Why Closing Medicare's 'Donut Hole' is a Terrible Idea

Many conservatives believe that George W. Bush betrayed their cause. Exhibit A, these conservatives say, is the Medicare Modernization Act of 2003. That law established Medicare’s prescription-drug benefit plan without offsetting spending cuts or tax increases, adding $16 trillion to our unfunded liabilities. And yet, if media reports are to be believed, some of these very same conservatives want to shower the program with even more taxpayer money, for no other reason than because it "polls well."

Here’s the background. When Congress passed the Medicare drug benefit—"Medicare Part D" in health-wonk parlance—the program included some cost-sharing measures designed to limit wasteful drug spending. The idea was this: if seniors simply received carte blanche to use whatever drugs they wanted, they would have no incentive to shop for value in their drug consumption. For example, seniors would have no incentive to use cheaper generic drugs instead of costlier branded ones. Drug companies would have the ability to charge whatever they liked, knowing that Medicare would pay for it regardless.

The donut hole was a far-sighted, and efficient, cost-sharing measure

In order to guard against these problems of overspending and overutilization, Congress incorporated a critical feature into Part D. The drug plan would require seniors to pay a share of their drug spending below a certain level, so as to ensure that they had "skin in the game" and would be discouraged from wasteful spending.

Seniors were required to pay for 25 percent of drug spending below a certain level ($2,830 in 2010) and 100 percent of drug spending in a middle level (between $2,830 and $6,440). After spending through the middle level, seniors would only pay 5 percent of any additional costs. It’s that middle level, where seniors pay 100 percent of the costs, that came to be derisively known as the "donut hole."

The thresholds were designed by actuaries who mined actual drug usage statistics to identify the optimal price points. The idea was to help seniors pay for basic drug coverage—like pills for high blood pressure and heart disease—while giving them the incentive to use generic drugs, which account for 80 percent of all U.S. prescriptions. Those seniors with truly serious and costly conditions would benefit from the backstop of catastrophic coverage.

This cost-sharing system has worked astonishingly well. Medicare Part D has spent 30 percent less money than the Congressional Budget Office originally projected it would. Last year, it became the first federal health program in memory in which spending actually decreased from year-to-year.

Obamacare closes the donut hole

As Congress was designing what we now know as Obamacare, Democrats were trying to figure out a way to placate seniors who would be upset that the program took $500 billion out of the program to create a new health-care entitlement. They came up with the idea of closing the donut hole. Beginning in 2011, the law provides a 50 percent discount for drug spending in the donut hole. Gradually, the donut hole goes away, such that, by 2020, seniors will only be liable for 25 percent of their drug spending until they hit the upper threshold (where they’re liable for 5 percent). In addition, the law lowered the upper cost-sharing threshold from $6,440 in 2010 to $4,550.

To put it simply, Obamacare takes hundreds of billions of dollars away from Medicare’s market-oriented Medicare Advantage program, and uses some of the savings to destroy the drug benefit’s most market-oriented feature. It’s a win-win for those who oppose market-oriented reforms.

The change was also a huge windfall for drug companies. Seniors would no longer have any disincentive to use their costliest medications. Because companies’ profit margins for most drugs exceed 95 percent, offering a 50 percent discount within the donut hole—in exchange for far greater drug usage overall—was a no-brainer.

The near-term cost amounted to less than 1 percent of drug-company revenues, with the possibility of substantial upside. Analysts at Goldman Sachs estimated in 2010 that drug companies stood to gain as much as $20 billion in extra drug spending from 2010-2019 from the donut-hole closure. "The additional benefit may arise from (1) the added incentive from the beneficiary’s lower out-of-pocket spend to remain on the branded drug vs. switching to a generic or stopping/reducing drug use, and (2) getting through the donut hole more quickly...increases utilization, as the government covers 95% of the drug spend and beneficiary covers 5%," analyst Jami Rubin wrote in a note to Goldman clients.

If you want to know why the pharmaceutical industry agreed to support Obamacare in a private deal with the White House, look no further.

Some Republicans seek to maintain donut-hole closure

Last week, Politico reported that Republicans "want to keep the Medicare ’donut hole’ closed," among other things, because "ripping these provisions from [Obamacare] is too politically risky."

But this makes little policy sense. Republicans have signed on to a substantial and courageous reform of Medicare, in the form of the Ryan plan, for which they have braved considerable strafing from the left. They’re going to take all those bullets, only to give a chunk of it back with the donut hole? Why bother doing anything about Medicare in the first place, then?

Any Democrat who tries to criticize a Republican for supporting the Part D donut hole will have to answer for his own support for Obamacare, which—unlike the Ryan plan—cuts Medicare for current retirees, and imposes a government-run rationing board upon the program.

Under the premium support plan, seniors will have all the options for themselves. If they want to pay for more generous drug coverage that closes the donut hole, they can: by covering the extra premium costs themselves. If they’d prefer to save money on their drug benefit, they can do that instead. So long as insurers have the freedom to design plans that seniors like, this will all evolve under reform in the most cost-efficient, consumer-friendly manner possible.

Indeed, prior to Obamacare, seniors could already do this within Part D. By paying an extra $32 or so per month, seniors could pay for extra coverage that filled in the donut hole. Was that really so barbaric?

This should be the message of Republicans this election year: that if seniors really want to close the donut hole, premium support will give them the opportunity to vote with their feet. Coercing other taxpayers to fund wasteful drug spending is a far less attractive—and less fair—approach.

This piece originally appeared in Forbes

This piece originally appeared in Forbes