The Medicare Drug Entitlement's High Cost to Seniors withEmployer-Based Coverage

Report Health Care Reform

The Medicare Drug Entitlement's High Cost to Seniors withEmployer-Based Coverage

October 2, 2003 9 min read
Derek Hunter
Former Research Assistant
Derek is a former Research Assistant.

When passing different versions of Medicare legislation (H.R. 1 and S. 1), providing a universal drug entitlement, the House and Senate each deliberately ignored the Joint Economic Committee's warning[1]: The entitlement will massively disrupt, one way or another, existing private drug coverage for millions of seniors, particularly the drug coverage provided by employer plans.


What the Drug Entitlement Will Mean for Seniors

According to the Congressional Budget Office (CBO), if either the House or the Senate bill were to become law, at least one-third of seniors who receive drug coverage through their former employer would lose that benefit.[2]


Deep Losses. Seniors who are dumped out of their current retiree benefits would lose both generally superior prescription drug coverage and thousands of dollars in deferred and future compensation. Throughout their working lives, seniors with employer-provided retiree drug coverage worked with the understanding that that coverage would be there for the rest of their lives. Some employers provided this benefit of their own free will, and others provided it through contractual obligation, such as union contracts like the United Auto Workers.


Retirees also forfeited pay during their working lives for a benefit they count on for the rest of their lives, the value of which could be as high as $110,000 throughout their retirement depending upon the quality of coverage.[3]


And that would be replaced with worse coverage. According to Ken Thorpe of Emory University, "The actuarial value of the proposed Medicare drug benefit is substantially less generous than retiree health plans."[4] His estimates place the number of seniors dropped from their current coverage at 4.1 million, broadly in line with CBO estimates.[5]


Disputes Over Employer Responses. Not everyone agrees with the CBO and Thorpe estimates. For example, the Employee Benefit Research Institute (EBRI) estimate is much lower: from 2 percent to 9 percent.[6]


However, an important caveat in the footnotes of the EBRI study shows that what they are saying is not necessarily different from what is being said by other analysts who are critical of the House and Senate bills. Footnote 5 of the EBRI report says, "We believe most employers will choose to 'wrap-around' Medicare for current retirees, as they generally do today."


In the context of the Medicare legislation, this is a crucial point.


Under a wrap-around policy an employer would cover the initial deductible and cost-sharing expenses up to a point for its retirees. However, this would have a perverse effect because neither the House nor Senate bills count monies paid by a former employer's plan as part of the beneficiary's cost-sharing in calculating when the beneficiary reaches the catastrophic coverage level. 


Thus, not only would employer-provided wrap-around coverage not fill in the coverage gaps in the new Part D Medicare benefit, it would instead bunch all of the cost-sharing together into one, even larger, coverage gap, which the beneficiary would have to pay out-of-pocket before reaching the catastrophic coverage level.


Under the House bill, those retirees would have to cover the next $3,500 on their own, while the Senate bill would require them to pay the $3,700. Once those out-of-pocket expenses were met, coverage would resume. The House bill would cover 100 percent of prescription costs over that limit, while the Senate bill would cover 90 percent.[7]


There is little doubt that seniors losing their private employer-based coverage, or having it scaled back to wrap-around coverage will end up paying more out of pocket for the new government drug benefit. Seniors who lose their employer-provided coverage would see their out-of-pocket costs increase by up to 50 percent under the Senate bill.[8] They would also fare poorly under the House bill.


What the Drug Entitlement Will Mean for Corporations

While seniors stand to lose coverage they know, trust, and have been promised, corporations would reduce their long-term liabilities for retiree drug coverage under both the House and Senate Medicare bills. One example of an industry that could save millions if Medicare covered prescription drugs and that has been lobbying for a universal drug entitlement is the auto industry.


The auto industry has a very high ratio of retirees to workers: roughly 475,000 retirees to only about 300,000 workers, with the ratio at General Motors being about 2 to 1.[9] According to a recent report in The Economist, "This burden, plus the fierce price-and-incentives competition in the industry, has savaged the finances of the Big Three."[10]


Given the potential savings to automakers, it is no wonder they have been "lobbying for years" for a universal drug entitlement in Medicare, financed by the taxpayers, and not one targeted only toward those seniors who need it.[11] Gary Lapidus, an analyst at Goldman Sachs, estimated that General Motors could save as much as $150 million annually and that the Ford Motor Company could save $50 million annually.[12]


Edward J. Kaleta, chairman of the Employers' Coalition on Medicare, a group lobbying on the Medicare legislation on behalf of large corporations, has said that "Congress should not discriminate against our retirees because they have employer-provided coverage. Our retirees should be treated the same as other Medicare beneficiaries."[13]


With literally billions of dollars at stake for corporations over the next 10 years, if the taxpayer ends up funding a new universal entitlement, however inferior to what current retirees receive or were promised that entitlement may be, it would be nearly impossible for publicly owned companies not to reduce to wrap-around coverage.


