THE BASIC POLICY OPTIONS

Beyond cost considerations, Congress must decide how to administer a prescription drug benefit for the Medicare population. One option is to deliver prescription drug coverage through a pluralistic system of competitive private providers,
similar to the way in which drugs are routinely delivered to most Americans enrolled in private health insurance plans.

Another leading option is simply to add a drug benefit to the existing Medicare program, prescribing drug coverage, the conditions of drug access, and pricing through a system of direct government control and regulation--similar to how other benefits are tightly controlled by law and government regulation in the current Medicare program.

One possible compromise is to combine the best features of the private sector (patient choice and market competition) with the best features of the public sector (security and predictability) in a public-private partnership. A good model for a public-private partnership already exists in the Federal Employees Health Benefits Program (FEHBP).

In the FEHBP, drug coverage is universal and fully integrated into private health insurance plans. Moreover, all of the competing health plans in the FEHBP are subject to the administrative authority of the U.S. Office of Personnel Management (OPM), the federal agency that administers civil service law.² Thus, federal employees and retirees have a choice of coverage and can seek better plans and benefits if they are dissatisfied with their drug coverage or any other benefit coverage. The President and leading Members of Congress from both political parties have embraced this well-tested model.

RISING COSTS AND GOVERNMENT RESTRICTIONS

Medicare faces formidable financial pressures. The Congressional Budget Office (CBO) projects that Medicare spending between 2004 and 2013 will amount to $3.9 trillion, including $271 billion for 2004.³ By 2013, when the first wave of the 77 million baby boomers has retired, the Hospitalization Insurance (HI) trust fund will be running a cash deficit, based on assumptions under current law, and these deficits will deepen for each following year during the entire period of the baby-boomers' retirement.⁴

Future Crisis
Medicare's projected deficits and the looming insolvency of the HI trust fund will place increasing demand on general revenues from the taxpayers to keep the program afloat. According to Thomas Saving, a professor at Texas A&M University and Medicare trustee, this means that by 2026, when the HI fund is exhausted, 20 percent of all federal income taxes will be required to finance Medicare alone.

Adding a prescription drug program to Medicare dramatically increases the financial pressures on taxpayers. According to the CBO, "For the period 2004 through 2013, CBO estimates that spending for prescription drugs by and on behalf of the Medicare population will total $1.8 trillion, or nearly 50 percent of the projected $3.9 trillion in Medicare outlays over that same period."⁵

As noted, many Members of Congress strongly oppose private-sector delivery of prescription drug coverage and would legislate a universal government-run drug benefit, effectively displacing the existing private market that delivers prescription drugs to the senior population. The costs of any future Medicare drug benefit would, of course, depend on its design and the incentives created by that design.

According to Professor Saving, adding a new Medicare drug benefit that pays just 25 percent of prescription drug costs would require 24 percent of all federal income tax revenue to pay for the entire Medicare program in 2026.⁶ A far more generous drug benefit paying 75 percent of drug costs would increase total Medicare costs to an estimated 35 percent of federal income tax revenue in 2026.⁷

Given the huge financial pressures on traditional Medicare, both Congress and the Medicare bureaucracy would be under relentless political and economic pressure to cut costs in such a Medicare prescription drug program.

Medicaid's Current Crisis
While Medicare faces long-term financial problems, Medicaid's financial difficulties are more immediate. States, which pay a large portion of Medicaid funding, are facing major financial problems because of the economic downturn and record spending increases in recent years. Medicaid enrollment is increasing, partially because of the downturn in the economy, and Medicaid spending is consuming ever-larger chunks of state budgets. Medicaid spending as a percent of state expenditures increased from just over 10 percent in 1987 to 20.4 percent in 2002.⁸

Unlike Medicare, Medicaid already covers outpatient prescription drugs. Medicaid is funded jointly by the federal government and the state governments, with the federal government providing the majority of the funding. State government officials determine, within federal limits, eligibility requirements and the precise configuration of benefits.

Like other Medicaid benefits, prescription drug benefits are subject to various pricing and regulatory restrictions. Faced with sharply rising costs, Medicaid is a showcase of how government officials can and do control prescription drug costs by limiting the available supply of drugs to patients.

LIMITING ACCESS TO PRESCRIPTION DRUGS

Attempting to control Medicaid costs, a number of states have started cutting back on prescription drug coverage for the poor. According to a major report of the Kaiser Commission on Medicaid and the Uninsured, 45 states impose various controls on prescription drugs.⁹ State officials have devised a variety of ways to implement restrictive prescription drug policies, including formularies, prior authorization requirements, and complicated reimbursement arrangements.

