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Contact Us Fall 2000; Volume 1, Number 1
Health Highlights

The Fiscal Dynamics of Drug Coverage for the Elderly: Policymakers Face Difficult Choices
Donald Moran, Kevin Kirby, Mary Jo Braid, Margaret Phillip
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The prescription drug spending of the elderly is likely to remain an important public policy issue, both for the coming Presidential and Congressional elections and the coming years. As drug spending continues to rise, policymakers will need to determine how to deal with a spending curve that could rise at unsustainable levels. While some would argue that it has already done so, all signs indicate that spending will continue to rise. This paper will explore the fiscal dynamics that policymakers will need to take into account when approaching drug coverage issues. It will discuss the roles of coinsurance, benefit caps, and deductibles, both in the current system and as elements of the design choices that must be made if Congress and the President decide to intervene. Finally, we will note that policymakers are essentially left with a choice between outpatient drug coverage and administered drug prices—a choice that should be made with the fiscal dynamics we will discuss in mind.

Recent rising drug expenditures have caused drug coverage and pricing issues to be a concern to private sector health insurers and an increasingly important issue in the public policy debate. Prescription drugs are now a more important part of the health care system than when Medicare was enacted in 1965. When Medicare was enacted, prescription drug coverage was not typically included in the private health insurance benefits that the Medicare program was modeled after. As the importance of prescription drugs has risen, so has coverage in the private sector, but the Medicare benefit structure has remained essentially as it was in 1965. While many Medicare beneficiaries have drug coverage from other sources (Medigap plans and retiree benefits), nearly a third of Medicare beneficiaries lack prescription drug coverage.1

It is clear that prescription drugs are an out-of-pocket expense for many seniors who may lack the resources to sustain high levels of prescription drug spending. Nearly 45 percent of beneficiaries without drug coverage have incomes at or below 200 percent of the federal poverty level (FPL).2 In addition, per capita spending on drugs among the elderly is over three times higher than among the non-elderly adult population. The elderly comprise 12 percent of the population but account for nearly one-third of total drug spending.3

As drug expenditures have gone up, much of the increase has been borne by Medicare beneficiaries themselves through out-of-pocket spending. Growing out-of-pocket costs are a particular problem for beneficiaries without drug coverage. In 1996, those with coverage spent an average of $253 out-of-pocket for drugs, compared to the average spending of $463 by those who did not have coverage, while those in poor health without coverage spent an average of $749 for drugs, compared to $423 in out-of-pocket spending for their covered counterparts.4

Out-of-pocket spending on prescription drugs is forecasted to further increase. This increase is attributed to both increasing expenditures and decreasing coverage. Expenditures for prescription drugs will continue to increase due to many factors, including the increasingly rapid introduction of new drug therapies, increased utilization, and increased prices. Decreasing coverage is taking the form of imposition of higher cost sharing requirements, both decreasing benefits limitations (caps), and higher deductibles and co-payments.5 Decreasing coverage exacerbates out-of-pocket spending by limiting the total amount an insurer will spend on drug benefits, leaving the consumer to absorb the rising cost of drug therapies.

The Distribution of Drug Costs Among the Elderly
Thumbnail of Figure 1
click to enlarge
One fact about drug spending by the elderly that is often ignored is that the amount spent on drugs is not distributed normally among the population. While the average annual amount spent on drugs for the entire elderly population is around $1,500 this year,6 it is the distribution of drug costs among the elderly that is most important to consider. As shown in Figure 1, approximately 15% of the elderly have no annual drug costs at all, and nearly 75% now spend less than $2,000 per year. In fact, ten percent of elderly beneficiaries account for more than 40% of all drug spending by the elderly. A high proportion of the risk associated with increased drug spending is concentrated in a small portion of the elderly population.

Such uneven distribution of costs in a population is exactly the type of case where insurance provides a social benefit. For example, the number of people who lose their house to a fire is very small, but the loss can be very great. As a result, many people purchase insurance. This works because no one can predict if they will be the unlucky one and most people are willing to pay a small amount to insure against that risk. The problem with insurance for drug costs is that high drug spending is not an entirely unpredictable event. Persons with chronic diseases can predict their drug costs from year to year. Conversely, generally healthy persons have a low probability of having high drug costs. This ability to predict your risk for needing a benefit causes what is called 'adverse risk selection' for insurance plans that offer a benefit that high-risk persons predict they will use.

The way that this works in the case of prescription drug coverage is as follows. For example, suppose that the average spending for prescription drugs for the entire population is $1,500 and a health insurer sets the premium at the average for the entire population. A consumer who expects to pay $750 per year for prescription drugs is unlikely to purchase a benefit costing $1,500 to insure against the likelihood that he or she will present a greater demand for drug usage. Assuming perfect knowledge, only those beneficiaries who believe they will spend $1,500 or more on drugs will purchase drug coverage that costs $1,500.

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Fall 2000, Volume 1, Number 1
Table of Contents
Editor's Note
Features: Election 2000
Health Highlights
In Focus
Glossary of Health Care Terms

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