Issue Analysis 101 – Clinton, Gore, and Congress: Medicare Reforms That Don’t Measure Up

Prompted by a host of concerns, politicians have begun to map out significant changes to Medicare’s operations, benefits, and financing. Some look to this year as an opportunity for the nation to finally address the broken Medicare system. Others, with an eye toward the election, would rather use the opportunity to bolster their political fortunes. But in the rush to propose more laws, agencies, taxes, and benefits, these politicians have generally overlooked retirees’ biggest need – more choices.

Medicare has reached a crossroads: it cannot survive indefinitely as a fee-for-service program absent massive tax increases, sweeping eligibility restrictions, rationing, or drastic benefit cuts. The National Bipartisan Commission on the Future of Medicare and the Congress have developed several alternatives that would significantly alter Medicare’s structure. In his recent State of the Union, President Clinton revived his plan to ‘reform’ Medicare, and Vice President Al Gore is touting it on the campaign trail. Their approach is to make Medicare coverage more expansive and to continue the current paradigm where bureaucrats and Congress micromanage seniors’ health care. There are astronomical cost increases associated with this endeavor. Other legislators have similarly bad ideas. A better approach would be to allow seniors to choose their health plan and use Medicare to pay most or all of their premiums, also known as a “premium support” or “competitive premium” model. Other legislative initiatives, in an attempt to compromise, amalgamate new mandates with more competition. Unfortunately, few of the proposals thus far incorporate the belief that seniors could do a better job of choosing their coverage than the bureaucratic and political elite in Washington, D.C.1

Whither Medicare?

Medicare spent over $210 billion last year, and is projected to cost nearly $500 billion in ten years (without any new benefits).

This spending accounted for more than 12 percent of all federal expenditures last year; in comparison, national defense spending was 16 percent.

Medicare currently has 39 million beneficiaries; in 2030, it will have 77 million.

There are now 4 workers per retiree; in 2020, there will be less than 3.

The Medicare Trust Fund is projected to go bankrupt by 2015.

Sources: Board of Trustees of the Federal Hospital Insurance Trust Fund, “1999 Annual Report,” March 30, 1999; Committee on Ways and Means, U.S. House of Representatives, “Medicare and Health Care Chartbook,” May 17, 1999; Budget of the United States Government, Fiscal Year 2000.

What is reform and why is it good?

When considering plans to reform Medicare, policymakers should look for truth in advertising: does a proposal truly reform Medicare, or just give seniors more (or less) of the same? A reform package is good if it applies lessons learned from the past and best practices from comparable programs or sectors of the economy. For Medicare, this means:

Giving seniors more choices. Medicare has traditionally provided seniors with a defined benefits package. Dissatisfaction with this package causes millions of seniors – more than half of all beneficiaries – to seek additional benefits through private, supplemental insurance policies (Medigap) or HMOs within the Medicare program (Medicare+Choice).

Lower costs, not higher taxes. Medicare now costs much more than its creators expected and will soon cost more than taxpayers can afford as costs escalate.

Achieving cost savings through consumer incentives and competition, not through government rationing, price controls, or new mandates. Price controls do not work, but instead produce rationing, as some health care providers cannot supply a service that costs more than the government will reimburse. Rationing (shortages caused by government-set prices) and mandates (forcing all seniors to pay for coverage that only some want) are fundamentally unfair.

Breaux-Thomas: Two Steps Forward…

The Balanced Budget Act of 1997 created a National Bipartisan Commission on the Future of Medicare, which held the responsibility for making recommendations to strengthen and improve Medicare’s financing and operations in time for the retirement of the Baby Boom generation (starting in 2011). Under the leadership of its chairmen, Senator John Breaux (D-La.) and Representative Bill Thomas (R-Calif.), the Commission developed a sweeping plan for Medicare reform that included more choices for seniors, lower costs, and broader coverage for outpatient prescription drugs, but also left out some important details. While the Breaux-Thomas proposal did not become a formal recommendation, a bipartisan majority of the commission supported it when the commission completed its work in March of 1999.

The rationale behind Breaux-Thomas is that Medicare would serve seniors better by allowing them to choose the type of plan and level of coverage that best suit their particular, individual circumstances. Presently, Congress and the Health Care Financing Administration (HCFA) define what services seniors receive, regulate how those services are delivered, and dictate how much Medicare will reimburse health care providers for their services. This one-size-fits-all model is called a “defined benefit” plan.

By contrast, under a “defined contribution” (or premium support) model like Breaux-Thomas, Medicare simply would provide seniors with the financial support necessary to choose their own health care plan. Beneficiaries could choose from several competing alternatives: the traditional government fee-for-service program, a managed care organization, private health insurance with or without a Medical Savings Account, or some other option. In a defined contribution program, Medicare’s payment might be set at a percentage of each senior’s health insurance premiums, at a flat dollar amount, or some combination of the two.2

The Commission modeled its overture on the Federal Employees Health Benefits Program (FEHBP). Federal employees, including members of Congress and their families, currently enjoy a wide range of choices through FEHBP, including traditional fee-for-service arrangements (FFS), preferred provider organizations (PPOs), and health maintenance organizations (HMOs). The government pays 75 percent of employees’ premiums, up to a generous limit. The Office of Management and Budget oversees the program by negotiating premiums with health plans; defining the basic package of benefits; reviewing and approving proposals from health plans; monitoring quality; and providing comparative information to beneficiaries.