Price Regulation
As states battle to control the cost of Medicaid, state officials see reducing the price of prescription drugs as a way to slow spending growth. In many states, in order to have a drug covered by Medicaid, pharmaceutical companies must agree to sell their products to the state at a discounted price--either "the greater of 15.1 percent of the average manufacturer's price (AMP) or the difference between the AMP and the manufacturer's best price and...an additional rebate for any price increase for a product that exceeds the increase in the Consumer Price Index (CPI-U)" for innovator drugs and 11 percent AMP for generic drugs.¹⁰

Some states, such as Florida and Michigan, are requiring additional rebates for listing drug companies' products in their drug formulary. If drug companies refuse to offer a rebate on a particular drug, patients in the affected state will have difficulty accessing that drug--assuming they can do so at all.

These Medicaid experiences are directly relevant to the upcoming debate on adding a prescription drug provision to Medicare. Price controls, while invariably appealing to politicians as a quick fix to rising costs, have enormously negative health and economic consequences. Members of Congress and senior citizens to whom they have promised artificially cheap drug coverage through traditional Medicare should be fully aware of these trade-offs. A poorly designed Medicare drug benefit would undoubtedly be accompanied by formidable pressures that drive up costs and result in political pressure to impose some form of price control system at least as strict as the pricing measures currently employed in Medicaid.

While Medicaid beneficiaries are faced with reduced prescription drug coverage, solid evidence from several industrialized countries indicates that pricing regulations and negotiations over government pricing compromise the availability of new drugs.¹¹ A study by the Boston Consulting Group in 1999 found significant delays in accessing new drugs in countries with price controls compared to those with relatively few. Belgium and Greece had an average delay of 12 months; France and Switzerland had an average delay of 10 months for new drugs to reach the market compared to the minimal delays in the United States, the United Kingdom, and Germany, which have significantly fewer market interventions.¹²

If Members of Congress promise current and future Medicare beneficiaries a cheap or low-cost prescription drug benefit through traditional Medicare, they will be tempted to control costs through price regulation of one form or another. If they resort to price regulation, Medicare patients can be expected to have difficulty accessing the latest, most effective drugs. In some cases, the effects of government price fixing will eat up precious time that sick Medicare patients do not have.

Drug Formularies
Formularies are preferred drug lists, the official lists of drugs made available to patients. Formularies exist in conventional employment-based health insurance in the private sector, but state officials also use them in the Medicaid program. Of the 43 states surveyed, 40 exclude some drugs from their formularies.¹³

Generic Substitution
The Kaiser Commission has reported that Medicaid officials in 16 states require the use of generic drugs over brand-name drugs because they are generally cheaper than brand-name drugs.¹⁴

Prior Authorization
In some states, officials require doctors to obtain prior authorization when prescribing newer or more expensive drugs before Medicaid will pay for them. Under the prior authorization process, state government officials require physicians to fill out burdensome paperwork, justify their decisions to a state board, and/or try less expensive generic drugs first (until they fail) before Medicaid will pay for certain (often brand-name) drugs. According to the Kaiser Commission, "Authorizations usually have several possible levels of review, with clerks or interns often making initial, simple decisions."¹⁵ Prior authorization is required for some drugs in 36 states.¹⁶

Prescribing and Dispensing Limitations
In some cases, officials even restrict the size of drug dosages, the number of prescriptions allowed in a month, and even the number of pills covered in a certain period of time. In addition, Medicaid takes an average of 20 months after a new drug is approved by the Food and Drug Administration (FDA) to add it to the Medicaid list of approved drugs. The picture is even bleaker for Medicaid patients: Amounts of medication per prescription, number of prescriptions per month, and number of refills are limited in 41 states.¹⁷

While the various forms of drug limitation may save the government money in the short term, the accumulated costs to patients and taxpayers over time can be high. Serious costs result from potentially ineffective treatment, treatment delay, the inevitable worsening of mistreated medical conditions, and repeated visits to doctors or medical specialists. Hence, many professional medical organizations and disease groups have gone on record against this method of cost control.¹⁸

Medicaid has imposed prescription drug restrictions that affect millions of poor and indigent persons enrolled in Medicaid. Under Medicare, patients' access to medical technology is already limited,¹⁹ and Medicare itself is administered by one of the most poorly performing federal agencies.²⁰ If Congress does not reform Medicare and instead retains the central planning and price regulation that govern both Medicaid and Medicare, similar cost controls are likely to be imposed on any new Medicare prescription drug plan. Under these circumstances, America's senior citizens in a government-managed drug benefit will pay a very high price in service quality.

