A Model Medicare Program

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The fiscal standoff in Washington shows little movement toward compromise, and nowhere is the impasse more unyielding than it is on Medicare. 

Proposals for reducing Medicare spending are often couched in the form of price controls -- for example, capping the maximum price that Medicare pays for products such as prescription drugs. 

Although on the surface price controls might seem logical, in practice they have multiple negative, unintended effects -- including, ultimately, higher prices and worse health. There are better ways of reining in costs while also fostering the continued innovation that the U.S. health-care system needs. 

We certainly need to slow the growth of health-care costs, especially for Medicare. Fortunately, the program has an in- house model for how to do this: Part D, the Medicare drug benefit passed in 2003. 

Part D gets high marks for controlling costs, protecting the elderly and driving the right kinds of health-care innovations. There is also much in the program that both the right and left can praise. 

Conservatives like Part D because private plans bargain with drug companies over prices and then compete with one another for senior citizens' business. Lower premiums attract more enrollees, leading to more profits for insurers and lower costs for taxpayers. Competition and consumer choice help keep costs down. 

Lower Costs 

Part D has features liberals love as well. Coverage is subsidized so that the lower-income elderly pay little or nothing for drug coverage, and wealthier seniors pay somewhat more. Medicare also defines the standard benefit all plans must cover, so competition is focused on price, specific drug coverage and the convenience that pharmacy-network plans offer. 

The result: Medicare Part D has cost more than 30 percent less than initially projected by the Congressional Budget Office in 2004 -- $304 billion compared with $449 billion. 

Part D plans also control costs by making broad use of generics. In cases where a substitute to a brand name was available, the generic was dispensed almost 93 percent of the time. A 2010 CBO study estimated that generic substitution reduced Part D spending by $33 billion in 2007 ($24 billion of that savings accrued to taxpayers). 

Part D premium costs to seniors have basically stayed flat in recent years, and the Centers for Medicare and Medicaid Services, the agency that oversees the program, predicts a 4 percent decline in premiums in 2014 as drug costs fall. 

Independent and internal government surveys have found that satisfaction with Part D plans is generally high. For instance, a 2012 survey by KRC Research found that 60 percent of seniors were very satisfied with their coverage, and 30 percent were somewhat satisfied -- with only 10 percent reporting they weren't satisfied. Senior citizens on limited incomes and eligible for Medicaid also reported high satisfaction ratings. Eight out of 10 seniors reported that Part D plans cover the medicines they need. 

Part D's emphasis on market pricing strikes the right balance between preserving affordability and spurring investment in pharmaceutical innovation. When patent protection expires for branded drugs, prices plummet and stay low. This allows society to reap far more of the benefits of medicines in the long term than they cost in the short term. Lipitor, which once cost dollars a day, is now pennies a day. 

Medicines for chronic illnesses can also prevent more expensive complications. Cheap statins, for instance, can prevent expensive heart attacks. Drugs, in other words, can substitute for much more expensive types of health-care labor and technology. So it's important to encourage more investment in medicines for diseases, such as Alzheimer's, that impose enormous costs on society and families. 

Mandatory Rebates 

Unfortunately, President Barack Obama wants to reap Medicare savings from Part D by imposing mandatory rebates -- that is, price controls -- on drug companies that participate in the program. (The rebates amount to price controls because they limit the prices manufacturers can charge government programs relative to prices companies charge in the private market.) 

To be fair, this would (at least for the moment) apply only to seniors who receive both Medicare and Medicaid coverage and some other low-income elderly. And this approach has also been endorsed by the bipartisan National Commission on Fiscal Responsibility and Reform. 

Although price controls lower government spending in the short term, they also create long-term problems. The CBO estimates that applying automatic Medicaid rebates to Part D's low-income population would reduce federal spending by $137 billion over 10 years. But lower revenue for manufacturers also translates into reduced incentives for future medical research and development, fewer jobs in the sector and higher prices to payers outside the favored government programs (that is, private insurers and employers). 

Far better to stick with the pricing model that has made Part D such a successful, and comparatively affordable, program to date. 

There are other areas, too, where we could contain health- care spending and improve health. 

We should focus on coordinating care for Medicare's poorest and sickest recipients by reducing the fragmentation between Medicare and Medicaid, which results in higher costs and worsened health. "Dual-eligible" seniors account for only 20 percent of the Medicare population but 31 percent of Medicare costs and 39 percent of Medicaid costs. United Health has estimated that better care coordination for this population could save $189 billion over the next 10 years. 

Another good idea is to cap the rate of growth of total federal health-care spending -- including Medicare and Medicaid -- putting all providers on notice that they have to focus on providing the most value to patients. 

Price Controls 

Some variation of this approach has been proposed by House Budget Committee Chairman Paul Ryan, by Obama and by the bipartisan plan put forward by former Senator Pete Domenici and former Federal Reserve Vice Chairman Alice Rivlin. 

Too often, policy makers in Washington reach for price controls first, imposing them without recognizing the unintended consequences and higher costs that often pop up elsewhere in the health-care system. 

We need to rationalize and update health-care programs that were cobbled together in the mid-20th century, with an eye on what really works, such as Part D. The best solution for preserving the safety net also means encouraging the right kinds of health-care innovations. 

(Paul Howard is the director and senior fellow of the Manhattan Institute's Center for Medical Progress. The opinions expressed are his own.) To contact the writer of this article: Paul Howard at phoward@Manhattan-Institute.org

To contact the editor responsible for this article: Katy Roberts at kroberts29@bloomberg.net.

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