In the Breaux-Thomas premium-support plan, a new Medicare board would perform these tasks. The agency that now runs Medicare, the Health Care Financing Administration (HCFA), would continue to manage Medicare’s fee-for-service program, but would divest much of its regulatory authority over private plans. Congress would only set coverage and treatment categories (as in FEHBP). Each participating plan would have to offer more than one policy to seniors, including a “high-option” with a higher deductible, outpatient prescription drug coverage, and a limit on beneficiaries’ out-of-pocket expenses (known as a stop-loss provision).3

What’s wrong with HCFA?

The Health Care Financing Agency (HCFA) is an enormous and bloated bureaucracy, managing the health care of one-in-four Americans. Already HCFA has caused nearly 750,000 seniors to lose their Medicare+Choice coverage. The impossible cost controls and 900 pages of regulations forces managed care providers out of the market, reducing choices for seniors. Over 6 million seniors have signed up for managed care, indicating a strong desire for this option.

This outline proceeds in the right direction. Seniors clearly would have a broader range of choices than they do now. The arrangement already works well for federal employees and Members of Congress by letting them choose the balance of coverage and cost that is right for their individual circumstances. Competition between providers would ensure cost savings and quality health care. If seniors are dissatisfied with a particular health plan, they can simply take their business elsewhere.

As seniors’ share of the costs would vary, they would have an incentive to choose more efficient, less expensive health care plans and providers. Cost savings would result from this consumer incentive. The Commission estimated that its proposal would reduce the rate of growth in Medicare spending by 1 to 1.5 percent from the long-term rate of growth of around 8 percent. Over the 10 years between 2000 and 2009, the Breaux-Thomas proposal would generate approximately $100 billion in cost savings.4

…and One Step Back

The Commission also proposed immediately expanding government coverage of outpatient prescription drugs for poor seniors to those with incomes at or below 135 percent of the poverty line (during the period of transition to a new system) and requiring every Medigap plan to include a prescription drug benefit. These new mandates would impose costs on both taxpayers and beneficiaries. Expanding government-provided prescription drug benefits would erase a significant portion (perhaps one-quarter) of the savings from moving to a premium-support system.5 The extra costs associated with this benefit will shorten Medicare’s lifespan, meaning that millions of Americans who will have paid Medicare taxes for decades may never receive any Medicare benefits.

Even worse, barring seniors from buying private, supplemental health insurance that does not have prescription drug coverage would dramatically increase their premiums, making it unaffordable for many. Faced with this premium increase, many seniors may drop Medigap coverage, contrary to the aims of those who think mandated benefits necessarily increase actual benefit coverage. As the Commission notes, “by requiring all beneficiaries purchasing Medigap to purchase a drug benefit, the cost of a drug benefit would be spread across a greater number of beneficiaries with varying health status and prescription drug needs.”6 But why force all seniors to buy something they may not want? This requirement is a serious shortcoming of a generally more market-based recommendation.

Sens. Breaux and Frist Move Reform Forward

Sens. Breaux and Bill Frist (R-Tenn.) recently introduced legislation incorporating most aspects of the Commission’s recommendation. Their bill, the “Medicare Preservation and Improvement Act of 1999” (S. 1895), creates a competitive premium system giving seniors an array of Medicare health plan providers. There would be standard-option plans with Medicare’s current benefits and high-benefit option plans, which would also have prescription drug coverage and a limit on seniors’ out-of-pocket expenses. HCFA and private-sector entities would offer both types of plans, and a new Medicare Board would regulate them.

Key Facts about Senior’s Drug Coverage and Spending

65 percent of senior citizens have insurance coverage for outpatient prescription medicines.

The average total drug expenditures per senior this year is estimated at $942.

The median out-of-pocket cost is about $200.

Source: Michael E. Gluck, “A Medicare Prescription Drug Benefit,” National Academy of Social Insurance, April 1999.

The government would pay a substantial portion of all seniors’ premiums in these plans. Medicare’s portion would be based upon the average cost of premiums for the standard plan nationwide. The government would pay the full cost of premiums up to 85 percent of the national average, and one-fifth of premiums between that point and the national average.7 Beneficiaries would bear all costs above the national average, and four-fifths of the cost of premiums between 85 and 100 percent of the national average.

By introducing legislation based on the work of the National Bipartisan Commission, these senators have provided a starting point for introducing competition into the Medicare system. Nevertheless, Congress must insure that the plan does not turn into another attempt by the government to micromanage seniors’ health care. Accordingly, it must closely examine some key details of the bill:

Reducing the Savings from Competition

The government would pay the full premium of the lowest cost high-option plan for seniors with incomes up to 135 percent of the poverty level. This is a dramatic expansion of the government’s level of support for seniors that may come at a high cost.

Every senior that buys a high-option plan would get a “discount,” funded by the government, on the portion of the premium attributed to drug coverage. Seniors with incomes between 135 and 150 percent of the poverty level would receive a discount of between 25 and 50 percent; seniors with higher incomes would receive a 25 percent discount. But why should taxpayers pay for additional coverage for seniors that choose the high-option plan and can afford to pay for it themselves?

The government would give extensive funding for new “Medicare Consumer Coalitions” to educate beneficiaries about their new choices. But this line item sounds like little more than a honey pot for liberal advocacy organizations such as the AARP or the National Council of Senior Citizens. Instead, health plans should write and pay for their own marketing materials.

The bill creates a new independent agency – the Medicare Board – with a new budget and new hiring and regulatory authority, yet it does little to reduce these powers at HCFA. In fact, it splits HCFA in two and adds a new director. If Congress wants a new bureaucracy to run Medicare, it must – at a minimum – cut HCFA’s staff and budget by a corresponding amount. And since neither HCFA or the Medicare Board will be directly responsible for millions of seniors’ care any longer (since many will choose private health plans), there ought to be a dramatic net reduction in the number of government employees and the billions of dollars spent administering the Medicare program.

