so that entities bearing some insurance risk would choose to 

provide it; further, such coverage would probably be available across the country. 

That conclusion, which stands in contrast to the experience of the Medicare+Choice 

program, is based in part on the fact that the kind of competing pharmacy networks 

needed to provide such a drug benefit are already well established nationwide. At 

the same time, CBO concludes that plans bearing insurance risk would incur additional costs that would not be borne by PBMs that are subject only to performance 

risk. Whether and to what extent those added costs might offset any reductions in 

Federal costs that accrued from having plan administrators face insurance risk 

would also depend on the specific provisions of the proposal. 

Finally, recent discussions have included the notion of linking drug coverage with 

reforms of the delivery mechanism for Medicare’s benefits. For example, the Bush 

Administration has put forward a set of principles for Medicare reform that suggests 

an ‘‘integrated’’ approach combining drug benefits and enrollment in private health 

plans. The budgetary implications of such an approach are, however, unclear—the 

Administration estimated that its initiative would cost a total of $400 billion 

through 2013 but did not submit sufficient details for CBO to make its own estimate. CBO is preparing to estimate the effects of any such proposals and looks forward to working with the Congress if and when such initiatives are introduced as 

legislation. 

Conclusion

In conclusion, I would be remiss if I did not emphasize the important trade-offs 

involved in all of the policies now under consideration. Even when considered in isolation, a Medicare drug benefit might address a number of objectives—but objectives 

21

that might be thought desirable in the abstract are often mutually incompatible, necessitating difficult choices. For example, providing extensive drug coverage to all 

Medicare beneficiaries at a low cost to all parties is not possible; either enrollees’ 

premiums or the government’s subsidy costs would be high. If most of the costs were 

paid through enrollees’ premiums to keep Federal spending low, some Medicare 

beneficiaries would be unwilling or unable to participate in the program, particularly if coverage was limited to catastrophic expenses. If, instead, costs were limited 

by capping the annual benefits paid to each enrollee, the program would fail to protect participants from the impact of catastrophic drug costs. Proposals have taken 

various approaches to balance those competing objectives. 

Looking at the Medicare program as a whole, the choices may be even more stark. 

If the program continues to operate as it is currently structured, its costs will rise 

significantly—even in the absence of program expansions such as a prescription 

drug benefit. In light of that outlook, policymakers may wish to incorporate two features in their approach to Medicare policy: a recognition of the larger economic and 

budgetary trade-offs, and consideration of the program structure that would best 

support Medicare’s overall objective of providing financing for high-quality medical 

care for the elderly and disabled. 

With regard to economic and budgetary trade-offs, two issues stand out. First, to 

the extent that the U.S. economy grows at a healthy pace, it will be better able to 

meet the Medicare population’s demands for health care. Put differently, the overall 

level of national income available in the future constitutes the reservoir from which 

the resources for both private needs and public programs will be drawn, and the 

nation must endeavor, in making public policy, to enlarge that reservoir to the 

greatest degree possible. Second, the potential pressures on the Federal budget from 

Medicare and other sources will necessitate trade-offs with other spending priorities 

if Federal programs are to remain close to their historical fraction of national income. 

Alternatively, public policy may steer a course toward devoting a larger fraction 

of the Federal budget and the economy as a whole to Medicare. Even if that occurs, 

it will be desirable to use those Medicare funds as efficiently as possible—to purchase the highest-value care with each dollar. Medicare beneficiaries (or their families), together with their health care providers, are best positioned to guide the use 

of additional dollars and to choose services that meet therapeutic demands and 

match individual tastes. Providing those parties with a broader range of choices and 

improved information, and ensuring their sensitivity to the cost of those services, 

should facilitate better decisionmaking. At the same time, an appropriate balance 

must be struck between providing stronger financial signals to beneficiaries about 

the cost of their care and providing protection against greater financial exposure—

in the program as a whole and in any drug benefit that is added to it. 

This concludes my testimony, and I look forward to answering any questions that 

the Committee may have.

Chairman THOMAS. Thank you very much, Doctor. Mr. Walker? 

f STATEMENT OF THE HONORABLE DAVID M. WALKER, COMPTROLLER GENERAL, U.S. GENERAL ACCOUNTING OFFICE 

Mr. WALKER. Thank you, Mr. Chairman, Ranking Member Rangel. It is a pleasure to be back before the full Committee on Ways 

and Means to discuss Medicare’s financial condition and proposals 

to add an outpatient prescription drug benefit. I will hit the highlights, if I can, Mr. Chairman. 

There are growing concerns about gaps in the Medicare program, 

most notably the lack of outpatient prescription drug coverage, 

which can leave Medicare’s most vulnerable beneficiaries with high 

out-of-pocket costs. At the same time, however, the recent publication of the 2003 trustees Annual Report reminds us that Medicare, 

based on its current design, with no prescription drug benefit, already faces a huge projected financial imbalance and that has 

worsened significantly in the past year. 

22

Furthermore, as the Medicare trustees made clear over 10 years 

ago, the current Medicare program is not fiscally sustainable in its 

present form. In fact, that was done in the year that I was a trustee of Social Security and Medicare. In 10 years, Hospital Insurance 

(HI) Trust Fund outlays will begin to exceed tax revenues, and by 

2026, the HI Trust Fund will be exhausted. However, trust fund 

insolvency does not mean that the program will cease to exist. Program tax revenues will cover a portion of projected annual expenditures thereafter. 

In the face of these short-term and long-term cost pressures, I 

continue to maintain that substantive financing and programmatic 

reforms are necessary to put Medicare on a sustainable footing for 

the future. The trustees’ intermediate projections in the 2003 report show that program outlays are expected to begin to exceed 

program tax revenues in 2013. That is when we go negative cash 

flow. Cash is key, not trust fund solvency. In fact, trust fund solvency can be misleading and give people a false sense of security 

as to not only the state of this program, but also Social Security. 

To finance these cash deficits, HI will have to draw on special 

issue Treasury securities acquired during the years of surpluses. To 

redeem those securities, the government will have to obtain cash 

through a combination of increased taxes, spending cuts, and/or increased borrowing from the public, through publicly held debt. Neither the decline in the cash surpluses nor the cash deficits will affect the payment of benefits for a member of years. The negative 

cash flow will place increased pressure on the Federal budget to 

raise resources necessary to meet the program’s ongoing costs. This 

pressure will only increase when Social Security begins to experience a negative cash flow just a few short years after the Medicare 

program. 

Importantly, the HI Trust Fund measure provides no information 

on Supplemental Medical Insurance (SMI), or Part B, SMI. The 

SMI’s expenditures, which currently account for about 43 percent 

of total Medicare spending, are projected to grow even faster than 

HI. 

Ultimately, the critical question is not how much the trust fund 

has in assets, but whether the government as a whole and the 

economy at large can afford the promised benefits now and in the 

future, and at what cost to other claims on available resources. As 

shown in the next chart, Medicare, Medicaid, and Social Security 

have already grown from 13 percent of Federal spending in 1962—

again, before Medicare and Medicaid were enacted into law—to 42 

percent of Federal spending in 2002. These percentages are expected to continue to increase in future years. 

As the next chart shows, GAO prepares long-term budget simulations twice a year, based upon CBO data and then going out much 

further, that seek to illustrate the likely fiscal consequences of the 

coming demographic tidal wave and rising health care cost. These 

simulations continue to show that to move into the future with no 

changes in Federal retirement and health programs is to envision 

a very different role for the Federal Government. In addition, while 

additional economic growth would help to ease our burden, the projected fiscal gap is too great for us to grow our way out of the problem. 

23

At the same time, it is important to look beyond the Federal 

budget to the economy as a whole. If we look at the next chart, we 

will see that Medicare, Medicaid, and Social Security are projected 

to represent an ever-increasing percentage of the overall economy. 

Under the 2003 trustees’ intermediate estimates and the CBO’s 

most recent long-term Medicare estimates, spending for these entitlement programs combined will grow to 14 percent of GDP in 2030 

from today’s 8.4 percent. 

Despite a common awareness of Medicare’s current and future 

fiscal plight, pressure has been building to address recognized gaps 

in Medicare’s coverage, especially the lack of a prescription drug 

benefit and protection against financially devastating medical 

costs. Filling these gaps would add expenses to an already fiscally 

overburdened program. Under the trustees’ 2003 intermediate assumptions, the present value of HI’s Part A’s actuarial deficit in 

current dollars is $6.2 trillion. We would have to have $6.2 trillion 

today invested at Treasury rates in order to fund the gap for Part 

A alone, a 20-percent increase from last year. 

As a result, it would be prudent for the Congress to consider 

tackling the greatest needs first and for making any benefit additions part of a larger structural reform effort. In addition, Congress 

may want to adopt a Medicare Hippocratic oath, namely, do not 

make Medicare’s already huge financial imbalance worse. 

In closing, Medicare’s financial challenge is very real and growing. The 21st century has arrived, and our demographic tidal wave 

is on the horizon. Frankly, we know that incorporating a prescription drug benefit in the existing Medicare program will add hundreds of billions of dollars to the program spending just over 10 

years. 

Finally, in my view, Congress should consider the estimated discounted present value of any major tax or spending actions like 

this as an integral part of any related discussion and debate and 

prior to enactment of any related legislation. This information is 

critical in light of our long-range fiscal challenge and the Congress’ 

overall stewardship obligations to the American people. 

Thank you, Mr. Chairman. I am happy to answer any questions 

you may have. 

[The prepared statement of Mr. Walker follows:]

Statement of The Honorable David M. Walker, Comptroller General, U.S. 

General Accounting Office 

Mr. Chairman and Members of the Committee: 

I am pleased to be here today as you discuss issues related to an outpatient prescription drug benefit for Medicare beneficiaries. There are growing concerns about 

gaps in the Medicare program, most notably the lack of outpatient prescription drug 

coverage, which may leave Medicare’s most vulnerable beneficiaries with high outof-pocket costs. Recent estimates suggest that, at any point in time, about a third 

of Medicare beneficiaries lack prescription drug coverage. The rest have at least 

some drug coverage through various sources—most commonly employer-sponsored 

health plans—although recent evidence indicates that this coverage is beginning to 

erode. 

At the same time, however, the recent publication of the 2003 Trustees’ Annual 

Report reminds us that Medicare in its current condition—with no prescription drug 

benefit—already faces a huge projected financial imbalance that has worsened significantly in the past year. Furthermore, as the Medicare trustees made clear over 

10 years ago, the current Medicare program is not fiscally sustainable in its present 

form. 

24

1 Under the Trustees 2003 intermediate assumptions, revenues from the HI payroll tax and 

the taxation of certain Social Security benefits are initially projected to cover about threefourths of projected expenditures once the trust fund is exhausted. This ratio, however, is projected to decline rapidly. 2 Congressional Budget Office, Monthly Budget Review (Washington, D.C.: Mar. 10, 2003). 3See U.S. General Accounting Office, Medicare Home Health Care: Payments to Home Health 

Agencies Are Considerably Higher than Costs, GAO–02–663 (Washington, D.C.: May 6, 2002) 

and Skilled Nursing Facilities: Medicare Payments Exceed Costs for Most but Not All Facilities, 

GAO–03–183 (Washington, D.C.: Dec. 31, 2002). 4 U.S. General Accounting Office, Medicare: Payments for Covered Outpatient Drugs Exceed 

Providers’ Costs, GAO–01–1118 (Washington, D.C.: Sept. 21, 2001). 

In 10 years, Hospital Insurance (HI) Trust Fund outlays will begin to exceed tax 

receipts, and by 2026 the HI Trust Fund will be exhausted. However, trust fund 

insolvency does not mean the program will cease to exist; program tax revenues will 

continue to cover a portion of projected annual expenditures.1

The huge fiscal pressures created by the retirement of the baby boom generation 

and rising health care costs are on our 10-year budget horizon. Between now and 

2035, the number of people age 65 and older will double. Federal health and retirement spending are expected to surge as people live longer and spend more time in 

retirement. In addition, advances in medical technology are likely to keep pushing 

up the cost of providing health care. Moreover, the baby boomers will have fewer 

workers to support them in retirement. 

We must also remember that Medicare has grown substantially as a percent of 

the Federal budget since its enactment in 1965. In addition, it is expected to represent an increasing percentage of the Federal budget in the years ahead. After a 

brief slowdown in the late 1990s, Medicare spending growth has recently accelerated. In fiscal year 2001, growth in program spending reached nearly 9 percent, 

with spending on certain services increasing much more rapidly. For example, 

spending for home health services grew about 30 percent and spending for skilled 

nursing facility care grew slightly over 20 percent. For the first 5 months of fiscal 

year 2003, Medicare spending has been growing at 7.6 percent.2

A significant problem that hobbles Medicare’s ability to achieve a desirable degree 

of efficiency is that the program too often pays overly generous rates for certain 

services and products. For example, for certain services, our recent work has shown 

substantially higher Medicare payments relative to providers’ costs—as much as 35 

percent higher for home health care and 19 percent higher for skilled nursing facility care.3 Similarly, Medicare has overpaid for various medical products. In 2001, 

we reported that Medicare paid over $1 billion more than other purchasers in 2000 

for certain outpatient drugs that the program covers. Excessive payments hurt not 

only the taxpayers but also the program’s beneficiaries or their supplemental insurers, as beneficiaries are generally liable for copayments equal to 20 percent of Medicare’s approved fee. For certain outpatient drugs, Medicare’s payments to providers 

were so high that the beneficiaries’ copayments exceeded the price at which providers could buy the drugs. The Centers for Medicare & Medicaid Services (CMS) 

has not acted on our recommendation that Medicare establish payment levels for 

drugs more closely related to actual market transaction costs, using information 

available to other public programs that pay at lower rates.4

In the face of these short-term and long-term cost pressures, I continue to maintain that substantive financing and programmatic reforms are necessary to put 

Medicare on a sustainable footing for the future. These fundamental reforms are 

vital to reducing the program’s growth, which threatens to absorb ever-increasing 

shares of the nation’s budgetary and economic resources. Thus, any proposals to 

help seniors with the costs of prescription drugs would need to be carefully crafted 

to avoid further erosion of the projected financial condition of the Medicare program. 

Stated differently, it will be prudent to adopt a modified Hippocratic oath for Medicare reform—namely, any such reform proposals should ‘‘do no further harm’’ to 

Medicare’s already serious long-range financial imbalance. 

As you deliberate on ways to modernize Medicare’s benefit package while striving 

for program sustainability, I would like to highlight several key considerations:

• The traditional measure of HI Trust Fund solvency is a misleading gauge of 

Medicare’s financial health. Long before the HI Trust Fund is projected to be 

insolvent, pressures on the rest of the Federal budget will grow as HI’s projected cash flow turns negative and the gap between program tax revenues 

and expenditures escalates. Moreover, a focus on the financial status of HI 

ignores the increasing burden Supplemental Medical Insurance (SMI)—Medicare Part B—will place on taxpayers and beneficiaries. 

25

5 Another small source of funding derives from the tax treatment of Social Security benefits. 

Under certain circumstances, up to 85 percent of an individual’s or couple’s Social Security benefits are subject to income taxes. Under present law, the Old-Age and Survivors Insurance (OASI) 

and Disability Insurance (DI) Trust Funds are credited with the income taxes attributable to 

the taxation of the first 50 percent of OASDI benefit payments. The remainder of the income 

taxes attributable to the taxation of up to 85 percent of OASDI benefit payments is credited 

to the HI Trust Fund. Any other income taxes paid by retirees would also help finance the general revenue contribution to SMI. 

• GAO’s most recent long-term budget simulations continue to show that, absent meaningful entitlement reforms, demographic trends and rising health 

care spending will drive escalating Federal deficits and debt. To obtain budget 

balance, massive spending cuts, tax increases, or some combination of the two 

would be necessary. Neither slowing the growth of discretionary spending nor 

allowing the 2001 tax reductions to sunset will eliminate the imbalance. In 

addition, while additional economic growth will help ease our burden, the potential fiscal gap is too great to grow our way out of the problem. 

• Under the huge budgetary pressures that we are sure to face in the coming 

years, we must set priorities so that any benefit expansions are in line with 

available resources. In this regard, the application of basic health insurance 

principles to any proposed benefit could help moderate the cost for both beneficiaries and taxpayers. Under these principles, beneficiaries receive protections against the risk of catastrophic medical expenses while remaining conscious of the cost of care through their premium contributions and cost-sharing arrangements. Given our already huge Medicare financial imbalance, it 

is also important that benefit expansion proposals include targeting mechanisms to ensure that Federal support is directed at the beneficiaries with the 

greatest financial risk. 

• The private sector’s use of entities called pharmacy benefit managers for controlling drug expenditures may be instructive for Medicare, but the program’s 

unique role and nature may moderate how these strategies will be used and 

the potential efficiency gains afforded in attempting to transfer these strategies to Medicare. 

Outlook Worsening for Medicare’s Long-Term Sustainability

Today the Medicare program faces a long-range and fundamental financing problem driven by known demographic trends and projected escalation of health care 

spending beyond general inflation. The lack of an immediate crisis in Medicare financing affects the nature of the challenge, but it does not eliminate the need for 

change. Within the next 10 years, the first baby boomers will begin to retire, putting 

increasing pressure on the Federal budget. From the perspectives of the program, 

the Federal budget, and the economy, Medicare in its present form is not sustainable. Acting sooner rather than later would allow changes to be phased in so that 

the individuals who are most likely to be affected, namely younger and future workers, will have time to adjust their retirement planning while helping to avoid related ‘‘expectation gaps.’’ Since there is considerable confusion about Medicare’s current financing arrangements, I would like to begin by describing the nature, timing, 

and extent of the financing problem. 

Demographic Trends and Expected Rise in Health Care Costs Drive Medicare’s 

Long-Term Financing Problem 

As you know, Medicare consists of two parts—HI and SMI. HI, which pays for 

inpatient hospital stays, skilled nursing care, hospice, and certain home health services, is financed by a payroll tax. Like Social Security, HI has always been largely 

a pay-as-you-go system. SMI, which pays for physician and outpatient hospital services, diagnostic tests, and certain other medical services, is financed by a combination of general revenues and beneficiary premiums. Beneficiary premiums pay for 

about one-fourth of SMI benefits, with the remainder financed by general revenues. 

These complex financing arrangements mean that current workers’ taxes primarily 

pay for current retirees’ benefits except for those financed by SMI premiums.5

As a result, the relative numbers of workers and beneficiaries have a major impact on Medicare’s financing. The ratio, however, is changing. In the future, relatively fewer workers will be available to shoulder Medicare’s financial burden. In 

2002 there were 4.9 working-age persons (18 to 64 years) per elderly person, but 

by 2030, this ratio is projected to decline to 2.8. For the HI portion of Medicare, 

in 2002 there were nearly 4 covered workers per HI beneficiary. Under their intermediate 2003 estimates, the Medicare trustees project that by 2030 there will be 

only 2.4 covered workers per HI beneficiary. (See fig. 1.) 

26

Figure 1.—Ratio of HI-Covered Workers to Beneficiaries

Source: CMS, Office of the Actuary. 

Note: Projections based on the intermediate assumptions of The 2003 Annual Report of the 

Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds.

The demographic challenge facing the system has several causes. People are retiring early and living longer. As the baby boom generation ages, the share of the population age 65 and over will escalate rapidly. A falling fertility rate is the other 

principal factor underlying the growth in the elderly’s share of the population. In 

the 1960s, the fertility rate was an average of 3 children per woman. Today it is 

a little over 2, and by 2030 it is expected to fall to 1.95—a rate that is below replacement. The combination of the aging of the baby boom generation, increased longevity, and a lower fertility rate will drive the elderly as a share of total population 

from today’s 12 percent to almost 20 percent in 2030. 

Taken together, these trends threaten both the financial solvency and fiscal sustainability of this important program. Labor force growth will continue to decline 

and by 2025 is expected to be less than a third of what it is today. (See fig. 2.) Relatively fewer workers will be available to produce the goods and services that all 

will consume. Without a major increase in productivity, low labor force growth will 

lead to slower growth in the economy and slower growth of Federal revenues. This 

in turn will only accentuate the overall pressure on the Federal budget. This slowing labor force growth is not always recognized as part of the Medicare debate, but 

it is expected to affect the ability of the Federal budget and the economy to sustain 

Medicare’s projected spending in the coming years. 


Insert 89405A.005
27

6 Under the trustees’ intermediate 2003 projections, this will occur for Social Security (OASDI) 

in 2018. 

Figure 2.—Labor Force Growth

Source: Social Security Administration, Office of the Chief Actuary, and GAO. 

Note: GAO analysis based on the intermediate assumptions of The 2003 Annual Report of the 

Board of Trustees of the Federal Old-Age and Survivors Insurance and the Federal Disability 

Insurance Trust Funds. Percentage change is calculated as a centered 5-year moving average.

The demographic trends I have described will affect both Medicare and Social Security, but Medicare presents a much greater, more complex, and more urgent challenge. Unlike Social Security, Medicare spending growth rates reflect not only a burgeoning beneficiary population, but also the escalation of health care costs at rates 

well exceeding general rates of inflation. The growth of medical technology has contributed to increases in the number and quality of health care services. Moreover, 

the actual costs of health care consumption are not transparent. Third-party payers 

largely insulate covered consumers from the cost of health care decisions. These factors and others contribute to making Medicare a greater and more complex fiscal 

challenge than Social Security. 

HI’s Trust Fund Faces Cash Flow Problems Long Before the HI Trust Fund 

Is Projected to Be Insolvent

Current projections of future HI income and outlays illustrate the timing and severity of Medicare’s fiscal challenge. Today, the HI Trust Fund takes in more in 

taxes than it spends. Largely because of the known demographic trends I have described, this situation will change. Under the trustees’ 2003 intermediate assumptions, program outlays are expected to begin to exceed program tax revenues in 

2013. (See fig. 3.) To finance these cash deficits, HI will need to draw on the specialissue Treasury securities acquired during the years of cash surpluses. For HI to ‘‘redeem’’ its securities, the government will need to obtain cash through some combination of increased taxes, spending cuts, and/or increased borrowing from the public (or, if the unified budget is in surplus, less debt reduction than would otherwise 

have been the case). Neither the decline in the cash surpluses nor the cash deficits 

will affect the payment of benefits, but the negative cash flow will place increased 

pressure on the Federal budget to raise the resources necessary to meet the program’s ongoing costs. This pressure will only increase when Social Security also experiences negative cash flow and joins HI as a net claimant on the rest of the budget.6


Insert 89405A.006
28

Figure 3.—Medicare’s HI Trust Fund Faces Cash Deficits as Baby Boomers 

Retire

Source: CMS, Office of the Actuary and GAO. 

Note: GAO analysis based on the intermediate assumptions of The 2003 Annual Report of the 

Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds.

The gap between HI income and costs shows the severity of HI’s financing problem over the longer term. This gap can also be expressed relative to taxable payroll 

(the HI Trust Fund’s funding base) over a 75-year period. This year, under the 

trustees’ 2003 intermediate estimates, the 75-year actuarial deficit is projected to 

be 2.40 percent of taxable payroll—a significant increase from last year’s projected 

deficit of 2.02 percent. This means that to bring the HI Trust Fund into balance 

over the 75-year period, either program outlays would have to be immediately reduced by 42 percent or program income immediately increased by 71 percent, or 

some combination of the two. These estimates of what it would take to achieve 75-

year trust fund solvency understate the extent of the problem because the program’s 

financial imbalance gets worse in the 76th and subsequent years. As each year 

passes, we drop a positive year and add a much bigger deficit year. 

The projected exhaustion date of the HI Trust Fund is a commonly used indicator 

of HI’s financial condition. Under the trustees’ 2003 intermediate estimates, the HI 

Trust Fund is projected to exhaust its assets in 2026. This solvency indicator provides information about HI’s financial condition, but it is not an adequate measure 

of Medicare’s sustainability for several reasons. In fact, the solvency measure can 

be misleading and can serve to give a false sense of security as to Medicare’s true 

financial condition. Specifically, HI Trust Fund balances do not provide meaningful 

information on the government’s fiscal capacity to pay benefits when program cash 

inflows fall below program outlays. As I have described, the government would need 

to come up with cash from other sources to pay for benefits once outlays exceeded 

program tax income. 

In addition, the HI Trust Fund measure provides no information on SMI. SMI’s 

expenditures, which currently account for about 43 percent of total Medicare spending, are projected to grow even faster than those of HI in the near future. Moreover, 

Medicare’s complex structure and financing arrangements mean that a shift of expenditures from HI to SMI can extend the solvency of the HI Trust Fund, creating 

the appearance of an improvement in the program’s financial condition. For example, the Balanced Budget Act of 1997 modified the home health benefit, which resulted in shifting a portion of home health spending from the HI Trust Fund to 

SMI. Although this shift extended HI Trust Fund solvency, it increased the draw 

on general revenues and beneficiary SMI premiums while generating little net savings. 

Ultimately, the critical question is not how much a trust fund has in assets, but 

whether the government as a whole and the economy can afford the promised benefits now and in the future and at what cost to other claims on available resources. 

To better monitor and communicate changes in future total program spending, new 

measures of Medicare’s sustainability are needed. As program changes are made, a 


Insert 89405A.007
29

7 ‘‘Mandatory spending’’ refers to outlays for entitlement programs such as food stamps, Medicare, and veterans’ pensions; payment of interest on the public debt; and outlays for certain nonentitlement programs such as payments to States from Forest Service receipts. In 2002 Social 

Security, Medicare, and Medicaid accounted for over 71 percent of mandatory spending. 

continued need will exist for measures of program sustainability that can signal potential future fiscal imbalance. Such measures might include the percentage of program funding provided by general revenues, the percentage of total Federal revenues or gross domestic product (GDP) devoted to Medicare, or program spending per 

enrollee. As such measures are developed, questions would need to be asked about 

actions to be taken if projections showed that program expenditures would exceed 

the chosen level. 

Absent Reform of Medicare and Other Entitlements for the Elderly, Budgetary Flexibility Will Disappear

Taken together, Medicare’s HI and SMI expenditures are expected to increase 

dramatically, rising from about 12 percent of Federal revenues in 2002 to more than 

one-quarter by midcentury. The budgetary challenge posed by the growth in Medicare becomes even more significant in combination with the expected growth in 

Medicaid and Social Security spending. As shown in figure 4, Medicare, Medicaid, 

and Social Security have already grown from 13 percent of Federal spending in 1962 

before Medicare and Medicaid were created to 42 percent in 2002. 

Figure 4.—Composition of Federal Spending by Budget Function, 1962, 

1982, and 2002

Source: CMS, Office of the Actuary and GAO.

This growth in spending on Federal entitlements for retirees will become increasingly unsustainable over the longer term, compounding an ongoing decline in budgetary flexibility. Over the past few decades, spending on mandatory programs has 

consumed an ever-increasing share of the Federal budget.7 In 1962, prior to the creation of the Medicare and Medicaid programs, spending for mandatory programs 

plus net interest accounted for about 32 percent of total Federal spending. By 2002, 

this share had almost doubled to approximately 63 percent of the budget. (See fig. 

5.) 


Insert 89405A.008
30

Figure 5.—Federal Spending for Mandatory and Discretionary Programs, 

Fiscal Years 1962, 1982, and 2002

In much of the past decade, reductions in defense spending helped accommodate 

the growth in these entitlement programs. However, even before the terrorist attacks of September 11, 2001, this ceased to be a viable option. Indeed, spending on 

defense and homeland security will grow as we seek to combat new threats to our 

nation’s security. 

GAO prepares long-term budget simulations that seek to illustrate the likely fiscal 

consequences of the coming demographic tidal wave and rising health care costs. 

These simulations continue to show that to move into the future with no changes 

in Federal retirement and health programs is to envision a very different role for 

the Federal Government. Assuming, for example, that the tax reductions enacted in 

2001 do not sunset and discretionary spending keeps pace with the economy, by 

midcentury Federal revenues may not even be adequate to pay Social Security and 

interest on the Federal debt. Spending for the current Medicare program—without 

any additional new benefits—is projected to account for more than one-quarter of 

all Federal revenues. To obtain budget balance, massive spending cuts, tax increases, or some combination of the two would be necessary. (See fig. 6.) Neither 

slowing the growth of discretionary spending nor allowing the tax reductions to sunset eliminates the imbalance. In addition, while additional economic growth would 

help ease our burden, the projected fiscal gap is too great for us to grow our way 

out of the problem. 


Insert 89405A.009
31

8 U.S. General Accounting Office, Fiscal Exposures: Improving the Budgetary Focus on LongTerm Costs and Uncertainties, GAO–03–213 (Washington, D.C.: Jan. 24, 2003). 

Figure 6.—Composition of Spending as a Share of GDP Assuming Discretionary Spending Grows With GDP After 2003 and the 2001 Tax Cuts Do 

Not Sunset

Source: GAO’s March 2003 analysis. 

Note: Assumes currently scheduled Social Security benefits are paid in full throughout the 

simulation period. Social Security and Medicare projections are based on the trustees’ 2003 intermediate assumptions.

Indeed, long-term budgetary flexibility is about more than Social Security and 

Medicare. While these programs dominate the long-term outlook, they are not the 

only Federal programs or activities that bind the future. The Federal Government 

undertakes a wide range of programs, responsibilities, and activities that obligate 

it to future spending or create an expectation for spending. A recent GAO report 

describes the range and measurement of such fiscal exposures—from explicit liabilities such as environmental cleanup requirements to the more implicit obligations 

presented by life-cycle costs of capital acquisition or disaster assistance.8 Making 

government fit the challenges of the future will require not only dealing with the 

drivers—such as entitlements for the elderly—but also looking at the range of other 

Federal activities. A fundamental review of what the Federal Government does and 

how it does it will be needed. This involves looking at the base of all major spending 

and tax policies to assess their appropriateness, priority, affordability, and sustainability in the years ahead. 

Medicare Is Projected to Absorb Ever-Increasing Shares of the Economy

At the same time, it is important to look beyond the Federal budget to the economy as a whole. Figure 7 shows the total future draw on the economy represented 

by Medicare, Medicaid, and Social Security. Under the 2003 trustees’ intermediate 

estimates and the Congressional Budget Office’s (CBO) most recent long-term Medicaid estimates, spending for these entitlement programs combined will grow to 14 

percent of GDP in 2030 from today’s 8.4 percent. Taken together, Social Security, 

Medicare, and Medicaid represent an unsustainable burden on future generations. 


Insert 89405A.010
32

9Testimony before the Senate Committee on Banking, Housing, and Urban Affairs, July 24, 

2001. 10 In 2008, the first baby boomers will reach age 62 and become eligible for Social Security 

benefits; in 2011, they will reach age 65 and become eligible for Medicare benefits. 

Figure 7: Social Security, Medicare, and Medicaid Spending as a 

Percentage of GDP

Source: CMS, Office of the Actuary, SSA, Office of the Chief Actuary, CBO, and GAO. 

Note: Projections based on the intermediate assumptions of the 2003 trustees’ Reports, CBO’s 

March 2003 short-term Medicaid estimates, and CBO’s June 2002 Medicaid long-term projections under midrange assumptions.

Although real incomes are projected to continue to rise, they are expected to grow 

more slowly than has historically been the case. At the same time, the demographic 

trends and projected rates of growth in health care spending I have described will 

mean rapid growth in entitlement spending. Taken together, these projections raise 

serious questions about the capacity of the relatively smaller number of future 

workers to absorb the rapidly escalating costs of these programs. 

As HI Trust Fund assets are redeemed to pay Medicare benefits and SMI expenditures continue to grow, the program will constitute a claim on real resources in the 

future. As a result, taking action now to increase the future pool of resources is important. To echo Federal Reserve Chairman Alan Greenspan, the crucial issue of 

saving in our economy relates to our ability to build an adequate capital stock to 

produce enough goods and services in the future to accommodate both retirees and 

workers in the future.9 The most direct way the Federal Government can raise national saving is by increasing government saving; that is, as the economy returns 

to a higher growth path, a balanced fiscal policy that recognizes our long-term challenges can help provide a strong foundation for economic growth and can enhance 

our future budgetary flexibility. It is my hope that we will think about the unprecedented challenge facing future generations in our aging society. Putting Medicare 

on a sustainable path for the future would help fulfill this generation’s stewardship 

responsibility to succeeding generations. It would also help to preserve some capacity for future generations to make their own choices for what role they want the 

Federal Government to play. 

As with Social Security, both sustainability and solvency considerations drive us 

to address Medicare’s fiscal challenges sooner rather than later. HI Trust Fund exhaustion may be more than 20 years away, but the squeeze on the Federal budget 

will begin as the baby boom generation begins to retire. This will begin as early as 

2008, when the leading edge of the baby boom generation becomes eligible for early 

retirement.10 CBO’s current 10-year budget and economic outlook reflects this. CBO 

projects that economic growth will slow from an average of 3.2 percent a year from 

2005 through 2008 to 2.7 percent from 2009 through 2013, reflecting slower labor 

force growth. At the same time, annual rates of growth in entitlement spending will 

begin to rise. Annual growth in Social Security outlays is projected to accelerate 


Insert 89405A.011
33

11This estimate represents the present value of HI’s future expenditures less future tax income, taking into account the amount of HI Trust Fund assets at hand at the beginning of the 

projection period and adjusting for the ending target trust fund balance. Excluding the ending 

target trust fund balance, HI’s unfunded obligation is estimated to be $5.9 trillion over the 75-

year period under the trustees’ 2003 intermediate assumptions. 

from 5.2 percent in 2007 to 6.6 percent in 2013. Annual growth in Medicare enrollees is expected to accelerate from 1.1 percent today to 2.9 percent in 2013. Acting 

sooner rather than later is essential to ease future fiscal pressures and also provide 

a more reasonable planning horizon for future retirees. We are now at a critical 

juncture. In less than a decade, the profound demographic shift that is a certainty 

will have begun. 

As Bleak Fiscal Future Looms, Efforts to Address Medicare Coverage Gaps 

Are Being Considered

Despite a common awareness of Medicare’s current and future fiscal plight, pressure has been building to address recognized gaps in Medicare coverage, especially 

the lack of a prescription drug benefit and protection against financially devastating 

medical costs. Filling these gaps could add significant expenses to an already fiscally 

overburdened program. Under the trustees’ 2003 intermediate assumptions, the 

present value of HI’s actuarial deficit is $6.2 trillion, a 20-percent increase from the 

prior year.11 This difficult situation argues for tackling the greatest needs first and 

for making any benefit additions part of a larger structural reform effort. 

The Medicare benefit package, largely designed in 1965, provides virtually no outpatient drug coverage. Beneficiaries may fill this coverage gap in various ways. According to the Medicare Current Beneficiary Survey, nearly two-thirds of Medicare 

beneficiaries had some form of drug coverage from a supplemental insurance policy, 

health plan, or public program at some point during 1999. All beneficiaries have the 

option to purchase supplemental policies—Medigap—when they first become eligible 

for Medicare at age 65. Those policies that include drug coverage tend to be expensive and provide only limited benefits. Some beneficiaries have access to coverage 

through employer-sponsored policies or private health plans that contract to serve 

Medicare beneficiaries. In recent years, coverage through these sources has become 

more expensive and less widely available. Beneficiaries whose incomes fall below 

certain thresholds may qualify for Medicaid or other public programs. More than 

one-third may lack drug coverage altogether. 

In recent years, prescription drug expenditures have grown substantially, both in 

total and as a share of all heath care outlays. Prescription drug spending grew an 

average of 15.9 percent per year from 1996 to 2001, more than double the 6.5 percent average growth rate for health care expenditures overall. (See table 1.) As a 

result, prescription drugs account for a growing share of health care spending, rising 

from 6.5 percent in 1996 to 9.9 percent in 2001. By 2012, prescription drug expenditures are expected to account for almost 15 percent of total health expenditures.

Table 1.—National Expenditures for Prescription Drugs and Health Care, 1996 to 2001

Year 

Prescription Drug

Expenditures

(in billions) 

Annual Growth In

Prescription Drug

Expenditures From

Previous Year

(percent) 

Annual Growth In

Health Care

Expenditures From

Previous Year

(percent) 

2001 $140.6 15.4 8.7

2000 121.8 17.3 6.9

1999 103.9 19.2 5.7

1998 87.2 15.1 5.4

1997 75.7 12.8 4.9

1996 67.2 10.5 5.0

Average annual growth from 

1996 through 2001 15.9 6.5

Source: CMS, Office of the Actuary. 

In 2002, CBO projected that the average Medicare beneficiary would use $2,440 

worth of prescription drugs in 2003. This is a substantial amount considering that 

34

12The Kaiser Family Foundation and Health Research and Education Trust, Employer Health 

Benefits: 2000 Annual Survey (Menlo Park, Calif. and Chicago: 2000). 13 U.S. General Accounting Office, Federal Employees’ Health Benefits: Effects of Using Pharmacy Benefit Managers on Health Plans, Enrollees, and Pharmacies, GAO–03–196 (Washington, 

D.C.: Jan. 10, 2003). FEHBP covered about 8.3 million Federal employees, retirees, and their 

dependents as of July 2002, and the three FEHBP plans we reviewed accounted for about 55 

percent of FEHBP enrollment. The FEHBP plans and PBMs we reviewed were Blue Cross and 

Blue Shield, which contracted with AdvancePCS for retail pharmacy services and Medco Health 

Solutions for mail-order services; Government Employees Hospital Association, which contracted 

with Medco Health Solutions; and PacifiCare of California, which contracted with Prescription 

Solutions, another subsidiary of PacifiCare Health Systems. 

some beneficiaries lack any drug coverage and others may have less coverage than 

in previous years. Moreover, significant numbers of beneficiaries have drug expenses 

much higher than those of the average beneficiary. CBO also estimated that, in 

2005, 12 percent of Medicare beneficiaries would have expenditures above $6,000. 