CHOICE IS THE KEY TO A SUPERIOR MEDICARE DRUG PROGRAM

Patients without a choice of health plans are often dissatisfied with the quality of their coverage.²¹

Federal employees and retirees have a very different situation under the Federal Employees Health Benefits Program, which covers them and their families--approximately 8.3 million Americans. All health plans in the FEHBP have drug coverage, and in recent years most of these plans have paid 80 percent or more of prescription drug costs. Most important, if federal workers or retirees do not like their health plan's drug coverage or its restrictions on coverage, they can choose another plan.

The ability of federal workers or retirees to "vote with their feet" and leave overly restrictive health plans is a key feature of the FEHBP. Not surprisingly, this power of personal choice also affects the character of pharmacy benefit managers (PBMs) who are common to these health plans and who often contract with health plans and administer drug benefits for health plans, including the negotiation of drug prices with pharmacies and drug manufacturers. They also process drug claims and employ formularies or preferred drug lists. According to the U.S. General Accounting Office (GAO), FEHBP health plans generally use PBMs, like those in private employer-based health insurance.²² The GAO also reports that PBMs in the FEHBP have "generally nonrestrictive drug formularies across a broad range of drugs and therapeutic categories."²³

In controlling costs, the GAO found that PBMs in the competitive environment of the FEHBP were successful in passing on significant savings.²⁴ In retail pharmacies, federal employees and retirees were able to secure an average discounted price for 14 selected "widely used brand name drugs" at about 18 percent below the average for "cash paying customers" without drug coverage. For four selected generic drugs, the GAO found that the PBM negotiated retail pharmacy prices that were 47 percent below the prices paid by cash-paying customers.²⁵

In the FEHBP, health plans that employ PBMs also use them to provide options for mail-order prescription drugs to federal employees and retirees. On average, the GAO found that prices of the 14 brand-name drugs were 27 percent lower for mail-order prescription drugs than prices at retail pharmacies, and the four generic drugs were 53 percent lower.²⁶

A Medicare reform proposal based on the FEHBP would give current and future senior citizens a superior program for prescription drug coverage without the kind of restrictions that are found in Medicaid today and will surely be imposed in Medicare tomorrow.

CONCLUSION

Medicaid, which provides medical benefits for the poor and the indigent, is imposing significant restrictions on patient access to prescription drugs. This is not surprising. In Medicare and Medicaid, there is no interaction between the demand for medical services and the supply of those goods and services. Free-market functions that control costs in every other sector of the economy are absent. Rather, cost control in Medicare and Medicaid is largely a function of political decision-making and budgetary allocations.

Government officials cannot control the demand for medical goods and services in these government programs; they can only control the supply. They routinely control cost by limiting supply, usually through some form of price regulation. In Medicaid, boards made up of government officials, pharmacists, and uninvolved doctors also limit the supply of drugs available to Medicaid patients, sometimes with clerks or interns making initial decisions when prior authorization is required.²⁷

For senior citizens, the Medicaid experience is a lesson. If Congress adopts a drug benefit through traditional Medicare without reforming that program to respond to consumer demand and patient choice, senior citizens can expect Medicare officials to impose similar restrictions on prescription drugs.

Medicaid limits and delays a doctor's choice of prescriptions for the patient, the number of prescriptions allowed per month, and the number of pills allowed per prescription. Access to the newest, most effective drugs is also limited.

Medicaid has these restrictions because of financial pressures and budget constraints. The financial pressures facing Medicare have hardly begun, but they will become even more formidable. Seniors should realize that efforts to control costs in Medicare will likely tie the hands of physicians by limiting treatment options, as they have in Medicaid.

There is a better way. Instead of a system based on government central planning and price fixing, Congress should encourage market competition and give full sway to patient choice. The best available model for a new Medicare program is the Federal Employees Health Benefits Program, the consumer-driven health program that covers federal workers and their families. Unlike many private employer-based plans, the FEHBP allows a broad choice of health plans, allowing individuals and families to choose the coverage they want, including prescription drug coverage. At the very least, the next generation of retirees should be able to choose the kind of prescription drug coverage that best suits their needs in a new and strengthened Medicare program.

Derek Hunter is a Research Assistant in the Center for Health Policy Studies at The Heritage Foundation.

APPENDIX

EXAMPLES OF STATES LIMITING DRUGS THROUGH
PRIOR AUTHORIZATION AND OTHER RESTRICTIONS

The following are examples of the ways by which state Medicaid officials use prior authorization and other bureaucratic methods to limit drug coverage.