Giving Seniors Limited Choices

All of the high-option plans must have outpatient prescription drug coverage with an actuarially-adjusted value of $800 and a limit on beneficiaries’ out-of-pocket costs of $2000.8 Plans cannot raise or lower these thresholds independently, which greatly constrains seniors’ selections. Seniors desiring more drug coverage or higher stop-loss limits would be out of luck.

Even worse, seniors could not purchase Medigap policies to provide additional coverage. In fact, only seniors in the HCFA-run standard-option plan would still have the right to buy Medigap policies.

There might be little variation in seniors’ cost-sharing obligations among plans, because plans could alter Medicare’s traditional cost-sharing arrangements only if their alteration was actuarially equivalent to seniors’ obligation in the traditional plan.

Moreover, health plans could be excluded from the program if the Medicare Board believes their offering would result in “favorable selection” of lower-cost beneficiaries, which may lessen the incentive to provide variety in benefit design.

Medicare Parts A and B would be combined, meaning that the small group of seniors not currently in Part B would have new premiums to pay.

Health plans could offer standard-option plans in an area only if they also offer a high-option plan. This might create a barrier to entry into the market for standard-option plans for smaller organizations without the resources to offer a prescription benefit or stop-loss protection.

These difficulties can be overcome. The plan does increase seniors’ freedom to choose their health care plan and recognizes the savings that can be obtained from allowing seniors these choices. However, the creation of new mandates and bureaucracies poses a threat that could dwarf any potential benefit s offered by the plan. The Breau-Frist plan could become even better by mixing more choices of competing benefits packages with fewer subsidies and mandates.

Congress Refuses to Take its Medicine

Other legislators have introduced several bills that would add coverage for outpatient prescription medicines to the roster of government-provided health benefits – without taking any other steps to reform Medicare. This action would be foolhardy for several reasons. Foremost among them is the fact that most seniors already have prescription drug coverage and thus do not need additional government assistance to obtain, maintain or replace it. Medicare Part A provides prescription drug coverage for seniors undergoing inpatient hospital care, in nursing facilities recovering from a hospital stay, and those in hospices facing terminal illnesses. In addition, two-thirds of seniors already have outpatient prescription drug coverage through supplemental Medigap insurance, employer-sponsored insurance, Medicare HMOs, state programs, or other sources; and Medicaid pays for prescription medicine for low-income retirees.9 Furthermore, it makes little sense to increase the costs of Medicare – and displace private funds – at a time when the program faces bankruptcy and cannot fund the benefits it has already promised to provide. Making new promises likely means levying additional taxes and/or raising seniors’ premiums.

Source: Michael E. Gluck, “A Medicare Prescription Drug Benefit,” National Academy of Social Insurance, April 1999, Table 1.

The bills introduced by dozens of senators and representatives typically use one (or more) of three methods to try to increase coverage: (1) creating a universal entitlement, (2) creating an entitlement limited by seniors’ income levels, or (3) massive intervention into the free-market system through price controls or repealing patent protections. One bill representative of each of these approaches is discussed herein.

Snowe-Wyden: Not the Fairest of Them All

Senators Olympia Snowe (R-Maine) and Ron Wyden (D-Ore.) have authored S. 1480, the Seniors Prescription Insurance Coverage Equity (SPICE) Act. The SPICE Act is a tax-and-spend scheme that would pay a percentage of seniors’ insurance premiums for supplemental policies that cover government-chosen prescription drugs (see table).10

Drug Insurance Premium Coverage Under the Seniors Prescription Insurance Coverage Equity (SPICE) Act If a Senior’s or Couple’s Income is… …Then Taxpayers Would Pay This Portion of Their Premiums

Up to 150% of the Poverty Level 100%

150% to 175% of the Poverty Level Between 100% and 25%

Over 175% of the Poverty Level 25%

Under the SPICE Act, seniors’ choices – group health plans offered by their former employer, Medicare+Choice plans, new group policies exclusively for seniors, and a new Medigap policy that would cover only outpatient prescriptions – would be forced to conform to government-set restrictions. The SPICE Act creates a new SPICE board to run the new SPICE office within the Department of Health and Human Services (HHS). It would create a model plan, develop enrollment procedures, approve plan and premium submissions, and review marketing materials. In creating a model plan, the SPICE board would decide what expensive or experimental drugs must be covered. These unelected officials could force insurers to cover an ever-expanding list of medicines, whether or not this coverage would be affordable or desirable for seniors. It would also have the power to determine procedures for withdrawing from a plan that might make it hard – even impossible – for seniors to leave SPICE.

In addition to pushing seniors into yet another one-size-fits-all benefits package, S. 1480 allows the SPICE board to end a plan’s participation in the program if it finds that “the entity offering the SPICE prescription drug coverage is purposefully engaged in activities intended to result in favorable selection” of beneficiaries.).11 The legislation does not define favorable selection or the criteria the SPICE board might use to divine a plan’s intentions. Faced with a potentially arbitrary regulatory regime, health plans will likely react conservatively. For example, Snowe-Wyden promises to allow plans to compete by having varying deductibles, co-payments, or even a limit on beneficiaries’ out-of-pocket expenses. But plans may feel compelled to avoid marketing or offering insurance products with features different from competing products for fear of engaging in “favorable selection” of their customers.