In focusing on the need for prescription drug coverage, we should not forget that 

Medicare does not provide complete protection from catastrophic losses. Under 

Medicare, beneficiaries have no limit on their out-of-pocket costs attributable to cost 

sharing. The average beneficiary who obtained services had a total liability for 

Medicare-covered services of $1,700, consisting of $1,154 in Medicare copayments 

and deductibles in addition to the $546 in annual Part B premiums in 1999, the 

most recent year for which data are available on the distribution of these costs. For 

beneficiaries with extensive health care needs, the burden can be much higher. In 

1999, about 1 million beneficiaries were liable for more than $5,000, and about 

260,000 were liable for more than $10,000 for covered services. In contrast, employer-sponsored health plans for active workers typically limited maximum annual 

out-of-pocket costs for covered services to less than $2,000 per year for single coverage.12

Recently, several proposals have been made to add a prescription drug benefit to 

the Medicare program. While different in scope and detail, the proposals have certain features in common—including use of a third-party entity to administer the 

new drug benefit. The remainder of my remarks will focus on the lessons learned 

from our work regarding the private sector’s use of such an entity to manage the 

drug benefits of insurers’ policyholders and health plans’ enrollees. 

Private Sector Strategies for Controlling Drug Expenditures May Be Instructive for Medicare

Some proposals to add a Medicare outpatient prescription drug benefit look to private sector strategies as a means to administer a drug benefit and control costs. 

Most employer-sponsored health plans contract with private entities, known as 

pharmacy benefit managers (PBM), to administer their prescription drug benefits, 

and those that do not contract with PBMs may have units in their organizations 

that serve the same administrative purpose. Typically, on behalf of the health plans, 

PBMs negotiate drug prices with pharmacies, negotiate rebates with drug manufacturers, process drug claims, operate mail-order pharmacies, and employ various 

cost-control techniques, such as formulary management and drug utilization reviews. In 2001, nearly 200 million Americans had their prescription drug benefits 

administered through PBMs. This year, we reported on the use of PBMs by health 

plans in the Federal Employees’ Health Benefits Program (FEHBP).13 In considering the application of these findings to Medicare, we are reminded that Medicare’s 

unique role and nature may temper how the strategies and potential efficiency gains 

afforded by private sector PBMs may be transferred to benefit the program. 

Private Sector Uses PBMs to Leverage Price Negotiations through Volume 

Purchasing

PBMs use purchasing volume to leverage their negotiations with pharmacies and 

drug manufacturers in seeking favorable prices in the form of discounts, rebates, or 

other advantages. Through negotiations, PBMs create networks of participating retail pharmacies, promising the pharmacies a greater volume of customers in exchange for discounted prices. PBMs may be able to secure larger discounts by limiting the number of network pharmacies. However, smaller networks provide beneficiaries fewer choices of retailers, thereby limiting convenient access. These are 

trade-offs health plans must consider in deciding how extensive a pharmacy network they want their PBMs to offer beneficiaries. The health plans we reviewed in 

our FEHBP study generally provided broad retail pharmacy networks. The average 

discounted prices PBMs obtained for drugs from retail pharmacies were about 18 

percent below the average prices cash-paying customers without drug coverage 

would have paid for 14 selected widely used brand-name drugs. For 4 selected geVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00038 Fmt 6633 Sfmt 6621 E:\HR\OC\89405.XXX 89405
35

14 A pharmacy and therapeutics committee within the health plan or a PBM typically makes 

decisions about whether to include particular brand-name or generic drugs on the plan’s formulary. 15Plans generally encourage the use of formulary drugs by having lower cost sharing or requiring special approval of a nonformulary drug. For example, health plans have increasingly 

adopted three-tiered cost-sharing strategies whereby enrollees incur the lowest out-of-pocket 

costs for using generic drugs, higher costs for brand-name drugs on the formulary, and the highest costs for brand-name drugs not included on the formulary. 16Our report compared the FEHBP plans’ formularies to the Department of Veterans Affairs 

(VA) National Formulary, considered by the Institute of Medicine to be not overly restrictive. 

Each FEHBP plan we reviewed included over 90 percent of the drugs listed on the VA formulary 

or therapeutically equivalent alternatives, and included at least one drug in 93 percent to 98 

percent of the therapeutic classes covered by VA. 

neric drugs, the PBM-negotiated retail pharmacy prices were 47 percent below the 

price paid by cash-paying customers. 

PBMs also use their leverage to negotiate with drug manufacturers for rebates. 

Rebates generally depend on the volume of a manufacturer’s products purchased. 

Health plans and PBMs can add to that volume by concentrating beneficiaries’ purchases for particular types of drugs with certain manufacturers. Health plans can 

steer their beneficiaries’ purchases to specific drugs through the use of a formulary—that is, a list of prescription drugs that health plans encourage physicians 

to prescribe and beneficiaries to use. Determining whether a drug should be on the 

formulary involves clinical evaluations based on a drug’s safety and effectiveness, 

and decisions on whether several drugs are therapeutically equivalent.14 Restricting 

the formulary to fewer drugs within a therapeutic class can provide the PBMs with 

greater leverage in negotiating higher rebates because they can help increase the 

manufacturer’s market share for certain drugs. However, a restricted formulary provides beneficiaries with fewer preferred drug alternatives and makes the policies 

governing coverage of nonformulary drugs or the cost sharing for them critical to 

beneficiaries.15

The FEHBP plans and PBMs we reviewed provided enrollees with generally nonrestrictive drug formularies across a broad range of drugs and therapeutic categories.16 The manufacturer rebates that the PBMs passed through to the FEHBP 

plans effectively reduced plans’ annual spending on prescription drugs by a range 

of 3 percent to 9 percent. The share of rebates PBMs passed through to the FEHBP 

plans varied subject to contractual agreements negotiated between the plans and 

the PBMs. 

PBMs also assisted the FEHBP plans by providing a less expensive mail-order 

drug option. Mail-order prices for the FEHBP plans we reviewed averaged about 27 

percent lower than cash-paying customers would pay for the same quantity at retail 

pharmacies for 14 brand-name drugs and 53 percent lower for 4 generic drugs. The 

FEHBP plans generally had lower cost-sharing requirements for drugs purchased 

through mail order, particularly for more expensive brand-name drugs or maintenance medications for chronic conditions. 

The claims and information processing capabilities PBMs offered also helped the 

FEHBP plans to manage drug costs and monitor quality of care. PBMs maintain 

a centralized database on each enrollee’s drug history that can be used to review 

for potential adverse drug interactions or potentially less expensive alternative 

medications. They also use claims data to monitor patterns of patient use, physician 

prescribing practices, and pharmacy dispensing practices. Their systems provide 

‘‘real-time’’ claims adjudication capabilities that allow a customer’s claim for a drug 

purchase to be approved or denied at the time the pharmacist begins the process 

of filling a prescription. Two plans in our FEHBP study reported savings ranging 

from 6 to 9 percent of the plan’s annual drug spending; the savings were associated 

primarily with real-time claims denials preventing early drug refills and safety 

advisories cautioning pharmacists about potential adverse interactions or therapy 

duplications. 

Use of Private-Sector Strategies in Medicare Would Represent Departure 

from Traditional Policies and Practices

While Medicare’s sheer size would provide it with significant leverage in negotiating with pharmacies and drug manufacturers, doing so would represent a departure from traditional Medicare. Medicare beneficiaries represent less than 15 percent of the population but a disproportionately higher share—about 40 percent—of 

prescription drug spending. However, because of Medicare’s design and obligations 

as a public program, its current purchasing strategies vary considerably from those 

of the private sector.

36

17GAO–01–1118. 18Since the enactment of the Omnibus Budget Reconciliation Act of 1990, drug manufacturers 

are required to provide rebates to State Medicaid programs on outpatient drugs based on the 

‘‘lowest’’ or ‘‘best’’ prices they charged other purchasers or a minimum of 15.1 percent of the average manufacturers’ price (AMP) for brand-name drugs. Rebates must be at least 11 percent 

of AMP for generic drugs. 19 U.S. General Accounting Office, Medicare: HCFA Faces Challenges to Control Improper 

Payments, GAO/T–HEHS–00–74, (Washington, D.C.: Mar. 9, 2000). 

• Any willing provider. In contrast with private payers’ reliance on selective 

contracting with providers and suppliers, the traditional Medicare program 

has generally allowed any hospital, physician, or other provider willing to accept Medicare’s reimbursements and requirements to participate in the program. With respect to drug purchasing in particular, private plans determine 

the extent of their enrollees’ access by the choices they make about the size 

of their participating pharmacy network and breadth of their drug formulary. 

Allowing any pharmacy willing to meet Medicare’s terms to participate or allowing all therapeutically equivalent drugs equal coverage on a formulary 

would restrict the program’s ability to secure advantageous prices. Moreover, 

health plans and PBMs currently make formulary determinations privately. 

In contrast, Medicare’s policies have historically been open to public comment. • Administrative rate-setting. Whereas private health plans typically rely on 

price negotiations to establish payment rates, Medicare generally establishes 

payment rates administratively. As discussed earlier, Medicare’s rates often 

exceed market prices and this is the case for some of the few outpatient prescription drugs covered by Medicare.17 The program’s method of paying for 

these drugs is prescribed in statute: In essence, Medicare pays 95 percent of 

a drug’s ‘‘average wholesale price’’ (AWP). Despite its name, however, AWP 

is not necessarily a price that wholesalers charge and is not based on the 

price of any actual sale of drugs by a manufacturer. AWPs are published by 

manufacturers in drug price compendia, and Medicare bases providers’ payments on these published AWPs. Other public and private purchasers typically use the leverage of volume and competition to secure better prices. By 

statute, Medicaid, the nation’s health insurance program for certain low-income Americans, is guaranteed manufacturers’ rebates based on prices 

charged other purchasers.18 Certain other public payers can pay at rates set 

in the Federal supply schedule, which uses verifiable confidential information 

on the prices drug manufacturers charge their ‘‘most favored’’ private customers. Manufacturers agree to these prices, in part, in exchange for the right 

to sell drugs to the more than 40 million Medicaid beneficiaries. • Low-budget program administration. Duplicating the type of controls PBMs 

have exercised over private-sector drug benefits would likely involve devoting 

a larger share of total expenditures to administration than is spent by Medicare currently. Medicare’s administrative costs historically have been extremely low, averaging about 2 percent of the cost of the services themselves.19 This level of expenditure may not be consistent with the level needed 

to review the volumes of claims data associated with prescription drugs for 

the elderly or acquire and maintain the on-line systems and databases PBMs 

use to employ such utilization controls as real-time claims adjudication. The 

number of prescriptions for Medicare beneficiaries could easily exceed the current number of claims for all other services combined, or over 1 billion annually. 

Decisions about the Extent of Latitude and Competition Allowed Are Critical to Administering a Medicare Drug Benefit

Medicare would undoubtedly need assistance from external entities to administer 

a drug benefit, just as it has used insurers to process claims in the traditional program and Medicare+Choice plans to go further by also managing services and assuming risk. Decisions about the roles assigned an entity or entities and the latitude allowed them in carrying out those roles would be critical. These decisions 

would undoubtedly affect the benefit’s value to beneficiaries and the efficiencies and 

savings secured for both beneficiaries and taxpayers. Some of these decisions parallel those made by FEHBP plans that I discussed—trade-offs about beneficiaries’ 

interests in broad pharmacy networks and formularies versus potential savings. 

Others stem from the uniqueness of Medicare, its likely disproportionate share of 

the drug market, and its position as a public program requiring transparency and 

fairness. 

Insurers and PBMs have been successful in securing some savings on drug purchases by leveraging their volume to move market share from one product to anVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00040 Fmt 6633 Sfmt 6621 E:\HR\OC\89405.XXX 89405
37

other. Medicare’s leverage, given that purchases by the elderly constitute about 40 

percent of the drug market, could be considerable. Yet the large market share may 

also be likely to attract considerable attention. The administration of a Medicare 

drug benefit could then be subject to the same intensity of external pressures from 

interested parties regarding program prices and rules that can often inhibit the program from operating efficiently today. The potential for micromanagement could 

compromise trying to use the very flexibility PBMs have employed in negotiating 

prices and selecting preferred providers in order to generate savings. An alternative 

would be to sacrifice some of the program’s leverage and grant flexibility to multiple 

PBMs or similar entities so that any one entity would be responsible for administering only a share of the market. 

Contracting with multiple PBMs or similar entities, however, would pose other 

challenges. If each had exclusive responsibility for a geographic area, beneficiaries 

who wanted certain drugs could be advantaged or disadvantaged merely because 

they lived in a particular area. To minimize inequities, Medicare could, like some 

private sector purchasers, specify core benefit characteristics or maintain clinical 

control over formulary decisions instead of delegating those decisions to its contractors. 

If multiple PBMs or similar entities operated in a designated area, beneficiaries 

could choose among them to administer their drug benefits. These organizations 

would compete for consumers directly on the basis of differences in their drug benefit offerings and administration. This contrasts with the private sector where drug 

benefits are typically part of an overall insurance plan, and PBMs typically compete 

for contracts with insurers or other purchasers. Competition could be favorable to 

beneficiaries if they were adequately informed about differences among competing 

entities offering drug benefits and shared in the savings. However, adequate oversight would need to be in place to ensure that fair and effective competition was 

maintained. For example, a means to ensure that beneficiaries received comprehensive user-friendly information about policy and benefit differences among competing 

entities would be necessary. Monitoring marketing and customer recruitment strategies and holding entities accountable for complying with Federal requirements 

would require adequate investment. The contracting entities could need protections 

as well. Some mechanism would be needed to risk adjust payments for differences 

in beneficiaries’ health status so that those entities enrolling a disproportionate 

share of high-use beneficiaries would not be disadvantaged. 

Concluding Observations

Medicare’s financial challenge is very real and growing. The 21st century has arrived and our demographic tidal wave is on the horizon. Within 5 years, individuals 

in the vanguard of the baby boom generation will be eligible for Social Security and 

3 years after that they will be eligible for Medicare. The future costs of serving the 

baby boomers are already becoming a factor in CBO’s short-term cost projections. 

Frankly, we know that incorporating a prescription drug benefit into the existing 

Medicare program will add hundreds of billions of dollars to program spending over 

just the next 10 years. For this reason, I cannot overstate the importance of adopting meaningful reforms to ensure that Medicare remains viable for future generations. Adding a drug benefit to Medicare requires serious consideration of how that 

benefit will affect overall program spending. If competing private entities are to be 

used to administer a drug benefit, it is important to understand how these entities 

can be used in the Medicare context to provide a benefit that balances beneficiary 

needs and cost containment. 

Medicare reform would be done best with considerable lead time to phase in 

changes and before the changes that are needed become dramatic and disruptive. 

Given the size of Medicare’s financial challenge, it is only realistic to expect that 

reforms intended to bring down future costs will have to proceed incrementally. We 

should begin this now, when retirees are still a far smaller proportion of the population than they will be in the future. The sooner we get started, the less difficult 

the task will be. 

We must also be mindful that health care costs compete with other legitimate priorities in the Federal budget, and their projected growth threatens to crowd out future generations’ flexibility to decide which competing priorities will be met. In making important fiscal decisions for our nation, policymakers need to consider the fundamental differences among wants, needs, and what both individuals and our nation 

can afford. This concept applies to all major aspects of government, from major 

weapons system acquisitions to issues affecting domestic programs. It also points to 

the fiduciary and stewardship responsibility that we all share to ensure the sustainability of Medicare for current and future generations within a broader context of 

providing for other important national needs and economic growth. 

38

The public sector can play an important role in educating the nation about the 

limits of public support. Currently, there is a wide gap between what patients and 

providers expect and what public programs are able to deliver. Moreover, there is 

insufficient understanding about the terms and conditions under which health care 

coverage is actually provided by the nation’s public and private payers. In this regard, GAO is preparing a health care framework that includes a set of principles 

to help policymakers in their efforts to assess various health financing reform options. This framework will examine health care issues systemwide and identify the 

interconnections between public programs that finance health care and the private 

insurance market. The framework can serve as a tool for defining policy goals and 

ensuring the use of consistent criteria for evaluating changes. By facilitating debate, 

the framework can encourage acceptance of changes necessary to put us on a path 

to fiscal sustainability. I fear that if we do not make such changes and adopt meaningful reforms, future generations will enjoy little flexibility to fund discretionary 

programs or make other valuable policy choices. 

Mr. Chairman, this concludes my prepared statement. I will be happy to answer 

any questions you or other Committee Members may have. 

Contacts and Acknowledgments

For future contacts regarding this testimony, please call William J. Scanlon, Director, Health Care Issues, at (202) 512–7114. Other individuals who made key contributions include Rashmi Agarwal, Linda Baker, John Dicken, Hannah Fein, Kathryn Linehan, James McTigue, Jennifer Rellick, and Melissa Wolf.

Chairman THOMAS. I thank both of you very much. 

It has sometimes been said, notwithstanding the charts, that the 

f solvency of Medicare is probably greater than in previous periods 

and that we really shouldn’t worry all that much about it because 

when the pressure increases on us, historically we have always 

done something. One of the concerns that the Chair has is that 

some of the easy choices were taken early. 

For example, when this Committee engages—and it will—in discussion of Social Security and the solvency of that trust fund, we 

are all mindful that currently the payroll tax is capped at a particular dollar amount. The HI Trust Fund already does not have 

the cap that could be removed. 

So, notwithstanding that 2013 and 2016 still seems like some 

time away, do you believe we have luxury of arguing that since we 

probably have as great a front-loaded number of years of solvency 

as we have had at any time in the past, that that is a comfort that 

we should wait awhile over? 

Mr. WALKER. We should not focus on the trust fund balance, for 

reasons that I articulated. I think we have three basic sustainability problems: At the lowest level, Medicare; at the next level, 

our health care system; and at the top level, our overall fiscal imbalance. 

Chairman THOMAS. Well, I tell you that I feel a little bit about 

Medicare as I probably feel even more about the health care system, because frankly when you compare us with other countries—

and sometimes you can’t do it on an absolute base, you have to look 

at other humans in the human condition and what they do—it isn’t 

so much how much we spend for health care in this country, and 

underscored as well for some of the government support programs 

like Medicare, it is how we spend it. One of the reasons we have 

been so concerned about wanting to try to make some fundamental 

modernizations or changes to Medicare is because without those, 

Medicare as a support structure isn’t fashioned in the best way to 

39

receive a major prescription drug addition—something as simple as 

the historical creation of the A and the so-called B, one from a 

dedicated trust fund, the other one from the general fund; and the 

fact that it doesn’t look much like an insurance policy or any provisions that would give us comfort that some of the things that we 

have seen work in other systems simply won’t work here by virtue 

of the way it was created and the failure to keep it up to date. 

Throwing on a prescription drug benefit doesn’t solve the underlying concerns over Medicare. Is that a fair statement? 

Mr. WALKER. I think it is fair to say that if the conditions that 

exist today had existed in 1965, you probably would have included 

a prescription drug benefit in Medicare to begin with. On the other 

hand, you probably also would have included a number of other 

cost-containment mechanisms that you do not have today. So, on 

one hand you are talking about adding a prescription drug benefit, 

which most employers have added since 1965, but they have also 

changed their health insurance coverage in many other ways, with 

targeting, deductibles, copays, and things of that nature, and Medicare has not. 

Chairman THOMAS. Let me just briefly, then, ask you some 

questions about the Medicare Payment Advisory Commission. They 

perform a very important role. We attempted to create a commission made up of professionals who have a broad background in 

health care touching any number of areas, along with some consumer advocates—who examine current conditions and make recommendations on assistance to various providers and other decisions that we need to make. 

One of the major changes that was made recently was to require 

MEDPAC, as we call it, to vote—because they have a chance to influence public policy, we thought it might be useful to require public votes so that people could see how the interests that may represent particular areas of health care voted on particular issues. I 

know MEDPAC recently made 17 recommendations to the House 

and specifically this Committee. What I found most striking about 

those recommendations, that where the 17 members—I believe it 

was 19 recommendations—where the 17 members made 19 recommendations, if you added up all the individual votes, and of 

course certain things happen in the House if it is a voice vote 

versus a recorded vote versus how many people are in opposition, 

we handle issues differently based upon the votes. When you add 

up all the votes of MEDPAC on those 19 recommendations, there 

were collectively 300 ayes for the position taken, and 2 nays. 

Given the depth and breadth of the professionalism and history 

of experience of MEDPAC, should this Committee be impressed by, 

ignore—how should we deal with recommendations that are presented to us by that body with a vote of 300 to 2? 

Mr. WALKER. Mr. Chairman, I have tried very hard to work 

with this Committee and others as Comptroller General of the 

United States to appoint MEDPAC members. I believe that we 

have significantly upgraded MEDPAC in the last several years. I 

believe that you need to give serious consideration to the recommendations that you receive from MEDPAC. They are hampered 

with a problem that this Committee, GAO, and many others have 

in that they don’t have an adequate amount of timely, accurate and 

40

useful health care information. Their basic recommendations are 

consistent with the work that GAO has done, and I think that you 

need to seriously consider their recommendations. 

I also think it was appropriate to increase the transparency and 

accountability of the votes associated with MEDPAC members. I 

think that was appropriate, given their substantial responsibilities 

and the sums involved. 

Chairman THOMAS. Have you had any feedback from the 

MEDPAC members themselves about their willingness and comfortableness with the transparency in the recorded votes, as a process, as opposed to what they used to do? 

Mr. WALKER. Well, initially there was some apprehension. I 

have not heard any concerns. I think there generally is an understanding that it was the right thing to do. 

Chairman THOMAS. I thank the gentlemen. Dr. Holtz-Eakin, it 

is always difficult to ask a new director of CBO about estimates 

that have been made in the past, although I assume you have a 

moral obligation to accept all of the product of previous CBOs and 

directors. Sometimes when people focus on the debate on the floor 

of the House example, with amendments or substitutes to bills, the 

discussion is couched in ways in which people can’t fairly judge or 

discriminate between approaches taken by various bills. One of the 

things I hope to do with this hearing is to at least begin the record 

with a clear understanding that there are consequences to choices 

that are made in the way you structure bills. I know this may be 

uncomfortable for some folk, but I don’t really know any other way 

to begin a process of talking about building a bill without asking 

some fairly direct questions, and asking you if you have the ability 

to compare particular structures. 

For example, included in the bill that passed the House last year 

was a provision that we called the best price policy, which would 

have required a degree of negotiation on discounts from pharmaceutical manufacturers without regard to an artificial so-called best 

price structure that is located in Medicare. I am always fearful 

when someone tells me they are going to give me the best price, 

especially if it is a structured best price. 

In looking at last year’s bill—and it is true, as was commented, 

there is no bill for the majority in yet. We are looking at these 

issues and want to make some decisions. In comparison, the gentleman from California, for example, Mr. Stark, does have a bill in 

this year—I believe it is H.R. 1199. Have you been able to score 

that bill yet, Doctor? 

Dr. HOLTZ-EAKIN. We do not yet have a score on the bill this 

year. We did, in fact, do work in previous years on these issues. 

Chairman THOMAS. Okay. So, we might be comparing last 

year’s bills rather than the current edition. 

Did the idea of negotiating discounts save money over a best 

price—first part of the question. Second part, for example, a tool 

that was utilized, I believe, in the previous bill, where you allow 

physicians to override formularies and provide an any-willing-provider structure for pharmacies. Those are two ways to deal with 

pricing. Can you comment on each in a comparison between them? 

Dr. HOLTZ-EAKIN. With the caveat that I am new to the job 

and may have to get back to you with particular details, I can say 

41

a couple of things on those issues. The first is that in looking at 

incentives and outcomes on cost containment, one really wants to 

look at incentives and the opportunity to undertake cost containment. So, with regard to the best-price provision, that leads to a 

greater incentive to try to negotiate a lower price from a manufacturer, and as a result, CBO did in fact, score that in previous legislation as saving about $18 billion. We would undertake to update 

that estimate this year. I am not sure exactly what the precise 

number would be. 

With regard to physician override, that clearly limits the ability 

to control costs and to undertake the control of the lowest possible 

source of a pharmaceutical. As a result, it would lead to higher 

costs, other things being equal. 

Chairman THOMAS. One of the debates, and I am sure it will 

ensue again this year, over models that might be constructed is the 

idea of creating a catastrophic or so-called stop-loss structure, 

where there is some exposure which most people believe that if you 

have copayments or other arrangements in which beneficiaries 

share in the costs, that there might be some savings over the long 

run by decisions that are made in part because of out-of-pocket 

costs in which the beneficiary is not insulated from all costs associated with the cost of pharmaceuticals. 

We provided a structure in the last bill which created a stop-loss 

arrangement. My understanding is, again comparing two specific 

solutions to in essence the same problem, that H.R. 1199 has a 

very low stop-loss structure, which might deal with so-called—price 

induction, is the phrase that is used—if you are dealing with, say, 

a $2,000 catastrophic as opposed to the structure that we had offered. 

What is your analysis of those different approaches to the question of exposure of beneficiaries to costs in an overall attempt to 

reduce the exposure to the Medicare trust fund? 

Dr. HOLTZ-EAKIN. Well, I again go back to the rules of thumb, 

which are incentive and opportunity. To the extent that beneficiaries have an incentive to control costs, you will get greater cost 

savings. Regarding larger subsidies, other things being equal, if 

you subsidize 90 percent of any insurance product versus, say, 70 

percent, the larger subsidy will lead to a lower incentive to control 

costs and will lead to higher prices and higher spending. 

Chairman THOMAS. So, the idea of an assistance to individuals 

to shield them to any cost exposure ironically would wind up with 

an overall higher price because the so-called incentive that was 

there is no incentive at all? 

Dr. HOLTZ-EAKIN. The key thing is to look comprehensively. To 

get total costs, you want to look comprehensively. So, you would 

want to look at incentives and opportunities for individuals as well 

as for providers. Focusing on the individual’s part, having limited 

incentives to control costs will lead to higher costs and higher 

prices. 

Chairman THOMAS. Then the bottom line of all of this questioning is that last year the bill that passed the House, along with 

the modernization of prescription drug and provider portions, cost 

somewhere in the vicinity of $350 billion, I believe, and the bill 

42

that was purported to meet essentially the same argument from 

the minority’s perspective cost what in last year’s dollars? Dr. HOLTZ-EAKIN. The CBO score last year was roughly $970 

billion. 

Chairman THOMAS. So, $350 billion to $970 billion. Of course 

that is the direct result of having a catastrophic, which in fact does 

not induce the appropriate behavior and therefore costs more and 

does not have competition, such as we indicated in not accepting 

some formulaic best price but rather requiring actually a negotiated process to produce best price. 

These are the kinds of questions that I think are important to 

understand why bills contain certain provisions. When you add up 

all the particulars, it does produce a product that either brings 

about particular results at a cost that is afforded under a budget 

proposal, or you get something that is up to three times as expensive and, ironically in terms of the way it is built, produces cost increases rather than cost savings. 

With that, I want to thank both of you for what you have done 

and, obviously as we move into a more formal discussion of solutions, what you are going to do for us. Does the gentleman from 

New York wish to inquire? 

Mr. RANGEL. Thank you, Mr. Chairman. Let me thank both of 

you for pointing out expertly the degree and the serious nature of 

the problem. Am I to assume that both of you studied the Housepassed bill in preparation for your testimony today? 

Dr. HOLTZ-EAKIN. I am familiar with the House-passed bill. I 

would not say that I am intimately familiar with all the details. 

Mr. WALKER. I am somewhat familiar with it, but I did not 

study it before today. 

Mr. RANGEL. Well, have you been privy to any draft of a bill 

that the majority intends to offer for our consideration at some 

point in time in the future? 

Dr. HOLTZ-EAKIN. We have to date not scored any particular 

bills at CBO. We have talked at the staff level in discussions about 

ideas, and no more. 

Mr. WALKER. I have not seen any proposed bill or framework 

for a bill. 

Mr. RANGEL. Do you think that professionally you could be of 

better assistance to this Committee if you had before you a bill as 

to the direction that we were going? 

Dr. HOLTZ-EAKIN. It will in the end be the Committee’s judgement whether I am of assistance or not. I will tell you that, in our 

experience at CBO, the details of proposals do in fact matter a 

great deal, and the greater specificity of an actual bill allows us to 

give a more precise answer, without question. 

Mr. WALKER. Obviously if you have a specific proposal, you can 

make more targeted comments as to what the likely pros and cons 

of that proposal are. 

Mr. RANGEL. That makes a lot of sense to me. I get the impression from the past conduct of this Committee that we are seeing 

both of you for the last time on this subject matter. 

[Laughter.] 

Mr. RANGEL. Not having the slightest clue as to which direction 

the majority is going to take us, we may ask you, in an impartial 

43

way, to meet with—if we don’t have a formal meeting, to share 

your opinions of whatever comes from the majority, wherever it 

comes from, so that we might be able to again visit with you and 

have a better understanding of the impact of the decisions that we 

will be making. I do hope that before we vote on this bill, assuming 

the bill comes back to this Committee and not go straight to the 

suspension calendar, that we would have an opportunity to discuss 

this further. 

Let me thank you for this meeting, Mr. Chairman. 

Chairman THOMAS. Thank the gentleman. I think you will find 

that oftentimes the most useful examination of an issue is in comparison with alternatives rather than examining it in some absolute environment, because then you have the opportunity to weigh 

real choices between real alternatives. The Chair hopes that as a 

plan is presented from the majority side that we will have an opportunity to examine one from the minority side as well. 

Does the gentleman from Illinois wish to inquire? 

Mr. CRANE. Thank you, Mr. Chairman. 

Now, Mr. Walker, I have in front of me the GAO Medicare Hospital Insurance Trust Fund projected deficit between 2010, starting 

roughly 2010 going on into 2040. Is that projection based on constant dollar value? 

Mr. WALKER. Yes, 2003 dollars. So, it is adjusted for inflation. 

It is the HI program alone. It does not include SMI. 

Mr. CRANE. The reason I ask that is I came to Congress in 1969 

and the dollar is worth about 10 cents today of what it was when 

I came here. You have a 30-year period here, and that 30-year period would result in a $300 billion deficit. Is that a $300 billion 

probable deficit or a $3 trillion deficit? 

Mr. WALKER. No, it is a $300 billion, based upon 2003 dollars. 

So, in other words——

Mr. CRANE. I know, constant dollars. 

Mr. WALKER. That is correct. 

Mr. CRANE. Would you honestly expect that to happen? 

Mr. WALKER. Well——

Mr. CRANE. How would you expect that to happen based on our 

performance here for the last 35 years? 

Mr. WALKER. We rely upon the trustees’ assumptions as to 

what they expect inflation is going to be when we end up coming 

up with the discount factors. I think if you look in the past at how 

the trustees have done in projecting what cost will be, if anything, 

their intermediate assumptions have been low, not high. So, I think 

it is a realistic picture, and I think the bottom line is it shows you 

have a serious problem. 

Mr. CRANE. Well, I remember when we worried about billions 

and now we are talking trillions, and it will be quadrillions in another 30 years at the rate we are going. Governments always have 

a way of resolving those problems by just escalating the quantity 

of money out there. That is something that has me troubled about 

any of these kinds of projections, based upon our performance over 

the past generation. 

Mr. WALKER. What I would suggest, Mr. Crane, if you also 

looked at it as a percentage of the budget or as a percentage of the 

44

GDP, which we also presented information on, that may be a more 

useful way for you to look at it. Either way, it is a problem. 

Mr. CRANE. Oh, yeah. Oh, no question about it, it is a problem. 

I would like to also ask you, Mr. Walker, in your testimony you 

say GAO’s long-term budget simulations show that absent meaningful entitlement reforms, demographic trends and rising health 

care spending will drive escalating Federal deficits and debt. Neither slowing the growth of discretionary spending nor allowing the 

2001 tax reductions to sunset will eliminate the imbalance. Given 

these estimates, it seems that it will be difficult to modernize Medicare that includes prescription drugs. If a modest drug benefit program that costs $400 billion is going to be hard to create due to 

budget constraints, wouldn’t a $1 trillion plan be next to impossible 

without massive tax increases, slashing other valuable Federal programs, cutting provider payments, and forcing seniors to pay large 

premiums and deductibles? 

Mr. WALKER. I think it is important, whether you are dealing 

on the spending side or the tax side, that you look at not just the 

10-year costs but also the long-range implications, including discounted present value amounts. Obviously, to the extent that you 

are talking about adding a benefit that costs a lot more money, 

that is going to worsen the long-range imbalance. We look at the 

bottom line, what is the bottom line. 

Mr. CRANE. One final question I would like to put to you, either 

one or both of you, and that has to do with the recognizing Medicare’s current benefit costs are escalating and to obtain ideas from 

CBO to slow that cost growth. The CBO projects that, absent any 

change in the law, annual spending on Medicare will more than 

double in 10 years to nearly $460 billion. An analysis by the Centers for Medicare and Medicaid Services Office of the Actuary demonstrates that Medicare spending last year spiked dramatically. 

What recommendations have you regarding controlling costs of the 

current program, and have you examined the recent MEDPAC recommendations and what do you think of those? 

Dr. HOLTZ-EAKIN. Congressman, it is not CBO’s role to make 

specific recommendations on how to control Medicare costs. I would 

be happy to discuss with you the implications of adopting any of 

the MEDPAC recommendations. We look forward to working with 

you on that. 

Mr. CRANE. Very good. Thank you. I yield back the balance of 

my time. 

Mr. MCCRERY. [Presiding.] Mr. Stark. 

Mr. STARK. Thank you, Mr. Chairman. I want to thank the witnesses. Mr. Walker, I wonder if you could comment on the effect 

on Medicare if the tax cuts were not extended and, instead of repealing the estate tax, we had merely gone with a fairly large exemption, say $3 or $4 million, as was suggested in an alternative 

plan; and that the taxes would rise as a share of the GDP. What 

kind of doomsday scenario—how would that change it, in effect? 

Mr. WALKER. We have done an overall budget simulation under 

several sets of assumptions. One set is the tax cut does not sunset; 

the other assumption is that it does sunset. Obviously, if it does 

sunset, then that makes the gap less in the outer years. At the 

same point in time, it does not come close to closing the gap. There 

45

is still a long-range problem irrespective of what the Congress decides to do there. 

Mr. STARK. Is the difference in those 2 scenarios about 25 years 

till implosion or explosion, is that correct? 

Mr. WALKER. It makes a bigger difference when you are starting to deal with the 2030 to 2050 period. You know, either way, 

you have really escalating deficits, but the timing in which you 

start seeing those deficits, obviously, is different. 

Mr. STARK. Did you do any studies on the change needed in 

the—if you assumed that we did not extend the 2001 tax cut or the 

inheritance tax demise, what kind of a payroll tax increase would 

be needed to——

Mr. WALKER. We didn’t do that. We looked at the larger fiscal 

picture, which is what the long-range budget simulation is intended to be. Mr. Stark, the trustees’ latest report for 2003 would 

show that if you wanted to solve the problem merely through increasing the tax rate for HI, you would have to increase the HI tax 

rate by 83 percent today in order to solve it just through that. That 

would only solve it for the next 75 years. Every year we have a big 

deficit beyond the 75 year horizon that has to be dealt with. 

Mr. STARK. Well, I might ask the same question, Dr. HoltzEakin. It is my understanding that we could pass the 75 year solvency test—which we have never achieved, I might add—if we increase the payroll tax by about 1.2 percent on both sides. Is that 

a number with which you gentlemen would concur? 

Mr. WALKER. Yes, 2.4 percent of taxable payroll. You are correct, 1.2 percent on each side, which would be an 83-percent increase. 

Mr. STARK. In a sense, that would pretty much solve, given 

what we know now about the increased spending on health care, 

that would solve this problem financially speaking for all time. 

Mr. WALKER. No, it does not. 

Mr. STARK. Seventy-five years. 

Mr. WALKER. That solves Part A, HI, for 75 years; it doesn’t do 

anything about SMI, it doesn’t do anything about the broader 

health care challenge or the long-range fiscal problem. 

Mr. STARK. Okay, so that is on the HI and the Part A side. The 

worst-case scenario for 75 years, which is about as far ahead as we 

care to plan. That is fair. Now, how much would it take in—have 

you then to solve the Part B side to provide enough additional general revenues to cover the 75 percent that we fund now. If this 

were done, how much more than not extending the 2001 tax cut 

and not eliminating the inheritance tax, how much more revenue 

would that—My understanding, that this total tax cut, including 

the interest cost, is about a $2 trillion loser. 

Mr. WALKER. Well, first, I think it is important——

Mr. STARK. Is that correct? 

Mr. WALKER. I don’t have the number. I can provide it for the 

record. I can tell you that—in fact CBO would probably be the 

right place to get that number, since they are the ones that are 

supposed to be doing the projections. I——

Mr. STARK. Give it to CBO. 

Mr. WALKER. I would say for the record, though, Mr. Stark, 

that the 2.4 percent is not worst-case. That is based on the interVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00049 Fmt 6633 Sfmt 6602 E:\HR\OC\89405.XXX 89405
46

mediate assumptions. The trustees have low-cost, high-cost, and intermediate cost estimates. So, it is not worst-case, and again, it 

only deals with HI, not SMI. 

Mr. MCCRERY. Before——

Mr. STARK. Could I—Mr. Chairman, I just the indulgence to 

hear Dr. Holtz——

Mr. MCCRERY. If Dr. Holtz-Eakin would like to answer, that is 

fine. 

Dr. HOLTZ-EAKIN. Briefly, I am not privy to the simulations 

that Mr. Walker has discussed. In the chart that I showed you, 

what we displayed was a rise in Medicare costs from about 2.5 percent of GDP to in excess of 9 percent of GDP over the 75 year horizon you are discussing. Those costs will have to be financed somehow. Spending is ultimately a burden on the economy. I would also 

point out to you that these are projections made under the assumption that health care costs rise 1 percentage point faster than GDP. 

Historically, Medicare costs have risen 2.8 percentage points faster 

than GDP. So, these projections actually contain the assumption 

that there will be steps taken to bring cost growth down. To the 

extent that that does not happen, these numbers would be, in fact, 

dramatically larger than the estimates that are in my written testimony. The particulars of the financing which you have been discussing, I would argue, are secondary to the ultimate observation 

that the outlays will rise as a fraction of the economic resources in 

this economy that are available to finance those programs and any 

others. 

Mr. MCCRERY. Dr. Holtz-Eakin, do these numbers include the 

addition of a prescription drug benefit? 

Dr. HOLTZ-EAKIN. No, they do not. 

