Medicare Savings: Cut Benefits to the Elderly or to Big Pharma's Windfall Profits?

prescribed pills

Potentially central to any fiscal deal later this year are savings in the government's popular Medicare program that currently helps about 52 million Americans obtain health care. However, the way those savings are achieved will have vastly different consequences for older Americans.

For example, Republican Rep. Paul Ryan's (WI) plan would undermine the ability of many tens of millions Americans to obtain affordable, quality health care, even after paying into the program with a lifetime of work, and put the program's effectiveness at risk.

Other proposals, including many made by the current White House, would protect beneficiaries and save money by improving the government's ability to wrestle value from parts of the for-profit health care industry, especially pharmaceutical firms that are among the economy's most profitable companies. (The average U.S. corporation makes a 2.2 percent profit; pharmaceutical companies make 16.4 percent on average). The White House's overall proposal is estimated to actually save more over the long run than Ryan's, without hurting Medicare beneficiaries or the viability of the Medicare program.

The Ryan plan would change Medicare from a guarantee of health care (with associated premiums, co-payments, and deductibles) to a "premium support" program. In other words, it would be a voucher program – the voucher being a flat payment given to beneficiaries to obtain either Medicare coverage or to buy a private insurance policy. This would increase costs significantly for Americans because annual increases in the amount of this voucher would likely fail to keep pace with the growth in health care costs from year to year. Thus, beneficiaries would have to pay increasingly more out of their own pockets for insurance coverage, either through Medicare or from private insurers.

Under the Ryan plan, a person who is currently 30 years old, and who will turn 67 in the year 2050 (the Ryan plan also moves Medicare eligibility up two years from 65), would pay, on average, $331,200 more in out-of-pocket expenses over their retirement, according to the Center for American Progress. A current 40-year-old, who turns 67 in 2040, would pay $216,600 more. A 49-year-old, who turns 66 in 2030, would pay $124,600 more.

Medicare recipients already spend more in out-of-pocket health care expenses – both in absolute amounts and as a percentage of their income ($4,068; 14.3 percent) – than non-Medicare households ($2,125; 4.1 percent), according to a 2009 Kaiser Family Foundation study.

The main reasons for the higher out-of-pocket spending are age and income. Most Americans who receive Medicare benefits are 65 and older (some benefits go to younger people with severe disabilities like Lou Gehrig's disease and end-stage renal disease – in total about 8.7 million out of 52 million have disabilities), and Medicare recipients have low annual incomes. In 2012, the median income of Medicare beneficiaries was $22,500, according to an Urban Institute analysis.

According to the nonpartisan Congressional Budget Office (CBO), under Ryan's plan, the out-of-pocket expenses of Medicare recipients would more than double by 2030 compared to their costs under the current Medicare system. CBO put it simply: "Paying more for health care would be particularly challenging for elderly people with less savings and lower income."

Ryan's plan would also have the added effect of putting the viability of the Medicare program itself at risk because it would sap away new enrollees from the traditional Medicare program as some of them buy private insurance instead. Traditional Medicare would then increasingly cover a population that on the whole would be smaller, older, and sicker than it would be otherwise, and this population would be more expensive to insure on a per person basis, explains Paul Van de Water of the Center on Budget and Policy Priorities. This would, in turn, have added effects:

[A]s the size of the Medicare population shrank, administrative costs would rise relative to benefit payments, traditional Medicare's power to demand lower payment rates from providers would erode, and providers would have less incentive to participate in the program. As a result, people now age 55 and older might well face higher premiums and cost sharing for traditional Medicare, a more limited choice of providers, or both.

This would unravel Medicare's effectiveness as a program and reduce its ability to leverage the purchasing power its size gives it to hold down health care costs for the rest of the economy – this would undo progress made in recent years and send the nation in the wrong direction.

There is no need to radically restructure Medicare to bring down costs. Indeed, health care reforms are already slowing the expected growth in the costs of the program.

"The Economic Report of the President shows in an illustrative calculation that it [Medicare spending] will rise only to 3.8 percent of GDP by 2085 -- not much higher than it is today -- if the per-beneficiary growth rate we have seen in the past five years keeps going," wrote Peter Orszag, former director of the Office of Management and Budget (OMB), in June. "If this happens, in other words, a major part of our long-term budget problem would disappear."

Cost growth could be curbed even more significantly with other modest changes that would make Medicare even more fiscally sustainable in the long run.