A new benefit program for retirees, absent Medicare reform, figures to be a costly proposition. Though the Congressional Budget Office has not yet evaluated S. 1480, a useful point of comparison might be President Clinton’s Medicare reform package, a section of which is similar to Snowe-Wyden. When fully implemented in 2008, the prescription drug subsidy in the Clinton plan is projected to cost over $29 billion per year.12 A salient difference between the two proposals is that Clinton’s plan pays for one-fourth of the cost of prescriptions up to a specified dollar amount, but the SPICE Act’s premiums would fund, on average, over one-fourth of premiums with no dollar limit. Thus, the cost of SPICE could exceed that of the Clinton proposal.

Funds for the SPICE program would come from two sources: tax dollars from the projected budget surplus and new tobacco taxes. First, the SPICE Act would make a large, new claim on the federal budget, while doing nothing to solve Medicare’s existing financial problems. Second, the SPICE Act would accelerate an already scheduled tax increase on tobacco (15 cents per pack of cigarettes) and add a new tax increase of 55 cents per pack. To a large extent, tobacco taxes are paid not by corporations, but by their customers, a majority of whom have incomes below $30,000.13 In essence, the proposal would raise taxes on the poor so government can subsidize medicine for all retirees, including the wealthy and seniors who already pay their own way. And if the revenues predicted from higher tobacco taxes do not materialize, the SPICE program would have to rely even more heavily on the projected surplus, raise seniors’ portion of their premiums, or both.

Under the guise of helping the needy, Snowe-Wyden would provide every senior citizen with a subsidy to buy insurance, regardless of his or her wealth or income. It is the same tired recipe of taxes and regulations that has made Medicare what it is today: an entitlement program shrouded in rhetoric of trust funds, individualized benefits, and private-sector competition. For both seniors and taxpayers, Snowe-Wyden is a fairy tale.

Senator Kennedy’s Bill: Tax-and-Spend Liberalism at Its Finest

Sen. Ted Kennedy (D-Mass.) has introduced the “Access to Rx Medications in Medicare Act of 1999,” a universal entitlement program that would dramatically increase Medicare costs.14 Under his bill, also known as S. 841, Medicare would pay most of the prescription costs for all retirees through Medicare Part B (see table). The coverage is strangely designed as a subsidy for some prescription bills with stop-loss protection for very high ones, leaving many people with high or very low bills with little to gain from the plan.

Prescription Coverage Under the Access to Rx Medications in Medicare Act of 1999 For drug costs between… Medicare would pay… And beneficiaries would pay…

$0 and $200 0% 100%

$200 and $1700 80% 20%

$1700 and $4200 0% 100%

Over $4200 100% 0%

Adding this benefit to Medicare could cost taxpayers $20 billion to $40 billion each year. Although the bill does not identify ways to pay for these new benefits, Democratic supporters mentioned new tobacco taxes, the budget surplus, and higher Medicare premiums as possibilities. And as the bill would raise the costs of Medicare Part B, seniors’ Part B premiums would rise as well.

Sen. Kennedy’s proposal also gives more power to the HCFA. Instead of directly administering this purchasing program, the Secretary of HHS would contract with pharmacy benefit managers (PBMs).15 Part and parcel with this authority would be the ability to control prices by refusing to award contracts to PBMs whose medicines are sold at prices not approved by the government. In addition, because PBMs negotiate prices to obtain discounts from pharmaceutical companies, they often try to push seniors toward cheaper medicines in order to constrain costs, rather than exactly what doctors may have prescribed for their patients. Finally, unless a retiree has coverage through a group health plan that HCFA deems adequate, HCFA would automatically enroll beneficiaries in one of the PBMs for their region of the country, whether or not they want to participate. Of course, these seniors would also have to pay the higher Part B premiums.

Expanding Medicare while doing nothing to ensure its long-term existence is a cynical political maneuver that would actually worsen health care for America’s elderly. Providing prescription drug coverage through Medicare in this fashion would naturally displace private-sector coverage by encouraging employers to drop this benefit for current and future retirees. Accordingly, the cost of this legislation may rise even higher. The worst aspect of this legislation is a premium hike for seniors who may not want or need Sen. Kennedy’s bloated program in the first place.

Representative Allen, et al.: Price Controls In All But Name

House Democrats, led by Rep. Tom Allen (D-Maine), have introduced the Prescription Drug Fairness for Seniors Act of 1999 (H.R. 664).16 The bill would require pharmaceutical companies to sell any drugs covered by Medicare to retail pharmacies in specified quantities at a specified price. To be precise, drug companies would have to make medicines available to every retail pharmacy at the lowest price it had given any other customer, and in the quantity that each pharmacy resells those medicines to Medicare beneficiaries. This discount is significant: in some cases, pharmacies could purchase medicines at a discount of at least 24 percent of the average non-federal wholesale price.17 It is important to note that the legislation does not require those pharmacies to resell the products to Medicare beneficiaries or to resell them at any particular price.

Though the Allen bill attempts to give Medicare beneficiaries access to medicine at lower prices, it would have much broader economic effects. One consequence – surely unintended – is that drug prices would rise for many other purchasers. Organizations that purchase pharmaceuticals in large quantities, such as government agencies or HMOs, are often able to leverage their economies of scale to negotiate a discounted price, similar to large purchasers in other markets. Manufacturers would be less likely to give sizable discounts to health insurers, HMOs, and state and federal government agencies if they are required to extend those discounts to a larger portion of the retail market. Medicare, Medicaid, state health care programs, private health insurers, and HMOs would then have to pay more for the affected medicines, costing taxpayers and individuals with private insurance billions of dollars. The bill essentially amounts to a tax increase to subsidize seniors’ medicines.

