How to keep medicare prices down

Moving Forward On Entitlements: Dan Mitchell

Entitlement spending will bury this country if we do nothing about it.

Drew Gonshorowski

June 6, 2012 at 7:03 am

Some policymakers have difficulty understanding competition’s role in health care. There is a historical reason: With a legacy of third-party micromanagement, something like Medicare Part D—a program where about 1,100 drug plans compete for enrollees—is remarkably foreign. Several analysts cite this program as a marked success for competition in health care. However, a recent Kaiser Family Foundation issue brief claimed that the effect of competition was overstated and unclear.

Interestingly, the arguments intended to downplay the role of competition actually provide evidence that Medicare Part D competition is working. Consider these examples.

Departure from original cost projections. There was a difference between budget projections and actual spending in Part D, which can be explained partly by an overestimate of Part D enrollment; still, market competition clearly provided savings. Enrollment in Medicare Part D was lower than the original Congressional Budget Office projections over the past six years by an average of 7.1 million people per year. Research calculations show, however, that this effect can account for only 17 percent of the difference in actual cost.

Prescription drug costs. One example of competition working is the “flat price trend.” In other words, people substitute their brand-name prescriptions with generics in order to save money. For example, if a patient was taking Niaspan, which averages around $125 for a prescription, he could switch to Niacin, a generic version, which costs $70 on average for the same refill. Many Medicare beneficiaries switch to generics just for this reason. Although brand-name drugs have experienced a modest increase in price, this generic effect has kept prices of prescription drugs relatively constant. Hence, spending grows more slowly.

Those who downplay the role of competition claim that such behavior is not competitive, but understanding this behavior in a context without competition is simply impossible. As Joseph Antos of the American Enterprise Institute points out, “If we paid for each individual prescription the way we pay for each individual health service, there would be no incentive for drug plans to encourage the use of generics over brands.” Competition in Medicare Part D allows individual choice to play a role in prescription drug consumption. This directly encourages generic substitution, since individuals seek out the best value.

Few patients switching plans. Another critique of competition is that a general reluctance to switch plans “reflects the large number of plan choices available combined with the costs in terms of time and energy of doing research and of actually making a switch.” This claim, taken from behavioral economics, does not negate a person’s price sensitivity. Experience with the Federal Employees Health Benefits Plan (FEHBP) shows that about 5 percent of patients switch plans each year. This reluctance to switch reflects well-documented satisfaction with plan choices. This only proves that people make decisions based on many factors, including how much they like their plans.

Considering the growth figures in Medicare, competition appears to be working. Spending in Medicare Parts A and B has grown at an average of 4.9 percent over the past six years, while Medicare Part D grew at 2.8 percent. Imagine if total Medicare spending grew at 2.8 percent—as opposed to its actual growth rate of 8.7 percent. This is the effect of market-based reforms. For example, if Heritage’s Saving the American Dream plan had been implemented five years ago, annual Medicare spending growth would have likely topped out at 3.5 percent.

In health care, competition allows individual behavior to drive down costs and constrains spending without top-down mandates that ultimately limit choice and freedom. A fundamental shift toward reform that focuses on consumer choice and market competition, like Heritage’s Saving the American Dream plan, is good not only for the federal budget, but also for the individual who desires to secure the best value for his or her health care dollars.

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