Medication Costs and Reimbursements

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Prescription drugs are an important part of medical care. Their proper use can lower hospital and nursing home stays and lead to an overall decline in health care expenditures. However, many older individuals lack insurance coverage for such medications. This has led to a national discussion of adding a prescription benefit to Medicare for senior citizens.

Prescription drug expenditures

According to the Centers for Medicare and Medicaid Services, national spending on prescription drugs in the United States totaled $85.2 billion in 1998, more than double the level of total spending in 1990. Spending for pharmaceuticals is expected to continue rising, by some estimates more than 10 percent annually until at least 2010.

This dramatic increase in prescription drug spending, much larger than that seen in other areas of medical care spending, has several causes. First, there has been a rapid increase in the number of new drugs entering the marketplace. From the early 1960s to the early 1990s, the annual number of new molecular entities (NMEs) receiving approval from the Food and Drug Administration (FDA) nearly doubled, from an average of fourteen in the 1960s to twenty-six in the early 1990s. By 1999, the annual number of NMEs approved had increased to thirty-nine. While some of these NMEs represent new treatments, many are intended as replacement drugs, possibly with fewer side effects. These new drugs are often more expensive than those they are intended to replace.

A second reason for the increase in prescription drug expenditures is the large amount of direct-to-consumer advertising for prescription drugs that has appeared since the FDA lifted its ban on such advertising in 1985. In response, pharmaceutical firm expenditures for direct-to-consumer advertisements rose significantly, from $55 million in 1991 to $1.8 billion in 1999 (National Institute for Health Care Management). This increase in advertising affects prescription drug expenditures in two ways. First, these advertisements lead to an increase in the demand for many name-brand prescription drugs. Second, the advertising expense increases the costs faced by pharmaceutical firms, which are in part passed on to consumers in the form of higher prescription drug prices.

Finally, the aging of the U.S. population is contributing to increased spending on pharmaceutical products. The number of individuals over age sixty-five has grown for the past several decades, and is expected to double between 2000 and 2050. This increases the number of individuals at risk for chronic and disabling conditions that often require prescription medications. For example, according to a study by the Department of Health and Human Services, in 1998, individuals age sixty-five and older accounted for forty-two cents of every dollar spent on prescription drugs even though they accounted for only approximately 13 percent of the population.

Each year, 87 percent of Medicare beneficiaries need to fill at least one prescription. The majority of Medicare beneficiaries (56 percent) use prescription drugs that cost more than $500 per year, and 38 percent use drugs that cost $1000 or more (Department of Health and Human Services). A 2000 study by John Poisal and George Chulis that examined prescription drug expenditures and insurance coverage of Medicare beneficiaries found that, in 1996, the average beneficiary spent $673 on prescription drugs.

Insurance coverage

Approximately one-third of all Medicare beneficiaries have no prescription drug coverage. This lack of coverage disproportionately affects Medicare beneficiaries near the poverty level, those in rural areas, and those age eighty-five and older. While some may receive assistance through state pharmacy programs, out-of-pocket expenditures for beneficiaries without coverage for prescriptions are significantly higher than for those with coverage. For example, Poisals' and Chulis's study found that in 1996, annual out-of-pocket expenditures averaged $463 for Medicare beneficiaries without prescription drug coverage, compared with $253 for those with coverage. These out-of-pocket differences existed even though beneficiaries without coverage filled five fewer prescriptions per year, on average, than those with prescription drug coverage.

Medicare beneficiaries with prescription drug coverage receive such coverage from a variety of sources. Poisal and Chulis report that the majority of Medicare beneficiaries receive supplemental drug coverage from private sources, either from an employer (31 percent) or from a purchased Medigap policy (10 percent). The remaining beneficiaries with drug coverage receive such coverage from Medicaid (11 percent) or through a Medicare HMO (8 percent).