On the other hand, seniors would be hurt by a second unintended consequence of this legislation: fewer medicines to treat their ailments. In some cases, pharmaceutical companies would continue to sell medicines at a discount to large purchasers, either because they must by law (to the Veterans’ Administration) or because those customers exert market power. Those discounts would then be available to retail pharmacies. Pharmaceutical companies would have to absorb the cost of these discounts, reducing their profit margins. Lower profits would discourage investors from funding research into new medicines, particularly for seniors, because they would be less likely to receive a return on investing in the search for cures for illnesses suffered by this demographic group. This problem is not trivial: the pharmaceutical industry, as a whole, spent approximately $17 billion in 1998, or 20 percent of all domestic revenues, in the research and development of new medicines.18

While promising seniors lower prices for medicine, the proposal ignores how markets work. Its market effects – higher health care premiums and costs, less research into new cures – would be grave, but not immediate. In the meantime (during their campaigns for re-election), the legislation’s sponsors could claim credit for giving seniors a “free lunch.” And like Senator Kennedy’s proposal, the Allen bill fails to provide any real, long-term solutions for Medicare.

Clinton and Gore’s Prescription: No Panacea

In June, the Clinton-Gore administration announced a plan to revamp Medicare’s benefits, financing, and delivery mechanisms. President Clinton identified three principles that reform should follow: making Medicare more competitive and efficient, modernizing Medicare’s benefits package, and strengthening Medicare’s financing. Regrettably, the proposal’s details would undercut these ideals. Masked by overblown rhetoric and hazy explanations, the plan does very little to truly reform the program; instead it adds more benefits, tax dollars, and bureaucracy to an already wasteful and Byzantine system. Not only would Clinton and Gore continue the command-and-control system of determining benefits for seniors, but they also would give the HCFA bureaucracy sweeping new powers and would abandon the framework of the Medicare Trust Fund by making Medicare dependent on general tax revenues. In the long run, seniors would be left with fewer choices and higher costs, taxpayers’ contributions to Medicare would rise, and government rationing would be inevitable.

More big government. Most of the interest in the Clinton-Gore plan attaches to the new outpatient prescription drug benefit, to be called Medicare Part D. The major design features of Part D are:

Retirees would pay a monthly premium to have Medicare Part D pay half the cost of their prescriptions up to an annual limit. There would be no deductible. The administration estimates that these premiums would start at $24 per month in 2002, rising to $44 per month in 2008; the Congressional Budget Office predicts that premiums would be 10 percent to 20 percent higher.19

The limit on Medicare’s share of the annual payments for seniors’ medicines would begin at $1,000 in 2002, rising to $2,500 in 2008, and be indexed to inflation thereafter.

The government would cover the premiums and co-payments for seniors with incomes of up to 135 percent of the poverty level; and the premiums for seniors incomes between 135 and 150 percent of the poverty level.

HHS would award regional contracts to companies to manage this pharmacy benefit for seniors in the traditional Medicare program.

Seniors in Medicare managed care plans would receive the benefit through these plans, which Medicare would reimburse with seniors’ premiums and tax collections. These Medicare+Choice plans could only offer prescription drug coverage with the design features of Medicare Part D. Medigap policies would be reformulated to account for, and ‘wrap-around’ this new program.

Retirees’ group health plans could continue to offer prescription drug benefits as they now do, and would receive a government subsidy for doing so.

Over the long term, the plan would herd retirees into this new government-run plan to the detriment of private health care coverage. While President Clinton described this benefit as optional and voluntary, Secretary Shalala acknowledged that Medicare’s actuary “is assuming that everyone will go into the program either through their employer’s retiree benefits, either through the HMO or through the fee for service.”20 Here’s why: beneficiaries are promised low initial premiums, no deductible, and first-dollar coverage. (The rationing and premium increases arrive later.) And there is no indication that seniors would be able to leave the Medicare Part D regime if they are dissatisfied with the steady premium increases or lack of choices.

If virtually all seniors do sign up for Medicare Part D, the demand for Medigap policies that include prescription drugs would dry up, and individual seniors would be left with few, if any, choices other than the government program. The supply of these Medigap policies would dwindle as well, since the plan would give regulators the authority to alter Medigap policies so that they provide complementary, but not duplicative, coverage to Medicare Part D. This means that seniors who now have these policies might lose their coverage. And even Medigap policies that continue to include drug coverage would be much more expensive: the market would be small, and Part D would have favorably selected seniors with moderate drug costs, leaving seniors with high drug costs as the potential customer base for any wrap-around policy.

Food vs. Medicine?

“In a nation bursting with prosperity, no senior should have to choose between buying food and buying medicine.”1 Other politicians also blithely assert this cliché as support for their proposal.2 In truth, “only 2 percent of people over 65 said they had difficulty obtaining prescription drugs.”3 For politicians like President Clinton to exploit this two percent of seniors for rhetorical purposes – when his own proposal would only provide a small benefit to seniors with high drug costs – is intellectually dishonest. In fact, one-fourth of seniors would have drug expenditures higher than the Clinton program’s cap on benefits.4 Were his legislative language to live up to this shibboleth, he would have to spend billions of dollars more than he has already proposed.

1 Press Conference, June 29, 1999.

2 See Testimony of Donna Shalala before the U.S. Senate Committee on Finance, July 22, 1999; Sen. Tim Johnson and Rep. Tom Allen, “The Prescriptions or the Rent?” Washington Post, August 3, 1999, p. A15; Johnson/allen; Press Release from Sen. Olympia Snowe, “Snowe and Wyden Lay Out Bipartisan Approach to Provide Prescription Drug Coverage for Seniors,” June 15, 1999; Sen. Edward Kennedy, Congressional Record, p. S3931; Senator John McCain, “Health Care Reform,” December 14, 1999, available at; etc.

