The decay of Medicare Part D

The decay of Medicare Part D
© Istock

The Trump administration recently floated ideas to cut the cost of drugs for those enrolled in Medicare. Among these was a proposal to shift some physician-administered drugs from Medicare’s Part B (which pays more for drugs that cost more, even if cheaper options exist), to its Part D (where price reductions for drugs can be negotiated, by steering patients to cost-effective alternatives). Part D’s payment structure has helped reduce the cost of Medicare’s prescription drug benefit well below the levels projected when it was established in 2003.

Yet a reinsurance provision in the design of Part D is gradually eliminating incentives to control the program’s drug costs. This should be reformed, but drug costs are merely one manifestation of Medicare’s open-ended incentives to inflate expenditures. It is by focusing on this larger context that policymakers can best improve value for taxpayers and Medicare beneficiaries alike.

When Medicare was originally established in 1965, it included hospital insurance (Part A) and paid for physician services (Part B), but did not cover prescription drugs. In fact, few 1960s health insurance plans covered prescription drugs. Whereas a hospitalization threatened sudden major costs, drug spending was seen as a modest low-variance expense. Nonetheless, Medicare did pay for drugs administered during the course of inpatient hospital admissions under Part A, and gradually extended coverage under Part B to physician-administered drugs to prevent doctors from hospitalizing patients just to get treatment paid for.


In 2015, Medicare spent $26 billion on Part B drugs — the majority of it on cancer therapies. The federal government reimburses medical practices for administering drugs covered under Part B at 106 percent of the Average Sales Price, even though practices purchased 75 percent of Part B drugs for less than 102 percent of the ASP. Rather than encouraging the cost-conscious treatment of patients, this arrangement inadvertently provides a higher commission to those employing more expensive drugs.

As a result, Part B drug spending is woefully inefficient. A 2011 report by the Inspector General of the Department of Health and Human Services found that taxpayers overpaid by $1.1 billion as a result of physicians treating macular degeneration (a form of blindness) with Lucentis at an average cost of $1,624, when Avastin (an equivalent off-label therapy) was available for an average of $43. While Avastin accounted for 57 percent of such treatments, Lucentis accounted for 97 percent of the costs.

When putting together the Part D Medicare prescription drug benefit in 2003, the Bush administration sought to avoid Part B’s incentives to inflate costs. Under this new benefit, the federal government was to provide risk-adjusted payments (worth around 75 percent of the cost of drugs) to Pharmacy Benefit Managers, who would in turn be responsible for purchasing drugs from manufacturers. Part D plans could compete to reduce supplemental premiums by securing discounts from drug makers, carefully administering formularies, managing utilization, and designing cost-sharing to steer patients to cheaper alternatives.

Medicare Part D cost taxpayers $59 billion in 2013 — 50 percent less than the Congressional Budget Office had predicted when the legislation was enacted. This was partly the result of lower-than-anticipated enrollment, but mostly due to the effectiveness of PBMs in purchasing cheaper versions of drugs. In 2015, 87 of Medicare Part D prescriptions were for generic drugs, compared with the OECD average of 41 percent. The creation of Part D also served to reduce the average price of branded drugs, as plans did more to steer enrollees to cheaper alternatives than physicians and individuals had previously done by themselves. The Trump administration hopes that shifting high-cost biologics from Part B to Part D could foster the development of biosimilar competitors, to generate comparable savings on physician-administered drugs.

Yet, while Part D was designed to make PBMs responsible for covering Medicare beneficiaries’ prescription drug needs at the lowest aggregate cost, its reinsurance provision is rapidly corroding this arrangement. When a beneficiary’s drug expenditures exceeds an annual threshold ($8,418 in 2017), the federal government assumes 80 percent of marginal costs incurred. Not only does this inflate expenditures beyond that threshold, it has encouraged PBMs to game the system so that beneficiaries reach this threshold artificially early.

As the reinsurance threshold excludes the value of drug rebates from manufacturers to PBMs, MedPAC, the federal agency established by Congress to advise it on Medicare payment policy, has warned that this payment structure has encouraged PBMs to favor high-cost high-rebate drugs. Rebates have soared from 9.6 percent of drug costs in 2007 to 22.0 percent in 2016. Combined with the proliferation of high-cost drugs, this has caused reinsurance to increasingly dominate the Part D program: rising from 31 percent of the federal subsidy in 2007 to 68 percent in 2016. As a result, PBMs are now mostly reimbursed for inflated costs — the fundamental problem which has plagued Medicare (including Part B drugs) since its inception, and to which Part D was supposed to offer an alternative.

Although the role of reinsurance within Part D should be pared back, a fuller solution requires Medicare reform broader than drug payment — and a shift away from open-ended reimbursement for costs incurred, to one which rewards competing organizations for delivering the full Medicare benefit package in the most cost-effective way. Thankfully, 41 percent of Medicare beneficiaries with prescription drug coverage are already enrolled in Medicare Advantage plans, which do exactly that.

Being responsible for the full spectrum of medical costs gives MA plans the incentive and ability to cross-subsidize prescription drug coverage, as this tends to be a cost-effective way of enhancing adherence to medication and preventing costly hospitalizations. As a result, while standalone Part D premiums average $492 per year, the majority of MA enrollees received prescription drug coverage for free. Part D benefits provided through MA must cover the same drugs as standalone plans, but their deductibles averaged only $131 rather than $400 in 2017.

As the modest steps of shifting Part B drugs into Part D and reforming the reinsurance component of Part D are both politically fraught, policymakers should prioritize the broader objective of encouraging beneficiaries to move to Medicare Advantage plans. This would also do more to enhance the overall efficiency of the Medicare program — and ensure that those enrolled benefit from the savings too.

Chris Pope is a senior fellow at the Manhattan Institute, a nonprofit group that works to advocate for limited government.