What the CBO Really Said About Medicare Drug Premiums

The Congressional Budget Office released a preliminary analysis of the House health care reform bill on Medicare Part D premiums. The headlines are… confusing.

On one hand, seniors will pay more in Part D premiums (which cover 25% of the cost of delivering the pharmacy benefit to those on Medicare).

On the other hand, seniors will pay less out of pocket for their drugs under this bill (although they are likely to purchase more drugs and more expensive drugs.) So, the average senior will pay less all-in for medicines under this bill. Further, over the next 14 years the legislation will eliminate the “donut hole” where out of pocket costs between $xx and $xx are not covered at all.

But wait, there is more. The government, over ten years will also pay less – largely because the bill will substantially increase the rebate the pharmaceutical manufacturers return to the government for drugs purchased by patients who are “dually eligible” for both Medicare and Medicaid. The original Part D legislation had a huge giveaway to the pharmaceutical companies by moving dual eligibles from Medicaid drug programs, with large mandated rebates, to private Part D plans, which have less leverage and net pay more for medications.

The pharmaceutical industry loses – but to the tune of $30 billion – not the $80 billion that Billy Tarzin of PhRMA says he negotiated with the Obama administration. The difference is that new bill will decrease out-of-pocket costs for seniors, and this will lead to an increase in use of medications and new revenue to offset some of the revenue lost to increased rebates and mandated discounts.

A somewhat more obscure loser in this legislation is commercial (non-Medicare) health plans. The CBO estimates that the increased Medicaid-style rebates will encourage the pharmaceutical industry to enforce more price discipline (since giving anyone a big discount forces the industry to give extra rebates for all those covered in this mandatory rebate. Therefore, while patients will on average pay less, and the government will pay less, the pharmaceutical companies will recoup some of their losses through increased volume, and are likely to recoup additional revenue from higher prices for those not covered by this legislation.

There’s a history of exactly this happening. In 1991, Congress passed a bill mandating large rebates to state Medicaid agencies. Between 1991 and 1994, the average discount achieved by nongovernmental purchasers decreased from 36% to 19%. This is a classic example where a well-intentioned regulation appears to disadvantage an industry – but it actually provides an unanticipated windfall to that industry. Game theory modeling predicted that this would happen – and that the mandatory rebates would benefit the pharmaceutical industry. Perhaps that’s why PhRMA is not aggressively challenging mandatory rebates – even though it would seem easy to make these appear to be a government “taking.”