3 Data from Department of Health and Human Services 1997 National Health Interview Survey cited by Robert M. Goldberg, “The ‘Gerontocracy’ Won’t Swallow Clinton’s Drug Plan,” The Wall Street Journal, June 28, 1999, p. A26.

4 Testimony of Dan L. Crippen, Director, Congressional Budget Office, before the U.S. Senate Committee on Finance, July 22, 1999 at Table 5.

Further, the Clinton-Gore plan prohibits Medicare+Choice plans from offering prescription drug benefits with a different structure than the Medicare Part D proposal. Together, this means that seniors with drug coverage from either of these sources would not be able to continue with them, even if they are satisfied.

Finally, employers would likely cease providing health insurance that includes drug coverage to their retiring employees. Why would an employer want to offer a benefit that the government already sponsors and funds? In acknowledgment of this problem, the administration’s proposal includes a subsidy for businesses that continue to offer this benefit: the government would give 67 percent of its Part D cost per beneficiary to employers who continue to provide a prescription drug benefit for retirees. Nevertheless, many employers that provide drug coverage to approximately 12 million retirees would still drop coverage. The Congressional Budget Office estimates that 3 million seniors would lose their coverage; PricewaterhouseCoopers puts the number between 6 million and 9 million.21

After wrecking the system of private health insurance for seniors, Medicare Part D would become the largest pharmaceutical purchaser in the world. It would gain monopoly power to determine the prices of many medicines, particularly those for the maladies that affect seniors. Two ill effects might result. First, drug manufacturers would face diminished investment incentives for this market, as under the Kennedy and Allen schemes. Second, the government’s use of PBMs as gatekeepers might limit beneficiaries’ access to the drugs prescribed by their doctors, particularly if PBM contracts create incentives to ration care.

Instead of targeting the seniors who need coverage but don’t have it, the Clinton plan gives a limited benefit to all seniors, regardless of whether they need additional coverage. Note that this is exactly the opposite of insurance. True insurance protects people against unexpected or financially catastrophic expenses after they have paid what they can afford to pay through premiums and a deductible. Part D does precisely the reverse – offering a subsidy for the first dollar, but capping the level of benefits for seniors that have high drug bills. It seems as if this part of the plan was designed to create a constituency, not to solve a problem. In sum, after the ten-year phase-in of the Clinton-Gore administration’s proposed Part D:

Seniors premiums’ would have doubled;

They would have limited benefits with no cap on out-of-pocket expenses;

There may be no exit from the new bureaucracy (and there probably would be no comparable retiree, Medicare+Choice, or Medigap insurance available anyway);

Part D would face the long-term financial problems Parts A and B now have; and

The new benefit would depend on transfers from the projected budget surplus.

More spending. In his 1999 State of the Union address, President Clinton proposed to reserve 16 percent of the projected budget surplus (including the Social Security surplus) over the next 15 years to Medicare. The detailed plan he released in June would add $794 billion in tax dollars over the next 15 years ($374 billion in the next ten) to Medicare. At the end of October, the Clinton-Gore administration revised this pledge, proposing to reserve one-third of the non-Social Security surplus for Medicare. This year’s State of the Union pegged the amount of funds needed to ‘save’ Medicare at nearly $400 billion over ten years.

Of course, a great deal of this new spending is devoted to the new prescription drug program. The White House projects $119 billion in new spending over ten years.22 The Congressional Budget Office, however, estimates a $168 billion price tag for Medicare Part D over ten years.23 In 2008, when the program is fully phased-in, it would cost taxpayers over $30 billion per year.24 What is even more dangerous from a fiscal perspective is that the administration is proposing to use this uncertain revenue stream to partially finance the permanent prescription drug entitlement. Similar sweet nothings produced the financial crisis Medicare now confronts.

Many more of these billions would go to the Hospital Insurance Trust Fund, to stave off insolvency. The administration asserts that transferring general revenues to the Trust Fund would extend its solvency until at least 2027. But this depends upon politicians not spending the projected surplus tax revenues on pork-barrel projects or other worthy programs. If politicians spend the surplus (as they have already done for FY2000 and part of FY2001), then the Trust Fund will not last as long as Clinton and Gore hope.

Furthermore, using general revenues to fund Medicare Part A means that Medicare would move even further from being an insurance program and closer to a typical welfare program. Currently, a 2.9 percent tax on all paychecks flows to the Hospital Insurance Trust Fund, which finances Medicare Part A, while Part B receives funds from general revenue. In the sober words of the General Accounting Office, moving money from the general fund to the Hospital Insurance Trust Fund “could serve to undermine the remaining fiscal discipline associated with the self-financing concept.”25 If the president would rather fund Medicare Part A from the general fund, why continue the ruse of the payroll tax?

More regulation instead of reform. The president and vice president propose to use best practices from the private sector to improve Medicare’s quality and efficiency. But having HCFA try to imitate the private sector cannot pass for true competition. And tinkering with Medicare’s payment structure and adding more regulations to private insurance is no substitute for real reform. Under the plan, Medicare would use lessons from the private sector in the following ways:

HHS could contract with Preferred Provider Organizations (PPOs) to serve Medicare beneficiaries. PPOs are managed-care companies that negotiate prices and standards of care with many doctors, hospitals, home health care agencies, and the like in particular areas; beneficiaries typically have lower cost-sharing with these preferred providers than those out of a PPO’s network.

