What Does Medicare Part D Say About the Ryan Plan?

Rep. Paul Ryan claims that huge savings under Medicare's Part D prescription drug program proves that competition will work for the full program. His critics argue that the savings have nothing to do with competition. As happens so often in Washington, both sides are focusing on the wrong issue.

As chairman of the House Budget Committee, Mr. Ryan is responsible for the premium support proposal that would put Medicare on a budget like most other federal programs. Medicare today promises to pay its share of the medical bills incurred by seniors, with no limit on the fiscal burden placed on taxpayers. Premium support would give seniors a subsidy to pay for insurance offered by competing health plans.

The budget would be tight, with the subsidy growing only with general price inflation rather than with growth in medical inflation or some other index that more closely mimics Medicare's cost trend in an unreformed system. Of course, that is the point. If you are trying to get control over federal spending and reduce our crushing debt burden, you must place binding budget limits on Medicare.

The critical question is, will this shift to a competitive Medicare program deprive seniors of needed care or expose them to unconscionable costs? That's where the Part D experience comes in. The Congressional Budget Office estimated that the prescription drug program would cost $551 billion between 2004 and 2013, offset by $142 billion in lower federal payments to state Medicaid programs. Medicare's cost experience has been far better.

The Medicare trustees report that federal outlays for Part D, netting out premiums paid by enrollees and payments made by states to "claw back" some Medicaid savings, totaled $214 billion through 2010. By 2013, we will have spent $375 billion -- 32 percent less than the CBO estimate.

Mr. Ryan says those savings are the result of the vigorous competition among the prescription drug plans. Over 1,100 plans are available nationwide this year, the smallest number since the start of the benefit in 2006. The extent of competition in this market undoubtedly came as a surprise to many. Then-Medicare administrator Tom Scully asserted that stand-alone drug plans "do not exist in nature," and CBO assumed that there would be a need for a government back-up plan in areas where there would not be at least two plan choices.

Opponents of premium support say that Part D savings are accounted for by two factors unrelated to competition. Enrollment in the program was lower than expected, averaging about 7.1 million fewer people than CBO projected each year. In addition, there was a decline in prescription drug spending as a result of "blockbuster" drugs losing their patent protection and fewer new drugs in the pipeline.

Neither factor accounts for the disparity between the CBO estimate and actual experience. To gauge the size of the enrollment effect, multiply the additional number of people assumed by CBO (7.1 million) by CBO's estimate of the federal cost per enrollee ($1,600) for each year. That totals about $92 billion through 2013, or only about 17 percent of the cost difference. Overstated enrollment contributes to CBO's high cost prediction, but other factors are more important.

The impact on the CBO estimate of generally lower drug spending due to a slowdown in innovation is more difficult to quantify. Comparing Medicare's spending trends with that of the entire health sector is revealing. Federal cost per Part D enrollee has grown only 1.8 percent a year between 2006 and 2009, while spending for Medicare Parts A and B grew 4.9 percent. The comparable figures (available only through 2009) for the country also show a lower drug trend: 2.8 percent growth for prescription drugs versus 3.4 percent for national health spending excluding pharmaceuticals. Clearly the slowdown in drug spending was far greater in Medicare than in the overall health market.

A portion of Part D's better cost performance is due to the slower introduction of new drugs and the movement of branded drugs to off-patent status. But we also saw considerable price sensitivity on the part of seniors and aggressive discounting by pharmaceutical manufacturers as plans fine-tuned their formularies and steered patients toward lower cost drugs.

Had Part D been structured like traditional fee-for-service Medicare, that would not have happened. 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. Indeed, economic and political incentives would drive out low-cost drugs (whether brand or generic) in favor of products with higher profit margins in a cost-plus payment environment. Those who doubt that need only look to Medicare's physician payment system, which is based on the cost of inputs, not the value of outputs.

Pricing is not the only thing that would have gone wrong had regulators designed Part D. Plans would have been given detailed instructions by the government on how to run their businesses -- much as the new "accountable care organization" concept has been buried under a stifling blanket of regulation. In the name of protecting defenseless seniors, strict controls on plans would have driven up costs and reduced the available choices.

The real lesson of Part D is hard for Washington policymakers to swallow. We cannot micromanage every aspect of the health care system if we expect to reduce Medicare spending in a way that can be sustained over the long term. Even the smartest experts cannot anticipate the future with any precision, and the divergence between the CBO estimate and program performance illustrates just that. Health plans freed from excessive regulation and perverse payment incentives are capable of finding better ways to provide the care patients need. And seniors, given the proper information, can navigate a system that offers them choices of competing plans.

Whether the Part D cost experience can be replicated in the broader context of premium support is anyone's guess. But Medicare reform is not solely about cutting the budget, and Mr. Ryan's proposal is not the last word on the issue.

The premium support concept rejects the Washington-centric approach that has characterized Medicare policy for nearly five decades, one that was reinforced by last year's health reform legislation. By loosening regulatory constraints, it opens the door to grass roots solutions to grass roots problems. Although serious discussion is probably over until after the election, Medicare spending will be back on the agenda in 2013, as will premium support.

Joseph Antos is the Wilson H. Taylor Scholar in Health Care and Retirement Policy at AEI.

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