Medicare Prescription Drug Coverage

Medicare Part D coverage was enacted in December 2003 as part of the MMA and became operational January 1, 2006. The program is voluntary and privately run. Anyone eligible for Part B coverage is also eligible for Medicare prescription drug coverage. Enrollees can purchase stand-alone drug coverage to complement traditional Medicare, or they can enroll in a Medicare Advantage plan that offers drug coverage. The stand-alone plans are sold by many private insurers. [The CMS web site [www.cms.hhs.gov] lists the approved plans in each area.]

The total cost of Part D coverage and the beneficiary's premium depends on the plan chosen. In 2006, the national average premium was expected to be about $32.20 per month [Boards of Trustees 2006]. However, the CMS reported that the actual average premium in 2006 was less than $24 per month [U.S. Department of Health and Human Services 2006a].

Beneficiaries who chose to participate in 2006 faced a $250 annual deductible. Once the deductible was satisfied, Medicare paid 75%, and the beneficiary paid 25% of the next $2,000 in covered prescription drug expenses. There was no Medicare coverage for expenditures between $2,250 and $5,100.

This is the so-called "donut hole" in which the beneficiary has no Medicare coverage. Beyond $5,100, Medicare paid 95% of any covered prescription drug expenditures during the year. This odd arrangement of benefits reflects the compromise in Congress through which the program provided catastrophic coverage in accord with health insurance principles and first-dollar coverage in accord with political principles, while not exceeding estimated spending levels that were acceptable to Congress and the president. The level of the deductible and the thresholds for the various phases of the coverage are adjusted each year to reflect inflation. However, beneficiaries do not have to select the standard benefits.

They may purchase plans that provide a smaller deductible and that provide coverage for all or part of the "donut hole." The plans may also differ with respect to the specific drugs that are covered in the formulary and the specific local drugstores that participate in each plan. In the summer of 2006, the CMS reported that approximately 87% of those beneficiaries who purchased coverage selected a plan with more-generous coverage than the standard plan [U.S. Department of Health and Human Services 2006a].

Currently, many Medicare beneficiaries obtain retiree health insurance coverage through their former employer. Congress was concerned that many of these plans would drop prescription drug coverage with the advent of Part D. Therefore, they provided a subsidy of 28% for drug spending in the range of $250 to $5,000 if the employer retiree plan offered prescription drug coverage that matched or exceeded the Part D benefit.

In addition, Part D legislation provides that Medicare beneficiaries with incomes below 135% and between 135 and 150% of the federal poverty line are eligible for a waiver or reduction of the deductible, elimination of the "donut hole," and reduced cohealth insurance rates. In 2006, the poverty line for an individual was $9,800 and $13,200 for a family of two [U.S. Department of Health and Human Services 2006b]. The Congressional Budget Office estimated that about one-third of beneficiaries would qualify under the low-income provisions [Antos and Calfee 2004]. As of mid-June 2006, approximately 78% of Medicare beneficiaries had prescription drug coverage from Medicare or a former private or federal government employer.

About one-third of these had coverage through the stand-alone program, with others obtaining drug coverage through Medicare Advantage, the employer drug coverage subsidy, automatic Medicare-Medicaid enrollment, or federal employee/military retiree coverage. Approximately 75% of those eligible for the low-income subsidy also had obtained drug coverage [U.S. Department of Health and Human Services 2006a].

In 2006, hospital inpatient services constituted 34% of spending, physicians and other suppliers received almost 25% of expenditures, and the new Part D prescription drug program accounted for 5%. The Congressional Budget Office [CBO 2007] estimated that by 2016 prescription drug benefits will comprise 17% of spending, with disproportionate reductions in shares seen in hospital and physician services. The CBO also projected that Medicare Advantage programs will increase from 15 to 24% of spending.

Medicare coverage is provided through two trust funds. The Hospital Insurance [HI] trust fund provides coverage for Part A services, largely inpatient hospital care and skilled nursing facility and home healthcare covered after a stay in the hospital.

The Supplementary Medical Insurance [SMI] trust fund provides coverage for Part B ambulatory services and Part D prescription drugs. Revenues from both the HI and SMI funds pay for Part C, Medicare managed care plans.

Eligibility for Medicare largely comes from working for ten years, paying FICA payroll taxes, and reaching age 65. Individuals may also purchase coverage on reaching age 65.

Medicare HI is funded with payroll taxes paid by current employees and their employers. Each nominally pays 1.45 of worker earnings. Medicare SMI is funded by voluntary beneficiary premium contributions for Part B and for Part D coverage, essentially matched three to one by general tax revenues.

The Medicare HI fund is currently projected to exhaust its assets in 2018. The SMI fund's revenues are always approximately equal to its expenditures because premiums and allocations of general tax revenues are adjusted to make this so.

Under current law and the actuarial assumptions of the Medicare Trustees, the Medicare program is expected to grow from about 3% to 6 to 8% of the U.S. gross domestic product within 20 to 30 years.

Discussion Question

Robert Reischauer [1997], now with the Urban Institute, has summarized several alternative big-idea approaches to solving the Medicare problem:

Replace the existing Medicare program with a program in which beneficiaries get a large-deductible Medicare policy; once the annual deductible is satisfied, the beneficiary has full coverage.

Replace the existing Medicare program with a voucher program in which Medicare gives each beneficiary a subsidy to buy private health health insurance.

Replace the existing Medicare program with a redefined set of core covered services and allow private insurers to bid with Medicare to provide these services. Allow beneficiaries to purchase supplemental coverage if they choose.

Keep the existing Medicare program but cut prices to providers and raise copays, deductibles, and premiums to beneficiaries.

Replace the existing Medicare program with a government-run program similar to the current Veterans Affairs system.

Any of these, of course, could be undertaken in the context of higher taxes as well. Discuss some of the advantages and disadvantages of each approach from the point of view of beneficiaries and taxpayers.