Mr. MCCRERY. How much difference would it make if we were 

to add a $400 billion or trillion——

Dr. HOLTZ-EAKIN. We would have to do a careful set of estimates. I would be happy to work with you on that. Four hundred 

billion dollars is roughly $50 billion a year over the 8 years of the 

budget window in which a drug benefit would be in effect. That is 

a number that is well under 1 percent of GDP. However, as I pointed out in my remarks, prescription drug spending has been growing more rapidly than Medicare spending as a whole, and so the 

long-term outlook would certainly be worse, other things being 

equal. The precise numbers—we could work with you to develop an 

estimate. 

Mr. MCCRERY. Mr. Walker. 

Mr. WALKER. I would hope that there would be an effort to 

come up with what would be the discounted present value of what 

the cost of the program would be, not just looking at the 10-year 

numbers, because they can be very misleading. I think it is important to look beyond that, because we don’t really start to hit the 

major part of the demographic tidal wave until beyond the 10 year 

point. Therefore, you can get a false sense of security if you just 

looked at 10-year numbers. They can explode beyond that. 

Mr. MCCRERY. Mr. Shaw. 

Mr. SHAW. Mr. Walker, I want to go back to a point that you 

covered in your testimony. This goes back to the first graph that 

you had up there, in which you talk about Medicare going into a 

47

cash deficit in the year 2013. In that regard, of course, we have 

Treasury bills that are in there, and they won’t be exhausted until 

what year? 

Mr. WALKER. The year 2026 is when the special issue Treasury 

securities will exhaust. 

Mr. SHAW. Does the fact that we are going through the process 

of cashing in Treasury bills, do they have any real economic value 

to the program? 

Mr. WALKER. I am not a Ph.D. economist, but I would say no, 

they don’t have an economic value. They have a legal significance, 

they have a moral significance, they represent a priority claim on 

future general revenues, but they do not have an economic value. 

Mr. SHAW. You may not be an economist, but you are certainly 

a well-versed certified public accountant (CPA). As such, you certainly know the difference between a real economic asset and one 

that is not. I certainly accept your explanation. So, what you are 

talking about and what you are telling this Committee is that 2013 

is the year in which, really, the system is going to have to—we are 

going to have to find other ways to pay benefits if we are going to 

keep taxes at their present level and not cut benefits. Is that correct? 

Mr. WALKER. Correct. You are either going to have to raise 

taxes, cut spending, or go into more public debt financing in order 

to convert these bonds into cash. 

Mr. SHAW. Now, the same thing applies to Social Security, 

doesn’t it? What year is that? 

Mr. WALKER. I believe it is 2018, Mr. Shaw. 

Mr. SHAW. It just changed recently, and I believe you are right. 

It was 2016. I think it has been changed. So, the same thing applies in Social Security, where there are not real—those Treasury 

bills are no real economic assets. It is simply evidence of a moral 

obligation that a future Congress is going to have to figure out how 

they are going to pay the benefits and how they are going to pay 

off those Treasury bills. Is that not correct? 

Mr. WALKER. That is true, and personally I think that Congress 

has a stewardship obligation. You need to look beyond just today. 

You need to look to future generations and what type of burdens 

are being passed on to them. 

Mr. SHAW. So, I guess regardless of what particular road the 

Congress may decide to go on eventually, we are going to have to, 

if we want to do something, we are going to have to start building 

up in some way real economic assets that the Social Security Administration as well as Medicare will have some type of a call on, 

unless we drastically restructure the system. Is that not correct? 

Mr. WALKER. Well, we are going to have to do something. There 

are different ways to reform Social Security and Medicare. The fact 

is, the Medicare problem is multiple times worse than the Social 

Security problem. 

Mr. CRANE. Will the gentleman yield? 

Mr. SHAW. I yield. 

Mr. CRANE. Is not one alternative solution also to increase the 

money supply? 

Dr. HOLTZ-EAKIN. No, sir. Over the long term, what will serve 

as resources to pay these obligations of the Federal Government 

48

and finance the private sector as a whole will be the real (inflationadjusted) economic resources. Those will develop independently of 

movements of the money supply in the short term. 

Mr. CRANE. Well, no, my point is that is what we have been 

doing for the last 30 years, is just increasing the money supply. We 

have a steady erosion of the integrity of our dollar, and we have 

had it going on for 30, 35 years. 

Dr. HOLTZ-EAKIN. The evolution of inflation in the United 

States is certainly one that we can discuss at length. I would point 

out that in both the presentations we have adjusted for that. We 

have taken out the inflation components and have isolated just the 

part that has to do with real economic growth. 

Mr. CRANE. Oh, I know you have in your projections, but what 

I’m saying is that is one of the alternatives that, sad to say, government can fall back on. 

Mr. SHAW. Let me reclaim my time, as it is about to expire. 

Again, as Mr. McCrery asked, on the previous chart that was up 

there, you have not built in any prescription drugs into your prediction? 

Mr. WALKER. No, this is the current program. It does not include any potential prescription drug benefit. 

Mr. SHAW. I thank you both for your testimony. I wish you 

could have brought us better news, but you have to tell us what 

you think and there is no sense in going after the messenger because the real problem lies with us right here. Thank you. Yield 

back. 

Mr. MCCRERY. Mr. Shaw makes an excellent point about the 

savings that we have in the trust fund. To make it crystal clear, 

it is kind of like me telling myself I am going to save for my son’s 

college education, and I am going to save 3 percent of my income. 

I write a check for 3 percent of my income, but instead of putting 

it in savings, I spend it on a car or a house or whatever and I write 

myself an IOU and put it in the drawer. So, that when my son gets 

to college age, I take those IOUs out and spend them on his college 

education. Well, clearly, I have to come up with the money somewhere to pay those IOUs. 

Mr. SHAW. Or he doesn’t go to college. 

Mr. MCCRERY. Or he doesn’t go to college. So, it is an excellent 

point that Mr. Shaw makes. It is not the trust fund that we need 

to worry about so much as it is the cash flow. 

Mr. Levin. 

Mr. LEVIN. Welcome. I was going to ask you about deficits, but 

I have decided not to do so. It is interesting that people shift in 

terms of their attitudes toward deficits. When it comes to tax cuts, 

we have been hearing deficits don’t matter. Then some of the same 

people who said that, when it comes to their desire to restructure 

Medicare, deficits are supremely important. It seems to me there 

needs to be some consistency in position. Some of us who have 

thought deficits have mattered and acted that way for the last 20 

years have tried to be consistent. 

It is also interesting, when it comes to estimates, there is also 

kind of the same pragmatic approach, to put it charitably. When 

people want to accomplish a certain purpose—in this case Medicare 

and restructuring it—they talk about these estimates as if they are 

49

divinely decreed. Then, if they are defending a so-called growth 

package, they say what Mitch Daniels said just a month ago or 2 

months ago, that these estimates, 10-year estimates are not just 

flawed but wildly misleading, to quote him exactly. 

So, I think I won’t pursue these issues here, but just talk about 

a few other things. By the way, in terms of projection in Medicare 

spending—maybe this isn’t fair to the new Director, but I think 

CBO’s estimates on Medicare spending the last 6 or 7 years, as I 

see the data, those estimates have not been very accurate, have 

they? They have overestimated actual spending in their projections. 

Or maybe you don’t have that data. 

Dr. HOLTZ-EAKIN. I don’t have the history in front of me. I will 

be happy to provide the history, if you would like that. I will point 

out that in doing its projections, CBO is constrained to project current law. In those circumstances, if after the projection is made the 

Congress chooses to alter physician payments or other attributes of 

the Medicare program, we will of necessity have our numbers be 

wrong after the fact. It is the nature of the projection process. We 

can happily go back and examine the history and find those situations where we might be able to improve it, given that we are constrained to project current law. 

Mr. LEVIN. Okay, if you would do that and provide us the information. I don’t mean to minimize the problem for 1 minute. I just 

think there needs to be a consistency and we should not be using 

these figures to suit our particular purpose and then the next week 

take the opportunity position. 

Let me ask Mr. Walker about your statements on page 2 about 

Medicare’s overly generous rates. I just saw some material from 

southeast Michigan hospitals that talked about $40 million losses. 

Would it be possible—I am not sure this is within your authority—

for you to come to Southeast Michigan and sit down with the hospitals and determine what the true picture is? Is that something 

consistent with your——

Mr. WALKER. Well, Mr. Levin, I don’t know that it is consistent. 

I would be happy to talk to you about what may or may not be appropriate for us to do. The reimbursement rates can vary based 

upon the type of provider involved, the locality involved, and a variety of factors. So, we have to be careful when we talk about averages because there can be significant variances from averages. 

Mr. LEVIN. Okay, let us do that. By the way, when you talk 

about overly generous rates for certain services and products, has 

that applied in some instances, some substantial instances to reimbursements or payments to Health Maintenance Organizations 

(HMOs), to managed care organizations? 

Mr. WALKER. We have reported on that, we have reported on 

skilled nursing, and a variety of things——

Mr. LEVIN. You have reported on overly generous payments to 

HMOs? 

Mr. WALKER. We have done some work on that and I would be 

happy to provide it to you. 

Mr. LEVIN. Thank you. 

Mr. WALKER. Again, one has to be careful, because there can 

be big variances from the average. 

50

Mr. LEVIN. That applies to HMOs, to various payment structures, right? 

Mr. WALKER. Correct. 

Mr. LEVIN. Thank you. 

Mr. MCCRERY. Mrs. Johnson. 

Mrs. JOHNSON OF CONNECTICUT. Thank you, Mr. Chairman, and thanks to both of you for laying out very clearly and 

quite starkly the problem that confronts us with the entitlements. 

It is absolutely clear that we have to add prescription drugs to 

Medicare with that information in mind. It would be very helpful, 

because Members on both sides of the aisle, whether they are on 

this Committee or the Committee on Commerce, in this body or the 

other body, whether on the major Committees or off the major 

Committees, are trying to think this through. I think it would be 

helpful if you took the charts that you did for us today, the primary 

ones having to do with out-year growth, and accommodated them 

for the assumption of $400 billion spent on increase in Medicare 

spending for the drug bill, 500, 600, 700, 800, 900, and a trillion. 

There was a trillion-dollar proposal last year that had some significant Members behind it, and all Members on both sides of the aisle 

need to see what the out-year impact of those different breaks 

would be. 

Then you both testified in one way or another to the minimum 

tools that Medicare has to control spending. So, it would be very 

useful if you could kind of do an analysis for us of the major plans, 

taking primarily the other body’s Democratic plan—because I think 

it is fair to say it was the best developed. Now, that may not be 

true, and I would certainly allow my Democrat House colleagues to 

determine what plan you should take. For instance, our plan last 

year had a lot of tools in it. Some of them were very controversial. 

We need to see what impact those tools would have on spending 

growth. 

For example, we allowed negotiating below the best price. The CBO gave us $18 billion credit for that. We required people to actually spend their own money to reach the catastrophic threshold—

not they’re employer’s money, not their insurance company’s 

money, their own money. That actually, I think, saved us, as I recall, $40 billion. 

So, Members on both sides need to see what are some of the tools 

that are employed in the major bills that are out there to control 

spending, and what has been the consequence. For example, if you 

write the premium in law, then you no longer have the ability for 

efficient plans that negotiate a better drug benefit for lower cost, 

to be able to charge less. You know, what are the implications of 

that? 

So, I think we need to get a better grasp, I think all Members 

need to have at their disposal a better grasp of what you can do. 

What happens if you change Medigap law so that Medigap is not 

allowed to cover the deductible and copayaments in Medicare? My 

understanding is that one tool that has worked is first dollar responsibility. 

So, I would like you to comment on particularly tools that we 

don’t have in Medicare that you think it would be advisable for us 

to consider having because of their impact on cost growth. As you 

51

comment on that, I would remind you, Dr. Holtz-Eakin, that we 

sent you a letter about prescription drugs and specific drugs that 

if people take they stay out of the hospital, they don’t get in an 

emergency room, they don’t even see the doctor as much. Where 

are we in the science—and you might want to comment on this, 

too, Mr. Walker—the science of being able to determine what portion of the prescription drug effort will actually reduce hospital and 

other costs, and how could we structure our bills to focus on those 

drugs in those diseases that are most likely to have the effect on 

the rest of the plan of reducing costs. Are any of you doing any 

analysis on the small percentage of seniors that have five chronic 

illnesses and are eating up the majority of the money, and how 

would—so that you can begin helping us think through, how do we 

focus on that? If we focus on the people with chronic illnesses, with 

five chronic illnesses, we should be able to reduce costs and at the 

same time improve quality of care. 

So, I have just laid out some tools here. We will be sending you—

in fact, I delivered today to you, Dr. Holtz-Eakin, a binder on the 

issue of chronic disease management and if we are able to feed in 

the seniors that meet that criteria, do we have a potential, and 

what is that potential in dollar amounts, to constrain cost growth 

and at the same time improve the quality of care. 

So, what ideas would you commend to us, what tools would you 

urge us to give Medicare to bend this cost curve? 

Dr. HOLTZ-EAKIN. Well, Congresswoman, if I could take those 

in reverse order. First of all, thank you for the information you provided to CBO. We will add it to the wealth of studies that we are 

examining. 

With regard to the ability to identify high-cost patients in Medicare, we are looking at the degree to which those high-cost patients 

are high-cost patients not just for 1 year, but for many years thereafter, and also, the degree to which they are identified with particular diagnoses and chronic illnesses. These are areas of active 

study at CBO. We look forward to working with you. We have not 

yet reached firm conclusions on the ability to move forward with 

a specific program to identify individuals and estimate cost savings 

from those kinds of approaches, but it is certainly under study. 

On the question before that, the degree to which prescription 

drugs will lower costs elsewhere, we have investigated this at some 

length. To date, while there are cases of specific diagnoses—particularly heart disease—where one can identify a tradeoff between 

prescription drugs and traditional therapies, on balance, the peerreviewed literature and the research community has not yet 

reached any kind of an indication that we get an overall saving 

from providing prescription drugs. It is an area in which CBO has 

a lot of interest, and we will continue to study it. 

On your first question regarding tools for cost containment, I 

would point you to the broad mantra of incentives and opportunity. 

To the extent that a prescription drug provider has incentives to 

control costs by being at risk for the insurance risk in a program 

and has tools available—opportunities to control costs by negotiating with manufacturers, by picking a single drug out of a class 

of drugs, and a variety of mechanisms of that type—one will get 

better cost containment from providers. The same lesson would 

52

apply on the beneficiary side as well. I would be happy to work 

with you on the particulars of those lists. 

Mr. WALKER. Mrs. Johnson, we have already done a fair 

amount of work on this and we have other work under way. We 

look forward to working with you and others on it. 

I think you make a good point. The Congress may well decide 

that it wants to update Medicare to include a prescription drug 

benefit because, had you designed Medicare today, you would undoubtedly have included a prescription drug benefit. However, it is 

also important to learn the lessons from what has happened since 

1965 in the design of insurance, of health insurance. You need to 

learn those lessons and try to design this benefit in a way that provides incentives to control cost. I think you also, frankly, in time 

are going to have to do the same thing for the whole Medicare program. I think you are going to have to fundamentally reassess the 

entire Medicare program because as it is presently designed it is 

unsustainable. We don’t have the right type of incentives, transparency and accountability mechanisms in place, and you are ultimately going to have to do it for the whole program. 

Mrs. JOHNSON OF CONNECTICUT. Thank you. 

Mr. MCCRERY. Dr. McDermott. 

Mr. MCDERMOTT. Mr. Chairman, I think we ought to have 

some truth in advertising here. This says this is going to be a Committee hearing on expanding coverage on prescription drugs. We 

don’t have any plan before us, neither one of the witnesses are 

talking about a plan that anybody is putting forward. So, I think 

what we are talking about is how to get rid of Medicare. So, I want 

to talk a little bit about Medicare. 

Mr. MCCRERY. You may proceed. 

Mr. MCDERMOTT. Dr. Reinhardt in his testimony suggests that 

there is data from the Dartmouth Study that in Texas they spend 

$9,000 per patient, or in Miami, $7,800 per patient, and in Oregon 

they spend $3,600 per patient. Now, there is a recent study that 

came out of the group up at Dartmouth that suggests there is no 

advantage, health-wise or satisfaction-wise, from either a double or 

a triple expenditure in Miami. Where are you with a proposal? 

Now, I say that I look at what happens with doctors’ fees, where 

we have set a global budget, and we said we were going to control 

how much money and therefore we figure out through the scheme 

how much we are going to pay. The thing we didn’t control was utilization. Utilization is out of control. 

The same is true in the South, or in many parts of the country. 

I wouldn’t just say the South, because it is not only in Baton Rouge 

and in Miami that you get these big expenditures, but it is other 

places. What you find is, it is longer hospital stays and it is more 

specialists seeing patients. 

I come from a place where if we were running a health care system like the State of Washington or Oregon or Minnesota, there 

would be no Medicare problem here. I wonder what you guys have 

as suggestions of how we fix the present system. What answer do 

you have to the utilization problem? We get as good results in 

Washington State as they get in Miami and Baton Rouge, for less 

than half the amount of money. 

53

Now, what is the solution? You are both supposed to have some 

ideas here for us, how we are supposed to fix the Medicare plan. 

Dr. HOLTZ-EAKIN. You are first. 

Mr. WALKER. Well, first let me say there are probably four 

things primarily driving the overall cost. There’s the number of 

persons involved; inflation—both overall inflation, and then health 

care costs in excess of that; there is utilization, which you properly 

point out; and there is intensity, the intensity of care. All these factors end up increasing the top line on health care costs. 

I would respectfully suggest, for any system to work, whether it 

be health care, whatever system it is, you have to have incentives 

for people to do the right thing, including controlling cost, reasonable transparency to make sure somebody’s looking; and appropriate accountability mechanisms if somebody tries to abuse the 

system. I would respectfully suggest our Medicare system does not 

meet any of those criteria. I would be more than happy to provide 

some information for consideration by the Congress. 

Mr. MCDERMOTT. I realize you have made a diagnosis, but 

what is the cure? Tell me the economic—see, I am not an economist 

like you guys are. I don’t understand dollars and cents. So, I am 

looking to you to tell me what mechanism you put in place for this 

incentive program. 

Mr. WALKER. Well, for one thing, I think that ultimately the 

Congress is going to need to reconsider fundamentally what is the 

promise. What is the promise in Medicare? Let me give you an example. 

If you look at health care, there are several important elements. 

One is guaranteed access at group rates. The second is the affordability of that. The third is protection against financial ruin due to 

catastrophic illness. There is room in-between. You can have guaranteed access to insurance at group rates. You could end up providing significant protection against financial ruin. You could end 

up having more cost-sharing, which is where you need more costsharing. Where you don’t have enough incentives to control cost. I 

also don’t think that we have adequate, timely, and useful information to analyze what is going on out there. The data that we have 

for health care is often 2 and 3 years old. Health care is a huge 

percentage of our economy. A lot of the data that MEDPAC and 

you have to rely upon to make decisions is old data and it is provided by providers, who have a fundamental conflict of interest. 

So, I would be happy to be able to provide some information for 

you to consider. It would be a fundamental review and assessment 

of the current system. You need a comprehensive review but will 

probably need to act incrementally. 

Mr. MCDERMOTT. Do you think the 52 percent that beneficiaries already pay is not enough incentive to control cost? Do you 

think that they are the ones—is that who? It sounds like they are 

the ones that you think ought to be controlling the costs, not the 

professionals. 

Mr. WALKER. No, I think there is clearly room, both on behalf 

of those who are being paid as well as the beneficiaries. So, I don’t 

think it is one side or the other. I think there are issues both ways. 

I would be happy to have a conversation with you about it. It is 

a large subject. 

54

Mr. MCCRERY. Mr. Ramstad. 

Mr. RAMSTAD. Thank you, Mr. Chairman. Thank you, gentlemen. 

Dr. Holtz-Eakin, I just want to try to get my arms around Medicare spending, putting it in a contextual basis, if you will. You stated that your projections show at CBO that overall Medicare spending is expected to quadruple by the year 2075 to more than 9 percent of GDP. I believe that the assumption was that we make no 

major changes to Medicare. Today the size of our GDP is roughly 

at $10 trillion. What does CBO estimate the GDP to be in 2075? 

If it is $10 trillion today, what is it going to be in 2075? 

Dr. HOLTZ-EAKIN. That is a number we could get for you. It 

is going to grow over the long term at an average annual rate of 

somewhere between 3 percent and 31⁄4 percent, and over long periods that will add tremendously to the overall size of the economy. 

I can get back to you with the precise number. 

Mr. RAMSTAD. Yeah, because I would like to know if we don’t 

make changes to Medicare, then according to your statement one 

can deduce that Medicare spending in 2075 would be 9 percent 

of——

Dr. HOLTZ-EAKIN. A very large number. 

Mr. RAMSTAD. A very large number. 

Dr. HOLTZ-EAKIN. We can get both large numbers for you, if 

you would like. 

Mr. RAMSTAD. Okay. I think that context is important, certainly. Then to follow up your colloquy with Mrs. Johnson, did I 

understand you to say that a prescription drug benefit for Medicare 

seniors should not be enacted without overall Medicare reform? 

Dr. HOLTZ-EAKIN. In the end, the Congress will decide the best 

path to go forward. My discussion with Mrs. Johnson was about 

the extent to which prescription drugs—the introduction of prescription drugs into a therapy—would provide cost saving elsewhere in the medical system. The evidence thus far does not indicate automatic cost saving so that you get an offset from traditional 

therapies when you introduce prescription drugs. 

Mr. WALKER. I said that I believed that it would be prudent to 

address both at the same time. 

Mr. RAMSTAD. That is right, it was your colloquy with Mrs. 

Johnson. Excuse me. 

Mr. WALKER. That is correct, that it would be prudent to engage in reforms of the program, not just to add on a prescription 

drug benefit. Congress ultimately can do whatever it wants, whether it is prudent or not. 

Mr. RAMSTAD. Again, Mr. Walker, asking you the question, is 

it a fair assessment of your statement that a prescription drug benefit for Medicare seniors should not be enacted without comprehensive Medicare reform? 

Mr. WALKER. My statement says, first, that I think it is evident 

that you are going to do something on prescription drugs, and it 

is arguably needed at this point in time. You should be careful 

about how you design that program, and you should also couple it 

with more comprehensive reforms—not just make the long-term 

situation worse. 

55

Mr. RAMSTAD. That certainly is responsive to the question. I 

very much appreciate that answer. I think that is what most of us 

believe, at least on this Committee, that to do it without the context, not within the context of overall Medicare reform is making 

a serious mistake, for the reasons you cited and alluded to. 

I just want to ask in my remaining couple of minutes, Dr. HoltzEakin, let me also say that I think Congress is fortunate to have 

an economist of your caliber at the helm. You do not have an easy 

job, either one of you gentlemen, and we appreciate your good 

work. 

Most of us, I think, who support a prescription drug benefit for 

seniors do see a cost saving to Medicare. Won’t there be a cost savings if seniors have greater access to prescription drug therapies 

rather than the more—what is documented is more costly and intrusive inpatient and outpatient treatments that are currently covered by Medicare? 

Dr. HOLTZ-EAKIN. While I applaud your intuition, in the end, 

when we do the cost estimates, we rely on the evidence that is 

available in the research community as a whole. While we have 

found specific instances in which there are cost savings, as a broad 

statement for the health care system as a whole, there is not evidence yet that that is taking place. So, I cannot offer that hope to 

you. 

Mr. RAMSTAD. Well, you are right. My intuition is based more 

on anecdotal experience than empirical data. I would like to see the 

study you allude to. 

Dr. HOLTZ-EAKIN. We will be happy to work with you on that 

and would look forward to any information you might be able to 

provide to CBO. 

Mr. RAMSTAD. It just seems counter-intuitive to me, but again, 

I defer to your empirical data. I would like to see those studies, if 

I could. 

Mr. WALKER. If I can, the evidence is that is not the case. The 

evidence is, is that but for a few exceptions where there may be 

a savings, that he has referred to, that in the aggregate there is 

not a savings. 

Mr. RAMSTAD. Again, to me that seems counter-intuitive, but I 

would like to explore that further. I thank you very much for being 

here today and your responsiveness to my questions. 

Mr. MCCRERY. On the next panel we have some health care 

economists, so maybe they can explore that with us at greater 

length. Generally, I think the response given by the two witnesses 

before us comports with what we have been told by health care 

economists before. Maybe part of the reason for that is that most 

of the medical expense for seniors occurs in the last 6 months of 

their lives. Regardless of the fact that we give them preventive care 

or medications or whatever, eventually they are going to get sick 

and die, and that means they are going to have the last 6 months 

of life which is going to be expensive. So, quality of life is one 

thing, but saving money is another. I am not sure the evidence, unfortunately, points to significant, if any, savings because of preventive care or a health care regimen. 

Mr. Kleczka. 

56

Mr. KLECZKA. Thank you, Mr. Chairman. I have a few concerns. Let me start with Mr. Walker. Could we put that chart back 

up on the trust fund deficit? 

My question, Mr. Walker, is if I were preparing a net worth 

statement for myself, I would naturally list the cash, right? If I had 

a promissory note due me, would that be listed as my asset? 

Mr. WALKER. If it was a good promissory note, yes. 

Mr. KLECZKA. No, don’t—good, bad, indifferent. It is a promise 

we made. We will make the judgment, not you. If it is a promissory 

note, that would be part of my asset base and end up in my net 

worth, would it not? 

Mr. WALKER. Yes, it would be considered. 

Mr. KLECZKA. Okay, that is why I think this chart is very disingenuous, to say the least, because you might contend that cash 

is king, but nevertheless it is not a true picture of the entire net 

worth of the HI Fund. The fact that we have promissory notes in 

the fund is Congress’ doing. At the time the cash, King Cash, is 

running out, this Congress or whatever Congress is going to have 

to make the judgment whether or not to make it whole. By presenting this chart, and your comments, you indicate, well, the 

money is gone, folks, and let us not kid each other, Congress is not 

going to raise taxes to replace it. You know, that is a decision we 

will make, not the comptroller general or the GAO. 

In 2013, if I were to include the trust fund balance, the money 

that is in treasuries, what would be the actual fiscal portrayal? In 

2013. Right now you have it at almost zero. 

Mr. WALKER. No, at 2013, what happens is you have—the annual income that you get from payroll taxes and other revenues is 

not adequate to pay current benefits. 

Mr. KLECZKA. I am fully aware of that. Now, we have been 

amassing a balance over the years because we saw this day coming 

years ago. 

Mr. WALKER. That is correct. 

Mr. KLECZKA. There is in fact a surplus. You chose not to reflect it because you are only doing a cash portrayal here. 

Mr. WALKER. No, I have reflected it. If you want to use real accounting here, Mr. Kleczka, real accounting, it is a $6.2 trillion deficit. That is real accounting. 

Mr. KLECZKA. Okay, now—no, no, no, no. Is there not a balance 

in a trust fund that is not cash, that is promissory notes? 

Mr. WALKER. That has value—it has legal significance. 

Mr. KLECZKA. What is that amount? 

Mr. WALKER. The amounts in the HI Trust Fund, let me see. 

Mr. KLECZKA. No, I am looking for a comparison in 2013. 

Mr. WALKER. Two hundred and eight billion dollars——

Mr. KLECZKA. Two hundred and eight billion dollars? 

Mr. WALKER. In the HI Trust Fund——

Mr. KLECZKA. For what year? 

Mr. WALKER. At the end of 2001, so at the end of 2002, $234.8 

billion. 

Mr. KLECZKA. All right, so that blue line would be much higher, and by the time you got to the red line, if you did an accurate 

accounting, that red would occur further out and would not be as 

57

dramatic if you did a true accounting using the entire trust fund 

balance that is in promissory notes. 

Mr. WALKER. Oh, we have that information. I have provided 

that before. 

Mr. KLECZKA. Could you possibly provide it again, maybe in an 

updated form? 

Mr. WALKER. I would be happy to. 

[The information follows:]

Medicare’s Hospital Insurance Trust Fund Balances 2002–25

Below are the Medicare trustees’ 2003 intermediate estimates for all years in 

which the HI Trust Fund is shown to have a positive balance. 

Estimates are provided in nominal and real (2003) dollars as of the end of calendar years.

CY 

HI Trust Fund (EOY)

(millions) 

HI Trust Fund (EOY)

(millions 2003$) 

2002 $234,831 $240,467

2003 $258,537 $258,537

2004 $282,587 $275,991

2005 $310,944 $295,714

2006 $341,790 $315,828

2007 $375,185 $336,580

2008 $410,486 $357,535

2009 $446,563 $377,612

2010 $482,284 $395,964

2011 $517,390 $412,427

2012 $551,710 $426,954

2013 $583,578 $438,451

2014 $611,621 $446,146

2015 $634,426 $449,310

2016 $649,966 $446,897

2017 $656,658 $438,356

2018 $652,578 $422,928

2019 $635,688 $399,980

2020 $603,483 $368,674

2021 $553,018 $328,006

2022 $480,545 $276,716

2023 $382,258 $213,707

2024 $254,600 $138,189

2025 $93,987 $49,527

Source: GAO analysis and data from the Office of the Actuary, Centers for Medicare & Medicaid Services. 

f

58

Mr. KLECZKA. So, at least we can honestly portray this. No one 

is talking cash-only, even though you might contend cash is king. 

I think you have to look at the total picture. If you are right, in 

year 2013 Congress shies away from making whole the trust fund 

and we don’t want to cut spending or whatever to make the money 

whole, we will put up with a riot from those who put money into 

the fund, but nevertheless that is a congressional not a GAO decision. 

Let me ask Dr. Holtz-Eakin a question about his chart. This is 

the one that is entitled Medicare Beneficiaries by Income Level and 

Drug Coverage. 

Now, as I look at this chart, at all income levels, the blue line 

is pretty hefty, indicating that seniors have drug coverage. Did you 

do an analysis of what type of coverage we are talking about? Is 

this a moderate policy, is it a Cadillac plan, is this a couple of 

generics, is it a Medicare Choice-type thing—which naturally they 

are dropping the drug coverage. Is there an analysis of what the 

blue means? Is that decent coverage? 

Dr. HOLTZ-EAKIN. Underneath those numbers are a wide variety of plans, in fact—some programs, which are employer——

Mr. KLECZKA. Medicare is in there also? 

Dr. HOLTZ-EAKIN. This is coverage of any type. So, it is also 

employer-provided plans and Medigap policies. To the extent that 

they have coverage from any source, it is reflected in this——

Mr. KLECZKA. So, it goes from low to high. So, it is not really 

an indicator for the Committee or for the Congress that there is 

adequate coverage out there, or sufficient, or a decent benefit being 

provided to seniors? It is just who has anything? 

Dr. HOLTZ-EAKIN. To the extent that we were trying to capture 

that, it is in the other graphs that show the degree to which beneficiaries would face out-of-pocket expenses versus covered expenses. 

Mr. KLECZKA. Have either or both of you gentlemen looked at 

the President’s drug plan that he submitted to the Congress? 

Mr. WALKER. I have not analyzed the President’s plan. 

Dr. HOLTZ-EAKIN. The President provided insufficient evidence 

for CBO to do any real analysis of it, as we discussed in our analysis of the President’s budget that we put out in March. 

Mr. STARK. Would the gentleman yield? 

Mr. MCCRERY. The gentleman’s time has expired. 

Ms. Dunn. 

Mr. STARK. I guess not. 

Ms. DUNN. Thank you very much, Mr. Chairman. Thank you for 

being here gentlemen. Mr. Walker, I want to go to a point that Mr. 

McDermott touched on briefly. In your testimony you stated that 

Medicare pays overly generous rates. That is not, we feel in my 

State of Washington, necessarily close to the truth. You also mentioned that Medicare’s payments are based on averages. I am very 

concerned about the variation in payments from one region to another. I am wondering if you come to us with any recommendations 

to create more equity in these payments. For example, do you have 

recommendations on the formula that is used to determine these 

payments? 

Mr. WALKER. Not today, Ms. Dunn. Let me say that what is in 

my testimony talks about the fact that GAO has done work that 

59

in some cases there are over-generous payments, not in all cases. 

We have also done work to show that there can be significant differences in what reimbursement rates are in different regions of 

the country, and also the reasonableness of what those reimbursements are between different types of providers. So, it is not a onesize-fits-all. I would be more than happy to follow up with you after 

the hearing, if you want. 

Ms. DUNN. Yeah, I would appreciate that. It is a continuing 

problem in our State, where we believe we produce the best medical care available in the country, and yet we are having a hard 

time holding onto our doctors and keeping our hospital doors open 

because the reimbursements aren’t there at the same rate that 

they are in many other States whose quality of care is not any better than ours. 

Mr. Walker, let me ask you, too, about a GAO report that was 

released in January. It was on the role of the pharmaceutical benefits managers (PBM) in the Federal Employee Health Benefits program. I am wondering if you can summarize your findings in that 

report. Did beneficiaries, for example, have sufficient access, do you 

think, to retail pharmacies? 

Mr. WALKER. I think the bottom line in that report is that 

PBMs are a tool that had been used, including by the Federal Employees Health Benefit Plan. It is a mechanism that the Congress 

may well want to consider in conjunction with providing a prescription drug benefit under Medicare. There are, however, some differences between how Medicare historically has been arranged—

any willing provider, and so forth. There is an opportunity for cost 

savings here with regard to PBMs, but there are some adjustments 

that are going to need to be made if you’re thinking about doing 

it under Medicare. 

Ms. DUNN. Your comment on access to retail pharmacies? 

Mr. WALKER. Most have a broad network. It can vary, but yes, 

there are access to retail pharmacies in some circumstances, yes. 

Ms. DUNN. Thank you. Thank you, Mr. Chairman. 

Mr. MCCRERY. Mr. Portman. 

Mr. PORTMAN. Thank you, Mr. Chairman. Let me start off, if 

I could, by following up on Ms. Dunn’s question. Your GAO report 

with regard to pharmacy benefit managers, it seems to me, gave 

us some good information with regard to the so-called brick-andmortar or retail pharmacies. Many of them were quite concerned 

with the bill that was enacted—not enacted, but passed by this 

Committee and by the House of Representatives last year. Despite 

the fact that we did not allow direct-mail pharmacies to have a 

dominant position, still they were concerned that they might not be 

accessed by the Medicare prescription drug plan we put forward. 

So, I think to the extent you can provide us this new information 

in relation to this new legislation we are hoping to put together 

this year, it would be very helpful. 

What I took from it was that in the experience of the Federal 

Employee Health Plan, that in fact there was access to retail pharmacies. Perhaps that is a good example for us to use and to try to 

allay some of those concerns, because all of us have them, particularly those of us who represent small towns where you have pharmacies that really provide more than just the prescription drug, 

60

but also more health maintenance and preventive health for beneficiaries. 

I would like to go back, though, if I could, to some of your earlier 

testimony. I apologize that you have to sit here and be told by some 

of our Committee Members that you are coming here to tell us how 

to get rid of Medicare. I feel just the opportunity about it. I think 

that is offensive to you, two professionals who, in the case of Mr. 

Walker, I know has spent a lot of time on this issue, and to our 

newest CBO Director. 

I appreciate the fact that you are giving us what I view as 

straight talk. This is a very politically charged issue, as you have 

seen here this morning. Again, Mr. Walker knows that from working on it in the past. We need good data. I thought you were responsible in terms of how you presented the solvency issue because 

it is true that the lines do cross at 2013. It is true that then Congress has choices to make. You laid out those choices very specifically, including borrowing, including tax increases, including reducing benefits. These are tough choices that, in my view, Congress 

will have a very tough time making in 10 short years. 

So, I thank you for bringing focus on that. We constantly hear 

that the year is 2027 or, now, 2026. So, I think, if anything, we 

need to bring more focus on the fact that we have a fiscal crisis 

that is more imminent. So, I appreciate that. I also appreciate the 

fact, again, you laid out what the options are at that point. So, I 

thank you for that. 

I guess my question for you, Mr. Walker, would be, when you 

talk about ‘‘true accounting,’’ you said in fact there would be a deficit—I believe you indicated that in response to Mr. Kleczka’s question—at 2013. What did you mean by that? 

Mr. WALKER. Well, what I meant by that was, if you were actually preparing a net worth statement and you were using accrual 

concepts, where you were trying to estimate what the discounted 

present value of what your future promises are and you look at 

what is the discounted present value of the revenue stream that 

you have to meet those promises, what is the gap, there is a $6.2 

trillion gap for HI. I am just trying to provide the facts. Congress 

is elected, Congress has to make the judgments on what to do with 

the facts. Sometimes people don’t like the facts, but they are nonetheless the facts. 

Second, as you properly point out, and I appreciate it, I was a 

trustee in Medicare for 5 years. I care very deeply about Social Security and Medicare. I was a trustee of Social Security as well. We 

have to start dealing with the facts. 

Mr. PORTMAN. Well, I appreciate that and I think, again, I 

view it just the opportunity. We are not talking about how to get 

rid of Medicare, we are talking about how to save Medicare. When 

you look at the demographic challenge we face with people living 

longer and with more and more baby boomers retiring—and I appreciate also the fact that your charts today indicate that, how 

much of it is due to the Medicare health care cost increases and 

that inflation is still, in my view, way too high to be sustained, but 

also just the aging population. My 98 year old grandmother, who 

is right now back in Cincinnati—if C–SPAN was on, she would 

probably be watching this, still very sharp—God bless her, but 

61

there are more and more people in that situation. Eighty-year-olds 

are our fastest growing group. So, it is important that you lay that 

out, too. It is not just the fact that health care costs are increasing 

at unsustainable levels; it is this aging population. 

Quickly to CBO: Your challenge is to help us determine whether 

some of these competition models really save money. I know that 

you have looked at some of these proposals. You indicated you 

hadn’t looked at the President’s proposal. My understanding is you 

have done some preliminary analysis of some of the proposals that 

they have for competition, and you have indicated they do not have 

significant savings. Is that not accurate? 

Dr. HOLTZ-EAKIN. To date, we have had staff-level discussions 

on a variety of prototypes and thoughts. It is an overstatement to 

say that CBO has scored any specific proposal, the President’s or 

otherwise. 

Mr. PORTMAN. Well, we appreciate your focusing on that over 

the next several months, because it is going to be critical to us to 

figure out how to keep high quality of care and deal with this huge 

challenge. I know you will look at it creatively, because some of the 

existing models, I think, are inadequate. Maybe the Federal Employee Health Benefits Plan that GAO looked at is one model. Any 

models out there with regard to competition—choice, which is 

something that our seniors want—we certainly look forward to, because the existing model is not one that can be sustained. Therefore it is a failed model. 

