SPECIAL REPORT: A tough pill to swallow

BY CHRIS POLLOCK

Last week republicans orchestrated the largest entitlement expansion in over 30 years by adopting a Medicare prescription drug benefit. Without a doubt, the program will provide welcome relief for many seniors who simply can’t afford the medicine they need. But this important goal has largely been subverted by the political interests of the plan’s biggest beneficiaries – President Bush and the pharmaceutical industry.

A worthy prescription drug plan would have targeted our limited resources toward the poor and uninsured seniors who really need federal help. Such a plan would also have attacked the real source of the crisis – rapidly rising costs spurred largely by the economics and profit motives of the drug industry. This bill largely does neither. The new benefit provides only modest protections to the seniors it intends to help, and it fails utterly to address the incentives it creates for the drug industry. By aiming to please seniors of all incomes and by subsidizing the very companies that contribute to the crisis, the plan is poised to send us even further into debt than the bill’s large (yet absurdly low-balled) cost projections suggest.

Bungling Insurance

Imagine a homeowner who spends 40 years paying for insurance but whose home never burns down. Is he upset for wasting all that money on insurance premiums? Of course not. The money was well spent, because it protected him from risk. That’s how insurance works: everyone pays into the system, but the payouts only go to those in need. Yet everyone with insurance is better off, because everyone knows that protection is there if he or she needs it.

The new Medicare drug benefit, like many of our government entitlements, isn’t well-designed insurance. With an important exception, it indiscriminately subsidizes all seniors, rather than targeting those most in need. One result is that many truly needy seniors get short-changed. Another is that the program is wildly more expensive than it needs to be given the level of benefits.

The laudable exception is that very low-income seniors – sadly, almost a third of the 35 million Americans over 65 – won’t pay deductibles or premiums or face the large coverage gap. Still, 2.8 million seniors with incomes under $13,000 are excluded from the subsidy because their assets exceed $6,000. And another 6 million seniors who have incomes over $13,000 but under $18,000 will face the same benefit schedule as the wealthy.

That makes 9 million seniors who likely have no drug insurance now and have little money to spare, but who aren’t given any special treatment. Take a look at the expected benefit numbers presented in Figure 2. Seniors qualifying for the standard benefit must have drug costs in excess of $810 per year before the plan even becomes a net benefit to them. If their costs were $6,000, they’d still pay over $4,000 out-of-pocket. Does that sound like something a senior can afford on a $15,000 income? No private insurance plan would ever offer such meager benefits.

The benefits are limited, of course, in a futile effort to keep costs down. But costs are so high in large part because the benefits go to all seniors, even those who can already afford drugs. The bill devotes billions to subsidize Health Savings Accounts (HSAs) that only the wealthy can afford. Another $70 billion subsidizes existing employer drug plans in the fear that once a Medicare benefit exists, employers will cancel their retiree drug benefits. But if the Medicare drug benefit focused on the poor, employers wouldn’t be tempted to skimp, since there wouldn’t be a fallback for most seniors with employer-funded drug benefits (these seniors tend to fall on the higher end of the income spectrum).

Critics decry means-testing or differentiating benefits based on wealth as unfair to middle and upper class seniors. Why should they be “punished” – deprived of benefits – just because they’re financially secure? But just like the homeowner whose house never burns down, wealthy seniors wouldn’t be punished by such a system. They would benefit from insurance even if they never received a payout, since the Medicare safety-net would be there if they needed it. They should be thankful, not disappointed, if their house never burns down.

Treating the drug benefit more like insurance would have been more honest, more affordable and more socially beneficial. For the same amount of money, we could have done vastly more to help the seniors in the most dire circumstances – namely, the poor and uninsured. Instead, the benefits are watered-down and the price tag inflated.

Ignoring Market Realities

More ominously, the Medicare bill’s ignorance of market realities may push the system toward an even costlier and less effective private alternative. Indeed, the bill actually contains the blueprint for the program’s own eventual Phoenix-like rebirth as a completely privatized Medicare system. At the program’s core, the public benefit provisions must invariably fail because the overall cost of the program has been massively understated and because intelligent cost containment provisions are totally absent. Once the unsustainable nature of the public benefit provisions becomes evident, the only stop-gap solution will be more substantial use of the program’s intrinsic private safety valves like HSAs and reliance on private insurance alternatives. Unless altered, the new prescription drug benefit provisions will cause the Medicare system to hemorrhage, leaving no choice but privatization despite more public involvement being the only long-term solution.

The official estimated cost of the Medicare reform package – $400 billion – massively understates the true cost. Ignoring arguments that the interest on the funds borrowed to pay for the benefit should be included in the cost, the true cost will still be in the trillions of dollars.

First, the Medicare reform package lacks intelligent cost controls. The pharmaceutical companies were well served by their legions of lobbyists. Except for the token generic drug rider attached to the Senate version, there is no substantial encouragement of cheaper generic alternatives. There is no mechanism for Medicare to apply its massive purchasing power to lower drug costs. Even the interim discount purchase card is being farmed out to private suppliers and any benefits, including the promised 15% discount, will only come from their various divided efforts. And there are no provisions concerning the production of independent information about the relative merits of prescription drugs. Doctors and consumers will continue to be substantially educated by the very companies selling higher-cost patented products.

Second, pharmaceutical companies will easily game the new Medicare system, driving costs many times beyond the current projections. With the aim of giving beneficiaries an incentive to compare costs when deciding which drugs to buy, the new Medicare program includes varying reimbursement percentages and an enormous coverage gap. But that check on spending only works if drug companies don’t alter their behavior in response to institution of the program. Is there any chance that drug companies will not use their legally sanctioned monopolies (patents) and heightened pricing power to extract rents from consumers with additional funds to spend?

Worse still, the possible gaming associated with the sale of existing products is minor compared to the effects this will have on future drug development. Imagine you are a drug company executive presented with the choice of either concentrating on the production of high-end drugs that will in all likelihood be 80%-95% covered by Medicare (80%-95% of whatever price you set, remember), or the production of moderately priced drugs which may not be covered at all. Will the new legislation have any effect on your choice and thus the nature of the prescription drugs market? If not, you aren’t going to keep your job very long.

The current cost estimates simply ext
rapolate past market behavior over the next decade. This is incredibly wrong. As pharmaceutical companies alter their pricing behavior and shift their development efforts, the costs of the Medicare program will spike. By the time this becomes obvious, there will be few choices – eviscerate the program or utilize the quick cost-cutting fix that is privatization.

In the end, the recently-passed Medicare reform bill, while a politically astute measure, is structurally flawed as a result of the crafters’ misguided belief that private markets invariably solve all. The bill will lead to the extinction of the program in its public form. And the privatization of Medicare is poor public policy because the only way to effectively deal with public goods problems (i.e. the development of drugs) is through collective, public solutions. At some point, we will have to come to terms with the truth that reform of our intellectual property system must precede any substantial reformation of the funding of our healthcare system.

Chris Giovinazzo pens a biweekly column, “Fair, Balanced, and Fair.” Fred Pollock pens a biweekly column, “Money Talks.”

Comments