Employer-provided coverage. Like many health insurance benefits from employment, drug benefits from former employers tend to be fairly generous. However, due to changes in accounting standards and rising health care costs, the proportion of firms offering health insurance coverage to retirees has been declining. Even firms that continue to provide such insurance have been reducing or eliminating prescription drug coverage. A 2000 study by Hewitt Associates indicated that 36 percent of large employers planned to reduce prescription drug coverage for retirees age sixty-five and over during the next three to five years.

Medigap policies. Individual Medicare beneficiaries purchase Medigap policies to cover some or all of the deductibles and copayments for Part A or Part B services, as well as some uncovered services, such as prescription drugs. Of the ten standard Medigap policies available, only three include prescription drug coverage. These policies have fairly large copayments and deductibles, and also include an annual limit on drug expenditures. For example, one standard policy has a $250 deductible and provides 50 percent coverage up to a limit of $1,250 per year. Another standard policy has the same deductible and coinsurance, but a coverage limit of $3,000 per year.

Medigap policies with drug coverage are generally much more expensive, and have experienced larger increases in monthly premiums than those that do not include drug coverage. A 2001 study by Weiss Ratings found that average premiums for Medigap plans covering prescription drugs increased by 37.2 percent from 1998 to 2000, while premiums for Medigap policies that have no drug coverage rose by only 15.5 percent during the same period.

Medicaid. Medicaid provides access to prescription drugs for the poorest Medicare beneficiaries. Medicare beneficiaries who, because of low income, qualify for Supplemental Security Income, or who are deemed to be medically needy because of their extensive medical costs, can qualify for full Medicaid benefits. These individuals pay neither the Medicare Part B premium nor any of Medicare's deductibles and copayments. In addition, they are eligible for all benefits provided by their state Medicaid program, including coverage for prescription drugs. Half of Medicare beneficiaries with incomes below the poverty threshold are covered by Medicaid.

Medicare HMOs. In 2000, 17 percent of Medicare beneficiaries were enrolled in Medicare HMOs. Of these beneficiaries, 80 percent are enrolled in HMO plans that include a prescription drug benefit (Health Care Financing Administration, 2000). There is, however, considerable variation in the scope and generosity of benefits across plans, and Medicare HMOs are not available in all geographic areas. Many plans use cost-containment measures in their prescription drug coverage, such as copayments and low spending limits (often as low as $1,000 annually). Studies show that Medicare beneficiaries often drop out of their HMO plans once they have exhausted their drug benefits. This has led to new restrictions on the ability of beneficiaries to switch plans during the year.

Prescription drug coverage in Canada

There is a national system of health insurance in Canada. This program, however, does not include coverage for prescription drugs. Instead, Canadian citizens may obtain supplemental coverage through an employer or by purchasing a policy in the private market. In addition, for certain segments of the population, such as senior citizens, each Canadian province provides public coverage for other health services that are excluded from the national health insurance. Prescription drugs are covered in these programs, but the exact level of benefits varies across income levels and across provinces.

Proposals to increase prescription drug coverage

Because of rising drug costs and the large number of Medicare beneficiaries without prescription drug coverage, there has been a growing debate in the United States concerning a national drug benefit for senior citizens. For such a benefit to become a reality, however, many decisions must be made. For example, who will be covered? Will the benefit be available to all Medicare beneficiaries or to only those below some specific income threshold? A 1999 study by the National Academy of Social Insurance (Gluck) indicated that providing a drug benefit for all Medicare recipients would increase the costs of the Medicare program by 7 to 13 percent over the next ten years. Other considerations include whether the plan would be voluntary, how the program would be administered, and which methods of cost containment should be used.

There have been four basic programs proposed with these factors in mind. These proposals vary in both scope and the level of federal involvement. Two of them involve changes in the current Medicare program.