Thank you, Mr. Chairman. 

Mr. MCCRERY. Mr. Pomeroy. 

Mr. POMEROY. Thank you, Mr. Chairman. I would like to begin 

by yielding such time as he may consume, but I hope it is not 

much, to Mr. Stark. 

Mr. STARK. I just want to go back, Dr. Holtz-Eakin. You said 

that there wasn’t adequate information on the President’s plan for 

you to estimate it. Did I hear that in response to a question back 

one or two? 

Dr. HOLTZ-EAKIN. In March, CBO conducted its traditional 

analysis of the President’s budgetary proposals. The information 

we had at that time was that there was to be a Medicare prescription drug proposal that would cost $400 billion over 10 years. That 

was the extent of the information. 

Mr. STARK. I did want to, and I heard Mr. Portman allude to 

this, too, that there was, according to the Wall Street Journal’s 

weekly gossip sheet here, a very high-ranking government official 

who recently told some Members of the other body that the Medicare overhaul plan could add hundreds of billions of dollars in costs 

and that the Administration’s cost-savings claims for its plan were 

disputed by the early data of a demonstration project. Small savings from encouraging seniors to opt for private plans would be offset by high administrative costs. I presume that—of course, that 

was just a shot in the dark by somebody who obviously didn’t have 

adequate information on the President’s plan. 

Mr. MCCRERY. In court we would call that hearsay. 

Mr. Pomeroy. 

Mr. POMEROY. Thank you. First of all, I want to salute each 

of you for your work. In particular, David Walker and I have had 

62

a chance to work together for years. I think we really have a winner with the comptroller general, a top-flight account, manager, 

and a health policy guru besides. So, you can certainly make a very 

important contribution going forward. I look forward to working 

with you in that regard. 

I think your testimony on page 14 is very interesting. Well, your 

testimony is interesting throughout, Mr. Walker, but I really like 

on page 14, you talk about basically, making government fit the 

challenges of the future will require not only dealing with the drivers, such as entitlements for the elderly, but looking at the range 

of other government activities. Fundamental review of what the 

Federal Government does and how well it does it will be needed. 

This involves—and this is the most important part in my opinion, 

relative to what faces this Congress at this day: This involves looking at the base of all major spending and tax policies to assess 

their appropriateness, priority, affordability, and sustainability in 

the years ahead. 

So, we had some discussion today about addressing prescription 

drugs in the context of an overall Medicare package, but it seems 

to me we ought to talk about Medicare much more in the context 

of the overall budget, especially the tax cuts that are the centerpiece of the Administration’s, the House-passed plan. 

Clearly a diminished revenue picture in light of the tax cuts proposed—first the growth package and follow along making the tax 

cuts permanent—will have what effect, Mr. Walker, on the ability 

of the Federal Government to meet these Medicare payments on a 

cash-flow basis as they come in in the next decade? 

Mr. WALKER. It will reduce the revenues available. I try to be 

an equal opportunity fact-provider. That is generally to be consistent and to be transparent. We have done a simulation that 

shows what the effect would be if Congress decided not to extend 

the tax cuts. It would have an effect, but it is not enough of an effect to solve the problem. We are still going to need to do what you 

read in my testimony. The difference may be less, but there is still 

a significant gap in——

Mr. POMEROY. Absolutely. I am certainly not suggesting it is 

simply a matter of just not doing tax cuts, everything is rosy. I 

think we also have to come to grips with the fact that we are making a difficult situation a great deal worse, are quite possibly putting us in a framework where we really can’t prudently commit the 

long-term commitment of a Medicare reform, including prescription 

drugs, if we would so significantly reduce the Federal revenue base. 

Mr. WALKER. I think you need to consider it in the broader context. I think there are three levels—the overall fiscal challenge, 

health care, and Medicare. I believe you need to look at all of those. 

Mr. POMEROY. Mr. Walker, because we operate in a 10-year 

budget window, but that really misses just around the corner what 

happens when the baby boomers retire and the costs hit, is there 

some analysis that you could do, or CBO could do, that would 

somehow help us as we look at revenue issues now what that 

means in terms of impact next decade relative to meeting these existing commitments, the Social Security and Medicare? 

Mr. WALKER. Well, I think one of the graphics that I showed 

was the long-range budget simulation gives you a feel for that. One 

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of the things I believe Congress needs to consider before it enacts 

legislation is that you need to consider the discounted present 

value cost of both spending and tax sides before you make the decisions. You need to consider what the bottom-line impact is. I believe that is very important, and should be consistent on both sides. 

I should also say one last thing. I think this Committee, Ways 

and Means, also needs to look very hard at existing tax incentives 

for health care. I would respectfully suggest that they are making 

many consumers less aware of the cost of health care and maybe 

fueling health care cost increases. 

Mr. MCCRERY. Thank the gentleman for that astute comment. 

Mr. Hulshof. 

Mr. HULSHOF. Thanks, Mr. Chairman. Those that will examine 

this record will examine the entire record, I feel compelled to respond to some of those who commented earlier, specifically to the 

Ranking Member and the gentleman from Washington State. It 

seems interesting, Mr. Chairman, that when the full Committee 

meets to consider a Chairman’s mark, we hear protestations about 

the fact we have not held hearings. Today we are holding hearings, 

and the objection from the other side, the lament, is that we don’t 

have a bill to consider. Which reminds me of an old law school 

axiom: When the facts are against you, you argue the law; when 

the law is against you, you argue the facts; and when the facts and 

the law are against you, you pound the podium. 

I would also say to the gentleman from North by-gosh Dakota, 

my friend—and even to Mr. Levin of Michigan earlier—who were 

talking about 10-year projection numbers. Mr. Levin specifically decried ‘‘the use of figures for particular political interests.’’ I think 

I jotted his comment down adequately. As recently as 1997, when 

this full Committee considered the Balanced Budget Act, there was 

never a hint or argument about a 10-year projection. There were 

5-year numbers, because the House operates under 5-year numbers. It is only since then that not only do we talk about 10-year 

implications, but now 15 and 20 and 30 year implications about tax 

cuts and the like. So, I think I just wanted to insert that editorial 

comment of my own and then get to a question. 

Dr. Holtz-Eakin, I am also privileged to serve on the Committee 

on the Budget along with this Committee. As we debated the Medicare proposal, prescription drug and modernization—and I do include those worlds equally, I would say that I think the CBO estimate alone may not fully inform us of the consequences of various 

prescription drug proposals. Let me ask your comments on that. 

We could have a $400 billion proposal that might lead to lower 

costs for purchasing prescription drugs, it could lead to more marketplace competition, it could lead to more innovative drugs being 

introduced into the marketplace. Or we could have a $400 billion 

proposal that could lead to no additional innovation, no price stabilization. So, really, what we choose to do—we can have this $400 

billion new proposal, and yet depending on which direction we go, 

and each of you talked about innovations and incentives and consequences of those incentives, how critical is it from an economist’s 

perspective that any Medicare modernization bill or prescription 

drug bill encourage competition among private firms, increase acVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00067 Fmt 6633 Sfmt 6602 E:\HR\OC\89405.XXX 89405
64

cess by new firms and encourage innovation for new drugs and 

technologies? 

Dr. HOLTZ-EAKIN. Speaking as an economist, it may be the 

case that, consistent with the charts we showed you, this Nation 

chooses to spend an increasing fraction of its wealth on medical 

care broadly defined. However, for those dollars to be used wisely, 

one must give participants the incentives and opportunity to channel those dollars to those particular drugs or therapies that are the 

ones that they value the most highly, and that is the traditional 

economic route to getting high value per dollar. 

Mr. HULSHOF. To go even—and to look at our current Medicare 

program, the current fee-for-service program is an any willing provider program. If we perpetuate that structure in a prescription 

drug program and we put aside the use of formularies or select contracting with pharmacies, what impact would that have on our 

ability to control costs? Maybe another way to ask you the question 

is, what incentives are there to control costs if the government 

holds 100 percent of the risk? 

Dr. HOLTZ-EAKIN. I think a concrete way to answer the question is to look back at previous CBO analyses of prescription drug 

proposals in previous Congresses and look at those situations in 

which there were perceived to be cost-containment incentives and 

opportunities on the part of providers—whether they were at risk 

for the insurance losses, whether they had tools available to choose 

low-priced drugs, whether there were price signals sent to beneficiaries to choose among providers on the basis of costs. All of 

those things figured into CBO’s cost estimates. 

Mr. HULSHOF. I appreciate both of you gentlemen, especially 

with the charts, which I think are quite telling. I have back in Missouri a fairly substantial town meeting coming up, and would ask 

the opportunity to use these charts that you have shown to us 

today to help explain some of the challenges that we have because 

I think they are quite telling. 

Mr. MCCRERY. Mr. English. 

Mr. ENGLISH. Mr. Chairman, will yield my time to Mr. 

Portman. 

Mr. PORTMAN. Well, thank you, Mr. English. I didn’t know I 

would have this opportunity, but let me go back to some of the earlier questions and some of the legitimate concerns that were raised 

on proposals that might be before this Committee and just make 

what is maybe an obvious point. 

Medicare and Social Security, as well as some other major controversial and, as I said earlier, politically controversial issues 

should be handled on a bipartisan basis, really have to be to be 

successful. I think it was President Jefferson who said a big issue 

should be more of a point of consensus rather than a bare minority 

or a bare majority. 

One of my concerns is that, as we criticize the various proposals, 

we are not hearing alternatives from the other side of the aisle as 

to what they would do with regard to these I think now well-defined solvency issues. 

So, I would just urge my colleagues on the other side give us 

your best ideas. We could always come up with a Medicare prescription drug coverage plan that costs $1 trillion a year or $1 trilVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00068 Fmt 6633 Sfmt 6602 E:\HR\OC\89405.XXX 89405
65

lion over the 10-year period, and Mrs. Johnson talked about that, 

that would be politically popular in certain circles. It would not be 

the responsible thing to do. 

We, instead, are trying to both provide this needed coverage 

which, in the modern day, must be there, but also modernize the 

program itself so that it can be sustained over time. So, I would 

just make the obvious point that, while it is easy to criticize and 

to poke holes in the various proposals that are going to come up, 

the responsible thing would be to offer alternative proposals. 

In the area of Social Security, we have the 75 year solvency 

standard criteria. I would suggest here the criteria might be some 

of the challenges you have faced us with today, including the crossing of the line, as I said earlier, between the revenue coming in, 

and the benefits being paid out in 2013 or even pushing it back to 

2026, coming up with some way to fund that interim period, but 

we need to have some standards, and I wonder if the two of you 

could perhaps comment on that, putting you on the spot here of, 

maybe Dr. Holtz-Eakin, you could go first. What should the standards be for Medicare modernization and prescription drug proposals that we could compare, instead of apples to oranges, apples 

to apples? What would you say would be the appropriate criteria? 

Dr. HOLTZ-EAKIN. In that area, I guess I would offer two 

thoughts. The first is that we presented our analysis of the longrun trajectory for Medicare looking at the current program relative 

to the size of the economy, and I think that is a useful baseline to 

use because it makes the point that in the end, the economy is the 

ultimate source of all of the resources to be devoted to health care 

and other needs. The second point is that the financing mechanisms that the Congress might choose to meet those needs are at 

their disposal. It could be debt financing; it could be tax financing 

or we could choose to lower the trajectory for Medicare outlays. 

So, I think that the right standard is to compare programs relative to the economy—especially over the long term—when making 

decisions in the present that have long-term consequences. 

With respect to comparing proposals on an apples-to-apples 

basis, the traditional way to do so is to attempt to make sure that 

proposals have the same value per dollar, and I can offer you only 

small comfort in that regard because whether a proposal is ‘‘worth 

it’’ in the eyes of the Congress will ultimately be your decision. We 

can provide you with the dollars and allow you to compare the dollars on an equal basis. Whether their proposals are worth it or not 

is a larger question. 

Mr. PORTMAN. Mr. Walker. 

Mr. WALKER. Mr. Portman, the GAO did some work in conjunction with Social Security, where we came up with a list of questions that we recommended that the Congress consider in deliberating any Social Security reform proposal. We are in the process 

of doing the same thing for health care, and I expect that that will 

be done within the next month. I would respectfully suggest that 

this Committee and the Congress as a whole may want to consider 

these questions in analyzing various proposals. We can be helpful 

in that regard, but in the final analysis, you are the elected officials. You have to make the judgments as to what is appropriate 

to do. 

66

I will agree with Doug to say that I think looking at things as 

a percentage of the economy, a percentage of the budget in different ways, moving beyond trust funds, which are really not trust 

funds in Webster’s Dictionary. They are accounting devices. That 

is what they are, nothing more, nothing less. 

Mr. PORTMAN. I think you have made that point clearly today 

early in your testimony, and I would just respectfully say that if 

you look at, as a percentage of our economy or as a percentage of 

our budget, what mandatory spending is, in general, of course, we 

have seen dramatic increases, and the projections are for even 

greater increases, I am not sure that that criteria is one that we 

would adhere to as Members. 

So, anything you can give us, in terms of those questions or even 

in terms of just establishing some criteria to be able to compare the 

various proposals on a fiscal basis would be very helpful. 

Mr. WALKER. Ours cover much more than cost. They cover access administration, quality and other issues. 

Mr. PORTMAN. Right, quality issues. 

Mr. WALKER. It is a much more balanced approach. It is not 

just focused on cost because in the end you need to consider more 

than just cost. 

Mr. PORTMAN. Right. Thank you, Mr. Chairman. 

Mr. MCCRERY. Mr. Becerra. 

Mr. BECERRA. Thank you, Mr. Chairman, and thank you to the 

two of you for your testimony and your time. 

I would like to, if I can actually for 1 second, refer back to the 

GAO chart. I want to make sure I am clear on something. In terms 

of the out-years, in 2050, the largest component that you identified 

there is net interest, and I am assuming that means the interest 

we pay on the national debt. 

Mr. WALKER. That is correct. 

Mr. BECERRA. It seems that it is not much smaller than the 

combined costs of Medicare, Medicaid and Social Security come 

2050. I know that the Congressman from North Dakota was asking 

some questions with regards to this, and I would like to follow up 

on what Mr. Pomeroy was asking. 

If we believe that the size of the debt, which will require interest 

payments larger than any other of these other programs and almost as large as three of our greatest programs combined, would 

it not seem that we would want to be making decisions today that 

help us decrease the size of the national debt, and therefore decrease not just for this year, but in the out-years the amount of interest payments we will be making on that debt? 

Mr. WALKER. I think a different way of saying it is deficits do 

matter. It is important. Obviously, the amount of the deficit, the 

nature of the deficit, the timing of the deficit—is it a time of war 

or recession—should be considered, but ultimately you need to get 

back into balance over the long term. 

Mr. BECERRA. If I am correct, the President’s budget proposal 

would have us with a deficit for each of the 10 years, in the succeeding 10 years of his plan, and thereby increasing the size of the 

national debt. If we were to eliminate his proposals to, one, permanently extend the 2001 tax cut, which is factored into this chart, 

but also eliminate the other proposed tax cut that he has of some 

67

$700 billion over 10 years, principally with regards to dividend repeal, tax repeal, would we see that very dark blue and large box 

under the year 2050 that represents net interest also come down? 

Mr. WALKER. That is correct. We have done that. It would come 

down, and it would come down significantly. It would still be significantly higher than it is today, and you would still have a significant long-range problem to deal with. 

Mr. BECERRA. So, even if we were to cut all of the President’s 

tax cuts, we still have a lot of work to do because there is a lot 

more that goes into making the national debt and the annual deficits that we are facing than just the tax cut. I think most folks understand that, but we have got to, at some point as you said, start 

to bring this budget back into balance. 

Certainly, if we are going to see a net interest payment that 

large, representing that high a percentage of our GDP, it would 

seem that we would want to start now to move toward that road 

of fiscal responsibility. 

Let me ask another question. Dr. Holtz-Eakin, I think you mentioned this in earlier testimony that about 70 percent of Medicare’s 

growth is due to excess health care cost growth which, as I think 

you have mentioned in the past, is not unique to Medicare. The private sector has faced this as well. 

If the private sector isn’t doing much better or any better, and 

some people would say it is doing worse, but if it is not doing any 

better than Medicare at controlling the growth and its costs, and 

in fact I think most people would agree that Medicare has done a 

better job than the private insurers in curtailing costs, how do we 

expect a program that would turn over, as the President proposes 

in his plan, Medicare or prescription drug benefits to private plans, 

in essence, privatizing senior’s health care, at least for prescription 

drugs, how would that help us reduce costs under Medicare? 

Dr. HOLTZ-EAKIN. There are really two answers to your questions. The first is that if one looks historically, if one goes back and 

looks at growth of costs for private-sector payers and growth of 

costs under Medicare, while on a year-to-year basis Medicare may 

be above or below the private sector, but on balance, they tend to 

end up in roughly the same place. 

Mr. BECERRA. Pretty close. 

Dr. HOLTZ-EAKIN. So, I wouldn’t characterize one as being faster or slower than the other in any sustained way. 

Then with respect to any proposals on prescription drugs and 

their cost-containment features, I would refer back to the things 

that I have mentioned already in my testimony. 

The degree to which there will be cost containment depends on—

in many, many detailed ways—on the particulars of the proposal 

and the degree to which there are features such as providers who 

are at risk and have incentives to control their costs, beneficiaries 

who are responsive to price signals and face some incentive to minimize costs, and a wide variety of other features of the proposal. 

As a blanket statement, it is impossible to characterize how that 

comes out. 

Mr. BECERRA. Mr. Chairman, I know my time has expired, if 

I could ask one last quick question. Do either of you believe that 

we could try to maintain the cost in a private-sector plan, when it 

68

comes to administrative costs at least, or those costs that are ancillary to the actual provision of health care. So, in the case of Medicare, we are talking about administrative costs, and in the case of 

a private plan, the administrative costs would probably be complemented with marketing costs and profit that would have to be 

added for the private plan. 

Is there any way that we could try to corral those costs for any 

private plan so that they are about what Medicare currently pays 

in administrative costs, which I understand is about 3 percent? 

Dr. HOLTZ-EAKIN. The evidence is, thus far, for existing private plans versus Medicare, is that administrative costs are higher 

for HMOs and Preferred Provider Organizations (PPOs) that we 

see. Going forward, how that would play out remains to be seen. 

Mr. MCCRERY. Mr. Cardin. 

Mr. CARDIN. Thank you, Mr. Chairman, and let me thank both 

of our witnesses. I am not sure we are asking the right question. 

So, let me see if I can at least get your view on this. We are looking 

at this to try to save the Federal Government money in the Medicare system, which I understand are the growth of the cost to the 

Federal taxpayer, but it seems to me that we are talking about 

health care costs increasing. To the extent that we put in these socalled reforms or deal with the changes as to what the Federal 

Government will pay, we may very well be adding to the burden 

of the individual and not really dealing with reducing health care 

costs or the growth of health care costs in the country. 

I am looking at MEDPAC’s study, which indicates today that for 

all beneficiaries, including institutionalized, and those in 

Medicare+Choice (M+C), Medicare covers 52 percent of the total 

cost. So, a large part is already being paid for by the beneficiaries 

directly and not by the Federal taxpayer. 

Then according to MEDPAC analysis of Medicare Current Beneficiary Survey (MCBS), growth in out-of-pocket costs for fee-forservice beneficiaries living in the community has outpaced growth 

and their income. The largest source of out-of-pocket growth has 

been for non-covered services. 

I could also go into those that are in some form of a managed 

care plan. The coverage for non-covered service has been shrinking. 

So, it seems to me that when you put that all together, we run a 

real danger of putting a lot of pressure here to reduce the Federal 

taxpayer share, but in fact will be placing more burdens on the individual. I would just appreciate your comments. Are we looking at 

this the wrong way? 

Mr. WALKER. Well, first, I think you have to keep in mind that 

that 52 percent number, as I understand it, just talks about Medicare, that you have Medigap paying costs——

Mr. CARDIN. That, in many cases, is 100 percent of the 

costs——

Mr. WALKER. No, it is not 100 percent, but you have got to consider that Medigap is paying costs, and employers are paying costs 

with regard to retiree health care. 

Mr. CARDIN. On every one of those cases, the individual beneficiary is paying for that. It may be paying for it in salary compensation, may be paying for it in full cost of the Medigap preVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00072 Fmt 6633 Sfmt 6602 E:\HR\OC\89405.XXX 89405
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miums. They might have some help through their prior employment arrangement——

Mr. WALKER. Right. 

Mr. CARDIN. Low-income people of course get some help. As far 

as the Medicare system, it is not paying it. 

Mr. WALKER. I understand, but the other thing you have to 

keep in mind with those numbers is that they also include nursing 

home costs, and one could debate whether that is solely a health 

care cost. I don’t believe that is solely a health care cost. Some of 

the services that are provided are not health-care related services 

when you are in a nursing home; housing or basic food, subsistence——

Mr. CARDIN. I think that is a good point on the 52 percent, but 

it still points out that if we are just shifting who is paying the cost 

here, the seniors, as a class, are already burdened in their out-ofpocket costs as it affects their standard of living that they have to 

pay for health care. 

Mr. WALKER. Mr. Cardin, you might not have been here when 

I mentioned that GAO is preparing a briefing report that I think 

would be helpful to this Committee and the Congress on what has 

happened in health care in the last number of years. I think you 

will be surprised to see that in the aggregate, the individual’s portion of health care costs has gone down dramatically in the last 40 

years, the percentage being paid by individuals, in the aggregate, 

of overall health care costs, but that varies by——

Mr. CARDIN. Does that include seniors? Are you saying seniors’ 

costs have gone down? 

Mr. WALKER. It varies by age group, but in the aggregate, if 

you look at who was paying health care costs back years ago——

Mr. CARDIN. Well, I would be curious to see how that breaks 

down by seniors. 

Mr. WALKER. Sure. 

Mr. CARDIN. That is what we are talking about today. 

Mr. WALKER. I understand that. No, I understand that. 

Mrs. JOHNSON OF CONNECTICUT. Will the gentleman yield 

a minute? 

Mr. CARDIN. I would be glad to. 

Mrs. JOHNSON OF CONNECTICUT. I think the point of your 

question was does people taking first-dollar coverage have an impact on utilization or is it just shifting who pays? 

Mr. CARDIN. Well, I am not sure about that because the utilization issue is a separate issue, and there has been no demonstration 

that we will get, there are over-utilizations adding to the cost here. 

Let me ask one more question, if I might, because my time is 

running short. The Chairman mentioned in the beginning $400 billion is in the budget for a Medicare prescription drug plan. Can you 

tell us just very quickly is that anywhere near enough money, in 

the ballpark, to cover a prescription drug plan which is typical for 

those under 65 that they have in commercial insurance, such as 

what Members of Congress would have in the Federal Employees 

Health Benefit plans? Would $400 billion come close to covering 

those types of costs? Just so we have some yardstick here as to the 

moneys that are being put on the table. 

70

Dr. HOLTZ-EAKIN. Mr. Congressman, I guess if I could ask a 

little clarification. When you say ‘‘those costs,’’ which costs do you 

refer to? Our baseline has about——

Mr. CARDIN. If we were going to provide the benefits of a typical plan provided those under 65, such as the Federal Employees 

Health Benefit Plan prescription drug coverage, how much money 

would it cost over 10 years? 

Dr. HOLTZ-EAKIN. The reason I asked is that if you go back to the charts we pointed out, out of a baseline of, say, $1.8 trillion, 

roughly three-eighths, or about $600 billion is currently out-ofpocket. If those costs are what you are trying to cover, then $400 

billion is two-thirds of that. 

If you are trying to construct a prescription benefit plan that 

would replace current sources of insurance coverage for prescription drugs, then the number would be much larger. So, it really depends upon the objective that you have in mind. Mr. CARDIN. In any case, it would be much larger than $400 

billion. If we had no deductibles and 25 percent co-pays, I am just 

looking at the Blue Cross Standard Option Plan, which has a 25 

percent co-insurance, no gaps in coverage, stop loss for all medical 

benefits, that would cost well in excess of $400 billion, I take it. 

Dr. HOLTZ-EAKIN. Clearly. 

Mr. CARDIN. Thank you, Mr. Chairman. 

Mr. MCCRERY. Mr. Stark, you have a quick follow-up? 

Mr. STARK. I just wanted to comment on Dr. Holtz-Eakin’s 

statement previously that the difference in increasing costs between Medicare and private plans. I am not sure that that is quite 

correct. 

Dr. Moon’s study recently indicated that over the previous 30 

years, health care cost increases for private insurance was 41 percent higher than Medicare. Now, for the first 15 years, approximately, they were almost identical, but that was prior to our putting any real cost controls into Medicare, and since we have put 

cost controls into Medicare, the rate of increase of the private insurers has been far higher in the last part of that 30-year period 

in every year and to a significant degree, and I would not want the 

record to suggest that private plans come anywhere close to the 

Medicare system insofar as controlling increase in costs. 

Dr. HOLTZ-EAKIN. I am not familiar with the details of that 

study. We would appreciate getting a copy. 

Mr. STARK. Yes, you certainly should be. 

Dr. HOLTZ-EAKIN. I would caution that, in making these comparisons, making sure that you compare apples with apples is usually the hard part. 

Mr. STARK. She adjusted this to age and, indeed, this was adjusted to compare exactly because there are two different populations, and this was thus adjusted. 

Mr. MCCRERY. Well, I appreciate the gentleman bringing that 

to our attention. I wonder if she included, though, things like compliance costs that the Medicare program imposes on the private 

sector that they have to comply with, and that is probably not accounted for in her numbers or certainly not in the 3-percent figure 

that we hear all the time, as far as the administrative costs of the 

Medicare system. I wonder if our witnesses would like to comment 

71

on whether the Medicare compliance costs are figured in when we 

talk about administrative costs. 

Dr. HOLTZ-EAKIN. With regard to the comparisons that are on 

the table, the compliance costs I can get back to—I do not know 

the details there. The CBO looked at the study, and we have a different interpretation of the historical data. In particular, the apples-to-apples comparison requires comparable benefits. I would be 

happy to work with the Congressman in making that comparison 

as clean as possible. 

Mr. MCCRERY. One question to Dr. Holtz-Eakin. On the question of whether we should write into law the premium dollar 

amount for the pharmaceutical plans, do you believe that a prescription drug plan, which does a very good job at negotiating with 

pharmaceutical manufacturers and others in the distribution chain, 

should have the same premium as a plan that doesn’t do a great 

job in those negotiations? 

Dr. HOLTZ-EAKIN. In looking at and evaluating such a plan, 

the degree to which plans can offer different prices sends a clear 

signal to beneficiaries to pursue lower-cost plans if those plans also 

meet the other parts of their desires. To the extent that mechanism 

is available, we will facilitate cost containment. On the other hand, 

it also presents the possibility that different beneficiaries will face 

different prices if they reside in different regions. Those are the 

elements that we considered in looking at those plans. 

Mr. MCCRERY. If we put the dollar amount in law, the incentive 

for a plan to do a better job would go away, wouldn’t it? 

Dr. HOLTZ-EAKIN. That is true. 

Mr. MCCRERY. Thank you. Thank you, gentlemen, very much 

for your testimony and your responses to our questions. I call the 

next panel. 

Ms. TUBBS JONES. Mr. Chairman——

Mr. MCCRERY. If you wish, you may inquire, although you 

missed the entire hearing, you may——

Ms. TUBBS JONES. Mr. Chairman, for the record, I did not miss 

the entire hearing. I had been here before, but I had to leave for 

another meeting. 

Mr. MCCRERY. Okay, you may inquire. 

Ms. TUBBS JONES. Just so the record is clear. I don’t want to 

make a big deal, but I did hear their testimony. 

Mr. MCCRERY. You did? 

Ms. TUBBS JONES. I did hear their testimony. 

Mr. MCCRERY. According to your staff, not here at the beginning. 

Ms. TUBBS JONES. Well, take my word, not my staff, okay? 

Mr. MCCRERY. You may inquire. 

Ms. TUBBS JONES. Thank you, Mr. Chairman. Mr. Walker, earlier in your testimony today, you were talking about percentages 

with regard to GDP. Do you recall that testimony? 

Mr. WALKER. Yes, I do. 

Ms. TUBBS JONES. My question goes to, and your responsibility 

as the U.S. Comptroller General, you are looking at all costs in the 

government, not just particularly in the health care, as we are talking about today. 

Mr. WALKER. That is correct, among other things. 

72

Ms. TUBBS JONES. Among other things, yes. 

What percentage of the GDP are the dollars that we have expended so far in the deployment of the military, the expenses in 

terms of machinery, and so forth, and the war in Iraq? What percentage of the GDP is that? 

Mr. WALKER. Well, just back of the envelope, the current request is I think $80 billion, if I am not mistaken. 

Ms. TUBBS JONES. Correct. 

Mr. WALKER. Sixty-billion dollars for the U.S. Department of 

Defense (DOD), but I think——

Ms. TUBBS JONES. It is $80 billion, the pack. The supplemental 

was $80——

Mr. WALKER. The DOD was $60——

Ms. TUBBS JONES. Right. 

Mr. WALKER. So, you take $60 billion, and the overall economy 

is, about $11 trillion. So, less than 1 percent. 

Ms. TUBBS JONES. Less than 1 percent. What percent of the 

GDP would the proposed—there is a proposal by the Democrats to 

fund a prescription drug benefit for senior citizens in conjunction 

with the existing Medicare program. Do you have any idea what 

percentage of the GDP that proposal is? 

Mr. WALKER. I am not familiar with any proposal that is on the 

table right now for a prescription drug benefit, but if you mean last 

year’s, last year’s was what, $900 billion, roughly, over 10 years? 

I don’t recall how much it is per year, but if you assume that it 

was about the same per year——

Ms. TUBBS JONES. Assume $900 billion. 

Mr. WALKER. Ninety-billion dollars, it would be less than 1 percent of GDP. 

Mr. STARK. Would the gentle-lady yield for just a moment? 

Ms. TUBBS JONES. Absolutely. 

Mr. STARK. The $80 billion for the Defense was 6 months, and 

ours was for 12 months—our drug benefit—so I would suspect that 

you would have to——

Mr. WALKER. We don’t know what the cost is going to be. 

Frankly, I have got a son who is a company commander with the 

Marine Corps in Iraq right now. So, we don’t know how long they 

are going to be there, and we don’t know what the cost is going to 

be. 

Ms. TUBBS JONES. You know what, my heart goes out to you 

having a son over there. I have lost two of my constituents, and 

the point is not to argue our patriotism. What I wanted to bring 

to the attention of the Committee and to those who are listening 

is the fact that previously Secretary Snow said it doesn’t matter 

what the cost of the war, it is minor in terms of the GDP. 

If you assume his statement is correct, and you assume that the 

1 percent of GDP is what you are suggesting the Democratic plan, 

though you are not familiar with it, would cost, that is minor, compared to the GDP, to pay for the cost of a prescription drug benefit 

for all seniors. Would you agree with that, sir? 

Mr. WALKER. I think you are comparing apples and oranges, 

though, with all due respects. 

Ms. TUBBS JONES. What are the apples from your perspective? 

73

Mr. WALKER. Let me tell you why I say that. You may or may 

not agree. 

Ms. TUBBS JONES. We have a short amount of time, just so you 

know that. 

Mr. WALKER. I understand that. The cost of the war is not 

going to be forever. We are not going to be in Iraq forever. However, the cost of a prescription drug benefit, unless Congress decides to rescind that benefit, after it passes, will be forever. 

Ms. TUBBS JONES. I understand the forever language, but the 

people that would be covered by the prescription drug benefit for 

as long as they live. They have been forever, most of them paying 

into our—are paying taxes, and they are forever our people. They 

are our mothers, our fathers, our sisters and brothers, and we are 

going to be forever grateful to them for the work that they have 

done to allow us to be sitting where they are sitting today. Fair? 

Mr. WALKER. I would agree with that. 

Ms. TUBBS JONES. Thank you. Dr. Holtz-Eakin, I am sorry. I 

would have asked you a question, but I can’t. I have run out of 

time. I am on yellow. At another juncture, I hope to be able to engage with you and ask you a few questions, and I yield back my 

time, Mr. Chairman, and I thank you for the opportunity to ask 

questions. 

Mr. MCCRERY. You are quite welcome. Thank you very much, 

gentlemen, for your testimony and your responses, and now I 

would like to call up our next panel; three Ph.D.’s, Dr. Stuart, Dr. 

Pauly and Dr. Reinhardt. 

We have testifying on our next panel—I am going to let Mr. 

Cardin introduce his constituent. Before I do that, I will say the 

other two witnesses are Dr. Uwe Reinhardt, who is a professor of 

Economics and Public Affairs, the Department of Economics and 

Woodrow Wilson School of Public and International Affairs at 

Princeton University; Dr. Mark Pauly, professor, Health Care Systems, the Wharton School, University of Pennsylvania. 

Mr. Cardin, if you would honor us with your——

Mr. CARDIN. We are very pleased to have Dr. Bruce Stuart with 

us today from the University of Maryland School of Pharmacy, the 

Peter Lamy Center on Drug Therapy and Aging. Dr. Stuart has 

been a tremendous help for us locally, as well as nationally, on 

these issues and it is a pleasure to have him here for the Committee on Ways and Means. 

Mr. MCCRERY. Thank you, Mr. Cardin, and thank all of you, 

gentlemen, for appearing today. Your written testimony will be 

submitted for the record. If you could, in about 5 minutes, summarize your testimony, we would appreciate it. Dr. Stuart, we will 

start with you. 

[Questions submitted to Mr. Walker from Mr. Houghton, and his 

responses follow:]

Question: I understand that historically when Congress has added a new 

benefit or when CMS makes a national coverage determination, all other 

insurance becomes secondary to Medicare regardless of whether it is offered through supplemental insurance, a private plan, or Medicaid. Is this 

correct? Is this coordinated sufficiently under current law and regulations 

so that all people, regardless of their coverage, understand the rules?

74

Response: Whether Medicare would be the primary or secondary payer depends 

on the type of other coverage the beneficiary has. In general, Medicare is the primary payer for covered services when a Medicare beneficiary has any of the following sources of supplemental coverage:

a. Medigap insurance, which is designed to supplement Medicare by paying certain cost-sharing requirements or non-covered services (42 U.S.C. § 1395ss), 

b. Medicaid, which statutorily is always the insurer of last resort (42 U.S.C. 

§ 1902(a)(25)), or 

c. employer-sponsored health coverage when the beneficiary and spouse are no 

longer employed.

In general, Medicare is the secondary payer for covered services when a Medicare 

beneficiary is:

a. working and has employer-sponsored group health coverage (42 U.S.C. 

§ 1395y(b)), 

b. not working but is covered by a working spouse’s employer group health 

plan, 

c. treated for a condition or an injury where a third party may be liable for 

medical services provided, or 

d. afflicted with end-stage renal disease during the 30-month coordination period.

The liability for Medicare or other payers to pay for these services depends on coverage determinations by CMS and the plans. One would have to look to the terms 

of the other plan’s coverage to determine how that plan’s coverage will be affected 

by a Medicare decision. For example, if Medicare began covering a health care service for which it would be the primary payer, a beneficiary’s other plan would either 

provide secondary coverage or no coverage depending on the terms of that plan. Alternatively, if an employer’s group health insurance is the primary payer but does 

not pay in full for certain Medicare-covered services, Medicare may provide secondary coverage; however, if the group plan denies payment for these services, 

Medicare may pay as primary payer. 

Accurately determining whether Medicare is the primary or the secondary payer 

and effectively coordinating these benefits requires that the CMS have timely information on any other sources of health coverage that a beneficiary may have both 

at the time of initial eligibility for Medicare and when any changes occur. CMS provides information to beneficiaries and providers about coordination of benefits, the 

need to provide accurate insurance information, and Medicare’s role as primary or 

secondary payer on its Web site (http://www.cms.hhs.gov/medicare/cob/) and through 

other means. 

There is no question that this issue is complex and making it understandable to 

everyone is challenging. Fortunately, the number of instances where confusion will 

arise is small relative to the numbers of Medicare beneficiaries and services. Medicare covers a broad variety of services, including inpatient hospital care, skilled 

nursing facility care, certain home health and hospice care, physician and outpatient 

services, diagnostic services, outpatient physical and occupational therapy, ambulance services, and other medical services and supplies. Coverage policies impose 

some limitations, but such policies are important as they seek to assure that Medicare only pays for necessary valued services.

Question: If we were to enact a drug benefit that allows employers the 

option to continue retiree coverage and tap into the Medicare drug subsidy, do you think it will be confusing for Medicare beneficiaries, especially 

if the ‘‘Medicare plan(s)’’ differs from the employer-sponsored plan? For example, a beneficiary may not know who pays each time they go to the pharmacy (whether it is the Federal Government, private insurer or paid out 

of pocket). Obviously we need a structure that retirees understand, can you 

make recommendations on how to avoid confusion in layering a Medicare 

benefit with employer sponsored coverage?

Response: I agree that it will be very important to provide Medicare beneficiaries 

with clear and comprehensive information about any choices they would have under 

a proposed Medicare drug benefit. As I stressed in my statement, if multiple private 

entities were selected to administer drug benefits, a means to ensure that beneficiaries receive comprehensive user-friendly information about policy and benefit 

differences among competing entities would be necessary. Similarly, such comprehensive information will be necessary to help beneficiaries determine how any 

new Medicare covered drugs would coordinate with existing sources of drug coverage, such as employer-sponsored group health plans and Medigap, as well as the 

effect on beneficiaries out-of-pocket payments. Beneficiaries will need such informaVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00078 Fmt 6633 Sfmt 6621 E:\HR\OC\89405.XXX 89405
75

tion to make informed decisions regarding whether to maintain or opt out of current 

supplemental coverage—an especially important decision as the availability of employer-sponsored retiree health benefits has generally declined over the last decade 

and many employer-sponsored group health plans have increased cost-sharing requirements. 

One option that you may consider to reduce confusion for Medicare beneficiaries 

maintaining employer coverage is to provide a subsidy for premiums of a private 

plan offering a drug benefit rather than having dual coverage through both a private plan and Medicare. Then each beneficiary with drug coverage would only be 

affected by one set of coverage and copayment rules. This would also avoid the situation we have now where supplementary insurance, like Medigap, ends up making 

beneficiaries less sensitive to the costs of services and contributes to the fiscal challenges the Medicare program faces today.