The president would expand the “Centers of Excellence” demonstration project nationwide. The Secretary of HHS would competitively select providers and facilities nationwide that would be paid a single rate for complex medical procedures, such as hip replacement surgery. While their reimbursement rate would be lower, the administration asserts that providers might gain from economies of scale, a government endorsement, and a reduction in overhead.

HHS could contract directly with physicians to act as primary care physicians (as they do in HMOs) for Medicare beneficiaries and with other organizations to manage care for beneficiaries with specific diseases. Beneficiaries might have lower cost sharing in these arrangements.

The administration would create a demonstration project to give bonus payments to physician group practices that spend less than HCFA-designated target levels.

HHS could negotiate prices and offer items and services for bidding in order to lower costs for Medicare Part B.

Other than the final point, these steps comprise a blueprint for rationing care. Taken together, they suggest that Medicare would attempt to mimic a managed care organization, albeit one without competition. On top of its current power to regulate prices through reimbursement rates, Medicare would gain the power to push providers out of Medicare. Letting HCFA choose winners and losers in the health care market would become little more than a tool for negotiating lower prices, regardless of the quality of care. Giving HCFA more power to control prices is not reform in a positive direction.

Sen. Breaux rightly described these changes as a “second cousin” to real competition.26 In a truly competitive market, for example, trade associations, accreditation boards, patients’ advocacy groups, medical researchers, other non-profit bodies, the news media, and informal networks of seniors would (and do) identify centers of excellence. The market – not HCFA – would determine reduced fee schedules for seniors who choose gatekeepers, utilization review, or other cost-constraining arrangements. Hospitals and doctors, not bureaucrats, would decide which services to bill as a package and what organizations should coordinate care. The reason is that these actors can innovate more nimbly and respond to local circumstances and preferences better than any policy wonk’s reform plan (even Clinton and Gore’s). Their plan would bring Medicare management techniques almost up to date, as they were when the program was created, but still inhibit the ability of providers to innovate further.

Consider, for example, how the plan fiddles with Part B co-payments and deductibles. Seniors’ $100 annual deductible for doctors’ services would be indexed to inflation, causing it to rise two or three dollars per year, but they would no longer have co-payments for preventive services such as mammographies and prostate cancer screenings. On the other hand, there would be a new 20 percent co-payment for clinical lab tests, in order to “address excess utilization and waste associated with first-dollar coverage.”27 Should these thresholds and percentages be carved onto stone tablets, or might it be more efficient for health plans to experiment and to find the optimal levels for particular market conditions and individual seniors?

As an even worse example of the same misguided impulse, the president would force seniors in the Medicare+Choice program into a one-size-fits-all benefit package. In the Clinton-Gore administration’s inaptly titled “Competitive Defined Benefit,” Medicare+Choice plans would have to offer identical packages of benefits, which the HCFA bureaucracy would delineate. To offer additional benefits – such as dental, travel, or prescription drug coverage – that are now part of their policies, they would have to charge beneficiaries a separate premium for extra benefits, even though they are now often provided for no additional cost. The president’s proposal, on its face, takes away benefits millions of seniors already have.

Another regulatory step would increase federal interference in the Medigap market. The president has proposed that HHS consider creating its own supplemental Medicare policy. Currently, the National Association of Insurance Commissioners (NAIC) and HCFA share oversight responsibility for Medigap policies. Insurance companies now may only offer new policies from among ten models that have been government-designed and -approved, which carry labels from A to J.28 Under the Clinton-Gore plan, instead of determining exactly which benefits all Medigap policies shall carry, HCFA would sell the policies directly – despite the overwhelming level of support for Medigap as presently structured. Having the government compete with and simultaneously regulate private industry would tilt the playing field decisively in favor of government insurance and against private insurance.

At bottom, the Clinton-Gore plan is a blatantly political document portrayed as reform. The outpatient prescription drug proposal is a bait-and-switch scam foisted on the elderly in an attempt to gain political support. The steps to make Medicare more competitive and efficient, such as the “Competitive Defined Benefit” proposal, are not genuinely competitive or defined or a benefit. And propping up the Medicare Trust Fund with an ill-defined infusion from an unrealized surplus is little more than robbing Peter to pay Paul. In the end, the Clinton plan would undercut competition in Medicare HMOs and private insurance, reduce quality prescription drug coverage, and further threaten Medicare’s long-term health.

Is it the Right Time for Reform?

Despite Medicare’s problems, the bills written so far indicate that politicians are more likely to make things worse than better (notwithstanding the basic recommendations of the National Bipartisan Commission on the Future of Medicare). Policies designed by the Clinton-Gore administration, Representative Allen, and Sens. Kennedy, Snowe, and Wyden would fail to fulfill one or more of the following criteria for reform:

Giving seniors more choices.

Lower costs, not higher taxes.

Achieving cost savings through consumer incentives and competition, not through government rationing, price controls, or new mandates.

Fortunately, politicians do not need to reinvent the wheel. They have already given themselves and federal employees a great deal of freedom through the FEBHP. The Bipartisan Commission accomplished its mission and developed recommendations mainly to strengthen and improve Medicare’s financing and operations. The Breaux-Frist bill starts down the right path, but needs significant changes to help ensure Medicare is truly re-formed as a self-sustaining program that will give the next generation of seniors the health care that each of them needs.

1Most of this paper focuses on the complex command-and-control system envisioned in the Clinton-Gore proposal.