Comprehensive Medicare reform. Since the late 1980s, analysts and policy makers have become increasingly concerned about the financial health of the Medicare program. Increasing health care costs and an aging population have led to dire predictions concerning the viability of this important government program. Many analysts have therefore called for a complete overhaul of the Medicare program. Such a reform would include an analysis of what types of coverage should be provided and how it should be financed. Important choices would have to be made concerning the level of benefits received by senior citizens, and cost-control methods would have to be adopted or expanded. It is possible that a prescription drug benefit could then be added to the program, but this would likely occur only in tandem with a reduction in other benefits or an increase in taxes and monthly premiums.

Addition of drug benefit to current Medicare. Instead of reforming the entire Medicare program, some analysts have suggested that the government simply add a new prescription drug benefit to the current program. This would be a voluntary program that would be financed through monthly premiums and general tax revenues (in much the same way that Part B of Medicare is financed). The federal government could make the benefit more affordable for low-income senior citizens by providing them with a subsidy.

Federal subsidies for private insurance. A third suggestion is for the federal government to provide subsidies to senior citizens so that they can purchase prescription drug coverage in the private market. This policy increases access and affordability of drugs to seniors with limited government involvement.

State programs. Last, the federal government could establish state grant programs targeted to provide drug coverage to low-income senior citizens. At the beginning of 2001, twenty-six states had some type of prescription drug program in place to assist senior citizens and disabled individuals. Many of these programs require senior citizens to pay part of the cost of the drugs, but the levels of these copayments vary widely from state to state.

Each of these proposed reforms has merit, yet they also generate concerns. It is possible that a prescription drug benefit could be added to the Medicare program, but this would likely occur only if other benefits are reduced or taxes and monthly premiums are increased. Accurately predicting future prescription drug costs will be difficult, and thus could lead to shortfalls in revenues for the program. This would result in more difficulty for the financially troubled Medicare program. If the prescription drug program through Medicare is voluntary and monthly premiums are sizable, there could be a great deal of adverse selection. Only Medicare beneficiaries requiring numerous prescriptions each year would join the program. This would make predicting the costs of the program much more complex. A federal subsidy to help senior citizens purchase drug coverage through private markets lowers government involvement, but will it be possible for the private market to provide prescription drug coverage that is affordable? Last, state government leaders may be reluctant to participate in a federal grant program if they are concerned that the federal government will eventually shift the cost of the program to the states as costs rise.

Linda S. Ghent

See also Medicaid; Medicare; Medigap.


Gluck, M. E. "A Medicare Prescription Drug Benefit." National Academy of Social Insurance Medicare Brief no. 1 (1999).

Health Canada. Canada's Health Care System. Ottawa, Ontario: Health Canada, 1999.

Health Care Financing Administration. Medicare 2000: 35 Years of Improving Americans' Health and Security. Washington, D.C.: U.S. Government Printing Office, 2000.

Health Care Financing Administration. National Health Care Expenditures Projections.

Hewitt Associates. Implications of Medicare Prescription Drug Proposals for Employers and Retirees. Menlo Park, Calif.: Henry J. Kaiser Family Foundation, 2000.

National Institute for Health Care Management. Prescription Drugs and Mass Media Advertising. Washington, D.C.: Government Printing Office, 2000.

Poisal, J. A., and Chulis, G. S. "Medicare Beneficiaries and Drug Coverage." Health Affairs 19 (2000): 248256.

U.S. Department of Health and Human Services. Prescription Drug Coverage, Spending, Utilization, and Prices. Washington, D.C.: U.S. Government Printing Office, 2000.

U.S. Food and Drug Administration, Center for Drug Evaluation and Research. CDER 1997 Report to the Nation: Improving Public Health through Human Drugs. Washington, D.C.: U.S. Government Printing Office, 1997.

U.S. Food and Drug Administration, Center for Drug Evaluation and Research. CDER 1999 Report to the Nation: Improving Public Health through Human Drugs. Washington, D.C.: U.S. Government Printing Office, 1999.

Weiss Ratings, Inc. Prescription Drug Costs Boost Medigap Premiums Dramatically: First in a Series on the History of Medigap Pricing. Palm Beach Gardens, Fla.: Weiss Ratings, 2001.

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Medication Costs and Reimbursements

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