Ramstad to Mr. Holtz-Eakin and his responses follow:]

[Questions submitted from Mr. Levin, Mrs. Johnson, and Mr. f Levin Question: Please provide a historical series of CBO’s projections 

for Medicare spending over the last six or seven years. 

Response: Table 1 shows the Congressional Budget Office’s (CBO’s) projections of 

Medicare spending and actual Medicare spending for the years 1995 to 2002 (with 

projections extending into future years as applicable). The projections of ‘‘baseline’’ 

spending shown there for each 10-year period-which were made in January or 

March of the previous year-reflect current law governing Medicare at that time. Actual spending will differ from projections for a variety of reasons, including subsequent changes in legislation or in the underlying economy. For example, the projections of Medicare spending made prior to the passage of the Balanced Budget Act 

of 1997 were substantially higher than the projections made after that point.

Johnson Question: As a supplement to the chart on long-term Medicare 

spending included in your testimony, please show the effect of adding prescription drug benefits at varying levels (with 10-year costs of $500 billion 

to $1 trillion). 

Response: Table 2 shows how Medicare spending as a share of gross domestic 

product (GDP) would vary depending on the size of the10-year drug benefit that was 

enacted. As the table indicates, Medicare spending in 2075 could range from 9.2 percent of GDP under current law to 12.5 percent if a drug benefit costing $1 trillion 

over 10 years was enacted today. The estimates incorporate the assumption that 

drug spending outside of the 10-year budget window will grow with the rest of Medicare (as a share of GDP). That assumption is preliminary and subject to review, and 

considerable uncertainty surrounds any projection made over such a long period.

Ramstad Question: Please provide estimates of GDP and Medicare spending in 2075 in nominal dollars. 

Response: Nominal GDP in 2075 will be $293 trillion, and Medicare transfers will 

total $27 trillion, according to CBO’s preliminary projections. Because such figures 

are difficult to compare with current levels of spending and economic output, the 

estimated share of GDP devoted to Medicare spending-in 2075, 9.2 percent-can be 

a more useful metric.

Table 1.—Medicare Baseline Actuals and Projections, 1995 to 2013 (Actuals shown in bold) 

Fiscal Year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

March 1996

Benefits 176.9 195.8 215.3 236.2 257.2 279.3 303.1 328.4 356.9 388.9

Premiums 20.2 20.0 20.6 22.6 24.0 25.1 26.2 27.4 28.6 30.0

Net Benefits 156.7 175.8 194.7 213.6 233.2 254.2 276.8 301.0 328.3 358.9

Jan 1997

Benefits 191.0 207.9 226.0 247.1 271.8 284.4 312.4 337.9 366.8

Premiums 20.0 20.2 21.4 22.4 23.4 24.5 25.6 26.7 28.0

Net Benefits 171.0 187.7 204.6 224.6 248.3 259.9 286.8 311.2 338.8

76

Table 1.—Medicare Baseline Actuals and Projections, 1995 to 2013 (Actuals shown in 

bold)—Continued

Fiscal Year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Jan 1998

Benefits 207.0 216.6 229.6 242.2 266.0 275.5 304.1 328.9

Premiums 20.4 20.9 22.8 25.2 28.0 31.1 34.6 38.5

Net Benefits 186.6 195.8 206.8 217.0 238.1 244.5 269.5 290.5

March 1999

Benefits 210.1 212.1 227.6 243.1 253.2 277.1 298.5

Premiums 20.8 21.5 23.2 25.4 27.7 30.6 34.1

Net Benefits 189.4 190.6 204.4 217.7 225.5 246.5 264.4

March 2000

Benefits 208.3 216.9 234.8 242.4 262.9 282.1

Premiums 21.6 21.8 23.3 25.4 28.1 31.1

Net Benefits 186.7 195.1 211.5 217.0 234.8 251.0

March 2001

Benefits 214.9 237.0 251.4 268.5 288.0

Premiums 21.9 23.6 26.9 30.0 33.3

Net Benefits 193.0 213.4 224.5 238.5 254.7

March 2002

Benefits 236.5 246.9 259.4 272.7

Premiums 23.7 25.9 27.8 29.7

Net Benefits 212.7 221.0 231.6 243.1

March 2003

Benefits 252.2 271.3 285.7

Premiums 26.0 28.3 31.6

Net Benefits 226.2 243.1 254.1

Table 1.—Medicare Baseline Actuals and Projections, 1995 to 2013 (Continued) 

Fiscal Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 

March 1996

Benefits 424.0 463.0

Premiums 31.1 32.1

Net Benefits 393.0 430.9

Jan 1997

Benefits 408.4 436.2 462.6

Premiums 29.3 30.7 32.3

Net Benefits 379.1 405.5 430.4

77

Table 1.—Medicare Baseline Actuals and Projections, 1995 to 2013 (Continued)—Continued

Fiscal Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 

Jan 1998

Benefits 365.6 375.3 415.4 447.0

Premiums 42.4 46.4 50.6 55.1

Net Benefits 323.3 329.0 364.7 391.9

March 1999

Benefits 328.4 343.0 377.8 409.5 442.9

Premiums 37.6 40.4 44.4 48.7 53.1

Net Benefits 290.8 302.5 333.4 360.8 389.8

March 2000

Benefits 308.4 318.7 347.8 373.4 401.7 432.5

Premiums 34.2 37.2 40.3 43.6 47.2 51.0

Net Benefits 274.2 281.5 307.5 329.8 354.5 381.5

March 2001

Benefits 313.7 331.7 360.6 389.1 420.3 454.2 499.3

Premiums 36.8 39.6 43.4 47.1 50.9 55.3 60.4

Net Benefits 276.9 292.1 317.2 342.0 369.4 398.9 438.9

March 2002

Benefits 293.1 308.5 335.0 361.2 389.0 418.9 454.1 482.7

Premiums 32.1 35.0 38.6 42.1 45.8 49.6 53.8 58.2

Net Premiums 261.0 273.5 296.4 319.1 343.2 369.3 400.3 424.5

March 2003

Benefits 305.0 317.6 341.2 364.6 390.9 419.4 453.6 480.2 522.0

Premiums 34.4 37.1 40.0 43.1 46.5 50.4 54.6 59.1 64.4

Net Benefits 270.6 280.5 301.2 321.5 344.4 369.0 399.0 421.1 457.7

Table 2.—Medicare Transfers as a Percentage of GDP Under Current Law and Various Scaled 

Drug Benefit Packages (Reflecting CBO’s Spring 2003 Baseline) 

Calendar Year 

Spending 

Under

Current Law 

Spending Under a Drug Benefit with Costs over the 2006-2013 Period of: 

$400

Billion 

$500

Billion 

$600

Billion 

$700

Billion 

$800

Billion 

$900

Billion 

$1

Trillion 

2005 2.4 2.5 2.5 2.5 2.5 2.5 2.5 2.5

2010 2.6 2.9 3.0 3.1 3.2 3.2 3.3 3.4

2015 3.0 3.4 3.5 3.6 3.7 3.8 3.9 4.0

2020 3.4 3.9 4.0 4.1 4.3 4.4 4.5 4.6

2025 4.0 4.6 4.7 4.9 5.0 5.1 5.3 5.4

2030 4.7 5.4 5.5 5.7 5.8 6.0 6.2 6.3

2035 5.3 6.1 6.2 6.4 6.6 6.8 6.9 7.1

2040 5.8 6.6 6.8 7.0 7.2 7.4 7.6 7.8

2045 6.1 7.0 7.2 7.4 7.6 7.8 8.0 8.3

2050 6.5 7.4 7.6 7.8 8.1 8.3 8.5 8.7

2055 6.9 7.9 8.1 8.3 8.6 8.8 9.1 9.3

2060 7.4 8.5 8.7 8.9 9.2 9.5 9.7 10.0

2065 7.9 9.1 9.4 9.6 9.9 10.2 10.5 10.8

2070 8.6 9.9 10.1 10.4 10.7 11.0 11.3 11.6

78

Table 2.—Medicare Transfers as a Percentage of GDP Under Current Law and Various Scaled 

Drug Benefit Packages (Reflecting CBO’s Spring 2003 Baseline)—Continued

Calendar Year 

Spending 

Under

Current Law 

Spending Under a Drug Benefit with Costs over the 2006-2013 Period of: 

$400

Billion 

$500

Billion 

$600

Billion 

$700

Billion 

$800

Billion 

$900

Billion 

$1

Trillion 

STATEMENT OF BRUCE STUART, PH.D., PROFESSOR AND DI2075 9.2 10.6 10.9 11.2 11.5 11.8 12.1 12.5

RECTOR, PETER LAMY CENTER ON DRUG THERAPY AND 

f AGING, UNIVERSITY OF MARYLAND SCHOOL OF PHARMACY, 

BALTIMORE, MARYLAND 

Dr. STUART. Thank you, Mr. Chairman, and Members of the 

Committee. I would like to use my brief remarks to address what 

I think is the most important question underlying the debate over 

a Medicare drug benefit, which is what will happen to beneficiaries 

if Congress fails to act. I hope to show you that recent trends in 

coverage put future beneficiaries at risk of having significantly reduced options for meaningful prescription benefits if legislative action is not taken soon. 

Although a higher proportion of beneficiaries had some form of 

prescription coverage in 2000 than ever before, the growth is 

unsustainable. It is due to two phenomena, a rise in Medicare 

HMO enrollments and a rapidly growing segment of beneficiaries 

with ill-defined and overlapping benefits. 

In fact, since 1995, there has been a slight decline in rates of 

drug coverage among beneficiaries who rely on a single prescription 

plan from an employer, a Medigap policy, Medicaid or other public 

program. By examining changes in these sources of coverage, we 

can develop a reasonably accurate forecast of what beneficiaries 

will face in the near future. 

Retiree health benefits offered by employers and unions represent the most generous private source of prescription coverage 

available to Medicare beneficiaries. Data from the MCBS show that 

the number of beneficiaries with prescription coverage from employer plans has remained steady at 34 percent from 1996 through 

the latest data release for 2000. 

This is actually a very surprising statistic, in light of the pullback in retiree health benefits reported by employers. According to 

annual Mercer/Foster Higgins surveys, the number of large employers offering employer coverage has dropped from 57 percent in 

1987 to just 23 percent in 2001. 

Why haven’t we seen a comparable decline in the MCBS data? 

Preliminary results from a study my colleagues and I are conducting for the Commonwealth Fund suggests that the answer lies 

in beneficiary demographics. We find that the proportion of younger beneficiaries with employee-sponsored health benefits dropped 

dramatically between 1996 and 2000, while there was a small increase in coverage for beneficiaries 70 and older. This pattern does 

not auger well for future retirees. 

The advent of Medicare+Choice in 1997 was followed by a major 

expansion in HMO enrollments. At the program’s peak in 1999, 

more than 7.5 million beneficiaries had enrolled, yet 22 percent of 

79

them left their plans that year, presumably for better coverage 

elsewhere. 

The HMO enrollees represent a large fraction of the beneficiary 

population with shifting sources of prescription benefits and gaps 

in coverage. Today, M+C enrollment has declined by a quarter and 

the drug coverage offered by the remaining plans is less generous 

than it was 4 years ago. 

Beyond M+C and employer coverage, the only other private 

source of prescription benefits available to beneficiaries is self-purchased coverage through a Medigap plan. In most States private 

carriers are permitted to offer three standardized plans with very 

limited benefit provisions that have not been updated in over a decade. Even this limited coverage may appeal to older people who 

have no other options. 

The catch is that many carriers do not sell these policies and 

those that do generally charge high premiums. In some cases, the 

premiums exceed the maximum value of the prescription coverage 

itself. In other words the market for Medigap plans is ill-equipped 

to provide meaningful coverage to Medicare beneficiaries who lose 

benefits because of pull-backs in HMOs and employer plans. 

The poorest elderly typically do not qualify for employer-sponsored health insurance and cannot afford the premiums for individual Medigap policies. Medicaid is available to those who meet 

stringent Federal and State means tests for income and assets. 

Some States have responded to the needs of those too poor to afford 

adequate medications, but not poor enough to qualify for traditional Medicaid by extending full Medicaid coverage to beneficiaries 

enrolled in the Federal Qualified Medicare Beneficiaries and Specified Low-Income Medicare Beneficiary programs. 

Thirty other States have enacted pharmaceutical assistance programs that subside prescription drug expenses for selected low-income populations. The latest development is the CMS Pharmacy 

Plus waiver program that encourages States to develop drug-assistance plans paid for through savings in traditional Medicaid. Five 

States have approved Pharmacy Plus Programs and 10 others are 

in the process of developing waiver applications. 

This flurry of activity at the State level might lead one to conclude that the needs of low-income Medicare beneficiaries are being 

adequately addressed. That would be a mistake. According to the 

MCBS, less than half of beneficiaries below the Federal poverty 

level are enrolled in Medicaid or another public program offering 

drug benefits during 2000. Only 1 in 5 beneficiaries, between 100 

and 150 percent of the poverty line, was enrolled in a public plan. 

The current patchwork of State programs is extremely fragile. 

Four of the 30 States that enacted pharmaceutical assistance programs have put them on indefinite hold because of budgetary problems. Massachusetts has frozen enrollments in its assistance plan. 

Some of the larger plans, including the Pennsylvania Program of 

All-Inclusive Care for the Elderly program are seriously underfunded. 

Let me rephrase the central question I posed at the beginning of 

my remarks. What should Congress learn from these recent trends 

as it prepares to enact a meaningful drug benefit? The first lesson 

is that strong action must be taken to avoid further erosion in reVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00083 Fmt 6633 Sfmt 6602 E:\HR\OC\89405.XXX 89405
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tiree health benefits. Subsidizing prescription coverage will reduce 

the burden on employers, but additional steps will be necessary to 

assure that firms maintain or, better yet, improve upon current 

coverage. 

Second, while managed care plans have clearly failed to provide 

meaningful drug benefits in the absence of government payment, 

it is just possible that covering drug costs in plan capitation rates 

may actually save the M+C program. 

Finally, as important as State programs can be in filling the gaps 

in prescription coverage, present circumstances call for a unified 

national program of prescription benefits available to all Medicare 

beneficiaries. 

Thank you very much. 

[The prepared statement of Dr. Stuart follows:]

Statement of Bruce Stuart, Ph.D., Professor and Director, Peter Lamy Center on Drug Therapy and Aging, University of Maryland, Baltimore, 

Maryland 

Mr. Chairman and distinguished Members of the House Ways and Means Committee. My name is Bruce Stuart. I am a Professor at the University of Maryland 

School of Pharmacy. I also direct the Peter Lamy Center on Drug Therapy and 

Aging which conducts research on Medicare beneficiaries’ drug coverage, utilization, 

and outcomes. I am pleased to be here this morning to address what I believe 

should be the core question underlying the debate over a Medicare drug benefit; 

namely, what will happen to beneficiaries if Congress fails to act? I will show that 

recent trends in coverage put future beneficiaries at risk of having significantly reduced options for meaningful prescription benefits if legislative action is not taken 

soon. 

First, the good news. The latest data from the Medicare Current Beneficiary Survey (MCBS) show that a higher proportion of beneficiaries had some form of prescription coverage in 2000 than ever before, reaching almost 79% of the beneficiary 

population with Medicare entitlement for the entire year. That is up from 69% in 

1995. Moreover, a higher percentage of those with drug benefits in 2000 maintained 

them throughout the year than in any previous year for which we have data. 

However, aggregate statistics can be misleading. The growth in prescription coverage between 1995 and 2000 is explained by two phenomena, a rise in Medicare 

HMO enrollment and a rapidly growing segment of beneficiaries with ill-defined and 

overlapping benefits. There was a slight decline in rates of prescription coverage 

among beneficiaries who relied on a single prescription plan from an employer, a 

Medigap policy, Medicaid, or other public program. By examining changes in these 

sources of prescription coverage, we can develop a reasonably accurate forecast of 

what beneficiaries will face in the near future. 

Supplemental health benefits offered by employers and unions represent the most 

generous private source of prescription coverage available to Medicare beneficiaries. 

No one knows exactly how many beneficiaries are entitled to employer-sponsored 

coverage. Not all retirees given the opportunity of health insurance choose to take 

it either because of cost or alternative coverage. Data from the MCBS show that 

the number of beneficiaries with employer-sponsored health plans peaked in 1997 

at 41% of the population and fell slightly to 39% in 2000. The proportion of beneficiaries with prescription coverage under employer plans has remained a steady 

34% from 1995 through the latest data release for 2000. These are actually very surprising statistics in light of the pull-back in retiree health benefits reported by employers. According to annual Mercer/Foster Higgins surveys, the number of large 

employers offering health coverage to Medicare-eligible retirees declined from 57 

percent in 1987 to 23 percent in 2001. Why haven’t we seen a comparable decline 

in the MCBS data? Preliminary results from a study my colleagues and I are conducting for The Commonwealth Fund suggest that the answer lies in beneficiary demographics. Younger beneficiaries aged 65 to 69 are more likely to be affected by 

changing employer policies on retirement benefits than beneficiaries aged 70 and 

older. Based on MCBS data, we found that the proportion of beneficiaries with employer-sponsored health benefits in the younger age band dropped dramatically between 1995 and 2000, while there was a small increase in coverage for the older 

group. This pattern does not auger well for future retirees. 

81

The advent of Medicare+Choice in 1997 was followed by a major expansion in 

HMO enrollments. At the program’s peak in 1999, more than seven and a half million beneficiaries had enrolled. Yet 22 percent of them left their plans that year, 

presumably to get better coverage elsewhere. HMO enrollees represent a large fraction of the beneficiary population with shifting sources of prescription benefits and 

gaps in coverage. For example, 50% of those who disenrolled from an M+C plan in 

1999 were left without prescription coverage. But even among those who stayed, 

only 65% were able to rely on M+C prescription coverage alone; 20% supplemented 

HMO drug benefits with other coverage, 7% had outside drug coverage and no M+C 

prescription benefits, and 9% had no prescription benefits from any source. Today, 

M+C enrollment has declined by a quarter, and the drug coverage offered by the 

remaining plans is far less generous than four years ago. Federal lock-in rules now 

scheduled for 2005 will presumably reduce the rate of M+C turnover, but that will 

not address the underlying reasons why beneficiaries move from plan to plan. Indeed, limiting beneficiaries’ ability to leave plans that no longer meet their needs 

will make them worse off, and may well lead to further erosion in M+C enrollments. 

Plan withdrawals and rising premiums will have a similar effect. 

Beyond M+C and employer coverage, the only other private source of prescription 

benefits available to Medicare beneficiaries is self-purchased coverage through a 

Medigap plan. In most States, private carriers are permitted to offer three standardized plans (H, I, and J) with maximum prescription coverage of $1,250 or $3,000 

per year. All three plans contain a $250 deductible and 50% coinsurance. These benefit provisions were created by Federal law over a decade ago, and have not been 

updated. But even this limited coverage may appeal to older people who have no 

other options. The catch is that many carriers do not sell the policies that cover 

drugs, and those that do generally charge high premiums that in some cases actually exceed the maximum value of the coverage itself. According to MCBS data, the 

proportion of non-institutionalized beneficiaries relying only on these policies hovered around 9% between 1995 through 2000 (another percent or two mixed self-purchased plans with other coverage). The real number may be only half that high. 

Most experts believe that beneficiary reports of self-purchased drug coverage are inflated with the inclusion of discount cards and other plans that do not provide true 

insurance. Whatever the real number, the market for Medigap plans is ill equipped 

to provide meaningful coverage to Medicare beneficiaries who lose benefits because 

of pull-backs in HMOs and employer plans. 

The poorest elderly typically do not qualify for employer-sponsored health insurance and can’t afford premiums for individual Medigap policies. Medicaid is available to those who meet Federal and State means tests for income and assets. Dual 

enrollment in Medicare and Medicaid dropped slowly throughout the nineteen-nineties as a result of rising beneficiary incomes and static income-eligibility criteria. A 

slight up tick in 2000 may signal a reversal in this trend, but traditional Medicaid 

is still available only to the poorest poor. Some states have responded to the needs 

of those too poor to afford adequate medications but not poor enough to qualify for 

traditional Medicaid by extending full Medicaid benefits, including prescription coverage, to Medicare beneficiaries enrolled in the Federal QMB and SLMB programs. 

Other States (30 as of this writing) have enacted pharmaceutical assistance programs that subsidize drug expenses for selected low-income populations. An additional eight States have drug discount card programs for Medicare beneficiaries. The 

latest development is the CMS ‘‘Pharmacy Plus’’ waiver program that encourages 

States to develop drug assistance plans paid for through savings in traditional Medicaid. Five States (Illinois, Wisconsin, South Carolina, Florida, and Maryland) have 

approved Pharmacy Plus programs. Ten others are in the process of developing 

waiver applications. 

This flurry of activity at the State level might lead one to conclude that low-income Medicare beneficiaries’ needs for drug coverage are being adequately addressed. That would be a mistake. According to the MCBS, 48% of beneficiaries 

below the Federal poverty line were enrolled in Medicaid or another public program 

offering drug benefits during 2000. Only 20% of beneficiaries in the band between 

100% and 150% of the poverty line were enrolled in a public plan. These proportions 

are not significantly higher than in 1995 when 46% and 18%, respectively, received 

such benefits. When data become available for 2001 and 2002, we may find that 

matters have improved. But even if that proves true, the current patchwork of State 

programs is extremely fragile. Four of the 30 States that have enacted pharmaceutical assistance programs have put them on indefinite hold because of budgetary 

problems. Massachusetts has frozen enrollment in its assistance program. Some of 

the largest plans, including the Pennsylvania PACE program are seriously under 

funded. The initial excitement surrounding the Pharmacy Plus program has turned 

to concern as States try to figure out how to pay for their new obligations without 

82

gutting traditional Medicaid. Unlike the Federal Government, State prohibitions 

against running budget deficits mean that assistance programs are most vulnerable 

to cuts at precisely the time they are most needed. 

Let me rephrase the central question I posed at the beginning: What should Congress learn from these recent trends as it prepares to enact a meaningful Medicare 

drug benefit? My optimism is based on the belief that our government will simply 

not permit the gains in drug coverage won by Medicare beneficiaries during the 

nineteen-nineties to be needlessly lost. The first lesson is that strong action must 

be taken to avoid further erosion in retiree health benefits. Subsidizing prescription 

coverage will reduce the burden on employers, but additional steps will be necessary 

to assure that firms maintain—or better yet—improve upon current coverage. Second, while managed care plans have clearly failed to provide meaningful drug benefits in the absence of government payment, it is just possible that including drug 

costs in plan capitation rates may actually save the M+C program. Finally, as important as State programs can be in filling gaps in prescription coverage, present 

circumstances call for a unified national program of prescription benefits available 

to all Medicare beneficiaries. 

Thank you.

Mr. MCCRERY. Dr. Pauly? 

f STATEMENT OF MARK V. PAULY, PH.D., PROFESSOR, HEALTH 

CARE SYSTEMS, WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA, PHILADELPHIA, PENNSYLVANIA 

Dr. PAULY. Thank you, Mr. Chairman and Members of the Committee. I have directed my prepared remarks at the issue of prescription drug coverage, but I would be happy to comment on the 

general issue of Medicare reform. 

The absence of outpatient prescription drug coverage for the 

quarter to a third of Medicare beneficiaries who don’t get such coverage poses for them a serious risk of both high out-of-pocket payments and the risk that they will fail to use drugs that are effective 

for their health and so be of concern to their fellow citizens. Are 

there ways to improve the situation? 

I believe that there are and that the best design for improvement 

that pays attention to the budget constraints for Medicare as a 

whole is one that builds on two important principles of public policy. First, that protection against financial risk should be based on 

a correct theory of insurance and, second, that coverage of concern 

for public policy should help people with low incomes pay for drugs 

they might otherwise forego, but that concern need not extend to 

beneficiaries with lower levels of spending and higher incomes who 

are able to pay for their drugs. 

I, first, consider the design of insurance coverage to maximize 

value. That is what we are trying to do here. This design is based 

on the common-sense principle that underlies all insurance. The 

purpose of insurance is to provide benefits when they are most 

needed. 

For the financial protection dimension of insurance, it is obvious 

that benefits are most needed when losses are greatest, since in 

such cases the threat to wealth and future standard of living is 

greatest. In contrast, insurance coverage is of low value, if it pays 

for low or below-average levels of expense. Since insurance itself always carries an administrative cost, such budgetable expenses usually should not be insured at the real cost of using resources to review claims and write checks. 

83

Insurance is supposed to pay for the rare high-cost event that 

spells financial disaster and not for the modest expense most people could reasonably expect year-after-year and could afford if it 

did occur. Insurance which did pay for small, predictable expenses 

would be insurance in name only. For the Medicare population, it 

would be roughly equivalent to an increase in Social Security payments, but made in a less transparent and less-efficient way. 

What about people who, because of the absence of insurance, 

failed to use beneficial care? We know for certain that the volume 

of drug use and drug spending is increased when insurance coverage is greater. This phenomenon of moral hazard mentioned earlier occurs for people at all income levels. In effect, insurance 

makes expensive drugs look cheap and inexpensive drugs look dirt 

cheap. 

This lower price appears to have an amazingly strong effect on 

everyone’s behavior. For example, our research indicated that lowering the copayment for prescription from $10 to $2 could produce 

up to a 65-percent increase in drug expenditure for people under 

age 65 who are middle class, privately insured, and the same order 

of magnitude is probably true for seniors. 

The evaluation, of course, of the increase in spending is uncertain. Some portion of it represents increase in spending that would 

receive social approbation. Other portions though, may represent 

the use of products which, even if of positive value, were not really 

worth what they cost. 

These two principles can be made highly consistent if we assume 

that lower income is associated with a lower use of drugs, other 

things equal, and that such low use is a matter of social concern. 

Then, the socially optimal coverage policy in a budget constraint 

world would provide virtually complete financial protection for 

those beneficiaries with incomes just above the Medicaid limit. 

In contrast, for the elderly middle class, who are about half of 

the elderly, the insurance of concern to government should cover 

expenses more generously as expenses rise, but should provide no 

coverage for small expenses, with the point of which coverage begins to take effect related to household income and wealth. A very 

simple version of such a scheme would involve insurance that provides full coverage of a deductible, with the deductible stated as a 

percentage of household income. 

There are two objections to this simple, but powerful model: 

First, because drug expenditures are not evenly spread over the 

population, some people criticize this model because most people 

will not collect from their insurance, but will either have to pay 

something or, even if the insurance is fully paid by taxes, will be 

miffed at not getting an equal slice of government largesse. 

As suggested earlier, if those unlucky people who have low drug 

expenses in a given time period need to receive a political payoff, 

providing low deductible or first-dollar coverage is an inefficient 

and inequitable (to those with zero expenses) way to do so; just increase Social Security with a cost of living adjustment that includes 

drug spending as a component. 

Of course, whether low risks are in or out, a somewhat more respectable argument is one that views front-end coverage as a way 

of dealing with adverse selection. The main problem with the arguVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00087 Fmt 6633 Sfmt 6602 E:\HR\OC\89405.XXX 89405
84

ment here is that adverse selection only helps the high risks if the 

low risks can be induced to pay more than the value of their benefits, but because the benefits for low risk are so small and so predictable, there is very little willingness to pay extra. 

I will also make just a few comments on how to pay for drugs. 

I have talked about the form of insurance coverage. The general 

principle of insurance here is pretty straightforward. The idea 

would be to pay an indemnity benefit that would cover products 

that are sold in competitive markets, and that might be a reasonable principle for generic drugs, although the Federal Trade Commission should continue to be vigilant about pricing of those products. 

The most serious problem arises, however, for products protected 

by patents. Society offers patents in order to induce drug firms to 

invest in research & development for new products. Once products 

are invented and fixed costs have been incurred, however, it is desirable to get final selling prices down. So, our choice, actually, is 

between cheap products now and good products later, but not between cheap, good products now and cheap, good products later. 

Thus, the part of the government that wants to contain medical 

costs is at war with the part that wants to foster medical progress. 

It is certain that if research & development is undertaken by rational profit-maximizing firms, lower prospective prices and payments will mean fewer good, new products. The key, obviously, is 

what are the nature of the good products that would be foregone. 

They would probably include orphan drugs and some things of substantial value. 

In the face of such uncertainty about what public policy might 

affirmatively do, in my judgment, the best policy is to try again to 

replicate as much as possible markets with patents that are otherwise competitive. This situation would be best accomplished if individuals could choose from a large number of different health plans, 

with the plans having different policies as to which drugs they pay 

for, what prices they pay and what advice and assistive services 

they provide. 

When there is a choice of plans, those plans must be allowed to 

differ in both coverage policies and premiums paid by the insured 

for choice to be meaningful. It does not help if there are multiple 

contractors administering exactly the same coverage at the same 

beneficiary premium. 

Competition between different plans cannot be guaranteed to 

yield lowest possible price, I think it is important to emphasize, but 

it probably will lead to the best price and the best tradeoff between 

price and quality that reflects the tradeoffs beneficiaries are willing 

to make between the different types of cost containment that provides incentives to squeeze out any insurer profit and that best 

deals with government-granted patent monopolies. 

My final comment, and in some ways saving the worst for last 

or, in some ways, the best for last, we know that the primary reason why health care costs rise in this country is because of the addition of beneficial, but costly, new technology. I think there are serious doubts about our ability to afford, certainly for public programs, and perhaps even privately, the rate of growth of beneficial, 

but new, technology that we have become used to over time. We 

85

live and will live in a world of limited resources, some technology 

should not be made available to all who will benefit from it, but 

we have found no institutional structure for saying, ‘‘No.’’ There is 

no institutional structure for making such cost-benefit tradeoffs 

and especially not for government-funded coverage like Medicare. 

So, three policy questions remain: 

First, how low a deductible at any given income level represents 

the appropriate combination of financial protection for seniors, appropriate incentives to use, but not overuse, drugs, and tax burdens 

on present and future taxpayers? 

Second, what tradeoffs should we make between inexpensive 

drugs today and better drugs for the future? 

Third, and most importantly, what rate of increase in spending 

for higher quality, but more costly, products we think is appropriate for the growing number of elders in our country? 

Thank you very much. 

[The prepared statement of Dr. Pauly follows:]

Statement of Mark V. Pauly, Ph.D., Professor, Health Care Systems, 

Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 

The absence of outpatient prescription drug coverage for those non-poor Medicare 

beneficiaries who did not have a job at a firm that offered drug coverage as a retirement benefit leaves a serious gap. This gap exposes a quarter to a third of beneficiaries to the risk of high out of pocket payments for drugs or to the risk that they 

will underuse drugs that are effective for their health, and so be a concern to their 

fellow citizens. Unsubsidized Medigap markets, required to undertake some community rating, are plagued with adverse selection because high prescription drug expenses are usually associated with chronic conditions with highly predictable drug 

expenses and consequent severe adverse selection. Are there ways to improve this 

situation? 

I believe that there are, and that the best design for improvement is one that is 

built on what (in my view) ought to be two important principles of public policy: 

(1) protection against financial risk should be based on a correct theory of insurance, 

and (2) coverage of concern for public policy should help people with low incomes 

pay for drugs they might otherwise forego, but that concern need not extend to 

beneficiaries with lower levels of spending who are able to pay for their drugs. I 

will elaborate on the implications of these two principles, and then suggest what 

they imply for practical benefits design and realistic public policy. Throughout, I will 

be sensitive to a third important aspect of public policy: even current levels of Medicare benefit are threatened, once the baby boom generation reaches retirement age, 

by high Medicare costs relative to levels of support at current tax rates; the feasibility of substantial increases in the distortive taxes paid for Medicare (largely by 

younger workers) is limited and therefore any new benefit should add as little as 

possible to the tax burden. Drug benefits for some parts of the Medicare population 

in some circumstances are of sufficient value to justify some increase in payment 

and taxes, but these increases should be kept as modest as possible. 

I first consider the design of insurance coverage to maximize value. This design 

is based on the common sense principle which underlies all insurance. The purpose 

of insurance is to provide benefits when they are most needed. For the financial protection dimension of insurance, it is obvious that benefits are most needed when 

losses are greatest, since in such cases the threat to wealth and future standards 

of living is greatest. In contrast, insurance coverage is of low value if it pays for 

low (below-average) levels of expenses; since insurance itself always carries an administrative cost, such budgetable expenses usually should not be insured at the 

real cost of using resources to review claims and write checks. Insurance is supposed to pay for the rare high cost event that spells financial disaster, and not for 

the modest expense most people could reasonably expect year after year, and could 

afford if it did occur. Insurance which did pay for such smaller predictable expenses 

would be insurance in name only; it would really be an income transfer (largely 

equivalent, for this population, to an increase in Social Security payments), but done 

in a less transparent and less efficient way. Put more explicitly, the rational and 

valuable insurance is coverage against financial catastrophes, and only such coverage is warranted on the basis of financial protection. 

86

What about the role of insurance as assistance to people who otherwise would not 

choose to obtain beneficial care? We know for certain that the volume of drug use 

and drug spending is increased when coverage is greater; this phenomenon occurs 

for people at all income levels. In effect, insurance makes expensive drugs look less 

expensive, and inexpensive drugs look dirt cheap; this lower price appears to have 

an amazingly strong impact on everyone’s behavior. For example, research indicates 

that lowering the copayment per prescription from $10 to $2 can produce a 65 percent increase in drug expenditure for privately insured middle class non-elderly, and 

the same is probably true for seniors. 

While the increase in use with coverage is certain, the social evaluation of this 

increase is uncertain. It may represent the use of highly beneficial drugs that reduce illness, frailty, and poor functional status about which there is substantial concern by others in the community. On the other hand, especially for beneficiaries who 

are not poor and not suffering from serious chronic conditions, this increased use 

may represent spending of low value (even if it is positive) relative to its cost. Since 

that cost must be paid by some other taxpayers if not paid by the beneficiary, those 

taxpayers may correctly judge this increase to be inefficient and unfair. 

These two principles are highly consistent if we assume that lower income is associated with lower use of drugs, other things equal, and that such low use is a matter 

of social concern. Then the socially optimal coverage policy would provide virtually 

complete financial protection for those beneficiaries with incomes just above the 

Medicaid limit. In contrast, for the middle class households that predominate among 

the elderly, the insurance of concern to the government should cover expenses more 

generously as expenses rise, but should provide no coverage for small expenses, with 

the point at which coverage begins to take effect related to household income and 

wealth. A very simple version of such a scheme (though one that can be fine tuned 

if need be) would involve insurance that provides full coverage above a deductible, 

with the deductible stated as a percentage of household income. Refinements of this 

approach might make the required deductible a smaller percentage of income for 

lower income households (‘‘progressive deductible’’), and might provide a corridor of 

coverage with percentage coinsurance before full coverage kicks in. 

Spreading the Gains and Adverse Selection

There are two objections to this simple but powerful model. First, because drug 

expenditures (like all losses for which insurance is rational) are unevenly distributed over households, within any time period some households (those with low or 

zero expenses) will get no insurance benefits, while a few households with very large 

expenses will get large benefits under catastrophic insurance. This is the way insurance is supposed to work, redistributing benefits from lucky people who are not ill 

and have low expenses to the few most unfortunate who have the greatest need for 

help. There is a cynical political view that American voters are unable to support 

an insurance plan which is based on catastrophic insurance principles, because 

‘‘most people will not collect anything from the insurance,’’ but will either have to 

pay something or, even if the insurance is fully paid by taxes, will be miffed at not 

getting an equal slice of government largesse. 

That argument has no support in any view of the political process as one that 

makes rational decisions to maximize the general well being of society or of a targeted population like senior citizens. In my view, Congress should play an educational and leadership role in explaining to citizens (who really and truly do understand it) that it is not in the long run desirable that most people ‘‘make money’’ 

from insurance; instead, insurance is supposed to help out the most unlucky. As 

suggested earlier, if those ‘‘unlucky’’ people who have low drug expenses in a given 

time period need to receive a political payoff, providing low deductible or first dollar 

coverage is an inefficient and inequitable (to those with zero expenses) way to do 

so; just increase Social Security benefits to keep with a ‘‘cost of living’’ that includes 

drug spending as a component. If some upfront health-related benefit must be offered to lower income people, it should be as flexible as possible (for example, usable 

for out of pocket payments or supplemental insurance to buy down the deductible), 

and not be pre-specified to be a particular percentage coinsurance. 

A somewhat more respectable argument is one that views ‘‘front-loaded’’ benefits 

as a possible response to adverse selection. Adverse selection is such a complicated 

and poorly understood phenomenon in health insurance that it can be used to justify 

almost anything. The notion here is that, if people can estimate in advance whether 

they will have high or low drug expenses in a given year, and if there is a positive 

uniform premium for voluntary catastrophic coverage, such coverage will not appeal 

to those with low expected expenses. They will not enter the risk pool, thus raising 

the average benefit per person in the pool. Of course, whether lower risks are in 

or out has no impact whatsoever on the actual expenses by or benefits to the higher 

87

risks, but the cosmetic effect of having a lower average benefit cost is thought to 

be desirable. More substantively, it is felt that if the lower risks are not ‘‘contributing,’’ that somehow means that the subsidy to the higher risks will need to be 

greater. 

Such a phenomenon is unlikely. But having the lower risks in the pool helps out 

the higher risks only if the amount of premium charged to the lower risks is in excess of their average claims, so that they cross subsidize the higher risks. But, especially in prescription drug insurance with high predictability of expenses in the 

short run, the lower risks will be unwilling to pay much above their expected 

claims. The claims are small and so pose little risk, and the claims are highly predictable. I take a medicine for a chronic condition that costs $30 per month but am 

otherwise healthy. I will not be willing to pay much more than $360 per year for 

drug insurance; I cannot be induced to cross subsidize voluntarily. Unless lower 

risks are terribly risk averse, there is no financial benefit from keeping them in the 

pool. 

How to Pay for Drugs

The general principle of insurance reimbursement is simple. The price or loss 

should be determined in competitive markets, and then insurance should indemnify 

insureds against some portion of that loss. The insurance should pay an indemnity 

whose value depends only on what the person’s illness is and the competitive expense for treating that illness. The price paid should be the market price, and 

should ideally be unaffected by and independent of the presence or absence of insurance. 