Two experts at the Urban Institute, after comparing spending in Medicare (and Medicaid) with private insurers, were critical of Ryan's approach and endorsed proposals more in line with those of the White House in a piece published in the prestigious New England Journal of Medicine last year. "We should continue adopting available strategies to contain costs within the programs' current structure, especially since many of those implemented in the past decade seem to be working, and many on the horizon appear promising," wrote John Holahan and Stacy McMorrow.

In contrast to Ryan's plan, President Obama's proposals are more balanced in how they would achieve cost savings and would preserve the structure of the Medicare program. The following reforms proposed by the White House, and a proposal made by the Department of Health and Human Services, would save substantial amounts of money.

Give Medicare Part D Power to Negotiate Drug Prices: $123 Billion

Medicare Part D is a program that subsidizes prescription drug purchases. For those whose income is less than 150 percent of the poverty line, a low-income subsidy helps pay for monthly premiums, annual deductibles, and drug co-payments. Low-income subsidy beneficiaries make up approximately 40 percent of all Part D beneficiaries, but they account for three-quarters of the government's spending on the program.1

When passing the law creating Medicare Part D in 2003, Congress explicitly barred the government from negotiating lower drug prices with manufacturers, even though the Department of Veterans Affairs (VA) and Medicaid do just that.

As a result, Medicare Part D pays about 58 percent more than the VA for the same drugs, according to a 2007 report by Families USA. One extreme example: "For Zocor (20 mg), a lipid-lowering agent, the lowest VA price for a year's treatment is $127.44, while the lowest Part D plan price is $1,485.96—a difference of $1,358.52, or 1,066 percent."

Similarly, "The Department of Health and Human Services Office of Inspector General has found substantial differences in rebate amounts and net prices paid for brand name drugs under Medicare and Medicaid, with Medicare receiving significantly lower rebates and paying higher prices than Medicaid—even for Medicaid beneficiaries also enrolled in Medicare," according to President Obama's Fiscal Year (FY) 2014 budget.

The White House proposes to allow Medicare Part D beneficiaries who qualify for a low-income subsidy (LIS) to benefit from the same prescription drug rebates that Medicaid recipients receive. OMB estimates the measure could save approximately $123 billion over the course of the next decade.

Increase Competition in the Pharmaceutical Industry: At Least $8 Billion

Increasing competition in the pharmaceutical industry in the Medicare and Medicaid programs could save an estimated $8-14 billion over ten years.

In an effort to curb increases in federal health care spending, the White House's FY 2014 budget directly addresses a rise in anti-competitive behavior by companies with respect to biologics, the medical products created by biologic processes rather than by chemical synthesis, such as vaccines, gene therapy, tissues, etc.

The White House supports two proposals that would increase access to biologic generics. First, by including measures to modify the length of "exclusivity," during which brand name companies are sheltered from competition, from 12 to seven years on new drugs and biologics, the president's plan would allow faster access to generic drugs, which bring down prices.

This measure also includes a proposition to prohibit additional periods of exclusivity for minor changes in product formulations through a process often referred to as "evergreening."2 In addition, the FY 2014 budget proposes allowing the Federal Trade Commission (FTC) to prohibit "pay-for-delay" agreements, or settlements between generic drug manufactures and brand-name pharmaceutical companies that delay bringing lower-cost medications to the marketplace.

According to the FTC, "pay-for-delay" anti-competitive practices reportedly cost consumers $3.5 billion annually in higher drug costs.

Over ten years, the president's proposal predicts $3 billion in savings through the Medicare and Medicaid programs by modifying the length of exclusivity, and $11 billion in savings through the prohibition of "pay-to-delay" agreements. Last year, the CBO estimated lower savings, or approximately just over $8 billion, from these two measures over the course of the next decade.

Align Medicare Policies on Bad Debt Payment with the Private Sector: $25 Billion

The White House has adopted a proposal by the Department of Health and Human Services Office of Inspector General (HHS OIG) that recommended the Centers for Medicare & Medicaid Services (CMS) "eliminate (or reduce) Medicare payments to hospitals for bad debt associated with beneficiaries' failure to pay their deductibles and coinsurance and modify Medicare's bad debt policies." Obama's proposal would reduce "bad debt payments from 65 percent generally to 25 percent for all eligible providers over three years starting in 2014."

