Medicare Prescription Drugs: A Case Study in Government Failure

Bernie Sanders and other socialists think health care should be provided by the state. Their latest version of that idea is “Medicare for all.”

How does Medicare stand 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.

Medicare was the last major insurer to cover drugs. When Medicare was created in 1965, the benefit structure was simply a copy of the standard Blue Cross plan being sold at the time. Since Blue Cross didn’t cover drugs, Medicare didn’t either. The reason Blue Cross didn’t cover drugs is that drugs played a very small role in the health care system in those days and they weren’t that expensive in any event.

With the passage of time, things changed. Today, we are getting our best health care return from spending on drugs. In comparison to just about anything else we do in medicine, the benefits per dollar of cost from drug therapy are much higher than benefits from doctor or hospital therapies.

Because drug coverage lowers the overall cost of health care and improves patient outcomes, by 2003 virtually every major health plan in the country was covering prescription drugs and had been doing so for quite some 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.

Why the difference? Private businesses will always tend to make changes when there are opportunities to lower costs and better serve their customers. In the political arena, however, nothing changes unless special interest pressures change.

Medicare drug coverage reflects politics, not rational insurance principles. 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.

From day one of its existence, however, Medicare 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 spent on 5 percent of the voters—people who may be too sick to vote at all.

Yet politics is the art of taking from Peter and giving to Paul. That will always be tempting to do if there are a lot more Pauls than there are Peters.

That is why in countries where a minister of health is allocating health care 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.

Those same political realities have affected the design of Medicare.

Medicare has a “donut hole” in its drug coverage. That is, 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 only reason for a “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 pocket. 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 percent of the cost of inexpensive drugs.

Medicare requires three premiums for three different insurance plans. Seniors in traditional Medicare are usually paying separate premiums to three different insurers: one for Part B coverage for doctor care, a second for Part D coverage for drugs, and a third for Medigap insurance to plug the holes in Part A (hospital care) and Part B.

Yet, because the suppliers of these three plans have differing financial interests, the results are waste, inefficiency and inferior patient care.

Consider the effect of having one insurer cover drugs, while the other two are covering medical care. If a diabetic skips his insulin and other medications, that is actually profitable for the drug insurer—since these are expenses it doesn’t have to cover. However, if such non-adherence to a drug regimen leads to emergency room visits and hospitalization, those are costs the other two insurers will have to bear.

The fact that the insurers have competing and opposing financial interests means that there is no possibility of alignment with the goal of cost-effective, well-managed care.

Medicare creates perverse incentives to tax the sick for the benefit of the healthy. When insurers are forced to charge community-rate (charging the same premium regardless of health status) and there is no adequate risk adjustment, they will have an incentive to overcharge the sick (to discourage their enrollment) and undercharge the healthy (to encourage their enrollment).

In Medicare Part D, this perverse incentive leads to distorting effects in the “rebate” system. Say a diabetic goes to a pharmacy where the list price of insulin is $100. Her 25 percent copayment amounts to $25. However, unbeknownst to her, the insurer is getting, say, a $90 rebate from the drug company that produces the insulin. That means that the real cost of the insulin to the insurer was only $10, so a fair out-of-pocket charge to the patient would be only $2.50, not $25.

What happens to that “profit,” which the insurer makes but doesn’t share with the patient? It gets competed away by charging lower premiums for buyers of Part D drug insurance.

In this way, the system causes the sick who need drugs to be overcharged while the relatively healthy premium payers are undercharged.

How the private sector differs. Roughly half of all Medicare enrollees are participating in the Medicare Advantage program—where they enroll in private plans that look very much like the plans employers offer. Although these plans are regulated by the Medicare bureaucracy, they have enough freedom and flexibility to avoid some of traditional Medicare’s worst features.

In Medicare Advantage (MA), for example, people are paying one premium to only one insurer, who is responsible for all costs. That means the insurer has a non-conflicted, integrated interest in keeping patients healthy and in minimizing costs.

Because of a highly sophisticated risk adjustment system, these plans have just as much economic incentive to attract the sick as they have to attract the healthy. So, instead of a rebate system, these plans pass along any discounts from drug producers to the patients—and even more so.

In the Houston area, for example, Aetna, Cigna, Elevance (Anthem) and Oscar offer MA plans that make maintenance drugs for the chronically ill completely free or available at a very nominal fee.

A diabetic, for example, would tend to pay nothing for insulin and other drugs and would have access to an endocrinologist at no charge or for a $5 copay. That is because the plans believe that by lowering these costs to the patient they are avoiding the higher costs of severe illness.

IntegraNet Health provides an additional benefit to some members of these plans—by eliminating the donut hole entirely, on the theory that costs are lower in the long run if patients do not skimp on their drugs.

Given the freedom to do so, private health care and private health insurance can meet patient needs far more effectively than health plans operated and directed by government.