2In the Breaux-Thomas proposal, the government would pay 88 percent of the cost of the average health insurance premiums for seniors. This percentage is the same as the government’s current combined share of the total expenditures on behalf of beneficiaries of Medicare Part A and Part B. The percentage of premium support would vary with the premium’s price. Medicare would pay the entire premium for a “standard-option” plan if it cost less than 85 percent of the national average; beneficiaries would bear the costs of premiums above the national average. “High-option” plans would be subsidized by Medicare at approximately 88 percent of costs.

3Under such a plan, it would be critical that Congress not prescribe, nor allow the bureaucracy to require, an expansive package of basic benefits, because to do so would eliminate much of the competition and choice integral to the plan’s success.

4Memorandum from Jeff Lemieux to the National Bipartisan Commission on the Future of Medicare, “Cost estimate of the Breaux-Thomas proposal,” March 14, 1999.

5Ibid. at Table 1.

6National Bipartisan Commission on the Future of Medicare, “Medicare Beneficiaries and Prescription Drugs,” March 6, 1999.

7The government’s payments to health plans would be adjusted for geographical and risk factors, but this would have no effect on a senior’s financial obligation.

8These numbers would apply in 2003. In later years, the stop-loss level would be indexed to the inflation in Medicare costs, while the value of the drug benefit would be adjusted for “reasonable” increases in drug costs. If the Medicare Board is interested in controlling costs, it might disallow increases deemed unreasonable, thereby degrading the value of the benefit. But if the Medicare Board’s reimbursements to health plans don’t cover the “reasonable” drug costs, the Board would essentially be able to implement price controls through the back door.

9HHS data for the year 2000 cited in National Economic Council and Domestic Policy Council, the White House, “Disturbing Truths and Dangerous Trends: The Facts About Medicare Beneficiaries and Prescription Drug Coverage,” July 22, 1999, p. 4.

10Several Medicare reform plans would provide subsidies for prescription drugs to seniors based on their level of income, but this formula is of limited value for segregating only needy seniors. Many have saved for retirement and, consequently, can and do spend more than their annual income.

11S. 1480, Section 1860B (a) (2) (B). One could argue that most, if not all, insurers are in the business of favorable selection. In plain English, this is called competition, for if approved claims exceed premiums for an extended period, bankruptcy ensues.

12Testimony of Dan L. Crippen, Director, Congressional Budget Office, before the Committee on Finance, U.S. Senate, July 22, 1999, Table 4.

13J. Scott Moody, “Federal Excise Taxes and the Distribution of Taxes Under Tax Reform,” Tax Foundation Background Paper No. 29, January 1999, p. 4.

14Representative Pete Stark has introduced a companion bill in the U.S. House, H.R. 1495.

15PBMs and other managed care organizations typically use a variety of cost-constraint techniques: formularies, referrals for specialists, utilization review, price negotiations, differential co-payments, selective contracting, and so forth. These methods are not intrinsically good or bad. It is important, however, that prices and practices be transparent, and that health care consumers have a choice among prices and practices, rather than having them required and implemented by the government. That is the difference between creating incentives for comparison shopping and rationing.

16Senator Kennedy later introduced a companion bill, S. 731.

17The Veterans Health Care Act of 1992 (P.L. 102-585) requires manufacturers of “innovator” drugs to provide discounts to the VA, DOD, Public Health Service and Indian Health Service of at least 24 percent from the average price for non-federal purchasers.

11Pharmaceutical Research and Manufacturers Association, Pharmaceutical Industry Profile 1999, Figure 2-1.

19Testimony of Dan L. Crippen, Director, Congressional Budget Office, before the U.S. Senate Committee on Finance, July 22, 1999. HCFA would set seniors’ premiums at a level that would raise enough to cover 25 percent of Part D’s overall costs; taxpayers would cover 25 percent; and co-payments would cover the remaining 50 percent of prescriptions in the program.

20Press Briefing by Secretary Of HHS Donna Shalala, National Economic Advisor Gene Sperling, and Deputy Assistant to the President for Health Policy Chris Jennings, June 29, 1999. The White House officially estimates that 31 million beneficiaries would enroll: see National Economic Council and Domestic Policy Council, the White House, “The President’s Plan to Modernize and Strengthen Medicare for the 21st Century: Detailed Description,” July 2, 1999, p. 38.

21Testimony of Dan L. Crippen, Director, Congressional Budget Office, before the U.S. Senate Committee on Finance, July 22, 1999; PricewaterhouseCoopers, “President Clinton’s Medicare Prescription Drug Benefit: An Analysis of Displacement of Employer-Sponsored Retiree Prescription Drug Coverage,” September 21, 1999, p. 1.

22National Economic Council and Domestic Policy Council, the White House, “The President’s Plan to Modernize and Strengthen Medicare for the 21st Century: Detailed Description,” July 2, 1999, p. 38.

23Testimony of Dan L. Crippen, Director, Congressional Budget Office, before the Committee on Finance, U.S. Senate, July 22, 1999, Table 4.


25Testimony of David M. Walker, Comptroller General of the United States, before the Committee on Finance, U.S. Senate, March 10, 1999.

26Press Release, “Breaux: Clinton Medicare Plan a Step Closer to Reform,” July 29, 1999.

27National Economic Council and Domestic Policy Council, the White House, “The President’s Plan to Modernize and Strengthen Medicare for the 21st Century: Detailed Description,” July 2, 1999, p. ii. Conversely, a key feature of the prescription drug part of the plan is first-dollar coverage.

28For example, Plans H, I, and J include coverage for prescription medicines. The Balanced Budget Act allowed insurers to add high deductible versions of two of these policies to the previous ten.

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