These changes would align Medicare's policies with those of the private sector, which does not pay for bad debt. Currently, Medicare will pay "when hospitals fail to make a reasonable effort to collect unpaid deductibles and coinsurance from Medicare beneficiaries who can afford to pay or to collect from other sources (such as beneficiaries' other insurance or Medicaid) that would pay the amounts on their behalf." In the last fiscal year, Medicare paid 70 percent of these bad debts.

The White House estimates its proposal will save $25 billion over ten years.

Harness the Market to Make Medicare Advantage Providers Compete: Up to $177 Billion

Medicare Advantage was created by law in 1997 and allows Medicare beneficiaries to obtain their insurance from private providers, which Medicare in turn reimburses, as opposed to having Medicare act directly as their insurer. In 2009, the Medicare Payment Advisory Commission (MedPAC) reported that Medicare paid Medicare Advantage beneficiaries 14 percent more on average – or $1,100 – than those covered by the traditional Medicare program.

MedPAC Chairman Glenn Hackbarth told Congress that these overpayments "contribute to the worsening long-range financial sustainability of the Medicare program."

The overpayments do not lead to better health care for beneficiaries; instead, they go to private insurers that act as middle men. According to the Center on Budget and Policy Priorities, "among private fee-for-service plans – the fastest-growing type of Medicare Advantage plan – about half of the overpayments goes to profits, marketing, and administrative costs."

The HHS OIG recommended that HHS ensure payments to Medicare Advantage providers are backed up by empirical data as one way to reduce overpayments.

One way to do this is by harnessing the power of the market through competition.

HHS has proposed the establishment of a competitive bidding system, which "would have allowed the market, not Medicare, to set MA [Medicare Advantage] payment rates." HHS estimated in 2010 that this would save $177.2 billion over 10 years.

Medicare Is Already More Cost Effective than Private Insurance

Some of the basis for conservative disdain for Medicare is the belief that the market, left to its own devices, can stem the rising costs of health care. However, health care costs are rising more in the private sector than they are for Medicare. Medicare has been part of the solution in controlling the rising costs of health care.

"Private health insurance spending per enrollee is projected to increase by 5.0% per year, about 1 percentage point faster than the GDP per capita. In contrast, Medicare expenditures per enrollee are expected to increase by 3.1% per year," wrote Holahan and McMorrow in the New England Journal of Medicine.

The Political Backdrop

In sum, we can save significant amounts of money without undermining Medicare and elderly Americans' access to health care. But you might not know this listening to politicians and commentators in the media.

"Many pundits seem unconsciously biased towards Medicare changes that hit beneficiaries (half of whom have incomes below $25,000), which they consider somehow more 'serious' in a budgetary sense than Medicare cost-saving changes affecting providers and health insurers or the prices that Medicare pays for prescription drugs," wrote Robert Greenstein, president of the Center on Budget and Policy Priorities, in a commentary in April.

Since the modest changes proposed by the White House and government agencies result in greater savings in the Medicare program – while protecting American's earned health care benefits – than the ideas championed by House Republicans, why are these proposals ignored? The short answer is politics.

Federal fiscal policy has lurched from one manufactured crisis to another since Republicans took control of the House after the 2010 midterm elections. In particular, House Republicans have used their power of the purse and their power to approve increases in the national debt to strong-arm the White House into agreeing to cutbacks in government programs.

So far, only discretionary spending – from the Defense Department to the U.S. Environmental Protection Agency ‒ has been targeted. However, mandatory spending – on programs such as Social Security, Medicare, and Medicaid ‒ makes up the majority of federal dollars spent.

As the nation approaches a new debt ceiling showdown sometime later this year, House Republicans will be targeting mandatory programs. Partially that's because "thanks to sequestration, discretionary spending has been slashed to the point where even conservatives say there aren't significant savings to be found," according to the National Journal.

But many Republicans are simply ideologically opposed to publicly funded health care.

To get a long-term debt deal, "one that gives Treasury borrowing authority for three and a half years, Obama would have to agree to" major changes to Medicare, several House Republicans told National Journal. "The plan to privatize Medicare, perhaps the most controversial aspect of the Ryan budget, is the holy grail for conservatives," noted the magazine.

Privatizing Medicare would cost more, not less. The fiscal challenges the program faces can be easily overcome by a few reforms that would reduce escalating payments to drug companies and private insurance companies and ensure Americans get quality health care at a reasonable cost – as they do today under Medicare.


1 Congressional Budget Office, "Spending Patterns for Prescription Drugs Under Medicare Part D", December 2011.
2 Ibid.

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