The principle of leaving price setting to the competitive market might work for 

drugs sold in competitive markets, such as generic drugs, although even here FTC 

oversight will be important. However, for drugs protected by patents, the situation 

is more complex. Patents are a government-granted monopoly for a limited period 

of time in order to provide incentives for research on and development of new products. The dilemma for citizens and for government agencies is this: once products 

are ‘‘invented’’ and fixed costs have been incurred, it is desirable to get final selling 

prices down. But such a strategy offers low priced existing products only at the cost 

of less development of new products. Thus the part of government that wants to 

contain medical costs is at war with the part that wants to foster medical progress. 

It is certain that, if research and development is undertaken by rational profit maximizing firms, lower prospective prices and profits will mean fewer new products. 

The key question here obviously is that of the value of products foregone relative 

to the benefits from lower prices, but no researcher or policymaker knows the answer to that question. For the present, we must plan policy in ignorance. 

In the face of such uncertainty about what public policy might affirmatively do, 

probably the best policy is again to try to replicate (as much as possible) markets 

with patents that are otherwise competitive, especially on the buyer or insurance 

side. Buyers should be free to walk away from products whose price is higher than 

what buyers think they are worth, but no set of buyers should be permitted to 

collude or combine to force prices down. This situation would best be accomplished 

if individuals could choose from a large number of different health plans, with the 

plans having different policies as to which drugs they pay for, what prices they pay, 

and what assistive services they provide. One would expect plans to impose some 

copayments that signal to insureds when covered drugs are sold at especially high 

prices relative to other alternatives; ‘‘triple tier’’ copayment or simple proportional 

coinsurance will accomplish this goal. I believe there is also merit in trying to approximate an indemnity payment conditional on the need for some drug in a given 

therapeutic class; the German health system model of reference pricing, in which 

a fixed amount adequate to buy one product in a class is paid but patients are free 

to buy more expensive products with their own money. More elaborate versions in 

which some fraction of the incremental cost is covered are also possible. 

When there is a choice of plans, these plans must be allowed to differ in both coverage policies and premiums paid by the insured for choice to be meaningful; it does 

not help if there are multiple contractors administering exactly the same coverage 

at the same beneficiary premium. ‘‘Competition’’ between different plans cannot be 

guaranteed to lead to the lowest possible price, but it probably will lead to the best 

price, the price that best reflects the tradeoffs beneficiaries are willing to make between different types of cost containment, that squeezes out any insurer profit, and 

that best deals with government granted patent monopolies. 

Final Comments

Although the case for catastrophic insurance coverage for seniors that extends to 

prescription drugs is overwhelming, the addition of that coverage makes Medicare’s 

88

long run future even more difficult to plan. The reason is that rising medical care 

and health insurance expenses are almost always driven by the addition of beneficial but costly new technology, and because pharmaceuticals have been the leading 

source of that new technology. Because we live (and will live) in a world of limited 

resources, some technologies should not be made available to all who would benefit 

from them. However, we have no institutional structure for making such cost-benefit 

tradeoffs, especially not for government-funded coverage like Medicare. The model 

of a panel of wise and dispassionate scientists determining coverage for all, tried 

in some other countries, has some serious problems; to let Congress decide on (and 

be lobbied about) coverage is even worse. My own suggestion would be to make a 

social decision about what level of contribution for Medicare is financially sustainable; make that amount of funding available to beneficiaries, and let them use it 

for a variety of loosely limited competing plans. See how this works, and only add 

to the budget if serious problems of access to highly beneficial products emerge. 

Such a strategy may be the best one for a constrained and uncertain future. 

Three essentially political questions remain: (1) How low a deductible at any 

given income level represents the appropriate combination of financial protection for 

seniors, appropriate incentives to use (but not overuse) drugs, and tax burdens on 

present and future taxpayers? (2) What tradeoffs should we make between inexpensive drugs today and better drugs for the future? And (3), most importantly, what 

rate of increase in spending for higher quality but more costly products do we think 

is appropriate for the growing numbers of elderly in our country?

Reinhardt. 

Mr. MCCRERY. On that sobering note, we will go to Dr. 

f

STATEMENT OF UWE E. REINHARDT, PH.D., PROFESSOR, ECONOMICS AND PUBLIC AFFAIRS, DEPARTMENT OF ECONOMICS AND THE WOODROW WILSON SCHOOL OF PUBLIC AND 

INTERNATIONAL AFFAIRS, PRINCETON UNIVERSITY, 

PRINCETON, NEW JERSEY 

Dr. REINHARDT. Thank you, Mr. Chairman, and Members of 

this Committee for inviting me to share my views on Medicare reform. I will concentrate mainly on Medicare reform and not on the 

prescription drug coverage. I am working on a paper on it. I 

haven’t totally through. Once I have, I will be happy to share on 

that. 

Now, my testimony grew out of a primer I had written for journalists who always kept asking the same questions and to be efficient, I just wrote this up and said call me back if it is not clear. 

The questions I was asked: What are the deficiencies of the traditional program and who is responsible for those deficiencies? 

The second question: What form should the competition between 

traditional Medicare and private insurance plans take? 

The third one was what are actually the goals of Medicare reform 

and are these achievable? 

Finally, what are some of the technical and political obstacles? 

Now, with respect to the shortcomings, the interesting thing is 

Medicare is a highly popular program. Survey after survey shows 

that if you array public and private insurance products, Medicare 

usually is among the top or the winner. So, you are trying to reform a program that is highly popular among not only the old, but 

also the young. It has shortcomings, and we have heard these. It 

has a strange insurance structure. It has no stop-loss protection, no 

catastrophic protection, doesn’t cover prescription drugs. 

89

I am asked who is responsible for it? The culture and language 

is bureaucracy. The word ‘‘bureaucracy’’ in America is a little bit 

like the word ‘‘French’’ is these days. It is always not good. 

I analyzed it, and I would defy anyone to prove me different. All 

of the shortcomings of the traditional Medicare program are the 

Congress’ responsibility. Think of Medicare as an insurance company. The management is the Health Care Financing Administration (HCFA) and now CMS. You are the board of directors. Then 

look down what good governance would require, and you would find 

the fault lies in the board of directors. 

If Medicare doesn’t have prescription drugs, that is Congress’ 

fault. If there has never been successful competitive bidding, that 

is Congress’ fault. 

I noticed Mr. Walker said that Medicare overpays for prescription drugs for oncologists, but straight shooter that he is, he points 

out on page 20, that it is in the statute. There is nothing CMS can 

really do about it. So, that is the first thing. There is no reason 

why this body, the board of directors, could not fix the deficiencies 

that are in Medicare, and there are many proposals around on the 

shelf to do this. This is not rocket science. 

The next question that gets asked is: What should be the nature 

of the competition? I think the reasons why some people feel that 

the proposals now before the Congress are actually out to destroy 

the existing Medicare is the idea to put $400 billion of taxpayer 

money and give that only to the private health plans as a comeon and not to put a drug benefit also in the traditional Medicare. 

That would, of course, be a policy quite consciously designed to 

destroy the old Medicare. Maybe that should be done, but it should 

be openly discussed as such. I think camouflaging that with pretty 

language does seem to me to be not proper in a democracy. 

The next question comes: What are actually the objectives of this 

reform? Here I have the most difficult problems with journalists. 

I, myself, I have heard again many times this morning that we 

need to reform Medicare. What are we really talking about? 

I list on page 7 of my testimony several goals, but let me pick 

on just two. If the idea is that Medicare reform will lower total 

health spending per elderly from all sources, I would almost assure 

you that will not be achieved. I have a chart on page 8 where I say, 

‘‘Where could those savings come from?’’

Would you believe that private health plans can get lower fees 

than the traditional Medicare? I don’t think so. 

Would you believe that you can reduce volume more than the 

traditional Medicare? Well, we have the managed care backlash. 

We have just been through it, and the Supreme Court now completely killed HMOs by having this ‘‘any willing provider’’ provision. 

So, the idea that you think you can reduce volume with private 

health plans in Dade County, Miami, and not trigger a backlash 

among the elderly, I doubt it. I think you will find there isn’t that 

much volume, unless Congress really gets control, unless you get 

into it. 

When it comes to SG&A, savings and administration, Medicare 

now spends less than 2 percent of the total expenditure on administration. I will put to you the proposition there is no insurance 

90

company in America that could run an insurance program this 

complex and spend only 2 percent on administration. In addition, 

they would have to market individually to the elderly, which Medicare does not, and they would have to give profits to shareholders, 

which Medicare does not. 

So, I believe there is no source of saving in SG&A. I think in 

chart A, I can ask my colleague here to audit it, I don’t think I 

have left anything out. This is, again, not rocket science. I put it 

all out there, and anyone who would argue that you can save total 

spending would have to tell me where in this map would you do 

it. 

Now if, on the other hand, the idea is to let total spending go 

where it may, but to limit just the taxpayers’ exposure, that of 

course you could do. The idea there would be to lighten the burden 

on the working population who pays payroll taxes and shift it to 

the elderly themselves. I think that could be debated, but I would 

think, in a democracy, that should be put honestly on the table for 

all the young and the elderly to see, so that one could have a forthright, democratic debate on this—democrat ‘‘small’’—rather than 

hiding that under some other goal. 

There are some obstacles that I see. The CMS—or HCFA formerly—has never succeeded to experiment with competitive bidding, yet competitive bidding is a core of this reform. So, ask yourself how would the health plans ever play along? They like administered prices because they can manipulate them. I don’t think they 

would like competitive bids. 

We don’t have a good risk-adjustment mechanism. The Dutch 

don’t, we don’t, the Germans don’t, and yet having a good risk adjuster is the sine qua non of a competitive insurance structure. We 

heard about the Winberg variations this morning. 

Finally, I do ask Medicare can’t ever really compete fairly with 

private plans because, say, Humana can pull out of Iowa if they 

don’t like it, but Medicare has to stay as the insurer of last resort. 

So, it will be very difficult ever to have a really level playing field 

in this field. 

Those are my remarks. Thank you. 

[The prepared statement of Dr. Reinhardt follows:]

Statement of Uwe Reinhardt, Ph.D., Professor, Economics and Public Affairs, Department of Economics, and Woodrow Wilson School of Public 

and International Affairs, Princeton University, Princeton, New Jersey 

My name is Uwe E. Reinhardt. I am Professor of Economics and Public Affairs 

at Princeton University’s Department of Economics and the Woodrow Wilson School 

of Public and International Affairs. At this hearing, I represent only my own views 

as a health economist and health policy analyst, and not those of any other person 

or institution. 

I would like to thank you, Mr. Chairman and your colleagues on this Committee 

for the opportunity to share with you my observations on proposals to extend coverage for prescription drugs to Medicare beneficiaries as part of a reform of the entire Medicare program. 

My statement before you, submitted for the hearing record, draws on a longer 

Primer for Journalists on Medicare Reform Proposals, which I have submitted to 

your Committee as well. It can be accessed at website http://www.wws.Princeton. 

EDU/∼chw/memberf.html (Click on ‘‘Uwe Reinhardt’’ and then on ‘‘Medicare Reform’’). 

The Primer was written in response to several inquiries by journalists on the 

Medicare reform proposal released by President Bush in early March. In the Primer, 

I have sought to comment on four questions frequently posed by journalists:

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A. What are the deficiencies of the traditional Medicare program, and who is 

responsible for them? 

B. What form should the competition between traditional Medicare and private 

insurance plans take? 

C. What are the goals posited for the proposed Medicare reform proposals, and 

are these goals achievable with the proposed reform? 

D. What might be the technical and political obstacles to such a reform?

In what follows, I shall respond to each of these questions. I assume throughout 

that the reform in question is the one sketched out in general terms by President 

Bush on March 3rd, 2003, although that proposal is so sketchy that one could easily, 

and quite inadvertently, do it injustice. But similar proposals had been proposed 

earlier by Senators John Breaux and Bill Frist, and by the Bipartisan Commission 

of the Future of Medicare in the mid 1990s. The general idea of these proposals is 

to have Medicare delegate the tasks of managing the cost of health care benefits 

and their quality to private health plans that would bid competitively for the Medicare business. All such plans, however, would allow Medicare beneficiaries to stay 

with the traditional Medicare program, in its current form. 

The purpose of my testimony—and of my Primer for Journalists on Medicare Reform—is not been to advocate a particular reform plan or to oppose one. The intent 

has merely to raise a series of questions that have either not been raised before or 

have never been satisfactorily answered, if they have cropped up before. The testimony, Mr. Chairman, is submitted to your Committee in that spirit. 

A. THE POPULARITY AND SHORTCOMINGS OF TRADITIONAL MEDICARE

The Abiding Popularity of the Program: In their recent paper ‘‘Medicare 

Versus Private Insurance: Rhetoric and Reality’’ (available on the Health Affairs 

Web Exclusive, October 9, 2002), health services researchers Karen Davis, Cathy 

Schoen, Michelle Doty and Katie Tenney report on a national survey of some 3,500 

adults, and conducted in mid 2001, according to which ‘‘Medicare beneficiaries are 

more satisfied with their health care under traditional Medicare than are persons 

under age sixty-five who are covered by private insurance.’’

This finding corroborates an earlier survey in 1998 by the Henry J. Kaiser Family 

Foundation entitled ‘‘National Medicare Policy Options Survey’’ (available on 

website http://kff.org), which similarly found that the traditional Medicare program 

earns very high marks among public and private health insurance products among 

Americans, both young and old. 

The Program’s Shortcomings: The popularity of traditional Medicare is all the 

more remarkable, because that program does have serious deficiencies, to wit:

1. It does not cover prescription drugs or long-term care other than that associated with an acute-care episode. 

2. It does not provide adequate catastrophic stop loss protection. 

3. It calls for considerable cost-sharing by patients at point of service—for exam- ple, $840 for the first day in a hospital episode, $210 per day for hospital stays 

in excess of 60 days, $420 per day for stays exceeding 60 days, and all costs 

for stays exceeding 150 days.

Indeed, because of its spotty benefit package, Medicare currently pays for only 

about 52% of the total health spending for Medicare beneficiaries (from all sources). 

Medicaid pays for another 12% and private insurers (so-called Medigap coverage 

provided by former employers or purchased directly by beneficiaries) another 12%. 

The beneficiaries themselves pay for 19% of their total spending out of pocket at 

point of service. For low-income beneficiaries, their out-of-pocket costs for health 

care tends to be around 30% of their meager incomes. 

The abiding popularity of the traditional Medicare program—in spite of its deficiencies—probably reflects three factors. 

First, unlike virtually all other private or public insurance products in this nation, 

which tend to be ephemeral, Medicare coverage is permanent. It does provide its 

beneficiaries with the genuine sense of security not enjoyed by most other insured 

Americans, which is a decided plus, especially for elderly people. 

Second, Medicare traditionally has offered beneficiaries completely free choice of 

providers and completely free choice of therapy for covered services. Usually, private 

insurance products have a variety of restrictions in this regard. 

Finally, most Medicare beneficiaries have plugged the gaps in coverage left by traditional Medicare with Medigap policies, or Medicaid comes to their rescue. 

Responsibility for the Medicare’s Current Shortcomings: It is customary 

among critics of traditional Medicare to blame its shortcomings on its ‘‘unwieldy bureaucracy,’’ the Department of Health and Human Services Centers for Medicare 

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and Medicaid Services (CMS), formerly the Health Care Financing Administration 

(HCFA). Among people with distaste for government, that theory has great currency. 

A major point I make to journalists is that this accusation is a bum rap. Responsibility for Medicare’s shortcomings rests almost wholly with the program’s Board of 

Directors—the Congress of the United States. For example:

If the traditional Medicare program does not cover prescription drugs, it is so 

because the collective will of the Congress of the United States has willed it so.

If the traditional Medicare program does not work as a prudent purchaser 

with selective centers of excellence or with other preferred providers known to 

give cost-effective care, it is so because Congress has expressly forbidden that 

kind of contracting and prudent purchasing.

If the traditional Medicare program does not engage in ‘‘disease management’’ 

or ‘‘managed care’’ of any type, it is so because Congress has not permitted Medicare to pursue these avenues.

If the traditional Medicare program has hardly ever had the benefit of being 

able to solicit competitive bids for the products and services it purchases on behalf of beneficiaries, it is so because the Congress has willed it so.

Until the early 1990s, private health insurers typically did not cover prescription 

drugs either. Virtually none of them employed any utilization or cost controls, and 

most of them paid providers whatever they were billed by the providers of health 

care, rather than negotiating fees. Consequently, throughout most of the 1980s, 

Medicare spending per beneficiary rose much less rapidly than did the (per capita) 

premiums charged by private health insurers. As is well known, that differential in 

favor of Medicare is observed today as well. 

To be explained, then, is why Congress decided to sit on its hands during the 

1990s, as private insurers began to modernize their approach to health insurance 

and cost containment. It is a question not properly posed to CMS. It is a question 

properly addressed to the Congress itself, which failed to expand Medicare’s benefit 

package in step with modern clinical developments, and which incessantly micromanaged Medicare’s bureaucracy, preventing the very innovations whose absence 

are now being deplored, sometimes by Members of Congress themselves. 

To illustrate, how can the Congress justify to the American people that it has 

budgeted for Medicare an administrative overhead allowance of less than 2%. No 

private health insurer could possibly manage so large and complex a program at so 

low an expense ratio? Congress’ posture on this budget item seems almost designed 

to prevent Medicare from managing its affairs effectively. Why is this so? 

Similarly, how can the Congress justify to the American people that the budget 

for operations research it appropriates for the CMS (about $15 million a year) is 

only about 0.0038% of total spending by the CMS? Consider, if you would, the graph 

on the next page. For decades Congress has been apprised by health services researcher John H. Wennberg, M.D. and his associates at Dartmouth University that, 

even after adjustment for inter-county differences in the age-gender composition of 

the elderly population, of case-mix severity and of practice costs, Medicare spending 

per statistically equivalent beneficiary varies by a factor of three across the nation 

(see the graph below). Remarkably, Congress has never shown any interest in funding research that might uncover what difference such spending differentials might 

have on the quality of the beneficiaries’ lives. It is all the more remarkable as the 

Congress expresses concern over the economic implications of the retiring Baby 

Boom. After all, if physicians in many of the Sunbelt States were to adopt the more 

conservative practice style of, say, the Mayo Clinic in Rochester, Minnesota, the retiring Baby Boom really would not be a major economic problem for this relatively 

young nation. 

Finally, how can the Congress justify to the American people that, during the 

1990s, it has consistently intervened with the bureaucracy on behalf of the health 

insurance industry, preventing experiments with competitive bidding for the Medicare business by private health plans? To quote in this regard from an analysis of 

this remarkable record by Bryan Dowd, Robert Coulam and Roger Feldman:

Most Medicare reform proposals would replace the current payment system 

with some for competitive pricing [of insurance products]. However, efforts over 

the past five years to demonstrate competitive pricing for M+C plans have been 

blocked repeatedly by Congress, even when the demonstrations were directly responsive to a congressional mandate. In the absence of political support, a demonstration of competitive pricing may be infeasible, and Congress could be forced 

93

1 Bryan Dowd, Robert Coulam, and Roger Feldman, ‘‘A Tale of Four Cities: Medicare Reform 

and Competitive Pricing,’’ Health Affairs, September/October, 2002; pp. 9–27. This volume of 

Health Affairs contains several other papers and commentaries on the issue of competitive bidding.

to take the risky step of implementing broad Medicare reforms with very little 

information about their effects.’’ 1

Source: John E. Wennberg et al., Dartmouth Atlas of Health Care 1999, AHA Press, 1999: 

Chapter One Table, pp. 33–40.

Viewed in their entirety, Congress’ policies on traditional Medicare convey the impression that Congress has deliberately stunted the evolution of Medicare in step 

with modern clinical and organizational developments. It is fair to inquire why that 

is so. 

B. WHAT FORM SHOULD COMPETITION BETWEEN TRADITIONAL 

MEDICARE AND PRIVATE HEALTH PLANS TAKE? 

As a general rule, it is always a good idea to subject publicly administered programs to competition from private-sector entities capable of delivering the same benefits, where that is feasible. For that reason, one should welcome any reform that 

sets up a fair and intellectually manageable competition between the traditional 

Medicare program and equivalent private-sector health insurance products, if only 

to offer citizens a wider choice—the ability to exit a relationship with the public program. 

The Virtue of Choice: We take it for granted that ‘‘more choice’’ always is to 

be preferred to ‘‘less choice’’ in the design of social programs, even though modern 

behavioral economists would warn us that there can be such a thing as too much 

choice. It happens when choices set before individuals are not accompanied by adequate information on these choices. It also happens when the sheer complexity of 

the choice menu overwhelms the individual’s capacity to make rational choices. 

If the Administration and the Congress wish to confront Medicare beneficiaries—

especially the frail elderly—with ever more complex choices in health insurance, it 

is incumbent upon government to accompany these choices with clear information 

about them and to structure them so as to make rational choice manageable by ordinary human beings. In this regard, one is not at all assured by the recent headline 

that ‘‘Medicare Officials Order End to Instructive Services’’ (The New York Times, 

January 25, 2003, p. A12). The article opens with the statement:


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2Medicare beneficiary choosing to stay in the traditional Medicare program would receive free 

of charge a drug-discount card—presumably administered by a pharmaceutical benefit management company or a private insurance carrier—to benefit from bulk purchasing. They would also 

have catastrophic coverage for drug spending exceeding an annual threshold, which is left unspecified. Low income beneficiaries would, in addition, receive a $600 annual subsidy toward 

their drug purchases. 

‘‘Running short of money, Medicare officials have ordered immediate cuts in 

a wide range of services that provide information, advice and assistance to Medicare beneficiaries.’’

Once again, the temptation here is to blame the ‘‘Medicare bureaucracy’’ for this 

budget reallocation. As I have noted above, the fault really lies with Congress’ insufficient appropriation for Medicare’s administrative expense. 

Be that as it may, if this is an augury to come for Medicare reform, then ‘‘more 

choice’’ may well end up as ‘‘more confusion’’ among beneficiaries and ‘‘more regret’’ 

and disillusionment ex post. If Congress really seeks to reform Medicare along the 

lines proposed by the President, then Congress must show better faith in regards 

to the information infrastructure the reform presupposes. 

The Fairness of Competition: The next question is what form the competition 

among alternative insurance products in Medicare should take. Two distinct visions 

of this competition are now put before the American people. 

One arrangement would be to style the choice and competition among health insurance products as one between (a) a modernized, government-run Medicare program that includes prescription drugs, preventive care and catastrophic coverage, 

and that is allowed by Congress to use techniques of modern ‘‘managed care’’ and 

(b) equivalent private-sector insurance products managed by private health plans. 

The arrangement would attempt to create a level playing field between a government-administered Medicare and private-sector competitors. 

An alternative arrangement—one deliberately designed to erode the popularity of 

the traditional Medicare program—is to style the choice and competition in Medicare as one between (a) the traditional, unreformed, government-run Medicare program, whose development has been and will continue to be deliberately stunted by 

the Congress and (b) more modern private-sector insurance products offered by private health plans. It appears to be the style of competition preferred by the President, who would endow the traditional Medicare program with only a skimpy drug 

benefit 2 and subsidize drug benefits through private plans more heavily, and who 

would otherwise not alter Medicare’s benefit package. 

No one, probably not even its proponents, would call the second style of competition fair. It is the analogue of a parent offering a high school graduate, as a graduation gift, a choice between (A) a Ford Taurus and (B) a similar Chevrolet, on the 

condition that the parents will pay for a CD player in the Ford Taurus and pick 

up the annual maintenance costs on it, but that they will not cover these items for 

the Chevrolet. It can be doubted that either GM or the kid would call this a fair 

choice. 

What rationale one might offer for styling the competition between Medicare and 

substitute private health plans in this unfair way. 

First, it might be argued that, under our system of political governance and campaign financing, it will always be impossible for Congress to modernize Medicare in 

step with changes in modern medicine. The argument would be that Congress and 

successive Administrations have managed Medicare as poorly as they have because, 

by its very nature and its method of campaign financing, American government 

manages everything it does poorly. It is a troublesome thought. 

Second, it may be argued that government-run health insurance programs are inherently cumbersome, because they must strive to be horizontally fair to all parties, 

while market mechanisms usually are not subject to that constraint, unless government imposes on them. To illustrate, Medicare must observe scrupulously horizontal 

equity in its dealings with hospitals and physicians. (Horizontal equity means two 

physicians or hospitals would always be treated the same way). There are public 

hearings on proposed changes, notices in the Federal Register, comment periods, and 

such. By contrast, private health plans need not be so fair. They can treat different 

physicians differently, if they can cut different deals with them, and they can 

change rules or contracts with providers and patients overnight, without much notice, and subject only to the tort system and contract law. Therein lies greater flexibility. 

A third argument for the proposed, unfair competition might be that, by their respective natures, private health insurance plans will always be more efficient than 

government-run insurance plans in anything they do. In principle, that hypothesis 

is amenable to empirical verification, after one has defined carefully what is meant 

95

by ‘‘efficient.’’ If there is a body of empirical research that convincingly supports this 

hypothesis (which there might be) I am not aware of it. In any event, if private 

health plans really are more efficient than is traditional Medicare, why then would 

they need the boost of a special public subsidy available only to them (and not the 

traditional Medicare) to be competitive with traditional Medicare? 

C. WHAT IS THE GOAL OF MEDICARE REFORM? 

It has never been clear to me just what the goal posited for Medicare reform 

might be, because usually the authors of such proposals remain silent on the subject. I can think of several distinct goals, to wit:

• Reduction in total health spending per Medicare beneficiary, from all 

sources, however it may be split between taxpayers and Medicare 

beneficiaries. • Reduction only in the taxpayer’s exposure to Medicare spending, 

even if it increased total health spending per Medicare beneficiary. • Obtaining better value for the health care dollar, whatever the 

source, and whatever Medicare reform does to total health spending 

per Medicare beneficiary, from whatever source. • Rescuing the private health insurance from a slow death march 

caused by the ever-finer risk segmentation that occurs under mass 

customization of private health insurance.

In what follows I shall briefly explore each goal in turn, referring readers to my 

Primer for a lengthier exploration. 

Goal 1—Reduction in Total Health Spending: If the goal of the proposed 

Medicare reform were to reduce total health spending per Medicare beneficiary—

from all sources, including the beneficiaries themselves—then I doubt that this goal 

will be achieved with the proposed reform. I come to this conclusion by ruminating 

on the sketch on the next page. 

Given the awesome power traditional Medicare has to set administered prices for 

Medicare, it can be doubted that private health plans can buy benefits for the beneficiaries at lower prices, or even at the prices Medicare now pays. It may be argued, 

of course, that these prices are too low, and that private health plans would set 

more appropriate, higher prices. Whatever the merits of that idea, however, it would 

drive up total health spending per Medicare beneficiary, not lower it, other things 

being equal.

It may be argued, next, that private health plans would lower total health spending per beneficiary by ‘‘managing’’ health care utilization (volume) more efficiently 


Insert 89405A.013
96

than does traditional Medicare, perhaps through disease management. At the abstract level, this argument has a certain appeal, especially in view of the previously 

cited Wennberg variations. But there are practical obstacles to this strategy. 

First, if attempts by private health plans to ‘‘manage’’ the utilization of health 

care by employees triggered a ‘‘managed care’’ backlash in the younger generations, 

one can only imagine what backlash that attempt would trigger among Medicare 

beneficiaries and their physicians, if these much maligned (though theoretically defensible) managed-care techniques were applied to the elderly population. 

Second, there is scant empirical evidence that the private health plans so far have 

performed much disease management. One would have thought that these plans 

should have been able to earn a fortune by managing health care properly in counties where their premiums were based on 95% of a very high Average Actuarial Per 

Capita Cost (AAPCC)—e.g., Dade County Miami, Baton Rouge, Louisiana, and so 

on. Yet when Congress capped the premiums paid the plans for the high cost countries under the Balance Budget Acts of 1997 (BBA 97) at an annual growth of 2%, 

the plans professed not to be able to manage with those premiums. Evidently, there 

are narrow limits to the plans ability to reduce utilization even in high-utilization 

areas. Third, the concept of Enhanced Medicare proposed by the President envisages 

health insurance products otherwise known as Preferred Provider organizations 

(PPOs), which resemble nothing so much as open-ended, unmanaged indemnity 

products. Such open-ended plans are unlikely to control volume significantly better 

(if at all) than traditional Medicare does now. 

Finally, it is doubtful that the total fraction of the premium that plans need for 

marketing, administration and profits (SG&A plus profits) under a privatized Medicare program will be lower than the sum of the administrative cost of traditional 

Medicare (less than 2% of expenditures, see graph below) plus those of Medigap 

policies.

Source: CMS, http://cms.hhs.gov/charts/default.asp, CMS Facts & Figures, II. CM Program 

Operations, June 2002 Edition, Slide II.6.

In sum, if, relative to traditional Medicare, private health plans would be unlikely 

to achieve (1) lower prices, (2) significantly lower volume or (3) lower SG&A costs, 

whence then would come any cost savings from privatizing Medicare? 

Goal 2—Limiting the Taxpayer’s Exposure to Medicare: If the goal of Medicare reform were merely to limit the taxpayer’s contribution to the health-care cost 

of Medicare beneficiaries (even if that drove up total health spending on them from 

all sources) that goal could be achieved with such a reform, at least theoretically. 

In effect, the reform would be designed to convert the Medicare program from its 

traditional structure of a defined benefit program (which saddles taxpayers with the 


Insert 89405A.014
97

risk of health care cost inflation) to a defined contribution program (which would 

shift the risk of future health-care cost inflation substantially onto the shoulders of 

Medicare beneficiaries). It would, in effect, represent a reallocation of an essentially 

uncontrollable fiscal burden from the young to the old. 

In view of the burden of the retiring Baby Boom and the inexorable decline in 

the number of workers per elderly in the decades ahead, such a strategy certainly 

deserves careful consideration. If that be the goal of Medicare reform, however, one 

would hope that those positing it would do so straightforwardly, for open debate in 

our democracy. 

Goal 3—Obtaining Better Value for the Dollar: It may be argued that private 

health plans can obtain better value for the Medicare dollar (regardless what total 

health spending on Medicare beneficiaries may be), because these plans know how 

to manage health care better than does traditional Medicare. 

Although that proposition has appeal, there is the caveat that any such attempt 

at ‘‘managed care’’ might trigger the backlash alluded to above. Indeed, the President’s proposed Enhanced Medicare is explicitly designed to spare Medicare beneficiaries these ‘‘managed care’’ techniques. 

Furthermore, there is no reason why traditional Medicare could not be allowed 

to purchase health care more prudently than it is now allowed to do and to engage 

in modern disease management. Government-run or -controlled health insurance 

programs abroad—e.g. in Germany—certainly are now experimenting with this approach. If Congress wished to attain better value for the health care dollar under 

traditional Medicare, it could certainly achieve that goal. 

If, on the other hand, Congress as a matter of fiat steadfastly refuses ever to 

allow traditional Medicare to manage itself and the care it procures more efficiently, 

then almost by definition and by deliberate design private health plans will have 

a comparative advantage in this regard. In that case, however, it would seem reasonable to ask Congress for an explicit justification of such a policy. 

Goal 4—Rescuing the Private Insurance Industry from Self-Afflicted Demise: In my Primer for journalists, I explore at greater length the effect that the 

ever-finer risk segmentation within the private health insurance sector will have on 

the fraction of the health care dollar that the private sector will control in the future. 

Although the sector currently covers two thirds of the American population, it accounts for only about one third of total national health spending. It is so, because 

fiscal responsibility for the more costly citizens—the blind and disabled and the elderly—has been left to the public sector. 

If the private insurance industry continues to segment risks as it has in recent 

years—through ever more sophisticated ‘‘mass customization’’ of its policies—then 

more and more chronically ill Americans will be flushed out of its book of business 

and onto the mercy of government. Thus, a decade hence the private sector might 

control only 25% of total health spending. 

One could think of the proposed Medicare reform as a strategy designed mainly 

to rescue the private insurance industry from this self-inflicted wound. It would be 

a purely political decision, of course, that one would be hard put to justify on economic grounds. 

D. OBSTACLES TO MEDICARE REFORM

Among the potential obstacles facing the proposed reform of the Medicare program, and listed in my Primer for journalists, are the following:

1. Competitive Bidding: Competitively bid premiums are the central core of 

most proposals to privatize Medicare, the President’s included. Competitively bid 

premiums are thought to be the main engine for quality and cost control. Yet, as 

noted earlier, previous attempts by Medicare to experiment with competitive bidding 

by private health plans has met with stiff resistance from the health plans. They 

have invariably been killed, courtesy of the good offices of the Congress. What assurance do the proponents of Medicare reform have that the plans would embrace 

the competitive bidding envisaged by the proposal? 

2. Risk Adjustments: Any system of competitive enrollment of diverse people by 

price-competitive private health insurance plans requires that the premiums paid 

the plans be adjusted for the actuarial risk of the enrollees choosing the plans. Unfortunately, no one in the world has yet developed a satisfactory risk-adjustment instrument for this purpose. The risk adjuster currently used by Medicare for its 

Medicare+Choice program, although fairly sophisticated by international standards, 

has been vehemently criticized by the health plans. Concretely, then, what ideas for 

risk adjustment do the advocates of the proposed reforms have? 

3. Wennberg Variations: There is the question how a reformed Medicare would 

cope with the previously cited Wennberg variations in Medicare spending. These 

98

variations have hitherto been politically acceptable, because they are known only to 

the cognoscenti. The proposed reform might flush them out to greater visibility and 

trigger political controversy. 

4. Insurer of Last Resort: Finally, there is the question how any competition 

between traditional Medicare and private health plans can ever be on a fully level 

playing field, if the private health plans are permitted to withdraw from certain regions of the country in which they cannot thrive, while traditional Medicare must 

stay as insurer of last resort. That facet of the proposed reform required further 

thought than it has hitherto been given.

for your testimony. I am going to turn, first, to the Chairman of 

Mr. MCCRERY. Thank you, Dr. Reinhardt, and thank all of you 

f the Subcommittee on Health, Mrs. Johnson. 

Mrs. JOHNSON OF CONNECTICUT. Thank you all for your 

thoughts and your very thoughtful testimony. 

Dr. Reinhardt, under program shortcomings, you mentioned prescription drugs, no stop loss and cost-sharing issues, but you don’t 

mention almost total lack of preventive, coverage of preventive benefits under Medicare, and more importantly, Medicare has no capability to provide management of chronic illness. Structurally, it 

doesn’t have that capability, and yet about 32 percent of the seniors that have 5 or more chronic illnesses are using 78 percent of 

the resources. 

So, when you say what could plans offer us, the private sector 

is far more advanced than is the public sector in managing care, 

not managing care in the old HMO model; managing care in the 

integrated disease protocols models. 

When you look at the number of people retiring and the length 

of time they are living, and the number of multiple diseases they 

are living with, do you think that there is no opportunity to save 

money in Medicare by better managing chronic disease? 

Dr. REINHARDT. Oh, no, I do believe—that is on page 10, my 

goal 3. I said it could be that we assume we get better value for 

the dollar, in particular, disease management, which is also I mentioned in the——

Mrs. JOHNSON OF CONNECTICUT. It is very much of an 

aside, and, to me, if 32 percent are using 78 percent of your resources, and that type of patient is going to grow, this is not an 

aside. 

If we want to bend long-term spending in Medicare, we can do 

exactly what has happened in other sectors of our economy. 

Through more integrated teamwork, through better use of technology, we have reduced costs and improved quality, and that is 

really what disease management does. It improves the quality of 

care for the individual patient, but it reduces the overall cost by 

reducing hospitalizations, emergency room visits, and in many instances even physician visits. 

If this were aggressively pursued in the near term, with CMS 

identifying these patients and giving them incentives to join such 

plans, the issue really isn’t would this save money, in my mind; the 

issue is how do you do it? How do you let both private-sector plans 

that have demonstrated that they are doing this well do this for 

our seniors, and how do you provide access to coordination of care, 

99

management of diabetes, management of heart disease, these kinds 

of things in rural areas where there is no plan? 

There almost invariably is some small hospital or medical practice that, with the resources, particularly the technology, could do 

this. This is springing up from the medical community, and it is 

better quality and lower cost. 

So, your analysis is interesting, but it is too focused on where we 

are now and the way we have always viewed care. If we are going 

to view care more holistically and more proactively, we will get 

higher-quality care, and we will be able to, in the long run, keep 

people out of dialysis. That will save us money. 

Dr. REINHARDT. Yes, Congresswoman Johnson, I agree there is 

some experiment or some initial experiments with disease management, but I think it would not be accurate to say that disease management is now widely practiced in the private sector. They, too, 

are only just beginning, and usually the mechanism they use is to 

contract/subcontract with specialized niche companies who do that. 

There is no reason the traditional Medicare couldn’t do that, too. 

It could deal with Centers of Excellence, it could do selective contracting. It could do almost all of it that a health plan can do. The 

real issue is it needs the authority from the Congress to do it. 

I think you might want to invite people like Marilyn Moon, who 

have thought much about this, who would tell you, you don’t necessarily have to join a private health plan to get disease management. 

Mrs. JOHNSON OF CONNECTICUT. My time is about to expire, and I want to see if anyone else has a comment. I agree with 

that, but I don’t think you want to exclude those systems that have 

more advanced capability than we do. I think you need to do both. 

Dr. REINHARDT. Not at all. In fact, I say I welcome always 

competition. Every public program, where feasible, should have 

competition from the private sector, whether it is Federal Express 

and the U.S. Post Office or health plans and Medicare. I totally 

agree with you on that. 

Mrs. JOHNSON OF CONNECTICUT. Dr. Pauly and Dr. Stuart. 

Do you have any comment? 

Dr. STUART. I am sorry? 

Mrs. JOHNSON OF CONNECTICUT. Do either of you have any 

comment on this aspect of cost control and Medicare? 

Dr. STUART. I was going to say that I have trouble hearing, and 

so if I ask you to repeat your question. I also might note that Medicare does not cover hearing aids. 

[Laughter.] 

Dr. STUART. Let me make a point about disease management. 

