Medicare Prescription Drugs – Part I

Democrats are bragging about lowering Medicare prescription drug prices. I’ve talked about the downside of that policy in recent blogs (The Real Cost of Lowering Drug Prices, Cancer Drug Breakthroughs Threatened). But there are many other reasons why Medicare is failing seniors.

John C. Goodman, healthcare economist writing in Forbes, asks us to consider how well Medicare stands up against private, free-market provision of similar services. Since Congress just acted on Medicare prescription drugs, let’s examine drug coverage in answering that question. He makes the following points:

Medicare was the last major insurer to cover drugs.

Medicare was created in 1965 and at that time the benefit structure was simply a copy of the standard Blue Cross plan being sold at that time. Since Blue Cross didn’t cover drugs, Medicare didn’t cover drugs. At the time drugs played a very small role in the healthcare system and they weren’t that expensive in any event.

All that has changed, however. Today we are getting our best healthcare return from spending on drugs. The benefits per dollar of cost from drug therapy are much higher than benefits from doctor or hospital therapies. The increase in life-expectancy that we have seen over those years has been largely due to new and effective drugs. These drugs have helped to lower the cost of healthcare while improving patient outcomes. As a result, since 2003 virtually every major health plan in the country now covers prescription drugs and has been doing so for a long time. Yet, Medicare was well into its fourth decade with no drug coverage – and it took a major effort in Congress to get coverage even then.

Medicare drug coverage reflects politics, not rational insurance principles.

While businesses respond to opportunities to lower costs and improve service, Medicare does not. Goodman says, “Whether it is auto insurance, home insurance or any other kind of insurance, certain principles usually govern insurance contracts. In general, people self-insure for small expenses which they can easily afford on their own and rely on third-party insurance for large expenses which could be financially devastating.”

But Medicare does not follow that principle. In fact, it turned that principle upside down. Whether the service was doctor, hospital, or drugs, Medicare traditionally has paid many small expenses that seniors could easily afford on their own, while leaving them exposed for tens of thousands of dollars of catastrophic costs.

Why the difference? In any insurance scheme, a small percent of the insured will make up a very large percent of the claims in any given year. In health insurance, for example, about half the money is spent on 5 percent of the insured. When the insurer is the government, that means that half the money will be spend on 5 percent of the voters – people who may be too sick to vote at all!

Here’s where socialized medicine systems figure into the equation. When a minister of health is allocating healthcare dollars, such as Britain or Canada, there is intense political pressure to take from the few who are sick and spend money on the many who are relatively healthy. These same political realities have affected Medicare.

Anyone who had used Medicare for drug coverage is familiar with the “donut hole.” After a certain point, Medicare pays less for drugs than it has been paying – until a patient’s costs reach another threshold and catastrophic coverage kicks in. The reason for this “donut hole” is to create a benefit for the many seniors with small drug costs. That benefit is “paid for” by making the few seniors with high drug costs pay more out of their own pockets. That’s also the reason why a very small number of seniors pay $10,000 or more every year for specialty drugs while the typical senior pays only 25% of the cost of inexpensive drugs.


(Next post – Part II of this series on Medicare.)

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