A New Plea for Corporate Welfare?

Some Members of Congress are now proposing new government subsidies or another set of special tax breaks as a way to prevent employers from dropping coverage they once promised to seniors. Under such a scenario, according to a recent report in The New York Times, "The tax credits would be available to employers who maintain drug coverage or supplement what Medicare provides."[14] Companies that provide wrap-around coverage would receive a tax credit while "the employer shifts the majority of the price and volume risk for drug coverage onto Medicare and its own retirees."[15]


The National Association of Manufacturers (NAM), the largest industrial trade association in the country with 14,000 members, supports the idea of a universal drug entitlement.[16] Most corporations and trade associations avoid making any direct pledge not to drop or reduce current retiree coverage. Congress itself, on the other hand, has already taken the first steps to enact a law to protect its own retirees (including retired Members of Congress) from seeing their benefits eliminated or reduced to the level they have enacted for all other retirees.[17]


The creation of a universal drug entitlement, displacing private coverage, follows a familiar pattern of bad policymaking. Congress first creates a program, say a new entitlement, with new fiscal obligations for the taxpayers. Congress then discovers that the creation of this new entitlement begets a series of unintended and very undesirable consequences. Then, to cope with the unintended consequences of the entitlement, Congress again hits the taxpayers with the cost of a quick fix for the problem that it (often unnecessarily) created in the first place.


Target Taxpayer Dollars to Those Who Need It

Senior citizens who currently receive prescription drug coverage through their former employer run serious risk of losing that coverage or seeing it significantly reduced by a universal drug entitlement added to Medicare. At the same time, corporations that provide retirees with prescription drug coverage stand to gain tens of millions of dollars in savings by either dropping retiree coverage altogether or scaling it back to provide wrap-around coverage in Medicare.


It is a mistake to saddle America's middle-class taxpayers with an unnecessary, universal drug entitlement of unknown cost. It is even worse to compound that fiscal mistake by asking those very same taxpayers to dig into their pockets and subsidize corporations so that the corporations will not dump their retirees into a congressionally mandated entitlement that they lobbied to create in the first place.


A better idea is simply to solve a real problem. Instead of creating a universal entitlement, Congress could address the real needs of real seniors who don't have drug coverage or access to drug coverage, and target taxpayer dollars to those who need the most help. That would be a rational, responsible, and fiscally sane course of action. It's not too late.

[1]Joint Economic Committee, U.S. Congress, "Medicare Beneficiaries' Link to Drug Coverage," April 10, 2003.

[2]Congressional Budget Office, "H.R. 1: Medicare Prescription Drug and Modernization Act of 2003 and S. 1: Prescription Drug and Medicare Improvement Act of 2003," CBO Cost Estimate, July 22, 2003.

[3]Lanhee J. Chen, "What Seniors Will Lose with a Universal Medicare Drug Entitlement," Heritage Foundation Backgrounder No. 1680, August 26, 2003.

[4] Ken Thorpe, "Potential Implications of the Medicare Prescription Drug Benefit on Retiree Health Care Benefits," Emory University, September 13, 2003.

[5] Ibid.

[6]Dallas L. Salisbury and Paul Fronstin, "How Many Medicare Beneficiaries Will Lose Employment-Based Retiree Health Benefits if Medicare Covers Outpatient Prescription Drugs?" Employee Benefit Research Institute, EBRI Special Analysis, July 18, 2003.

[7]For a more detailed discussion, see Edmund F. Haislmaier, "How Congress's Medicare Drug Provision Would Reduce Seniors' Existing Private Coverage," Heritage Foundation Backgrounder No. 1668, July 17, 2003.

[8]Lanhee J. Chen, "How the Senate Medicare Drug Bill Would Raise Senior Citizens' Out-of-Pocket Drug Costs," Heritage Foundation Web Memo No. 312, July 15, 2003.

[9]"Still Power in the Union?" The Economist, August 30, 2003, p. 45.


[11]Sarah A. Webster, "Medicare Drug Plan May Save Carmakers Millions; Retiree Health Bills in Congress Likely to Affect UAW Talks," Detroit Free Press, July 8, 2003.


[13]Robert Pear, "Retirees Alarmed at Threat of Cuts in Drug Benefits," The New York Times, September 16, 2003.


[15]Haislmaier, "How Congress's Medicare Drug Provision Would Reduce Seniors' Existing Private Coverage."

[16]Letter to William M. Thomas, Chairman, House Ways and Means Committee, from E. Neil Trautwein, Director, Employment Policy, National Association of Manufacturers, June 11, 2003.

[17]For a discussion of this remarkable attempt to create a double standard in the treatment of congressional and federal retirees, see Derek Hunter and Robert E. Moffit, Ph.D., "Unfit for Senators, But Good Enough for You," Heritage Foundation Commentary, July 23, 2003.


Derek Hunter

Former Research Assistant