Disease management, actually, as it is practiced by these niche 

companies, typically plays a heavy role in terms of prescription 

drug therapy. So, it would be very, very difficult for Medicare, as 

it is currently constructed, to encourage disease management, because one of the central elements of disease management in the 

private sector is simply not available to Medicare. So, I think that 

simply making prescription drugs available would actually make it 

feasible to develop disease management approaches. 

Dr. PAULY. Well, I am both more and less optimistic than Professor Reinhardt. I think if we judge from the competition between 

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managed care and fee-for-service in the private sector, although we 

don’t have any definitive estimates, my entry in the office pool is 

that managed care saved about 15 percent. Now, that was a onetime saving, but it was what resulted in very low rates of growth 

for private sector spending from about 1994 to 2000. You might be 

able to see that same sort of saving within Medicare, but it would 

require what managed care required in the private sector, which is 

limitation, greater limitations on patients and providers, and that 

would fly in the face of what people love about today’s Medicare. 

I will say though I am, in 4 years, contemplating being eligible for 

Medicare, and one of the things I worry about is a point that 

Chairman Thomas made this morning. I worry about the relevant 

comparator, you need to have the relevant comparator. My judgment is today’s Medicare is not sustainable. I am not sure whether 

it is sustainable for the next 4 years, but is certainly not for as long 

as I hope to be around and a burden on my children. So, I think 

the affection that people feel for a very generous program, of whose 

cost they pay less than 10 percent, is not something that we can 

continue to hold out for future generations of elderly people, so we 

need to think about how to change that. 

The good news is that some private sector plans may be able to 

save money, although they will probably require some restrictions 

that Medicare beneficiaries are not used to. The bad news is that 

potentially the savings that private sector plans can achieve, which 

in part result from obtaining lower prices and discounts to providers, Medicare may have already achieved. So, at least the part 

about better negotiation with providers, at least to judge from the 

complaints of hospitals and physicians these days, Medicare may 

have already made those cuts, so there may not be as much of a 

gain. 

In keeping with the tradition of economists as professional wet 

blankets, I guess what I see as the main advantage of competition 

in Medicare is that when the inevitable restrictions come, I would 

rather have a choice of how to have those restrictions imposed on 

me, rather than have them decided unilaterally and in a monopolistic way. 

Mrs. JOHNSON OF CONNECTICUT. Thank you. 

Dr. PAULY. It is a kind of name your poison phenomenon. 

Mrs. JOHNSON OF CONNECTICUT. Thank you. My time has 

well expired. Sorry. 

Mr. MCCRERY. Mr. Stark. 

Mr. STARK. Thank you, Mr. Chairman. I am confused about 

what it is we are trying to hear today. I wanted to ask Dr. 

Reinhardt some questions, but I would ask Dr. Pauly, if he would 

be so good—he mentions the research about lowering the copayment produces a 65-percent increase, and if you could at some 

point after the hearing or subsequently just give me a reference to 

that, I would be interested in looking into that further. 

I wanted to get to why we are talking about Medicare reform, as 

in quotation marks, and that is, what are we trying to do? I am 

going to ask Dr. Reinhardt to give me what my choices are, and 

also to comment on this often stated theory that competition and 

free enterprise are what is missing in controlling the delivery of 

health care, medical care, to particularly seniors. For one thing, I 

101

am confused when people talk about choice in prescriptions. I don’t 

know if anybody in this room, including some of the physicians, 

could tell me what half the prescription drugs that are advertised 

in People Magazine do for you or to you. I am sure that none of 

us are apt to go off and buy some just for the hell of it if we don’t 

know what is going to drop off or quit working if we take this stuff. 

I don’t know any of us that know the cost of any of these tests. I 

have often stated that if I offered witnesses a half-price proctological examination at George Washington this afternoon, would 

you run up and take it? No, you wouldn’t. Only if your doctor told 

you to you might. 

So, what is this market based on? I went to a school where they 

taught marketing, and they had some economists there and they 

talked about having to have a knowledge of the market and how 

do consumers decide if they don’t know what the hell they are buying? 

So, I wonder, Dr. Reinhardt, if you could elaborate for us a little 

bit about what—accepting your challenge that we have to fix it, 

what in broad terms are our options in fixing it, which is to provide 

a proper amount of medical care to all Americans, and what factors 

would help us most, free market, complete competitive bidding? Go 

ahead. 

Dr. REINHARDT. Well, starting with the latter, the competitive 

bidding, California Public Employees Retirement System, which is 

the biggest purchaser of health care in California, your State, last 

year had 25-percent premium increase. These were highly competitive plans, and the question of course you have to ask yourself in 

Congress, is that the kind of cost control that we can afford; is that 

sustainable, or how do you make this sustainable? I think your 

only option is to roll that responsibility over on the elderly, which 

maybe should be done, but I think that should be openly discussed 

to what extent that is the goal of Medicare reform. 

I think whenever you hear people say the people should have 

more ‘‘skin in the game,’’ as the language is, fiscal skin in the 

game, what is actually really being talked about though—and 

again, maybe that should be done—you want to ration health care 

by price and ability to pay, and it is the lower half of the income 

distribution who should carry the burden because think of someone 

in the top first or second percentile of the income distribution, 

someone making more than $200,000. What does it actually mean 

for them? I’m in that position. Cost sharing doesn’t mean a thing 

to me. Whatever it is, I’ll pay it. So, it has zero effect on people 

like me, but if you were a gas station attendant, cost sharing has 

a major effect. So, we are saying like food is rationed and like housing and clothes, we would like to ration health care. That way the 

burden would mainly be borne by the lower half of the income distribution. 

There is no reason why a nation might not choose that as long 

as you are honest about it, that is what markets—or cost sharing, 

that is what it really achieves. I am not—I think I am more inclined, as Mark says, to have some choice as always, because most 

airlines are the same, lousy food, lousy planes, but it does give you 

some pleasure to be able to tell one airline to go to hell. I have 

often done it, just the last minute I have rebooked, and I think that 

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is sort of what Mark—pick your own poison, so to speak. There is 

some virtue in that, and that is why some competition is obviously 

very good. When the President talks about enhancement Medicare, 

which is essentially PPOs, which is essentially warmed-over feefor-service, unmanaged. I cannot imagine where the savings would 

come from, other than this ability, Mark says, to have some choice 

is always a good thing. 

Again, I want to emphasize I am not at all against it; I am for 

it. I would worry about having a popular program such as Medicare—which is not more expensive, as Marilyn Moon’s research 

shows—abolished simply because some people don’t like the esthetics of it. 

Mr. STARK. Thank you. 

Mrs. JOHNSON OF CONNECTICUT. [Presiding.] Mr. 

McDermott. 

Mr. MCDERMOTT. Dr. Reinhardt, knowing the injunction about 

not casting pearls before swine—there are very few of us left—but 

I would like to give you a Blue Book question. If a country can for 

120 years provide a guaranteed set of benefits, including prescription drugs, as Germany has done, what is it that is wrong with 

Medicare that—or what do we need to change in Medicare to make 

the same thing possible for the elderly in this country? 

Dr. REINHARDT. Well, you would need to modernize the benefit 

package. It is sometimes overlooked that until 1990, Medicare was 

the more innovative program that kept step. Medicare covered 

renal dialysis when it was technically feasible. Medicare introduced 

diagnosis related groups. Medicare introduced the fee schedule. It 

was only after 1990, when the private plans introduced prescription drugs, that Medicare fell behind. Those plans also didn’t cover 

preventive care until about 1992. So, when you talk about modernizing, mainly it is that you have to have a modern benefit package. 

What makes Germany cheap are two things. One, simplicity. It 

is a very simple program. It has very low administration. There 

was a McKinsey Global Institute study that showed in 1990 Americans actually got $390 less health care—doctor visits, pills, and so 

forth. So, we were clinically more efficient, they said, because we 

spent less. Ninety percent of that was spent on administration. 

I am on the board of the Duke University health system. We consolidated our billing, and I was told we have 900 people in the billing department. I got kind of angry, and I said, well, is that Medicare—Medicare compliance? The answer, no. For the most part it 

is because we have 60 different plans, each with their own rules, 

they don’t pay. Medicare pays within 20 days, it is electronic. Private is still all paper. 

So, Germans save a lot of money on administration by having 

standard billing forms, standard fee schedules, and those kind of 

things; where here there are no fee schedules. We have a market 

without prices. I defy anyone to give me the website in Washington, DC where I could find out what different physicians cost. 

Each fee schedule has 9,000 items in it. How would you technically 

even do this? You need somebody to negotiate these things for you. 

I think that is, of course, Medicare’s advantage. It is a simple program. Prices could be negotiated, too. You set them, but they could 

103

be negotiated, the way Germans do it, and make the program a lot 

simpler. 

There is no question, Germany’s population today is as old as 

ours will be only in the year 2020. Yet Germany’s spending per 

capita is about 57 percent of ours. There is no discernable difference in health status. 

Mr. MCDERMOTT. What is their mechanism by which they control the pharmaceutical industry? The pharmaceutical industry is 

as big in Germany as it is in this country, I think, on some relative 

scale. How did they deal with the cost of pharmaceuticals? 

Dr. REINHARDT. They use what I think both Professor Pauly 

and I would call a market approach called reference pricing, where 

they classify groups into therapeutically equivalent classes of 

drugs, reimburse fully—not the cheapest, but sort of the third way 

up drug—and then tell the patient if you want a more expensive 

drug, you have to pay the whole difference between that benchmark, the reference price, and that brand-name price, out of pocket. That has really worked, substantially, in Germany. 

In addition, though, they also put a budget on top of drug spending. Reference pricing is very much hated by the pharmaceutical 

industry, because in Germany the prices of brand names tended to 

collapse to the reference price. The pharmaceutical industry then 

fears that there won’t be enough of a margin for innovation. That 

has been the argument. 

Mr. MCDERMOTT. Do you agree to that, that if we put reference pricing in our system, suddenly there would be not enough 

money in the system for innovation? 

Dr. REINHARDT. I think what you need to do to build those 

groups is to have absolutely first-rate science to make sure that 

really better drugs actually don’t get penalized, that it is only the 

me-too drugs that you push down. That is where there might be 

some controversy. 

I think as a general rule, if you take money away from the pharmaceutical industry, every item in their income will probably go 

down. They are spending 13 percent of revenue goes for research 

and development (R&D). If you took a buck away, there might be 

maybe 13 cents of R&D might disappear. Marketing would disappear, too, and other things as well. When you take a dollar away 

from a drug company, I don’t think Mark and I would say you lose 

a dollar R&D. That is not true. 

Mr. MCDERMOTT. Thank you. 

Mrs. JOHNSON OF CONNECTICUT. Mr. Becerra. 

Mr. BECERRA. Thank you, Madam Chair. Thank you to the 

three of you for your testimony. If I can, I would like to just follow 

up on a couple of things that Dr. Reinhardt mentioned earlier. 

First, Dr. Reinhardt, you mentioned that Congress as the board 

of directors, as you said, could, if it chose, address some of the concerns that we have with the current system of Medicare. Let me 

ask you this—and I would pose this to the three of you. Should we, 

if we end up with a privatized system of health care for our seniors, whether it is for prescription drugs or general for Medicare, 

should we require attributes all providers, private insurers, in the 

case of a private plan, be required to offer a plan in all geographic 

parts of the country? Which is something that, I think, Dr. 

104

Reinhardt, you mentioned that Medicare doesn’t have a choice in 

Iowa or anywhere else, it has to offer to that senior. Should we impose that as a requirement on any private insurer if we go toward 

a privatized system of Medicare? 

Dr. PAULY. No, I don’t think so. I think some insurers, the Blue 

Cross insurers, although it is changing, wouldn’t be capable of offering something country-wide. I think it would do a lot of violence 

to the current structure of insurance markets. 

Mr. BECERRA. Who would then cover——

Dr. PAULY. Let me say what I think, what——

Mr. BECERRA. Dr. Pauly, if I could ask you, who would then 

cover, if it wouldn’t be Blue Cross or any other private insurer——

Dr. PAULY. Well, it doesn’t have to be every insurer in every location. If—and this is the next point I wanted to make—if insurers 

are not willing to enter Iowa or wherever, or Ohio, where I came 

from, or Pennsylvania, where I am now, that is a sign that the current payment rates are inadequate. The solution to that is not to 

force them to enter areas where they are sure to lose money. Even 

if you are able to be effective, they will de-market their services 

and provide very poor service. The solution is to adjust the payment rates so that it is equally profitable, at least as much as you 

can approximate it, for insurers to enter in all parts of the country. 

That will surely mean, as we heard some discussion this morning, 

paying more in some areas than others because in rural areas you 

can’t have the same kind of economies of scale as you can have in 

urban areas, but on the other hand, you are not paying big-city 

prices, either. 

Mr. BECERRA. That doesn’t seem to reduce the cost overall of 

Medicare if we are having to increase the costs that we pay in certain parts of the country to encourage the private sector to go into 

those areas that Medicare currently services. 

Dr. PAULY. No, I think this would be an attempt to be more equitable and even-handed in providing access. 

Mr. BECERRA. It would increase costs? 

Dr. PAULY. I am not sure it would increase costs. That depends——

Mr. BECERRA. Well, if it doesn’t increase costs, why can’t we 

keep the level of reimbursement as it is, what Medicare currently 

is receiving, or what we are providing it to offer these services? 

Dr. PAULY. You would lower it in some places and raise it in 

others if you thought access was currently unequal. 

Mr. BECERRA. I see. I see. I don’t know, Dr. Stuart, if you wish 

to add anything to that? 

Dr. STUART. No. 

Mr. BECERRA. A question with regard to what Dr. Reinhardt 

said in terms of the total health care spending and how you come 

up with that calculation, the fees times the volume plus your costs. 

Do any of the other panelists disagree with what Dr. Reinhardt has 

identified as the variables, the factors that we would take into consideration, that formula for determining overall costs? Dr. Stuart 

or Dr. Pauly? Any disagreement? I don’t want you to go into it, just 

to—I wonder if you agree or disagree. 

Dr. STUART. Well, I think it is an accounting framework, and 

the elements of the accounts are there. So, one might disagree in 

105

terms of where savings might be obtained in one of the elements 

as opposed to another element. I think, certainly, the model itself 

is complete. 

Mr. BECERRA. Can anyone identify for me a private insurer 

which today administrative costs that are lower than what Medicare spends? There, Medicare doesn’t market, so it doesn’t have 

marketing expenses. It also doesn’t seek to secure a profit. So, if 

we could factor in marketing and profit into that cost of administration, can anyone name for me a private insurer that right now 

offers a health plan and benefits for a lower administrative cost as 

I have defined it than does Medicare? 

Dr. PAULY. Well, the literature says—actually, it doesn’t identify private insurers by name, but the traditional estimates in the 

literature on group insurance are that large group insurance, say 

the General Motors-type firm, would have administrative costs of 

around 5 percent. 

Mr. BECERRA. That is still higher than Medicare. 

Dr. PAULY. It is still higher than Medicare, but the difference, 

as you mentioned is that Medicare raises its money via compulsory 

taxes and private insurers don’t have that luxury or that privilege. 

To my understanding, the pure cost of claims processing is not terribly different between Medicare and private insurers. The primary 

difference, the thing that explains why Medicare is at 3 percent 

and private insurance on average is at around 13 percent, are 

those selling costs. You have to talk people into private insurance. 

You don’t have to talk them into Medicare because it is 10 percent 

subsidized—only paying 10 percent of the price, and also billing 

costs. When people buy private insurance, somebody has to remind 

them to pay their bill every year. 

So, there are a lot of good things to say about Medicare, but I 

actually think the administrative cost saving is somewhat of a red 

herring. If you compared kind of equivalent costs for doing equivalent things, the people up on Security Boulevard are wonderful people, but I don’t think they are any better or worse than the private 

sector. 

Mr. BECERRA. I think that is a very good point in terms of the 

marketing, that as a mandated program you don’t have marketing 

costs, you don’t have to try to go out there and solicit business. Dr. 

Stuart, did you want——

Dr. STUART. I think there are a couple of other elements here 

on, actually, both sides of the argument. One of the arguments behind the difference in measuring administrative costs in a public 

program and a private program is that although what you count 

as an administrative cost in a private program might show up in 

terms of higher prices or in terms of inefficiencies in the public program. So, you have to be careful when you are just looking at that 

stratum that goes to administration on the balance sheet, or on the 

income statement. 

The other thing that I might note is that the administrative costs 

under Medicare are managed. Those costs are determined by budgets. You determine how much Medicare spends on administration 

by how much you are willing to give CMS to carry out its mandate. 

Mr. BECERRA. My time has expired. I would just like to make 

sure that—I didn’t hear anybody mention a particular private plan 

106

in place that offers its services for a lower administrative cost than 

does Medicare. I think the point is well taken, though, in terms of 

marketing. There may be some value in having a mandated system 

which doesn’t require marketing nor the profit element in terms of 

costs that ultimately seniors have to absorb in order to be provided 

with a health care benefit. 

I thank you very much, and thank you, Madam Chairman. 

Mrs. JOHNSON OF CONNECTICUT. Thank you. Before I recognize the next speaker, I would like to point out that Medicare’s administrative costs do not include Treasury’s costs of collecting the 

Medicare tax nor the inspector general’s cost of their portion of 

overseeing Medicare with the fraud and abuse function, which the 

private sector covers. 

In addition, I don’t know, and I will ask the experts, has anyone 

ever done any study of the combined administrative costs by the 

government and the administrative costs that the payor pays on 

the provider? For instance, Medicare imposes much heavier costs 

on home care providers than private sector providers impose on 

home care providers. That is one of the reasons why I am trying 

to eliminate the Outcomes Assessment Information System form 

for private-care patients. So, has there been any combined look at 

administrative costs of both the government and those on its providers that it has imposed, versus the private sector’s administrative costs and the administrative costs that they impose on providers? 

Dr. REINHARDT. I think that is a good point and worth a study. 

There are compliance costs with Medicare, particularly when you 

have a corporate integrity agreement, which is one of those letters 

that oblige you to be audited and so on. What struck me in the 

Duke example—and I have asked in the other company on whose 

board I am, too—the unbelievable back-and-forth to get a claim 

paid, that goes back several times. 

Mrs. JOHNSON OF CONNECTICUT. In Medicare, you mean? 

Dr. REINHARDT. In the private plan, where your payment days 

outstanding may be 90 or 100 days. So, if you take Duke, for example, we have a float of $250 million a year that has to be financed. 

I asked, well, why aren’t we getting paid? They told me, well, Medicare is not the problem; we get paid in 20 days. 

Mrs. JOHNSON OF CONNECTICUT. Dr. Reinhardt, if I may interrupt you, if you have ever been to a doctor trying to get paid 

for comprehensive physical versus a detailed physical with very different payment rates, you can see exactly this long paper trail. I 

have one hospital that has an intensivist overseeing their intensive 

care unit. It is saving Medicare money. We have a code for this and 

never, ever have they been able to get paid under the Code. They 

just provide more and more documentation. 

So, frankly, I am loaded with examples of that kind of problem 

going on over months or years. At one point, Medicare stopped paying for all partial hospitalizations in my State and it took us 9 

months to straighten it out. So, I would have to have a study show 

me that there were more serious payment controversies in the private sector than those in the public sector. 

Dr. REINHARDT. Well, as I said, it really would be worth studying. 

107

Mrs. JOHNSON OF CONNECTICUT. It would be worth it. 

Dr. REINHARDT. I would include an administrative cost on the 

private side; also, of course, the claims processing. I don’t do it. I 

just refuse. My wife does it. She tells me that her claims processing 

is worse than doing the income tax. She does the income tax, too. 

So, we have a good apple-to-apple. She says dealing with the insurance is a lot worse. 

Mrs. JOHNSON OF CONNECTICUT. On the other hand, having 

just broken my ankle about a year ago and being a Medicare recipient, I can tell you the number of mailings that I received for a simple broken ankle was scandalous, from Medicare, scandalous. So, I 

do think we should try to find that, and any of you—and let me 

let the others comment and then we will let the other two Members 

question before we have to go. So, briefly. 

Dr. PAULY. Just two comments. First, there are estimates of the 

administrative cost at hospitals for third-party payment and they 

run around 20 percent. So, they are certainly not trivial. I haven’t 

ever seen any Medicare versus private sector. Of course, if it is 

hopeless to try to get money out of Medicare, there is no point in 

a doctor wasting administrative costs. 

Mrs. JOHNSON OF CONNECTICUT. We do have only 13 minutes left, and I have two questioners——

Dr. PAULY. Some physicians feel that way. The other point I 

wanted to make, though, I think an important, often neglected to 

mention, administrative cost to the Medicare system is, well, the 

slogan is one-size-fits-all. I don’t much like that sloganeering, but 

people buy Medigap coverage to tailor Medicare to their own desires. So, really, the administrative costs of Medigap plans ought 

to be attributed to Medicare. If you did that, you would end up 

with a lot more than 3 percent. 

Mrs. JOHNSON OF CONNECTICUT. A very valid point. I am 

sorry, Dr. Stuart, since we only have 15——

Dr. STUART. Let me just take 1 minute to suggest an area in 

which administrative costs are going to be a major concern for Congress as it considers the Medicare drug benefit, and that is the administrative costs that are imposed on the private sector by private 

plans developing wildly different formularies. I can tell you that 

this is very costly to medical practices, because the physicians can’t 

figure out which patients are covered under which plan and which 

drugs they should get. It is particularly costly on pharmacies because the patient comes in and the drug is not covered under the 

formulary——

Mrs. JOHNSON OF CONNECTICUT. That is a very important 

consideration. We may get back to you on that. Mr. Pomeroy. 

Mr. POMEROY. My time is very brief, but I want to ensure my 

colleague, Ms. Tubbs Jones, also has time. So, I think that I will 

pull back out of the weeds a little bit of how we restructure Medicare. I will note consensus across the panel that some work is 

needed here, even though there may be substantial difference in 

terms of how we proceed. 

The thing that I am wondering about is regardless of what we 

have by way of exact delivery of benefit mechanism under the 

name of Medicare, how we pay for it in the next decade if we don’t 

do some preparatory work this decade to strengthen the financial 

108

position of our country to prepare for the entitlement hit of baby 

boomers. It would seem to me specifically that paying down the 

debt this decade would make more sense than adding to it significantly, because I believe borrowing in the next decade will absolutely be essential to cash flow the requirements that we see in the 

Medicare trust fund. 

If we could run across the panel and give us your counsel on that 

one. Would it be better to increase the debt or decrease the debt 

for purposes of preparing to meet the entitlement challenge of baby 

boomers, or is it your position that we should simply back off of 

those entitlement commitments. Dr. Reinhardt? 

Dr. REINHARDT. Well, I would have been in favor of not increasing the deficit, actually try as much as possible to have a surplus and buy back the debt. That is really supply side economics. 

How would that work? You could imagine the Medicare trust fund 

just buying through the Treasury, buying back bonds. Those bonds 

would be owned by pension funds. They would have to recycle that 

money into the private sector. That is the clearest way to get 100 

percent of that money into investment. If you instead give it in tax 

cuts to individuals, like myself, who benefits from these tax cuts, 

I might buy a new Mercedes—in fact, I have—with the money and 

it might not yield productivity. 

So, I believe going the route of having less of a deficit. Once the 

day will come when Europeans may not wish to hold dollars or 

other nations, they may wish to hold euros. That seems already to 

be happening. It could be happening throughout the Middle East. 

You will see interest rates skyrocket in the United States. 

So, I think the fiscal policy we are now on, to my mind is not 

the right path. 

Dr. PAULY. Well, I would risk controversy by saying I prefer a 

smaller debt to a larger debt. I don’t think that is the most important thing that will determine the future viability of the Medicare 

and other entitlement programs. I think it is the overall economic 

health of the economy, so that the rate of growth of gross national 

product (GNP) and the level of real GNP is a lot more important 

than the level of debt. Other things equal, lower debt is better than 

larger debt, but if the economy can be made to operate better, that 

is going to be much more important. That is the first thing I would 

do to save Medicare. 

Mr. POMEROY. Significantly higher debt could even interfere, 

perhaps, with some of the economic——

Dr. PAULY. Well, it is the ratio of debt to GNP that you ought 

to pay attention to, not the absolute level of debt. I would rather 

work on the GNP side than——

Mr. POMEROY. I accept that, but for the known fiscal hit we all 

know about—lives in being with existing entitlement commitments—that it seems to me should also be factored in, unless we 

are straight-up talking about diminishing those entitlement commitments. 

Dr. PAULY. Well, I personally think we ought to start talking 

about diminishing those entitlement commitments because, given 

the demographics, I don’t see any way to avoid that. I guess that 

is the other solution—this is only my own personal solution—have 

more grandchildren. That would help a lot. 

109

Mr. POMEROY. Thank you. Thank you very much, Dr. Pauly. 

Dr. STUART. Well, I will make it three in terms of reducing the 

debt. I happen to believe that the absolute level of the debt is important as well as the relative level of the debt, and I am concerned 

to see the debt rising as fast as it is. 

I do think, however, that when one makes decisions about Medicare, it is going to be very difficult, if not impossible, to make a decision about the entire program. I really believe that is true. So, 

what that means is that you are going to have to deal with incremental changes within that program. So, when we, each of us received the invitation to talk today about modernization in Medicare 

with a prescription drug benefit, I think the prescription drug benefit should be treated on its own merits. What you really need to 

do is you need to say is this something a modern Medicare program 

should have—and I believe you will say yes—and then the question 

is how best to do it. 

Mrs. JOHNSON OF CONNECTICUT. All but 8 seconds of the 

gentleman’s time has expired, so if we may move on to Ms. Tubbs 

Jones. We have 5 minutes before the vote. 

Ms. TUBBS JONES. Five minutes? 

Mrs. JOHNSON OF CONNECTICUT. Five minutes. You can 

take 4 minutes. 

Ms. TUBBS JONES. I won’t take that long, probably. Dr. Pauly, 

you say you are from Ohio. Where? 

Dr. PAULY. Cincinnati. 

Ms. TUBBS JONES. Cincinnati, oh, the other end of the State. 

They say it is like Cleveland and Cincinnati are in two different 

States. All joking aside, one of the biggest problems we have had 

with health care in Ohio is the fact that the private insurers have 

not been required to contract, that they could just give notice and 

say ‘‘I’m gone’’ and in 30 days the people having health care under 

the HMOs in Ohio have just run away. So, then we end up with 

people with no health care coverage. That is why I have a real dilemma with pushing Medicare into the HMOs, based on the experience that my Medicaid constituents have had with the HMOs. 

Real short: How do I resolve that problem? If I agree I want to 

go with private insurers, how do I resolve the running away from 

my constituents? 

Dr. PAULY. Well, you have to pay them enough to make it worth 

their while to stay. 

Ms. TUBBS JONES. Except when they enter into the contract, 

they know what I am going to pay them. 

Dr. PAULY. Presumably, they run away when the contract is expired, not before. 

Ms. TUBBS JONES. Well, we have had it as terrible as 30 days. 

I am not going to argue that. That is my dilemma with the private 

insurers. 

Dr. PAULY. Then I would say write more iron-clad contracts. 

The fundamental aspect of private firms is that they need to be 

able to cover their costs in order to remain in business. 

Ms. TUBBS JONES. Dr. Reinhardt, how do I resolve this issue 

as we reform Medicare? 

Dr. REINHARDT. Well, one is to pay more. Then Congress, of 

course, loses any sense of budgetary control, have even less than 

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they have now. Or the alternative is to make sure the old Medicare 

is always there as a fallback position, which would be my—my favoring that program is because it is a fallback position. 

Ms. TUBBS JONES. Why do we always have to worry about deficit spending when it comes to programs such as Medicare and 

Medicaid, and we don’t ever worry about deficit spending when it 

comes to things like military spending and the other issues? I voted 

for the Supplemental, and I support the military. I am just wondering why that number always comes up. Dr. Pauly? 

Dr. PAULY. Well, I don’t worry about deficit spending for Medicaid, at least the part of it that pays for children, because I view 

you are making an investment in children and that is as good as 

an investment in national security. I think for senior citizens, in 

a way, it is more difficult because it is less easy to make the argument that the spending will yield returns. 

Ms. TUBBS JONES. If I was sitting at the table and I had to 

decide whether you got services, and you would live or not live, you 

would want me to let you live, wouldn’t you? Or give you the treatment that was necessary for you to hang around for a little while? 

Dr. PAULY. Well, certainly, but those are presumably not the 

services that we are talking about rationing or not rationing. 

Ms. TUBBS JONES. In your prior testimony, you alluded to it. 

I am going to end my time, Madam Chairman. Thank you, gentlemen, for giving us this opportunity. 

Mrs. JOHNSON OF CONNECTICUT. Thank you very much for 

being here. I appreciate it very much. I do hope we will get a 

chance to pursue this conversation later on as the bill develops. 

Thank you. 

[Whereupon, at 2:41 p.m., the hearing was adjourned.] 

[Submissions for the record follow:]

Statement of Cori E. Uccello, and John M. Bertko, American Academy of 

Actuaries

The American Academy of Actuaries appreciates the opportunity to provide comments on issues related to expanding coverage of prescription drugs in Medicare. 

The Academy is the non-partisan public policy organization for actuaries of all specialties in the United States. 

This statement focuses on three areas that Congress needs to address as it designs a Medicare prescription drug benefit:

• First, if enrollment in the drug program is voluntary, the program must be 

designed to minimize adverse selection. That is, actual program enrollment 

needs to be nearly universal, broad enough to include healthy participants as 

well as those who would be expected to be high utilizers of the program. Otherwise, per-enrollee costs could become too high, potentially leading to the 

need for increased beneficiary premium contributions and cost sharing, and 

discouraging the participation of private entities that administer and/or deliver the benefit. • Second, the plan must include components that will help minimize per script 

costs, contain drug utilization, and keep total spending to an affordable level. 

Otherwise, drug spending under the program will grow much faster than projected, further endangering the solvency of the overall Medicare program. • Finally, policymakers may want to add risk-sharing provisions during the 

first few years after implementation to private sector organizations administering or delivering the benefit. Risk-sharing provisions are especially important in the early years of the program, until pent-up demand levels off and 

utilization data for previously uninsured beneficiaries becomes available.

These issues are discussed in more detail below, along with options for addressing 

them. 

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Adverse Selection

Adverse selection can be a problem in any voluntary health insurance program. 

Because people in poor health are more likely to purchase coverage, and to purchase 

more generous coverage in particular, premiums will increase significantly to cover 

the impact of this selection. Indeed, in typical private insurance programs in which 

premiums are paid entirely by participants, the average cost for those who enroll 

will be well above the average of all potential applicants. As premiums are set higher to reflect the higher costs of enrollees, even fewer applicants are willing to pay 

them, further increasing selection effects and the average per enrollee cost. 

The potential for adverse selection is even greater for a stand-alone Medicare prescription drug program because seniors can better predict their future drug costs 

than their other health care costs. The key to minimizing adverse selection in a 

Medicare prescription drug program is to increase participation rates, which can be 

accomplished through various means, including:

• Premium subsidies. When deciding whether to participate in the program, 

many seniors will evaluate the perceived value of the program and compare 

their expected out-of-pocket drug costs to the plan’s premiums. Those who expect to have covered drug costs that are less than the premium required to 

participate will be less likely to enroll. Premium subsidies reduce the direct 

cost of participation, increasing the number of eligible individuals who will 

expect their likely benefit from the program to exceed the premium cost, and 

thus will increase enrollment. 

• ‘‘Default’’ enrollment. Making enrollment in the drug program the default 

option (i.e., seniors desiring not to be in the program would have to take a 

step to opt out) would increase enrollment. 

• Penalty for delay. Mandating that enrollment in the drug plan be on a 

guaranteed-issue basis would ensure that all seniors have access to the benefit, regardless of health status. However, these enrollment features could encourage seniors to delay enrollment until they expected to incur significant 

prescription drug expenses. Limiting guaranteed issue to an initial open enrollment period, or providing some other meaningful penalty for late enrollment, would encourage individuals with low current drug expenditures to consider their future needs and protect themselves by enrolling. 

• Risk Adjustment. In the absence of universal coverage, some degree of adverse selection is inevitable. Risk adjustment and/or other types of reinsurance arrangements can reduce the incentives an insurer might have to avoid 

enrolling high-risk individuals. These options are discussed in more detail 

below.

The combination of these elements would help to reduce adverse selection, thereby 

increasing the program’s long-term stability. In addition, because private insurers 

would hesitate to offer plans if they feared they would be selected against, reducing 

adverse selection would also increase the likelihood that insurers or other organizations would participate in the program. 

Drug Utilization Management

The CBO estimates that prescription drug spending by the Medicare population 

will total $95 billion this year and will nearly triple to $284 billion by 2013. The 

introduction of a Medicare prescription drug program would likely increase drug 

spending even further due to induced or pent-up demand. In other words, because 

drug coverage would reduce the out-of-pocket costs of prescription drugs to consumers, they would be able to afford to use more drugs. One-third or more of seniors 

currently lack prescription drug coverage. Prescription drug spending by this population is very likely to increase dramatically if they obtain comprehensive drug coverage. Utilization could increase even among seniors with drug coverage (e.g., 

through a retiree health plan, Medigap, Medicare+Choice plan) if the Medicare prescription drug plan is more comprehensive than their current plan. 

The long-term sustainability of a Medicare prescription drug plan depends in part 

on the extent to which the plan can manage drug utilization and spending. Many 

tools are available to help contain utilization and costs, including patient cost sharing, limiting the range of drugs covered, and drug utilization management mechanisms.

• Patient cost sharing. Patient cost sharing through deductibles, copayments, 

and/or coinsurance will reduce the overall cost of the program in two ways. 

First, it directly reduces the share of the costs borne by the insurance program. Second, and equally important, cost sharing will also make patients 

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more sensitive to prescription drug costs, thereby reducing utilization to that 

which is medically necessary and, ultimately, overall costs.

Deductibles are amounts that must be paid out-of-pocket before drug coverage 

begins. Aside from lowering the cost of benefits paid, low or modest deductibles 

help hold down administrative costs by eliminating claims processing for small 

amounts. Large deductibles in effect result in catastrophic coverage, which provides coverage for those most in financial need of assistance at a relatively low 

cost. 

With coinsurance, the patient is responsible for a percentage of the drug cost. 

Copayments, on the other hand, are a fixed amount per prescription and have 

the advantage of being more predictable to patients. However, copayments 

might not make patients as sensitive to the costs of drugs as does coinsurance. 

Also, whereas coinsurance automatically adjusts for increases in drug costs, copayments (and deductibles) need to be increased periodically as drug costs rise, 

or overall program costs will increase faster than drug costs. 

By making patients more sensitive to costs, cost sharing will decrease prescription drug utilization. Although the goal of cost sharing is to reduce unnecessary utilization, it will likely reduce necessary utilization to some extent as 

well. Reducing the cost-sharing requirements for lower-income seniors will help 

minimize the extent to which cost sharing discourages needed care. However, 

some minimal level of cost sharing should be present for even the lowest income 

levels to deter unnecessary utilization.

• Formularies. Formularies are lists of a plan’s preferred medications and are 

used to encourage the use of less costly drugs. There are three types of 

formularies—open, closed, and incentive. Under open formularies, all drugs 

are available with no incentive to choose one over the other, although programs can be designed to encourage use of preferred medications (e.g. therapeutic interchange programs). In contrast, closed formularies limit the drugs 

available under the plan to those listed in the formulary. Incentive-based 

formularies contain cost-sharing differentials for preferred and non-preferred 

brand name drugs, and generic drugs, thereby giving patients a financial incentive to request preferred or generic medications. Nevertheless a non-preferred drug may be the only drug that is fully effective for a particular person, leaving the beneficiary paying more unless exceptions are available.

Merck-Medco, a pharmacy benefit manager (PBM), has estimated that the 

cost savings that derive from formularies can range from 2 percent to 3 percent 

for an open formulary with compliance interventions to 5 percent to 9 percent 

for a three-tier incentive-based formulary. It is important, however, that any 

formulary be broad enough to include drugs in each therapeutic category and 

class of covered outpatient drugs. In addition, the formulary must be periodically reviewed and modified to reflect new drugs being introduced and updated 

clinical information.

• Drug Management Mechanisms. Insurers and/or pharmacy benefit managers have several mechanisms they can use to help contain drug costs:

Prior authorization requires physicians to receive authorization that the drug 

is appropriate for the medical condition and could save from 1 percent to 2 percent of drug spending. Because it is expensive to administer, prior authorization 

is typically reserved for expensive drugs that have potential for excessive use 

or misuse. 

Maximum dispensing limits restrict the quantity of medication a patient receives over time or per fill, and could also save about 1 percent to 2 percent 

of drug spending. This technique may be appropriate for therapies in which the 

potential for excessive use affects either cost or clinical outcomes. 

Step therapies are used to check the medical appropriateness of using a 

newer, more expensive medication (i.e. a second-line drug) rather than a traditional medication (i.e. a first-line drug) for the same condition. This technique 

encourages the use of traditional therapies if they are more cost-effective than 

newer therapies and the new therapies offer minimal to no additional clinical 

benefit. Step therapies could save from 1 percent to 3 percent of drug spending. 

Online drug utilization review can be performed electronically at the point of 

sale to ensure that the patient is eligible for the plan and that the prescription 

has not been refilled too soon. It can also screen for any drug interactions and 

perform other systematic checks. This concurrent review can save up to 4 percent of drug spending. 

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1The Federal Government has large-scale experience with the use of risk corridors through 

its TriCare contracts, which provide health benefits to military personnel, their dependents, and 

military retirees. In addition, there are other risk corridors now being used in Medicare Private 

Fee For Service and PPO demonstrations. 

Risk Sharing 

Many of the recent Medicare prescription drug coverage proposals suggest not 

only using private sector organizations to deliver the benefits, but also having these 

organizations share in the financial risk. Although private sector organizations have 

some experience with the risks associated with providing prescription drug coverage, 

either through employment-based, Medicare+Choice, or Medigap plans, these organizations lack experience with the overall senior market and there are increased 

risks associated with a new Medicare prescription drug benefit. In addition to adverse selection risks related to the program’s overall participation rates, a Medicare 

prescription drug plan is also subject to risks associated with the difficulty in pricing the benefit adequately and plan-specific adverse selection. Each of these risks 

is discussed below, along with potential methods of addressing these risks. 

Pricing Risk

It will likely be difficult for private sector organizations to estimate the per capita 

costs of a stand-alone prescription drug program for several reasons. First, the costs 

for seniors who are currently without drug coverage are uncertain. About one-third 

of current Medicare beneficiaries lack any prescription drug coverage. Their future 

prescription drug consumption will likely increase under a Medicare prescription 

drug benefit, but it is unclear how large that increase will be. Understating these 

costs could result in large losses to private sector entities. Overstating these costs 

could result in overpayments by the government. 

Moreover, the lack of comprehensive data on current prescription drug usage by 

seniors makes it difficult to estimate costs under the program, even for those seniors 

who currently have prescription drug coverage. For instance, using cost estimates 

derived from Medigap plans could be unreliable. On one hand, these estimates could 

overstate costs due to the likely adverse selection from seniors who choose these 

plans. On the other hand, using spending data for seniors with relatively limited 

Medigap prescription drug coverage could understate costs under a more comprehensive prescription drug program. Because of the potentially enormous volume 

of senior drug spending, even a 10 percent misestimate in a single large State could 

cause a $100 million loss (or unexpected gain). 

Not only is it difficult to accurately estimate initial levels of prescription drug 

spending, it is difficult to estimate the trends in spending. Drug spending among 

the nonelderly with employment-based coverage has grown recently, as much as 15 

to 20 percent per year, due to a combination of higher drug prices, increased utilization, and the introduction of new and expensive drugs. On one hand, a Medicare 

prescription drug program that provides near-full coverage may have cost increases 

of that magnitude. On the other hand, drug utilization may not increase as quickly 

among the senior population if they are already using many drugs. 

In order to mitigate the pricing risk issue, policymakers may wish to consider 

shared risk arrangements that protect the government from over-paying and provide protection for those organizations willing to participate. Risk corridors provide 

a mechanism to limit an organization’s potential losses and gains to a more acceptable level. Reinsurance could also limit an organization’s potential losses. In addition, using performance standards for administrative tasks in the first several years 

of a new Medicare prescription drug program could ease the transition to an insurance risk-based system. Each of these is discussed in more detail below.

• Risk corridors are contractual safeguards that can limit both the downside 

risk and upside gain for an insurance organization.1 In a typical arrangement, a best estimate of the claims and administrative cost of a benefit would 

be made. Gains or losses inside a risk corridor around that estimated level 

would be the full responsibility of the private sector organization. Additional 

gains or losses beyond the risk corridor would be shared with or borne by the 

Federal Government. As a result, an at-risk organization such as an insurance company would be able to offer coverage, but its risk would be limited. 

The example below illustrates how risk corridors work:

Best estimate of annual Medicare $1,000 per year per senior 

prescription drug premium 

First-year Medicare prescription drug ±1 percent 

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risk corridor 

(i.e., the corridor is 2 percent wide around the best 

estimate)

Dollars at risk per senior in first year $10 per year per senior possible gain or loss

Federal Government responsibility Losses in excess of $1,010 Gains if costs are less than $990 per year per senior 

In this example, if the insurance company enrolled 1 million seniors, its maximum loss would be $10 million (1 million seniors times $10 maximum loss per 

senior), with the government covering any losses over $10 million. Similarly, if 

cost estimates proved to be conservative, then the Federal Government would 

recover any gains that exceeded $10 million. 

Risk corridors or other risk-sharing arrangements might be essential during 

the first few years of a Medicare prescription drug program. During the period 

in which risk corridors are in place, both insurers and the Federal Government 

would be able to gather the drug expenditure data needed to make more accurate cost estimates for future years. As a result, this mechanism could be useful 

as a transition to full-risk contracting. (In the past, the Federal Government 

has had the time to conduct pilots or demonstrations on a small scale to gather 

the necessary beneficiary data, before implementing a new program. That time 

may not be available for a new Medicare prescription drug program.) 

For example, in the second year, the risk corridor could be expanded from 

±1.0 percent (a corridor 2 percent wide) to ±2.5 percent (a corridor 5 percent 

wide) to allow for greater incentives for the private sector organization. Other 

provisions could include some cost sharing (e.g., 10 percent) outside the corridor. 

In other words, the insurer would be responsible for all claims within the first 

2.5 percent corridor, then 10 percent within an additional 5 percent corridor.

• Aggregate Reinsurance is another option to limit insurers’ downside risk. 

Under aggregate reinsurance, the Federal Government would pay all or a percentage of claims once a private plan’s aggregate claims paid exceed a predetermined threshold. This threshold is typically expressed as a percentage 

of aggregate expected claims (for example, a first-year aggregate limit might 

be 102 percent of projected paid claims). Insurers would keep all gains if actual claims are lower than expected. Government-provided aggregate reinsurance protection is similar to a one-sided risk corridor. In other words, the insurer would keep all gains, regardless of the size, if actual spending is less 

than expected, but would bear the losses only up to a certain point if spending is greater than expected. However, aggregate reinsurance may be easier 

to administer than risk corridors. Other mechanisms, like premium stabilization reserves, funded by some level of underwriting gains, could be added to 

limit the possibility of unintended funding windfalls.

• Individual Reinsurance can protect a plan from unexpected high claims 

from individual beneficiaries. Although there is much less variation in prescription drug spending among Medicare beneficiaries compared to other 

health spending, plans can still be at risk for unusually high claims among 

individual enrollees. Under individual reinsurance, the Federal Government 

would pay all or a percentage of claims once an individual enrollee’s claims 

exceed a pre-determined threshold (typically expressed as a dollar amount, 

such as $7,500). Individual reinsurance, however, would not provide much 

protection for plans from higher than expected aggregate costs under the 

threshold, which could occur especially in the first few years of the program 

due to induced or pent-up demand.

• Performance standards are another approach that can be used to encourage cost containment. These measure plan administrators against certain criteria and require them to put a certain amount of administrative fees at risk 

for their performance. For example, a plan could have a negotiated goal that 

a certain percentage of prescription drug scripts be generic (e.g., 50 percent) 

in order to hold down costs. If this goal is met, then the Federal Government 

would provide the organization with its full administrative fee payment. Otherwise, a portion of the administrative fee payment would be forfeited. Again, 

such incentives might be particularly important during the first few years of 

program operation. After two or more years in this pilot state, the contract 

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could be converted into a full-risk contract, in which the organization would 

bear the insurance risk. 

An important issue is the required duration of a risk corridor or reinsurance 

stage. Although prescription drug claims are typically paid much more quickly 

than other medical claims, sometimes within two to four weeks of being incurred, it is likely that any bidding process would require a pilot stage for the 

first two years. In year one, no data would be available to determine the best 

estimate of claim costs. Bidding for year two would begin almost immediately 

during the first year, so, once again, very little data would be available. By the 

second year of a contract, a full first year of data would be available and bidding for the third program year could proceed on an at-risk basis, or with a 

wider corridor. 

Plan-Specific Adverse Selection

Even if adverse selection is minimized in the program as a whole, a particular 

plan could end up with a disproportionate share of seniors with high prescription 

drug expenditures. If payments to the plan do not reflect this, then the plan could 

be at risk for large losses. Risk adjustment could be used to adjust the payments 

to the plans to take into account the health status of the beneficiaries who participate in the program. Risk adjustment helps to make payments to competing plans 

more equitable and can reduce the incentives for competing plans to avoid beneficiaries with higher than average prescription drug needs. Risk adjustment may 

also help stabilize experience among private plans, causing less disruption for plan 

participants. 

Several risk adjustment mechanisms for acute care services have been developed 

using pharmacy data. Pharmacy-based models can also be used as risk adjustment 

mechanisms for prescription drug utilization. Although risk adjustment can help account for the differences in participant health status across plans, no current risk 

adjustment system is designed to compensate each competitor for the full financial 

effects of adverse selection. 

Conclusion

Proposals to add a prescription drug benefit to Medicare need to address issues 

related to adverse selection, drug utilization management, and risk sharing. Adverse 

selection will be minimized to the extent that participation is nearly universal. This 

can be accomplished through high premium subsidies, default enrollment, and penalties for delayed enrollment. 

The long-term sustainability of a Medicare prescription drug program also depends on the extent to which the program manages drug utilization and spending. 

Patient cost sharing, formularies, and other drug management mechanisms can 

each help contain costs. 

Finally, policymakers may want to provide provisions to minimize the financial 

risk of private sector organizations administering or delivering the benefit in the 

first few years of the program. Risk corridors, reinsurance, and performance standards could be used in the initial years of a prescription drug program while organizations collect important data. Risk adjustment could provide additional protection 

to private organizations, thereby increasing their willingness to participate.

Statement of David G. Schulke, Executive Vice President, American Health 

Quality Association 

f The American Health Quality Association represents independent private organizations—known as Quality Improvement Organizations (QIOs)—that work under 

contracts with the Centers for Medicare and Medicaid Services (CMS) to improve 

the quality of care for Medicare beneficiaries in all 50 States and every U.S. territory. Congress created the QIOs to monitor and improve the quality of care delivered to Medicare beneficiaries and supports the national work of the QIOs with approximately $333 million annually from the Medicare Trust Fund, or about $8 per 

beneficiary per year. 

Past policy efforts to develop a Medicare prescription drug benefit for the 21st 

century have focused almost exclusively on financing a benefit. Very little attention 

was given to including initiatives in the drug benefit to ensure a benefit is safe and 

continuously monitored to maximize the quality of outpatient pharmacotherapy. 

It is absolutely critical to create an integrated quality improvement program. Otherwise, beneficiaries are likely to be ill-served by a carved-out drug benefit that opVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00119 Fmt 6633 Sfmt 6621 E:\HR\OC\89405.XXX 89405
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[i]Lui GG, Christensen, DB, ‘‘The Continuing Challenge of Inappropriate Prescribing in the 

Elderly: An Update of the Evidence.’’ J Am Pharm Assoc, 42(6), p847–857, 2002. [ii] Johnson JA, Bootman JL, ‘‘Drug-related morbidity and mortality. A cost-of-illness model.’’ 

Arch Intern Med (United States), 155(18), p1949–56, 1995. [iii] Harrison DL, Bootman JL, Cox ER. ‘‘Cost-effectiveness of consultant pharmacists in managing drug-related morbidity and mortality at nursing facilities.’’ Am J Health Syst Pharm, 

55(15), p1588–94, 1998. [iv] Ernst FR, Grizzle AJ, ‘‘Drug-related morbidity and mortality: updating the cost-of-illness 

model.’’ J Am Pharm Assoc, 41(2), p191–199, 2001.

erates separately from the Medicare hospital and outpatient benefits and data systems.

Building a Safe Drug Benefit.

A Medicare outpatient prescription drug benefit presents an opportunity to improve the quality of life for our nation’s seniors, but also brings the real risk of increased morbidity and mortality associated with an increase in the use of medications. It is reasonable to predict that with an outpatient prescription drug benefit, 

more seniors will receive more drugs. Expanding access to and availability of drugs, 

without a complementary investment in quality improvement, will exacerbate the 

unacceptable cost and incidence of hospital and long-term care admissions associated with medication use. A recent meta-analysis of 11 different studies reviewing 

drug use in the elderly population found that ‘‘[t]he reported prevalence of elderly 

patients using at least one inappropriately prescribed drug ranged from a high of 

40% for a population of nursing home patients to 21.3% for community-dwelling patients over age 65.’’ [i]

Pharmacoeconomists at The University of Arizona have tracked the costs associated with drug therapy since the early 1990s.[ii],[iii] In the spring of 2001 these researchers published the following statement: ‘‘Overall, the cost of drug-related morbidity and mortality [in the ambulatory care environment] in the United States exceeded $177.4 billion in 2000. Hospital admissions accounted for nearly 70% ($121.5 

billion) of total costs, followed by long-term-care admissions, which accounted for 

18% ($32.8 billion).’’ [iv]

Integrating Medical and Pharmacy Data Systems through Medicare QIOs.

Historically, attempts to address the morbidity and mortality associated with 

medication use have been stymied by the inability of practitioners in various disciplines to access certain medical or pharmacy records that would otherwise provide 

a comprehensive picture of a patient’s true medication use history. As this Committee discusses building a Medicare prescription drug benefit for the 21st century, 

it is essential that the new statutes and regulations include language that provide 

the QIOs with access to pharmacy claims data. Regardless of how a drug benefit 

is administered, the Secretary of HHS must have unrestricted access to pharmacy 

claims data to use in directing the activities of the QIOs. QIOs were created by Congress with the necessary confidentiality protections and staff expertise to permit 

them to combine medical and pharmacy data to guide health care systems improvement. 

Most congressional proposals forwarded to date rely on the pharmacy benefit administrators to process pharmacy claims data and take certain quality improvement 

steps at the point of service when the pharmacy claims data suggests medication 

misadventures. The good work of the pharmacy benefit administrators is limited by 

the information present in the pharmacy claim. Without integration of the data 

present in the medical record and pharmacy record, systematic failures leading to 

inappropriate prescribing and dispensing will continue to happen everyday.

Integration of Data Systems through QIOs Is Critical—A Study of Outpatient Beta-Blocker Use in Heart Attack Victims.

QIOs use data to track progress and improve provider performance, reducing errors by focusing on treatment processes, mostly pharmacotherapy. Since 1996, QIOs 

have worked on local projects to improve clinical indicators in care for diseases and 

conditions that broadly afflict seniors. Among the diseases targeted for quality improvement by the QIOs, treating heart attack victims with beta-blockers offers an 

example of how the QIOs could further their current inpatient efforts with appropriate access to data gathered with an outpatient prescription drug benefit. 

Medical practitioners have known for several decades that the secondary prevention benefits of beta-blocker therapy after heart attack include reduced hospital readmissions, reduced incidence of further heart attacks, and decreased overall morVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00120 Fmt 6633 Sfmt 6621 E:\HR\OC\89405.XXX 89405
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[v]Soumerai, SB, McLaughlin TJ, et al. ‘‘Adverse outcomes of underuse of beta-blockers in elderly survivors of acute myocardial infarction.’’ JAMA, 227, p115–121, 1997. [vi] Ryan TJ, et al. ‘‘ACC/AHA guidelines for the management of patient with acute myocardial 

infarction. A report of the ACC/AHA Task Force on Practice Guidelines (Committee on Management of AMI).’’ J Am Coll Cardiol, 28, p328–348, 1996. [vii]Krumholz HM, et al. ‘‘National use and effectiveness of beta-blockers for the treatment of 

elderly patients after AMI: National Cooperative Cardiovascular Project.’’ JAMA, 280, p623–629, 

1998. [viii] Butler J, et al. ‘‘Outpatient adherence to beta-blocker therapy after AMI.’’ J Am Coll 

Cardiol, 40(9), 1589–1595, 2002. [ix] Jencks SJ, et al. ‘‘Change in the Quality of Care Delivered to Medicare Beneficiaries 1998–

1999 to 2000–2001.’’ JAMA, 289, p305–312, 2003. 

tality.[v] The evidence is so convincing that the American College of Cardiology and 

the American Heart Association guidelines for the management of heart attack recommend routine beta-blocker therapy for all patients without a contraindication.[vi]

Despite the evidence and expert recommendations, the use of beta blockers after 

heart attacks remains considerably suboptimal, with 20–30% of appropriate patients 

lacking this essential therapy.[vii] The reason is unlikely to be cost. Beta-blocker 

therapy in the outpatient setting is one of the most affordable medications available 

to patients. A 90-day supply of this life-saving medication usually costs less than 

$10.00. 

QIOs work to ensure that patients discharged from the hospital following a heart 

attack leave the hospital with a prescription for a beta-blocker. In the November 

2002 issue of the Journal of the American College of Cardiology (JACC), researchers 

report that many patients never fill prescriptions for their discharge medication, 

and many of those that do discontinue the use of beta-blockers shortly after filling 

the prescription. The study’s authors conclude: ‘‘Patients not discharged on betablockers are unlikely to be started on them as outpatients. For patients who are discharged on beta-blockers after AMI, there is a significant decline in use after discharge. Quality improvement efforts need to be focused on improving discharge planning and to continue these efforts after discharge.’’ [viii] During 

the QIO’s Sixth Scope of Work (1999–2002), QIOs were responsible for improving 

the national rate of beta-blocker order at discharge by 7%.[ix]

In his study published in JACC, Butler and colleagues found that the first step 

to preventing heart attack recurrence is to make sure a prescription is written and 

ordered at the time of the patient’s discharge from a heart attack hospitalization. 

If this is done, the study shows there is a 10 TIMES greater likelihood of getting 

that patient started on inexpensive, effective beta blocker drugs that 20–30% of 

Medicare heart attack patients still do not receive, almost 40 years after the first 

marketing of propranolol, the first beta blocker. 

The authors of the study utilized data for the dually enrolled population of patients (those receiving Medicare and Medicaid benefits simultaneously), as this is 

the only population of seniors for which there is comprehensive drug therapy claims 

data. This same kind of monitoring should be available for all beneficiaries. It is 

critical for Medicare to have the drug claims/utilization data so QIOs can identify 

heart attack patients who don’t fill a prescription for beta blockers post discharge, 

or who stop filling prescriptions (almost one quarter do after 6 months, according 

to the study)—and give their physicians assistance in getting the prescription started or changed (the latter might be needed if the patient didn’t like the particular 

beta blocker initially prescribed and has consciously stopped taking it due to unacceptable or intolerable side effects). QIOs are ideally suited to identify patients at 

highest risk for hospital readmission or death due to poor beta-blocker adherence 

(i.e., patients taking beta-blockers post heart attack). We believe the QIOs unique 

ability to integrate medical information with pharmacy claims/utilization data complement pharmacy adherence programs that may be currently managed by benefit 

administrators.

QIO Confidentiality Requirements.

The confidentiality of information collected or developed by a Medicare QIO is assured by Section 1160 of the Social Security Act. It was the intent of Congress in 

drafting this provision to provide safeguards for information identifying a specific 

patient, practitioner or reviewer. These safeguards foster an environment that is 

conducive to quality improvement efforts.

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Recommendations.

The American Health Quality Association has drafted the following legislative 

specifications we ask the Committee to include in this year’s Medicare outpatient 

prescription drug benefit bill.

Legislative Specifications for the 108th Congress.

1) Give the QIOs responsibility for the outpatient drug benefit analogous 

to the responsibility they have for all other Title 18 benefits:

Add new ‘Sec ll. Review Authority—. Section 1154(a)(1) is amended by adding ‘and section ll after ‘1876’.

2) Instruct the QIOs to make assistance available to providers, practitioners and benefit administrators to improve the quality of care under the 

new drug benefit.

Prescription Drug Therapy Quality Improvement.—Section 1154(a) is amended by 

adding a new paragraph 17:

‘‘(17) With respect to items and services provided under Title XVIII Part ll

the organization shall execute its responsibilities under subsection (a)(1)(A) and 

(B) by making available to providers, practitioners and benefit administrators 

assistance in establishing quality improvement projects focused on prescription 

drug or drug-related therapies. For the purposes of this part and title XVIII, 

the functions described in this paragraph shall be treated as a review function.’’

3) Include legislative language instructing prescription drug benefit administrators to provide patient specific pharmacy claims and drug utilization data to the Secretary of HHS. Suggested wording:

‘‘Requirements for Prescription Drug Plan Sponsors, Contracts, Establishment 

of Standards.—Any agreement between the Secretary and a benefit administrator for this purpose shall provide the Secretary with all patient specific pharmacy claims and drug utilization data.’’

4) Include legislative language providing appropriate availability of prescription drug claims data to the QIOs for quality improvement purposes.

Suggested wording:

‘‘Data Availability.—The Secretary shall provide the utilization and quality control peer review organizations with the patient specific pharmacy claims and 

drug utilization data to permit the organizations to perform the functions described in 1154(a)(17).’’

fLong Term Care Pharmacy Alliance 

Washington, DC 20037

April 8, 2003

The Honorable William M. Thomas 

Chairman 

Committee on Ways and Means 

U.S. House of Representatives 

1102 Longworth H.O.B. 

Washington, DC 20515

Dear Chairman Thomas:

On behalf of the Long Term Care Pharmacy Alliance, I am writing to submit this 

statement for the record of your Committee’s April 9, 2003 hearing on ‘‘Expanding 

Coverage of Prescription Drugs in Medicare.’’

We appreciate your leadership in considering issues related to the creation of a 

new Medicare prescription drug benefit, and we would like to take this opportunity 

to highlight the special pharmacy needs of the nation’s frail elderly residing in nursing facilities. We want to work constructively with you to ensure the continued provision of quality services to these particularly vulnerable seniors. 

While most Medicare beneficiaries are able to walk into pharmacies to pick up 

their prescriptions or to receive vials of pills through the mail, a sizable percentage 

of beneficiaries cannot do so and need special services that retail and mail order 

pharmacies do not provide. Nursing home residents have specific diseases and multiple co-morbidities that require specialized pharmacy care. Without such treatment, 

we cannot expect positive therapeutic outcomes for these patients. Failure to take 

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into consideration the special pharmacy needs of the frail and institutionalized elderly will lead to a marked increase in medication errors and other adverse events. 

Pharmacy benefit managers and insurance companies are not equipped to administer a Medicare drug benefit to this vulnerable population, because they lack the 

necessary experience, infrastructure and expertise. By contrast, members of the 

Long Term Care Pharmacy Alliance are the nation’s major operators of pharmacies 

that serve the frail and institutionalized elderly, and they specialize in serving the 

needs of patients in long-term care settings. 

LTCPA members’ patients are elderly, frail, chronically ill, and can no longer care 

for themselves. They require a level of pharmacy care that goes well beyond what 

the typical retail or mail order pharmacy provides to its customers. To meet these 

needs, long-term pharmacies provide specialized packaging, 24-hour delivery, intravenous and infusion therapy services, geriatric-specific formularies, clinical consultation and other services that are indispensable in the long-term care environment. 

Without ensuring that nursing-home residents and other patients with special 

needs can receive these specialized pharmacy services, a Medicare prescription drug 

benefit could actually endanger the health of beneficiaries residing in nursing facilities. We look forward to working with you on a specific proposal to ensure appropriate coverage of pharmaceutical services for Medicare beneficiaries who reside in 

nursing homes. 

If you have any questions or would like additional information, please feel free 

to contact me at (202) 457–6000. Thank you for your consideration of our views.

Very sincerely yours, 

John F. Jonas 

cc: The Honorable Charles B. Rangel 

The Honorable Nancy L. Johnson

Statement of the National Association of Chain Drug Stores, Alexandria, 

The Honorable Fortney H. Stark

fVirginia 

Mr. Chairman and Members of the Subcommittee. The National Association of 

Chain Drug Stores (NACDS) is pleased to submit this statement for the hearing on 

Designing a Medicare Prescription Drug Benefit for the 21st Century. 

NACDS represents over 200 pharmacy companies that operate nearly 35,000 community-based retail pharmacies. NACDS members employ nearly 100,000 pharmacists and provide about 70 percent of all outpatient prescriptions. The majority 

of our prescriptions are paid for by third party insurance companies and pharmacy 

benefit managers—over 85 percent—so we have a significant amount of experience 

in operating in the current pharmacy benefit marketplace. Our industry and the patients that we serve will be significantly affected by the structure and operation of 

any new Medicare pharmacy benefit. For that reason, we need to be engaged and 

involved in the policy discussions regarding a Medicare pharmacy benefit. We believe that we can provide a unique perspective on what we feel will work best for 

Medicare program, seniors, and the taxpayers.

Principles for a 21st Century Medicare Pharmacy Benefit

It is often said that no one would design a contemporary Medicare program without a prescription drug benefit. We agree. Prescription medications are the most 

widely used and cost-effective health care interventions used by patients today. 

Modern prescription drugs have extended and improved the lives of millions of 

Americans and saved millions of dollars through shortened length of illnesses, increased productivity, and reductions in hospitalization and medical procedures. 

Community pharmacy is proud of its role in assuring the safe and effective use of 

these therapies. 

That is why we believe that any new program to expand prescription drug coverage to seniors should be a pharmacy benefit, not just a prescription drug benefit. 

Too often, we think of a prescription drug benefit as only providing a ‘‘drug product’’ 

to seniors. We believe that this is a serious mistake. Seniors take so many more 

prescription medications than younger individuals. For that reason, seniors need 

ready access to community-pharmacy-based education, counseling, and medication 

therapy management, in addition to the drug product, so they can take their medications appropriately to achieve the intended medical outcomes. 

NACDS, along with seven other national pharmacy and related organizations, developed principles for and components of a quality, cost-effective pharmacy benefit. 

Among other items, pharmacy believes that the best way to develop the Medicare 

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1GAO Report on Federal Employees’ Health Benefits: Effects of Using Pharmacy Benefit Managers on Health Plans, Enrollees, and Pharmacies, January 2003.

pharmacy benefit for the 21st century would be to incorporate the following elements:

• Create transparency and full pass through of any rebates, discounts, or other 

price concessions received by administrators of the pharmacy benefit so that 

Medicare and seniors benefit from their purchasing power; 

• Include policies that promote the utilization of generic drugs when appropriate; 

• Provide seniors with access to meaningful, community-based medication therapy management services with appropriate compensation for pharmacies; 

• Give seniors access to the community-based pharmacy provider of their 

choice; 

• Break down any artificial barriers created by drug plan administrators that 

impede competition and steer patients to higher-cost brands or limit their 

choice of pharmacy provider; 

• Do not economically coerce seniors to use other prescription delivery mechanisms, such as out-of-state mail order; 

• Assure that community pharmacies are adequately compensated in providing 

services to meet the health care needs of our nation’s seniors. 

• Allow the intense competitive forces that exist among pharmacies and manufacturers to work to reduce costs without the interference of a self-interested 

middleman.

We believe that these are among the most important principles that can be included in any future pharmacy benefit. We also want to describe for the Subcommittee some observations about trends in the marketplace that are important 

to consider as the Medicare pharmacy benefit debate moves forward.

FEHBP and DOD Use Different Approaches to Prescription Drug Benefit Design

The Federal Employees Health Benefits Program (FEHB) is often pointed to as 

the model for Medicare reform. Frankly, we believe that a more careful examination 

of the prescription drug benefit programs in FEHBP will give policymakers ample 

evidence to re-evaluate some of the major models being proposed that would rely 

primarily on pharmacy benefit managers (PBMs) to provide a prescription drug benefit. 

Anyone who is following the health policy, business, and financial news would 

find that important public health and public policy questions are being raised about 

the current practices of PBMs, and whether they are holding down drug costs, or 

responsible, in part, for their significant increases. 

The experience of the government’s own FEHBP should be instructive to Members 

of Congress as they consider the true effectiveness and competitiveness of this approach to providing a prescription drug benefit for seniors. Our analysis indicates 

that escalating prescription drug spending in the FEHBP program—which is administered by some of the same PBMs that would be used for Medicare—has contributed significantly in recent years to the sharp premium increases seen in the program. In fact, these PBMs have a poor track record in managing FEHBP drug program costs. For example, the Office of Personnel Management’s (OPM) own data indicate that drug cost increases were responsible for 40 percent of the 10.5% premium increase in 2001, 37 percent of the 13.3% premium increase in 2002, and 30 

percent of the 11.1% premium increase in 2003. 

Keep in mind that the average age of the FEHBP population is about 47 years 

of age, while that of traditional older Medicare population is about 70. Medicare 

beneficiaries have more chronic conditions, requiring greater drug use, which results 

in higher per capita expenditures than the much-younger, healthier FEHBP population. For example, the average Medicare beneficiary uses four times more prescriptions—about 21 prescriptions each year—than the average individual under 65 

years of age, who uses about 5. If the PBMs have not been able to manage prescription drug spending in the FEHBP program’s younger, healthier population, why 

should we believe that they would be any more effective in the higher-cost Medicare 

population? 

A recent General Accounting Office (GAO) report 1 found that PBMs would not 

disclose the amount of rebates and other price concessions that they receive from 

drug manufacturers. These price concessions take many forms and have many different names. The bottom line is that the Medicare programs, seniors, and taxVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00124 Fmt 6633 Sfmt 6621 E:\HR\OC\89405.XXX 89405
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payers should benefit from these financial incentives, and the best way to assure 

that they are passed along is to require transparency in their reporting by the 

PBMs. We urge that such provisions be included in any final Medicare pharmacy 

benefit program. 

PBMs’ Anti-Competitive Practices Not Aligned with Goals of Payors or Medicare

Any Medicare pharmacy benefit for the 21st century should emphasize choice and 

access. These goals can only be attained if the structure of the pharmacy benefit 

breaks down many of the artificial, anti-competitive barriers erected by the PBMs. 

Many public and private payors are rethinking their PBM strategies because they 

recognize that PBMs have overpromised and underdelivered. The goal of payors to 

reduce prescription drug costs is not necessarily aligned with that of the PBMs, 

which is to drive manufacturers rebates to gain higher operating profits for the 

PBM. These rebates are generated by promoting the use of higher-cost brand name 

drugs. What follows is an excellent example of how rebates create perverse incentives and anti-competitive practices in the marketplace:

Most PBM-administered prescription drug benefit plans have both a community 

retail pharmacy network and a mail order pharmacy component (i.e. Medco, Express, Advance PCS, Caremark). In most cases, these mail order pharmacies are 

owned by the PBM, and the PBM uses the patient-identifiable information that 

they obtain from processing a retail pharmacy claim, to switch patients to their 

own mail-order facilities.

The PBMs have financial incentive to do this because they receive significant rebates from brand name manufacturers for moving (or increasing) a particular 

manufacturer’s market share, so the more product that is dispensed through mail, 

the more rebates the PBM receives. This is not always cost-effective for the payor 

or the patient, since it increases copays for the patient and overall costs for the 

payor. Moreover, the retail pharmacy doesn’t receive rebates and has no incentive 

to provide higher-cost brand name drugs.

In fact, retail pharmacies use more lower-cost generics than mail, so the net cost 

to the payor and the patient is actually lower for drugs dispensed through retail. 

(Latest data found that mail order uses 37% generics, while retail uses generics 

in 49% of the cases).

But, to force patients to obtain their brand name drugs through mail, these 

PBMs artificially limit the quantity of brand name drugs that a retail pharmacy 

can dispense.

That is, while PBMs may incorrectly contend that State pharmacy practice laws 

prohibit retail pharmacies from dispensing a 90-day supply of medications, this is 

not the case. Some States do have limits on the amount of controlled substances 

that can be provided, but these restrictions would occur for any pharmacy outlet 

that dispenses these drugs. PBMs, however, will not allow pharmacies to provide 

any more than a 30-day supply because they want to run those prescriptions 

through their mail order facility so they can collect the manufacturer rebates.

Mail order operations are direct competitors to community pharmacies. PBMs 

should not be allowed to use information obtained through a retail prescription 

claims transaction to switch patients to mail order for their own financial gain. 

To avoid this anti-competitive practice, PBMs should not be allowed to be both the 

community pharmacy network contractor and mail order contractor within the 

same region, since this creates a competitive conflict with community retail pharmacies. In addition, pharmacies should be allowed to continue to provide maintenance medications to patients (i.e. fill a 90-day supply of maintenance medication). 

PBMs should not contractually prohibit pharmacies from providing these medications. PBMs should not use any coverage or cost sharing incentive that would create incentives for seniors to use one method of pharmacy distribution over another.

Some of these anti-competitive issues can be addressed by including strong ‘‘transparency’’ provisions in the Medicare pharmacy benefit. Pricing transparency is necessary for the efficient operation of markets, and also allows consumers and others 

to make the best purchasing choices. Right now, the PBM industry is operating 

without this necessary transparency. 

The Medicare program and seniors should benefit directly from any and all price 

concessions given to plan administrators and PBMs. These price concessions take 

many forms—rebates, discounts, formulary placement fees, market share movement 

fees, data collection and analysis fees, and others. 

If made transparent, and passed along, these incentives will ultimately reduce the 

cost of the benefit to Medicare and to seniors. It will also reduce the incentives that 

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PBMs have to erect these anti-competitive barriers that increase cost and can negatively impact quality of care. 

The PBM industry argues against transparency because they know it will more 

fully expose that their business model centers almost exclusively on deriving and 

retaining rebates from drug manufacturers that are not passed along to plan sponsors. We urge policymakers to make sure that transparency is a hallmark of any 

Medicare pharmacy benefit.

Department of Defense (DOD) Recognizes PBM Influences

In contrast to the FEHBP program, which relies on private sector PBMs, the 

DOD’s Tricare program has developed prescription drug models that are more cognizant of the negative influences of PBM rebates. Their approach uses a pharmacy 

benefits administrator (PBA) type model, which is the approach being taken by 

more and more public and private sector payors. 

The PBA model relies on a benefits administrator to adjudicate and pay claims, 

determine eligibility, create networks, and perform other operational functions to 

run the program. The PBA doesn’t become involved with direct rebate negotiations 

with manufacturers, and is therefore not in a position to retain these rebates or develop policies that would encourage the dispensing of drugs for which they are receiving rebates. 

For example, the Tricare National Mail Order Program (NMOP) program passes 

along to DOD all the rebates that the DOD negotiates with pharmaceutical companies. This program is administered by Express Scripts, so even the traditional PBMs 

are able to participate in models that use PBA-type approaches. Building on the success of the NMOP program, DOD recently announced that its Tricare national retail 

pharmacy contract would operate in a similar manner. The DOD has recognized 

that PBMs retain a significant portion of manufacturer rebates and want these rebates to accrue to the DOD and the military eligibles and retirees. Thus, there are 

two major Federal Government health care programs using different approaches—

with very different outcomes—to provide pharmacy benefits to two important populations. 

NACDS and community pharmacy support approaches to delivering a Medicare 

pharmacy benefit that take the perverse rebate incentives out of the system, since 

it results in nothing more than limiting seniors’ access to needed medications and 

the pharmacy of their choice. 

Medicare, seniors, and taxpayers would all benefit from a system where any manufacturer or pharmacy price concessions are passed along to the senior, and anticompetitive incentives to dispense larger quantities of brand name medications or 

restrict the use of generics are eliminated.

Marketplace Has Responded with Discounts for Low-Income Seniors

We believe that the market has changed significantly since the Department of 

Health and Human Services (HHS) announced its original Medicare-endorsed PBMbased discount card program in July 2001. For example, manufacturers now offer 

prescription drug assistance through participating retail pharmacies. These programs include ‘‘Lilly Answers,’’ ‘‘Pfizer’s Living Share Program’’ and the ‘‘Together 

Rx Program’’ all of which assure that truly needy low-income seniors are able to obtain meaningful savings on brand name prescription medications at their participating local pharmacy. 

These private-sector approaches obviate the need for government-mandated programs on the private sector. Over 150 brand name prescription drugs are available 

at discounts of up to 40 percent. In fact, the best competition occurs in the market 

when manufacturers and pharmacies compete without the interference of a middleman PBM that has the government’s sanction to create artificial barriers to competition in the marketplace. 

By HHS’ own estimate, their Medicare-endorsed PBM-based discount card program, such as those envisioned by CMS, would only generate savings of 10 to 13 

percent for seniors on the cost of their prescriptions. Almost all of these savings 

would come from reduction in the prices that pharmacies charge, not a reduction 

in the price that the manufacturer charges the pharmacy for the drug. Moreover, 

these discount card programs—which already exist in the market—overuse highercost brand name drugs, rather than lower-cost generics. That is because PBMs earn 

rebates from drug manufacturers by promoting the use of their brand name drugs. 

These practices lead to higher prescription drug bills for seniors, not lower ones. 

Under a Medicare-endorsed discount card program, seniors’ access to needed prescription medications and their choice of pharmacy would be restricted. Under these 

other newer programs, however, seniors do not have to make choices between varVerDate jul 14 2003 02:56 Sep 27, 2003 Jkt 089405 PO 00000 Frm 00126 Fmt 6633 Sfmt 6621 E:\HR\OC\89405.XXX 89405
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ious discount programs, switch their medication from a drug they may be taking to 

another drug just to get a discount, and don’t have to give up using their local pharmacy. In our opinion, this is better health care for seniors. 

We would ask that you reconsider your approach to legislating a Medicare-endorsed discount card program that would be of little benefit to seniors and would 

significantly harm community pharmacies. Instead, we ask that you work with us 

to assure that private-sector approaches continue to be developed, which will help 

seniors obtain their prescription medications in the short term, while we work on 

a model for longer term Medicare reform that incorporates these important privatesector approaches.

Conclusion

NACDS believes that the Subcommittee is asking the right questions regarding 

the best way to structure a Medicare prescription drug benefit that will serve the 

needs of Medicare beneficiaries and pharmacies in the 21st century. Contrary to 

popular opinion, today’s market for prescription drug benefits has structural flaws 

that are being recognized by many public and private payors as impeding competition and unnecessarily increasing costs. These payors are responding by taking their 

benefit management functions in house, or by using a pharmacy benefits administrator (PBA) model. We believe that any pharmacy benefit should rely on the competitive market forces that already exist among pharmaceutical manufacturers and 

retail pharmacies, and that artificial barriers should not be erected to impede this 

competition. 

The Committee should also take note of the market shift that appears to be occurring—both in private and public sector programs—away from PBM models and toward PBA or in-house administration models. These approaches help assure that 

the plan sponsors reap the benefits of their purchasing power, rather than having 

it diluted by a middleman. 

In order to provide the most competitive pharmacy benefit possible, policymakers 

should assure that the following components are incorporated into the program: 1) 

transparency and pass through of all PBM-derived rebates, concessions, and discounts; 2) assurances that PBMs do not erect artificial barriers to seniors’ access 

to the pharmacy of their choice, such as through restrictive networks, limitations 

on the quantity of medication that retail pharmacies can provide, or differential cost 

sharing to provide seniors with incentives to use mail order over retail pharmacies; 

3) limits on the activities performed by PBMs so that they function more as PBAs, 

and do not become involved in patient care functions, which is the purview of the 

health professionals; and, 4) restrictions on the ability of the PBM to serve both as 

the retail network administrator and the mail order provider in the same region, 

which is an inherent conflict of interest since PBMs are direct competitors of retail 

pharmacies. 

NACDS and its member companies look forward to working with the Subcommittee and full Committee on developing this Medicare pharmacy benefit. 

Thank you for an opportunity to submit this statement.

Æ